Masters Energy Inc.
TSX : MSY

Masters Energy Inc.

July 27, 2005 09:00 ET

Masters Energy Inc. Reports Second Quarter 2005 Interim Results

CALGARY, ALBERTA--(CCNMatthews - July 27, 2005) - Masters Energy Inc. (TSX:MSY) ("Masters" or the "Company") is pleased to report financial and operating results for the three and six month periods ended June 30, 2005. Several significant accomplishments were achieved during the period;

- Increased year to date 2005 production 61 percent in comparison to similar period in 2004.

- Cash flow from operations for first half of 2005 increased 95 percent to $4.8 million compared to the first half of 2004.

- Cash flow per share in the second quarter 2005 increased 30% over first quarter 2005.

- Drilled a total of 11 wells resulting in 3 (3.0 net) oil and 7 (4.8 net) gas wells for an overall success rate of 91%.

- Closed an acquisition of properties in the Peace River Arch which provides the Company with a second core area.



HIGHLIGHTS Three Months Ended Six Months Ended
June 30 June 30
2005 2004 2005 2004
------------------------------------------------------------------------
(Unaudited)
Financial ($ thousands, except
per share amounts)
Gross revenue 4,802 2,922 8,716 4,950

Cash flow from operations 2,699 1,391 4,768 2,447
Per share - basic 0.19 0.10 0.33 0.19
- diluted 0.18 0.10 0.32 0.19

Net earnings (loss) 643 (49) 1,200 473
Per share - basic .04 - 0.08 0.04
- diluted .04 - 0.08 0.04

Capital expenditures 10,358 2,761 13,466 5,149

Working capital (deficiency) 323 (1,533) 323 (1,533)

Long-term debt 13,137 - 13,137 -

Operations
Production
Crude oil (bbls/d) 715 556 697 522
NGL (bbls/d) 11 9 9 5
Natural gas (mcf/d) 3,055 1,653 2,798 1,215
Total production (boe/d at 6:1) 1,236 841 1,172 730

Average sales price
Crude oil ($/bbl) 41.64 37.10 39.95 35.46
NGL ($/bbl) 49.56 36.86 48.26 38.06
Natural gas ($/mcf) 7.34 6.51 7.11 6.78


Presidents Message to the Shareholders

In the first half of 2005, Masters completed an 11 well drilling program with 91 percent success and acquired producing properties in the Peace River Arch area of Alberta. The results of the drilling program are:

- Three (3.0 net) oil wells were drilled and brought onstream at Little Bow validating the independent reservoir simulation study completed in 2004. In addition, two (1.5 net) natural gas wells were drilled at Little Bow and tied in during the second quarter.

- at Hector two (2.0 net) natural gas wells were drilled and completed during the second quarter and are expected to be tied in during the third quarter.

- one natural gas well (0.3 net) at Roche was drilled and put onstream.

- at Tangent two (1.0 net) natural gas wells were drilled and completed.

On June 3, 2005 Masters acquired strategic oil and gas assets within the Tangent area for $7.6 million. The recently completed wells at Tangent will be tied into the acquired facilities during the third quarter of 2005. The acquisition provides the following:

- approximately 0.9 mmcf per day of production, 1.2 mmcf per day to be tied-in during the balance of the year, 0.75 mmcf per day of behind pipe production capability which will be exploited in the third and fourth quarters.

- interests in several strategic field facilities.

- 9,500 net acres of undeveloped land and a large seismic data base.

The area is prospective in eight distinct geological formations and the Company has identified several drilling opportunities on the acquired lands. The area is accessible year round and a multi-well drilling program is planned for the remainder of the year. The acquisition was financed through a draw down of Masters available bank facility.

Production for the second quarter of 2005 averaged 1,236 boe per day, an increase of 47 percent over the 2004 second quarter production and an increase of 12 percent over the first quarter of 2005. The production increase is the result of a successful drilling program and closing the June 2005 acquisition. Currently, total corporate production is approximately 1,400 boe per day (50% natural gas).

Throughout 2005 approximately 25 wells will be drilled with the majority of the activity in the second half of 2005 focused on the Little Bow and Tangent areas. Expansion of the existing water injection facility at Little Bow is underway and further infill drilling will be conducted after construction of the facility is completed. At Tangent, reactivation, recompletion and tie-in activities are underway with a multi well drilling program planned to start later in the third quarter.

OUTLOOK

The recent acquisition at Tangent provides the Company with a second core area. Both the Little Bow and Tangent properties create a strong production base from which the Company can grow. With an experienced technical team, a strong balance sheet, a large undeveloped land base (93,000 net acres) and a significant number of internally generated prospects, the Company is well positioned for growth. For 2005 the Company anticipates production to average 1,400 to 1,500 boe per day (50 percent natural gas) and forecasts an exit rate of 1,900 boe per day (60 percent natural gas).

In addition to the ongoing exploration and development program, Masters has a strong desire to grow through acquisitions and will continue to seek acquisitions that are strategic to the Company. The acquisition of the northern Peace River Arch oil and gas properties demonstrates our desire to pursue opportunities that will add meaningful growth and value for our shareholders.

Commodity prices have been extremely strong and are expected to remain strong in the future. In particular, the average wellhead price Masters received for crude oil increased from $38 per barrel in the first quarter to $42 in the second quarter and is currently at $54 per barrel. The increase is due to a combination of higher reference prices and a narrowing of the quality differential at Little Bow. Increased prices combined with higher production volumes resulted in a 30 percent increase in the cash flow per share in the second quarter compared to the first quarter of 2005.

