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

                   For the Fiscal Year Ended December 31, 1999

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

                          Commission File Number 0-9579


                           HALLWOOD ENERGY CORPORATION
             (Exact name of registrant as specified in its charter)


              Delaware                                           84-1489099
(State or other jurisdiction of                               (I.R.S. Employer
incorporation or organization)                            Identification Number)

      4610 South Ulster Street
                  Suite 200
            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
        None                                                       None

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

                        Common Stock, par value $.01 per share
          Series A Cumulative Preferred Stock, par value $.01 per share

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. [ ]

The  aggregate  market value of the common shares held by  nonaffiliates  of the
registrant as of March 6, 2000 was approximately $37,353.000.

Number of Shares  outstanding as of March 6, 2000:
 Common Stock 9,999,754
 Series A Cumulative Preferred Stock 2,290,349

                       Documents Incorporated by Reference
The information called for by Part III of Form 10-K is incorporated by reference
to the definitive  proxy statement for the annual meeting of stockholders of the
Company to be filed with the Securities  and Exchange  Commission not later than
120 days after December 31, 1999.


<PAGE>


                                     PART I


ITEM 1 - BUSINESS

Hallwood Energy Corporation  ("HEC" or the "Company") is a Delaware  corporation
engaged in the development,  exploration,  acquisition and production of oil and
gas  properties.  HEC began  operations  June 8, 1999,  in  connection  with the
consolidation  ("Consolidation")  of Hallwood Energy Partners,  L.P. ("HEP") and
Hallwood Consolidated  Resources Corporation ("HCRC") and the acquisition of the
direct energy interests of The Hallwood Group Incorporated  ("Hallwood  Group").
For accounting purposes, the Consolidation has been treated as a purchase by HEP
of the common stock of HCRC and the direct energy  interests of Hallwood  Group.
Accordingly,  the  assets and  liabilities  of HEP,  including  its 46% share of
assets and  liabilities  of HCRC  owned  prior to the  Consolidation,  have been
recorded at historical  cost, and the remaining  assets and  liabilities of HCRC
and the  direct  energy  interests  of  Hallwood  Group  have been  recorded  at
estimated fair values as of the date of purchase.  All information presented for
periods  prior to June 8, 1999  represents  the  historical  information  of HEP
because HEP was considered to be the acquiring  entity for accounting  purposes.
The  financial   statements  for  periods  prior  to  June  8,  1999  have  been
retroactively  restated to reflect the corporate structure of HEC, and all share
and per  share  information  assumes  that the  shares  of HEC  issued to HEP in
connection with the Consolidation were outstanding for all periods prior to June
8, 1999. The Company's  properties are primarily  located in the Rocky Mountain,
Greater  Permian and Gulf Coast regions of the United States.  On March 6, 2000,
HEC had 100 employees.

Marketing

The oil and gas produced from the  properties  owned by HEC has  typically  been
marketed through normal channels for such products.  The Company generally sells
its oil at local field prices  generally  paid 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, HEC has entered into financial
contracts  for  hedging the price of between  12% and 54% of its  estimated  oil
production for 2000 through 2001.

All of HEC's natural gas  production is sold on the spot market or in short-term
contracts and is transported in intrastate  and  interstate  pipelines.  HEC has
entered into financial contracts for hedging the price of between 34% and 43% of
its estimated gas production for 2000 through 2002.

The purpose of the hedges is to provide  protection  against price decreases 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 an increase or decrease in 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.  HEC 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 HEC's  business
because there are numerous other  purchasers in the areas in which HEC sells its
production.  However,  for the years ended  December  31,  1999,  1998 and 1997,
purchases  by the  following  companies  exceeded  10% of the  total oil and gas
revenues of the Company:

                                   1999              1998             1997
                                   ----              ----             ----

Conoco Inc.                          19%               23%             20%
El Paso Field Services Company       14%               11%             11%
Plains All American Inc.             14%
Marathon Petroleum Company                                             16%

Factors,  if they  were to occur,  which  might  adversely  affect  HEC  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.



<PAGE>


Competition

HEC encounters  competition from other oil and gas companies in all areas of its
operations,  including  the  acquisition  of  exploratory  prospects  and proven
properties.  The  Company's  competitors  include major  integrated  oil and gas
companies  and  numerous  independent  oil and gas  companies,  individuals  and
drilling and income programs.  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 HEC 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.

Title to Properties

The Company believes it has satisfactory  title to all of its material producing
properties in accordance  with standards  generally  accepted in the oil and gas
industry. As is customary in the industry in the case of undeveloped properties,
little  investigation  of  record  title  is  made at the  time of  acquisition.
Investigations,  including a title opinion of legal counsel,  generally are made
before  commencement  of drilling  operations.  To the extent title  opinions or
other investigations reflect title defects, the Company,  rather than the seller
of undeveloped property, typically is responsible to cure any such title defects
at the  Company's  expense.  If the  Company  was unable to remedy or cure title
defects  of a nature  such that it would not be  prudent  to  commence  drilling
operations  on the  property,  the  Company  could  suffer a loss of its  entire
investment in such property.  The Company's  properties are subject to customary
royalty,  overriding royalty,  carried,  net profits,  working and other similar
interests,  liens incident to operating agreements,  liens for current taxes and
other  burdens.  In  addition,  the  Company's  credit  facility  is  secured by
approximately  80% in value of the oil and natural gas  interests of the Company
and other assets of the Company.

Environmental Considerations

The  exploration  for, and  development of, oil and gas involves 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 Company  cannot  predict what
effect possible future public or private action may have on the business of HEC.
The Company 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, 1999,  HEC has not been fined or
cited for any  environmental  violations  which  would have a  material  adverse
effect  upon  capital  expenditures,  earnings,  cash  flows or the  competitive
position of HEC in the oil and gas industry.

Insurance Coverage

HEC is subject to all the risks inherent in the exploration for, and development
of, oil and gas, including blowouts,  fires and other casualties.  HEC maintains
insurance  coverage as is  customary  for  entities of a similar size engaged in
operations  similar to that of HEC, 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 HEC's earnings, cash flows and financial position.



<PAGE>


Year 2000

In prior years,  the Company  discussed  the nature and progress of its plans to
become Year 2000 compliant.  In late 1999, the Company completed its remediation
and  testing  of  systems.  As a result  of those  planning  and  implementation
efforts,  the Company  experienced  no  significant  disruptions  in it critical
information  technology and  non-information  technology  systems,  and believes
those systems successfully responded to the Year 2000 date change.

The  Company  is not aware of any  material  problems  resulting  from Year 2000
issues,  either with its  products,  its internal  systems,  or the products and
services of third  parties.  The Company  will  continue to monitor its computer
applications and those of its suppliers and vendors  throughout the Year 2000 to
ensure that any latent Year 2000 matters that may arise are addressed properly.

Cautionary Statement Regarding Forward-Looking Statements

In the interest of providing the shareholders with certain information regarding
the Company'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  meanings  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 Company are, to the
knowledge  and in the  judgment of the  officers  and  directors of the Company,
expected to prove true and come to pass,  there can be no assurances that any of
these  expectations  will  prove  correct  or that any of the  actions  that are
planned  will be taken.  Forward-looking  statements  involve  known and unknown
risks and  uncertainties  which may cause the Company'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 others:

Volatility of oil and gas prices. It is impossible to predict future oil and gas
price  movements with  certainty.  Declines in oil and gas prices may materially
adversely  affect  HEC's  financial  condition,  liquidity,  ability  to finance
planned capital expenditures and results of operations. Lower oil and gas prices
may also reduce the amount of oil and gas that HEC can produce economically.

HEC's  revenues,  profitability,  future  growth and ability to borrow  funds or
obtain additional capital, as well as the carrying value of its properties, will
be substantially  dependent upon prevailing prices of oil and gas. Historically,
the markets for oil and gas have been volatile,  and they are likely to continue
to be  volatile  in the  future.  Prices  for oil and  gas are  subject  to wide
fluctuation in response to relatively  minor changes in the supply of and demand
for oil and gas, market uncertainty and a variety of additional factors that are
beyond HEC's control.

Hedging  arrangements  may expose the  Company to  financial  loss.  In order to
reduce its exposure to short-term fluctuations in the prices of oil and gas, the
Company periodically enters into hedging arrangements.  The hedging arrangements
apply to only a  portion  of its  production  and  provide  only  partial  price
protection against declines in oil and gas prices. Such hedging arrangements may
expose the Company to risk of financial  loss in some  circumstances,  including
instances where production is less than expected or where the other party to any
hedging arrangement fails to perform. In addition,  the hedging arrangements may
limit the benefit to the Company of increases in the prices of oil or gas.

Similarly,  in order to  reduce  its  exposure  to  short-term  fluctuations  in
interest rates and to provide a measure of  predictability  for a portion of its
interest  payments  under its debt  facilities,  the Company  has  entered  into
contracts to hedge its interest payments on a portion of its variable rate debt.
These  hedges  provide  only partial  protection  against  increases in interest
rates.  These hedging  arrangements  may expose the Company to risk of financial
loss in some  circumstances,  including  instances  where the other party to any
hedging arrangement fails to perform. In addition,  the hedging arrangements may
limit the benefit to the Company of declines in interest rates.


<PAGE>


Competition from larger, more established oil and gas companies.  HEC encounters
competition  from  other oil and gas  companies  in all areas of its  operation,
including the acquisition of exploratory prospects and proven properties.  HEC's
competitors  include  major  integrated  oil  and  gas  companies  and  numerous
independent oil and gas companies, individuals and drilling and income programs.
Many of its competitors are large, well-established companies with substantially
larger  operating  staffs and greater capital  resources than HEC's and, in many
instances,  have been engaged in the oil and gas business for a much longer time
than HEC. Those companies may be able to pay more for exploratory  prospects and
productive oil and gas properties,  and may be able to define, evaluate, bid for
and purchase a greater number of properties  and prospects than HEC's  financial
or human  resources  permit.  HEC's ability to explore for oil and gas prospects
and to acquire  additional  properties in the future will be dependent  upon its
ability to conduct its operations,  to evaluate and select  suitable  properties
and to consummate transactions in highly competitive environments.

Risks of drilling  activities.  HEC's success will be materially  dependent upon
the continued success of its drilling program.  HEC's future drilling activities
may not be successful and, if drilling activities are unsuccessful, such failure
will have an adverse  effect on HEC's future results of operations and financial
condition. Oil and gas drilling involves numerous risks, including the risk that
no commercially  productive oil or gas reservoirs  will be encountered,  even if
the reserves targeted are classified as proved. The cost of drilling, completing
and  operating  wells  is  often  uncertain,  and  drilling  operations  may  be
curtailed,  delayed or canceled  as a result of a variety of factors,  including
unexpected  drilling  conditions,  pressure  or  irregularities  in  formations,
equipment  failures or accidents,  adverse weather  conditions,  compliance with
governmental  requirements  and  shortages  or  delays  in the  availability  of
drilling  rigs  and the  delivery  of  equipment.  Although  HEC has  identified
numerous drilling prospects,  there can be no assurance that such prospects will
be  drilled  or that  oil or gas  will be  produced  from  any  such  identified
prospects or any other prospects.

Availability  of capital is  important  to the  Company's  ability to grow.  The
acquisition  of  reserves  is capital  intensive,  and  funding for the costs of
acquisition  may be  greater  than the  Company's  cash flow can  provide.  As a
result,  additional financing may be required,  and the availability or terms of
any such additional financing cannot be assured. In the event sufficient capital
resources  are not  available  to the  Company,  it may  negatively  affect  the
Company's  flexibility  in planning  for and  reacting  to possible  acquisition
activities.

Risks  relating to the  acquisition  of oil and gas  properties.  The successful
acquisition  of  producing  properties  requires an  assessment  of  recoverable
reserves,  future oil and gas prices,  operating costs, potential  environmental
and other  liabilities  and other  factors.  Such  assessments  are  necessarily
inexact and their  accuracy  inherently  uncertain.  In connection  with such an
assessment, HEC will perform a review of the subject properties that it believes
to be generally  consistent  with  industry  practices.  This  usually  includes
on-site  inspections  and the review of reports  filed with  various  regulatory
entities.  Such a review,  however,  will not reveal all  existing or  potential
problems,  nor will it permit a buyer to become  sufficiently  familiar with the
properties to fully assess their deficiencies and capabilities.  Inspections may
not always be performed on every well, and structural and environmental problems
are not necessarily observable even when an inspection is undertaken.  Even when
problems  are  identified,  the  seller  may be  unwilling  or unable to provide
effective  contractual  protection against all or part of these problems.  There
can be no assurances that any  acquisition of property  interests by HEC will be
successful  and, if an  acquisition is  unsuccessful,  that the failure will not
have an adverse  effect on HEC's  future  results of  operations  and  financial
condition.

Hazards  relating  to well  operations  and lack of  insurance.  The oil and gas
business involves certain hazards such as well blowouts; craterings; explosions;
uncontrollable flows of oil, gas or well fluids; fires; formations with abnormal
pressures;  pollution;  and releases of toxic gas or other environmental hazards
and risks, any of which could result in substantial  losses to HEC. In addition,
HEC may be  liable  for  environmental  damages  caused  by  previous  owners of
property  purchased or leased by HEC. As a result,  substantial  liabilities  to
third  parties or  governmental  entities may be incurred,  the payment of which
could reduce or eliminate the funds  available for  exploration,  development or
acquisitions or result in the loss of HEC's properties.  While HEC believes that
it  maintains  all types of  insurance  commonly  maintained  in the oil and gas
industry, it does not maintain business interruption insurance. In addition, HEC
cannot  predict with  certainty the  circumstances  under which an insurer might
deny coverage.  The occurrence of an event not fully covered by insurance  could
have a materially  adverse  effect on HEC's  financial  condition and results of
operations.

Future oil and gas  production  depends on  continually  replacing and expanding
reserves.  In  general,  the volume of  production  from oil and gas  properties
declines  as  reserves  are  depleted,  with the rate of  decline  depending  on
reservoir  characteristics.  HEC's future oil and gas production is,  therefore,
highly  dependent  upon its  ability to  economically  find,  develop or acquire
additional reserves in commercial quantities.  Except to the extent HEC acquires
properties  containing  proved reserves or conducts  successful  exploration and
development  activities,  or both,  the proved  reserves of HEC will  decline as
reserves are produced.  The business of exploring  for,  developing or acquiring
reserves  is  capital-intensive.  To the  extent  cash flow from  operations  is
reduced,  and external reserves of capital become limited or unavailable,  HEC's
ability to make the  necessary  capital  investments  to  maintain or expand its
asset base of oil and gas reserves would be impaired. In addition,  there can be
no  assurance  that  HEC's  future  exploration,   development  and  acquisition
activities will result in additional proved reserves or that HEC will be able to
drill productive wells at acceptable costs. Furthermore, although HEC's revenues
could  increase if  prevailing  prices for oil and gas  increase  significantly,
HEC's finding and development costs could also increase.

Estimates of reserves and future cash flows are imprecise. Reservoir engineering
is a subjective process of estimating  underground  accumulations of oil and gas
that  cannot  be  measured  in  an  exact  manner.   Estimates  of  economically
recoverable oil and gas reserves and of future net cash flows necessarily depend
upon a number of variable factors and assumptions, such as historical production
from the area compared with production from other producing  areas,  the assumed
effects of regulations by  governmental  agencies,  and  assumptions  concerning
future oil and gas prices,  future operating costs,  severance and excise taxes,
development costs and workover and remedial costs, all of which may in fact vary
considerably  from  actual  results.   For  these  reasons,   estimates  of  the
economically   recoverable  quantities  of  oil  and  gas  attributable  to  any
particular group of properties,  classifications  of such reserves based on risk
of  recovery,  and  estimates  of the future net cash flows  expected  from them
prepared by  different  engineers,  or by the same  engineers  but at  different
times,  may vary  substantially,  and such reserve  estimates  may be subject to
downward or upward adjustment based upon such factors.  In addition,  the status
of the  exploration  and  development  program  of any oil and  gas  company  is
ever-changing.  Consequently,  reserve  estimates  also vary over  time.  Actual
production, revenues and expenditures with respect to HEC's reserves will likely
vary from estimates, and such variances may be material.


ITEM 2 - PROPERTIES

Exploration and Development Projects and Acquisitions

In 1999, HEC incurred  $24,162,000 in direct  property  additions,  development,
exploitation, and exploration costs. The costs were comprised of $11,093,000 for
property acquisitions and approximately $13,069,000 for domestic exploration and
development.  HEC's  1999  capital  program  led to the  replacement,  including
revisions  to prior year  reserves,  of 95% of 1999  production  using  year-end
prices of $24.32 per bbl and $2.00 per mcf. Excluded from these calculations are
the reserves of HCRC and the direct  interests of Hallwood Group acquired in the
Consolidation.  Also  excluded  from the  calculations  are sales of reserves in
place in 1999, which were approximately 9% of 1999 production.

Property Sales

During 1999, HEC received  approximately  $388,000 for the sale of approximately
420  non-strategic  wells located  principally  in Texas but also included wells
located in Louisiana, Mississippi, North Dakota, New Mexico, Oklahoma, and Utah.

Regional Area Descriptions and 1999 Capital Budget

The  following  discussion of HEC's  properties  and capital  projects  contains
forward-looking statements that are based on current expectations, estimates and
projections about the oil and gas industry, management's beliefs and assumptions
made  by   management.   Words  such  as  "projects,"   "believes,"   "expects,"
"anticipates,"  "estimates,"  "plans,"  "could,"  variations  of such  words and
similar  expressions are intended to identify such  forward-looking  statements.
Please  refer  to  the  section   entitled   "Cautionary   Statement   Regarding
Forward-Looking  Statements"  under Item 1. for a  discussion  of factors  which
could affect the outcome of the forward-looking statements.

