Monterey Exploration Ltd.
TSX : MXL

Monterey Exploration Ltd.

August 13, 2009 16:31 ET

Monterey Exploration Ltd. Announces Financial and Operating Results for the Three and Six Months Ended June 30, 2009

CALGARY, ALBERTA--(Marketwire - Aug. 13, 2009) - Monterey Exploration Ltd. ("Monterey" or the "Corporation") (TSX:MXL) is pleased to provide its financial and operating results for the three and six months ended June 30, 2009.

Monterey's interim financial statements for the three and six months ended June 30, 2009 and management's discussion and analysis for the three months ended June 30, 2009 are available on SEDAR at www.sedar.com and on Monterey's website at www.montereyexploration.com.

SECOND QUARTER 2009 HIGHLIGHTS

- Achieved average daily production for the quarter of 2,329 barrels of oil equivalent per day ("boe/d"), an 82 percent increase compared with 1,280 boe/d during the comparative quarter in 2008.

- Generated quarterly funds flow from operations of $0.8 million versus $4.4 million of funds flow from operations generated in the second quarter of 2008. The reduction in funds flow from operations is due to Monterey receiving an average natural gas price of $3.60 per mcf, about 60 percent less than the $9.03 per mcf in the second quarter of 2008. Second quarter funds flow from operations per basic and diluted share in 2009 was $0.03.

- 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 identified a current best estimate of net 659 billion cubic feet of DPIP in the upper Montney as disclosed in the Corporation's previous press release dated May 14, 2009. As at December 31, 2008, Monterey had no proved or probable reserves assigned to the Groundbirch Montney project.

SUBSEQUENT DEVELOPMENTS

- In July 2009 completed the disposition of 3 sections of undeveloped non-core lands in the Town area of NEBC for total net proceeds of $2.7 million. Monterey had recorded no reserves or production associated with the disposed lands. The proceeds from the disposition will be used to assist in the financing of the Groundbirch area drilling and completion operations scheduled to be carried out in the second half of 2009.

OVERVIEW

Monterey's second quarter capital spending program of $1.1 million was almost entirely directed towards operations at Groundbirch. The expenditures were comprised of the remaining drilling costs associated with the successful vertical Montney exploration test well drilled in the first quarter, the design, consultation and regulatory application costs related to the natural gas facility application, and survey and licensing costs associated with the next phase of exploration and development drilling activity. The Corporation's total capital expenditures for the first half of the year prior to dispositions totaled $5.3 million.

Production averaged 2,329 boe/d in the second quarter and 2,390 boe/d over the first half of the year exceeding the Corporation's guidance of 2,300 to 2,350 boe/d for the first six months of 2009.

Monterey disposed of 3 sections of undeveloped non-core lands in the Town area of NEBC for net proceeds of $2.7 million. The transaction was completed on July 13, 2009. There were no reserves or production recorded by the Corporation with the disposed lands and the proceeds from this disposition will assist in financing Groundbirch area drilling operations scheduled in the second half of 2009.



FINANCIAL & OPERATING SUMMARIES

Financial: Three Months Ended Six Months Ended
---------- June 30, June 30,
2009 2008 2009 2008
Production Revenue(1)
(000's) $ 5,597 $ 7,227 $ 13,211 $ 13,671

Funds Flow(4) :
(000's) $ 844 $ 4,417 $ 3,464 $ 7,964
Per share(5) :
Basic $ 0.03 $ 0.18 $ 0.11 $ 0.32
Diluted $ 0.03 $ 0.17 $ 0.10 $ 0.31

Net Earnings (loss):
(000's) $ (5,485) $ 601 $ (9,659) $ 1,712
Per share:
Basic $ (0.17) $ 0.02 $ (0.29) $ 0.07
Diluted $ (0.17) $ 0.02 $ (0.29) $ 0.07

Total Capital Expenditures
(000's) $ 1,104 $ 2,167 $ (714) $ 14,753

Ending Net Debt (6)
(000's) $ 34,152 $ 21,999 $ 34,152 $ 21,999

Share Data:
Outstanding:
Common 32,902,500 25,106,796 32,902,500 25,106,796
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Total basic 32,902,500 25,106,796 32,902,500 25,106,796
Stock options 3,135,666 2,150,666 3,135,666 2,150,666
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Total diluted 36,038,166 27,257,462 36,038,166 27,257,462
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Weighted average shares
outstanding:
Basic 32,902,500 25,106,796 32,902,500 25,082,508
Diluted 33,136,082 25,329,319 33,136,082 25,305,031
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Operations: Three Months Ended Six Months Ended
----------- June 30, June 30,
2009 2008 2009 2008
Average Daily Production:
Light oil and NGL (bbl/d) 470 181 466 211
Natural gas (mcf/d) 11,151 6,598 11,543 6,883
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Oil equivalent (boe/d) 2,329 1,280 2,390 1,358
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Unit of Production Summary:
Light oil and NGL ($/bbl) 44.81 105.92 41.38 92.87
Natural gas ($/mcf)(1) 3.60 9.03 4.62 8.02
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Oil equivalent ($/boe)(1) 26.42 62.03 30.55 55.32
Royalties ($/boe) (4.29) (11.09) (4.92) (10.49)
Operating expenses ($/boe) (11.93) (13.59) (11.73) (12.98)
Transportation expenses
($/boe) (1.50) (1.62) (1.68) (1.65)
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Operating income(2) ($/boe) 8.70 35.73 12.22 30.20
Unrealized loss on
financial instruments
($/boe) - 8.52 - 8.02
General & administrative(3)
($/boe) (3.46) (4.32) (3.10) (3.98)
Net interest expense
($/boe) (1.25) (2.03) (1.10) (2.02)
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Funds flow(5) ($/boe) 3.99 37.90 8.02 32.22
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Drilling:
Gross Wells:
Natural gas - - 1 7
Oil - - - -
Dry & abandoned - 1 - 1
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Total - 1 1 8
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Net Wells:
Natural gas - - 1.0 2.9
Oil - - - -
Dry & abandoned - 1.0 - 1.0
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Total - 1.0 1.0 3.9
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OPERATIONAL UPDATE

Monterey is in the final stages of preparation to commence horizontal drilling operations at Groundbirch. As of late July, the Corporation has received all of the licenses required for the next phase of drilling at Groundbirch which consist of two test/development horizontal's on the 5 section 100 percent working interest block, one horizontal step-out well and one vertical exploration test on the 10 section 75 percent working interest land block.

Construction of an 11 mile all season access road in the Groundbirch area has been completed by a competitor. Monterey's first scheduled horizontal location is located 2.5 miles off of this new road and the Corporation is currently constructing the lease access and the surface location for the well. Operators targeting the Montney formation in the Groundbirch area have remained extremely active through the summer months with 8 drilling rigs currently active within 20 miles of Monterey's existing development area.

OUTLOOK

The Corporation's business plan remains focused on value creation for shareholders through strict operational and capital allocation discipline. In this current commodity price environment, it is apparent that successful natural gas companies operating in western Canada will need to focus their technical expertise on finding and developing natural gas plays that can withstand prolonged commodity pricing below $5.00 per mcf. Management believes that the Montney project at Groundbirch is one such play that has the potential to add significant value to Monterey by generating a positive rate of return at today's pricing.

Monterey is increasing the 2009 capital expenditure guidance from the existing $10 million to $13-$15 million based on the scheduled operations at Groundbirch. The recent disposition of undeveloped lands in the Town area will assist in financing the increased expenditures. All remaining capital spending during the second half of the year will be applied towards the Montney project at Groundbirch. Currently, no future capital spending over the remainder of 2009 is anticipated to be applied to near term production addition projects; as a result the Corporation's production guidance for the year is expected to average approximately 2,200 boe/d.

The solid production performance of the underlying asset base through the first half of 2009 and a deep inventory of development projects in excess of $75 million have allowed Monterey to focus all of the remaining 2009 capital program on the Montney project at Groundbirch. Management is very encouraged by the preliminary results observed at Groundbirch on and adjacent to the Corporation's existing land holdings and looks forward to updating the shareholders in the near future as the project continues to develop.

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 use of proceeds from the land disposition at Town, scheduled drilling operations at Grounbirch, certain expected actions to be performed and completed by industry partners, the performance characteristics of production from Monterey's developed oil and gas properties, approval and timing of applications and requests made to regulatory authorities, the access to and availability of production facilities, expectations regarding the ability to add to reserves through exploration and development activities, projections and costs and expenses and crude oil and natural gas production levels. 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; 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 including Monterey's continued access to existing credit facilities; 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 and six months ended June 30, 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 month and six months ended June 30, 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 are contained under the heading "Forward Looking Statements & Advisories". Disclosures in respect of the non-GAAP measures and Forward Looking Statements & Advisories are contained at the end of this MD&A.

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 August 12, 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.

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. Except for the items disclosed under "Accounting Pronouncements and Account Policy Changes", the accounting policies and estimates used to prepare the financial statements for the three and six months ended June 30, 2009 are consistent with those disclosed in Monterey's financial statements and MD&A for the year ended December 31, 2008. For a detailed discussion of the accounting policies and critical accounting estimates used please refer to the Corporation's December 31, 2008 year ended financial statements and MD&A.

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.

