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, 2000

[ ]    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 1, 2001 was approximately $77,378,000.

Number of Shares outstanding as of March 1, 2001:
                                    Common Stock 9,659,239
                                    Series A Cumulative Preferred Stock2,263,573

                       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, 2000.

                                  Page 1 of 61


<PAGE>


                                     PART I

ITEM 1 - BUSINESS

Hallwood  Energy  Corporation  ("Hallwood"  or  the  "Company")  is  a  Delaware
corporation engaged in the development,  exploration, acquisition and production
of oil and gas properties. Hallwood 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 Hallwood,  and all
share and per share  information  assumes that the shares of Hallwood  issued to
HEP Unitholders 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 1, 2001, Hallwood had 73 employees.

Marketing

The oil and gas produced  from the  properties  owned by Hallwood 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,  Hallwood has entered
into  financial  contracts  for  hedging  the price of between 9% and 33% of its
estimated oil production for 2001 through 2002.

All of  Hallwood's  natural  gas  production  is sold on the spot  market  or in
short-term contracts and is transported in intrastate and interstate  pipelines.
Hallwood has entered into  financial  contracts for hedging the price of between
25% and 51% of its estimated gas production for 2001 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.  Hallwood 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 Hallwood's business
because there are numerous other purchasers in the areas in which Hallwood sells
its production.  However,  for the years ended December 31, 2000, 1999 and 1998,
purchases  by the  following  companies  exceeded  10% of the  total oil and gas
revenues of the Company:

                                       2000              1999             1998
                                       ----              ----             ----

El Paso Field Services Company           18%               14%              11%
Plains All American Inc.                 15%               14%
Conoco Inc.                              14%               19%              23%



<PAGE>


Competition

Hallwood 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 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 Hallwood 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
Hallwood. 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, 2000, Hallwood 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 Hallwood in the oil and gas industry.

Insurance Coverage

Hallwood  is subject  to all the risks  inherent  in the  exploration  for,  and
development of, oil and gas,  including  blowouts,  fires and other  casualties.
Hallwood maintains  insurance coverage as is customary for entities of a similar
size engaged in  operations  similar to that of  Hallwood,  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 Hallwood'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 its 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.

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 Hallwood'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   Hallwood  can  produce
economically.

Hallwood'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 Hallwood'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.  Hallwood
encounters  competition  from  other oil and gas  companies  in all areas of its
operation,  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.   Many  of  its   competitors   are   large,
well-established  companies  with  substantially  larger  operating  staffs  and
greater capital  resources than  Hallwood's  and, in many  instances,  have been
engaged in the oil and gas business for a much longer time than Hallwood.  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  Hallwood's  financial or human
resources permit. The Company'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.  Hallwood's success will be materially  dependent
upon the continued success of its drilling  program.  Hallwood's future drilling
activities may not be successful and, if drilling  activities are  unsuccessful,
such  failure  will have an  adverse  effect on  Hallwood'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
Hallwood 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.  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,  Hallwood'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  Hallwood's  future  exploration,  development  and  acquisition
activities  will result in additional  proved  reserves or that Hallwood will be
able to  drill  productive  wells at  acceptable  costs.  Furthermore,  although
Hallwood's revenues could increase if prevailing prices for oil and gas increase
significantly, Hallwood's finding and development costs could also increase.

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,  Hallwood  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 Hallwood will be successful and, if an acquisition is unsuccessful,  that the
failure  will not  have an  adverse  effect  on  Hallwood's  future  results  of
operations and financial condition.


<PAGE>


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  Hallwood.  In
addition,  Hallwood may be liable for  environmental  damages caused by previous
owners of property  purchased  or leased by Hallwood.  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  Hallwood's  properties.
While  Hallwood  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,  Hallwood 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
Hallwood'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.   Hallwood'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
Hallwood acquires  properties  containing proved reserves or conducts successful
exploration and development activities, or both, the proved reserves of Hallwood
will decline as reserves are produced.

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 Hallwood's  reserves will
likely vary from estimates, and such variances may be material.

ITEM 2 - PROPERTIES

Exploration and Development Projects and Acquisitions

In  2000,   Hallwood   incurred   $25,807,000  in  direct  property   additions,
development,  exploitation,  and exploration  costs. The costs were comprised of
$9,320,000 for property acquisitions and approximately  $16,487,000 for domestic
exploration and  development.  Hallwood also issued 417,406 shares of its common
stock valued at  $3,315,000 as part of a property  acquisition  completed in the
third quarter. Hallwood's 2000 capital program led to the replacement, including
revisions to prior year  reserves,  of 329% of 2000  production  using  year-end
prices of $27.00 per bbl and $9.25 per mcf.  Sales of reserves in place in 2000,
which  were  approximately  176% of  2000  production,  are  excluded  from  the
replacement calculation.


<PAGE>


Property Sales

During  2000,  Hallwood  received  approximately  $21,698,000  for  the  sale of
approximately  500  non-strategic  wells  located  in the  Keystone,  Merkle and
Weesatche  areas of Texas,  and  various  oil and gas wells in  Oklahoma,  North
Dakota,  Montana and Kansas.  The  proceeds  from these sales were all  credited
against oil and gas properties without gain or loss recognition.  The wells sold
represented approximately 35% of Hallwood's total well count as of the beginning
of the year,  approximately  16% of Hallwood's  reserve value, and approximately
11% of its operating cash flow based on five year average reserve  pricing.  The
completion  of Hallwood's  2000 sales effort has enabled  Hallwood to reduce its
level of debt and to focus on a four state  core area  including  Colorado,  New
Mexico, Texas and Louisiana.

Regional Area Descriptions and 2000 Capital Budget

The following discussion of Hallwood'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.

Gulf Coast Region

Hallwood's significant interests in the Gulf Coast Region in Louisiana and South
and East Texas consist of interests in eleven operated and producing  wells, one
nonproducing  well and four  nonoperated  wells  located  in  Lafayette  Parish,
Louisiana. The wells produce principally from the Bol Mex formation at 13,500 to
14,500 feet. Seven additional operated producing gas wells and four nonproducing
wells are located primarily in the Lapice Field in St. James Parish,  Louisiana.
In South and East Texas,  Hallwood has interests in approximately  250 producing
wells, 81 of which are operated by the Company,  and produce  primarily from the
Austin  Chalk,  Lower  Frio,  Travis  Peak,  Rodessa,  Pettit and Cotton  Valley
formations  at depths from 7,000 to 13,000 feet.  In these same areas,  Hallwood
owns  interests  in eight  nonoperated  wells.  During 2000,  Hallwood  expended
approximately  $19,896,000 (68%),  including the stock issuance described below,
of its capital budget in this region.  Hallwood plans five exploration  projects
and 11 exploitation and development projects in the area in 2001.

Property Acquisition.  On August 30, 2000, Hallwood completed the acquisition of
interests in 34 producing  wells,  five service  wells and 69 inactive  wells in
five fields located in Chambers, San Patricio and Frio Counties in Texas and St.
James and Assumption Parishes in Louisiana, as well as approximately 7,000 acres
of  undeveloped  leasehold and 3-D seismic data.  Total  consideration  included
approximately $3.875 million in cash and 417,406 shares of Hallwood common stock
valued at approximately  $3.3 million.  The properties include 13 Bcfe of proved
reserves,  21% of which are proved developed producing.  Hallwood plans to spend
more than $4 million over the next two years  developing the proved  undeveloped
reserves  and  anticipates  spending  $4.8  million  over the next two  years to
acquire  or shoot  3-D  seismic.  Hallwood  feels  that  significant  additional
recoveries  may be gained  with the  application  of 3-D seismic  imaging.  This
acquisition yields an estimated purchase cost per proven mcfe of $0.55. Hallwood
believes this acquisition fits  strategically with its ongoing activities in the
Gulf  Coast and South  Texas and  Hallwood  will  operate  virtually  all of the
properties acquired.

Yoakum  Gorge  Project.  In 2000,  Hallwood  continued  its  participation  with
non-operated  and operated Wilcox  projects  located in the Yoakum Gorge area of
Lavaca County,  Texas.  During 2000,  Hallwood  participated with four different
operators in the drilling or recompletion of nine wells. Four of the wells, with
working  interests of 12.5%,  3.1%, 15.9% and 28.8%, are producing at a combined
rate of 9,220 gross mcf per day. A decision  will be made in first  quarter 2001
whether or not to sidetrack  another well in a more optimum position relative to
the area fault block.  Hallwood plans to own a 50% working interest in the well.
Another  operated,  unsuccessful  recompletion  was attempted in an uphole sand.
Hallwood owns a 90% working interest in this well. Hallwood's exploration and


<PAGE>


development  expenditures  in the Yoakum Gorge area have  totaled  approximately
$3,524,000 for the year 2000.  Hallwood  anticipates  continued  activity in the
area resulting from additional  exploitation of the 1999 Seisgen Acquisition and
from the  reprocessing  and  evaluation  of land and 3-D seismic data  purchased
during  the  third  quarter  of  2000.  With  the  recent   $1,975,000   seismic
acquisition,  Hallwood  now owns  approximately  381 square miles of 3-D seismic
data in the area. In addition to reprocessing  Hallwood's seismic data, Hallwood
is also reprocessing  80-square miles of seismic with another operator. At least
two exploration projects are currently planned for 2001.

During 2000,  Hallwood  participated  in the drilling or  recompletion  of seven
wells in  neighboring  Victoria  County,  Texas,  where  the  objective  was the
shallower  Frio  sands.  Four of the wells are  producing,  one was  plugged and
abandoned,  and two are waiting on  completion.  Hallwood  averages a 5% working
interest in the wells.  In  addition,  Hallwood  anticipates  that its  drilling
activity  in the  shallower  Frio and Yegua  formations  in Lavaca  County  will
increase over the next several quarters.  While the potential  reserves in these
shallower wells are not as great as in the Wilcox, averaging between .5 Bcfe and
1.5 Bcfe gross per well, the risk and expense to drill the wells are lower.

Goliad County Expanded Wilcox Project. During 2000, a 16,500-foot  non-operated,
discovery well was completed in the Upper Wilcox, and is producing approximately
1,800  mcf  per  day.  Hallwood  owns a  20.8%  working  interest  in the  well.
Hallwood's  drilling  and  leasehold   acquisition  costs  during  2000  totaled
approximately $1,375,000.

Louisiana.  In May 2000, Hallwood successfully completed a 13,600-foot Bol Mex 3
well located in the Scott Field.  The well had  stabilized  production  rates of
approximately  25,000  mcf  per  day and  500  barrels  of oil  per day  through
mid-August, but as a result of sand production has since been choked back to its
current  level of  approximately  10,000 mcf per day and 225  barrels of oil per
day.  In 2000,  Hallwood's  drilling  and  completion  costs  for the well  were
approximately  $1,634,000.  Hallwood owns an approximate 35% working interest in
the well.  The  originally  targeted  upper zone  remains as behind  pipe proved
nonproducing reserves while the lower zone is produced.  Hallwood's plans in the
area  include  a Bol Mex 16 Klump  exploration  well  testing  sands  which  are
productive in nearby  fields and a Flambeau  prospect  exploration  well testing
Marg Tex sands  productive  in the  adjacent  fault  block.  The Bol Mex well is
currently   drilling  and  land  and  leasehold  costs  incurred  in  2000  were
approximately  $172,000.  Hallwood will have an approximate 28% working interest
in the well that has a gross 200 Bcfe  potential  and an estimated  $5.6 million
completed well cost. The Marg Tex well is also currently drilling. Hallwood will
have a 35%  working  interest in this well that has a 22 Bcfe  potential  and is
estimated  to have a dry hole  cost of $2.86  million.  Hallwood  also  incurred
$135,000  acquiring  377 small  working  interests  totaling less than 1% in the
Scott Field and in the Bol Mex 16 exploration acreage.

Boca Chica Prospect. During 2000, a twenty-three square mile proprietary seismic
shoot was completed in the Gulf of Mexico and is currently being reprocessed and
reevaluated. If the results are favorable,  Hallwood plans to participate in the
reentry of a directionally  drilled 10,000-foot  exploration well in the Big Hum
formation  from the shore to the bottom  hole  location  under the waters of the
Gulf of Mexico.  Hallwood will have an approximate  25% working  interest in the
well, which has unrisked reserve potential of 20 Bcfe. The reserve potential for
the field in which this exploratory well is located is 70 Bcfe and would require
the drilling of multiple wells.

