BPZ Resources, Inc. Q2 2008 Earnings Call Transcript

| About: BPZ Energy (BZP)

BPZ Resources, Inc. (BZP) Q2 2008 Earnings Call Transcript August 12, 2008 10:00 AM ET

Executives

Greg Smith – Director of IR and Corporate Communications

Ed Caminos – CFO

Manolo Zuñiga – President and CEO

Analysts

Subhash Chandra – Jefferies

Neil Dingmann – Dahlman Rose

John Freeman – Raymond James

Tom Covington – Broadpoint Capital

Irene Haas - Canaccord Adams

Ron Sanchez – Spencer Edwards

Chris Pikul – Morgan Keegan

Ed Asuncion [ph]

Operator

Good morning and welcome to the BPZ Energy quarterly earnings call. This call is being recorded. At this time, I’d like to turn the conference over to Mr. Greg Smith. Mr. Smith, please go ahead.

Greg Smith

Good morning. Welcome and thank you for joining us this morning on our first and what will be a regular quarterly call. I’m Greg Smith, Director of Investor Relations and Corporate Communications here at BPZ. Present with me here on the call are Manolo Zuñiga, our President and Chief Executive Officer, Ed Caminos, our Chief Financial Officer and Heath Cleaver, our Corporate Controller.

Before we move on, I want to mention that this presentation contains certain statements that may be deemed to be forward looking statements. All statements, other than statements of historical facts including this presentation that address activities, events or future developments that BPZ’s management expects, believes or anticipates will or may occur in the future are forward-looking statements. Such statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond our control.

This presentation will be available on the company’s website following this call and the full forward-looking statement can be found on the company’s website, page 2 of every investor presentation.

First, Ed Caminos, our Chief Financial Officer, will give a brief review of second quarter results. He will then discuss our balance sheet and some comments on upcoming financings.

Manolo Zuñiga, Chief Executive Officer, will then give an update on operations in Northwest Peru. This overview will include an update on key elements of our business including our Corvina drilling operations and our production of oil in Corvina. Manolo will also give an overview of the Memorandum of Understanding recently signed with Shell as well as a brief operational update.

Following the presentations, we will be available for questions. We ask, however, that questions be asked initially by the analysts covering our stock, and if time allows, we will open the call for other questions. We have allotted approximately 45 minutes for this call.

I’ll now turn the call over to Mr. Ed Caminos.

Ed Caminos

Thanks Greg and good morning to everyone listening in to the call. I would like to take a few minutes to discuss BPZ’s second quarter results and financing activities.

For the second quarter, we generated $7 million in revenues. It is interesting to point out that we began selling oil again in mid June, subsequent to the January 31st, 2008 tanker incident. During the quarter we produced 81,766 barrels and sold 59,186 barrels. The average sales price, net of royalties, was approximately $119.00 per barrel.

Lease operating expense was $1.1 million or $19.27 per barrel and depreciation, depletion and amortization was $1.1 million or $18.28 per barrel. Second quarter lease operating prices per barrel were higher than expected due to partial production during the period.

G&A expense was $9.9 million. Included in G&A was $3.9 million related to non-cash stock-based compensation. The G&A increase was due to the continued ramp-up in our operational activities.

In addition, we had other Income of $700,000 which was derived from our 10% ownership in the Santa Elena property in Ecuador as well as interest income and a realized foreign currency gain primarily related to the early recovery of Value Added Taxes in Peru.

We incurred minimum income tax expense of $148,000 in Peru associated with the three months of oil sales under our extended well testing program. With all that said, we reported an operating loss of $5.2 million and a net loss of $4.7 million or $0.06 per share, basic and diluted.

Turning our attention to the Company’s financing activities during the quarter we closed the over-allotment of 200,000 shares of common stock, netting proceeds of $3.6 million. This over-allotment was in connection with our previously announced public offering of 2 million shares of common stock through a firm commitment underwritten offering in the first quarter of 2008 which netted proceeds of $37.6 million.

We also exercised our right to convert $15.5 million of debt with IFC, the International Finance Corporation by issuing 1.5 million shares of common stock. We have also been working diligently on securing a reserve based credit facility for up to $215 million with IFC and a large international bank and I am pleased to report that this is nearing a conclusion.

There will be two tranches in this facility. One is a $15 million senior debt piece for IFC’s account, and the other is a $200 million facility which will be underwritten and subsequently syndicated. We expect that the first tranche of $15 million will be closed later this week, with funding in approximately 30 days. These funds will be used to make the initial down payment for the manufacturing of three turbines for our gas-to-power plant, essentially kicking-off the project. The rate for this revolving credit facility is expected to be LIBOR plus 2 ½ to 3 points. The goal is to close the second tranche by early fourth quarter this year.

