Pearl Exploration and Production Ltd.
TSX VENTURE : PXX

Pearl Exploration and Production Ltd.

August 14, 2008 16:30 ET

Pearl Announces Second Quarter 2008 Financial and Operating Results

CALGARY, ALBERTA--(Marketwire - Aug. 14, 2008) - Pearl Exploration and Production Ltd. ("Pearl" or the "Company") (TSX VENTURE:PXX)(FIRST NORTH:PXXS) is pleased to announce the results for the second quarter ended June 30, 2008.



FINANCIAL AND OPERATING HIGHLIGHTS
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Three months ended June 30 Six months ended June 30
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2008 2007 2008 2007
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FINANCIAL ($000's,
except per share data)
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Total revenue 45,493 23,520 89,508 42,942
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Cash flow from
operations before
working capital
changes (2) 28,023 162 47,475 5,201
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Per common share
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Basic and diluted ($) 0.15 - 0.25 0.04
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Net income (loss) 6,688 (7,225) 2,898 (24,853)
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Per common share
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Basic and diluted ($) 0.04 (0.05) 0.02 (0.19)
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Capital expenditures 17,605 51,310 35,117 93,341
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Total assets 543,123 620,792 543,123 620,792
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Total long-term
financial liabilities 16,128 167,656 16,128 167,656
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Working capital
(deficiency) 57,371 (98,510) 57,371 (98,510)
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Shareholders' equity 493,699 453,135 493,699 453,135
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OPERATIONAL
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Daily Production
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Oil - net production
(bbls/d) 6,660 5,934 7,679 5,282
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Gas - net production
(mcf/d) 9,402 11,757 10,080 12,834
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Total net production
(boe/d) 8,246 7,910 9,375 7,441
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Product Pricing
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Oil - average selling
price per bbl ($) 84.57 41.29 72.41 39.13
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Gas - average selling
price per mcf ($) 9.80 6.81 8.73 7.10
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Weighted average sales
price per boe ($) 79.74 41.40 68.97 40.29
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Royalties ($/boe) 19.93 8.78 16.93 8.62
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Operating costs (including
transportation
expenses) ($/boe) 16.60 16.70 19.07 17.19
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Petroleum and Natural
Gas ("PNG") Netback
(3) ($/boe) 43.21 15.92 32.97 14.48
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Common Share
Information
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Weighted average
shares outstanding
(basic) 189,241,716 133,935,248 189,241,716 132,479,881
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Weighted average
shares outstanding
(diluted) 189,241,716 134,286,661 189,241,716 132,774,515
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Shares outstanding
at end of period 189,241,716 133,949,589 189,241,716 133,949,589
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Volume traded
during the quarter 37,100,752 38,104,966 74,455,243 52,011,946
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Share price ($)
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High 2.73 5.93 2.80 5.93
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Low 1.60 4.00 1.43 3.90
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Close (end of
period) 2.10 5.07 2.10 5.07
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(1) Oil equivalent amounts referenced have been calculated using a
conversion rate of six thousand cubic feet of natural gas to one barrel
of oil. BOEs may be misleading, particularly if used in isolation. A
BOE conversion ratio of 6 mcf:1 bbl is based on an energy equivalency.

(2) Cash flow from operations before working capital changes and cash flow
per share do not have standardized meanings prescribed by Canadian
Generally Accepted Accounting Principles ("GAAP") and therefore may not
be comparable to similar measures used by other companies. Cash flow
from operations before working capital changes includes all cash flow
from operating activities and is calculated before changes in non-cash
working capital. Cash flow from operations before working capital
changes is reconciled with net loss on the Consolidated Statement of
Cash. Management uses these non-GAAP measurements for its own
performance measures and to provide its shareholders and investors with
a measurement of the Company's efficiency and its ability to fund a
portion of its future growth expenditures.

(3) Petroleum and Natural Gas ("PNG") netback is a non-GAAP measure used
by management as a measure of operating efficiency and profitability
and may not be comparable to similar measures used by other companies.
It is calculated by deducting royalties, operating costs and
transportation costs from petroleum and natural gas revenues.


Message from the President

To our shareholders,

The second quarter of 2008 was the best financial and operational quarter in the Company's history. Primarily due to substantially higher oil and gas prices realized in the second quarter and the sale of non-core assets, the Company posted its highest profit and cash flow numbers to date of $6.7 million and $28 million respectively. Combining this financial performance with the closing of the sale of the non-core assets in North Central Saskatchewan, the Company is in a very strong financial position with over $52 million in positive working capital after deducting long term debt at the end of the second quarter. Second quarter realized well-head pricing averaged $84.57 per barrel for our heavy oil and 9.80/Mcf for gas resulting in wellhead netbacks of $43.21/Boe.

From an operational standpoint, we continue to focus on our 4 core assets which we believe will ultimately be the main value driver in the Company. During the first half of 2008 Pearl drilled four net horizontal wells in our Mooney area. Three of the new wells will form the basis of a polymer pilot which has been accelerated to be initiated in the fourth quarter of 2008. Preliminary results from the pilot are expected by early 2009. Plans for a field wide polymer flood implementation are expected to be finalized by the second quarter of 2009 with implementation targeted as early as the end of 2009. Permitting for the implementation of the waterflood continues on schedule (have received two of five permits required) with its initiation expected in the fourth quarter, 2008 and continuing into the first half of 2009. In addition, plans are underway to commence a development drilling program by year end, 2008 to extend the productive area to the west with the goals of increasing production and proven and probable reserves.

In Onion Lake the Cyclic Steam Stimulation (CSS) thermal pilot commenced steam injection on May 15th over a month ahead of schedule. The first steam cycle on the first well was completed on June 19th and the well is currently producing over 140 barrels of oil per day which is above the expected modeling predictions. Steam injection on the second well began on June 20th and first production commenced on August 11, 2008. If these positive results continue , to be observed in the pilot wells, we will be in a position to commence planning on a commercial thermal development program early in 2009 subject to successful negotiation of thermal development terms with Onion Lake Energy.

At San Miguel, Pearl and its 50% partner TXCO have finished construction of its Steam-Assisted Gravity Drainage (SAGD) pilot located within the Chittim "B" Field. Steam injection commenced on June 1, 2008 with preliminary results expected by the first quarter of 2009. Temperature monitoring of the well pair indicates that the steam chamber is building as anticipated. At the Saner Ranch Field, construction is continuing on the second production pilot. The Saner Ranch pilot includes both a vertical inverted five spot well pattern and a horizontal three well pattern utilizing a modified Fracture Assisted Steamflood Technology (FAST) process. The three horizontal wells were drilled and completed successfully in the second quarter, 2008. All major long lead time items for the pilot are on site with assembly of facilities and infrastructure installation proceeding on schedule. The pilot is expected to be operational in the third quarter of 2008 and preliminary results are expected during the first half of 2009. By the end of the second quarter of 2009, Pearl and its partner expect to select which of the three recovery techniques will use be used to form the basis of a commercial development project.

At Blackrod, the Company has entered into an agreement to acquire an additional 30% working interest in 3,886 contiguous hectares of oil sands leases in the project area. In addition, Pearl is continuing with its plans to drill a 10 to 15 core well program in the 2008/2009 winter to further delineate this deposit and gather additional petrophysical data. Pearl remains on track to initiate steaming at its Steam-Assisted Gravity Drainage (SAGD) pilot, comprised of single well pair pilot and related facilities, during the first half of 2009. The application for the required governmental approvals of the thermal SAGD pilot project was submitted in May of 2008.

The Company's production for the second quarter averaged 8,246 Boe/d, down from the previous quarter due to the sale of a portion of our non-core assets and natural decline. Current production is approximately 5,600 barrels a day due to a temporary curtailment of 600 Boe/d of production in our Mooney area while we install some in-field infrastructure and approximately 300 Boe/d of shut-in production awaiting workovers in other areas. We anticipate having all of this shut-in production back on-line by late August, 2008.

