Monterey Exploration Ltd.
TSX : MXL

Monterey Exploration Ltd.

May 14, 2009 21:11 ET

Monterey Exploration Ltd. Announces Financial and Operating Results for the Three Months Ended March 31, 2009

CALGARY, ALBERTA--(Marketwire - May 14, 2009) - Monterey Exploration Ltd. ("Monterey" or the "Corporation") (TSX:MXL) is pleased to provide its financial and operating results for the three months ended March 31, 2009.

Monterey's interim financial statements for the three months ended March 31, 2009 and management's discussion and analysis for the three months ended March 31, 2009 are available on SEDAR at www.sedar.com and on Monterey's website at www.montereyexploration.com.

FIRST QUARTER 2009 HIGHLIGHTS

- Drilled and cased a successful exploratory test well at Groundbirch targeting the upper Montney gas formation. The operation completed the earning of 10 contiguous sections (7.5 net) directly offsetting Monterey's existing Groundbirch landholdings. The Corporation's total landholdings at Groundbirch now consist of 15 operated sections (12.5 net) concentrated in the heart of the Montney fairway.

- Achieved average daily production for the quarter of 2,451 barrels of oil equivalent per day ("boe/d"), a 71 percent increase compared with 1,435 boe/d during the comparative quarter in 2008.

- Generated quarterly funds flow from operations of $2.6 million versus $3.5 million of funds flow from operations generated in the first quarter of 2008. First quarter funds flow from operations per diluted share was $0.08.

- Renewed the Corporation's credit facility whereby total funds available under the credit facility remain unchanged at $45.0 million with the next review of the credit facility scheduled to be completed prior to June 2010.

- Completed the disposition of 1.4 net sections of undeveloped non-core Montney lands and one non-producing wellbore at Dawson on January 29, 2009 for net proceeds of $6.0 million.

RECENT DEVELOPMENTS

- Monterey engaged GLJ Petroleum Consultants Ltd. to prepare an independent evaluation of the Discovered Petroleum Initially-In-Place ("DPIP") on 5 net sections of Monterey's Montney landholdings in the Groundbirch area of northeast British Columbia ("NEBC"). The evaluation has identified a current best estimate of net 659 billion cubic feet of DPIP in the upper Montney formation. Monterey holds a working interest in an additional 10 (7.5 net) sections of Montney acreage directly offsetting the lands discussed above which have not yet been assigned any DPIP.



FINANCIAL & OPERATING SUMMARIES

Financial Three Months Ended
---------- March 31,
2009 2008
Production Revenue(1) (000's) $ 7,614 $ 6,444

Funds Flow from Operations(2) :
(000's) $ 2,620 $ 3,301
Per share(3) :
Basic and diluted $ 0.08 $ 0.14

Net Earnings / (Loss):
(000's) $ (4,174) $ 1,111
Per share:
Basic and diluted $ (0.13) $ 0.04

Total Capital Expenditures(4) (000's) $ (1,818) $ 12,586

Ending Net Debt (5) (000's) $ 33,872 $ 24,101

Share Data:
Outstanding:
Common 32,902,500 20,045,700
Non-voting common - 5,061,096
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Basic 32,902,500 25,106,796
Stock options 3,135,666 2,150,666
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Fully diluted 36,038,166 27,257,462
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Weighted average shares outstanding:
Basic 32,902,500 25,058,218
Diluted 32,932,759 25,254,541


Operations
-----------
Three Months Ended
March 31,
2009 2008
Average Daily Production:
Light oil and NGL (bbl/d) 461 241
Natural gas (mcf/d) 11,939 7,168
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Oil equivalent (boe/d) 2,451 1,435
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Unit of Production Summary:
Average prices:
Light oil and NGL ($/bbl) 37.84 83.07
Natural gas(1) ($/mcf) 5.59 7.09
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Oil equivalent(1) ($/boe) 34.52 49.34
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Funds flow from Operations(2) Summary ($/boe)
Revenue(1) 34.52 49.34
Royalties (5.53) (9.95)
Operating expenses (11.54) (12.45)
Transportation expenses (1.85) (1.67)
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Operating income(6) 15.60 25.27
Unrealized (gain) on financial instruments - 7.59
General & administrative(7) (2.76) (3.68)
Interest expense (0.95) (2.02)
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Funds flow from operations(2) ($/boe) 11.89 27.16
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Drilling Three Months Ended
--------- March 31,
2009 2008
Gross Wells:
Natural gas 1 7
Oil - -
Dry & abandoned - -
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Total 1 7
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Net Wells:
Natural gas 1.0 2.9
Oil - -
Dry & abandoned - -
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Total 1.0 2.9
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2009 FIRST QUARTER OPERATIONAL UPDATE

Monterey's first quarter capital program was directed towards tie-in operations on four wells (1.75 net) that were drilled and completed in 2008 and the 100 percent working interest stratigraphic Montney test well that was drilled at Groundbirch. The Corporation's total capital expenditures for the quarter were $4.2 million, $2.5 million of which was allocated towards the successful vertical Montney test well.

Production for the first quarter averaged 2,451 boe/d which represents a 15 percent quarter increase over the fourth quarter of 2008 and a 71 percent increase relative to the comparative quarter in 2008. The Corporation averaged approximately 2,400 boe/d for the month of April based on field production estimates.

Groundbirch Montney project update

Monterey completed the drill and case of a 2,800 meter Montney test well on Monterey's existing 100 percent working interest lands at Groundbirch at the end of the first quarter. The test well converted a 10 (7.5 net) section license of contiguous land directly offsetting Monterey's existing land holdings to a five year lease and the resulting project area consists of 15 gross (12.5 net) sections of concentrated Monterey controlled and operated land holdings situated in the heart of the Montney fairway.

Based on Monterey's drilling results and the test results of two immediate offset wells as discussed in Monterey's press release dated March 23rd, 2009, the Corporation is currently in the field surveying the first two horizontal test/development locations. The first 100 percent working interest horizontal location will directly offset Monterey's vertical strat test drilled in the first quarter of 2009. The second location will be located 2 miles West on the recently earned 75 percent working interest land block. Both wells are expected to be licensed by early August to commence drilling operations in the second half of 2009.

Monterey has completed the engineering design and submitted for approval in late January 2009 an application to the British Columbia Oil and Gas Commission for the construction of a 28 million cubic feet per day natural gas processing facility. Once this application is approved, it will give Monterey the ability to proceed from an infrastructure standpoint with full scale development of a 100 percent working interest controlled and operated Montney natural gas project in the Groundbirch area of NEBC.

Montney evaluation

Monterey engaged GLJ Petroleum Consultants Ltd. ("GLJ") to prepare an independent evaluation effective March 31, 2009 of the Discovered Petroleum Initially-In-Place ("DPIP") as defined in the Canadian Oil and Gas Evaluation Handbook ("COGE Handbook"), on five 100 percent working interest sections of Montney landholdings in the Groundbirch area of NEBC. GLJ has estimated that there exists a net 659 billion cubic feet ("bcf") of DPIP on these lands. Monterey's first planned horizontal development well and future industry activity directly offsetting should provide additional information to help assess the ultimate potential of the above noted lands.

GLJ has provided a best estimate of the DPIP for the Montney formation on 5 net sections of prospective lands at Groundbirch. There are an additional 7.5 net sections of Monterey lands directly offsetting these lands that have not yet been assigned any DPIP. It should be noted that given the early stages of development, the best estimate of DPIP may change significantly in the future with further exploration and development activity and the amount of contingent resources, as defined in the COGE Handbook, has yet to be determined. Additional drilling and testing are required to confirm deliverability potential and commercial economic development. The resource estimates provided herein are estimates only and the actual resources may be greater or less than the estimates provided herein. A recovery factor for the resources identified has not been estimated by GLJ. A recovery project cannot be defined for these volumes of DPIP at this time. There is no certainty that it will be commercially viable to produce any portion of this natural gas currently classified as DPIP.

At December 31, 2008, Monterey had no proved or probable reserve bookings assigned to the Groundbirch Montney project.

OUTLOOK

Monterey is increasing its first half production guidance to 2,300 - 2,350 boe/d from the previously stated 2,200 boe/d. First quarter production averaged 2,451 boe/d and current base production continues to exceed the Corporation's original 2009 projections. Monterey continues to maintain its previous 2009 capital expenditure guidance of $10 million with approximately $5 million being allocated to the first half of the year.

Monterey's business plan remains focused on value creation for shareholders through strict operational and capital allocation discipline. This is being achieved by allocating resources and capital only to the key projects that require additional spending to significantly increase the future potential upside value. The Corporation will continue to conserve capital and maintain balance sheet strength during this downward cycle in commodity price.

The Corporation completed the earning on the Brassey project in the fourth quarter of 2008 proving the merits of the latest horizontal drilling and completion technology to develop the large Cadomin resource. Also, the drilling of the first vertical test well on the Groundbirch Montney project continues the evaluation process to determine ultimate potential size and scale of the Montney in-place resource while significantly adding to the Corporation's land position. These are examples of a capital allocation strategy that has to date amassed a development inventory in excess of $100 million of drilling locations. Management is very encouraged by the results to date in these two resource plays in NEBC and looks forward to the opportunity to fully execute the development of these plays as the economic conditions improve.

Monterey's annual and special meeting of shareholders is scheduled for Wednesday June 24th, 2009 at 2:30 PM in the Plaza Room of the Metropolitan Conference Centre, 333 Fourth Avenue SW, Calgary, Alberta.

Notes:

(1) Includes gain or loss on financial instruments from commodity price hedging activities.

(2) Funds flow from operations is not defined by Canadian generally accepted accounting principles ("GAAP") and thus is referred to as a non-GAAP measure; other entities may calculate funds flow differently than Monterey. Funds flow from operations is described in the Corporation's management discussion and analysis dated March 31, 2009 and is based on cash provided by operating activities before changes in non-cash working capital and asset retirement expenditures.

(3) Funds flow from operations per share is not defined by Canadian GAAP and thus is referred to as a non-GAAP measure. Funds flow from operations per share, is described in the Corporation's management discussion and analysis, and calculated by dividing funds flow by the weighted average number of shares outstanding during the period consistent with the calculation of net income per share.

(4) Total capital expenditures is not defined by Canadian GAAP and thus is referred to as a non-GAAP measure. Total capital expenditures, is described in the Corporation's management discussion and analysis, and is equal to the property and equipment additions, as disclosed under Investing activities in the Statements of Cash Flows of the Corporation financial statements, plus the outlays in respect of oil and gas properties acquisitions and corporate acquisitions (including the costs of the acquisition and the allocation to long lived asset retirement ), less the net proceeds received from the disposition of oil and gas properties.

(5) Net debt is not defined by Canadian GAAP and thus is referred to as a non-GAAP measure. Net debt, is described in the Corporation's management discussion and analysis, and is equal to total bank indebtedness plus capital lease obligations and less working capital (excluding financial instrument assets or liabilities).

(6) Operating income is not defined by GAAP and thus is referred to as a non-GAAP measure; other entities may calculate operating income differently than Monterey. Operating income, is described in the Corporation's management discussion and analysis, and is calculated by deducting the sum of royalty, operating and transportation expenses from production revenue and gains or losses from financial instruments.

(7) Excludes capitalized general & administrative expenditures and stock-based compensation expense.

Forward Looking Statements & Advisories

This press release contains forward-looking statements, including but not limited to, statements concerning the amount and on-stream timing of new production, the performance characteristics of production from Monterey's developed oil and gas properties, drilling locations, approval and timing of applications and requests made to regulatory authorities, the access to and availability of production facilities, the timing of construction and start-up of new production facilities, certain expected actions to be performed and completed by industry partners, anticipated market prices received by Monterey for its production, the amount of future net revenues from the sale of crude oil and natural gas reserves, expectations regarding the ability to continually add to reserves through acquisitions exploration and development activities, projections and costs and expenses, crude oil and natural gas production levels, Monterey's continued access to existing credit facilities, future operating and financial results, expectations regarding operating costs, anticipated interest and foreign exchange rates, supply and demand for crude oil and natural gas, average royalty rates, availability of tax pools and amount of general and administrative expenses. Additionally, the use of any of the words "anticipate", "continue", "estimate", "expect", "forecast", "future", "may", "will", "project", "should", "believe" and similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, certain of which are beyond the Corporation's control, including the impact of general economic conditions; volatility in market prices for crude oil and natural gas; industry conditions; volatility of commodity prices; currency fluctuation; imprecision of reserve estimates;
liabilities inherent in crude oil and natural gas operations; environmental risks; incorrect assessments of the value of acquisitions and exploration and development programs; competition from other producers; the lack of availability of qualified personnel or management; changes in income tax laws or changes in tax laws and incentive programs relating to the oil and gas industry; hazards such as fire, explosion, blowouts, cratering, and spills, each of which could result in substantial damage to wells, production facilities, other property and the environment or in personal injury; stock market volatility; and ability to access sufficient capital from internal and external sources. As a consequence, Monterey's actual results may differ materially from those expressed in, or implied by, the forward-looking statements. Although Monterey believes that the expectations reflected in such forward-looking statements or information are reasonable, undue reliance should not be placed on forward-looking statements as the Corporation can give no assurance that such expectations will prove to be correct. Actual results may differ materially from those expressed or implied in any forward-looking statements made by, or on behalf of, Monterey. In addition to other factors and assumptions which may be identified in this press release and other documents filed by the Corporation, assumptions have been made regarding, among other things: the impact of increasing competition; the general stability of the economic and political environment in which Monterey operates; the ability of the Corporation to obtain qualified staff, equipment and services in a timely and cost efficient manner; drilling results; the ability of the operator of the projects which the Corporation has an interest in to operate the field in a safe, efficient and effective manner; Monterey's ability to obtain financing on acceptable terms; field production rates and decline rates; the ability to replace and expand oil and natural gas reserves through acquisition, development or exploration; the timing and costs of pipeline, storage and facility construction and expansion; the ability of the Corporation to secure adequate product transportation; future oil and natural gas prices; currency, exchange and interest rates; the regulatory framework regarding royalties, taxes and environmental matters in the jurisdictions in which the Corporation operates; and Monterey's ability to successfully market its oil and natural gas products. Readers are cautioned that the foregoing list of factors is not exhaustive. Forward-looking statements contained in this press release are made as at the date of this press and Monterey disclaims any intent or obligation to update publicly or to revise any of the included forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by applicable securities laws.

