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:

· Deviations in and volatility of the market price of crude oil produced by us;

· Uncertainties in the estimation of proved reserves and in the projection of future rates of production;

· Timing and amount of production;

· The availability of, and our ability to raise additional capital resources and provide liquidity to meet cash flow needs;

· Fluctuations in foreign currency exchange rates and interest rates;

· Our ability to find, acquire, lease, develop, and produce from new properties; and

· The other risks and uncertainties which are described below under "RISK FACTORS."

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 214 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:

                Details of Oil and Gas Properties and Activities
              Field  Acreage Producing wells # Proven Reserves (bbls)
             Qian112  5,115         190              1,963,319
             Da34     2,298          7                168,335
             Gu31     1,779          7                 62,533
             He301    2,471         14                274,637
             Total   11,663         218              2,468,824

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 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 September 30, 2008, the Company had a total of 218 producing wells, including 190 producing wells at the Qian'an 112 oilfield, 14 producing wells at the Hetingbao 301 oilfield, 7 producing wells at the Daan 34 oilfield and 7 producing wells at the Gudian 31 oilfield.
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 the monthly mean price calculated from the Mean of Platts Singapore ("MOPS") daily price for sour, heavy Indonesian crude, as measured during the previous month. Platts is an international commodity and trading company that collects and publishes pricing data on a wide range of petroleum and non-petroleum commodity types. The price paid to the Company is FOB at the local Jilin Province PetroChina oil storage depot.

PetroChina pays the Company monthly in arrears, on approximately the 15th day after the end of each month. The amount paid to the Company in the first two months of each calendar quarter is decreased by the amount of oil surcharge tax the Company will owe to the PRC government at the end of that calendar quarter. PetroChina holds those amounts back from the Company until the end of each calendar quarter, and then pays those amounts to the Company with the balance due for oil deliveries in the final month of the quarter. For this reason, the Accounts Receivable balance at the end of each quarter is larger than the prior month's oil sales revenue, because it includes the oil surcharge tax amounts the Company owes for the first two months of the quarter. For example, as of September 30, 2008, the Company's Accounts Receivable balance totaled $10,595,234, which is all due to the Company from PetroChina, and includes amounts related to the following items:

September Oil Sales, net of oil surcharge: $6,114,279 Quarterly total oil surcharge: $4,480,955

Operating Performance

Our operating performance is influenced by several factors, the most significant of which are the price we receive for our oil and the quantities of oil that we are able to produce. The world price for oil has overall influence on the prices that we receive for our oil production. The prices received for different grades of oil are based upon the world price of oil, which is then adjusted based upon the particular grade. Typically light oil is sold at a premium, while heavy grades of crude (such as the type we produce from the four fields we operate) are discounted.

Our oil development and acquisition activities require substantial and continuing capital expenditures. Historically, the sources of financing to fund our capital expenditures have included:

· Cash flow from operations;

· Sales of equity securities;

· Loans from shareholders; and

· Extension of credit from our suppliers, including particularly our suppliers of well drilling and completion services.

For the three months ended September 30, 2008 (the "Current Quarter"), the sale price we received for our crude oil production averaged $111.90 per barrel, compared with $72.90 per barrel for the three months ended September 30, 2007 (the "Comparable Quarter"). For the nine months ended September 30, 2008 (the "Current Period"), the sale price we received for our crude oil production average $103.60 per barrel, compared with $65.80 per barrel for the nine months ended September 30, 2007 (the "Comparable Period").

Our oil producing activities are accounted for using the full cost method of accounting. Under this accounting method, we capitalize all costs incurred in connection with the acquisition of oil properties and the exploration for and development of oil reserves. These costs include lease acquisition costs, geological and geophysical expenditures, costs of drilling productive and non-productive wells (to date, all of the wells we have drilled have been productive wells), conversion of productive wells into production support infrastructure such as water-injection wells, and overhead expenses directly related to land and property acquisition and exploration and development activities. Proceeds from the disposition of oil properties are accounted for as a reduction in capitalized costs, with no gain or loss recognized unless a disposition involves a material change in the relationship between capitalized costs and reserves, in which case the gain or loss is recognized.

Depreciation of the capitalized costs of oil properties, including estimated future development costs, is based upon estimates of proved oil reserves and production. Unproved oil properties are not amortized, but are individually assessed for impairment. The cost of any impaired property is transferred to the balance of oil properties being depleted. Reserve values are calculated annually, at our fiscal year-end, by a third-party geological consulting company, and are estimated in accordance with Statement of Financial Accounting Standards No. 19 ("FAS 19") - Financial Accounting and Reporting by Oil and Gas Producing Companies (as amended), SEC Regulation S-K and Regulation S-X under the Securities Act of 1933 and the Securities Exchange Act of 1934, and the SEC's Industry Guide 2.

