UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

MISSION RESOURCES CORPORATION

(713) 495-3000
Registrant’s telephone number, including area code

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]  No [   ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  [   ]  NO [X]

As of November 8, 2004, 40,967,937 shares of common stock of Mission Resources Corporation were outstanding.

MISSION RESOURCES CORPORATION

INDEX

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MISSION RESOURCES CORPORATION

ITEM 1. Financial Statements

MISSION RESOURCES CORPORATION

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands)

See accompanying notes to condensed consolidated financial statements

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MISSION RESOURCES CORPORATION

CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share information)

See accompanying notes to condensed consolidated financial statements

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MISSION RESOURCES CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except per share information)

See accompanying notes to condensed consolidated financial statements

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MISSION RESOURCES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

See accompanying notes to condensed consolidated financial statements

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MISSION RESOURCES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)

(Amounts in thousands)

See accompanying notes to condensed consolidated financial statements

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MISSION RESOURCES CORPORATION

1. Summary of Significant Accounting Policies

     The accompanying unaudited consolidated financial statements have been prepared in accordance with instructions to Form 10-Q and, therefore, do not include all disclosures required by accounting principles generally accepted in the United States of America. However, in the opinion of management, these statements include all adjustments, which are of a normal recurring nature, necessary to present fairly Mission Resources Corporation’s (the “Company” or “Mission”) financial position at September 30, 2004, and the results of operations and changes in cash flows for the periods ended September 30, 2004 and 2003. Interim period results are not necessarily indicative of results of operations or cash flows for a full year. These financial statements should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

Principles of Consolidation

     The consolidated financial statements include the accounts of Mission Resources Corporation and its wholly owned subsidiaries. Mission owns a 26.6% interest in the White Shoal Pipeline Corporation that is accounted for using the equity method. Mission’s net investment of approximately $229,550 at September 30, 2004 is included in the other assets line of the Consolidated Balance Sheet.

Oil and Gas Property Accounting

     The Company uses the full cost method of accounting for its investment in oil and gas properties. Under this method of accounting, all costs of acquisition, exploration and development of oil and gas reserves (including such costs as leasehold acquisition costs, geological expenditure, dry hole costs, tangible and intangible development costs and direct internal costs) are capitalized as the cost of oil and gas properties when incurred. To the extent that capitalized costs of oil and gas properties, net of accumulated depreciation, depletion and amortization, exceed the discounted future net revenues of proved oil and gas reserves net of deferred taxes, such excess capitalized costs would be charged to operations. No such charges to operations were required during the three and nine month periods ending September 30, 2004 or 2003.

Royalties Payable

     The accrued liabilities line of the Consolidated Balance Sheet includes approximately $3.0 million of royalties that are awaiting completion of title opinions. Upon receipt of the title opinions and executed division orders, Mission will be required to make payment. Since June 30, 2004, Mission has made payments and reduced the June 30, 2004 balance of $4.6 million to the $3.0 million balance at September 30, 2004. This liability may increase in size as the well produces or decrease as title opinions are completed and royalties paid. Typically, royalties are paid within one to two months after the production is sold.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

Receivables

     Joint interest receivables are recorded at the invoiced amount and typically do not bear interest. The Company reviews collectibility of such receivables monthly. Balances over ninety days past due and exceeding $30,000 are reviewed individually for collectibility. Account balances are charged against earnings when the Company determines the potential for recovery is remote. During the three months ended September 30, 2004, no such receivables were charged against earnings; however, during the nine months ended September 30, 2004, approximately $399,000 of such receivables were charged against earnings. The income charge is included in the interest and other income line of the Consolidated Statement of Operations. The Company does not have any off-balance sheet credit exposure related to its customers.

     From time to time, certain other receivables are created and may be significant. The Company had recorded a receivable of approximately $1.5 million from a private oil and gas company representing six months of override revenue. On November 8, 2004 the Company received $1.5 million as full payment of this receivable.

Comprehensive Income

     Comprehensive income includes all changes in a company’s equity except those resulting from investments by owners and distributions to owners. The Company’s total comprehensive income for the three months and nine months ended September 30, 2004 and 2003 was as follows (in thousands):

     The accumulated balance of other comprehensive loss related to hedge accounting is as follows (in thousands):

Stock-Based Employee Compensation Plans

     At September 30, 2004, the Company has two active stock-based employee compensation plans: the 1996 Stock Incentive Plan and the 2004 Stock Incentive Plan. The 2004 Plan was approved by the Board of Directors on March 4, 2004 and by the Company’s stockholders at the May 19, 2004 annual stockholders’ meeting. One inactive plan, the 1994 Stock Incentive Plan,

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

still has options outstanding that have not expired or been exercised; however, no new options can be granted under the plan. The Company accounts for the plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income for options granted under those plans when the exercise price of the option is equal to the market value of the underlying common stock on the date of the grant. Net income would be affected; however, if the exercise price of the option differed from the market price.

     SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, amends SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation and to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. SFAS No. 148 amends APB Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim financial information. Had compensation cost for the Company’s stock option compensation plans been determined based on the fair value at the grant dates for awards under these plans consistent with the method of SFAS No. 123, the Company’s pro forma net income (loss) and pro forma net income (loss) per share of common stock would have been as follows:

Recently Adopted Pronouncements

     Staff Accounting Bulletin (“SAB”) No. 106, regarding the application of FASB Statement No. 143, Accounting for Asset Retirement Obligations, by oil and gas producing companies following the full cost accounting method was issued in September 2004. SAB 106 provided an interpretation of how a company, after adopting Statement 143, should compute the full cost ceiling to avoid double-counting the expected future cash outflows associated with asset retirement costs. The provisions of this interpretation have been applied by the Company and have no financial impact.

