UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    Form 10-K
MARK ONE
   |X|        ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
              SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]

                   For the Fiscal Year Ended December 31, 1996

   |_|           TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
                 SECURITIES EXCHANGE ACT OF 1934

                          Commission File Number 1-8921


                         HALLWOOD ENERGY PARTNERS, L. P.
             (Exact name of registrant as specified in its charter)



          Delaware                                                    84-0987088
(State or other jurisdiction of                                 (I.R.S. Employer
incorporation or organization)                            Identification Number)
4582 South Ulster Street Parkway
            Suite 1700
      Denver, Colorado                                                    80237
(Address of principal executive offices)                              (Zip Code)

       Registrant's telephone number, including area code: (303) 850-7373

           Securities Registered Pursuant to Section 12(b) of the Act:

                                                           Name of each exchange
              Title of each class                            on which registered
Class A Units of Limited Partnership Interests           American Stock Exchange
Class C Units of Limited Partnership Interests           American Stock Exchange

           Securities Registered Pursuant to Section 12(g) of the Act:
                                      None

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

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of  registrant's  knowledge,  in  definitive  proxy  or  information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|


The  aggregate  market  value  of  the  Class  A  and  Class  C  Units  held  by
nonaffiliates  of  the  registrant  as  of  March  20,  1997  was  approximately
$67,601,500.
Number of Units outstanding as of March 20, 1997
   Class A                                                            9,977,254
   Class B                                                              143,773
   Class C                                                              664,063

                    Page 1 of 69 (Exhibits Begin on Page 53)



<PAGE>



                                     PART I


ITEM 1 - BUSINESS

Hallwood  Energy  Partners,  L.P.  ("HEP" or the  "Partnership"),  is a publicly
traded Delaware  limited  partnership  engaged in the production and sale of oil
and gas and in the  acquisition,  exploration,  development and operation of oil
and gas  properties.  The principal  objectives of HEP are to maintain or expand
its reserve base and to provide cash  distributions  to the holders of its units
of limited partner interests ("Units"). HEPGP Ltd. became the general partner of
HEP on  November  26, 1996 after the former  general  partner,  Hallwood  Energy
Corporation  ("HEC")  merged into The  Hallwood  Group  Incorporated  ("Hallwood
Group").  HEPGP Ltd. is a limited  partnership  of which  Hallwood  Group is the
limited  partner and  Hallwood  G.P.,  Inc.  ("Hallwood  G.P.),  a wholly  owned
subsidiary of Hallwood Group, is the general partner.  HEP commenced  operations
in August 1985 after  completing an exchange offer in which HEP acquired oil and
gas properties and operations  from HEC, 24 oil and gas limited  partnerships of
which HEC was the general partner and certain  working  interest owners that had
participated in wells with HEC and the limited partnerships.

The  activities  of HEP  are  conducted  by HEP  Operating  Partners,  L.P.
("HEPO") and EDP Operating,  Ltd. ("EDPO").  HEP is the sole limited partner and
HEPGP Ltd. is the sole general partner of HEPO and of EDPO.  Solely for purposes
of simplicity  herein,  unless  otherwise  indicated,  all  references to HEP in
connection with the ownership, exploration, development or production of oil and
gas properties include HEPO and EDPO.

HEP does not  engage in any  other  line of  business  nor does it have any
employees.  Hallwood Petroleum, Inc. ("HPI"), an affiliated entity, operates the
properties and  administers the day to day activities of HEP and its affiliates.
On March 20, 1997, HPI had 127 employees.

Marketing

The oil and gas produced from the  properties  owned by HEP has  typically  been
marketed  through normal  channels for such  products.  Oil is generally sold to
purchasers at a premium over field prices posted by the principal  purchasers of
crude oil in the areas where the majority of producing  properties  are located.
In response to the  volatility  in the oil markets,  HEP entered into  financial
contracts  for  hedging  the price of  between 3% and 46% of its  estimated  oil
production for 1997 through 1999.

The  majority  of  HEP's  gas  production  is sold  on the  spot  market  and is
transported in intrastate and interstate  pipelines.  HEP entered into financial
contracts  for  hedging the price of between  18% and 54% of its  estimated  gas
production for 1997 through 2000.

The purpose of the hedges is to provide  protection  against  price drops and to
provide a measure of stability in the  volatile  environment  of oil and natural
gas  spot  pricing.  The  amounts  received  or paid  upon  settlement  of these
contracts is recognized as oil or gas revenue at the time the hedged volumes are
sold.

Both oil and natural  gas are  purchased  by  refineries,  major oil  companies,
public  utilities,  industrial  customers  and  other  users and  processors  of
petroleum  products.  HEP is not  confined  to,  nor  dependent  upon,  any  one
purchaser  or  small  group  of  purchasers.  Accordingly,  the loss of a single
purchaser,  or a few  purchasers,  would not  materially  affect HEP's  business
because  there  are  numerous  purchasers  in the  areas in which  HEP sells its
production.  However,  for the years ended  December  31,  1996,  1995 and 1994,
purchases  by the  following  companies  exceeded  10% of the  total oil and gas
revenues of the Partnership:


                                       -2-

<PAGE>





                                     1996               1995               1994
                                     ----               ----               ----

Conoco Inc.                           28%                30%                23%
Marathon Petroleum Company            11%                14%                12%

Factors,  if they  were to occur,  which  might  adversely  affect  HEP  include
decreases  in oil and gas  prices,  the  reduced  availability  of a market  for
production,  rising operational costs of producing oil and gas, compliance with,
and  changes  in,  environmental   control  statutes  and  increasing  costs  of
transportation.

Competition

In the course of its exploration and  development  activities,  HEP must compete
with other entities for the  acquisition  of  undeveloped  acreage and desirable
leaseholds. As described above under "Marketing," production is sold on the spot
market,  thereby reducing sales competition;  however,  oil and gas must compete
with coal, atomic energy, hydro-electric power and other forms of energy.

Regulation

Production and sale of oil and gas is subject to federal and state  governmental
regulation  in a variety of ways,  including  environmental  regulations,  labor
laws,  interstate  sales,  excise  taxes and  federal and Indian  lands  royalty
payments.  Failure  to  comply  with  these  regulations  may  result  in fines,
cancellation of licenses to do business and  cancellation  of federal,  state or
Indian leases.

The  production of oil and gas is subject to regulation by the state  regulatory
agencies  in the  states in which HEP does  business.  These  agencies  make and
enforce regulations to prevent waste of oil and gas and to protect the rights of
owners to produce oil and gas from a common reservoir.  The regulatory  agencies
regulate the amount of oil and gas produced by  assigning  allowable  production
rates to wells capable of producing oil and gas.

Environmental Considerations

The  exploration  for, and  development  of, oil and gas involve the extraction,
production and transportation of materials which, under certain conditions,  can
be  hazardous or can cause  environmental  pollution  problems.  In light of the
current  interest in environmental  matters,  the general partner cannot predict
what effect possible future public or private action may have on the business of
HEP. The general partner is continually taking actions it believes are necessary
in its operations to ensure conformity with applicable federal,  state and local
environmental  regulations and does not presently anticipate that the compliance
with federal,  state and local  environmental  regulations  will have a material
adverse  effect  upon  capital  expenditures,   earnings,   cash  flows  or  the
competitive position of HEP in the oil and gas industry.

Insurance Coverage

HEP is subject to all the risks inherent in the exploration for, and development
of, oil and gas, including blowouts,  fires and other casualties.  HEP maintains
insurance  coverage as is  customary  for  entities of a similar size engaged in
operations  similar to that of HEP, but losses can occur from uninsurable  risks
or in amounts in excess of existing  insurance  coverage.  The  occurrence of an
event which is not  insured or not fully  insured  could have an adverse  impact
upon HEP's earnings, cash flows and financial position.




                                                        -3-

<PAGE>



ITEM 2 - PROPERTIES

Exploration and Development Projects

In 1996, HEP incurred  $12,615,000 in direct property  additions and exploration
and  development  costs,  and  approximately  $441,000  for the purchase of HCRC
shares.  The costs were  comprised  of  approximately  $9,467,000  for  domestic
exploration  and  development  expenditures  and  approximately  $3,148,000  for
property  acquisitions.  In 1996, HEP participated in approximately 120 drilling
or recompletion  projects,  the highlights of which are discussed  below.  HEP's
1996 capital program led to the replacement,  through drilling and acquisitions,
of 75% of the equivalent  barrels  produced  during 1996.  Overall  replacement,
including revisions to prior year reserves,  was 145% of 1996 production.  Sales
of reserves  in place in 1996 which were  approximately  8% of 1996  production,
were  excluded  from  this  calculation.  Approximately  $1,325,000  of the 1996
capital  expenditures  were for  land  and  seismic  data  anticipated  to yield
prospects for 1997 and subsequent years.

Property Sales

During the first quarter of 1996, HEP received approximately  $1,300,000 for the
sale of its  interests in the Hoople  Field in Crosby  County,  Texas.  HEP also
received $88,000 in early April for the sale of various nonstrategic  properties
at auction. In June 1996, HEP completed the sale of its interests in the Bethany
Longstreet area of Louisiana  (approximately  575,000 equivalent barrels of oil,
measured using December 31, 1995 pricing) for approximately $3,800,000.

Capital Projects

During the second quarter of 1996,  HEP purchased  12,965 shares of common stock
of HCRC for $34 per  share.  The shares  were  originally  purchased  by HCRC in
connection  with an odd lot repurchase  offer and then were resold to HEP at the
price paid by HCRC for such shares.

HEP continued to devote capital resources to the West Texas Kermit area in 1996.
During 1996,  HEP drilled or  participated  in the drilling of seventeen  wells,
fifteen of which were successful, and participated in nine recompletions, six of
which were successful,  for a total cost to HEP of approximately $1,359,000. The
wells in this area are currently  producing  approximately  750 gross equivalent
barrels of oil per day. HEP's interest in these wells averages 22%. HEP plans to
drill or  recomplete  up to  fifteen  additional  wells in 1997.  HEP has  begun
discussing  secondary  recovery  operations  with the  other  working  interests
owners.

During 1996,  HEP acquired 106 square miles of three  dimensional  (3-D) seismic
data on the Cowden Ranch in Crane County,  Texas.  The prospect is operated by a
major oil company, and HEP has a 12.5% working interest. HEP's share of costs in
1996 is $435,000. Seismic interpretation was completed in the third quarter. Two
exploratory wells, both of which were dry, were drilled in the fourth quarter at
a cost to HEP of  $160,000,  and a third  exploratory  well is being  drilled in
1997.

HEP  acquired 3-D seismic  data and related  acreage in the Merkel  Project Area
which  covers  18 square  miles in Jones,  Taylor  and  Nolan  Counties,  Texas.
Expenditures by HEP during 1996 totaled $515,000. Thus far, HEP has participated
in drilling eight wells on four exploration prospects for a total cost to HEP of
$184,000, including one well drilled in late 1995. Seven of the eight wells have
been successful.  These wells are currently  producing  approximately  375 gross
barrels of oil per day. HEP's  nonoperating  interest in this  production is 9%.
HEP  acquired  an  additional  74 square  miles of 3-D  seismic  data,  which is
presently  being  interpreted in the same area.  HEP's working  interest in this
area averages 27.5%, and prospect  exploratory  drilling will begin in the first
quarter of 1997.  HEP  anticipates at least ten prospects will be tested in 1997
and subsequent years on this portion of the project area.


                                                        -4-

<PAGE>



HEP  participated in the drilling of two nonoperated  wells in Williams  County,
North  Dakota in the latter part of 1995 and the first  quarter of 1996,  one of
which was dry and the other only marginally successful,  for a total cost to HEP
of approximately  $330,000. HEP also drilled an exploratory dry hole in Richland
County,  Montana,  at a cost of $150,000.  HEP completed an Interlake  Formation
development  well,  drilled  in the  second  quarter,  at a total cost to HEP of
approximately  $600,000.  This well is currently producing at a rate of 80 gross
barrels of oil per day, and HEP's interest is 45%.

HEP incurred approximately $235,000 in the first quarter, net to HEP's interest,
for four  recompletions  and one drilled  well in the Rocker "b" Ranch in Reagan
County,  Texas.  During the first quarter,  HEP also acquired  interests in five
additional  producing leases on the Rocker "b" Ranch for a total of $93,000.  In
prior years, HEP financed  $6,033,000 of its drilling through Hallwood Spraberry
Drilling  Company,  L.L.C.  ("HSD") on the Rocker "b" Ranch.  Effective April 1,
1996,  HEP repaid  its share of the debt of HSD  through  additional  borrowings
under its bank credit  agreement  and assumed  direct  ownership of its share of
HSD's  properties.  In the second and third  quarters of 1996,  HEP  recompleted
seven wells, three of which were successful, and drilled one additional well for
a total cost to HEP of  $270,000.  Current  production  from all Rocker "b" 1996
capital  projects  averages 185 gross  equivalent  barrels of oil per day. HEP's
share of this production is approximately  29%. Minimal  additional  drilling or
workovers  are expected in the area in 1997.  HEP drilled or worked over a total
of 95 wells in this area over the past three years.

In the San Juan Basin area,  HEP acquired  interests in four wells in Rio Arriba
County,  New Mexico,  and through an affiliate,  LaPlata Associates LLC ("LPA"),
acquired  interests  in 34 coal bed  methane  wells  located in LaPlata  County,
Colorado for  $1,734,000.  HEP's  interest in the wells added nine bcf of gas to
its reserve base,  which  represents  approximately  55% of its  estimated  1996
production.   The   acquisition   was   completed   on   July  1,   1996.   Nine
refracs/recompletions  have been completed  since July 1 at a net cost to HEP of
approximately  $690,000.  The  recompletion  work  has  performed  according  to
expectations.  Numerous  other  facility  projects were  completed in 1996 at an
estimated net cost to HEP of $270,000.  Gross  production has increased by 4,000
mcf of gas per day as a result  of the work  done  thus  far.  Similar  activity
levels in 1997 are  anticipated  on these newly  acquired  properties.  In other
parts of the New  Mexico  portion of the San Juan Basin  area,  HEP  recompleted
three  wells,  two of which were  successful,  drilled  two wells and  converted
another well to be a produced  water disposal well. The total cost for this work
was $575,000, and HEP's interest in this area is approximately 50%.

HEP participated in a 13 square mile 3-D seismic shoot at the Packsaddle Project
in the Big Horn Basin of Wyoming. The data is now being processed and additional
development  and  exploration is expected in the area  following  HEP's previous
discovery. HEP's ownership in the Big Horn Basin continues to increase through a
joint venture  created to evaluate a 4,000 mile 2-D Seismic Data Base from which
HEP hopes to create additional drillable prospects.

In September,  HEP spent $225,000 for a recompletion of the A. L. Boudreaux well
into a  shallower  interval  of the  Bol  Mex 3  Formation  after  the  previous
completion  in the  Bol  Mex 3  Formation  began  to  produce  water  and  sand.
Production  after the  recompletion is averaging 21 mmcf per day and 420 barrels
of condensate per day.

HEP also incurred  approximately $150,000 in 1996 for the successful drilling of
a 10,000 foot  exploratory  well in a  structural  3-D seismic play in Glasscock
County,  Texas.  Production  from this  well is  currently  averaging  250 gross
equivalent  barrels  of oil  per  day.  HEP's  interest  in  this  well  is 13%.
Additional  nonproducing reserves from another zone were recorded at year end as
well. As of year end, HEP has committed to at least one more exploratory well in
1997.

Numerous other projects,  which are  individually  less  significant,  have been
completed or are underway in Kansas, Louisiana,  Texas and New Mexico, including
participation in five other 3-D seismic data  acquisition  programs not included
in the above activity.

1997 Plans

For 1997,  HEP's capital  budget,  which will be paid from cash  generated  from
operations  and cash on hand,  has been set at  $12,500,000.  In addition to the
above mentioned  plans,  HEP's domestic  exploration  plans include  projects in
Texas, Wyoming, Oklahoma,  Colorado, Louisiana and New Mexico. HEP will continue
to consider international projects in 1997 on a selective basis.


                                                        -5-

<PAGE>



HEP  will   aggressively   pursue   exploitation  and  development  of  existing
opportunities in Texas, Wyoming,  Colorado,  Kansas, New Mexico and Utah. HEP is
also actively pursuing acquisitions in strategic areas.

Partnership Reserves, Production and Discussion by Significant Areas and Fields

The following  table  presents the December 31, 1996 reserve data by significant
areas and fields.