We are also negotiating an additional $120 million debt facility to fund the development of the gas to power project. We are negotiating the engineering procurement and construction contracts that will be conditions precedent to the credit facility. We anticipate closing the loan by year end 2008.

I will now switch from a quarterly discussion to a year-to-date discussion in line with our Consolidated Statement of Cash Flows, as reported. We are happy to report that we had positive cash flow from operations of $2.3 million. Again, I would like to re-emphasize, that we did not start selling oil until June of 2008. We anticipate our performance over the next quarter will yield even more favorable results. We incurred 48.8 million in CapEx during the six months ended June 30th. We incurred of that $14.2 million related to drilling and testing the 18XD well, which is currently producing oil and we also incurred approximately 10.9 million related to the current drilling on the 20XD well. We incurred $10.2 million related to the FPSO. Now that our FPSO is online, we anticipate enhanced operational performance which we expect will favorably impact production during the third quarter.

In addition, in February of this year, we acquired, under a capital lease, the BPZ-02 deck barge for $7.0 million to support our upcoming Albacora drilling operations. We also incurred $1.3 million related to performing well control and refurbishment activities at the Albacora platform. Finally, we incurred $1.3 million to support the continuation of our development initiatives associated with our gas-to-power project.

This concludes the financial portion of this call. Manolo will now give an operations update. Manolo.

Manolo Zuñiga

Thanks Ed. Good morning everyone and again thank you for joining us. First I want to update you on the drilling campaign in Corvina where we continue drilling the CX11-20XD well. As we have previously discussed, this well is the most challenging well to date for the company to drill. This highly deviated well, nearly 77 degrees, will cross more prospective sands than any other well we have drilled. We expect to cross both oil and gas zones, although initially this well would be completed as an oil producer. We will use a work over rig at a later date to dual complete the well.

The objective of this well is to reach the lowest known sands in the formation that our geologic models show could be oil bearing as they rise up dip above the water levels in the formation. As I mentioned, this is a complex well to drill and we will provide updates as soon as we have them available. Oil production in Corvina from the CX11 platform is progressing. We are still ramping up production as a result of commissioning the FPSO, which needed an additional flow line from the platform to the FPSO to allow us to fully ramp up production. That flow line has been installed and pending successful testing we expect to continue ramping slowly to approximately 5,500 barrels per day.

Once the 20XD well comes online in September, we expect to ramp up to between 7,000 and 8,000 bopd. This increase in production in September should allow the Company to meet the market’s expectation of 5,000 to 6,000 bopd average for the third quarter of this year. We have agreed to terms to purchase a double hull transport barge which should be in Peru by the end of the third quarter. This redundancy in the fleet is necessary to maintain flow rates in Corvina and to allow us for a seamless transition to Albacora.

As Ed mentioned in his comments, we are close to wrapping up the IFC senior debt financing. The closing of the first tranche of $15 million is significant as it is the first senior debt for the Company and will trigger the subsequent tranches as well as kick off the gas to power project. This senior debt financing is a key milestone for the company as it will show the market the Company’s ability to finance ongoing operations without accessing the capital markets especially now that we have signed an MOU with Shell whereby we will accelerate the appraisal of the oil assets.

Speaking of Shell, we continue negotiations on the final Farm Out Agreement. I would like to highlight a few of the details of the MOU signed with Shell. First of all it is important to point out is that BPZ remains the operator in the blocks involved in this partnership. Shell will invest $300 million in three phases to prove up sufficient gas reserves in Blocks Z-1, XIX, and XXIII for an LNG project, always taking into consideration the needs of the local market.

The main target is obviously the Mancora gas play, which we believe extends approximately 60 miles through all three blocks. This blanket formation has several wells that have tested gas or have previously drilled wells that have excellent shows in the logs that lead both BPZ and Shell to believe that this could be a significant gas play. We intend to drill the first well on this play in the Pampa la Gallina prospect located in Block XIX, and in tomorrow’s webcast presentation we will provide more details on this upcoming well.

While Shell invests to prove up gas reserves that normally take longer to put on production, BPZ will continue to develop its oil assets which is why we will go to Albacora right after Corvina. More details of the MOU can be found in our press release that is available on our web site. Regarding Albacora, our next oil project, I would like to announce that we have successfully controlled the three shut in wells at the platform and refurbishment is underway. We expect to be able to spud the first well in early 2009. The initial drilling program calls for at least two new wells, starting with a twin to the 8-X-2 well drilled by Tenneco in the 70’s that flow tested 4,600 bopd and 20 Mmcf of rich gas. After the initial drilling campaign, we will bring a work over rig to the platform to begin the work on the three wells previously drilled by Belco in the 80’s. Albacora is progressing as planned.