Production, Average Sales Prices, and Production Costs

Our business operations are characterized by frequent, and sometimes
significant, changes in the price we receive for the crude oil we produce and in
the volumes of crude oil we produce. The following table shows selected
operating data for each of the three and nine months ended September 30, 2008
and September 30, 2007.

                                             Three months ended September 30          Nine months ended September 30
                                                 2008                  2007               2008                 2007
Oil Output (Bbl)                                     172,730             86,222              422,788            174,280
Avg. Sale Price ($/bbl)                    $          111.90       $      72.90     $         103.60       $      65.80

Operating Revenue                          $      19,060,007       $  5,826,506     $     44,051,519       $ 11,804,007

Cost of Sales
Production Costs                                     895,155            704,568            2,390,432          1,669,166
Depreciation                                       3,774,327          1,361,732            8,155,321          2,601,561
Amortization                                           2,975              2,695                8,743              7,972
Oil Surcharge                                      4,480,955            848,315            9,865,655          1,500,902

Gross Profit                               $       9,906,595       $  2,909,196     $     23,631,368       $  6,024,406

RESULTS OF OPERATIONS

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

Revenues. Revenues for the Current Quarter were $19,060,007 compared to $5,826,506 for the Comparable Quarter, an increase of $13,233,501, or 227%. This increase was due to an increase in both crude oil production and the average price we received for our crude oil. Our output of crude oil for the Current Quarter was 172,730 barrels compared to 86,222 barrels for the Comparable Quarter. The increase in production was mainly because of (i) refracturing and other technical improvements made on the existing wells; (ii) implementation of a water injection network which efficiently prevented the decrease of production of existing wells and helped to maintain certain production levels of such wells; and (iii) 30 new wells brought into production during the third quarter of 2008.

Cost of sales. Cost of sales increased by 214% from $2,917,310 for the three months ended September 30, 2007 to $9,153,412 for the three months ended September 30, 2008. The increase in cost of sales resulted primarily from increases in direct production costs, depreciation of oil and gas properties, and the payment of the government oil surcharge. For the three months ended September 30, 2008, the Company paid an oil surcharge of $4,480,955 to the PRC government as compared to $848,315 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. This government oil surcharge tax is paid by the Company on a quarterly basis, following the end of each quarter. In addition, depreciation of oil and gas properties increased from $1,361,732 for the three months period ended September 30, 2007 to $3,774,327 for the three months period ended September 30, 2008, an increase of 177%. The increase in the depreciation of oil and gas properties was mainly attributable to the higher volumes of oil produced and the addition of 30 new wells to the depreciable production equipment base during the third quarter of 2008.

Operating Expenses. Operating expenses totaled $978,700 for the Current Quarter, compared to $290,676 for the Comparable Quarter, an increase of 237% . This increase is primarily a result of an increase of approximately $600,000 in selling, general and administrative costs. This increase includes $319,648 of non-cash charges associated with common stock and option grants made to officers, directors and senior staff of the company.

Other Income (Expense). Other expenses increased from $34,878 for the three months ended September 30, 2007 to $871,451 for the three months ended September 30, 2008. This increase is primarily the result of increases in (i) amortization of discount on debenture and (ii) interest expense. The amount of amortization of discount on debenture recorded in the Current Quarter was $486,803, compared with $0 in the Comparable Quarter.

Net Income. Net income increased by 229% from $1,499,495 for the three months ended September 30, 2007 to $4,938,917 for the three months ended September 30, 2008, primarily as a result of a 227% increase in sales as described above.

Nine Months Ended September 30, 2008 Compared To Nine Months Ended September 30, 2007

Revenues. Revenues for the nine months ended September 30, 2008 were $44,051,519 compared to $11,804,007 for the nine months ended September 30, 2007, an increase of $32,247,512, or 273%. This increase was due to an increase in crude oil production and crude oil price. Our output of crude oil for the nine months ended September 30, 2008 was 422,788 barrels compared to 174,280 barrels for the same nine months in 2007. The increase in production was mainly because of (i) refracturing and other technical improvements made on the existing wells; (ii) implementation of a water injection network which efficiently prevented the decrease of production of existing wells and helped to maintain certain production levels of such wells; and (iii) 61 new wells brought into production during the first three quarters of 2008.

Cost of sales. Cost of sales increased by 253% from $5,779,601 for the nine months ended September 30, 2007 to $20,420,151 for the nine months ended September 30, 2008. The increase in cost of sales resulted primarily from the increase in production volumes and the payment of oil surcharge. For the nine months ended September 30, 2008, the Company paid an oil surcharge of $9,865,655 to the PRC government as compared to $1,500,902 paid for the same nine 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 $2,601,561 for the nine months period ended September 30, 2007 to $8,155,321 for the nine months period ended September 30, 2008, an increase of 214%. The increase in the depreciation of oil and gas properties was mainly attributable to the increased volume of crude oil produced and the addition of depreciable assets associated with the 61 new wells brought into production during the first nine months of 2008.