<TABLE>
<CAPTION>

                                      Proved Reserve Quantities             Present Value of Future Net Cash Flows
                                                                            Proved              Proved
                                     Mcf of Gas       Bbls of Oil         Undeveloped          Developed         Total
                                                                       (In thousands)

<S>                                         <C>               <C>                  <C>              <C>           <C>     
Scott/West Ridge                            20,014              412                                 $ 60,211      $ 60,211
West Texas                                  18,317            5,127                 $3,871            47,872        51,743
Kansas                                         827              592                    354             3,892         4,246
San Juan Basin                              26,663                                                    15,566        15,566
Southeastern New Mexico                      8,095              249                                   15,068        15,068
Other                                       14,626            1,151                  2,428            56,738        59,166
                                            ------            -----                  -----          --------      --------
                                            88,542            7,531                 $6,653          $199,347      $206,000
                                            ======            =====                  =====           =======       =======
</TABLE>

The following  table presents the oil and gas production for  significant  areas
and fields.

<TABLE>
<CAPTION>

                                                       Production for the                         Production for the
                                                         Year Ended 1996                           Year Ended 1995
                                                        -----------------                          ----------------
                                                  Mcf of Gas          Bbls of Oil           Mcf of Gas           Bbls of Oil
                                                  ----------          -----------           ----------           -----------
                                                                        (In thousands)

<S>                                                 <C>                     <C>               <C>                    <C>
Scott/West Ridge                                    3,548                   73                4,501                  108
West Texas                                          1,325                  455                1,351                  458
Kansas                                                 86                   45                  146                   60
San Juan Basin                                      2,993                                     3,216
Southeastern New Mexico                             1,462                   40                2,067                   52
Other                                               3,372                  359                1,754                  315
                                                   ------                 ----               ------                 ----
                                                   12,786                  972               13,035                  993
                                                   ======                 ====               ======                 ====
</TABLE>

The following  table presents the  Partnership's  extensions and  discoveries by
significant areas and fields.

<TABLE>
<CAPTION>

                                                     For the Year Ended 1996                   For the Year Ended 1995
                                                 Mcf of Gas          Bbls of Oil           Mcf of Gas           Bbls of Oil
                                                                              (In thousands)

<S>                                                   <C>                  <C>                <C>                  <C>  
West Texas                                            619                  370                3,560                1,397
Kansas                                                 63                                                             19
San Juan Basin                                        670                                       794
Southeastern New Mexico                                20                   31                  432                   97
Other                                                 311                   83                1,211                  389
                                                   ------                  ---                -----                -----
                                                    1,683                  484                5,997                1,902
                                                    =====                  ===                =====                =====

</TABLE>

                                                        -6-

<PAGE>



Scott/West Ridge

The Scott/West  Ridge area consists of 10 active gas wells, one shut-in gas well
and six salt water disposal wells located in Lafayette  Parish,  Louisiana.  The
wells produce  principally  from the Bol Mex formations at 13,500 to 14,500 feet
and are operated by HPI.  The four most  significant  wells in the area,  all of
which were  drilled by HPI since  1989,  are the A. L.  Boudreaux  #1, the G. S.
Boudreaux  Estate #1, the Lessin Fontenot #1 and the Evangeline  Shrine Club #1.
During 1996, HEP performed one workover in this area which was  successful,  and
HEP participated in one unsuccessful exploration well operated by another party.

West Texas

The West Texas area is comprised of three significant groups of properties.  The
West Texas  Spraberry  area  consists of 363  producing  wells,  nine salt water
disposal wells and 24 shut-in wells in Dawson, Upton, Reagan and Irion Counties.
HPI operates 387 of these wells.  Most of the current  production from the wells
is from the Upper and Lower Spraberry,  Clearfork, Canyon, Dean and Fusselman at
depths ranging from 5,000 feet to 9,000 feet. During 1996, HEP sold its interest
in 35 operated and 31 outside  operated  properties in this area.  Adding to the
field discovered in 1995, HEP successfully  drilled two wells and recompleted 23
wells in eastern Reagan County, 19 of which were successful.
HEP plans several recompletions in this area in 1997.

The West Texas  Kermit/Keystone area consists of 48 producing wells, 33 of which
are operated by HPI. The primary  focus of this area is the  development  of the
Holt and San Andres  formations  at a depth of 5,100  feet on several  leases in
Winkler County.  During 1996, HEP drilled 15 wells, 12 of which were successful.
During 1997 up to 16 wells may be drilled.  A study is underway  for a secondary
recovery project.

The West Texas  Merkel/SW Lana area consists of seven  producing wells in Jones,
Nolan and Taylor Counties,  Texas. All of these wells are outside operated.  The
primary focus of the area is exploitation of the Canyon,  Strawn and Ellenburger
formations.  HEP conducted a 3-D seismic  project during 1996 and,  during 1997,
will drill locations identified by the seismic project.

Kansas

The Kansas area  consists of 223 producing  wells,  of which 213 are operated by
HPI and 10 are operated by  unaffiliated  entities.  The wells are located in 15
counties primarily in the Central Kansas Uplift and produce principally from the
Arbuckle and numerous  Lansing-Kansas  City  formation  zones from 3,000 feet to
6,500  feet.  During  1996,  HEP  drilled one  successful  development  well and
performed 15 recompletions,  nine of which were successful. The Kansas area is a
mature operation where recompletions and limited development  drilling represent
the most prudent plans for future asset base protection. HEP plans to sell three
properties  in this  area in 1997 and  will  continue  to  evaluate  and  divest
nonstrategic properties.

San Juan Basin

The San Juan Basin  region  consists of wells  located in San Juan  County,  New
Mexico and LaPlata  County,  Colorado.  In 1996,  HEP and Hallwood  Consolidated
Resources  Corporation ("HCRC") acquired interests in 38 wells from a subsidiary
of Public  Service  Company of  Colorado.  The wells are  located  primarily  in
LaPlata  County,  Colorado  and produce  from the  Fruitland  Coal  formation at
approximately 3,200 feet. An unaffiliated large East Coast financial institution
formed an entity to effectively  utilize the Section 29 tax credits generated by
the  wells.  The  project  was  financed  through a third  party  lender  with a
production payment structure.  Since the acquisition,  HEP has recompleted 10 of
the newly acquired wells, seven successfully.  Several additional  recompletions
will be done in 1997.


                                                        -7-

<PAGE>



In San Juan County,  New Mexico, HPI operates 54 wells, 34 of which produce from
the Fruitland Coal formation at approximately 2,200 feet and 20 of which produce
from the Pictured  Cliffs,  Mesa Verde and Dakota  formations  at 1,200 to 7,000
feet.  During 1996, HPI  successfully  drilled two  additional  coal bed methane
wells,  recompleted a well for use as a salt water  disposal well in the Entrada
formation and  recompleted  two Fruitland Coal wells,  one  successfully.  HEP's
acreage position has been fully drilled.  Several  recompletions are planned for
1997.

Southeastern New Mexico

The Southeastern New Mexico area consists of 60 producing wells, 38 of which are
operated by HPI, which produce primarily gas and are located on the northwestern
edge of the Delaware Basin in Lea, Eddy and Chaves Counties,  New Mexico.  These
wells  produce at depths  ranging from  approximately  2,500 feet to 14,000 feet
from the Delaware,  Atoka, Bone Springs and Morrow formations.  During 1996, HEP
participated  as a nonoperator  in two  successful  development  wells and as an
operator, performed four recompletions,  three of which were successful.  During
1997, HEP plans to perform several additional recompletions.

Average Sales Prices and Production Costs

The  following  table  presents  the average oil and gas sales price and average
production  costs per equivalent  barrel computed at the ratio of six mcf of gas
to one barrel of oil.

<TABLE>
<CAPTION>

                                                                  1996               1995               1994
                                                                 ------             ------             -----

<S>                                                              <C>                <C>                <C>   
Oil and condensate -
   includes the effects of hedging (per bbl)                     $20.10             $17.36             $16.47
Natural gas -
   includes the effects of hedging (per mcf)                       2.24               1.82               1.97
Production costs (per equivalent bbl of oil)                       3.71               3.57               3.88

Productive Oil and Gas Wells
</TABLE>

The following  table  summarizes the productive oil and gas wells as of December
31, 1996 attributable to HEP's direct interests.  Productive wells are producing
wells and wells capable of production. Gross wells are the total number of wells
in  which  HEP has an  interest.  Net  wells  are the  sum of  HEP's  fractional
interests owned in the gross wells.


                                           Gross               Net

Productive Wells
   Oil                                       736                273
   Gas                                       369                127
                                          ------                ---
      Total                                1,105                400
                                           =====                ===


                                                        -8-

<PAGE>



Oil and Gas Acreage

The following table sets forth the developed and undeveloped  leasehold  acreage
held  directly by HEP as of December 31, 1996.  Developed  acres are acres which
are spaced or  assignable to productive  wells.  Undeveloped  acres are acres on
which wells have not been  drilled or completed to a point that would permit the
production of commercial quantities of oil and gas, regardless of whether or not
such acreage contains proved reserves. Gross acres are the total number of acres
in which HEP has a working  interest.  Net acres are the sum of HEP's fractional
interests owned in the gross acres.


                                           Gross               Net

Developed acreage                         176,795             79,311
Undeveloped acreage                       130,618             50,103
                                          -------            -------
      Total                               307,413            129,414
                                          =======            =======

States in which HEP holds undeveloped acreage include Texas, Louisiana, Montana,
Wyoming, New Mexico, Kansas, Colorado, North Dakota and Michigan.

Drilling Activity

The following table sets forth the number of wells  attributable to HEP's direct
interest drilled in the most recent three years.

<TABLE>
<CAPTION>

                                                                    Year Ended December 31,
                                                                   ------------------------
                                                     1996                         1995                         1994
                                                    ------                       ------                       -----
                                              Gross           Net          Gross           Net           Gross          Net

Development Wells:
<S>                                             <C>            <C>            <C>          <C>             <C>          <C> 
   Productive                                   29             6.6            66           28.0            30           14.6
   Dry                                           4              .9             2             .5             4             .7
                                               ---            ----           ---         ------           ---         ------
      Total                                     33             7.5            68           28.5            34           15.3
                                                ==             ===            ==           ====            ==           ====

Exploratory Wells:
   Productive                                    2              .2             5             .6             2             .1
   Dry                                           4              .6             1             .9             6            1.2
                                               ---            ----           ---         ------           ---          -----
      Total                                      6              .8             6            1.5             8            1.3
                                               ===            ====           ===          =====           ===          =====
</TABLE>

Office Space

HPI leases  office space in Denver,  Colorado  containing  approximately  41,000
square  feet,  for  approximately  $600,000  per year.  The lease  payments  are
included in the  allocation  of general and  administrative  expenses to HEP and
other affiliated entities. HEP is guarantor of 60% of the lease obligation,  and
HCRC is guarantor of the remaining 40% of the obligation.


ITEM 3 - LEGAL PROCEEDINGS

See Notes 12 and 13 to the financial  statements  included in Item 8 - Financial
Statements and Supplementary Data.



                                                        -9-

<PAGE>



ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter of 1996.


                                                      PART II


ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED UNITHOLDER MATTERS

HEP's Class A Units are traded on the American Stock  Exchange (the  "Exchange")
under the  symbol  "HEP." As of March 20,  1997,  9,977,254  Class A Units  were
outstanding,  held by  approximately  20,995  unitholders  of record and 143,773
Class B Units were  outstanding,  held by Hallwood Group.  The Class B Units are
not publicly traded.  The following table sets forth, for the periods indicated,
the high and low reported  sales prices for the Class A Units as reported on the
Exchange  and the  distributions  paid per  Class A Unit  for the  corresponding
periods.  The Class B Units  received a $.20 per unit  distribution  per quarter
during 1995. HEP's debt agreements limit aggregate  distributions paid by HEP in
any  twelve  month  period to 50% of cash flow from  operations  before  working
capital changes plus distributions received from affiliates.


 Class A Units                  High               Low             Distributions

First quarter 1995             6 1/4              5 3/8                 $.20
Second quarter 1995            5 15/16            5 1/8                  .20
Third quarter 1995             5 1/2              4                      .20
Fourth quarter 1995            4 11/16            3 3/4                  .20
                                                                         ---
                                                                        $.80

First quarter 1996             5 1/4              3 3/4                 $.13
Second quarter 1996            6 3/4              4 5/8                  .13
Third quarter 1996             7 3/8              5 7/8                  .13
Fourth quarter 1996            9                  6 1/4                  .13
                                                                         ---
                                                                        $.52

On January 17, 1996, HEP's new Class C Units began trading on the Exchange under
the  symbol  "HEPCWI."  As of  March  20,  1997,  664,063  Class  C  Units  were
outstanding,  held by approximately  15,856 unitholders of record. The following
table sets forth,  for the periods  indicated,  the high and low reported  sales
prices for the Class C Units as reported on the Exchange and distributions  paid
per Class C Unit for the corresponding periods.


   Class C Units               High               Low             Distributions

First quarter 1996             7 7/8              6 1/2               $  .25
Second quarter 1996            8 1/2              7 3/8                  .25
Third quarter 1996             9 5/8              8 3/16                 .25
Fourth quarter 1996            9 7/8              8 3/4                  .25
                                                                        ----
                                                                       $1.00



                                                       -10-

<PAGE>



ITEM 6 - SELECTED FINANCIAL DATA

The following table sets forth selected financial data regarding HEP's financial
position and results of operations as of the dates indicated. As a result of the
issuance of Class A Units in connection with a litigation  settlement,  all Unit
and per Unit  information  for  periods  prior  to  December  31,  1995 has been
retroactively restated.

<TABLE>
<CAPTION>

                                                               As of and For the Years Ended December 31,
                                                               ------------------------------------------
                                                1996               1995               1994               1993               1992
                                               ------             ------             ------             ------             -----
                                                                      (In thousands except per Unit)

Summary of Operations
<S>                                             <C>                <C>                <C>               <C>                 <C>    
   Oil and gas revenues and
      pipeline operations                       $50,644            $43,454            $43,899           $ 44,106            $52,755
   Litigation settlement                                                                                  11,466
   Total revenue                                 51,066             43,780             44,482             49,613             60,730
   Production operating
      expense                                    11,511             11,298             12,177             11,200             14,107
   Depreciation, depletion and
      amortization                               13,500             15,827             18,168             17,076             18,866
   Impairment                                                       10,943              7,345
   General and administrative
      expense                                     4,540              5,580              5,630              6,812              7,732
   Net income (loss)                             15,726            (9,031)           (10,093)             13,064              3,613
   Net income (loss) per Class A
      and Class B Unit                             1.34             (1.07)             (1.20)               1.14                .21
   Distributions per Class A
      and Class B Unit                              .52                .80                .80                .80                .80

Balance Sheet
   Working capital (deficit)                  $ (1,355)          $ (4,363)          $ (9,390)           $  7,020           $  6,306
   Property, plant and
      equipment, net                             88,549             94,926            107,414            122,133            129,029
   Total assets                                 122,792            125,152            136,281            171,624            186,087
   Long-term debt                                29,461             37,557             25,898             38,010             52,814
   Long-term contract
      settlement obligation                       2,512              2,397              2,666              3,673              4,179
   Long-term lawsuit
      settlement liability                                                                                                    2,370
   Deferred liability                             1,533              1,718              1,931              1,504              1,626
   Minority interest in
      affiliates                                  3,336              3,042              2,923              3,346              3,782
   Partners' capital                             64,215             57,572             78,803             98,576             89,779

</TABLE>



                                                       -11-

<PAGE>



ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS, LIQUIDITY AND CAPITAL RESOURCES

Liquidity and Capital Resources

Cash Flow

HEP generated $26,423,000 of cash flow from operating activities during 1996.

   The other primary cash inflows were:

   o  $9,000,000 in proceeds from long-term debt;

   o  $5,294,000 in proceeds from the sale of property.

   Cash was used primarily for:

   o  Distributions to partners of $8,176,000;

   o Additions to property,  exploration  and  development  costs  incurred of
       $12,615,000;

   o  Payments of long-term debt of $11,373,000;

   o  Refinance of Spraberry investment of $4,715,000,

   o  Payments of contract settlement obligations of $305,000.

When combined with miscellaneous other cash activity during the year, the result
was an increase in HEP's cash of $563,000,  from $4,977,000 at December 31, 1995
to $5,540,000 at December 31, 1996.