In addition to the wells scheduled to be drilled at Tangent for the remainder of the year, the Company has identified a significant number of exploration leads which will provide a high level of drilling activity in 2006.

In summary, Masters is now in a position to achieve significant growth throughout the remainder of 2005 and into 2006. We are very excited and optimistic about the future of the Company.



On behalf of the Board of Directors,

Geoff C. Merritt
President and Chief Executive Officer
July 27, 2005


MANAGEMENT'S DISCUSSION AND ANALYSIS

ADVISORIES

Management's discussion and analysis ("MD&A") of Masters Energy Inc. ("Masters or the Company"), provided as of July 27, 2005, should be read in conjunction with the unaudited financial statements presented for the three and six months ended June 30, 2005 and 2004 and the audited financial statements for the year ended December 31, 2004.

Basis of Presentation - The financial data presented below has been prepared in accordance with Canadian generally accepted accounting principles ("GAAP"). The reporting and the measurement currency is the Canadian dollar.

Non-GAAP Measurements - The MD&A contains the term cash flow from operations, which should not be considered an alternative to, or more meaningful than net earnings or cash flow from operating activities as determined in accordance with GAAP as an indicator of the Company's performance. Masters' determination of cash flow from operations and cash flow per share may not be comparable to that reported by other companies. The reconciliation between net earnings and cash flow from operations can be found in the statements of cash flows in the audited financial statements. The Company presents cash flow from operations per share, which is prohibited under GAAP. Per share amounts are calculated using weighted average shares outstanding consistent with the calculation of earnings per share.

BOE Presentation - The calculations of barrels of oil equivalent ("boe") are based on a conversion rate of six thousand cubic feet ("mcf") of natural gas to one barrel ("bbl") of crude oil. Boe's may be misleading, particularly if used in isolation. A boe conversion ratio of 6 mcf: 1 bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

Forward Looking Information - This MD&A contains forward looking or outlook information with regard to Masters within the meaning of applicable securities laws. Forward looking statements may include estimates, plans, expectation, forecasts, guidance or other statements that are not statements of fact. Masters believes the expectations reflected in such forward looking statements are reasonable. However, no assurance can be given that such expectations will prove to be correct. These statements are subject to certain risks and uncertainties and may be based on assumptions that could cause actual results to differ materially from those anticipated or implied in the forward looking statements. These risks include but are not limited to: crude oil and natural gas price volatility, exchange rate and interest rate fluctuations, availability of services and supplies, market competition, uncertainties in the estimates of reserves, the timing of development expenditures, production levels and the timing of achieving such levels, the Company's ability to replace and expand oil and gas reserves, the sources and adequacy of funding for capital investments, future growth prospects and current and expected financial requirements of the Company, the cost of future reclamation and site restoration, the Company's ability to enter into or renew leases, the Company's ability to secure adequate product transportation, changes in environmental and other regulations and general economic conditions. These statements speak only as of the date of this MD&A and the Company does not undertake an obligation to update our forward-looking statements except as required by law.



PRODUCTION

Production Summary Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
---------------------------------------
Total Production
Crude oil (bbl) 65,091 50,628 126,097 95,038
Natural gas liquids (NGL) (bbl) 1,014 821 1,585 961
Natural gas (mcf) 277,992 150,404 506,428 221,051
Total equivalent (boe) 112,437 76,516 212,087 132,841
Daily Production
Crude oil (bbl/d) 715 556 697 522
NGL (bbl/d) 11 9 9 5
Natural gas (mcf/d) 3,055 1,653 2,798 1,215
Total equivalent (boe/d) 1,236 841 1,172 730


Production volume for the second quarter ended June 30, 2005 averaged 1,236 boe per day, an increase of 47 percent in comparison with the second quarter of 2004. Oil and NGL production for the second quarter of 2005 increased 28 percent to 726 barrels per day from 565 barrels per day in the same period in 2004. Natural gas production for the second quarter ended June 30, 2005 increased 85 percent to 3.1 mmcf per day from 1.7 mmcf per day for the three months ended June 30, 2004. Year to date equivalent production for the first six months of 2005 of 1,172 boe per day, increased 61 percent in comparison to the same period for 2004. Production increased during 2005 as a result of successful wells being drilled and tied-in and the acquisition of the Peace River Arch properties early in June 2005.



PRICES

Commodity Prices Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
---------------------------------------

Crude oil ($/bbl) 41.64 37.10 39.95 35.46
---------------------------------------
---------------------------------------
NGL ($/bbl) 49.56 36.86 48.26 38.06
---------------------------------------
---------------------------------------
Natural gas ($/mcf) 7.34 6.51 7.11 6.78
---------------------------------------
---------------------------------------


West Texas Intermediate ("WTI") is the benchmark for North American oil prices and is the crude type that the NYMEX futures contracts are priced against. Canadian crude oil prices are based on refiners' postings at hubs such as Edmonton and Hardisty, Alberta. The Canadian postings are based on the WTI price at Cushing, Oklahoma less a transportation differential, the US/Canadian currency exchange rate, adjusted for relative quality and regional market conditions.