Since HEP was  considered  the acquiring  entity for  accounting  purposes,  the
expenditures  discussed  below represent the costs incurred by HEP prior to June
8, 1999, plus the costs incurred on a consolidated basis after June 8, 1999.

Gulf Coast Region

HEC has  significant  interests in the Gulf Coast Region in Louisiana  and South
and East Texas.  The  Louisiana  interests  are located in Lafayette  Parish and
consist of 13  producing  gas wells and the  associated  water  handling and gas
treating facilities. The wells produce principally from the Bol Mex formation at
13,500 to 14,500  feet and seven are  operated  by HEC. In South and East Texas,
HEC has interests in approximately 151 producing wells, 45 of which are operated
by the Company and produce primarily from the Austin Chalk,  Paluxy,  Lower Frio
and Cotton Valley  formations at depths from 7,000 to 13,000 feet.  During 1999,
HEC  expended  approximately  $16,251,000  (67%) of its  capital  budget in this
region.   Of  this  amount,   approximately   $7,230,000  was  for  the  Seisgen
Exploration,   Inc.  ("Seisgen")  acquisition  described  below.  The  following
discussion relates to major 1999 capital projects within the region.

Seisgen Acquisition. In October 1999, HEC acquired from Seisgen, interests in 34
wells located principally in the Yoakum Gorge area of Lavaca County,  Texas. The
proven reserves have a net present value, discounted at 10% of $5,182,000, using
non-escalated  prices of $2.50 mcf of gas and $18.50 per barrel of oil. HEC also
acquired   significant   non-producing   assets  including  drilling  locations,
exploration  acreage and 3-D seismic data. HEC believes that the acquisition has
significant upside potential value and expands opportunities in the Yoakum Gorge
area  where  HEC  has  been  active  since  1998.  Specifically,   in  1998  HEC
participated in a successful  non-operated  exploration  discovery in the Wilcox
formation using  proprietary 3-D seismic data. In 1999, HEC participated in five
additional non-operated directional wells testing the Wilcox Steven Sands. Three
of the wells are  producing  and two of the  wells  are  drilling  or are in the
process of being  completed  as of December  31,  1999.  The average rate of the
producing wells at December 31, 1999 is approximately  12,775 gross mcf per well
per day. HEC owns an average 28% working interest in four of the producing wells
and 12.5%  working  interests in the  remaining  two wells.  HEC's 1999 drilling
costs incurred are approximately $3,130,000.  During 2000, HEC plans to drill at
least three additional development wells and three exploration wells.

Bell  Project.  During  1998,  HEC drilled one  successful  well within the Bell
prospect  located in Houston County,  Texas.  HEC owns a 60% working interest in
this operated  well. In 1999, HEC  sidetracked  another well to test reserves in
the Buda and Georgetown  formations  using a stacked dual lateral well.  Initial
tests of the Georgetown  formation showed it water prone, but the Buda formation
is currently  being tested and is producing  oil. At December 31, 1999,  HEC was
also drilling a dual lateral Buda formation  development well which is currently
being completed.  HEC owns 36% working  interests in the wells drilling or being
completed. The horizontal lateral sections are between 4,000-8,000 feet, and the
total vertical depth of the wells range from  9,000-10,000  feet. HEC's costs in
1999 were  approximately  $1,446,000  for all drilling and prospect costs in the
area. During 2000, HEC plans to drill as many as five wells in the area.

Scott Field Area.  During 1999, the two most significant wells in the Field, the
A.L.  Boudreaux  #1, and the G.S.  Boudreaux  Estate #1 went  offline.  The A.L.
Boudreaux #1 was successfully restored to commercial production of 11.7 mmcf per
day and 250 bopd following a workover,  although post-workover reserves are less
than had been  previously  estimated.  The G.S.  Boudreaux well was lost, but an
alternate  unit well began  drilling  in the  fourth  quarter of 1999 to recover
additional  gas believed to be remaining  in the fault block.  Also  drilling at
December 31, 1999, was a well in a fault block adjacent to the A. L.  Boudreaux.
In February of 2000,  based on the drilling  results,  this well was plugged and
abandoned.  In 2000, HEC's plans include an exploration test of the deeper Klump
Sands productive in nearby fields.

Mirasoles Project. In 1999, HEC began completion of a 17,000-foot Frio Formation
exploration  well located in Kenedy County,  Texas. In 1998,  eight  prospective
horizons were identified while drilling this large  structural  prospect defined
by 63 miles of  proprietary  3-D seismic  data.  Stimulation  of the deepest and
highest  potential  zone was not possible due to mechanical  problems.  HEC then
tested three shallower Frio zones, but found only  subcommercial  oil production
rather than gas as anticipated.  In 1999, HEC incurred approximately  $1,473,000
related to this project.  HEC operates the well and owns a 35% working interest.
The well is temporarily  abandoned and HEC, as operator,  is currently proposing
the abandonment of the well and project.

Boca Chica  Project.  In 1999, HEC incurred  approximately  $313,000 for seismic
data and all costs  associated with its  participation  in an exploration  well,
which was  directionally  drilled from the shore to a bottom hole location under
the waters of the Gulf of Mexico.  This 10,000-foot  exploration well in the Big
Hum  formation  tested  wet,  yet  the  exploration  results  were  sufficiently
encouraging  that working  interest owners shot 3-D seismic over the area in the
third quarter of 1999. Though the 3-D seismic  interpretation is still underway,
HEC  anticipates  that during 2000 another well will be drilled.  HEC owns a 25%
working interest in the well.

Greater Permian Region

HEC has significant interests in the Greater Permian Region, which includes West
Texas and  Southeast  New  Mexico.  In this  region,  HEC has  interests  in 436
productive oil and gas wells (359 of which are operated), 30 shut-in oil and gas
wells (28  operated)  and 13 operated  salt water  disposal  wells or  injection
wells. In 1999, HEC expended approximately $1,362,000 (6%) of its capital budget
on projects in this area.  The  following is a  description  of the  significant
areas and 1999 capital projects within the Greater Permian Region.

Carlsbad/Catclaw  Area.  HEC's  interests  in the  Carlsbad/Catclaw  Area  as of
December 31, 1999 consisted of 59 producing wells that produce primarily natural
gas and two shut-in wells. The wells are located on the northwestern edge of the
Delaware  Basin in Lea,  Eddy and  Chaves  Counties,  New  Mexico.  The  Company
operates  33  of  these  wells.   The  wells  produce  at  depths  ranging  from
approximately  2,500 feet to 14,000 feet from the Delaware,  Atoka, Bone Springs
and Morrow formations. In 1999, HEC spent approximately $475,000 recompleting or
drilling four  producing  development  wells.  HEC expects to continue  operated
development drilling in Lea County.

Spraberry  Area.  HEC's interests in the Spraberry Area consist of 377 producing
wells,  13 salt-water  disposal  wells,  and 28 shut-in wells in Dawson,  Upton,
Reagan and Irion Counties,  Texas. The Company operates 326 of the producing oil
and gas wells.  Current  production  is  predominately  from the Upper and Lower
Spraberry,  Clearfork Canyon,  Dean, and Fusselman  formations at depths ranging
from 5,000 feet to 9,000 feet. During 1999, HEC plugged 66 wells in the area and
anticipates  an additional 10 wells will be plugged in 2000.  The Spraberry area
is a mature  operation where  aggressive  operating  expense control and limited
development drilling typify the management of the area.

Rocky Mountain Region

HEC has  significant  interests  in the Rocky  Mountain  Region,  which  include
producing  properties  in  Colorado,  Montana,  North Dakota and  Northwest  New
Mexico.  The Company has interests in 218  producing  oil and gas wells,  176 of
which are operated by HEC, 22 shut-in wells, and five salt-water disposal wells.
HEC expended  approximately  $4,183,000 (17%) of its 1999 capital budget in this
area. A discussion of the major projects in the region follows.

Colorado  Western  Slope  Project.  HEC drilled and completed  three  5,500-foot
Dakota  Formation  wells in 1999.  The wells are  located  in  Garfield  County,
Colorado.  HEC owns 100% working interests in the wells. Sales of production for
all three wells in November 1999 had combined rates of approximately 1,450 gross
mcf per day.  HEC's total  costs in 1999 for the three wells were  approximately
$1,854,000.  HEC has identified 13 additional development locations and in 2000,
plans to drill up to nine additional wells and to recomplete two wells.

Toole  County  Area.  HEC's  interests  in the Toole  County Area  consist of 61
producing  wells and 17 shut-in wells,  66 of which are operated by the Company.
The oil wells produce from the Nisku formation at depths of approximately  3,000
feet,  and the gas wells produce from the Bow Island  formation at depths of 900
to 1,200 feet. HEC plans to divest this area in 2000.

San Juan Basin Project - Colorado and New Mexico. HEC's interest in the San Juan
Basin  consists of 80 producing  gas wells (75  operated),  12 operated  shut-in
wells and three  operated salt water  disposal wells located in San Juan County,
New Mexico and LaPlata County,  Colorado. HEC operates 52 producing wells in New
Mexico,  31 of which produce from the Fruitland Coal formation at  approximately
2,200  feet and 21 of which  produce  from the  Picture  Cliffs,  Mesa Verde and
Dakota  formations at 1,200 to 7,000 feet. HEC also operates 23 producing  wells
in La Plata County,  Colorado.  The wells in Colorado produce from the Fruitland
Coal formation at depths of 1,800-2,200  feet.  During 1999,  $676,500 was spent
for the purchase of overriding  royalty  interests  and working  interests in 18
coal bed methane properties already operated by HEC, located in San Juan County,
New Mexico.  Most of the  interests  purchased  qualify  for tax  credits  under
Section 29 of the Internal Revenue Code. In order to monetize these credits, the
majority of the acquired  interests were sold to 44 Canyon LLC ("44 Canyon"),  a
special  purpose entity owned by a large East Coast  financial  institution,  by
HEC, in exchange for cash, a production payment,  and promissory notes. In 1999,
HEC along with some of its peers,  petitioned  the Colorado Oil & Gas Commission
to allow for  optional  infill  drilling  on 160 acre  spacing  in the  Colorado
Fruitland  Coal  formation.  If approved,  additional  drilling of as many as 17
wells would result in the area.  Although no application for additional drilling
has  been  made  in New  Mexico,  with  regulatory  approval,  14  new  drilling
opportunities  would be created in the area, as well. In addition,  in 1999, HEC
installed an additional  gas-gathering pipeline in LaPlata County, Colorado. HEC
anticipates  that the additional line will help lower system  pressures and will
increase production by 1,000 mcf per day. Additional water disposal capacity was
completed in the fourth  quarter of 1999.  HEC's costs  incurred in 1999 for the
additional pipeline and water disposal facilities were approximately $395,000.

Other

At December 31, 1999, HEC owned various other interests in properties in Kansas,
Oklahoma, California, and South Central Texas. The remaining $2,366,000 (10%) of
HEC's capital  expenditures  incurred in 1999 were devoted to technical  general
and  administrative  expenditures,  delay rental costs,  and for numerous  other
projects  which were completed or are underway and which are  individually  less
significant.

Future Plans

At December 31, 1999,  HEC's plans were to sell its  interests in  approximately
500  non-strategic  oil and gas wells in 2000.  These sales are being made in an
effort to better  focus the  Company on its core areas of  Colorado,  Utah,  New
Mexico,  Texas,  and Louisiana and at the same time reduce its level of debt and
administrative  overhead. These wells represent approximately 34% of HEC's total
well count,  approximately  16% of HEC's reserve value, and approximately 11% of
its operating  cash flow based on five year average  reserve  pricing.  Proceeds
from the sales will be used initially to reduce debt. Subsequent to December 31,
1999 and through March 6, 2000,  approximately  145 of the non-strategic oil and
gas wells located in the Keystone, Merkle, and Weesatche areas of Texas, as well
as various oil and gas wells in  Oklahoma,  North  Dakota and Montana  have been
sold. As a result of successful  sales  negotiations,  sales proceeds in four of
the five areas  exceeded the net present value,  discounted at 10%,  recorded in
HEC's January 1, 2000, five year average price reserve report. Purchase and sale
agreements for properties located in Williston Basin, Montana,  North Dakota and
Kansas are  currently  being  negotiated.  Efforts to sell the  remainder of the
non-strategic oil and gas wells are ongoing.

For 2000,  HEC's capital  budget,  which will be provided by cash generated from
operations and cash on hand has been set at $24,000,000.  The Company expects to
allocate its capital budget for 2000 among its core areas as follows:

Gulf Coast Region                                $14,500,000
Greater Permian Region                               500,000
Rocky Mountain Region                              7,000,000
Other                                              2,000,000
                                                 -----------
                                                 $24,000,000


Company Reserves, Production and Discussion by Significant Regions

The following  table  presents the December 31, 1999 reserve data by significant
regions.
<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>
Gulf Coast Region                     24,945            1,328           $11,743         $  29,593        $  41,336
Greater Permian Region                30,071            5,540             3,123            52,896           56,019
Rocky Mountain Region                 93,838            1,322             1,415            89,590           91,005
Other                                  2,814            3,491               783            18,857           19,640
                                    --------          -------           -------          --------         --------
                                     151,668           11,681           $17,064          $190,936         $208,000
                                     =======           ======            ======           =======          =======
</TABLE>

The following table presents the oil and gas production for significant  regions
for the periods indicated.
<TABLE>
<CAPTION>

                                             Production for the                            Production for the
                                        Year Ended December 31, 1999                  Year Ended December 31, 1998
                                        ----------------------------                  ----------------------------
                                     Mcf of Gas             Bbls of Oil              Mcf Gas              Bbls of Oil
                                     ----------             -----------              -------              -----------
                                                                      (In thousands)

<S>                                      <C>                      <C>                  <C>                      <C>
Gulf Coast Region                        5,234                    189                  5,291                    175
Greater Permian Region                   2,758                    437                  2,893                    401
Rocky Mountain Region                    9,862                    151                  5,233                    133
Other                                      409                    148                    620                     78
                                      --------                    ---               --------                  -----
                                        18,263                    925                 14,037                    787
                                        ======                    ===                 ======                   ====
</TABLE>

The  following  table  presents the  Company's  extensions  and  discoveries  by
significant regions.
<TABLE>
<CAPTION>

                                    For the Year Ended December 31, 1999          For the Year Ended December 31, 1998
                                    ------------------------------------          ------------------------------------
                                     Mcf of Gas             Bbls of Oil            Mcf of Gas             Bbls of Oil
                                     ----------             -----------            ----------             -----------
                                                                      (In thousands)

<S>                                      <C>                      <C>                  <C>                      <C>
Gulf Coast Region                        5,708                    113                  1,201                    164
Greater Permian Region                     291                     58                    217                    167
Rocky Mountain Region                    4,346                      9                     78                     83
Other                                      584                                            46                      1
                                      --------                -------               --------                 ------
                                        10,929                    180                  1,542                    415
                                        ======                    ===                  =====                   ====
</TABLE>

Average Sales Prices and Production Costs

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

                                                       1999              1998              1997
                                                      ------            ------            -----

Oil and condensate -
<S>                                                    <C>               <C>               <C>
  includes the effects of hedging (per bbl)            $16.52            $13.65            $19.08
Natural gas -
   includes the effects of hedging (per mcf)             1.90              2.02              2.31
Production costs (per equivalent mcf of gas)              .72               .65               .67
</TABLE>



<PAGE>


Productive Oil and Gas Wells

The following  table  summarizes the productive oil and gas wells as of December
31, 1999 attributable to HEC's direct interests.  Productive wells are producing
wells and wells capable of production. Gross wells are the total number of wells
in  which  HEC has an  interest.  Net  wells  are the  sum of  HEC's  fractional
interests owned in the gross wells.

                                    Gross Net

Productive Wells
  Oil                                            826               526
  Gas                                            435               228
                                              ------               ---
    Total                                      1,261               754
                                               =====               ===

Oil and Gas Acreage

The following table sets forth the developed and undeveloped  leasehold  acreage
held  directly by HEC as of December 31, 1999.  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 HEC has a working  interest.  Net acres are the sum of HEC's fractional
interests owned in the gross acres.

                                               Gross         Net
                                                 (in thousands)

Developed acreage                               272          144
Undeveloped acreage                             666          168
                                                ---          ---
    Total                                       938          312
                                                ===          ===

At December 31, 1999, HEC held undeveloped acreage in Texas, Louisiana, Montana,
Utah, Oklahoma, New Mexico, Kansas, Colorado, North Dakota and California.

Drilling Activity

The following table sets forth the number of wells  attributable to HEC's direct
interests drilled in the most recent three years.
<TABLE>
<CAPTION>

                                                               Year Ended December 31,
                                               1999                        1998                        1997
                                              ------                      ------                      -----
                                       Gross          Net          Gross          Net          Gross          Net
                                       -----          ---          -----          ---          -----          ---

Development Wells:
<S>                                       <C>          <C>           <C>          <C>            <C>          <C>
   Productive                             1            .5            12           3.6            23           4.5
   Dry                                    1            .5             5           1.5             5            .8
                                        ---           ---           ---           ---           ---          ----
    Total                                 2             1            17           5.1            28           5.3
                                        ===           ===            ==           ===            ==           ===

Exploratory Wells:
   Productive                            11           4.1            17           4.3            14           2.2
   Dry                                    8           2.4            17           3.0            22           5.4
                                        ---           ---            --           ---            --           ---
    Total                                19           6.5            34           7.3            36           7.6
                                        ===           ===            ==           ===            ==           ===
</TABLE>



<PAGE>


Office Space

HEC leases office space in Denver, Colorado, for approximately $600,000 per year
under a lease that terminates on December 31, 2006. HEC also  sub-leases  office
space in Houston,  Texas for  approximately  $42,000 per year under a lease that
terminates on October 14, 2001.