     The FASB issued Interpretation No. 46 (R ), Consolidation of Variable Interest Entities, an interpretation of APB No. 51, in January 2003. This interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the interpretation. The interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The Company does not own an interest in any variable interest entities; therefore, this interpretation does not have any effect on its financial statements. The provisions of this interpretation will be applied in the future should Mission acquire or establish a variable interest entity.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

Asset Retirement Obligations

     In July 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which provided accounting requirements for retirement obligations associated with tangible long-lived assets. SFAS No. 143 requires that the Company record a liability for the fair value of its asset retirement obligation, primarily comprised of its plugging and abandonment liabilities, in the period in which it is incurred if a reasonable estimate of fair value can be made. The liability is accreted at the end of each period through charges to operating expense. The amount of the asset retirement obligation is added to the carrying amount of the asset and this additional carrying amount is depreciated over the life of the asset. If the obligation is settled for other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement.

     The Company adopted the provisions of SFAS No. 143 with a calculation effective January 1, 2003. The Company’s assets are primarily working interests in producing oil and gas properties and related support facilities. The life of these assets is generally determined by the estimation of the quantity of oil or gas reserves available for production and the amount of time such production should require. The cost of retiring such assets, the asset retirement obligation, is typically referred to as abandonment costs. The Company hired independent engineers to provide estimates of current abandonment costs on all its properties, applied valuation techniques appropriate under SFAS No. 143, and in 2003 recorded a net initial asset retirement obligation of $44.3 million on its Consolidated Balance Sheet. An asset retirement cost of $14.4 million was simultaneously capitalized in the oil and gas properties section of the Consolidated Balance Sheet. The adoption of SFAS No. 143 was accounted for as a change in accounting principle in 2003, requiring that a $2.7 million charge, net of $935,000 in deferred tax be recorded to income as a cumulative effect of the change in accounting principle.

     The following table shows changes in the asset retirement obligation that have occurred in 2004 (amounts in thousands):

Reclassifications

     Certain reclassifications of prior period statements have been made to conform with current reporting practices.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

Use of Estimates

     In order to prepare these financial statements in conformity with accounting principles generally accepted in the United States, management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities, and reserve information. Actual results could differ from those estimates.

2. Stockholders’ Equity

     On February 25, 2004, the Company acquired $15 million of its 10 7/8% senior subordinated notes due 2007 from Stellar Funding, Ltd. in exchange for 6.25 million shares of the Company’s common stock. On March 15, 2004, the Company acquired an additional $15 million of its 10 7/8% senior subordinated notes due 2007 from Harbert Distressed Investment Master Fund, Ltd. in exchange for 6.0 million shares of the Company’s common stock.

     On April 8, 2004, Mission issued 312,000 shares of its common stock in lieu of cash to its financial advisors as a fee for services rendered during the debt refinancing discussed below in Note 3. The $1.2 million fair value of this consideration was recorded as deferred financing costs in the other assets line of the Consolidated Balance Sheet.

     On August 4, 2004, the Compensation Committee of the Board of Directors of the Company granted to Robert L. Cavnar, Chairman, President and CEO of the Company, a nonqualified option to acquire 800,000 shares of the Company’s common stock. This option was granted to replace the grant of 800,000 share appreciation rights made to Mr. Cavnar in November 2003. The option was granted under the 2004 Incentive Plan, has a term of 10 years, is fully vested and has a strike price of $0.55 per share, which is the same exercise price as the surrendered share appreciation rights. As a result of this option having an exercise price below the market value for the Company’s common stock at the time of issuance, the Company recognized a non-cash compensation expense of approximately $4.1 million ($2.6 million, net of tax) in the third quarter of 2004.

     The following represents a reconciliation of the numerator and denominator of the basic earnings per share computation to the numerator and denominator of the diluted earnings per share computation for the three and nine months ended September 30, 2004 and 2003, respectively. Additionally, potentially dilutive options and warrants that are not in the money are excluded from the computation of diluted earnings per share. For the three months ended September 30, 2004 and 2003, the potentially dilutive options and warrants excluded represented 0.4 million and 1.0 million shares, respectively. For the nine months ended September 30, 2004 and 2003, the potentially dilutive options and warrants excluded represented 2.1 million and 1.1 million shares, respectively.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

SFAS No. 128 reconciliation (amounts in thousands except per share amounts):

     * 2,132 shares were excluded from this calculation because to include would have been antidilutive.

     As of September 30, 2004 and 2003, Mission held in treasury 389,323 shares of its common stock that had been acquired at an aggregate price of $1.9 million. These treasury shares are reported at cost as a reduction to Stockholders’ Equity on the Consolidated Balance Sheet.

3. Long Term Debt

Refinancing

     On April 8, 2004, Mission issued new senior notes, announced the redemption of its 10 7/8% senior subordinated notes due 2007 (the “10 7/8% Notes”), and replaced both its revolving credit facility and its term loan. Those transactions and the details of the resulting debt are discussed below.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

9 7/8% Notes

     On April 8, 2004, Mission issued $130.0 million of its 9 7/8% senior notes due 2011 (the “9 7/8% Notes”) which are guaranteed on an unsubordinated, unsecured basis by all of its current subsidiaries. Interest on the notes is payable semi-annually, on each April 1 and October 1, commencing on October 1, 2004.