During the second quarter of 2005 North America continued to see historically high price levels for WTI crude oil primarily due to concerns over supply. As a result, the average price for a barrel of WTI crude during the period increased over $14.94(US) to $53.22(US) from the second quarter of 2004. The average price for a barrel of WTI crude during the first six months of 2005 increased over $14.79(US) to $51.55(US) from the first half of 2004. The Canadian dollar strengthened relative to the US dollar during the course of the year. The average currency exchange rate for $1.00 Canadian increased from $0.748(US) in the first half of 2004 to $0.810(US) in the similar period of 2005. As a result, this lowered the effective price received in Canadian dollars for delivery of crude within Canadian markets. The quality price differential postings on medium type crudes increased during 2005. The average differential between Edmonton light sweet crude postings and Hardisty Bow River medium crude was approximately $24.57 per bbl in the second quarter of 2005 versus $13.51 per bbl in the second quarter of 2004. The widening differential has impacted Masters' oil revenues and cash flow, as the majority of the Company's crude oil production during the first half of the 2005 year is medium gravity crude. Masters' average field price received for crude during the first six months of 2005 was $39.95 per barrel versus $64.08 per barrel for light sweet postings at Edmonton, Alberta.

The Company's crude oil field price for the second quarter of 2005 increased 12 percent to $41.64 per barrel from the average price received in the second quarter of 2004. For the first half of 2005 the crude field price increased 13 percent to $39.95 per barrel from the average price received during the comparable period in 2004.

US natural gas prices are typically referenced off NYMEX at Henry Hub, Louisiana while Canadian prices are referenced at Nova Inventory Transfer ("NIT") or the AECO Hub. Most of Masters' natural gas is sold to the spot market according to the AECO reference price. Masters did not enter into any fixed or hedged type gas sales contracts during 2004 or 2005. The average natural gas price received during the second quarter of 2005 was $7.34 per mcf, an increase of 13 percent from the price received in the same period of 2004. The average natural gas price received for the first half of 2005 was $7.11 per mcf, an increase of five percent from the price received in the first six months of 2004.



REVENUES

Revenue Summary
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands, except as indicated) 2005 2004 2005 2004
------------------------------------------------------------------------
Crude oil revenue 2,710 1,878 5,037 3,370
NGL revenue 50 30 76 37
Natural gas revenue 2,041 996 3,602 1,515
---------------------------------------
Total resource revenue 4,801 2,904 8,715 4,922
Interest and other revenue 1 18 1 28
---------------------------------------
Total revenue 4,802 2,922 8,716 4,950
---------------------------------------
---------------------------------------
Total revenue per boe ($) 42.71 38.10 41.09 35.82
---------------------------------------
---------------------------------------


Resource revenues for the second quarter of 2005 increased 65 percent to $4.8 million from the similar period in 2004 as commodity prices remained strong and production volumes continued to grow. The oil and natural gas revenue for the first half of 2005 was $8.7 million an increase of 77 percent over the same period of 2004 as sales from operations in 2004 included Terraquest from the effective date of the acquisition on February 26, 2004.

Interest and other income earned on surplus cash totaled $28 thousand during 2004. During 2004 surplus cash was invested in exploration and development capital spending and acquisitions and as a result there is no interest income earned during 2005.



ROYALTIES

Royalties Summary
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands, except as indicated) 2005 2004 2005 2004
------------------------------------------------------------------------
Crown 881 440 1,530 837
ARTC (132) (43) (229) (43)
---------------------------------------
Crown, net of ARTC 749 397 1,301 794
Freehold and other 117 63 176 75
---------------------------------------
Net royalties 866 460 1,477 869
---------------------------------------
---------------------------------------
Per boe ($) 7.70 6.01 6.96 6.54
---------------------------------------
---------------------------------------
Average royalty rate (%) 18.1 15.8 16.9 17.7


For the three months ended June 30, 2005, royalties, net of Alberta royalty tax credit, totaled $0.8 million for an average royalty rate relative to oil and gas revenues of 18 percent. The composition of the royalty expense incurred during the period was 86 percent paid to crown and the balance to freehold royalty owners. On a boe basis, royalties for the period were $7.70 per boe. For the similar period in 2004 the royalty rate averaged 16 percent of oil and gas revenues or $6.01 per boe.

For the six months ended June 30, 2005 royalties totaled $1.5 million for an average royalty rate of 17 percent or $6.96 per boe. For the comparable period in 2004 the royalty rate averaged 18 percent or $6.54 per boe.

Forecasted royalty rates for 2005 are anticipated to be consistent with 2004 rates. The Company anticipates maximizing its ARTC claim on Crown royalties during 2005.



OPERATING EXPENSES

Operating Expense Summary
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands, except as indicated) 2005 2004 2005 2004
------------------------------------------------------------------------
Production expenses 894 752 1,697 1,138
Transportation costs - 16 - 16
---------------------------------------
Total operating expenses 894 768 1,697 1,154
---------------------------------------
---------------------------------------
Per boe ($) 7.96 10.03 8.00 8.69
---------------------------------------
---------------------------------------


Operating expenses for the three months ended June 30, 2005 was $0.9 million, an increase of 17 percent compared to $0.8 million the same period in 2004 primarily as a result of higher production. On a boe basis, the 2005 period to date operating expenses decreased 21 percent to an average cost of $7.96 per boe produced from $10.03 per boe in the same period in 2004. Operating expenses per boe in the first half of 2005 have decreased eight percent compared to the average boe operating expense for the 2004 year primarily due to higher volumes produced through existing facilities.

