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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------

                                   FORM 10-Q

(MARK ONE)

   [X]         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                      FOR THE QUARTER ENDED JUNE 30, 1997

                                       OR
   [_]        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                         COMMISSION FILE NUMBER 1-12311

                            ------------------------

                            MONTEREY RESOURCES, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

                    DELAWARE                       76-0511993
            (STATE OF INCORPORATION)    (I.R.S. EMPLOYER IDENTIFICATION NO.)

                               5201 TRUXTUN AVENUE
                              BAKERSFIELD, CA 93309
          (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (805) 322-3992

                            ------------------------

     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 [_]

       Shares of Common Stock outstanding at July 31, 1997 -- 54,775,499

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<PAGE>
                          PART I  FINANCIAL STATEMENTS

                                                                            PAGE
                                                                            ----

Statement of Operations
  Three Months and Six Months Ended June 30, 1997 and 1996 ............        2
Balance Sheet
  June 30, 1997 and December 31, 1996 .................................        3
Statement of Cash Flows
  Three Months and Six Months Ended June 30, 1997 and 1996 ............        4
Statement of Division Equity and
  Shareholders' Equity Six Months Ended June 30, 1997 and 1996 ........        5
Notes to Financial Statements .........................................        6
Management's Discussion and Analysis of Financial Condition
  and Results of Operations ...........................................       12

                                       1
<PAGE>
                            MONTEREY RESOURCES, INC.
                      STATEMENT OF OPERATIONS (UNAUDITED)
                (IN MILLIONS OF DOLLARS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                        THREE MONTHS ENDED     SIX MONTHS ENDED
                                             JUNE 30,              JUNE 30,
                                       --------------------  --------------------
                                         1997       1996       1997       1996
                                       ---------  ---------  ---------  ---------
<S>                                    <C>        <C>        <C>        <C>      
Revenues
     Sales of crude oil and liquids
       produced......................  $    63.9  $    66.8  $   138.6  $   125.7
     Sales of natural gas produced...        0.3        0.3        0.6        0.7
     Sales of crude oil purchased....       10.3        1.2       19.9        1.2
     Other...........................        0.1        0.1        0.4        0.5
                                       ---------  ---------  ---------  ---------
                                            74.6       68.4      159.5      128.1
                                       ---------  ---------  ---------  ---------
Costs and Expenses
     Production and operating........       29.6       24.4       60.7       49.0
     Cost of crude oil purchased.....       10.7        1.2       21.4        1.2
     Exploration, including dry hole
       costs.........................        0.5        0.6        0.8        0.9
     Depletion, depreciation and
       amortization..................        9.7        9.5       19.0       18.1
     General and administrative......        3.8        2.1        6.5        3.9
     Taxes (other than income).......        3.4        2.4        6.0        4.3
                                       ---------  ---------  ---------  ---------
                                            57.7       40.2      114.4       77.4
                                       ---------  ---------  ---------  ---------
Income from Operations...............       16.9       28.2       45.1       50.7
     Interest income.................        0.4     --            0.8     --
     Interest expense................       (4.9)      (6.4)      (9.6)     (12.9)
     Interest capitalized............        0.5        0.2        0.7        0.4
                                       ---------  ---------  ---------  ---------
Income Before Income Taxes...........       12.9       22.0       37.0       38.2
     Income taxes....................       (3.5)      (8.0)     (12.0)     (13.9)
                                       ---------  ---------  ---------  ---------
Net Income...........................  $     9.4  $    14.0  $    25.0  $    24.3
                                       =========  =========  =========  =========
Net Income Per Share.................  $    0.17  $  --      $    0.46  $  --
                                       =========  =========  =========  =========
Pro Forma Net Income Per Share.......  $  --      $    0.25  $  --      $    0.44
                                       =========  =========  =========  =========
Number of shares used in computing
  net income per share (in
  millions)..........................       54.8       54.8       54.8       54.8
                                       =========  =========  =========  =========
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                       2
<PAGE>
                            MONTEREY RESOURCES, INC.
                                 BALANCE SHEET
                            (IN MILLIONS OF DOLLARS)

                                             JUNE 30,      DECEMBER 31,
                                               1997            1996
                                           ------------    ------------
                                           (UNAUDITED)
                 ASSETS
Current Assets
     Cash and cash equivalents..........     $   14.4        $    9.3
     Accounts receivable................         40.5            46.4
     Inventories........................          1.4             1.7
     Other current assets...............         10.6             9.3
                                           ------------    ------------
                                                 66.9            66.7
                                           ------------    ------------
Properties and Equipment, at cost
     Oil and gas (on the basis of
      successful efforts accounting)....      1,053.7         1,016.1
     Other..............................         15.7            14.2
                                           ------------    ------------
                                              1,069.4         1,030.3
     Accumulated depletion, depreciation
      and amortization..................       (670.3)         (651.3)
                                           ------------    ------------
                                                399.1           379.0
                                           ------------    ------------
Other Assets............................          1.5             1.5
                                           ------------    ------------
                                             $  467.5        $  447.2
                                           ============    ============
         LIABILITIES AND EQUITY
Current Liabilities
     Accounts payable...................     $   38.6        $   34.2
     Dividends payable..................          8.2          --
     Interest payable...................          4.7             4.7
     Taxes payable......................       --                 5.8
     Accrued employee benefits..........          1.1             1.1
     Other current liabilities..........          2.8             3.0
                                           ------------    ------------
                                                 55.4            48.8
                                           ------------    ------------
Long-Term Debt..........................        185.0           175.0
                                           ------------    ------------
Other Long-Term Obligations.............          3.8             3.5
                                           ------------    ------------
Deferred Income Taxes...................         41.6            43.2
                                           ------------    ------------
Commitments and Contingencies (Note
  5)....................................       --              --
                                           ------------    ------------
Shareholders' Equity
     Preferred stock....................       --              --
     Common stock.......................          0.5             0.5
     Paid-in capital....................        171.0           170.8
     Unamortized restricted stock
      awards............................         (1.0)           (1.0)
     Retained earnings..................         11.2             6.4
                                           ------------    ------------
                                                181.7           176.7
                                           ------------    ------------
                                             $  467.5        $  447.2
                                           ============    ============

   The accompanying notes are an integral part of these financial statements.