Martinsville  Prospect.  Hallwood  acquired a 45%  interest in the  Martinsville
Prospect located in Nacogdoches County, Texas during the fourth quarter of 2000.
The initial  well for this  prospect is presently  drilling  and one  additional
stacked dual lateral James Lime  horizontal  well is planned for 2001.  Hallwood
also plans to drill one or more horizontal James Lime wells on nearby acreage in
the North  Trawick  Field.  Total  costs  for this  project  were  approximately
$146,000 in 2000.

Bell Prospect.  During 2000, Hallwood incurred  approximately $930,000 for costs
associated  with  completing  two wells,  and for  various  gas  gathering,  gas
treating,  and produced  water-handling  facility costs associated with the Bell
prospect area. One well tested the Georgetown formation and was completed in the
Buda formation and the other well is a dual lateral Buda  formation  development
well. Both wells are currently  producing.  Seven potential  drilling  locations
exist.


<PAGE>


Greater Permian Region

Hallwood has significant interests in the Greater Permian Region, which includes
West Texas and Southeast New Mexico.  In this region,  Hallwood has interests in
400 productive oil and gas wells (321 of which are  operated),  8  nonproductive
oil and gas wells (five operated) and 13 operated  salt-water disposal wells. In
2000, Hallwood expended approximately  $2,794,000 (10%) of its capital budget on
projects  in  this  area.   Hallwood  plans  one  exploration   project  and  24
exploitation and development projects in 2001. The following is a description of
the  significant  areas and 2000  capital  projects  within the Greater  Permian
Region.

Carlsbad/Catclaw  Area.  Hallwood's interests in the Carlsbad/Catclaw Area as of
December  31,  2000  consist  of  85  producing  oil  and  gas  wells  and  four
nonproducing  wells.  The  wells are  located  on the  northwestern  edge of the
Delaware  Basin in Lea,  Eddy and  Chaves  Counties,  New  Mexico.  The  Company
operates  36  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 2000, Hallwood spent  approximately  $364,000 for one
recompletion  and for costs  associated  with  producing  wells.  Hallwood  also
participated  in the testing of a horizontal well drilled in the Red Hills field
located in Lea County, New Mexico. Gross unrisked reserve potential for the well
is approximately 65 Bcfe and Hallwood owns an approximate 3.5% working interest.
Hallwood incurred  approximately $161,000 for drilling costs on the well and the
results of drilling are currently being evaluated.  If deemed to be a commercial
well, seven additional wells could be drilled.

Spraberry  Area.  Hallwood's  interests  in the  Spraberry  Area  consist of 315
producing wells, located in Dawson, Upton, Reagan and Irion Counties, Texas. The
Company  operates 292 of the producing oil and gas wells and also owns interests
in four nonproducing  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.  In 2000,  Hallwood  initiated a 20 well
infill drilling program in its Greater Permian Basin and Hallwood estimates that
over sixty 80-acre infill drilling  locations exist in this area.  Historically,
West Texas  Permian  production  has been  predictable,  and a drilling  program
coupled with an appropriate  crude oil hedging  program can be expected to yield
relatively  safe and  adequate  returns.  During  the  fourth  quarter  of 2000,
Hallwood successfully drilled and completed three wells out of the 20 prospects,
is currently  completing a fourth  well,  and began  drilling a fifth well which
will be completed in first quarter of 2001.  Total costs on the projects  during
2000 were  approximately  $2,080,000.  Hallwood  plans to drill the remaining 15
wells in 2001.  The top 20  prospects  could yield an overall  rate of return in
excess of 40% giving effect to moderate commodity prices and increased costs for
oilfield goods and services and rig costs.

Rocky Mountain Region

Hallwood has significant  interests in the Rocky Mountain Region,  which include
producing  properties  in Colorado  and  Northwest  New Mexico.  The Company has
interests  in 125  producing  oil and gas wells,  119 of which are  operated  by
Hallwood,  10 nonproducing wells, and three salt-water disposal wells.  Hallwood
expended approximately  $2,661,000 (9%) of its 2000 capital budget in this area.
Hallwood plans 11 exploitation and development projects in the area in 2001. The
following  is a  description  of the major  projects for the region for the year
2000.

Colorado Western Slope Project.  During 2000,  Hallwood  incurred  approximately
$987,000 in the  Colorado  Western  Slope area to drill two wells,  workover two
wells  and  perform  maintenance  work  on  several  others.  The  post-workover
production rates have increased on the wells effected.

San Juan Basin Project - Colorado and New Mexico. Hallwood's interest in the San
Juan  Basin  consists  of 83  producing  gas wells (78  operated),  10  operated
nonproducing  wells and three  salt  water  disposal  wells  located in San Juan
County, New Mexico and LaPlata County, Colorado.  Hallwood operates 52 producing
wells in New Mexico,  33 of which produce from the Fruitland  Coal  formation at
approximately  2,200 feet and 19 of which produce from the Picture Cliffs,  Mesa
Verde and Dakota  formations  at 1,200 to 7,000 feet.  Hallwood also operates 26
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. Hallwood, along with
many other  industry  partners,  made  application  to the  Colorado Oil and Gas
Commission for field wide infill drilling in the Fruitland Coal  formation.  The
application  was to reduce  the  present  320-acre  spacing  units to 160 acres,
because the existing  spacing units could not be adequately  drained by a single
well.  Approval  was  granted  in July 2000,  and could  result in as many as 18
locations on the acreage in which Hallwood has an indirect  interest through its
special purpose tax credit vehicle.  During the fourth quarter of 2000, Hallwood
completed the first two infill recompletions,  which are performing as expected.
A third well was completed in the first quarter of 2001,  and a fourth  location
is  currently   drilling.   Total  year  2000  costs  for  these  projects  were
approximately $482,000. Five or more locations will be drilled in 2001 and up to
nine  locations  will be drilled in 2002.  Rig  availability  will  dictate  the
ultimate  number of locations  drilled in 2001.  Gross reserves per well average
4.5 Bcfe with gross average  total  completed  well costs of $492,000.  In 2000,
Hallwood also incurred  approximately  $860,000 for  maintenance,  gas gathering
systems, a sidetrack,  interest  acquisitions and miscellaneous  projects in the
area.

In addition to the Colorado infill locations,  Hallwood has the potential for 14
similar  locations in New Mexico if infill  drilling is permitted  there.  Total
completed  well costs in this area average  $354,000 and gross reserves per well
averaged  3.6  Bcfe.  Overall,  Hallwood's  drilling  program  in  this  area is
anticipated to yield finding and  development  costs of $0.35 to $0.45 per mcfe,
on a net basis and net reserve additions of up to 71 Bcfe. Additional upside may
exist as evidenced by secondary  recovery  projects  already underway in the San
Juan Basin.  These pilot secondary  recovery projects involving CO2 and nitrogen
injection may be additive to Hallwood properties. There can be no assurance that
these  projects  will yield  positive  results but current data suggests that an
additional 200 Bcfe of gross recoverable gas may exist.

Other

The remaining  $3,771,000 (13%) of Hallwood's capital  expenditures  incurred in
2000 was devoted to technical  general and  administrative  expenditures,  delay
rental costs,  and numerous  other projects which were completed or are underway
and which are individually less significant.

Future Plans

Hallwood's  capital  budget  for  2001  is  expected  to  be  $50,000,000,  with
$30,000,000 targeted for exploration,  exploitation,  and development. In total,
Hallwood plans to participate in 8 exploration  projects and 54 exploitation and
development projects during 2001. Fifteen percent of the capital budget has been
allocated to the San Juan Basin,  30% to the Greater Permian Basin, 15% to South
Texas, 30% to South Louisiana, and 10% to other areas. An additional $20,000,000
is available for  acquisitions,  debt reduction,  stock  repurchases,  and other
capital projects.

During 2000,  Hallwood  experienced a rig  availability  shortage.  For the year
2001,  Hallwood has  aggressively  pursued  reservation  of rigs to  accommodate
Hallwood's  continuous  drilling plans.  These efforts have resulted in a record
number of rigs  currently  under  contract  and/or  drilling (5  operated  and 5
non-operated).  Substantial drilling,  completion and operational cost increases
are being experienced throughout the industry.

Company Reserves, Production and Discussion by Significant Regions

The following  table  presents the December 31, 2000 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       Developed        Undeveloped          Total
                                   ----------       -----------       ---------        -----------          -----
                                                                   (In thousands)

<S>                                   <C>               <C>           <C>               <C>               <C>
Gulf Coast Region                     28,360            1,672         $  81,546         $  47,902         $129,448
Greater Permian Region                33,234            7,134            93,294            16,465          109,759
Rocky Mountain Region                121,228               17           245,299            71,494          316,793
                                     -------         --------           -------          --------          -------
                                     182,822            8,823          $420,139          $135,861         $556,000
                                     =======            =====           =======           =======          =======
</TABLE>



<PAGE>


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, 2000                  Year Ended December 31, 1999
                                        ----------------------------                  ----------------------------
                                     Mcf of Gas             Bbls of Oil              Mcf Gas              Bbls of Oil
                                     ----------             -----------              -------              -----------
                                                                      (In thousands)

<S>                                      <C>                      <C>                  <C>                      <C>
Gulf Coast Region                        7,196                    166                  5,234                    189
Greater Permian Region                   2,643                    403                  2,758                    437
Rocky Mountain Region                   12,229                      2                  9,862                    151
Other                                      180                    111                    409                    148
                                      --------                    ---               --------                    ---
                                        22,248                    682                 18,263                    925
                                        ======                    ===                 ======                    ===
</TABLE>

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

                                    For the Year Ended December 31, 2000          For the Year Ended December 31, 1999
                                    ------------------------------------          ------------------------------------
                                     Mcf of Gas             Bbls of Oil            Mcf of Gas             Bbls of Oil
                                     ----------             -----------            ----------             -----------
                                                                      (In thousands)

<S>                                      <C>                       <C>                 <C>                      <C>
Gulf Coast Region                        3,611                     63                  5,708                    113
Greater Permian Region                   4,670                  1,563                    291                     58
Rocky Mountain Region                   44,945                                         4,346                      9
Other                                                                                    584
                                   -----------               --------               --------
                                        53,226                  1,626                 10,929                    180
                                        ======                  =====                 ======                    ===
</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>

                                                       2000              1999              1998
                                                      ------            ------            -----

<S>                                                    <C>                <C>               <C>
Oil and condensate -                                   $23.64             $16.52            $13.65
Natural gas -                                            2.68               1.90              2.02
Production costs (per equivalent mcf of gas)              .80               .72               .65
</TABLE>

Productive Oil and Gas Wells

The following  table  summarizes the productive oil and gas wells as of December
31,  2000 owned by  Hallwood.  Productive  wells are  producing  wells and wells
capable  of  production.  Gross  wells  are the  total  number of wells in which
Hallwood  has an  interest.  Net  wells  are  the sum of  Hallwood's  fractional
interests owned in the gross wells.

                                              Gross              Net

Productive Wells

  Oil                                            447               302
  Gas                                            360               166
                                                 ---               ---
    Total                                        807               468
                                                 ===               ===



<PAGE>


Oil and Gas Acreage

The following table sets forth the developed and undeveloped  leasehold  acreage
held  directly by Hallwood as of December  31, 2000.  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  Hallwood  has a  working  interest.  Net  acres  are the sum of
Hallwood's fractional interests owned in the gross acres.

                                               Gross         Net
                                               -----         ---
                                                (in thousands)

Developed acreage                               214          118
Undeveloped acreage                             123           62
                                                ---         ----
    Total                                       337          180
                                                ===          ===

At December 31, 2000, Hallwood held undeveloped acreage in Texas, Louisiana, New
Mexico, Colorado, and California.