     A portion of the net proceeds from the offering of the 9 7/8% Notes was set aside to redeem, on May 10, 2004, the $87.4 million aggregate principal amount of the 10 7/8% Notes that remained outstanding. On April 8, 2004, the remainder of the net proceeds from the offering of the 9 7/8% Notes, together with $21.5 million that was advanced under the new senior secured revolving credit facility (as described below) and $25.0 million that was borrowed under the new second lien term loan (as described below), was used to completely discharge all of the Company’s outstanding indebtedness under its prior revolving credit facility and term loan.

     At any time on or after April 9, 2005 and prior to April 9, 2008, the Company may redeem up to 35% of the aggregate original principal amount of the 9 7/8% Notes, using the net proceeds of equity offerings, at a redemption price equal to 109.875% of the principal amount of the 9 7/8% Notes, plus accrued and unpaid interest. On or after April 9, 2008, the Company may redeem all or a portion of the 9 7/8% Notes at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest, if redeemed during the twelve-month period beginning on April 9 of the years indicated below:

     If the Company experiences specific kinds of change of control, it may be required to purchase all or part of the 9 7/8% Notes at a price equal to 101% of the principal amount together with accrued and unpaid interest.

     The 9 7/8% Notes contain covenants that, subject to certain exceptions and qualifications, limit the Company’s ability and the ability of certain of its subsidiaries to:

•		incur additional indebtedness or issue certain types of preferred stock or redeemable stock;
•		transfer or sell assets;
•		enter into sale and leaseback transactions;
•		pay dividends or make other distributions on stock, redeem stock or redeem subordinated debt;
•		enter into transactions with affiliates;
•		create liens on its assets;
•		guarantee other indebtedness;
•		enter into agreements that restrict dividends from subsidiaries;
•		make investments;

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

•		sell capital stock of subsidiaries; and
•		merge or consolidate.

     Standard and Poor’s and Moody’s currently publish debt ratings for the 9 7/8% Notes. Their ratings consider a number of items including the Company’s debt levels, planned asset sales, near-term and long-term production growth opportunities, capital allocation challenges and commodity price levels. Standard & Poor’s rating on the 9 7/8% Notes is “CCC” and Moody’s rating is “Caa2.” A decline in credit ratings will not create a default or other unfavorable change in the 9 7/8% Notes.

Senior Secured Revolving Credit Facility

     On April 8, 2004, the Company entered into a new senior secured revolving credit facility led by Wells Fargo Bank, N.A. The facility, which matures on April 8, 2007, is secured by a first priority mortgage and security interest in at least 85% of the Company’s oil and gas properties, all of the ownership interests of all of the Company’s subsidiaries, and the Company’s equipment, accounts receivable, inventory, contract rights, general intangibles and other assets. The facility is also guaranteed by all of the Company’s subsidiaries.

     Availability under the facility, which includes a $3 million subfacility for standby letters of credit, is subject to a borrowing base that is determined at the sole discretion of the facility lenders. The initial borrowing base of the facility was $50 million, of which $30 million was available for general corporate purposes and $20 million was available for the acquisition of oil and gas properties approved by the lenders. The borrowing base is redetermined on each April 1 and October 1. Mission and the lenders each have the option to request one unscheduled interim redetermination between scheduled redetermination dates. On October 1, 2004, it was determined that there will be no change in the borrowing base.

     On April 8, 2004, the Company was advanced $21.5 million under the facility, which amount, together with a portion of the net proceeds from the offering of the 9 7/8% Notes and $25 million that was borrowed under the new second lien term loan (as described below), was used to completely discharge all of the Company’s outstanding indebtedness under its prior revolving credit facility and term loan. At September 30, 2004, $10.0 million in borrowings were outstanding and $39.9 million was available for borrowing ($20 million of which is restricted to the acquisition of oil and gas properties approved by the lenders).

     Advances under the facility bear interest, at the Company’s option, at either (i) a margin (which varies from 25.0 basis points to 125.0 basis points based upon utilization of the borrowing base) over the base rate, which is the higher of (a) Wells Fargo’s prime rate in effect on that day, and (b) the federal funds rate in effect on that day as announced by the Federal Reserve Bank of New York, plus 0.5%; or (ii) a margin (which varies from 175.0 basis points to 275.0 basis points based upon utilization of the borrowing base) over LIBOR. The Company is allowed to prepay any base rate or LIBOR loan without penalty, provided that each prepayment is at least $500,000 and multiples of $100,000 in excess thereof, plus accrued and unpaid interest.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

     Standby letters of credit may be issued under the $3 million letter of credit subfacility. Mission is required to pay, to the issuer of the letter of credit, with respect to each issued letter of credit, (i) a per annum letter of credit fee equal to the LIBOR margin then in effect multiplied by the face amount of such letter of credit plus (ii) an issuing fee of the greater of $500 or 12.5 basis points.

     The facility requires the Company to hedge forward, on a rolling 12-month basis, 50% of proved producing volumes projected to be produced over the following 12 months. The Company is also required to hedge forward, on a rolling 12-month basis, 25% of proved producing volumes projected to be produced over the succeeding 12-month period. Any time that Mission has borrowings under the facility in excess of 70% of the borrowing base available for general corporate purposes, the agent under the facility may require Mission to hedge a percentage of projected production volumes on terms acceptable to the agent.