                                       3
<PAGE>
                            MONTEREY RESOURCES, INC.
                      STATEMENT OF CASH FLOWS (UNAUDITED)
                            (IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
                                        THREE MONTHS ENDED     SIX MONTHS ENDED
                                             JUNE 30,              JUNE 30,
                                       --------------------  --------------------
                                         1997       1996       1997       1996
                                       ---------  ---------  ---------  ---------
<S>                                    <C>        <C>        <C>        <C>  
Operating Activities:
  Net income.........................  $     9.4  $    14.0  $    25.0  $    24.3
  Adjustments to reconcile net income
     to net cash
     provided by operating
     activities:
     Depreciation, depletion and
       amortization..................        9.7        9.5       19.0       18.1
     Deferred income taxes...........       (1.8)       3.2       (1.7)       5.5
     Other...........................        0.2        0.3        0.5        0.2
     Changes in operating assets and
       liabilities
       Decrease (increase) in
          accounts receivable........       23.6       (2.8)       5.9       (9.0)
       Decrease (increase) in other
          current assets.............        0.5        0.1        0.4       (0.2)
       Increase (decrease) in
          accounts payable...........      (10.1)       4.5        6.1        6.9
       Increase (decrease) in
          interest payable...........        4.6        6.4     --         --
       Increase (decrease) in other
          current liabilities........       (8.5)    --           (5.8)    --
       Net change in other assets and
          liabilities................       (2.8)       0.7       (1.4)       1.8
                                       ---------  ---------  ---------  ---------
Net Cash Provided by Operating
  Activities.........................       24.8       35.9       48.0       47.6
                                       ---------  ---------  ---------  ---------
Investing Activities:
  Capital expenditures...............      (21.2)     (17.2)     (38.7)     (26.8)
  Acquisition of producing
     properties......................       (2.1)      (2.6)      (2.2)      (2.6)
                                       ---------  ---------  ---------  ---------
Net Cash Used in Investing
  Activities.........................      (23.3)     (19.8)     (40.9)     (29.4)
                                       ---------  ---------  ---------  ---------
Financing Activities:
  Net change in line of credit.......       10.0     --           10.0     --
  Dividends..........................      (12.0)    --          (12.0)    --
  Dividends to Parent................     --          (16.1)    --          (18.2)
                                       ---------  ---------  ---------  ---------
Net Cash Used in Financing
  Activities.........................       (2.0)     (16.1)      (2.0)     (18.2)
                                       ---------  ---------  ---------  ---------
Net (Decrease) Increase in Cash and
  Cash Equivalents...................       (0.5)    --            5.1     --
Cash and Cash Equivalents at
  Beginning of Period................       14.9     --            9.3     --
                                       ---------  ---------  ---------  ---------
Cash and Cash Equivalents at End of
  Period.............................  $    14.4  $  --      $    14.4  $  --
                                       =========  =========  =========  =========
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                       4
<PAGE>
                            MONTEREY RESOURCES, INC.
       STATEMENT OF DIVISION EQUITY AND SHAREHOLDERS' EQUITY (UNAUDITED)
                        (SHARES AND DOLLARS IN MILLIONS)

<TABLE>
<CAPTION>
                                                                                                                       TOTAL
                                                                                                                      DIVISION
                                                         COMMON STOCK                 UNAMORTIZED                    EQUITY AND
                                           DIVISION    ----------------    PAID-IN     RESTRICTED     RETAINED     SHAREHOLDERS'
                                            EQUITY     SHARES    AMOUNT    CAPITAL    STOCK AWARDS    EARNINGS         EQUITY
                                           --------    ------    ------    -------    ------------    ---------    --------------
<S>                                         <C>        <C>       <C>       <C>           <C>            <C>            <C>   
Balance at December 31, 1995............    $  45.0      --      $--       $ --          $--            $--            $ 45.0
Net income..............................       24.3      --       --         --          --             --               24.3
Dividends to parent.....................      (18.2)     --       --         --          --             --              (18.2)
                                           --------    ------    ------    -------    ------------    ---------    --------------
Balance at June 30, 1996................    $  51.1      --      $--       $ --          $--            $--            $ 51.1
                                           ========    ======    ======    =======    ============    =========    ==============
Balance at December 31, 1996............    $ --         54.8    $ 0.5     $ 170.8       $ (1.0)        $ 6.4          $176.7
Net income..............................      --         --       --         --          --              25.0            25.0
Dividends declared......................      --         --       --         --          --             (20.2)          (20.2)
Employee stock compensation.............      --         --       --           0.2       --             --                0.2
                                           --------    ------    ------    -------    ------------    ---------    --------------
Balance at June 30, 1997................    $ --         54.8    $ 0.5     $ 171.0       $ (1.0)        $11.2          $181.7
                                           ========    ======    ======    =======    ============    =========    ==============
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                       5
<PAGE>
                            MONTEREY RESOURCES, INC.
                         NOTES TO FINANCIAL STATEMENTS
                                  (UNAUDITED)

(1)  ACCOUNTING POLICIES

     Monterey Resources, Inc. (the "Company" or "Monterey") is an
independent oil and gas company engaged in the production, development and
acquisition of crude oil and natural gas in the State of California. The Company
conducted its operations as the Western Division of Santa Fe Energy Resources,
Inc. ("SFR") until the November 1996 initial public offering ("IPO") of its
common stock. On June 9, 1997, the Company formed Monterey Acquisition
Corporation ("MAC") for the purpose of acquiring McFarland Energy, Inc.
("McFarland"). MAC had no operations during the quarter ended June 30, 1997.
As of June 30, 1997, SFR owned approximately 83% of the outstanding shares of
Monterey's common stock.

     The financial statements for the quarter and six months ended June 30, 1996
include proportional allocations from certain SFR income statement and balance
sheet accounts, which are considered reasonable and necessary by management to
properly reflect the actual costs of the Western Division's operations. The
Western Division's results of operations include corporate overhead allocations
as follows: (i) production and operating expense includes $0.6 million for the
quarter and $1.3 million for the six months; (ii) exploration expense includes
$0.1 million for the quarter and $0.2 million for the six months; (iii) general
and administrative expense includes $2.9 million for the quarter and $4.5
million for the six months (before joint interest recoveries). If the Western
Division had been a separate, unaffiliated entity, the Company estimates that
general and administrative expense would have been higher by $0.3 million for
the quarter and $0.8 million for the six months. SFR provided cash management
services to the Western Division through a centralized treasury system and
therefore all intercompany accounts were settled daily and no cash balances were
maintained by the Western Division. All cash generated by operations, after
considering revenues and deductions for expenses (including corporate
allocations), capital expenditures and working capital requirements, were deemed
to be cash dividends to SFR.

     The accompanying unaudited financial statements of Monterey reflect, in the
opinion of management, all adjustments, consisting only of normal and recurring
adjustments and the allocations noted above, necessary to present fairly the
Company's financial position at June 30, 1997 and the Company's results of
operations and cash flows for the three-month and six-month periods ended June
30, 1997 and 1996. Interim period results are not necessarily indicative of the
results of operations or cash flows for a full year period.