Drilling Activity

The  following  table sets forth the number of wells  drilled by Hallwood in the
most recent three years.
<TABLE>
<CAPTION>

                                                               Year Ended December 31,

                                               2000                        1999                        1998
                                              ------                      ------                      -----
                                       Gross          Net          Gross          Net          Gross          Net
                                       -----          ---          -----          ---          -----          ---

Development Wells:
<S>                                       <C>         <C>             <C>          <C>           <C>          <C>
   Productive                             6           2.4             1            .5            12           3.6
   Dry                                    1            .8             1            .5             5           1.5
                                         --           ---            --           ---           ---           ---
    Total                                 7           3.2             2             1            17           5.1
                                         ==           ===            ==           ===            ==           ===

Exploratory Wells:
   Productive                            34          15.7            11           4.1            17           4.3
   Dry                                    8           3.8             8           2.4            17           3.0
                                         --          ----            --           ---            --           ---
    Total                                42          19.5            19           6.5            34           7.3
                                         ==          ====            ==           ===            ==           ===
</TABLE>

Office Space

Hallwood leases office space in Denver, Colorado, for approximately $600,000 per
year under a lease that  terminates  on December  31,  2006 and office  space in
Midland,  Texas for approximately  $7,000 per year under a lease that terminates
on September 30, 2003.  Hallwood 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 13 and 14 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 2000.


<PAGE>


                                     PART II

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

Hallwood's common stock began trading over the counter on NASDAQ National Market
System under the symbol  "HECO" on June 9, 1999.  Hallwood's  Series A Preferred
Stock began trading on the NASDAQ under the symbol  "HECOP" on June 11, 1999. As
of March 1, 2001, there were 12,763  registered  holders of record of Hallwood's
common  stock and 7,901  registered  holders  of record of  Hallwood'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

First quarter 2000                                          $  6             $3 11/16
Second quarter 2000                                           9 7/16          3 7/8
Third quarter 2000                                           10 1/16          7 7/16
Fourth quarter 2000                                           9 13/16         7 5/16

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

First quarter 2000                                          $  7 7/8         $6 1/2               $.25
Second quarter 2000                                           8 1/8           7 1/8                .25
Third quarter 2000                                            9 1/2           7 9/16               .25
Fourth quarter 2000                                           9 3/4           8 3/4                .25
                                                                                                   ---
                                                                                                  $1.00
</TABLE>

Hallwood's  debt agreements  limit  aggregate  dividends paid by Hallwood 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  Hallwood  is 50% or more of the  borrowing  base.  Aggregate
dividends  paid by  Hallwood  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.


<PAGE>


ITEM 6 - SELECTED FINANCIAL DATA

The following  table sets forth selected  financial  data  regarding  Hallwood'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 Hallwood,  and all share and per share information assumes that the shares of
Hallwood 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,
                                                       -----------------------------------------
                                          2000           1999            1998           1997             1996
                                          ----          ------          ------         -------          -----
                                                            (In thousands except per Share)

Summary of Operations
   Oil and gas revenues and
<S>                                      <C>            <C>             <C>              <C>             <C>
    pipeline operations                  $82,760        $56,523         $43,177          $44,707         $50,644
   Total revenue                          83,280         56,881          43,586           45,103          51,066
   Production operating expense           20,954         17,100          12,175           11,060          11,511
   Depreciation, depletion and
    amortization                          23,849         21,027          15,720           11,961          13,500
   Impairment                                                            14,000
   General and administrative
    expense                               11,683          7,395           5,045            5,333           4,540
   Net income (loss)                      17,923          2,880         (13,895)          12,803          15,726
   Basic net income (loss) per
    share                                   1.61            .06           (2.92)            2.17            2.69
   Diluted net income (loss) per
    share                                   1.60            .06           (2.92)            2.14            2.69
   Dividends per common share                  -            .21            1.26             1.25            1.34
   Dividends per preferred share            1.00           1.00            1.00             1.00            1.00

Balance Sheet

   Working capital (deficit)          $    3,393     $    3,371      $   (8,722)      $     (973)     $   (1,355)
   Property, plant and equipment, net    164,505        181,621         105,005           94,331          88,549
   Total assets                          197,767        212,774         139,091          131,603         122,792
   Long-term debt                         79,387        109,357          40,381           34,986          29,461
   Long-term contract settlement
    obligation                                                                                             2,512
   Deferred revenue and other              1,037          1,066           1,050            1,180           1,533
   Minority interest in affiliates             -            582           2,788            3,258           3,336
   Stockholders' equity                   89,261         75,387          62,632           69,064          64,215
</TABLE>


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

Overview

Hallwood 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.


<PAGE>


Liquidity and Capital Resources

Cash Flow

Hallwood  generated  $35,527,000 of cash flow from operating  activities  during
2000.

   The other primary cash inflows were:

   o  Proceeds from the sale of property of $21,698,000 and,

   o  Proceeds from long-term debt of $7,000,000,

   Cash was used primarily for:

   o  Payments of long-term debt of $37,200,000;

   o  Additions to property, exploration and development costs of $25,807,000;

   o  Purchase of preferred and common stock of $5,123,000 and,

   o Dividends to shareholders of $2,271,000.

When combined with miscellaneous other cash activity during the year, the result
was a decrease  of  $6,146,000  in  Hallwood's  cash and cash  equivalents  from
$10,480,000 at December 31, 1999 to $4,334,000 at December 31, 2000.

Property Purchases, Sales and Capital Budget

In  2000,   Hallwood   incurred   $25,807,000  in  direct  property   additions,
development,  exploitation,  and exploration  costs. The costs were comprised of
$9,320,000 for property acquisitions and approximately  $16,487,000 for domestic
exploration and  development.  Hallwood also issued 417,406 shares of its common
stock valued at  $3,315,000 as part of a property  acquisition  completed in the
third quarter. Hallwood's 2000 capital program led to the replacement, including
revisions to prior year  reserves,  of 329% of 2000  production  using  year-end
prices of $27.00 per bbl and $9.25 per mcf.  Sales of reserves in place in 2000,
which  were  approximately  176% of  2000  production,  are  excluded  from  the
replacement calculation.

Property Sales

During  2000,  Hallwood  received  approximately  $21,698,000  for  the  sale of
approximately  500  non-strategic  wells  located in the Keystone,  Merkle,  and
Weesatche  areas of Texas,  and  various  oil and gas wells in  Oklahoma,  North
Dakota,  Montana,  and Kansas.  The proceeds  from these sales were all credited
against oil and gas properties without gain or loss recognition.  The wells sold
represented approximately 35% of Hallwood's total well count as of the beginning
of the year,  approximately  16% of Hallwood's  reserve value, and approximately
11% of its operating cash flow based on five year average reserve  pricing.  The
completion  of Hallwood's  2000 sales effort has enabled  Hallwood to reduce its
level of debt, and to focus on its core areas of Colorado, New Mexico, Texas and
Louisiana.


<PAGE>


Regional Area Descriptions and 2000 Capital Budget

In the Gulf Coast Region,  Hallwood  acquired  interests in 34 producing  wells,
five service wells and 69 inactive wells in five fields located in Chambers, San
Patricio  and Frio  Counties in Texas and St. James and  Assumption  Parishes in
Louisiana, as well as approximately 7,000 acres of undeveloped leasehold and 3-D
seismic data. Total consideration  included approximately $3.875 million in cash
and Hallwood  stock valued at  approximately  $3.3 million.  In the Yoakum Gorge
area,  Hallwood  participated  with four different  operators in the drilling or
recompletion of nine wells. Hallwood's exploration and development  expenditures
in the Yoakum  Gorge area have  totaled  approximately  $3,524,000  for the year
2000. During the third quarter of 2000,  Hallwood purchased land and 3-D seismic
in the area for  approximately  $1,975,000.  Hallwood's  drilling and  leasehold
acquisition costs during 2000 totaled approximately  $1,375,000 for the drilling
of a 16,500-foot  nonoperated  discovery well in the Upper Wilcox.  In the Scott
field,   Hallwood  successfully  drilled  a  13,600-foot  Bol  Mex  3  well  for
approximately  $1,634,000.  In 2000, Hallwood's costs associated with completing
two  wells,  and  for  various  gas  gathering,   gas  treating,   and  produced
water-handling facilities in the Bell prospect totaled approximately $930,000.

In the Greater Permian  Region,  Hallwood spent  approximately  $364,000 for one
recompletion  and for costs  associated  with  producing  wells.  Hallwood  also
incurred  approximately  $161,000  for  drilling  costs  on  a  horizontal  well
currently being evaluated.  In the Spraberry area, Hallwood successfully drilled
and completed three wells in the fourth quarter, completed an additional well in
the first  quarter,  and has  started  drilling a fifth well in the area.  Total
costs on the projects during 2000 were approximately $2,080,000.

Hallwood incurred  approximately  $987,000 in the Colorado Western Slope area to
drill two wells,  workover  two wells and  perform  maintenance  work on several
others.  During  the  fourth  quarter  of 2000,  Hallwood  completed  two infill
recompletions as part of the Colorado San Juan Basin infill drilling program.  A
third well was completed during the first quarter of 2001, and a fourth well has
begun drilling.  Total costs for these projects  during 2000 were  approximately
$482,000.  Hallwood also incurred  approximately  $860,000 for maintenance,  gas
gathering systems, a sidetrack, interest acquisitions and miscellaneous projects
in the area.

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

Recent Developments

Hallwood has engaged Petrie Parkman & Co. to assist the Company in  identifying,
considering and evaluating various strategic options and alternatives.  Hallwood
expects to  consider a number of  different  alternatives,  including  strategic
alliances,  property  and/or  company  acquisitions,  a  merger  or  sale of the
Company,  sale of all or part of the  Company's  properties,  restructuring  and
continuing to exploit its inventory of drilling prospects. There is no assurance
that any transaction will be entered into or completed.

Dividends

On December 19, 2000,  Hallwood declared a quarterly dividend of $.25 per Series
A  Cumulative   Preferred  share,  which  was  paid  on  February  15,  2001  to
shareholders  of record on December 31, 2000.  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. Hallwood may not declare or pay dividends to common shareholders
unless full cumulative dividends have been paid on the preferred stock.

Stock Repurchases

On February 18, 2000, Hallwood 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.

On May 5, 2000,  the  Company  repurchased  a block of 360,000  shares of common
stock at $5.00  per  share.  These  shares  are held as  treasury  shares by the
Company.

During March 2000, the Board of Directors of Hallwood approved the repurchase of
up to $5,000,000 of common and preferred stock of Hallwood through a combination
of an odd-lot  program for certain  common and  preferred  shareholders  and the
repurchase of common shares in the open market.

Under the odd-lot  program,  the Company  offered to purchase  holdings of 99 or
fewer  common  shares,  or 20 or  fewer  Series  A  Preferred  shares  from  its
shareholders  of record as of April 10,  2000.  The  original  offer was for the
period from April 21, 2000 through May 22,  2000.  The closing date of the offer
was subsequently extended until June 12, 2000.

Under the odd-lot  program,  the Company  repurchased  213,404  shares of common
stock at an  average  price of $6.19 per share.  The  Company  also  repurchased
26,776 shares of preferred  shares at an average  price of $7.84 per share.  The
common shares  repurchased  under the odd-lot program are being held as treasury
shares, and the preferred shares repurchased have been cancelled.

During the second  quarter of 2000, the Company  purchased  91,050 shares of its
common stock on the open market. The purchase prices ranged from $4.10 per share
to $7.75 per  share.  These  shares are being  held by the  Company as  treasury
shares.

During the third quarter of 2000,  the Company  purchased  100,000 shares of its
common stock at $8.625 per share.  These  shares are held as treasury  shares by
the Company.

Stock Option Plans

On June 9, 1999,  the  Compensation  Committee  of Hallwood  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,  Hallwood 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,  one-third  vested on June 8,
2000 and the  remaining  one-third  will vest on June 8,  2001.  During the year
2000,  27,000  of  these  options  expired  and  54,000  of these  options  were
cancelled.

On January 28, 2000, the  Compensation  Committee of Hallwood 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, one-third vested on January 28, 2001 and the remaining one-third will vest
on  January  28,  2002.  During  the year  2000,  6,533 of  these  options  were
exercised,  19,600 of these  options  expired  and 3,267 of these  options  were
cancelled.

On January 31, 2001, the  Compensation  Committee of Hallwood granted options to
purchase 398,867 shares of common stock at an exercise price of $9.875 per share
which  was equal to the fair  market  value of the  Common  Stock on the date of
grant. The options expire on January 31, 2008, 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 31, 2002 and one-third on January
31, 2003.