     The facility also contains the following restrictions on hedging arrangements and interest rate agreements: (i) the hedge provider must be a lender under the facility or an unsecured counterparty acceptable to the agent under the facility; and (ii) total notional volume must be not more than 75% of scheduled proved producing net production quantities in any period or, with respect to interest rate agreements, notional principal amount must not exceed 75% of outstanding loans, including future reductions in the borrowing base.

     The facility contains the following covenants which are considered important to Mission’s operations. At September 30, 2004, Mission was in compliance with each of the following covenants:

•		The Company is required to maintain a current ratio of consolidated current assets (as defined in the facility) to consolidated current liabilities (as defined in the facility) of not less than 1.0 to 1.0;
•		The Company is required to maintain (on an annualized basis until the passing of four fiscal quarters and thereafter on a rolling four quarter basis) an interest coverage ratio (as defined in the facility) of no less than (i) 2.50 for June 30, 2004 through December 31, 2004, (ii) 2.75 for March 31, 2005 through June 30, 2005, and (iii) 3.0 for September 30, 2005 and thereafter;
•		The Company is required to maintain (on an annualized basis until the passing of four fiscal quarters and thereafter on a rolling four quarter basis) a leverage ratio (as defined in the facility) of no more than (i) 3.75 for June 30, 2004 through September 30, 2004, and (ii) 3.5 for December 31, 2004 and thereafter; and
•		The Company is required to maintain a tangible net worth (as defined in the facility) of not less than 85% of tangible net worth at March 31, 2004, plus 50% of positive net income after tax distributions, plus 100% of equity offerings after March 31, 2004, excluding any asset impairment charges.

     The facility also includes restrictions with respect to changes in the nature of the Company’s business; sale of all or a substantial or material part of its assets; mergers, acquisitions, reorganizations and recapitalizations; liens; guarantees; debt; leases; dividends and other distributions; investments; debt prepayments; sale-leasebacks; capital expenditures; lease expenditures; and transactions with affiliates.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

Second Lien Term Loan

     On April 8, 2004, Mission entered into a second lien term loan with a syndicate of lenders arranged by Guggenheim Corporate Funding, LLC. The loan, which matures on April 8, 2008, is secured by a second priority security interest in the assets securing the senior secured revolving credit facility. The facility is also guaranteed by all of Mission’s subsidiaries. On April 8, 2004, the Company borrowed the $25.0 million under the loan, which amount, together with a portion of the net proceeds from the offering of the 9 7/8% Notes and $21.5 million borrowed under the senior secured revolving credit facility (as described above), was used to completely discharge all of the outstanding indebtedness under the prior revolving credit facility and term loan.

     The loan accrues interest in each monthly interest period at the rate of 30-day LIBOR plus 525 basis points per annum, payable monthly in cash. The Company may prepay the loan at any time after the date six months and one day after April 8, 2004 in whole or in part in multiples of $1 million at the prices (expressed as percentages of principal amount) set forth below, plus accrued and unpaid interest, if prepaid during each successive 12-month period beginning on April 9th of each year indicated below:

provided, however, that no prepayment shall be made prior to the date six months and one day after April 8, 2004.

     The loan contains covenants that are no more restrictive than those contained in the senior secured revolving credit facility.

Redeemed 10 7/8% Notes

     In April 1997, the Company issued $100 million of 10 7/8% Notes due 2007. On May 29, 2001, the Company issued an additional $125 million of 10 7/8% Notes with identical terms to the notes issued in April 1997 at a premium of $1.9 million. The premium, shown separately on the Consolidated Balance Sheet, was amortized as a reduction of interest expense over the life of the 10 7/8% Notes so that the effective interest rate on the additional 10 7/8% Notes was 10.5%. Interest on the 10 7/8% Notes was payable semi-annually on April 1 and October 1.

     On March 28, 2003, the Company acquired, in a private transaction with various funds affiliated with Farallon Capital Management, LLC, approximately $97.6 million in principal amount of the 10 7/8% Notes for approximately $71.7 million, plus accrued interest. Including costs of the transaction and the removal of $2.2 million of previously deferred financing costs related to the acquired 10 7/8% Notes, the Company recognized a $22.4 million gain on the extinguishment of the 10 7/8% Notes.

     In December 2003, February 2004 and March 2004, the Company, in three private transactions, acquired $40.0 million aggregate principal amount of the 10 7/8% Notes in exchange for an aggregate of 16.75 million shares of its common stock as summarized below.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

     On May 10, 2004, the remaining $87.4 million of 10 7/8% Notes were redeemed at a premium of approximately $1.6 million. This premium is included in the $4.1 million ($2.6 million, net of tax) net loss on extinguishment of debt reported in the three month period ended June 30, 2004.

Former Credit Facilities

     The Company was party to a $150.0 million credit facility with a syndicate of lenders. The credit facility was a revolving facility, expiring May 16, 2004, which allowed Mission to borrow, repay and re-borrow under the facility from time to time. The total amount which might be borrowed under the facility was limited by the borrowing base periodically set by the lenders based on Mission’s oil and gas reserves and other factors deemed relevant by the lenders. The facility was re-paid in full and cancelled on March 28, 2003.

     On March 28, 2003, simultaneously with the acquisition of $97.6 million in principal amount of the 10 7/8% Notes, the Company amended and restated the credit facility with new lenders, led by Farallon Energy Lending, LLC. Deferred financing costs of $947,000 relating to the previously existing facility were charged to earnings as a reduction in the gain on extinguishment of debt. Under the amended and restated facility, the Company borrowed $80.0 million, the proceeds of which were used to acquire approximately $97.6 million face amount of 10 7/8% Notes, to pay accrued interest on the 10 7/8% Notes purchased, and to pay closing costs. The amended and restated facility was cancelled in April 2004 and was replaced by the “Senior Secured Revolving Credit Facility” discussed above.

