The following discussion and analysis of financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Forward-looking statements can be identified by the fact that they do not relate strictly to historic or current facts. They use words such as "anticipate," "estimate," "project," "intend," "plan," "believe" and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. In particular, these include statements relating to:

• Our expectation of continued growth in the demand for our oil;

• Our expectation that we will continue to have adequate liquidity from cash flows from operations;

• A variety of market, operational, geologic, permitting, labor and weather related factors; and

• The other risks and uncertainties which are described below under "RISK FACTORS", including, but not limited to, the following:

• Unanticipated conditions may cause profitability to fluctuate.

• Decreases in purchases of oil by our customer will adversely affect our revenues.

Overview

We are engaged in the exploration and production of crude oil in Northern China. We have an arrangement with the Jilin Refinery of PetroChina Group to sell our crude oil production for use in the China marketplace. We currently operate 188 producing wells located in four oilfields in Northern China and have plans for additional drilling projects.

In particular, through two of our subsidiaries, Song Yuan City Yu Qiao Oil and Gas Development Co. Ltd. ("Yu Qiao") and Chang Ling Longde Oil and Gas Development Co. Ltd. ("LongDe"), we have entered into binding sales agreements with the PetroChina Group, whereby we sell our crude oil production for use in the China marketplace.

We currently operate 4 oilfields located in Northern China, which include:

                                     Acreage (Gross developed
Field                                    and undeveloped)         Producing Oil Wells    Proved Reserves (Bbls)
Qian'an 112                                               5,115                   163                  1,963,319
Daan 34                                                   2,298                     7                    168,335
Gudian 31                                                 1,779                     7                     62,533
Hetingbao 301                                             2,471                    11                    274,637

The following chart illustrates our company's organizational structure.

[[Image Removed]]

Organizational History

We were incorporated in the State of Nevada on August 20, 1999 under the name Draco Holding Corporation. On March 29, 2004, we executed an Agreement for Share Exchange with Hong Xiang Petroleum Group Limited, a corporation organized and existing under the laws of the British Virgin Islands ("Hong Xiang"), and the individual shareholders owning 100% of the outstanding common shares of Hong Xiang (the "Hong Xiang Shareholders").

Pursuant to the Agreement for Share Exchange, we issued 18,700,000 shares of our common stock to the Hong Xiang Shareholders in exchange for all of the shares of capital stock of Hong Xiang owned by the Hong Xiang Shareholders at closing, and Hong Xiang became our wholly-owned subsidiary. On June 28, 2004, we changed our name to China North East Petroleum Holdings Ltd.

During 2004, we acquired a 100% ownership in Song Yuan City Hong Xiang Petroleum Technical Services Co., Ltd. ("Hong Xiang Technical"), and Hong Xiang Technical in turn acquired a 100% interest in Song Yuan City Yu Qiao Qianan Hong Xiang Oil and Gas Development Co., Ltd. ("Hong Xiang Oil Development"), which was engaged in the exploration and production of crude oil in the Jilin region of the PRC.

As a result of the Yu Qiao acquisition discussed below, all operations, assets and liabilities of the Company's subsidiary Hong Xiang Oil Development were transferred to Yu Qiao on March 19, 2007. Since Hong Xiang Oil Development and Hong Xiang Technical were no longer necessary elements of the Company's corporate structure, and they were liquidated and dissolved.

PetroChina Oil Leases

Pursuant to a 20-year exclusive Cooperative Oil Lease (the "Oil Lease"), among PetroChina Group, Yu Qiao and the Company, entered into in May 2002, the Company has the right to explore, develop and produce oil at Qian'an 112 Oilfield. Pursuant to the Oil Lease, (i) PetroChina is entitled to 20% of the Company's oil production for the first ten years of the Oil Lease term and 40% of the Company's oil production for the remaining ten years of the Oil Lease term; and
(ii) Yu Qiao is entitled to 2% of the Company's oil production as a management fee. The payment of management fee was stopped following the acquisition of Yu Qiao by the Company.

LongDe is a party to a 20-year contract with PetroChina Group entered into in May 2003, pursuant to which LongDe has the right to explore, develop and produce oil at the Hetingbao 301 oilfield in the PRC. Pursuant to such between PetroChina and LongDe, PetroChina is entitled to 20% of LongDe's output in the first ten years and 40% of LongDe's output thereafter until the end of the contract.

As the controlling shareholder of Yu Qiao, the Company has the rights to extract and develop Qian'an 112 and other oil fields under contracts that Yu Qiao has entered into with PetroChina. These oilfields include the Daan 34 oilfield and Gudian 31 oilfield in Jilin Province.

Song Yuan Technical Joint Venture

On July 26, 2006, the Company entered into a joint venture agreement with Wang Hong Jun ("Mr. Wang"), the president and a stockholder of the Company and Ju Guizhi ("Ms. Ju"), mother of Mr. Wang, to contribute to the increased registered capital of Song Yuan North East Petroleum Technical Service Co. Ltd. ("Song Yuan Technical"). The purpose of Song Yuan Technical is to acquire oil and gas properties and to engage in the exploration of crude oil in the PRC. The Company owns a 90% equity interest in Song Yuan Technical, and Ms. Ju owns the remaining 10% equity interest in Song Yuan Technical.