     These financial statements and the notes thereto should be read in
conjunction with the Company's annual report on Form 10-K for the year ended
December 31, 1996.

(2)  PRO FORMA PER SHARE DATA

     Common shares outstanding at November 19, 1996, the closing date of the
Company's IPO, have been included in the pro forma per share calculations as if
such shares were outstanding for all periods prior to November 19, 1996.

(3)  STATEMENT OF CASH FLOWS

     The Company made interest and income tax payments as follows during the
three-month and six-month periods ended June 30, 1997 and 1996 (in millions of
dollars):

                                    THREE MONTHS ENDED     SIX MONTHS ENDED
                                         JUNE 30,              JUNE 30,
                                   --------------------  --------------------
                                     1997       1996       1997       1996
                                   ---------  ---------  ---------  ---------
     Interest payments...........        4.7        6.4        9.3       12.9
     Income tax payments.........       14.7     --           20.7     --

                                       6
<PAGE>
                            MONTEREY RESOURCES, INC.
            NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

(4)  SUBSEQUENT EVENTS

     On July 24, 1997, the Company completed its acquisition of McFarland. MAC
merged with and into McFarland, and as a consequence, McFarland is now a wholly
owned subsidiary of the Company. The Company paid $18.55 per share for each of
the 5,727,422 shares outstanding. McFarland's principal producing properties are
located in the Midway-Sunset field adjacent to properties owned by the Company.

     SFR's Spin Off of its interest in the Company was completed on July 25,
1997 with a tax-free distribution of its Monterey shares to SFR shareholders.

     Pursuant to the terms of a letter agreement dated as of June 13, 1996, a
fee is payable by the Company to Chase Securities Inc. and Petrie Parkman & Co.,
Inc. as a result of consummation of the Spin Off. The total amount of such fee
is equal to the product of (a) the sum of the market value of the shares of the
Company's common stock distributed in the Spin Off (based upon the average
closing price of the Company's common stock during the ten trading days after
the Spin Off) PLUS the aggregate principal amount of long-term indebtedness
assumed by the Company in connection with the Spin Off (which totalled $175.0
million) TIMES (b) 0.5%, LESS $1.0 million. The average market value of the
Company's common stock for the ten trading days after the Spin Off was
approximately $14.98 per share, yielding a total fee payable of approximately
$3.3 million, of which half is payable to each of Chase Securities and Petrie
Parkman. In addition, a fee of $200,000 was paid on July 25, 1997 to GKH
Partners, L.P. One of the Company's directors is associated with GKH Partners.

(5)  COMMITMENTS AND CONTINGENCIES

  HEDGING

     The Company's 1996 financial statements include the impact of oil and gas
hedging losses which were allocated by SFR. SFR from time to time entered into
such transactions in order to reduce exposure to fluctuations in market prices
of oil and natural gas. Oil hedging losses were allocated to the Company based
upon relative hedged volumes and were recognized as a reduction of oil revenues
in the period in which the hedged production was sold. Such amounts totaled $0.8
million and $2.5 million for the quarter and six-month period ended June 30,
1996, respectively. Currently the Company has no oil hedges in place and, going
forward, the Company does not expect to hedge a substantial portion of its oil
production.

     Additionally, during the first six months of 1996, SFR hedged 20 MMcf per
day of the natural gas purchased for use in the Company's steam generation
operations. Such hedges resulted in a $1.5 million and a $3.2 million increase
in the Company's production and operating costs for the quarter and six-month
period ended June 30, 1996, respectively. While the Company currently has no
natural gas hedges in place, the Company's management may determine that such
arrangements are appropriate in the future in order to reduce the Company's
exposure to increases in gas prices.

     On June 17, 1997 the Company entered into an interest rate swap with a bank
with a notional principal amount of $100 million. Under the terms of the swap,
which is effective for the period July 21, 1997 through July 21, 2003, during
any quarterly period at the beginning of which a floating rate specified in the
agreement is less than 6.74%, the Company must pay the bank interest for such
quarterly period on the principal amount at the difference between the rates.
Should the floating rate be in excess of 6.74%, the bank must pay the Company
interest for such quarterly period on the principal amount at the difference
between the rates.

  SPIN OFF TAX INDEMNITY AGREEMENT.

     To protect SFR from Federal and state income taxes, penalties, interest and
additions to tax that would be incurred by it if the Spin Off by SFR were
determined to be a taxable event, the Company and SFR have entered into an
agreement under which the Company has agreed to indemnify SFR with respect to
tax liabilities resulting primarily from actions taken by the Company at any
time during the one-year period

                                       7
<PAGE>
                            MONTEREY RESOURCES, INC.
            NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

after the Spin Off (or if certain tax legislation is enacted and is applicable
to the Spin Off, such longer period as is required for the Spin Off to be tax
free to SFR) (the "Restricted Period"). The Company has also agreed that,
unless it obtains an opinion of counsel or a supplemental ruling from the
Internal Revenue Service that such action will not adversely affect the
qualification of the Spin Off as tax-free, the Company will not merge or
consolidate with another corporation, liquidate or partially liquidate, sell or
transfer all or substantially all of its assets or redeem or otherwise
repurchase any of its stock or issue additional shares of the Company's capital
stock during such Restricted Period. The Company's obligations under this
agreement could possibly deter offers or other efforts by third parties to
obtain control of the Company during such Restricted Period, which could deprive
the Company's stockholders of opportunities to sell their shares of Common Stock
at prices higher than prevailing market prices.

     The Company believes that if the Company is required to make payments
pursuant to such agreement, the amount that the Company would pay to SFR would
have a material adverse effect on the Company's financial condition and results
of operations. The actions for which the Company is required to indemnify SFR
pursuant to this agreement are within the Company's control, and the Company has
no intention of taking any actions during the Restricted Period that would have
such effect.

  ENVIRONMENTAL REGULATION

     Federal, state and local laws and regulations relating to environmental
quality control affect the Company in all of its oil and gas operations. Set
forth below are descriptions of three sites for which the Company has been
identified as a potentially responsible party ("PRP") and for which the
Company may be held jointly and severally liable with other PRPs.