However, in the event that subsequent events are reasonably likely to cause actual results to differ materially from material forward-looking statements or information previously disclosed by Monterey for a period that is not yet complete, Monterey will provide disclosure on such events and the anticipated impact of such events.

Discovered Petroleum Initially in Place

This press release contains references to estimates of gas classified as Discovered Petroleum initially in Place ("DPIP") in the Corporation's Groundbirch area in British Columbia which are not, and should not be confused with oil and gas reserves. "Discovered Petroleum Initially in Place" is defined in the COGE Handbook as the quantity of hydrocarbons that are estimated, as of a given date, to be contained in known accumulations. DPIP is divided into recoverable and unrecoverable portions, with the estimated future recoverable portion classified as reserves and contingent resources. There is no certainty that it will be commercially viable to produce any portion of this DPIP. Resources do not constitute, and should not be confused with, reserves.

BOE Disclosure

Disclosure provided herein in respect of barrels of oil equivalent (boe) may be misleading, particularly if used in isolation. A boe conversion ratio of 6 Mcf: 1 boe is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

Non-GAAP Measures

Within this press release, references are made to terms commonly used in the oil and gas industry. Management uses funds flow from operations, operating income and capital expenditures to analyze operating performance. These measures do not have standardized meanings prescribed by GAAP, and may not be comparable to similar measures presented by other companies. For this press release the measures used are: (i) Funds flow from operations is determined by using cash flow from operations before changes in non-cash operating working capital and asset retirement expenditures; (ii) Operating income is calculated by deducting royalties, operating costs and transportation costs from sales revenues and hedging gains / (losses); (iii) Total capital expenditures is equal to capital expenditures plus the recorded cost of oil and gas properties of corporate acquisitions, including the costs of the acquisition and the allocation to long lived asset retirement; (iv) Funds flow per basic and funds flow per diluted share is calculated by dividing funds flow as described earlier, by the total number of respective weighted average basic and diluted common shares outstanding during the period; (v) Net debt is equal to total bank indebtedness plus capital lease obligations less/(plus) non-cash working capital/(deficit); and (vi) fully diluted share figures are calculated by adding the number of common shares underlying the outstanding stock options to the number of common shares outstanding (i.e. basic outstanding common shares) at the respective date. For additional information concerning Monterey's use of non-GAAP measures and reconciliations to the applicable GAAP measures, please see Monterey's management's discussion and analysis for the three months ended March 31, 2009 available at www.sedar.com.

MANAGEMENT'S DISCUSSION AND ANALYSIS

This Management's Discussion and Analysis ("MD&A") should be read in conjunction with Monterey's unaudited interim Financial Statements for the three months ended March 31, 2009 and audited Financial Statements and notes thereto for the year ended December 31, 2008. The Financial Statements have been prepared in Canadian dollars and in accordance with Canadian generally accepted accounting principles ("GAAP").

This MD&A contains forward-looking statements, non-GAAP measures, and disclosures of barrels of oil equivalent volumes. Readers are referred to the advisories concerning forward-looking statements, non-GAAP measures, and barrels of oil equivalent conversions contained under the heading "Forward Looking Statements & Advisories".

Additional information regarding Monterey Exploration Ltd. such as the audited Financial Statements, Annual Information Form and other disclosure documents can be found on SEDAR at www.sedar.com or on the Corporation's website www.montereyexploration.com.

This MD&A is dated May 14, 2009.

Monterey Exploration Ltd. ("Monterey" or the "Corporation") is continued under the Business Corporations Act (Alberta) and is engaged in the acquisition, exploration, development and production of natural gas, natural gas liquids and crude oil in the Western Canadian Sedimentary Basin.

FORWARD LOOKING STATEMENTS & ADVISORIES

Certain information regarding Monterey set forth in this MD&A, including but not limited to Management's expectations regarding the timing of its IFRS change over plans, expectations regarding its financial capabilities, continued availability of debt financing, expectations regarding tax pool expiries, expectations concerning future funds flow from operations, future exploration and development activities, planned capital expenditures, treatment under royalty regimes, plans regarding the development of the Corporation's project inventory and expectations relating to production levels and forecast production may constitute forward-looking statements under applicable securities laws and regulations involve substantial known and unknown risks and uncertainties. The use of any of the words "anticipate", "continue", "estimate", "expect", "may", "will", "project", "should", "believe" and similar expressions are intended to identify forward-looking statements. Such statements represent Monterey's internal projections, estimates or beliefs concerning, among other things, an outlook on the estimated amounts and timing of capital expenditures, anticipated future debt, revenues or other expectations, beliefs, plans, objectives, assumptions, intentions or statements about future events or performance. These statements are only predictions and actual events or results may differ materially. In addition, statements relating to "reserves" or "resources" are deemed to be forward looking statements, as they involve the implied assessment, based on certain estimates and assumptions, that the resources and reserves described can be profitably produced in the future. Although Monterey believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievement since such expectations are inherently subject to significant business, economic, competitive, political and social uncertainties and contingencies. Many factors could cause Monterey's actual results to differ materially from those expressed or implied in any forward-looking statements made by, or on behalf of, Monterey.

The forward-looking statements included in this MD&A also include, but are not limited to, statements with respect to the size of, and future net revenues from, crude oil and natural gas reserves; the focus of capital expenditures; expectations regarding the ability to raise capital and to continually add to reserves through acquisitions and development; projections of market prices and costs; the performance characteristics of Monterey's crude oil and natural gas properties; crude oil and natural gas production levels; Monterey's future operating and financial results; expectations regarding Monterey's capital expenditure programs; supply and demand for crude oil and natural gas; average royalty rates; development drilling; amount of general and administrative expenses; treatment under governmental regulatory regimes and tax laws; the risk of non-capital losses expiring unutilized; and expectations regarding operating costs.

These forward-looking statements are subject to numerous risks and uncertainties, certain of which are beyond the Corporation's control, including the impact of general economic conditions; volatility in market prices for crude oil and natural gas; industry conditions; volatility of commodity prices; currency fluctuation; imprecision of reserve estimates; liabilities inherent in crude oil and natural gas operations; environmental risks; incorrect assessments of the value of acquisitions and exploration and development programs; competition from other producers; the lack of availability of qualified personnel or management; changes in income tax laws or changes in tax laws and incentive programs relating to the oil and gas industry; hazards such as fire, explosion, blowouts, cratering, and spills, each of which could result in substantial damage to wells, production facilities, other property and the environment or in personal injury; stock market volatility; and ability to access sufficient capital from internal and external sources.

With respect to forward-looking statements contained in this MD&A, Monterey has made assumptions regarding: the success of exploration and development activities, the impact of increasing competition; the general stability of the economic and political environment in which Monterey operates; the ability of the Corporation to obtain qualified staff, equipment and services in a timely and cost efficient manner; drilling results; the ability of the operator of the projects which the Corporation has an interest in to operate the field in a safe, efficient and effective manner; Monterey's ability to obtain financing on acceptable terms; field production rates and decline rates; the ability to replace and expand oil and natural gas reserves through acquisition, development or exploration; the timing and costs of pipeline, storage and facility construction and expansion; the ability of the Corporation to secure adequate product transportation; future oil and natural gas prices; currency, exchange and interest rates; the regulatory framework regarding royalties, taxes and environmental matters in the jurisdictions in which the Corporation operates; and Monterey's ability to successfully market its oil and natural gas products.

Management has included the above summary of assumptions and risks related to forward-looking information provided in this MD&A in order to provide readers with a more complete perspective on Monterey's future operations and such information may not be appropriate for other purposes. Monterey's actual results, performance or achievement could differ materially from those expressed in, or implied by, these forward-looking statements and, accordingly, no assurance can be given that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what benefits that Monterey will derive there from. Readers are cautioned that the foregoing lists of factors are not exhaustive. These forward-looking statements are made as of the date of this MD&A and Monterey disclaims any intent or obligation to update publicly any forward-looking statements, whether as a result of new information, future events or results or otherwise, other than as required by applicable securities laws.

However, in the event that subsequent events are reasonably likely to cause actual results to differ materially from material forward-looking statements or information previously disclosed by Monterey for a period that is not yet complete, Monterey will provide disclosure on such events and the anticipated impact of such events.

The reporting and measurement currency is the Canadian dollar. For the purpose of calculating unit costs, natural gas is converted to a barrel of oil equivalent ("boe"), which may be misleading if used in isolation. A boe conversion ratio of six thousand cubic feet of natural gas equal to one barrel of oil equivalent is used by Monterey and is based on an energy equivalency method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

Please note that certain tables presented in this MD&A may not add due to rounding.

NON-GAAP MEASURES

Within this MD&A, references are made to terms commonly used in the oil and gas industry. Management uses funds flow from operations, operating income, capital expenditures and net debt to analyze operating performance. These measures do not have standardized meanings prescribed by GAAP, and may not be comparable to similar measures presented by other companies. For this MD&A the measures used are: (i) Funds flow from operations; (ii) Operating income; (iii) Capital expenditures; (iv) Total capital expenditures (v) Funds flow from operations per basic and funds flow from operations per diluted share is calculated by dividing funds flow from operations as described earlier, by the total number of respective weighted average basic and diluted common shares outstanding during the period; (vi) Net debt; (vii) Net current surplus (deficiency); and (viii) Estimated forward cash flow being funds flow from operations for a particular month adjusted for one time or extraordinary items which is then annualized. This non-GAAP measure provides a quick and reasonably accurate estimate, under current business conditions, of the funds flow from operations for the next twelve months.

The following tables reconcile the non-GAAP measures used in this Management Discussion and Analysis to the most directly comparable measure calculated in accordance with GAAP:



Funds flow from operations
---------------------------
Three months Three months Three months
ended Mar 31, ended Dec 31, ended Mar 31,
($000's) 2009 2008 2008
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Cash flow provided by (used in)
operating activities $ 2,032 $ 677 $ 3,276
Changes in non-cash working
capital 202 2,844 228
Asset retirement expenditures 386 173 43
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Funds flow from operations $ 2,620 $ 3,694 $ 3,547
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Funds flow from operations is an important measure to Management and investors because it provides a better indication of Monterey's internal funds generated from ongoing operations, versus cash flow provided by (used in) operating activities. Cash flow from (used in) operating activities takes into account the net change in non-cash working capital items and asset retirement expenditures which may vary significantly from one period to the next, are likely to be infrequently incurred or are not considered part of normal operations.



Operating income
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Three months Three months Three months
ended Mar 31, ended Dec 31, ended Mar 31,
($000's) 2009 2008 2008
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Net earnings (loss) $ (4,174) $ (2,110) $ 1,111
Add: Future income tax expense
(recovery) - 26 (1,731)
Add: Depreciation, depletion
and accretion 6,712 5,431 3,080
Add: Net interest expense 209 275 263
Add: General and administrative 691 569 578
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Operating income $ 3,438 $ 4,191 $ 3,301
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Management views operating income as an important measure of the Corporation's viability and contribution from the operation of its core business and is reflective of Monterey's gross margin.



Capital expenditures and Total capital expenditures
----------------------------------------------------
Three months Three months Three months
ended Mar 31, ended Dec 31, ended Mar 31,
($000's) 2009 2008 2008
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Cash flow used in investing
activities $ (2,246) $ 15,574 $ 8,008
Business combination
transaction costs - 140 -
Change in non-cash working
capital 428 (4,745) 4,578
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Capital expenditures $ (1,818) $ 10,969 $ 12,586
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Upper Lake business
combination costs - (69) -
Long lived asset retirement - - -
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Total capital expenditures $ (1,818) $ 10,900 $ 12,586
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Capital expenditures measure the net cash resources directed to exploring for and developing of oil and gas reserves along with the investment in office furniture and equipment to support Monterey's business activities. While total capital expenditures is comprised of capital expenditures plus the recorded cost of oil and gas properties of corporate acquisitions, including the costs of the acquisition and the allocation to long lived asset retirement. These measures are each considered by Management to be better measures than capital additions recorded under GAAP to determine the Corporation's success and efficiency in growing its reserves and reserve value.

Capital expenditures indicate the investment customarily incurred in the exploration and development activities and is readily comparable to other periods. The capital additions under GAAP include non-cash adjustments, such as long lived asset retirement costs, that impair Management's and the reader's ability to accurately assess Monterey's performance in respect of adding reserves organically and complemented with property acquisitions. Reserve growth from organic and property acquisitions activities represent the typical methods employed by the Corporation.

Total capital expenditures also includes the incremental costs incurred to increase Monterey's reserve base via business combinations. The total capital expenditures measure is provided in addition to capital expenditures as growth via corporate acquisition has historically been atypical of Monterey's activities. Total capital expenditures measure assists the reader to assess the Corporation's overall performance to increase its reserves.



Net debt
---------
As at As at As at
Mar 31, Dec 31, Mar 31,
($000's) 2009 2008 2008
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Bank indebtedness $ 31,052 $ 35,286 $ 18,227
Less: Current assets (3,900) (5,661) (4,821)
Add: Accounts payable and
accrued liabilities 6,540 8,075 10,695
Add: Obligation under capital
lease 180 224 -
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Net debt $ 33,872 $ 37,924 $ 24,101
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Net debt is an important measure as it provides a measure of the net obligations that can be reasonably expected to be settled with the Corporation's assets in the near term. Total liabilities under GAAP, also include asset retirement obligations as well as liabilities arising from financial instruments for which the timing of settlement with the Corporation's existing and future assets involve greater use of estimation and as a result the timing and amount expended to satisfy the obligation may be subject to significant variation.



