<PAGE>

                UNITED STATES SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                   FORM 10-KSB

(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACT OF 1934
For the fiscal year ended December 31, 1997

[ ] 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 0-21523

                              Virginia Gas Company
                 (Name of small business issuer in its charter)


         Delaware                                 87-0443823
(State or other jurisdiction of                 (I.R.S. Employer
incorporation or organization)                 Identification No.)

         200 East Main Street, Abingdon, Virginia 24210, (540) 676-2380
         (Address and telephone number of principal executive offices)


    Securities registered pursuant to Section 12(b) of the Exchange Act: None
      Securities registered pursuant to Section 12(g) of the Exchange Act:
                     Common Stock, Par Value $.001 Per Share
                        Warrants to purchase Common Stock

Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. [ X ] Yes [ ] No

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.
[    ]

Revenues for the fiscal year ended December 31, 1997 were $9,343,627.

The aggregate market value of the voting Common Stock, par value $.001 per
share, held by nonaffiliates of the Registrant as of March 24, 1998 was
approximately $32,622,285.

As of March 24, 1998, the Registrant had outstanding 5,504,906 shares of Common
Stock, par value $.001.


<PAGE>


                      VIRGINIA GAS COMPANY AND SUBSIDIARIES

                          Annual Report on Form 10-KSB
                      For the Year Ended December 31, 1997

                                Table of Contents

<TABLE>
<CAPTION>
    Item                                                                                         Page
    Number                                   Caption                                             Number
<S>                                                                                              <C>
                 Part I
       1         Business                                                                           3
       2         Properties                                                                         9
       3         Legal Proceedings                                                                  9
       4         Submission of Matters to a Vote of Security Holders                                9
                 Part II
       5         Market for Common Equity and Related Stockholder Matters                           9
       6         Management's Discussion and Analysis                                              10
       7         Financial Statements                                                              16
       8         Changes in and Disagreements with Accountants on Accounting and Financial
                 Disclosure                                                                        34
                 Part III
       9         Directors and Executive Officers of the Company                                   34
      10         Executive Compensation                                                            34
      11         Security Ownership of Certain Beneficial Owners and Management                    34
      12         Certain Relationships and Related Transactions                                    34
      13         Exhibits and Reports on Form 8-K                                                  35
                 Signatures                                                                        39
</TABLE>


                                       2

<PAGE>


Item 1.  BUSINESS

General

         Virginia Gas Company (the "Company") was organized in 1987 under the
laws of the state of Delaware. The Company, directly or through affiliated
companies, is primarily engaged in the storage, marketing, distribution,
gathering, exploration, and production of natural gas, and the distribution of
propane gas. The Company's principal assets are located in the southwestern
counties of the Commonwealth of Virginia.

         The Company's business has developed in response to the growing need
for natural gas storage, pipelines and distribution in its market area,
resulting principally from economic growth and the impact of deregulation.
Deregulation has given natural gas customers more flexibility in negotiating
their natural gas purchases and transportation contracts. The Company's pipeline
connections to the East Tennessee Natural Gas ("ETNG"), CNG Transmission Company
("CNG") and Columbia Gas Transmission Company ("TCO") interstate pipeline
systems, and to the Company's adjacent storage facilities, are being combined to
create a hub which provides opportunities for more efficient gas distribution,
including to local, growing markets. At present, the Company's business
primarily consists of: (i) producing, gathering and marketing natural gas from
wells in which the Company has an ownership interest to municipal distributors,
local distribution companies and major oil and gas companies; (ii) storing
natural gas for municipal distributors and local distribution companies which
have supplied their own gas, or purchased it from third parties or the Company;
and (iii) distributing propane and natural gas purchased from third parties or
the Company to local industrial, commercial and residential customers.

         The Company's principal sources of revenue have varied depending on its
level of activity in any given segment of natural gas operations. From 1987 to
1992, substantially all of the Company's income was derived from exploration,
development and production of natural gas and from fees derived from managing
wells. From 1993 to 1996, the Company's income reflected the growth of its
storage operations. In 1996 and 1997, the Company initiated its propane
distribution and gas marketing operations, respectively. Currently, the Company
is developing transmission pipeline projects and expanding its storage capacity
and expects to derive future income primarily from natural gas storage and
transportation fees.

         Management believes that current upward trends in the economy, a
favorable regulatory environment, the deregulation of the industry which has
resulted in end-users' ability to purchase gas on a competitive basis from a
greater variety of sources, and the increasing availability of natural gas as a
form of energy for residential, commercial and industrial markets will enable
the Company to expand into new markets and to better develop its current
markets.

Subsidiaries and Affiliates

         The Company has four consolidated wholly-owned subsidiaries: Virginia
Gas Exploration Company (the "Exploration Company"), Virginia Gas Pipeline
Company (the "Pipeline Company"), Virginia Gas Propane Company (the "Propane
Company") and Virginia Gas Marketing Company (the "Marketing Company").
Affiliates of the Company, Virginia Gas Distribution Company (the "Distribution
Company") and Virginia Gas Storage Company (the "Storage Company"), are each
owned 50% by the Company and 50% by one individual investor, who has no
affiliation with either the Company, or any executive officer, director or
controlling shareholder of the Company.