ITEM 3 - LEGAL PROCEEDINGS

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


ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS

No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter of 1999.



                                     PART II


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

HEC's common  stock began  trading  over the counter on NASDAQ  National  Market
System under the symbol "HECO" on June 9, 1999.  HEC's Series A Preferred  Stock
began  trading on the NASDAQ under the symbol  "HECOP" on June 11,  1999.  As of
March 6, 2000,  there were 18,808  registered  holders of record of HEC's common
stock and 12,566 registered holders of record of HEC's Series A Preferred Stock.
The  following  table sets forth,  for the periods  indicated,  the high and low
closing bid  quotations  for each class of stock as reported by the Nasdaq Stock
Market,  Inc.  and the  dividends  paid per  Series A  Preferred  share  for the
corresponding  periods.  No common stock  dividends were paid during the periods
shown.
<TABLE>
<CAPTION>

Common Stock                                                   High             Low              Dividends
------------                                                   ----             ---              ---------

<S>                                                          <C>              <C>                <C>
Second quarter 1999 (from June 9, 1999)                      $8 3/8           $5 3/8
Third quarter 1999                                            7 3/4            5 1/8
Fourth quarter 1999                                           7                3 1/2

Series A Preferred Stock

Second quarter 1999 (from June 11, 1999)                     $8 3/4           $7 3/4             $ .25
Third quarter 1999                                            8 7/8            8 1/8               .25
Fourth quarter 1999                                           8 5/16         7                     .25
                                                                                                  ----
                                                                                                 $ .75
</TABLE>



<PAGE>


Prior to the  Consolidation,  HEP's  Class A Units were  traded on the  American
Stock Exchange (the "Exchange") under the symbol "HEP" through June 8, 1999. 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.
<TABLE>
<CAPTION>

Class A Units                                                High            Low             Distributions
-------------                                                ----            ---             -------------

<S>                                                         <C>         <C>                       <C>
First quarter 1998                                          $8 5/8      $6 3/8                   $.13
Second quarter 1998                                          7                                    .13
                                                                         6
Third quarter 1998                                           7               4                    .13
                                                                         11/16
Fourth quarter 1998                                          5 7/8           3                    .13
                                                                                                  ---
                                                                                                 $.52

First quarter 1999                                          $4 3/8         $3                    $.13
Second quarter 1999 (through June 8, 1999)                   4 3/8          3 1/2                  --
                                                                                                  ----
                                                                                                 $.13

</TABLE>

On January 17, 1996, HEP's Class C Units began trading on the Exchange under the
symbol  "HEPC." On  February  17,  1998,  HEP closed its public  offering of 1.8
million Class C Units which were priced at $10.00 per Unit.  HEP's Class C Units
stopped trading on June 8, 1999. 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.
<TABLE>
<CAPTION>

Class C Units                                                 High           Low           Distributions
-------------                                                 ----           ---           -------------

<S>                                                          <C>            <C>               <C>
First quarter 1998                                           $11            $9 1/8             $  .25
Second quarter 1998                                            9 13/16       8 3/8               .25
Third quarter 1998                                             8 1/2         6 3/4               .25
Fourth quarter 1998                                            7 15/16       5 7/8               .25
                                                                                               -----
                                                                                               $1.00

First quarter 1999                                          $  8 1/2       $6 3/16            $  .25
Second quarter 1999 (through June 8, 1999)                     8 9/16        7 3/16               --
                                                                                              ------
                                                                                              $  .25
</TABLE>

HEC's debt agreements limit aggregate  dividends paid by HEC in any twelve month
period to 50% of cash flow from  operations  before working  capital changes and
50% of distributions  received from affiliates,  if the principal amount of debt
of HEC is 50% or more of the borrowing base. Aggregate dividends paid by HEC are
limited to 65% of cash flow from  operations  before working capital changes and
65% of distributions  received from affiliates,  if the principal amount of debt
is less than 50% of the borrowing base.

On February 18, 2000,  HEC  repurchased  and retired  43,816  shares of Series A
Preferred Stock from its affiliate, Hallwood Group for $303,426. The shares were
repurchased  for $6.925 per share which  represented  the average of the closing
prices of the stock during the five days prior to February 18, 2000.




<PAGE>


ITEM 6 - SELECTED FINANCIAL DATA

The following table sets forth selected financial data regarding HEC's financial
position and results of operations as of the dates  indicated.  All  information
presented  for  periods  prior  to  June  8,  1999   represents  the  historical
information  of HEP because HEP was  considered to be the  acquiring  entity for
accounting purposes. The financial information for periods prior to June 8, 1999
have been retroactively  restated to reflect the corporate structure of HEC, and
all share and per share information assumes that the shares of HEC issued to HEP
in connection with the  Consolidation  were outstanding for all periods prior to
June 8, 1999.
<TABLE>
<CAPTION>

                                                       As of and For the Year Ended December 31,
                                                       -----------------------------------------
                                          1999            1998           1997             1996           1995
                                         ------          ------         -------          ------         -----
                                                            (In thousands except per Share)

Summary of Operations
   Oil and gas revenues and
<S>                                   <C>             <C>              <C>             <C>           <C>
     pipeline operations              $   56,523      $   43,177       $   44,707      $   50,644    $   43,454
   Total revenue                          56,881          43,586           45,103          51,066        43,780
   Production operating expense           17,100          12,175           11,060          11,511        11,298
   Depreciation, depletion and
     amortization                         21,027          15,720           11,961          13,500        15,827
   Impairment                                             14,000                                         10,943
   General and administrative
     expense                               7,395           5,045            5,333           4,540         5,580
   Net income (loss)                       2,880         (13,895)          12,803          15,726        (9,031)
   Basic net income (loss) per share
                                             .06           (2.92)            2.17            2.69         (1.61)
   Diluted net income (loss) per
     share                                   .06           (2.92)            2.14            2.69         (1.61)
   Dividends per common share                .21            1.26             1.25            1.34          1.78
   Dividends per preferred share            1.00            1.00             1.00            1.00

Balance Sheet
   Working capital (deficit)          $    3,371      $   (8,722)      $     (973)     $   (1,355)   $   (4,363)
   Property, plant and equipment,
     net                                 181,621         105,005           94,331          88,549        94,926
   Total assets                          212,774         139,091          131,603         122,792       125,152
   Long-term debt                        109,357          40,381           34,986          29,461        37,557
   Long-term contract settlement
     obligation                                                                             2,512         2,397
   Deferred liability and other            1,066           1,050            1,180           1,533         1,718
   Minority interest in affiliates           582           2,788            3,258           3,336         3,042
   Stockholders' equity                   75,387          62,632           69,064          64,215        57,572
</TABLE>


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

Overview

HEC began  operations on June 8, 1999, in connection with the  Consolidation  of
HEP and HCRC and the  acquisition of the direct  property  interests of Hallwood
Group. For accounting purposes, the Consolidation has been treated as a purchase
by HEP of the common stock of HCRC and the direct  energy  interests of Hallwood
Group.  Generally accepted accounting principles require reporting of results on
a basis that makes it  difficult  to compare  to prior  years.  Therefore,  this
Overview  provides  certain  information  on a pro forma basis to facilitate the
comparison with prior periods.

Pro Forma Results

The following pro forma information is prepared as if the Consolidation had been
completed on January 1, 1997.

                                 For the Year Ended December 31,
                                 -------------------------------
                             1999              1998             1997
                             ----              ----             ----
                                   (in thousands except prices)

Prices
  Gas (per mcf)              $1.88             $1.96            $2.25
  Oil (per bbl)             $15.84            $13.33           $19.01

Production
  Gas (mcf)                 22,360            22,291           17,786
  Oil (bbl)                  1,177             1,386            1,362

Gas revenue                $42,111           $43,752          $40,095
Oil revenue                 18,638            18,477           25,888
Lease operating expense     21,187            21,705           19,318

Liquidity and Capital Resources

Cash Flow

HEC generated $18,238,000 of cash flow from operating activities during 1999.

   The other primary cash inflows were:

   o  Proceeds from long-term debt of $13,000,000;

   o  Distributions received from affiliate of $1,833,000;

   o  Proceeds from the sale of property of $388,000;

   Cash was used primarily for:

   o  Additions to property, exploration and development costs of $24,162,000;

o        Costs incurred in connection with the Consolidation of $2,933,000;

   o  Payments of long-term debt of $3,000,000 and,

   o Dividends to shareholders of $4,061,000.

When combined with miscellaneous other cash activity during the year, the result
was a decrease of $1,394,000 in HEC's cash and cash equivalents from $11,874,000
at December 31, 1998 to $10,480,000 at December 31, 1999.



<PAGE>


Property Purchases, Sales and Capital Budget

In 1999, HEC incurred  $24,162,000 in direct  property  additions,  development,
exploitation, and exploration costs. The costs were comprised of $11,093,000 for
property acquisitions and approximately $13,069,000 for domestic exploration and
development.  HEC's  1999  capital  program  led to the  replacement,  including
revisions  to prior year  reserves,  of 95% of 1999  production  using  year-end
prices of $24.32 per bbl and $2.00 per mcf. Excluded from these calculations are
the reserves of HCRC and the direct  interests of Hallwood Group acquired in the
Consolidation.  Also excluded are sales of reserves in place in 1999, which were
approximately 9% of 1999 production.

Regional Area Descriptions and 1999 Capital Budget

Since HEP was  considered  the acquiring  entity for  accounting  purposes,  the
expenditures  discussed  below represent the costs incurred by HEP prior to June
8, 1999, plus the costs incurred on a consolidated basis after June 8, 1999.

In the Gulf  Coast  Region,  HEC  expended  approximately  $7,230,000  acquiring
interests in 34 wells and significant  non-producing  assets including  drilling
locations,  exploration acreage and 3-D seismic.  Most of the assets are located
in Yoakum Gorge area of Lavaca County,  Texas. In addition,  in the Yoakum Gorge
area, HEC  participated in a successful  non-operated  exploration  discovery in
1998, and in 1999, HEC participated in five additional non-operated  directional
wells testing the Wilcox Steven Sands. HEC's 1999 drilling costs incurred in the
Yoakum Gorge area were approximately $3,130,000. HEC drilled one successful well
and sidetracked two additional wells within the Bell prospect located in Houston
County,  Texas.  HEC's  costs  in 1999  were  approximately  $1,446,000  for all
drilling  and  prospect  costs  within  the Bell area.  HEC spent  approximately
$1,473,000 for completion attempts on the Mirasoles  exploration well located in
Kenedy County, Texas. In 1999, HEC incurred  approximately  $313,000 for seismic
and all costs associated with its  participation  in the Boca Chica  exploration
well.

In the Greater Permian Region, HEC spent approximately  $475,000 recompleting or
drilling four producing development wells.

In the Rocky Mountain  Region,  HEC drilled and completed three wells located in
Garfield County,  Colorado.  Drilling costs were approximately  $1,854,000.  HEC
incurred  $676,500 for the purchase of overriding  royalty interests and working
interests in 18 coal bed methane  properties already operated by HEC, located in
San Juan  County,  New  Mexico.  In the same area,  HEC  incurred  approximately
$395,000 for additional pipeline and water disposal facilities.

See  Item 2 -  Properties,  for  further  discussion  of HEC's  exploration  and
development projects.

Long-lived  assets,  other  than  oil  and gas  properties,  are  evaluated  for
impairment  whenever  events  or  changes  in  circumstances  indicate  that the
carrying amount may not be recoverable.  To date, the Company has not recognized
any impairment losses on long-lived assets other than oil and gas properties.

Dividends

On December  13, 1999,  HEC  declared a quarterly  dividend of $.25 per Series A
Cumulative  Preferred share, which was paid on February 15, 2000 to shareholders
of record on December 31, 1999. This amount was accrued as of the year-end.

The Series A Cumulative  Preferred Stock has a dividend  preference of $1.00 per
share per year.  HEC may not  declare or pay  dividends  to common  shareholders
unless full cumulative dividends have been paid on the preferred stock.



<PAGE>


Stock Option Plans

On June 9, 1999, HEC granted options to purchase  600,000 shares of common stock
at an exercise price of $7.00 per share which was equal to the fair market value
on the date of grant.  On November 22, 1999,  HEC granted an  additional  61,500
options to purchase  common stock at an exercise  price of $7.00 per share which
was greater  than the fair market  value of the common  stock on the date of the
grant. The options expire on June 9, 2006, unless sooner terminated  pursuant to
the  provisions of the plan.  One-third of the options vested on the grant date,
and the remainder vest one-third on June 8, 2000 and one-third on June 8, 2001.

On January 28, 2000,  HEC granted  options to purchase  238,500 shares of common
stock at an  exercise  price of  $4.625  per  share  which was equal to the fair
market  value of the common  stock on the date of grant.  The options  expire on
January 28, 2007,  unless sooner  terminated  pursuant to the  provisions of the
plan.  One-third of the options  vested on the grant date and the remainder vest
one-third on January 28, 2001 and one-third on January 28, 2002.

Prior to the Consolidation,  the following HEP options were outstanding.  All of
these options were cancelled on June 8, 1999.
<TABLE>
<CAPTION>

                                                      Number of Options
                                            Outstanding               Exercisable              Exercise Price

<S>                                            <C>                       <C>                       <C>
Class A Unit Options                           390,400                   390,400                   $  5.75
Class A Unit Options                            25,500                    17,000                   $  6.625
Class C Unit Options                           120,000                   120,000                    $10.00
</TABLE>

Financing

On June 8, 1999, HEC and its lenders entered into an Amended and Restated Credit
Agreement (as amended,  the "Credit  Agreement")  to extend the term date of its
line of credit to May 31, 2002.  The lenders are Morgan  Guaranty Trust Company,
First Union National Bank and Bank of America. The terms of the Credit Agreement
were  amended on October 15,  1999,  to,  among other  matters,  increase  HEC's
borrowing base to $90,000,000. At December 31, 1999, HEC had amounts outstanding
of $86,200,000.

HEC's plans are to sell its interests in approximately 500 non-strategic oil and
gas wells during 2000.  These  property sales will enable HEC to better focus on
its core  areas  while at the same time  reduce its level of  outstanding  debt.
Subsequent to December 31, 1999 and through March 6, 2000, approximately 145 oil
and  gas  properties  have  been  sold  and  HEC has  repaid  $6,000,000  of its
borrowings under the Credit Agreement. On January 27, 2000, the Credit Agreement
was further amended to reduce HEC's borrowing base to reflect the property sales
made by the  Company and to waive  compliance  with an asset sale  covenant.  On
February 9, 2000,  HEC's  borrowing  base was further  reduced to $84,479,000 to
reflect the most recent  property sales,  and therefore  HEC's unused  borrowing
base totaled $4,279,000 at March 6, 2000.

Borrowings  against  the  Credit  Agreement  bear  interest  at the lower of the
Certificate  of Deposit rate plus from 1.375% to 2.125%,  prime plus 1/2% or the
Euro-Dollar rate plus from 1.25% to 2.0%. The applicable  interest rate was 8.5%
at December 31, 1999. Interest is payable monthly.  Quarterly principal payments
of  $11,457,000  are  calculated to include  repayments  of the  borrowing  made
subsequent to December 31, 1999 and commence May 31, 2002.

The  borrowing  base  for  the  Credit   Agreement  is  typically   redetermined
semiannually,  although the lenders have the right to make a redetermination  at
anytime. The Credit Agreement is secured by a first lien on approximately 80% in
value of HEC's oil and gas properties.  Additionally,  aggregate  dividends paid
and stock  repurchased  by HEC in any 12 month period are limited to 50% of cash
flow from operations before working capital changes and  distributions  received
from  affiliates,  if the principal  amount of debt of HEC is 50% or more of the
borrowing  base.  Aggregate  dividends  paid and  stock  repurchased  by HEC are
limited to 65% of cash flow from  operations  before working capital changes and
distributions received from affiliates,  if the principal amount of debt is less
than 50% of the borrowing base.
At the  time  of the  Consolidation,  HCRC  had  $25,000,000  of  10.32%  Senior
Subordinated Notes ("Subordinated  Notes") due December 23, 2007 and warrants to
purchase  common stock which were held by The  Prudential  Insurance  Company of
America  ("Prudential").  On June 8, 1999, the Amended and Restated Subordinated
Note and Warrant Purchase  Agreement (the "Note Agreement") was amended to issue
warrants to  Prudential to purchase  309,278  shares of HEC's Common Stock at an
exercise price of $7.00 per share.  The terms of the Note Agreement were further
amended on October  15,  1999 to exclude  certain  hedging  transactions  of the
subsidiaries  of HEC from the  calculation of  indebtedness.  In connection with
this amendment, the Company received a written waiver under the Credit Agreement
of the restriction on amendments to the Note Agreement.  The Subordinated  Notes
bear  interest  at the rate of 10.32% per annum on the unpaid  balance,  payable
quarterly.  Annual  principal  payments of $5,000,000  are due December 23, 2003
through December 23, 2007.

HEC recorded  the  Subordinated  Notes and the warrants  based upon the relative
fair values of the  Subordinated  Notes without the warrants and of the warrants
themselves at the time of Consolidation.  The allocated value of the warrants of
$1,956,000  was  recorded as  additional  paid-in-capital.  The  discount on the
Subordinated  Notes is being amortized over the term of the  Subordinated  Notes
using the interest method of amortization.