Acquisition of LongDe

In order to comply with certain PRC laws relating to foreign entities' ownership of oil and gas company in the PRC, prior to March 17, 2008, Song Yuan Technical directly owned a 70% equity interest in LongDe, while Sun Peng and Ai Chang Shan, respectively, owned 10% and 20% of the equity interests in Long De in trust for Song Yuan Technical. On March 17, 2008, Song Yuan Technical additionally acquired an additional 20% equity interest in LongDe, of which it acquired a 10% of the equity interest in LongDe from Sun Peng, and 10% of the equity interest in LongDe from Ai Chang Shan. Accordingly, Song Yuan Technical now owns directly 90% of the equity interests in LongDe, with Ai ChangShan holding the remaining 10% in trust for in trust for Song Yuan Technical. The acquisition of LongDe was made pursuant to the laws of the PRC. As a 90% owner of Song Yuan Technical, the Company effectively controls LongDe.

Acquisition of Yu Qiao

On January 26, 2007, the Company, through its 90% owned subsidiary Song Yuan Technical, acquired beneficial ownership of all of the interests in Yu Qiao from Ms. Ju. In consideration for such acquisition, the Company issued to Ms. Ju an aggregate of 10 million shares of its common stock (the "Acquisition Shares"), having a market value of approximately U.S.$3.1 million. However, on June 29, 2007, the Company, Mr. Wang and Ms. Ju entered into an agreement pursuant to which, among other things, all of the Acquisition Shares were contributed to the Company.

In order to comply with certain PRC laws relating to foreign entities' ownership of oil and gas company in the PRC, the former owners of Yu Qiao, Wang Pingwu and Meng Xiangyun, held 10%, and 20% of the equity interests, respectively, in Yu Qiao in trust for the benefit of Song Yuan Technical. The laws of the PRC govern the agreements by which the Company acquired Yu Qiao and by which the former owners of Yu Qiao hold equity interests in trust. See "Regulations Affecting Our Business" under "Risk Factors." Subsequently, on March 17, 2008, Song Yuan Technical acquired from Meng Xiangyun the 20% equity interest which he had held in Yu Qiao. Accordingly, Song Yuan Technical currently directly holds a 90% equity interest in Yu Qiao, while Wang Hongjun holds a 10% equity interest in Yu Qiao in trust for the benefit of Song Yuan Technical. Thus the Company, through Song Yuan Technical, currently effectively controls 90% of the equity interests in Yu Qiao, while the remaining 10% equity interests in Yu Qiao is effectively controlled by Ms. Ju.

Oil and Gas Properties and Activities

As of June 30, 2008, the Company had a total of 188 producing wells, including 163 producing wells at the Qian'an 112 oilfield, 11 producing wells at the Hetingbao 301 oilfield, 7 producing wells at the Daan 34 oilfield and 7 producing wells at the Gudian 31 oilfield. There were 103 traditional sucker-rod pumping machines in operation.

All of the Company's crude oil production is sold to the Jilin Refinery of PetroChina Group. The approximate distance of each of the Company's oil fields from the Jilin Refinery is as follows: the Qian'an 112 oilfield is four kilometers away, the Hetingbao 301 oilfield is three kilometers away, the Daan 34 oilfield is fifteen kilometers away and the Gudian Oilfield 31 is thirty kilometers away.

PetroChina pays the Company a price per barrel equal to Mean of Platts Singapore ("MOPS") price for the previous month. MOPS price is the mean price of oil traded through Singapore as per data from Platts, a commodity and trading company. The price is FOB the Jilin Refinery.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2008 Compared To Three Months Ended June 30, 2007

Revenues. Revenues for the quarter ended June 30, 2008 were $14,167,538 compared to $4,097,554 for the quarter ended June 30, 2007, an increase of $10,069,984, or 246%. This increase was due to an increase in crude oil production and crude oil price. Our output of crude oil for the three months ended June 30, 2008 was 18,319 tons compared to 8,365 tons for the same quarter in 2007. The increase in production was mainly because of (i) refracturing and other technical improvements made on the existing wells; (ii) water injection network which efficiently prevented the decrease of production of existing wells and maintain certain production levels of such wells; and (iii) 27 new wells brought into production during the second quarter of 2008.

Cost of sales. Cost of sales increased by 227% from $1,976,519 for the three months ended June 30, 2007 to $6,465,580 for the three months ended June 30, 2008. The increase in cost of sales resulted primarily from the increase in production, depreciation of oil and gas properties and the payment of oil surcharge. For the three months ended June 30, 2008, the Company paid an oil surcharge of $3,173,380 to the PRC government as compared to $495,456 paid for the same quarter in 2007. Under a regulation introduced in June 2006, a surcharge of 20% is imposed on the portion of the selling price of crude oil which exceeds $40 per barrel and a surcharge of 40% is imposed on the portion of the selling price of crude oil which exceeds $60 per barrel. In addition, depreciation of oil and gas properties increased from $850,602 for the three months period ended June 30, 2007 to $2,506,302 for the three months period ended June 30, 2008, an increase of 195%. The increase in the depreciation of oil and gas properties was mainly attributable to cost associated with the addition of 23 new wells brought into production during the second quarter of 2008.