Operating Expenses. Operating expenses increased by 109% from $939,316 for the nine months ended September 30, 2007 to $1,960,278 for the nine months ended September 30, 2008. This increase is primarily a result of an increase of approximately $645,000 in selling, general and administrative costs and $240,000 in consulting fees.

Other Income (Expense). Other income decreased from $180,684 for the nine months ended September 30, 2007 to a total expense of $2,086,952 for the nine months ended September 30, 2008. This decrease in other income (expense) is primarily the result of increases in (i) amortization of discount on debenture and (ii) interest expense. The amount of amortization of discount on debenture recorded in the Current Period was $1,135,874, compared to $0 in the Comparable Period.

Net Income. Net income increased by 295% from $3,040,425 for the nine months ended September 30, 2007 to $11,999,183 for the nine months ended September 30, 2008, primarily as a result of a 273% increase in sales as described above.

LIQUIDITY AND CAPITAL RESOURCES

Our capital resources consist primarily of cash flows from our oil producing properties. Our level of earnings and cash flows depend upon many factors, including the price we receive for crude oil we produce.

As of September 30, 2008, the Company had cash and cash equivalents of $7,762,017, total current assets of $20,915,661 and current liabilities of approximately $21,434,767. For the nine months ended September 30, 2008, our primary sources of liquidity were approximately $16,456,955 provide by operating activities and approximately $12,277,334 in cash provided by financing activities.

Net cash provided by operating activities was $16,456,955 for the Current Period compared to net cash provided by operating activities of $9,187,144 for the Comparable Period. The increase in net cash provided by operating activities is primarily related to the increase in net income and non-cash charges such as depreciation and amortization during the nine month period ended September 30, 2008. Additionally, an increase in the amount of income tax payable provided substantial operating cash flow for the Company. These factors were somewhat offset by increases in accounts receivable of $5,742,601, increased prepaid expenses related to the drilling of new wells in the amount of $1,863,807, deferred financing costs of $1,186,229 and a reduction in the amount of accounts payable in the amount of $3,458,626.

The reduction in accounts payable relates primarily to costs related to the drilling of wells accrued in 2007. The Company seeks to strategically manage the level of trade credit that it has outstanding with key well drilling and completion suppliers, and at times elects to pay down the current and long-term accounts payable balances with these suppliers in advance of stated due dates in order to strengthen the Company's negotiating leverage with these suppliers for current and/or future drilling projects. The increase in accounts receivable is due to the increase in sales of crude oil to PetroChina during the quarter.

Net cash used in investing activities was $19,618,655 for the nine months ended September 30, 2008 compared to $10,005,089 for the same period in 2007. This increase is primarily due to the increase in purchase of oil and gas properties of $9,308,192 during the nine months ended September 30, 2008 associated with the cost of drilling and bringing new wells into production.

Net cash provided by financing activities was $12,277,334 for the nine months ended September 30, 2008, primarily as a result of the financing by Lotusbox Investments Limited, which was completed in the first quarter of 2008.

The Company has paid for the development of its producing oil wells 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 is continually evaluating opportunities to expand production and grow the Company's operations, including via acquisition of additional leased oil fields or expansion into related businesses such as the provision of oil field services. The Company's ability to obtain additional capital to achieve certain of these expansion goals will 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 could be substantial given the Company's business and development goals. However, the Company anticipates that cash flows from operations will be sufficient to fund continued development at the four oil fields it currently operates.

Capital Commitments

As of September 30, 2008, the Company had capital commitments of $3,888,000 with a contractor for the completion of drilling of 17 oil wells under construction.

Crude Oil Price Trends

Changes in crude oil prices significantly affect our revenues, financial condition and cash flows. Markets for crude oil have historically been volatile and we expect this trend to continue. Prices for crude oil typically fluctuate in response to relatively minor changes in supply and demand, market uncertainty, seasonal, economic, political and other factors beyond our control. Although we are unable to accurately predict the prices we receive for our oil, any significant or sustained decline in oil prices may materially adversely affect our financial condition, liquidity, ability to obtain future debt or equity financing and operating results.

Production Trends
Like all other oil exploration and production companies, we experience natural production declines at existing wells. We recognize that oil production from a given well naturally decreases over time and that a downward trend in our overall production could occur unless the natural declines are offset by additional production from new wells, investment in measures to increase the production from existing wells (such as CO2 and water injection), or . . .