Property Purchases, Sales and Capital Budget

In 1996, HEP incurred  $12,615,000 in direct property  additions and exploration
and  development  costs,  and  approximately  $441,000  for the purchase of HCRC
shares.  The costs were  comprised  of  approximately  $9,467,000  for  domestic
exploration  and  development  expenditures  and  approximately  $3,148,000  for
property  acquisitions.  HEP's  1996  capital  program  led to the  replacement,
through  acquisitions  and drilling,  of 75% of the equivalent  barrels produced
during 1996. Overall  replacement,  including  revisions to prior year reserves,
was 145% of its 1996 production.

HEP's  significant  direct  exploration  and  development  expenditures  in 1996
included  approximately  $1,359,000 for the drilling of seventeen wells, fifteen
of which were successful, and participation in nine recompletions,  six of which
were successful,  in the West Texas Kermit area;  approximately $435,000 for 3-D
seismic data and $160,000 for two exploratory  wells, both of which were dry, in
Crane  County,  Texas;  approximately  $515,000 for 3-D seismic data and related
acreage  and  $184,000  for the  drilling  of eight  wells,  seven of which were
successful, in the Merkel Project area in Texas;  approximately $330,000 for the
drilling of two nonoperated wells, one of which was successful, in North Dakota;
approximately  $150,000 for an exploratory dry hole and  approximately  $600,000
for an Interlake Formation development well in Montana;  approximately  $505,000
for 11  recompletions  and two  drilled  wells  in  Reagan  County,  Texas;  and
approximately $225,000 for the recompletion of one well in Louisiana.


                                                       -12-

<PAGE>



In the San Juan Basin area of Colorado and New Mexico, HEP, directly and through
an affiliate  acquired  interests in 38 coal bed methane  wells for  $1,734,000.
Nine  recompletions have been performed in this area for a cost of approximately
$690,000,  and numerous other facility projects were completed for approximately
$270,000. HEP spent approximately $575,000 in New Mexico for the recompletion of
three wells and the drilling of two wells in New Mexico.

HEP received  $1,300,000 during 1996 for the sale of its interests in the Hoople
Field in Crosby County,  Texas,  $3,800,000 for the sale of its interests in the
Bethany  Longstreet  area of  Louisiana  and  $88,000  for the  sale of  various
nonstrategic properties.

For 1997,  HEP's capital  budget,  which will be paid from cash  generated  from
operations  and  cash on  hand,  has been  set at  $12,500,000.  HEP's  domestic
exploitation  plans include  projects in Texas,  Wyoming,  Louisiana,  Oklahoma,
Colorado and New Mexico. HEP will continue to consider international projects in
1997, utilizing stringent screening criteria.

During 1996,  HEP adopted  Statement of Financial  Accounting  Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" ("SFAS 121"). SFAS 121 provides the standards for accounting for
the  impairment  of  various  long-lived  assets.  Substantially  all  of  HEP's
long-lived  assets  consist of oil and gas  properties,  which are accounted for
using the full cost method of  accounting,  which  requires an  impairment to be
recorded when total  capitalized  costs exceed the present value,  discounted at
10%,  of  estimated  future  net  revenues  from  proved  oil and gas  reserves.
Therefore,  the  adoption  of SFAS 121 did not  have a  material  effect  on the
financial position or results of operations of HEP.

See Item 2 - Properties, for further discussion.

Distributions

On January  19,  1996,  HEP paid a dividend of one new Class C Unit for every 15
HEP Class A Units held as of the record date of December 18,  1995.  Pursuant to
the  regulations  of the American Stock  Exchange,  holders of Class A Units who
sold their Units between  December 14, 1995 and January 19, 1996 also sold their
right to receive the associated Class C Unit dividend. Class C Units are a newly
created class of units that trade separately from HEP's Class A Units. The Class
C Units have a distribution preference of $1.00 per year, payable quarterly, and
distributions  on the new units  commenced  the first  quarter of 1996.  Class C
Units  were  created  to give HEP  greater  flexibility  in  structuring  future
acquisitions by allowing HEP to issue a security with a fixed distribution rate.
During 1996, HEP declared  distributions  of $.52 per Class A Unit and $1.00 per
Class C Unit to its Unitholders.

The Board of Directors of HEP's General Partner is considering the  distribution
level for  future  quarters,  taking  into  account  oil and gas  prices and the
capital needs of HEP.

Unit Option Plan

On January 31, 1995, the board of directors of the general partner  approved the
adoption  of the  1995  Unit  Option  Plan to be used  for  the  motivation  and
retention of directors,  employees and consultants  performing services for HEP.
The plan  authorizes the issuance of options to purchase  425,000 Class A Units.
Grants of the total options  authorized  were made on January 31, 1995,  vesting
one-third  at that time,  an  additional  one-third  on January 31, 1996 and the
remaining  one-third on January 31, 1997.  The exercise  price of the options is
$5.75,  which was the closing price of the Class A Units on January 30, 1995. No
options have been exercised.


                                                       -13-

<PAGE>



During 1996,  HEP adopted the  disclosure  provisions  of Statement of Financial
Accounting  Standards No. 123,  "Accounting for Stock Based Compensation" ("SFAS
123"). SFAS 123 requires entities to use the fair value method to either account
for,  or  disclose,  stock based  compensation  in their  financial  statements.
Because the  Partnership  elected the  disclosure  provisions  of SFAS 123,  the
adoption of SFAS 123 did not have a material effect on the financial position or
results of operations of HEP.

Financing

During the first quarter of 1995, HEP and its lenders  amended HEP's Amended and
Restated Credit  Agreement  ("Credit  Agreement") to extend the term date of its
line of credit to May 31, 1997.  Under the Credit  Agreement  and an Amended and
Restated Note  Purchase  Agreement  ("Note  Purchase  Agreement")  (collectively
referred  to  as  the  "Credit  Facilities"),   HEP  has  a  borrowing  base  of
$48,000,000.  HEP has amounts  outstanding  at December 31, 1996 of  $26,700,000
under the Credit  Agreement and  $8,571,000  under the Note Purchase  Agreement.
HEP's  borrowing base is further reduced by an outstanding  contract  settlement
obligation  of  $2,512,000;   therefore,   its  unused  borrowing  base  totaled
$10,217,000 at March 20, 1997.

Borrowings under the Note Purchase  Agreement bear interest at an annual rate of
11.85%,  which is payable  quarterly.  Annual  principal  payments of $4,286,000
began April 30,  1992,  and the debt is required to be paid in full on April 30,
1998.  HEP  intends to fund the  payment  due in April 1997  through  additional
borrowings under the Credit  Agreement;  thus, no portion of HEP's Note Purchase
Agreement is classified as current as of December 31, 1996.

Borrowings  against  the  Credit  Agreement  bear  interest  at the lower of the
Certificate of Deposit rate plus 1.875%, prime plus 1/2% or the Euro-Dollar rate
plus 1.75%. At December 31, 1996 the applicable interest rate was 7.4%. Interest
is payable  monthly,  and 16  quarterly  principal  payments of  $1,937,000,  as
adjusted for the  anticipated  borrowings  to fund the Note  Purchase  Agreement
payment due in 1997,  commence May 31, 1997.  HEP intends to extend the maturity
date of its  Credit  Agreement  prior to the  commencement  of the  amortization
period.

The borrowing base for the Credit  Facilities is  redetermined  semiannually  in
March and September of each year.  The Credit  Facilities are secured by a first
lien  on   approximately   80%  in  value  of  HEP's  oil  and  gas  properties.
Additionally,  aggregate  distributions  paid by HEP in any 12 month  period are
limited to 50% of cash flow from operations  before working capital changes plus
distributions received from affiliates.

HEP entered into contracts to hedge its interest rate payments on $10,000,000 of
its  debt  through  the end of 1996,  $15,000,000  for each of 1997 and 1998 and
$10,000,000  for each of 1999 and 2000.  HEP does not use the hedges for trading
purposes,  but rather for the purpose of  providing a measure of  predictability
for a portion of HEP's interest  payments under its debt agreement,  which has a
floating  interest  rate.  In  general,  it is HEP's  goal to  hedge  50% of the
principal amount of its debt for the next two years and 25% for each year of the
remaining term of the debt. HEP has entered into four hedges, one of which is an
interest  rate  collar  pursuant  to which it pays a floor  rate of 7.55%  and a
ceiling rate of 9.85%,  and the others are interest  rate swaps with fixed rates
ranging from 5.75% to 6.57%.  The amounts  received or paid upon  settlement  of
these  transactions  are recognized as interest expense at the time the interest
payments are due.

Gas Balancing

HEP uses the sales method for  recording its gas  balancing.  Under this method,
HEP   recognizes   revenue  on  all  of  its  sales  of   production,   and  any
over-production or under-production is recovered or repaid at a future date.

As of December 31,  1996,  HEP had a net  over-produced  position of 166,000 mcf
($372,000  valued at average annual gas prices).  The general  partner  believes
that this  imbalance can be made up from  production  on existing  wells or from
wells which will be drilled as offsets to existing wells and that this imbalance
will not have a material  effect on HEP's results of  operations,  liquidity and
capital  resources.  The  reserves  disclosed  in Item 8 have been  decreased by
166,000 mcf in order to reflect HEP's gas balancing position.

                                                       -14-

<PAGE>



Cautionary Statement Regarding Forward-Looking Statements

In the  interest  of  providing  the  Partnership's  Unitholders  and  potential
investors with certain information  regarding the Partnership's future plans and
operations,   certain   statements  set  forth  in  this  Form  10-K  relate  to
management's future plans and objectives.  Such statements are  "forward-looking
statements"  within the meaning of Section 27A of the Securities Act of 1933, as
amended,  and Section 21E of the  Securities  Exchange act of 1934,  as amended.
Although any forward-looking statements contained in this Form 10-K or otherwise
expressed by or on behalf of the  Partnership  are, to the  knowledge and in the
judgment of the officers and directors of the General Partner, expected to prove
true and to come to pass,  management  is not able to predict  the  future  with
absolute certainty.  Forward-looking  statements involve known and unknown risks
and  uncertainties  which may cause the  Partnership's  actual  performance  and
financial  results in future periods to differ  materially  from any projection,
estimate or forecasted  result.  These risks and  uncertainties  include,  among
other things, volatility of oil and gas prices,  competition,  risks inherent in
the Partnership's  oil and gas operations,  the inexact nature of interpretation
of seismic and other  geological and  geophysical  data,  imprecision of reserve
estimates, the Partnership's ability to replace and expand oil and gas reserves,
and such  other  risks  and  uncertainties  described  from  time to time in the
Partnership's  periodic  reports and filings  with the  Securities  and Exchange
Commission. Accordingly,  Unitholders and potential investors are cautioned that
certain events or circumstances  could cause actual results to differ materially
from those projected.

Inflation and Changing Prices

Prices obtained for oil and gas production depend upon numerous factors that are
beyond  the  control  of HEP,  including  the  extent of  domestic  and  foreign
production,  imports of foreign  oil,  market  demand,  domestic  and  worldwide
economic and political  conditions,  and  government  regulations  and tax laws.
Prices  for both oil and gas have  fluctuated  significantly  from 1994  through
1996. The following  table presents the average prices received per year by HEP,
and the effects of the hedging transactions discussed below.

<TABLE>
<CAPTION>

                      Oil                        Oil                        Gas                        Gas
              (excluding effects         (including effects         (excluding effects         (including effects
                  of hedging                 of hedging                 of hedging                 of hedging
                 transactions)              transactions)              transactions)              transactions)
                   (per bbl)                  (per bbl)                  (per mcf)                  (per mcf)

<C>                 <C>                        <C>                         <C>                        <C>  
1996                $20.85                     $20.10                      $2.38                      $2.24
1995                 16.98                      17.36                       1.58                       1.82
1994                 15.50                      16.47                       1.90                       1.97
</TABLE>

HEP has entered into numerous financial  contracts to hedge the price of its oil
and  natural  gas.  The purpose of the hedges is to provide  protection  against
price drops and to provide a measure of stability in the volatile environment of
oil and natural gas spot pricing.

The following table provides a summary of HEP's financial contracts:


                                         Oil
                            Percent of
                            Production                  Contract
      Period                  Hedged                   Floor Price
                                                        (per bbl)

       1997                    46%                       $17.78
       1998                    16%                       $15.33
       1999                     3%                       $15.88


                                                       -15-

<PAGE>



Between  16% and 100% of the oil  volumes  hedged in each year are  subject to a
participating  hedge  whereby HEP will receive the contract  price if the posted
futures  price is lower than the contract  price,  and will receive the contract
price plus between 25% and 75% of the difference  between the contract price and
the  posted  futures  price if the  posted  futures  price is  greater  than the
contract  price.  Between  32% and 100% of the  volumes  hedged in each year are
subject to a collar agreement whereby HEP will receive the contract price if the
spot price is lower than the contract price,  the cap price if the spot price is
higher  than the cap price,  and the spot  price if that  price is  between  the
contract price and the cap price. The cap prices range from $17.50 to $19.35 per
barrel.


                                         Gas
                            Percent of
                            Production                  Contract
      Period                  Hedged                   Floor Price
                                                        (per mcf)

       1997                    54%                        $1.97
       1998                    48%                        $2.02
       1999                    24%                        $1.86
       2000                    18%                        $2.01

Between  0% and 43% of the gas  volumes  hedged  in each year are  subject  to a
collar  agreement  whereby HEP will receive the contract price if the spot price
is lower than the contract price, the cap price if the spot price is higher than
the cap price,  and the spot price if that price is between the  contract  price
and the cap price. The cap prices range from $2.78 to $2.93 per mcf.

During the first quarter  through  February 26, 1997, the oil price (for barrels
not hedged) averaged between $20.00 and $25.00 per barrel.  The average price of
natural gas (for mcf not hedged) was between $1.00 and $4.40 per mcf.

Inflation

Inflation did not have a material  impact on HEP in 1996 and is not  anticipated
to have a material impact in 1997.

Results of Operations

The  following  tables are  presented  to contrast  HEP's  revenue,  expense and
earnings for discussion purposes.  Significant fluctuations are discussed in the
accompanying  narrative.  The "direct  owned"  column  represents  HEP's  direct
royalty and  working  interests  in oil and gas  properties.  The "Mays"  column
represents the results of operations of six May Limited  Partnerships  which are
consolidated  with HEP. In 1996, HEP owned  interests which ranged from 54.5% to
68.5% of the Mays;  in 1995 HEP's  ownership  in the Mays  ranged  from 54.5% to
68.3%; and in 1994 HEP's ownership in the Mays ranged from 54.1% to 67.8%.