I would like to spend a few minutes touching on other operational activities. First I would like to say that the new onshore drilling rig is scheduled for delivery by year end or the beginning of 2009. To help expedite mobilization of supplies and crews to our operations, we have signed a 30 year contract to refurbish and operate a dock at Caleta Cruz. The dock will allow us to significantly cut down on delivery time of equipment to the offshore platforms as compared to our current point of origin for equipment in the port Paita, approximately 16 hours by barge from our operations.

The Caleta Cruz dock is approximately 2 hours from our platforms and will save the company approximately $700,000 annually in diesel fuel charges alone. BPZ will spend approximately $2 million to refurbish the dock which we expect to be ready by the middle of 2009. In addition to the double hull vessel mentioned earlier, we added another vessel to our fleet to serve as the tender assist barge in Albacora as mentioned by Ed.

Finally, I want to touch base on comments I have received regarding the insider trading activity. Recently we announced that the Company’s Board of Directors had approved the implementation of SEC approved 10b5-1 plans for certain insiders. A press release was issued that discussed four key Form 4 filers who put plans in place; myself, my father, Dr. Fernando Zuñiga y Rivero, Chairman of the Board; Frederic Briens, Chief Operating Officer; and Ed Caminos, Chief Financial Officer.

In that release we stated that these stock sales were being executed via the plan. These plans are put in place and once in place, are executed on behalf of the executives without input from them to avoid any issues with the SEC. My management team is fully committed to the success of this company. The sales of the shares are for the reasons stated in the release; to diversify personal holdings; to set up educational funds for our children; to make charitable contributions; estate planning; and portfolio diversity.

Each person on the senior management team with plans in place are divesting only a small fraction of the shares they own. The programmed sales are over the course of one year, and in no way should these sales give anyone the impression that there are issues with the company. Again, my management team is fully committed and you have my word on that.

In conclusion, before we go to questions, BPZ Energy is in the midst of building reserves, thus building an asset base for which the company will be, and should be valued. As such, it is interesting to note that we are currently trading at a discount to our 2P PV10 value from Corvina reserves alone. While production is important, it is reserve growth that will be the major factor in growing the company.

We are still only working in Corvina, one of 50 mapped prospects. We have an exciting opportunity with Shell that once we sign the final joint venture agreement, will give us a partner who can create a market for large gas reserves. We are building an excellent revenue stream from Corvina alone, that will keep the company from having to go to the market to fund our capital expenditures, and we are gearing up to drill in two new prospects next year so as to diversify our revenue streams. Step by step, we will continue to execute on our plan, and accelerate whenever possible.

Thank you for your time and your interest in BPZ Energy. Now I open the floor for questions.

Question-and-Answer Session

Operator

(Operator instructions) We’ll go first to Subhash Chandra with Jefferies.

Subhash Chandra – Jefferies

Yes. Manolo, could you outline second half CapEx, by quarter if possible?

Manolo Zuñiga

Well, we have in the presentation that we’re going to give tomorrow, we provide an outline, from – until the end of the year, we have about an additional $75 million of CapEx, and that is –

Subhash Chandra – Jefferies

I’m sorry, Manolo, that was the second half CapEx?

Manolo Zuñiga

Yes.

Subhash Chandra – Jefferies

Okay. I can wait till tomorrow, but if you had maybe some of the details, just curious on sort of breakdown of that CapEx between wells and infrastructure.

Manolo Zuñiga

Mostly, it’s in the current wells that we’re drilling that went sort of behind the schedule, and so with – then on the next well, that’s the -- most of the capital goes there. Then of course, it’s on getting the Albacora platform fully refurbished. We’ve been getting also in all of the materials for the well in both the Albacora well and the Block XIX well.

And also we are starting to work on the Piedra Redonda platform as we will meet to drill a well in that one which will target gas sometime next year. And then with some other logistics issues, including for example the repair of the Caleta Cruz dock that we have contracted nowadays and so on. But the two main things are the Corvina well, that is still ongoing and they’ve -- through all its completion and then the next well. Those are the key.

We have also, Subhash as you know, we mentioned in the presentation the IUC financing is imminent. This initial tranche of $50 million will be used to put the down payment on the three turbines that we’re buying from GE.