                                       3
<PAGE>



         The Pipeline Company, the Distribution Company and the Storage Company
are the holders of Certificates of Public Convenience and Necessity ("CPCN")
issued by the Virginia State Corporation Commission ("VSCC") that are required
for such companies to conduct their business. The Pipeline Company's and a
portion of the Storage Company's operations are regulated by both the VSCC and
the Federal Energy Regulatory Commission ("FERC"). In connection with the
financing of the Distribution Company's distribution business, and the Storage
Company and Pipeline Company's storage and related pipeline businesses, the
Company participated in four tax exempt bond issues in 1994, 1995 and 1997 that
provided financing for these various projects. Funds from such financings were
allocated, as needed, to the various subsidiaries and affiliates and each such
entity has provided the Company with interest-bearing promissory notes
evidencing its obligation to repay the funds advanced by the Company.


Storage Operations

         The Company has the only two underground natural gas storage facilities
in the Commonwealth of Virginia. One of these facilities is located in Smyth and
Washington counties (the "Saltville Facility"), while the other facility is
located in Scott and Washington counties (the "Early Grove Field"). The Pipeline
company owns the Saltville Facility while the Storage Company owns and operates
the Early Grove Field.

         The Pipeline Company developed the Saltville Facility for use as a high
rate, peak usage storage facility. The Saltville Facility uses caverns created
in underground salt beds to store natural gas. The Company's engineering staff
believes the ultimate working gas capacity of the Saltville Facility could be up
to 10 Bcf. In June 1996 the Pipeline Company filed an application with the VSCC
for a CPCN for the operation of the Saltville Facility. In July 1996 the VSCC
issued an order authorizing the Pipeline Company to begin service on an interim
basis using the rates set forth in the application. The CPCN was issued to the
Pipeline Company in December 1997. In November 1996, the Pipeline Company
received a limited jurisdiction certificate from the FERC authorizing the
Pipeline Company to engage in the sale, transportation (including storage), or
assignment of natural gas that is subject to FERC's jurisdiction under the
Natural Gas Act, and to charge rates for its interstate service equal to the
intrastate rates approved by the VSCC. The Saltville Facility provides 10-day,
60-day and 90-day service and 20-day refill capacity. In August 1996 the
Pipeline Company injected the first working gas into the field. Peak daily
withdrawal rates of 40,000 MMBtu were achieved in January 1997.

         The Early Grove Field is an underground natural gas storage facility
owned and operated by the Storage Company. The Storage Company has received a
CPCN from the VSCC, authorizing it to engage in the sale, transportation
(including storage), or assignment of natural gas and to charge rates approved
by the VSCC. The Early Grove Field includes 29 storage wells and a certificated
area of 2,900 acres. Contracted storage volume for 60-day, 90-day and 150-day
service has increased from 520,000 MMBtu for the 1994/1995 heating season to
1,835,000 MMBtu for the 1997/1998 heating season. The deliverability of the
Early Grove Field has been increased by reworking existing wells, drilling new
wells, injecting additional base gas, installing larger diameter pipe, new
compression equipment, and increasing the maximum operating pressure of the
field to 2,000 PSI from 1,400 PSI. Peak January deliverability has been
increased from 1,000 MMBtu to over 20,000 MMBtu per day from 1992 to 1997.
Further improvements, including drilling new wells, adding additional base gas
and increasing the maximum operating pressure to up to 2,400 PSI, are being
considered. Proposed improvements could increase the field's capacity to
2,200,000 MMBtu in the future.

                                       4
<PAGE>


         The Company is continually assessing the feasibility of developing
additional natural gas storage facilities in its area of operation and is
analyzing available geological and geophysical data and land records related
thereto.

Pipeline Operations

         The Company has begun construction and is currently acquiring remaining
rights-of-way and permits for the construction of a 71.5 mile intrastate
pipeline ("P-25") which will connect the Company's Saltville Facility and
transport natural gas to growing markets in Smyth, Wythe and Pulaski Counties in
southwestern Virginia. These areas currently are served only by ETNG's #3300
interstate pipeline, which currently has insufficient capacity to meet the
area's needs.

         The P-25 pipeline will be constructed and maintained consistent with
applicable federal, state and local laws and regulations and accepted industry
practice. The first phase of construction will consist of twinning the ETNG line
to the town of Marion. The remaining phases will extend the P-25 pipeline from
Marion to Radford, Virginia. The Company has entered into a 15-year contract
with United Cities Gas Company ("UCG"), the local distribution company which
serves Smyth, Wythe and Pulaski Counties, to provide pipeline capacity to supply
20,000 MMBtu per day, or 67% of planned pipeline capacity. Completion of the
P-25 pipeline is expected by late 1998. The Company filed an application for a
CPCN with the VSCC in January 1997 for authorization to develop, construct, own
and operate the P-25 pipeline. This CPCN was received by the Company in December
1997.