     The Company has been identified as one of over 250 PRPs at a superfund site
in Los Angeles County, California (the "OII site"). The site was operated by a
third party as a waste disposal facility from 1948 until 1983. The Environmental
Protection Agency ("EPA") is requiring the PRPs to undertake remediation of
the site in several phases, which include site monitoring and leachate control,
gas control and final remediation. In November 1988 the EPA and a group of PRPs
that includes the Company entered into a consent decree covering the site
monitoring and leachate control phases of remediation. The Company was a member
of the group Coalition Undertaking Remediation Efforts ("CURE") which was
responsible for constructing and operating the leachate treatment plant. This
phase is now complete and the Company's share of costs with respect to this
phase was $0.9 million. Another consent decree provides for the predesign,
design and construction of a landfill gas treatment system to harness and market
methane gas emissions. The Company is a member of the New CURE group which is
responsible for the gas treatment system construction and operation and landfill
cover. Currently, New CURE is in the design stage of the gas treatment system.
The Company's share of costs of this phase is expected to be $1.6 million and
such costs have been provided for in the financial statements. Pursuant to
consent decrees settling lawsuits against the municipalities and transporters
not named by the EPA as PRPs, such parties are required to pay approximately $84
million of which approximately $76 million will be credited against future
expenses. The EPA and the PRPs are currently negotiating the final closure
requirements. After taking into consideration the credits from the
municipalities and transporters, the Company estimates that its share of final
costs of the closure will be approximately $0.8 million which amount has been
provided for by the Company in its financial statements. The Company has entered
into a Joint Defense Agreement with the other PRPs to defend against a lawsuit
filed in September 1994 by ninety-five homeowners alleging, among other things,
nuisance, trespass, strict liability and infliction of emotional distress. A
second lawsuit has been filed by thirty-three additional homeowners and the
Company and the other PRPs have entered into a Joint Defense Agreement. At this
stage of the lawsuit the Company is not able to estimate costs or potential
liability.

     In 1994 the Company received a request from the EPA for information
pursuant to Section 104(e) of CERCLA and a letter ordering the Company and seven
other PRPs to negotiate with the EPA regarding implementation of a remedial plan
for a site located in Santa Fe Springs, California (the "Santa Fe Springs

                                       8
<PAGE>
                            MONTEREY RESOURCES, INC.
            NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Site"). The Company owned the property on which the site is located from 1921
to 1932. During that time the property was leased to another company and in 1932
the property was sold to that company. During the time the other company leased
or owned the property and for a period thereafter, hazardous wastes were
allegedly disposed at the site. The Company filed its response to the Section
104(e) order setting forth its position and defenses based on the fact that the
other company was the lessee and operator of the site during the time the
Company was the owner of the property. However, the Company has also given its
Notice of Intent to comply with the EPA's order to prepare a remediation design
plan. In March, 1997 the EPA issued an Amended Order for Remedial Design to the
original eight PRPs plus an additional thirteen PRPs. The Amended Order directs
the twenty-one PRPs to complete certain work required under the original order,
plus additional remedial design and investigative work. The total cost to
complete this work and to complete the final remedy (including ongoing
operations and maintenance) is currently estimated to be $5 million. Past costs
incurred by the EPA for this site for which the EPA is seeking reimbursement
totals approximately $6 million. The Company has provided $250,000 in its
financial statements for its share of future costs at the Santa Fe Springs Site.

     In 1995 the Company and eleven other companies received notice that they
have been identified as PRPs by the California Department of Toxic Substances
Control (the "DTSC") as having generated and/or transported hazardous waste to
the Environmental Protection Corporation ("EPC") Eastside Landfill during its
fourteen-year operation from 1971 to 1985 (the "Eastside Site"). EPC has since
liquidated its assets and placed the proceeds in trust (the "EPC Trust") for
closure and post-closure activities. However, these monies may not be sufficient
to close the site. The PRPs have entered into an enforceable agreement with the
DTSC to characterize the contamination at the site and prepare a focused
remedial investigation and feasibility study. The cost of the remedial
investigation and feasibility study is estimated to be $1 million, the cost of
which will be shared by the PRPs and the EPC Trust. The ultimate costs of
subsequent phases will not be known until the remedial investigation and
feasibility study is completed and a remediation plan is accepted by the DTSC.
The Company currently estimates final remediation could cost $2 million to $6
million and believes the monies in the EPC Trust will be sufficient to fund the
lower end of this range of costs. The DTSC recently designated 27 new PRPs for
the Eastside Site. The Company has provided $80,000 in its financial statements
for its share of costs related to this site.

     Pursuant to the Contribution Agreement, the Company agreed to indemnify and
hold harmless SFR from and against any costs incurred in the future relating to
environmental liabilities of the Western Division assets (other than the assets
retained by SFR), including any costs or expenses incurred at any of the OII
Site, the Santa Fe Springs Site and the Eastside Site, and any costs or
liabilities that may arise in the future that are attributable to laws, rules or
regulations in respect of any property or interest therein located in California
and formerly owned or operated by the Western Division or its predecessors. SFR
agreed to indemnify the Company from and against any costs relating to
environmental liabilities of any assets or operations of SFR (whether or not
currently owned or operated by SFR) to the extent not attributable to the
Western Division (other than the assets retained by SFR).

  EMPLOYMENT AGREEMENTS

     The Company has entered into employment agreements ("Employment
Agreements") with eight key employees. The initial term of seven of the
agreements expire on December 31, 1998; however, beginning January 1, 1998 and
on each January 1 thereafter the term of the agreements will automatically be
extended for additional one-year periods, unless by September 30 of the
preceding year the Company gives notice that the agreement will not be so
extended. The term of each is automatically extended for a period of two years
following a Change in Control (as defined herein). The other employment
agreement has an initial term which expires on December 31, 1999, is
automatically extended for one-year periods beginning January 1, 1999 and is
automatically extended for a three-year period following a Change in Control.

                                       9
<PAGE>
                            MONTEREY RESOURCES, INC.
            NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

     In the event that following a change in control employment is terminated
for reasons specified in the Employment Agreements, the agreements provide for
(i) payment of certain amounts to the employee based on the employee's salary
and bonus under the Company's Incentive Compensation Plan; (ii) payout of
nonvested restricted stock, phantom units, stock options, if any, and (iii)
continuation of certain insurance benefits for a period of up to 24 to 36
months. The payments and benefits are payable pursuant to the Employment
Agreements only to the extent they are not paid out under the terms of any other
plan of the Company. In addition, payments and benefits under certain employment
agreements are subject to further limitation based on certain provisions of the
Internal Revenue Code.

  OTHER MATTERS

     The Company has certain long-term contracts ranging up to twelve years for
the supply and transportation of approximately 20 million cubic feet per day of
natural gas to the Company's operations in Kern County, California. In the
aggregate, these contracts involve a minimum commitment on the part of the
Company of approximately $12.2 million per year (based on prices equal to 102%
of the applicable index and transportation charges in effect for June 1997).