Subhash Chandra – Jefferies.

And on that point, all this additional liquidity have – so how do you see, I guess the 15 will be taken down day one, how do you see yourself progressing to the 200 and 120 to 2009, do you think that all that’s committed by year-end ’09?

Manolo Zuñiga

Yes. That’s probably correct. We intend to have both financings closed by the end of the year and the monies would be coming in almost immediately. The one of the power project is more dependent on the timing on construction and half of the cost is of course, you have to build the turbines from GE and then the other is the construction of the gas pipelines, the gas plant and then the actual construction of the power plant. And that’s also timed, but it goes through the whole year. The intention is to have the power plant ready by, I’m going to say, second quarter 2010 at the latest.

Subhash Chandra – Jefferies

And one final one for me, so what do you think on the power plant used to be I guess the turbines themselves had to be back ordered, there was delays there. Has that used up and what do you see as sort of the major constraints on getting the project done in time?

Manolo Zuñiga

This is why we would like to sign the agreement with GE as soon as possible. We’re talking about in the next few weeks to have it signed. That way, we enter the Q [ph] and then by 18th of next year, by November, they are scheduled to be delivered and then it takes only a few months to put everything together. By that time, the base of the power plant is all set up, so that’s why I am talking about end of the first quarter or early second quarter of 2010 to have it ready.

Ed Caminos

Subhash, this is Ed Caminos. One last comment on that as well is that in the $15 million portion of the credit facility, we were allowed to cross lend to the gas and power company in order to put down the payment necessary to kick off that manufacturing of those turbines.

Subhash Chandra – Jefferies

Okay, got it. Thanks.

Operator

Our next question is from Neil Dingmann with Dahlman Rose.

Neil Dingmann – Dahlman Rose

Good morning guys.

Manolo Zuñiga

Hello Neil.

Neil Dingmann – Dahlman Rose

First question, as far as infrastructure, Manolo, you went over a good bit of this. But just wondering as far as now, I know you’ve added some things to the platform at Corvina, just wondering where you said -- if you’re all set now as far as a few things. One, where you said around the platform and production, as far as current Corvina, when you move over to the Albacora, what type of infrastructure – how does that sit? And then back over again after you’re done over there, back to a second Corvina platform, was wondering if you'll just update on the infrastructure overall.

Manolo Zuñiga

Just to give you an idea, and tomorrow we are going to have a nice table showing the production records and our views for the current quarter. We are producing about 4300 barrels per day up to 4500, (inaudible) but we have only one production line. We’ve seen a lot of bad pressures which limits the production and the stable line is finally in today were supposed to be tested and like tomorrow or Thursday, we’ll be using it. We should see an increase in production, as I mentioned in my presentation, to up to 5500 barrels a day or something like that.

It is difficult to predict always, these are new wells. But this is – as you can imagine, an excellent cash flow for us, so it takes – take enough extra time to set everything up. We’re still in the process of doing the final checking from the FPSO. There’s always little things that you have to adjust here and there.

One of the issues that we’ve been having also is the transportation of the oil to the refinery. Sometimes, there is a backlog of tankers waiting to deliver oil in the refinery and that then delays our going back to the platform, and then we have to curtail somewhat the production because our FPSO then gets full of oil. That’s why, we’re bringing the second double hull tankers and as such, we will have, between the FPSO and the two transportation barges, about 120,000 barrels of storage capacity. This will give plenty of capacity to maintain production constant.

All of these things that we’re seeing in Corvina, we intend to apply in Albacora. Corvina being a great learning experience for us. In Albacora, as soon as we drill the first well, we intend to put it on production and we’re going to use the same concept. We’re going to bring a transportation barge and bring – put a line immediately and start producing right away. So, a lot of the things that we are seeing in Albacora, we intend to apply in Albacora and do it better and more efficiently. And the intent is to continue doing that as we target other assets.

Neil Dingmann – Dahlman Rose

Very good. And then wondering over on now the 20 and then after you move to the 15, will you just test just the lower zones of each of those or how much test you want on those two wells?

Manolo Zuñiga

The idea is to test the lower zone, the lower sands which are unknown. So, that’s the key concept and then to put on production the remaining zones. So we are still almost there. It’s taking us longer to drill this well but we should get there soon enough.

Neil Dingmann – Dahlman Rose

And then do you anticipate going forward on any type of hedges?