         Substantially all of the operations conducted through the P-25 pipeline
will constitute common carrier pipeline activities. Such common carrier
activities are those under which transportation in the pipeline is available at
tariffs published with the VSCC to any shipper of natural gas who requests such
services, provided that each product for which transportation is requested
satisfies the conditions and specifications for transportation.

         The Company has recently initiated environmental studies and
acquisitions of rights-of-way for permits for the construction of a 40-mile
intrastate pipeline ("P-24"). When completed, the P-24 pipeline would connect
the Company's Saltville Facility and the P-25 pipeline to the CNG interstate
pipeline system. The P-24 pipeline is expected to provide a strategic
interconnect between the ETNG and CNG interstate pipeline systems.

Natural Gas and Propane Distribution Operations

         The Company, through the Distribution Company, owns and operates 33
miles of distribution pipelines and provides natural gas service to over 200
customers in Russell and Buchanan Counties in Virginia. Construction of a
10-mile pipeline providing service to the town of Lebanon in Russell County was
completed in June 1997. The Distribution Company has a CPCN authorizing it to
provide natural gas service in these counties. In January 1997, the Distribution
Company filed an application with the VSCC to extend its service territory to
include all of Dickenson and Tazewell Counties in Virginia, with the exception
of the service territory in Tazewell County currently certificated to
Commonwealth Public Service Corporation. This application was subsequently
amended to include the town of Saltville, Virginia as part of the proposed
service territory. In December 1997, the VSCC issued CPCNs to the Distribution
Company authorizing it to provide natural gas service to the western portion of
Tazewell County, excluding the service territory allotted to Commonwealth Public
Service Corporation, all of Dickenson County, and the town of Saltville. The
Distribution Company's tariff rates are approved by the VSCC.

                                       5
<PAGE>


         The Distribution Company has a firm transportation service contract for
a ten-year term with East Tennessee Natural Gas for the winter months of
November through March, and an interruptible transportation contract with ETNG
for the remainder of the year.

         In 1996, the Company commenced distribution of propane gas in
southwestern Virginia. Because of shared costs and similarities such as easily
converted appliances, many natural gas utilities provide both products to their
customers. Customers often do not distinguish between the two forms of gas when
used in the home. The Company intends, in part, to develop its propane
distribution business through selective acquisitions. In that regard, the
Company acquired a portion of Blue Grass Oils, Inc.'s existing propane
distribution business in Buchanan, Dickenson and Russell Counties and in the
western part of Tazewell County, Virginia in April 1997. The Company is also
expanding its propane distribution operations through an aggressive growth
program. At the end of 1997, the Company was providing propane gas service to
over 1,900 customers in southwestern Virginia.

Exploration, Production, Gathering, and Marketing Operations

         Drilling Activity. The Company did not drill or complete any natural
gas wells during 1996 or 1997.

         Service Operations. The Company engages in the business of supervising
drilling operations and operating producing wells. As of December 31, 1997 the
Company operated 80 wells located in Virginia and West Virginia. As operator of
producing wells, the Company is responsible for the maintenance and verification
of all production records, distribution of production proceeds and information,
and compliance with various state and federal regulations. Generally, the
Company provides the routine day-to-day production operations for producing
wells and is paid for such services on a per well, monthly fee basis.

         Gas Gathering Operations. The Company and the Storage Company operate
various unregulated natural gas gathering systems located mainly in Dickenson
and Buchanan Counties in Virginia which connect the Company's operated wells to
interstate pipelines. The gathering systems consist of 102.6 miles of pipeline,
two 640 horsepower compressor stations and one 120 horsepower compressor
station. The gathering systems connect the Company's natural gas production to
the ETNG, CNG and TCO interstate pipeline systems as well as to the Distribution
Company's distribution system.

         For such natural gas gathering services, the Company and the Storage
Company collect certain transportation allowances from producers (owners of
natural gas). Transportation allowances vary depending upon contractual
arrangements and currently range from $.05 to $.50 per MMBtu.

         Marketing. In 1997 the Company commenced marketing operations of
natural gas. The Company currently markets and sells natural gas provided from
Company-operated wells and facilities. The Company anticipates that future
expansion of its marketing operations will include purchases of natural gas
supplies from third party sources, storing these supplies in its Saltville
Facility and marketing these supplies to its customers.

                                       6
<PAGE>


Competition

         The Company competes with major utility companies and pipeline
companies in the areas of utility services and pipeline operations. The
deregulation of the natural gas industry has provided the Company with marketing
and transportation opportunities; however, other pipeline companies, marketers
and brokers with resources far greater than the Company likewise are the
beneficiaries of such deregulation. While the Company and the Storage Company
currently own and operate the only underground natural gas storage facilities in
Virginia, it is possible that other distribution and marketing companies could
develop other underground natural gas storage facilities and companies could
rely on other methods of storage such as above-ground stored liquefied natural
gas. The Company competes in the areas of exploration, production,
transportation and marketing of natural gas and distribution of propane with
major oil companies, other independent oil and gas concerns and individual
producers and operators. Many of the Company's competitors have substantially
greater financial and other resources than the Company.