Net current deficiency
-----------------------
As at As at As at
Mar 31, Dec 31, Mar 31,
($000's) 2009 2008 2008
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Current liabilities $ 37,772 $ 43,540 $ 29,913
Less: Current assets (3,900) (5,661) (4,821)
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Working capital deficit 33,872 37,879 25,092
Less: Current portion of bank
indebtedness (31,052) (35,286) (18,227)
Less: Current portion of obligation
under capital lease (180) (179) -
Less: Current portion of
financial instrument liabilities - - (991)
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Net current deficiency $ 2,640 $ 2,414 $ 5,874
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Net current deficiency is a key measure for the Corporation as it gives a measure of net working capital excluding unrealized financial instrument assets and liabilities. Unrealized financial instrument assets and liabilities for Monterey primarily consist of the estimated future settlement value of forward financial contracts which are not necessarily indicative of the actual net cash inflows or outflows at the settlement date of the financial instruments.

FREQUENTLY USED TERMS

In this document certain terms are used frequently. For instance, Monterey Exploration Ltd. is commonly referred to as either "Monterey" or the "Corporation" and barrels of oil equivalent are regularly noted with the term "boe".



Term or abbreviation
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"boe" Barrel(s) of oil equivalent
"mcf" Thousand cubic feet
"bbl" Barrel
"GJ" Gigajoule
"LIBOR" London Interbank Offered Rate
"m" preceding a volumetric measure 1,000 units of the volumetric measure
"mm" preceding a volumetric measure 1,000,000 units of the volumetric
measure
"NGL" Natural gas liquids
"NEBC" Northeast British Columbia
"Upper Lake Upper Lake Oil and Gas Ltd.


CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of the financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. In determining estimates required to prepare the Corporation's financial statements, management uses available information it considers to be reasonable under the circumstances. Readers are cautioned that actual results could differ from these estimates.

Other critical accounting estimates that affect Monterey's financial statements include:

Full Cost Accounting

Monterey follows the full cost method of accounting, whereby all costs associated with the exploration and development of oil and natural gas reserves are capitalized in cost centers on a country-by-country basis. Such costs include lease acquisition costs, geological and geophysical costs, carrying charges of non-producing properties, costs of drilling both productive and non-productive wells, the cost of petroleum and natural gas production equipment and overhead charges directly related to exploration and development activities. Gains or losses are not recognized upon the disposition of oil and natural gas properties unless crediting the proceeds against accumulated costs would result in a change in the rate of depletion by 20% or more.

Depletion and Depreciation

Costs capitalized under the full cost method of accounting, together with estimated future capital costs associated with proved reserves, are depreciated and depleted using the unit-of production method which is based on gross production and estimated proved oil and natural gas reserves as determined by independent reserve evaluators. The cost of unproven properties is excluded from the depreciation and depletion base. These unproven properties are assessed periodically to ascertain if impairment has occurred. When proved reserves are assigned or the property is considered impaired the costs of the property or the amount of the impairment is added to the costs subject to depletion. For purposes of the depletion and depreciation calculations, oil and natural gas reserves are converted to a common unit of measure on the basis of their relative energy content, being six thousand cubic feet of natural gas to one barrel of oil equivalent. Depreciation of office furniture and equipment is provided for over its useful lives using the declining balance method at a rate of 25%.

Ceiling Test

Oil and natural gas properties and equipment are evaluated at least annually at year-end to determine whether the carrying amount in a cost centre is recoverable and does not exceed the fair market value of the properties in the cost centre. The carrying amounts are assessed to be recoverable when the sum of the undiscounted funds flows expected from the properties and the cost of major development projects exceeds the carrying amount of the cost centre. When the carrying amount is not assessed to be recoverable, an impairment loss is recognized to the extent that the carrying amount of the cost centre exceeds the sum of the discounted funds flows expected from the production of proved plus probable reserves, the lower of cost and market of unproved properties and the cost of major development projects of the cost centre. The funds flows are estimated using expected future product prices and costs and are discounted using a risk-free interest rate.

Asset Retirement Obligations

Estimated costs associated with Monterey's asset retirement obligations are subject to uncertainty associated with the method, timing, and extent of future retirement activities. At March 31, 2009, Management's estimate of Monterey's total inflation adjusted, undiscounted, asset retirement liabilities was approximately $8.0 million.

Purchase Price Allocations

The cost of corporate and asset acquisitions are allocated to the acquired assets and liabilities based on their fair value at the time of acquisition. Management use assumptions and estimates in determining the fair values of assets acquired and liabilities assumed, which are inherently subjective. Purchase price allocations affect the Corporation's reported assets, liabilities and future net earnings.

Income Taxes

All tax filings are subject to subsequent government audit and potential reassessments. Accordingly, final income tax liabilities as assessed by the government may differ materially from amounts estimated and recorded by Monterey.

Financial Instruments

The determination of fair value of financial instruments often relies on the use of estimates and judgment based on the best quality of information that is available at the time. The ultimate value of consideration received or paid for the settlement of financial instruments in future periods may materially differ from those estimated fair values at the end of each reporting period.

Stock-based Compensation

Stock-based Compensation expense is determined with the use of estimates and information available at the date of an option's grant. The ultimate settlement of the underlying stock option through an option exercise or the expiry of the option depends on the value of the Corporation's future share price, and the number of option forfeitures at the maturity of an option grant.

ACCOUNTING PRONOUNCEMENTS AND ACCOUNTING POLICY CHANGES

During the first quarter of 2009, Monterey adopted CICA handbook section 3064, Goodwill and Intangible Assets. The handbook section applies to goodwill subsequent to initial recognition and establishes standards for the recognition, measurement and disclosure of goodwill and intangible assets. Adoption of the new disclosure requirement did not have an impact on the Corporation's financial statements or disclosure in the notes to the financial statements.

During the second quarter of 2008, the accounting standards board ("AcSB") has confirmed the date of changeover to international financial reporting standards ("IFRS") will be for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2011. Management has taken steps to educate its staff and reviewed its accounting systems to determine the differences between Canadian GAAP and IFRS. An implementation plan for the changeover from Canadian GAAP to IFRS will be prepared later in 2009. Changes in accounting policies are likely going to have a material impact on Monterey's financial statements; however Management is not able to quantify the impacts at this time.

INTERNAL CONTROLS REPORTING

Disclosure Controls and Procedures

The Chief Executive Officer and the Chief Financial Officer, together with other members of Management, have designed Monterey's disclosure controls and procedures to provide reasonable assurance that material information relating to the Corporation is disclosed in a timely manner and free from material misstatement. As at December 31, 2008, an evaluation of the effectiveness of Monterey's disclosure controls and procedures was conducted in accordance with Multilateral Instrument 52-109, Certification of Disclosure in Issuers' Annual Financial and Interim Filings, based on that evaluation, the Chief executive Officer and the Chief Financial Officer concluded that the design and operation of Monterey's disclosure controls and procedures were effective as at December 31, 2008.

In March 2009, subsequent to the Corporation's filing of its Annual Information Form ("AIF") for the year ended December 31, 2008 it was determined that certain reserve information contained in the AIF was inconsistent with the form requirements. Upon discovery of these errors the AIF was corrected and a revised AIF was filed. As a result of this event the Chief Executive Officer and Chief Financial Officer determined that the individuals involved were fully educated as to the data required to be disclosed in the AIF. In addition, where data is associated with an independent external party Monterey will not consider the disclosure material to be complete until a written consent from the independent external party is received permitting the disclosure of the information in a public document.

Internal Controls over Financial Reporting

Also in accordance with Multilateral Instrument 52-109, the Chief Executive Officer and Chief Financial Officer of Monterey are responsible for establishing and maintaining adequate internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Canadian generally accepted accounting principles. The Chief Executive Officer and Chief Financial Officer directed the assessment of the design and operating effectiveness of Monterey's internal controls over financial reporting as at December 31, 2008 and based on that assessment determined that the Corporation's internal control over financial reporting was, in all material respects, appropriately designed and operated effectively.

During the three months ended March 31, 2009, there have been no material changes in the design or operation of the Corporation's internal controls over financial reporting.

Summary

Due to inherent limitations of a control system, including the Corporation's disclosure controls and procedures and internal controls over financial reporting, no matter how well conceived or operated may not prevent or detect misstatements, errors or fraud and can only provide reasonable assurance that the objectives of the control system are met.

RISKS & UNCERTAINTIES

Some of the risks that Monterey is exposed to which impact Management's ability to execute the Corporation's business plan include but are not limited to:

- Exploration, development and production activities

Monterey's success depends upon its ability to find, secure rights, acquire, develop and commercially produce oil and natural gas reserves. Risks associated with the exploration, finding and development and production of oil and gas reserves is impacted by: attracting, hiring and retaining knowledgeable and experienced staff; competition for prospective land for exploration and development activities; geological and operational risks; application of changing or new technologies, imprecision of reserve estimates and valuation; timely receipt of required regulatory approvals; ability to secure or obtain equipment, services and supplies when needed; weather; field operating risks; and existence and ability to access production infrastructure to deliver production to market.

Management attempts to manage and overcome these risks by careful addition of staff, early identification and evaluation of opportunities; careful planning of operations and development of contingency plans; developing continuing relationships with reliable suppliers of services, equipment and supplies; and carrying appropriate levels of insurance.

- Global financial crisis

During 2008 market conditions and events led to significant disruptions of international credit markets and the overall deterioration of worldwide economic conditions leading to increased volatility in markets (including financial and product markets), reduced liquidity, widening of corporate spreads, increased credit losses and tightening of credit conditions. Governments throughout the world have been required to intervene in preventing the collapse of banks, insurers and financial institutions. These conditions have impacted Monterey due to continued volatility of commodity prices, currency exchange, interest rates, access to and the amount of debt and equity financing available, and the Corporation's valuations (stock market trading price and net asset value) have been negatively impacted.

Management has attempted to mitigate the impacts of the global recession and uncertain credit markets by disposing of a non-core property to reduce debt, reducing the size of the capital expenditure program to approximate funds flow from operations, fixing the cost of debt through the issue of guaranteed notes and entering into a new credit facility that allows Monterey to continue to access up to $45 million in borrowings from the lender. Under the new credit facility the term of the facility has been increased from May 31, 2009 until the lender's next review which is scheduled to be completed prior to June 1, 2010.

- Capital requirements

The Corporation's core business requires sufficient funds for the future acquisition, exploration, development and production of oil and natural gas reserves. Economic conditions, such as the current worldwide recession can cause significant volatility of commodity prices meaning that internal generation of funds or reasonable return of investment is uncertain. In addition the global credit crisis can result in a reduction in the access to, timing, amount and cost of debt thus making Monterey's ability to conduct or complete exploration and development activities more difficult.

Management ensures that projects are adequately evaluated to estimate viability under challenging economic conditions. In addition development of capital spending plans are carefully prepared and are subject to ongoing review to ensure that sufficient financial resources are available and that projects will earn a positive return on investment. Management manages the components of its balance sheet, remains apprised of developments in the equity markets and changes in the current and forecasted commodity prices to maintain financial flexibility so that the business plans can be carried out.

- Third party credit risk

Monterey may be exposed to third party credit risk through its contractual arrangements with joint venture partners, purchasers of production and other parties. During challenging economic periods the Corporation's access of funds needed to finance the ongoing business or settle obligations due may be impacted by an increase in the amount of time required to collect or the lack of collectability of accounts receivables.

Management mitigates this risk by entering into joint ventures or sell production to a diverse portfolio of entities that have sufficient capital resources and an established record of paying obligations when due. The Corporation monitors the amount and aging of accounts receivable to improve collectability and when necessary issues cash calls to collect payment in advance from a partner for its share of a project.

- Climate change

The determination of the impact of climate change is currently unknown and cannot be reasonably estimated. Physical access to opportunities and timing to conduct operations could change or become more costly. Potential new laws or regulatory requirements to control greenhouse gases or other emissions may increase the cost and the method of conducting exploration, development, production and processing oil and gas. Lastly new taxes, tariffs, penalties or costs to acquire offsetting credits as a result of finding, developing, producing, transporting and selling oil and gas may also impair the commercial viability of Monterey's activities or the oil and gas industry overall.

Management continues to monitor developments in this evolving area. Methods to be used to mitigate the risks associated with climate change include: education to understand the impact of physical changes in the environment on Monterey's operations and new and changes to laws or regulatory requirements, and careful planning to determine cost effective means to perform Monterey's exploration, development and production activities and ensure compliance with laws and regulations.

- Changes in laws and regulations

On October 25, 2007 the Government of Alberta released the New Royalty Framework ("NRF") outlining revisions to its crown royalty program that became effective on January 1, 2009. To mitigate the impact of unintended consequences resulting for the NRF the Government of Alberta has introduced a number of programs, including: (i) In April 2008, the Government of Alberta announced a new program to support exploration and development of deep oil and gas reserves that would be uneconomic under the NRF. The incentives associated with the new program applies to oil exploration wells and natural gas wells having depths greater than 2,000 meters and 2,500 meters, respectively; (ii) on November 19, 2008 the Government of Alberta introduced a five-year transitional royalty program to promote new drilling. Companies that drill new conventional oil or natural gas wells between the depths of 1,000 and 3,500 meters, will be granted a one-time option per well to adopt the new transitional rates or those outlined in the NRF. The transitional royalty rates for conventional oil will range from 10 percent to 39 percent, and transitional royalty rates for conventional gas will range from five percent to 30 percent. These transitional rates have lower maximum royalty rates in comparison to royalty rates under the NRF which range from zero to 50 percent on oil production and five percent to 50 percent for natural gas production; and (iii) on March 3, 2009, the Government of Alberta announced a three-point incentive program to stimulate new and continued economic activity in Alberta which included a drilling royalty credit for new conventional oil and natural gas wells and a new royalty incentive program. Under the drilling royalty credit program a $200 per meter royalty credit will be available on new conventional oil and gas wells drilled between April 1, 2009 and March 31, 2010. The new well incentive program will apply to wells beginning production of conventional oil and natural gas between April 1, 2009 and March 31, 2010 and provides for a maximum 5% royalty rate for the first 12 months of production, up to a maximum of 50,000 barrels of oil or 500 mmcf of natural gas.