Manolo Zuñiga

Not yet, given that it’s a brand new field with only a handful of wells, anything can happen in one well and then you’re committed to certain hedges. It is difficult. Fortunately for us, the IFC financing is not requiring any type of hedge. They understand this issue. They understand also that fact that we have a very focused production in one platform. This is why the need for us to expand our projects and go to Albacora, Delfin, Block XIX, and try to bring revenues from other sources is key, which I will diversify. There’s always an inherent risk of having just one production coming from one place, as you will know, Neil. And this is why the Shell deal is so good, because in the next few years, Shell will put in the money to upgrade gas reserves and as you will know, they take time to develop. Meanwhile, we are taking care of the oils and putting it into production as fast as we can. So it is a great deal for us.

Neil Dingmann – Dahlman Rose

All right guys, let's put on activity.

Manolo Zuñiga

Thank you.

Operator

Our next question is from John Freeman, Raymond James.

John Freeman – Raymond James

Good morning guys. First question I have is kind of a follow-up to Subhash’s comments on cutbacks. When do you anticipate being able to provide ’09 kind of cutbacks plans?

Manolo Zuñiga

We are working on that right now and actually, I am going back to Peru next week and have a meeting with my technical team. We’re trying to not only finalize the ’09 budget but we’re working on this 4 or 5 year plan which is extremely important for us. As I have mentioned on the Shell MOU, it is divided in three phases. It is a total of 12 wells we’re going to be drilling targeting gas. In two of those 12 wells, we’re going to also target the deepwater prospect in the Z-1 block, but we also have to appraise our oil access in Corvina, Albacora, Delfin, and Mero in the eventuality that there is enough gas for an LNG project. We then try to align the partnership by selling half of our oil reserve to Shell. So, therefore, we better have all of these properly appraised in the next five years, and that’s what I am working on right now trying to get all of these in place. As you can imagine, the amount of ramping up on production that we’re going to have on operation, I should say, by adding additional platforms, additional drilling rigs, and so on.

John Freeman – Raymond James

Okay. And then on the 20 XD, I’m not trying to hold you to specific dates or anything, but just in terms of conceptually thinking about how the well plays out in terms of getting the total depth whether it’s in a couple of weeks or what have you, and then the drill stem test, and then opening up the more shallow zones, just ballpark kind of timeframe, what can you add and how that plays out?

Manolo Zuñiga

We’re thinking that by September, we should have the well on production and we’re confident on that. There’s always a risk associated with completing a well. Some of these people that have followed us from the beginning know that, for example, in our first well the 21 XD, after cementing, we had a gas kick and then my guys took two months to get things in order to be able to finally test the well or not. So, there’s always things associated with finishing a well. I always tell people that, no rest till a well is on production, I am not at ease. The intent is to finish drilling, the testing, the completion, and then by early September have it on production.

John Freeman – Raymond James

Okay. And then, last question I have for Ed and I apologize if I missed this, but what is the cost on refurbishing the Albacora platform?

Ed Caminos

The Albacora platform refurbishment should be approximately $5 million. Included in that number is also the well control for pre-shutting wells, which we have completed.

John Freeman – Raymond James

Great. Thanks guys.

Ed Caminos

Thank you.

Operator

We’ll go next to Tom Covington with Broadpoint Capital.

Tom Covington – Broadpoint Capital

Good morning everybody. A question for you Manolo, it sounds like you are well satisfied with the performance of the first three wells, not talking about the reservoir’s performance, it’s just a matter of getting the installation of the second flow on in there, as well as getting the 20 XD on line is really going to impact near term production. Is that sort of a good fair assessment?

Manolo Zuñiga

It is. And the plan for us is to then go and drill the following well, and then we have – don’t forget to bring our work-over rig to work over that 18 XD where we had some cementing issues in the lower sands where we see a water channeling from below and we see it now. That well – I would tell people, we’re not producing from three wells. We are basically producing from two and a third [ph] well probably because the 18 XD has half of the sands trapped below and then water channeling from below that, it always impacts your production. Once we do that, plus the 15 XD, plus the 20 XD, the idea of maintaining as we have mentioned next year, about 7000 barrels of production is very good.

Tom Covington – Broadpoint Capital

And remind me again of the upside on the 20 XD in terms of lower sands, what are you looking at, what’s the upside there in terms of oil in place you’re looking at?

Manolo Zuñiga

We’ve been looking at something in the order of 20 million of oil in place according to a model. And this, of course, assumes that there’s no water there and the sand quality is the same.

Tom Covington – Broadpoint Capital

Okay. I’ll add one final question on the G&A. How do you look going forward in terms of how do you want us to model going forward?