Regulation

         VSCC Regulation. The Company's and the Storage Company's natural gas
storage operations are regulated primarily by the VSCC and the FERC, which has
jurisdiction over interstate sales of storage services. Storage rates are
subject to VSCC approval and are based on the cost of service of the facility,
which provide for an approved rate of return. A facility can apply for revised
rates based on actual costs if they are higher than previously anticipated and
conversely the VSCC may require a reduction in rates if returns are higher than
anticipated.

         The Company's non-gathering pipeline operations will also be regulated
by the VSCC. Substantially all of the operations conducted through these
pipelines would constitute common carrier pipeline activities. Such common
carrier activities are those under which transportation in the pipeline is
available at tariff rates published with the VSCC to any shipper of natural gas
who requests such services, provided that each product for which transportation
is requested satisfies the conditions and specifications for transportation.

         The natural gas distribution operations of the Distribution Company are
also regulated by the VSCC, which regulates the rates which may be charged to
end-users, setting them at levels sufficient to recover the cost of service to
its customers including an approved rate of return.

         The Company's gathering facilities and propane distribution operations
are not subject to service or rate regulation from the VSCC.

         FERC Regulation. The Company's operations either are not governed by,
or by virtue of limited jurisdiction certificates having been issued by FERC,
are exempt from, further regulation by FERC under the Natural Gas Act.

                                       7
<PAGE>


         Environmental and Safety Regulation. The operations of the Company are
subject to various federal, state and local environmental laws. In particular,
operations in Virginia are subject to the Virginia Clean Air Act as administered
by the Virginia Department of Environmental Quality ("VDEQ"). The Virginia Clean
Air Act restricts emissions from wells, pipelines and processing plants, and the
VDEQ may curtail operations not meeting minimum standards. The design,
construction, operation and maintenance of the Company's VSCC jurisdictional
facilities are subject to the safety regulations established by the United
States Department of Transportation pursuant to the Natural Gas Pipeline Safety
Act of 1968, as amended, or by state agency regulations meeting the requirements
thereunder. The Company is also subject to other federal, state and local laws
covering the handling or discharge into the environment of materials used by the
Company, or otherwise relating to protection of the environment, safety and
health.

         Expenditures for environmental control facilities and for remediation
have not been significant in relation to the results of operations of the
Company. The Company believes, however, that it is reasonably likely that the
trend in environmental legislation and regulations will continue to be toward
stricter standards. The Company is unaware of future environmental standards
that are reasonably likely to be adopted that will have a material effect on the
Company's results of operations, but there can be no assurance such standards
will not be adopted in the future.

Title to Properties

         Substantially all of the properties comprising the Saltville Facility
and the Early Grove Field are situated on land not owned by the Company or the
Storage Company.

         The Company's rights to develop and operate the Saltville Facility are
derived from a deed from the Industrial Development Authority of the town of
Saltville. The deed provides the Company with rights to store gas, rights to use
any facilities and surface area for natural gas storage use and rights to remove
salts to create cavities for natural gas storage. The deed encompasses
approximately 11,000 acres of storage rights in Washington and Smyth Counties,
Virginia.

         The Storage Company's rights to develop and operate the Early Grove
Field are derived from its ownership of mineral leasehold rights and from
surface easements.

         The Company's existing pipelines, and gathering systems and
distribution systems are situated on land not owned by the Company but as to
which the Company and its affiliates have easements from the landowners
permitting the use of such land for the construction and operation of pipeline
facilities. The Company has received or intends to receive franchises,
easements, licenses, permits and other authorizations to construct and operate
proposed or future pipelines, gathering systems and distribution systems within
the jurisdiction of various cities, counties and other government agencies and
jurisdictions, as well as along and across waterways and rights-of-way for
federal, state, county and city highways, streets and roads.

         Substantially all of the Company's producing property interests are
held pursuant to leases from third parties. The Company has obtained title
opinions on substantially all of its producing properties and believes that it
has satisfactory title to such properties in accordance with standards generally
accepted in the natural gas industry. The Company's producing properties are
subject to customary royalty interests, liens for current taxes and other
burdens which the Company believes do not materially interfere with the use of
or affect the value of such producing properties.

                                       8
<PAGE>


Employees

         As of December 31, 1997, the Company, its subsidiaries and affiliated
companies employed 46 persons on a full time basis, none of whom is covered by a
collective bargaining agreement.

Item 2. PROPERTIES

         See Item 1 for a discussion of properties and locations and Note 8 of
Notes to the Consolidated Financial Statements contained in Part II, Item 7 for
a discussion of any liens or encumbrances.

Item 3. LEGAL PROCEEDINGS

         There is no pending nor, to the knowledge of the Company, any
threatened litigation against the Company or its Subsidiaries or Affiliates
which could have a material adverse effect on their financial position.


Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         No matters were submitted to a vote of security holders during the
fourth quarter of 1997.