As part of its risk management strategy,  HEC enters into financial contracts to
hedge the interest rate payments  under its Credit  Agreement.  HEC does not use
the hedges for trading purposes, but rather to protect against the volatility of
interest rates under its Credit  Agreement,  which has a floating interest rate.
The  amounts  received  or  paid  upon  settlement  of  these  transactions  are
recognized as interest expense at the time the interest payments are due.

All contracts are interest rate swaps with fixed rates. As of March 6, 2000, HEC
was a party to eight contracts with three different counterparties.

The following table provides a summary of HEC's financial contracts.

                                                                    Average
                               Amount of Contract
               Period                       Debt Hedged            Floor Rate

               2000                         $45,000,000                5.65%
               2001                          36,000,000                5.23
               2002                          37,500,000                5.23
               2003                          37,500,000                5.23
               2004                           6,000,000                5.23

Gas Balancing

HEC uses the sales method for  recording its gas  balancing.  Under this method,
HEC   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,  1999,  HEC had a net  over-produced  position of 496,000 mcf
($992,000  valued at  year-end  gas  prices).  The  Company  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 HEC's  results of  operations,  liquidity and capital
resources.  The reserves  disclosed in Item 8 have been decreased by 496,000 mcf
in order to reflect HEC's gas balancing position.

Recently Issued Accounting Pronouncements

In June 1998,  the  Financial  Accounting  Standards  Board issued  Statement of
Financial  Accounting  Standards No. 133 "Accounting for Derivative  Instruments
and  Hedging  Activities"  ("SFAS  133").  SFAS 133  establishes  standards  for
derivative  instruments,  including certain derivative  instruments  embedded in
other  contracts  (collectively  referred  to as  derivatives)  and for  hedging
activities. SFAS 133 requires that an entity recognize all derivatives as either
assets or liabilities  in the statement of financial  position and measure those
instruments  at fair value.  If certain  conditions are met, a derivative may be
specifically  designated  as (a) a hedge of the  exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted  transaction,  or
(c) a hedge of the foreign  currency  exposure of a net  investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated  forecasted transaction. The accounting for changes
in the fair value of a derivative (gains and losses) depends on the intended use
of the  derivative  and the  resulting  designation.  The Company is required to
adopt SFAS 133 on January 1, 2001.  The Company has not completed the process of
evaluating the impact that will result from adopting SFAS 133.

Forward Looking Statements

Please refer to the section entitled  "Cautionary  Statement  Regarding  Forward
Looking  Statements under Item 1. for a discussion of factors which could affect
the outcome of forward looking statements used by the Company.

Inflation and Changing Prices

Prices obtained for oil and gas production depend upon numerous factors that are
beyond  the  control  of HEC,  including  the  extent of  domestic  and  foreign
production,  imports of foreign  oil,  market  demand,  domestic  and  worldwide
economic and political conditions,  storage capacity and government  regulations
and tax laws.  Prices for both oil and gas  fluctuated  from 1997 through  1999,
with a  distinct  downward  trend in both oil and gas  prices  occurring  in the
calendar year 1998 through the first quarter of 1999. Prices began to rebound in
April 1999.

The following  table presents the weighted  average prices  received per year by
HEC, 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)

<S>                     <C>                       <C>                        <C>                       <C>
1999                    $18.16                    $16.52                     $2.06                     $1.90
1998                     12.82                     13.65                      1.99                      2.02
1997                     19.35                     19.08                      2.54                      2.31
</TABLE>

As part of its risk management strategy,  HEC enters into financial contracts to
hedge the price of its oil and  natural  gas.  The  purpose  of the hedges is to
provide protection against price decreases 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 hedge contracts are recognized as oil or gas
revenue at the time the hedged volumes are sold.

HEC's  philosophy is to use derivatives to provide a measure of stability in the
volatile  price  environment  of oil and  gas,  and to  furnish  an  element  of
predictability in the cash flow of the Company. In general,  the Company expects
to hedge  up to 50%,  on a total  equivalent  volume  basis,  of its oil and gas
production for the next two forward  years,  and 30% for each of the three years
thereafter. The Company does not ordinarily intend to hedge more than 65% of any
one commodity.  In addition,  HEC will, in most cases,  enter into  transactions
with minimum  fixed prices for the  production  subject to the  contracts.  This
philosophy may be modified as circumstances require.

The  financial  contracts  used by HEC to hedge the price of its oil and natural
gas  production  are swaps,  collars and  participating  hedges.  Under the swap
contracts,  HEC 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. As of March 6, 2000,
HEC was a party to 16 financial contracts with three different counterparties.



<PAGE>


The following table provides a summary of HEC's financial contracts.

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

     2000                          54%                   $18.47
     2001                          12%                    19.16



<PAGE>


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

     2000                         42%                     $1.97
     2001                         43%                     $1.99
     2002                         34%                     $1.95

Between  11% and 13% of the gas  volumes  hedged in each year are  subject  to a
collar  agreement  whereby HEC 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 $2.54 per mcf to $2.65 per mcf.

During the first quarter  through March 6, 2000, the weighted  average oil price
(for barrels not hedged) was approximately  $26.50 per barrel,  and the weighted
average  price of natural gas (for mcf not hedged) was  approximately  $2.25 per
mcf.

Inflation

Inflation  did not have a material  impact on HEC in 1999,  1998 and 1997 and is
not anticipated to have a material impact in 2000.

Results of Operations

For accounting purposes, the Consolidation has been treated as a purchase by HEP
of the common stock of HCRC and the direct energy  interests of Hallwood  Group.
Accordingly,  all  information  presented  for  periods  prior  to June 8,  1999
represents  the  historical  information of HEP because HEP was considered to be
the acquiring entity for accounting purposes.

1999 Compared to 1998

The  following  table is  presented  to  contrast  HEC's  oil and gas  price and
production for discussion  purposes.  Significant  fluctuations are discussed in
the accompanying narrative.

                              1999             1998
                              ----             ----

Gas
  Production (mcf)          18,263,000       14,037,000
  Price (per mcf)                $1.90            $2.02
Oil
  Production (bbl)             925,000          787,000
  Price (per bbl)               $16.52           $13.65



<PAGE>


Gas Revenue

Gas revenue increased $6,373,000 during 1999 compared with 1998. The increase is
comprised of an increase in gas  production  from  14,037,000 mcf during 1998 to
18,263,000  mcf during 1999,  partially  offset by a decrease in the average gas
price  from  $2.02 per mcf in 1998 to $1.90  per mcf in 1999.  The  increase  in
production  is primarily due to the  Consolidation  which caused a 4,478,000 mcf
increase in gas  production.  This  increase was  partially  offset by decreased
production  resulting  from a  production  decline on two  significant  wells in
Louisiana  caused by increased rates of water production on the wells and normal
production declines.

The effect of HEC's  hedging  transactions  as described  under  "Inflation  and
Changing  Prices" was to decrease  HEC's average gas price from $2.06 per mcf to
$1.90 per mcf, representing a $2,922,000 decrease in gas revenues for 1999.

Oil Revenue

Oil revenue increased $4,539,000 during 1999 compared with 1998. The increase is
comprised of an increase in the average oil price from $13.65 per barrel in 1998
to $16.52 per barrel in 1999,  combined  with an  increase in  production,  from
787,000 barrels in 1998 to 925,000 barrels in 1999. The  Consolidation  caused a
production  increase of 242,000 barrels of oil which was partially offset by the
production  decline on two wells in Louisiana,  as discussed  above,  and normal
production declines.

The effect of HEC's hedging transactions was to decrease HEC's average oil price
from $18.16 per barrel to $16.52 per barrel,  resulting in a $1,517,000 decrease
in oil revenue for 1999.

Pipeline and Other

Pipeline and other  revenue  consists  primarily of  facilities  income from two
gathering  systems  located  in New  Mexico,  revenues  derived  from salt water
disposal and incentive payments related to certain wells in San Juan County, New
Mexico and LaPlata  County,  Colorado.  Pipeline  facilities  and other  revenue
increased  $2,434,000  during 1999 compared with 1998. The increase is comprised
of a  $1,716,000  increase  due to the  Consolidation  and a  $718,000  increase
primarily due to an increase in incentive  payment  income  resulting from HEC's
acquisition of a volumetric production payment during May 1998.

Interest Income

The  decrease  in interest  income of $51,000  during  1999  compared  with 1998
resulted from a lower average cash balance during 1999.

Production Operating Expense

Production  operating  expense  increased  $4,925,000  during 1999 compared with
1998.   The  increase  is  comprised  of  a  $5,527,000   increase  due  to  the
Consolidation,  partially offset by a decrease of $602,000  primarily  resulting
from cost savings measures implemented in Kansas and West Texas during 1999.

Facilities Operating Expense

Facilities  operating  expense  represents  operating  expenses  associated with
various smaller  gathering  systems  operated by HEC. The increase in facilities
operating expense of $128,000 is primarily due to increased maintenance activity
during 1999 compared with 1998.

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 HEC.
These expenses increased $2,350,000 during 1999 compared with 1998 primarily due
to the Consolidation.


<PAGE>


Depreciation, Depletion and Amortization Expense

Depreciation,  depletion and amortization  expense  increased  $5,307,000 during
1999  compared  with 1998.  The increase is due to as higher  capitalized  costs
during 1999 primarily due to the Consolidation and property  acquisitions during
1999.

Impairment of Oil and Gas Properties

Impairment  of oil  and gas  properties  during  1998  represents  the  property
impairments  recorded during 1998 because capitalized costs exceeded the present
value  (discounted at 10%) of estimated  future net revenues from proved oil and
gas reserves at June 30, 1998,  September 30, 1998 and December 31, 1998,  based
on prices of $13.00 per  barrel of oil and $2.00 per mcf of gas,  $12.80 per bbl
of oil and $1.90 per mcf of gas and  $10.00  per bbl of oil and $1.90 per mcf of
gas, respectively.

Interest Expense

Interest  expense  increased  $4,018  during  1999 as  compared  with 1998.  The
increase  is due to a  higher  average  outstanding  debt  balance  during  1999
resulting from the Consolidation and additional borrowings.

Equity in Earnings (Loss) of HCRC

Equity  in  earnings  (loss)  of  HCRC  represents  HEC's  share  of its  equity
investment  in HCRC  prior to the  Consolidation.  HEC's  equity in loss of HCRC
during  1998  represents  twelve  months of activity  whereas  the 1999  balance
represents activity until June 8, 1999. Additionally,  the 1998 balance includes
HEC's share of the property impairments recorded by HCRC.

Minority Interest in Net Income of Affiliates

Minority interest in net income of affiliates represents  unaffiliated partners'
interest  in the net income of the May  Partnerships.  The  decrease of $647,000
during 1999 compared with 1998 is primarily due to the  liquidation  of three of
the six May Partnerships on March 31, 1999.

Litigation

Litigation  income during 1999  represents  insurance  proceeds  received by HEC
which  reimbursed  costs  previously paid in connection with a property  related
claim  partially  offset by costs  accrued for the  settlement  of a take-or-pay
related  claim.  Litigation  expense  during 1998 includes the settlement of the
Ellender  lawsuit  described  in Item 8, Note 13,  and the costs  related to the
Arcadia arbitration described in Item 8, Note 12.

1998 Compared to 1997

The  following  table is  presented  to  contrast  HEC's  oil and gas  price and
production for discussion  purposes.  Significant  fluctuations are discussed in
the accompanying narrative.

                              1998             1997
                              ----             ----

Gas
  Production (mcf)          14,037,000       11,774,000
  Price (per mcf)                $2.02            $2.31
Oil
  Production (bbl)             787,000          770,000
  Price (per bbl)               $13.65           $19.08



<PAGE>


Gas Revenue

Gas revenue increased $1,146,000 during 1998 compared with 1997. The increase is
comprised of an increase in gas  production  from  11,774,000 mcf during 1997 to
14,037,000  mcf during 1998,  partially  offset by a decrease in the average gas
price from $2.31 per mcf in 1997 to $2.02 per mcf in 1998.  Production increased
because  two  temporarily  shut-in  wells were back on line.  The two wells were
temporarily  shut-in during the second quarter of 1997 while workover procedures
were  performed.  The increase in gas  production is also due to an expansion of
the gathering system in San Juan County, New Mexico during 1998.

The effect of HEC's hedging transactions was to increase HEC's average gas price
from $1.99 per mcf to $2.02 per mcf,  representing  a $421,000  increase  in gas
revenues for 1998.

Oil Revenue

Oil revenue decreased $3,949,000 during 1998 compared with 1997. The decrease is
comprised  of a decrease in the average oil price from $19.08 per barrel in 1997
to $13.65 per barrel in 1998,  partially  offset by an increase  in  production,
from 770,000  barrels in 1997 to 787,000 barrels in 1998.  Production  increased
slightly because two temporarily  shut-in wells were back on line. The two wells
were  temporarily  shut-in  during  the second  quarter  of 1997 while  workover
procedures  were  performed.  The  production  increase was partially  offset by
normal production declines.

The effect of HEC's hedging transactions was to increase HEC's average oil price
from $12.82 per barrel to $13.65 per barrel, resulting in a $653,000 increase in
oil revenue for 1998.

Pipeline and Other

Pipeline facilities and other revenue increased  $1,273,000 during 1998 compared
with 1997  primarily due to an increase in incentive  payment  income  resulting
from HEC's acquisition of a volumetric production payment during May 1998.

Interest Income

The  increase  in interest  income of $13,000  during  1998  compared  with 1997
resulted from a higher average cash balance during 1998 compared with 1997.

Production Operating Expense

Production  operating  expense  increased  $1,115,000  during 1998 compared with
1997.  The  increase is due to  increased  operating  costs  resulting  from the
drilling  projects  completed  during 1997 as well as the  additional  operating
expenses related to the properties  acquired in the Arcadia  acquisition  during
October 1998.

Facilities Operating Expense

The decrease in  facilities  operating  expense of $143,000 is primarily  due to
decreased maintenance activity during 1998 compared with 1997.

General and Administrative Expense

General and administrative  expense decreased $288,000 during 1998 compared with
1997 primarily due to a decrease in performance based compensation during 1998.

Depreciation, Depletion and Amortization Expense

Depreciation,  depletion and amortization  expense  increased  $3,759,000 during
1998  compared  with  1997.  The  increase  is due to a  higher  depletion  rate
resulting  from the  increased  production  discussed  above  as well as  higher
capitalized costs during 1998.
Impairment of Oil and Gas Properties

Impairment  of oil  and gas  properties  during  1998  represents  the  property
impairments  recorded during 1998 because capitalized costs exceeded the present
value  (discounted at 10%) of estimated  future net revenues from proved oil and
gas reserves at June 30, 1998,  September 30, 1998 and December 31, 1998,  based
on prices of $13.00 per  barrel of oil and $2.00 per mcf of gas,  $12.80 per bbl
of oil and $1.90 per mcf of gas and  $10.00  per bbl of oil and $1.90 per mcf of
gas, respectively.

Interest Expense

Interest expense decreased $299,000 during 1998 compared with 1997. The decrease
is due to a lower average  outstanding  debt balance  during 1998 as compared to
1997.

Equity in Earnings (Loss) of HCRC

HEC's equity in HCRC's earnings decreased  $6,236,000 during 1998 as compared to
1997. The decrease is primarily the result of property  impairments  recorded by
HCRC during 1998.

Minority Interest in Net Income of Affiliates

Minority  interest in net income of affiliates  decreased  $821,000  during 1998
compared  with 1997 due to a decrease in the net income of the May  Partnerships
resulting primarily from lower oil and gas prices and decreased  production from
their properties.

Litigation

Litigation  expense during 1998 includes the settlement of the Ellender  lawsuit
described  in Item 8, Note 13 and the costs  related to the Arcadia  arbitration
described  in Item 8, Note 12.  Litigation  income  during 1997 is  comprised of
insurance  proceeds  which  reimbursed a portion of expense  incurred in a prior
period to settle certain litigation.


<PAGE>


ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

HEC's primary market risks relate to changes in interest rates and in the prices
received  from sales of oil and  natural  gas.  HEC's  primary  risk  management
strategy is to partially  mitigate the risk of adverse changes in its cash flows
caused by increases in interest rates on its variable rate debt and decreases in
oil and natural gas prices, by entering into derivative  financial and commodity
instruments,  including swaps,  collars and  participating  commodity hedges. By
hedging only a portion of its market risk exposures,  HEC is able to participate
in the increased  earnings and cash flows  associated with decreases in interest
rates and  increases  in oil and natural gas prices;  however,  it is exposed to
risk on the unhedged  portion of its variable  rate debt and oil and natural gas
production.

Historically,  HEC has  attempted to hedge the exposure  related to its variable
rate debt and its  forecasted oil and natural gas production in amounts which it
believes are prudent  based on the prices of available  derivatives  and, in the
case of production hedges, the Company's  deliverable  volumes.  HEC attempts to
manage the exposure to adverse  changes in the fair value of its fixed rate debt
agreements by issuing fixed rate debt only when business  conditions  and market
conditions are favorable.

HEC does not use or hold derivative instruments for trading purposes nor does it
use derivative instruments with leveraged features. HEC's derivative instruments
are designated and effective as hedges against its identified  risks, and do not
of themselves  expose HEC to market risk because any adverse  change in the cash
flows associated with the derivative  instrument is accompanied by an offsetting
change in the cash flows of the hedged transaction.