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



<PAGE>


Financing

On June 8, 1999,  Hallwood 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  were Morgan  Guaranty  Trust
Company, First Union National Bank and Bank of America. Effective June 30, 2000,
Wells Fargo Bank replaced Bank of America as one of Hallwood's lenders under its
Credit  Agreement.  Effective  June 30, 2000,  Hallwood's  Credit  Agreement was
amended to set Hallwood's borrowing base at $70,000,000.  Subsequent to December
31, 2000, Hallwood borrowed an additional $6,000,000 under its Credit Agreement,
therefore, Hallwood's unused borrowing base was $8,000,000 as of March 1, 2001.

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% plus
from .25% to 1% or the  Euro-Dollar  rate plus from 1.25% to 2.0%.  The weighted
average  interest  rate was 8.6% at  December  31,  2000.  Interest  is  payable
monthly.  Quarterly  principal  payments of $8,857,000 are scheduled to 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 Hallwood's oil and gas properties.  Additionally,  aggregate  dividends
paid and stock repurchased by Hallwood 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 Hallwood is 50% or
more of the borrowing base.  Aggregate  dividends paid and stock  repurchased by
Hallwood 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 Hallwood's  Common Stock at
an  exercise  price of $7.00 per  share.  The terms of the Note  Agreement  were
further amended on June 30, 2000 to exclude certain hedging  transactions of the
subsidiaries  of Hallwood 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.

Hallwood  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,  Hallwood  enters  into  financial
contracts  to hedge the  interest  rate  payments  under its  Credit  Agreement.
Hallwood  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 December 31, 2000
and as of March 1,  2001,  Hallwood  was a party to eight  contracts  with three
different counterparties.


<PAGE>


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

                                                                    Average
                                             Amount of              Contract
               Period                       Debt Hedged            Floor Rate

               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

Hallwood  uses the sales  method for  recording  its gas  balancing.  Under this
method,  Hallwood 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, 2000,  Hallwood had a net  over-produced  position of 243,000
mcf  ($651,000  valued  at  average  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  Hallwood's  results  of  operations,  liquidity  and
capital  resources.  The  reserves  disclosed  in Item 8 have been  decreased by
243,000 mcf in order to reflect Hallwood's gas balancing position.

Recently Issued Accounting Pronouncements

Statement of Financial  Accounting  Standards No. 133 "Accounting for Derivative
Instruments  and Hedging  Activities"  ("SFAS 133"), is effective for all fiscal
years  beginning  after June 15,  2000.  SFAS 133, as amended  and  interpreted,
establishes  accounting  and  reporting  standards for  derivative  instruments,
including certain derivative  instruments  embedded in other contracts,  and for
hedging activities. All derivatives, whether designated in hedging relationships
or not, will be required to be recorded on the balance  sheet at fair value.  If
the  derivative  is designated  as a fair-value  hedge,  the changes in the fair
value of the derivative  and the hedged item will be recognized in earnings.  If
the derivative is designated as a cash-flow hedge,  changes in the fair value of
the  derivative  will be  recorded  in other  comprehensive  income  and will be
recognized in the income statement when the hedged item affects  earnings.  SFAS
133  defines new  requirements  for  designation  and  documentation  of hedging
relationships as well as ongoing effectiveness assessments in order to use hedge
accounting.  For a derivative that does not qualify as a hedge,  changes in fair
value will be recognized in earnings.

The Company adopted SFAS 133 on January 1, 2001. In connection with the adoption
of SFAS 133, all derivatives within the Company were identified pursuant to SFAS
133 requirements.  The Company  determined that all of its oil and gas commodity
swaps and collars,  as well as its interest  rate swaps should be  designated as
cash flow hedges.  Since the Company's  derivatives  are designated as cash flow
hedges, changes in the fair value of the derivatives will be recognized in other
comprehensive  income until the hedged item is  recognized  in  earnings.  Hedge
effectiveness  will be measured based on the relative  changes in the fair value
between the  derivative  contract and the hedged item over time.  Any changes in
fair value  resulting  from  ineffectiveness,  as  defined by SFAS 133,  will be
recognized immediately in current earnings.

The adoption of SFAS 133 as of January 1, 2001 resulted in the  recognition of a
current  asset of $163,000,  a current  liability of  $36,228,000,  a noncurrent
asset of $316,000 and a noncurrent  liability of  $8,067,000,  with a net-of-tax
cumulative effect adjustment reducing other comprehensive income by $28,919,000.

The Derivatives Implementation Group continues to address certain implementation
issues that may have an impact on the application of this  accounting  standard.
Management  of the Company is unable to determine  the effects of such issues at
this time.


<PAGE>


Forward Looking Statements

The information in Item 7. 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 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  Hallwood,  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 1998 through 2000. The
following  table  presents  the  weighted  average  prices  received per year by
Hallwood, 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>
2000                    $29.12                    $23.64                     $3.44                     $2.68
1999                     18.16                     16.52                      2.06                      1.90
1998                     12.82                     13.65                      1.99                      2.02
</TABLE>

As  part  of its  risk  management  strategy,  Hallwood  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.

Hallwood'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.  The Company is  authorized  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,   Hallwood  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  Hallwood  to hedge  the price of its oil and
natural gas production are swaps and collars. Under the swap contracts, Hallwood
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 December 31, 2000 and March
1, 2001,  Hallwood was a party to 22 financial  contracts  with three  different
counterparties.

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

                                 Oil

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

     2001                          33%                   $23.14
     2002                           9%                    23.10



<PAGE>





                                 Gas

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

     2001                         51%                     $2.24
     2002                         25%                      2.09

Between  9% and 12% of the gas  volumes  hedged  in each year are  subject  to a
collar  agreement  whereby  Hallwood 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 $2.62 per mcf to
$2.77 per mcf.

During the first quarter  through March 1, 2001, the weighted  average oil price
(for barrels not hedged) was approximately  $28.35 per barrel,  and the weighted
average  price of natural gas (for mcf not hedged) was  approximately  $6.25 per
mcf.

Inflation

Inflation did not have a material  impact on Hallwood in 1999 or 1998.  However,
substantial drilling, completion and operational cost increases were experienced
throughout the industry and became  evident in the later half of 2000.  Hallwood
expects to experience  continued  inflationary  pressure for oil field goods and
services in the year 2001.

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.

2000 Compared to 1999

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

                              2000             1999
                              ----             ----
Gas
  Production (mcf)          22,248,000       18,263,000
  Price (per mcf)                $2.68            $1.90
Oil
  Production (bbl)             682,000          925,000
  Price (per bbl)               $23.64           $16.52

Gas Revenue

Gas revenue increased  $24,888,000  during 2000 compared with 1999. The increase
is comprised of an increase in gas production from 18,263,000 mcf during 1999 to
22,248,000  mcf during 2000, and an increase in the average gas price from $1.90
per mcf in  1999 to  $2.68  per mcf in  2000.  The  increase  in  production  is
primarily due to the Consolidation  which caused a 4,134,000 mcf increase in gas
production,  partially  offset by a decrease in production due to property sales
during the first and second quarters of 2000.

The effect of Hallwood's hedging  transactions as described under "Inflation and
Changing Prices" was to decrease Hallwood's average gas price from $3.44 per mcf
to $2.68 per mcf, representing a $16,908,000 decrease in gas revenues for 2000.

Oil Revenue

Oil revenue  increased  $844,000 during 2000 compared with 1999. The increase is
comprised of an increase in the average oil price from $16.52 per barrel in 1999
to $23.64 per barrel in 2000, partially offset by a decrease in production, from
925,000  barrels in 1999 to 682,000  barrels in 2000. The decrease in production
is primarily due to the property sales discussed  above,  partially offset by an
increase in production of 144,000 barrels due to the Consolidation.

The effect of Hallwood's hedging transactions was to decrease Hallwood's average
oil price from $29.12 per barrel to $23.64 per barrel, resulting in a $3,737,000
decrease in oil revenue for 2000.

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 Section 29 tax credit  incentive  payments related to certain wells
in San Juan County, New Mexico and LaPlata County, Colorado. Pipeline facilities
and other revenue  increased  $505,000  during 2000 compared with 1999 primarily
due to additional revenue from the Consolidation.

Interest Income

The  increase in  interest  income of $162,000  during 2000  compared  with 1999
resulted primarily from a higher average cash balance during 2000.

Production Operating Expense

Production  operating  expense  increased  $3,854,000  during 2000 compared with
1999.   The  increase  is  comprised  of  a  $3,700,000   increase  due  to  the
Consolidation  and increased  production taxes resulting from the higher oil and
gas prices discussed above,  partially  offset by decreased  operating  expenses
resulting from the property sales during 2000.

Facilities Operating Expense

Facilities  operating  expense  represents  operating  expenses  associated with
various  smaller  gathering  systems  operated  by  Hallwood.  The  decrease  in
facilities   operating  expense  of  $136,000  is  primarily  due  to  decreased
maintenance activity during 2000 compared with 1999.

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
Hallwood.  These expenses  increased  $4,288,000  during 2000 compared with 1999
primarily due to an increase in incentive based compensation expense during 2000
and increased expenses due to the Consolidation.

Depreciation, Depletion and Amortization Expense

Depreciation,  depletion and amortization  expense  increased  $2,822,000 during
2000  compared  with 1999.  The increase is due to as higher  capitalized  costs
during 2000 primarily due to the Consolidation.

Interest Expense

Interest  expense  increased  $1,783,000  during 2000 as compared with 1999. The
increase is primarily due to higher interest rates during 2000.

Equity in Loss of HCRC

Equity in loss of HCRC represents  Hallwood's share of its equity  investment in
HCRC  prior to the  Consolidation.  This loss  decreased  to zero  during  2000,
compared  with  1999,  as a  result  of  the  Consolidation.  The  1999  balance
represents activity until June 8, 1999.

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 $202,000
during  2000  compared  with 1999 is  primarily  due to the  liquidation  of the
remaining three May Partnerships in April 2000.

Litigation

Litigation  expense  during 2000 is comprised  primarily of the costs related to
the  settlement  of  the  employment  litigation  described  in  Note  14 of the
accompanying  financial  statements  and costs  related to the  settlement  of a
pipeline  imbalance from prior years.  These  expenses were partially  offset by
insurance  proceeds  which  reimbursed a portion of the costs paid to settle the
lawsuits  assumed by Hallwood in connection with the  Consolidation as described
in Note 14 of the accompanying  financial  statements.  Litigation income during
1999 represents  insurance  proceeds received by Hallwood 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.

Provision (Benefit) for Income Taxes

The current benefit for income taxes during 2000 is comprised of a provision for
federal  income taxes and a benefit for state income taxes.  The net benefit was
the result of a $6,471,000 reduction in the valuation allowance primarily due to
an  $8,971,000  increase in taxable  temporary  differences  during 2000 and the
effect of partially removing the valuation allowance to result in a $680,000 net
deferred tax asset, the Company's  estimated  realizable portion of net deferred
tax assets.  The effective tax rate during 2000 is lower than the statutory rate
primarily  because  of the  use of net  operating  loss  carryforwards  and  the
reduction in the  valuation  allowance.  The  effective  tax rate during 1999 is
lower than the statutory rate primarily because of the use of net operating loss
carryforwards.

1999 Compared to 1998

The following  table is presented to contrast  Hallwood'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

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 Hallwood's hedging transactions was to decrease Hallwood'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 Hallwood's hedging transactions was to decrease Hallwood'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 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 Section 29
tax credit incentive  payment income resulting from Hallwood'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

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

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.


<PAGE>


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 Loss of HCRC

Hallwood'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  Hallwood's  share  of the  property
impairments recorded by HCRC.

Minority Interest in Net Income of Affiliates

The decrease in the minority  interest in net income of  affiliates  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 Hallwood
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 Note 14 of the accompanying  financial statements,
and the costs  related to the Arcadia  arbitration  described  in Note 13 of the
accompanying financial statements.


<PAGE>


ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Hallwood's  primary  market risks relate to changes in interest rates and in the
prices  received  from sales of oil and natural  gas.  Hallwood'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 and  collars.  By hedging  only a
portion of its market risk  exposures,  Hallwood 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,  Hallwood  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.  Hallwood
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.