Pearl is very pleased with the significant progress we have made in all of our core projects including operating steam flood pilots in both Onion Lake, Saskatchewan and San Miguel, Texas and the acceleration of our polymer pilot in the Mooney area of Alberta. Due to very favourable commodity prices and our recent disposition of some non-core properties, Pearl is in a very strong financial position to continue to work these projects through to development decision points expected in the first half of 2009. As a result of the strong financial results we have achieved in the first half of 2008 and the sale some of our non-core assets, Pearl's Board of Directors has approved an expansion of our 2008 capital budget to $135 million, which is approximately $75 million higher than our original approved budget. The increase in the budget will be deployed principally in our resource to reserve conversion efforts in our Mooney project as well as other areas. We strongly believe that we are now in a position to start to realize the substantial imbedded resource value in our core areas and it is our intention to pursue this value without incurring any unnecessary dilution to our shareholders and as such we have no intention of undertaking any financings in the foreseeable future. In addition, we continue to look for opportunities to divest our remaining portfolio of non-core assets as we focus our technical and financial resources exclusively on our large resource conversion projects.

On behalf of the Board,

Keith Hill, President and CEO

August 13, 2008

PEARL EXPLORATION AND PRODUCTION LTD.

MANAGEMENT'S DISCUSSION AND ANALYSIS

Three months ended June 30, 2008 and 2007

Management's discussion and analysis ("MD&A") of Pearl Exploration and Production Ltd.'s (the "Company" or "Pearl") financial condition and results of operations should be read in conjunction with the unaudited consolidated financial statements for the three and six months ended June 30, 2008 and 2007 as contained in this interim report and the MD&A and audited financial statements for the fifteen months ended December 31, 2007 and twelve months ended September 30, 2006 contained in the Company's 2007 Financial Report. The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and are presented in Canadian dollars unless otherwise indicated. The effective date of this MD&A is August 13th, 2008.

Additional information relating to the Company is available on SEDAR at www.sedar.com and on the Company's web-site at www.pearleandp.com.

Forward-Looking Statements

Certain information regarding the Company contained herein may constitute forward-looking statements. Forward-looking statements may include estimates, plans, expectations, opinions, forecasts, projections, guidance or other statements that are not statements of fact. By their nature, forward-looking statements and information involve assumptions, inherent risks and uncertainties, many of which are difficult to predict, and are usually beyond the control of management, that could cause actual results to be materially different from those expressed by these forward-looking statements and information. The Company does not undertake to update or re-issue the forward-looking statements and information that may be contained herein, whether as a result of new information, future events or otherwise. The Company's forward-looking statements are expressly qualified in their entirety by this cautionary statement.

OVERVIEW

Pearl is a Canadian-based oil and gas company whose common shares are traded on the TSX Venture Exchange under the symbol "PXX". Pearl's main focus is large, heavy oil projects in Canada and the USA. The Company also holds interests in a number of natural gas properties.

Pearl's core properties include:

- Onion Lake, Saskatchewan - heavy oil;

- Mooney, Alberta - heavy oil;

- Blackrod, Alberta - heavy oil;

- San Miguel, Texas - heavy oil

OPERATIONS UPDATE

Onion Lake Heavy Oil Project - Saskatchewan

In Onion Lake the Cyclic Steam Stimulation (CSS) thermal pilot commenced steam injection on May 15th, over a month ahead of schedule. The first steam cycle on the first well was completed on June 19th and the well is currently producing approximately 140 barrels of oil per day which is above expected modeling predictions. Steam injection on the second well began on June 20th and first production commenced on August 11, 2008.

Mooney Heavy Oil Project - Alberta

During the first half of 2008 Pearl drilled four net horizontal wells in our Mooney area. Three of the new wells will form the basis of a polymer pilot which has been accelerated to be initiated in Q4 2008. Preliminary results from the pilot are expected by Q1 2009. Plans for a field wide polymer flood implementation are expected to be finalized by Q2 2009 with implementation targeted as early as the end of 2009. Permits have now been obtained for the implementation of the waterflood with its initiation expected in Q4 2008 and continuing into the first half of 2009. In addition, plans are underway to commence a development drilling program by year end to extend the productive area to the west with the goals of increasing production and proven and probable reserves.

Blackrod Heavy Oil Project - Alberta

At Blackrod, as previously announced, the Company has entered into an agreement to acquire an additional 30% working interest in 3,886 contiguous hectares of oil sands leases in the project area. In addition, Pearl is continuing with its plans to drill a 10 to 15 stratigraphic core well program in the 2008/2009 winter to further delineate this deposit and gather additional petrophysical data. Pearl remains on track to initiate steaming at its Steam-Assisted Gravity Drainage ("SAGD") pilot, comprised of single well pair pilot and related facilities, during the first half of 2009. The application for the required governmental approvals of the thermal SAGD pilot project was submitted in May of 2008.

San Miguel Heavy Oil Project - Maverick Basin, South Texas

At San Miguel, Pearl and its 50% partner TXCO have finished construction of its SAGD pilot located within the Chittim "B" field. Steam injection commenced on June 1, 2008 with preliminary results expected by Q1 2009. Temperature monitoring of the well pair indicates that the steam chamber is building as anticipated. At the Saner Ranch portion of the field, construction is continuing on the second production pilot. The Saner Ranch pilot includes both a vertical inverted five spot well pattern and a horizontal three well pattern utilizing a modified Fracture Assisted Steamflood Technology (FAST) process. The three horizontal wells were drilled and completed successfully in Q2 2008. All major long lead time items for the pilot are on site with assembly of facilities and infrastructure installation proceeding on schedule. The pilot is expected to be operational in the third quarter of 2008 and allow preliminary results to be analyzed during the first half of 2009. By the end of the second quarter of 2009, Pearl expects to select which of the three recovery techniques will be used to form the basis of a commercial development project.

Other Properties - Alberta, Saskatchewan

During the current quarter, the Company sold certain non-core heavy oil producing assets for $75 million. These assets were located in the Lloydminster, Celtic, Pikes Peak and Thunderchild areas of Saskatchewan and were part of the non-core asset package that the Company announced its intention to rationalize on January 8, 2008.

Other Properties - U.S.

The Company also holds interests in several other areas in the United States, including Queen City gas fields, the West Rozel and Gunnison Wedge in Utah, Promised Land in Montana and Queen City gas fields in Texas, however, there is limited or no production from these areas and there are only minor evaluation plans contemplated for these lands in 2008. However, the Company believes certain of these lands contain large resource potential and may, based upon further evaluation, be developed in the future.

RESULTS OF OPERATIONS



Oil and Gas Production, Pricing and Revenue

Three months ended June 30 Six months ended June 30
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2008 2007 2008 2007
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Daily production/
sales volumes (1)
Oil (bbl/d) 6,660 5,934 7,679 5,282
Natural gas (mcf/d) 9,402 11,757 10,080 12,834
Combined (1) (boe/d) 8,246 7,910 9,375 7,441

Product pricing ($)
Crude oil - per bbl 84.57 41.29 72.41 39.13
Natural gas - per mcf 9.80 6.81 8.73 7.10
Combined - per boe 79.74 41.40 68.97 40.29

Revenue (000's)
PNG revenue - gross 59,839 29,801 117,669 54,265
Royalties (14,956) (6,322) (28,887) (11,607)
PNG revenue - net 44,883 23,479 88,782 42,658
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- gas production converted at 6:1
(1) Includes small amounts of NGLs not separately identified in the table


For the three months ended June 30, 2008 production is relatively consistent with the prior year three-months ended June 30, 2007 due to the company disposing of non-core properties during the quarter representing approximately thirty percent of daily production.