The majority of Monterey's production is from properties located in the province of British Columbia; as such the changes outlined above will only have a nominal impact on Monterey's current operations. Approximately 19 percent of the Corporation's production is from wells located in the province of Alberta; furthermore Monterey's Alberta production is largely from low productivity and shallow depth wells. Nonetheless the Corporation's ability to attract investment capital for future investment in Alberta may be impacted by the negative effect the NRF will have on the economics of capital projects located in the province of Alberta.

In February 2009 the Government of British Columbia announced changes to the Deep Royalty Program under which royalty credits can be earned as a result of the vertical depth or the length of the horizontal leg of new drills. Royalties earned by the drilling of a well are applied against the crown royalties on production from the well. The changes announced have favorably adjusted the factor applied to calculating the royalty earned as a result of the length of the horizontal well. These changes will improve the economic viability of future horizontal wells to be drilled by Monterey in the Brassey and Groundbirch areas of NEBC.

SIGNIFICANT EVENTS

During the first quarter of 2009, the following items had a significant impact on either the current or future operations of the Corporation:

- Drilled and cased Monterey's first exploratory test well at Groundbirch targeting the Montney gas formation and resulted in the Corporation earning a 75 percent working interest in an additional 10 (7.5 net) sections of contiguous undeveloped land. The Corporation's total landholdings at Groundbirch now consist of 15 (12.5 net) sections.

- Average daily production for the first quarter of 2,451 barrels of oil equivalent per day ("boe/d"), a 71 percent increase compared with 1,435 boe/d during the comparative quarter in 2008.

- Renewed the Corporation's credit facility, whereby total funds available under the credit facility remain unchanged at $45 million. The next review of the credit facility by the lender is scheduled to be completed prior to June 2010.

- Generated quarterly funds flow from operations of $2.6 million, versus $3.5 million of funds flow from operations generated in the first quarter of 2008. First quarter funds flow from operations per diluted share was $0.08 for the first quarter of 2009 and $0.14 during the first quarter of 2008.

- Completed the disposition of 1.4 net sections of undeveloped non-core Montney lands and one non-producing well at Dawson on January 29, 2009 for net proceeds of $6.0 million.



SUMMARY OF FINANCIAL AND OPERATING RESULTS

In $000's unless referring to
volumetric measures or Three months Three months Three months
otherwise noted ended ended ended
(unaudited) Mar 31, 2009 Dec 31, 2008 Mar 31, 2008
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Average sales volumes:
Natural gas (mcf/d) 11,939 10,058 7,168
Oil and NGLs (bbl/d) 461 453 241
----------------------------------------------------------------------------
Oil equivalent (boe/d) 2,451 2,130 1,435
----------------------------------------------------------------------------
Average sales prices:
Natural gas ($/mcf) (1) $ 5.59 $ 7.35 $ 7.09
Oil and NGLs ($/bbl) $ 37.84 $ 51.78 $ 83.07
----------------------------------------------------------------------------
Oil equivalent ($/boe) (1) $ 34.52 $ 45.75 $ 49.34
----------------------------------------------------------------------------
Financial:
Production revenue (1) $ 7,614 $ 8,965 $ 6,444
Operating income $ 3,438 $ 4,191 $ 3,301
Funds flow from operations $ 2,620 $ 3,694 $ 3,547
Net earnings (loss) $ (4,174) $ (2,110) $ 1,111
Total capital expenditures
(net of disposition proceeds) $ (1,818) $ 10,900 $ 12,586
Per Share:
Funds flow from operations per
share:
Basic and diluted $ 0.08 $ 0.11 $ 0.14
Net earnings (loss) per share:
Basic and diluted $ (0.13) $ (0.06) $ 0.04
Financial Position:
Net debt (surplus) $ 33,872 $ 37,924 $ 24,101
Total assets $ 137,060 $ 147,119 $ 101,970
Total long-term liabilities $ 4,274 $ 4,516 $ 2,486
Shareholders' equity $ 95,014 $ 99,063 $ 69,571
Share data:
Outstanding:
Common shares 32,902,500 32,902,500 20,045,700
Non-voting shares - - 5,061,096
----------------------------------------------------------------------------
Total outstanding 32,902,500 32,902,500 25,106,796
Stock options 3,135,666 3,135,666 2,150,666
----------------------------------------------------------------------------
Total diluted shares outstanding 36,038,166 36,038,166 27,257,462
----------------------------------------------------------------------------
Weighted average:
Basic 32,902,500 32,902,500 25,058,218
Diluted 32,932,759 32,904,058 25,254,541
----------------------------------------------------------------------------
----------------------------------------------------------------------------

(1) Includes processing and marketing revenue and gains / losses on
financial instruments.


FIRST QUARTER 2009 VERSUS FOURTH QUARTER 2008

Three months Three months
ended Mar 31, ended Dec 31, Percentage
2009 2008 Change
----------------------------------------------------------------------------
Average sales volumes:
Natural gas (mcf/d) 11,939 10,058 19
Oil and NGLs (bbl/d) 461 453 2
----------------------------------------------------------------------------
Oil equivalent (boe/d) 2,451 2,130 15
----------------------------------------------------------------------------

Average sales prices:
Natural gas ($/mcf) 5.59 7.35 (24)
Oil and NGLs ($/bbl) 37.84 51.78 (27)
----------------------------------------------------------------------------
Oil equivalent ($/boe) 34.52 45.75 (25)
----------------------------------------------------------------------------


Sales Volumes

For the three months ended March 31, 2009, Monterey's average daily production was 2,451 boe/d, which is 15 percent higher than the 2,130 boe/d average daily production for the fourth quarter of 2008. The positive volume variance reflects the impact of new Brassey production placed on-stream in the midst of the fourth quarter of 2008, volumes regained as a result of the December 2008 settlement of a labour strike at a major gas third party operated processing facility in NEBC and new wells drilled in 2008 in the Ferrybank and Smoky areas of Alberta were placed on production during early 2009.

Realized Prices

Monterey's average realized natural gas price during the first quarter of 2009 was $5.59 per mcf, a decrease of 24 percent relative to the Corporation's average realized natural gas price per mcf of $7.35 during the fourth quarter of 2008. Monterey's average realized liquids price for the first quarter of 2008 decreased by 27 percent when compared to the fourth quarter.

The decrease in Monterey's average sales prices for natural gas and liquids during the first quarter is a reflection of lower commodity prices due to changes in the demand-supply balance as a result of the current global recession.

Royalties

During the first quarter, the Corporation had an average royalty cost per boe of $5.53. In comparison to the fourth quarter of 2008, the Corporation had an average royalty cost per boe of $7.98. The decrease in royalty costs per boe over the fourth quarter of 2008 was due to lower average realized commodity prices during the first quarter. In addition to lower average realized commodity prices, the application of deep drilling royalty credits, earned by Monterey as a result of drilling activities during the fourth quarter of 2008 at Brassey in British Columbia, contributed towards the Corporation's reduction in royalties in 2009. As a percentage of Monterey's first quarter production revenue, the Corporation's average royalty rate decreased to 16 percent of production revenue in the first quarter from 17 percent in the fourth quarter.

Operating Costs

Relative to the fourth quarter of 2008, operating costs per boe decreased to $11.54 from $14.61 per boe. The primary reasons for the favorable variance during the first quarter of 2009 are the combination of the impact of new production having a lower unit of production operating expense and that the majority of the incremental operating expenses associated with winter operating conditions, such as construction of ice roads, mechanical equipment repairs and thawing of frozen hydrates, are primarily incurred during the fourth quarter.

Transportation Costs

Transportation costs during the first quarter of 2009 increased in relation to the fourth quarter of 2008 due to increased production volumes. On a per boe basis, the unit transportation cost for the first quarter of $1.85 per boe is nominally higher than Monterey's transportation cost per boe of $1.78 during the fourth quarter of 2008.

Operating Income

During the first quarter of 2009, Monterey's average realized operating income per boe decreased to $15.60, from $21.38 during the fourth quarter of 2008, a decrease of approximately 27 percent. The decrease in commodity prices accounts for the majority of the reduction in 2009 operating income when compared to the fourth quarter of 2008.



Change due to:
-------------------------
Three months Three months
ended Mar 31, ended Dec 31,
($000's) 2009 Price/Cost Volume 2008
----------------------------------------------------------------------------
Operating Income:
Production revenue
Natural gas sales $ 6,043 (1,859) 1,097 $ 6,805
Oil and NGLs sales 1,571 (579) (10) 2,160
----------------------------------------------------------------------------

7,614 (2,438) 1,087 8,965

Royalties 1,220 (540) 197 1,563
Operating costs 2,547 (677) 361 2,863
Transportation costs 409 17 44 348
----------------------------------------------------------------------------

Operating income $ 3,438 (1,238) 485 $ 4,191
----------------------------------------------------------------------------
$/boe $ 15.60 $ 21.38
----------------------------------------------------------------------------


Depletion, Depreciation and Accretion ("DD&A")

Three months Three months
ended Mar 31, ended Dec 31,
(in $000's except per boe amounts) 2009 2008
----------------------------------------------------------------------------
Oil and gas properties $ 6,509 $ 5,274
Office equipment 18 32
Asset retirement accretion 185 125
----------------------------------------------------------------------------
$ 6,712 $ 5,431
----------------------------------------------------------------------------
$/boe $ 30.43 $ 27.72
----------------------------------------------------------------------------


DD&A expense for the first quarter of 2009 increased by approximately $1.3 million over the previous quarter. The increase in total DD&A expense was a result of higher production volumes. The increase in DD&A per boe reflects the disposal of the Corporation's Dawson property, which had a lower average cost per proved reserve in relation to Monterey's corporate average, as well as the impact of capital expenditures incurred in respect of the Corporation's exploratory test well at Groundbirch. The Groundbirch well has not yet been completed and as such Monterey has not recognized proved reserves associated with the well.

General & Administrative ("G&A")

Total G&A, including stock-based compensation expense, costs for the first quarter of 2009 are marginally lower than costs incurred during the fourth quarter of 2008. On a per boe basis, G&A expenses decreased by $0.64 due to the benefit of increased economies of scale associated with the increase in production volumes realized without increasing general and administrative costs.

The combination of expensed and capitalized G&A expenses, excluding stock-based compensation expenses, in the first quarter of 2009 increased to $0.9 million or about 10 percent more than the fourth quarter of 2008. The increased costs in 2009 reflect incremental costs of being a public entity. Total, expensed plus capitalized, stock-based compensation costs in the first quarter of 2009 fell by about 43 percent relative to the fourth quarter of 2008. The decrease in stock-based compensation costs is explained by the method of recognizing the valuation of stock options granted, approximately 41 percent of the value of all the Monterey stock option grants were fully recognized by the end of the fourth quarter of 2008.



Three Months Three Months
ended Mar 31, ended Dec 31,
(in $000's except per boe amounts) 2009 2008
----------------------------------------------------------------------------
Expensed G&A:
General and administrative expenses $ 609 $ 433
Stock-based compensation 82 136
----------------------------------------------------------------------------
Total expensed G&A $ 691 $ 569
----------------------------------------------------------------------------
$/boe $ 3.13 $ 2.90
----------------------------------------------------------------------------
Capitalized G&A:
General and administrative expenses $ 247 $ 344
Stock-based compensation and income tax adjustment 44 85
----------------------------------------------------------------------------
Total capitalized G&A $ 291 $ 429
----------------------------------------------------------------------------
$/boe $ 1.32 $ 2.19
----------------------------------------------------------------------------

Total G&A costs $ 982 $ 998
----------------------------------------------------------------------------
$/boe $ 4.45 $ 5.09
----------------------------------------------------------------------------


The capitalized general and administrative costs include both general and administrative cash expenditures and non-cash stock-based compensation associated with exploration and development activities. The table below provides additional disclosure of the components of capitalized general and administrative costs.



Three Months Three Months
ended Mar 31, ended Dec 31,
(in $000's) 2009 2008
----------------------------------------------------------------------------
Salaries and employment costs $ 197 $ 294
Office rent 48 48
Other general and administrative costs 2 2
----------------------------------------------------------------------------
Capitalized cash general and administrative costs $ 247 $ 344
----------------------------------------------------------------------------
Capitalized stock-based compensation 44 85
----------------------------------------------------------------------------
Capitalized non-cash costs $ 44 $ 85
----------------------------------------------------------------------------

Total capitalized general and administrative costs $ 291 $ 429
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Interest
Three Months Three Months
ended Mar 31, ended Dec 31,
(in $000's except per boe amounts) 2009 2008
----------------------------------------------------------------------------
Interest expense $ 217 $ 276
Interest income (8) -
----------------------------------------------------------------------------
Net interest expense $ 209 $ 276
----------------------------------------------------------------------------
$/boe $ 0.95 $ 1.40
----------------------------------------------------------------------------


The 24 percent decrease in the first quarter's net interest expense, relative to the fourth quarter of 2008 is the net result of reduction in bank debt accompanied by falling interest rates. The decrease in interest expense per boe from $1.40 during the fourth quarter of 2008 is mainly due to both lower overall interest expense and incremental production volumes as discussed above.