Hallwood does not use or hold derivative  instruments  for trading  purposes nor
does  it  use  derivative   instruments  with  leveraged  features.   Hallwood's
derivative  instruments  are  designated  and  effective  as hedges  against its
identified  risks,  and do not of  themselves  expose  Hallwood  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.  Hallwood 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 Hallwood'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) - Hallwood uses both fixed and variable rate
debt to partially finance  operations and capital  expenditures.  As of December
31, 2000, Hallwood's debt consists of $56,000,000 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.
Hallwood  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,  Hallwood  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 Hallwood'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 $1,120,000
during 2001,  assuming that  outstanding  borrowings  under the Credit Agreement
remain at current levels.  This loss in income and cash flows would be offset by
a $720,000  increase in income and cash flows  associated with the interest rate
swap and collar agreements that are in effect for 2001.

A hypothetical  decrease in interest rates of two percentage  points would cause
an  increase  in the  fair  market  value of  $1,696,000  in  Hallwood's  Senior
Subordinated Notes from their fair value at December 31, 2000.


<PAGE>


Commodity Price Risk (non trading) - Hallwood 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  Hallwood'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 December 31, 2000, Hallwood has
entered  into  derivative  commodity  hedges  covering an  aggregate  of 358,000
barrels of oil and 15,929,000  mcf of gas that extend through 2002.  Under these
contracts,  Hallwood  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,  2000 would  cause a loss in income and cash flows of  $20,380,000
during 2001,  assuming that oil and gas production  remain at 2000 levels.  This
loss in income and cash flows would be offset by a $9,976,000 increase in income
and cash flows associated with the oil and natural gas derivative contracts that
are in effect for 2001.


<PAGE>


ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

              INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                                                                      Page No.

FINANCIAL STATEMENTS:

Independent Auditors' Report                                                29

Consolidated Balance Sheets at December 31, 2000 and 1999                30-31

Consolidated Statements of Operations for the years ended
   December 31, 2000, 1999 and 1998                                         32

Consolidated Statements of Stockholders' Equity for the years
   ended December 31, 2000, 1999 and 1998                                   33

Consolidated Statements of Cash Flows for the years ended
   December 31, 2000, 1999 and 1998                                         34

Notes to Consolidated Financial Statements                               35-54

SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED)                 55-58



<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, 2000 and 1999 and for each of the three years in
the  period  ended  December  31,  2000,  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 auditing standards generally accepted
in the  United  States of  America.  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, 2000 and 1999, and the results of its operations and its cash flows
for each of the three years in the period ended  December 31, 2000 in conformity
with accounting principles generally accepted in the United States of America.

DELOITTE & TOUCHE LLP

Denver, Colorado
March 1, 2001


<PAGE>
<TABLE>
<CAPTION>


                           HALLWOOD ENERGY CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                                 (In thousands)

                                                                                   December 31,
                                                                          2000                      1999

CURRENT ASSETS

<S>                                                                   <C>                         <C>
   Cash and cash equivalents                                          $    4,334                  $  10,480
   Accounts receivable:
     Oil and gas revenues                                                 20,618                     12,442
     Trade                                                                 3,911                      4,918
   Due from affiliates                                                       685                        704
   Prepaid expenses and other current assets                               1,927                      1,209
                                                                       ---------                  ---------
       Total                                                              31,475                     29,753
                                                                        --------                   --------

PROPERTY,  PLANT  AND  EQUIPMENT,  at cost
Oil and gas  properties  (full  cost method):
     Proved mineral interests                                            765,262                    758,473
     Unproved mineral interests                                            6,557                      6,543
   Furniture, fixtures and other                                           1,249                      1,941
                                                                       ---------                  ---------
       Total                                                             773,068                    766,957

   Less accumulated depreciation, depletion,
    amortization and property impairment                                (608,563)                  (585,336)
                                                                         --------                  ---------
       Total                                                             164,505                    181,621
                                                                         -------                    -------

OTHER ASSETS
   Deferred tax asset                                                        680
   Deferred expenses and other assets                                      1,107                      1,400
                                                                       ---------                  ---------
       Total                                                               1,787                      1,400
                                                                       ---------                  ---------

TOTAL ASSETS                                                            $197,767                   $212,774
                                                                         =======                    =======



















<FN>

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


<PAGE>

<TABLE>
<CAPTION>

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


                                                                                        December 31,
                                                                                        ------------
                                                                               2000                       1999
                                                                              ------                     -----
CURRENT LIABILITIES
<S>                                                                          <C>                       <C>
   Accounts payable and accrued liabilities                                  $  28,082                 $  26,382
                                                                              --------                  --------

NONCURRENT LIABILITIES
   Long-term debt                                                               79,387                   109,357
   Deferred revenue and other                                                    1,037                     1,066
                                                                             ---------                 ---------
       Total                                                                    80,424                   110,423
                                                                              --------                   -------

         Total liabilities                                                     108,506                   136,805
                                                                               -------                   -------

MINORITY INTEREST IN AFFILIATES                                                                              582
                                                                        --------------                ----------

COMMITMENTS AND CONTINGENCIES (NOTE 15)

STOCKHOLDERS' EQUITY

   Series A Cumulative Preferred Stock;  5,000,000 shares
     authorized; 2,263,573 shares issued and outstanding in 2000
     and 2,334,165 shares issued and outstanding in 1999                         20,873                    21,368
   Common Stock par value $.01 per share; 25,000,000 shares
     authorized; 10,423,693 shares issued and 9,659,239 shares
     outstanding in 2000 and 9,999,754 shares issued and
     outstanding in 1999                                                            104                       100
   Additional paid-in capital                                                    70,085                    67,883
   Retained earnings (accumulated deficit)                                        2,809                   (13,982)
   Less cost of treasury stock of 764,454 common shares in 2000                  (4,610)
                                                                              ---------                    -------
         Stockholders' equity - net                                              89,261                    75,387
                                                                               --------                  --------

 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                    $197,767                  $212,774
                                                                                =======                   =======


















<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,
                                                                          -------------------------------
                                                                      2000             1999              1998
                                                                     ------           ------            -----

REVENUES:

<S>                                                                <C>              <C>               <C>
  Gas revenue                                                      $  59,627        $  34,739         $  28,366
  Oil revenue                                                         16,124           15,280            10,741
  Pipeline, facilities and other                                       7,009            6,504             4,070
  Interest                                                               520              358               409
                                                                  ----------      -----------       -----------
                                                                      83,280           56,881            43,586
                                                                    --------         --------          --------

EXPENSES:

  Production operating                                                20,954           17,100            12,175
  Facilities operating                                                   490              626               498
  General and administrative                                          11,683            7,395             5,045
  Depreciation, depletion and amortization                            23,849           21,027            15,720
  Impairment of oil and gas properties                                                                   14,000
  Interest                                                             8,598            6,815             2,797
                                                                   ---------        ---------         ---------
                                                                      65,574           52,963            50,235
                                                                    --------         --------          --------

OTHER INCOME (EXPENSES):

  Equity in loss of HCRC                                                                 (419)           (4,888)
  Minority interest in net income of affiliates                          (127)           (329)             (976)
  Litigation                                                             (493)             48            (1,382)
                                                                   ----------     -----------          --------
                                                                         (620)           (700)           (7,246)
                                                                   ----------      ----------          --------

INCOME (LOSS) BEFORE INCOME TAXES                                     17,086            3,218           (13,895)

PROVISION (BENEFIT) FOR INCOME TAXES:

  Current                                                                (157)            338
  Deferred                                                               (680)
                                                                   ----------     --------------         --------
                                                                         (837)            338
                                                                   ----------     -----------            --------

NET INCOME (LOSS)                                                     17,923            2,880           (13,895)

PREFERRED DIVIDENDS                                                    2,271            2,368             2,464
                                                                   ---------        ---------         ---------

NET INCOME (LOSS) ATTRIBUTABLE TO
  COMMON SHAREHOLDERS                                            $    15,652      $       512       $   (16,359)
                                                                  ==========        =========        ===========
     NET INCOME (LOSS) PER SHARE - BASIC                         $      1.61      $       .06       $     (2.92)
                                                                  ==========       ==========        ==========

     NET INCOME (LOSS) PER SHARE - DILUTED                       $      1.60      $       .06       $     (2.92)
                                                                  ==========       ==========        ==========

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
  BASIC                                                                9,695            8,083             5,600
                                                                   =========        =========          ========
  DILUTED                                                              9,772            8,083             5,600
                                                                   =========        =========          ========

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

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

     Provision for income taxes
                                                                                   ---------          -----------
     Net income (loss)                                                             $  3,218           $ (13,895)
                                                                                   =========           ========

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

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

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

<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)

                                       Series A
                                      Cumulative         Common     Additional     Retained Earnings        Treasury
                                     Preferred Stock     Stock    Paid-in-Capital  Accumulated Deficit)       Stock          Total
                                     --------------    ---------  --------------- --------------------      -------      --------

<S>                                      <C>           <C>         <C>                   <C>                <C>         <C>
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
  Issuance of common stock for
   property acquisition                                      4        3,311                                                 3,315
  Dividends                                                           (1,139)              (1,132)                         (2,271)
  Repurchase of common shares                                                                             $  (4,610)       (4,610)
  Repurchase of preferred shares             (513)                                                                           (513)
  Exercise of stock options                                              30                                                    30
  Net income                                                                               17,923                          17,923
                                     ------------     --------    -------------           -------       ----------      ---------
Balance, December 31, 2000               $ 20,873      $   104     $ 70,085             $   2,809         $  (4,610)    $  89,261
                                          =======       ======      =======              ========          ========      ========




<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,
                                                                             ---------------------------------
                                                                       2000                 1999                 1998
                                                                      ------               ------               -----

OPERATING ACTIVITIES:

<S>                                                                   <C>               <C>                  <C>
  Net income (loss)                                                   $17,923           $    2,880           $ (13,895)
  Adjustments to reconcile net income (loss) to net
       Depreciation, depletion and amortization                        23,849               21,027               15,720
       Impairment of oil and gas properties                                                                      14,000
       Depreciation charged to affiliates                                 200                  220                  249
       Amortization of deferred loan costs and debt discount              450                  282                   82
       Minority interest in net income of affiliates                      127                  329                  976
       Recoupment of take-or-pay liability                               (52)                (416)                (130)
       Deferred tax benefit                                             (680)
       Equity in loss of HCRC                                                                  419                4,888
       Undistributed earnings of affiliates                                                (1,177)              (1,319)
       Gain on asset disposals                                                                                    (188)
         Noncash interest expense                                                                                    15

  Changes in operating assets and liabilities provided
       Oil and gas revenues receivable                                (8,647)              (2,642)                2,861
       Trade receivables                                                1,007                (529)                1,029
       Due from affiliates                                                246              (3,992)                (362)
       Prepaid expenses and other current assets                        (718)                  385                (247)
       Deferred expenses and other assets                                  73                  193                (408)
       Accounts payable and accrued liabilities                         1,749                1,259                3,006
                                                                   ----------            ---------            ---------
         Net cash provided by operating activities                     35,527               18,238               26,277
                                                                     --------             --------             --------

INVESTING ACTIVITIES:

  Additions to property, plant and equipment                          (9,320)             (11,093)             (28,756)
  Exploration and development costs incurred                         (16,487)             (13,069)             (12,180)
  Costs incurred in connection with the Consolidation                                      (2,933)
  Proceeds from sales of property, plant and equipment                 21,698                  388                  454
  Distributions received from affiliate                                                      1,833                1,583
  Investment in affiliates                                                                                         (20)
                                                                --------------       --------------       ------------
         Net cash used in investing activities                        (4,109)             (24,874)             (38,919)
                                                                   ---------             --------             --------

FINANCING ACTIVITIES:

  Payments of long-term debt                                         (37,200)              (3,000)             (18,286)
  Proceeds from long-term debt                                          7,000               13,000               33,000
  Dividends paid                                                      (2,271)              (4,061)              (9,495)
  Purchase of common shares held in treasury                          (4,610)
  Purchase and cancellation of preferred shares                         (513)
  Exercise of options                                                      30                                       199
  Proceeds from equity offering, net
    of syndication costs                                                                                         16,518
  Distributions paid by consolidated affiliates
    to minority interest                                                                       (429)            (1,446)
  Payment of contract settlement                                                                                (2,767)
  Capital contribution                                                                                              171
  Debt issuance costs                                                                        (268)
                                                                --------------          ---------               --------
         Net cash provided by (used in) financing activities         (37,564)                5,242               17,894
                                                                    --------             ---------             --------

NET INCREASE (DECREASE) IN CASH AND CASH
  EQUIVALENTS                                                         (6,146)               (1,394)               5,252

CASH AND CASH EQUIVALENTS:
  BEGINNING OF YEAR                                                    10,480               11,874                6,622
                                                                     --------             --------            ---------
  END OF YEAR                                                      $    4,334            $  10,480            $  11,874
                                                                    =========             ========             ========
<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  ("Hallwood"  or  the  "Company")  is  a  Delaware
corporation engaged in the development,  exploration, acquisition and production
of oil and gas properties. Hallwood 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 Hallwood,  and all
share and per share  information  assumes that the shares of Hallwood  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.