                                                       -16-

<PAGE>

<TABLE>
<CAPTION>


                                         
                                                           TABLE OF HEP EARNINGS FOR MANAGEMENT DISCUSSION
                                                                      (In thousands except price)



                                               For the Year Ended December 31, 1996        For the Year Ended December 31, 1995
                                               ------------------------------------        ------------------------------------
                                               Direct                                   Direct
                                                Owned       Mays      Total              Owned          Mays               Total

<S>                                             <C>         <C>       <C>                <C>             <C>               <C>
Oil production (bbl)                                862         110       972                895             98                993
Gas production (mcf)                             11,003       1,783    12,786             11,497          1,538             13,035

Average oil price                                $19.82      $21.52    $20.10             $17.32         $17.74             $17.36
Average gas price                                $ 2.11      $ 3.05    $ 2.24             $ 1.81         $ 1.92             $ 1.82

Oil revenue                                     $17,167      $2,367   $19,534           $ 15,501        $ 1,739           $ 17,240
Gas revenue                                      23,178       5,440    28,618             20,822          2,948             23,770
Pipeline, facilities and other revenue            2,492                 2,492              2,444                             2,444
Interest income                                     356          66       422                263             63                326
                                               --------     -------  --------          ---------       --------          ---------

      Total revenue                              43,193       7,873    51,066             39,030          4,750             43,780
                                                 ------       -----    ------            -------         ------            -------

Production operating expense                     10,782         729    11,511             10,658            640             11,298
Facilities operating expense                        726                   726                794                               794
General and administrative expense                4,131         409     4,540              5,131            449              5,580
Depreciation, depletion, and amortization        11,729       1,771    13,500             14,058          1,769             15,827
Impairment of oil and gas properties                                                      10,943                            10,943
Interest expense                                  3,878                 3,878              4,245                             4,245
Litigation settlement expense                       223           7       230                337             49                386
Equity in (income) loss of HCRC                 (1,768)               (1,768)              2,273                             2,273
Minority interest                                             2,723     2,723                             1,465              1,465
                                            -----------       -----   -------       ------------          -----            -------

   Total expense                                 29,701       5,639    35,340             48,439          4,372             52,811
                                                 ------       -----    ------            -------         ------            -------

      Net income (loss)                         $13,492      $2,234   $15,726         $  (9,409)       $    378         $  (9,031)
                                                 ======       =====    ======          ========         =======          ========
</TABLE>


                                                                -17-

<PAGE>



<TABLE>
<CAPTION>

                                                                


                                                                
                                           TABLE OF HEP EARNINGS FOR MANAGEMENT DISCUSSION
                                                     (In thousands except price)
                                                For the Year Ended December 31, 1994



                                                                Direct
                                                                 Owned              Mays               Total

<S>                                                              <C>                <C>                <C>
Oil production (bbl)                                                 826                113                939
Gas production (mcf)                                              11,521              1,687             13,208

Average oil price                                                 $16.54             $15.98             $16.47
Average gas price                                                 $ 1.93             $ 2.22             $ 1.97

Oil revenue                                                     $ 13,664            $ 1,806           $ 15,470
Gas revenue                                                       22,287              3,739             26,026
Pipeline, facilities and other revenue                             2,403                                 2,403
Interest income                                                      525                 58                583
                                                               ---------           --------          ---------

      Total revenue                                               38,879              5,603             44,482
                                                                 -------             ------            -------

Production operating expense                                      11,491                686             12,177
Facilities operating expense                                         730                                   730
General and administrative expense                                 5,107                523              5,630
Depreciation, depletion, and amortization                         15,894              2,274             18,168
Impairment of oil and gas properties                               7,345                                 7,345
Interest expense                                                   3,839                                 3,839
Litigation settlement expense                                      3,370                                 3,370
Equity in loss of HCRC                                             1,499                                 1,499
Minority interest                                                                     1,822              1,822
Other                                                                (5)                                   (5)
                                                            -----------          ----------       -----------
   Total expense                                                  49,270              5,305             54,575
                                                                 -------             ------            -------

      Net income (loss)                                        $(10,391)           $    298          $(10,093)
                                                                =======             =======           =======
</TABLE>


                                                                -18-

<PAGE>



1996 Compared to 1995

Oil Revenue

Oil revenue increased $2,294,000 during 1996 as compared with 1995. The increase
is  comprised  of a 16% increase in the average oil price from $17.36 per barrel
in 1995 to  $20.10  per  barrel  in 1996,  partially  offset  by a  decrease  in
production,  from  993,000  barrels  in 1995 to  972,000  barrels  in 1996.  The
decrease in production is due to property sales and normal production declines.

The effect of HEP's hedging transactions described under "Inflation and Changing
Prices" was to decrease HEP's average oil price from $20.85 per barrel to $20.10
per barrel, resulting in a $729,000 decrease in oil revenue for 1996.

Gas Revenue

Gas revenue  increased  by  $4,848,000  during 1996 as compared  with 1995.  The
increase is  comprised of a 23% increase in the average gas price from $1.82 per
mcf in 1995 to $2.24  per mcf in 1996,  partially  offset by a  decrease  in gas
production  from  13,035,000  mcf during 1995 to 12,786,000 mcf during 1996. The
decrease in  production is due to decreases in allowable  production  limits and
normal  production  declines,  partially  offset by  increased  production  from
exploratory and  developmental  drilling  projects in Montana,  Wyoming and West
Texas.

The effect of HEP's  hedging  transactions  as described  under  "Inflation  and
Changing  Prices" was to decrease  HEP's average gas price from $2.38 per mcf to
$2.24 per mcf, representing a $1,790,000 decrease in gas revenues for 1996.

Interest Income

The  increase in interest  income of $96,000  during 1996 as compared  with 1995
resulted from a higher average cash balance during 1996 as compared with 1995.

Production Operating Expense

Production  operating  expense  increased  $213,000 during 1996 as compared with
1995,  primarily  as a  result  of  increased  production  taxes  due to the 17%
increase in oil and gas revenue during 1996 discussed above.

Facilities Operating Expense

Facilities  operating  expense  represents  operating  expenses  associated with
various smaller  gathering  systems  operated by HEP. The decrease in facilities
operating expense of $68,000 is primarily due to decreased  maintenance activity
during 1996.

General and Administrative Expense

General  and   administrative   expense   includes  costs  incurred  for  direct
administrative  services such as legal,  audit and reserve  reports,  as well as
allocated  internal overhead incurred by the operating company on behalf of HEP.
These expenses decreased  $1,040,000 during 1996 as compared with 1995 primarily
due to a decrease  in  performance  based  compensation,  a decrease in salaries
expense and employee  benefits expense due to personnel  reductions  during 1995
and lower legal expense in 1996 due to the  settlement of a significant  lawsuit
during 1995.

Depreciation, Depletion and Amortization Expense

Depreciation,  depletion and amortization  expense  decreased  $2,327,000 during
1996 as  compared  with 1995.  The  decrease  is  primarily  the result of lower
capitalized  costs in 1996 as compared with 1995,  primarily due to the property
impairments recorded during 1995 and 1994.

                                                       -19-

<PAGE>



Interest Expense

Interest  expense  decreased by $367,000  during 1996 as compared with 1995. The
decrease  is due to a lower  average  outstanding  debt  balance  during 1996 as
compared to 1995.

Litigation Settlement Expense

Litigation  settlement  expense  during  1996 and  1995  consists  primarily  of
expenses incurred to settle various  individually  insignificant  claims against
HEP.

Equity in Earnings (Loss) of HCRC

Equity in earnings of HCRC  represents  HEP's share of its equity  investment in
HCRC.  HEP's equity in HCRC's  earnings  increased by $4,041,000  during 1996 as
compared to 1995. The increase is primarily the result of a 6% increase in HEP's
ownership of HCRC resulting from HEP's purchase of 12,965 shares of common stock
of HCRC during the second  quarter of 1996.  Also  contributing  to the increase
were higher oil and gas prices for HCRC during 1996 and the inclusion in 1995 of
impairment  expense  resulting  from  the  write-off  of  its  investment  in an
Indonesian project and other property impairments.

1995 Compared to 1994

Oil Revenue

Oil revenue increased $1,770,000 during 1995 as compared with 1994. The increase
is comprised of a 5% increase in the average oil price from $16.47 per barrel in
1994 to $17.36 per barrel in 1995,  combined  with a 6% increase in  production,
from  939,000  barrels  in 1994 to  993,000  barrels in 1995.  The  increase  in
production is due to increased  production from developmental  drilling projects
in West Texas, offset by normal production declines.

The effect of HEP's hedging transactions described under "Inflation and Changing
Prices" was to increase HEP's average oil price from $16.98 per barrel to $17.36
per barrel, resulting in a $377,000 increase in revenue for 1995.

Gas Revenue

Gas revenue  decreased  by  $2,256,000  during 1995 as compared  with 1994.  The
decrease is comprised of a slight decrease in gas production from 13,208,000 mcf
during 1994 to  13,035,000  mcf during 1995  combined with an 8% decrease in the
average  gas price  from  $1.97  per mcf in 1994 to $1.82  per mcf in 1995.  The
decrease in  production is due to decreases in allowable  production  limits and
normal  production  declines,  partially  offset by  increased  production  from
developmental drilling projects in West Texas.

The effect of HEP's hedging transactions was to increase HEP's average gas price
from $1.58 per mcf to $1.82 per mcf,  representing  an  $3,128,000  increase  in
revenues for 1995.

Interest Income

The decrease in interest  income of $257,000  during 1995 as compared  with 1994
resulted from a lower average cash balance during 1995 as compared with 1994.

Production Operating Expense

Production  operating  expense  decreased  $879,000 during 1995 as compared with
1994, primarily as a result of general cost reductions in West Texas.


                                                       -20-

<PAGE>



Facilities Operating Expense

Facilities  operating  expense  represents  operating  expenses  associated with
various smaller  gathering  systems  operated by HEP. The increase in facilities
operating  expense of  $64,000 is  primarily  due to the  increased  maintenance
activity during 1995.

Depreciation, Depletion and Amortization Expense

Depreciation,  depletion and amortization  expense  decreased  $2,341,000 during
1995 as  compared  with 1994.  The  decrease  is  primarily  the result of lower
capitalized  costs in 1995 as compared with 1994,  primarily due to the property
impairment  recorded during the second quarter of 1995 and the fourth quarter of
1994.

Impairment of Oil and Gas Properties

Impairment of oil and gas  properties  during 1995  represents the impairment of
$7,000,000  recorded  because  capitalized  costs at June 30, 1995  exceeded the
present value  (discounted at 10%) of estimated  future net revenues from proved
oil and gas reserves,  based on prices at that date of $16.50 per bbl of oil and
$1.50  per  mcf of gas,  as well as the  write-off  of  HEP's  investment  in an
Indonesian  project of  $3,943,000.  The  impairment  of oil and gas  properties
during 1994 represents an impairment of $6,000,000  recorded because capitalized
costs at December 31, 1994  exceeded the present  value  (discounted  at 10%) of
estimated future net revenues from proved oil and gas reserves,  based on prices
at that date of $15.80  per bbl of oil and $1.72 per mcf of gas,  as well as the
write-off of certain foreign drilling projects of $1,345,000.

Interest Expense

Interest  expense  increased by $406,000  during 1995 as compared with 1994. The
increase is due to a higher  average  outstanding  debt  balance  during 1995 as
compared to 1994.

Litigation Settlement Expense

Litigation  settlement  expense  during  1995  consists  primarily  of  expenses
incurred  to settle  various  individually  insignificant  claims  against  HEP.
Litigation  settlement  expense during 1994  represents the settlement of claims
against HEP which are further  discussed in Note 13 to the Financial  Statements
included in Item 8, as well as an amount paid to settle a claim for royalties on
a 1989 take-or-pay settlement.

Equity in Earnings (Loss) of HCRC

HEP's  equity in HCRC's loss  increased  by $774,000  during 1995 as compared to
1994.  The  increase  is  primarily  the  result  of HCRC's  impairment  expense
resulting from the write-off of its  investment in an Indonesian  project during
1995, as well as a second quarter 1995 property impairment recorded by HCRC.


                                                       -21-

<PAGE>


<TABLE>
<CAPTION>

ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                               INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


FINANCIAL STATEMENTS:                                                                                         Page

<S>                                                                                                           <C>    
Independent Auditors' Report                                                                                     23

Consolidated Balance Sheets at December 31, 1996 and 1995                                                     24-25

Consolidated Statements of Operations for the years
  ended December 31, 1996, 1995 and 1994                                                                         26

Consolidated Statements of Partners' Capital for the
  years ended December 31, 1996, 1995 and 1994                                                                   27

Consolidated Statements of Cash Flows for the years
  ended December 31, 1996, 1995 and 1994                                                                         28

Notes to Consolidated Financial Statements                                                                    29-43

SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION - (UNAUDITED)                                                    44-47

</TABLE>


                                                       -22-

<PAGE>



                          INDEPENDENT AUDITORS' REPORT


To the Partners of Hallwood Energy Partners, L.P.:

We have  audited  the  consolidated  financial  statements  of  Hallwood  Energy
Partners,  L.P. as of December 31, 1996 and 1995 and for each of the three years
in the period  ended  December  31,  1996,  listed in the index at Item 8. These
financial statements are the responsibility of the partnership's management. Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  such consolidated  financial  statements present fairly, in all
material respects,  the financial position of Hallwood Energy Partners,  L.P. at
December 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended  December 31, 1996 in conformity
with generally accepted accounting principles.



DELOITTE & TOUCHE LLP

Denver, Colorado
February 28, 1997




                                                       -23-

<PAGE>

<TABLE>
<CAPTION>


                                          HALLWOOD ENERGY PARTNERS, L.P.
                                            CONSOLIDATED BALANCE SHEETS
                                                  (In thousands)


                                                                                          December 31,
                                                                                    1996               1995

CURRENT ASSETS
<S>                                                                              <C>                <C>      
   Cash and cash equivalents                                                     $   5,540          $   4,977
   Accounts receivable:
      Oil and gas revenues                                                           9,405              6,767
      Trade                                                                          4,507              2,860
   Due from affiliates                                                                                  2,808
   Prepaid expenses and other current assets                                           928              1,091
                                                                                 ---------           --------
        Total                                                                       20,380             18,503
                                                                                   -------            -------

PROPERTY,  PLANT  AND  EQUIPMENT,  at cost  Oil and gas  properties  (full  cost
   method):
      Proved mineral interests                                                     607,875            601,323
      Unproved mineral interests - domestic                                          1,244                684
   Furniture, fixtures and other                                                     3,366              3,090
                                                                                  --------          ---------
        Total                                                                      612,485            605,097

   Less accumulated depreciation, depletion,
      amortization and property impairment                                       (523,936)          (510,171)
                                                                                 --------            -------
        Total                                                                       88,549             94,926
                                                                                  --------           --------

OTHER ASSETS
   Investment in common stock of HCRC                                               13,700             11,491
   Deferred expenses and other assets                                                  163                232
                                                                                ----------         ----------
        Total                                                                       13,863             11,723
                                                                                  --------           --------

TOTAL ASSETS                                                                      $122,792           $125,152
                                                                                   =======            =======
















<FN>

                                         (Continued on the following page)
</FN>
</TABLE>

                                                       -24-

<PAGE>
<TABLE>
<CAPTION>



                                          HALLWOOD ENERGY PARTNERS, L.P.
                                            CONSOLIDATED BALANCE SHEETS
                                                  (In thousands)


                                                                                           December 31,
                                                                                    1996               1995

CURRENT LIABILITIES
<S>                                                                               <C>                <C>     
   Accounts payable and accrued liabilities                                       $ 15,185           $ 17,344
   Due to affiliates                                                                   159
   Net working capital deficit of affiliate                                            581              5,061
   Current portion of contract settlement                                                                 374
   Current portion of long-term debt                                                 5,810                 87
                                                                                  --------         ----------
        Total                                                                       21,735             22,866
                                                                                   -------            -------

NONCURRENT LIABILITIES
   Long-term debt                                                                   29,461             37,557
   Contract settlement                                                               2,512              2,397
   Deferred liability                                                                1,533              1,718
                                                                                  --------           --------
        Total                                                                       33,506             41,672
                                                                                   -------            -------

           Total Liabilities                                                        55,241             64,538
                                                                                   -------            -------

MINORITY INTEREST IN AFFILIATES                                                      3,336              3,042
                                                                                  --------            -------

COMMITMENTS AND CONTINGENCIES (NOTE 14)

PARTNERS' CAPITAL
   Class A Units - 9,977,254 Units issued, 9,077,949 and
      9,193,159 outstanding in 1996 and 1995, respectively                          61,487             59,614
   Class B Subordinated Units - 143,773 Units issued
      and outstanding                                                                1,254              1,062
   Class C Units - 664,063 Units issued and outstanding in 1996
      (none in 1995)                                                                 5,146
   General Partner                                                                   3,307              2,981
   Treasury Units - 899,305 and 784,095
      Units in 1996 and 1995, respectively                                         (6,979)            (6,085)
                                                                                  -------            -------
           Partners' Capital - Net                                                  64,215             57,572
                                                                                   -------            -------

TOTAL LIABILITIES AND PARTNERS' CAPITAL                                           $122,792           $125,152
                                                                                  ========            =======









<FN>

               The accompanying notes are an integral part of the
                             financial statements.
</FN>
</TABLE>

                                                       -25-

<PAGE>
<TABLE>
<CAPTION>



                                          HALLWOOD ENERGY PARTNERS, L.P.
                                       CONSOLIDATED STATEMENTS OF OPERATIONS
                                          (In thousands except per Unit)


     
                                                                                 For the Years Ended December 31,
                                                                          1996               1995               1994

REVENUES:
<S>                                                                      <C>               <C>                <C>      
   Oil revenue                                                           $ 19,534          $  17,240          $  15,470
   Gas revenue                                                             28,618             23,770             26,026
   Pipeline, facilities and other                                           2,492              2,444              2,403
   Interest                                                                   422                326                583
                                                                        ---------         ----------         ----------
                                                                           51,066             43,780             44,482
                                                                          -------           --------           --------

EXPENSES:
   Production operating                                                    11,511             11,298             12,177
   Facilities operating                                                       726                794                730
   General and administrative                                               4,540              5,580              5,630
   Depreciation, depletion and amortization                                13,500             15,827             18,168
   Impairment of oil and gas properties                                                       10,943              7,345
   Interest                                                                 3,878              4,245              3,839
   Litigation settlement                                                      230                386              3,370
                                                                        ---------         ----------          ---------
                                                                           34,385             49,073             51,259
                                                                          -------           --------           --------