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 six months ended June 30, 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 non-core properties 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. The Corporation has access to borrowings under the credit facility 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 to 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 routinely 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

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 favorably adjusted the factor applied to calculating the royalty credits earned. On August 6, 2009 British Columbia announced an oil and gas stimulus package consisting of four royalty and two regulatory initiatives designed to attract investment in oil and gas activities in the province. The royalty changes include: (i) introduction of a reduction in the royalty rate for all wells drilled from September 2009 to June 2010 to two percent applied to the first year's production from successful drilling; (ii) an increase of 15% in the Deep Well royalty credits that are earned by drilling natural gas wells; (iii) reduction in the depth of horizontal wells to 1,900 meters to qualify a well as eligible for the Deep Royalty Credit Program; and (iv) allocation of an additional $50 million that can be earned in infrastructure royalty credits as a result of investment in oil and gas roads and pipelines. The regulatory initiatives include permission for commingling production and amendments to the drilling license regulation.

The royalty rate reduction and the changes in the Deep Well Royalty Credit Program announced by the province of British Columbia will favorably impact the planned and future operations of Monterey by improving the economical viability future drilling, particularly horizontal wells to be drilled in the Groundbirch, Brassey and Squirrel areas of NEBC. The enhancement to the infrastructure royalty credit program may offset a portion of the Corporation's investment in the construction of a gas plant in the Groundbirch area.

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; (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; and (iv) on June 25, 2009 the Alberta government announced that it would be extending the terms of the drilling royalty credit and new royalty incentive programs which were originally announced in March 2009, by one year, thereby extending the expiry of both programs by one year from March 2010 to March 2011.

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; and the majority of Monterey's drilling operations have historically been conducted in the province of British Columbia. As a result the regulatory changes in the province of Alberta outlined above will only have a nominal impact on Monterey's current operations. 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.

SIGNIFICANT EVENTS

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

- Achieved average daily production for the quarter of 2,329 barrels of oil equivalent per day ("boe/d"), an 82 percent increase compared with 1,280 boe/d during the comparative quarter in 2008.

- Generated quarterly funds flow from operations of $0.8 million versus $4.4 million of funds flow from operations generated in the second quarter of 2008. The reduction in funds flow from operations is due to Monterey receiving an average natural gas price of $3.60 per mcf, about 60 percent less than the $9.03 per mcf in the second quarter of 2008. Second quarter funds flow from operations per basic and diluted share in 2009 was $0.03.

- 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 identified a current best estimate of net 659 billion cubic feet of DPIP in the upper Montney as disclosed in the Corporation's previous press release dated May 14, 2009.

- In July 2009, completed the disposition of 3 sections of undeveloped non-core lands in the Town area of NEBC for total net proceeds of $2.7 million. There where no reserves or production associated to these lands and proceeds from the disposition will be applied to the second half drilling operations scheduled at Groundbirch.



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) June 30, 2009 Mar 31, 2009 June 30, 2008
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Average sales volumes:

Natural gas (mcf/d) 11,151 11,939 6,598

Oil and NGLs (bbl/d) 470 461 181
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Oil equivalent (boe/d) 2,329 2,451 1,280
----------------------------------------------------------------------------

Average sales prices:

Natural gas ($/mcf) (1) $ 3.60 $ 5.59 $ 9.03

Oil and NGLs ($/bbl) $ 44.81 $ 37.84 $ 105.92
----------------------------------------------------------------------------

Oil equivalent ($/boe) (1) $ 26.42 $ 34.52 $ 62.03
----------------------------------------------------------------------------

Financial:

Production revenue (1) $ 5,597 $ 7,614 $ 7,227

Operating income (2) $ 1,842 $ 3,438 $ 4,163

Funds flow from operations (2) $ 844 $ 2,620 $ 4,417

Net earnings (loss) $ (5,485) $ (4,174) $ 601

Total capital expenditures (net
of disposition proceeds) (2) $ 1,104 $ (1,818) $ 2,167

Per Share:

Funds flow from operations per
share (2):
Basic $ 0.03 $ 0.08 $ 0.18
Diluted $ 0.03 $ 0.08 $ 0.17

Net earnings (loss) per share:
Basic and diluted $ (0.17) $ (0.13) $ 0.02

Financial Position:
Net debt (2) $ 34,152 $ 33,872 $ 21,999
Total assets $ 131,162 $ 137,060 $ 100,460
Total long-term liabilities $ 4,439 $ 4,274 $ 2,417
Shareholders' equity $ 89,657 $ 95,014 $ 70,309

Share data:
Outstanding:
Common shares 32,902,500 32,902,500 25,106,796
----------------------------------------------------------------------------
Stock options 3,135,666 3,135,666 2,150,666
----------------------------------------------------------------------------
Total diluted shares 36,038,166 36,038,166 27,257,462
----------------------------------------------------------------------------
Weighted average:
Basic 32,902,500 32,902,500 25,106,796
Diluted 33,136,082 32,932,759 25,329,319
----------------------------------------------------------------------------
----------------------------------------------------------------------------


In $000's unless referring to
volumetric measures or Six months Six months
otherwise noted ended ended
(unaudited) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Average sales volumes:

Natural gas (mcf/d) 11,543 6,883

Oil and NGLs (bbl/d) 466 211
----------------------------------------------------------------------------

Oil equivalent (boe/d) 2,390 1,358
----------------------------------------------------------------------------

Average sales prices:

Natural gas ($/mcf) (1) $ 4.62 $ 8.02

Oil and NGLs ($/bbl) $ 41.38 $ 92.87
----------------------------------------------------------------------------

Oil equivalent ($/boe) (1) $ 30.55 $ 55.32
----------------------------------------------------------------------------

Financial:

Production revenue (1) $ 13,211 $ 13,671

Operating income (2) $ 5,280 $ 7,464

Funds flow from operations (2) $ 3,464 $ 7,964

Net earnings (loss) $ (9,659) $ 1,712

Total capital expenditures (net
of disposition proceeds) (2) $ (714) $ 14,753

Per Share:

Funds flow from operations per
share (2):
Basic $ 0.11 $ 0.32
Diluted $ 0.10 $ 0.31

Net earnings (loss) per share:
Basic and diluted $ (0.29) $ 0.07

Financial Position:
Net debt (2) $ 34,152 $ 21,999
Total assets $ 131,162 $ 100,460
Total long-term liabilities $ 4,439 $ 2,417
Shareholders' equity $ 89,657 $ 70,309

Share data:
Outstanding:
Common shares 32,902,500 25,106,796
----------------------------------------------------------------------------
Stock options 3,135,666 2,150,666
----------------------------------------------------------------------------
Total diluted shares 36,038,166 27,257,462
----------------------------------------------------------------------------
Weighted average:
Basic 32,902,500 25,082,508
Diluted 33,136,082 25,305,031
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Includes processing and marketing revenue and gains / losses on
financial instruments.
(2) See non-GAAP measure section for additional disclosure.


SECOND QUARTER 2009 VERSUS FIRST QUARTER 2009

Three months Three months
ended ended Percentage
June 30, 2009 Mar. 31, 2009 Change
----------------------------------------------------------------------------
Average sales volumes:
Natural gas (mcf/d) 11,151 11,939 (7)
Oil and NGLs (bbl/d) 470 461 2
----------------------------------------------------------------------------
Oil equivalent (boe/d) 2,329 2,451 (5)
----------------------------------------------------------------------------

Average sales prices:
Natural gas ($/mcf) 3.60 5.59 (36)
Oil and NGLs ($/bbl) 44.81 37.84 18
----------------------------------------------------------------------------
Oil equivalent ($/boe) 26.42 34.52 (23)
----------------------------------------------------------------------------


Sales Volumes

For the three months ended June 30, 2009, Monterey's average daily production was 2,329 boe/d, which is five percent lower than the 2,451 boe/d average daily production for the first quarter of 2009. The decrease reflects natural declines at the Corporation's areas and no production was added from exploration and development activities due to the 2009 reduction in capital expenditures.

Realized Prices

Monterey's average realized natural gas price during the second quarter of 2009 was $3.60 per mcf, a decrease of 36 percent relative to the Corporation's average realized natural gas price per mcf of $5.59 during the first quarter of 2009. Monterey's average realized liquids price for the second quarter of 2009 increased by 18 percent when compared to the first quarter.

The decrease in Monterey's average sales prices for natural gas during the second quarter is a reflection of lower commodity prices due to changes in the demand-supply balance as a result of the current global recession. The increase in the Corporation's average price received for its liquids sales represents higher anticipated North American demand due to the commencement of the summer driving season.

Royalties

During the second quarter of 2009, the Corporation had an average royalty cost per boe of $4.29; and $5.53 per boe in the first quarter. The decrease in royalty costs per boe over the first quarter of 2009 was due to lower average realized natural gas prices during the second quarter. As a percentage of Monterey's second quarter production revenue, the Corporation's average royalty rate remained at 16 percent, which was the same as the first quarter.

Operating Costs

Relative to the first quarter of 2009, operating costs per boe increased to $11.93 from $11.54 per boe. The primary reason for the increase during the second quarter of 2009 is due to lower average sales volumes in relation to Monterey's fixed operating costs.

Transportation Costs

Transportation costs during the second quarter of 2009 decreased in relation to the first quarter of 2009 due to lower production volumes. On a per boe basis, the unit transportation cost for the second quarter of $1.50 per boe is nominally lower than Monterey's transportation cost per boe of $1.85 during the first quarter of 2009.

Operating Income

During the second quarter of 2009, Monterey's average realized operating income per boe decreased to $8.70, from $15.60 realized in the first quarter of 2009, a decrease of approximately 44 percent. The decrease in natural gas prices accounts for the majority of the reduction in operating income relative to the first quarter of 2009.