Operating expenses per boe for the balance of 2005 are anticipated to remain consistent with the year to date results.



Netback Analysis
Three Months Ended Six Months Ended
June 30, June 30,
($ per boe) 2005 2004 2005 2004
------------------------------------------------------------------------
Oil and gas revenues 42.71 38.10 41.09 35.82
Royalties, net of ARTC (7.70) (6.01) (6.96) (6.54)
Operating expenses (7.96) (10.03) (8.00) (8.69)
---------------------------------------
Netback 27.05 22.06 26.13 20.59
---------------------------------------
---------------------------------------


Operating income netback per boe for 2005 has increased due to a combination of higher commodity prices received on oil and natural gas production and lower operating expenses.



GENERAL and ADMINISTRATIVE

General and Administrative
Expense Summary
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands, except as indicated) 2005 2004 2005 2004
------------------------------------------------------------------------
Gross general and administrative 421 403 1,019 698
Operating recoveries (28) (36) (50) (43)
Capitalized expenses (144) (129) (357) (240)
---------------------------------------
General and administrative
expense, before stock based
compensation 249 238 612 415
Future stock based compensation
expense 57 45 114 62
---------------------------------------
Total general and administrative
expense 306 283 726 477
---------------------------------------
---------------------------------------
General and administrative
expense, before stock based
compensation, per boe ($) 2.22 3.12 3.16 3.12
---------------------------------------
---------------------------------------
Total general and administrative
expense per boe ($) 2.72 3.70 3.41 3.59
---------------------------------------
---------------------------------------


During the second quarter of 2005, net general and administrative costs before stock based compensation remained essentially the same as the second quarter 2004. The increase in the year to date 2005 general and administrative costs compared to the first half of 2004 is mainly due to the Company performing its first annual public reporting and regulatory filing during the period, as well as performance-based compensation paid during the first quarter of 2005.

Total general and administrative expenses for the remainder of 2005 are anticipated to be similar to 2004. Based on forecasted production and capital spending, 2005 staff levels are anticipated to be similar to 2004. For the remainder of 2005, net general and administrative expense, before the provision of stock based compensation expense, is anticipated to average $2.00 per boe.

INTEREST EXPENSE

Interest expense during the second quarter of 2005 was $87 thousand ($37 thousand - 2004) due to higher average debt levels. Interest expense for the first six months of 2005 was $133 thousand ($37 thousand - 2004) as a result of increased debt for capital invested in exploration, development and acquisition activities.



DEPLETION, DEPRECIATION and ACCRETION

Depletion, Depreciation and Accretion Summary

Three Months Ended Six Months Ended
June 30, June 30,
($ thousands except as indicated) 2005 2004 2005 2004
------------------------------------------------------------------------
Depletion 1,479 1,042 2,655 1,796
Depreciation 2 3 4 6
Accretion on asset retirement
obligations 31 44 56 75
---------------------------------------
Total depletion, depreciation
and accretion expense 1,512 1,089 2,715 1,877
---------------------------------------
---------------------------------------
Depletion, depreciation and
accretion expense per boe 13.44 14.23 12.80 14.12
---------------------------------------
---------------------------------------


For the second quarter of 2005, depletion, depreciation and accretion expense increased 39 percent to $1.5 million from $1.1 million for the same period in 2004. The increase is due to higher production in 2005. On a boe basis depletion, depreciation and accretion for the second quarter of June 2005 decreased six percent to $13.44 from $14.23 in the same period in 2004. The decrease in boe depletion charges is a result of the lower cost of reserve additions during 2005.

For the six months ended June 30, 2005, depletion, depreciation and accretion expense increased 45 percent to $2.7 million from $1.9 million for the same period in 2004 primarily due higher production. For the first six months of 2005 the depletion, depreciation and accretion per boe decreased nine percent to $12.80 per boe as result of the lower cost for reserve additions during 2005.

At June 30, 2005, the impairment recognition portion of the ceiling test indicated the estimated undiscounted future cash flows from proven reserves exceeded the carrying values of producing petroleum and natural gas properties and therefore a ceiling test adjustment was not required.



INCOME TAXES

Income Tax Summary

Three Months Ended Six Months Ended
June 30, June 30,
($ thousands except as indicated) 2005 2004 2005 2004
------------------------------------------------------------------------
Future income taxes 494 334 768 63
Capital taxes - - - -
---------------------------------------
Total income taxes 494 334 768 63
---------------------------------------
Effective tax rate (%) 43.4 - 39.0 -
---------------------------------------


The future income tax expense provision for the three months ended June 30, 2005 increased to $0.5 million from a future tax expense of $0.3 million in the same period in 2004. For the six months ended June 30, 2005 future income tax expense increased to $0.8 million from $0.1million in the comparable period in 2004. The increase in 2005 future tax expense was primarily due to higher earnings before taxes. In 2004, an one percent reduction to the Alberta corporate income tax rate was recognized.

As at June 30, 2005, the Company has approximately $40.4 million in tax pools to shelter taxable income in the future years.

NET EARNINGS and CASH FLOW FROM OPERATIONS

Net earnings increased to $0.6 million for the three months ended June 30, 2005 compared to a loss of $0.1 million during the same period in 2004. The increase was mainly due to higher production and commodity prices per boe received over the same period in 2004. Net earnings per share basic and diluted for the quarter were $0.04 per share compared to $ nil per share during the same quarter in 2004.

