**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                             |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                               |
|       |       | **FOR THE  QUARTERLY PERIOD ENDED JUNE 30, 2005**                                                                                                                                                                                                             |
|       |       | ** **                                                                                                                                                                                                                                                         |
|       |       | **OR**                                                                                                                                                                                                                                                             |
|       |       |                                                                                                                                                                                                                                                               |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                            |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                         |
| ** ** | ** ** | **FOR THE  TRANSITION PERIOD FROM                      TO                   ** |

 

**Commission file number 1-10389**

 

**WESTERNGAS RESOURCES, INC.**

(Exact name of registrantas specified in its charter)

 
| **Delaware**                                                                         |   | **84-1127613**                        |
|--------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)                     |   | (I.R.S. Employer  Identification No.) |
|                                                                                 |   |                                  |
| **1099 18th  Street, Suite 1200, Denver, Colorado**                             |   | **80202**                             |
| (Address of principal  executive offices)                                            |   | (Zip Code)                            |
|                                                                                 |   |                                  |
| **(303)  452-5603**                                                                  |
| Registrant’s telephone  number, including area code                             |
|                                                                                 |
| **No  Changes**                                                                      |
| (Former name, former  address and former fiscal year, if changed since last report). |

 

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

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). Yes  ý  No o

 

On August 5, 2005,there were 74,617,902 shares of the registrant’s Common Stock outstanding.

 

 

----

 

**WesternGas Resources, Inc.**

**Form 10-Q**

**Table ofContents**

 
| PART I - Financial Information |    |
|-------------------------------------|---------|
|                                |    |   |   |
|                                | Item 1. | Financial Statements |   |
|                                |    |   |   |
|                                |    | Consolidated Balance Sheet -  June 30, 2005 and December 31, 2004 |   |
|                                |    |   |   |
|                                |    | Consolidated Statement of  Cash Flows - Six Months Ended June 30, 2005 and 2004 |   |
|                                |    |   |   |
|                                |    | Consolidated Statement of  Operations –Three and Six Months Ended June 30, 2005 and 2004 |   |
|                                |    |   |   |
|                                |    | Consolidated Statement of  Changes in Stockholders’ Equity - Six Months Ended June 30, 2005 |   |
|                                |    |   |   |
|                                |    | Notes to Consolidated  Financial Statements |   |
|                                |    |   |   |
|                                | Item 2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                |    |   |   |
|                                | Item 3. | Quantitative and  Qualitative Disclosures about Market Risk |   |
|                                |    |   |   |
|                                | Item 4. | Controls and  Procedures |   |
|                                |    |   |   |
| PART II - Other  Information   |    |
|                                |    |   |   |
|                                | Item 1. | Legal Proceedings |   |
|                                |    |   |   |
|                                | Item 4. | Submission of Matters to a  Vote of Security Holders |   |
|                                |    |   |   |
|                                | Item 6. | Exhibits |   |
|                                |    |   |   |
| Signatures                          |    |
|                                     |         |  |  |  |

 

2

----

 

**PART I - FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIALSTATEMENTS**

 

WESTERNGAS RESOURCES, INC.

CONSOLIDATED BALANCESHEET

(Unaudited)

(Dollars inthousands, except share data)

 
| ** **                                                                                                           | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                               |       | ** **              |       | ** **                  |       |
|                                                                                                                 |       |                    |       |                        |       |
| Current assets:                                                                                                      |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                           |       | $                       | 6,038      |                        | $          | 390 |   |
| Trade accounts  receivable, net                                                                                      |       | 331,300                 |       | 393,750                     |       |
| Product  inventory                                                                                                   |       | 92,096                  |       | 94,604                      |       |
| Assets from  price risk management activities                                                                        |       | 17,131                  |       | 22,238                      |       |
| Other                                                                                                                |       | 11,766                  |       | 12,494                      |       |
| Total current  assets                                                                                                |       | 458,331                 |       | 523,476                     |       |
|                                                                                                                 |       |                    |       |                        |       |
| Property and equipment:                                                                                              |       |                    |       |                        |       |
| Gas gathering,  processing and transportation                                                                        |       | 1,215,286               |       | 1,150,904                   |       |
| Oil and gas  properties and equipment (successful efforts method)                                                    |       | 549,715                 |       | 495,314                     |       |
| Construction in  progress                                                                                            |       | 219,866                 |       | 150,273                     |       |
|                                                                                                                 |       | 1,984,867               |       | 1,796,491                   |       |
| Less:  Accumulated depreciation, depletion and amortization                                                          |       | (620,606                | )          | (570,582                    | )          |
|                                                                                                                 |       |                    |       |                        |       |
| Total property  and equipment, net                                                                                   |       | 1,364,261               |       | 1,225,909                   |       |
|                                                                                                                 |       |                    |       |                        |       |
| Other assets:                                                                                                        |       |                    |       |                        |       |
| Gas purchase  contracts (net of accumulated amortization of $41,606 and $40,652,  respectively)                      |       | 33,044                  |       | 27,704                      |       |
| Assets from  price risk management activities                                                                        |       | 539                     |       | 618                         |       |
| Equity  investments                                                                                                  |       | 36,084                  |       | 35,729                      |       |
| Other                                                                                                                |       | 25,796                  |       | 26,676                      |       |
|                                                                                                                 |       |                    |       |                        |       |
| Total other  assets                                                                                                  |       | 95,463                  |       | 90,727                      |       |
|                                                                                                                 |       |                    |       |                        |       |
| TOTAL  ASSETS                                                                                                        |       | $                       | 1,918,055  |                        | $          | 1,840,112 |   |
|                                                                                                                 |       |                    |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                           | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current  liabilities:                                                                                                |       |                    |       |                        |       |
| Accounts payable                                                                                                     |       | $                       | 357,560    |                        | $          | 400,672 |   |
| Accrued expenses                                                                                                     |       | 57,541                  |       | 60,472                      |       |
| Liabilities from  price risk management activities                                                                   |       | 17,474                  |       | 11,099                      |       |
| Dividends  payable                                                                                                   |       | 3,733                   |       | 3,704                       |       |
| Total current  liabilities                                                                                           |       | 436,308                 |       | 475,947                     |       |
|                                                                                                                 |       |                    |       |                        |       |
| Long-term debt                                                                                                       |       | 417,000                 |       | 382,000                     |       |
| Liabilities from  price risk management activities                                                                   |       | 1,437                   |       | 417                         |       |
| Other long-term  liabilities                                                                                         |       | 59,325                  |       | 51,827                      |       |
| Deferred income  taxes payable, net                                                                                  |       | 265,755                 |       | 247,893                     |       |
|                                                                                                                 |       |                    |       |                        |       |
| Total liabilities                                                                                                    |       | 1,179,825               |       | 1,158,084                   |       |
|                                                                                                                 |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                           |       |                    |       |                        |       |
| Common stock,  par value $.10; 100,000,000 shares authorized; 74,612,053 and 74,078,733  shares issued, respectively |       | 7,483                   |       | 7,430                       |       |
| Treasury stock,  at cost; 50,032 common shares in treasury                                                           |       | (788                    | )          | (788                        | )          |
| Unearned compensation                                                                                                |       | (10,741                 | )          | —                      |       |
| Additional  paid-in capital                                                                                          |       | 407,693                 |       | 392,437                     |       |
| Retained  earnings                                                                                                   |       | 337,208                 |       | 278,687                     |       |
| Accumulated  other comprehensive income                                                                              |       | (2,625                  | )          | 4,262                       |       |
|                                                                                                                 |       |                    |       |                        |       |
| Total  stockholders’ equity                                                                                     |       | 738,230                 |       | 682,028                     |       |
|                                                                                                                 |       |                    |       |                        |       |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                     |       | $                       | 1,918,055  |                        | $          | 1,840,112 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

3

----

 

WESTERN GASRESOURCES, INC.

CONSOLIDATEDSTATEMENT OF CASH FLOWS

(Unaudited)

(Dollars inthousands)

 
| ** **                                                                              | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
|                                                                                    |       | **2005**                            | ** ** | **2004** | ** ** |
| Reconciliation  of net income to net cash provided by operating activities:             |       |                                |       |   |   |
| Net income                                                                              |       | $                                   | 65,946     |   | $ | 43,063 |   |
| Add income items  that do not affect cash:                                              |       |                                |       |   |   |
| Depreciation,  depletion and amortization                                               |       | 59,877                              |       | 44,974 |   |
| Loss on sale of  assets                                                                 |       | 27                                  |       | 1,639 |   |
| Deferred income  taxes                                                                  |       | 24,542                              |       | 24,089 |   |
| Non-cash change  in fair value of derivatives                                           |       | 4,236                               |       | 4,696 |   |
| Cumulative  effect of a change in accounting principle                                  |       | —                              |       | (4,714 | ) |
| Compensation  expense from common stock options and restricted stock                    |       | 926                                 |       | 476 |   |
| Other non-cash  items, net                                                              |       | (1,532                              | )          | 1,815 |   |
|                                                                                    |       |                                |       |   |   |
| Adjustments to  working capital to arrive at net cash provided by operating activities: |       |                                |       |   |   |
| (Increase)  decrease in trade accounts receivable                                       |       | 62,655                              |       | (22,016 | ) |
| (Increase)  decrease in product inventory                                               |       | 1,933                               |       | (3,008 | ) |
| (Increase) in  other current assets                                                     |       | (11,379                             | )          | (3,856 | ) |
| (Increase)  decrease in other assets and liabilities, net                               |       | (565                                | )          | 322 |   |
| Increase  (decrease) in accounts payable                                                |       | (57,156                             | )          | 2,975 |   |
| Increase  (decrease) in accrued expenses                                                |       | 10,592                              |       | (2,323 | ) |
|                                                                                    |       |                                |       |   |   |
| Net cash  provided by operating activities                                              |       | 160,102                             |       | 88,132 |   |
|                                                                                    |       |                                |       |   |   |
| Cash flows from  investing activities:                                                  |       |                                |       |   |   |
|                                                                                    |       |                                |       |   |   |
| Purchases of  property and equipment, including acquisitions                            |       | (193,112                            | )          | (79,548 | ) |
| Distributions  from equity investees                                                    |       | 613                                 |       | 1,196 |   |
| Proceeds from  the dispositions of property and equipment                               |       | 1,411                               |       | 697 |   |
|                                                                                    |       |                                |       |   |   |
| Net cash used in  investing activities                                                  |       | (191,088                            | )          | (77,655 | ) |
|                                                                                    |       |                                |       |   |   |
| Cash flows from  financing activities:                                                  |       |                                |       |   |   |
|                                                                                    |       |                                |       |   |   |
| Proceeds from  exercise of common stock options                                         |       | 2,735                               |       | 3,492 |   |
| Change in  outstanding checks                                                           |       | 6,335                               |       | 26,168 |   |
| Borrowings under  revolving credit facility                                             |       | 1,789,015                           |       | 810,630 |   |
| Payments on  revolving credit facility                                                  |       | (1,754,015                          | )          | (809,630 | ) |
| Borrowings of  long-term debt                                                           |       | 25,000                              |       | 100,000 |   |
| Payments on  long-term debt                                                             |       | (25,000                             | )          | (155,000 | ) |
| Debt issue costs  paid                                                                  |       | (40                                 | )          | (1,827 | ) |
| Payments for the  redemption of preferred stock                                         |       | —                              |       | (1,930 | ) |
| Dividends paid                                                                          |       | (7,396                              | )          | (5,610 | ) |
|                                                                                    |       |                                |       |   |   |
| Net cash  provided by (used in) financing activities                                    |       | 36,634                              |       | (33,707 | ) |
|                                                                                    |       |                                |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                   |       | 5,648                               |       | (23,230 | ) |
|                                                                                    |       |                                |       |   |   |
| Cash and cash  equivalents at beginning of period                                       |       | 390                                 |       | 26,116 |   |
|                                                                                    |       |                                |       |   |   |
| Cash and cash  equivalents at end of period                                             |       | $                                   | 6,038      |   | $ | 2,886 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

4

----

 

WESTERN GAS RESOURCES,INC.

CONSOLIDATED STATEMENT OFOPERATIONS

(Unaudited)

(Dollars in thousands,except share and per share amounts)

 
| ** **                                                                                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
|                                                                                              |       | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** |   |
| Revenues:                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Sale of gas                                                                                       |       | $                                     | 678,087    |                                | $          | 595,881 |   | $ | 1,374,306 |   | $ | 1,261,191 |   |
| Sale of natural  gas liquids                                                                      |       | 149,481                               |       | 102,021                             |       | 282,450 |   | 194,936 |   |
| Gathering,  processing and transportation revenue                                                 |       | 27,823                                |       | 24,410                              |       | 51,703 |   | 41,239 |   |
| Price risk  management activities                                                                 |       | 4,375                                 |       | 3,460                               |       | 4,335 |   | (2,020 | ) |
| Other                                                                                             |       | 1,430                                 |       | 531                                 |       | 2,717 |   | 2,173 |   |
| Total revenues                                                                                    |       | 861,196                               |       | 726,303                             |       | 1,715,511 |   | 1,497,519 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Costs and  expenses:                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Product  purchases                                                                                |       | 707,516                               |       | 602,166                             |       | 1,414,870 |   | 1,259,508 |   |
| Plant and  transportation operating expense                                                       |       | 26,831                                |       | 22,255                              |       | 54,530 |   | 44,189 |   |
| Oil and gas  exploration and production expense                                                   |       | 24,059                                |       | 19,812                              |       | 48,955 |   | 36,922 |   |
| Depreciation,  depletion and amortization                                                         |       | 30,799                                |       | 22,348                              |       | 59,877 |   | 44,974 |   |
| (Gain) loss on  sale of assets                                                                    |       | (1                                    | )          | 1,639                               |       | 27 |   | 1,639 |   |
| Selling and  administrative expense                                                               |       | 17,537                                |       | 17,255                              |       | 30,069 |   | 27,201 |   |
| (Earnings) from  equity investments                                                               |       | (2,246                                | )          | (1,776                              | )          | (4,380 | ) | (3,702 | ) |
| Loss from early  extinguishment of debt                                                           |       | —                                |       | 10,662                              |       | — |   | 10,662 |   |
| Interest expense                                                                                  |       | 4,033                                 |       | 5,351                               |       | 7,553 |   | 11,153 |   |
| Total costs and  expenses                                                                         |       | 808,528                               |       | 699,712                             |       | 1,611,501 |   | 1,432,546 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Income before  taxes                                                                              |       | 52,668                                |       | 26,591                              |       | 104,010 |   | 64,973 |   |
| Provision for  income taxes:                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Current                                                                                           |       | 6,172                                 |       | (1,008                              | )          | 13,522 |   | 2,535 |   |
| Deferred                                                                                          |       | 13,178                                |       | 13,624                              |       | 24,542 |   | 24,089 |   |
| Total provision  for income taxes                                                                 |       | 19,350                                |       | 12,616                              |       | 38,064 |   | 26,624 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Income before  cumulative effect of change in accounting principle                                |       | 33,318                                |       | 13,975                              |       | 65,946 |   | 38,349 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Cumulative  effect of change in accounting principle, net of tax of $2,710                        |       | —                                |       | —                              |       | — |   | 4,714 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Net income                                                                                        |       | 33,318                                |       | 13,975                              |       | 65,946 |   | 43,063 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Preferred stock  requirements                                                                     |       | —                                |       | (19                                 | )          | — |   | (835 | ) |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Income  attributable to common stock                                                              |       | $                                     | 33,318     |                                | $          | 13,956 |   | $ | 65,946 |   | $ | 42,228 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Net income per  share of common stock before cumulative effect of change in accounting  principle |       | $                                     | .45        |                                | $          | .19 |   | $ | .89 |   | $ | .53 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Cumulative  effect of change in accounting principle                                              |       | $                                     | —     |                                | $          | — |   | $ | — |   | $ | .07 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Earnings per  share of common stock                                                               |       | $                                     | .45        |                                | $          | .19 |   | $ | .89 |   | $ | .60 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Weighted average  shares of common stock outstanding (1)                                          |       | 74,234,424                            |       | 73,158,240                          |       | 74,191,346 |   | 70,942,578 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Income  attributable to common stock – assuming dilution                                     |       | $                                     | 33,318     |                                | $          | 13,975 |   | $ | 65,946 |   | $ | 42,228 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Earnings per share of common stock – assuming dilution                                       |       | $                                     | .44        |                                | $          | .19 |   | $ | .87 |   | $ | .58 |   |
|                                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Weighted average  shares of common stock outstanding - assuming dilution (1)                      |       | 75,678,389                            |       | 75,329,143                          |       | 75,603,310 |   | 72,820,040 |   |

 

----

(1) Common stockoutstanding reflects the effect of a June 2004 stock split.

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

5

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WESTERN GASRESOURCES, INC.

CONSOLIDATEDSTATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(Dollars inthousands, except share amounts)

 
| ** **                                             | ** ** | **Shares  of Common  Stock** | ** ** | **Shares  of Common  Stock  in Treasury** | ** ** | **Common  Stock** | ** ** | **Treasury  Stock** | ** ** | **Unearned  Compensation** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)  Net of Tax** | ** ** | **Total  Stock-  holders’  Equity** |    |
|--------------------------------------------------------|------------|------------------------------|------------|-------------------------------------------|------------|-------------------|------------|---------------------|------------|----------------------------|------------|----------------------------------|------------|------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------|---------|
| ** **                                             | ** ** | ** **                   | ** ** | ** **                                | ** ** | ** **        | ** ** | ** **          | ** ** | ** **                 | ** ** | ** **                       | ** ** | ** **             | ** ** | ** **                                                       | ** ** | ** **                               |    |
| Balance at  December 31, 2004                     |       | 74,078,733                   |       | 50,032                                    |       | $                 | 7,430      |                | $          | (788                       | )          | $                                | —     |                   | $          | 392,437                                                          |       | $                                        | 278,687 |   | $ | 4,262 |   | $ | 682,028 |   |
| Comprehensive  income:                                 |       |                         |       |                                      |       |              |       |                |       |                       |       |                             |       |                   |       |                                                             |       |                                     |    |
| Net income                                             |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | 65,946                 |       | —                                                           |       | 65,946                                   |    |
| Translation adjustments                                |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | —                 |       | (2,510                                                           | )          | (2,510                                   | )       |
| Other  comprehensive income                            |       |                         |       |                                      |       |              |       |                |       |                       |       |                             |       |                   |       |                                                             |       |                                     |    |
| From equity  investees                                 |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | —                 |       | 77                                                               |       | 77                                       |    |
| Reclassification  adjustment for settled contracts     |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | —                 |       | (623                                                             | )          | (623                                     | )       |
| Changes in fair  value of outstanding hedge positions  |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | —                 |       | (2,339                                                           | )          | (2,339                                   | )       |
| Change in  estimated ineffectiveness                   |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | —                 |       | 79                                                               |       | 79                                       |    |
| Fair value of new  hedge positions                     |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | —                 |       | (1,571                                                           | )          | (1,571                                   | )       |
| Change in  accumulated derivative comprehensive income |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | —                 |       | (4,454                                                           | )          | (4,454                                   | )       |
| Total  comprehensive income, net of tax                |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | —                 |       | —                                                           |       | 59,059                                   |    |
| Stock options  exercised                               |       | 171,060                      |       | —                                    |       | 17                |       | —              |       | —                     |       | 2,718                            |       | —                 |       | —                                                           |       | 2,735                                    |    |
| Compensation  expense from common stock options        |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | 463                              |       | —                 |       | —                                                           |       | 463                                      |    |
| Unearned compensation  on restricted stock             |       | 362,260                      |       | —                                    |       | 36                |       | —              |       | (10,741                    | )          | 11,168                           |       | —                 |       | —                                                           |       | 463                                      |    |
| Tax benefit  related to stock options exercised        |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | 907                              |       | —                 |       | —                                                           |       | 907                                      |    |
| Dividends  declared on common stock                    |       | —                       |       | —                                    |       | —            |       | —              |       | —                     |       | —                           |       | (7,425                 | )          | —                                                           |       | (7,425                                   | )       |
|                                                   |       |                         |       |                                      |       |              |       |                |       |                       |       |                             |       |                   |       |                                                             |       |                                     |    |
| Balance at  June 30, 2005                         |       | 74,612,053                   |       | 50,032                                    |       | $                 | 7,483      |                | $          | (788                       | )          | $                                | (10,741    | )                      | $          | 407,693                                                          |       | $                                        | 337,208 |   | $ | (2,625 | ) | $ | 738,230 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

 

6

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WESTERNGAS RESOURCES, INC.