4. Derivative Instruments and Hedging Activities

     The Company produces and sells crude oil, natural gas and natural gas liquids. As a result, its operating results can be significantly affected by fluctuations in commodity prices caused by changing market forces. The Company periodically seeks to reduce its exposure to price volatility by hedging a portion of its production through swaps, options and other commodity derivative instruments. A combination of options, structured as a costless collar, is the Company’s preferred hedge instrument because there are no up-front costs and protection is given against low prices. Such hedges assure that Mission receives NYMEX prices no lower than

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

the price floor and no higher than the price ceiling for hedged production. The Company has also entered into some commodity swaps that fix the NYMEX price to be received. Hedging activities decreased revenues by $5.7 million and $3.5 million for the three month periods ended September 30, 2004 and 2003, respectively, and by $12.8 million and $13.2 million for the nine month periods ended September 30, 2004 and 2003, respectively.

     The Company’s 12-month average realized price, excluding hedges, for natural gas was $0.03 per MCF less than the NYMEX MMBTU price. The Company’s 12-month average realized price, excluding hedges, for oil was $1.29 per BBL less than the NYMEX price. Realized prices differ from NYMEX as a result of factors such as the location of the property, the heating content of natural gas and the quality of oil. The gas differential stated above excludes the impact of the Mist field gas production that is sold at an annually fixed price.

     The Company has elected to designate all hedges by applying the interpretations from the FASB’s Derivative Implementation Group issue G-20 (“DIG G-20”). By using the DIG G-20 approach, because the Company’s collars and swaps meet specific criteria, the time value component is included in the hedge relationship and is recorded to other comprehensive income (“OCI”) rather than to income, which reduces earnings variability.

     Should ineffectiveness occur for reasons other than time, that ineffectiveness is recognized currently and is reported in the interest and other income line of the Consolidated Statement of Operations. The Company has acquired a license for software specifically designed to make the complex calculations required by SFAS No. 133, including calculating ineffectiveness. The Company recognized a net gain related to the ineffectiveness of its cash flow hedges in the three month period ended September 30, 2004 of approximately $433,000 and a net loss related to the ineffectiveness of its cash flow hedges for the nine month period ended September 30, 2004 of approximately $132,000. As the existing hedges settle over the next two years, gains or losses in OCI will be reclassified to earnings. Using September 30, 2004 strip prices, the amount expected to be reclassified over the next twelve months will be an $11.5 million loss, net of taxes.

     The following tables detail the cash flow commodity hedges that were in place at September 30, 2004:

Oil Hedges

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

Gas Hedges

     The Company may also enter into financial instruments such as interest rate swaps to manage the impact of interest rates. The Company paid $1.3 million in February 2003 to cancel an interest rate swap under which Mission received a fixed interest rate and paid a floating interest rate. The swap originated in 1998 and had a notional value of $80 million.

5. Income Taxes

     The provision for federal and state income taxes for the three months and nine months ended September 30, 2004 was based upon a 36% and 35% effective tax rate, respectively. In assessing the realizability of the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the recognition of future taxable income during the periods in which those temporary differences are available. Based upon projections for future state taxable income, management believes it is more likely than not that the Company will not realize its entire deferred tax asset related to state income taxes. In addition, management believes it is more likely than not that the Company will not realize its deferred tax asset related to the impairment of the interest in Carpatsky. A valuation allowance of approximately $ 5.1 million has been recorded at September 30, 2004.

     On December 17, 2003, the Company issued 4.5 million shares of common stock in exchange for the surrender of $10 million of the 10 7/8% Notes. As a result of this transaction, management believes that the Company has experienced an “ownership change” as defined in Section 382 of the Internal Revenue Code, which could result in the imposition of significant limitations on the future use of the Company’s existing net operating loss (NOL) and tax credit carryforwards in the future. The limitations imposed by Section 382 could have an affect upon the Company’s ability to fully utilize its net operating loss and tax credit carryforwards to offset future taxable income and related tax liabilities. Quarterly, we review the estimated impact that a 382 Limitation may have upon the future availability of our net operating losses. Based on that review, as of September 30, 2004, no limitation has been reflected because there is not one indicated.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

6. Guarantees

     In 1993 and 1996 the Company entered into agreements with surety companies and with Torch Energy Advisors Incorporated (“Torch”) and Nuevo Energy Company (“Nuevo”) whereby the surety companies agreed to issue such bonds to the Company, Torch and/or Nuevo. However, Torch, Nuevo and the Company agreed to be jointly and severally liable to the surety company for any liabilities arising under any bonds issued to the Company, Torch and/or Nuevo. Torch currently has no bonds outstanding pursuant to these agreements and Nuevo has issued approximately $34.3 million of bonds. The Company has notified the sureties that it will not be responsible for any new bonds issued to Torch or Nuevo. However, the sureties are permitted under these agreements to seek reimbursement from the Company, as well and from Torch and Nuevo, if the surety makes any payments under the bonds issued to Torch and Nuevo. On May 17, 2004, Plains Exploration and Production Company announced it had completed the acquisition of Nuevo Energy Company effective May 14, 2004.