FUNDS FLOW FROM OPERATIONS
Three months Three months
ended Mar 31, ended Dec 31,
(in $000's except per boe amounts) 2009 2008
----------------------------------------------------------------------------
Operating income $ 3,438 $ 4,191
Unrealized (gain) / loss on financial instruments - 212
General and administrative expenses (1) (609) (433)
Net interest expense (209) (276)
----------------------------------------------------------------------------
Funds flow from operations $ 2,620 $ 3,694
----------------------------------------------------------------------------

Operating income per boe $ 15.60 $ 21.38
Unrealized (gain) / loss on financial instruments - 1.08
General and administrative expenses (1) (2.76) (2.21)
Net interest expense (0.95) (1.40)
----------------------------------------------------------------------------
Funds flow from operations per boe (2) $ 11.89 $ 18.85
----------------------------------------------------------------------------

(1) Excluding stock-based compensation.
(2) Funds flow from operations per boe is funds flow from operations divided
by total boe production in the period.


Monterey's funds flow from operations for the first quarter decreased by approximately $1.1 million in comparison to the fourth quarter of 2008 as a result lower commodity prices being partially offset by higher sales volumes.

First quarter unit funds flow from operations of $11.89 per boe was about 37 percent less than the $18.85 per boe recorded in the fourth quarter. Increased sales volumes resulting from placing on-stream new production from successful exploration and development activities in the Smoky and Ferrybank areas of Alberta did not offset the impact of falling product prices.



FIRST QUARTER 2009 VERSUS FIRST QUARTER 2008

Three months ended
Mar 31, Mar 31, Percentage
2009 2008 Change
----------------------------------------------------------------------------
Average sales volumes:
Natural gas (Mcf/d) 11,939 7,168 67
Oil and NGLs (Bbl/d) 461 241 91
----------------------------------------------------------------------------
Oil equivalent (Boe/d) 2,451 1,435 71
----------------------------------------------------------------------------

Average sales prices:
Natural gas ($/Mcf) 5.59 8.61 (35)
Natural gas including financial instruments
($/Mcf) 5.59 7.09 (21)
Oil and NGLs ($/Bbl) 37.84 83.07 (54)
----------------------------------------------------------------------------
Oil equivalent ($/Boe) 34.52 56.92 (39)
Oil equivalent including financial instruments
($/Boe) 34.52 49.34 (30)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Sales Volumes

For the three months ended March 31, 2009, Monterey's average daily production was 2,451 boe per day, a 1,016 boe per day or 71 percent increase compared to the average daily production for the first quarter of 2008. The increase in production relative to the first quarter of 2008 represents production additions resulting from new production as a result of successful drilling operations conducted in 2008 in the Brassey, Squirrel, Laprise, Ferrybank and Smoky areas, production enhancements resulting from Monterey assuming operatorship of the Harmattan area oil unit and production acquired as a result of the August 31, 2008 acquisition of Upper Lake Oil & Gas Ltd. ("Upper Lake").

Realized Prices

Monterey's average natural gas price including financial instruments during the first quarter of 2009 was $5.59 per mcf, a decrease of 35 percent in relation to the average natural gas price during the comparative quarter in 2008. While Monterey's average realized liquids price decreased by 54 percent in comparison to the first quarter of 2008.

The decrease in the Corporation's average realized sales prices in 2009 is a reflection of lower commodity prices due to changes in the demand-supply balance as a result of the current global recession.

Royalties

Monterey's average royalty rate in the first quarter of 2009 of 16 percent of production revenue was one percent lower than the Corporation's average royalty rate of 17 percent recorded in 2008. The decrease in average realized commodity prices in the current quarter primarily led to the decrease in Monterey's average royalty rate.

Operating Costs

Relative to the first quarter of 2008, operating costs per boe decreased by $0.91 or nine percent during the current quarter to $11.54. The 2009 decrease is explained by optimization activities completed at Monterey's Harmattan area during the current quarter and the impact of new production having a lower unit of production operating expense than Monterey's existing base production.

Transportation Costs

Transportation costs of $1.85 per boe for the first quarter of 2009 increased by 11 percent from costs incurred during the first quarter of 2008. The increase is the result of new production volumes added from Monterey's Brassey area, which has higher transportation costs in relation to the Corporation's remaining base production.

Operating Income

On a per boe basis Monterey's average operating income for the first quarter of 2009 decreased by $9.67 per boe to $15.60, predominately due to decreases in the prices received for the Corporation's sales volumes over the comparative quarter of 2008.



Three months Three months
ended Mar 31, Change due to: ended Mar 31,
---------------------
($000's) 2009 Price/Cost Volume 2008
----------------------------------------------------------------------------
Operating Income:
Production revenue
Natural gas sales $ 6,043 (3,207) 3,635 $ 5,615
Oil and NGLs sales 1,571 (1,878) 1,629 1,820
Gain / (loss) from financial
instruments - 991 - (991)
----------------------------------------------------------------------------
7,614 (4,094) 5,264 6,444

Royalties 1,220 (974) 895 1,299
Operating costs 2,547 (199) 1,120 1,626
Transportation costs 409 41 150 218
----------------------------------------------------------------------------

Operating income $ 3,438 (2,962) 3,099 $ 3,301
----------------------------------------------------------------------------
$/boe $ 15.60 $ 25.27
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Depletion, Depreciation and Accretion Expense

Three months Three months
ended Mar 31, ended Mar 31,
(in $000's except per boe amounts) 2009 2008
----------------------------------------------------------------------------
Oil and gas properties $ 6,509 $ 2,993
Office equipment 18 9
Asset retirement accretion 185 78
----------------------------------------------------------------------------
$ 6,712 $ 3,080
----------------------------------------------------------------------------
$/boe $ 30.43 $ 23.58
----------------------------------------------------------------------------


In comparison to the three months ended March 31, 2008, the DD&A provision in 2009 increased 118 percent due to the combination of a 29 percent increase in the unit DD&A expense per boe and a 71 percent growth in production volumes. DD&A expense per boe increased by $6.85 as proved reserves added from 2008 exploration and development activities and acquired in the Upper Lake transaction had a higher average cost relative to Monterey existing total proved reserves. In addition, the disposition of Monterey's Dawson property had a lower average DD&A cost per boe relative to the majority of the Corporation's other properties and no proved reserve additions have yet been recognized for the 2009 first quarter drilling activities. In the first quarter the Corporation only drilled one well, a stratagraphic test well in the Groundbirch area. The Groundbirch well has not been completed and as such Monterey has not currently recognized proved reserves associated with the well.

General & Administrative

Total General and Administrative expense for the first quarter of 2009 was $0.1 million higher than total G&A expense for the same quarter during 2008. The increase is largely due to additional costs associated with Monterey being a public corporation in 2009. The average cost per boe for 2009 total G&A costs fell 35 percent to $4.45 per boe reflecting economies of scale as 2009 production grew 71 percent.

The combination of expensed and capitalized G&A expenses, excluding stock-based compensation expenses, in the first quarter of 2009 increased to $0.9 million or about 16 percent more than the first quarter of 2008. The sources of the increased costs in 2009 are office rental expenses and incremental costs of being a public entity. On the other hand total, expensed plus capitalized, stock-based compensation costs in the first quarter of 2009 fell by about 21 percent relative to the first quarter of 2008. The decrease in stock-based compensation costs is explained by the method of recognizing the valuation of stock options granted, approximately 41 percent of the value of all the Monterey stock option grants were fully recognized by the end of the fourth quarter of 2008.

The following table summarizes the G&A costs recorded for each of the first quarters of 2009 and 2008.



Three months Three months
ended Mar 31, ended Mar 31,
(in $000's except per boe amounts) 2009 2008
----------------------------------------------------------------------------
Expensed G&A:
General and administrative expenses $ 609 $ 481
Stock-based compensation 82 97
----------------------------------------------------------------------------
Total expensed G&A $ 691 $ 578
----------------------------------------------------------------------------
$/boe $ 3.13 $ 4.43
----------------------------------------------------------------------------
Capitalized G&A:
General and administrative expenses $ 247 $ 258
Stock-based compensation and income tax adjustment 44 62
----------------------------------------------------------------------------
Total capitalized G&A $ 291 $ 321
----------------------------------------------------------------------------
$/boe $ 1.32 $ 2.45
----------------------------------------------------------------------------

Total G&A costs $ 982 $ 899
----------------------------------------------------------------------------
$/boe $ 4.45 $ 6.88
----------------------------------------------------------------------------


The capitalized general and administrative costs include both general and administrative cash expenditures and non-cash stock-based compensation associated with exploration and development activities. The table below provides additional disclosure of the components of capitalized general and administrative costs.



Three months Three months
ended Mar 31, ended Mar 31,
(in $000's) 2009 2008
----------------------------------------------------------------------------
Salaries and employment costs $ 197 $ 189
Office rent 48 20
Other general and administrative costs 2 18
----------------------------------------------------------------------------
Capitalized cash general and administrative costs $ 247 $ 227
----------------------------------------------------------------------------
Capitalized stock-based compensation 44 131
----------------------------------------------------------------------------
Capitalized non-cash costs $ 44 $ 131
----------------------------------------------------------------------------

Total capitalized general and administrative costs $ 291 $ 358
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Interest
Three months Three months
ended Mar 31, ended Mar 31,
(in $000's except per boe amounts) 2009 2008
----------------------------------------------------------------------------
Interest expense $ 217 $ 266
Interest income (8) (3)
----------------------------------------------------------------------------
Net interest expense $ 209 $ 263
----------------------------------------------------------------------------
$/boe $ 0.95 $ 2.02
----------------------------------------------------------------------------


Despite increased bank debt in the first quarter of 2009 net interest expenses are lower than net interest expenses during the comparative quarter of 2008. The reduction in interest costs reflects lower interest rates and the absence of incremental interest charges arising from remaining flow through expenditure requirements. The economies of scale arising from Monterey's growth in production volumes reduced the Corporation's 2009 unit of production interest expense to $0.95 per boe approximately 53 percent less than recorded in the first quarter of 2008.



FUNDS FLOW FROM OPERATIONS

Three months ended
Mar 31, Mar 31,
(in $000's except per boe amounts) 2009 2008
----------------------------------------------------------------------------

Operating income $ 3,438 $ 3,301
Unrealized (gain)/loss on financial instruments - 991
General and administrative expenses (1) (609) (481)
Net interest expense (209) (264)
----------------------------------------------------------------------------
Funds flow from operations $ 2,620 $ 3,547
----------------------------------------------------------------------------

Operating income per boe $ 15.60 $ 25.27
Unrealized loss on financial instruments - 7.59
General and administrative expenses (1) (2.76) (3.68)
Net interest expense (0.95) (2.02)
----------------------------------------------------------------------------
Funds flow from operations per boe (2) $ 11.89 $ 27.16
----------------------------------------------------------------------------
(1) Excluding stock-based compensation.
(2) Funds flow from operations per boe is equal to funds flow from
operations divided by total boe production in the period.


The Corporation's funds flow from operations for the current quarter of $2.6 million was 26 percent lower than the $3.5 million reported during first quarter of 2008. The decrease was due to significantly lower commodity prices received for Monterey's sales volumes partially offset by the Corporation's 71 percent increase in average sales volumes.

On a per unit basis, funds flow from operations of $11.89 per boe is about a 56 percent reduction relative to the first quarter of 2008. Similar to the absolute dollar figures, the reduction in 2009 is explained by the lower commodity prices slightly tempered by the growth in production volumes.

INCOME TAXES

During the three months ended March 31, 2009 Monterey did not pay any cash taxes and currently does not anticipate the payment of any cash income taxes in the foreseeable future. At March 31, 2009 Monterey has tax pools totaling approximately $194.5 million available to be utilized against future taxable income. The tax pools include approximately $55.4 million in non-capital losses to reduce future taxable income, $58.0 million in Canadian exploration and development expenses, $48.0 million in oil and gas property expenses, $31.8 million in tangible expenses and $1.3 million of share issue costs.

In accordance with GAAP the financial statements do not reflect the full value of benefit of the tax pools. In order to recognize the value of the pools in the financial statements, the Corporation has to demonstrate consistent positive earnings before income taxes over an extended number of fiscal periods.

Based upon the application of the March 31, 2009 tax pools against future net funds flow from operations that will be generated from estimated proved developed producing reserves, approximately $0.6 million and $17.5 million of the non-capital losses may expire unutilized at the end of 2009 and 2012 respectively. Nonetheless, Management anticipates that increased funds flow from operations resulting from future successful exploration and development activities and acquisitions will reduce this risk of non-capital losses expiring unutilized.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2009, Monterey's financial statements reflected total capitalization of nearly $128.9 million consisting of $33.9 million in net debt and $95.0 million in equity. Management reviews its net debt to equity ratio and net debt to forward cash flow and compares the ratios to accepted prudent financial ratios, against the ratios of similar sized publicly listed entities operating in the upstream oil and gas exploration and development industry and the anticipated business environment, opportunities and operations of the Corporation. If any of Monterey's ratios did not meet Management's expectations then actions such as an equity financing, disposition of oil and gas properties, reduction of capital expenditure programs would be undertaken to ensure the Corporation is able to settle it obligations when due and to carry on conducting business.



Capitalization
($000's) Mar 31, 2009 Dec 31, 2008
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net current deficiency $ 2,640 $ 2,414
Bank indebtedness 31,052 35,286
Obligations under capital lease 180 224
Share capital 92,944 92,944
Contributed surplus 3,803 3,678
Retained earnings (deficit) (1,733) 2,441
----------------------------------------------------------------------------
Total Capitalization $ 128,886 $ 136,987
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Net current deficiency

As at March 31, 2009 Monterey had a net current deficiency of $2.6 million. During the first quarter, Monterey collected a significant portion of accounts receivable which were outstanding as at December 31, 2008, while the decrease in the average realized commodity price on Monterey's first quarter sales offset the impacts of higher sales volumes, lower payables from reduced capital activity during the 2008/2009 winter drilling season and increases in the Corporation's prepaid current assets as a result of stamping fees paid in respect of guaranteed note borrowings. The net effect of these items resulted in a nine percent increase in Monterey's net current deficiency from the end of 2008.