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

***GENERAL***

 

We have prepared theaccompanying unaudited interim consolidated financial statements under the rules andregulations of the Securities and Exchange Commission, or SEC.  As provided by such rules andregulations, we have condensed or omitted certain information and notesnormally included in annual financial statements prepared in conformity withaccounting principles generally accepted in the United States of America.

 

The interim consolidatedfinancial statements presented herein should be read in conjunction with theConsolidated Financial Statements and Notes thereto included in our AnnualReport on Form 10-K for the year ended December 31, 2004.  The interim consolidated financial statementsas of June 30, 2005 and for the three and six-month periods ended June 30,2005 and 2004 included herein are unaudited but reflect, in the opinion ofmanagement, all adjustments (which include only normal recurring adjustments)necessary to fairly state the results for such periods.  The results of operations for the three andsix-months ended June 30, 2005 are not necessarily indicative of theresults of operations expected for the year ended December 31, 2005.

 

In June 2005, werevised our classification in the Statement of Cash Flows for the six monthsended June 30, 2004, of the Change in the balance of outstanding checksfrom a component of Net cash provided by operating activities to a component ofCash flows from financing activities. This change in classification had the effect of decreasing previouslyreported cash provided by operating activities by $26.2 million for the sixmonths ended June 30, 2004, with a corresponding decrease in cash flowsused in financing activities.

 

##### ***EQUITY TRANSACTIONS***

 

***Conversion of Preferred Stock.*** In December 2003, we issued a notice ofredemption for a total of 800,000 shares of our $2.625 cumulative convertiblepreferred stock.  The holders of theseshares had the right to convert them into shares of our common stock in lieu ofreceiving the redemption price in cash.  In January 2004, we issued an additional 1,979,244 shares of commonstock to holders who elected to convert their shares and paid $672,000 in cashproceeds to complete this redemption.  In March 2004, we issued an additional notice of redemption for theremaining 1,260,000 shares of our $2.625 cumulative convertible preferredstock.  In April 2004, we issued anadditional 3,113,582 shares of common stock to holders who elected to converttheir shares and paid $391,000 in cash proceeds to complete thisredemption.  After these redemptions, the$2.625 cumulative convertible preferred stock was delisted from trading on theNew York Stock Exchange and was deregistered by the SEC.

 

In the second quarter of2005, we granted approximately 362,000 shares of restricted common stock to ouremployees.  In conjunction with the grantof restricted stock, we will record as compensation expense over the three-yearvesting period, the value of the restricted stock on the date of grant.  Accordingly, we recorded unearnedcompensation of $10.7 million in Stockholders' equity and unearned compensationexpense of $463,000 in the second quarter of 2005.

 

***EARNINGSPER SHARE OF COMMON STOCK***

 

Earningsper share of common stock are computed by dividing income attributable tocommon stock by the weighted average shares of common stock outstanding.  In addition, earnings per share of commonstock - assuming dilution is computed by dividing income attributable to commonstock by the weighted average shares of common stock outstanding as adjustedfor potential common shares.  Incomeattributable to common stock is net income less preferred stock dividends.   The following table presents the dividendsdeclared by us for each class of our outstanding equity securities (dollars inthousands, except per share amounts):

 
| ** **                     | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------|------------|---------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **2005**                        | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Common Stock                   |       | $                               | 3,732      |                               | $          | 3,684 |   | $ | 7,425 |   | $ | 5,449 |   |
| Preferred Stock                |       | —                          |       | 19                                 |       | — |   | 835 |   |
| Total Dividends  Declared      |       | $                               | 3,732      |                               | $          | 3,703 |   | $ | 7,425 |   | $ | 6,284 |   |
|                           |       |                            |       |                               |       |   |   |   |   |
| Dividends  Declared Per Share: |       |                            |       |                               |       |   |   |   |   |
| Common Stock                   |       | $                               | 0.05       |                               | $          | 0.05 |   | $ | 0.10 |   | $ | 0.08 |   |
| Preferred Stock                |       | —                          |       | $                                  | 0.66       |   | — |   | $ | 1.31 |   |

 

CommonStock options, unvested restricted stock granted and, until the finalconversion or redemption in April 2004, our $2.625 cumulative convertiblepreferred stock are potential common shares. The following is areconciliation of the weighted average shares of common stock outstanding tothe weighted average common shares outstanding – assuming dilution.

 

7

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| ** **                                                               | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------|------------|------------------------------------|------------|
| ** **                                                               | ** ** | **2005**                        | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted average  shares of common stock outstanding                     |       | 74,234,424                      |       | 73,158,240                         |       | 74,191,346 |   | 70,942,578 |   |
| Potential common  shares from:                                           |       |                            |       |                               |       |   |   |   |   |
| Common stock  options and restricted stock                               |       | 1,443,965                       |       | 1,921,653                          |       | 1,411,964 |   | 1,877,462 |   |
| $2.625  Cumulative Convertible Preferred Stock                           |       | —                          |       | 249,250                            |       | — |   | — |   |
| Weighted average  shares of common stock outstanding - assuming dilution |       | 75,678,389                      |       | 75,329,143                         |       | 75,603,310 |   | 72,820,040 |   |

 

Thecalculation of fully diluted earnings per share reflect potential common shares,if dilutive, and any related preferred dividends.

 

***ACCUMULATED OTHER COMPREHENSIVE INCOME***

 

Includedin Accumulated other comprehensive income at June 30, 2005 were unrealizedlosses of $4.0 million from the fair value of derivatives designated as cashflow hedges and unrealized gains of $2.5 million of cumulative foreign currencytranslation adjustments.

 

Includedin Accumulated other comprehensive income at June 30, 2004 were unrealizedlosses of $3.5 million from the fair value of derivatives designated as cashflow hedges and unrealized gains of $1.7 million of cumulative foreign currencytranslation adjustments.

 

##### ***REVENUE RECOGNITION***

 

In the Gas Gathering,Processing and Treating segment, we recognize revenue for our services at thetime the service is performed. We record revenue from our gas and NGL marketingactivities, including sales of our equity production, upon transfer oftitle.  In accordance with EmergingIssues Task Force, or EITF, 03-11 “Reporting Realized Gains and Losses onDerivative Instruments That are Subject to FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities, and Not Held forTrading Purposes as Defined in Issue No. 02-3”, we record revenue on our physical gas and NGL marketing activitieson a gross basis versus sales net of purchases basis because we obtain title toall the gas and NGLs that we buy including third-party purchases, bear the riskof loss and credit exposure on these transactions, and it is our intention uponentering these contracts to take physical delivery of the product.  Gas imbalances on our production areaccounted for using the sales method. Gas imbalances on our production at June 30, 2005 and 2004 areimmaterial.  For our marketingactivities, we utilize mark-to-market accounting for our derivatives.  Under mark-to-market accounting, the expectedmargin to be realized over the term of the transaction is recorded in the monthof origination.  To the extent that a transaction is not fully hedged under the accountingrules or there is any hedge ineffectiveness, additional gains or lossesassociated with the transaction may be reported in future periods.  In our Transportation segment, werealize revenue on a monthly basis from firm capacity contracts under which theshipper pays for transport capacity whether or not the capacity is used andfrom interruptible contracts where a fee is charged based upon volumesdelivered from the pipeline.

 

***OTHER MATTERS***

 

##### ***Depreciation,Depletion and Amortization of Oil and Gas Properties. ***Wefollow the successful efforts method of accounting for oil and gas explorationand production activities.  Effective January 1,2004, we redefined the asset groupings for the calculation of depreciation anddepletion on our oil and gas properties from a well-by-well basis to a fieldwide basis for each of the Jonah, Pinedale and Sand Wash fields and to agrouping of all wells drilled into related coal seams for the Powder RiverBasin.  The cumulative effect of thechange in depreciation and depletion methodology for the six months ended June 30,2004 was a benefit of $4.7 million, net of tax, or $0.07 per share of common stock- assuming dilution, and is presented in the Consolidated Statement ofOperations under the caption Cumulative effect of change in accountingprinciple, net of tax.

 

***Price Reporting to Gas Trade Publications. *** In 2003, we learned that several employees inour marketing department furnished inaccurate information regarding natural gastransactions to energy publications, which compile and report energy indexprices.  In July 2004, we reached asettlement of this matter with the Commodities Futures Trading Commission, orCFTC.  In conjunction with thissettlement, we paid a civil penalty of $7.0 million, and as a result ourearnings per common share in the second quarter and six months ended June 30,2004 were reduced by $0.09 and $0.10, respectively.   In the second quarter of 2005, we reached asettlement of a related claim with a private litigant for $3.8 millionafter-tax, or $0.05 per common share for both the three and six months ended June 30,2005.  For additional information, seeLegal Proceedings in these Notes to Consolidated Financial Statements.

 

8

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***INCOME TAXES***

 

The Total provision forincome taxes, as a percentage of Income before taxes was approximately 36.7% and36.6%, respectively, during the quarter and six months ended June 30, 2005as compared to 47.4% and 41.0%, respectively, in the same periods of 2004.  This decrease is due to the civil penaltypaid to the CFTC in 2004, which was non-deductible for tax purposes.

 

***DERIVATIVE INSTRUMENTS AND HEDGINGACTIVITIES***

 

A net loss was recognizedin earnings through Sale of residue gas and Sale of natural gas liquids duringthe three and six months ended June 30, 2005 from hedging activities of$657,000 and $170,000, respectively. Also during these periods we recognized a loss from hedgeineffectiveness of $37,000 and $125,000, respectively, through Price riskmanagement activities.

 

The gains and lossescurrently reflected in Accumulated other comprehensive income will bereclassified to earnings as the hedged gas or NGLs is sold.  Based on the prices for our products on June 30,2005, approximately $4.0 million of losses in Accumulated other comprehensiveincome will be reclassified to earnings, of which $2.5 million will bereclassified in the remainder of 2005.

 

***SUPPLEMENTARYCASH FLOW INFORMATION***

 

Interest paid was $11.7million and  $13.3 million for the sixmonths ended June 30, 2005 and 2004, respectively. A total of $11.0 million and $7.7 million was paid in income taxes inthe six months ended June 30, 2005 and 2004, respectively. Assetretirement obligations of $7.7 million were recorded for capitalized assets forthe six months ended June 30, 2005. The asset retirement and associated obligations are non-cashtransactions for presentation on the Consolidated Statement of Cash Flows.

 

***STOCK COMPENSATION***

 

Aspermitted under SFAS No. 123, “Accounting for Stock-Based Compensation”,we have elected to continue to measure compensation costs for stock-basedemployee compensation plans as prescribed by Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees.”  We have complied with the pro formadisclosure requirements of SFAS No. 123 as required under thepronouncement.  We realize an income taxbenefit from the exercise of non-qualified stock options related to the amountby which the market price at the date of exercise exceeds the optionprice.  This tax benefit is credited toAdditional paid-in capital.

 

Inthe second quarter of 2005, we granted approximately 747,000 options topurchase our common stock at the market price based on the average closingprice for the ten days prior to grant and approximately 362,000 shares ofrestricted common stock to our employees. In conjunction with the grant of restricted stock, we will record ascompensation expense over the three-year vesting period, the value of therestricted stock on the date of grant. Accordingly, we recorded unearned compensation expense of $463,000 inthe second quarter of 2005.

 

SFASNo. 123 requires pro forma disclosures for each quarter that a Statementof Operations is presented.  Thefollowing is a summary of the options to purchaseour common stock granted during the quarters and six months ended June 30,2005 and 2004, respectively.

 
| ** **                 | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------|------------|---------------------------------|------------|------------------------------------|------------|
| ** **                 | ** ** | **2005**                        | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| 2002 Plan                  |       | 54,000                          |       | 40,000                             |       | 137,000 |   | 75,000 |   |
| 2002 Directors’  Plan |       | 32,000                          |       | 32,000                             |       | 32,000 |   | 32,000 |   |
| 2005 Plan                  |       | 747,000                         |       | —                             |       | 747,000 |   | — |   |
| Total options  granted     |       | 833,000                         |       | 72,000                             |       | 916,000 |   | 107,000 |   |

 

Thefollowing is a summary of the weighted average fair value per share of theoptions granted during the quarters andsix months ended June 30, 2005 and 2004, respectively.

 

9

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| ** **                 | ** ** | **Quarter Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------|------------|---------------------------------|------------|------------------------------------|------------|
| ** **                 | ** ** | **2005**                        | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| 2002 Plan                  |       | $                               | 14.04      |                               | $          | 14.89 |   | $ | 15.01 |   | $ | 13.20 |   |
| 2002 Directors’  Plan |       | $                               | 14.79      |                               | $          | 12.13 |   | $ | 14.79 |   | $ | 12.13 |   |
| 2005 Plan                  |       | $                               | 13.25      |                               | —     |   | $ | 13.25 |   | — |   |

 

Thesevalues for the options granted during the quarter andsix months ended June 30, 2005 were estimated using the Black-Scholesoption-pricing model with the following assumptions:

 
| ** **                      | ** ** | **Quarter Ended June 30, 2005** | ** ** | **Six Months Ended June 30, 2005** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|
| ** **                      | ** ** | **2002 Plan**                        | ** ** | **2002  Directors’  Plan**         | ** ** | **2005 Plan** | ** ** | **2002 Plan** | ** ** | **2002  Directors’  Plan** | ** ** | **2005  Plan** | ** ** |
| Risk-free  interest rate        |       | 4.30                                 | %          | 4.38                                    | %          | 4.27 | % | 4.35 | % | 4.38 | % | 4.27 | % |
| Expected life  (in years)       |       | 7                                    |       | 7                                       |       | 7 |   | 7 |   | 7 |   | 7 |   |
| Expected  volatility            |       | 37                                   | %          | 37                                      | %          | 37 | % | 37 | % | 37 | % | 37 | % |
| Expected  dividends (quarterly) |       | $                                    | 0.05       |                                    | $          | 0.05 |   | $ | 0.05 |   | $ | 0.05 |   | $ | 0.05 |   | $ | 0.05 |   |
|                                 |            |                                      |            |                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

UnderSFAS No. 123, the fair market value of the options at the grant date isamortized over the appropriate vesting period for purposes of calculatingcompensation expense.  If we had recordedcompensation expense for our grants under our stock-based compensation plansconsistent with the fair value method under this pronouncement, our net income,income attributable to common stock, earnings per share of common stock andearnings per share of common stock - assuming dilution would approximate thepro forma amounts below (dollars in thousands, except per share amounts):

 
| ** **                                                                                                                                     | ** ** | **Quarter Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2005  As Reported**           | ** ** | **2005  Pro Forma** | ** ** | **2004  As Reported** | ** ** | **2004  Pro Forma** | ** ** |
| Net income                                                                                                                                     |       | $                               | 33,318     |   | $ | 30,814 |   | $ | 13,975 |   | $ | 12,808 |   |
| Net income  attributable to common stock                                                                                                       |       | 33,318                          |       | 30,814 |   | 13,956 |   | 12,789 |   |
| Earnings per  share of common stock                                                                                                            |       | 0.45                            |       | 0.42 |   | 0.19 |   | 0.18 |   |
| Earnings per  share of common stock - assuming dilution                                                                                        |       | 0.44                            |       | 0.41 |   | 0.19 |   | 0.17 |   |
| Stock-based  employee compensation cost, net of related tax effects, included in net  income                                                   |       | 412                             |       | — |   | 188 |   | — |   |
| Stock-based  employee compensation cost, net of related tax effects, includable in net  income if the fair value based method had been applied |       | $                               | —     |   | $ | 2,916 |   | $ | — |   | $ | 1,355 |   |

 
| ** **                                                                                                                                     | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **2005  As Reported**              | ** ** | **2005  Pro Forma** | ** ** | **2004  As Reported** | ** ** | **2004  Pro Forma** | ** ** |
| Net income                                                                                                                                     |       | $                                  | 65,946     |   | $ | 61,763 |   | $ | 43,063 |   | $ | 40,754 |   |
| Net income  attributable to common stock                                                                                                       |       | 65,946                             |       | 61,763 |   | 42,228 |   | 39,919 |   |
| Earnings per  share of common stock                                                                                                            |       | 0.89                               |       | 0.83 |   | 0.60 |   | 0.56 |   |
| Earnings per  share of common stock–assuming dilution                                                                                     |       | 0.87                               |       | 0.82 |   | 0.58 |   | 0.55 |   |
| Stock-based  employee compensation cost, net of related tax effects, included in net  income                                                   |       | 585                                |       | — |   | 300 |   | — |   |
| Stock-based  employee compensation cost, net of related tax effects, includable in net  income if the fair value based method had been applied |       | $                                  | —     |   | $ | 4,768 |   | $ | — |   | $ | 2,609 |   |

 

10

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***SEGMENTREPORTING***

 

Weoperate in four principal business segments, as follows:  Gas Gathering, Processing and Treating;Exploration and Production; Marketing; and Transportation.  Management separately monitors these segmentsfor performance against our internal forecast, and these segments areconsistent with our internal financial reporting package.  These segments have been identified basedupon the differing products and services, regulatory environment and theexpertise required for these operations.

 

***Gas Gathering, Processing and Treating.***  In this segment, collectively with theMarketing and Transportation segments referred to as the midstream operations,we connect producers’ wells (including those of our Exploration and Productionsegment) to our gathering systems for delivery to our processing or treatingplants, process the natural gas to extract NGLs and treat the natural gas inorder to meet pipeline specifications. In some areas, where no processing is required, we gather and compressproducers’ gas and deliver it to pipelines for further delivery to market.  Except for volumes taken in kind by ourproducers, the Marketing segment sells the residue gas and NGLs extracted atmost of our facilities.