     The Company’s subsidiaries, Mission E&P Limited Partnership, Mission Holdings LLC and Black Hawk Oil Company are guarantors under the Senior Secured Revolving Credit Facility, the Second Lien Term Loan and the indenture for the 9 7/8% Notes.

7. Supplemental Guarantor Information — UNAUDITED

     Mission E&P Limited Partnership, Mission Holdings LLC and Black Hawk Oil Company, all subsidiaries of Mission Resources Corporation (collectively, the “Guarantor Subsidiaries”) are guarantors under the Senior Secured Revolving Credit Facility, the Second Lien Term Loan and the indenture for the 9 7/8% Notes. The Company does not believe that separate financial statements and other disclosures concerning the Guarantor Subsidiaries would provide any additional information that would be material to investors in making an investment decision.

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

CONDENSED CONSOLIDATING BALANCE SHEETS – UNAUDITED
As of September 30, 2004
(In thousands)

CONDENSED CONSOLIDATING INCOME STATEMENTS — UNAUDITED
For the Nine Months Ended September 30, 2004
(In thousands)

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MISSION RESOURCES CORPORATION
Notes to Consolidated Financial Statements

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS — UNAUDITED
For the Nine Months Ended September 30, 2004
(In thousands)

CONDENSED CONSOLIDATING BALANCE SHEETS – UNAUDITED
As of December 31, 2003
(In thousands)

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MISSION RESOURCES CORPORATION

8. Subsequent Events

     On November 9, 2004, the Compensation Committee of the Company’s Board of Directors approved an amendment to the Company’s employment agreements with Messrs. Cavnar, Piacenti, Eells, Munsell and Nicknish, making consistent the gross-up provisions relating to parachute payments under Section 280G of the Internal Revenue Code to include payments made pursuant to agreements, plans, instruments or obligations other than the employment agreements.

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MISSION RESOURCES CORPORATION

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

          Mission is an independent oil and gas exploration and production company. We drill for, acquire, develop and produce natural gas and crude oil. Our property portfolio is comprised of long-lived, low-risk assets, like those in the Permian Basin, and multi-reservoir, high-productivity assets found along the Gulf Coast and in the Gulf of Mexico. Our operational focus remains on efficient, well managed upstream natural gas and crude oil exploration and production. We will continue to pursue complementary acquisitions when the appropriate opportunities present themselves.

Results of Operations

The following table sets forth certain operating information for the Company for the periods presented:

Three Months Ended September 30, 2004 and 2003

Net Income (Loss)

          Net income for the three months ended September 30, 2004 was $868,000 or $0.02 per share. Net loss for the three months ended September 30, 2003 was $3.8 million or $0.16 per share. Higher gas volumes, higher commodity prices and lower interest expense were the primary reasons for the improvement in the current quarter of 2004. This was partially offset by lower oil volumes resulting from property sales in 2003. In addition, net income was negatively impacted in the three month period ended September 30, 2004 by the recognition of $4.1 million in non-cash compensation expense ($2.6 million, net of taxes) as a result of the issuance to our Chairman and CEO of stock options to replace stock appreciation rights.

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MISSION RESOURCES CORPORATION

Oil and Gas Revenues

          Oil revenues for the three months ended September 30, 2004 were $13.6 million, as compared to $13.7 million for the respective period in 2003. Oil production decreased 20% from 539,000 barrels in the three month period ended September 30, 2003 to 430,000 barrels for the same period of 2004. The sale of the Raccoon Bend and East Texas fields in the last half of 2003 accounted for the production decrease. Realized oil prices averaged $31.58 per barrel in the three month period ended September 30, 2004, as compared to $25.33 per barrel in the three month period ended September 30, 2003.

          Gas revenues increased 101% from $10.4 million reported for the three month period ended September 30, 2003 to $20.9 million for the three month period ended September 30, 2004. This increase was driven by both production and price increases. Gas production was up 54% compared to the same quarter of 2003 with 3,916 MMCF and 2,540 MMCF produced for the three month periods ended September 30, 2004 and 2003, respectively. The January and April 2004 acquisitions of the Jalmat field in Lea County, New Mexico and new production from the LeBlanc #1 well in Vermilion Parish, Louisiana, the South Marsh Island A-11 and C-5 wells, offshore Louisiana, and the High Island 553 A-7 recompletion, offshore Texas, accounted for most of the production increase. Realized gas prices averaged $5.34 per MCF, or 30% higher, in the three month period ended September 30, 2004 as compared to $4.10 per MCF in the comparable period of 2003.

          The realized prices discussed above include the impact of oil and gas hedges. Decreases of $3.5 million and $5.7 million related to hedging activity were reflected in oil and gas revenues for the three months ended September 30, 2003 and September 30, 2004, respectively.

Interest and Other Income (Loss)

          Interest and other income was a net gain of $508,000 for the three months ended September 30, 2004 and was a net gain of $170,000 for the three months ended September 30, 2003. Activity for 2003 included a gain of $187,000 from the amortization of Other Comprehensive Income (“OCI”) related to cancelled hedges. In the third quarter of 2004, a $433,000 gain on hedge ineffectiveness was the most significant item.

Lease Operating Expenses

          Lease operating expenses decreased from $8.3 million in the three months ended September 30, 2003 to $8.1 million for the same period of 2004 or from $1.44 per MCFE to $1.24 per MCFE on a per unit basis. This decline is primarily related to the 2003 sales of high cost oil properties and the subsequent redeployment of proceeds into lower cost gas properties. In the fourth quarter, we expect to be on the high side of our lease operating expense guidance for two reasons. First, workovers are being performed in today's pricing environment that probably would not have been done in the past, and second, there has been an increase in the cost of basic oil field services. We expect these increased costs to continue into 2005.