Change due to:
-------------------
Three months Three months
ended ended
($000's) June 30, 2009 Price/Cost Volume Mar. 31, 2009
----------------------------------------------------------------------------
Operating Income:
Production revenue
Natural gas sales $ 3,681 (2,026) (336) $ 6,043
Oil and NGLs sales 1,916 298 47 1,571
----------------------------------------------------------------------------

5,597 (1,728) (289) 7,614

Royalties 909 (263) (48) 1,220
Operating costs 2,527 81 (101) 2,547
Transportation costs 319 (74) (16) 409
----------------------------------------------------------------------------

Operating income $ 1,842 (1,472) (124) $ 3,438
----------------------------------------------------------------------------
$/boe $ 8.70 $ 15.60
----------------------------------------------------------------------------


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

Three months Three months
ended ended
(in $000's except per boe amounts) June 30, 2009 Mar. 31, 2009
----------------------------------------------------------------------------
Oil and gas properties $ 6,046 $ 6,509
Office equipment 16 18
Asset retirement accretion 185 185
----------------------------------------------------------------------------
$ 6,247 $ 6,712
----------------------------------------------------------------------------
$/boe $ 29.48 $ 30.43
----------------------------------------------------------------------------


DD&A expense for the second quarter of 2009 decreased by approximately $0.5 million over the previous quarter. The decrease in total DD&A expense was a primarily the result of lower production volumes due to natural declines.

General & Administrative ("G&A")

Per unit total G&A costs, including stock-based compensation expense, of $5.23 per boe for the second quarter of 2009 represents an increase of $0.78 per boe over the first quarter of 2009. Costs associated with the Corporation's annual reporting documents such as the publishing of an annual report contributed to the increase over the previous quarter.

The combination of expensed and capitalized G&A expenses, excluding stock-based compensation expenses, in the second quarter of 2009 increased to $1.1 million or about 13 percent more than the first quarter of 2009. The increased costs in 2009 are primarily due to the incremental costs of being a public entity.



Three Months Three Months
ended ended
(in $000's except per boe amounts) June 30, 2009 Mar. 31, 2009
----------------------------------------------------------------------------
Expensed G&A:
General and administrative expenses $ 734 $ 609
Stock-based compensation 82 82
----------------------------------------------------------------------------
Total expensed G&A $ 816 $ 691
----------------------------------------------------------------------------
$/boe $ 3.85 $ 3.13
----------------------------------------------------------------------------
Capitalized G&A:
General and administrative expenses $ 248 $ 247
Stock-based compensation and income tax
adjustment 45 44
----------------------------------------------------------------------------
Total capitalized G&A $ 293 $ 291
----------------------------------------------------------------------------
$/boe $ 1.38 $ 1.32
----------------------------------------------------------------------------

Total G&A costs $ 1,109 $ 982
----------------------------------------------------------------------------
$/boe $ 5.23 $ 4.45
----------------------------------------------------------------------------


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 ended
(in $000's) June 30, 2009 Mar. 31, 2009
----------------------------------------------------------------------------
Salaries and employment costs $ 198 $ 197
Office rent 48 48
Other general and administrative costs 2 2
----------------------------------------------------------------------------
Capitalized cash general and administrative
costs $ 248 $ 247
----------------------------------------------------------------------------
Capitalized stock-based compensation 45 44
----------------------------------------------------------------------------
Capitalized non-cash costs $ 45 $ 44
----------------------------------------------------------------------------

Total capitalized general and administrative
costs $ 293 $ 291
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Interest

Three Months Three Months
ended ended
(in $000's except per boe amounts) June 30, 2009 Mar. 31, 2009
----------------------------------------------------------------------------
Interest expense $ 309 $ 217
Interest income (45) (8)
----------------------------------------------------------------------------
Net interest expense $ 264 $ 209
----------------------------------------------------------------------------
$/boe $ 1.25 $ 0.95
----------------------------------------------------------------------------


The increase in the second quarter's net interest expense and net interest expense per boe, relative to the first quarter of 2009 is the result of higher average bank debt during the period and the increased cost of borrowing under the new bank credit facility.



FUNDS FLOW FROM OPERATIONS

Three months Three months
ended ended
(in $000's except per boe amounts) June 30, 2009 Mar. 31, 2009
----------------------------------------------------------------------------
Operating income $ 1,842 $ 3,438
General and administrative expenses (1) (734) (609)
Net interest expense (264) (209)
----------------------------------------------------------------------------
Funds flow from operations $ 844 $ 2,620
----------------------------------------------------------------------------

Operating income per boe $ 8.70 $ 15.60
General and administrative expenses (1) (3.46) (2.76)
Net interest expense (1.25) (0.95)
----------------------------------------------------------------------------
Funds flow from operations per boe (2) $ 3.99 $ 11.89
----------------------------------------------------------------------------
(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 second quarter decreased by approximately $1.8 million relative to the first quarter of 2009 largely as a result lower natural gas prices.

Second quarter unit funds flow from operations of $3.99 per boe was 66 percent less than the $11.89 per boe recorded in the first quarter. Falling natural gas prices combined with the five percent decrease in production during the second quarter are the primary reasons for the decrease.



SECOND QUARTER 2009 VERSUS SECOND QUARTER 2008

Three months ended
June 30, June 30, Percentage
2009 2008 Change
----------------------------------------------------------------------------
Average sales volumes:
Natural gas (mcf/d) 11,151 6,598 69
Oil and NGLs (bbl/d) 470 181 160
----------------------------------------------------------------------------
Oil equivalent (boe/d) 2,329 1,280 82
----------------------------------------------------------------------------

Average sales prices:
Natural gas ($/mcf) 3.60 11.44 (69)
Natural gas including
financial instruments ($/mcf) 3.60 9.03 (60)
Oil and NGLs ($/bbl) 44.81 105.92 (58)
----------------------------------------------------------------------------
Oil equivalent ($/boe) 26.42 74.41 (64)
Oil equivalent including
financial instruments ($/boe) 26.42 62.03 (57)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Sales Volumes

For the three months ended June 30, 2009, Monterey's average daily production was 2,329 boe per day, a 1,049 boe per day which is an 82 percent increase compared to the average daily production for the second quarter of 2008. The increase in production relative to the second 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.

Realized Prices

Monterey's average natural gas price including financial instruments during the second quarter of 2009 was $3.60 per mcf, a decrease of 69 percent in relation to the $9.03 per mcf average natural gas price during the comparative quarter in 2008.

The Corporation's average realized liquids price of $44.81 per barrel is a decrease of 58 percent in comparison to the $105.92 realized in the second quarter of 2008.

Both North American natural gas and worldwide crude oil prices were at or near all time highs in the second quarter of 2008; while energy prices in the second quarter of 2009 have been depressed by the reduction in demand for commodities during the global recession.

Royalties

Monterey's average royalty rate in the second quarter of 2009 of 16 percent of production revenue was about the same as the Corporation's average royalty rate of 15 percent recorded in 2008. On a per boe basis, the Corporation's royalty cost of $4.29 compares favorably to the comparative quarter of 2008 when Monterey's royalty cost per boe was $11.09, primarily due to higher commodity prices.

The royalty expense for the second quarter of 2009 was $909,000 which is about 30 percent less than in 2008. The change is then net impact of lower prices received on the sale of oil and gas production, see realized prices discussion above, offset against the 2009 increase in sales volumes, also discussed above.

Operating Costs

Relative to the second quarter of 2008, operating costs per boe decreased by $1.66 or 12 percent during the current quarter to $11.93. The 2009 decrease is explained by optimization activities completed at Monterey's Harmattan area and the impact of new production, added in late 2008 and early 2009, having a lower unit of production operating expense than Monterey's existing base production.

In 2009 operating costs have totaled $2.5 million which is nearly 60 percent higher than the $1.6 million for second quarter of 2008. The 2009 increase reflects the increase in sales volumes as discussed above.

Transportation Costs

Transportation costs of $1.50 per boe for the second quarter of 2009 decreased by seven percent from transportation costs per boe incurred during the second quarter of 2008 of $1.62. The decrease is the result of the October 31, 2008 expiry of firm service transportation agreements with a higher average transportation cost per unit.

Transportation costs for the second quarter of 2009 totaled $319,000, about 68 percent higher than costs recorded in 2008. Lower costs per unit as discussed immediately above were offset by higher natural gas production in 2009.

Operating Income
In the second quarter of 2009 operating income amounted to $1.8 million, about 56 percent less than the $4.2 million recorded in 2008. On a per boe basis Monterey's average operating income of $8.70 per boe for the second quarter of 2009 decreased by 76 percent when compared to the same period of 2008. The change in each of the absolute dollar amount and the per unit figure are the net result of higher sales volumes offset by significantly reduced oil and gas commodity prices.