 

Substantially all gasflowing through our gathering, processing and treating facilities is suppliedunder three types of contracts providing for the purchase, treating orprocessing of natural gas for periods ranging from one month to twenty years orin some cases for the life of the oil and gas lease.  Approximately 68% of our plant facilities’gross margin, or revenues at the plant less product purchases, for the month ofJune 2005 was pursuant to percentage-of-proceeds agreements in which weare typically responsible for the marketing of the gas and NGLs.  Under these agreements, we pay producers aspecified percentage of the net proceeds received from the sale of the gas andthe NGLs.

 

Approximately 21% of ourplant facilities’ gross margin for the month of June 2005 was pursuant tocontracts that are primarily fee-based from which we receive a set fee for eachMcf of gas gathered and/or processed. This type of contract provides us with asteady revenue stream that is not dependent on commodity prices, except to theextent that low prices may cause a producer to delay drilling.

 

Approximately 11% of ourplant facilities’ gross margin for the month of June 2005 was pursuant tocontracts with “keepwhole” arrangements or wellhead purchase contracts.  Under these contracts, we retain the NGLsrecovered by the processing facility and keep the producers whole by returningto the producers at the tailgate of the plant an amount of residue gas equal ona Btu basis to the natural gas received at the plant inlet.  The “keepwhole” component of the contractspermits us to benefit when the value of the NGLs is greater as a liquid than asa portion of the residue gas stream. However, we are adversely affected when the value of the NGLs is loweras a liquid than as a portion of the residue gas stream.

 

***Exploration and Production.***  The activities of the Exploration andProduction segment include the exploration and development of gas propertiesprimarily in the Rocky Mountain area and other unconventional gas plays,including those where our gathering and/or processing facilities are located.  The Marketing segment sells the majority ofthe production from these properties and remits to the Exploration andProduction segment all of the proceeds from the sales of its gas net oftransportation charges.

 

***Marketing.***  Our Marketing segment buys and sells gas andNGLs in the United States and Canada from and to a variety of customers.  Revenues in this segment are sensitive tochanges in the market prices of the underlying commodities.  The marketing of products purchased fromthird parties typically results in low sales margins relative to the salesprice.  We sell our products underagreements with varying terms and conditions in order to match seasonal andother changes in demand.  Also includedin this segment are our Canadian marketing operations, which are conductedthrough our wholly owned subsidiary WGR Canada, Inc. and are immaterialfor separate presentation.

 

***Transportation.***  The Transportation segment reflects theoperations of Western’s MIGC, Inc. and MGTC, Inc. pipelines.   The majority of the revenue presented inthis segment is derived from transportation of residue gas for our Marketingsegment and other third parties.  TheTransportation segments’ firm capacity contracts range in duration fromeighteen months to approximately thirteen years.

 

***Segment Information.*** Thefollowing tables set forth our segment information as of and for the quarterand six months ended June 30, 2005 and 2004 (dollars in thousands).  Due to our integrated operations, the use ofallocations in the determination of business segment information isnecessary.  Inter-segment revenues arevalued at prices comparable to those of unaffiliated customers.  In the interim segment information, priorperiod Corporate Plant operating and transportation expense of $(484,000) and$451,000 for the quarter and six months ended June 30, 2004, respectively,has been reclassified to the Gas Gathering and Processing segment to conform tothe presentation used in 2005.

 

11

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**Quarter Ended June 30, 2005:**

 
| ** **                                        | ** ** | **Gas  Gathering  and  Processing** | ** ** | **Exploration  and  Production** | ** ** | **Marketing** | ** ** | **Trans-  portation** | ** ** | **Corporate** | ** ** | **Eliminating  Entries** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|-------------------------------------|------------|----------------------------------|------------|---------------|------------|-----------------------|------------|---------------|------------|--------------------------|------------|-----------|------------|
| Revenues from  unaffiliated customers:            |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Sale of gas                                       |       | $                                   | 956        |                             | $          | 3,040         |       | $                     | 673,235    |          | $          | 409                      |       | $         | —     |   | $ | — |   | $ | 677,640 |   |
| Sale of natural  gas liquids                      |       | 3                                   |       | —                           |       | 150,581       |       | —                |       | —        |       | —                   |       | 150,584   |       |
| Equity hedges:                                    |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Gas                                               |       | 68                                  |       | 378                              |       | —        |       | —                |       | —        |       | —                   |       | 446       |       |
| Liquids                                           |       | (1,103                              | )          | —                           |       | —        |       | —                |       | —        |       | —                   |       | (1,103    | )          |
| Gathering,  processing and transportation revenue |       | 26,154                              |       | —                           |       | —        |       | 1,669                 |       | —        |       | —                   |       | 27,823    |       |
| Total revenues  from unaffiliated customers       |       | 26,078                              |       | 3,418                            |       | 823,816       |       | 2,078                 |       | —        |       | —                   |       | 855,390   |       |
| Inter-segment  revenues                           |       | 300,326                             |       | 78,376                           |       | 24,940        |       | 3,353                 |       | 10            |       | (407,005                 | )          | —    |       |
| Price risk  management activities                 |       | (37                                 | )          | —                           |       | 4,412         |       | —                |       | —        |       | —                   |       | 4,375     |       |
| Interest income                                   |       | —                              |       | 4                                |       | 18            |       | —                |       | 12,435        |       | (12,457                  | )          | —    |       |
| Other, net                                        |       | 1,089                               |       | 118                              |       | 3             |       | —                |       | 221           |       | —                   |       | 1,431     |       |
| Total revenues                                    |       | 327,456                             |       | 81,916                           |       | 853,189       |       | 5,431                 |       | 12,666        |       | (419,462                 | )          | 861,196   |       |
|                                              |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Product purchases                                 |       | 252,906                             |       | 1,084                            |       | 849,636       |       | 776                   |       | —        |       | (396,886                 | )          | 707,516   |       |
| Plant and  transportation operating expense       |       | 25,852                              |       | 164                              |       | 144           |       | 1,653                 |       | —        |       | (982                     | )          | 26,831    |       |
| Oil and gas  exploration and production expense   |       | —                              |       | 33,155                           |       | —        |       | —                |       | —        |       | (9,096                   | )          | 24,059    |       |
| (Earnings) from  equity investments               |       | (2,246                              | )          | —                           |       | —        |       | —                |       | —        |       | —                   |       | (2,246    | )          |
| Segment-operating  profit                         |       | 50,944                              |       | 47,513                           |       | 3,409         |       | 3,002                 |       | 12,666        |       | (12,498                  | )          | 105,036   |       |
|                                              |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Depreciation,  depletion and amortization         |       | 11,594                              |       | 16,899                           |       | 35            |       | 436                   |       | 1,835         |       | —                   |       | 30,799    |       |
| Selling and  administrative expense               |       | —                              |       | —                           |       | —        |       | —                |       | 17,546        |       | (9                       | )          | 17,537    |       |
| (Gain) loss on  sale of assets                    |       | (213                                | )          | 61                               |       | —        |       | 151                   |       | —        |       | —                   |       | (1        | )          |
| Interest expense                                  |       | —                              |       | 3                                |       | 587           |       | (194                  | )          | 16,094        |       | (12,457                  | )          | 4,033     |       |
| Income before  taxes                              |       | $                                   | 39,563     |                             | $          | 30,550        |       | $                     | 2,787      |          | $          | 2,609                    |       | $         | (22,809    | ) | $ | (32 | ) | $ | 52,668 |   |
|                                              |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Identifiable  assets:                             |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Equity investment                                 |       | $                                   | 32,675     |                             | —     |          | —     |                  | $          | 1,150         |       | $                        | 857,160    |      | $          | (854,901 | ) | $ | 36,084 |   |
| Property and  equipment                           |       | 725,336                             |       | $                                | 539,888    |          | $          | 13                    |       | 38,586        |       | 60,438                   |       | —    |       | 1,364,261 |   |
| Other allocated  assets                           |       | 38,465                              |       | 13,960                           |       | 161,869       |       | 35,804                |       | 335,807       |       | (68,195                  | )          | 517,710   |       |
| Total  identifiable assets                        |       | $                                   | 796,476    |                             | $          | 553,848       |       | $                     | 161,882    |          | $          | 75,540                   |       | $         | 1,253,405  |   | $ | (923,096 | ) | $ | 1,918,055 |   |

 

**Quarter Ended June 30, 2004:**

 
| ** **                                        | ** ** | **Gas  Gathering  and  Processing** | ** ** | **Exploration  and  Production** | ** ** | **Marketing** | ** ** | **Trans-  portation** | ** ** | **Corporate** | ** ** | **Eliminating  Entries** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|-------------------------------------|------------|----------------------------------|------------|---------------|------------|-----------------------|------------|---------------|------------|--------------------------|------------|-----------|------------|
| Revenues from  unaffiliated customers:            |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Sale of gas                                       |       | $                                   | 965        |                             | $          | 1,544         |       | $                     | 591,336    |          | $          | 303                      |       | $         | —     |   | $ | — |   | $ | 594,148 |   |
| Sale of natural  gas liquids                      |       | 2                                   |       | —                           |       | 104,605       |       | —                |       | —        |       | —                   |       | 104,607   |       |
| Equity hedges:                                    |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Gas                                               |       | 116                                 |       | 1,617                            |       | —        |       | —                |       | —        |       | —                   |       | 1,733     |       |
| Liquids                                           |       | (2,586                              | )          | —                           |       | —        |       | —                |       | —        |       | —                   |       | (2,586    | )          |
| Gathering,  processing and transportation revenue |       | 22,756                              |       | —                           |       | —        |       | 1,654                 |       | —        |       | —                   |       | 24,410    |       |
| Total revenues  from unaffiliated customers       |       | 21,253                              |       | 3,161                            |       | 695,941       |       | 1,957                 |       | —        |       | —                   |       | 722,312   |       |
| Inter-segment  revenues                           |       | 251,772                             |       | 60,425                           |       | 14,796        |       | 3,711                 |       | —        |       | (330,704                 | )          | —    |       |
| Price risk  management activities                 |       | (5                                  | )          | —                           |       | 3,465         |       | —                |       | —        |       | —                   |       | 3,460     |       |
| Interest income                                   |       | —                              |       | 3                                |       | —        |       | —                |       | 4,333         |       | (4,336                   | )          | —    |       |
| Other, net                                        |       | 471                                 |       | —                           |       | 7             |       | 47                    |       | 6             |       | —                   |       | 531       |       |
| Total revenues                                    |       | 273,491                             |       | 63,589                           |       | 714,209       |       | 5,715                 |       | 4,339         |       | (335,040                 | )          | 726,303   |       |
|                                              |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Product purchases                                 |       | 212,543                             |       | 304                              |       | 710,825       |       | 1,374                 |       | —        |       | (322,880                 | )          | 602,166   |       |
| Plant and  transportation operating expense       |       | 21,189                              |       | (178                             | )          | 70            |       | 1,812                 |       | —        |       | (638                     | )          | 22,255    |       |
| Oil and gas exploration  and production expense   |       | —                              |       | 26,904                           |       | —        |       | —                |       | —        |       | (7,092                   | )          | 19,812    |       |
| (Earnings) from  equity investments               |       | (1,776                              | )          | —                           |       | —        |       | —                |       | —        |       | —                   |       | (1,776    | )          |
| Segment-operating  profit                         |       | 41,535                              |       | 36,559                           |       | 3,314         |       | 2,529                 |       | 4,339         |       | (4,430                   | )          | 83,846    |       |
|                                              |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Depreciation,  depletion and amortization         |       | 9,211                               |       | 10,875                           |       | 35            |       | 408                   |       | 1,819         |       | —                   |       | 22,348    |       |
| Selling and  administrative expense               |       | —                              |       | —                           |       | —        |       | —                |       | 17,266        |       | (11                      | )          | 17,255    |       |
| (Gain) loss on  sale of assets                    |       | 244                                 |       | (196                             | )          | —        |       | —                |       | 292           |       | 1,299                    |       | 1,639     |       |
| Loss from early  extinguishment of debt           |       | —                              |       | —                           |       | —        |       | —                |       | 10,662        |       | —                   |       | 10,662    |       |
| Interest expense                                  |       | —                              |       | 8                                |       | 82            |       | (71                   | )          | 9,668         |       | (4,336                   | )          | 5,351     |       |
| Income before  taxes                              |       | $                                   | 32,080     |                             | $          | 25,872        |       | $                     | 3,197      |          | $          | 2,192                    |       | $         | (35,368    | ) | $ | (1,382 | ) | $ | 26,591 |   |
|                                              |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Identifiable  assets:                             |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Equity investment                                 |       | $                                   | 2,469      |                             | —     |          | —     |                  | —     |          | $          | 697,196                  |       | $         | (662,882   | ) | $ | 36,783 |   |
| Property and  equipment                           |       | 623,982                             |       | $                                | 321,009    |          | $          | 1,253                 |       | $             | 38,225     |                     | 56,240     |      | (569       | ) | 1,040,140 |   |
| Other allocated  assets                           |       | 2,739                               |       | 7,004                            |       | 124,759       |       | 44,951                |       | 281,912       |       | (38,451                  | )          | 422,914   |       |
| Total  identifiable assets                        |       | $                                   | 629,190    |                             | $          | 328,013       |       | $                     | 126,012    |          | $          | 83,176                   |       | $         | 1,035,348  |   | $ | (701,902 | ) | $ | 1,499,837 |   |

 

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**Six Months Ended June 30, 2005:**

 
| ** **                                        | ** ** | **Gas  Gathering  and  Processing** | ** ** | **Exploration  and  Production** | ** ** | **Marketing** | ** ** | **Trans-  portation** | ** ** | **Corporate** | ** ** | **Eliminating  Entries** | ** ** | **Total** |      |
|---------------------------------------------------|------------|-------------------------------------|------------|----------------------------------|------------|---------------|------------|-----------------------|------------|---------------|------------|--------------------------|------------|-----------|-----------|
| Revenues from  unaffiliated customers:            |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |      |
| Sale of gas                                       |       | $                                   | 729        |                             | $          | 7,075         |       | $                     | 1,363,568  |          | $          | 1,154                    |       | $         | —    |   | $ | — |   | $ | 1,372,526 |   |
| Sale of natural  gas liquids                      |       | 51                                  |       | —                           |       | 284,347       |       | —                |       | —        |       | —                   |       | 284,398   |      |
| Equity hedges:                                    |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |      |
| Gas                                               |       | 175                                 |       | 1,604                            |       | —        |       | —                |       | —        |       | —                   |       | 1,779     |      |
| Liquids                                           |       | (1,949                              | )          | —                           |       | —        |       | —                |       | —        |       | —                   |       | (1,949    | )         |
| Gathering,  processing and transportation revenue |       | 48,447                              |       | (162                             | )          | —        |       | 3,419                 |       | —        |       | —                   |       | 51,704    |      |
| Total revenues  from unaffiliated customers       |       | 47,453                              |       | 8,517                            |       | 1,647,915     |       | 4,573                 |       | —        |       | —                   |       | 1,708,458 |      |
| Inter-segment  revenues                           |       | 576,179                             |       | 147,643                          |       | 42,644        |       | 6,795                 |       | 20            |       | (773,281                 | )          | —    |      |
| Price risk  management activities                 |       | (125                                | )          | —                           |       | 4,460         |       | —                |       | —        |       | —                   |       | 4,335     |      |
| Interest income                                   |       | —                              |       | 8                                |       | 18            |       | —                |       | 21,937        |       | (21,963                  | )          | —    |      |
| Other, net                                        |       | 2,194                               |       | 120                              |       | 3             |       | —                |       | 401           |       | —                   |       | 2,718     |      |
| Total revenues                                    |       | 625,701                             |       | 156,288                          |       | 1,695,040     |       | 11,368                |       | 22,358        |       | (795,244                 | )          | 1,715,511 |      |
|                                              |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |      |
| Product purchases                                 |       | 474,358                             |       | 2,364                            |       | 1,689,680     |       | 1,634                 |       | —        |       | (753,166                 | )          | 1,414,870 |      |
| Plant and  transportation operating expense       |       | 52,491                              |       | 168                              |       | 146           |       | 3,464                 |       | —        |       | (1,739                   | )          | 54,530    |      |
| Oil and gas  exploration and production expense   |       | —                              |       | 67,294                           |       | —        |       | —                |       | —        |       | (18,339                  | )          | 48,955    |      |
| (Earnings) from  equity investments               |       | (4,380                              | )          | —                           |       | —        |       | —                |       | —        |       | —                   |       | (4,380    | )         |
| Segment-operating  profit                         |       | 103,232                             |       | 86,462                           |       | 5,214         |       | 6,270                 |       | 22,358        |       | (22,000                  | )          | 201,536   |      |
|                                              |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |      |
| Depreciation, depletion  and amortization         |       | 22,872                              |       | 32,528                           |       | 71            |       | 839                   |       | 3,567         |       | —                   |       | 59,877    |      |
| Selling and  administrative expense               |       | —                              |       | —                           |       | —        |       | —                |       | 30,089        |       | (20                      | )          | 30,069    |      |
| (Gain) loss on  sale of assets                    |       | (182                                | )          | 61                               |       | —        |       | 148                   |       | —        |       | —                   |       | 27        |      |
| Interest expense                                  |       | 5                                   |       | 4                                |       | 589           |       | (348                  | )          | 29,266        |       | (21,963                  | )          | 7,553     |      |
| Income before  taxes                              |       | $                                   | 80,537     |                             | $          | 53,869        |       | $                     | 4,554      |          | $          | 5,631                    |       | $         | (40,564   | ) | $ | (17 | ) | $ | 104,010 |   |
|                                              |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |      |
| Identifiable  assets:                             |       |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |      |
| Equity investment                                 |       | $                                   | 32,675     |                             | —     |          | —     |                  | $          | 1,150         |       | $                        | 857,160    |      | $         | (854,901 | ) | $ | 36,084 |   |
| Property and  equipment                           |       | 725,336                             |       | $                                | 539,888    |          | $          | 13                    |       | 38,586        |       | 60,438                   |       | —    |      | 1,364,261 |   |
| Other allocated  assets                           |       | 38,465                              |       | 13,960                           |       | 161,869       |       | 35,804                |       | 335,807       |       | (68,195                  | )          | 517,710   |      |
| Total  identifiable assets                        |       | $                                   | 796,476    |                             | $          | 553,848       |       | $                     | 161,882    |          | $          | 75,540                   |       | $         | 1,253,405 |   | $ | (923,096 | ) | $ | 1,918,055 |   |

 