OTHER INCOME (EXPENSES):
   Equity in earnings (loss) of HCRC                                        1,768            (2,273)            (1,499)
   Minority interest in net income of affiliates                          (2,723)            (1,465)            (1,822)
   Other                                                                                                              5
                                                                     ------------      -------------       ------------
                                                                            (955)            (3,738)            (3,316)
                                                                       ---------          ---------          ---------

NET INCOME (LOSS)                                                          15,726            (9,031)           (10,093)

CLASS C UNIT DISTRIBUTIONS ($1.00 PER UNIT)                                   664
                                                                        ---------

NET INCOME (LOSS) ATTRIBUTABLE TO
   GENERAL PARTNER, CLASS A AND
   CLASS B LIMITED PARTNERS                                              $ 15,062         $  (9,031)         $ (10,093)
                                                                          =======          ========           ========

ALLOCATION OF NET INCOME (LOSS):

General partner                                                         $   2,569          $   1,289          $   1,631
                                                                         ========           ========           ========
Class A and Class B Limited partners                                     $ 12,493          $(10,320)          $(11,724)
                                                                          =======           =======            =======
   Per Class A Unit and Class B Unit                                   $     1.34        $    (1.07)       $     (1.20)
                                                                        =========         =========         ==========
   Weighted average Class A Units and Class B Units
      and equivalent Units outstanding                                      9,292              9,683              9,807
                                                                         ========          =========          =========


<FN>

               The accompanying notes are an integral part of the
                             financial statements.
</FN>
</TABLE>

                                                       -26-

<PAGE>


<TABLE>
<CAPTION>


                                                   HALLWOOD ENERGY PARTNERS, L.P.
                                            CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL
                                                     (In thousands except Units)



                                 General             Class A             Class B             Class C              Treasury
                                  Partner              Units               Units               Units                 Units

<S>                                <C>                <C>                  <C>                <C>                    <C>     
Balance, December 31, 1993         $ 4,872            $ 95,956             $ 1,662                                   $(3,914)
Increase in Treasury
   Units                                                                                                                 (26)
Syndication costs                                         (34)
Distributions                      (2,452)             (7,052)               (116)
Net income (loss)                    1,631            (11,528)               (196)
                                    ------            -------             -------

Balance, December 31, 1994           4,051              77,342               1,350                                    (3,940)
Increase in Treasury
  Units                                                                                                               (2,145)
Syndication costs                                         (63)
Distributions                      (2,359)             (7,517)               (116)
Net income (loss)                    1,289            (10,148)               (172)
                                    ------            -------             -------

Balance, December 31, 1995           2,981              59,614               1,062                                    (6,085)
Increase in Treasury
   Units                                                                                                                (894)
Syndication costs                                         (12)
Issuance of Class C Units                              (5,146)                                  $5,146
Distributions                      (2,243)             (5,270)                                   (664)
Net income                           2,569              12,301                 192                 664
                                    ------             -------             -------              ------

Balance, December 31, 1996         $ 3,307            $ 61,487             $ 1,254              $5,146               $(6,979)
                                    ======             =======              ======               =====                ======



<FN>

               The accompanying notes are an integral part of the
                             financial statements.
</FN>
</TABLE>



                                                                -27-

<PAGE>

<TABLE>
<CAPTION>


                                          HALLWOOD ENERGY PARTNERS, L.P.
                                       CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                  (In thousands)


                                                                               For the Years Ended December 31,
                                                                          1996               1995               1994

OPERATING ACTIVITIES:
<S>                                                                      <C>                <C>                <C>      
   Net income (loss)                                                     $ 15,726           $ (9,031)          $(10,093)
   Adjustments to reconcile net income (loss) to net
     cash provided by operating activities:
        Depreciation, depletion, amortization and
           impairment                                                      13,500             26,770             25,513
        Depreciation charged to affiliates                                    265                256                348
        Amortization of deferred loan costs and other
           assets                                                             167                201                260
        Noncash interest expense                                              219                289                394
        Minority interest in net income                                     2,723              1,465              1,822
        Take-or-pay recoupment                                               (376)              (571)              (313)
        Equity in (earnings) loss of HCRC                                  (1,768)             2,273              1,499
        Undistributed (earnings) loss of affiliates                          (187)              (886)               158
                                                                        ---------           --------          ---------

           Cash from operations before working capital
             changes                                                       30,269             20,766             19,588

   Changes in  operating  assets and  liabilities  provided  (used)  cash net of
     noncash activity:
        Oil and gas revenues receivable                                    (2,638)              (547)             3,341
        Trade receivables                                                  (1,647)               182              2,757
        Due from affiliates                                                 2,808             (1,161)            (1,529)
        Prepaid expenses and other current assets                             163                261              3,590
        Accounts payable and accrued liabilities                           (2,159)            (1,052)            (6,172)
        Due to affiliates                                                    (373)
           Net cash provided by operating activities                       26,423             18,449             21,575
                                                                          -------            -------            -------

INVESTING ACTIVITIES:
   Additions to property, plant and equipment                              (3,148)            (2,727)            (3,657)
   Exploration and development costs incurred                              (9,467)            (8,404)            (9,978)
   Proceeds from sales of property, plant and equipment                     5,294                394              2,599
   Investment in affiliates                                                  (449)
   Refinance of Spraberry investment                                       (4,715)
   Other investing activities                                                                                       (25)
                                                                     ------------       ------------         ----------
           Net cash used in investing activities                          (12,485)           (10,737)           (11,061)
                                                                          -------            -------            -------

FINANCING ACTIVITIES:
   Payments of long-term debt                                             (11,373)            (7,379)           (12,375)
   Proceeds from long-term debt                                             9,000             15,000              4,300
   Distributions paid                                                      (8,176)           (10,020)            (9,547)
   Distributions paid by consolidated affiliates to
     minority interest                                                     (2,429)            (1,346)            (2,245)
   Payment of contract settlement                                            (305)            (1,336)            (1,343)
   Other financing activities                                                 (92)               (63)               (34)
                                                                       ----------         ----------         ----------
           Net cash used in financing activities                          (13,375)            (5,144)           (21,244)
                                                                          -------           --------            -------

NET INCREASE (DECREASE) IN CASH AND CASH
   EQUIVALENTS                                                                563              2,568            (10,730)

CASH AND CASH EQUIVALENTS:

   BEGINNING OF YEAR                                                        4,977              2,409             13,139
                                                                         --------           --------            -------

   END OF YEAR                                                          $   5,540          $   4,977          $   2,409
                                                                         ========           ========           ========
<FN>

               The accompanying notes are an integral part of the
                             financial statements.
</FN>
</TABLE>

                                                       -28-

<PAGE>



                         HALLWOOD ENERGY PARTNERS, L.P.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Hallwood Energy Partners, L.P. ("HEP" or the "Partnership") is a publicly traded
Delaware limited partnership engaged in the production,  sale and transportation
of oil and gas and in the acquisition, exploration, development and operation of
oil and gas properties.  The  Partnership's  properties are primarily located in
the Rocky  Mountain,  Mid-Continent,  Texas and Gulf Coast regions of the United
States.  The  principal  objectives of HEP are to maintain or expand its reserve
base and to provide  cash  distributions  to  holders of its units  representing
limited partner  interests  ("Units").  HEPGP Ltd. became the general partner of
HEP on  November  26, 1996 after its former  general  partner,  Hallwood  Energy
Corporation  ("HEC")  merged into The  Hallwood  Group  Incorporated  ("Hallwood
Group").  HEPGP Ltd. is a limited  partnership  of which  Hallwood  Group is the
limited  partner and  Hallwood  G.P.,  Inc.  ("Hallwood  G.P."),  a wholly owned
subsidiary of Hallwood Group, is the general partner.  HEP commenced  operations
in August 1985 after  completing an exchange offer in which HEP acquired oil and
gas properties and operations  from HEC, 24 oil and gas limited  partnerships of
which HEC was the general partner,  and certain working interest owners that had
participated in wells with HEC and the limited partnerships.

The activities of HEP are conducted  through HEP Operating  Partners,  L.P.
("HEPO") and EDP Operating,  Ltd. ("EDPO").  HEP is the sole limited partner and
HEPGP Ltd. is the sole general partner of HEPO and EDPO.  Solely for purposes of
simplicity  herein,  unless  otherwise  indicated,  all  references  to  HEP  in
connection with the ownership, exploration, development or production of oil and
gas properties include HEPO and EDPO.

Accounting Policies

Consolidation

HEP fully consolidates  majority owned entities and reflects a minority interest
in the consolidated  financial statements.  HEP accounts for its interest in 50%
or less  owned  affiliated  oil  and  gas  partnerships  and  limited  liability
companies  using the  proportionate  consolidation  method of accounting.  HEP's
investment in approximately  46% of the common stock of its affiliate,  Hallwood
Consolidated  Resources  Corporation ("HCRC"), is accounted for under the equity
method.

The  accompanying  financial  statements  include  the  activities  of HEP,  its
subsidiaries,  Hallwood  Petroleum,  Inc. ("HPI") and Hallwood Oil and Gas, Inc.
("Hallwood  Oil") and majority owned  affiliates,  the May Limited  Partnerships
1983-1, 1983-2, 1983-3, 1984-1, 1984-2, 1984-3 ("Mays").

Derivatives

HEP has entered into numerous financial  contracts to hedge the price of its oil
and  natural  gas.  The purpose of the hedges is to provide  protection  against
price drops and to provide a measure of stability in the volatile environment of
oil and natural gas spot pricing.  The amounts  received or paid upon settlement
of these  contracts are  recognized as oil or gas revenue at the time the hedged
volumes are sold.

Gas Balancing

HEP uses the sales method for  recording its gas  balancing.  Under this method,
HEP   recognizes   revenue  on  all  of  its  sales  of   production,   and  any
over-production or under-production is recovered at a future date.



                                                       -29-

<PAGE>



As of December 31,  1996,  HEP had a net  over-produced  position of 166,000 mcf
($372,000 valued at average gas prices).  The general partner believes that this
imbalance can be made up from or repaid by production on existing  wells or from
wells which will be drilled as offsets to existing wells and that this imbalance
will not have a material  effect on HEP's results of  operations,  liquidity and
capital resources.  HEP's oil and gas reserves as of December 31, 1996 have been
decreased by 166,000 mcf in order to reflect HEP's gas balancing position.

Allocations

Partnership  costs and revenues are  allocated  to  Unitholders  and the general
partner pursuant to the partnership agreement as set forth below.


                                            Unitholders          General Partner

Property Costs and Revenues
   Initial acquisition costs -
     Acreage other than exploratory             100%                    0%
     Exploratory acreage                         98%                    2%
   Producing wells -
     Costs and revenues                          98%                    2%
   Development wells (1) -
     Costs through completion                   100%                    0%
     All other costs and revenues                95%                    5%
   Exploratory wells (1) -
     Costs through completion                    90%                   10%
     All other costs and revenues                75%                   25%
   All other costs and revenues                  98%                    2%

   (1)  These  percentages  are for wells  drilled  under  the EDPO  partnership
        agreement.  The  majority of wells  drilled  under the HEPO  partnership
        agreement  share  costs  through  completion  in a ratio  of 7.5% to the
        general  partner and 92.5% to the  Unitholders and share all other costs
        and  revenues in a ratio of 18.75% to the general  partner and 81.25% to
        the Unitholders.

Property, Plant and Equipment

HEP follows the full cost method of accounting  whereby all costs related to the
acquisition of oil and gas  properties  are  capitalized in a single cost center
("full cost pool") and are amortized over the productive  life of the underlying
proved  reserves  using the units of production  method.  Proceeds from property
sales are generally credited to the full cost pool.

Capitalized  costs of oil and gas  properties  may not exceed an amount equal to
the present  value,  discounted  at 10%, of estimated  future net revenues  from
proved oil and gas reserves  plus the cost, or estimated  fair market value,  if
lower, of unproved properties.  Should capitalized costs exceed this ceiling, an
impairment is recognized.  The present value of estimated future net revenues is
computed  by  applying  current  prices  of  oil  and  gas to  estimated  future
production of proved oil and gas reserves as of year end, less estimated  future
expenditures  to be incurred in developing  and  producing  the proved  reserves
assuming continuation of existing economic conditions.

HEP does not  accrue  costs  for  future  site  restoration,  dismantlement  and
abandonment  costs  related  to  proved  oil  and  gas  properties  because  the
Partnership estimates that such costs will be offset by the salvage value of the
equipment sold upon abandonment of such properties.  The Partnership's estimates
are based upon its historical  experience and upon review of current  properties
and restoration obligations.



                                                       -30-

<PAGE>



Unproved  properties are withheld from the amortization  base until such time as
they  are  either   developed  or  abandoned.   The   properties  are  evaluated
periodically for impairment.

During 1996, HEP adopted  Statement of Financial  Accounting  Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" ("SFAS 121"). SFAS 121 provides the standards for accounting for
the  impairment  of  various  long-lived  assets.  Substantially  all  of  HEP's
long-lived  assets  consist of oil and gas  properties  which are  evaluated for
impairment as described above. Therefore,  the adoption of SFAS 121 did not have
a material effect on the financial position or results of operations of HEP.

Deferred Liability

The deferred  liability as of December 31, 1996 and 1995  consists  primarily of
HEP's share of the unrecouped portion of a 1989 take-or-pay settlement, which is
recoupable in gas volumes.

Distributions

HEP paid a $.13 per  Class A Unit and a $.25 per  Class C Unit  distribution  on
February 14, 1997 to Unitholders of record on December 31, 1996. This amount and
the general  partner  distribution  were accrued as of year end. At December 31,
1996 and 1995, distributions payable of $1,996,000 and $2,477,000,  respectively
were  included  in  accounts  payable  and  accrued  liabilities.  HEP  declared
distributions  of $.52 per  Class A Unit and $1.00 per Class C Unit for 1996 and
$.80 per Class A and Class B Unit for 1995.

Income Taxes

No provision for federal income taxes is included in HEP's financial  statements
because,  as a partnership,  it is not subject to federal income tax and the tax
effect of its  activities  accrues to the  partners.  In certain  circumstances,
partnerships  may be  held  to be  associations  taxable  as  corporations.  The
Internal Revenue Service has issued regulations  specifying  circumstances under
current  law when such a finding may be made,  and  management  has  obtained an
opinion of counsel  based on those  regulations  that HEP is not an  association
taxable as a  corporation.  A finding  that HEP is an  association  taxable as a
corporation could have a material adverse effect on the financial position, cash
flows and results of operations of HEP.

As a result of the differences in the accounting  treatment of certain items for
income tax  purposes  as  opposed to  financial  reporting  purposes,  primarily
depreciation,  depletion  and  amortization  of oil and gas  properties  and the
recognition  of intangible  drilling  costs as an expense or capital  item,  the
income  tax basis of oil and gas  properties  differs  from the  basis  used for
financial  reporting  purposes.  At December  31, 1996 and 1995,  the income tax
bases  of  the   Partnership's   oil  and  gas  properties  were   approximately
$122,000,000 and $129,000,000, respectively.

Cash and Cash Equivalents

All highly  liquid  investments  purchased  with an  original  maturity of three
months or less are considered to be cash equivalents.

Computation of Net Income Per Unit

Net  income  per Class A and Class B Unit is  computed  by  dividing  net income
attributable to the Class A and Class B limited  partners'  interest (net income
excluding  income  attributable to the general partner and Class C Units) by the
weighted  average number of Class A Units,  Class B Units and equivalent Class A
and Class B Units outstanding. The options to acquire Class A Units described in
Note 9 are  considered  to be Unit  equivalents  since June 1, 1996  because the
market price of the Class A Units has exceeded the exercise price of the options
since that date. The number of equivalent  Units was computed using the treasury
stock method  which  assumes that the increase in the number of Units is reduced
by the number of Units which could have been repurchased by the Partnership with
the proceeds from the

                                                       -31-

<PAGE>



exercise  of the options  (which  were  assumed to have been made at the average
market price of the Class A Units during the reporting period). All Unit and per
Unit  information  has been restated to reflect the issuance of Class A Units in
connection with a lawsuit settlement further described in Note 12.