Three months Change due to: Three months
ended ------------------- ended
($000's) June 30, 2009 Price/Cost Volume June 30, 2008
----------------------------------------------------------------------------
Operating Income:

Production revenue
Natural gas sales $ 3,681 (8,027) 4,780 $ 6,928
Oil and NGLs sales 1,916 (2,613) 2,787 1,742
Loss from financial
instruments - 1,443 - (1,443)
----------------------------------------------------------------------------
5,597 (9,197) 7,567 7,227

Royalties 909 (1,441) 1,058 1,292
Operating costs 2,527 (352) 1,296 1,583
Transportation costs 319 (25) 155 189
----------------------------------------------------------------------------

Operating income $ 1,842 (7,379) 5,058 $ 4,163
----------------------------------------------------------------------------
$/boe $ 8.70 $ 35.73
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Depletion, Depreciation and Accretion Expense

Three months Three months
ended ended
(in $000's except per boe amounts) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------
Oil and gas properties $ 6,046 $ 2,647
Office equipment 16 8
Asset retirement accretion 185 82
----------------------------------------------------------------------------
$ 6,247 $ 2,737
----------------------------------------------------------------------------
$/boe $ 29.48 $ 23.49
----------------------------------------------------------------------------


In comparison to the three months ended June 30, 2008, the DD&A provision in 2009 increased by $3.5 million as a result of 26 percent increase in per unit DD&A costs and 82 percent growth in production volumes. DD&A expense per boe increased by $5.99 to $29.48 per boe 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.

General & Administrative

Total General and Administrative expense of $1.1 million for the second quarter of 2009 was $0.2 million higher than total G&A expense for the same quarter during 2008.

The combination of expensed and capitalized G&A expenses, excluding stock-based compensation expenses, in the second quarter of 2009 increased to nearly $0.9 million or about 39 percent more than the second quarter of 2008. The sources of the increased costs in 2009 are mainly higher office rental expenses and incremental costs of being a public entity.

On a per boe basis, 2009 expensed G&A costs fell to 26 percent to $3.85 per boe, capitalized G&A costs decreased 38 percent to $1.38 per boe and total G&A costs dropped 30 percent to $5.23 per boe, the decrease in unit expensed, capitalized and total G&A costs represents economies of scale achieved from higher average sales volumes following the acquisition of Upper Lake Oil & Gas Ltd. and successful drilling activities in the second half of 2008 being place on-stream.



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

Three months Three months
ended ended
(in $000's except per boe amounts) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------
Expensed G&A:
General and administrative expenses $ 734 $ 503
Stock-based compensation 82 103
----------------------------------------------------------------------------
Total expensed G&A $ 816 $ 606
----------------------------------------------------------------------------
$/boe $ 3.85 $ 5.20
----------------------------------------------------------------------------
Capitalized G&A:
General and administrative expenses $ 248 $ 205
Stock-based compensation 45 53
----------------------------------------------------------------------------
Total capitalized G&A $ 293 $ 258
----------------------------------------------------------------------------
$/boe $ 1.38 $ 2.22
----------------------------------------------------------------------------

Total G&A costs $ 1,109 $ 864
----------------------------------------------------------------------------
$/boe $ 5.23 $ 7.42
----------------------------------------------------------------------------


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 ended
(in $000's) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------
Salaries and employment costs $ 198 $ 180
Office rent 48 25
Other general and administrative costs 2 -
----------------------------------------------------------------------------
Capitalized cash general and administrative
costs $ 248 $ 205
----------------------------------------------------------------------------
Capitalized stock-based compensation $ 45 $ 53
----------------------------------------------------------------------------

Total capitalized general and administrative
costs $ 293 $ 258
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Interest

Three months Three months
ended ended
(in $000's except per boe amounts ) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------
Interest expense $ 309 $ 251
Interest income (45) (15)
----------------------------------------------------------------------------
Net interest expense $ 264 $ 236
----------------------------------------------------------------------------
$/boe $ 1.25 $ 2.03
----------------------------------------------------------------------------


The Corporation's average outstanding bank debt was higher during the second quarter of 2009 combined with the increased borrowing costs under the new bank credit facility in effect during the second quarter of 2009 resulted in higher net interest expense compared to the second quarter of 2008.



FUNDS FLOW FROM OPERATIONS

Three months Three months
ended ended
(in $000's except per boe amounts) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------

Operating income $ 1,842 $ 4,163
Unrealized loss on financial instruments - 993
General and administrative expenses (1) (734) (503)
Net interest expense (264) (236)
----------------------------------------------------------------------------
Funds flow from operations $ 844 $ 4,417
----------------------------------------------------------------------------

Operating income per boe $ 8.70 $ 35.73
Unrealized loss on financial instruments - 8.52
General and administrative expenses (1) (3.46) (4.32)
Net interest expense (1.25) (2.03)
----------------------------------------------------------------------------
Funds flow from operations per boe (2) $ 3.99 $ 37.90
----------------------------------------------------------------------------
(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 $0.8 million was 81 percent lower than the $4.4 million reported during second quarter of 2008. The decrease was mainly due to the 64 percent decrease in commodity prices received for Monterey's sales volumes nominally offset by the Corporation's 82 percent increase in average sales volumes.

On a per unit basis, funds flow from operations of $3.99 per boe decreased by 89 percent relative to the second quarter of 2008. Similar to the absolute dollar figures, the reduction in 2009 is explained by lower commodity prices tempered by the 82 percent growth in production volumes.



YEAR-TO-DATE JUNE 30, 2009 VERSUS YEAR-TO-DATE JUNE 30, 2008

Six months ended
June 30, June 30, Percentage
2009 2008 Change
----------------------------------------------------------------------------
Average sales volumes:
Natural gas (mcf/d) 11,543 6,883 68
Oil and NGLs (bbl/d) 466 211 121
----------------------------------------------------------------------------
Oil equivalent (boe/d) 2,390 1,358 76
----------------------------------------------------------------------------

Average sales prices:
Natural gas ($/mcf) 4.62 9.96 (54)
Natural gas including
financial instruments ($/mcf) 4.62 8.02 (42)
Oil and NGLs ($/bbl) 41.38 92.87 (55)
----------------------------------------------------------------------------
Oil equivalent ($/boe) 30.55 65.17 (53)
Oil equivalent including
financial instruments ($/boe) 30.55 55.32 (45)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Sales Volumes

For the first half of 2009, Monterey's average daily production was 2,390 boe per day, a 1,032 boe per day or 76 percent increase compared to the average daily production for the first half of 2008. The increase in production relative to the first half of 2008 represents production additions resulting from new production as a result of successful drilling operations conducted in the second half of 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 during the first six months of 2009 was $4.62 per mcf, a decrease of 54 percent in relation to the average natural gas price during the comparative period during 2008, while Monterey's average realized liquids price decreased by 55 percent in comparison to the first half of 2008.

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

Royalties

Monterey's average royalty rate during the first half of 2009 of 16 percent of production revenue was the same as the Corporation's average royalty rate of 16 percent recorded in 2008. Royalty expense totaled $2.1 million of the first half of 2009, about 18 percent less than the $2.6 million for the same period of 2008.

The difference in the royalty expense in 2009 and 2008 is explained by the increase in sales volumes, and the reduction in realized prices, both discussed above.

Operating Costs

Relative to the first half of 2008, operating costs per boe decreased by $1.25 or 10 percent during the current period to $11.73. The 2009 decrease is explained by optimization activities completed at Monterey's Harmattan area during the first half of 2009 and the impact of new production, added in late 2008 and early 2009, having a lower unit of production operating expense than Monterey's existing base production.

In 2009 operating costs have totaled $5.1 million which is 58 percent higher than the $3.2 million for the first six months of 2008. The 2009 total reflects the 76 percent increase in sales volumes as discussed above.

Transportation Costs

Transportation costs of $1.68 per boe for the first half of 2009 increased nominally by two percent from costs incurred during the first half 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.

Transportation costs for the first six months of 2009 totaled $0.7 million, about 79 percent higher than costs recorded in 2008. Higher natural gas production, see sales volume discussion above, nominally offset by lower per unit costs, as discussed immediately above, explain the 2009 increase.

Operating Income

In the first half of 2009 operating income amounted to $5.3 million, about 29 percent less than the $7.5 million recorded in 2008. On a per boe basis Monterey's average operating income for the first half of 2009 of $12.22 per boe is 60 percent less than the $30.20 per boe recorded in 2008. The change in each of the absolute dollar amount and the per unit figure are the net result of higher sales volumes offset by significantly reduced oil and gas commodity prices.



Six months Change due to: Six months
ended -------------------- ended
($000's) June 30, 2009 Price/Cost Volume June 30, 2008
----------------------------------------------------------------------------
Operating Income:

Production revenue
Natural gas sales $ 9,725 (11,195) 8,377 $ 12,543
Oil and NGLs sales 3,486 (4,341) 4,265 3,562
Gain / (loss) from
financial instruments - 2,434 - (2,434)
----------------------------------------------------------------------------
13,211 (13,102) 12,642 13,671

Royalties 2,129 (2,406) 1,944 2,591
Operating costs 5,074 (541) 2,406 3,209
Transportation costs 728 15 306 407
----------------------------------------------------------------------------
Operating income $ 5,280 (10,170) 7,986 $ 7,464
----------------------------------------------------------------------------
$/boe $ 12.22 $ 30.20
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Depletion, Depreciation and Accretion Expense

Six months Six months
ended ended
(in $000's except per boe amounts) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------
Oil and gas properties $ 12,555 $ 5,640
Office equipment 34 17
Asset retirement accretion 370 160
----------------------------------------------------------------------------
$ 12,959 $ 5,817
----------------------------------------------------------------------------
$/boe $ 29.96 $ 23.54
----------------------------------------------------------------------------


In comparison to the first half of 2008, the DD&A provision in 2009 more than doubled to nearly $13.0 million. The DD&A provision increase is due to the combination of a 27 percent increase in the unit DD&A expense per boe and a 76 percent growth in production volumes.