Bank indebtedness

At March 31, 2009, the Corporation had total bank indebtedness of $31.1 million, resulting from Canadian drawings against the credit facility in the form of guaranteed rate notes with terms to maturity of less than one year. During the quarter, at Management's request, the Lender conducted the annual review of the credit facility. As a result of the review, Monterey and the Lender agreed to a new $45 million demand revolving credit facility (the "New Facility"). In association with the New Facility, Monterey paid approximately $0.1 million to the Lender in respect of commitment fees and will also pay, upon maturity of the outstanding guaranteed notes, $0.3 million in respect of stamping fee adjustments. The annual review of the New Facility is scheduled to be completed prior to June 1, 2010.

Under the New Facility, Monterey will continue to have the ability to borrow from the Lender up to $45 million in the form of: (i) revolving prime based and US prime based borrowing in multiples of $25,000; (ii) issue of guaranteed notes and LIBOR borrowing subject to minimum borrowings of $1 million and additional amounts in multiples of $0.1 million having terms to maturity from 15 to 365 days from the date of issue; and (iii) letters of credit/guarantee, to a cumulative maximum of $12.5 million, for a period of up to one year. The New Facility will also continue Monterey's access to the previously established derivates facility, whereby the Corporation may enter into U.S. foreign exchange forwards contracts or interest and commodity derivatives contracts with the Lender. Covenants on Monterey's derivatives facility continue to limit the commodity derivatives contracts entered into by the Corporation to a maximum of 50% of Monterey's annualized before royalties production as report in the most recently completed calendar quarter and that the term of any commodity contract will not exceed a period of two years.

Under the New Facility interest rates on: (i) Canadian and US dollar prime based borrowing will be at the applicable Lender's prime lending rate plus 1.25%; (ii) on the issue of guaranteed notes or LIBOR borrowing Monterey will pay the base rate plus a stamping fee of 2.5% per annum; and a fee equal to 1.25% per annum, payable at issue, on letters of credit/guarantee. Monterey borrowings in excess of $40.5 million will incur interest at an additional 1% per annum. Monterey will also pay a monthly stand-by fee on the average unused portion of the New Facility at a rate of 0.35% per annum.

The covenants and requirements under the New Facility remain unchanged from those in the previous credit facility.

The Lender has the right to demand repayment of all borrowings at any time without notice or terminate the availability of the unused portion of the New Facility five business days after serving notice to the Corporation. Monterey has the right to draw against the New Facility, repay amounts borrowed or convert the type of borrowings subject to providing same day notice for borrowings less than $5.0 million and one business day notice for borrowings of $5.0 million or more.

The New Facility is guaranteed by a Monterey general security agreement providing a floating charge on all the Corporation's lands and a security interest over all present and subsequently acquired personal property. Consistent with terms under Monterey's previous credit facility, Monterey is obligated to meet certain covenants including providing certain financial and engineering information in a timely manner; however, Monterey is not required to meet any specific numerical financial covenants, such as a debt to equity ratio or minimum working capital or liquidity amounts.

Currently the undrawn amount available under the new facility and the anticipated funds flow from operations will be sufficient for Monterey to complete its planned capital expenditure program and settle its obligations for 2009 and nearly the first half of 2010. In the event that business conditions deteriorated to the point where the Lender felt that it was unable to advance all of the funds under the New Facility, if necessary, management would consider additional dispositions of non-core properties, delay the timing of the planned exploration and development program or consider equity funding options available to Monterey to ensure that the Corporation remains a going concern.

Share Capital

At May 14, 2009, Monterey had 32,902,500 voting common shares, and 3,135,666 stock options (1,566,669 exercisable at March 31, 2009) outstanding.

Contributed Surplus

The Corporation's contributed surplus is equal to the fair value of stock options accrued over the vesting period of the stock options. The fair value of the stock options is estimated at the date the options are granted using the Black-Scholes option pricing model. When shares are issued as a result of the exercise of stock options the fair value of the stock option reflected in contributed surplus is credited to share capital and the contributed surplus balance reduced.



CAPITAL EXPENDITURES

Three Months ended
Mar 31, Mar 31,
($000's) 2009 2008
----------------------------------------------------------------------------
Land and retention $ 84 $ 4,350
Geological and geophysical 113 455
Drilling and completions 2,920 6,096
Production equipment and facilities 838 1,174
Capitalized G&A 247 258
----------------------------------------------------------------------------

Exploration and development expenditures $ 4,202 $ 12,333
Property acquisitions - 246
Office furniture, equipment and software (4) 7
----------------------------------------------------------------------------

Capital expenditures before dispositions $ 4,198 $ 12,586
Property dispositions (6,016) -
----------------------------------------------------------------------------

Capital expenditures $ (1,818) $ 12,586
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Monterey's total capital spending before dispositions was approximately $4.2 million. Exploration and development activity during the quarter was focused on the drilling of a 100 percent working interest exploratory test well in the Groundbirch area of British Columbia. The drilling of the Groundbirch well resulted in Monterey earning 10 sections (7.5 net) of prospective Montney land located contiguous to the Corporation's existing Groundbirch holdings. At March 31, 2009, the Corporation's total landholdings at Groundbirch consist of 15 (12.5 net) sections.



COMMITMENTS

As at March 31, 2009 Monterey has the following contractual obligations:

Recognized in Less
financial than 1 - 3 4 - 5 After 5
($000's) statements 1 Year years years years Total
----------------------------------------------------------------------------
Credit Facility Yes $ 31,052 $ - $ - $ - $31,052
Stamping fees No 302 - - - 302
Asset retirement(1) Yes - 157 749 7,097 8,003
Leases No 443 1,050 642 - 2,135
----------------------------------------------------------------------------
Total $ 31,797 $ 1,207 $ 1,391 $ 7,097 $41,492
----------------------------------------------------------------------------
(1) Asset retirement costs shown are undiscounted.


Leases

Monterey is committed to future payments under an operating sublease for office space and parking facilities totaling approximately $2.0 million ($0.4 million per year until October 30, 2014). In addition to the office lease, Monterey also has a capital lease obligation on oil and gas equipment that expires at the end of March 2010, with a total obligation of approximately $0.2 million.

RELATED PARTY TRANSACTIONS

Legal Services

A director of Monterey is a partner at a law firm that provides legal services to the Corporation. During the first quarter, the Corporation incurred approximately $32,000 in legal services and disbursements received from this related party. At March 31, 2009 Monterey did not have an outstanding payable to this related party law firm; however, the Corporation has accrued $5,000 for amounts owed to the law firm for legal fees and disbursements which have not yet been billed.

Transactions with Shareholder

During the three months ended March 31, 2009, the Corporation had transactions totaling approximately $60,000 with an entity that holds approximately 24% of the outstanding common shares of Monterey. The transactions primarily consisted of Monterey's participation in the joint exploration, development and production of petroleum and natural gas properties. All transactions were completed on an arm's length basis consistent with normal industry terms. The value of the transactions between Monterey and the related party were recorded at the carrying amount, which approximated their fair value. At March 31, 2009, Monterey's records include $12,000 in accounts receivable and $7,000 in accounts payable with this corporate shareholder.

Common Management and Directors

Certain directors of Monterey are also the directors or management of other entities that participate in joint operations with the Corporation. Transactions with these related parties are on terms that are consistent with parties dealing at arm's-length. During the first quarter of 2009, the aggregate value of transactions entered into between Monterey and these entities was approximately $380,000, and Monterey had outstanding payables to the related parties of $49,000 and accounts receivables due to Monterey of approximately $135,000 at March 31, 2009.

OUTLOOK

Monterey is increasing its production guidance for the first six months of 2009 to 2,300 - 2,350 boe/d from the previously stated 2,200 boe/d. First quarter production averaged 2,451 boe/d and current base production continues to exceed the Corporation's original 2009 projections. The Corporation continues to maintain its previous 2009 capital expenditure guidance of $10 million with $5 million being allocated to the first half of the year.

Monterey's business plan remains focused on value creation for shareholders through strict operational and capital allocation discipline. This is being achieved by allocating resources and capital only to the key projects that require additional spending to significantly increase the future potential upside value. The Corporation will continue to conserve capital and maintain balance sheet strength during this downward cycle in commodity price.

The Corporation completed the earning on the Brassey project in the fourth quarter of 2008 proving the merits of the latest horizontal drilling and completion technology to develop the large Cadomin resource. Also, the drilling of the first vertical test well on the Groundbirch Montney project continues the evaluation process to determine ultimate potential size and scale of the Montney in-place resource while significantly adding to the Corporation's land position. These are examples of a capital allocation strategy that has to date amassed a development inventory in excess of $100 million of drilling locations. Management is very encouraged by the results to date in these two low-risk resource plays in NEBC and looks forward to being able to fully execute the development of these plays as the economic conditions improve.

SENSITIVITY ANALYSIS

Monterey's financial performance is impacted by changes in production and the business environment. The table below indicates the key factors impacting Monterey's financial performance for the second quarter of 2009. The table below indicates Monterey's assumptions and the impact to funds flow from operations over the April 1, 2009 to June 30, 2009 period as a result of a change in each key item.



Impact on
Funds flow from
Monterey operations
Variable Assumption Variance ($000's)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Natural gas production 11.0 - 12.0 mmcf/d 1.0 mmcf/d 145
Natural gas prices $4.00 mcf $1.00/mcf 880
WTI oil price $52.00US $1.00US 30
Foreign exchange rate $1.19Cdn : $1.00US $0.01Cdn 60
Bank prime lending rate 2.31% 1.00% 25


QUARTERLY SUMMARY INFORMATION

----------------------------------------------------------------------------
----------------------------------------------------------------------------
(in thousands, except for Three Months Ended
commodity prices, per share -----------------------------------------
amounts, or unless otherwise Mar. 31, Dec. 31, Sept. 30, Jun. 30,
noted) 2009 2008 2008 2008
----------------------------------------------------------------------------

Average sales volumes:
Light oil and NGL (bbl/d) 461 453 292 181
Natural gas (mcf/d) 11,939 10,058 8,400 6,598
----------------------------------------------------------------------------
Oil equivalent (boe/d) 2,451 2,130 1,691 1,280
----------------------------------------------------------------------------

Average sales prices:
Light oil and NGL ($/bbl) $ 37.84 $ 51.78 $101.08 $105.92
Natural gas ($/mcf)(1) $ 5.59 $ 7.35 $ 10.24 $ 9.03
----------------------------------------------------------------------------
Oil equivalent ($/boe)(1) $ 34.52 $ 45.75 $ 68.45 $ 62.03
----------------------------------------------------------------------------

Financial:

Production revenue(1) $ 7,614 $ 8,965 $10,652 $ 7,227
Operating income(1) $ 3,438 $ 4,191 $ 6,445 $ 4,163
Funds flow from operations $ 2,620 $ 3,694 $ 3,345 $ 4,417
Net earnings / (loss) $(4,174) $(2,110) $ 1,301 $ 601
Total capital expenditures $(1,818) $10,900 $40,930 $ 2,165
Net current surplus / (deficiency) $(2,640) $(2,414) $(7,486) $(3,961)
Bank debt $31,052 $35,510 $22,606 $18,038
----------------------------------------------------------------------------

Per share:
Funds flow from operations:
Basic $ 0.08 $ 0.11 $ 0.12 $ 0.18
Diluted $ 0.08 $ 0.11 $ 0.12 $ 0.17
Earnings / (loss):
Basic $ (0.13) $ (0.06) $ 0.05 $ 0.02
Diluted $ (0.13) $ (0.06) $ 0.05 $ 0.02
----------------------------------------------------------------------------

Share data:
Outstanding:
Common shares 32,903 32,903 32,903 25,107
Non-voting common shares - - - -
----------------------------------------------------------------------------
Total outstanding 32,903 32,903 32,903 25,107

Equalization warrants - - - -

Stock options 3,136 3,136 2,771 2,151
----------------------------------------------------------------------------

Total diluted shares outstanding 36,039 36,039 35,674 27,258
----------------------------------------------------------------------------
Weighted average:

Basic 32,903 32,903 27,818 25,107

Diluted 32,933 32,904 27,818 25,329
----------------------------------------------------------------------------
----------------------------------------------------------------------------


----------------------------------------------------------------------------
----------------------------------------------------------------------------
(in thousands, except for Three Months Ended
commodity prices, per share ----------------------------------------
amounts, or unless otherwise Mar. 31, Dec. 31, Sept. 30, Jun. 30,
noted) 2008 2007 2007 2007
----------------------------------------------------------------------------

Average sales volumes:
Light oil and NGL (bbl/d) 241 212 288 234
Natural gas (mcf/d) 7,168 7,969 7,484 8,055
----------------------------------------------------------------------------
Oil equivalent (boe/d) 1,435 1,540 1,535 1,577
----------------------------------------------------------------------------

Average sales prices:
Light oil and NGL ($/bbl) $ 83.07 $ 80.32 $ 67.84 $ 62.30
Natural gas ($/mcf)(1) $ 7.09 $ 6.54 $ 6.00 $ 8.45
----------------------------------------------------------------------------
Oil equivalent ($/boe)(1) $ 49.34 $ 44.95 $ 42.17 $ 52.49
----------------------------------------------------------------------------

Financial:

Production revenue(1) $ 6,444 $ 6,366 $ 5,957 $ 7,531
Operating income(1) $ 3,301 $ 3,126 $ 3,716 $ 4,221
Funds flow from operations $ 3,547 $ 2,588 $ 3,327 $ 3,283
Net earnings / (loss) $ 1,111 $(1,101) $ (113) $ 597
Total capital expenditures $12,586 $ 3,615 $12,956 $ 3,286
Net current surplus / (deficiency) $(5,874) $(1,517) $(4,492) $ 516
Bank debt $18,227 $13,625 $14,875 $10,170
----------------------------------------------------------------------------

Per share:
Funds flow from operations:
Basic $ 0.14 $ 0.11 $ 0.14 $ 0.14
Diluted $ 0.14 $ 0.11 $ 0.14 $ 0.11
Earnings / (loss):
Basic $ 0.04 $ (0.04) $(0.00) $ 0.03
Diluted $ 0.04 $ (0.04) $(0.00) $ 0.02
----------------------------------------------------------------------------