Significant increase in revenue for both the three and six months ended June 30, 2008 is primarily due to the higher market pricing for heavy oil and natural gas in 2008.

Royalties



Three months ended June 30 Six months ended June 30
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2008 2007 2008 2007
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Royalties 14,956 6,322 28,887 11,607
as a percentage of
PNG revenue 25% 21% 25% 21%
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Royalties represent charges against production or revenue by governments and landowners. Royalties for the three and six months ended June 30, 2008 increased over the comparable periods of 2007. This increase is consistent with the increase in revenues during the period.

Royalties as a percentage of revenue increased from 21% during the three and six months ended June 30, 2007 to 25% in the three and six months ended June 30, 2008 principally due to higher market pricing. These percentages are consistent with the expectations given the nature of the royalty calculations.

PNG Operating Expenses and Netbacks



Three months ended June 30 Six months ended June 30
-------------------------------- ---------------------------------
2008 2007 2008 2007
--------------- ---------------- ---------------- ----------------
Per Per Per Per
Total boe Total boe Total boe Total boe
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Average
daily
product-
ion 8,246 7,910 9,375 7,441
Gross
PNG
revenue 59,839 79.74 29,801 41.40 117,669 68.97 54,265 40.29
Royal-
ties (14,956) (19.93) (6,322) (8.78) (28,887) (16.93) (11,607) (8.62)
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Net PNG
revenue 44,883 59.81 23,479 32.62 88,782 52.04 42,658 31.67
Operat-
ing
costs (11,453) (15.26) (10,949) (15.21) (30,337) (17.78) (21,081) (15.65)
Transport-
ation (1,003) (1.34) (1,074) (1.49) (2,201) (1.29) (2,073) (1.54)
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PNG
netback 32,427 43.21 11,456 15.92 56,244 32.97 19,504 14.48
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Operating Expenses

Second quarter operating costs on a per boe basis were fairly consistent when compared to the same period in 2007, averaging $15.26 for the three months ended June 30, 2008 in comparison to $15.21 per boe in 2007. For the six months ended June 30, 2008 operating costs were $17.78 per boe as compared to $15.65 for the six months ended June 30, 2007. The increase in per unit operating costs for the six month period is principally due to several factors, that occurred in the first quarter, including (i) high cost of propane; (ii) timing of focusing resources on developing efficiencies with regards to operating costs; and (iii) $2.2 million or $2.28 per boe of underestimated 3rd party costs that related to prior periods that was recognized in the first quarter. Installation of a fuel gas system has helped to alleviate the high cost of propane in the second quarter.

PNG netbacks are significantly higher in both the three and six months ended June 30, 2008 when compared to 2007 results. The increase is largely due to the higher price of oil and gas in 2008.

General and Administrative Expenses ("G&A")

General and administrative expenses were $3.4 million in the second quarter of 2008 compared to $4.0 million in 2007. On a per unit basis, G&A was $4.51 per boe compared to $5.49 per boe in 2007. General and administrative costs have decreased by $0.98 per boe from the same period in 2007 due to an increase in production and a corporate focus on decreasing administrative costs and an overall decrease in corporate acquisition activities.

G&A for the six months ended June 30, 2008 was $6.4 million or $3.76 per boe compared to $6.5 million or $4.83 per boe in 2007. The decrease of $1.07 per boe from 2007 is again principally due to an increase in production and a corporate focus on decreasing administrative costs and an overall decrease in corporate acquisition activities.

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

DD&A expense was $19.0 million or $24.49 per boe for the three months ended June 30, 2008 in comparison to $22.3 million or $31.01 per boe for the three months ended June 30, 2007. For the six months ended June 30, DD&A expense was $44.0 million or $25.17 per boe in comparison to $39.9 million or $29.60 for the same period of 2007. The lower rate in 2008 is due to increased proved reserves as a result of the significant drilling and acquisition activity in 2007.

Interest Expense

Interest expense for the three months ended June 30, 2008 was $0.4 million in comparison to $1.2 million for the three months ended June 30, 2007. Interest expense relates to the Company's bank debt. The Company had an average debt level of $27.6 million and an effective interest rate of 5.77% for the three months ended June 30, 2008. Lower interest expense is due to a lower dependence on debt financing during the period.

For the six months ended June 30, 2008 interest expense was $0.8 million in comparison to $1.6 million for the same period in 2007. The Company's average debt balance was $22.2 million with an effective interest rate of 6.11% for the six months ended June 30, 2008. Lower interest expense is due to a lower dependence on debt financing during the period.

Change in unrealized loss of gas pricing contracts

The change in unrealized loss of gas pricing contracts for the six months ended June 30, 2007 relates to gas contracts acquired as part of the Atlas acquisition in December, 2006.

Income Taxes

The provision for future income taxes for the quarter ended June 30, 2008 was $2.3 million compared to a recovery of $3.1 million for the three months ended June 30, 2007. As at June 30, 2008, the Company has recognized a future tax asset of $2.4 million as the Company believes, based on estimated cash flows from existing reserves, that it is more likely than not to realize these assets

For the six months ended June 30, 2008, future income taxes were $0.01 million in comparison to $0.4 million for the comparable period in 2007.

Current tax of $0.7 million for the three months ended June 30, 2008 is comprised of Saskatchewan capital tax and resource surcharge. The $6.6 million for the same period of 2007 is taxes payable as a result of the sale of certain assets in the United States.

Net Income (Loss)

Net income for the quarter ended June 30, 2008 was $6.7 million in comparison to a net loss of $7.2 million for the quarter ended June 30, 2007. Earnings for the six months ended June 30, 2008 were $2.9 million, a $27.8 million improvement over the six months ended June 30, 2007 reported net loss of $24.9 million. The significant increase in 2008 net income is mainly due to increased revenues caused by the high market price for heavy oil and natural gas in the first half of 2008.

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2008, the Company had $42.0 million of remaining credit capacity available under its $37.0 million extendible term credit facility and $10.0 million demand revolving credit facility.

At June 30, 2008, the Company had working capital of $57.4 million compared to a working capital deficit of $34.2 million at December 31, 2007.

Funds from operations were $28.0 million for the three months ended June 30, 2008 compared to funds from operations of $0.2 million for the three months ended June 30, 2007. For the six months ended June 30, 2008 funds from operations were $47.5 million as compared to $5.2 million for the six months ended June 30, 2007. The improvement in funds from operations is principally due to higher commodity prices and to a lesser extent lower G&A expenses.

Net cash used in financing activities for the quarter ended June 30, 2008 was $20.0 million compared to net cash from financing activities of $35.5 million for the quarter ended June 30, 2007. During the current quarter the Company repaid $20.0 million on its credit facility. Significant financing activities from the quarter ended June 30, 2007 included (i) an advance of $35.4 million of debt, and (ii) the exercise of $0.1 million in stock options.

Net cash from financing activities was $5.0 million for the six months ended June 30, 2008 in comparison to net cash used in financing activities of $20.1 million for the six months ended June 30, 2007. An advance of $5.0 million on the Company's bank loan was the only financing activity for the current period. Significant financing activities from the six months ended June 30, 2007 included a net repayment of $20.7 million of the Company's debt.

Net cash from investing activities was $44.1 million for the three months ended June 30, 2008 compared to net cash used in investing activities of $35.2 million for the three months ended June 30, 2007. During the current quarter, the Company sold certain non-core heavy oil producing assets for $75 million and spent $17.6 million on exploration, development and lease acquisition activities. Investing activities during the quarter ended June 30, 2007 included: (i) $51.3 million spent on exploration, development and lease acquisition activities; (ii) $2.5 million used to acquire additional shares in Serrano, and (iii) $10.0 million from the sale of Bayou Bend shares.