Operating Expenses. Operating expenses increased by 213% from $349,223 for the three months ended June 30, 2007 to $1,093,552 for the three months ended June 30, 2008. The increase is primarily a result of increase in (i) amortization of deferred financing costs; (ii) amortization of discount of debenture and (iii) consulting fees.

Net Income. Net income increased by 201% from $1,253,567 for the three months ended June 30, 2007 to $3,779,007 for the three months ended June 30, 2008, primarily as a result of a 246% increase in sales as described above.

Six Months Ended June 30, 2008 Compared To Six Months Ended June 30, 2007

Revenues. Revenues for the six months ended June 30, 2008 were $24,991,512 compared to $5,977,501 for the six months ended June 30, 2007, an increase of $19,014,011, or 318%. This increase was due to an increase in crude oil production and crude oil price. Our output of crude oil for the six months ended June 30, 2008 was 33,883 tons compared to 12,732 tons for the same six months in 2007. The increase in production was mainly because of (i) refracturing and other technical improvements made on the existing wells; (ii) water injection network which efficiently prevented the decrease of production of existing wells and maintain certain production levels of such wells; and
(iii) 31 new wells brought into production during the first two quarters of 2008.

Cost of sales. Cost of sales increased by 294% from $2,862,291 for the six months ended June 30, 2007 to $11,266,739 for the six months ended June 30, 2008. The increase in cost of sales resulted primarily from the increase in production and the payment of oil surcharge. For the six months ended June 30, 2008, the Company paid an oil surcharge of $5,384,700 to the PRC government as compared to $652,587 paid for the same six months in 2007. Under a regulation introduced in June 2006, a surcharge of 20% is imposed on the portion of the selling price of crude oil which exceeds $40 per barrel and a surcharge of 40% is imposed on the portion of the selling price of crude oil which exceeds $60 per barrel. In addition, depreciation of oil and gas properties increased from $1,239,829 for the six months period ended June 30, 2007 to $4,380,994 for the three months period ended June 30, 2008, an increase of 253%. The increase in the depreciation of oil and gas properties was mainly attributable to cost associated with the addition of 31 new wells brought into production during the first six months of 2008

Operating Expenses. Operating expenses increased by 167% from $648,640 for the six months ended June 30, 2007 to $1,729,501 for the six months ended June 30, 2008. The increase is primarily a result of increase in (i) amortization of deferred financing costs; (ii) amortization of discount of debenture and (iii) consulting fees.

Net Income. Net income increased by 358% from $1,540,930 for the six months ended June 30, 2007 to $7,060,266 for the six months ended June 30, 2008, primarily as a result of a 318% increase in sales as described above.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2008, the Company had cash and cash equivalents of $2,427,588, total current assets of $13,977,030 and current liabilities of approximately $13,257,934. For the six months ended June 30, 2008, our primary source of liquidity was approximately $13,549,746 in cash provided by financing activities.

Net cash used in operating activities was $327,205 for the six months ended June 30, 2008 compared to net cash provided by operating activities of $4,203,145 for the same period in 2007. The decrease in net cash provided by operating activities is primarily related to increase in operating liabilities during the six months period ended June 30, 2008, including, accounts receivable of $3,362,131, prepaid expenses related to drilling of new wells in the amount of $2,099,397, deferred financing cost of $1,186,229 and accounts payable in the amount of $9,735,812 primarily comprised of costs related to the drilling of well accrued in 2007. The accounts receivable is due to the increase in production and sales of crude oil to PetroChina and a 15-day time lag in payment from PetroChina.

Net cash used in investing activities was $9,498,032 for the six months ended June 30, 2008 compared to $5,437,745 for the same period in 2007. This decrease is primarily due to the increase in purchase of oil and gas properties of $3,240,636 during the six months ended June 30, 2008 associated with the cost of drilling and bringing new wells into production.

Net cash provided by financing activities was $13,549,746 for the six months ended June 30, 2008 as a result of the financing by Lotusbox Investments Limited completed in the first quarter of 2008.

The Company has paid for the development and oil wells under construction with cash from operations as well as by funds raised as a result of the financing by Lotusbox Investments Limited. To fully implement the Company's business plan and growth strategy the Company may require additional resources. The Company's ability to obtain additional capital will also depend on market conditions, national and global economies and other factors beyond its control. We cannot assure you that the Company will be able to implement or capitalize on various financing alternatives or otherwise obtain required capital, the need for which is substantial given its operating loss history and its business and development plan.

Capital Commitments

As of June 30, 2008, the Company had capital commitments of $6,629,000 with two contractors for the completion of drilling of 27 oil wells under construction.