Taxes Other Than Income

          The table below details the components of taxes other than income and their respective changes between the periods (dollars in thousands).

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MISSION RESOURCES CORPORATION

          Taxes other than income increased from $2.1 million in the three months ended September 30, 2003 to $2.7 million for the same period of 2004. In general, production taxes increase as revenue and production increases. In 2004, the increase in production taxes was disproportionately larger than our revenue increases because Louisiana’s tax rate on natural gas increased by 40% and a significant portion of our gas production increase is from Louisiana properties. Offsetting this increase is a 35% reduction in our property taxes. This is due to the sale of many Texas properties late in 2003, and their replacement with properties in New Mexico, which has lower property tax rates than Texas.

Depreciation, Depletion and Amortization

          Depreciation, depletion and amortization (“DD&A”) was $11.7 million for the three months ended September 30, 2004 and $10.0 million for the three months ended September 30, 2003. The 12.5% increase in production, on an MCFE basis, discussed under Oil and Gas Revenues above, accounts for the majority of the variance. In addition, DD&A per MCFE has increased from $1.71 per MCFE in the third quarter of 2003 to $1.77 per MCFE in the third quarter of 2004. The increase in DD&A on a per MCFE basis reflects the impact of decreases in reserves due to property sales in 2003. This was partially offset by reserve additions described in our July 1, 2004 reserve report prepared by Netherland, Sewell and Associates, Inc.

General and Administrative Expenses

          General and administrative expenses (“G&A”) were $7.0 million in the three month period ended September 30, 2004, and were $2.6 million in the three month period ended September 30, 2003. This increase is primarily the result of the recognition of a non-cash compensation expense of $4.1 million from the issuance to our Chairman and CEO of stock options to replace stock appreciation rights. The options were granted with a strike price of $0.55 per share, which is the same exercise price as the surrendered stock appreciation rights. As a result of these options having an exercise price below the market value for Mission’s common stock, we were required to recognize this non-cash expense. In the fourth quarter, we expect to incur additional accounting fees relating to Sarbanes-Oxley Act compliance.

Interest Expense

          Interest expense decreased 41% to $3.9 million for the three months ended September 30, 2004 from $6.6 million in the same period in 2003. The following table details the components of interest and their respective changes between the periods (dollars in thousands).

          Throughout 2003 and early 2004, interest expense on the term loan was based on an $80 million principal balance at 12.0% interest. On April 8, 2004, as part of the debt refinancing, the principal balance on the term loan was repaid and replaced with a senior secured revolving credit facility and a second lien term loan with a combined balance of $35 million and rates between 3.1% and 7.0%. This decrease in principal balance and interest rates resulted in a significant reduction in interest paid in the

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MISSION RESOURCES CORPORATION

three month period ending September 30, 2004, as compared to the same period in 2003. Also, the 10 7/8% senior notes were replaced with 9 7/8% notes resulting in a 13% reduction in interest paid, net of amortized premiums.

Income Taxes

          The provision for federal and state income taxes for the three months ended September 30, 2004 was based upon a 36% effective tax rate. There is a $5.1 million valuation allowance on deferred taxes applicable at September 30, 2004. In assessing the realizability of the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based upon projections for future state taxable income, management believes it is more likely than not that the Company will not realize its entire deferred tax asset related to state income taxes.

Nine Months Ended September 30, 2004 and 2003

Net Income (loss)

          Net income for the nine months ended September 30, 2004 was $122,000 or $0.00 per share. Net income for the nine months ended September 30, 2003 was $3.9 million or $0.16 per share. The nine months ended September 30, 2003 included a $22.4 million gain ($14.5 million, net of taxes) from the repurchase and retirement of 10 7/8% Notes in March 2003. Absent the large gain in 2003, the results for the nine month period ended September 30, 2003 would have been a $10.6 million net loss. The improvement in the nine month period ended September 30, 2004 resulted from increased gas production, higher oil and gas prices and lower interest and lease operating expenses. This was partially offset by an increase in G&A expense of $4.1 million ($2.6 million, net of taxes) from the issuance to our Chairman and CEO of stock options to replace stock appreciation rights.

Oil and Gas Revenues

          Oil revenues for the nine months ended September 30, 2004 were $36.5 million, as compared to $41.3 million for the respective period in 2003. Oil production decreased 24% from 1,635 MBBLs in the nine month period ended September 30, 2003 to 1,235 MBBLs for the same period of 2004. The sale of the Raccoon Bend and East Texas fields in the last half of 2003 accounts for the production decrease. Higher realized oil prices that averaged $29.54 per barrel in the nine month period ended September 30, 2004, as compared to $25.29 per barrel in the nine month period ended September 30, 2003 partially offset the oil production decline.

          Gas revenues increased 78% from $32.9 million reported for the nine months ended September 30, 2003 to $58.4 million for the same period 2004. Gas production was up 49% compared to the same period of 2003 with 10,863 MMCF and 7,293 MMCF for the nine month periods ended September 30, 2004 and 2003, respectively. The January and April 2004 acquisitions of the Jalmat field in Lea County, New Mexico along with production increases from the LeBlanc #1 well in Vermilion Parish, Louisiana, the South Marsh Island A-11 and C-5 wells, offshore Louisiana, and the High Island 553 A-7 recompletion, offshore Texas, account for most of the production increase. Higher realized gas prices that averaged $5.38 per MCF, or 19% higher, in the nine month period ended September 30, 2004 as compared to $4.51 per MCF in the comparable period of 2003.