DD&A expense per boe increased by 27 percent to $29.96 per boe. Proved reserves added by 2008 exploration and development activities and acquired in the Upper Lake transaction had a higher average cost relative to Monterey existing total proved reserves.

General & Administrative

Total General and Administrative costs, including stock-based compensation expense for the first half of 2009 was nearly $2.1 million or 19 percent higher than total G&A expense for the same period during 2008. The increase is largely due to additional costs associated with Monterey being a public corporation in 2009.

The combination of expensed and capitalized G&A expenses, excluding the stock-based compensation provision, for the first six months of 2009 increased to $1.8 million or nearly 27 percent more than the same period of 2008. The sources of the increase in G&A expenses in 2009 are higher office rental expenses and the incremental costs of being a public entity.

On a per unit basis, 2009 expensed G&A expenses decreased 27 percent to $3.48 per boe, capitalized G&A costs fell 42 percent to $1.35 per boe and total G&A charges dropped 32 percent to $4.83 per boe, the decrease in each of per unit expensed, capitalized and total G&A expenses represents economies of scale achieved by higher average sales volumes following the acquisition of Upper Lake Oil and Gas Ltd. in August 2008 and successful drilling activities in the second half of 2008 being placed on-stream.



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

Six months Six months
ended ended
(in $000's except per boe amounts) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------
Expensed G&A:
General and administrative expenses $ 1,343 $ 985
Stock-based compensation 164 199
----------------------------------------------------------------------------
Total expensed G&A $ 1,507 $ 1,184
----------------------------------------------------------------------------
$/boe $ 3.48 $ 4.79
----------------------------------------------------------------------------
Capitalized G&A:
General and administrative expenses $ 495 $ 464
Stock-based compensation 89 115
----------------------------------------------------------------------------
Total capitalized G&A $ 584 $ 579
----------------------------------------------------------------------------
$/boe $ 1.35 $ 2.34
----------------------------------------------------------------------------

Total G&A costs $ 2,091 $ 1,763
----------------------------------------------------------------------------
$/boe $ 4.83 $ 7.13
----------------------------------------------------------------------------


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.



Six months Six months
ended ended
(in $000's) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------
Salaries and employment costs $ 395 $ 390
Office rent 96 50
Other general and administrative costs 4 24
----------------------------------------------------------------------------
Capitalized cash general and administrative
costs $ 495 $ 464
----------------------------------------------------------------------------
Capitalized stock-based compensation $ 89 $ 115
----------------------------------------------------------------------------

Total capitalized general and administrative
costs $ 584 $ 579
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Interest
Six months Six months
ended ended
(in $000's except per boe amounts) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------
Interest expense $ 526 $ 517
Interest income (53) (18)
----------------------------------------------------------------------------
Net interest expense $ 473 $ 499
----------------------------------------------------------------------------
$/boe $ 1.10 $ 2.02
----------------------------------------------------------------------------


Despite increased bank debt in the first half of 2009 net interest expenses and the increase in borrowing costs under the bank credit facility in place in the second quarter of 2009 net interest expense is marginally lower than net interest expense recorded in the comparative period of 2008. The reduction in interest costs reflects the lower prime lending rate 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 $1.10 per boe approximately 46 percent less than amounts recorded in the first half of 2008.



FUNDS FLOW FROM OPERATIONS

Six months Six months
ended ended
(in $000's except per boe amounts) June 30, 2009 June 30, 2008
----------------------------------------------------------------------------

Operating income $ 5,280 $ 7,464
Unrealized loss on financial instruments - 1,984
General and administrative expenses (1) (1,343) (985)
Net interest expense (473) (499)
----------------------------------------------------------------------------
Funds flow from operations $ 3,464 $ 7,964
----------------------------------------------------------------------------

Operating income per boe $ 12.22 $ 30.20
Unrealized loss on financial instruments - 8.02
General and administrative expenses (1) (3.10) (3.98)
Net interest expense (1.10) (2.02)
----------------------------------------------------------------------------
Funds flow from operations per boe (2) $ 8.02 $ 32.22
----------------------------------------------------------------------------
(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 first six months of 2009 of $3.5 million was 56 percent lower than the $8.0 million reported during first six months of 2008. The decrease was largely due to lower realized oil and gas prices received for Monterey's sales volumes partially offset by the Corporation's 76 percent increase in average sales volumes.

On a per unit basis, funds flow from operations of $8.02 per boe is about a 75 percent reduction relative to the first half 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 and six months ended June 30, 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 June 30, 2009 Monterey has tax pools totaling approximately $194.8 million available to be utilized against future taxable income. The tax pools include approximately $54.8 million in non-capital losses to reduce future taxable income, $58.7 million in Canadian exploration and development expenses, $48.0 million in oil and gas property expenses, $32.1 million in tangible expenses and $1.2 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 June 30, 2009 tax pools against future net funds flow from operations that will be generated from estimated proved developed producing reserves, approximately $3.3 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 will reduce this risk of non-capital losses expiring unutilized.

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2009, Monterey's financial statements reflected total capitalization of nearly $123.8 million consisting of $34.2 million in net debt and $89.7 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) June 30, 2009 Dec. 31, 2008
----------------------------------------------------------------------------
Net current deficiency $ 931 $ 2,414
Bank indebtedness 33,085 35,286
Obligation under capital lease 136 224
Share capital 92,944 92,944
Contributed surplus 3,931 3,678
Retained earnings (deficit) (7,218) 2,441
----------------------------------------------------------------------------
Total Capitalization $ 123,809 $ 136,987
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Net current deficiency

As at June 30, 2009 Monterey had a net current deficiency of $0.9 million which is nearly $1.5 million less than the Corporation's net current deficiency on December 31, 2008.

During the first half of 2009, Monterey's outstanding accounts receivable balance has been reduced by $1.0 million as a result of an increased emphasis on the collection of billings outstanding in excess of 60 days and the impact of lower natural gas prices on sales of June 2009 sale of production. Prepaid expenses and deposits increased by $1.2 million in 2009 largely due to the recording of stamping fees paid on guaranteed note borrowings. The accounts payable balance is $2.6 million lower at June 30, 2009 than at December 31, 2009, this is primarily due the very limited exploration and development spending incurred during the second quarter of 2009. The net effect of these items resulted in a 61 percent decrease in Monterey's net current deficiency from the end of 2008.

Bank indebtedness

At June 30, 2009, the Corporation had total bank indebtedness of $33.1 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. The drawings are comprised of $32.7 million in guaranteed notes, having various maturity dates over the July 2009 to February 2010 period, and revolving overdraft borrowings of $0.4 million. In addition, Monterey has issued approximately $149,000 in letters of credit/guarantee under the facility.

During the first quarter, at Management's request, the Corporation's lender (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 "Facility"). In association with the 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 next annual review of the Facility is scheduled to be completed prior to June 1, 2010.

Under the Facility, Monterey has 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 Facility maintains 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 60% 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 terms of the 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 also pays a monthly stand-by fee on the average unused portion of the Facility at a rate of 0.35% per annum.

The covenants and requirements under the 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 Facility five business days after serving notice to the Corporation. Monterey has the right to draw against the 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 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. Under the terms of the 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 Facility and the anticipated funds flow from operations and proceeds from the oil and the gas property disposition completed after June 30, 2009 will be sufficient for Monterey to complete its planned capital expenditure program and settle its obligations for 2009 and at least the first five months 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 Facility, if necessary, management would consider additional dispositions of non-core properties, delay the timing of the planned exploration and development program or consider other balance sheet measures available to Monterey to ensure that the Corporation remains a going concern.

Share Capital

At August 12, 2009, Monterey had 32,902,500 voting common shares, and 3,135,666 stock options (1,566,669 exercisable at June 30, 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 Six Months ended
June 30, June 30, June 30, June 30,
($000's) 2009 2008 2009 2008
----------------------------------------------------------------------------
Land and lease retention $ 27 $ 615 $ 111 $ 4,965
Geological and geophysical 15 170 128 625
Drilling and completions 494 1,838 3,414 7,935
Production equipment and facilities 320 570 1,158 1,744
Capitalized G&A 248 206 495 464
----------------------------------------------------------------------------

Exploration and development
expenditures $ 1,104 $ 3,399 $ 5,306 $ 15,733
Property acquisitions - 31 - 277
Office furniture, equipment and
software - 4 (4) 10
----------------------------------------------------------------------------

Capital expenditures before
dispositions $ 1,104 $ 3,434 $ 5,302 $ 16,020
Property dispositions - (1,267) (6,016) (1,267)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Capital expenditures $ 1,104 $ 2,167 $ (714) $ 14,753
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Monterey's second quarter capital spending program of $1.1 million was almost entirely directed towards operations at Groundbirch. It was comprised of the drilling costs associated with the successful vertical Montney exploration test well spud late in the first quarter, the facility design, consultation and application costs related to the processing facility application and survey and licensing costs associated with the next phase of exploration and development drilling locations. The Corporation's total capital expenditures for the first half of the year, prior to dispositions, amounted to $5.3 million.



COMMITMENTS

As at June 30, 2009 Monterey has the following contractual obligations:

Recognized Less
in financial than 1 1 - 3 4 - 5 After 5
($000's) statements Year years years years Total
----------------------------------------------------------------------------
Credit Facility Yes $33,085 $ - $ - $ - $ 33,085
Stamping fees No 302 - - - 302
Asset retirement(1) Yes - 753 727 6,503 7,983
Leases No 175 1,050 642 - 1,867
----------------------------------------------------------------------------
Total $33,562 $ 1,803 $ 1,369 $ 6,503 $ 43,237
----------------------------------------------------------------------------
(1) Asset retirement costs shown are undiscounted.