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                       $     (.07)      $    (2.92)                       $    (3.80)
                                  =======                           =======        =========                         =========
Net income (loss)
   Per share - diluted          $     .06                        $     (.07)     $    (2.92)                       $    (3.80)
                                 ========                         =========       =========                         =========
</TABLE>

Accounting Policies

Consolidation

Hallwood 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 through March
31,  2000 when they were  liquidated  and the May Limited  Partnerships  1983-1,
1983-2 and 1983-3 through March 31, 1999 when they were liquidated.


<PAGE>


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 during 1999 and 1998. Because
of the  Company's  net  operating  loss  carryforwards,  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 1999 or 1998 on a pro forma basis.

Derivatives

As of December 31, 2000, Hallwood was a party to 22 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 December 31, 2000,  Hallwood 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

Hallwood  uses the sales  method for  recording  its gas  balancing.  Under this
method,  Hallwood 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, 2000,  Hallwood had a net  over-produced  position of 243,000
mcf  ($651,000  valued  at  average  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  Hallwood's  results  of  operations,  liquidity  and
capital resources.  Hallwood's oil and gas reserves as of December 31, 2000 have
been  decreased  by 243,000  mcf in order to reflect  Hallwood's  gas  balancing
position.

Property, Plant and Equipment

Hallwood 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.

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,  Hallwood
recorded oil and gas property impairments totaling $14,000,000. Hallwood did not
record any property impairments during 2000 or 1999.

Hallwood 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, Hallwood has not recognized any
impairment losses on long-lived assets other than oil and gas properties.

Dividends

On December 19, 2000,  Hallwood declared a quarterly dividend of $.25 per Series
A  Cumulative   Preferred  share,  which  was  paid  on  February  15,  2001  to
shareholders  of record on  December  31,  2000.  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. Hallwood 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 granted during 1999
described  in Note 9 have been  ignored in the  computation  of  diluted  income
(loss) per share in all periods because their inclusion would be anti-dilutive.

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) to
                                                    Common
                                                  Shareholders        Shares          Per Share
                                                  ------------        ------          ---------
                                                 (In thousands except per Share data)

For the Year Ended December 31, 2000

<S>                                                   <C>               <C>             <C>
   Net income per share - basic                       $ 15,652          9,695           $  1.61
                                                                                         ======
   Effect of options                                                       77
                                                 -------------       --------
   Net income per share - diluted                     $ 15,652          9,772           $  1.60
                                                       =======         ======            ======

For the Year Ended December 31, 1999

   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)
                                                       ======           =====             =====
</TABLE>



<PAGE>


Stock Based Compensation

The Company accounts for stock-based  compensation using the intrinsic method of
accounting.  Under this method,  compensation  cost,  if any, is measured as the
excess of the  quoted  market  price of the  Company's  stock at the date of the
grant  over the amount an  employee  must pay to  acquire  the stock.  Pro forma
disclosures  utilizing the fair value accounting  method are included in Note 10
to the consolidated financial statements.

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 Hallwood
sells its production; therefore, the loss of its significant customers would not
adversely affect Hallwood's  operations.  For the years ended December 31, 2000,
1999 and 1998,  purchases by the following  companies  exceeded 10% of the total
oil and gas revenues of the Company:


<PAGE>


                                     2000             1999              1998
                                     ----             ----              ----

El Paso Field Services Company       18%               14%              11%
Plains All American Inc.             15%               14%
Conoco Inc.                          14%               19%              23%

Environmental Concerns

Hallwood  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, 2000, Hallwood 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
Hallwood 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, 2000, 1999 and 1998.  Therefore,  total comprehensive  income
(loss) is the same as net income (loss) for those periods.

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,  Hallwood's  operations consist of one
reportable segment.

Recently Issued Accounting Pronouncements

Statement of Financial  Accounting  Standards No. 133 "Accounting for Derivative
Instruments  and Hedging  Activities"  ("SFAS 133"), is effective for all fiscal
years  beginning  after June 15,  2000.  SFAS 133, as amended  and  interpreted,
establishes  accounting  and  reporting  standards for  derivative  instruments,
including certain derivative  instruments  embedded in other contracts,  and for
hedging activities. All derivatives, whether designated in hedging relationships
or not, will be required to be recorded on the balance  sheet at fair value.  If
the  derivative  is designated  as a fair-value  hedge,  the changes in the fair
value of the derivative  and the hedged item will be recognized in earnings.  If
the derivative is designated as a cash-flow hedge,  changes in the fair value of
the  derivative  will be  recorded  in other  comprehensive  income  and will be
recognized in the income statement when the hedged item affects  earnings.  SFAS
133  defines new  requirements  for  designation  and  documentation  of hedging
relationships as well as ongoing effectiveness assessments in order to use hedge
accounting.  For a derivative that does not qualify as a hedge,  changes in fair
value will be recognized in earnings.

The Company adopted SFAS 133 on January 1, 2001. In connection with the adoption
of SFAS 133, all derivatives within the Company were identified pursuant to SFAS
133 requirements.  The Company  determined that all of its oil and gas commodity
swaps and collars,  as well as its interest  rate swaps should be  designated as
cash flow hedges.  Since the Company's  derivatives  are designated as cash flow
hedges, changes in the fair value of the derivatives will be recognized in other
comprehensive  income until the hedged item is  recognized  in  earnings.  Hedge
effectiveness  will be measured based on the relative  changes in the fair value
between the  derivative  contract and the hedged item over time.  Any changes in
fair value  resulting  from  ineffectiveness,  as  defined by SFAS 133,  will be
recognized immediately in current earnings.

The adoption of SFAS 133 as of January 1, 2001 resulted in the  recognition of a
current  asset of $163,000,  a current  liability of  $36,228,000,  a noncurrent
asset of $316,000 and a noncurrent  liability of  $8,067,000,  with a net-of-tax
cumulative effect adjustment reducing other comprehensive income by $28,919,000.

The Derivatives Implementation Group continues to address certain implementation
issues that may have an impact on the application of this  accounting  standard.
Management  of the Company is unable to determine  the effects of such issues at
this time.

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 Hallwood's oil and
gas activities:

                                      For the Year Ended December 31,
                                      -------------------------------
                                  2000             1999              1998
                                  ----             ----              ----
                                              (In thousands)

Property acquisition costs:
  Proved                         $ 12,621        $  85,235           $28,397
  Unproved                             14            3,849               379
Development costs                  12,290            7,302             8,087
Exploration costs                   4,197            5,767             6,043
                                  -------        ---------           -------
      Total                       $29,122         $102,153           $42,906
                                   ======          =======            ======

Depreciation,  depletion,  amortization and impairment expense related to proved
oil and gas  properties  per  equivalent  mcf of production  for the years ended
December 31, 2000, 1999 and 1998, was $.91, $.88 and $1.58, respectively.


<PAGE>


At December 31, unproved properties consist of the following:

                                 2000             1999
                                 ----             ----
                                    (In thousands)

Texas                            $5,716           $4,898
New Mexico                          430
Louisiana                           293
North Dakota                                       1,009
Other                               118              636
                                 ------           ------
                                 $6,557           $6,543
                                  =====            =====


NOTE 3 - PRINCIPAL ACQUISITIONS AND SALES

On August 30,  2000,  Hallwood  completed  the  acquisition  of  interests in 34
producing wells, five service wells and 69 inactive wells in five fields located
in  Chambers,  San  Patricio  and Frio  Counties  in  Texas  and St.  James  and
Assumption  Parishes  in  Louisiana,  as well as  approximately  7,000  acres of
undeveloped  leasehold  and 3-D  seismic  data.  The  total  purchase  price was
comprised of  $3,875,000 in cash and 417,406  shares of Hallwood's  common stock
valued at $3,315,000.

During 2000,  Hallwood sold its interests in approximately 500 non-strategic oil
and gas wells located in the Keystone,  Merkle and Weesatche  areas of Texas, as
well as various  wells in  Kansas,  Oklahoma,  North  Dakota  and  Montana.  The
proceeds from the Company's  property  sales during 2000 were  $21,698,000  (all
credited  against oil and gas properties  without gain or loss  recognition)  of
which $21,000,000 was used to pay down borrowings under the Credit Agreement.

On  October  20,  1999,   Hallwood  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 13,  Hallwood  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,  Hallwood 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 Hallwood and HCRC purchased the volumetric  production  payment
from the affiliate of Enron Corp.  Hallwood funded its $17,257,000  share of the
acquisition  price  from  operating  cash flow and  borrowings  under its Credit
Agreement.

NOTE 4 - DERIVATIVES

As  part  of its  risk  management  strategy,  Hallwood  enters  into  financial
contracts to hedge the price of its oil and natural gas.  Hallwood  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  Hallwood  to hedge  the price of its oil and
natural gas production are swaps,  collars and participating  hedges.  Under the
swap contracts,  Hallwood 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 December
31, 2000,  Hallwood was a party to 22 financial  contracts with three  different
counterparties.

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

                                   Oil

                         Quantity of Production

      Period                     Hedged                     Contract Floor Price
      ------                ----------------                --------------------
                                 (bbls)                            (per bbl)

       1998                       175,000                             $16.62
       1999                       325,000                              15.43
       2000                       372,000                              19.07
       2001                       285,000                              23.14
       2002                        73,000                              23.10



<PAGE>


                                   Gas

                         Quantity of Production

      Period                     Hedged                     Contract Floor Price
      ------                ----------------                --------------------
                                  (mcf)                            (per mcf)

       1998                     7,101,000                              $2.09
       1999                    15,574,000                               1.85
       2000                    11,000,000                               2.12
       2001                    10,789,000                               2.24
       2002                     5,140,000                               2.09

From 2000 forward, between 9% and 12% of the gas volumes hedged in each year are
subject to a collar  agreement  whereby Hallwood 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 $2.62 per mcf to
$2.77 per mcf.

In the event of nonperformance by the counterparties to the financial contracts,
Hallwood  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 Hallwood's  hedges are secured by the lien
on  Hallwood's  oil and gas  properties  which also  secures  Hallwood's  Credit
Agreement described in Note 6.

NOTE 5 - INVESTMENT IN AFFILIATED CORPORATION

During 1998 and through June 8, 1999, Hallwood accounted for its approximate 46%
interest  in HCRC  using the  equity  method of  accounting.  As a result of the
Consolidation,  Hallwood's  investment  in HCRC was  eliminated.  The  following
presents summarized  financial  information in thousands,  for HCRC for the year
ended December 31, 1998.

Revenue                                                   $  32,410
Net loss                                                     (20,279)

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

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


<PAGE>


Costs Incurred in Oil and Gas Activities for the Year-Ended December 31, 1998:

Acquisition costs                                          $ 12,879
Development costs                                             2,636
Exploration costs                                             2,606
                                                           --------
     Total                                                 $ 18,121
                                                            =======

Oil and gas revenue                                        $ 10,372
Production operating expense                                  (4,272)
Depreciation, depletion, amortization
     Net loss from oil and gas activities                  $  (7,673)
                                                            ========

Proved Oil and Gas Reserve Quantities:

                                                        Gas              Oil
                                                        Mcf              Bbl
                                                            (unaudited)

December 31, 1998                                     32,000            1,470
                                                      ======            =====

Standardized Measure of Discounted Future Net Cash Flows:

                                                         (unaudited)

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


NOTE 6 - DEBT

Hallwood's  long-term  debt at  December  31,  2000  and 1999  consisted  of the
following:

                                               2000             1999
                                               ----             ----
                                                  (In thousands)

Credit Agreement                           $  56,000        $  86,200
Note Agreement                                25,000           25,000
Debt discount                                 (1,613)          (1,843)
                                            --------        ---------

Long-term debt                             $  79,387         $109,357
                                            ========          =======

On June 8, 1999,  Hallwood 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  were Morgan  Guaranty  Trust
Company, First Union National Bank and Bank of America. Effective June 30, 2000,
Wells Fargo Bank replaced Bank of America as one of Hallwood's lenders under its
Credit  Agreement.  Effective  June 30, 2000,  Hallwood's  Credit  Agreement was
amended to set Hallwood's borrowing base at $70,000,000.  Subsequent to December
31, 2000, Hallwood borrowed an additional $6,000,000 under its Credit Agreement,
therefore, Hallwood's unused borrowing base was $8,000,000 as of March 1, 2001.