          The realized prices discussed above include the impact of oil and gas hedges. Decreases of $12.8 million and $13.2 million related to hedging activity were reflected in oil and gas revenues for the nine months ended September 30, 2004 and 2003, respectively.

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MISSION RESOURCES CORPORATION

Extinguishment of Debt

          From March 2003 through April 2004, in several steps, we significantly changed Mission’s debt structure. In March 2003, 43% of the 10 7/8% Notes were acquired and retired at a net gain on extinguishment of debt of $22.4 million ($14.5 million net of taxes). In 2004, $30 million of the 10 7/8% Notes were redeemed and our other credit facilities were cancelled and refinanced for a net loss of $2.6 million ($1.7 million, net of taxes)

Interest and Other Income (Loss)

          Interest and other income was a net loss of $681,000 for the nine months ended September 30, 2004 and was a net gain of $892,000 for the nine months ended September 30, 2003. Activity for 2003 includes a gain of $603,000 from the amortization of OCI related to cancelled hedges and $341,000 of equity in the earnings of White Shoal Pipeline Corporation. In the first nine months of 2004, bad debt expense of approximately $399,000 related to joint interest receivables, hedge ineffectiveness loss of $132,000 and plugging and abandonment costs of $293,000 on properties that we no longer own accounted for most of the loss.

Lease Operating Expenses

          Lease operating expense decreased from $25.6 million in the nine months ended September 30, 2003 to $21.3 million for the same period of 2004. This decline of approximately 17% is primarily related to our 2003 sales of high cost properties and the subsequent redeployment of proceeds into lower cost gas properties. Lease operating expenses decreased approximately 22% on a per MCFE basis between the periods to $1.16 per MCFE. In the second quarter of 2004, we recovered approximately $575,000 of previously paid Waddell Ranch field lease operating expenses. Exclusive of this recovery, recurring lease operating expense on an MCFE basis was $1.20 for the nine months ending September 30, 2004. In the fourth quarter, we expect to be on the high side of our lease operating expense guidance for two reasons. First, workovers are being performed in today's pricing environment that probably would not have been done in the past, and second, there has been an increase in the cost of basic oil field services. We expect these increased costs to continue into 2005.

Taxes Other Than Income

          The table below details the components of taxes other than income and their respective changes between the periods (dollars in thousands).

          Taxes other than income decreased from $7.0 million in the nine months ended September 30, 2003 to $6.8 million for the same period of 2004. As a result of the sale of Texas properties late in 2003, and their replacement with properties in New Mexico, a state with lower property taxes than Texas, our property taxes have been reduced by 47%. In general, production taxes increase as revenue and production increases. In 2004, the increase in production taxes was disporportionately larger than our revenue increases because Louisiana’s tax rate on natural gas increased by 40%.

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MISSION RESOURCES CORPORATION

Depreciation, Depletion and Amortization

          DD&A was $33.9 million for the nine months ended September 30, 2004 and $28.0 million for the nine months ended September 30, 2003. DD&A per MCFE has increased from $1.61 per MCFE in the nine months ended September 30, 2003 to $1.83 per MCFE for the same period in 2004. The increase in DD&A on a per MCFE basis reflects the impact of decreases in reserves due to property sales in 2003. This was partially offset by the Jalmat acquisition in January and April 2004 and reserve additions described in our July 1, 2004 reserve report prepared by Netherland, Sewell and Associates, Inc. Also, approximately $1.9 million of the increase is the result of an overall volume increase of 6.8%.

General and Administrative Expenses

          G&A expenses were $12.8 million in the nine month period ended September 30, 2004 and were $8.0 million in the nine month period ended September 30, 2003. This increase is primarily the result of the recognition of a non-cash compensation expense of $4.1 million from the issuance of stock options to replace stock appreciation rights. The options were granted with a strike price of $0.55 per share, which is the same exercise price as the surrendered stock appreciation rights. As a result of these options having an exercise price below the market value for Mission’s common stock, we were required to recognize this non-cash expense. Additional investor relations costs also accounted for a portion of the increase. In the fourth quarter, we expect to incur additional accounting fees relating to Sarbanes-Oxley Act compliance.

Interest Expense

          Interest expense decreased 18% to $15.6 million for the nine months ended September 30, 2004 from $19.0 million for the same period in 2003. The following table details the components of interest and their respective changes between the periods (dollars in thousands).

          The interest rate swap was cancelled in February 2003 and was not replaced. Throughout 2003 and early 2004, we repurchased approximately $137.6 million in 10 7/8% Notes. On May 10, 2004 the remaining $87.4 million of 10 7/8% Notes were redeemed. The redemption of all the 10 7/8% Notes and subsequent issuance of the 9 7/8% Notes resulted in a significant reduction in interest paid in the first nine months of 2004 as compared to the same period in 2003. Also, throughout 2003 and early 2004 interest expense on the term loan was based on an $80 million principal balance at 12% interest. On April 8, 2004, as part of the debt refinancing, the principal balance on the term loan was repaid and replaced with a senior secured revolving credit facility and a second lien term loan with a combined balance of $35 million and rates between 3.1% and 7.0%. This significant decrease in balance and interest rates resulted in a reduction in interest paid in the nine month period ending September 30, 2004, as compared to the same period in 2003.

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