                                     Part II

Item 5. Market for Common Equity and Related Stockholder Matters

                       APPROXIMATE NUMBER OF STOCKHOLDERS


<TABLE>
<CAPTION>
                                                         Number of Stockholders
                                                            of Record as of
                                                           December 31, 1997
                     Title of Class
<S>                                                      <C>
Common stock, par value $.001                                     1,600
Warrants to purchase common stock                                   26
</TABLE>

                                       9

<PAGE>


         The Common Stock of the Company is traded on the Nasdaq National Market
under the symbol "VGCO." The following table sets forth, for the periods
indicated, the high and low sales prices of the common stock, compiled from
quotations supplied by the Nasdaq Monthly Statistical Report (the stock began
trading on October 4, 1996), in addition to dividends per share declared for the
periods indicated:

<TABLE>
<CAPTION>
                                                          Price Range of
                                                           Common Stock
                                                      ------------------------       Dividends
                                                        High             Low         per Share
                                                      -------          -------      ----------
<S>                                                   <C>             <C>           <C>
1996
      Fourth Quarter                                  $  7 3/4        $  6 1/2       $  0.0125
1997
      First Quarter                                     10 1/2           7 1/4          0.0150
      Second Quarter                                    10 3/4           8 3/4          0.0175
      Third Quarter                                     10 3/4           8 3/4          0.0175
      Fourth Quarter                                         9               8          0.0175
1998
      First Quarter (through March 24)                       9           7 1/4          --
</TABLE>


         The Company paid cash dividends on its Common Stock for each of the
years 1992 through 1997. There is no assurance that the Board of Directors of
the Company will authorize the Company to continue to pay cash dividends on its
Common Stock in the future.

Item 6. Management's Discussion and Analysis


         The following discussion of the historical financial condition and
results of operations of the Company should be read in conjunction with the
consolidated financial statements and related notes contained in Part II, Item
7.

General

         The Company derives revenues from its storage, exploration, production,
gathering, marketing and propane distribution operations. From its 50%
investments in the Storage Company and the Distribution Company, the Company
derives earnings from the storage, gathering and distribution operations of
these companies. The Company accounts for its investments in these companies
using the equity method.

         In its storage business, the Company receives fees for use of its
storage space in addition to injection and withdrawal fees for the use of
compression facilities, collectively referred to as storage revenues. Storage
charges to customers are in accordance with storage rates included in tariffs
approved by the Virginia State Corporation Commission.

                                       10
<PAGE>


         In its exploration and production business, the Company receives
revenues from the sale of its natural gas production. The Company also receives
revenues from managing the construction, drilling, development and operation of
natural gas facilities, including management and operations fees. In its natural
gas gathering business, revenues are generated from its ownership interest in
gathering pipelines for natural gas traveling through its gathering systems. In
its gas marketing operations, the Company generates revenues from the sale of
natural gas. In its propane distribution business, the Company generates
revenues from the sale of propane to industrial, commercial and residential
customers.

         In the Storage Company's unregulated natural gas gathering business,
revenues are generated from its ownership interest in gathering pipelines for
natural gas traveling through its gathering systems. The Storage Company also
provides unregulated winter gas supply services.

         In its distribution operations, the Distribution Company's gross
profits are realized by the difference between the prices at which it purchases
and the prices at which it sells natural gas to its industrial, commercial and
residential customers. The prices at which the Distribution Company sells
natural gas to its customers are in accordance with the rate schedules in its
tariff filed with the Virginia State Corporation Commission. The Distribution
Company purchases natural gas under short-term contracts which reflect the
market price of natural gas.

Results of Operations for Years 1997 and 1996

         Overview. During the year ended December 31, 1997, the Company recorded
net income of $908,000, compared to $608,000 for 1996. Net income per common
share available to common stockholders for the years was $0.22 in 1997 compared
with $0.21 in 1996. The number of weighted average shares used in calculating
income per common share was 3,943,274 and 1,637,576 for the years ended December
31, 1997 and 1996, respectively. The adoption of SFAS No. 128 in 1997 resulted
in no change to previously reported net income per share.

         Revenues. Total revenues increased 237% to $9.3 million for the year
ended December 31, 1997 compared to $2.8 million for 1996. Natural gas sales and
well operation revenues totaled $4.5 million for 1997 compared to $652,000 in
1996. The increase primarily reflects the formation of the Company's marketing
operations during the first quarter of 1997. Sales of natural gas during 1997
totaled $4,199,000 on sales volumes of 1,594,000 MMBtu. These gas sales included
sales of natural gas totaling $570,000 to a natural gas storage customer of the
Company. Exploration and production revenues, reflecting the Company's revenue
interest in these sales of natural gas, consisted of natural gas sales of
$388,000 and well operation revenues of $265,000 during 1997 compared to
$374,000 and $278,000, respectively, for 1996.

         Propane sales totaled $643,000 during 1997 on sales volumes of 652,000
gallons, compared with 1996 sales of $47,000 on sales volumes of 51,000 gallons.

         Natural gas storage revenues totaled $2.4 million for the year ended
December 31, 1997, compared with $769,000 for 1996. Initial injections of
customer gas into the Company's storage facility located in Saltville, Virginia,
began in August 1996.

         Management revenues, interest and other income increased 42% to $1.7
million in 1997, compared to $1.2 million in 1996, primarily as a result of an
increase in interest income of $486,000.