Notes 1, 4 and 6 to the financial  statements  provide  further  disclosure with
respect to derivatives and related accounting policies.

All derivative activity is carried out by personnel who have appropriate skills,
experience and supervision.  The personnel involved in derivative  activity must
follow prescribed  trading limits and parameters that are regularly  reviewed by
the Board of  Directors  and by  senior  management.  HEC uses only  well-known,
conventional  derivative  instruments  and attempts to manage its credit risk by
entering into financial contracts with reputable financial institutions.

Following are disclosures  regarding HEC's market risk sensitive  instruments by
major category.  Investors and other users are cautioned to avoid simplistic use
of these  disclosures.  Users should  realize  that the actual  impact of future
interest rate and commodity  price movements will likely differ from the amounts
disclosed  below due to ongoing  changes in risk exposure  levels and concurrent
adjustments  to hedging  positions.  It is not  possible to  accurately  predict
future movements in interest rates and oil and natural gas prices.

Interest  Rate Risks (non  trading) - HEC uses both fixed and variable rate debt
to partially  finance  operations and capital  expenditures.  As of December 31,
1999,  HEC's  debt  consists  of  $86,200,000  in  borrowings  under its  Credit
Agreement which bears interest at a variable rate, and $25,000,000 in borrowings
under its 10.32% Senior  Subordinated Notes which bear interest at a fixed rate.
HEC hedges a portion of the risk associated with this variable rate debt through
derivative instruments,  which consist of interest rate swaps and collars. Under
the swap  contracts,  HEC makes  interest  payments on its Credit  Agreement  as
scheduled and receives or makes payments based on the  differential  between the
fixed rate of the swap and a floating  rate plus a defined  differential.  These
instruments  reduce HEC's  exposure to increases in interest rates on the hedged
portion of its debt by enabling it to  effectively  pay a fixed rate of interest
or a rate which only  fluctuates  within a  predetermined  ceiling and floor.  A
hypothetical  increase in interest rates of two percentage  points would cause a
loss in  income  and  cash  flows  of  $1,724,000  during  2000,  assuming  that
outstanding borrowings under the Credit Agreement remain at current levels. This
loss in income and cash flows  would be offset by a $900,000  increase in income
and cash flows associated with the interest rate swap and collar agreements that
are in effect for 2000.

A hypothetical  decrease in interest rates of two percentage  points would cause
an increase in the fair market value of $1,989,000 in HEC's Senior  Subordinated
Notes from their fair value at December 31, 1999.


<PAGE>


Commodity  Price  Risk (non  trading)  - HEC  hedges a portion of the price risk
associated  with the sale of its oil and natural gas production  through the use
of derivative commodity  instruments,  which consist of swaps and collars. These
instruments  reduce HEC's exposure to decreases in oil and natural gas prices on
the hedged  portion of its  production by enabling it to  effectively  receive a
fixed price on its oil and gas sales or a price that only  fluctuates  between a
predetermined  floor and  ceiling.  As of March 6, 2000,  HEC has  entered  into
derivative  commodity hedges covering an aggregate of 445,000 barrels of oil and
21,243,000 mcf of gas that extend through 2002. Under these contracts, HEC sells
its oil and natural 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 amount  received or paid upon
settlement  of these  contracts is  recognized as oil or natural gas revenues at
the time the hedged volumes are sold. A hypothetical decrease in oil and natural
gas prices of 10% from the prices in effect as of December  31, 1999 would cause
a loss in income and cash flows of $5,999,000 during 2000, assuming that oil and
gas production  remain at 1999 levels.  This loss in income and cash flows would
be offset by a $2,914,000  increase in income and cash flows associated with the
oil and natural gas derivative contracts that are in effect for 2000.




<PAGE>


ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

              INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


                                                                Page No.

FINANCIAL STATEMENTS:

Independent Auditors' Report                                          28

Consolidated Balance Sheets at December 31, 1999 and 1998          29-30

Consolidated Statements of Operations for the years ended
   December 31, 1999, 1998 and 1997                                   31

Consolidated Statements of Stockholders' Equity for the years
   ended December 31, 1999, 1998 and 1997                             32

Consolidated Statements of Cash Flows for the years ended
   December 31, 1999, 1998 and 1997                                   33

Notes to Consolidated Financial Statements                         34-51

SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED)           52-55



<PAGE>


                          INDEPENDENT AUDITORS' REPORT


To the Shareholders of Hallwood Energy Corporation:

We have  audited  the  consolidated  financial  statements  of  Hallwood  Energy
Corporation  as of December 31, 1999 and 1998 and for each of the three years in
the  period  ended  December  31,  1999,  listed in the  index at Item 8.  These
financial  statements are the  responsibility of the Company'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  Corporation at
December 31, 1999 and 1998, and the results of its operations and its cash flows
for each of the three years in the period ended  December 31, 1999 in conformity
with generally accepted accounting principles.



DELOITTE & TOUCHE LLP

Denver, Colorado
March 6, 2000



<PAGE>

<TABLE>
<CAPTION>

                           HALLWOOD ENERGY CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                                 (In thousands)


                                                                                   December 31,
                                                                                 --------------
                                                                          1999                      1998
                                                                         ------                    -----

CURRENT ASSETS
<S>                                                                    <C>                        <C>
   Cash and cash equivalents                                           $  10,480                  $  11,874
   Accounts receivable:
     Oil and gas revenues                                                 12,442                      5,911
     Trade                                                                 4,918                      4,040
   Due from affiliates                                                       704                        119
   Prepaid expenses and other current assets                               1,209                      1,338
   Net working capital of affiliate                                                                     236
                                                                   -------------                 ----------
       Total                                                              29,753                     23,518
                                                                        --------                   --------

PROPERTY,  PLANT  AND  EQUIPMENT,  at cost
  Oil and gas  properties  (full  cost method):
     Proved mineral interests                                            758,473                    664,799
     Unproved mineral interests                                            6,543                      2,694
   Furniture, fixtures and other                                           1,941                      3,411
                                                                       ---------                  ---------
       Total                                                             766,957                    670,904

   Less accumulated depreciation, depletion,
     amortization and property impairment                               (585,336)                  (565,899)
                                                                         -------                    -------
       Total                                                             181,621                    105,005
                                                                         -------                    -------

OTHER ASSETS
   Investment in common stock of HCRC                                                                10,160
   Deferred expenses and other assets                                      1,400                        408
                                                                       ---------                 ----------
       Total                                                               1,400                     10,568
                                                                       ---------                   --------

TOTAL ASSETS                                                            $212,774                   $139,091
                                                                         =======                    =======



















<FN>

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


<PAGE>

<TABLE>
<CAPTION>

                           HALLWOOD ENERGY CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                          (In thousands, except shares)


                                                                                        December 31,
                                                                                        ------------
                                                                               1999                       1998
                                                                              ------                     -----

CURRENT LIABILITIES
<S>                                                                          <C>                       <C>
   Accounts payable and accrued liabilities                                  $  26,382                 $  22,921
   Current portion of long-term debt                                                                       9,319
                                                                         -------------                 ---------
       Total                                                                    26,382                    32,240
                                                                              --------                  --------

NONCURRENT LIABILITIES
   Long-term debt                                                              109,357                    40,381
   Deferred revenue and other                                                    1,066                     1,050
                                                                             ---------                 ---------
       Total                                                                   110,423                    41,431
                                                                               -------                  --------

         Total liabilities                                                     136,805                    73,671
                                                                               -------                  --------

MINORITY INTEREST IN AFFILIATES                                                    582                     2,788
                                                                            ----------                 ---------

COMMITMENTS AND CONTINGENCIES (NOTE 14)

STOCKHOLDERS' EQUITY
   Series A Cumulative Preferred Stock;  5,000,000 shares authorized;  2,334,165
     shares issued and outstanding in 1999
     and 1998                                                                    21,386                    21,386
   Common Stock par value $.01 per share; 25,000,000 shares
     authorized; 9,999,754 shares issued and outstanding in 1999
     and 5,599,754 shares issued and outstanding in 1998                            100                        56
   Additional paid-in capital                                                    67,883                    58,052
   Accumulated deficit                                                          (13,982)                   (16,862)
                                                                               --------                   --------
         Stockholders' equity - net                                              75,387                     62,632
                                                                               --------                   --------

 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                    $212,774                   $139,091
                                                                                =======                    =======


















<FN>

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


<PAGE>

<TABLE>
<CAPTION>

                           HALLWOOD ENERGY CORPORATION
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (In thousands except per share data)


                                                                          For the Year Ended December 31,
                                                                          -------------------------------
                                                                      1999             1998              1997
                                                                     ------           ------            -----

REVENUES:
<S>                                                                 <C>              <C>               <C>
  Gas revenue                                                       $ 34,739         $ 28,366          $ 27,220
  Oil revenue                                                         15,280           10,741            14,690
  Pipeline, facilities and other                                       6,504            4,070             2,797
  Interest                                                               358              409               396
                                                                   ---------        ---------         ---------
                                                                      56,881           43,586            45,103
                                                                     -------          -------           -------

EXPENSES:
  Production operating                                                17,100           12,175            11,060
  Facilities operating                                                   626              498               641
  General and administrative                                           7,395            5,045             5,333
  Depreciation, depletion and amortization                            21,027           15,720            11,961
  Impairment of oil and gas properties                                                 14,000
  Interest                                                             6,815            2,797             3,096
                                                                    --------         --------          --------
                                                                      52,963           50,235            32,091
                                                                     -------          -------           -------

OTHER INCOME (EXPENSES):
  Equity in earnings (loss) of HCRC                                     (419)          (4,888)            1,348
  Minority interest in net income of affiliates                         (329)            (976)           (1,797)
  Litigation                                                              48           (1,382)              240
                                                                  ----------         --------          --------
                                                                        (700)          (7,246)             (209)
                                                                   ---------         --------          --------

INCOME (LOSS) BEFORE INCOME TAXES                                      3,218          (13,895)           12,803

PROVISION FOR INCOME TAXES:
  Current                                                                338
                                                                   ---------      ------------

NET INCOME (LOSS)                                                      2,880          (13,895)           12,803

PREFERRED DIVIDENDS                                                    2,368            2,464               664
                                                                    --------         --------          --------

NET INCOME (LOSS) ATTRIBUTABLE TO
   COMMON SHAREHOLDERS                                            $      512        $ (16,359)        $  12,139
                                                                   =========         ========          ========

     NET INCOME (LOSS) PER SHARE - BASIC                         $       .06      $     (2.92)       $     2.17
                                                                  ==========       ==========         =========

     NET INCOME (LOSS) PER SHARE - DILUTED                       $       .06      $     (2.92)       $     2.14
                                                                  ==========       ==========         =========

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING                             8,083            5,600             5,600
                                                                    ========         ========          ========

PRO FORMA INFORMATION ASSUMING PROVISION
   FOR INCOME TAXES APPLIED RETROACTIVELY (NOTE 1)

     Income (loss) before income taxes                             $   3,218         $(13,895)          $  12,803

     Provision for income taxes                                      -------          --------           -------

     Net income (loss)                                             $   3,218         $ (13,895)       $  12,803
                                                                    ========         ==========        ========

     Net income (loss) attributable to common shareholders         $     850         $ (16,359)        $ 12,139
                                                                   ==========          ========        =========

     Net income (loss) per share - basic                           $    .11         $     (2.92)     $      2.17
                                                                       =====         ===========      ===========

     Net income (loss) per share - diluted                         $    .11         $     (2.92)      $    2.14
                                                                       =====         ===========         ======




<FN>

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


<PAGE>

<TABLE>
<CAPTION>

                           HALLWOOD ENERGY CORPORATION
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                 (In thousands)


                                      ries A Cumulative
                                       Preferred Stock       Common       Additional       Accumulated
                                                              Stock     Paid-in-Capital     Deficit                  Total
                                                            ---------   ---------------  --------------           --------

<S>                                       <C>              <C>            <C>              <C>                     <C>
Balance, December 31, 1996                $   4,868         $     56      $  75,061        $ (15,770)              $  64,215
  Dividends                                                                   (7,676)                                  (7,676)
  Net income                                                                                   12,803                  12,803
  Other                                                                         (278)                                    (278)
                                       ------------      ------------   ------------     ------------            ------------

Balance, December 31, 1997                    4,868                56         67,107           (2,967)                 69,064
  Issuance of preferred stock, net of
     syndication costs                       16,518                                                                    16,518
  Capital contribution                                                           171                                      171
  Exercise of stock options                                                      199                                      199
  Dividends                                                                   (9,495)                                  (9,495)
  Net loss                                                                                    (13,895)                (13,895)
  Other                                                                           70                                       70
                                       ------------      ------------   ------------     ------------            ------------

Balance, December 31, 1998                   21,386                56         58,052          (16,862)                 62,632
  Issuance of common stock in the
     Consolidation                                                 44         13,892                                   13,936
  Dividends                                                                    (4,061)                                 (4,061)
  Net income                                                                                    2,880                   2,880
                                       ------------      ------------   ------------        ---------               ---------

Balance, December 31, 1999                $  21,386         $     100      $  67,883        $ (13,982)              $  75,387
                                           ========          ========       ========         ========                ========








<FN>

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

<PAGE>
<TABLE>
<CAPTION>


                           HALLWOOD ENERGY CORPORATION
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)


                                                                               For the Year Ended December 31,
                                                                             ---------------------------------
                                                                       1999                 1998                 1997
                                                                      ------               ------               -----

OPERATING ACTIVITIES:
<S>                                                                <C>                  <C>                   <C>
  Net income (loss)                                                $    2,880           $ (13,895)            $  12,803
  Adjustments to reconcile net income (loss) to net
    cash provided by operating activities:
       Depreciation, depletion and amortization                        21,027               15,720               11,961
       Impairment of oil and gas properties                                                 14,000
       Depreciation charged to affiliates                                 220                  249                  221
       Gain on asset disposals                                                               (188)
       Amortization of deferred loan costs and debt discount              282                   82                   81
       Noncash interest expense                                                                 15                  241
       Minority interest in net income                                    329                  976                1,797
       Recoupment of take-or-pay liability                              (416)                (130)                 (126)
       Equity in (earnings) loss of HCRC                                  419                4,888               (1,348)
       Undistributed (earnings) loss of affiliates                    (1,177)              (1,319)                  197

  Changes in  operating  assets  and  liabilities  provided  (used)  cash net of
       noncash activity:
         Oil and gas revenues receivable                              (2,642)                2,861                  633
         Trade receivables                                              (529)                1,029                 (562)
         Due from affiliates                                          (3,992)                (362)               (2,948)
         Prepaid expenses and other assets                                385                (247)                 (163)
         Deferred expenses and other assets                               193                (408)
         Accounts payable and accrued liabilities                       1,259                3,006                4,730
         Due to affiliates                                                                                         (133)
                                                                -------------         ------------           ----------
           Net cash provided by operating activities                   18,238               26,277               27,384
                                                                     --------             --------             --------

INVESTING ACTIVITIES:
  Additions to property, plant and equipment                         (11,093)             (28,756)               (3,233)
  Exploration and development costs incurred                         (13,069)             (12,180)              (12,983)
  Costs incurred in connection with the Consolidation                 (2,933)
  Proceeds from sales of property, plant and equipment                    388                  454                  133
  Distributions received from affiliate                                 1,833                1,583
  Investment in affiliates                                                                    (20)                  (76)
  Other investing activities                                                                                        (29)
                                                                -------------        -------------          -----------
           Net cash used in investing activities                     (24,874)             (38,919)              (16,188)
                                                                    --------             --------              --------

FINANCING ACTIVITIES:
  Payments of long-term debt                                          (3,000)             (18,286)               (7,285)
  Proceeds from equity offering, net
    of syndication costs                                                                    16,518
  Proceeds from long-term debt                                         13,000               33,000                7,000
  Dividends paid                                                      (4,061)              (9,495)               (7,676)
  Distributions paid by consolidated affiliates
    to minority interest                                                (429)              (1,446)               (1,875)
  Payment of contract settlement                                                           (2,767)
  Exercise of options                                                                          199
  Capital contribution                                                                         171
  Debt issuance costs                                                   (268)
  Other financing activities                                                                                       (278)
                                                                -------------        -------------           ----------
           Net cash provided by (used in) financing activities          5,242               17,894              (10,114)
                                                                    ---------             --------             --------

NET INCREASE (DECREASE) IN CASH AND CASH
  EQUIVALENTS                                                         (1,394)                5,252                1,082

CASH AND CASH EQUIVALENTS:

  BEGINNING OF YEAR                                                    11,874                6,622                5,540
                                                                     --------            ---------            ---------

  END OF YEAR                                                       $  10,480            $  11,874           $    6,622
                                                                     ========             ========            =========
<FN>

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


<PAGE>


                           HALLWOOD ENERGY CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES


Hallwood Energy Corporation  ("HEC" or the "Company") is a Delaware  corporation
engaged in the development,  exploration,  acquisition and production of oil and
gas  properties.  HEC began  operations  June 8, 1999,  in  connection  with the
consolidation  ("Consolidation")  of Hallwood Energy Partners,  L.P. ("HEP") and
Hallwood Consolidated  Resources Corporation ("HCRC") and the acquisition of the
direct energy interests of The Hallwood Group Incorporated  ("Hallwood  Group").
For accounting purposes, the Consolidation has been treated as a purchase by HEP
of the common stock of HCRC and the direct energy  interests of Hallwood  Group.
Accordingly,  the  assets and  liabilities  of HEP,  including  its 46% share of
assets and  liabilities  of HCRC  owned  prior to the  Consolidation,  have been
recorded at historical  cost, and the remaining  assets and  liabilities of HCRC
and the  direct  energy  interests  of  Hallwood  Group  have been  recorded  at
estimated fair values as of the date of purchase.  All information presented for
periods  prior to June 8, 1999  represents  the  historical  information  of HEP
because HEP was considered to be the acquiring  entity for accounting  purposes.
The  financial   statements  for  periods  prior  to  June  8,  1999  have  been
retroactively  restated to reflect the corporate structure of HEC, and all share
and per  share  information  assumes  that the  shares  of HEC  issued to HEP in
connection with the Consolidation were outstanding for all periods prior to June
8, 1999. The Company's  properties are primarily  located in the Rocky Mountain,
Mid-Continent, Greater Permian and Gulf Coast regions of the United States.