Net cash from investing activities for the six months ended June 30, 2008 was $8.0 million compared to net cash used in investing activities of $70.6 million in the same period of 2007. In addition to the $75 million from the sale of assets, the Company spent $35.1 million on exploration, development and lease acquisition activities during the first six months of 2008. During the six months ended June 30, 2007 the Company's exploration, development and lease acquisition activities totaled $93.3 million, corporate acquisition costs totaled $11.7 million and the sale of Bayou Bend shares generated $10.0 million.

The 2008 capital program and budget of $61.0 million has been established based on the Company's projected cash flow for the year. In 2008, the Company intends to focus its efforts chiefly on converting resources to reserves and increasing operational efficiencies in core areas.

In the future the Company may consider additional issuances of common shares or debt instruments to assist with financing its ongoing oil and gas exploration, development and acquisition activities to the extent that sufficient cash flow from operations is unavailable. In addition, the Company may consider divesting additional non-core oil and gas assets or farming out interests in oil and gas properties to finance its operations. Accordingly, the Company's consolidated financial statements are presented on a going-concern basis.

CAPITAL EXPENDITURES

Capital expenditures for the three and six months ended June 30, 2008 and 2007 are as follows:



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2008 2007 2008 2007
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Land 172,341 202,102 863,993 804,703
Seismic 202,845 250,971 561,214 1,009,467
Drilling and completion 8,945,931 35,020,604 13,505,511 68,203,944
Equipment 6,767,716 11,551,858 19,187,757 17,700,630
Other 439,289 180,725 561,003 1,266,994
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Total exploration and
development 16,528,122 47,206,260 34,679,478 88,985,738
Corporate acquisition - - - 8,809,049
Property acquisitions 1,133,391 5,450,595 1,279,712 5,702,996
Property dispositions (75,392,870) (8,847,317) (76,178,194) (8,847,317)
--------------------------------------------------------------------------
Total capital
expenditures (57,731,357) 43,809,538 (40,219,005) 94,650,466
--------------------------------------------------------------------------


RELATED PARTY TRANSACTIONS

Tanganyika Oil Company Ltd. ("Tanganyika") provides administrative and technical services to the Company from time to time based upon time and expenses incurred by Tanganyika. For the six months ended June 30, 2008, Tanganyika charged the Company $56,099 (2007 - $89,902). Tanganyika and Pearl have certain directors and officers in common.

Namdo Management Services Ltd. ("Namdo") provides executive and support services to the Company. For the six months ended June 30, 2008, the Company paid Namdo $90,000 (2007 - $nil). Namdo is a private corporation owned by Lukas H. Lundin, a director of the Company.

RISKS AND UNCERTAINTIES

The Company is exposed to a number of risks and uncertainties inherent in exploring for, developing and producing crude oil and natural gas. These risks and uncertainties include, but are not limited to, the following:

- risk of finding and producing reserves economically;

- uncertainty associated with obtaining drilling licenses and other consents and approvals;

- production risks associated with sour hydrocarbons;

- marketing reserves at acceptable prices;

- cost of capital risk associated with securing the needed capital to carry out the Company's operations;

- risk of fluctuating foreign currency exchange rates;

- risk of governmental policies, social instability or other political, economic or diplomatic developments in its operations;

- market risks associated with investing the Company's cash reserves in interest bearing depository instruments; and

- environmental risks related to its oil and gas properties.

Many of the previously mentioned risks are beyond the Company's control, and it is impossible to ensure that any exploration drilling program will result in commercial operations. The Company does not currently utilize derivative instruments to hedge its commodity price, foreign currency exchange or interest rate risks.

Pearl strives to minimize and manage these risks in a number of ways, including:

- Employing qualified professional and technical staff;

- Communicating openly with members of the public regarding its activities;

- Concentrating in a limited number of areas;

- Utilizing the latest technology for finding and developing reserves;

- Constructing high-quality, environmentally sensitive, safe production facilities;

- Maximizing operational control of drilling and producing operations; and

ENVIRONMENTAL RISKS

All phases of the oil and natural gas business present environmental risks and hazards and are subject to environmental regulation pursuant to a variety of federal, provincial and local laws and regulations. Compliance with such legislation can require significant expenditures and a breach may result in the imposition of fines and penalties, some of which may be material. Environmental legislation is evolving in a manner expected to result in stricter standards and enforcement, larger fines and liability and potentially increased capital expenditures and operating costs. In 2002, the Government of Canada ratified the Kyoto Protocol (the "Protocol"), which calls for Canada to reduce its greenhouse gas emissions to specified levels. There has been much public debate with respect to Canada's ability to meet these targets and the government's strategy or alternative strategies with respect to climate change and the control of greenhouse gases. Implementation of strategies for reducing greenhouse gases, whether to meet the limits required by the Protocol or as otherwise determined, could have a material impact on the nature of oil and natural gas operations, including those of the Company. Given the evolving nature of the debate related to climate change and the control of greenhouse gases and resulting requirements, it is not possible to predict either the nature of those requirements or the impact on the Company and its operations and financial condition.

NEW ACCOUNTING STANDARDS ADOPTED

As disclosed in the December 31, 2007 annual audited consolidated financial statements, on January 1, 2008, the Company adopted the new CICA Handbook Sections 3862 "Financial Instruments - Disclosures", 3863 "Financial Instruments - Presentation", and 1535 "Capital Disclosures". The adoption of these standards has had no material impact on the Company's net income or cash flows. Additional information on the implementation of these new standards can be found in Note 3 to the Interim Consolidated Financial Statements.

RECENT ACCOUNTING PRONOUNCEMENTS

Goodwill and Intangible Assets

As of January 1, 2009, Pearl will be required to adopt Section 3064 "Goodwill and Intangible Assets", which revises the requirement for recognition, measurement, presentation and disclosure of intangible assets and replaces the existing Goodwill and Intangible Asset standard. The adoption of this standard should not have a material impact on the Company's consolidated financial statements.

International Financial Reporting Standards

In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a strategic plan for the direction of accounting standards in Canada. As part of that plan, the Accounting Standards Board confirmed in February, 2008 that International Reporting Standards ("IFRS") will replace Canadian GAAP for profit-oriented Canadian publicly accountable enterprises in 2011. Pearl is assessing the potential impact of this change and developing a plan accordingly.

INTERNAL CONTROLS OVER FINANCIAL REPORTING

The Company has, under the supervision of its chief financial officer, designed a process for internal control over financial reporting, which process has been effected by the Company's board of directors and management. The process was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the Company's GAAP and incorporates policies and procedures as described above. There have been no changes in the Company's systems of internal control over financial reporting that would materially affect, or is reasonably likely to materially affect, the Company's internal controls over financial reporting.

It should be noted that a control system, including the Company's disclosure and internal controls and procedures, no matter how well conceived can provide only reasonable, but not absolute, assurance that the objectives of the control system will be met and it should not be expected that the disclosure and internal controls and procedures will prevent all errors or fraud.

OUTLOOK

The Company plans to continue pursuing large North American heavy oil resource opportunities to add to its portfolio, to seek to rationalize non-core assets, and to focus on conversion of resources to reserves and development of its existing interests in the USA and Canada.

BOES

Throughout this MD&A the calculation of barrels of oil equivalent (boe) is calculated at a conversion rate of six thousand cubic feet (mcf) of natural gas for one barrel of oil and is based on an energy equivalence conversion method. BOEs may be misleading, particularly if used in isolation. A boe conversion ratio of 6 mcf:1 bbl is based on an energy equivalence conversion method primarily applicable at the burner tip and does not represent a value equivalence at the wellhead.

NON-GAAP MEASURES

Included in this report are references to terms commonly used in the oil and gas industry, such as, cash flow and funds from operations which represent cash flow from operating activities expressed before changes in non-cash working capital, long-term receivable and asset retirement costs incurred and are used by the Company to analyze operating performance, leverage and liquidity. These terms do not have standardized meanings prescribed by Generally Accepted Accounting Principles and therefore may not be comparable with the calculations of similar measures for other entities. Consequently, these are referred to as non-GAAP measures.