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**Six Months Ended June 30, 2004:**

 
|                                              |   | **Gas  Gathering  and  Processing** | ** ** | **Exploration  and  Production** | ** ** | **Marketing** | ** ** | **Trans-  portation** | ** ** | **Corporate** | ** ** | **Eliminating  Entries** | ** ** | **Total** | ** ** |
|---------------------------------------------------|--------|-------------------------------------|------------|----------------------------------|------------|---------------|------------|-----------------------|------------|---------------|------------|--------------------------|------------|-----------|------------|
| Revenues from  unaffiliated customers:            |   |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Sale of gas                                       |   | $                                   | 1,889      |                             | $          | 3,783         |       | $                     | 1,251,272  |          | $          | 865                      |       | $         | —     |   | $ | — |   | $ | 1,257,809 |   |
| Sale of natural  gas liquids                      |   | 3                                   |       | —                           |       | 199,911       |       | —                |       | —        |       | —                   |       | 199,914   |       |
| Equity hedges:                                    |   |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Gas                                               |   | 265                                 |       | 3,117                            |       | —        |       | —                |       | —        |       | —                   |       | 3,382     |       |
| Liquids                                           |   | (4,978                              | )          | —                           |       | —        |       | —                |       | —        |       | —                   |       | (4,978    | )          |
| Gathering,  processing and transportation revenue |   | 37,842                              |       | —                           |       | —        |       | 3,397                 |       | —        |       | —                   |       | 41,239    |       |
| Total revenues  from unaffiliated customers       |   | 35,021                              |       | 6,900                            |       | 1,451,183     |       | 4,262                 |       | —        |       | —                   |       | 1,497,366 |       |
| Inter-segment  revenues                           |   | 509,424                             |       | 116,356                          |       | 27,601        |       | 7,145                 |       | —        |       | (660,526                 | )          | —    |       |
| Price risk  management activities                 |   | (26                                 | )          | —                           |       | (1,994        | )          | —                |       | —        |       | —                   |       | (2,020    | )          |
| Interest income                                   |   | —                              |       | 3                                |       | —        |       | —                |       | 8,342         |       | (8,345                   | )          | —    |       |
| Other, net                                        |   | 812                                 |       | 1                                |       | 5             |       | 47                    |       | 1,308         |       | —                   |       | 2,173     |       |
| Total revenues                                    |   | 545,231                             |       | 123,260                          |       | 1,476,795     |       | 11,454                |       | 9,650         |       | (668,871                 | )          | 1,497,519 |       |
|                                              |   |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Product purchases                                 |   | 428,120                             |       | 932                              |       | 1,470,694     |       | 2,955                 |       | —        |       | (643,193                 | )          | 1,259,508 |       |
| Plant and  transportation operating expense       |   | 42,288                              |       | 70                               |       | (172          | )          | 3,572                 |       | —        |       | (1,569                   | )          | 44,189    |       |
| Oil and gas  exploration and production expense   |   | —                              |       | 52,585                           |       | —        |       | —                |       | —        |       | (15,663                  | )          | 36,922    |       |
| (Earnings) from  equity investments               |   | (3,702                              | )          | —                           |       | —        |       | —                |       | —        |       | —                   |       | (3,702    | )          |
| Segment-operating  profit                         |   | 78,525                              |       | 69,673                           |       | 6,273         |       | 4,927                 |       | 9,650         |       | (8,446                   | )          | 160,602   |       |
|                                              |   |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Depreciation,  depletion and amortization         |   | 18,212                              |       | 21,866                           |       | 52            |       | 824                   |       | 4,020         |       | —                   |       | 44,974    |       |
| Selling and  administrative expense               |   | —                              |       | —                           |       | —        |       | —                |       | 27,227        |       | (26                      | )          | 27,201    |       |
| (Gain) loss on  sale of assets                    |   | 244                                 |       | (196                             | )          | —        |       | —                |       | 292           |       | 1,299                    |       | 1,639     |       |
| Loss from early  extinguishment of debt           |   | —                              |       | —                           |       | —        |       | —                |       | 10,662        |       | —                   |       | 10,662    |       |
| Interest expense                                  |   | —                              |       | 42                               |       | 177           |       | (133                  | )          | 19,412        |       | (8,345                   | )          | 11,153    |       |
| Income before  taxes                              |   | $                                   | 60,069     |                             | $          | 47,961        |       | $                     | 6,044      |          | $          | 4,236                    |       | $         | (51,963    | ) | $ | (1,374 | ) | $ | 64,973 |   |
|                                              |   |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Identifiable  assets:                             |   |                                |       |                             |       |          |       |                  |       |          |       |                     |       |      |       |
| Equity investment                                 |   | $                                   | 2,469      |                             | —     |          | —     |                  | —     |          | $          | 697,196                  |       | $         | (662,882   | ) | $ | 36,783 |   |
| Property and equipment                            |   | 623,982                             |       | $                                | 321,009    |          | $          | 1,253                 |       | $             | 38,225     |                     | 56,240     |      | (569       | ) | 1,040,140 |   |
| Other allocated  assets                           |   | 2,739                               |       | 7,004                            |       | 124,759       |       | 44,951                |       | 281,912       |       | (38,451                  | )          | 422,914   |       |
| Total  identifiable assets                        |   | $                                   | 629,190    |                             | $          | 328,013       |       | $                     | 126,012    |          | $          | 83,176                   |       | $         | 1,035,348  |   | $ | (701,902 | ) | $ | 1,499,837 |   |

 

***LEGALPROCEEDINGS***

 

***Gracey et al. v. Western Gas Resources, Inc. et al.,United States District Court, Southern District of New York, CaseNo. 03-CV-6186 (vm) (S.D.N.Y.). ***On September 17,2004, the plaintiffs, traders of natural gas futures contracts on NYMEX, filedthis action on behalf of themselves and a putative class of other similarlysituated plaintiffs.  In the complaint,the plaintiffs claim that we manipulated the prices of natural gas futures onthe NYMEX in violation of the Commodity Exchange Act, or CEA, by reportingallegedly “inaccurate, misleading and false trading information” to tradepublications that compile and publish indices of natural gas spot prices.  In addition, the complaint asserts that weaided and abetted the alleged CEA violations of others.  In June 2005, while admitting noliability, we entered into a Stipulation and Agreement of

 

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Settlement with theplaintiffs for $5.9 million.  Thissettlement is subject to approval by the court and was accrued in the secondquarter of 2005.

 

***UnitedStates of America and ex rel. Jack J. Grynberg v. Western Gas Resources, Inc.,et al., United States District Court, District of Colorado, Civil Action No. 97-D-1427. ***We, along with over 300 other naturalgas companies, are defendants in litigation filed on September 30, 1997, in72 separate actions filed by Mr. Grynberg on behalf of the federalgovernment.  The allegations made by Mr. Grynbergare that established gas measurement and royalty calculation practicesimproperly deprived the federal government of appropriate natural gas royaltiesand violate 31 U. S. C. 3729 (a) (7) of the False Claims Act.  The cases have been consolidated to theUnited States District Court for the District of Wyoming.  Discovery on the jurisdictional issues isbeing completed to determine if this matter qualifies as a qui tam, or class,action.  The defendants’ joint Motion toDismiss was argued before a Special Master on March 17 and 18, 2005 and,as a result thereof, the Special Master has recommended to the court thatclaims against several of the defendants, including Western, be dismissed. Therecommendation is pending before the court.

 

***OtherLitigation.**** * We are involved in various other litigationand administrative proceedings arising in the normal course of business.  In the opinion of our management, anyliabilities that may result from these claims will not, individually or in theaggregate, have a material adverse effect on our financial position, results ofoperations or cash flow.

 

***RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS***

 

We continually monitorand revise our accounting policies as new rules are issued.  At this time, there are several newaccounting pronouncements that have recently been issued, but not yet adopted,which will have an impact on our accounting when they become effective.  The following pronouncements have been issuedbut not yet adopted.

 

**SFASNo. 123(R).**  SFAS No. 123 (Revised 2004),“*Share Based Payment”*, or SFAS No. 123(R),**was issued in December 2004and now must be adopted for annual periods that begin after June 15,2005.  This pronouncement requirescompanies to expense the fair value of employee stock options and other formsof stock based compensation.  We intendto adopt this pronouncement in the first quarter of 2006.  Currently, we are complying with the proforma disclosure requirements of SFAS No. 123, *“Accounting for Stock Based Compensation.*”  SFAS 123(R) provides for various methods of adoption.We have not yet determined which method of adoption we will utilize.

 

**SFAS No. 151.**   SFASNo. 151, “*Inventory Costs, an amendmentof ARB No. 43, Chapter 4”*was issued in November 2004 andis effective for the Company for inventory costs incurred in fiscal yearsbeginning after June 15, 2005, and will be applied prospectively.  SFAS No. 151 amends APB Opinion No. 43,Chapter 4, “Inventory Pricing” to clarify the accounting for abnormal amountsof costs and the allocation of fixed production overheads.  We will adopt SFAS No. 151 onJanuary 1, 2006 and believe that the adoption of this pronouncement willnot affect our results of operations, financial position or cash flow.

 

**SFAS No. 153.**   SFASNo. 153, “*Exchanges of NonmonetaryAssets, an amendment of APB Opinion No. 29”*was issued in December 2004and is effective for the Company for nonmonetary asset exchanges occurring infiscal periods beginning after June 15, 2005, and will be appliedprospectively.  SFAS No. 153 amendsAPB Opinion No. 29, *Accounting forNonmonetary Transactions*.  Theguidance in APB Opinion No. 29 is based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of the assetsexchanged but included certain exceptions to that principle.  SFAS No. 153 amends APB Opinion No. 29to eliminate the exception for nonmonetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of nonmonetaryassets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flowsof the entity are expected to change significantly as a result of the exchange.We adopted SFAS No. 153 on July 1, 2005.

 

**EITF No. 04-13.  **At its November 2004 meeting, the Emerging Issues TaskForce, or EITF, of the FASB began discussion of Issue No. 04-13, “Accountingfor Purchases and Sales of Inventory with the Same Counterparty.”  This Issue addresses the question of when itis appropriate to measure non-monetary purchases and sales of inventory at fairvalue and record them in cost of sales and revenues and when they should berecorded as an exchange measured at the book value of the item sold. This issueis currently on the agenda for the September 2005 meeting of theEITF.  The implementation of this EITF,if approved, may reduce revenues and related costs but will not have a materialimpact on our results of operations, financial position or cash flows.

 

In order to minimizetransportation costs or make product available at a location of our customer’spreference, from time to time, we will enter into arrangements to buy productfrom a party at one location and arrange to sell a like quantity of product tothis same party at another location.  Inaccordance with EITF 03-11, we recordrevenue on these transactions on a

 

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gross basis versus salesnet of purchases basis because we obtain title to the product that we buy, bearthe risk of loss, credit and performance exposure on these transactions, andtake physical delivery of the product. For the quarters ended June 30, 2005 and 2004, we recorded revenuesof $34.6 million and $24.2 million, respectively, and product purchases of$30.8 million and $20.6 million, respectively, for transactions which wereentered into concurrently and with the intent to buy and sell like quantitieswith the same counterparty at different locations and at market prices at thoselocations.  For the six months ended June 30,2005 and 2004, we recorded revenues of $63.3 million and $49.4 million,respectively, and product purchases of $57.5 million and $44.5 million,respectively, for these types of transactions.

 

**FSP FAS 19-1.**  In April 2005, the FASB Staff issuedFASB Staff Position, or FSP, FAS 19-1, “Accounting for SuspendedWell Costs.” This FSP amends SFAS 19, “Financial Accounting and Reportingby Oil and Gas Producing Companies,” as it pertains to capitalizing the costsof drilling exploratory wells pending determination of whether the well hasfound proved reserves.  FSP, FAS 19-1states that exploratory well costs should continue to be capitalized if thewell has found a sufficient quantity of reserves to justify its completion as aproducing well and the entity is making progress assessing reserves and theeconomic and operational viability of the project.  We adopted this FSP in the second quarter of2005, as required, and it did not have a material impact on our results ofoperations, financial position or cash flows.

 

Exploratorylease rentals and geological and geophysical costs are charged to expense asincurred.  Exploratory drilling costs arecapitalized when incurred pending the determination of whether a well has foundproved reserves.  A determination ofwhether a well has found proved reserves is made shortly after drilling iscompleted. The determination is based on a process that relies oninterpretations of available geological, geophysical, and engineeringdata.  If an exploratory well isdetermined to be unsuccessful, the capitalized drilling costs will be chargedto expense in the period the determination is made.  If an exploratory well requires a majorcapital expenditure before production can begin, the cost of drilling theexploratory well will continue to be carried as an asset pending determinationof whether proved reserves have been found only as long as: i) the well hasfound a sufficient quantity of reserves to justify its completion as aproducing well if the required capital expenditure is made, and ii) drilling ofadditional exploratory wells is under way or firmly planned for the nearfuture. If the drilling of additional exploratory wells in the area is notunder way or firmly planned, or if the well has not found a commerciallyproducible quantity of reserves, the exploratory well is assumed to beimpaired, and its costs are charged to expense. 

 

Thefollowing table reflects the net changes in capitalized exploratory well costsduring the six months ended June 30, 2005 (000s).

 
| ** **                                                                                            | ** ** | **Six Months Ended  June 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| Beginning  balance at December 31, 2004                                                               |       | $                                   | 48,546     |   |
| Additions to  capitalized exploratory well costs pending the determination of proved  reserves        |       | 37,613                              |       |
| Reclassifications  to wells, facilities, and equipment based on the determination of proved  reserves |       | (4,290                              | )          |
| Capitalized exploratory  well costs charged to expense                                                |       | (1,599                              | )          |
| Ending balance                                                                                        |       | $                                   | 80,270     |   |

 

Substantially all of our exploratory wells that have been capitalizedfor a period greater than one year are located in the Powder River Basin.  In this basin, we drill wells into variouscoal seams.  In order to produce gas fromthe coal seams, a period of dewatering lasting from a few to twenty-fourmonths, or in some cases longer, is required prior to obtaining sufficient gasproduction to justify capital expenditures for compression and gathering, andto classify the reserves as proven.  Inorder to accelerate the dewatering time, we drill additional exploratory wellsin these areas.

 

**FASBInterpretation No. 47. **FASBInterpretation No. 47, “Accounting for Conditional Asset RetirementObligations, an interpretation of FASB Statement No. 143”, or FIN 47, wasissued in March 2005 and is effective in fiscal periods beginning after December 31,2005.  FIN 47 clarifies the term “conditionalasset retirement obligation” as used in FASB Statement 143, “Accounting forAsset Retirement Obligations”. Conditional asset retirement obligations as used in FASB Statement 143refers to a legal obligation to perform an asset retirement activity in whichthe timing and (or) method of settlement are conditional on a future event thatmay or may not be within the control of the entity. The obligation to performan asset retirement activity is unconditional even though uncertainty existsabout the timing and (or) method of settlement. Accordingly, an entity isrequired to recognize a liability for the fair value of a conditional assetretirement obligation if the fair value of the liability can be reasonablyestimated. When sufficient information exists, uncertainty about the timing and(or) method of settlement should be factored into the measurement of theliability. We will adopt this interpretation on January 1, 2006 and do notexpect the pronouncement to have a material impact on our results of operation,financial position or cash flows.

 

**SFASNo. 154.**   In May 2005, the FASB issued SFAS No. 154,“Accounting Changes and Error Corrections, a replacement of AccountingPrinciples Board Opinion (APB) No. 20, Accounting Changes, and FASBStatement No. 3, Reporting Accounting Changes in Interim FinancialStatements.” This Statement requires retrospective application to prior periods’financial statements of a change in accounting principle. It applies both tovoluntary changes and to changes required by an accounting pronouncement if thepronouncement does not include specific transition provisions. APB 20previously required that most voluntary changes in accounting principles berecognized by recording the cumulative effect of a change in accountingprinciple. SFAS 154 is effective for fiscal years beginning after December 15,2005. We plan to adopt this statement on January 1, 2006 and it is notexpected to have a material effect on the financial statements upon adoption.

 

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**ITEM 2.****    MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussion and analysis relates to factors that haveaffected our consolidated financial condition and results of operations for thethree and six months ended June 30, 2005 and 2004.  Certain prior year amounts have beenreclassified to conform to the presentation used in 2005.  You should also refer to our interim consolidatedfinancial statements and notes thereto included elsewhere in this document.  This section, as well as other sections inthis Form 10-Q, contain “forward-looking statements” within the meaning of thePrivate Securities Litigation Reform Act of 1995, which can be identified bythe use of forward-looking terminology, such as “may,” “intend,” “will,” “expect,”“anticipate,” “estimate,” or “continue” or the negative thereof or othervariations thereon or comparable terminology. In addition to the important factors referred to herein, numerousfactors affecting the gas processing industry generally and in the specificmarkets for gas and NGLs in which we operate could cause actual results todiffer materially from those in such forward-looking statements.

 

***COMPANY OVERVIEW***

 

***Business Strategy.****** *** Maximizing the value of our existing coreassets is the focal point of our business strategy.  Our core assets are our fully integratedupstream and midstream assets in the Powder River and Greater Green RiverBasins in Wyoming, the San Juan Basin in New Mexico, and our midstreamoperations in west Texas and Oklahoma. Our long-term business plan is to increase stockholder value by: (i)doubling proven natural gas reserves and equity production of natural gas fromthe levels achieved in 2001 over a five year period; (ii) meeting or exceedingthroughput projections in our midstream operations; and (iii) optimizing annualreturns.

 

***Industry and Company Overview.******  ***In North America, our industry has experienced severalconsecutive years of declining natural gas production despite increased drillingactivity.  Most of the major gasproducing areas, such as the Gulf of Mexico, are mature and are in productiondecline.  Our efforts, while concentratedin the Rocky Mountain area, extend into a variety of diverse unconventional gasplays, where there are estimated to be large quantities of undevelopedgas.  We are well positioned for futureproduction growth with a large inventory of undeveloped drilling locations inthe Powder River, the Greater Green River and San Juan Basins to meet thegrowing demand for clean burning natural gas. In addition, our exploration effort leverages off of our upstream andmidstream expertise in unconventional natural gas resource plays in order toadd new company-building projects and to position us for long-term growth.

 

In the United States, the federal government largely retains themineral rights to the undeveloped reserves in the areas in which we are active;accordingly, the development and production of these reserves requires permitsfrom federal governmental agencies including the Bureau of Land Management, orBLM, and state agencies such as the Wyoming Department of EnvironmentalQuality, or DEQ.  A significant challengein developing these reserves is the difficulty encountered by the industry inobtaining the required permits in a timely manner.  We believe that our technical expertise indeveloping environmentally responsible solutions to the problems encountered inthe development of gas reserves will be a competitive advantage in overcomingthis challenge.

 

Additionally, to date we have been successful in obtaining drillingrigs and related oil field services to accomplish our drilling plans.  However, we believe that as we expand intonew areas and continue the development of the areas in which we currently participate, obtaining rigs, related services andexperienced employees in a timely manner will become increasingly difficult.

 

Our operations are conducted through the following four businesssegments:

 

***Exploration and Production.****** ***We explorefor, develop and produce natural gas reserves independently and to enhance andsupport our existing gathering and processing operations. Our producingproperties are primarily located in the Powder River, Greater Green River, SanJuan, and Sand Wash Basins.  These playsprovide low geologic risk, and are multi-year development projects.  These provide us with the opportunity tosteadily increase our production volume over time at reasonable operating andlow finding and development costs.  Inthe second quarter of 2005, our average production sold was 167 MMcfe per day,which is a 13% increase over the daily average production volume sold in thesecond quarter of 2004.