At December 31, 1996 and 1995, HEP owned approximately 46% and 40%, respectively
of the outstanding  common stock of HCRC, which owns  approximately 19% of HEP's
Class A Units;  consequently,  HEP has an interest in 899,305 and 784,095 of its
own Units as of  December  31,  1996 and  1995,  respectively.  These  Units are
treated as treasury Units in the accompanying financial statements.

Use of Estimates

The  preparation of the financial  statements for the  Partnership in conformity
with  generally  accepted  accounting  principles  requires  management  to make
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities  and disclosure of contingent  assets and liabilities at the date of
the  financial  statements  and the  reported  amounts of revenues  and expenses
during the reporting period. Actual results could differ from these estimates.

Significant Customers

Although the  Partnership  sells the majority of its oil and gas production to a
few  purchasers,  there are numerous  other  purchasers in the area in which HEP
sells its production, therefore, the loss of its significant customers would not
adversely affect HEP's  operations.  For the years ended December 31, 1996, 1995
and 1994, purchases by the following companies exceeded 10% of the total oil and
gas revenues of the Partnership:


                                     1996               1995               1994
                                     ----               ----               ----

Conoco Inc.                            28%                30%                23%
Marathon Petroleum Company             11%                14%                12%

Environmental Concerns

HEP is continually taking actions it believes are necessary in its operations to
ensure  conformity  with  applicable  federal,  state  and  local  environmental
regulations.  As of December 31,  1996,  HEP has not been fined or cited for any
environmental violations which would have a material adverse effect upon capital
expenditures,  earnings  or the  competitive  position of HEP in the oil and gas
industry.

Reclassifications

Certain  reclassifications  have been made to prior years' amounts to conform to
the classifications used in the current year.




                                                       -32-

<PAGE>



NOTE 2 - OIL AND GAS PROPERTIES

The following table summarizes certain cost information related to HEP's oil and
gas activities:
<TABLE>
<CAPTION>


                                                 For the Years Ended December 31,
                                                  1996               1995               1994
                                                          (In thousands)

Property acquisition costs:
<S>                                             <C>                <C>                <C>    
   Proved                                       $ 2,321            $ 2,727            $ 3,724
   Unproved                                         560                793                183
Development costs                                 9,587             11,880              4,995
Exploration costs                                   831              2,368              4,983
                                               --------             ------             ------
     Total                                      $13,299            $17,768            $13,885
                                                 ======             ======             ======
</TABLE>

Depreciation,  depletion,  amortization and impairment expense related to proved
oil and gas properties,  per equivalent barrel of production for the years ended
December 31, 1996, 1995 and 1994, was $4.35, $7.21 and $.70, respectively.

At December 31, unproved properties consist of the following:


                                                1996               1995
                                                ----               ----
                                                     (In thousands)

Texas                                         $1,062               $227
South Louisiana                                   11                 86
Utah                                                                137
Other                                            171                234
                                              ------                ---
                                              $1,244               $684
                                               =====                ===


NOTE 3 - PRINCIPAL ACQUISITIONS AND SALES

1996

On July 1, 1996, HEP and HCRC completed a transaction  involving the acquisition
from Fuel Resources Development Co., a wholly owned subsidiary of Public Service
Company of Colorado, and other interest owners of their interests in 38 coal bed
methane wells located in LaPlata  County,  Colorado and Rio Arriba  County,  New
Mexico.  Thirty-four  of the wells,  estimated to have  reserves of 53 bcf, were
assigned to 44 Canyon LLC ("44  Canyon"),  a special  purpose  entity owned by a
large east coast financial institution.  The wells qualify for tax credits under
Section 29 of the Internal Revenue Code. HPI manages and operates the properties
on behalf of 44 Canyon. The $28.4 million purchase price was funded by 44 Canyon
through the sale of a  volumetric  production  payment to an  affiliate of Enron
Capital & Trade  Resources  Corp.,  a subsidiary  of Enron Corp.,  the sale of a
subordinated  production  payment and certain other property interests for $3.45
million to an affiliate of HEP and HCRC, and additional cash  contributed by the
owners  of 44  Canyon.  The  affiliate  of HEP  and  HCRC  which  purchased  the
subordinated production payment and other property interests is owned equally by
HEP and HCRC. The interests in the four wells in Rio Arriba County were acquired
directly by HEP and HCRC.

1995

During 1995, HEP had no individually significant property acquisitions or sales.


                                                       -33-

<PAGE>



1994

During the second  quarter of 1994,  HEP and HCRC  formed a limited  partnership
with a third party for the purpose of producing  natural gas  qualified  for the
Section 29 tax credit  under the  Internal  Revenue  Code.  A limited  liability
company  owned by HEP and HCRC is the  general  partner of the  partnership.  In
1994,  HEP and HCRC sold a term  working  interest in certain  wells in San Juan
County,  New Mexico to the limited  partnership.  In November 1996, HEP and HCRC
sold  to  the  limited  partnership  their  80%  reversionary  interest  in  the
properties owned by the limited partnership.  As consideration for the sale, HEP
and HCRC received a production  payment, an increase in incentive payments and a
90% springing reversionary interest in the properties.

In  the  1994  transaction,  HEP  and  HCRC  received  a cash  payment  totaling
$3,400,000.  HEP recorded its $1,870,000 share of the cash payment received as a
credit to oil and gas properties in the accompanying financial statements.  As a
result of the 1994 and 1996  transactions,  HEP and HCRC receive 97% of the cash
flow from  production  from the wells sold until 22.3 bcf are produced  from the
wells  (from  November  1,  1996)  and 80% of the  cash  flow  until  31 bcf are
produced.  HEP and HCRC also receive quarterly cash incentive  payments equal to
34% of the Section 29 tax credit  generated from the  production  from the wells
until 10.3 bcf are  produced  from the wells (from  November  1, 1996),  and 55%
thereafter. HEP and HCRC share in all proceeds 55% and 45%, respectively.


NOTE 4 - DERIVATIVES

HEP has entered into numerous financial  contracts to hedge the price of its oil
and natural gas. HEP does not use these hedges for trading purposes,  but rather
for the purpose of providing a protection  against  price drops and to provide a
measure of  stability in the  volatile  environment  of oil and natural gas spot
pricing.  The amounts  received or paid upon  settlement  of these  contracts is
recognized as oil or gas revenue at the time the hedged volumes are sold.

The  financial  contracts  used by HEP to hedge the price of its oil and natural
gas  production  are swaps,  collars and  participating  hedges.  Under the swap
contracts,  HEP sells  its oil and gas  production  at spot  market  prices  and
receives or makes payments based on the differential  between the contract price
and a floating price which is based on spot market indices.

The following table provides a summary of HEP's financial contracts:


                                   Oil
                      Quantity of Production
      Period                  Hedged              Contract Floor Price
                              (bbl)                     (per bbl)

       1994                   361,000                    $17.93
       1995                   380,000                     17.41
       1996                   300,000                     18.33
       1997                   346,000                     17.78
       1998                   103,000                     15.38
       1999                   16,000                      15.88

From 1997 forward,  between 16% and 100% of the oil volumes  hedged in each year
are subject to a participating hedge whereby HEP will receive the contract price
if the posted futures price is lower than the contract  price,  and will receive
the  contract  price plus  between  25% and 75% of the  difference  between  the
contract  price and the  posted  futures  price if the posted  futures  price is
greater than the contract price. From 1997 forward,  between 32% and 100% of the
volumes hedged in each year are subject to a collar  agreement  whereby HEP will
receive the contract  price if the spot price is lower than the contract  price,
the cap price if the spot price is higher than the cap price, and the spot price
if that price is between the  contract  price and the cap price.  The cap prices
range from $17.50 to $19.35.

                                                       -34-

<PAGE>




                                   Gas
                      Quantity of Production
      Period                  Hedged              Contract Floor Price
                              (mcf)                     (per mcf)

       1994                 6,461,000                    $1.88
       1995                 6,439,000                     1.94
       1996                 5,479,000                     1.94
       1997                 5,386,000                     1.97
       1998                 4,235,000                     2.02
       1999                 1,860,000                     1.86
       2000                 1,244,000                     2.01

From 1997 forward, between 0% and 43% of the gas volumes hedged in each year are
subject to a collar agreement whereby HEP will receive the contract price if the
spot price is lower than the contract price,  the cap price if the spot price is
higher  than the cap price,  and the spot  price if that  price is  between  the
contract price and the cap price. The cap prices range from $2.78 to $2.93.

In the event of nonperformance by the counterparties to the financial contracts,
HEP is exposed to credit loss, but has no  off-balance  sheet risk of accounting
loss.  The  Partnership  anticipates  that  the  counterparties  will be able to
satisfy their obligations under the contracts because the counterparties consist
of  well-established  banking  and  financial  institutions  which  have been in
operation  for many  years.  Certain of HEP's  hedges are secured by the lien on
HEP's  oil and  gas  properties  which  also  secures  HEP's  Credit  Facilities
described in Note 6.


NOTE 5 - INVESTMENT IN AFFILIATED CORPORATION

HEP accounts for its approximate 46% interest in HCRC using the equity method of
accounting.  The following presents summarized financial information for HCRC at
December 31, 1996, 1995 and 1994:


                                   1996               1995               1994
                                  ------             ------             -----
                                                 (In thousands)

Current assets                   $10,802            $ 8,312            $ 7,076
Noncurrent assets                 67,616             65,627             55,049
Current liabilities               10,849             15,514              6,646
Noncurrent liabilities            24,558             21,790             11,890
Revenue                           34,445             25,484             20,644
Net income (loss)                  8,160             (4,670)            (2,974)

No other individual entity in which HEP owns an interest  comprises in excess of
10% of the revenues, net income or assets of HEP.

HCRC repurchased  approximately  99,000 and 26,000 shares of its common stock in
odd lot repurchase offers which were completed January 26, 1996 and May 3, 1996,
respectively.  HCRC  resold  12,965 of these  shares to HEP at the price paid by
HCRC for such shares. As a result of these transactions, HEP's ownership in HCRC
increased from 40% to 46% at the end of May 1996.

The following  amounts  represent HEP's share of the property  related costs and
reserve quantities and values of its equity investee HCRC (in thousands):


                                                       -35-

<PAGE>



Capitalized Costs Relating to Oil and Gas Activities:
<TABLE>
<CAPTION>


                                                                       As of December 31,
                                                               1996                   1995                    1994
                                                              ------                 ------                  -----

<S>                                                       <C>                     <C>                      <C>     
Unproved properties                                       $      573              $     230                $  1,052
Proved properties                                            113,085                 94,925                  89,284
Accumulated depreciation, depletion,
   amortization and property impairment                     (89,175)               (74,168)                (68,587)
                                                            -------                -------                 -------
Net property                                                $ 24,482               $ 20,987                $ 21,749
                                                             =======                =======                 =======

Costs Incurred in Oil and Gas Activities:


                                                                For the Years Ended December 31,
                                                                --------------------------------
                                                               1996                   1995                    1994
                                                              ------                 ------                  -----

Acquisition costs                                             $1,008               $  4,168                  $1,531
Development costs                                              3,670                  2,124                   1,531
Exploration costs                                                382                    845                     825
                                                             -------                -------                   -----
   Total                                                      $5,060               $  7,137                  $3,887
                                                               =====                =======                   =====

Results of Operations for Oil and Gas Activities:


                                                                 For the Years Ended December 31,
                                                                 --------------------------------
                                                               1996                   1995                    1994
                                                              ------                 ------                  -----

Oil and gas revenue                                          $11,690               $  7,825                 $ 6,522
Production operating expense                                 (3,790)                (2,894)                 (3,008)
Depreciation, depletion, amortization
   and property impairment expense                           (3,257)                (2,792)                 (3,695)
Income tax benefit (expense)                                      23                  (813)                      73
                                                            --------                ------                   ------
   Net income (loss) from oil and gas
     activities                                              $ 4,666                $ 1,326                $  (108)
                                                              ======                 ======                 ======
</TABLE>

Proved Oil and Gas Reserve Quantities:


                                                    Gas                   Oil
                                                    Mcf                   Bbl
                                                           (unaudited)

Balance, December 31, 1996                        22,786                 2,680
                                                  ======                 =====
Balance, December 31, 1995                        15,782                 2,482
                                                  ======                 =====
Balance, December 31, 1994                        14,548                 1,771
                                                  ======                 =====


                                                       -36-

<PAGE>



Standardized Measure of Discounted Future Net Cash Flows:


                                   (unaudited)

December 31, 1996                    $47,701
                                      ======
December 31, 1995                    $25,532
                                      ======
December 31, 1994                    $16,466
                                      ======


NOTE 6 - DEBT

HEP's long-term debt at December 31, 1996 and 1995 consisted of the following:


                                                  1996               1995
                                                 ------             -----
                                                       (In thousands)

Note Purchase Agreement                         $ 8,571            $12,857

Credit Agreement                                 26,700             24,700

Other                                                                   87

Total                                            35,271             37,644
Less current maturities                         (5,810)               (87)
                                                ------          ---------
Long-term debt                                  $29,461            $37,557
                                                 ======             ======

During the first quarter of 1995, HEP and its lenders  amended HEP's Amended and
Restated Credit  Agreement  ("Credit  Agreement") to extend the term date of its
line of credit to May 31, 1997.  Under the Credit  Agreement  and an Amended and
Restated Note  Purchase  Agreement  ("Note  Purchase  Agreement")  (collectively
referred  to  as  the  "Credit  Facilities"),   HEP  has  a  borrowing  base  of
$48,000,000.  HEP has amounts  outstanding  at December 31, 1996 of  $26,700,000
under the Credit  Agreement and  $8,571,000  under the Note Purchase  Agreement.
HEP's  borrowing base is further reduced by an outstanding  contract  settlement
obligation of $2,512,000  (See Note 7);  therefore,  its unused  borrowing  base
totaled $10,217,000 at February 28, 1997.

Borrowings under the Note Purchase  Agreement bear interest at an annual rate of
11.85%,  which is payable  quarterly.  Annual  principal  payments of $4,286,000
began April 30,  1992,  and the debt is required to be paid in full on April 30,
1998.  HEP  intends to fund the  payment  due in April 1997  through  additional
borrowings under the Credit  Agreement;  thus, no portion of HEP's Note Purchase
Agreement is classified as current as of December 31, 1996.

Borrowings  against  the  Credit  Agreement  bear  interest  at the lower of the
Certificate of Deposit rate plus 1.875%, prime plus 1/2% or the Euro-Dollar rate
plus 1.75%. At December 31, 1996 the applicable interest rate was 7.4%. Interest
is payable  monthly,  and 16  quarterly  principal  payments of  $1,937,000,  as
adjusted for the  anticipated  borrowings  to fund the Note  Purchase  Agreement
payment due in 1997,  commence May 31, 1997.  HEP intends to extend the maturity
date of its  Credit  Agreement  prior to the  commencement  of the  amortization
period.

The borrowing base for the Credit  Facilities is  redetermined  semiannually  in
March and September of each year.  The Credit  Facilities are secured by a first
lien  on   approximately   80%  in  value  of  HEP's  oil  and  gas  properties.
Additionally,  aggregate  distributions  paid by HEP in any 12 month  period are
limited to 50% of cash flow from operations  before working capital changes plus
distributions received from affiliates.



                                                       -37-

<PAGE>



HEP entered into contracts to hedge its interest rate payments on $10,000,000 of
its  debt  through  the end of 1996,  $15,000,000  for each of 1997 and 1998 and
$10,000,000  for each of 1999 and 2000.  HEP does not use the hedges for trading
purposes,  but rather for the purpose of  providing a measure of  predictability
for a portion of HEP's interest  payments  under its debt agreement  which has a
floating  interest  rate.  In  general,  it is HEP's  goal to  hedge  50% of the
principal amount of its debt for the next two years and 25% for each year of the
remaining term of the debt. HEP has entered into four hedges, of which one is an
interest  rate  collar  pursuant  to which it pays a floor  rate of 7.55%  and a
ceiling rate of 9.85%,  and the others are interest  rate swaps with fixed rates
ranging from 5.75% to 6.57%.  The amounts  received or paid upon  settlement  of
these  transactions  are recognized as interest expense at the time the interest
payments are due.