PEARL EXPLORATION AND PRODUCTION LTD.

--------------------------------------------------------------------------
Consolidated Balance Sheet
(unaudited)
--------------------------------------------------------------------------
December 31,
June 30, 2008 2007
--------------------------------------------------------------------------

Assets
Current assets
Cash $ 54,749,247 $ 4,799,186
Accounts receivable 31,438,092 25,134,435
Income taxes and capital taxes receivable 2,770,506 2,618,015
Prepaid expenses and deposits 1,709,938 3,195,770
-------------- --------------
90,667,783 35,747,406

Investments (note 5) 9,362,895 9,362,895
Petroleum and natural gas properties
(note 6) 440,703,675 528,352,540
Future income tax 2,388,711 2,402,532
-------------- --------------
$ 543,123,064 $ 575,865,373
-------------- --------------
-------------- --------------

Liabilities
Current liabilities
Accounts payable and accrued liabilities 33,296,598 69,899,310
-------------- --------------
33,296,598 69,899,310
-------------- --------------
Long-term liabilities
Asset retirement obligation (note 8) 11,127,830 16,586,030
Bank loan (note 7) 5,000,000 -
-------------- --------------
49,424,428 86,485,340

Shareholders' equity
Share capital (note 10) 723,121,821 723,121,821
Contributed surplus (note 11) 10,199,209 8,778,124
Deficit (239,622,394) (242,519,912)
-------------- --------------
493,698,636 489,380,033
-------------- --------------
$ 543,123,064 $ 575,865,373
-------------- --------------
-------------- --------------
Commitments (note 13)
Contingencies (note 16)

See accompanying notes to consolidated financial statements


PEARL EXPLORATION AND PRODUCTION LTD.

--------------------------------------------------------------------------
Consolidated Statement of Operations and Deficit
(unaudited)
--------------------------------------------------------------------------
Three months ended June 30 Six months ended June 30
----------------------------- ---------------------------
2008 2007 2008 2007
-------------- ------------- ------------ -------------
Revenue
Oil and
gas sales $ 59,838,652 $ 29,801,464 117,668,622 $ 54,265,280
Interest income 609,621 40,057 726,137 283,540
Royalties (14,955,541) (6,321,753) (28,886,998) (11,606,568)
-------------- ------------- ------------ -------------
45,492,732 23,519,768 89,507,761 42,942,252
-------------- ------------- ------------ -------------

Expenses
Production costs 11,453,121 10,948,973 30,336,956 21,081,407
Transportation
costs 1,003,274 1,074,032 2,200,605 2,073,150
General and
administrative 3,386,367 3,952,930 6,413,160 6,511,460
Depletion,
depreciation
and accretion 18,992,228 22,322,286 44,035,359 39,859,293
Stock-based
compensation 519,964 917,621 1,421,084 1,875,396
Interest 442,942 1,239,918 781,725 1,638,583
Change in
unrealized
loss of gas
pricing
contracts - - - 487,760
Foreign
currency
exchange
loss (gain) (1,026) 96,673 (36,711) 268,222
-------------- ------------- ------------ -------------
35,796,870 40,552,433 85,152,178 73,795,271
-------------- ------------- ------------ -------------

Other items
Gain on sale
of assets - (13,270,044) - (13,270,044)
-------------- ------------- ------------ -------------
- (13,270,044) - (13,270,044)
-------------- ------------- ------------ -------------

Income (loss)
before
income taxes 9,695,862 (3,762,621) 4,355,583 (17,582,975)
-------------- ------------- ------------ -------------

Income taxes
Future income
taxes
(recovery) 2,263,340 (3,120,243) 13,821 392,770
Income taxes
and capital
taxes 744,976 6,582,979 1,444,244 6,877,671
-------------- ------------- ------------ -------------
3,008,316 3,462,736 1,458,065 7,270,441
-------------- ------------- ------------ -------------

-------------- ------------- ------------ -------------
Net income
(loss)
for the
period 6,687,546 (7,225,357) 2,897,518 (24,853,416)
-------------- ------------- ------------ -------------

Deficit,
beginning of
period (246,309,940) (38,205,227) (242,519,912) (20,577,168)
-------------- ------------- ------------ -------------

Deficit,
end of
period $ (239,622,394) $ (45,430,584) (239,622,394) $ (45,430,584)
-------------- ------------- ------------ -------------
-------------- ------------- ------------ -------------

Basic and
diluted
income
(loss)
per share $ 0.04 $ (0.05) 0.02 $ (0.19)
Weighted
average
number of
common
shares
used in
computing
earnings
per share:
basic 189,241,716 133,935,248 189,241,716 132,479,881
diluted 189,241,716 133,935,248 189,241,716 132,479,881

See accompanying notes to consolidated financial statements


--------------------------------------------------------------------------
Consolidated Statement of Comprehensive Income (Loss) and
Accumulated Other Comprehensive Income
(unaudited)
--------------------------------------------------------------------------

Three months ended June 30 Six months ended June 30
----------------------------- ---------------------------
2008 2007 2008 2007
-------------- ------------- ------------ -------------
Net income
(loss) $ 6,687,546 $ (7,225,357) $ 2,897,518 $ (24,853,416)
Other
comprehensive
income, net
of tax
Items affecting
comprehensive
income - 750,000 - 750,000

-------------- ------------- ------------ -------------
Comprehensive
income (loss) $ 6,687,546 $ (6,475,357) $ 2,897,518 $ (24,103,416)
-------------- ------------- ------------ -------------
-------------- ------------- ------------ -------------

Accumulated
other
comprehensive
income,
beginning
of period $ - $ - $ - $ -
Other
comprehensive
income, net
of taxes - 750,000 - 750,000

-------------- ------------- ------------ -------------
Accumulated
other
comprehensive
income end of
period $ - $ 750,000 $ - $ 750,000
-------------- ------------- ------------ -------------
-------------- ------------- ------------ -------------

See accompanying notes to consolidated financial statements


PEARL EXPLORATION AND PRODUCTION LTD.

--------------------------------------------------------------------------
Consolidated Statements of Cash Flows
(unaudited)
--------------------------------------------------------------------------

Three months ended June 30 Six months ended June 30
----------------------------- ---------------------------
2008 2007 2008 2007
-------------- ------------- ------------ -------------
Operating
activities
Comprehensive
income (loss) $ 6,687,546 $ (6,475,357) $ 2,897,518 $ (24,103,416)
Items not
involving cash:
Mark to market
gain on
available-for-
sale financial
asset - (750,000) - (750,000)
Writedown
(recovery) of
accounts
receivable (189,597) 1,252,000 (189,597) 1,252,000
Gain on sale
of assets - (13,270,044) - (13,270,044)
Depletion,
depreciation
and accretion 18,992,228 22,322,286 44,035,359 39,859,293
Stock-based
compensation 519,964 917,621 1,421,084 1,875,396
Future income
tax (recovery) 2,263,340 (3,120,243) 13,821 392,770
Change in
unrealized loss
of gas pricing
contracts - - - 487,760
Foreign exchange
loss (gain) (1,026) 96,673 (36,711) 268,222
Abandonment costs (248,971) (811,338) (666,129) (811,338)
-------------- ------------- ------------ -------------
28,023,484 161,598 47,475,345 5,200,643
-------------- ------------- ------------ -------------

Changes in
non-cash
working capital
balances
related to
operations 3,165,847 (1,283,202) (10,558,937) (2,146,070)
Long term
accounts
receivable - - - 1,066,758
-------------- ------------- ------------ -------------
31,189,331 (1,121,604) 36,916,408 4,121,331
-------------- ------------- ------------ -------------