 

We continue to seek to add additional upstream core projects that arefocused on Rocky Mountain natural gas. We will utilize our expertise in exploration and low-risk development ofunconventional gas reservoirs including tight-gas sands, coal bed methane,biogenic, and shale gas plays to evaluate acquisitions of either additionalleaseholds, proven and undeveloped reserves or companies with operationsprimarily focused in the Rockies.  We mayalso evaluate unconventional gas reservoirs in areas outside the Rockies wherewe can leverage our related exploration, production and gatheringexpertise.  In

 

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January 2005, we opened anoffice in Calgary, Alberta, Canada to evaluate opportunities in the WesternCanadian Sedimentary Basin.  Overall, atJune 30, 2005, we have acquired the drilling rights on approximately 1.6million net acres in various Rocky Mountain basins and continue to expand ourleasehold positions.

 

***Gathering, Processing and Treating. ***Our coreoperations are in well-established areas such as the Permian, Anadarko, PowderRiver, Greater Green River, and San Juan Basins.  We connect natural gas from gas and oil wellsto our gathering systems for delivery to our processing or treating plantsunder contracts with terms ranging from one month to the life of the lease. Atour plants we process natural gas to extract NGLs and treat natural gas inorder to meet pipeline specifications. We provide these services to major oil and gas companies, to independentproducers of various sizes and for our own production.  We believe that our low cost of operations,our high on-line time and our safety records are key elements in our ability tocompete effectively and provide reliable service to our customers.  Our expertise in gathering, processing andtreating operations can enhance the economics of developing new upstreamprojects.

 

This segment of our operations has provided a stream of operatingprofit that is available for reinvestment into other projects or other segmentsof our business.  Overall throughput inour facilities during the second quarter of 2005 remained relatively constantas compared to the same period in 2004 and averaged a total of 1.4 Bcf per day.

 

***Transportation.****** *** In the Powder River Basin, we own oneinterstate pipeline, MIGC, Inc., and one intrastate pipeline, MGTC, Inc., whichtransport natural gas for producers and energy marketers under fee schedulesregulated by state or federal agencies.

 

***Marketing.****** ***The primary goalof our gas-marketing segment is to ensure that the product from ourprocessing facilities and upstream activities is delivered timely to themarket.  Additionally, our gas marketingoperations seek to preserve and enhance the value received for our equityvolumes of natural gas.  This goal isachieved through the use of hedges on the production of our equity natural gasand NGLs and through the use of firm transportation capacity.  We also buy and sell natural gas and NGLs inthe wholesale market in the United States and in Canada.  These third-party sales, our firmtransportation capacity on interstate pipelines and our gas storage positions,combined with the stable supply of gas from our facilities and production,enable us to respond quickly to changing market conditions and to takeadvantage of seasonal price variations and peak demand periods.

 

***RESULTS OF OPERATIONS***

 

**Three and six months ended June 30, 2005 compared to the three and sixmonths ended June 30, 2004**

**(Dollars in thousands, except per shareamounts and operating data).**

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | ** **  | ** ** | **Six Months Ended** | ** ** | ** **  | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-------------|------------|----------------------|------------|-------------|------------|
| ** **                                           | ** ** | **June 30,**           | ** ** | **Percent** | ** ** | **June 30,**         | ** ** | **Percent** | ** ** |
| ** **                                           | ** ** | **2005**               | ** ** | **2004**    | ** ** | **Change**           | ** ** | **2005**    | ** ** | **2004** | ** ** | **Change** | ** ** |
|                                                 |       |                   |       |        |       |                 |       |        |       |   |   |   |   |
| **Financial results:**                               |       |                   |       |        |       |                 |       |        |       |   |   |   |   |
| Revenues                                             |       | $                      | 861,196    |        | $          | 726,303              |       | 19          |       | $ | 1,715,511 |   | $ | 1,497,519 |   | 15 |   |
| Net income                                           |       | 33,318                 |       | 13,975      |       | 138                  |       | 65,946      |       | 43,063 |   | 53 |   |
| Earnings per share of common  stock                  |       | 0.45                   |       | 0.19        |       | 137                  |       | 0.89        |       | 0.60 |   | 48 |   |
| Earnings per share of common stock -  diluted        |       | 0.44                   |       | 0.19        |       | 132                  |       | 0.87        |       | 0.58 |   | 50 |   |
| Net cash (used in) provided by operating  activities |       | 42,706                 |       | (36,364     | )          | 217                  |       | 160,102     |       | 88,132 |   | 82 |   |
| Net cash (used in) investing activities              |       | (76,847                | )          | (42,529     | )          | 81                   |       | (191,088    | )          | (77,655 | ) | 146 |   |
| Net cash (used in) provided by financing  activities |       | $                      | 38,454     |        | $          | 50,012               |       | (23         | )          | $ | 36,634 |   | $ | (33,707 | ) | 209 |   |
|                                                 |       |                   |       |        |       |                 |       |        |       |   |   |   |   |
| **Operating data:**                                  |       |                   |       |        |       |                 |       |        |       |   |   |   |   |
| Average gas sales (MMcf/D)                           |       | 1,162                  |       | 1,190       |       | (2                   | )          | 1,231       |       | 1,279 |   | (4 | ) |
| Average NGL sales (MGal/D)                           |       | 1,876                  |       | 1,643       |       | 14                   |       | 1,819       |       | 1,627 |   | 12 |   |
| Average gas prices ($/Mcf)                           |       | $                      | 6.38       |        | $          | 5.49                 |       | 16          |       | $ | 6.13 |   | $ | 5.40 |   | 14 |   |
| Average NGL prices ($/Gal)                           |       | $                      | 0.88       |        | $          | 0.68                 |       | 29          |       | $ | 0.86 |   | $ | 0.66 |   | 30 |   |

 

Net income increased $19.4 million for thethree months ended June 30, 2005, compared to the same period in 2004.  The increase in net income was primarilyattributable to higher production of equity gas volumes and higher commodityprices in the second quarter of 2005.  Inaddition, the second quarter of 2004 was negatively impacted by an after-taxcharge associated with a settlement with the CFTC of $7.0 million, and an after-tax charge associated with the earlyextinguishment

 

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oflong-term debt of $6.7 million. In the second quarter of 2005, we had an increase in operating costs anddepreciation, depletion and amortization and an after-tax charge of $3.8million recorded in connection with a settlement of litigation.

 

Net income increased $22.9 million for thesix months ended June 30, 2005, compared to the same period in 2004. Thisincrease was primarily attributable to higher production ofequity gas volumes and higher commodity prices. In addition, the first six months of 2004 were negatively impacted by the 2004 settlement with the CFTC, and the 2004early extinguishment of long-term debt. Partially offsetting these items in the 2004 period was the cumulativeeffect of a change in accounting principle.  Effective as of January 1, 2004, we revisedour depreciation and depletion methodology for our oil and gas properties.  This change in accounting principle resultedin a cumulative reduction of depreciation for periods prior to 2004 of $4.7million, net of tax, in 2004.

 

Revenues from the sale of gas increased $82.2 million to $678.1 millionfor the three months ended June 30, 2005 compared to the same period in2004.  This increase was primarily due toa significant increase in product prices, which more than offset a decrease insales volume of third-party product in the three months ended June 30, 2005compared to the same period in 2004. Average gas prices realized by us increased $0.89 per Mcf to $6.38 perMcf for the quarter ended June 30, 2005 compared to the same period in2004.  Included in the realized gas pricewere approximately $446,000 of gains recognized in thethree months ended June 30, 2005 related to futures positions on equity gasvolumes.  We have entered into additionalfutures positions for approximately 60% of our equity gas for the remainder of2005 and to a lesser extent in 2006.  Seefurther discussion in “Item 3. Quantitative and Qualitative Disclosures About Market Risk.” Average gas sales volumes decreased slightly to 1,162 MMcf per day forthe quarter ended June 30, 2005 compared to the same period in 2004.

 

Revenues from the sale of gas increased $113.1 million to $1,374.3million for the six months ended June 30, 2005 compared to the same period in2004.  This increase was primarily due toa significant increase in product prices, which more than offset a decrease insales volume of third-party product in the six months ended June 30, 2005,compared to the same period in 2004. Average gas prices realized by us increased $0.73 per Mcf to $6.13 perMcf for the six months ended June 30, 2005 compared to the same period in2004.  Included in the realized gas pricewere approximately $1.8 million of gains recognized in the six months endedJune 30, 2005 related to futures positions on equity gas volumes.  We have entered into additional futurespositions for approximately 60% of our equity gas for the remainder of 2005 andto a lesser extent in 2006.  See furtherdiscussion in “Item 3. Quantitative and Qualitative Disclosures About Market Risk.” Average gas sales volumes decreased slightly to 1,231 MMcf per day forthe six months ended June 30, 2005 compared to the same period in 2004.

 

Revenues from the sale of NGLs increased $47.5 million to $149.5million for the three months ended June 30, 2005 compared to the same period in2004.  This is primarily due to asignificant increase in product prices and an increase in sales volumes.  Average NGL prices realized by us increased$0.20 per gallon to $0.88 per gallon for the three months ended June 30, 2005compared to the same period in 2004. Included in the realized NGL price were approximately $1.1 million oflosses recognized in the three months ended June 30, 2005 related to futurespositions on equity NGL volumes.  We haveentered into additional futures positions for approximately 30% of our equityNGL production for the remainder of 2005 and to a lesser extent in 2006.  See further discussion in “Item 3.Quantitative and Qualitative Disclosures About MarketRisk.”  Average NGL sales volumesincreased 233 MGal per day to 1,876 MGal per day for the three months endedJune 30, 2005 compared to the same period in 2004.  This increase is due to the acquisition ofseveral facilities in February 2005.

 

Revenues from the sale of NGLs increased approximately $87.5 million to$282.5 million for the six months ended June 30, 2005 compared to the sameperiod in 2004.  This is primarily due toa significant increase in product prices and an increase in sales volumes.  Average NGL prices realized by us increased$0.20 per gallon to $0.86 per gallon for the six months ended June 30, 2005compared to the same period in 2004. Included in the realized NGL price were approximately $1.9 million oflosses recognized in the six months ended June 30, 2005 related to futurespositions on equity NGL volumes.  We haveentered into additional futures positions for approximately 30% of our equityNGL production for the remainder of 2005 and to a lesser extent in 2006.  See further discussion in “Item 3.Quantitative and Qualitative Disclosures About MarketRisk.”  Average NGL sales volumesincreased 192 MGal per day to 1,819 MGal per day for the six months ended June30, 2005 compared to the same period in 2004. This increase is due to theacquisition of several facilities in February 2005.

 

Product purchases increased by $105.4 million and $155.4 million forthe quarter and six months ended June 30, 2005, respectively, compared to thesame periods in 2004.  These increases inproduct purchases were the result of higher product prices.  Overall, combined product purchases as apercentage of sales of all products was 86% in both the quarter ended June 30,2005 and 2004.  Combined productpurchases as a percentage of sales of all products decreased to 85% for the sixmonths ended June 30, 2005 from 86% in 2004. The reduction in thispercentage is primarily the result of a decrease in the sale of third partyproduct and an increase in the sale of equity production.

 

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Plant and transportation operating expense increased by $4.6 millionand $10.3 million, respectively, for the three and six months ended June 30,2005 compared to the same periods in 2004. The increase for the quarter ended June 30, 2005 as compared to the sameperiod in 2004 was substantially due to increased property tax, labor andrepairs and maintenance expenses and the October 2004 and February 2005 assetacquisitions. The increase for the six months ended June 30, 2005 as comparedto the same period in 2004 was substantially due to increased property tax,labor and third-party gathering expenses and the October 2004 and February 2005asset acquisitions.

 

Oil and gas exploration and production expense increased by $4.2million and $12.0 million, respectively, for the three and six months endedJune 30, 2005 compared to the same periods in 2004.  The increase for the quarter ended June 30,2005 as compared to the same period in 2004 was substantially due to increasedproduction taxes and expenses associated with the San Juan properties acquiredin October 2004. The increase for the six months ended June 30, 2005 ascompared to the same period in 2004 was substantially due to increased leaseoperating expenses, or LOE, in the Powder River Basin coal bed development andexpenses associated with the San Juan properties acquired in 2004. Overall, LOEaveraged $0.80 per Mcf and $0.83 per Mcf for the quarter and six months endedJune 30, 2005 and LOE in the Powder River Basin coal bed development averaged$0.92 per Mcf and $0.89 per Mcf in the quarter and six months ended June 30,2005, respectively.  In the Powder RiverBasin, these represent increases of $0.14 and $0.10 per Mcf from the sameperiods in 2004.  The increase in LOE perMcf in the Powder River Basin is substantially due to higher water handlingcharges on dewatering wells in several new pilot areas that have no offsettinggas production as yet, contract labor, and fuel and operating costs of wellheadblowers in the Powder River Basin as well as increased costs related toinitiating operations of the San Juan Basin production assets.

 

Depreciation,depletion and amortization increased by $8.5 million and $14.9 million,respectively, for the three and six months ended June 30, 2005 as compared tothe same periods in 2004.  For thequarter ended June 30, 2005 as compared to the same period in 2004, we had a $2.4million increase in DD&A in our midstream operations primarily due to ourexpanding CBM gathering system in the Powder River Basin and the October 2004 andFebruary 2005 acquisitions of additional midstream assets, and a $6.0 millionincrease in DD&A in our upstream operations primarily due to our continueddevelopment in the Powder River Basin, downward revisions to reserves in thePowder River Basin based on the December 2004 reserve report, and our October2004 acquisition of producing properties in the San Juan Basin.  For the six months ended June 30, 2005 ascompared to the same period in 2004, we had a $4.7 million increase in DD&Ain our midstream operations and a $10.6 million increase in our upstreamoperations primarily due to those items mentioned above.

 

Selling andadministrative expenses increased by $282,000 and $2.9 million for the threeand six months ended June 30, 2005 as compared to the same period in 2004.  The increase in selling and administrativeexpenses for the six months ended June 30, 2005 as compared to 2004 wasprimarily the result of increased administrative salaries, insurance, auditexpenses, and compensation expense related to our restricted stock plan.  Additionally, a charge of $5.9 million wasrecorded in the second quarter of 2005 in connection with a settlement oflitigation and a charge associated with a settlement with the CFTC of $7.0million was recorded in the second quarter of 2004.

 

The Total provision for income taxes, as a percentage of Income beforetaxes was approximately 36.7% and 36.6%, respectively, during the quarter andsix months ended June 30, 2005 as compared to 47.4% and 41.0%,respectively, in same periods of 2004. This decrease is due to the civilpenalty paid to the CFTC in 2004, which was non-deductible for tax purposes.

 

***Cash Flow Information***

 

Cash flows from operatingactivities increased by $72.0 million in the first six months of 2005 comparedto the same period in 2004. This increase was primarily due to the increase innet income and the timing of cash receipts and payables.

 

Cash flows used in investingactivities increased by $113.4 million in the first six months of 2005 comparedto the same period in 2004.  Thisincrease was primarily due to an increased level of capital expendituresincluding the February 2005 acquisition of additional midstream assets in theGreater Green River Basin.

 

Cash flows used in financingactivities decreased by $70.3 million in the first six months of 2005 comparedto the same period in 2004.  Thisdecrease was due to a significant reduction in our outstanding debt in thefirst six months of 2004, as compared to the utilization of funds provided byfinancing activities to fund our capital investments in 2005.

 

***Segment Information***

 

***GasGathering, Processing and Treating.***  The Gas Gathering, Processing and Treatingsegment realized segment-operating profit of $103.2 million for the six monthsended June 30, 2005 compared to $78.5 million in the same period in

 

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2004.  The increase in operating profit in thissegment in the 2005 periods is primarily due to higher realized prices and theresulting increase in net margin as shown below.  

 
| ** **                | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **2005**                    | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Gross Margin ($/Mcf)      |       | $                           | 0.60       |                           | $          | 0.53 |   | $ | 0.62 |   | $ | 0.51 |   |
| Operating Expense ($/Mcf) |       | 0.20                        |       | 0.18                           |       | 0.21 |   | 0.18 |   |
| Net Margin ($/Mcf)        |       | 0.40                        |       | 0.35                           |       | 0.41 |   | 0.33 |   |
|                           |            |                             |            |                                |            |  |  |  |  |  |  |  |  |

 

***Explorationand Production.*** The Exploration and Production segment realized segment -operatingprofit of $86.5 million for the six months ended June 30, 2005 compared to$69.7 million in 2004. The increase is due to increased equity production,higher product prices, and the acquisition of production assets in the San Juanbasin in the fourth quarter of 2004. During the first six months of 2005, our production of natural gas ascompared to the same period in 2004 increased by 13% to 29.9 Bcfe.  The following table sets forth the averagesales price received for our oil and gas products in the quarter and six monthsended June 30, 2005 and 2004.

 
| ** **                                                    | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                                                    | ** ** | **2005**                    | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Average sales price: (1)                                      |       |                        |       |                           |       |   |   |   |   |
| Oil ($/Bbl)                                                   |       | $                           | 47.88      |                           | $          | 33.89 |   | $ | 45.58 |   | $ | 33.68 |   |
| Gas ($/Mcf),  excluding the effect of  hedging positions |       | 5.34                        |       | 4.59                           |       | 5.11 |   | 4.49 |   |
| Gas ($/Mcf), including the effect of  hedging positions       |       | 5.36                        |       | 4.71                           |       | 5.17 |   | 4.61 |   |
|                                                          |       |                        |       |                           |       |   |   |   |   |
| Production and other costs:                                   |       |                        |       |                           |       |   |   |   |   |
| Lease operating expense ($/Mcfe)                              |       | 0.80                        |       | 0.66                           |       | 0.83 |   | 0.65 |   |
| Production tax expense ($/Mcfe)                               |       | 0.59                        |       | 0.48                           |       | 0.53 |   | 0.50 |   |
| Gathering and transportation expense ($/Mcfe)                 |       |                        |       |                           |       |   |   |   |   |
| Inter-segment charges                                         |       | 0.60                        |       | 0.53                           |       | 0.61 |   | 0.59 |   |
| Third-party charges                                           |       | 0.16                        |       | 0.20                           |       | 0.18 |   | 0.13 |   |
| Other expenses ($/Mcfe)                                       |       | 0.04                        |       | 0.02                           |       | 0.02 |   | 0.01 |   |
| Total costs ($/Mcfe)                                          |       | $                           | 2.19       |                           | $          | 1.89 |   | $ | 2.17 |   | $ | 1.88 |   |

 

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(1) The prices received for NGLs areincluded in the price received for gas. 

 

***Marketing.***  The Marketing segment realizedsegment-operating profit of $5.2 million for the six months ended June 30, 2005compared to $6.3 million in the same period of 2004.  The decrease was due to lower pricedifferentials between the Rocky Mountain and Mid Continent market centers,which reduced the Marketing segment’s ability to capitalize on ourtransportation contracts.

 

***Transportation.***  The Transportation segment realizedsegment-operating profit of $6.3 million for the six months ended June 30, 2005compared to $4.9 million in the same period of 2004.  The Transportation segment includes theresults from the MIGC and MGTC pipelines in the Powder River Basin.

 

***RecentlyIssued Accounting Pronouncements.***  We continually monitor and revise ouraccounting policies as new rules are issued. See Notes to Consolidated Financial Statements (Unaudited) in Item 1 ofthis Form 10-Q for a detailed description of recently issued accountingpronouncements.