For the six months ended June 30, 2005, net earnings increased 154 percent to $1.2 million compared to $0.5 million during the comparable period in 2004. The increase in net earnings was mainly due to higher commodity prices received and lower expenses per boe.

Cash flow from operations increased 94 percent to $2.7 million for the three months ended June 31, 2005 compared to $1.4 million during the same period in 2004. For the first half of 2005 cash flow from operations increased 95 percent to $4.8 million compared to $2.4 million during the first six months of 2004. The increase in cash flow is primarily due to higher production and commodity prices.

CAPITAL EXPENDITURES

During the first half of 2005 the Company spent approximately $5.9 million in exploration and development capital expenditures compared to $5.1 million spent in the first half of 2004. The Company drilled 11 wells (8.8 net) with a success rate of 91 percent and added over 5,600 net undeveloped acres during the period. For the first six months ended June 30, 2005 the total capital expenditures were $13.5 million comprising of $5.9 million spent on exploration and development expenditures and $7.6 million to acquire the properties in the Peace River Arch area of Alberta. The acquisition provided natural gas production of 0.9 mmcf per day, interests in several strategic field facilities, 9,500 net acres of undeveloped land and a large seismic data base associated with the acquired properties. Total capital expenditures during the six months ended June 30, 2004 were $24.7 million that included $5.1 million spent on exploration and development expenditures and $19.6 million for the acquisition and merger of Terraquest Energy Corporation on February 26, 2004.



Three Months Ended Six Months Ended
June 30, June 30,
($ thousands) 2005 2004 2005 2004
------------------------------------------------------------------------
Land 351 206 639 356
Geological and geophysical 106 131 323 237
Drilling and completions 1,907 1,638 4,041 3,348
Equipping and facilities 442 786 905 1,206
Other - - 6 2
---------------------------------------
Total exploration and
development capital 2,806 2,761 5,914 5,149
Terraquest Energy Corporation - - - 19,584
Producing property acquisition 7,552 - 7,552 -
---------------------------------------
Total capital expenditures 10,358 2,761 13,466 24,733
---------------------------------------
---------------------------------------


Drilling Results

During the second quarter of 2005 the Company drilled five wells resulting in four natural gas wells and one dry and abandoned well for an overall success rate of 80 percent. For the first half of 2005, the Company drilled 11 wells resulting in three oil wells, seven natural gas wells and one dry and abandoned well for an overall success rate of 91 percent.



Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
(wells) Gross Net Gross Net
------------------------------------------------------------------------
Oil - - 3 3.0
Natural Gas 4 3.5 7 4.8
Dry 1 1.0 1 1.0
---------------------------------------
Total 5 4.5 11 8.8
---------------------------------------
---------------------------------------
Success rate (%) 80 78 91 89
---------------------------------------
---------------------------------------


CONTRACTUAL OBLIGATIONS

Effective September 1, 2005, the Company is committed under a lease on its office premises expiring August 31, 2010 for future annual minimum rental payments, excluding estimated operating costs, of $87,096 for the first three years and $92,892 for the remainder of the lease term. The Company has the option to terminate the office lease at the end of the second year, subject to a termination payment of $69,000.

There are no commodity hedge contracts outstanding as at June 30, 2005.

LIQUIDITY and CAPITAL RESOURCES

The Company's total capitalization at June 30, 2005 was $69.5 million with the market value of common shares representing 75 percent of total capitalization. Net debt represented nine percent and asset retirement obligations and future income taxes accounted for six percent.



Total Market Capitalization
($ thousands except as indicated) 2005 %
------------------------------------------------------------------------
Common shares outstanding (thousands) 14,364
Share price, June 30, 2005 3.64
--------------------------
Total market capitalization 52,285 75
--------------------------

Working capital (323)
Bank debt 13,137
--------------------------
Net debt 12,814 19
--------------------------
Asset retirement obligation 3,566 5
Future income taxes 798 1
--------------------------
Total capitalization 69,463 100
--------------------------
--------------------------
Net debt to total capitalization 0.19:1
--------------------------
--------------------------


At June 30, 2005 the Company had borrowed approximately $13.1 million and had working capital of $0.3 million totaling $12.8 million of total net debt. This net debt amount represents approximately 1.2 times the annualized second quarter 2005 cash flow from operations.

The Company has a bank revolving term facility of $16.0 million to fund future activities. The facility is a borrowing base facility that is determined by the Company's latest reserve assessment, results of operations, current and forecasted commodity prices and the prevailing economic market. The facility is reviewed semi-annually with the next date October 31, 2005. As at June 30, 2005, the Company had drawn $13.1 million of the revolving term facility and the amount is recorded as a long-term liability.

The Company's future investing activities, which consist primarily of capital expenditures on oil and gas activities, will be funded with working capital, cash flow from operations and a limited amount of bank debt.

As at July 27, 2005 the issued and outstanding common shares of the Company were 14,470,313, options outstanding were 1,130,000 and performance warrants outstanding of 935,000.

SELECTED QUARTERLY INFORMATION

The financial data presented below has been prepared in accordance with Canadian generally accepted accounting principles. The reporting and measurement currency is the Canadian dollar. The Company commenced oil and gas operations after acquiring the Little Bow property on December 22, 2003.