Financing
activities
Advances of
bank loan - 35,400,000 25,000,000 74,000,000
Repayments of
bank loan (20,000,000) - (20,000,000) (94,670,719)
Exercise of
stock options - 119,100 - 571,225
-------------- ------------- ------------ -------------
(20,000,000) 35,519,100 5,000,000 (20,099,494)
-------------- ------------- ------------ -------------

Investing
activities
Acquisition of
Cipher
Exploration Inc. - - - (8,809,049)
Acquisition of
Serrano shares - (2,500,000) - (2,500,000)
Proceeds from
sale of
investments - 10,000,000 - 10,000,000
Proceeds from
sale of assets 75,336,231 - 75,336,231
Additions to
petroleum and
natural gas
properties (17,604,874) (51,309,538) (35,117,226) (93,341,417)
Changes in
non-cash
working capital
from investing (13,664,741) 8,566,025 (32,185,352) 24,035,820
-------------- ------------- ------------ -------------
44,066,616 (35,243,513) 8,033,653 (70,614,646)
-------------- ------------- ------------ -------------

Net increase
(decrease)
in cash 55,255,947 (846,017) 49,950,061 (86,592,809)
Cash, beginning
of period (506,700) 5,311,410 4,799,186 91,058,203
-------------- ------------- ------------ -------------
Cash, end of
period $ 54,749,247 $ 4,465,393 $ 54,749,247 $ 4,465,394
-------------- ------------- ------------ -------------
-------------- ------------- ------------ -------------

Supplementary
Information
Interest paid $ 442,942 $ 1,185,719 $ 781,725 $ 1,602,360
Capital
taxes paid $ 651,554 $ - $ 1,009,957 $ -

See accompanying notes to consolidated financial statements


PEARL EXPLORATION AND PRODUCTION LTD.

Notes to the Consolidated Financial Statements

(unaudited)

1. NATURE OF OPERATIONS

Pearl Exploration and Production Ltd. (collectively with its subsidiaries, the "Company" or "Pearl") is listed and traded on the TSX Venture Exchange under the trading symbol "PXX". The Company is engaged in the business of oil and gas exploration and development in North America.

2. BASIS OF PRESENTATION

The interim consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: Pearl E&P Canada Ltd., Pearl Exploration and Production USA Ltd., Pearl Exploration and Production Montana Ltd., Newmex Energy (USA) Inc., Valkyries Texas Corp., and Valkyries Texas Gas Ltd. Both Cipher Exploration Inc. and Watch Resources Ltd. were amalgamated with Pearl E & P Canada Ltd. on January 1, 2008.

The interim consolidated financial statements for the Company have been prepared in accordance with accounting principles generally accepted in Canada, using the same accounting policies and methods of computation as set out in note 3 to the audited consolidated financial statements in the Company's Financial Report for the fifteen months ended December 31, 2007. The disclosures provided herein are incremental to those included with the audited consolidated financial statements. The interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the fifteen months ended December 31, 2007 and the interim consolidated financial statements for the quarter ended March 31, 2008.

3. CHANGES IN ACCOUNTING POLICIES

As disclosed in the December 31, 2007 annual audited Consolidated Financial Statements, on January 1, 2008, the Company adopted the following Canadian Institute of Chartered Accountants ("CICA") Handbook Sections:

- Section 3862 "Financial Instruments - Disclosures" and Section 3863 "Financial Instruments - Presentation", which replace Section 3861 "Financial Instruments - Disclosure and Presentation". The new disclosure standard increases the emphasis on the risks associated with financial instruments and how those risks are managed (See Note 14). The new presentation standard carries forward the former presentation requirements.

- Section 1535 "Capital Disclosures", The new standard requires the Company to disclose its objectives, policies and processes for managing its capital structure (See Note 12).

4. RECENT ACCOUNTING PRONOUNCEMENTS

As of January 1, 2009, the Company will be required to adopt the CICA Handbook Section 3064, "Goodwill and Intangible Assets", which will replace the existing Goodwill and Intangible Assets standard. The new standard revises the requirement for recognition, measurement, presentation and disclosure of intangible assets. The adoption of this standard should not have a material impact on the Company's Consolidated Financial Statements.

In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a strategic plan for the direction of accounting standards in Canada. As part of that plan, accounting standards in Canada for public companies are expected to converge with International Financial Reporting Standards ("IFRS") for fiscal periods commencing on or after January 1, 2011. The Company is assessing the potential impacts of this changeover and developing its plan accordingly.

5. INVESTMENTS



---------------------------
June 30, December 31,
2008 2007
---------------------------

Investment in Serrano Energy Ltd. ("Serrano") $ 5,500,000 $ 5,500,000
Asset-backed commercial paper ("ABCP") 3,862,895 3,862,895
---------------------------
$ 9,362,895 $ 9,362,895
---------------------------


The Company owns approximately 4.0 million shares of Serrano. On April 29, 2008 Serrano executed a subscription agreement which will change Pearl's ownership interest in Serrano from 37 percent to approximately 18 percent, this transaction has not closed as of June 30, 2008.

The Company holds an investment in ABCP as part of the Watch acquisition on October 19, 2007. Prior to the acquisition of Watch major participants in the third party sponsored ABCP market announced a proposed solution to the liquidity problem in the ABCP market. A restructuring plan was ultimately submitted to the Ontario Superior Court of Justice under the Companies Creditors Arrangement Act (CCAA) which was sanctioned on June 5, 2008. The restructuring plan is now currently under appeal and the Ontario Court of Appeal has not yet issued a decision on the matter. Should the restructuring plan be successful, the ABCP investment will be converted into notes with maturities matching the underlying assets. The notes will bear interest rates commensurate with the nature of the underlying assets including the cost of a margin funding facility.

At the time of the acquisition of Watch the Company determined that the estimated fair value of the ABCP was $1.1 million less than the face value. The valuation technique used by the Company to estimate the fair value of its investments in ABCP incorporates probability - weighted discounted cash flows considering the best available public information regarding market conditions and other factors that a market participant would consider for such investments. The Company has determined that no further adjustment is required at this time. However, continuing uncertainties regarding the value of the assets which underlie the ABCP, the amount and timing of cash flows and the outcome of the restructuring process could give rise to a further change in the value of the Company's investment in ABCP which would impact the Company's earnings.

6. PETROLEUM AND NATURAL GAS PROPERTIES



------------------------------------------------
June 30, 2008
------------------------------------------------
Accumulated
depreciation
and
Cost depletion Net book value
Petroleum and natural gas
properties $ 579,165,224 $ 139,983,506 $ 439,181,718
Office equipment 2,081,291 559,334 1,521,957
------------------------------------------------
$ 581,246,515 $ 140,542,840 $ 440,703,675
------------------------------------------------

------------------------------------------------
December 31, 2007
------------------------------------------------
Accumulated
depreciation
and
Cost depletion Net book value
Petroleum and natural gas
properties $ 623,916,051 $ 96,763,951 $ 527,152,100
Office equipment 1,520,287 319,847 1,200,440
------------------------------------------------
$ 625,436,338 $ 97,083,798 $ 528,352,540
------------------------------------------------


The depletion and ceiling test calculations have excluded the cost of unproved properties of $59.8 million (December 31, 2007 - $61.0 million) and included the cost of future development costs of $102.3 million (December 31, 2007 - $145.0 million).

7. BANK CREDIT FACILITY

The Company has a credit facility with a Canadian chartered bank which is comprised of a $37 million revolving 364-day extendible term facility, and a $10 million demand revolving operating facility. The Company may borrow, repay and re-borrow advances with the aggregated outstanding not to exceed the total credit facility. The facility bears interest at the bank prime rate payable monthly and is secured by a general securities agreement.

The facility is subject to annual reviews. The next scheduled review will take place on May 31, 2009.