Ed Caminos

Obviously, as continue to ramp up our operations and continue to take on more and more projects, G&A should – it naturally will continue to progress along with that. Not to the extent that we’ve seen over the past year to year-and-a-half. Obviously, we went from zero to where we are today rather quickly. In Houston, it will be limited growth. Obviously, Peru will be the location of that G&A growth. So I would say to look at our current year numbers and increase those by 10% to 15% over the next year so it would be good.

Tom Covington – Broadpoint Capital

Okay. Thank you very much gentlemen.

Ed Caminos

Thank you.

Operator

We’ll go next to Irene Haas of Canaccord Adams.

Irene Haas - Canaccord Adams

Yes, hi. A quick question on the double hull tanker, what is the size of it? And secondarily, when you get to Albacora, you’re going to produce right away, are there any associated gas and if yes, how do you treat that? And then thirdly, just a straight forward question on G&A, should we assume this quarter’s G&A for the second half of the year, similar lease operating expense, what would the per unit cost be in DD&A? So, three questions.

Manolo Zuñiga

On the first one, Irene, the double hull barge is 45,000 net of oil and it looks brand new if that’s finishing its five year dry bulking and so it’s a beauty, and comes with its own tug boat. So it’s a whole package.

In Albacora, the plan right now, as I mentioned is, once we drill and test, immediately we will set up a line and sort of repeat what we have in Corvina that we know now we have done it once and put the line into an equivalent (inaudible) and then with its own transportation barge. In Albacora, as you always have while drilling and testing wells, you'll have your own testing equipment as a platform. And the testing equipment also allows you to flare the associated gas.

In Corvina, we just recently removed all of the testing equipment, now that we have the FPSO that has all of the production equipment on top of that barge. So, we go on a – steps, as always. So in Albacora, we drill and we will have in the second deck all of the testing equipment that will allow us to flare the associated gas. And then once we – and then we can take the oil into the transportation barge to the refinery. Eventually, it’ll have its own FPSO and what we’re looking at is in the future, they maybe bringing a much bigger tanker that will pick up oil from both the Albacora and Corvina platforms at the same time.

Irene Haas - Canaccord Adams

Okay, great. And then the cost structure question.

Manolo Zuñiga

And then on G&A, here is Ed and he’s telling -- nodding their head that, yes, that’ll be a good –

Ed Caminos

Yes, Irene, sorry, this is Ed. I think the two questions were G&A and LOE?

Irene Haas - Canaccord Adams

Yes.

Ed Caminos

On G&A, we are using – what we’re looking at is basically averaging out the six months of this year and use that as the second half projection.

Irene Haas - Canaccord Adams

Okay. So it’s about $9 million for the first half, right, not counting the non-cash?

Ed Caminos

Right.

Irene Haas - Canaccord Adams

Okay. So, you’re saying that second half you are going to spend $9 million on G&A, then how about lease operating, and DD&A on a per unit basis?

Ed Caminos

On the LOE, we would expect that to come down over the second half of the year, obviously, as we ramp up and maintain a higher production. Again as we mentioned earlier on the call, we only had partial production during Q2, really during the month of June. So, we would expect that number to come down a substantial amount during the second half of the year. I don’t have that calculation number at hand at the moment. On DD&A, that number will come down a bit but not as drastically or significantly as LOE until we obviously bring on more reserves both from oil and gas.

Irene Haas - Canaccord Adams

Okay. That’s great. Thanks.

Operator

(Operator instructions) We’ll go to Ron Sanchez with Spencer Edwards.

Manolo Zuñiga

Hello.

Ron Sanchez – Spencer Edwards

Yes, sir.

Manolo Zuñiga

Hello.

Ron Sanchez – Spencer Edwards

Yes. Manolo, I was just wondering what is the – on your current oil sales, what kind of price are you getting and how expensive is the transportation costs? One question, and also, I was just wondering what kind of reserves are you looking at for Corvina by the time you’re finished.

Manolo Zuñiga

Right now, the transportation cost is probably in the order of about $3 per barrel, that’s how much it’s costing us to take the oil. In the oil price that we get, there is a discount averaging about $10 from West Texas Intermediate and this is an average from the beginning of the year. And our crude oil is based on a basket of crude oils which consists on Oman, Suez and Fortis, which are sometimes more related to Brent than West Texas. For example, when West Texas was dipping quickly in the last couple of weeks, our oil was almost the same as West Texas Intermediate. But, on average, you can assume $10 just to be on the safe side.

Ron Sanchez – Spencer Edwards

I see. And what kind of gas reserves do you think you’re going to end up with off Corvina alone?