Leases

Monterey is committed to future payments under an operating lease for head office space and parking facilities totaling approximately $1.9 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 in 2014. For the remainder of 2009, the Corporation is committed to making equal monthly payments totaling $175,000.

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 six months ended June 30, 2009, the Corporation incurred approximately $49,000 in legal services and disbursements associated with this related party. At June 30, 2009 the Corporation's 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.

Transactions with Shareholder

During the six months ended June 30, 2009, the Corporation had transactions totaling approximately $107,000 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 June 30, 2009, Monterey's records include $14,000 in accounts receivable and $11,000 in accounts payable with this 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 half of 2009, the aggregate value of transactions entered into between Monterey and these entities was approximately $1,232,000. At June 30, 2009 Monterey's records include outstanding payables owed to the related parties of $72,000 and accounts receivables due to Monterey of approximately $135,000.

SUBSEQUENT EVENT

In July 2009, Monterey completed the disposition of 3 sections of undeveloped non-core lands in the Town area of NEBC for total net proceeds of $2.7 million. There where no reserves or production associated to these lands and proceeds from the disposition will be applied to the second half drilling operations scheduled at Groundbirch.

OUTLOOK

Monterey is increasing the full year capital expenditure guidance from $10 million to $13 million based on the recent disposition of undeveloped lands and the scheduled operations at Groundbirch. All remaining exploration and development capital spending during the second half of the year will be directed to the Montney development in the Groundbirch area. With no further capital in the second half of the year being applied to near term production addition projects, production guidance for the full year 2009 is estimated to be approximately 2,200 boe/d.

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 half of 2009. The table below indicates Monterey's assumptions and the impact to funds flow from operations over the July 1, 2009 to December 31, 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 9.0 - 10.0 mmcf/d 1.0 mmcf/d 370
Natural gas prices $4.20 mcf $1.00/mcf 1,545
WTI oil price $66.00US $1.00US 50
Foreign exchange rate $ 1.15Cdn : $1.00US $0.01Cdn 115
Bank prime lending rate 2.25% 1.00% 45


QUARTERLY SUMMARY INFORMATION

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

Average sales volumes:
Natural gas (mcf/d) 11,151 11,939 10,058 8,400
Light oil and NGL (bbl/d) 470 461 453 292
----------------------------------------------------------------------------
Oil equivalent (boe/d) 2,329 2,451 2,130 1,691
----------------------------------------------------------------------------

Average sales prices:
Natural gas ($/mcf)(1) $ 3.60 $ 5.59 $ 7.35 $ 10.24
Light oil and NGL ($/bbl) $ 44.81 $ 37.84 $ 51.78 $ 101.08
----------------------------------------------------------------------------
Oil equivalent ($/boe)(1) $ 26.42 $ 34.52 $ 45.75 $ 68.45
----------------------------------------------------------------------------

Financial:
Production revenue(1) $ 5,597 $ 7,614 $ 8,965 $ 10,652
Operating income(1) $ 1,842 $ 3,438 $ 4,191 $ 6,445
Funds flow from operations $ 844 $ 2,620 $ 3,694 $ 3,345
Net earnings / (loss) $ (5,485) $ (4,174) $ (2,110) $ 1,301
Total capital expenditures $ 1,104 $ (1,818) $ 10,900 $ 40,930
Net current surplus / (deficiency) $ (931) $ (2,640) $ (2,414) $ (7,486)
Bank debt (2) $ 33,221 $ 31,052 $ 35,510 $ 22,606
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Per share:
Funds flow from operations:
Basic $ 0.03 $ 0.08 $ 0.11 $ 0.12
Diluted $ 0.03 $ 0.08 $ 0.11 $ 0.12
Earnings / (loss):
Basic $ ( 0.17) $ ( 0.13) $ (0.06) $ 0.05
Diluted $ ( 0.17) $ ( 0.13) $ (0.06) $ 0.05
----------------------------------------------------------------------------

Share data:
Outstanding:
Common shares 32,903 32,903 32,903 32,903
Non-voting common shares - - - -
----------------------------------------------------------------------------
Total outstanding 32,903 32,903 32,903 32,903
Stock options 3,136 3,136 3,136 2,771
----------------------------------------------------------------------------
Total diluted shares outstanding 36,039 36,039 36,039 35,674
----------------------------------------------------------------------------
Weighted average:
Basic 32,903 32,903 32,903 27,818
Diluted 33,136 32,933 32,904 27,818
----------------------------------------------------------------------------
----------------------------------------------------------------------------


-----------------------------------------
June 30, Mar. 31, Dec. 31, Sept. 30,
2008 2008 2007 2007
----------------------------------------------------------------------------

Average sales volumes:
Natural gas (mcf/d) 6,598 7,168 7,969 7,484
Light oil and NGL (bbl/d) 181 241 212 288
----------------------------------------------------------------------------
Oil equivalent (boe/d) 1,280 1,435 1,540 1,535
----------------------------------------------------------------------------

Average sales prices:
Natural gas ($/mcf)(1) $ 9.03 $ 7.09 $ 6.54 $ 6.00
Light oil and NGL ($/bbl) $ 105.92 $ 83.07 $ 80.32 $ 67.84
----------------------------------------------------------------------------
Oil equivalent ($/boe)(1) $ 62.03 $ 49.34 $ 44.95 $ 42.17
----------------------------------------------------------------------------

Financial:
Production revenue(1) $ 7,227 $ 6,444 $ 6,366 $ 5,957
Operating income(1) $ 4,163 $ 3,301 $ 3,126 $ 3,716
Funds flow from operations $ 4,417 $ 3,547 $ 2,588 $ 3,327
Net earnings / (loss) $ 601 $ 1,111 $ (1,101) $ (113)
Total capital expenditures $ 2,167 $ 12,586 $ 3,615 $ 12,956
Net current surplus / (deficiency) $ (3,961) $ (5,874) $ (1,517) $ (4,492)
Bank debt (2) $ 18,038 $ 18,227 $ 13,625 $ 4,875
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Per share:
Funds flow from operations:
Basic $ 0.18 $ 0.14 $ 0.11 $ 0.14
Diluted $ 0.17 $ 0.14 $ 0.11 $ 0.14
Earnings / (loss):
Basic $ 0.02 $ 0.04 $ (0.04) $ (0.00)
Diluted $ 0.02 $ 0.04 $ (0.04) $ (0.00)
----------------------------------------------------------------------------

Share data:
Outstanding:
Common shares 25,107 20,046 19,993 18,378
Non-voting common shares - 5,061 5,061 5,061
----------------------------------------------------------------------------
Total outstanding 25,107 25,107 25,054 23,439
Stock options 2,151 2,151 2,296 1,676
----------------------------------------------------------------------------
Total diluted shares outstanding 27,258 27,258 27,350 25,115
----------------------------------------------------------------------------
Weighted average:
Basic 25,107 25,058 24,528 23,439
Diluted 25,329 25,255 24,684 23,474
----------------------------------------------------------------------------
----------------------------------------------------------------------------

(1) Includes gains and losses from financial instruments
(2) Bank debt includes obligation under capital lease


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 Three Six Six
months months months months
ended ended ended ended
June 30, June 30, June 30, June 30,
($000's) 2009 2008 2009 2008
----------------------------------------------------------------------------
Cash provided by operating
activities $ 1,517 $ 4,650 $ 3,549 $ 7,926
Changes in non-cash working capital (693) (381) (491) (153)
Asset retirement expenditures 20 148 406 191
----------------------------------------------------------------------------
Funds flow from operations $ 844 $ 4,417 $ 3,464 $ 7,964
----------------------------------------------------------------------------


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

Three Three Six Six
months months months months
ended ended ended ended
June 30, June 30, June 30, June 30,
($000's) 2009 2008 2009 2008
----------------------------------------------------------------------------
Net earnings (loss) $ (5,485) $ 601 $ (9,659) $ 1,712
Add: Future income tax expense
(recovery) - (17) - (1,748)
Add: Depreciation, depletion and
accretion 6,247 2,737 12,959 5,817
Add: Net interest expense 264 236 473 499
Add: General and administrative 816 606 1,507 1,184
----------------------------------------------------------------------------
Operating income $ 1,842 $ 4,163 $ 5,280 $ 7,464
----------------------------------------------------------------------------


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 Three Six Six
months months months months
ended ended ended ended
June 30, June 30, June 30, June 30,
($000's) 2009 2008 2009 2008
----------------------------------------------------------------------------
Cash used in investing activities $ 3,506 $ 4,461 $ 1,260 $ 12,469
Change in non-cash working capital (2,402) (2,294) (1,974) 2,284
----------------------------------------------------------------------------
Capital expenditures and total
capital expenditures $ 1,104 $ 2,167 $ (714) $ 14,753
----------------------------------------------------------------------------


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
($000's) June 30, 2009 Dec. 31, 2008
----------------------------------------------------------------------------
Bank indebtedness $ 33,085 $ 35,286
Less: Current assets (2,914) (5,661)
Add: Accounts payable and accrued liabilities 3,845 8,075
Add: Obligation under capital lease 136 224
----------------------------------------------------------------------------
Net debt $ 34,152 $ 37,924
----------------------------------------------------------------------------


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
($000's) June 30, 2009 Dec. 31, 2008
----------------------------------------------------------------------------
Current liabilities $ 37,066 $ 43,540
Less: Current assets (2,914) (5,661)
----------------------------------------------------------------------------
Working capital deficit 34,152 37,879
Less: Current portion of bank indebtedness (33,085) (35,286)
Less: Current portion of obligation under
capital lease (136) (179)
----------------------------------------------------------------------------
Net current deficiency $ 931 $ 2,414
----------------------------------------------------------------------------


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. As at June 30, 2009 and December 31, 2008, Monterey did not participate in forward financial contracts for which unrealized gains or losses would arise.