The following pro forma information  presents the financial  information of HEP,
HCRC and the direct property interests of Hallwood Group as if the Consolidation
had taken place on January 1 of each year presented. Any additional provision or
benefit for income taxes is excluded because of the Company's net operating loss
carryforwards and related valuation allowance.
<TABLE>
<CAPTION>

                                                                For the Year Ended December 31,
                                                     1999                                              1998
                                 --------------------------------------------      ------------------------
                                     As           Acquired                             As           Acquired
                                  Reported       Interests         Pro Forma        Reported        Interests        Pro Forma
                                  --------       ----------        ---------        --------        ---------        ---------
                                                             (In thousands except per Share data)

<S>                               <C>              <C>              <C>            <C>              <C>              <C>
Revenues                          $56,881          $11,874          $68,755        $ 43,586         $ 25,181         $ 68,767
Net income (loss)                   2,880           (1,163)           1,717          (13,895)       (21,597)          (35,492)
Net income (loss)
   attributable to
     common
     shareholders                     512           (1,163)            (651)         (16,359)       (21,597)          (37,956)
Net income (loss)
   per share - basic            $     .06                        $     (.08)      $    (2.92)                     $     (6.78)
                                 ========                         =========        =========                       ==========
Net income (loss)
   per share - diluted          $     .06                        $     (.08)      $    (2.92)                     $     (6.78)
                                 ========                         =========        =========                       ==========
</TABLE>



<PAGE>


Accounting Policies

Consolidation

HEC  fully  consolidates  entities  in which it owns a greater  than 50%  equity
interest  and  reflects  a  minority  interest  in  the  consolidated  financial
statements.  The accompanying  financial  statements  include the majority owned
affiliates,  the May  Limited  Partnerships  1984-1,  1984-2  and 1984-3 for all
periods and the May Limited Partnerships 1983-1, 1983-2 and 1983-3 through March
31, 1999 when they were liquidated.

Pro Forma Information

The pro forma  information  included in the  statements of  operations  has been
presented to reflect the provision for income taxes,  using statutory  rates, as
though the Company  had been a taxable  corporation  for all periods  presented.
Because  of the  Company's  net  operating  loss  carryforwards  and its  recent
operating losses, it is assumed that the Company would have had a full valuation
allowance.  Accordingly,  no  provision  or benefit  for  income  taxes has been
recorded in any period.

Derivatives

As of March 6,  2000,  HEC was a party to 16  financial  contracts  to hedge the
price of its oil and  natural  gas.  The  purpose  of the  hedges is to  protect
against  price  decreases  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.

As of March 6, 2000, HEC was a party to eight  financial  contracts to hedge the
interest  payments under its Credit  Agreement.  The purpose of the hedges is to
protect against the variability of the interest rates under its Credit Agreement
which has a floating interest rate. 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

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

As of December 31,  1999,  HEC had a net  over-produced  position of 496,000 mcf
($992,000  valued at  year-end  gas  prices).  The  Company  believes  that this
imbalance can be made up with  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 HEC's  results of  operations,  liquidity and capital
resources.  HEC's  oil and gas  reserves  as of  December  31,  1999  have  been
decreased by 496,000 mcf in order to reflect HEC's gas balancing position.

Property, Plant and Equipment

HEC follows the full cost method of accounting  whereby all costs related to the
acquisition  and  development  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.



<PAGE>


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.  During the second, third
and fourth  quarters  of 1998,  using oil and gas prices of $13.00 per barrel of
oil and $2.00 per mcf of gas,  $12.80 per barrel of oil and $1.90 per mcf of gas
and  $10.00  per  barrel  of oil and  $1.90  per mcf of gas,  respectively,  HEC
recorded  oil and gas property  impairments  totaling  $14,000,000.  HEC did not
record any property impairments during 1999 or 1997.

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

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.

Long-lived  assets,  other than oil and gas  properties  which are evaluated for
impairment as described above,  are evaluated for impairment  whenever events or
changes  in  circumstances   indicate  that  the  carrying  amount  may  not  be
recoverable. To date, HEC has not recognized any impairment losses on long-lived
assets other than oil and gas properties.

Dividends

On December  13, 1999,  HEC  declared a quarterly  dividend of $.25 per Series A
Cumulative  Preferred share, which was paid on February 15, 2000 to shareholders
of record on December 31, 1999. This amount was accrued as of year-end.

The Series A Cumulative  Preferred Stock has a dividend  preference of $1.00 per
share per year.  HEC may not  declare or pay  dividends  to common  shareholders
unless full cumulative dividends have been paid on the preferred stock.

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 (Loss) Per Share

Basic  income  (loss)  per share is  computed  by  dividing  net  income  (loss)
attributable to the common shareholders by the weighted average number of common
shares outstanding during the periods.  Diluted income per common share includes
the potential dilution that could occur upon exercise of the options or warrants
to acquire  common stock  computed using the treasury stock method which assumes
that the  increase  in the  number of shares is  reduced by the number of shares
which could have been  repurchased  by the Company  with the  proceeds  from the
exercise of the options or warrants (which were assumed to have been made at the
average  market price of the common  shares during the  reporting  period).  The
warrants described in Note 6 have been ignored in the computation of diluted net
income (loss) per share in all periods and the stock options described in Note 9
have been ignored in the  computation of diluted income (loss) per share in 1999
and 1998 because their inclusion would be anti-dilutive.



<PAGE>


The following  table  reconciles  the number of shares  outstanding  used in the
calculation of basic and diluted income (loss) per share.
<TABLE>
<CAPTION>

                                     Income
                                                     (Loss)           Shares          Per Share
                                                     ------           ------          ---------
                                                 (In thousands except per Share data)

For the Year Ended December 31, 1999
<S>                                                <C>                  <C>             <C>
   Net income per share - basic                    $       512          8,083           $   .06
                                                    ----------         ------            ======
   Net income per share - diluted                  $       512          8,083           $   .06
                                                    ==========         ======            ======

For the Year Ended December 31, 1998
   Net loss per share - basic                        $(16,359)          5,600            $(2.92)
                                                       ------           -----             =====
   Net loss per share - diluted                      $(16,359)          5,600            $(2.92)
                                                       ======           =====             =====

For the Year Ended December 31, 1997
   Net income per share - basic                       $ 12,139          5,600            $ 2.17
                                                                                          =====
   Effect of options                                                       83
                                                 -------------        -------
   Net income per share - diluted                     $ 12,139          5,683            $ 2.14
                                                       =======          =====             =====
</TABLE>

Use of Estimates

The  preparation of the financial  statements for the Company 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 Company  sells the majority of its oil and gas  production to a few
purchasers,  there are numerous other  purchasers in the area in which HEC sells
its  production;  therefore,  the loss of its  significant  customers  would not
adversely affect HEC's  operations.  For the years ended December 31, 1999, 1998
and 1997, purchases by the following companies exceeded 10% of the total oil and
gas revenues of the Company:



<PAGE>


                                         1999             1998              1997
                                         ----             ----              ----

Conoco Inc.                              19%               23%              20%
El Paso Field Services Company           14%               11%              11%
Plains All American Inc.                 14%
Marathon Petroleum Company                                                  16%

Environmental Concerns

HEC 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,  1999,  HEC 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 HEC in the oil and gas
industry.

Other Comprehensive Income

The Company does not have any items of other comprehensive  income for the years
ended December 31, 1999, 1998 and 1997.  Therefore,  total comprehensive  income
(loss) is the same as net income (loss) for those periods.



<PAGE>


Segments

The Company engages in the development,  production and sale of oil and gas, and
the  acquisition,   exploration,  development  and  operation  of  oil  and  gas
properties  in  the  continental  United  States.  In  addition,  the  Company's
activities  exhibit  similar  economic  characteristics  and  involve  the  same
products, production processes, class of customers, and methods of distribution.
Management of the Company  evaluates its  performance  as a whole rather than by
product  or  geographically.  As a  result,  HEC's  operations  consist  of  one
reportable segment.

Recently Issued Accounting Pronouncements

In June 1998,  the  Financial  Accounting  Standards  Board issued  Statement of
Financial  Accounting  Standards No. 133 "Accounting for Derivative  Instruments
and  Hedging  Activities"  ("SFAS  133").  SFAS 133  establishes  standards  for
derivative  instruments,  including certain derivative  instruments  embedded in
other  contracts  (collectively  referred  to as  derivatives)  and for  hedging
activities. SFAS 133 requires that an entity recognize all derivatives as either
assets or liabilities  in the statement of financial  position and measure those
instruments  at fair value.  If certain  conditions are met, a derivative may be
specifically  designated  as (a) a hedge of the  exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted  transaction,  or
(c) a hedge of the foreign  currency  exposure of a net  investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated  forecasted transaction. The accounting for changes
in the fair value of a derivative (gains and losses) depends on the intended use
of the  derivative  and the  resulting  designation.  The Company is required to
adopt SFAS 133 on January 1, 2001.  The Company has not completed the process of
evaluating the impact that will result from adopting SFAS 133.

Reclassifications

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


NOTE 2 - OIL AND GAS PROPERTIES

The following  table  summarizes cost  information  related to HEC's oil and gas
activities:

                                          For the Year Ended December 31,
                                          -------------------------------
                                      1999             1998              1997
                                      ----             ----              ----
                                                  (In thousands)

Property acquisition costs:
  Proved                            $  85,235          $28,397           $ 1,942
  Unproved                              3,849              379             1,071
Development costs                       7,302            8,087             7,607
Exploration costs                       5,767            6,043             6,950
                                    ---------          -------           -------
      Total                          $102,153          $42,906           $17,570
                                      =======           ======            ======

Depreciation,  depletion,  amortization and impairment expense related to proved
oil and gas  properties  per  equivalent  mcf of production  for the years ended
December 31, 1999, 1998 and 1997, was $.88, $1.58 and $.73, respectively.



<PAGE>


At December 31, unproved properties consist of the following:

                                  1999             1998
                                  ----             ----
                                     (In thousands)

Texas                             $4,898           $1,857
North Dakota                       1,009              499
Other                                636              338
                                  ------           ------
                                  $6,543           $2,694
                                   =====            =====


NOTE 3 - PRINCIPAL ACQUISITIONS AND SALES

On October 20, 1999, HEC acquired oil and gas properties located  principally in
the  Yoakum  Gorge  area of Lavaca  County,  Texas  for  $7,230,000  and  future
contingent  consideration.  The  acquisition  was  comprised  of interests in 34
wells, drilling locations, exploration acreage and 3-D seismic data.

As a result of the arbitration discussed in Note 12, HEC completed an $8,200,000
acquisition  of properties  located  primarily in Texas during October 1998. The
acquisition  included  interests  in 570 wells,  numerous  proven  and  unproven
drilling locations, exploration acreage and 3-D seismic data.

In July  1996,  HEC and its  affiliate,  HCRC,  acquired  interests  in 38 wells
located primarily in LaPlata County,  Colorado. An unaffiliated large East Coast
financial institution formed an entity to utilize the tax credits generated from
the wells.  The project was financed by an  affiliate  of Enron Corp.  through a
volumetric  production  payment.  During May 1998, a limited  liability  company
owned equally by HEC and HCRC purchased the volumetric  production  payment from
the affiliate of Enron Corp. HEC funded its $17,257,000 share of the acquisition
price from operating cash flow and borrowings under its Credit Agreement.

During 1997, HEC had no individually significant property acquisitions or sales.

Subsequent  to  December  31,  1999  and  through   March  6,  2000,   HEC  sold
approximately  145 oil and gas properties  located in Texas,  Oklahoma and North
Dakota for approximately  $7,100,000.  HEC used $6,000,000 of the sales proceeds
to pay  down  its  outstanding  debt and the  remainder  was  used  for  general
operations and capital projects.


NOTE 4 - DERIVATIVES

As part of its risk management strategy,  HEC enters into financial contracts to
hedge the price of its oil and natural  gas.  HEC does not use these  hedges for
trading  purposes,  but rather for the purpose of providing  protection  against
price  decreases  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 HEC to hedge the price of its oil and natural
gas  production  are swaps,  collars and  participating  hedges.  Under the swap
contracts,  HEC 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. As of March 6, 2000,
HEC was a party to 16 financial contracts with three different counterparties.



<PAGE>


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

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

       1997                       346,000                             $17.78
       1998                       175,000                              16.62
       1999                       325,000                              15.43
       2000                       372,000                              18.47
       2001                        73,000                              19.16



<PAGE>


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

       1997                     5,386,000                              $1.97
       1998                     7,101,000                               2.09
       1999                    15,574,000                               1.85
       2000                     9,040,000                               1.97
       2001                     7,355,000                               1.99
       2002                     4,848,000                               1.95

From 1999  forward,  between 11% and 13% of the gas volumes  hedged in each year
are subject to a collar agreement whereby HEC 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 price  ranges  from $2.54 per mcf to
$2.65 per mcf.

In the event of nonperformance by the counterparties to the financial contracts,
HEC is exposed to credit loss, but has no  off-balance  sheet risk of accounting
loss. The Company  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 HEC's hedges are secured by the lien on HEC's oil and
gas properties which also secures HEC's Credit Agreement described in Note 6.


NOTE 5 - INVESTMENT IN AFFILIATED CORPORATION

During 1998 and 1997,  HEC  accounted for its  approximate  46% interest in HCRC
using the equity method of accounting.  As a result of the Consolidation,  HEC's
investment in HCRC was eliminated.  The following presents summarized  financial
information for HCRC at December 31, 1998 and 1997.

                                           1998             1997
                                           ----             ----
                                               (In thousands)

Current assets                            $12,566          $15,145
Noncurrent assets                          88,601           77,226
Current liabilities                        18,262           11,007
Noncurrent liabilities                     53,316           32,678
Revenue                                    32,410           32,411
Net income (loss)                          (20,279)          5,585

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


<PAGE>


The following  amounts  represent HEC's share of the property  related costs and
reserve  quantities  and values of its equity  investee  HCRC as of December 31,
1998 and 1997, prior to its elimination on June 8, 1999 (in thousands):

Capitalized Costs Relating to Oil and Gas Activities:

                                                    As of December 31,
                                                  1998             1997
                                                  ----             ----

Unproved properties                            $   1,286        $   1,040
Proved properties                                147,600          118,966
Accumulated depreciation, depletion,
  amortization and property impairment           (100,890)         (92,511)
                                                  -------          -------
Net property                                    $ 47,996         $ 27,495
                                                 =======          =======

Costs Incurred in Oil and Gas Activities:

                                  For the Year Ended December 31,
                                      1998             1997
                                      ----             ----

Acquisition costs                   $ 12,879          $ 1,303
Development costs                      2,636            2,060
Exploration costs                      2,606            2,851
                                    --------           ------
     Total                          $ 18,121          $ 6,214
                                     =======           ======



<PAGE>


                                                 For the Year Ended December 31,
                                                     1998             1997
                                                     ----             ----

Oil and gas revenue                                $ 10,372          $10,889
Production operating expense                          (4,272)          (3,746)
Depreciation, depletion, amortization
  and property impairment expense                    (13,773)          (3,336)
Income tax benefit (expense)                                             (761)
                                                  ---------          --------
     Net income (loss) from oil and gas activities $  (7,673)       $  3,046
                                                    ========         =======

Proved Oil and Gas Reserve Quantities:

                                                    Gas              Oil
                                                    Mcf              Bbl
                                                        (unaudited)

Balance, December 31, 1998                        32,000            1,470
                                                  ======            =====
Balance, December 31, 1997                        27,268            2,065
                                                  ======            =====

Standardized Measure of Discounted Future Net Cash Flows:

                                   (unaudited)

December 31, 1998                                      $30,134
                                                        ======
December 31, 1997                                      $31,245
                                                        ======




<PAGE>


NOTE 6 - DEBT

HEC's long-term debt at December 31, 1999 and 1998 consisted of the following:

                                              1999             1998
                                              ----             ----
                                                 (In thousands)

Credit Agreement                          $  86,200        $  49,700
Note Agreement                               25,000
Debt discount                                (1,843)
                                          ---------           -------

Total debt                                   109,357          49,700
Less current maturities                                       (9,319)
                                        -------------      ---------
Long-term debt                              $109,357       $  40,381
                                             =======        ========

On June 8, 1999, HEC and its lenders entered into an Amended and Restated Credit
Agreement (as amended,  the "Credit  Agreement")  to extend the term date of its
line of credit to May 31, 2002.  The lenders are Morgan  Guaranty Trust Company,
First Union National Bank and Bank of America. The terms of the Credit Agreement
were  amended on October 15,  1999,  to,  among other  matters,  increase  HEC's
borrowing base to $90,000,000. At December 31, 1999, HEC had amounts outstanding
of $86,200,000.