                                       11
<PAGE>


         Costs and Expenses. Total operating costs and expenses increased $5.5
million to $6.8 million for the year ended December 31, 1997, compared to $1.3
million for 1996. Production and purchased gas expenses increased to $1.2
million in 1997 from $134,000 in 1996. This increase reflects increased
production expenses, increased purchased gas expense attributed to the expanding
propane distribution operations and purchased gas expense related to the sale of
natural gas to a storage customer of the Company.

         Operation and maintenance expenses totaled $684,000 in 1997 compared to
$173,000 in 1996, primarily reflecting operating costs related to the Saltville
storage facility in addition to the propane distribution operations.

         Cost of natural gas sold, related to the Company's marketing of natural
gas, totaled $3.1 million for the year ended December 31, 1997, compared to zero
in 1996, reflecting the initiation of marketing operations and the corresponding
costs.

         General and administrative costs totaled $1.0 million in 1997, an
increase of $354,000 from 1996 costs of $646,000. This increase largely reflects
the growth in Company operations and the accompanying growth in personnel and
facilities.

         Depreciation, depletion and amortization increased 108% to $806,000 for
the year ended December 31, 1997 from $387,000 in 1996. This increase reflects
the recovery of costs for capital projects recently placed into service,
including the Company's Saltville storage facility and the expanding propane
distribution operations.

         Interest Expense. Interest expense increased 50% to $1.5 million in
1997 from $1.0 million in 1996, primarily due to additional tax-exempt bond
financing and short-term borrowings. The Company capitalizes interest on
expenditures for significant projects while activities are in progress to bring
the assets to their intended use. Capitalized interest totaled $328,000 in 1997
and $290,000 in 1996.

         Equity in Earnings of Affiliates. The Company has a 50% ownership
interest in two affiliated companies which provide natural gas storage,
gathering and distribution services. The Company accounts for its investments in
these companies using the equity method. For the year ended December 31, 1997,
the Company's equity in earnings of these affiliates decreased 36% to $217,000
from $340,000 in 1996. This decrease reflects increased operating expenses
related to natural gas storage and distribution operations in addition to higher
interest costs.

         Income Taxes. Using the asset-and-liability method, deferred income
taxes reflect the temporary differences between assets and liabilities
recognized for financial reporting purposes and amounts recognized for income
tax purposes. The Company's provision for income taxes as a percentage of income
before its equity in earnings of affiliates (the Company's equity in earnings of
affiliates is reflected on a post-income tax basis) was 30% in 1997 and 36% in
1996.

         Equity Investments

         Natural Gas Storage. Storage revenues from the Early Grove storage
facility totaled $2.5 million in 1997, an increase of $400,000 over 1996
revenues of $2.1 million. This increase is attributable to an increase in leased
storage capacity at the facility.

                                       12
<PAGE>


         Natural Gas Gathering. Gathering revenues totaled $312,000 in 1997,
reflecting a decrease of $66,000 from 1996 gathering revenues of $378,000. This
decrease primarily reflects a decrease in system throughput during 1997 of
204,068 MMBtu. Revenues from winter service and other natural gas sales totaled
$1.5 million in 1997 compared to $1.1 million in 1996. Purchased gas expense
related to these sales totaled $1.3 million and $974,000 for the years ended
December 31, 1997 and 1996, respectively.

         Natural Gas Distribution. Distribution revenues increased to $891,000
in 1997 from $629,000 in 1996, an increase of 42%. This increase primarily
reflects increased usage by industrial customers, reflecting 1997 expansions of
distribution facilities in Russell County. Sales volumes for 1997 totaled
172,939 MMBtu, an increase of 59,561 MMBtu from 1996 sales volumes of 113,378
MMBtu. Purchased gas costs related to these sales totaled $513,000 and $330,000
in 1997 and 1996, respectively.

         The Distribution Company incurred a loss on operations for the year.
The expansion of distribution facilities in Russell County for a major customer
resulted in increased expenses for the Company, which will not be fully
recoverable until late 1998 or early 1999 when the customer's natural gas usage
is expected to approach normal capacity. Similarly, natural gas contracts,
linked to the price of fuel oil and/or propane, for several commercial customers
suffered modest revenue shortfalls due to falling prices for fuel oil and
propane. Efforts are currently underway for renegotiating these contracts and,
if successful, the Distribution Company expects to obtain better results from
operations in 1998.

Liquidity and Capital Resources

         Working Capital

         At December 31, 1997, the Company's working capital reflected a $13.0
million surplus, an increase in working capital from the $430,000 deficit at
December 31, 1996. The Company's current ratio at December 31, 1997 was 7.95, an
increase from the ratio of 0.87 at December 31, 1996. The combined working
capital of the Storage Company and the Distribution Company decreased to a $1.3
million deficit at December 31, 1997 from the $600,000 deficit at December 31,
1996. The combined current ratio of these companies was 0.64 at December 31,
1997.