8. ASSET RETIREMENT OBLIGATION

The total future asset retirement obligation was estimated based on the Company's net ownership interest in all wells and facilities, the estimated costs to abandon and reclaim the wells and facilities and the estimated timing of the costs to be incurred in future periods. The total undiscounted amount of the estimated cash flows required to settle the asset retirement obligations is approximately $27.6 million which will be incurred over the next 48 years with the majority of costs incurred between 2008 and 2025. A credit adjusted risk-free rate of 8 percent and an inflation factor of 1.5 percent was used to calculate the fair value of the asset retirement obligation.

Changes to the asset retirement obligation were as follows:



---------------------------
June 30, December 31,
2008 2007
---------------------------
Asset retirement obligation at beginning of
period $ 16,586,030 $ 3,772,479
Liabilities acquired through acquisitions,
net of dispositions (5,866,897) 9,822,642
Liabilities incurred during the period 498,509 2,987,539
Actual remediation expenses (666,129) (1,164,822)
Accretion 576,317 1,168,192
---------------------------
Asset retirement obligation at end of period $ 11,127,830 $ 16,586,030
---------------------------


9. RELATED PARTY TRANSACTIONS

During the six months ended June 30, 2008 the Company entered into the following transactions with related parties in the normal course of business, which are recorded at the exchange amount established and agreed to by the related parties:

(a) The Company paid $56,099 (2007 - $59,111) to Tanganyika Oil Company Ltd. ("Tanganyika") for administrative and other services. The Company and Tanganyika have certain officers and directors in common.

(b) The Company paid $45,000 (2007 - $nil) to Namdo Management Services Ltd. ("Namdo") for executive and support services pursuant to a services agreement. Namdo is a private corporation owned by Lukas H. Lundin, a director of the Company.

10. SHARE CAPITAL

(a) Authorized:

The Company is authorized to issue an unlimited number of common shares.



(b) Common Shares Issued:

Number of Shares Attributed Value
---------------- -------------------
Balance as at June 30, 2008 and
December 31, 2007 189,241,716 $ 723,121,821
---------------- -------------------

(c) Warrants Outstanding:

--------------------------------------------------------------------------
Weighted average
Number of whole exercise price
warrants per share
--------------------------------------------------------------------------
Balance as at June 30, 2008 and
December 31, 2007 4,091,800 $ 0.98
--------------------------------------------------------------------------


(i) Four million warrants were issued pursuant to the San Miguel acquisition in November 2005. Each warrant entitles the holder thereof to purchase an additional common share of the Company at a price of $1.00, exercisable from the date the San Miguel heavy oil project achieves an average daily producing rate of 5,000 barrels of oil per day, averaged over 30 consecutive days, until November 18, 2008.

(ii) In connection with the December, 2005 Palo Duro acquisition, the Company issued 270,000 warrants. This number was subsequently reduced by 66% to 91,800 when the vendor exercised a back-in right on March 3, 2006. Each remaining warrant provides the warrant holder with the right to receive an additional common share of the Company, within 75 days of September 15, 2008, for no additional consideration, if the average production rate per well drilled in the Palo Duro shale gas project is at least 1.5 million cubic feet equivalent per day, based on the initial 60 days of production. The number of warrants ultimately issued will be reduced pro rata to the actual average production rate if the actual average production rate per well drilled by September 15, 2008 is less than 1.5 million cubic feet equivalent per day.

11. STOCK-BASED COMPENSATION

The Company has a stock option plan (the "plan") for directors, officers, consultants and employees of the Company and its subsidiaries. A total of 18,924,172 stock options are authorized to be issued under the plan. Stock options have terms of two to five years, vest over periods of up to three years and are exercisable at the market prices of the shares on the dates that the options were granted. All of the options are subject to a four-month "hold" period.

The continuity of stock options issued and outstanding is as follows:



Number of Weighted Average
Options Exercise Price $
---------------- -------------------
Outstanding December 31, 2007 7,726,357 3.98
Granted 172,000 1.93
Cancelled (856,098) 4.21
Expired (1,321,667) 4.13
---------------- -------------------
Outstanding at June 30, 2008 5,720,592 3.84
---------------- -------------------


The following stock options were outstanding at June 30, 2008:



Options Outstanding Options Exercisable
------------------------------------------------------------------

Weighted- Weighted- Weighted- Weighted-
Range of Average Average Average Average
Exercise Exercise Life Exercise Life
Prices ($) Number Price ($) (Years) Number Price ($) (Years)
--------------------------------------------------------------------------
1.59 - 3.00 2,052,500 2.48 4.49 -
3.01 - 4.50 1,520,759 3.92 3.07 770,759 4.30 1.93
4.51 - 5.28 2,147,333 5.10 3.32 835,666 5.12 2.94
--------------------------------------------------------------------------
5,720,592 3.84 3.68 1,606,425 4.73 2.46
--------------------------------------------------------------------------


Compensation expense of $1,804,097, net of recovery of $383,012 for cancelled stock options, has been recorded in the Consolidated Statements of Operations and Deficit for the six months ended June 30, 2008 (2007 - $1,875,396). The fair value of common share options granted is estimated on the date of grant using the Black-Scholes option pricing model. The weighted average fair value of options granted during 2008 and the assumptions used in their determination are as noted below:



Six Months Ended
June 30, 2008
----------------

Weighted average fair value
of stock options granted (per option) $ 0.82
Expected life of stock options (years) 3.00
Volatility (weighted average) 61%
Risk free rate of return (weighted average) 3.04%
Expected dividend yield 0%


Contributed surplus continuity June 30, 2008 December 31, 2007
---------------------------------

Balance, beginning of the period $ 8,778,124 $ 4,791,060
Stock-based compensation 1,804,097 4,636,916
Stock-based compensation allocated
to contributed surplus as part of
Watch acquisition - 575,448
Recovery of expense on cancelled
stock options (383,012) (590,137)
Transfer to share capital on
exercise of options - (635,163)
---------------------------------
Balance, end of period $ 10,199,209 $ 8,778,124
---------------------------------


12. CAPITAL MANAGEMENT

The Company's capital management strategy is designed to minimize the use of long term debt and maintaining positive working capital. This strategy should provide the financial flexibility to fund the Company's capital program and profitable growth opportunities.

Financial covenants associated with the Company's credit facility are reviewed regularly and controls are in place to maintain compliance with these covenants. The Company complied with all covenants for the six months ended June 30, 2008.

13. COMMITMENTS AND CONTRACTUAL OBLIGATIONS

The Company enters into commitments and contractual obligations in the normal course of business, including the purchase of services, farm-in agreements, royalty agreements, operating agreements, transportation agreements, processing agreements, right of way agreements and lease agreements for vehicles.

The Company has a nine-year operating lease for office space.



---------------------------------------------------------------------------
Subsequent
2008 2009 2010 2011 2012 to 2012
---------------------------------------------------------------------------
Office rent $542,380 $1,084,760 $1,084,760 $1,152,557 $1,220,355 $4,576,331
---------------------------------------------------------------------------


The Company has contracted drilling rig services over the next two years. In the event that the Company does not utilize the minimum contracted days, the Company would be obligated to pay the rig operators a variable rate based on days not utilized under the contracts. Subsequent to quarter end the Company completed renegotiating the contract and the maximum commitment related to these contracts is approximately $4.2 million, which can be reduced by farm-outs to other operators.

14. FINANCIAL INSTRUMENTS

The Company does not utilize derivative instruments to manage risks. The Company is exposed to the following risks related to financial assets and liabilities:

(a) Commodity price risk

The Company is exposed to risks associated with fluctuating commodity prices. At this time, the Company does not use derivative financial instruments to manage its exposure to this risk.

(b) Foreign currency exchange risk

The Company is exposed to risks arising from fluctuations in foreign currency exchange rates and the volatility of those rates. This exposure primarily relates to: (i) certain expenditure commitments, deposits, accounts receivable, and accounts payable which are denominated in US dollars, and (ii) its operations in the United States.