Share data:
Outstanding:
Common shares 20,046 19,993 18,378 18,378
Non-voting common shares 5,061 5,061 5,061 5,061
----------------------------------------------------------------------------
Total outstanding 25,107 25,054 23,439 23,439

Equalization warrants - - - 5,266

Stock options 2,151 2,296 1,676 1,676
----------------------------------------------------------------------------

Total diluted shares outstanding 27,258 27,350 25,115 30,381
----------------------------------------------------------------------------
Weighted average:

Basic 25,058 24,528 23,439 23,439

Diluted 25,255 24,684 23,474 29,023
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Includes gains and losses from financial instruments


MONTEREY EXPLORATION LTD.
Balance Sheets
($000's)
(unaudited)

March 31, December 31,
2009 2008
----------------------------------------------------------------------------
Assets
Current assets:
Accounts receivable $ 2,653 $ 4,980
Prepaid expenses and deposits 1,247 681
----------------------------------------------------------------------------

3,900 5,661

Property and equipment (Note 4) 133,160 141,458
----------------------------------------------------------------------------

$ 137,060 $ 147,119
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Liabilities and Shareholders' Equity
Current liabilities:
Bank indebtedness (Note 5) $ 31,052 $ 35,286
Accounts payable and accrued liabilities 6,540 8,075
Obligation under capital lease 180 179
----------------------------------------------------------------------------

37,772 43,540

Obligation under capital lease - 45
Asset retirement obligations (Note 6) 4,274 4,471

Shareholders' equity:
Share capital (Note 7) 92,944 92,944
Contributed surplus (Note 7) 3,803 3,678
Retained earnings (deficit) (1,733) 2,441
----------------------------------------------------------------------------

95,014 99,063
----------------------------------------------------------------------------
Commitments (Note 11)
$ 137,060 $ 147,119
----------------------------------------------------------------------------
----------------------------------------------------------------------------

See accompanying notes to the interim unaudited financial statements

Approved on behalf of the Board:

(signed) "Chris G. Webster" (signed) "William V. Bradley"
Director Director


MONTEREY EXPLORATION LTD.
Statements of Earnings (Loss) and Retained Earnings (Deficit)
For the three months ended
($000's)
(unaudited)

March 31, March 31,
2009 2008
----------------------------------------------------------------------------
Revenues:
Production $ 7,614 $ 7,435
Royalties (1,220) (1,299)
Realized loss on financial instruments - (991)
Interest 8 3
----------------------------------------------------------------------------

6,402 5,148
----------------------------------------------------------------------------
Expenses:
Operating 2,547 1,626
Transportation costs 409 218
General and administrative 691 578
Interest 217 266
Depreciation, depletion and accretion 6,712 3,080
----------------------------------------------------------------------------

10,576 5,768
----------------------------------------------------------------------------
Loss before income taxes: (4,174) (620)
Future income tax recovery (Note 9) - (1,731)
----------------------------------------------------------------------------
Net earnings (loss) (4,174) 1,111
Retained earnings, beginning of period 2,441 1,538
----------------------------------------------------------------------------

Retained earnings (deficit), end of period $ (1,733) $ 2,649
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Net earnings (loss) per share (Note 7)
Basic and diluted $ (0.13) $ 0.04
----------------------------------------------------------------------------

See accompanying notes to the interim unaudited financial statements


MONTEREY EXPLORATION LTD.
Statements of Cash Flows
For the three months ended
($000's)
(unaudited)

March 31, March 31,
2009 2008
----------------------------------------------------------------------------

Cash provided by (used in):

Operating activities:
Net earnings (loss) $ (4,174) $ 1,111
Items not requiring cash from operations:
Unrealized loss on financial instruments - 991
Stock-based compensation 82 96
Depreciation, depletion and accretion 6,712 3,080
Future income tax recovery - (1,731)
Asset retirement expenditures (386) (43)
Change in non-cash working capital items (Note 10) (202) (228)
----------------------------------------------------------------------------

2,032 3,276
----------------------------------------------------------------------------

Financing activities:
Increase (decrease) in bank indebtedness (4,234) 4,602
Issue of common shares - 123
Obligation under capital lease repayments (44) -
Change in non-cash working capital items (Note 10) - -
----------------------------------------------------------------------------

(4,278) 4,725
----------------------------------------------------------------------------

Investing activities:
Property and equipment additions (4,198) (12,340)
Oil and natural gas property acquisitions - (246)
Oil and natural gas property dispositions 6,016 -
Change in non-cash working capital items (Note 10) 428 4,578
----------------------------------------------------------------------------

2,246 (8,008)
----------------------------------------------------------------------------

Change in cash and cash equivalents - (7)
Cash and cash equivalents, beginning of period - 7
----------------------------------------------------------------------------

Cash and cash equivalents, end of period $ - $ -
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Supplemental cash flow disclosure (Note 10)

See accompanying notes to the interim unaudited financial statements


MONTEREY EXPLORATION LTD.
Notes to the interim unaudited Financial Statements
For the three months ended March 31, 2009


1. NATURE OF OPERATIONS AND RE-ORGANIZATION

Monterey Exploration Ltd. (the "Corporation" or "Monterey") is incorporated under the Business Corporations Act (Alberta) and is engaged in the acquisition, exploration, development and production of natural gas, natural gas liquids and crude oil in the Western Canadian Sedimentary Basin.

2. SIGNIFICANT ACCOUNTING POLICIES

a) Basis of presentation

Management has prepared the interim unaudited financial statements in accordance with Canadian generally accepted accounting principles following the same accounting policies and methods of their application as the Corporation's financial statements for the year ended December 31, 2008, except as described in note 2(b). The interim unaudited financial statements should be read in conjunction with Monterey's financial statements for the year ended December 31, 2008. All amounts are stated in thousands of Canadian dollars, except where otherwise indicated.

b) Changes in accounting policies

On January 1, 2009, Monterey adopted Section 3064 "Goodwill and Other Intangible Assets" issued by the CICA. Under the new accounting standard, criteria for the recognition, measurement and disclosure of Goodwill and Other Intangible Assets are clarified. Adoption of the new accounting standard did not result in changes to Monterey's financial statements or note disclosures.

On January 1, 2011, the Corporation will be required to adopt International Financial Reporting Standards ("IFRS") and prepare its financial statements under this new set of standards, thereby replacing the preparation of Monterey's financial statements using Canadian generally accepted accounting principles.

3. FINANCIAL INSTRUMENTS

At March 31, 2009, Monterey's financial instruments include cash and cash equivalents, accounts receivable, accounts payable, bank indebtedness and capital lease. The Corporation's financial instruments have been classified accordingly: i) held for trading - cash and cash equivalents, and ii) loans and receivables - accounts receivable, and iii) other liabilities - accounts payable, bank indebtedness and capital lease.

Monterey's loans and receivables are recorded at their amortized cost.

Monterey has exposure to market risk, credit risk, and liquidity risk. A discussion of how the Corporation is exposed and manages each type of risk is noted below:

a) Market risk

(i) Commodity price risk:

The Corporation is primarily exposed to market risk in the form of commodity price volatility. Monterey's objective for commodity price risk management is to ensure that sufficient protection exists to enable the Corporation to meet planned capital expenditures in the event of downward movements in commodity prices. The Corporation's Board of Directors ("Board") has authorized Management to enter into forward financial and physical risk management contracts on Monterey's production. Management may, subject to approval by the Corporation's Board, commit up to 50 percent of Monterey's annualized, production before royalties as reported in the most recently completed calendar quarter to forward risk management contracts. In addition, the term of any commodity contract cannot exceed a period of two years.

As at, and during the three months ended March 31, 2009, the Corporation did not enter into any fixed price derivative contracts associated with future production. In the past, and the Corporation's policy when entering into derivative financial instruments, has been to initially record derivative financial instruments at their fair value, and subsequently mark to market at the end of each reporting period.

(ii) Interest rate risk:

Monterey's capital and operating expenditures are funded by any combination of the following: bank indebtedness, working capital, cash flow from operations and the issuance of equity. To the extent that expenditures are funded by incurring additional bank indebtedness, the Corporation has a contractual obligation to repay those funds borrowed plus interest on those borrowings. Changes in Canadian interest rates result in variation in the interest expense on funds borrowed by the Corporation.

Monterey's Board manages the Corporation's exposure to interest rate risk by restricting planned expenditures, and in turn controlling the amount of bank indebtedness that Monterey may incur. The Corporation may also minimize its exposure to interest rate risk by issuing equity or selling assets to reduce bank indebtedness or by fixing the interest rate on short-term borrowings through the issue of guaranteed notes.

At March 31, 2009, Monterey had total bank indebtedness of approximately $31.1 million. Assuming that the Corporation maintained its existing bank indebtedness for one year, a 1.00% change in Canadian interest rates would result in a variance of approximately $0.3 million in Monterey's average annualized interest expense.

b) Credit risk

A substantial majority of Monterey's petroleum and natural gas production is marketed under standard industry terms, with a pre-arranged monthly settlement day for payment of revenues from Monterey's purchasers of its sales volumes. In addition Monterey may conduct oil and gas operations jointly, as both the operator or as a participant, with partners. As a result, the Corporation is exposed to credit risk as a financial loss would result if Monterey's customers or joint venture partners failed to meet their contractual obligations to reimburse the Corporation for its accounts receivables. At March 31, 2009, Monterey only had approximately $47,000 in accounts receivable that were over 90 days, with a significant majority of receivables outstanding for less than 60 days. Since inception, the Corporation has never written off an accounts receivable amount to bad debt expense.

Monterey's accounts receivable are with established customers and joint operating partners in the petroleum and natural gas industry and are subject to normal industry credit risks.

Monterey's policy is to manage its credit risk by transacting with customers and entities that have good established credit ratings, and by diversifying its sales with a large group of customers. The Corporation may further mitigate its credit risk by requesting payment from joint venture partners for the partners' share of the anticipated expenditures, and withholding production from joint venture partners in the event of non-payment.

At March 31, 2009, Monterey did not have a provision for doubtful accounts as the majority of its receivables have been outstanding for less than 60 days, and the Corporation has a favorable collection history.

c) Liquidity risk

Liquidity risk is the risk that Monterey cannot meet its financial obligations as they come due. During times of extreme downward volatility in commodity prices, the Corporation manages this risk by maintaining net debt (bank debt plus capital lease obligation and non-cash working capital deficit or less non-cash working capital surplus) below the total amount of borrowings available under the Corporation's credit facility. The Corporation may reduce its net debt through the issuance of equity, the disposal of assets or by reducing anticipated capital expenditures to an amount less than cash flow generated from operations.

Under normal circumstances, the Corporation will manage its liquidity risk by maintaining a ratio of net debt to estimated forward cash flow (being the current month cash flow from operations plus asset retirement expenditures, changes in non-cash working capital and adjusted for one time or extraordinary items, the net amount is then annualized) of less than 2.5. Should the ratio calculated exceed 2.5 the Board and Management of Monterey can reduce capital expenditures, or endeavor to issue equity, or seek buyers for the Corporation's assets to reduce the Corporation's net debt to meet the net debt to forward cash flow ratio of 2.5. As at March 31, 2009 the ratio of net debt to forward cash flow was in excess of 2.5 (refer to detailed discussion in Note 8). In order to bring the Corporation's net debt to forward cash flow ratio below 2.5 by the end of 2009, Monterey reduced its bank indebtedness by disposing the Corporation's property at Dawson, in British Columbia for approximate net cash proceeds of $6.0 million, renewed its credit facility thereby retaining the total amounts available to Monterey at $45.0 million until May 2010, as well as reduced planned capital expenditures to levels below forecasted cash flow.



4. PROPERTY AND EQUIPMENT

Accumulated
depletion and
($000's) Cost depreciation Net book value
----------------------------------------------------------------------------

Oil and natural gas properties $ 173,354 $ 40,444 $ 132,910
Office furniture and equipment 380 130 250
----------------------------------------------------------------------------

March 31, 2009 $ 173,734 $ 40,574 $ 133,160
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Accumulated
depletion and
($000's) Cost depreciation Net book value
----------------------------------------------------------------------------

Oil and natural gas properties $ 175,118 $ 33,935 $ 141,183
Office furniture and equipment 387 112 275
----------------------------------------------------------------------------

December 31, 2008 $ 175,505 $ 34,047 $ 141,458
----------------------------------------------------------------------------
----------------------------------------------------------------------------


During the three months ended March 31, 2009, Monterey capitalized, to the cost of oil and natural gas properties, approximately $291,000 of general and administrative expenses that were directly related to exploration and development activities (year ended December 31, 2008 - $1,279,000). This amount includes approximately $43,000 (year ended December 31, 2008 - $258,000) of noncash expenditures associated with stock-based compensation expenses.

Undeveloped property costs of $8,963,000 were excluded from the depletion and depreciation calculation of oil and natural gas properties at March 31, 2009 (year ended December 31, 2008 - $9,718,000). Future costs of $15,331,000 to develop proved undeveloped reserves have been included in the depletion and depreciation calculation of oil and natural gas properties at March 31, 2009 (year ended December 31, 2008 - $24,042,000).

5. BANK INDEBTEDNESS, BANK DEBT & DERIVATIVES FACILITY

The Corporation has access to a demand revolving credit facility of $45 million and a derivatives facility with a Canadian banking institution (the "Lender"). The credit facility permits Canadian and U.S. dollar borrowings to finance the Corporation's operations. As at March 31, 2009, Monterey had bank indebtedness of approximately $31.1 million, primarily in the form of guaranteed rate notes with terms to maturity of less than one year.

During the quarter, at Management's request, the Lender conducted the annual review of the credit facility. As a result of the review, Monterey and the Lender agreed to a new $45 million demand revolving credit facility (the "New Facility"). In association with the New Facility, Monterey paid approximately $0.1 million to the Lender in respect of commitment fees and will also pay, upon maturity of the outstanding guaranteed notes, $0.3 million in respect of stamping fee adjustments. The annual review of the New Facility is scheduled to be completed prior to June 1, 2010.