         Investing and Financing Activities

         The Company's cash requirements in the past have been met out of cash
generated from operations, proceeds from the issuance of the Company's common
stock, amounts borrowed in conjunction with tax-exempt bonds issued by the
Industrial Development Authorities of Russell and Buchanan Counties, Virginia in
addition to other borrowings. The Company's rapid pace of growth and the timing
of the completion of financing transactions periodically have limited the
Company's short-term liquidity. On December 31, 1997, the Company had a cash and
cash equivalent balance of $11,751,000 compared to $1,653,000 at December 31,
1996.

         Capital investments of $6.9 million in 1997 reflect primarily the
continued development of the Saltville storage facility ($3.7 million), the P-25
pipeline project ($0.95 million) and the expansion of propane distribution
facilities ($1.7 million).

         Capital investments of $11.6 million in 1996 reflect primarily the
development of the Saltville storage facility ($10.3 million) and the P-25
pipeline project ($0.9 million).

                                       13
<PAGE>


         In September 1997, the Company completed a secondary public offering of
its common stock. The offering resulted in the issuance of an additional
2,300,000 common shares of the Company at $8.50 per share. Net proceeds realized
from the offering approximated $17.5 million. The common stock of the Company is
traded on the Nasdaq National Market under the symbol "VGCO."

         In October 1996, the Company completed an initial public offering of
its common stock. The offering resulted in the issuance of an additional
1,533,000 common shares of the Company at $6 per share. Net proceeds realized
from the offering approximated $8 million.

         In July 1996 the Company issued 42,000 shares of its common stock to an
officer of the Company. The net proceeds of the sale of these shares were
$252,000.

         In May 1996 the Company issued 800,058 shares of its common stock to
one investor pursuant to a private placement. The net proceeds of the sale of
these shares were approximately $4.4 million.

         The Company's material capital expenditure commitments for 1998 are
expected to include $12.9 million for the development of the P-25 intrastate
pipeline and $2.9 million for continued development of the Saltville storage
facility. Funding for these commitments will be obtained from a portion of the
proceeds of the September 1997 secondary public offering, proceeds from
additional borrowings and operating cash flows of the Company.

Recent Accounting Pronouncements

         Effective for the fiscal year ended December 31, 1998, the Company is
required to adopt SFAS No. 130 "Reporting Comprehensive Income" and SFAS No. 131
"Disclosures About Segments of an Enterprise and Related Information." The
Company does not expect that adoption of these standards will have a material
impact on the Company's financial position or results of operations. The
adoption of SFAS No. 130 will require reporting comprehensive income in an
alternative format prescribed by the standard.

Year 2000 Issue

         The Company uses vendor-supported software exclusively. After
discussions with vendors, the Company believes that the year 2000 issue has been
appropriately addressed and does not expect the year 2000 issue to have a
material adverse impact on the financial position, results of operations, or
cash flows in future periods.

Debt Refinancing

         On March 19, 1998 the Company completed a significant financing
arrangement with the John Hancock Mutual Life Insurance Companies. Under the
terms of the arrangement, Virginia Gas Company issued to John Hancock $24
million of 8.5% senior notes due 2012. With the proceeds, the Company retired
approximately $19.5 million of industrial revenue bonds which had an average
interest rate of 9%. The remaining proceeds will be used to develop segments of
the Company's pipeline expansion projects and to fund other planned corporate
expansions. In addition, the retirement of the industrial revenue bonds
released, for the Company's use, another $2.1 million (including interest
earned through March 19, 1998) of reserve funds associated with the issuance
of the bonds. These funds will also be used to fund planned corporate
expansions.

                                       14
<PAGE>

         As a result of the refinancing described above, the Company will incur,
during the first quarter of 1998, a one time after tax charge to earnings of
approximately $815,000. This is due to accelerated amortization of issue costs
previously expensed over the term of the industrial revenue bonds, and
defeasement premiums, interest, and fees associated with the 1994 Russell
County bond issue.

                                       15
<PAGE>


Item 7. Financial Statements



                      Virginia Gas Company and Subsidiaries
                   Index to Consolidated Financial Statements


<TABLE>
<CAPTION>
                                                                                                      Page
                                                                                                     ------
<S>                                                                                                  <C>
Report of Independent Public Accountants                                                               17
Consolidated Balance Sheets as of December 31, 1997 and 1996                                           18
Consolidated Statements of Income for the years ended December 31, 1997 and 1996                       19
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 1997 and 1996                                                                             20
Consolidated Statements of Cash Flows for the years ended December 31, 1997 and 1996                   21
Notes to Consolidated Financial Statements                                                             22
</TABLE>

                                       16
<PAGE>


                    Report of Independent Public Accountants


To the Board of Directors and Stockholders of
Virginia Gas Company:

We have audited the accompanying consolidated balance sheets of Virginia Gas
Company and Subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Virginia Gas Company and
Subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.