     On July 16, 1997 the Company was served with a petition (the "Complaint")
filed by The Prudential Insurance Company of America ("Prudential") alleging
breach of fiduciary duty, breach of contract, fraud, constructive fraud, and
negligent misrepresentation. The Complaint relates to the alleged conduct of the
Company's predecessor in interest, SFR, as the General Partner of the South
Belridge Limited Partnership (the "Partnership"). Prudential is the sole
limited partner in the Partnership. Prudential alleges that SFR failed to
develop the Partnership's property in accordance with the Partnership Agreement.
In November, 1996, SFR's interest in the Partnership was assigned to the
Company. The Company is in the process of investigating the allegations made by
Prudential in its Complaint. Based on the information currently available to it,
the Company believes that it has valid defenses to Prudential's claims and
intends to vigorously defend this lawsuit.

     There are other claims and actions, including certain other environmental
matters, pending against the Company. While the outcome of lawsuits or other
proceedings against the Company cannot be predicted with certainty, management
does not expect these matters to have a material adverse effect on the business,
financial condition or liquidity of the Company.

(5)  SHAREHOLDER RIGHTS PLAN

     On July 16, 1997, the Company adopted a shareholder rights plan pursuant to
which preferred stock purchase rights were distributed for each share of Common
Stock held as of the close of business on July 25, 1997. The plan was adopted in
accordance with the Company's contractual obligations to SFR as part of the
planned Spin Off of SFR's ownership in Monterey to SFR shareholders. The Rights
will expire on August 31, 1999.

     Each Right will entitle shareholders to buy one one-hundredth ( 1/100) of a
share of a new series of Junior Preferred Stock of the Company for each share
owned of the Company's Common Stock at an exercise price of $45 per one
one-hundredth of a share. The Rights will be exercisable only if a person
acquires beneficial ownership of 15% or more of Monterey's outstanding Common
Stock or commences a tender or exchange offer upon consummation of which such
person would beneficially own 15% or more of the Company's outstanding Common
Stock.

     If any person acquires beneficial ownership of 15% or more of Monterey's
Common Stock (an "Acquiring Person"), then each Right not owned by such person
or certain related parties will entitle its holders to purchase, at the Right's
then-current exercise price, shares of Monterey's Common Stock having a value
equal to twice the Right's then-current exercise price. In addition, if after a
person has become an Acquiring Person, Monterey is involved in a merger of other
business combination transaction with another person in which the Company is not
the surviving entity or its Common Stock is exchanged or converted, or

                                       10
<PAGE>
                            MONTEREY RESOURCES, INC.
            NOTES TO FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

the Company sells 50% or more of its assets or earning power to another person,
each Right will entitle its holder to purchase, at the Right's then-current
exercise price, shares of common stock of such other person (or the principal
party to such transaction) having a value equal to twice the Right's
then-current exercise price.

     Monterey will generally be entitled to redeem the Rights in whole, but not
in part, at $0.01 per Right payable in cash or Common Stock, subject to
adjustment, at any time until 10 days after the first public announcement that
an Acquiring Person has become such.

                                       11
<PAGE>
          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                           AND RESULTS OF OPERATIONS

     The Company reported net income of $9.4 million, or $0.17 per share, for
the second quarter of 1997, compared to $14.0 million, or $0.25 per share on a
pro forma basis, in the second quarter of 1996. The decreased earnings resulted
from lower realized heavy oil prices and higher steam fuel costs, partially
offset by increased production. Crude oil and liquids production totaled 50,300
barrels per day in the second quarter of 1997, compared to 46,400 barrels per
day in the second quarter of 1996. The Company's average sales price per barrel
of $14.09 was $1.77 lower than the average price of $15.86 realized in the
second quarter of 1996. Natural gas production declined to 3.2 million cubic
feet per day in the second quarter of 1997 from 3.7 million cubic feet per day
in the second quarter of 1996.

     The Company reported net income of $25.0 million, or $0.46 per share, for
the first six months of 1997, compared to $24.3 million, or $0.44 per share on a
pro forma basis, for the first six months of 1996. The increased earnings
resulted from increased production partially offset by lower realized heavy oil
prices and higher steam fuel costs. Crude oil and liquids production totaled
50,200 barrels per day for the first six months of 1997, compared to 45,100
barrels per day for the first six months of 1996. The Company's average sales
price per barrel of $15.33 was $0.06 lower than the average price of $15.39
realized in the first six months of 1996. Natural gas production declined to 3.1
million cubic feet per day for the first six months of 1997 from 3.6 million
cubic feet per day for the first six months of 1996.

GENERAL

     The discussion presented herein relates to the operations of the Company
for the three-month and six-month periods ended June 30, 1997, and to the
operations of the Western Division for the three-month and six-month periods
ended June 30, 1996.

     As an independent oil and gas producer, the Company's results of operations
are dependent upon the difference between the prices received for oil and gas
and the costs of finding and producing such resources. The Company produces most
of its oil and gas from long-lived fields in the San Joaquin Valley of
California utilizing various thermally enhanced oil recovery ("EOR") methods.
The market price of heavy (i.e., low gravity, high viscosity) and sour (i.e.,
high sulfur content) crude oils produced in these fields is lower than sweeter,
light (i.e., low sulfur and low viscosity) crude oils, reflecting higher
transportation and refining costs. In addition, the lifting costs of heavy crude
oils are generally higher than the lifting costs of light crude oils. As a
result, even relatively modest changes in crude oil prices may significantly
affect the Company's revenues, results of operations, cash flows and proved
reserves. In addition, prolonged periods of high or low oil prices may have a
material effect on the Company's financial condition and results of operations.

     The average realized sales price of the Company's crude oil and liquids for
the first half of 1997 was $15.33 per barrel, or approximately 78% of the
average posted price of $19.58 per barrel for West Texas Intermediate ("WTI")
crude oil (an industry posted price generally indicative of prices for sweeter
light crude oil).

     Crude oil prices are subject to significant changes in response to
fluctuations in the domestic and world supply and demand and other market
conditions, as well as the world political situation as it relates to OPEC, the
Middle East and various producing countries. Since the beginning of 1994, the
average sales price (unhedged) received by the Company ranged from a low of
$8.80 per barrel for the first quarter of 1994 to a high of $17.29 per barrel in
the fourth quarter of 1996. Based on operating results for the first half of
1997, the Company estimates that a $1.00 per barrel increase or decrease in its
average crude oil sales price would result in a corresponding $9.1 million
change in income from operations and a $5.5 million change in cash flow from
operating activities. The foregoing estimates do not give effect to changes in
any other factors that may result from a change in oil prices.