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", "depends", "estimate", "expect", "may", "will", "project", "should", "believe", "would", "potential" 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 retain or 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.

Discovered Petroleum Initially in Place

This MD&A 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

For the purpose of calculating unit measures, natural gas is converted to a boe at a conversion rate of six thousand cubic feet of natural gas being equal to one boe. Disclosure provided herein in respect of 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.

MONTEREY EXPLORATION LTD.

Financial Statements

For the three and six months ended June 30, 2009

MANAGEMENT'S REPORT

The accompanying financial statements of Monterey Exploration Ltd. ("Monterey" or the "Corporation") have been prepared by Management in accordance with Canadian generally accepted accounting principles.

Management is responsible for the integrity of the financial information. Internal control systems are designed and maintained to provide reasonable assurance that assets are safeguarded from loss or unauthorized use and to produce reliable accounting records for financial reporting purposes.

Management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses for the period. These estimates and assumptions are based on Management's best information and judgment and, in the near term are not expected to materially change the recorded amounts of assets, liabilities, revenues and expenses. The financial statements have been prepared using policies and procedures established by Management and outlined in the notes to the accompanying financial statements and reflect fairly the Corporation's financial condition and results of operations.

The Board of Directors is responsible for ensuring that Management fulfills its responsibilities for financial reporting and internal control. The Board exercises this responsibility through the Audit Committee of the Board of Directors, with assistance from the Reserve Committee regarding the annual independent evaluation of Monterey's petroleum and natural gas reserves. The Audit Committee meets regularly with Management and the independent auditors to ensure that Management's responsibilities are properly discharged, to review the financial statements and recommend that the financial statements be presented to the Board of Directors for approval. The Audit Committee also considers the independence of the external auditors, reviews the services provided and the fees charged by the external auditors. The external auditors have access to the Audit Committee without the presence of Management.

The Audit Committee of the Board of Directors reviewed the unaudited financial statements of Monterey Exploration Ltd. as at June 30, 2009 as compiled by Management. The Board of Directors on the recommendation of the Audit Committee has approved these financial statements.



(signed) "Patrick D. Manuel" (signed) "David M. Fisher"
Patrick D. Manuel David M. Fisher
President & Chief Executive Officer Vice President, Finance & Chief
Financial Officer
August 12, 2009


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

June 30, December 31,
2009 2008
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Assets
Current assets:
Accounts receivable $ 1,804 $ 4,980
Prepaid expenses and deposits 1,110 681
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2,914 5,661

Property and equipment (Note 4) 128,248 141,458
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$ 131,162 $ 147,119
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Liabilities and Shareholders' Equity
Current liabilities:
Bank indebtedness (Note 5) $ 33,085 $ 35,286
Accounts payable and accrued liabilities 3,845 8,075
Obligation under capital lease 136 179
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37,066 43,540

Obligation under capital lease - 45
Asset retirement obligations (Note 6) 4,439 4,471

Shareholders' equity:
Share capital (Note 7) 92,944 92,944
Contributed surplus (Note 7) 3,931 3,678
Retained earnings (deficit) (7,218) 2,441
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89,657 99,063
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Commitment (Note 11)
Subsequent event (Note 13)

$ 131,162 $ 147,119
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See accompanying notes to the interim unaudited financial statements

Approved on behalf of the Board:

Chris G. Webster William V. Bradley
Director Director


MONTEREY EXPLORATION LTD.
Statements of Earnings (Loss) and Retained Earnings (Deficit)
($000's) (unaudited)

Three months ended Six months ended
-------------------- --------------------
June 30, June 30, June 30, June 30,
2009 2008 2009 2008
----------------------------------------------------------------------------
Revenues:
$ 5,597 $ 8,670 Production $ 13,211 $16,105
(909) (1,292) Royalties (2,129) (2,591)
- (1,443) Loss on financial instruments - (2,434)
45 15 Interest 53 18
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4,733 5,950 11,135 11,098
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Expenses:
2,527 1,583 Operating 5,074 3,209
319 189 Transportation costs 728 407
816 606 General and administrative 1,507 1,184
309 251 Interest 526 517
Depreciation, depletion and
6,247 2,737 accretion 12,959 5,817
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10,218 5,366 20,794 11,134
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(5,485) 584 Earnings (loss) before income taxes: (9,659) (36)
- 17 Future income tax recovery (Note 9) - 1,748
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(5,485) 601 Net earnings (loss) (9,659) 1,712
Retained earnings (deficit),
(1,733) 2,649 beginning of period 2,441 1,538
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Retained earnings (deficit), end of
$(7,218) $ 3,250 period $ (7,218) $ 3,250
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Net earnings (loss) per share (Note 7)
$ (0.17) $ 0.02 Basic $ (0.29) $ 0.07
$ (0.17) $ 0.02 Diluted $ (0.29) $ 0.07

See accompanying notes to the interim unaudited financial statements


MONTEREY EXPLORATION LTD.
Statements of Cash Flows
($000's)
(unaudited)

Three Months ended Six Months ended
-------------------- --------------------
June 30, June 30, June 30, June 30,
2009 2008 2009 2008
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Cash provided by (used in):

Operating activities:
$(5,485) $ 601 Net earnings (loss) $(9,659) $ 1,712
Items not requiring cash from
operations:

- 993 Unrealized financial instrument loss - 1,984
82 103 Stock-based compensation 164 199
Depreciation, depletion and
6,247 2,737 accretion 12,959 5,817
- (17) Future income tax recovery - (1,748)
(20) (148) Asset retirement expenditures (406) (191)
Change in non-cash working capital
693 381 items (Note 10) 491 153
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1,517 4,650 3,549 7,926
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Financing activities:
Increase / (decrease) in bank
2,033 (189) indebtedness (2,201) 4,413
(44) - Obligation under capital lease (88) -
Issue of common shares, net of share
- - issue costs - 123
Change in non-cash working capital items
- - (Note 10) - -
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1,989 (189) (2,289) 4,536
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Investing activities:
Oil and natural gas property
- (31) acquisitions - (277)
Oil and natural gas property
- 1,267 dispositions 6,016 1,267
(1,104) (3,403) Property and equipment additions (5,302) (15,743)
Change in non-cash working capital
(2,402) (2,294) items (Note 10) (1,974) 2,284
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(3,506) (4,461) (1,260) (12,469)
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- - Change in cash - (7)
- - Cash, beginning of period - 7
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$ - $ - Cash, end of period $ - $ -
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Supplemental cash flow information (Note 10)

See accompanying notes to the interim unaudited financial statements


MONTEREY EXPLORATION LTD.
Notes to the interim unaudited Financial Statements For the three and six
months ended June 30, 2009


1. NATURE OF OPERATIONS

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 June 30, 2009, Monterey's financial instruments include accounts receivable, accounts payable, bank indebtedness and obligation under capital lease. The Corporation's financial instruments have been classified accordingly: loans and receivables - accounts receivable, and other liabilities
- accounts payable, bank indebtedness and obligation under 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 to 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 and six months ended June 30, 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.

At June 30, 2009, Monterey had total bank indebtedness of approximately $33.1 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 June 30, 2009, Monterey had approximately $27,000 in accounts receivable that were over 90 days, with the majority of receivables outstanding for less than 30 days.

At June 30, 2009, Monterey did not have a provision for doubtful accounts as the majority of its receivables have been outstanding for less than 30 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.

In order to control the Corporation's exposure to liquidity risk, Monterey has actively taken steps to manage its bank indebtedness, including: disposition of non-core undeveloped oil and gas properties in January 2009 for approximate net cash proceeds of $6.0 million; renewed its credit facility of $45.0 million until May 2010; reduced planned capital expenditures, net of dispositions, to an amount less than anticipated cash generated by operating activities (excluding the impact of the change in non-cash working capital items); and subsequent to the second quarter, disposed additional non-core undeveloped oil and gas properties for cash proceeds of $2.7 million.



4. PROPERTY AND EQUIPMENT

Accumulated
depletion and
($000's) Cost depreciation Net book value
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Oil and natural gas properties $ 174,503 $ 46,491 $ 128,012
Office furniture and equipment 381 145 236
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June 30, 2009 $ 174,884 $ 46,636 $ 128,248
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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
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December 31, 2008 $ 175,505 $ 34,047 $ 141,458
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During the six months ended June 30, 2009, Monterey capitalized, to the cost of oil and natural gas properties, approximately $584,000 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 $89,000 (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 June 30, 2009 (year ended December 31, 2008 - $9,718,000). Future costs of $14,852,000 to develop proved undeveloped reserves have been included in the depletion and depreciation calculation of oil and natural gas properties at June 30, 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 (the "Facility") of $45 million and a derivatives facility with a Canadian banking institution (the "Lender"). The Facility permits Canadian and U.S. dollar borrowings to finance the Corporation's operations. As at June 30, 2009, Monterey had bank indebtedness of approximately $33.1 million, primarily in the form of guaranteed rate notes with terms to maturity of less than one year. In addition, the Corporation has issued approximately $149,000 in letters of credit/guarantee under the Facility.