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% plus
from .25% to 1% or the  Euro-Dollar  rate plus from 1.25% to 2.0%.  The weighted
average  interest  rate was 8.6% at  December  31,  2000.  Interest  is  payable
monthly.  Quarterly  principal  payments of $8,857,000 are scheduled to commence
May 31, 2002.


<PAGE>


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 Hallwood's oil and gas properties.  Additionally,  aggregate  dividends
paid and stock repurchased by Hallwood 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 Hallwood is 50% or
more of the borrowing base.  Aggregate  dividends paid and stock  repurchased by
Hallwood 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 Hallwood's  Common Stock at
an  exercise  price of $7.00 per  share.  The terms of the Note  Agreement  were
further amended on June 30, 2000 to exclude certain hedging  transactions of the
subsidiaries  of Hallwood 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.

Hallwood  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, 2000, Hallwood's debt maturity schedule is as follows.

                                  (In thousands)

2001                            $          --
2002                                   24,000
2003                                   37,000
2004                                    5,000
2005                                    5,000
Thereafter                              8,387
                                      -------
  Total                               $79,387
                                       ======

As  part  of its  risk  management  strategy,  Hallwood  enters  into  financial
contracts  to hedge the  interest  rate  payments  under its  Credit  Agreement.
Hallwood  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 December 31, 2000,
Hallwood was a party to eight contracts with three different counterparties.


<PAGE>


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

                                                  Average
                           Amount of              Contract
Period                    Debt Hedged            Floor Rate

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

Hallwood'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,  Hallwood is authorized  to issue up to 25,000,000  shares of
Hallwood  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 Hallwood common stock are entitled
to participate in dividends, if any, as may be declared from time to time by the
board of directors of Hallwood.  Upon liquidation,  the common  shareholders are
entitled to receive a pro rata share of all of the assets of  Hallwood  that are
available for distribution to such holders. The holders of Hallwood common stock
have no preemptive  rights with respect to future  issuances of Hallwood  common
stock.

Preferred Stock

Hallwood 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 Hallwood
Board of Directors.

In  connection  with the  Consolidation,  the  Board of  Directors  of  Hallwood
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  Hallwood  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 Hallwood  has funds  legally  available to pay them,
without interest on a daily basis.  Hallwood 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 Hallwood,  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  Hallwood  in a  liquidation  or
dissolution.


<PAGE>


The  Hallwood  preferred  stock is  redeemable  at the option of Hallwood  after
December 31,  2003.  After that date,  Hallwood  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 Hallwood  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 Hallwood 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 Hallwood's  outstanding  common stock. The rights will expire on June
7, 2009.

Hallwood  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.

NOTE 8 - STOCK REPURCHASES

On February 18, 2000, Hallwood 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.

On May 5, 2000,  the  Company  repurchased  a block of 360,000  shares of common
stock at $5.00  per  share.  These  shares  are held as  treasury  shares by the
Company.

During March 2000, the Board of Directors of Hallwood approved the repurchase of
up to $5,000,000 of common and preferred stock of Hallwood through a combination
of an odd-lot  program for certain  common and  preferred  shareholders  and the
repurchase of common shares in the open market.

Under the odd-lot  program,  the Company  offered to purchase  holdings of 99 or
fewer  common  shares,  or 20 or  fewer  Series  A  Preferred  shares  from  its
shareholders  of record as of April 10,  2000.  The  original  offer was for the
period from April 21, 2000 through May 22,  2000.  The closing date of the offer
was subsequently extended until June 12, 2000.

Under the odd-lot  program,  the Company  repurchased  213,404  shares of common
stock at an  average  price of $6.19 per share.  The  Company  also  repurchased
26,776 shares of preferred  shares at an average  price of $7.84 per share.  The
common shares  repurchased  under the odd-lot program are being held as treasury
shares, and the preferred shares repurchased have been cancelled.

During the second  quarter of 2000, the Company  purchased  91,050 shares of its
common stock on the open market. The purchase prices ranged from $4.10 per share
to $7.75 per  share.  These  shares are being  held by the  Company as  treasury
shares.

During the third quarter of 2000,  the Company  purchased  100,000 shares of its
common stock at $8.625 per share.  These  shares are held as treasury  shares by
the Company.

NOTE 9 - INCOME TAXES

The following is a summary of the income tax  provision  (benefit) for the years
ended December 31, 2000 and 1999. Hallwood was not a taxable entity prior to the
Consolidation on June 8, 1999:

                        For the Years Ended December 31,

                                                        2000                1999
                                                        ----                ----
                                                            (in thousands)

State                                                 $(292)                $338
Federal - Current                                       135
          Deferred                                     (680)
                                                       ----                 ----
            Total                                     $(837)                $338
                                                       ====                  ===

Reconciliation  of the expected tax at the  statutory  tax rate to the effective
tax is as follows for the years ended December 31, 2000 and 1999:

                        For the Years Ended December 31,

                                              2000                   1999
                                              ----                   ----
                                                     (in thousands)

Expected tax expense at the
State taxes net of federal benefit               30                      223
Taxes on income prior to June 8, 1999                                  (440)
Change in valuation allowance                (6,471)                   (789)
Other                                          (205)                     250
                                            -------                   ------
     Effective tax expense                 $   (837)                 $   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, 2000 and 1999 are as follows:

                                          For the Years Ended December 31,
                                              2000                   1999
                                              ----                   ----
                                                     (in thousands)

Deferred tax assets and (liabilities):
  Net operating loss carryforward            $10,819                 $ 7,758
  Capital loss carryforward                    1,442                   1,458
  Minimum tax credit carryforward                669                     534
  Temporary differences between
   book and tax basis of property             (8,039)                    932
                                              ------                  -------
       Total                                   4,891                  10,682

  Valuation allowance                         (4,211)                 (10,682)
                                             -------                  -------

Net deferred tax asset                     $     680               $     -0-
                                            ========                ========



<PAGE>


Realization  of the Company's  deferred tax asset is dependent on its generating
sufficient  taxable  income prior to the  expiration of any net  operating  loss
carryforwards.  Although  realization is not assured,  management believes it is
more likely than not that the  recorded  deferred  tax asset,  net of  valuation
allowance  provided,   will  be  realized.  The  Company's  net  operating  loss
carryforwards  expire  between  2010 and 2019,  the  capital  loss  carryforward
expires in 2001 and the minimum tax credit carryforward has no expiration date.

NOTE 10 - 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. On June 9, 1999, the  Compensation  Committee of Hallwood adopted
an incentive  plan that is  substantially  the same as the incentive plan of HEP
and HCRC. The specified percentage was 2.80% for each of 2000 and 1999 and 2.75%
for 1998. 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 each of 2000, 1999
and 1998) of the remaining net present value of the  qualifying  wells,  and the
award for that year  terminates.  The  expenses  attributable  to the plans were
$917,000  in 2000,  $220,000 in 1999 and  $125,000  in 1998 and are  included in
general and administrative expense in the accompanying financial statements.

On June 9, 1999,  the  Compensation  Committee  of Hallwood  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,  Hallwood 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,  one-third  vested on June 8,
2000 and the  remaining  one-third  will vest on June 8,  2001.  During the year
2000,  27,000  of  these  options  expired  and  54,000  of these  options  were
cancelled.

On January 28, 2000, the  Compensation  Committee of Hallwood 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, one-third vested on January 28, 2001 and the remaining one-third will vest
on  January  28,  2002.  During  the year  2000,  6,533 of  these  options  were
exercised,  19,600 of these  options  expired  and 3,267 of these  options  were
cancelled.

On January 31, 2001, the  Compensation  Committee of Hallwood granted options to
purchase 398,867 shares of common stock at an exercise price of $9.875 per share
which  was equal to the fair  market  value of the  Common  Stock on the date of
grant. The options expire on January 31, 2008, 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 31, 2002 and one-third on January
31, 2003.

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



<PAGE>


A summary of options  granted to purchase  Hallwood common stock and the changes
therein during the years ended December 31, 2000 and 1999 is presented below:
<TABLE>
<CAPTION>

                                                            2000                               1999
                                                          --------                           ------
                                                                   Weighted                           Weighted
                                                                   Average                            Average
                                                                   Exercise                           Exercise
                                                  Shares            Price            Shares            Price

<S>                                               <C>              <C>                                <C>
Outstanding at beginning of year                  661,500          $ 7.00                 --          $    --
Granted                                           238,500            4.625           661,500             7.00
Exercised                                          (6,533)           4.625
Expired                                           (46,600)           6.00
Cancelled                                         (57,267)           6.87
                                                 --------           -----       -------------         -------
Outstanding at end of  year                       789,600          $ 6.37            661,500           $ 7.00
                                                  =======           =====            =======            =====

 Options exercisable at year-end                  456,700          $ 6.64            220,500           $ 7.00
                                                  =======           ======           =======            =====

 Weighted average fair value of options
   granted during the year                                         $ 3.19                              $ 4.71
                                                                    =====                               =====
 Weighted average remaining contractual
   life of options outstanding                                     6.3 years                          7 years
</TABLE>


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

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

<S>                                               <C>              <C>               <C>                <C>
Outstanding at beginning of year                  415,900          $  5.80           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
                                            =============        =========           =======             ====

   Options exercisable at year-end                     --       $       --           398,900            $5.80
                                            =============        =========           =======             ====

 Weighted average fair value of options
   granted during the year                                                                               $1.14
                                                                                                         =====
 Weighted average remaining contractual
   life of options outstanding                                                                      7.2 years
</TABLE>



<PAGE>


A summary of options  granted to purchase Class C Units and the changes  therein
during the years 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>
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
                                              ============         ========         ========             =====

 Weighted average fair value of options
   granted during the year                                                                              $  1.22
                                                                                                          =====
 Weighted average remaining contractual
   life of options outstanding                                                                       10 years
</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,  Hallwood's net income (loss) and net income (loss) per share would
have been reduced to the pro forma amounts indicated below:

                                             2000         1999          1998
                                             ----         ----          ----

Net income (loss):        As reported    $17,923,000  $2,880,000   $(13,895,000)
                            pro forma     16,593,000     930,000    (14,022,000)
Net income (loss)
   per share - basic:     As reported          $1.61      $  .06         $(2.92)
                            pro forma          $1.48       $(.18)        $(2.94)

Net income (loss)
   per share - diluted:   As reported          $1.60      $  .06         $(2.92)
                            pro forma          $1.47       $(.18)        $(2.94)

The fair value of the common stock  options  granted  during 2000 and 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                    Granted
                               January 28, 2000           November 22, 1999             June 9, 1999
                               ----------------           -----------------             ------------

<S>                              <C>                          <C>                       <C>
Expected dividend yield            --                          --                         --
Expected price volatility           64%                         68%                        68%
Risk-free interest rate              6.7%                        6.4%                       5.8%
Expected life of options             7 years                     7 years                    7 years
</TABLE>



<PAGE>


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

                                          1998 Class A              1998 Class C
                                            Options                   Options

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


NOTE 11 - 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.  Hallwood has  receivables  from affiliates of
$685,000  and  $704,000  at  December  31,  2000 and 1999,  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  and  1998,   Hallwood   incurred
approximately  $124,000 and $274,000,  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. Hallwood
also  incurred  $117,000,   $195,000  and  $317,000  in  2000,  1999  and  1998,
respectively,  representing  costs incurred by Hallwood Group and its affiliates
on behalf of the Company.

On February 18, 2000, Hallwood 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.