Manolo Zuñiga

On gas reserves, we still have to drill down deep wells that will add additional reserve. Right now, we are talking about something in the order of 300 Bcf and my expectation is to be able to go to somewhere in the order of 350 Bcf in the future, and that is to sustain our power project for more than 20 years. A note on oil, we have already the certification done on a 2P [ph] basis in the order of 38 million and then it has a possible component which is very dependent on the possibility that an aquifer will kick in and help sweep the oil very nicely, and as such increasing the recovery factor from 25% to 40%.

Ron Sanchez – Spencer Edwards

Sure, thank you sir.

Ed Caminos

Ron, just one quick follow-up comment on the transportation cost, the $3 to $4 number that Manolo mentioned. That is under a 6000 to 8000 barrel per day scenario, which as we mentioned, we are expecting to ramp up to that towards – during the second half of this year. Obviously, with limited production during the last quarter, those costs per barrel will be higher.

Ron Sanchez – Spencer Edwards

Okay.

Operator

And we have a question from Chris Pikul, Morgan Keegan.

Chris Pikul – Morgan Keegan

Hey Manolo, can you just confirm to us what you’re seeing as far as the drilling of the 20XD and is that confirming to the model and the potential for the lower oil gas contract or oil well reserves [ph]?

Manolo Zuñiga

We have tapped into the Zorritos formation. From a structural point of view, the model is working very good and we have yet to go through the plan to see what we see there right now. We have seen some of the gas sands above as we expected, that is fairly now due to same work [ph].

Chris Pikul – Morgan Keegan

Can you just discuss briefly that the potential of North Albacora, I mean, that’s up to 350 million barrels of 3P.

Manolo Zuñiga

Yes, we’ve been doing a lot of geologic modeling in Albacora. We were using a lot of the things that we learned in Corvina. For example, the fact that you have low resistivity sands in Corvina, I always like to point that we have tested gas for example from sands that have very low resistivity, which means that these are low resistivity sands with good potential. In Albacora, we see the same effect, very interesting, because the amount of additional pay that you could end up with is substantial. And then we’ve been working on the understanding of the deposition [ph] environment and all of that points to the possibility of having something very interesting.

In the 8-X-2 well, the well drilled by Tenneco and has tested so much oil and gas, if you look at the presentations that we’ve been showing in the last few conferences, those tests came only from the top third part of the section. The lower-two-thirds were not tested at all, and in many cases, it has even more resistivity than the ones above and the middle sands which the oil shows. So it’s something that is extremely exciting for us and that’s why we are drilling the twin to 8-X-2 and then fully test the entire section.

Chris Pikul – Morgan Keegan

Great, thank you.

Operator

Ladies and gentlemen, we will take our final question from Ed Asuncion [ph], a Private Investor.

Ed Asuncion

Good morning gentlemen. I want to make I understand the MOU, so do I understand correctly that there are some costs that you’re going to spend the CapEx in ‘08, that if in fact you were to enter into the agreement with Shell as currently contemplated, those would end up getting partially reimbursed to you, such as the Albacora refurbishment?

Manolo Zuñiga

Yes, although we don’t expect to finalize the agreement until the end of the year, it’s going to happen effective date of – right now and the reason is that we are already working on the Block XIX well and the Albacora well, and they need to absorb all of those costs. The effective date is going to be just about July basically. The Albacore fact is very interesting. We have a model that shows that we would encounter an intercalation of oil and gas sands and we are hoping more prevalence in the oil than the gas. They want to see the possibility that the gas – the potential gas reserves are significantly in the lower Zorritos and they proposed to us to join venture on that first well and provide -- they will put half of the money for the refurbishment of the platform and the drilling of the first well, and then we will split the gas half and half, but we will keep 100% of the oil, and I like the idea.

Ed Asuncion

Yes.

Manolo Zuñiga

And then the MOU is truly significant and I want to make a point on this. Shell, which is one of the biggest companies in the world, comes into Peru once again after 10 years. I took the gas from the Shell two weeks ago to Peru to meet with the President of Perupetro with the minister and also we had a press conference. The day we had the meeting with the minister and Perupetro was exactly 10 years and 1 day since they had left Peru. It was a very emotional, getting back home sort of meeting, and they made their point and the guys from Shell were very specific. They said, we are coming here because we’ve seen that there could be something big, otherwise we will not be here. And we are trusting BPZ to continue running the operations because we see that they run operations like we do. Their involvement in the project is a testament of our technical abilities and of course the potential of the field.