Under the Facility, Monterey has 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 Facility permits Monterey's access to a 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 limit the commodity derivatives contracts entered into by the Corporation to a maximum of 60% 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 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 also pays a monthly stand-by fee on the average unused portion of the Facility at a rate of 0.35% per annum.

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 Facility five business days after serving notice to the Corporation. Monterey has the right to draw against the 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 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. 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. The next review of the Facility will be completed prior to June 2010.

Upon maturity of certain borrowings in the form of guaranteed notes in March 2010, the Corporation will pay the Lender $0.3 million in respect of stamping fee adjustments.

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 June 30, 2009 the total undiscounted amount of cash flows required to settle its asset retirement obligations is approximately $8.0 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 and six months
ended June 30, 2009, is as follows:

Three months ended Six months ended
($000's) June 30, 2009 June 30, 2009
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Balance, beginning of period $ 4,274 $ 4,471

1Liabilities incurred and acquired - 14
Liabilities disposed - (10)
Accretion expense 185 370
Liabilities settled (20) (406)
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Balance, June 30, 2009 $ 4,439 $ 4,439
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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, June 30, 2009 and December 31,
2008 32,902,500 $ 92,944
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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.

From time to time, Monterey will impose a Black-out Period on employees, management, directors and consultants that hold stock options granted by Monterey which prohibits the exercise of stock options prior to the public dissemination of material information concerning the Corporation.

During the second quarter, Monterey's shareholders approved certain amendments to the Corporation's stock option plan. The key amendments approved by Monterey's shareholders include: i) extension of the expiry date of stock options which would otherwise expire within any "Black-out Period" by 10 business days from the date that the Black-out Period ends, ii) provide the stock option grantee with the right to request, approval of the request at the sole discretion of the Corporation, to settle exercised stock options in exchange for a cash payment equal to the number of common shares that would be otherwise issued multiplied by the difference between the current market price of Monterey's common shares and the stock option exercise price, iii) in the event the Corporation sells or merges all or substantially all of the property or assets of Monterey to another party, this party shall be required to assume the obligations of stock option grants previously granted under the stock option plan, iv) Monterey's board of directors may make certain changes to the Corporation's stock option plan without shareholder approval, provided that the stock option plan may not be amended without shareholder approval in the case of increases in the percentage of the common shares issuable on the exercise of stock option grants in excess of 10 percent of the issued and outstanding common shares of Monterey, extend the expiry date of any outstanding stock option held by insiders, permit an optionholder to transfer or assign stock options to a new beneficial holder, increase the number of common shares that may be granted to insiders in excess of existing restrictions under the stock option plan or to amend the amending or discontinuance provisions of the stock option plan.

During the six months ended June 30, 2009 the Corporation did not grant any stock options to acquire common shares. In addition, 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 June 30, 2009:

Weighted average
exercise price
Number ($ per share)
----------------------------------------------------------------------------

Outstanding, June 30, 2009 and December 31,
2008 3,135,666 $2.12
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The following table summarizes the stock options outstanding and exercisable
under the stock option plan at June 30, 2009:

Options outstanding Options exercisable
----------------------------------------------------------------------------
Number Weighted Number
outstanding average Weighted exercisable Weighted
Range of at remaining average at average
exercise June 30, contractual exercise June 30, exercise
prices 2009 life price 2009 price
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$ 0.55 535,000 4.5 $0.55 - $0.55
$ 2.00 - $2.90 2,479,666 2.6 $2.39 1,486,002 $2.41
$ 3.49 121,000 2.6 $3.49 80,667 $3.49
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3,135,666 2.9 $2.12 1,566,669 $2.46
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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 June 30, 2009:

($000's)
----------------------------------------------------------------------------
Balance, December 31, 2008 $ 3,678
Stock-based compensation recognized during 2009 253
----------------------------------------------------------------------------
Balance, June 30, 2009 $ 3,931
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f) Per share amounts

For the three and six months ended June 30, 2009 there were 32,902,500 basic and 33,136,082 diluted weighted average shares outstanding. For the three months ended June 30, 2008 there were 25,106,796 basic and 25,329,319 diluted weighted average shares outstanding. For the six months ended June 30, 2008 there were 25,082,508 basic and 25,305,031 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 the Corporation's capital structure supports investor, lender and stakeholder confidence.

Low natural gas prices in 2009 related to the current global recession has led to the net debt to forward cash flow ratio exceeding the Corporation's objective of 2.5. This current business environment has meant that the net debt to forward cash ratio objective of 2.5 is not reasonably attainable at this time. Monterey's Management will continue to calculate and monitor the net debt to forward cash flow ratio; however until business conditions stabilize and natural gas prices recover, liquidity, control of the amount of debt and enhancing the entity's net asset value are Management's primary objectives.

As at June 30, 2009, the Corporation's total equity exceeded total liabilities resulting in a liability to equity ratio of 0.46. In support of achieving the primary objectives, Management will direct its attention to ensure that the amount of net debt does not exceed credit available under the Facility thus enabling the Corporation to continue operations with the intention of developing and growing Monterey's reserve base.

Management has taken various actions to reduce the Corporation's amount of outstanding debt and subsequently strengthen the balance sheet. Actions taken during 2009 include reduction of planned capital spending, disposition of a non-core oil and gas property for net proceeds of $6.0 million, renewal of the Facility to eliminate the risks in respect of the cost and the amount of bank debt borrowing available to Monterey, and subsequent to June 30, 2009, completed an additional disposition of a non-core undeveloped oil and gas property for net proceeds of $2.7 million. 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 contribute to Monterey maintaining liquidity, controlling its debt and enhancing net asset value.

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 six months ended June 30, 2009 and June 30, 2008:



($000's) 2009 2008
----------------------------------------------------------------------------
Loss before income taxes $ (9,659) $ (36)

Combined federal and provincial statutory tax rate 29.30% 30.30%
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Expected income tax recovery $ (2,830) $ (11)
Increase (decrease) resulting from the tax effect
of:
Stock-based compensation expense 48 60
Other 2 1
Effect of change in enacted income tax rate 475 151
Change in valuation allowance 2,305 (1,949)
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Income tax recovery $ - $ (1,748)
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The components of the Corporation's future income tax assets and
liabilities, as at June 30, 2009 and December 31, 2008 are as follows:

($000's) 2009 2008
----------------------------------------------------------------------------
Future income tax assets:
Property and equipment $ 2,448 $ -
Share issue costs 323 416
Non-capital losses 14,885 15,966
Asset retirement obligation 1,119 1,148
Valuation allowance (18,775) (16,471)
----------------------------------------------------------------------------

$ - $ 1,059

Future income tax liability:
Property and equipment - (1,059)
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Net future income tax asset $ - $ -
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----------------------------------------------------------------------------


At June 30, 2009, subject to confirmation by income tax authorities, Monterey has approximately $194,801,000 of income tax deductions, including non-capital losses of approximately $54,794,000, available for application against future taxable income. The 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 $ 9,825
2010 15,986
2011 28,318
2012 665
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Non-capital losses available $ 54,794
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10. SUPPLEMENTAL CASH FLOW INFORMATION

a) Change in non-cash working capital items:

Three Three Six Six
months months months months
ended ended ended ended
June 30, June 30, June 30, June 30,
($000's) 2009 2008 2009 2008
----------------------------------------------------------------------------
Change in non-cash working
capital:
Accounts receivable $ 849 $ 2,130 $ 3,176 $ 1,021
Prepaid expenses and deposits 137 (1,060) (429) (1,217)
Accounts payable (2,695) (2,983) (4,230) 2,633
----------------------------------------------------------------------------
$ (1,709) $ (1,913) $ (1,483) $ 2,437
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Changes in non-cash working
capital related to:
Operating activities $ 693 $ 381 $ 491 $ 153
Financing activities - - - -
Investing activities (2,402) (2,294) (1,974) 2,284
----------------------------------------------------------------------------
$ (1,709) $ (1,913) $ (1,483) $ 2,437
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----------------------------------------------------------------------------


b) Supplementary cash flow information:

Three Three Six Six
months months months months
ended ended ended ended
June 30, June 30, June 30, June 30,
($000's) 2009 2008 2009 2008
----------------------------------------------------------------------------
Cash interest paid $ 80 $ 199 $ 581 $ 402
Cash taxes paid - - - -
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11. COMMITMENT

a) Office lease

Monterey is committed to future payments under an operating lease for head office space and parking facilities totaling approximately $1.9 million until October 30, 2014. Of this total, Monterey is committed to equal monthly payments totaling $175,000 over the remainder of 2009, $350,000 for each of the years from 2010 to 2013, and $292,000 in 2014.

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 six months ended June 30, 2009, the Corporation incurred approximately $49,000 in legal services and disbursements associated with this related party. At June 30, 2009 the Corporation's 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 six months ended June 30, 2009, the Corporation had transactions totaling approximately $107,000 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 June 30, 2009, Monterey's records include $14,000 in accounts receivable and $11,000 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 half of 2009, the aggregate value of transactions entered into between Monterey and these entities was approximately $1,232,000. At June 30, 2009 Monterey's records include outstanding payables owed to the related parties of $72,000 and accounts receivables due to Monterey of approximately $135,000.

13. SUBSEQUENT EVENT

Subsequent to June 30, 2009, the Corporation disposed of 3 net sections of non-core undeveloped lands for total proceeds of $2.7 million.

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