     The price of natural gas fluctuates due to supply and demand, which may be
affected by weather conditions, the level of natural gas in storage and other
economic factors. Increases in the price of natural gas adversely impact the
Company's results of operations because the natural gas consumed in the

                                       12
<PAGE>
Company's EOR operations exceeds the amount of natural gas produced by the
Company. Based on operating results for the first half of 1997, the Company
estimates that a $0.10 per Mcf increase (or decrease) in the average domestic
natural gas sales price would result in a $0.9 million decrease (or increase) in
income from operations and a $0.5 million decrease (or increase) in cash flow
from operating activities. The foregoing estimates do not give effect to changes
in any other factors that may result from a change in natural gas prices.

     In February 1996 the Bureau of Land Management ("BLM") of the United
States Department of the Interior (which oversees the Company's leases of
Federal lands) agreed, effective as of June 1, 1996, to reduce the royalties
payable on any Federal lease that produces crude oil with a weighted average API
gravity of less than 20 degrees. The reduced royalty rates are based upon the
weighted average API gravity of the heavy oil produced from the subject Federal
leases and are as low as 3.9%, compared to 12.5% before the reduction. The
reduced royalty rates continue in effect for 12-month periods, after which the
operator can establish a new reduced rate for continued heavy oil production by
submitting an application. As a result of this program, the Company's royalty
rate on its Federal leases has been reduced from 12.5% to an average of 4.8%,
resulting in a net increase in the production attributable to the Company's net
revenue interests in such leases of approximately 1.6 MBbls per day. During the
period that such royalty reduction is in effect, the Company (and other working
interests owners, if any) will bear all of the thermal EOR costs to produce the
heavy oil from such properties. The royalty reduction will be terminated upon
the first to occur of (i) the determination by the BLM that the WTI average oil
price (as adjusted for inflation) has remained above $24 per barrel for six
consecutive months and (ii) such time after September 10, 1999, as the Secretary
of the Interior determines that the heavy oil royalty rate reduction has not
produced the intended results (i.e., to reduce the loss of otherwise recoverable
reserves).

     The Company's 1996 financial statements include the impact of oil and gas
hedging losses which were allocated by SFR. SFR from time to time entered into
such transactions in order to reduce exposure to fluctuations in market prices
of oil and natural gas. Oil hedging losses were allocated to the Company based
upon relative hedged volumes and were recognized as a reduction of oil revenues
in the period in which the hedged production was sold. Such amounts totaled $0.8
million and $2.5 million for the quarter and six-month period ended June 30,
1996, respectively. Currently the Company has no oil hedges in place and, going
forward, the Company does not expect to hedge a substantial portion of its oil
production.

     Additionally, during the first six months of 1996, SFR hedged 20 MMcf per
day of the natural gas purchased for use in the Company's steam generation
operations. Such hedges resulted in a $1.5 million and a $3.2 million increase
in the Company's production and operating costs for the quarter and six-month
period ended June 30, 1996, respectively. While the Company currently has no
natural gas hedges in place, the Company's management may determine that such
arrangements are appropriate in the future in order to reduce the Company's
exposure to increases in gas prices.

                                       13
<PAGE>
RESULTS OF OPERATIONS

     The following table reflects certain components of the Company's revenues
(expressed in millions of dollars) and expenses (expressed in dollars per BOE)
for the periods indicated:

<TABLE>
<CAPTION>
                                        THREE MONTHS ENDED        SIX MONTHS
                                                                    ENDED
                                             JUNE 30,              JUNE 30,
                                       --------------------  --------------------
                                         1997       1996       1997       1996
                                       ---------  ---------  ---------  ---------
<S>                                       <C>        <C>       <C>        <C>  
REVENUES:
Crude Oil and Liquids Produced:
     Average realized sales prices
       ($/Bbl)
       Unhedged......................      14.09      16.04      15.33      15.69
       Hedged........................      14.09      15.86      15.33      15.39
     Sales volumes (MBbls/d).........       50.3       46.4       50.2       45.1
     Revenues ($ Millions)
       Sales.........................       64.5       67.8      139.4      128.7
       Hedging.......................     --           (0.8)    --           (2.5)
       Net profits payments..........       (0.6)      (0.2)      (0.8)      (0.5)
                                       ---------  ---------  ---------  ---------
          Total......................       63.9       66.8      138.6      125.7
                                       =========  =========  =========  =========
Natural Gas Produced:
     Average realized sales prices
       ($/Mcf).......................       0.90       0.94       1.06       1.05
     Sales volumes (MMcf/d)..........        3.2        3.7        3.1        3.6
     Revenues ($ Millions)...........        0.3        0.3        0.6        0.7
EXPENSES PER BOE:
Production and operating expenses:
     Steam generation................       2.80       2.32(1)    3.00       2.40(2)
     Lease operating.................       3.60       3.39       3.61       3.50
          Total......................       6.40       5.71(1)    6.61       5.90(2)
Exploration, including dry holes.....       0.10       0.15       0.08       0.11
Depletion, depreciation and
amortization.........................       2.10       2.23       2.07       2.18
General and administrative...........       0.83       0.48       0.71       0.47
Taxes (other than income)............       0.72       0.56       0.65       0.52
Interest, net........................       0.97       1.46       0.97       1.50
</TABLE>

------------

(1) Includes $0.35 per BOE loss on hedging, see "-- General". Excluding such
    hedging losses, historical steam generation costs would have been $1.97 per
    BOE and historical total production costs would have been $5.36 per BOE.

(2) Includes $0.39 per BOE loss on hedging. See " -- General". Excluding such
    hedging losses, historical steam generation costs would have been $2.01 per
    BOE and historical total production costs would have been $5.51 per BOE.

THREE MONTHS ENDED JUNE 30, 1997, COMPARED TO THREE MONTHS ENDED JUNE 30, 1996

     Revenues of $74.6 million for the second quarter of 1997 were $6.2 million,
or 9%, greater than the $68.4 million reported for the second quarter of 1996.
The variance primarily reflects greater sales volumes ($4.9 million) and the
sales of crude oil purchased ($9.1 million) partially offset by a decrease in
the realized price for crude oil ($7.5 million). The sales of crude oil
purchased represents sales of higher gravity third-party crude which is
purchased and blended with the Company's heavy production to enhance the
available transportation and marketing opportunities. Such activity varies
directly with marketing conditions.

     Costs and expenses of $57.7 million for the second quarter of 1997 were
$17.5 million, or 44%, higher than the $40.2 million reported in the second
quarter of 1996. This variance primarily reflects an increase in

                                       14
<PAGE>
the cost of crude oil purchased ($9.5 million) due to increased marketing
activity. In addition, production and operating costs were higher due to greater
production volumes and increased steam fuel costs ($5.2 million). General and
administrative costs included higher personnel and other costs due to the
Company operating as a separate, unaffiliated entity and non-recurring
transition costs ($1.8 million).