Now, having that many, many times for the last few years, we are going to bring our partner to the table, and I always say in all our presentations that we are looking for a strategic partner, somebody that understood gas, understood the marketing of gas, understood deepwater drilling, understood environmental issues, understood social issues. And so, all of these are extremely important, you can have a bundle of gas and you don't handle your social issues correctly, you won’t be able to get in or out, and you Ed, know that pretty well and all of the analysts as well.

So Shell, we have been discussing this project with them for more than a year, so they have done a very thorough review of all of the data. They have had access to all of the information and they believe, as we do, that there could be a potential. And I would like to emphasize the word potential. We still need to drill the well. So, this first well in Block XIX is going to start tapping into these. Next year, we go into Piedra Redonda, the offshore field that already tested gas and then we go down in Block XXIII and do a twin to the Z-1 [ph] that also shows a lot of pay but was never tested. With these three wells, it’s going to tell us a lot about this gas potential, so Shell is putting all of that money for the gas. We are not putting a penny ourselves because this is something that will not bring revenues for a while. Meanwhile, we are dedicating our effort to appraise our volume and put it on production as fast as we can. And eventually, we will do a full alignment and they will come in into the oil and maybe also into the power project.

They understand also the importance of the power project. Even the minister, while at a meeting asked me, Manolo, when is your power project going to be ready because in Peru, they are having trouble with supply right now. This deal with Shell is extremely, extremely important. We are going to add 3-D Seismic on the offshore with some more 2-D Seismic on the onshore. The 3-D Seismic in the offshore especially very important for us, as you can imagine, so all of that pay under this MOU.

The MOU is in phases of course, you cannot commit a company to invest $300 million in one shot. Everything takes time, so we have set it up in phases. So it is the first phase, which means the first few wells are successful, we go into the second phase, and if that is successful, we go into the third one at which time they will (inaudible). There should be enough gas here. We will venture into the LNG project. We will have the option to participate in the LNG plant and then they take the gas FOB but we will have access to the optimum price of gas in the international market and that is something that they bring to the table. And they actually want to make sure that we enjoy that benefit. So it is a truly excellent arrangement between the two companies.

Ed Asuncion

Thank you. That’s very helpful. But just to bring this down to some numbers, out of the $35 million of CapEx that you’d previously spent for the second half, can you give us an idea of what portion of that might then be effectively reimbursed to BPZ upon signing the definitive agreement?

Manolo Zuñiga

It won’t be too much because basically some of the cost on the Albacora platform is refurbishing, so we are talking about $2.5 million maybe for us to be refurbished. And by that time, we have yet to start drilling in Block XIX and so we will probably have – and the drilling rating in Block XIX that it’s been built out by (inaudible). We do not have to put any money down until the last minute when we have to mobilize the rig, so all together maybe we might get back about $9 million [ph], so it’s not a huge amount of money initially. Next year, that first well in Block XIX, it goes into their full account. They pay for all of that and they will be paying for half of the well in Albacora. Also, that alone helps quite a bit. Then in Albacora, we continue our appraisal for the oil. Once we test oil and gas, they’re going to be happy with that and then we continue our appraisal on the oil sand from then on at our own expense. That we will be putting on production also right away.

Ed Asuncion

Okay, thanks.

Manolo Zuñiga

And Albacora, something important to mention is this is a 36-38 API oil. This is very light, very sweet, very nice oil. We won’t have a discount.

Ed Asuncion

Yes, okay. Thank you. Two other questions on other matters – quick questions. Royalties, how are you reflecting royalties in your P&L? I don’t see a separate line for them.

Ed Caminos

This is Ed Caminos. The royalties are netted against the revenue numbers, so the line item revenues there is net of royalties.

Ed Asuncion

Okay, that is kind of what I thought, thank you. And then if you work to you’re your production goals and if oil were to stay at the current strip price, when do you expect to become a current income tax payer in Peru?

Ed Caminos

We’re working on that -- our tax strategy now. Although we do have a large NOL in Peru which we anticipate using over the next couple of years anyway. So I don’t have an exact number for that, we’re still working through those scenarios with our tax advisers in Peru as well, but again it should not be very long.

Ed Asuncion

Okay, thank you very much.

Operator

Ladies and gentlemen, that does conclude the question-and-answer session today. At this time, Mr. Smith, I will turn the conference back to you for additional or closing remarks.

Greg Smith

I just want to thank everybody for attending and let us know if you have any follow-up questions, you can reach me by e-mail at greg_smith@bpzenergy.com and we will do our best to turn those back around to you as quickly as possible. Again, thank you for your cooperation and your attendance.

Operator

That does conclude today’s conference. Thank you for your participation. You may disconnect at this time.

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