 

#### ***LIQUIDITY AND CAPITALRESOURCES***

 

#### **Our sources of liquidity and capital resourceshistorically have been net cash provided by operating activities, fundsavailable under our financing facilities and proceeds from offerings of debtand equity securities.  In the past,these sources have been sufficient to meet our needs and finance the growth ofour business.  We can give no assurancethat the historical sources of liquidity and capital resources will beavailable for future development and acquisition projects, and we may berequired to seek additional or alternative financing sources.  Product prices, hedges of equity production,sales of inventory, the volume of natural gas processed by our facilities, thevolume of natural gas produced from our producing properties, the margin onthird-party product purchased for resale, as well as the timely collection ofour receivables are all expected to have significant influences on our futurenet cash provided by operating activities. Additionally, our future growth will be dependent upon obtainingadditions to dedicated plant reserves, acquisitions, new project development,marketing results,**

 

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#### **efficient** operation of ourfacilities and our ability to obtain financing at favorable terms.

 

During the past several years, we have beensuccessful in developing additional reserves of natural gas and increasing ourequity natural gas production.  However,the overall level of drilling and production associated with our producingproperties will depend upon, among other factors, the price for gas,availability of transportation capacity to market centers, the energy andenvironmental policy and regulation by governmental agencies, the drillingschedules of the operators of our non-operated properties, the issuance ofdrilling and water disposal permits, the availability of oil field services,and the length of time for wells in the Powder River Basin to be dewatered,none of which is within our control.  Asignificant reduction in the level of our production or a significant reductionin natural gas prices could have a material adverse effect on our financialcondition, results of operations and cash flows.

 

Althoughsome of our plants have experienced natural declines in dedicated reserves,overall we have been successful in connecting additional reserves to more thanoffset these declines.  However, theoverall level of drilling associated with our plant facilities will dependupon, among other factors, the prices for oil and gas, the drilling budgets ofthird-party producers, availability of transportation capacity to marketcenters, the energy and environmental policy and regulation by governmentalagencies, the pace at which drilling permits are received, and the availabilityof foreign oil and gas, none of which is within our control. There is noassurance that we will continue to be successful in replacing the dedicatedreserves processed at our facilities. Any prolonged reduction in prices for natural gas and NGLs may depressthe levels of exploration, development and production by third parties.  Lower levels of these activities could resultin a corresponding decline in the demand for our gathering, processing andtreating services.  A significantreduction in any of these activities could have a material adverse effect onour financial condition, results of operations and cash flows.

 

Webelieve that the amounts available to be borrowed under our financingfacilities, together with net cash provided by operating activities, willprovide us with sufficient funds to connect new reserves, maintain our existingfacilities and complete our current capital expenditure program.  Depending on the timing and the amount of ourfuture projects, we may be required to seek additional sources of capital.  Our ability to secure such capital isrestricted by our financing facilities, although we may request additionalborrowing capacity from our lenders, seek waivers from our lenders to permit usto borrow funds from third-parties, seek replacement financing facilities fromother lenders, use stock as a currency for acquisitions, sell existing assetsor use a combination of alternatives. While we believe that we would be able to secure additional financing,if required, we can provide no assurance that we will be able to do so or as tothe terms of any additional financing. In July 2005, we utilized amounts available under our revolving creditfacility to fund a scheduled principal repayment of $10.0 million under ourmaster shelf agreement.

 

Wehave effective shelf registration statements filed with the SEC for anaggregate of $262.0 million of debt securities, preferred stock or commonstock.  These shelf registrations allowus to access the debt and equity markets, subject to market conditions.

 

***Sources and Uses of Funds*.**  Our sources and uses of funds for the sixmonths ended June 30, 2005 are summarized as follows (dollars in thousands):

 
| **Sources of funds:**                                            |   |    |      |
|------------------------------------------------------------------|--------|---------|-----------|
| Borrowings under our revolving credit  facility                  |   | $       | 1,789,015 |   |
| Borrowings under our master shelf agreement                      |   | 25,000  |      |
| Proceeds from the dispositions of property  and equipment        |   | 1,411   |      |
| Net cash provided by operating activities                        |   | 160,102 |      |
| Distributions from equity investments                            |   | 613     |      |
| Change in outstanding checks                                     |   | 6,335   |      |
| Proceeds from exercise of common stock  options                  |   | 2,735   |      |
| Total sources of funds                                           |   | $       | 1,985,211 |   |
|                                                             |   |    |      |
| **Uses of funds:**                                               |   |    |      |
| Payments related to long-term debt  (including debt issue costs) |   | $       | 1,754,055 |   |
| Capital expenditures                                             |   | 193,112 |      |
| Payments made under our master shelf  agreement                  |   | 25,000  |      |
| Common dividends paid                                            |   | 7,396   |      |
| Total uses of funds                                              |   | $       | 1,979,563 |   |

 

***Capital InvestmentProgram.***  Wecurrently anticipate capital expenditures in 2005 of approximately $376.4million.  Overall, capital expendituresin the Powder River Basin CBM development and in the Greater Green River Basinoperations

 

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represent34% and 29%, respectively, of the total 2005 budget.  Due to drilling and regulatory uncertaintiesthat are beyond our control, we can make no assurance that our capital budgetfor 2005 will not change or that we will actually incur this level of capitalexpenditures.  This budget may beincreased to provide for acquisitions if approved by our board of directors.

 

The 2005 capital budget and our capital expenditures during the sixmonths ended June 30, 2005 are presented in the following table (dollars inmillions):

 
| **Type of Capital Expenditure**                              | ** ** | **2005  Capital Budget** | ** ** | **Year to Date  Capital Expenditures** | ** ** |
|--------------------------------------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| Gathering, processing, treating and  pipeline assets (1)     |       | $                        | 132.8      |                                   | $          | 61.5 |   |
| Exploration and production and lease  acquisition activities |       | 204.3                    |       | 102.8                                  |       |
| Acquisition of Greater Green River Basin  midstream assets   |       | 28.0                     |       | 28.0                                   |       |
| Information technology and other items                       |       | 3.0                      |       | 2.4                                    |       |
| Capitalized interest and overhead                            |       | 8.3                      |       | 6.0                                    |       |
| Total Capital Expenditures                                   |       | $                        | 376.4      |                                   | $          | 200.7 |   |

 

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(1)Includes $13.7 million budgeted in 2005 and $3.0 million expended in the sixmonths ended June 30, 2005 for maintaining existing facilities.

 

***ContractualCommitments and Obligations***

 

##### ***Contractual Cash Obligations.***  A summary of our contractualcash obligations as of June 30, 2005 is as follows (dollars in thousands):

 
| ** **                                | ** ** | ** **             | ** ** | **Payments by Period** | ** ** |
|-------------------------------------------|------------|------------------------|------------|------------------------|------------|
| **Type of Obligation**                    | ** ** | **Total  Obligations** | ** ** | **Due in  2005**       | ** ** | **Due in  2006 – 2007** | ** ** | **Due in  2008 – 2009** | ** ** | **Due  Thereafter** | ** ** |
| Guarantee of Fort Union Project Financing |       | $                      | 4,316      |                   | $          | 439 |   | $ | 1,931 |   | $ | 1,946 |   | $ | — |   |
| Operating Leases                          |       | 78,616                 |       | 8,900                  |       | 32,871 |   | 25,037 |   | 11,808 |   |
| Firm Transportation Capacity Agreements   |       | 232,468                |       | 19,547                 |       | 72,325 |   | 59,440 |   | 81,156 |   |
| Firm Storage Capacity Agreements          |       | 30,198                 |       | 4,621                  |       | 11,605 |   | 5,045 |   | 8,927 |   |
| Long-term Debt                            |       | 417,000                |       | 10,000                 |       | 20,000 |   | 262,000 |   | 125,000 |   |
| Interest on Long-term Debt (1)            |       | 98,780                 |       | 10,495                 |       | 39,995 |   | 32,399 |   | 15,891 |   |
| Total Contractual Cash Obligations        |       | $                      | 861,378    |                   | $          | 54,002 |   | $ | 178,727 |   | $ | 385,867 |   | $ | 242,782 |   |

 

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(1)The interest rate assumed on the revolving credit facility at June 30, 2005 is4.5% per annum.

 

***Guarantee of Fort Union Project Financing.***   We own a 13% equity interest in Fort UnionGas Gathering, L.L.C., or Fort Union, and are the construction manager andfield operator.  Fort Union gathers andtreats natural gas in the Powder River Basin in northeast Wyoming.  Initial construction and any expansions ofthe gathering header and treating system have been project financed by FortUnion.  This debt is amortizing on anannual basis with the final payment due in 2009.  Our requirement to fund under this guaranteewould be reduced by the value of assets held by Fort Union.  This guarantee is not reflected on ourConsolidated Balance Sheet.

 

***Operating Leases.****** **** *In the ordinary course of ourbusiness operations, we enter into operating leases for office space, and foroffice, communication, transportation and compressionequipment.  Payments made on these leasesare a component of operating expenses and are reflected on the ConsolidatedStatement of Operations and, as operating leases, are not reflected on ourConsolidated Balance Sheet.  Our leaseshave terms ranging from one month to ten years and the majority of the leaseshave return or fair market purchase options available at various times duringthe lease.  If we were to exercise thepurchase options on all the leased compression equipment, these purchase optionswould require the capital expenditure of approximately $44.9 million between2007 and 2013.

 

***Firm Transportation Capacity.***  Access to firm transportation is alsoa significant element of our business strategy. Firm transportation ensures that our equity production has access todownstream markets and allows us to capture incremental profit when pricingdifferentials between physical locations occur. Firm transportation agreements generally require the payment of fixedmonthly fees regardless of the quantity of gas that flows under a particularagreement.  These agreements are notreflected on our Consolidated Balance Sheet.

 

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At June 30, 2005, the fixed fees associated with our existing contractsfor firm transportation capacity during 2005 will average approximately $0.16per Mcf.  The associated contract periodsrange from one month to twelve years. Under firm transportation contracts, we are required to pay the feesassociated with these contracts whether or not the transportation is used.

 

***Firm Storage CapacityAgreements*.******  Wecustomarily store gas in underground storage facilities to ensure an adequatesupply for long-term sales contracts and to capture seasonal pricedifferentials.  As of June 30, 2005, wehad contracts in place for approximately 17.6 Bcf of storage capacity atvarious third-party facilities.  Firmstorage agreements generally require the payment of fixed monthly feesregardless of the quantity of gas that is in storage under a particularagreement.  Of the total storage capacity under contract,approximately 7.0 Bcf is under contract to our Canadian subsidiary, WGR Canada,Inc., and Western guarantees the subsidiary’s performance under thesecontracts.  This subsidiary is whollyowned by us and fully consolidated in our financial statements.

 

The feesassociated with these contracts in 2005 will average $0.59 per Mcf of annualcapacity.  The associated contractperiods at June 30, 2005 had an average term of 34 months.  At June 30, 2005, we held gas in ourcontracted storage facilities and in imbalances of approximately 18.8 Bcf at anaverage cost of $6.05 per Mcf compared to 14.5 Bcf at an average cost of $5.33 per Mcf at June30, 2004.  These positions are forstorage withdrawals within the next 12 months. At the time we place product into storage, we contract for the sale ofthat product, physically or financially, and do not speculate on the futurevalue of the product.  Theseagreements for storage capacity are not reflected on our Consolidated BalanceSheet.

 

From time to time, we lease NGL storage space at major tradinglocations to facilitate the distribution of products. At June 30, 2005, we heldNGLs in storage at various third-party facilities of 2,917 MGal, consisting primarilyof propane and ethane, at an average cost of $0.32 per gallon compared to 2,755MGal at an average cost of $0.28 per gallon at June 30, 2004.

 

#### ***Long-termDebt***

 

***Revolving Credit Facility.****** ***The commitment under the revolving creditfacility totals $500 million and matures in June 2009.  At June 30, 2005, $262.0 million wasoutstanding under this facility.  Loansmade under this facility are secured by a pledge of the capital stock of oursignificant subsidiaries, and these subsidiaries also guarantee the borrowingsunder the facility.

 

The borrowings under ourcredit facility bear interest at Eurodollar rates or a base rate, as requestedby us, plus an applicable percentage based on our debt to capitalizationratio.  The base rate is the agent’spublished prime rate.  We also pay aquarterly commitment fee ranging between 0.20% and 0.375%, depending on ourdebt to capitalization ratio.  This feeis paid on unused amounts of the commitment. At June 30, 2005, the interest rate payable on borrowings under thisfacility was approximately 4.5% per year. Under the credit facility, we are subject to a number of covenants,including: maintaining a total debt to capitalization ratio of not more than55% and maintaining a ratio of EBITDA, as defined in the credit facility, tointerest over the last four quarters in excess of 3.0 to 1.0.  The credit facility ranks equally withborrowings under our master shelf agreement with The Prudential InsuranceCompany.  This facility has been ratedBa1 by Moody’s and BB+ by S&P.

 

***Master Shelf Agreement.****** ***Amountsoutstanding under our master shelf agreement at July 31, 2005 are as indicatedin the following table (dollars in thousands):

 
| **Issue Date**   | ** ** | **Amount** | ** ** | **Interest  Rate** | ** ** | **Final  Maturity** | ** **    | **Principal  Repayment Schedule** | ** **                        |
|------------------|------------|------------|------------|--------------------|------------|---------------------|---------------|-----------------------------------|-----------------------------------|
| July 28, 1995    |       | $          | 20,000     |               | 7.61       | %                   | July 28, 2007 |                              | $10,000 on July 28, 2006 and 2007 |   |
| June 30, 2004    |       | 100,000    |       | 5.92               | %          | June 30, 2011       |          | Single payment at maturity        |                              |
| January 18, 2005 |       | 25,000     |       | 5.57               | %          | January 18, 2015    |          | Single payment at maturity        |                              |
| Total            |       | $          | 145,000    |               |       |                |          |                              |                              |   |

 

Our borrowings under ourmaster shelf agreement are secured by a pledge of the capital stock of oursignificant subsidiaries.  Thesesubsidiaries also guarantee the borrowings under this facility.  All of the borrowings under our master shelfagreement can be prepaid prior to their final maturity by paying ayield-maintenance fee.  Under our mastershelf agreement, we are subject to a number of covenants, including:maintaining a total debt to capitalization ratio of not more than 55% andmaintaining a quarterly test of EBITDA, as defined in our master shelfagreement, to interest for the last four quarters in excess of 3.0 to 1.0.

 

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In July 2005, we fundeda scheduled payment of $10.0 million on these notes with a borrowing under ourrevolving credit facility.

 

***Upstream Operations***

 

A vital aspect of ourlong-term business plan is to double proven natural gas reserves and equityproduction of natural gas from the level at December 31, 2001 over a five-yearperiod.  In order to achieve this goal,we will focus on continued development of our leasehold positions in the PowderRiver Basin CBM development, the Greater Green River Basin, the San Juan Basin,and the Sand Wash Basin. Each of our existing upstream projects is fullyintegrated with our midstream operations. In other words, in each of these areas, we provide the gathering,compression, processing, marketing or transportation services for both our ownproduction and for third-party operators. Additionally, we are actively pursuing new exploration, development andproducing property acquisition opportunities.

 

#### **Our principal upstream operations are summarized inthe following table: **

 
| ** **             | ** ** | **As of June 30, 2005**      | ** ** | ** **                 | ** ** |
|------------------------|------------|------------------------------|------------|----------------------------|------------|
| **Production Area**    | ** ** | **Gross Acres  Under Lease** | ** ** | **Net Acres  Under Lease** | ** ** | **Gross  Productive  Gas Wells** | ** ** | **Net  Productive  Gas Wells** | ** ** | **Net Production  S****old  (Mmcfe per day)******* | ** ** |
| Powder River Basin     |       | 1,041,000                    |       | 531,000                    |       | 4,603 |   | 2,179 |   | 113 |   |
| Jonah/Pinedale Field   |       | 178,000                      |       | 45,000                     |       | 254 |   | 29 |   | 36 |   |
| San Juan Basin         |       | 27,000                       |       | 26,000                     |       | 147 |   | 127 |   | 10 |   |
| Sand Wash Basin        |       | 141,000                      |       | 134,000                    |       | 19 |   | 19 |   | 5 |   |
| Denver-Julesburg Basin |       | 393,000                      |       | 339,000                    |       | 9 |   | 9 |   | — |   |
| Other                  |       | 592,000                      |       | 516,000                    |       | 13 |   | 3 |   | 1 |   |
| Total                  |       | 2,372,000                    |       | 1,591,000                  |       | 5,045 |   | 2,366 |   | 165 |   |

 

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*Average for the six months ended June 30, 2005.

 

***Drilling Results.***** **Thefollowing table sets forth the number of wells we drilled during the six monthsended June 30, 2005 and 2004 in each of our major producing areas.  This information should not be consideredindicative of future performance, nor should it be assumed that there isnecessarily any correlation between the number ofproductive wells drilled, quantities of reserves found or economic value.

 

| ** **             | ** ** | ** **               | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------|------------|--------------------------|------------|-------------------------------|------------|
| ** **             | ** ** | ** **               | ** ** | **2005**                      | ** ** | **2004** | ** ** |
| **Productive Area**    | ** ** | **Type of Well Drilled** | ** ** | **Gross**                     | ** ** | **Net** | ** ** | **Gross** | ** ** | **Net** | ** ** |
| Powder River Basin CBM |       | Productive               |       | 365                           |       | 181 |   | 309 |   | 159 |   |
|                   |       |                     |       |                          |       |   |   |   |   |   |   |
| Jonah/Pinedale Field   |       | Productive               |       | 44                            |       | 4 |   | 22 |   | 2 |   |
|                   |       | Dry  exploratory         |       | 1                             |       | 0 |   | 0 |   | 0 |   |
|                   |       |                     |       |                          |       |   |   |   |   |   |   |
| San Juan Basin         |       | Productive               |       | 27                            |       | 25 |   | 0 |   | 0 |   |
|                   |       |                     |       |                          |       |   |   |   |   |   |   |
| Sand Wash Basin        |       | Productive               |       | 0                             |       | 0 |   | 4 |   | 4 |   |
|                   |       | Dry  exploratory         |       | 1                             |       | 1 |   | 1 |   | 1 |   |
|                   |       |                     |       |                          |       |   |   |   |   |   |   |
| Other                  |       | Exploratory  productive  |       | 10                            |       | 4 |   | 0 |   | 0 |   |

 

***Powder River Basin Coal Bed Methane.****** ***We continue to develop our Powder River Basin CBMreserves and expand the associated gathering system in northeast Wyoming.  Our net production sold from the Powder RiverBasin CBM averaged 113 MMcf per day in the first six months of 2005.

 

Our production from the Big George coal continues to increase and was108 MMcf per day gross at June 30, 2005, or 45 MMcf per day net, from the AllNight Creek Unit, Pleasantville, SG Palo, Bullwhacker,Schoonover and Kingsbury Unit areas.  Inthe Big George coal, as of July 2005, we had 878 gross wells dewatering andproducing gas, 473 gross wells dewatering and 653 gross wells drilled and in various stages of completion and hook-up inpreparation for dewatering and production.