At December 31, 1996, HEP's debt maturity schedule is as follows:


                      (In thousands)

1997                            $ 5,810
1998                             12,032
1999                              7,746
2000                              7,746
2001                              1,937
                                 ------
Total                           $35,271
                                 ======


NOTE 7 - CONTRACT SETTLEMENT OBLIGATION

In the first quarter of 1989,  HEP settled a take-or-pay  contract  claim on its
Bethany-Longstreet  field.  In  accordance  with the  settlement,  HEP  received
$7,623,000 in cash. This amount was recoupable in cash or gas volumes from April
1992  through  March  1996,  with a cash  balloon  payment  due during the first
quarter of 1998. A liability  has been  recorded  equal to the present  value of
this amount discounted at 10.68%,  HEP's estimated borrowing cost at the time of
settlement.  HEP also repaid $1,629,000 which represented  suspended payments to
the pipeline for previous years in equal monthly  installments  of $33,937 which
began April 1992 and continued  through March 1996.  This amount was  previously
recorded  as an  offset  to the full  cost  pool at the time  the  contract  was
initially  abrogated by the pipeline.  As payment of this obligation was made it
was charged to the full cost pool.

At December 31, 1996, the long-term  contract  settlement  balance consists of a
payment of $2,767,000 due in March 1998, net of unaccreted discount of $255,000.


NOTE 8 - PARTNERS' CAPITAL

HEP Units that trade on the American  Stock  Exchange under the symbol "HEP" are
referred to as "Class A Units," and Units that trade under the symbol "HEPC" are
referred to as "Class C Units."

Class B Subordinated Units

The Class B Units have equal  liquidation  rights and identical  tax  allocation
rights and provisions to the Class A Units.  However, the Class B Units have the
following subordinated distribution provisions:

1.  Distribution  rights  equal to Class A Units  while  the  Class A Units
    receive distributions of $.20 or more per Class A Unit per calendar quarter.

2.  No current distribution right should Class A Units receive distributions 
    less than $.20 per Class A Unit for any calendar quarter.


                                                       -38-

<PAGE>



3.   An accumulated  distribution  deficit account is maintained for the benefit
     of the Class B Units for any  distributions  suspended  under 2 above.  The
     amount in the deficit account is payable in whole or in part to the Class B
     Unitholders in any quarter in which  distributions equal to or greater than
     $.20 per Class A Unit are made on Class A Units.

The  Class B Units  may be  converted  into  Class A Units on a 1:1 ratio at the
option of the holder or holders thereof.  Upon conversion,  any amount remaining
unpaid in the accumulated distribution deficit account relating to Class B Units
converted is waived.

The Class B Units vote as a separate class on all matters  required or otherwise
brought for a vote of the Unitholders of HEP.

Class C Units

The Class C Units were issued on January 19, 1996 to Class A Unitholders  in the
ratio of one Class C Unit for every 15 Class A Units outstanding.  In connection
with the issuance of the Class C Units,  HEP transferred  $5,146,000 of partners
capital from the Class A  Unitholders  to the Class C  Unitholders  based on the
initial trading price of the Class C Units.

The Class C Units  have a  distribution  preference  of $1.00 per year,  payable
quarterly,  commencing in the first quarter of 1996. HEP may not declare or make
any cash  distributions  on the Class A or Class B Units  unless all accrued and
unpaid distributions on the Class C Units have been paid.

Class  C  Units  vote  as a  separate  class  on all  matters  submitted  to the
unitholders of HEP for a vote.

Rights Plan

On February 6, 1995 the board of directors of the general  partner  approved the
adoption of a rights  plan  designed  to protect  Unitholders  in the event of a
takeover  action  that  would  otherwise  deny  them  the  full  value  of their
investment.

Under the terms of the rights plan, one right was  distributed  for each Class A
Unit of HEP to holders of record at the close of business on February  17, 1995.
The rights trade with the Class A Units. The rights will become exercisable only
in the event, with certain  exceptions,  that an acquiring party accumulates 15%
or more of HEP's Class A Units,  or if a party announces an offer to acquire 30%
or more of HEP. The rights will expire on February 6, 2005.  In  addition,  upon
the  occurrence  of certain  events,  holders of the rights  will be entitled to
purchase,  for $24, either HEP Class A Units or shares in an "acquiring entity,"
with a market value at that time of $48.

HEP will generally be entitled to redeem the rights at one cent per right at any
time until the tenth day  following  the  acquisition  of a 15%  position in its
Units.


NOTE 9 - EMPLOYEE INCENTIVE PLANS

Every year beginning in 1992, the Board of Directors of the general  partner has
adopted an  incentive  plan.  Each year the Board of  Directors  determines  the
percentage  of HEP's  interest  in the cash flow  from  certain  wells  drilled,
recompleted or enhanced during the year allocated to the incentive plan for that
year. The specified  percentage  was 2.4% for 1996,  1.4% for domestic wells for
1995 and 1% for  domestic  wells  for 1994.  In 1994 and  1995,  HEP also had an
international  incentive plan and the percentage  interest in cash flow for that
plan was 3%.  Beginning  in 1996,  the  domestic  and  international  plans were
combined.  The specified percentage of cash flow is then allocated among certain
key employees who are  participants  in the Plan for that year. Each award under
the plan (with regard to domestic  properties)  represents  the right to receive
for  five  years a  portion  of the  specified  share  of the  cash  award,  the
participants are each paid a share of an amount equal to a specified  percentage
(80% for 1995 and 1996 and 40% for

                                                       -39-

<PAGE>



1994) of the remaining net present value of the qualifying  wells, and the award
for that year terminates.  The expenses  attributable to the plans were $148,000
in 1996,  $119,000 in 1995 and  $88,000 in 1994 and are  included in general and
administrative expense in the accompanying financial statements.

On January 31, 1995, the board of directors of the general partner  approved the
adoption of the Unit Option Plan ("Option  Plan") to be used for the  motivation
and retention of directors,  employees and consultants  performing  services for
HEP. The plan  authorizes  the issuance of options to purchase  425,000  Class A
Units.  Grants of the total  options  authorized  were made on January 31, 1995,
vesting one-third at that time, an additional  one-third on January 31, 1996 and
the remaining  one-third on January 31, 1997.  The exercise price of the options
is $5.75, which was the closing price of the Class A Units on January 30, 1995.

A summary of options granted under the Option Plan as of December 31, 1996 and 
1995 and the changes therein  during the years then ended on those dates is 
presented below:

<TABLE>
<CAPTION>

                                                             1996                                     1995
                                                             ------                                    ----
                                                                       Exercise                                 Exercise
                                                    Units                Price               Units                Price

<S>                                                <C>                    <C>               <C>                    <C>
Outstanding at beginning of year                   425,000                $5.75
Granted                                                                                      425,000               $5.75
                                             -------------              -------              -------                ----
Outstanding at end of year                         425,000                $5.75              425,000               $5.75
                                                   =======                 ====              =======                ====

Options exercisable at year end                    283,330                                   141,665
                                                   =======                                   =======
</TABLE>

The  Partnership  has adopted the  disclosure-only  provisions  of  Statement of
Financial   Accounting   Standards   No.  123,   "Accounting   for   Stock-Based
Compensation"  ("SFAS  123").   Accordingly,   no  compensation  cost  has  been
recognized  for the Option Plan.  Had  compensation  expense for the Option Plan
been  determined  based on the  fair  value at the  grant  date for the  options
awarded in 1995  consistent  with the  provisions of SFAS 123,  HEP's net income
(loss) and net income  (loss) per Unit would have been  reduced to the pro forma
amounts indicated below:


                                                     1996               1995
                                                    ------             -----

Net income (loss):           as reported         $15,726,000       $(9,031,000)
                             pro forma            15,544,000        (9,432,000)
Net income (loss)
  per Class A and B Unit: as reported                  $1.34            $(1.07)
                             pro forma                  1.32             (1.11)

The fair value of the Unit options for disclosure  purposes was estimated on the
date of the grant using the Binomial  Option  Pricing  Model with the  following
assumptions:


Expected dividend yield                                      6%
Expected price volatility                                   28%
Risk-free interest rate                                      7.6%
Expected life of options                                   10 years



                                                       -40-

<PAGE>



NOTE 10 - RELATED PARTY TRANSACTIONS

HPI manages and operates certain oil and gas properties on behalf of independent
joint interest owners,  HEP and its affiliates.  In such capacity,  HPI pays all
costs and expenses of operations and  distributes  all revenues  associated with
such  properties.  HPI has payables to affiliates of HEP of $159,000 at December
31, 1996 and  receivables  from  affiliates of HEP of $2,808,000 at December 31,
1995,  which  represent net revenues net of operating  costs and  expenses.  The
intercompany balances are settled monthly.

HPI is  reimbursed  by HEP for costs and expenses  which  includes  office rent,
salaries and associated overhead for personnel of HPI engaged in the acquisition
and  evaluation  of oil and gas  properties  (technical  expenditures  which are
capitalized as costs of oil and gas  properties) and lease operating and general
and   administrative   expenses   necessary  to  conduct  the  business  of  HEP
(nontechnical  expenditures  which are expensed as general and administrative or
production operating expenses).  Reimbursements  during 1996, 1995 and 1994 were
as follows:


                        1996                   1995                    1994
                       ------                 ------                  -----
                                           (In thousands)

Technical              $1,249                 $1,100                   $ 747
Nontechnical            1,110                  1,321                   1,502

Included in the  nontechnical  allocation  attributable to HEP's direct interest
for  1996,  1995 and 1994 is  approximately  $152,000,  $156,000  and  $159,000,
respectively,  of  consulting  fees under a consulting  agreement  with Hallwood
Group.
 Also included in the nontechnical allocation is $309,000, $369,000 and $363,000
in 1996, 1995 and 1994,  respectively,  representing  costs incurred by Hallwood
Group and its affiliates on behalf of the Partnership.

During the third quarter of 1994,  HPI entered into a consulting  agreement with
its Chairman of the Board to provide advisory services  regarding the activities
of its  affiliates.  The amount of consulting  fees allocated to the Partnership
under this agreement is $125,000 in both 1996 and 1995 and $62,500 in 1994.


NOTE 11 - STATEMENT OF CASH FLOWS

Cash paid during 1996, 1995 and 1994 for interest totaled $3,492,000, $3,356,000
and $3,185,000, respectively.


NOTE 12 - LITIGATION SETTLEMENTS

In September  1995, the court order approving the settlement in the class action
lawsuit styled In re.  Hallwood  Energy  Partners,  L.P.  Securities  Litigation
became  final.  As part of the  settlement,  on  September  28,  1995,  HEP paid
$2,870,000  in cash (which was  recorded as an expense in the  December 31, 1994
financial  statements as the estimated cost  associated with the litigation) and
issued 1,158,696 Class A Units with a market value of $5,330,000 to a nominee of
the class.  HCRC  subsequently  exercised an option to purchase these Units from
the nominee for $5,330,000 in cash. Other  defendants  contributed an additional
$900,000 in cash to the  settlement.  The net  proceeds of the  settlement  were
distributed to a class consisting of former owners of limited partner  interests
in Energy Development  Partners,  Ltd. ("EDP") who exchanged their units in that
entity  for Units of HEP  pursuant  to the  merger of EDP and HEP on May 9, 1990
(the "Transaction").


                                                       -41-

<PAGE>



Upon  issuance,  these  Class A Units  were  treated,  for  financial  statement
purposes, as additional Class A Units issued in connection with the Transaction,
which was accounted for as a reorganization of entities under common control, in
a  manner  similar  to a  pooling  of  interest,  and  have  been  reflected  as
outstanding  Class A Units since May 9, 1990, the date of the Transaction.  As a
result of the  settlement,  the number of Units  outstanding  and the net income
(loss) per Class A Unit and Class B Unit have been  retroactively  restated  for
all periods subsequent to the Transaction date.


NOTE 13 - LEGAL PROCEEDINGS

In June 1996, HEP and the other parties to the lawsuits styled Lamson  Petroleum
Corporation  v.  Hallwood  Petroleum,  Inc.  et al.  settled the  lawsuits.  The
plaintiffs in the lawsuits  claimed they had valid leases  covering  streets and
roads in the units of the A. L. Boudreaux #1 well, G. S. Boudreaux #1 well, Paul
Castille  #1  well,  Evangeline  Shrine  Club #1 well and  Duhon #1 well,  which
represented approximately .4% to 2.3% of HEP's interest in these properties, and
they were  entitled to a portion of the  production  from the wells  dating from
February 1990. In the settlement,  HEP and the plaintiffs agreed to cross-convey
interests in certain leases to one another, and HEP agreed to pay the plaintiffs
$728,000.  HEP has not recognized  revenue  attributable to the contested leases
since January 1993. These revenues plus accrued interest, totaling $506,000, had
been placed in escrow pending the resolution of the lawsuits.  The excess of the
cash paid over the  escrowed  amounts,  is reflected  as  litigation  settlement
expense in the accompanying  financial  statements.  The cross-conveyance of the
interests in the leases  resulted in a decrease in HEP's reserves of $374,000 in
future net revenues, discounted at 10%.

The  Partnership  is involved in other legal  proceedings  and claims which have
arisen  in the  ordinary  course  of its  business  and have  not  been  finally
adjudicated. The Partnership believes that its liability, if any, as a result of
such proceedings and claims will not materially affect its financial  condition,
cash flows or operations.


NOTE 14 - COMMITMENTS

HPI leases office  facilities  under operating leases which expire in 1999. Rent
expense  under these leases is allocated  to HEP and its  affiliates.  Remaining
commitments under these leases mature as follows:


            Year Ending
            December 31,                       Annual Rentals
                                               (in thousands)

                1997                               $ 632
                1998                                 632
                1999                                 316
                                                     ---
                                                   $1,580


NOTE 15 - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

The following disclosure of the estimated fair value of financial instruments is
made in accordance  with the  requirements of SFAS No. 107,  "Disclosures  about
Fair Value of Financial Instruments." The estimated fair value amounts have been
determined  by  the  Partnership,   using  available   market   information  and
appropriate   valuation   methodologies.   However,   considerable  judgment  is
necessarily  required in  interpreting  market data to develop the  estimates of
fair value.  Accordingly,  the estimates  presented  herein are not  necessarily
indicative of the amounts that the Partnership could realize in a current market
exchange.   The  use  of  different   market   assumptions   and/or   estimation
methodologies may have a material effect on the estimated fair value amounts.


                                                       -42-

<PAGE>

<TABLE>
<CAPTION>



                                                                                December 31, 1996
                                                                       Carrying                  Estimated Fair
                                                                         Amount                       Value
                                                                                  (In thousands)

Liabilities:
<S>                                                                      <C>                         <C>        
   Interest rate hedge contracts                                         $      -0-                  $       250
   Oil and gas hedge contracts                                                  -0-                       20,000
   Current portion of long-term debt                                          5,810                        5,810
   Long-term debt                                                            29,461                       29,716
   Contract settlement                                                        2,512                        2,524
</TABLE>

The  estimated  fair value of the interest  rate hedge  contracts is computed by
multiplying  the difference  between the year end interest rate and the contract
interest rate by the amounts  under  contract.  This amount has been  discounted
using an interest rate that could be available to the Partnership.

The  estimated  fair value of the oil and gas hedge  contracts is  determined by
multiplying  the  difference  between  year end oil and gas prices and the hedge
contract  prices  by  the  quantities  under  contract.  This  amount  has  been
discounted using an interest rate that could be available to the Partnership.

The current  portion of long-term  debt is carried in the  accompanying  balance
sheets at an amount which is a reasonable estimate of its fair value.

The estimated fair value of long-term debt and contract settlement is determined
using  interest  rates that could be  available to the  Partnership  for similar
instruments with similar terms.

The fair value  estimates  presented  herein are based on pertinent  information
available to  management  as of December 31, 1996.  Although  management  is not
aware of any factors that would  significantly  affect the estimated  fair value
amounts,  such  amounts have not been  comprehensively  revalued for purposes of
these financial  statements since that date, and current estimates of fair value
may differ significantly from the amounts presented herein.



                                                       -43-

<PAGE>



                         HALLWOOD ENERGY PARTNERS, L.P.
                  SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION
                                DECEMBER 31, 1996
                                   (Unaudited)


The  following  reserve  quantity and future net cash flow  information  for HEP
represents proved reserves which are located in the United States.  The reserves
have been  estimated by HPI's in-house  engineers.  A majority of these reserves
has been reviewed by independent  petroleum engineers.  The determination of oil
and  gas  reserves  is  based  on  estimates   which  are  highly   complex  and
interpretive.  The  estimates  are subject to  continuing  change as  additional
information becomes available.