(Unaudited) 2005 2004
-----------------------------------------------
Operations Q2 Q1 Q4 Q3 Q2 Q1
-----------------------------------------------
Production
- Oil (bbl/d) 715 678 588 597 556 488
- NGL (bbl/d) 11 6 13 5 9 2
- Natural Gas (mcf/d) 3,055 2,538 2,406 1,980 1,653 800
- Equivalent (boe/d) 1,236 1,107 1,002 932 841 619
Pricing
- Oil, before hedging
($/bbl) 41.64 38.14 36.91 42.40 37.10 33.60
- Hedging costs - - (0.01) (4.25) - -
-----------------------------------------------
- Oil, after hedging
($/bbl) 41.64 38.14 36.90 38.15 37.10 33.60
- NGL ($/bbl) 49.56 46.12 50.72 40.20 36.86 45.11
- Natural Gas ($/mcf) 7.34 6.83 6.62 6.24 6.51 7.35
- Equivalent ($/boe) 42.71 39.28 38.09 37.90 37.95 35.82
Financial
($ thousands except share
and per share amounts)
Total revenue 4,802 3,914 3,501 3,258 2,922 2,028
Cash flow from
operations 2,699 2,069 1,676 1,513 1,391 1,055
Net earnings (loss) 643 557 (124) 79 (49) 521
- basic per share 0.04 0.04 (0.01) 0.01 0.00 0.05
- diluted per share 0.04 0.04 (0.01) 0.01 0.00 0.05
Capital spending
- Exploration and
development 2,806 3,108 3,240 2,531 2,761 2,388
- Acquisitions 7,552 - - - - 20,174
Total assets 48,130 38,830 37,291 35,518 34,833 34,271
Working capital
(deficiency) 323 (5,155) (4,116) (2,551) (1,533) (163)
Long-term debt 13,137 - - - - -
Shareholders' equity 28,884 28,184 27,570 27,639 27,504 27,508
Weighted average
common shares
outstanding
(thousands)
- basic 14,364 14,364 14,364 14,364 14,364 10,987
- diluted 14,931 14,801 14,614 14,553 14,505 11,184
Share trading activity
- volume (thousands)
-- total 3,096 4,149 2,858 910 868 220
-- daily 48 67 45 14 14 12
- price ($ per share)
-- high 3.80 4.20 2.85 2.77 2.69 3.25
-- low 3.05 2.31 2.30 2.25 2.00 2.45
-- closing 3.64 3.40 2.60 2.70 2.40 2.55


Factors that caused variations over the quarters -

- The Company completed three acquisitions since its initial financing in the fourth quarter of 2003 which has impacted production growth:

-- The acquisition of the Little Bow property in Southern Alberta on December 22, 2003 added approximately 450 boe per day consisting of approximately 90 percent crude oil production. Proved and probable reserves acquired were approximately 1.4 million boe with an estimated reserve life index of 8.6 years.

-- The acquisition of Terraquest Energy Corporation on February 26, 2004 added production of approximately 400 boe per day consisting of approximately 60 percent natural gas. Proved and probable reserves acquired were approximately 1.1 million boe with an estimated reserve life index of 7.9 years based on the production at the time of acquisition.

-- The acquisition of producing properties in the Peace River Arch area of Northwest Alberta on June 3, 2005 added approximately 150 boe per day consisting of natural gas production. Proved and probable reserves acquired were approximately 0.5 million boe with an estimated reserve life index of 7.0 years.

- Production growth subsequent to the acquisitions is a result of the Company's exploration, development and exploitation activities. The timing of production is subject to timing of drilling and facility construction.

- The growth in revenue and cash flow is the combination of increased production and strong commodity prices. Generally commodity prices were consistently strong throughout 2004 and 2005. Oil prices for medium grade quality crude experienced a large drop in the latter portion of the fourth quarter 2004 due to wider than historical quality differentials. This impacted the prices received by Masters during the fourth quarter of 2004 and the first half of 2005 as a majority of the crude production is of medium quality.

- The net earnings are impacted by depletion, depreciation, accretion and future income taxes. The Company estimates its reserves every quarter based on its acquisition and drilling activities. The annual reserves are determined by independent reservoir engineers the results of which can affect fourth quarter reserve additions. Future income taxes have been impacted with the enacted changes to the federal and provincial income tax rates for the oil and gas industry.

- Capital spending is influenced with the development of future drilling prospects and seasonal field conditions. The capital spending was funded through cash flow and bank debt.



Masters Energy Inc.
Balance Sheets

June 30, December 31,
($ thousands) 2005 2004
------------------------------------------------------------------------
(Unaudited) (Audited)
Assets

Current assets
Accounts receivable $ 1,840 $ 2,116
Prepaid expenses and deposits 228 415
----------- ------------
2,068 2,531

Property and equipment (note 2) 46,062 34,760
----------- ------------
$ 48,130 $ 37,291
----------- ------------
----------- ------------
Liabilities

Current liabilities
Accounts payable and accrued liabilities $ 1,745 $ 3,223
Bank debt (note 3) - 3,424
----------- ------------
1,745 6,647
Long-term bank debt (note 3) 13,137 -
Asset retirement obligations (note 4) 3,566 3,044
Future income taxes (note 6) 798 30
----------- ------------
19,246 9,721
----------- ------------
Shareholders' Equity

Share capital 27,042 27,042
Contributed surplus 324 210
Retained earnings 1,518 318
----------- ------------
28,884 27,570
----------- ------------
$ 48,130 $ 37,291
----------- ------------
----------- ------------

See accompanying notes to the financial statements.