     Interest expense of $4.9 million for the second quarter of 1997 was $1.5
million, or 23%, lower than the $6.4 million reported in the second quarter of
1996. This variance relates to the SFR Series E and F Notes retired in November
1996.

     Income taxes for the second quarter of 1997 were $3.5 million, down 56%
from the $8.0 million reported in the second quarter of 1996. This variance is
primarily attributable to the decrease in pre-tax income. The Company's
effective tax rate was 27.1% for the second quarter of 1997 as compared to 36.4%
for the second quarter of 1996, reflecting an increase in the amount of EOR
credits available to the Company relative to pre-tax income.

SIX MONTHS ENDED JUNE 30, 1997, COMPARED TO SIX MONTHS ENDED JUNE 30, 1996

     Revenues of $159.5 million for the first six months of 1997 were $31.4
million, or 25%, greater than the $128.1 million reported for the first half of
1996. The variance primarily reflects greater sales volumes ($13.6 million) and
the sales of crude oil purchased ($18.7 million) partially offset by a decrease
in the realized price of crude oil ($0.5 million).

     Costs and expenses of $114.4 million for the first six months of 1997 were
$37.0 million, or 48%, higher than the $77.4 million reported in the first half
of 1996. This variance primarily reflects an increase in the cost of crude oil
purchased ($20.2 million) due to increased marketing activity. In addition,
production and operating costs were higher due to greater production volumes and
increased steam fuel costs ($11.7 million). General and administrative costs
included higher personnel costs due to the Company operating as a separate,
unaffiliated entity and non-recurring transition costs ($2.6 million). Taxes
other than income taxes increased due to greater production volumes and higher
ad valorem taxes ($1.7 million).

     Interest expense of $9.6 million for the first six months of 1997 was $3.3
million, or 26%, lower than the $12.9 million reported in the first half of
1996. This variance relates to the SFR Series E and F Notes retired in November
1996.

     Income taxes for the first six months of 1997 were $12.0 million, down 14%
from the $13.9 million reported in the same period in 1996. The Company's
effective tax rate was 32.4% for the first half of 1996 as compared to 36.4% for
the first half of 1996, reflecting an increase in the amount of EOR credits
available to the Company relative to pre-tax income.

LIQUIDITY AND CAPITAL RESOURCES

     The Company's cash flow from operating activities is a function of the
volumes of oil and gas produced from the Company's properties and the sales
prices received therefor. Since crude oil and natural gas are depleting assets,
unless the Company replaces the oil and gas produced from its properties, the
Company's assets will be depleted over time and its ability to incur debt at
constant or declining prices will be reduced. The Company increased its proved
reserves (net of production and sales) by approximately 17% from December 31,
1991 to December 31, 1996; however, no assurances can be given that similar
increases will occur in the future. Historically, the Company has funded
development and exploration expenditures and working capital requirements
primarily from cash provided by operating activities; however, the future levels
of operating cash flows, which are significantly affected by oil and gas prices,
may limit the cash available for future exploration, development and acquisition
activities. Net cash provided by operating activities totaled $48.0 million for
the first half of 1997; net cash used for capital expenditures and producing
property acquisitions in such period totaled $40.9 million. The Company intends
to continue to meet its short-term (through 1997) and long-term (the foreseeable
future after 1997) liquidity needs with cash provided by operating activities,
supplemented from time to time with borrowings under its credit facility
(defined herein as the New Facility) and, if appropriate, other debt and equity
financing.

                                       15
<PAGE>
     The Company expects to increase its capital expenditures (including the
McFarland and other acquisitions) from an average of $35.8 million per year over
the five-year period ended December 31, 1996 to approximately $194.5 million in
1997. However, the actual amount expended by the Company in 1997 will be based
upon numerous factors, the majority of which are outside its control, including,
without limitation, prevailing oil and natural gas prices and the outlook
therefor and the availability of funds. The Company intends to fund such future
capital expenditures with cash provided by operating activities and borrowings
under the New Facility.

     In November 1996 the Company issued the Senior Notes which were exchanged
for $175.0 million of Series G Notes previously issued by SFR. The Senior Notes
bear interest at 10.61% per annum and mature $25 million per year in each of the
years 1999 through 2005.

     Effective November 13, 1996 the Company entered into a credit facility
which matures November 13, 2000 (the "First Facility"). The First Facility
permits the Company to obtain revolving credit loans and issue letters of credit
in an aggregate amount of up to $75.0 million, with the aggregate amount of
letters of credit outstanding at any time limited to $15.0 million. Borrowings
are unsecured and interest rates are tied to the bank's prime rate or eurodollar
rate, at the option of the Company. Effective July 22, 1997 the Company
terminated the First Facility and entered into a new credit facility which
matures in July, 2002 (the "New Facility"). The New Facility permits the
Company to obtain revolving credit loans and issue letters of credit in an
aggregate amount of up to $200 million, with the aggregate amount of letters of
credit outstanding at one time limited to $50 million. Borrowings are unsecured
and interest rates are tied to the bank's prime rate or eurodollar rate, at the
option of the Company. On July 22, 1997 the Company drew $100 million under the
New Facility to fund the McFarland acquisition. On July 31, 1997, interest
accrued on the New Facility at 6.375% subject to adjustment under the interest
rate swap described below.

     On June 17, 1997 the Company entered into an interest rate swap with a bank
with a notional principal amount of $100 million. Under the terms of the swap,
which is effective for the period July 21, 1997 through July 21, 2003, during
any quarterly period at the beginning of which a floating rate specified in the
agreement is less than 6.74%, the Company must pay the bank interest for such
quarterly period on the principal amount at the difference between the rates.
Should the floating rate be in excess of 6.74%, the bank must pay the Company
interest for such quarterly period on the principal amount at the difference
between the rates.

     The New Facility and Senior Notes include covenants that restrict the
Company's ability to take certain actions, including the ability to incur
additional indebtedness and to pay dividends on capital stock. To the extent
that the Company is restricted from incurring additional indebtedness under the
Senior Notes or the New Facility, the cash available for use in its operations
may be reduced. Under the most restrictive of these covenants on a pro forma
basis at June 30 1997, giving effect to the McFarland acquisition, the Company
could incur up to $81.5 million of additional indebtedness, or incur a lesser
amount and pay dividends of up to $66.7 million.

     At June 30, 1997, the Company had $10.0 million in loans and $2.4 million
of letters of credit outstanding under the First Facility.