 

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Drilling in the Powder River Basin is dependent on the receipt ofvarious regulatory permits, including BLM drilling permits, DEQ water dischargepermits, and the Wyoming State Engineer’s Office reservoir permits.  Most of our undeveloped prospects from theBig George formation are located in the Powder River drainage area.  Water management techniques utilized by us,and approved by the DEQ on a site-specific basis, have included containment ortreating.  In order to facilitate theprocessing of our water discharge permit applications, on the west side of thebasin, and in advance of the final requirements of the DEQ, we have installedand tested various types of water treatment facilities and are treating thewater produced in some areas of the basin and, with the approval of the DEQ,discharging this water into the Powder River. We believe many of the future developments in the Big George coal willlikely require water treatment facilities. These treating operations have added and will add to the cost ofdevelopment and operations in these areas. We continue to evaluate several options for water treatment and areworking with the governmental agencies to identify effective and cost efficientmethods.

 

Our 2005 capital budget for the Powder River Basin coal bed project isestimated at $81.2 million for the drilling of 850 gross wells, of which $56.0 millionwas spent in the first six months of 2005. In 2005, in the Big George and related coals, we plan to participate inthe drilling of 730 gross wells, or 365 net wells, and in the Wyodak andrelated coals, we plan to participate in an additional 120 gross wells, or 60net wells.  An estimated 640 wells of the850 well program will be on federal leaseholds andrequire drilling permits from the BLM. The remaining 210 well locations are on fee or state leaseholds.  Together with our co-developer, as of July31, 2005, we have drilling permits approved for 557, or 87% of the federalwells planned for 2005.  Federal drillingpermit applications for another 389 locations have been submitted to theBLM.  Timely receipt of these permitswould allow us to complete our planned 2005 drilling program, and a portion ofour 2006 drilling program, on federal leaseholds.

 

Approximately 300 gross wells in our 2005-drilling program will requirepermits to treat produced water.  Theremainder of the wells to be drilled in 2005 will require more conventionaltypes of water discharge permits, such as reservoir containment or surfacedischarge.  To date, we, together withour co-developer in this area, have received water discharge permits from theDEQ for approximately 71% of the wells we plan to drill in 2005.  An additional 293 permit applications havebeen submitted to the DEQ which, when combined with permits received, is morethan enough necessary to complete our 2005 drilling program.  Historically, the DEQ permit process hasrequired approximately 120 to 150 days from initial submittal to finalapproval.  There is, however, noassurance as to the future timing of the receipt of drilling and waterdischarge permits, the success of our drilling program, or the dewatering timeas our development progresses into the western and northern parts of the PowderRiver Basin.

 

On April 30, 2003, the BLM issued the final Record of Decision, or ROD,for the Powder River Basin Oil & Gas Environmental Impact Statement, orEIS.  The ROD requires additional surveysfor plant and animal species, cultural surveys and noxious weed mitigationprior to the BLM granting a drilling permit. A number of cases have been filed by environmental groups against theBLM in Wyoming disputing the validity of the EIS and ROD.  Due to our interests in developing federalleases in the Powder River Basin, we are an intervenor defendant in each of theforegoing cases.  In one of these casesfiled in the United States District Court of Montana, the court was asked to address the adequacy of the Montana PowderRiver Basin ROD and whether the BLM should have issued a single EIS for thePowder River Basin.  Under an Order datedMarch 4, 2005, the court found that a single EIS for the Powder River Basin isnot required under the National Environmental Policy Act, or NEPA. This Order has been subsequentlyappealed.  As these cases proceed,the BLM, in the event of any adverse rulings, may be required to performfurther environmental analysis and, in addition, could be ordered to ceaseissuing drilling permits until it has completed such further analysis.  Consequently, our ability to receive permitsand develop our leases may be delayed or restricted by the outcome of thesecases.

 

On August 10, 2004, the Tenth Circuit Court of Appeals issued itsdecision in Pennaco Energy, Inc. v. United States Department of the Interior.  The court upheld a decision by the InteriorBoard of Land Appeals, or IBLA, that the BLM had not complied with the NEPA inissuing three federal leases to Pennaco Energy, Inc. in the Powder River Basinfor coalbed methane development.  We arenot a party to the case, and the IBLA and Tenth Circuit decisions do not directlyaddress any federal leases held by us. In order to resolve the issues raised in the Pennaco decision andrelated issues, the BLM filed for and received public comment on two proposedenvironmental assessments.  Aftercompletion of the environmental assessments, we were advised that the BLMbelieves the issues raised in the Pennaco decision will be resolved.  We cannot predict what other actions theDepartment of Interior or third parties might take in response to this matter,or how the decision and actions taken by the BLM in response to the decisionmay affect the pace of federal leasing or permitting and development in thePowder River Basin.

 

A complaint was filed on January 31, 2005 in the U.S. District Court ofWyoming against the BLM and the Department of Interior.  The complaint alleges that the BLM violatedNEPA “as described in Pennaco Energy, Inc. v. United States

 

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Department ofthe Interior” because the BLM did not consider theeffects of CBM development prior to issuing five leases, including one issuedto us.  On July 12, 2005, the plaintiffsamended their complaint by deleting four of the five leases included in theirJanuary 31, 2005 complaint, including the lease in which we hold an interest.  Additionally, the plaintiffs added 45 otherleases to their Amended Complaint, including nine leases in which we hold aninterest.  These nine leases coverapproximately 5,300 gross and 2,650 net acres. The plaintiffs have asked the court for a  “review of the issuance” of theseleases.  We cannot predict what actions,if any, the Department of the Interior, third parties,or the court might take in response to this case, or how these actions mayaffect the pace of federal drilling or permitting and development of the PowderRiver Basin.

 

***Jonah/Pinedale Fields.***  Our exploration and production assets in theGreen River Basin of southwest Wyoming are located in the Pinedale Anticlineand Jonah Field areas.  During 2005, weexpect to participate in the drilling of 80 gross wells, or approximately ninenet wells, on the Pinedale Anticline. Our capital budget for 2005 in the Pinedale Anticline area provides forexpenditures of approximately $47.9 million for drilling costs and productionequipment, of which $23.9 million was spent in the first six months of2005.  Due to drilling and regulatoryuncertainties, which are beyond our control, there can be no assurance that wewill incur this level of capital expenditure during 2005.

 

#### ***Midstream Operations***

#### ** **

Ourmidstream operations consist of our gathering, processing, treating, marketing and transportation operations.  An important element of our long-termbusiness plan is to meet or exceed throughput projections in these areas and tooptimize their profitability.  To achievethis goal, we must continue our efforts to add to natural gas throughput levelsthrough new well connections and through the expansion or acquisition ofgathering or processing systems in those basins in which we currently operateor in new basins.  We also seek toincrease the efficiency of our operations by modernization of equipment and theconsolidation of existing facilities.

 

***GasGathering, Processing and Treating.*** We operatea variety of gathering, processing and treating facilities, or plantoperations, as presented on the Principal Gathering and Processing FacilitiesTable set forth below.  Our operationsare located in some of the most actively drilled oil and gas producing basins in theUnited States.  Six of ourprocessing plants can further separate, or fractionate, the mixed NGL streaminto ethane, propane, normal butane and natural gasoline to obtain a highervalue for the NGLs, and three of our plants are capable of processing andtreating natural gas containing hydrogen sulfide or other impurities thatrequire removal prior to delivery to market pipelines.  Inaddition to our integrated upstream and midstream operations in the PowderRiver and Green River Basins in Wyoming, and in the San Juan Basin in NewMexico, ourcore assets include our plant operations located in west Texas andOklahoma.  We believe that our coreassets have stable production rates, provide a significant operating cash flowand continue to provide us with strategic growth opportunities.

 

In February 2005, we completed the purchase of certain natural gasgathering and processing assets in the eastern Greater Green River Basin forapproximately $28.0 million, before closing adjustments.  We currently plan to integrate portions ofthe acquired systems into our Red Desert plant and our Table Rock, Wamsutterand Desert Springs gathering systems during theremainder of 2005.

 

In April 2005, we entered into an agreement to acquire a 200 MMcf perday cryogenic processing facility for $9.0 million.  We intend to spend an additional $28.5million to install this facility and expand our Chaney Dell/Westana processingand gathering complex.  We currentlyexpect that this facility will be operational in the second quarter of 2006.

 

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***Principal Gathering and Processing Facilities Table.***  The following table provides informationconcerning our principal gathering, processing and treating facilities at June30, 2005.

 
| ** **                    | ** ** | **Year**                | ** ** | **Gas**                      | ** ** | **Gas**                               | ** ** | **Average for the Six Months Ended  June 30, 2005** | ** ** |
|-------------------------------|------------|-------------------------|------------|------------------------------|------------|---------------------------------------|------------|-----------------------------------------------------|------------|
| **Facilities (1)**            | ** ** | **Placed  in  Service** | ** ** | **Gathering  System  Miles** | ** ** | **Throughput  Capacity  (MMcf/D)(2)** | ** ** | **Gas  Throughput  (MMcf/D) (3)**                   | ** ** | **Gas  Production  (MMcf/D)(4)** | ** ** | **NGL  Production  (MGal/D) (4)** | ** ** |
| Texas                         |       |                    |       |                         |       |                                  |       |                                                |       |   |   |   |   |
| Gomez Treating (5)            |       | 1971                    |       | 389                          |       | 280                                   |       | 87                                                  |       | 79 |   | — |   |
| Midkiff/Benedum               |       | 1949                    |       | 2,344                        |       | 165                                   |       | 145                                                 |       | 93 |   | 858 |   |
| Mitchell Puckett Treating (5) |       | 1972                    |       | 126                          |       | 120                                   |       | 36                                                  |       | 22 |   | 1 |   |
| Wyoming                       |       |                    |       |                         |       |                                  |       |                                                |       |   |   |   |   |
| Coal Bed Methane Gathering    |       | 1990                    |       | 1,369                        |       | 548                                   |       | 391                                                 |       | 354 |   | — |   |
| Desert Springs Gathering      |       | 1979                    |       | 65                           |       | 10                                    |       | 6                                                   |       | 5 |   | 21 |   |
| Fort Union Gas Gathering(12)  |       | 1999                    |       | 167                          |       | 635                                   |       | 484                                                 |       | 484 |   | — |   |
| Granger Complex (6)(7)(8)     |       | 1987                    |       | 714                          |       | 325                                   |       | 287                                                 |       | 248 |   | 389 |   |
| Granger Straddle Plant        |       | 2004                    |       | —                       |       | 200                                   |       | 138                                                 |       | — |   | 10 |   |
| Hilight Complex (6)           |       | 1969                    |       | 658                          |       | 124                                   |       | 17                                                  |       | 12 |   | 61 |   |
| Kitty/Amos Draw (6)           |       | 1969                    |       | 321                          |       | 17                                    |       | 5                                                   |       | 3 |   | 24 |   |
| Newcastle (6)                 |       | 1981                    |       | 146                          |       | 5                                     |       | 3                                                   |       | 2 |   | 21 |   |
| Patrick Draw(6) (9)           |       | 1997                    |       | 284                          |       | 150                                   |       | 28                                                  |       | 24 |   | 61 |   |
| Red Desert (6)                |       | 1979                    |       | 127                          |       | 42                                    |       | 18                                                  |       | 31 |   | 57 |   |
| Rendezvous (10)               |       | 2001                    |       | 238                          |       | 325                                   |       | 331                                                 |       | 331 |   | — |   |
| Reno Junction (7)             |       | 1991                    |       | —                       |       | —                                |       | —                                              |       | — |   | 116 |   |
| Table Rock Gathering          |       | 1979                    |       | 100                          |       | 20                                    |       | 12                                                  |       | 12 |   | — |   |
| Wamsutter Gathering (11)      |       | 1979                    |       | 243                          |       | 50                                    |       | 48                                                  |       | 43 |   | 26 |   |
| Wind River Gathering          |       | 1979                    |       | 137                          |       | 80                                    |       | 48                                                  |       | 47 |   | — |   |
| Oklahoma                      |       |                    |       |                         |       |                                  |       |                                                |       |   |   |   |   |
| Chaney Dell/Westana           |       | 1966                    |       | 3,359                        |       | 175                                   |       | 197                                                 |       | 175 |   | 308 |   |
| New Mexico                    |       |                    |       |                         |       |                                  |       |                                                |       |   |   |   |   |
| San Juan River (5)            |       | 1955                    |       | 277                          |       | 60                                    |       | 26                                                  |       | 21 |   | 37 |   |
| Utah                          |       |                    |       |                         |       |                                  |       |                                                |       |   |   |   |   |
| Four Corners Gathering        |       | 1988                    |       | 104                          |       | 15                                    |       | 3                                                   |       | 2 |   | 15 |   |
| Yellow Creek (9) (13)         |       | 1985                    |       | —                       |       | —                                |       | —                                              |       | — |   | 73 |   |
| Total                         |       |                    |       | 11,168                       |       | 3,346                                 |       | 2,310                                               |       | 1,988 |   | 2,078 |   |

 

----

| (1)  | Our interest in all facilities is 100% except for Midkiff/Benedum  (73%); Newcastle (50%); Fort Union (13%) and Rendezvous (50%). We operate all  facilities, and all data include our interests and the interests of other  joint interest owners and producers of gas volumes dedicated to the facility.  Unless otherwise indicated, all facilities shown in the table are gathering,  processing or treating facilities. |
|------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  | Gas throughput capacity is as of June 30, 2005 and represents  capacity in accordance with design specifications unless other constraints  exist, including permitting or field compression limits.                                                                                                                                                                                                                          |
| (3)  | Aggregate natural gas volumes delivered into our gathering systems.                                                                                                                                                                                                                                                                                                                                                          |
| (4)  | Volumes of gas and NGLs are allocated to a facility when a well is  connected to that facility; volumes exclude NGLs fractionated for  third-parties.                                                                                                                                                                                                                                                                        |
| (5)  | Sour gas facility (capable of processing or treating gas containing  hydrogen sulfide and/or carbon dioxide).                                                                                                                                                                                                                                                                                                                |
| (6)  | Processing facility that includes fractionation (capable of  fractionating raw NGLs into end-use products).                                                                                                                                                                                                                                                                                                                  |
| (7)  | NGL production includes conversion of third-party feedstock to  iso-butane.                                                                                                                                                                                                                                                                                                                                                  |
| (8)  | The Granger Complex includes the Lincoln Road facility. The volume  information for this facility is reported with the volume information for  Granger.                                                                                                                                                                                                                                                                      |
| (9)  | This facility was acquired in a transaction, which was completed on  February 1, 2005.                                                                                                                                                                                                                                                                                                                                       |
| (10) | The majority of the gas gathered by the Rendezvous gas gathering  system is delivered to our Granger facility and is included with the volume  information reported for Granger.                                                                                                                                                                                                                                             |
| (11) | A portion of the gas gathered by the Wamsutter gas gathering system  is delivered to our Red Desert facility and is included with the volume  information reported for Red Desert.                                                                                                                                                                                                                                           |
| (12) | A portion of the gas gathered by Fort Union is also reported under  Coal Bed Methane Gathering.                                                                                                                                                                                                                                                                                                                              |
| (13) | NGL fractionation facility that receives product from third-parties  via liquids pipeline and truck.                                                                                                                                                                                                                                                                                                                         |

 

28

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##### ***TransportationOperations***

 

##### ***We own and operate MIGC, Inc., an interstate pipeline located in thePowder River Basin, and MGTC, Inc., an intrastate pipeline located in northeastWyoming.  MIGC charges a Federal EnergyRegulatory Commission, or FERC, approved tariff and is connected to pipelinesowned by Colorado Interstate Gas Company, Williston Basin Interstate PipelineCompany, Kinder Morgan Interstate Pipeline Co., Wyoming Interstate Company,Ltd. and MGTC.  MIGC earns fees on amonthly basis from firm capacity contracts under which the shipper pays fortransport capacity whether or not the capacity is used and from interruptiblecontracts where a fee is charged based upon volumes received into the pipeline.  Contracts with third parties for capacity onMIGC range in duration from one month to approximately five years, and the feescharged averaged $0.35 per Mcf in the first six months of 2005.  MGTC, a public utility, providestransportation and gas sales to various cities in Wyoming at rates that aresubject to the approval of the Wyoming Public Service Commission.***

 

The following table provides information concerning our principaltransportation assets at June 30, 2005.

 
| ** **                        | ** ** | ** **                  | ** ** | ** **                | ** ** | **Average for the Six Months Ended  June 30, 2005** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|---------------------------|------------|-----------------------------------------------------|------------|
| **Transportation Facilities (1)** | ** ** | **Year Placed  In Service** | ** ** | **Transportation  Miles** | ** ** | **Pipeline Capacity  (MMcf/D) (2)**                 | ** ** | **Gas Throughput  (MMcf/D) (3)** | ** ** |
| MIGC                              |       | 1970                        |       | 263                       |       | 130                                                 |       | 138 |   |
| MGTC                              |       | 1963                        |       | 251                       |       | 18                                                  |       | 10 |   |
| Total                             |       |                        |       | 514                       |       | 148                                                 |       | 148 |   |

 

----

(1)                      Our interestin both facilities is 100%, and we operate both facilities.

(2)                      Pipelinecapacity represents certificated capacity at the Powder River junction only anddoes not include interruptible capacity or capacity at other delivery points.

(3)                      Aggregatevolumes transported by a pipeline.

 

***Marketing***

 

***Gas*.****  **We market gasproduced at our wells and at our plants and gas purchased from third-parties toend-users, local distribution companies, or LDCs, pipelines and other marketingcompanies throughout the United States and Canada.  In addition to our offices in Denver, we havemarketing offices in Houston, Texas and Calgary, Alberta.  Third-party sales, firm transportation capacityon interstate pipelines and our gas storage positions, combined with the stablesupply of gas from our facilities and production, enable us to respond quicklyto changing market conditions and to take advantage of seasonal pricevariations and peak demand periods.  Oneof the primary goals of our gas marketing operations continues to be thepreservation and enhancement of the value received for our equity volumes ofnatural gas.  This goal is achievedthrough the use of hedges on the production of our equity natural gas andthrough the use of firm transportation capacity.

 

***NGLs*.***** ***We market NGLs, or ethane,propane, iso-butane, normal butane, natural gasoline and condensate, producedat our plants and purchased from third-parties, in the Rocky Mountain,Mid-Continent and Southwestern regions of the United States.  A majority of our production of NGLs moves tothe Gulf Coast area, which is the largest NGL market in the United States.  Through the development of end-use marketsand distribution capabilities, we seek to ensure that products from our plantsmove on a reliable basis, avoiding curtailment of production. Consumers of NGLsare primarily the petrochemical industry, the petroleum refining industry andthe retail and industrial fuel markets. As an example, the petrochemical industry uses ethane, propane, normalbutane and natural gasoline as feedstocks in the production of ethylene, whichis used in the production of various plastics products.  Further, consumers use propane for homeheating, transportation and agricultural applications.  Price, seasonality and the economy primarilyaffect the demand for NGLs.