The  standardized  measure  of  discounted  future  net cash  flows  provides  a
comparison  of  HEP's  proved  oil and  gas  reserves  from  year  to  year.  No
consideration  has been given to future  income taxes for HEP as it is not a tax
paying  entity.  Under the  guidelines  set forth by the Securities and Exchange
Commission  (SEC),  the  calculation  is  performed  using year end  prices.  At
December 31, 1996, oil and gas prices  averaged  $24.18 per bbl of oil and $3.76
per  mcf  of gas  for  HEP,  including  its  indirect  interests  in  affiliated
partnerships and the Mays.  Future  production costs are based on year end costs
and include  severance  taxes. The present value of future cash inflows is based
on a 10% discount rate. The reserve  calculations  using these December 31, 1996
prices result in 7.5 million bbls of oil, and 88.5 billion cubic feet of gas and
a standardized measure of $206,000,000.  The Mays are included on a consolidated
basis, and 63,000 bbls of oil and 1.7 billion cubic feet of gas,  representing a
discounted  present  value  of  $6,800,000  are  attributable  to  the  minority
ownership  of these  entities.  This  standardized  measure  is not  necessarily
representative  of the  market  value of HEP's  properties.  The  portion of the
reserves  attributable to the general partner's interest totaled 300,000 bbls of
oil and 6 billion cubic feet of gas with a  standardized  measure of $16,000,000
at December 31, 1996.

HEP's  standardized  measure  of future  net cash  flows has been  decreased  by
$20,000,000  at December 31, 1996 for the effects of its hedge  contracts.  This
amount  represents  the  difference  between year end oil and gas prices and the
hedge  contract  prices  multiplied  by  the  quantities  subject  to  contract,
discounted at 10%.

                                                       -44-

<PAGE>

<TABLE>
<CAPTION>


                                          HALLWOOD ENERGY PARTNERS, L.P.
                                                RESERVE QUANTITIES
                                                  (In thousands)
                                                    (Unaudited)



                                                                                          Gas                     Oil
                                                                                           Mcf                    Bbls
Proved Reserves:
<S>                                                                                     <C>                      <C>  
   Balance, December 31, 1993                                                           91,607                   5,453

   Extensions and discoveries                                                            5,985                   1,052
   Revisions of previous estimates                                                       1,318                   1,113
   Sales of reserves in place                                                            (816)                    (84)
   Purchase of reserves in place                                                           699                     143
   Production                                                                         (13,208)                   (939)
                                                                                      -------                 -------

   Balance, December 31, 1994                                                           85,585                   6,738

   Extensions and discoveries                                                            5,997                   1,902
   Revisions of previous estimates                                                       4,248                     464
   Sales of reserves in place                                                             (45)                    (41)
   Purchase of reserves in place                                                           362                      28
   Production                                                                         (13,035)                   (993)
                                                                                      -------                  ------

   Balance, December 31, 1995                                                           83,112                   8,098

   Extensions and discoveries                                                            1,683                     484
   Revisions of previous estimates                                                      10,552                     385
   Sales of reserves in place                                                          (3,369)                   (481)
   Purchase of reserves in place                                                         9,350                      17
   Production                                                                         (12,786)                   (972)
                                                                                      -------                  ------

   Balance, December 31, 1996                                                           88,542                   7,531
                                                                                       =======                  ======

Proved Developed Reserves:
   Balance, December 31, 1994                                                           79,699                   6,166
                                                                                       =======                  ======
   Balance, December 31, 1995                                                           77,378                   7,444
                                                                                       =======                  ======
   Balance, December 31, 1996                                                           85,848                   7,056
                                                                                       =======                  ======
</TABLE>



                                                       -45-

<PAGE>

<TABLE>
<CAPTION>


                                          HALLWOOD ENERGY PARTNERS, L. P.
                             STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
                                                  (In thousands)
                                                    (Unaudited)



                                                                                 December 31,
                                                                        1996                   1995               1994
                                                                       ------                 ------             -----

<S>                                                                  <C>                    <C>                <C>     
Future cash flows                                                    $509,000               $317,000           $262,000
Future production and development costs                              (175,000)              (130,000)          (109,000)
                                                                     --------                -------            -------
Future net cash flows before discount                                 334,000                187,000            153,000
10% discount to present value                                        (128,000)               (63,000)           (49,000)
                                                                     --------                -------            -------
Standardized measure of discounted future net
   cash flows                                                        $206,000               $124,000           $104,000
                                                                      =======                =======            =======
</TABLE>


                                                       -46-

<PAGE>

<TABLE>
<CAPTION>


                                          HALLWOOD ENERGY PARTNERS, L. P.
                      CHANGES IN THE STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
                                                  (In thousands)
                                                    (Unaudited)



                                                                       For the Years Ended December 31,
                                                                        1996                   1995               1994

Standardized measure of discounted future net
<S>                                                                  <C>                    <C>                <C>     
   cash flows at beginning of year                                   $124,000               $104,000           $121,000
Sales of oil and gas produced, net of
   production costs                                                  (35,915)               (29,712)           (29,319)
Net changes in prices and production costs                             75,085                 17,015           (19,175)
Extensions and discoveries, net of future
   production and development costs                                     7,144                 16,836             10,537
Changes in estimated future development costs                         (7,492)               (11,868)            (5,614)
Development costs incurred                                              9,195                 11,880              4,995
Revisions of previous quantity estimates                               20,032                  6,817              6,852
Purchases of reserves in place                                         14,721                    513              1,334
Sales of reserves in place                                            (9,742)                  (281)            (1,131)
Accretion of discount                                                  12,400                 10,400             12,100
Changes in production rates and other                                 (3,428)                (1,600)              2,421
                                                                   ---------              ---------           ---------
Standardized measure of discounted future net
   cash flows at end of year                                         $206,000               $124,000           $104,000
                                                                      =======                =======            =======

</TABLE>

                                                       -47-

<PAGE>



ITEM 9 -   DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
           DISCLOSURES

None.


                                                     PART III


ITEM 10 -    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The registrant is a limited  partnership  managed by the general partner and has
no officers or directors.  The general partner is HEPGP Ltd., a Colorado limited
partnership.  The  general  partner of HEPGP Ltd.  is  Hallwood  G.P.,  Inc.,  a
Delaware corporation, which is a wholly owned subsidiary of Hallwood Group.

The principal  duties and powers of the general partner are arranging  financing
for HEP,  seeking out,  negotiating  and acquiring  for HEP suitable  leases and
other prospects,  managing  properties owned by HEP,  generally  dealing for HEP
with third  parties and attending to the general  administration  of HEP and its
relations with the limited partners.

HEPGP Ltd.  is the sole  general  partner of HEP.  HEPGP Ltd.  is a limited
partnership, and its general partner is Hallwood G. P., Inc. Hallwood Petroleum,
Inc.  ("HPI")  performs  duties related to the management of HEP,  including the
operation of various properties in which HEP owns an interest.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the  Securities  Exchange Act of 1934 requires the officers and
directors of Hallwood  G.P.,  Inc., and persons who own more than ten percent of
HEP's  Units,  to file reports of  ownership  and changes in ownership  with the
Securities  and Exchange  Commission.  Officers,  directors and greater than ten
percent  owners are required by SEC regulation to furnish HEP with copies of all
Section 16(a) forms they file.

Based  solely on its  review  of the  copies of such  forms  received  by it, or
written  representations  from  certain  reporting  persons  that no forms  were
required for those persons,  HEP believes  that,  during the year ended December
31, 1996,  all officers and  directors of Hallwood  G.P.,  Inc. and greater than
ten-percent beneficial owners complied with applicable filing requirements.


ITEM 11 -    EXECUTIVE COMPENSATION

HEP pays no salaries or other direct remuneration to officers,  directors or key
employees of the general  partner.  HEP is charged for a portion of compensation
paid  by  HPI  based  upon  HPI's   allocation   procedures  which  are  applied
consistently to all entities which it manages.

For information regarding  reimbursement made to the general partner and HPI see
Item 8 - Financial  Statements and Supplementary  Data (Note 10 to the Financial
Statements).


                                                       -48-

<PAGE>



ITEM 12 -    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following  table sets forth  information as of February 27, 1997,  about any
individual,  partnership  or  corporation  which  is  known  to  HEP  to be  the
beneficial owner of more than 5% of each class of Units issued and outstanding.
<TABLE>
<CAPTION>


                                                         Class A                Class A                 Class C        Class C
                                                           Unit                   Unit                    Unit           Unit
     Name and Address of Owner                            Amount                Percent                  Amount        Percent
     -------------------------                           --------               -------                 --------       -------
<S>                                                         <C>                   <C>                        <C>         <C>
The Hallwood Group Incorporated                             657,260 (1)           6.5       (1)              43,816      6.6
3710 Rawlins Street, Suite 1500
Dallas, Texas 75219
Hallwood Consolidated Resources Corporation               1,948,189               19.5                      129,877      19.5
4582 S. Ulster Street Parkway, Suite 1700
Denver, Colorado 80237
Heartland Advisors, Inc.                                  1,045,500 (2)           10.5      (2)
790 North Milwaukee Street
Milwaukee, WI 53202
<FN>

   (1)  Includes 143,773 Class B Units (100% of the Class B Units) which are convertible into Class A Units one-
        for-one.

   (2)  According to the  Amendment  to Schedule 13G filed  February 14, 1997 by
        Heartland  Advisors,  Inc., the Units to which the schedule  relates are
        held in investment  advisory accounts of Heartland  Advisors,  Inc. As a
        result, various persons have the right to receive or the power to direct
        the receipt of dividends  from,  or the  proceeds  from the sale of, the
        securities.  No such account is known to have such an interest  relating
        to more than 5% of the class.
</FN>
</TABLE>

As of February 27, 1997,  officers and  directors of the general  partner,  as a
group,  held 803 Class A Units and  currently  exercisable  options to  purchase
386,750 Class A Units, or 3.7% of the total Class A Units currently  outstanding
assuming  exercise of all  currently  exercisable  options  held by officers and
directors,  and 52 Class C Units,  or less than .01% of the total  Class C Units
currently outstanding.

See  Item  8 -  Financial  Statements  and  Supplementary  Data  (Note  9 to the
Financial Statements) for a description of HEP's Unit Option Plan.


ITEM 13 -    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

See  Item 8 -  Financial  Statements  and  Supplementary  Data  (Note  10 to the
Financial Statements).



                                                       -49-

<PAGE>



                                                      PART IV

ITEM 14 -    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

   (a)  Financial Statements and Financial Statement Schedules.
         (See Index at Item 8).
   (b)  Reports on Form 8-K.
        HEP filed no current  reports on Form 8-K during the last quarter of the
   period covered by this report. (c) Exhibits.

   (1)  4.1    -  Third Amended and Restated Agreement of Limited Partnership of
                    Hallwood Energy Partners, L. P.
   (5)  4.2    -  Unit Purchase Rights Agreement dated as of February 6, 1995 
                    between HEP and The First National Bank of Boston.
   (9)  4.3    -  First Amendment to the Third Amended and Restated Agreement of
                    Limited Partnership of Hallwood Energy Partners, L. P.
        4.4    -  Amendment to the Third Amended and Restated Agreement of 
                    Limited Partnership of Hallwood Energy Partners, L.P.
   (3)  10.1   -  Third Amended and Restated Agreement of Limited Partnership of
                    HEP Operating Partners, L.P.
   (7)  10.3   -  Second Amended and Restated Credit Agreement dated March 31, 
                    1995.
   (2)  10.4   -  Amended and Restated Note Purchase Agreement dated May 7,1990.
                   (Exhibit 10.2)
   (3)  10.5   -  Amended and Restated Agreement of Limited Partnership of EDP
                   Operating, Ltd.
   (6)  10.6   -  Financial Consulting Agreement between The Hallwood Group 
                   Incorporated and Hallwood Petroleum, Inc. dated June 30,1993.
   (4)  10.7   -  Financial Consulting Agreement between The Hallwood Group
                   Incorporated and Hallwood Petroleum, Inc. dated June 30,1994.
*  (4)  10.8   -  Compensation Agreement between Hallwood Petroleum, Inc. and
                   Anthony J. Gumbiner dated August 1, 1994.
*  (7)  10.9   -  Domestic Incentive Plan between the Partnership and Hallwood
                   Petroleum, Inc. dated January 14, 1993.
*  (8)  10.10  -  1995 Unit Option Plan
*  (7)  10.11  -  1995 Unit Option Plan Loan Program
        10.12  -  Amendment to the Third Amended and Restated Agreement of 
                   Limited Partnership of HEP Operating Partners, L.P.
        10.13  -  Second Amendment to the Second Amended and Restated Agreement
                   of Limited Partnership of EDP Operating, Ltd.
   (9)  21     -  Subsidiaries of Registrant
        23.1   -  Consent of Deloitte & Touche LLP
        23.2   -  Consent of Deloitte & Touche LLP
        23.3   -  Consent of Deloitte & Touche LLP


        (1)  Incorporated  by  reference  to  Prospectus/Proxy  Statement  dated
             February 14, 1990 as  supplemented  March 22, 1990,  March 30, 1990
             and April 5, 1990,  of Hallwood  Energy  Partners,  L. P., filed as
             part of Registration Statement No. 33-33452.
        (2)  Incorporated by reference to the exhibit shown in parentheses filed
             with  current  report on Form 8-K  dated  May 9,  1990 of  Hallwood
             Energy Partners, L.P.
        (3)  Incorporated by reference to the same exhibit number filed with the
             Registrant's  Annual  Report on Form  10-K for  fiscal  year  ended
             December 31, 1990.
        (4)  Incorporated by reference to the same exhibit number filed with the
             Registrant's  Quarterly  Report on Form 10-Q for the quarter  ended
             September 30, 1994.
        (5)  Incorporated by reference to Exhibit 1 filed with the  Registrant's
             Form 8-A for Limited  Partner Unit  Purchase  Rights filed with the
             SEC on February 8, 1995.
        (6)  Incorporated by reference to the same exhibit number filed with the
             Registrant's  Annual  Report on Form  10-K for  fiscal  year  ended
             December 31, 1993.


                                                       -50-

<PAGE>



        (7)  Incorporated  by reference  to the same  exhibit  number filed with
             Registrant's  Quarterly  Report on Form 10-Q for the quarter  ended
             March 31, 1995.
        (8)  Incorporated by reference to the same exhibit number filed with the
             Registrant's  Annual  Report on Form  10-K for  fiscal  year  ended
             December 31, 1994.
        (9)  Incorporated by reference to the same exhibit number filed with the
             Registrant's  Annual  Report on Form 10-K for the fiscal year ended
             December 31, 1995.

        *Designates management contracts or compensatory plans or arrangements.

                                                       -51-

<PAGE>



SIGNATURES

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

                                                HALLWOOD ENERGY PARTNERS, L.P.
                                                BY:     HEPGP LTD.
                                                        General Partner
                                                BY:     HALLWOOD G.P., INC.
                                                        General Partner


Date: March 20, 1997                            By:/s/William L. Guzzetti
     -------------------------------------------   ----------------------
                                                       William L. Guzzetti
                                                       President and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>


                 Signature                                  Capacity                               Date



<S>                                           <C>                                    <C>  
/s/Anthony J. Gumbiner                        Chairman of the Board and              March 20, 1997
----------------------------------------------                                       --------------
Anthony J. Gumbiner                           Director (Chief Executive Officer)


                                              Director                               March 20, 1997
Brian M. Troup


 /s/Hans-Peter Holinger                       Director                               March 20, 1997
Hans-Peter Holinger


/s/Rex A. Sebastian                           Director                               March 20, 1997
Rex A. Sebastian


/s/Nathan C. Collins                          Director                               March 20, 1997
Nathan C. Collins


/s/Robert S. Pfeiffer                         Principal Accounting Officer           March 20, 1997
----------------------------------------------                                       --------------
Robert S. Pfeiffer
</TABLE>



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<TABLE>
<CAPTION>


                                                 INDEX TO EXHIBITS


                                                                                                               Page
<S>                                                                                                           <C>

4.4      Amendment to the Third Amended and Restated Agreement of Limited 
          partnership of Hallwood Energy Partners, L.P.                                                         55

10.12    Amendment to the Third Amended and Restated Agreement of Limited 
          Partnership of HEP Operating Partners, L.P                                                            59

10.13    Second Amendment to the Second Amended and Restated Agreement of 
          Limited Partnership of EDP Operating, Ltd.                                                            62

23.1     Consent of Deloitte & Touche LLP                                                                       65

23.2     Consent of Deloitte & Touche LLP                                                                       67

23.3     Consent of Deloitte & Touche LLP                                                                       69
</TABLE>

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