Under the New Facility, Monterey will continue to have the ability to borrow from the Lender up to $45 million in the form of: (i) revolving prime based and US prime based borrowing in multiples of $25,000; (ii) issue of guaranteed notes and LIBOR borrowing subject to minimum borrowings of $1 million and additional amounts in multiples of $0.1 million having terms to maturity from 15 to 365 days from the date of issue; and (iii) letters of credit/guarantee, to a cumulative maximum of $12.5 million, for a period of up to one year. The New Facility will continue Monterey's access to the previously established derivates facility, whereby the Corporation may enter into U.S. foreign exchange forwards contracts or interest and commodity derivatives contracts with the Lender. Covenants on Monterey's derivatives facility continue to limit the commodity derivatives contracts entered into by the Corporation to a maximum of 50% of Monterey's annualized before royalties production as report in the most recently completed calendar quarter and that the term of any commodity contract will not exceed a period of two years.

Under the New Facility interest rates on: (i) Canadian and US dollar prime based borrowing will be at the applicable Lender's prime lending rate plus 1.25%; (ii) on the issue of guaranteed notes or LIBOR borrowing Monterey will pay the base rate plus a stamping fee of 2.5% per annum; and a fee equal to 1.25% per annum, payable at issue, on letters of credit/guarantee. Monterey borrowings in excess of $40.5 million will incur interest at an additional 1% per annum. Monterey will also pay a monthly stand-by fee on the average unused portion of the New Facility at a rate of 0.35% per annum.

The covenants and requirements under the New Facility remain unchanged from those in the previous credit facility.

The Lender has the right to demand repayment of all borrowings at any time without notice or terminate the availability of the unused portion of the New Facility five business days after serving notice to the Corporation. Monterey has the right to draw against the New Facility, repay amounts borrowed or convert the type of borrowings subject to providing same day notice for borrowings less than $5.0 million and one business day notice for borrowings of $5.0 million or more.

The New Facility is guaranteed by a Monterey general security agreement providing a floating charge on all the Corporation's lands and a security interest over all present and subsequently acquired personal property. Consistent with terms under Monterey's previous credit facility, Monterey is obligated to meet certain covenants including providing certain financial and engineering information in a timely manner; however, Monterey is not required to meet any specific numerical financial covenants, such as a debt to equity ratio or minimum working capital or liquidity amounts.

6. ASSET RETIREMENT OBLIGATIONS

Monterey's asset retirement obligation results from net ownership interests in oil and natural gas properties including well sites, gathering systems, compression and processing facilities. The Corporation estimates that at March 31, 2009 the total undiscounted amount of cash flows required to settle its asset retirement obligations is approximately $8.2 million (inflation adjusted). The timing for settlement of these obligations is based on the economic lives of the underlying assets. The majority of the costs associated with the asset retirement obligations are anticipated to be incurred between the next 15 to 20 years. Monterey used a credit-adjusted risk-free rate of 8.75% and an inflation rate of 2% to calculate the fair value of the asset retirement obligations.

The changes in the asset retirement obligation for the three months ended March 31, 2009, is as follows:



Three months ended
($000's) March 31, 2009
----------------------------------------------------------------------------

Balance, beginning of period $ 4,471

Liabilities incurred and acquired 14
Liabilities disposed (10)
Accretion expense 185
Liabilities settled (386)
----------------------------------------------------------------------------

Balance, March 31, 2009 $ 4,274
----------------------------------------------------------------------------
----------------------------------------------------------------------------


7. SHARE CAPITAL

a) Authorized

Monterey is authorized to issue an unlimited number of common shares and unlimited number of non-voting common shares.



b) Issued

Common shares Number ($000's)
----------------------------------------------------------------------------

Share capital, March 31, 2009 and December 31, 2008 32,902,500 $ 92,944
----------------------------------------------------------------------------
----------------------------------------------------------------------------


(i) Common shares held in escrow

On January 12, 2009, 5,061,096 Common Shares held by directors, management, employees and consultants (the "Service Providers") of the Corporation were released from escrow pursuant to an escrow agreement dated December 29, 2005.

c) Stock options

Monterey has established a stock option plan whereby employees, management, directors and consultants may be granted options to purchase common shares. Options granted vest in equal amounts annually over a three-year period and expire five years from the date of grant. The stock options outstanding may not exceed 10% of the outstanding common shares.

During the period ended March 31, 2009: the Corporation granted no stock options to acquire common shares, no stock options were exercised resulting in the issue of common shares, and no stock options expired or were cancelled.



The following table provides a summary of the outstanding stock options as
at March 31, 2009:

Weighted average
exercise price
Number ($ per share)
----------------------------------------------------------------------------
Outstanding, March 31, 2009 and December 31,
2008 3,135,666 $2.12
----------------------------------------------------------------------------


The following table summarizes the stock options outstanding and exercisable
under the stock option plan at March 31, 2009:

Options outstanding Options exercisable
----------------------------------------------------------------------------
Number Weighted Number
outstanding average Weighted exercisable Weighted
Range of at remaining average at average
exercise March 31, contractual exercise March exercise
prices 2009 life price 31, 2009 price
----------------------------------------------------------------------------
$0.55 535,000 4.7 $0.55 - $0.55
$2.00 - $2.90 2,479,666 2.9 $2.39 1,486,002 $2.41
$3.49 121,000 2.8 $3.49 80,667 $3.49
----------------------------------------------------------------------------
3,135,666 3.2 $2.12 1,566,669 $2.46
----------------------------------------------------------------------------
----------------------------------------------------------------------------


d) Stock-based compensation

The Corporation uses the fair value based method for the determination of the stock-based compensation costs. The fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model.



e) Contributed surplus

The following table reconciles the contributed surplus at March 31, 2009:

($000's)
----------------------------------------------------------------------------
Balance, December 31, 2008 $ 3,678
Stock-based compensation recognized during 2009 125
----------------------------------------------------------------------------
Balance, March 31, 2009 $ 3,803
----------------------------------------------------------------------------
----------------------------------------------------------------------------


f) Per share amounts

For the three months ended March 31, 2009 there were 32,902,500 basic and 32,932,759 diluted weighted average shares outstanding. For the three months ended March 31, 2008 there were 25,058,218 basic and 25,254,541 diluted weighted average shares outstanding.

8. CAPITAL DISCLOSURES

Monterey's objectives for managing its capital consist of:

a. Providing an adequate level of return to shareholders of the Corporation, relative to the risk of Monterey's assets.

b. Preserving a strong balance sheet with sufficient capital from shareholders to develop existing and prospective assets.

Monterey's main objective is to build a profitable growing energy corporation. As such, the Corporation's primary capital management objective is to promote investor, lender and stakeholder confidence that Monterey is able to meet its obligations and will continue to carry on its business.

Monterey manages its capital structure by issuing new equity or debt, adjusting planned capital spending, or through the sale of assets to reduce debt. Processes primarily utilized to effectively manage capital include ongoing calculation of certain key financial ratios such as total liabilities to equity and net debt (as described under Liquidity risk in Note 3) to forward cash flow (also described under Liquidity risk in Note 3) and comparing the Corporation's ratios against: (i) accepted prudent financial management ratios; (ii) the ratios of similar sized publicly listed entities operating in the Canadian upstream oil and gas industry; and (iii) the anticipated business environment, opportunities and the operations of the Corporation. In addition to the key financial ratios Monterey will also periodically review other measures such as net asset value, funds flow from operations per share and debt adjusted funds flow from operations per share to provide additional indications that that the Corporation's capital structure supports investor, lender and stakeholder confidence.

At March 31, 2009, the Corporation's total equity exceeded total liabilities by approximately $53.0 million, had a total liability to equity ratio of 0.44, a net debt to forward cash flow from operations ratio of 3.9 on net debt of $33.9 million. Monterey's net debt to forward cash flow of 3.9 is greater than the Corporation's objective in the management of capital resources.

Abnormally low natural gas prices resulting from lower industrial demand in North America as a result of the current global recession led to the net debt to forward cash flow ratio exceeding the objective of 2.5. As a result Management has taken action, during the three months ending March 31, 2009 to reduce the amount of debt and preserve and subsequently strengthen the balance sheet. Actions taken include reduction of planned capital spending by approximately $5.0 million, disposition of a non-core oil and gas property for net proceeds of $6.0 million and negotiation of the New Credit Facility to eliminate the risks in respect of the amount of bank debt borrowing available to Monterey and the cost of bank debt. Management will continue to consider further reductions in planned capital spending, investigate additional property dispositions, contemplate farm-out opportunities that would result in independent third parties earning a portion of Monterey's interest by paying a disproportionate share of the exploration and development expenditures, and may investigate other balance sheet measures all of which could contribute to reducing Monterey's net debt to forward cash flow ratio back to or below the 2.5 objective by the end of 2009.

9. INCOME TAXES

The provision for income tax differs from the result that would be obtained by applying the applicable statutory federal and provincial income tax rates to net earnings before income taxes. This difference results from the following items for the three months ended March 31, 2009 and March 31, 2008:



($000's) 2009 2008
----------------------------------------------------------------------------
Loss before income taxes $ (4,174) $ (620)

Combined federal and provincial statutory tax
rate 29.31% 30.11%
----------------------------------------------------------------------------

Expected income tax recovery $ (1,224) $ (187)

Increase (decrease) resulting from the tax
effect of:
Stock-based compensation expense 24 29
Other 1 1
Effect of change in enacted income tax rate 231 214
Change in valuation allowance 968 (1,788)
----------------------------------------------------------------------------

Income tax recovery $ - $ (1,731)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The components of the Corporation's future income tax assets and liabilities, as at March 31, 2009 and December 31, 2008 are as follows:



($000's) 2009 2008
----------------------------------------------------------------------------
Future income tax assets:
Property and equipment $ 819 $ -
Share issue costs 368 416
Non-capital losses 15,173 15,966
Asset retirement obligation 1,078 1,148
Valuation allowance (17,438) (16,471)
----------------------------------------------------------------------------

$ - $ 1,059

Future income tax liability:
Property and equipment - (1,059)
----------------------------------------------------------------------------

Net future income tax asset $ - $ -
----------------------------------------------------------------------------
----------------------------------------------------------------------------


At March 31, 2009, subject to confirmation by income tax authorities, Monterey has approximately $194,526,000 of income tax deductions, including non-capital losses of approximately $55,438,000, available for application against future taxable income. The full benefit of which has not been included in these financial statements.



The Corporation's non-capital losses, if not utilized, expire as follows:

($000's)
----------------------------------------------------------------------------
2009 $ 10,469
2010 15,986
2011 28,318
2012 665
----------------------------------------------------------------------------

Non-capital losses available $ 55,438
----------------------------------------------------------------------------
----------------------------------------------------------------------------


10. SUPPLEMENTAL CASH FLOW INFORMATION

a) Increase (decrease) in non-cash working capital items:

Three months Three months
ended ended
($000's) Mar 31, 2009 Mar 31, 2008
----------------------------------------------------------------------------
Change in non-cash working capital:
Accounts receivable $ 2,327 $ (1,109)
Prepaid expenses and deposits (566) (157)
Accounts payable (1,535) 5,616
----------------------------------------------------------------------------
$ 226 $ 4,350
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Changes in non-cash working capital
related to:
Operating activities $ (202) $ (228)
Financing activities - -
Investing activities 428 4,578
----------------------------------------------------------------------------
$ 226 $ 4,350
----------------------------------------------------------------------------
----------------------------------------------------------------------------


b) Supplementary cash flow information:

Three months Three months
ended ended
($000's) Mar 31, 2009 Mar 31, 2008
----------------------------------------------------------------------------
Interest paid $ 501 $ 203
----------------------------------------------------------------------------


11. COMMITMENTS

a) Office lease

Monterey is committed to future payments under an operating lease for head office space and parking facilities totaling approximately $2.0 million until October 30, 2014. Of this total, Monterey is committed to payments of $350,000 for each of the years from 2010 to 2013, and $292,000 million in 2014. For the remainder of 2009, the Corporation is committed to making equal monthly payments totaling $263,000.

12. RELATED PARTY TRANSACTIONS

a) Legal services

A director of Monterey is a partner at a law firm that provides legal services to the Corporation. During the first quarter, the Corporation incurred approximately $32,000 in legal services and disbursements associated with this related party. At March 31, 2009 the Corporation has accounts payable include an accrual of $5,000 for amounts owed to the law firm for legal fees and disbursements which have not yet been billed.


b) Transactions with shareholder

During the three months ended March 31, 2009, the Corporation had transactions totaling approximately $60,000 with an entity that holds approximately 24% of the outstanding common shares of Monterey. The transactions primarily consisted of Monterey's participation in the joint exploration, development and production of petroleum and natural gas properties. All transactions were completed on an arm's length basis consistent with normal industry terms. The value of the transactions between Monterey and the related party were recorded at the carrying amount, which approximated their fair value. At March 31, 2009, Monterey's records include $12,000 in accounts receivable and $7,000 in accounts payable with this shareholder.

c) Common management and directors

Certain directors of Monterey are also the directors or management of other entities that participate in joint operations with the Corporation. Transactions with these related parties are on terms that are consistent with parties dealing at arm's length. During the first quarter of 2009, the aggregate value of transactions entered into between Monterey and these entities was approximately $380,000. At March 31, 2009 Monterey's records include outstanding payables owed to the related parties of $49,000 and accounts receivables due to Monterey of approximately $135,000.

Contact Information

  • Monterey Exploration Ltd.
    Patrick D. Manuel, P.Eng.
    President and Chief Executive Officer
    (403) 691-7725
    or
    Monterey Exploration Ltd.
    David M. Fisher, C.A.
    Vice President, Finance & Chief Financial Officer
    (403) 691-7725
    Website: www.montereyexploration.com