HEC's plans are to sell its interests in approximately 500 non-strategic oil and
gas wells during 2000.  These  property sales will enable HEC to better focus on
its core  areas  while at the same time  reduce its level of  outstanding  debt.
Subsequent to December 31, 1999 and through March 6, 2000, approximately 145 oil
and  gas  properties  have  been  sold  and  HEC has  repaid  $6,000,000  of its
borrowings under the Credit Agreement. On January 27, 2000, the Credit Agreement
was further amended to reduce HEC's borrowing base to reflect the property sales
made by the  Company and to waive  compliance  with an asset sale  covenant.  On
February 9, 2000,  HEC's  borrowing  base was further  reduced to $84,479,000 to
reflect the most recent  property sales,  and therefore  HEC's unused  borrowing
base totaled $4,279,000 at March 6, 2000.

Borrowings  against  the  Credit  Agreement  bear  interest  at the lower of the
Certificate  of Deposit rate plus from 1.375% to 2.125%,  prime plus 1/2% or the
Euro-Dollar rate plus from 1.25% to 2.0%. The applicable  interest rate was 8.5%
at December 31, 1999. Interest is payable monthly.  Quarterly principal payments
of  $11,457,000  are  calculated to include the repayments of the borrowing made
subsequent to December 31, 1999 and commence May 31, 2002.

The  borrowing  base  for  the  Credit   Agreement  is  typically   redetermined
semiannually,  although the lenders have the right to make a redetermination  at
anytime. The Credit Agreement is secured by a first lien on approximately 80% in
value of HEC's oil and gas properties.  Additionally,  aggregate  dividends paid
and stock  repurchased  by HEC in any 12 month period are limited to 50% of cash
flow from operations before working capital changes and  distributions  received
from  affiliates,  if the principal  amount of debt of HEC is 50% or more of the
borrowing  base.  Aggregate  dividends  paid and  stock  repurchased  by HEC are
limited to 65% of cash flow from  operations  before working capital changes and
distributions received from affiliates,  if the principal amount of debt is less
than 50% of the borrowing base.

At the  time  of the  Consolidation,  HCRC  had  $25,000,000  of  10.32%  Senior
Subordinated Notes ("Subordinated  Notes") due December 23, 2007 and warrants to
purchase  common stock which were held by The  Prudential  Insurance  Company of
America  ("Prudential").  On June 8, 1999, the Amended and Restated Subordinated
Note and Warrant Purchase  Agreement (the "Note Agreement") was amended to issue
warrants to  Prudential to purchase  309,278  shares of HEC's Common Stock at an
exercise price of $7.00 per share.  The terms of the Note Agreement were further
amended on October  15,  1999 to exclude  certain  hedging  transactions  of the
subsidiaries  of HEC from the  calculation of  indebtedness.  In connection with
this amendment, the Company received a written waiver under the Credit Agreement
of the restriction on amendment to the Note Agreement.  The  Subordinated  Notes
bear  interest  at the rate of 10.32% per annum on the unpaid  balance,  payable
quarterly.  Annual  principal  payments of $5,000,000  are due December 23, 2003
through December 23, 2007.


<PAGE>


HEC recorded  the  Subordinated  Notes and the warrants  based upon the relative
fair values of the  Subordinated  Notes without the warrants and of the warrants
themselves at the time of Consolidation.  The allocated value of the warrants of
$1,956,000  was  recorded as  additional  paid-in-capital.  The  discount on the
Subordinated  Notes is being amortized over the term of the  Subordinated  Notes
using the interest method of amortization.

At December 31, 1999, HEC's debt maturity schedule is as follows.

                                  (In thousands)

2000                            $          --
2001                                       --
2002                                   36,943
2003                                   54,257
2004                                    5,000
Thereafter                             13,157
                                     --------
  Total                              $109,357
                                      =======

As part of its risk management strategy,  HEC enters into financial contracts to
hedge the interest rate payments  under its Credit  Agreement.  HEC does not use
the hedges for trading purposes, but rather to protect against the volatility of
the cash flows under its Credit  Agreement,  which has a floating interest rate.
The  amounts  received  or  paid  upon  settlement  of  these  transactions  are
recognized as interest expense at the time the interest payments are due.

All contracts are interest rate swaps with fixed rates. As of March 6, 2000, HEC
was a party to eight contracts with three different counterparties.

The following table provides a summary of HEC's financial contracts.

                                                  Average
                           Amount of              Contract
Period                    Debt Hedged            Floor Rate

1997                      $15,000,000                6.56%
1998                       15,000,000                6.84%
1999                       40,000,000                5.70%
2000                       45,000,000                5.65%
2001                       36,000,000                5.23%
2002                       37,500,000                5.23%
2003                       37,500,000                5.23%
2004                        6,000,000                5.23%


NOTE 7 - STOCKHOLDERS' EQUITY

HEC's stock  trades on the NASDAQ  under the symbol  "HECO" for Common Stock and
"HECOP" for Series A Cumulative Preferred Stock.

Common Stock

Under its charter,  HEC is authorized  to issue up to  25,000,000  shares of HEC
common  stock with a par value of $.01 per share.  The common  shareholders  are
entitled to one vote per share on all matters  voted on by  shareholders.  After
giving  effect to any  preferential  rights of any  series  of  preferred  stock
outstanding,  the holders of HEC common  stock are  entitled to  participate  in
dividends,  if any,  as may be  declared  from  time to  time  by the  board  of
directors of HEC.  Upon  liquidation,  the common  shareholders  are entitled to
receive  a pro rata  share of all of the  assets of HEC that are  available  for
distribution to such holders. The holders of HEC common stock have no preemptive
rights with respect to future issuances of HEC common stock.
Preferred Stock

HEC is authorized to issue up to 5,000,000  shares of preferred  stock from time
to time,  in one or more  series,  without  shareholder  approval and to fix the
designation,   preferences,   conversion   or  other  rights,   voting   powers,
restrictions,   limitations  as  to  dividends,  qualifications  and  terms  and
conditions of redemption of any series that may be  established by the HEC Board
of Directors.

In  connection  with  the  Consolidation,  the  Board  of  Directors  of HEC has
authorized  the  issuance of 2,334,165  shares of Series A cumulative  preferred
stock.  Each share of preferred  stock is entitled to one vote on all matters on
which  shareholders may vote. The preferred  shareholders vote together with the
common shareholders in the election of directors and vote as a separate class on
all other matters.

Preferred  shareholders are entitled to receive cumulative cash dividends at the
rate of $1.00 per share per year,  if  declared  by the HEC Board of  Directors.
Dividends  are paid  quarterly  in  arrears  commencing  on June 30,  1999.  The
dividends are fully cumulative and accumulate, whether or not earned or declared
and whether or not HEC has funds legally available to pay them, without interest
on a daily basis.  HEC may not declare or pay  dividends to common  shareholders
unless full cumulative dividends have been paid on the preferred stock.

Upon  liquidation or  dissolution of HEC, all accrued  dividends must be paid to
the preferred  shareholders  before any assets may be  distributed to the common
shareholders.  Once all accrued  preferred  dividends  are paid,  the  preferred
shareholders are entitled to participate equally with the common shareholders in
the distribution of the remaining assets of HEC in a liquidation or dissolution.

The HEC preferred  stock is  redeemable at the option of HEC after  December 31,
2003.  After that date, HEC may redeem shares of preferred  stock in whole or in
part at any time at a  redemption  price  of  $10.00  per  share,  plus  accrued
dividends  which are unpaid on the redemption  date.  Preferred stock may not be
redeemed in part if full  cumulative  dividends  have not been paid or set aside
for payment with respect to all prior dividend periods.

Rights Plan

During the second  quarter of 1999,  the board of  directors of HEC approved the
adoption of a rights plan  designed  to protect  shareholders  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 common
share of HEC to holders of record at the close of business on June 8, 1999.  The
rights trade with the common stock.  The rights will become  exercisable only in
the event, with certain  exceptions,  that an acquiring party accumulates 15% or
more of HEC's outstanding common stock. The rights will expire on June 7, 2009.

HEC 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
common shares.

Issuance of HEP Units

On February  17,  1998,  HEP closed its public  offering of 1.8 million  Class C
Units, priced at $10.00 per Unit. Proceeds to HEP, net of underwriting expenses,
were  approximately  $16,518,000.  HEP used  $14,000,000  of the net proceeds to
repay borrowings  under its Credit Agreement and applied the remaining  proceeds
toward the repayment of HEP's outstanding contract settlement obligation.



<PAGE>


NOTE 8 - INCOME TAXES

The  following  is a summary  of the  income  tax  provision  for the year ended
December  31, 1999 (in  thousands).  HEC was not a taxable  entity  prior to the
Consolidation on June 8, 1999:

State                                                   $338
Federal - Current
          Deferred
            Total                                       $338
                                                         ===

Reconciliation  of the expected tax at the  statutory  tax rate to the effective
tax is as follows for the year ended December 31, 1999 (in thousands):

Expected tax expense at the
  statutory rate                                      $1,094
State taxes net of federal benefit                       223
Taxes on income prior to June 8, 1999                   (440)
Change in valuation allowance                           (789)
Other                                                    250
                                                      ------
     Effective tax expense                           $   338
                                                      ======

Deferred  income  taxes  reflect  the net tax effects of  temporary  differences
between the carrying  amounts of assets and liabilities for financial  reporting
purposes  and the  amount  used for  income  tax  purposes.  The tax  effects of
significant  items comprising the Company's  deferred tax assets and liabilities
as of December 31, 1999 (in thousands) are as follows:

Deferred tax assets and (liabilities):
  Net operating loss carryforward                   $  7,758
  Capital loss carryforward                            1,458
  Minimum tax credit carryforward                        534
  Temporary differences between
     book and tax basis of property                     (215)
                                                    --------
       Total                                           9,535

  Valuation allowance                                 (9,535)
                                                      ------

Net deferred tax asset                            $      -0-
                                                   =========

The Company's net operating loss carryforwards expire between 2008 and 2019, the
capital  loss   carryforward   expires  in  2001  and  the  minimum  tax  credit
carryforward has no expiration date.


NOTE 9 - EMPLOYEE INCENTIVE PLANS

Every  year  beginning  in 1992,  the Boards of  Directors  of HEP and HCRC have
adopted an  incentive  plan.  Each year the Boards of  Directors  determine  the
percentage  of each  entities  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 2.80% for 1999, 2.75% for 1998, and
2.40% for 1997. The specified  percentage of cash flow is then  allocated  among
certain key employees who are  designated by the boards as  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,  at the conclusion of which the  participants
are each  paid a share of an amount  equal to a  specified  percentage  (80% for
1999, 1998 and 1997) of the remaining net present value of the qualifying wells,
and the award for that year terminates.  The expenses  attributable to the plans
were $220,000 in 1999, $125,000 in 1998 and $277,000 in 1997 and are included in
general and administrative expense in the accompanying financial statements.

On June 9, 1999,  the  Compensation  Committee of HEC adopted an incentive  plan
that is  substantially  the  same as the  incentive  plan of HEP and  HCRC,  and
specified  that the  percentage  of cash flow  allocated to the new plan for the
remainder of 1999 be 2.80%,  the same as was  allocated for the 1999 plan by HEP
and HCRC.

On June 9, 1999, the  Compensation  Committee of HEC granted options to purchase
600,000 shares of common stock at an exercise price of $7.00 per share which was
equal to the fair market value on the date of grant.  On November 22, 1999,  HEC
granted an  additional  61,500  options to purchase  common stock at an exercise
price of $7.00 per share  which was greater  than the fair  market  value of the
common  stock on the date of the  grant.  The  options  expire on June 9,  2006,
unless sooner  terminated  pursuant to the provisions of the plan.  One-third of
the options  vested on the grant date,  and the remainder vest one-third on June
8, 2000 and one-third on June 8, 2001.

On January 28,  2000,  the  Compensation  Committee  of HEC  granted  options to
purchase 238,500 shares of common stock at an exercise price of $4.625 per share
which  was equal to the fair  market  value of the  common  stock on the date of
grant. The options expire on January 28, 2007, unless sooner terminated pursuant
to the provisions of the plan. One-third of the options vested on the grant date
and the  remainder  vest  one-third on January 28, 2001 and one-third on January
28, 2002.

Prior to the Consolidation,  the following HEP options were outstanding.  All of
these options were cancelled on June 8, 1999.

                                 Number of Options
                           Outstanding      Exercisable     Exercise Price


Class A Unit Options        390,400           390,400          $  5.75
Class A Unit Options         25,500            17,000          $  6.625
Class C Unit Options        120,000           120,000           $10.00

A summary  of options  granted to  purchase  HEC  common  stock and the  changes
therein during the year-ended December 31, 1999 is presented below:

                                                            Weighted
                                                            Average
                                                            Exercise
                                            Shares           Price

Outstanding at beginning of year                --          $    --
Granted                                     661,500            7.00
                                            -------            ----
Outstanding at end of year                  661,500           $7.00
                                            =======            ====

Options exercisable                         220,500           $7.00
                                            =======            ====



<PAGE>


A summary of options  granted to purchase Class A Units and the changes  therein
during the years-ended December 31, 1999, 1998, and 1997 is presented below:



<PAGE>
<TABLE>
<CAPTION>


                                              1999                        1998                        1997
                                             ------                      ------                      -----
                                                  Weighted                    Weighted                    Weighted
                                                  Average                     Average                     Average
                                                  Exercise                    Exercise                    Exercise
                                     Units         Price         Units         Price         Units         Price
                                     -----         -----         -----         -----         -----         -----

Outstanding at beginning
<S>                                 <C>          <C>             <C>            <C>          <C>            <C>
   of year                          415,900      $  5.80         425,000        $5.75        425,000        $5.75
Granted                                                           25,500         6.625
 Exercised                                                      (34,600)         5.75
 Cancelled                         (415,900)     $  5.80
                                    -------       ------     -------------   --------    -------------
 Outstanding at end of  year                -- $       --        415,900        $5.80        425,000        $5.75
                                 =============  =========        =======         ====        =======         ====

 Options exercisable at year-end            -- $       --        398,900        $5.80        425,000        $5.75
                                 =============  =========        =======         ====        =======         ====
</TABLE>

A summary of options  granted to purchase  Class C Unit  Options and the changes
therein during the year ended December 31, 1999 and 1998 is presented below:
<TABLE>
<CAPTION>

                                                            1999                               1998
                                                            ----                               ----
                                                                    Weighted                           Weighted
                                                                Average Exercise                   Average Exercise
                                                                     Price                              Price
                                                   Units                               Units

<S>                                               <C>                <C>            <C>                 <C>
Outstanding at beginning of year                  120,000            $10.00               --         $      --
Granted                                                                              120,000             10.00
Cancelled                                        (120,000)            10.00
                                                  -------             -----       --------------
Outstanding at end of year                               --      $       --          120,000            $10.00
                                              =============       =========          =======             =====

Options exercisable at year-end                          --      $       --           60,000            $10.00
                                              =============       =========         ========             =====
</TABLE>

The Company 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 options
granted.  Had compensation  expense for options granted been determined based on
the fair value at the grant date for the options, consistent with the provisions
of SFAS 123,  HEC's net income (loss) and net income (loss) per share would have
been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>

                                                       1999               1998                1997
                                                       ----               ----                ----

<S>                                                 <C>              <C>                  <C>
Net income(loss):               as reported         $2,880,000       $(13,895,000)        $12,803,000
                                pro forma              930,000        (14,022,000)         12,730,000
Net income (loss) per share - basic:
                                as reported             $  .06             $(2.92)              $2.17
                                pro forma                $(.18)            $(2.94)              $2.15
Net income (loss) per share - diluted:
                                as reported             $  .06             $(2.92)              $2.14
                                pro forma                $(.18)            $(2.94)              $2.12
</TABLE>



<PAGE>


The fair value of the common stock options  granted  during 1999, for disclosure
purposes was estimated on the dates of grant using the Black-Scholes Model using
the following assumptions.
<TABLE>
<CAPTION>

                              Common Stock Options
                                    Granted                   Granted
                                  June 9, 1999           November 22, 1999
                                  ------------           -----------------

<S>                                <C>                      <C>
Expected dividend yield             --                       --
Expected price volatility           68%                      68%
Risk-free interest rate               5.8%                     6.4%
Expected life of options              7 years                  7 years
</TABLE>

The fair value of the unit options  granted during 1998 and 1995, for disclosure
purposes was estimated on the dates of grant using the Binomial  Option  Pricing
Model using the following assumptions:

                              1995 Class A       1998 Class A       1998 Class C
                                 Options            Options            Options

Expected dividend yield             6%                 8%              11%
Expected price volatility         28%                27%               29%
Risk-free interest rate             7.6%               6.4%              6.4%
Expected life of options          10 years           10 years          10 years


NOTE 10 - RELATED PARTY TRANSACTIONS

The Company  manages and operates  certain oil and gas  properties  on behalf of
independent  joint interest  owners and its  affiliates.  In such capacity,  the
Company pays all costs and expenses of operations and  distributes  all revenues
associated with such properties. HEC has receivables from affiliates of $704,000
and $119,000 at December 31, 1999 and 1998,  respectively,  which  represent net
revenues net of operating  costs and expenses.  The balances with affiliates are
settled monthly.

During  the  years  ended  December  31,  1999,  1998  and  1997,  HEC  incurred
approximately $124,000, $274,000 and $275,000,  respectively, of consulting fees
under a consulting  agreement with Hallwood Group. The consulting  agreement was
terminated effective June 8, 1999 in connection with the Consolidation. HEC also
incurred $195,000,  $317,000 and $301,000 in 1999, 1998 and 1997,  respectively,
representing  costs  incurred by Hallwood  Group and its affiliates on behalf of
the Company.