 

29

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**ITEM 3.****     QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Our commodity price risk management program has two primaryobjectives.  The first goal is to preserveand enhance the value of our equity volumes of gas and NGLs with regard to theimpact of commodity price movements on cash flow and net income in relation tothose anticipated by our operating budget. The second goal is to manage price risk related to our marketingactivities to protect profit margins. This risk relates to fixed price purchase and sale commitments, thevalue of storage inventories and exposure to physical market price volatility.

 

We utilize a combination of fixed price forward contracts,exchange-traded futures and options, as well as fixed index swaps, basis swapsand options traded in the over-the-counter, or OTC, market to accomplish thesegoals.  These instruments allow us topreserve value and protect margins because corresponding losses or gains in thevalue of the financial instruments offset gains or losses in the physicalmarket.

 

We also use financial instruments to reduce basis risk.  Basis is the difference in price between thephysical commodity being hedged and the price of the futures contract used forhedging.  Basis risk is the risk that anadverse change in the futures market will not be completely offset by an equaland opposite change in the cash price of the commodity being hedged.  Basis risk exists in natural gas primarilydue to the geographic price differentials between cash market locations andfutures contract delivery locations.

 

We enter into futures transactions on the New York Mercantile Exchange,or NYMEX, and through OTC swaps and options with various counterparties,consisting primarily of investment banks, financial institutions and othernatural gas companies.  We conduct creditreviews of all of our OTC counterparties and have agreements with many of theseparties that contain collateral requirements. We generally use standardized swap agreements that allow for offset ofpositive and negative OTC exposures with the same counterparty.  OTC exposure is marked-to-market daily forthe credit review process.  Our exposureto OTC credit risk is reduced by our ability to require a margin deposit fromour counterparties based upon the mark-to-market value of their netexposure.  We are also subject to margindeposit requirements under these same agreements and under margin depositrequirements for our NYMEX transactions. At June 30, 2005, we had $15.1 million of margin deposits outstanding.

 

We continually monitor and review the credit exposure to our marketingcounterparties.  In recent months theprices of natural gas and NGLs, and therefore our credit exposures, haveincreased significantly.  In order tominimize our credit exposures, we have utilized existing netting agreements toreduce our net credit exposure, established new netting agreements withadditional customers, terminated several long-term marketing obligations,negotiated accelerated payment terms with several customers, and increased theamount of credit which we make available to substantial companies which meetour credit requirements.  Although nettingagreements similar to those that we utilize have been upheld by bankruptcycourts in the past, if any of the customers with whom we have nettingagreements were to file for bankruptcy, we can provide no assurance that ouragreements will not be challenged or as to the outcome of any challenge.

 

The use of financial instruments may expose us to the risk of financialloss in some circumstances, including instances when (i) our equity volumes areless than expected, (ii) our customers fail to purchase or deliver thecontracted quantities of natural gas or NGLs, or (iii) our OTC counterpartiesfail to perform.  To the extent that weengage in hedging activities, we may be prevented from realizing the benefitsof favorable price changes in the physical market.  However, we are similarly insulated againstdecreases in these prices.

 

***Risk Policy andControl.**** *We control the extent of riskmanagement and marketing activities through policies and procedures thatinvolve the senior level of management. On a daily basis, our marketing activities are audited and monitored byour independent risk oversight department, or IRO.  This department reports to the ChiefFinancial Officer, thereby providing a separation of duties from the marketingdepartment.  Additionally, the IROreports monthly to the Risk Management Committee, or RMC.  This committee is comprised of corporatemanagers and officers and is responsible for developing the policies andguidelines that control the management and measurement of risk, subject to theapproval of the board of directors. The RMC is also responsible for settingrisk limits including value-at-risk and dollar stop loss limits, subject to theapproval of our board of directors.

 

***Hedge Positions.***** ** The hedge contracts are designated andaccounted for as cash flow hedges.  Assuch, gains and losses related to the effective portions of the changes in thefair value of the derivatives are recorded in Accumulated other comprehensiveincome, a component of Stockholders’ equity. Realized gains or losses on these cash flow hedges are recognized in theConsolidated Statement of Operations through Sale of gas or Sale of natural gasliquids when the hedged transactions occur.

 

30

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To qualify as cash flow hedges, the hedge instruments must be designatedas cash flow hedges and changes in their fair value must be highly correlatedwith changes in the price of the forecasted transaction being hedged so thatour exposure to the risk of commodity price changes is reduced.  To meet this requirement, we hedge the priceof the commodity and, if applicable, the basis between that derivative’scontract delivery location and the cash market location used for the actualsale of the product.  This structureattains a high level of effectiveness, ensuring that a change in the price ofthe forecasted transaction will result in an equal and opposite change in thecash price of the hedged commodity.  Weutilize crude oil as a surrogate hedge for natural gasoline and condensate.  Our hedges are tested for effectiveness atinception and on a quarterly basis thereafter. We use regression analysis based on a five-year period of time for thistest.  Gains or losses from theineffective portions of changes in the fair value of cash flow hedges arerecognized currently in earnings through Price risk management activities.  During the first six months of 2005, werecognized a loss of $125,000 from the ineffective portions of our hedges.

 

***Outstanding Equity Hedge Positions and the Associated Basis for 2005and 2006.*** The following table details our hedge positions as of June 30,2005.  In order to determine the hedgedprice to the particular operating region, deduct the basis differential fromthe settle price.  The prices for NGLs donot include the cost of the hedges of approximately $312,000 as of June 30,2005.  There is no associated cost forthe natural gas hedges.

 
| **Product**                         | ** ** | **Year** | ** ** | **Quantity and Settle Price**                                                                                                    | ** ** | **Hedge of Basis Differential**                                                                                                                                                                                                                                             |
|-------------------------------------|------------|----------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Natural gas                         |       | 2005     |       | 80,000 MMBtu per day  with an average minimum price of $4.75 per MMBtu and an average maximum price  of $8.88 per MMBtu.         |       | Mid-Continent – 60,000  MMBtu per day with an average basis price of $0.42 per MMBtu.  Permian – 5,000 MMBtu per day with an average basis price of $0.48 per MMBtu.  Rocky Mountain – 15,000 MMBtu per day with an average basis price of $0.72  per MMBtu. |
|                                |       |     |       |                                                                                                                             |       |                                                                                                                                                                                                                                                                        |
|                                |       | 2006     |       | 40,000 MMBtu per day  with an average minimum price of $6.00 per MMBtu and an average maximum price  of $10.13 per MMBtu.        |       | Mid-Continent – 40,000  MMBtu per day with an average basis price of $0.55 per MMBtu.                                                                                                                                                                                  |
|                                |       |     |       |                                                                                                                             |       |                                                                                                                                                                                                                                                                        |
| Crude, Condensate, Natural Gasoline |       | 2005     |       | 50,000 Barrels per  month with an average minimum price of $31.00 per barrel and an average  maximum price of $48.01 per barrel. |       | Not Applicable                                                                                                                                                                                                                                                              |
|                                |       |     |       |                                                                                                                             |       |                                                                                                                                                                                                                                                                        |
|                                |       | 2006     |       | 25,000 Barrels per  month with an average minimum price of $40.00 per barrel and an average  maximum price of $70.00 per barrel. |       | Not Applicable                                                                                                                                                                                                                                                              |
|                                |       |     |       |                                                                                                                             |       |                                                                                                                                                                                                                                                                        |
| Propane                             |       | 2005     |       | 75,000 Barrels per  month with an average minimum price of $0.52 per gallon and an average  maximum price of $0.88 per gallon.   |       | Not Applicable                                                                                                                                                                                                                                                              |
|                                |       |     |       |                                                                                                                             |       |                                                                                                                                                                                                                                                                        |
| Ethane                              |       | 2005     |       | 75,000 Barrels per  month. Floor at $0.38 per gallon.                                                                            |       | Not Applicable                                                                                                                                                                                                                                                              |

 

31

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Account balances related to hedging transactions (designated as cashflow hedges under SFAS 133) at June 30, 2005 were $2.9 million in Currentassets from price risk management activities, $8.4 million in Currentliabilities from price risk management activities, $1.0 million in Liabilitiesfrom price risk management activities, ($2.3) million in Deferred income taxespayable, net, and a $4.0 million after-tax unrealized loss in Accumulated othercomprehensive income, a component of Stockholders’ equity.  Approximately $2.5 million of the unrealizedloss in Accumulated other comprehensive income will be reclassified to earningsin the remainder of 2005.

 

***Summary of Derivative Positions.***  A summary of the change in our derivativeposition from December 31, 2004 to June 30, 2005 is as follows (dollars inthousands):

 
| Fair value of contracts outstanding at  December 31, 2004              |   | $      | 11,341 |   |
|------------------------------------------------------------------------|--------|--------|--------|--------|
| Decrease in value due to change in price                               |   | (7,745 | )      |
| Increase in value due to new contracts  entered into during the period |   | 1,592  |   |
| (Gains) realized during the period from  existing and new contracts    |   | (6,429 | )      |
| Changes in fair value attributable to  changes in valuation techniques |   | — |   |
| Fair value of contracts outstanding at June  30, 2005                  |   | $      | (1,241 | )      |

 

A summary of our outstanding derivative positions at June 30, 2005 isas follows (dollars in thousands):

 
| ** **                       | ** ** | **Fair Value of Contracts at June 30, 2005** | ** ** |
|----------------------------------|------------|----------------------------------------------|------------|
| **Source of Fair Value**         | ** ** | **Total  Fair Value**                        | ** ** | **Maturing  In 2005** | ** ** | **Maturing In  2006-2007** | ** ** | **Maturing In  2008-2009** | ** ** | **Maturing  Thereafter** | ** ** |
| Exchange published prices        |       | $                                            | (4,867     | ) | $ | (810 | ) | $ | (4,057 | ) | — |   | — |   |
| Other actively quoted prices (1) |       | 12,697                                       |       | 4,343 |   | 8,329 |   | $ | 24 |   | — |   |
| Other valuation methods (2)      |       | (9,071                                       | )          | (6,411 | ) | (2,659 | ) | — |   | — |   |
| Total fair value                 |       | $                                            | (1,241     | ) | $ | (2,878 | ) | $ | 1,613 |   | $ | 24 |   | — |   |

 

----

(1)          Other actively quoted prices are derived frombroker quotations, trade publications, and industry indices.

(2)          Other valuation methods are the Black-Scholesoption-pricing model utilizing prices and volatility obtained from brokerquotations, trade publications, and industry indices.

 

***Foreign Currency DerivativeMarket Risk***.  As a normal part of our business, we enterinto physical gas transactions which are payable in Canadian dollars.  We enter into forward purchases and sales ofCanadian dollars from time to time to fix the cost of our future Canadiandollar denominated natural gas purchase, sale, storage, and transportationobligations.  This is done to protectmarketing margins from adverse changes in the United States and Canadian dollarexchange rate between the time the commitment for the payment obligation ismade and the actual payment date of such obligation.  As of June 30, 2005, we had sold forwardcontracts for  $33.0million in Canadian dollars in exchange for $27.0 million in United Statesdollars, and the fair market value of these contracts was a gain of  $36,000 in United States dollars.

 

**ITEM 4.**      **CONTROLS AND PROCEDURES**

 

***Disclosure Controls and Procedures.***

 

Under the direction of our Chief Executive Officerand President, or CEO, and our Executive Vice President and Chief FinancialOfficer, or CFO, we reviewed and evaluated the effectiveness of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended) as of the end of the periodcovered by this report.  Based on suchevaluation, our CEO and CFO concluded, as of the date of such evaluation, thatour disclosure controls and procedures are effective.

 

***Changes in InternalControl over Financial Reporting.***

 

Therehave not been any changes in our internal control over financial reporting duringthe quarter ended June 30, 2005, that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

32

----

 

**PARTII - OTHER INFORMATION**

 

**ITEM 1.****    LEGALPROCEEDINGS**

 

Reference is made to “Notes to Consolidated Financial Statements(Unaudited)  –Legal Proceedings,” in Item 1 of this Form 10-Q and incorporated by referencein this Item 1.

 

**ITEM 4.****    SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

The following matterswere voted on at our Annual Meeting of Stockholders held on May 6, 2005:

 

Brion G. Wise, Richard B. Robinson and Peter A. Dea were elected asclass one directors to serve until their terms expire in 2008 and until theirsuccessors have been elected.  Theresults of the election were as follows.

 
| ** **          | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|---------------------|------------|---------------|------------|--------------------|------------|
| Peter A. Dea        |       | 67,569,057    |       | 2,753,169          |       |
| Richard B. Robinson |       | 66,497,342    |       | 3,824,884          |       |
| Brion G. Wise       |       | 66,682,697    |       | 3,639,529          |       |

 

Our other directors whose terms did not expire on the date of theAnnual Meeting, James A. Senty, Walter L. Stonehocker, Joseph E. Reid, Bill M.Sanderson, Ward Sauvage, and, Dean Phillips continued in office.  Mr. Sauvage subsequently resigned as a memberof our board of directors on July 15, 2005 due to health reasons.

 

Our 2005 Stock Incentive Plan, which provides for the issuance ofoptions to purchase 2.5 million shares of common stock and 1.5 million sharesof restricted common stock, was approved as follows:

 
| ** **                | ** ** | **Votes For** | ** ** | **Votes Against** | ** ** | **Abstentions** | ** ** | **Broker Non-votes** | ** ** |
|---------------------------|------------|---------------|------------|-------------------|------------|-----------------|------------|----------------------|------------|
| 2005 Stock Incentive Plan |       | 54,960,656    |       | 6,358,752         |       | 116,102         |       | 8,886,716            |       |

 

33

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**ITEM 6.****    EXHIBITS**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                      |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  |       | **Description**                                                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                            |
| 3.1         |       | Certificate  of Incorporation of Western Gas Resources, Inc. (previously filed as Exhibit  3.1 to our Registration Statement on Form S-1, Registration No. 33-31604 and  incorporated herein by reference).                                     |
|        |       |                                                                                                                                                                                                                                            |
| 3.2         |       | Certificate  of Amendment to the Certificate of Incorporation of Western Gas Resources,  Inc. (previously filed as Exhibit 3.2 to our Registration Statement on Form  S-1, Registration No. 33-31604 and incorporated herein by reference).     |
|        |       |                                                                                                                                                                                                                                            |
| 3.3         |       | Certificate of  Designation, Preferences and Rights of Series A Junior Participating Preferred  Stock (previously filed as part of Exhibit 1 to our Form 8-A filed on March  30, 2001 and incorporated herein by reference).                    |
|        |       |                                                                                                                                                                                                                                            |
| 3.4         |       | Amended and Restated  Bylaws of Western Gas Resources, Inc. adopted by the Board of Directors on  May 7, 2004 (previously filed as Exhibit 99.1 to our Current Report on Form  8-K filed on May 11, 2004 and incorporated herein by reference). |
|        |       |                                                                                                                                                                                                                                            |
| 10.1        |       | Western Gas Resources, Inc. 2005 Stock Incentive Plan (previously  filed as Exhibit 4.7 to our Registration Statement on Form S-8 filed on May  31, 2005 and incorporated herein by reference).*                                                |
|        |       |                                                                                                                                                                                                                                            |
| 10.2        |       | Amendment to Employment Agreement of Peter A. Dea (previously filed  as Exhibit 10.1 to our Current Report on Form 8-K filed on May 23, 2005 and  incorporated herein by reference).*                                                           |
|        |       |                                                                                                                                                                                                                                            |
| 31.1        |       | Section 302  Certification of the Chief Executive Officer.                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                            |
| 31.2        |       | Section 302  Certification of the Chief Financial Officer.                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                            |
| 32.1        |       | Section 906  Certification of the Chief Executive Officer and Chief Financial Officer.                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                            |
|             |
|        |       | * Management contract or compensating plan or arrangement.                                                                                                                                                                                      |

 

34

----

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                 | WESTERN GAS RESOURCES, INC. |                                               |
|----------------------|-----------------------------|----------------------------------------------------|
|                 | (Registrant)                |
|                 |                        |                                               |
|                 |                        |                                               |
| Date: August 8, 2005 | By:                         | /s/ PETER A. DEA                                   |   |
|                 |                        | Peter A. Dea                                       |
|                 |                        | Chief Executive Officer and President              |
|                 |                        |                                               |
|                 |                        |                                               |
| Date: August 8, 2005 | By:                         | /s/ WILLIAM J. KRYSIAK                             |   |
|                 |                        | William J. Krysiak                                 |
|                 |                        | Executive Vice President - Chief Financial Officer |
|                 |                        | (Principal Financial and Accounting Officer)       |
|                      |                             |                                                    |  |  |

 

----

 

INDEX TO EXHIBITS

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                       |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                                                  |
|        |       |                                                                                                                                                                                                                                             |
| 3.1         |       | Certificate  of Incorporation of Western Gas Resources, Inc. (previously filed as Exhibit  3.1 to our Registration Statement on Form S-1, Registration No. 33-31604 and  incorporated herein by reference).                                      |
|        |       |                                                                                                                                                                                                                                             |
| 3.2         |       | Certificate  of Amendment to the Certificate of Incorporation of Western Gas Resources,  Inc. (previously filed as Exhibit 3.2 to our Registration Statement on Form  S-1, Registration No. 33-31604 and incorporated herein by reference).      |
|        |       |                                                                                                                                                                                                                                             |
| 3.3         |       | Certificate  of Designation, Preferences and Rights of Series A Junior Participating  Preferred Stock (previously filed as part of Exhibit 1 to our Form 8-A filed  on March 30, 2001 and incorporated herein by reference).                     |
|        |       |                                                                                                                                                                                                                                             |
| 3.4         |       | Amended  and Restated Bylaws of Western Gas Resources, Inc. adopted by the Board of  Directors on May 7, 2004 (previously filed as Exhibit 99.1 to our Current  Report on Form 8-K filed on May 11, 2004 and incorporated herein by  reference). |
|        |       |                                                                                                                                                                                                                                             |
| 10.1        |       | Western Gas Resources, Inc. 2005 Stock Incentive Plan (previously  filed as Exhibit 4.7 to our Registration Statement on Form S-8 filed on May  31, 2005 and incorporated herein by reference).*                                                 |
|        |       |                                                                                                                                                                                                                                             |
| 10.2        |       | Amendment to Employment Agreement of Peter A. Dea (previously filed  as Exhibit 10.1 to our Current Report on Form 8-K filed on May 23, 2005 and  incorporated herein by reference).*                                                            |
|        |       |                                                                                                                                                                                                                                             |
| 31.1        |       | Section 302  Certification of the Chief Executive Officer.                                                                                                                                                                                  |
|        |       |                                                                                                                                                                                                                                             |
| 31.2        |       | Section 302  Certification of the Chief Financial Officer.                                                                                                                                                                                  |
|        |       |                                                                                                                                                                                                                                             |
| 32.1        |       | Section 906  Certification of the Chief Executive Officer and Chief Financial Officer.                                                                                                                                                      |
|        |       |                                                                                                                                                                                                                                             |
|             |
|        |       | * Management contract or compensating plan or arrangement.                                                                                                                                                                                       |

 

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