DIVIDENDS

     The Company currently intends to pay to its stockholders a quarterly
dividend of $0.15 per share of common stock ($0.60 annually). The Company
declared a dividend of $0.15 per outstanding common share, which was paid July
22, 1997 to the stockholders of record as of June 30, 1997. The determination of
the amount of future cash dividends, if any, to be declared and paid will depend
upon declaration by the Company's board of directors and upon the Company's
financial condition, earnings and funds from operations, the level of its
capital and exploration expenditures, dividend restrictions contained in the
Credit Facility and the Senior Notes as described in " -- Liquidity and Capital
Resources," future business prospects and such other matters as the Company's
directors deem relevant.

                                       16
<PAGE>
ENVIRONMENTAL MATTERS

     Almost all phases of the Company's oil and gas operations are subject to
stringent environmental regulation by governmental authorities. Such regulation
has increased the costs of planning, designing, drilling, installing, operating
and abandoning oil and gas wells and other facilities. The Company has expended
significant financial and managerial resources to comply with such regulations.
These efforts include both Company employees responsible for environmental
compliance and paid consultants who have evaluated known sites for which the
Company may face environmental liability and who monitor the Company's
properties and waste handling and disposal practices. All oilfield wastes are
disposed of at facilities authorized to accept such wastes. Although the Company
believes its operations and facilities are in general compliance with applicable
environmental regulations, risks of substantial costs and liabilities are
inherent in oil and gas operations. It is possible that other developments, such
as increasingly strict environmental laws, regulations and enforcement policies
or claims for damages to property, employees, other persons and the environment
resulting from the Company's operations, could result in significant costs and
liabilities in the future. As it has done in the past, the Company intends to
fund its cost of environmental compliance from operating cash flows.

RECENT ACCOUNTING PRONOUNCEMENTS

     The Financial Accounting Standards Board ("FASB") recently issued
Statement of Financial Accounting Standards ("FAS") No. 128, "Earnings per
Share", which establishes new guidelines for calculating and reporting earnings
per share in financial statements for periods ending after December 15, 1997.
This rule is not expected to have a material effect on the Company's reported
earnings per share.

     The FASB issued FAS No. 130, "Reporting Comprehensive Income" during June
1997. This statement requires disclosure of changes in equity from nonowner
sources in a new primary financial statement and as a separate caption within
the stockholders' equity section of the balance sheet. It is effective for
periods beginning after December 15, 1997.

     Also during June 1997, the FASB issued FAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information". This Statement does not
affect the Company since it operates in a single segment. It is effective for
periods beginning after December 15, 1997.

SPIN OFF COMPLETED

     As of June 30, 1997, SFR owned approximately 83% of the outstanding shares
of Monterey's common stock. SFR's spin off of its interest in the Company was
completed on July 25, 1997 with a tax-free distribution of its Monterey shares
to SFR shareholders.

     Pursuant to the terms of a letter agreement dated as of June 13, 1996, a
fee is payable by the Company to Chase Securities Inc. and Petrie Parkman & Co.,
Inc. as a result of consummation of the Spin Off. The total amount of such fee
is equal to the product of (a) the sum of the market value of the shares of the
Company's common stock distributed in the Spin Off (based upon the average
closing price of the Company's common stock during the ten trading days after
the Spin Off) PLUS the aggregate principal amount of long-term indebtedness
assumed by the Company in connection with the Spin Off (which totalled $175.0
million) TIMES (b) 0.5%, LESS $1.0 million. The average market value of the
Company's common stock for the ten trading days after the Spin Off was
approximately $14.98 per share, yielding a total fee payable of approximately
$3.3 million, of which half is payable to each of Chase Securities and Petrie
Parkman. In addition, a fee of $200,000 was paid on July 25, 1997 to GKH
Partners, L.P. One of the Company's directors is associated with GKH Partners.

MCFARLAND ACQUISITION

     On July 24, 1997, the Company completed its acquisition of McFarland
Energy, Inc. ("McFarland"). Monterey Acquisition Corporation, a wholly owned
subsidiary of the Company, merged with and into McFarland, and as a consequence,
McFarland is now a wholly owned subsidiary of the Company. The

                                       17
<PAGE>
Company paid $18.55 per share for each of the 5,727,422 shares outstanding.
McFarland's principal producing properties are located in the Midway Sunset
Field adjacent to properties owned by the Company.

OTHER MATTERS

     On July 16, 1997 the Company was served with a petition (the "Complaint")
filed by The Prudential Insurance Company of America ("Prudential") alleging
breach of fiduciary duty, breach of contract, fraud, constructive fraud, and
negligent misrepresentation. The Complaint relates to the alleged conduct of the
Company's predecessor in interest, SFR, as the General Partner of the South
Belridge Limited Partnership (the "Partnership"). Prudential is the sole
limited partner in the Partnership. Prudential alleges that SFR failed to
develop the Partnership's property in accordance with the Partnership Agreement.
In November, 1996, SFR's interest in the Partnership was assigned to the
Company. The Company is in the process of investigating the allegations made by
Prudential in its Complaint. Based on the information currently available to it,
the Company believes that it has valid defenses to Prudential's claims and
intends to vigorously defend this lawsuit.

FORWARD-LOOKING STATEMENTS

     In its discussion and analysis of financial condition and results of
operations, the Company has included certain statements (other than statements
of historical fact) that constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. When used herein, the words "budget,"
"budgeted," "anticipates," "expects," "believes," "seeks," "goals,"
"intends", "plans" or "projects" and similar expressions are intended to
identify forward-looking statements. It is important to note that the Company's
actual results could differ materially from those projected by such
forward-looking statements. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable and such forward-
looking statements are based upon the best data available at the time this
report is filed with the Securities and Exchange Commission, no assurance can be
given that such expectations will prove correct. Factors that could cause the
Company's results to differ materially from the results discussed in such
forward-looking statements include, but are not limited to, the following:
production variances from expectations, volatility of oil and gas prices,
environmental risks, uncertainties about estimates of reserves, competition,
government regulation or action, litigation, drilling and operations
performance, labor disputes, and the ability of the Company to implement its
business strategy. All such forward-looking statements in this document are
expressly qualified in their entirety by the cautionary statements in this
paragraph.

                                    PART II
                               OTHER INFORMATION

     Item 6.  Exhibits and Reports on Form 8-K

     (a)  Exhibits

               None

     (b)  Reports on Form 8-K

                                             DATE          ITEM
                                        --------------     ----
                                         June 20, 1997       5
                                         July 17, 1997       5

                                       18
<PAGE>
                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                                MONTEREY RESOURCES, INC.
                                                      (Registrant)

                                        By /s/ GERALD R. CARMAN
                                               GERALD R. CARMAN
                                       VICE PRESIDENT, CHIEF FINANCIAL
                                                  OFFICER
                                                AND TREASURER
                                       (PRINCIPAL FINANCIAL OFFICER AND
                                        PRINCIPAL ACCOUNTING OFFICER)

Dated: August 12, 1997

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