NOTE 12 - STATEMENT OF CASH FLOWS

During 2000,  Hallwood's  noncash  investing  activity  included the issuance of
417,406  shares of common stock for the  acquisition  of oil and gas property as
described in Note 3.

During 1999, 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 Hallwood common stock
to HCRC and 1,800,000 shares of Hallwood 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 2000, 1999 and 1998 for interest totaled $7,953,000, $6,583,000
and  $2,700,000,  respectively.  Cash paid for income taxes during 2000 and 1999
was $594,000 and $375,000, respectively. There was no cash paid for income taxes
during 1998 as Hallwood was not a tax paying entity.

NOTE 13 - 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 the "Hallwood  Entities"),  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 the Hallwood
Entities were required to purchase an  additional  $8,000,000 in properties  and
denied  Arcadia's  claim for attorney's  fees. The  arbitrators  granted Arcadia
prejudgment  interest on the adjusted  purchase price, in the amount of $904,000
of which Hallwood'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,  Hallwood 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. Hallwood's share of the purchase price was $8,200,000.

NOTE 14 - LEGAL SETTLEMENTS

In connection  with the  Consolidation,  Hallwood  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 and dismissed.  During
February 2000,  Hallwood paid  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.  During  May  2000,  the  Company
received  a   settlement   offer  from  its   insurance   company  to  reimburse
approximately $419,000 of the costs paid in connection with these lawsuits. This
amount  was  received  by the  Company  during  the  third  quarter  of 2000 and
recognized as litigation income.

In connection with the 1995 closing of the Jakarta,  Indonesia office of HEP and
HCRC, three former  employees filed a lawsuit against those entities,  primarily
based on allegations that their employment contracts had been breached. The case
was tried in 1997, and after appeals, a final judgment of $487,820 plus interest
was awarded to the plaintiffs.  The amount due was accrued as of March 31, 2000,
and was paid to the plaintiffs in the second quarter of 2000.

Concise  Oil and Gas  Partnership  ("Concise"),  a wholly  owned  subsidiary  of
Hallwood 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.


<PAGE>


NOTE 15 - 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. The Company also leases office space in Midland,  Texas for  approximately
$7,000  per  year  under  a  lease  that   terminates  on  September  30,  2003.
Additionally,   Hallwood   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)

           2001                      $   644
           2002                          608
           2003                          606
           2004                          601
           2005                          689
        Thereafter                       689
                                      ------
                                      $3,837
                                      ======

Rent expense for the years ended December 31, 2000,  1999 and 1998 was $645,000,
$421,000 and $287,000, respectively.

NOTE 16 - 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, 2000                  December 31, 1999
                                              -----------------                  -----------------
                                         Carrying         Estimated         Carrying         Estimated
                                          Amount          Fair Value         Amount          Fair Value
                                          ------          ----------         ------          ----------
                                                                  (In thousands)

 Assets (Liabilities):
<S>                                   <C>               <C>              <C>                <C>
 Interest rate hedge contracts        $         --      $       482      $        --        $     2,156
 Oil and gas hedge contracts                   --            (44,406)             --             (4,558)
 Long-term debt                            (79,387)          (78,685)        (109,357)         (109,021)
</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, 2000.  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.

NOTE 17 - SELECTED QUARTERLY FINANCIAL DATA

The following represents selected quarterly financial  information for the years
ended December 31, 2000 and 1999.
<TABLE>
<CAPTION>

                                                                 Quarter Ended
                2000                     March 31,         June 30,       September 30,     December 31,
                ----                     ---------         --------       -------------     ------------
                                                                  (Unaudited)
                                                      (In thousands except per share data)

<S>                                     <C>               <C>               <C>              <C>
Gross revenue                           $  21,809         $  19,719         $ 20,737         $  21,015

Net revenue from oil and gas
 operations                                16,174            14,909           15,238            14,995
Net income (1)                              4,405             4,182            7,333             2,003

Net income per common share:
  Basic                                       .38               .37              .72               .15
  Diluted                                     .38               .37              .70               .14

                1999

Gross revenue (2)                      $    9,982         $  12,068        $  16,943         $  17,888

Net revenue from oil and gas
  operations (2)                            6,633             8,423           11,465            12,276

Net income (loss) (3)                       (318)             1,713              707               778

Net income per common share:
  Basic                                     (.17)               .17              .02               .02
  Diluted                                   (.17)               .17              .02               .02
</TABLE>



<PAGE>



(1)             The increase in net income  during the third  quarter of 2000 is
                primarily  due  to  an  income  tax  benefit  resulting  from  a
                reduction in the Company's  valuation allowance primarily due to
                an increase in taxable temporary differences during 2000 and the
                effect of partially  removing the valuation  allowance to result
                in an net  deferred  tax asset which  represents  the  Company's
                estimated  realizable  portion of net deferred  tax assets.  The
                decrease  in net income  during  the  fourth  quarter of 2000 is
                primarily  due to an  increase  in  general  and  administrative
                expenses  due to higher  incentive  based  compensation  expense
                during 2000.

(2)             The  increase in gross  revenue and net revenue from oil and gas
                operations each quarter during 1999 represents the effect of the
                Consolidation  as well as  increasing  oil and gas prices during
                1999.

(3)             The net loss during the first  quarter of 1999 is primarily  the
                result of lower oil and gas prices.  The  increase in net income
                during the second quarter of 1999 is primarily due to higher oil
                and gas prices and increased  operating  revenue  resulting from
                the Consolidation.


<PAGE>


                           HALLWOOD ENERGY CORPORATION
                  SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION
                                DECEMBER 31, 2000
                                   (Unaudited)

The following reserve quantity and future net cash flow information for Hallwood
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  Hallwood's  proved oil and gas reserves  from year to year.  The
standardized measure of discounted future net cash flows as of December 31, 2000
has been  reduced by  $97,902,000  for the effects of future  income  taxes.  No
consideration  has been given to future  income  taxes as of December  31, 1999,
because  the  tax  basis  of  Hallwood's   properties  and  net  operating  loss
carryforwards  exceeded  future net cash flows.  No  consideration  was given to
future  income  taxes as of December  31, 1998  because  Hallwood  was not a tax
paying entity during that year. 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,  2000,  1999 and 1998 were
$27.00  per bbl and $9.25 per mcf,  $24.32  per bbl and $2.00 per mcf and $10.00
per bbl and $1.90 per mcf, respectively,  for Hallwood.  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, 2000 prices  result in 8.8 million  bbls of oil,  and
182.8 billion cubic feet of gas and a standardized measure of $556,000,000. This
standardized  measure is not necessarily  representative  of the market value of
Hallwood's properties.

Hallwood's  standardized  measure of future net cash flows has been decreased by
$93,175,000  at December 31, 2000 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, 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

   Extensions and discoveries                                             53,226                      1,626
   Revisions of previous estimates                                         3,362                      1,207
   Sales of reserves in place                                            (12,724)                    (5,610)
   Purchases of reserves in place                                          9,538                        601
   Production                                                            (22,248)                      (682)
                                                                        --------                  ---------

   Balance, December 31, 2000                                            182,822                      8,823
                                                                         =======                   ========

Proved Developed Reserves:

   Balance, December 31, 1998                                             90,915                      3,577
                                                                        ========                   ========
   Balance, December 31, 1999                                            139,839                     10,301
                                                                         =======                    =======
   Balance, December 31, 2000                                            121,765                      6,162
                                                                         =======                   ========
</TABLE>



<PAGE>

<TABLE>
<CAPTION>

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

                                                                           December 31,
                                                       2000                     1999                     1998
                                                       ----                     ----                     ----

<S>                                                 <C>                      <C>                     <C>
Future cash flows                                   $1,721,000               $  597,000              $  245,000
Future production and development costs               (475,000)                (263,000)               (102,000)
Provision for income taxes                            (186,000)
                                                      --------            -------------
Future net cash flows before discount                1,060,000                  334,000                 143,000
10% discount to present value                         (504,000)                (126,000)                (42,000)
                                                     ---------                 --------               ---------
Standardized measure of discounted
   future net cash flows                           $   556,000               $  208,000              $  101,000
                                                   -==========                =========               =========
</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,
                                                                               -------------------------------
                                                                      2000                   1999                  1998
                                                                      ----                   ----                  ----

Standardized measure of discounted future net
<S>                                                                  <C>                    <C>                   <C>
 cash flows at beginning of year                                     $208,000               $101,000              $129,000

Sales of oil and gas produced, net of production costs                (54,677)              (32,919)               (26,932)

Net changes in prices and production costs                            421,701                12,454                (21,211)

Extensions and discoveries, net of future production
  and development costs                                               180,847                11,719                  3,546

Changes in estimated future development costs                         (43,212)              (12,959)                (9,738)

Development costs incurred                                             12,290                 7,302                  8,087

Revisions of previous quantity estimates                               30,448                 2,674                (15,547)

Purchases of reserves in place                                         37,742               108,449                 23,802

Sales of reserves in place                                           (133,188)               (2,124)                  (399)

Accretion of discount                                                  20,778                10,136                 12,936

Changes in income taxes                                               (97,902)

Changes in production rates and other                                 (26,827)                2,268                 (2,544)
                                                                     --------              --------               --------

Standardized measure of discounted future net
  cash flows at end of year                                          $556,000              $208,000               $101,000
                                                                      =======               =======                =======

</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 Hallwood relating to Hallwood's 2001 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 Hallwood relating to Hallwood's 2001 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 Hallwood relating to Hallwood's 2001 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 Hallwood relating to Hallwood's 2001 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.

         Hallwood filed a report on Form 8-K on September 8, 2000, reporting the
         press releases made by the Company during September 2000.

  (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
   (4)  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
        10.91*    - Amended and Restated  Phantom  Working  Interest  Incentive
                    Plan of Hallwood Energy  Corporation  dated as of January
                    31, 2001.
   (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
   (4)  10.14     - Amendment No. 2 and Waiver to Credit Agreement, dated as of
                    January 27, 2000
   (5)  10.15     - Amendment No. 3 to Credit Agreement, dated as of April 27,
                    2000
   (5)  10.16     - Amendment No. 4 to Credit Agreement, dated as of May 9, 2000
   (6)  10.17     - Amendment No. 5 to Credit Agreement, dated as of June 30,
                    2000
        10.18     - Letter Amendment No. 2 to Note Agreement, dated as of
                    June 30, 2000
   (1)  21        - Subsidiaries of the Registrant
        23        - Consent of Deloitte & Touche LLP

(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
         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
         Quarterly Report on Form 10-Q for the quarter ended September 30, 1999.
(4)      Incorporated  by reference to the same exhibit  number filed with the
         Annual Report on Form 10-K for the  year-ended  December 31, 1999.
(5)      Incorporated  by reference  to the same exhibit  number  filed with the
         Quarterly  Report on Form 10-Q for the quarter  ended March 31, 2000.
(6)      Incorporated  by reference to the same exhibit number filed with the
         Quarterly  Report on Form 10-Q for the quarter ended June 30, 2000.

         *Designates management contracts or compensatory plans or arrangements.


<PAGE>


62

p:\legal.div\sra\temporary\phantom.doc

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 1, 2001                             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 1, 2001
-----------------------
Anthony J. Gumbiner     Director (Chief Executive Officer)

 /s/William L. Guzzetti    President and Director                March 1, 2001
-----------------------
William L. Guzzetti

 /s/Hans-Peter Holinger         Director                         March 1, 2001
-----------------------
Hans-Peter Holinger

 /s/Rex A. Sebastian            Director                         March 1, 2001
-----------------------
Rex A. Sebastian

 /s/Nathan C. Collins           Director                         March 1, 2001
-----------------------
Nathan C. Collins

 /s/John R. Isaac, Jr.          Director                         March 1, 2001
----------------------
John R. Isaac, Jr.

 /s/Jerry A. Lubliner           Director                         March 1, 2001
---------------------
Jerry A. Lubliner

 /s/Hamilton P. Schrauff        Director                         March 1, 2001
----------------------
Hamilton P. Schrauff

 /s/Bill M. Van Meter           Director                         March 1, 2001
----------------------
Bill M. Van Meter

 /s/William J. Baumgartner      Vice President                    March 1, 2001
--------------------------
William J. Baumgartner       Chief Financial Officer
                           (Principal Financial and
                               Accounting Officer)