Approved on behalf of the board,

____________________________ ______________________________
William R. Stedman, Director Douglas H. Mitchell, Director


Masters Energy Inc.
Statements of Earnings and Retained Earnings
(Unaudited)

Three Months Ended Six Months Ended
($ thousands except share June 30, June 30,
and per share amounts) 2005 2004 2005 2004
------------------------------------------------------------------------

Revenue
Petroleum and natural gas
sales $ 4,802 $ 2,922 $ 8,716 $ 4,950
Royalties, net of Alberta
Royalty Tax Credit (866) (460) (1,477) (869)
----------- --------- --------- ---------
3,936 2,462 7,239 4,081
----------- --------- --------- ---------
Expenses
Operating 894 768 1,697 1,154
General and administrative 306 283 726 477
Interest 87 37 133 37
Depletion, depreciation
and accretion 1,512 1,089 2,715 1,877
----------- --------- --------- ---------
2,799 2,177 5,271 3,545
----------- --------- --------- ---------
Earnings before taxes 1,137 285 1,968 536
Future income taxes (note 6) 494 334 768 63
----------- --------- --------- ---------
Net earnings (loss) 643 (49) 1,200 473
Retained earnings (deficit),
beginning of period 875 412 318 (110)
----------- --------- --------- ---------
Retained earnings,
end of period $ 1,518 $ 363 $ 1,518 $ 363
----------- --------- --------- ---------
----------- --------- --------- ---------
Earnings (loss) per share
- basic and diluted (note 5) $ 0.04 $ 0.00 $ 0.08 $ 0.04
----------- --------- --------- ---------
----------- --------- --------- ---------
Weighted average number of
shares outstanding
Basic 14,363,647 14,363,647 14,363,647 12,675,140
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------

Diluted 14,931,360 14,504,760 14,866,257 12,844,388
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------

See accompanying notes to the financial statements.


Masters Energy Inc.
Statements of Cash Flows
(Unaudited)

Three Months Ended Six Months Ended
June 30, June 30,
($ thousands) 2005 2004 2005 2004
------------------------------------------------------------------------
Cash provided by (used for):

Operating activities
Net earnings (loss) $ 643 $ (49) $ 1,200 $ 473
Add (deduct) non-cash items
Depletion, depreciation
and accretion 1,512 1,089 2,715 1,877
Settlement of asset
retirement costs (7) (28) (29) (28)
Future income tax expense 494 334 768 63
Stock-based compensation
expense 57 45 114 62
----------- --------- --------- ---------
2,699 1,391 4,768 2,447
Changes in non-cash working
capital (346) 341 (1,865) 275
----------- --------- --------- ---------
2,353 1,732 2,903 2,722
----------- --------- --------- ---------
Financing activities
Increase (repayment)
in bank debt 9,713 - 9,713 (7,032)
Changes in non-cash working
capital (1,683) 1,055 - 1,055
----------- --------- --------- ---------
8,030 1,055 9,713 (5,977)
----------- --------- --------- ---------
Investing activities
Exploration and development (2,806) (2,761) (5,914) (5,149)
Producing property
acquisition (7,552) - (7,552) -
Costs related to the
acquisition of Terraquest - - - (295)
----------- --------- --------- ---------
(10,358) (2,761) (13,466) (5,444)
Changes in non-cash working
capital (25) (1,014) 850 (695)
----------- --------- --------- ---------
(10,383) (3,775) (12,616) (6,139)
----------- --------- --------- ---------
Decrease in cash - (988) - (9,394)

Cash and cash equivalents,
beginning of period - 1,109 - 9,515
----------- --------- --------- ---------
Cash and cash equivalents,
end of period $ - $ 121 $ - $ 121
----------- --------- --------- ---------
----------- --------- --------- ---------

Supplemental Cash Flow
Information
Interest income received $ - $ 18 $ - $ 27
Interest paid $ 87 $ 8 $ 133 $ 8
Capital taxes paid $ - $ 34 $ - $ 34
------------------------------------------------------------------------
------------------------------------------------------------------------

See accompanying notes to the financial statements.


Masters Energy Inc.
Notes to the Financial Statements
(Unaudited)


1. Accounting Policies

The interim financial statements of Masters Energy Inc. ("the Company") have been prepared following the same accounting policies and methods of computation as the financial statements of the Company for the year ended December 31, 2004. The disclosures provided below are incremental to those included with the annual financial statements. These interim financial statements should be read in conjunction with the financial statements and notes disclosed in the Company's annual report for the year ended December 31, 2004.

The Company is engaged in the exploration, development and production of petroleum and natural gas in Western Canada. The financial statements are stated in Canadian dollars and have been prepared in accordance with Canadian generally accepted accounting principles.



2. Property and equipment

($ thousands) Accumulated
Depletion
and Net Book
As at June 30, 2005 Cost Depreciation Value
---------------------------------- -------- ------------ ---------
Petroleum and natural gas
properties and well equipment $ 53,007 $ 6,973 $ 46,034
Office equipment 49 21 28
---------------------------------- -------- ------------ ---------
$ 53,056 $ 6,994 $ 46,062
---------------------------------- -------- ------------ ---------
---------------------------------- -------- ------------ ---------


As at December 31, 2004 (Audited)
----------------------------------

Petroleum and natural gas
properties and well equipment $ 39,052 $ 4,317 $ 34,735
Office equipment 42 17 25
---------------------------------- -------- ------------ ---------
$ 39,094 $ 4,334 $ 34,760
---------------------------------- -------- ------------ ---------
---------------------------------- -------- ------------ ---------


The value of undeveloped lands excluded from costs subject to depletion was $7.1 million at June 30, 2005 ($5.5 million - December 31, 2004).

