Mewtwo, his heart having been softened by the selfless example of Ash Ketchum and Hubie the penguin back in his birthland in the eastern Kanto region, has now traveled to the western region of Johto in search of a location that is unreachable by the prying eyes and harsh judgments of humans for the sake of his band of cloned Pokémon, with whose welfare Mewtwo is solely concerned. He eventually finds the perfect hideaway: a huge mountain named Mt. Quena, surrounded by steep cliffs that are practically impossible to scale, but in its top is a forest and a freshwater lake that makes for a near-utopia for all the Bug Pokémon living there. This is a perfect fit for Mewtwo's band, so thus they settle in the top of Mt. Quena and begin a new, safe life, with Mewtwo watching over as their guardian, as he feels they cannot belong in the world as they were not born in it (Interestingly enough, he seems particularly close to the Pikachu and Meowth clones, possibly reflecting how important their templates were in his change of heart).
At the end of the first movie, Mewtwo erased all memory of the events from all those involved. However, due to his not being on New Island at the time, Giovanni has not forgotten about Mewtwo, and has been concocting a military plan of assault upon wherever Mewtwo has settled to take the Pokémon back for himself. He at last locates Mewtwo in his new mountain retreat and begins his operation to assault and capture Mewtwo and bend his will to Giovanni's. The Team Rocket combat unit heads towards Mt. Quena.
Ash and his friends and Pikachu, on their Pokémon journey as always, are now passing through the area around Mt. Quena, but complications with the weather and the bus service force them to stay at a cabin at the foot of the mountain, where they would meet the Pokémon naturalists Luna Carson and Cullen Calix and the spunky young girl Domino who works for a Pokémon institute. Hubie, Marina and their friends had travelled with Luna to spend a month at the cabin.
But then a break-in and attempted thievery of Pikachu by the classic antics of the Team Rocket trio Jessie, James, and Meowth, and soon a series of turbulent events involving a scuffle on a hot air balloon, leads everyone into the airspace of Mt. Quena.
There everyone sees the approaching Combat Unit, and Domino, revealing herself in league with Team Rocket Organization as elite Agent 009 (or, as she calls herself, The Black Tulip), pops their balloon and sends everyone else plummeting onto the mountain while she returns to Giovanni to report on Mewtwo's status.
Pikachu, Marina and Bonkers are seperated from Hubie, Ash and the others and end up on the island with Jessie, James and Meowth. There they meet Pikachu's clone who tries to attack them, only to be stopped by Mewtwo.
Upon realising that the Team Rocket Combat Unit is approaching, the Pikachu clone rounds up a few of the clones to evacuate the island and agrees to take Marina, Bonkers and Pikachu with them. But as they reach shore, Giovanni arrives to capture the clones. Mewtwo, however arrives to stop him
Giovanni eventually succeeds in capturing Mewtwo with the threat that the other Pokémon clones would be his to capture and experiment if Mewtwo didn't comply. Domino even uses one of her tulips to attack Marina, but Bonkers pushes her out of the way and takes the blast.
Ash, Misty, Brock, Hubie, Rocko, Petra, Beanie and Timmy finally reunite with Marina, Pikachu and Bonkers. But Domino arrives and puts them all in custody. Giovanni's operation is successful, and he immediately capitalizes by ordering the construction of a new Team Rocket base on the mountain.
The characters and all other cloned Pokémon that attempted to protect Mewtwo are then locked away in a prison cell, along with two mother Pokémon attempting to protect their offspring. While in the cell Meowth translates what the other Pokémon are saying: "They're coming... and they're very angry. They're mad at whoever is polluting the lake and they've come to stop them." Domino eventually releases Jessie and James and puts them to work cleaning the new base.
While in the cell, Marina and Bonkers tell Hubie and the others about Mewtwo. Rocko demands that they find a way to bust out and save him.
Giovanni's greed for new Team Rocket bases becomes his worst mistake; without warning, a swarm of furious Bug Pokémon (that Meowth was referring to) from the mountain sabotages the Team Rocket base that is polluting the freshwater lake, and the ensuing chaos allows Ash, Hubie, Marina and everyone to escape and scatter. Ash, Hubie and everyone find Mewtwo, believing that this is the first time they've seen Mewtwo, and they all try to free Mewtwo from the machines that are suppressing his mind and body, partly as thanks for Mewtwo protecting Pikachu, Marina and Bonkers earlier. However, Mewtwo is weak from using what was left of his power and strength to destroy the machines that held him, putting his life force in jeopardy, but Ash and Hubie carry Mewtwo away from Giovanni's battle while Brock, Misty, Marina, Rocko, Bonkers, Petra, Beanie and Timmy and the other clones along with the bug Pokémon keep Team Rocket occupied.
Mewtwo asks Ash and Hubie are helping him, to which Ash and Hubie reply that you don't need a reason to help someone in trouble. Mewtwo reflects that Ash and Hubie may be one-of-a-kind, but Hubie says that everyone is. As they reach the heart of the mountain, Ash throws Mewtwo into a healing spring that restores his power, prompting Mewtwo to finally accept that he is a real Pokémon, as the water affects him just as it affected others. The Pokémon clone rises and uses all his psychic powers to move the lake and the spring underground, and then uses his mind-erasing powers to clear Giovanni's mind of Mewtwo, the clones, and Mt. Quena. Team Rocket are transported away from the mountain, with the exception of Jessie, James and Meowth, who had hidden in a cave during the battle.
Ash, Meowth, Hubie and his friends and various Pokémon convince Mewtwo not to erase their minds as well, because though Mewtwo would mean well to do so to keep knowledge of this natural sanctuary hidden from the destructive tendencies of humanity, Ash and Hubie assure that they would permanently keep the mountain's secret unrevealed at any rate. Mewtwo agrees and personally thanks Ash and Hubie for all their help and understanding, and he departs on his own as all the Clone Pokémon leave to lead life as natural Pokémon in the wild, sending Ash and co. in a Pikachu balloon and Jessie, James and Meowth in their normal balloon. As Ash, Misty and Brock were walking through a city, Ash hears Mewtwo's voice say "I will remember you always". The narrator concludes with the rumors of a Pokémon who traversed the city at night.
Meanwhile, it is revealed that Mewtwo returned the memories of New Island to Hubie, Marina and their friends. Bonkers, however is saddened as he had grown to like the cloned Pikachu a lot. But moments later, the clone suddenly appears and leaps into Bonkers arms. Hubie guesses that after everything that's occured, Pikachu's clone had realised it could trust them and invites it to join them. Bonkers gives the clone Pikachu the name "Pikatwo" while Marina embraces Hubie stating that this could be the start of a wonderful thing.