On February 18, 2000,  HEC  repurchased  and retired  43,816  shares of Series A
Preferred Stock from it affiliate,  Hallwood Group for $303,426. The shares were
repurchased  for $6.925 per share which  represented  the average of the closing
prices of the stock during the five days prior to February 18, 2000.




<PAGE>


NOTE 11 - STATEMENT OF CASH FLOWS

In connection with the  Consolidation,  the purchase of the common stock of HCRC
and the direct  energy  interests  of Hallwood  Group was  recorded  through the
issuance  of  approximately  2,600,000  shares of HEC  common  stock to HCRC and
1,800,000  shares of HEC common stock to Hallwood  Group based on the  estimated
fair value of the assets acquired and the liabilities  assumed as of the date of
purchase. This noncash investing activity is summarized as follows:

                                                             Fair Value of
                                                           Acquired Interest
                                                           -----------------
                                                            (In thousands)

Current assets                                                $   4,823
Oil and gas properties                                           81,348
Other assets                                                      1,140
Current liabilities                                              (2,606)
Long-term debt                                                  (49,544)
Other noncurrent liabilities                                        (62)

Cash paid during 1999, 1998 and 1997 for interest totaled $6,583,000, $2,700,000
and  $2,775,000,  respectively.  Cash  paid for  income  taxes  during  1999 was
$375,000.  There was no cash paid for income  taxes  during 1998 and 1997 as HEC
was not a tax paying entity.


NOTE 12 - ARBITRATION

In connection with the Demand for Arbitration  filed by Arcadia  Exploration and
Production Company ("Arcadia") with the American Arbitration Association against
Hallwood Energy Partners,  L.P., Hallwood  Consolidated  Resources  Corporation,
E.M.  Nominee  Partnership  Company and  Hallwood  Consolidated  Partners,  L.P.
(collectively  referred  to as  "Hallwood"),  the  arbitrators  ruled  that  the
original  agreement  entered  into  in  August  1997  to  purchase  oil  and gas
properties  for  $16,400,000  should  proceed,  with a  reduction  in the  total
purchase price of  approximately  $2,500,000 for title defects.  The arbitrators
also ruled that Arcadia was not entitled to enforce its claim that  Hallwood was
required to purchase an additional $8,000,000 in properties and denied Arcadia's
claim for attorneys fees. The arbitrators granted Arcadia  prejudgment  interest
on the adjusted  purchase  price, in the amount of $904,000 of which HEC's share
was  $452,000.  That  amount was  accrued in the  December  31,  1998  financial
statements of the Company and was paid during the second quarter of 1999.

In October  1998,  HEC closed the  acquisition  of oil and gas  properties  from
Arcadia  pursuant to the ruling which included  interests in  approximately  570
wells, numerous proven and unproven drilling locations, exploration acreage, and
3-D seismic data. HEC's share of the purchase price was $8,200,000.


NOTE 13 - LEGAL SETTLEMENTS

In connection with the Consolidation, HEC assumed the liability for two lawsuits
filed against  Hallwood Group and certain  individuals and related to the direct
energy  interests  acquired from Hallwood Group.  These lawsuits,  both filed in
federal court in Denver,  Colorado,  have been settled. HEC was obligated to pay
approximately  $673,000 in connection with these  lawsuits,  and that amount was
accrued as a liability on the Company's  balance  sheet in  connection  with the
Consolidation.  The court  gave its final  approval  for the  settlement  during
January 2000 and the settlement amount was paid by HEC during February 2000.




<PAGE>


Concise Oil and Gas Partnership  ("Concise"),  a wholly owned  subsidiary of HEC
was a  defendant  in a lawsuit  styled  Dr.  Allen J.  Ellender,  Jr. et al. vs.
Goldking  Production  Company,  et  al.,  filed  in the  Thirty-Second  Judicial
District Court, Terrebonne Parish, Louisiana on May 30, 1996. The portion of the
lawsuit against Concise was settled in  consideration  of the payment by Concise
of $600,000.  This amount was recorded as litigation  settlement  expense in the
second  quarter of 1998.  Concise has been  dismissed  with  prejudice  from the
lawsuit.

In addition to the litigation  noted above, the Company and its subsidiaries are
from time to time subject to routine  litigation and claims  incidental to their
business, which the Company believes will be resolved without material effect on
the Company's financial condition, cash flows or operations.


NOTE 14 - COMMITMENTS

The  Company  currently  leases  office  facilities  in  Denver,   Colorado  for
approximately  $600,000  per year,  under a lease which  expires on December 31,
2006.  HEC also  sub-leases  office  space in Houston,  Texas for  approximately
$42,000  per year,  under a lease that  expires on October 14,  2001.  Remaining
commitments under these leases mature as follows:

        Year Ending
       December 31,               Annual Rentals
                                  (In thousands)

           2000                      $   643
           2001                          636
           2002                          601
           2003                          601
           2004                          601
        Thereafter                     1,379
                                       -----
                                      $4,461

Rent expense for the years ended December 31, 1999,  1998 and 1997 was $421,000,
$287,000 and $288,000, respectively.


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 Company,  using available  market  information and appropriate
valuation   methodologies.   However,   considerable  judgment  is  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  Company  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.
<TABLE>
<CAPTION>

                                              December 31, 1999                  December 31, 1998
                                              -----------------                  -----------------
                                         Carrying         Estimated         Carrying         Estimated
                                          Amount          Fair Value         Amount          Fair Value
                                          ------          ----------         ------          ----------
                                                                  (In thousands)

Assets (Liabilities):
<S>                                   <C>               <C>              <C>                 <C>
  Interest rate hedge contracts       $            --   $     2,156      $            --     $   4,254
  Oil and gas hedge contracts                  --             (4,558)             --               (812)
  Long-term debt                          (109,357)         (109,021)         (49,700)          (49,700)
</TABLE>

The  estimated  fair value of the interest  rate hedge  contracts is computed by
multiplying the difference between the quoted contract termination 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 Company.

The  estimated  fair value of the oil and gas hedge  contracts is  determined by
multiplying the difference between the quoted termination prices for oil and gas
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 Company.

The estimated fair value of long-term debt is computed using interest rates that
could be available to the Company for similar instruments with similar terms.

The fair value  estimates  presented  herein are based on pertinent  information
available to  management  as of December 31, 1999.  Although  management  is not
aware of any factors that would  significantly  affect the estimated  fair value
amounts, such amounts have not been comprehensively  reevaluated for purposes of
these financial  statements since that date, and current estimates of fair value
may differ significantly from the amounts presented herein.


<PAGE>


                           HALLWOOD ENERGY CORPORATION
                  SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION
                                DECEMBER 31, 1999
                                   (Unaudited)


The  following  reserve  quantity and future net cash flow  information  for HEC
represents proved reserves which are located in the United States.  The reserves
have been  estimated by the Company'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  HEC's  proved  oil and  gas  reserves  from  year  to  year.  No
consideration  has been given to future  income  taxes as of December  31, 1999,
because the tax basis of HEC's  properties and net operating loss  carryforwards
exceed future net cash flows. No consideration  was given to future income taxes
as of December 31, 1998 and 1997 because HEC was not a tax paying  entity during
these  years.  Under the  guidelines  set forth by the  Securities  and Exchange
Commission  (SEC), the calculation is performed using year-end  prices.  The oil
and gas prices used at December 31, 1999,  1998 and 1997 were $24.32 per bbl and
$2.00 per mcf, $10.00 per bbl and $1.90 per mcf and $16.90 per bbl and $2.30 per
mcf,  respectively,  for HEC, including the May Partnerships.  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, 1999 prices  result in 11.7  million bbls of oil, and
151.7 billion cubic feet of gas and a standardized measure of $208,000,000.  The
Mays are included on a consolidated  basis, and 8,000 bbls of oil and .1 billion
cubic feet of gas,  representing  a  discounted  present  value of $352,000  are
attributable  to the minority  ownership of these  entities.  This  standardized
measure  is  not  necessarily  representative  of  the  market  value  of  HEC's
properties.

HEC's  standardized  measure  of future  net cash  flows has been  decreased  by
$3,357,000  at December  31, 1999 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%.


<PAGE>

<TABLE>
<CAPTION>

                           HALLWOOD ENERGY CORPORATION
                               RESERVE QUANTITIES
                                 (In thousands)
                                   (Unaudited)



                                                                          Gas                        Oil
                                                                          ---                        ---
                                                                          Mcf                       Bbls

Proved Reserves:
<S>                                                                      <C>                         <C>
   Balance, December 31, 1996                                             88,542                      7,531

   Extensions and discoveries                                              4,228                        817
   Revisions of previous estimates                                        11,578                     (1,930)
   Sales of reserves in place                                               (140)                        (9)
   Purchases of reserves in place                                            619                        128
   Production                                                            (11,774)                      (770)
                                                                         -------                   --------

   Balance, December 31, 1997                                             93,053                      5,767

   Extensions and discoveries                                              1,542                        415
   Revisions of previous estimates                                        (9,369)                    (1,385)
   Sales of reserves in place                                               (244)                       (35)
   Purchases of reserves in place                                         23,994                        512
   Production                                                            (14,037)                      (787)
                                                                        --------                   --------

   Balance, December 31, 1998                                             94,939                      4,487

   Extensions and discoveries                                             10,929                        180
   Revisions of previous estimates                                       (10,730)                     2,245
   Sales of reserves in place                                             (1,067)                      (185)
   Purchases of reserves in place                                         75,860                      5,879
   Production                                                            (18,263)                      (925)
                                                                        --------                   --------

   Balance, December 31, 1999                                            151,668                     11,681
                                                                         =======                     ======

Proved Developed Reserves:
   Balance, December 31, 1997                                             89,816                      5,181
                                                                        ========                    =======
   Balance, December 31, 1998                                             90,915                      3,577
                                                                        ========                    =======
   Balance, December 31, 1999                                            139,839                     10,301
                                                                         =======                     ======
</TABLE>



<PAGE>

<TABLE>
<CAPTION>

                           HALLWOOD ENERGY CORPORATION
            STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
                                 (In thousands)
                                   (Unaudited)


                                                                            December 31,
                                                  -----------------------------------------------------------
                                                       1999                     1998                     1997
                                                       ----                     ----                     ----

<S>                                                 <C>                      <C>                     <C>
Future cash flows                                   $  597,000               $  245,000              $  293,000
Future production and development costs               (263,000)                (102,000)               (115,000)
                                                      --------                  -------                --------
Future net cash flows before discount                  334,000                  143,000                 178,000
10% discount to present value                         (126,000)                 (42,000)                (49,000)
                                                      --------                ---------               ---------
Standardized measure of discounted
   future net cash flows                            $  208,000               $  101,000              $  129,000
                                                     =========                =========               =========
</TABLE>




<PAGE>

<TABLE>
<CAPTION>

                           HALLWOOD ENERGY CORPORATION
     CHANGES IN THE STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
                                 (In thousands)
                                   (Unaudited)



                                                                               For the Year Ended December 31,
                                                                               -------------------------------
                                                                      1999                   1998                  1997
                                                                      ----                   ----                  ----

Standardized measure of discounted future net
<S>                                                                  <C>                   <C>                    <C>
   cash flows at beginning of year                                   $101,000              $129,000               $206,000

Sales of oil and gas produced, net of production costs                (32,919)              (26,932)              (30,209)

Net changes in prices and production costs                             12,454               (21,211)              (78,965)

Extensions and discoveries, net of future production
  and development costs                                                11,719                 3,546                  9,592

Changes in estimated future development costs                         (12,959)               (9,738)              (10,012)

Development costs incurred                                              7,302                 8,087                  7,607

Revisions of previous quantity estimates                                2,674               (15,547)                   (8)

Purchases of reserves in place                                        108,449                23,802                  1,457

Sales of reserves in place                                             (2,124)                 (399)                 (204)

Accretion of discount                                                  10,136                12,936                 20,600

Changes in production rates and other                                   2,268                (2,544)                 3,142
                                                                     --------              --------               --------

Standardized measure of discounted future net
  cash flows at end of year                                          $208,000              $101,000               $129,000
                                                                      =======               =======                =======
</TABLE>



<PAGE>


ITEM 9 -     DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
             DISCLOSURES

None.


                                    PART III


ITEM 10 -    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information  required by this item will be included in the definitive  proxy
statement of HEC  relating to HEC's 2000 Annual  Meeting of  Shareholders  to be
filed with the SEC pursuant to Regulation 14A, which information is incorporated
herein by reference.


ITEM 11 - EXECUTIVE COMPENSATION

The information  required by this item will be included in the definitive  proxy
statement of HEC  relating to HEC's 2000 Annual  Meeting of  Shareholders  to be
filed with the SEC pursuant to Regulation 14A, which information is incorporated
herein by reference.


ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
             MANAGEMENT

The information  required by this item will be included in the definitive  proxy
statement of HEC  relating to HEC's 2000 Annual  Meeting of  Shareholders  to be
filed with the SEC pursuant to Regulation 14A, which information is incorporated
herein by reference.


ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information  required by this item will be included in the definitive  proxy
statement of HEC  relating to HEC's 2000 Annual  Meeting of  Shareholders  to be
filed with the SEC pursuant to Regulation 14A, which information is incorporated
herein by reference.


                                                   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.

         HEC filed no current reports on Form 8-K during the last quarter of the
         period covered by this report.

(c)      Exhibits.


<PAGE>


   (1)   3.1      - Certificate of Incorporation of Hallwood Energy Corporation
   (1)   3.2      - Bylaws of Hallwood Energy Corporation
   (1)   4.1      - Certificate  of  Designations  of the Series A  Cumulative
                    Preferred  Stock of  Hallwood
                    Energy Corporation
   (2)   4.1.1    - Executed  Rights  Agreement  dated as of June 8, 1999,
                    between the Company and Registrar and Transfer Company
   (1)   4.2      - Form of Certificate of Designation of Series A Junior
                    Participating  Preferred  Stock of Hallwood Energy
                    Corporation
   (1)  10.1      - Form of Rights Agreement
   (1)  10.2*     - 1999 Long-Term Incentive Plan of Hallwood Energy Corporation
   (1)  10.3*     - 1999 Long-Term Incentive Plan Loan Program of Hallwood
                    Energy Corporation
    (2) 10.5      - Registration  Rights  Agreement  dated as of June 8, 1999,
                    between  the  Company and The Prudential Insurance Company
                    of America
   (2)  10.6*     - Change of Control  Agreement  between the Company  and
                    Certain  Executives,  dated as of June 9, 1999
        10.61*    - Amended Schedule for Change of Control Contracts, dated as
                    of December 13, 1999
   (2)  10.7      - Amended and Restated  Credit  Agreement  dated as of
                    June 8, 1999,  among the Company and certain of its
                    subsidiaries and the Banks listed therein
   (2)  10.8      - Agreement  Regarding  Initial Exercise Price dated
                    June 9, 1999,  between the Company and The Prudential
                    Insurance Company of America
   (2)  10.9*     - Phantom Working Interest  Incentive Plan of Hallwood Energy
                    Corporation dated as of June 8, 1999
   (2)  10.10     - Amended and Restated Subordinated  Note and Warrant Purchase
                    Agreement dated as of June 8,  1999,  between  Hallwood
                    Consolidated   Resources  Corporation  and  The  Prudential
                    Insurance Company of America
   (2)  10.11     - Common Stock  Purchase  Warrant dated June 8, 1999 between
                    the Company and The Prudential Insurance Company of America
   (3)  10.12     - Amendment No. 1 to Credit Agreement, dated as of
                    October 15, 1999
   (3)  10.13     - Letter Amendment No. 1 to Note Agreement, dated as of
                    October 15, 1999
        10.14     - Amendment No. 2 and Waiver to Credit Agreement, dated as of
                    January 27, 2000
   (1)  21        - Subsidiaries of the Registrant
        27        - Financial Data Schedule
   ---------------

(1)     Incorporated  by reference to the same Exhibit number filed with
        Registrant's  Registration  Statement No. 33-77409.
(2)     Incorporated  by  reference  to the same  exhibit  number filed with the
        Registrant's  Quarterly  Report on Form 10-Q for the quarter  ended June
        30, 1999.
(3)     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, 1999.


         *Designates management contracts or compensatory plans or arrangements.


<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 CORPORATION


Date:  March 6, 2000                        By: /s/William L.Guzzetti
-----------------------                         ---------------------
                                                 William L. Guzzetti
                                                 President

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.

          Signature                         Capacity                    Date


/s/Anthony J. Gumbiner              Chairman of the Board and     March 6, 2000
----------------------
Anthony J. Gumbiner                 Director (Chief Executive Officer)


/s/William L. Guzzetti              President and Director        March 6, 2000
----------------------
William L. Guzzetti


/s/Hans-Peter Holinger              Director                      March 6, 2000
----------------------
Hans-Peter Holinger


/s/Rex A. Sebastian                 Director                      March 6, 2000
---------------------
Rex A. Sebastian


/s/Nathan C. Collins                Director                      March 6, 2000
---------------------
Nathan C. Collins


/s/John R. Isaac, Jr.               Director                      March 6, 2000
---------------------
John R. Isaac, Jr.


                                    Director                      March 6, 2000
---------------------
Jerry A. Lubliner


/s/Hamilton P. Schrauff             Director                      March 6, 2000
------------------------
Hamilton P. Schrauff


                                    Director                      March 6, 2000
------------------------
Bill M. Van Meter


/s/William J. Baumgartner           Vice President                March 6, 2000
-------------------------
William J. Baumgartner              Chief Financial Officer
                                    (Principal Financial and
                                    Accounting Officer)