During the six months ended June 30, 2005, $0.4 million ($0.2 million - June 30, 2004) of general and administrative costs were capitalized.

3. Bank debt

The Company has access to a revolving term credit facility with a Canadian chartered bank. As of May 27, 2005 the Company increased its bank debt facility to a maximum of $16.0 million. The credit facility may be drawn or repaid directly or with bankers' acceptances. Direct advances bear interest at the bank's prime lending rate and the bankers' acceptances bear interest at the applicable bankers' acceptance rate plus a stamping fee.

The Company has available a $2.5(USD) million demand swap facility, to assist in financing the contingent exposure of settlement for financial commodity swaps. The facility bears interest at a US base rate per annum on amounts drawn.

The revolving term credit facility is available for a period of 364 days until April 30, 2006. Up to 60 days prior to April 30, 2006 the Company may request an extension of the revolving facility for a period of another 364 days, subject to the bank's approval. If the Company does not request for the extension or the bank does not agree to the extension, the credit facility principal borrowed will be permanently repaid with one payment 366 days subsequent to the revolver date. The nature of the lending facility is such that it is recognized as a long-term liability.

As of June 30, 2005, $13.1 million ($3.4 million - December 31, 2004) has been drawn against the revolving credit facility.

Security pledged for the facilities consists of a general assignment of book debts, a $40.0 million demand debenture, secured by a first floating charge over all the assets of the Company. The next review of the credit facility is to occur on or before October 31, 2005.

4. Asset retirement obligation

The following table summarizes changes in the asset retirement obligation for the periods ended as indicated:



Six Months Year Ended
Ended December 31,
($ thousands) June 30, 2005 2004
------------------------------------------------------------------------
(Audited)
Asset retirement obligation,
beginning of period $ 3,044 $ 1,198
Adjustments - (119)
Liabilities acquired 284 1,770
Liabilities incurred 211 119
Asset retirement expenditures (29) (95)
Accretion expense 56 171
------- --------
Asset retirement obligation, end of period $ 3,566 $ 3,044
------- --------
------- --------


The total estimated, undiscounted cash flows required to settle the obligations, before considering salvage, is $4.9 million as at June 30, 2005 ($4.4 million - December 31, 2004) which has been discounted using a weighted average credit-adjusted risk-free interest rate of 6.9 percent. The Company expects these obligations to be settled in approximately 1 to 14 years.

5. Per share amounts

Per share amounts have been calculated using the basic weighted average number of common shares outstanding of 14,363,647 during the three and six month periods ended June 30, 2005 (12,675,140 - six months ended June 30, 2004). For the three month period ended June 30, 2005, a total of 567,713 (141,113 - 2004) were added to the total to take into account the dilutive effect of the options and warrants for the period. A total of 502,610 common shares were added to take into account the dilutive effect during the six month period ended June 30, 2005 (169,249 - 2004).

6. Future income taxes

(a) The provision for income tax expense differs from that which would be expected from applying the combined effective Canadian federal and provincial income tax rate of 37.62% (38.62% - 2004) to income before income taxes. The difference results from the following:



Three Months Ended Six Months Ended
June 30 June 30
($ thousands) 2005 2004 2005 2004
------------------------------------------------------------------------
Expected income tax expense $428 $108 $741 $207

Increase (decrease) resulting from:
Non-deductible crown payments 260 94 378 236
Resource allowance (214) (102) (339) (191)
Impact in effective tax rate
applied 42 57 20 (145)
Stock based compensation expense 23 17 43 24
Other (45) 160 (75) (68)
----- ---- ----- -----
Total tax expense $494 $334 $768 $ 63
----- ---- ----- -----
----- ---- ----- -----


(b) The components of the future income tax liability are as follows:

June 30, December 31,
($ thousands) 2005 2004
------------------------------------------------------------------------
Carrying value of property and equipment
in excess of available tax deductions $2,354 $2,141
Asset retirement obligation (1,158) (987)
Non-capital loss carryforwards - (640)
Share issuance costs (398) (484)
-------- ------------
$ 798 $ 30
-------- ------------
-------- ------------


Masters Energy Inc. is an Alberta based corporation engaged in the business of acquiring or exploring for and developing oil and natural gas reserves in western Canada. Masters' common shares are listed on the Toronto Stock Exchange under the trading symbol "MSY".

ADVISORY

The Toronto Stock Exchange has neither approved nor disapproved of the information contained herein. Certain information regarding the Company, including management's assessment of future plans and operations, may constitute forward-looking statements under applicable securities law and necessarily involve risks associated with oil and gas exploration, production, marketing and transportation such as loss of market, volatility of prices, currency fluctuations, impression of reserve estimates, environmental risks, competition from other producers and ability to access sufficient capital from internal and external sources: as a consequence, actual results may differ materially from those anticipated. The Company assumes no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those contemplated by the forward-looking statements.

Contact Information

  • Masters Energy Inc.
    Geoff Merritt
    President and CEO
    (403) 290-1785
    or
    Masters Energy Inc.
    Randall Boyd
    Chief Financial Officer
    (403) 290-1785
    Website: www.mastersenergy.com