(c) Fair values

The carrying amounts of financial instruments comprising cash, accounts receivable and accounts payable approximate their fair value due to the immediate or short-term nature of these financial instruments.

(d) Credit Risk

The Company's accounts receivable are with customers and joint venture partners in the petroleum and natural gas business and are subject to normal credit risks. Management believes that there is no unusual exposure associated with the collection of the receivables due to the size and reputation of the companies and to the continuing joint venture relationship.

(e) Interest Rate Risk

The Company is exposed to interest rate risk in relation to interest expense on its revolving credit facility.

15. SEGMENTED INFORMATION

The Company presently has one reportable business segment, that being oil and gas exploration and development. The Company's operations are carried on in the following geographic locations:



Three Months Ended June 30, 2008
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues, net of royalties 45,208,914 283,818 45,492,732

Expenses 35,255,324 542,572 35,797,896
Foreign currency gain (6,942) 5,916 (1,026)
--------------------------------------
Net income (loss) before income
taxes 9,960,532 (264,670) 9,695,861
Income taxes (recovery) 3,019,878 (11,562) 3,008,316
--------------------------------------
Net income (loss) 6,940,654 (253,108) 6,687,545
--------------------------------------
--------------------------------------

Segment assets 480,145,188 62,977,876 543,123,064
--------------------------------------
Segment petroleum and natural gas
Properties 385,191,972 55,511,703 440,703,675
--------------------------------------
Capital additions 11,713,508 5,891,366 17,604,874
--------------------------------------

Six Months Ended June 30, 2008
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues, net of royalties 88,845,179 662,582 89,507,761

Expenses 84,392,158 796,731 85,188,889
Foreign currency gain (11,288) (25,423) (36,711)
--------------------------------------
Net income (loss) before income
taxes 4,464,309 (108,726) 4,355,582
Income taxes (recovery) 1,460,989 (2,924) 1,458,065
--------------------------------------
Net income (loss) 3,003,320 (105,802) 2,897,517
--------------------------------------
--------------------------------------

Segment assets 480,145,188 62,977,876 543,123,064
--------------------------------------
Segment petroleum and natural gas
Properties 385,191,972 55,511,703 440,703,675
--------------------------------------
Capital additions 25,215,281 9,901,945 35,117,226
--------------------------------------

Three Months Ended June 30, 2007
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues, net of royalties 23,330,845 188,923 23,519,768

Expenses 40,214,337 241,423 40,455,760
Foreign currency loss 96,673 - 96,673
Gain on sale of assets - (13,270,044) (13,270,044)
--------------------------------------
Loss before income taxes (16,980,165) 13,217,544 (3,762,621)
Income taxes (recovery) (2,988,890) 6,451,626 3,462,736
--------------------------------------
Net loss (13,991,275) 6,765,918 (7,225,357)
--------------------------------------
--------------------------------------

Segment assets 581,178,300 39,613,292 620,791,592
--------------------------------------
Goodwill 159,863,578 - 159,863,578
--------------------------------------
Segment petroleum and natural gas
Properties 384,617,319 26,393,375 411,010,694
--------------------------------------
Capital additions 49,351,062 1,958,476 51,309,538
--------------------------------------

Six Months Ended June 30, 2007
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
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Total revenues, net of royalties 42,419,896 522,356 42,942,252

Expenses 72,568,796 958,253 73,527,049
Foreign currency loss 268,222 - 268,222
Gain on sale of assets - (13,270,044) (13,270,044)
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Loss before income taxes (30,417,122) 12,834,147 (17,582,975)
Income taxes (recovery) 818,815 6,451,626 7,270,441
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Net loss (31,235,937) 6,382,521 (24,853,416)
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Segment assets 581,178,300 39,613,292 620,791,592
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Goodwill 159,863,578 - 159,863,578
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Segment petroleum and natural gas
Properties 384,617,319 26,393,375 411,010,694
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Capital additions 87,566,854 5,774,563 93,341,417
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16. CONTINGENCIES

(a) In connection with the November, 2007 property acquisition from PetroHunter, the Company may be required to pay a performance payment of US $9.8 million in cash at such time as either: (i) production from the assets reaches 5,000 bopd; or (ii) proven reserves from the assets is greater than 50 million barrels of oil, if either condition is met prior to November 6th, 2010. The Company did not reach an agreement with a third party and therefore the performance payment was reduced and the contingent shares were not issued.

(b) Four million warrants were issued pursuant to the San Miguel property acquisition in November 2005. Each warrant entitles the holder thereof to purchase an additional common share of the Company at a price of $1.00, exercisable from the date the San Miguel heavy oil project achieves an average daily producing rate of 5,000 barrels of oil per day, averaged over 30 consecutive days, until November 18, 2008.

(c) In connection with the December, 2005 Palo Duro property acquisition, the Company has 91,800 warrants outstanding, entitling the holder to receive an additional Pearl common share within 75 days of September 15, 2008, for no additional consideration, if the average production rate per well drilled in the Palo Duro shale gas project is at least 1.5 million cubic feet equivalent per day, based on the initial 60 days of production. The number of warrants ultimately issued will be reduced pro rata to the actual average production rate if the actual average production rate per well drilled by September 15, 2008 is less than 1.5 million cubic feet equivalent per day.

17. SUBSEQUENT EVENTS

On July 16th, 2008 the Company announced that it had entered into an agreement to acquire an additional 30% working interest in 3,886 contiguous hectares of oil sands leases in its Blackrod project, located south of Fort McMurray, in the Athabasca Oil Sands region of northern Alberta. The acquisition is expected to close in August, 2008. The cost of the acquisition will be paid in increments with $4.5 million payable at closing; $4 million payable when the steam assisted gravity drainage ("SAGD") pilot achieves gross accumulated production of 100,000 Bbls; $4 million payable when full scale commercial development achieves 5,000 Bbl/d of production as reported to the Alberta government for one month; and $3 million payable when full scale commercial development achieves 10,000 Bbl/d of production as reported to the Alberta government for the duration of one month.

In July 2008, SemCanada sought protection under the Companies' Creditors Arrangement Act (CCAA). The Company uses SemCanada to market some of its oil and natural gas production and is exposed to approximately $500,000 in receivables relating to the period from June 1 to July 21, 2008. At this time it is unknown how much of that amount will be collectible.

18. COMPARATIVE FIGURES

Certain comparative figures have been reclassified to conform to the presentation adopted in 2008.

Pearl Exploration and Production Ltd. is a public company focused on delivering disciplined growth by establishing a North American portfolio of heavy oil projects with an emphasis on large resource opportunities. Additional information on Pearl is available on the Company's website at www.pearleandp.com.

Pearl's Certified Advisor on First North is E. Ohman J:or Fondkommission AB.

Forward-looking statements: This document contains statements about expected or anticipated future events and financial results that are forward-looking in nature and as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, the regulatory process and actions, technical issues, new legislation, competitive and general economic factors and conditions, the uncertainties resulting from potential delays or changes in plans, the occurrence of unexpected events, and the Company's capability to execute and implement its future plans. Actual results may differ materially from those projected by management. For such statements, we claim the safe harbour for forward-looking statements within the meaning of the Private Securities Legislation Reform Act of 1995.

Contact Information

  • Pearl Exploration and Production Ltd.
    Keith Hill
    President and Chief Executive Officer
    (604) 689-7842
    Email: khill@namdo.com
    or
    Pearl Exploration and Production Ltd.
    Sophia Shane
    Corporate Development
    (604) 806-3575
    Email: sophias@namdo.com
    or
    Pearl Exploration and Production Ltd.
    Randy Neely
    Chief Financial Officer
    (403) 716-4054
    Email: randy.neely@pxx.ca
    Website: www.pearleandp.com