ARTHUR ANDERSEN LLP

Richmond, Virginia
March 6, 1998
(except with respect to the
   matter discussed in Note 15,
   as to which the date is
   March 19, 1998)

                                       17
<PAGE>


                      Virginia Gas Company and Subsidiaries

                           Consolidated Balance Sheets
                        As of December 31, 1997 and 1996

<TABLE>
<CAPTION>

                                     Assets
                                                                                             1997                 1996
                                                                                          -----------          -----------
<S>                                                                                       <C>                  <C>
Current assets:
    Cash and cash equivalents                                                             $11,750,899          $ 1,652,838
    Accounts receivable                                                                     2,681,818            1,073,276
    Notes receivable                                                                          120,898              114,556
    Other current assets                                                                      305,223              134,862
                                                                                          -----------          -----------
                  Total current assets                                                     14,858,838            2,975,532

Property and equipment, net                                                                22,459,289           16,343,480
Investment in affiliated companies                                                          4,459,937            4,243,020
Notes receivable - affiliated companies                                                    12,900,164            9,371,062
Other assets                                                                                1,159,272              577,309
                                                                                          -----------          -----------
                  Total assets                                                            $55,837,500          $33,510,403
                                                                                          -----------          -----------
                                                                                          -----------          -----------
                      Liabilities and Stockholders' Equity

Current liabilities:
    Notes payable                                                                         $      --            $   250,000
    Current portion of long-term debt                                                         218,611            1,244,490
    Accounts payable                                                                        1,092,846            1,197,555
    Funds held for future distribution                                                        511,099              544,475
    Other current liabilities                                                                  46,111              168,709
                                                                                          -----------          -----------
                  Total current liabilities                                                 1,868,667            3,405,229

Long-term debt                                                                             19,728,422           12,137,729

Deferred income taxes                                                                         925,908              629,914
                                                                                          -----------          -----------
                  Total liabilities                                                        22,522,997           16,172,872
                                                                                          -----------          -----------
Stockholders' equity:
    Preferred stock - No par, 2,000 shares authorized, issued, and
       outstanding as of December 31, 1996                                                       --              1,725,000
    Common stock - par value $.001, 10,000,000 shares authorized, 5,504,906 and
       3,150,744 shares issued and outstanding as of December 31, 1997 and 1996,
       respectively                                                                             5,505                3,151
    Additional paid-in capital                                                             31,241,082           14,152,137
    Retained earnings                                                                       2,067,916            1,457,243
                                                                                          -----------          -----------
                  Total stockholders' equity                                               33,314,503           17,337,531
                                                                                          -----------          -----------
                  Total liabilities and stockholders' equity                              $55,837,500          $33,510,403
                                                                                          -----------          -----------
                                                                                          -----------          -----------
</TABLE>

 The accompanying notes are an integral part of these consolidated balance
 sheets.

                                       18
<PAGE>




                      Virginia Gas Company and Subsidiaries


                        Consolidated Statements of Income
                 For the Years Ended December 31, 1997 and 1996



<TABLE>
<CAPTION>
                                                                      1997               1996
                                                                   ----------          ----------
<S>                                                                <C>                 <C>
Revenue:
    Operating revenue                                              $7,897,394          $1,772,970
    Interest and other income                                       1,446,233             996,748
                                                                   ----------          ----------
                                                                    9,343,627           2,769,718
                                                                   ----------          ----------
Expenses:
    Cost of natural gas sold                                        3,105,310                --
    Purchased gas expense                                           1,025,014              28,537
    General and administrative                                      1,003,464             645,673
    Depreciation, depletion, and amortization                         806,469             387,116
    Operation and maintenance expense                                 683,763             173,445
    Production expenses                                               216,290             105,910
                                                                   ----------          ----------
                                                                    6,840,310           1,340,681
                                                                   ----------          ----------
Other expense:
    Interest                                                        1,513,964           1,006,800
    Other                                                                --                 2,771
                                                                   ----------          ----------
                                                                    1,513,964           1,009,571
                                                                   ----------          ----------
Income before earnings of affiliated companies and income
   taxes                                                              989,353             419,466
Equity in earnings of affiliated companies                            216,917             339,927
                                                                   ----------          ----------
Income before income taxes                                          1,206,270             759,393
Provision for income taxes                                            298,663             151,827
                                                                   ----------          ----------
Net income                                                         $  907,607          $  607,566
                                                                   ----------          ----------
                                                                   ----------          ----------
Net income available to common stockholders                        $  850,552          $  347,566
                                                                   ----------          ----------
                                                                   ----------          ----------
Basic and dilutive net income per common share                     $     0.22          $     0.21
                                                                   ----------          ----------
                                                                   ----------          ----------
</TABLE>


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



                                       19

<PAGE>


                      Virginia Gas Company and Subsidiaries


           Consolidated Statements of Changes in Stockholders' Equity
                 For the Years Ended December 31, 1997 and 1996



<TABLE>
<CAPTION>
                                                                                               Additional
                                                            Preferred          Common            Paid-in           Retained
                                                              Stock            Stock             Capital           Earnings
                                                           ------------      ------------      ------------      ------------
<S>                                                        <C>               <C>               <C>               <C>
Balance, December 31, 1995                                 $  1,725,000      $  2,288,741      $    275,000      $  1,141,183
    Issuance of 800,058 shares of common stock                     --           4,401,317              --                --
    Change from no par to $.001 par value of common
       stock                                                       --          (6,688,522)        6,688,522              --
    Issuance of 42,000 shares of common stock                      --                  42           251,958              --
    Issuance of 40,000 shares of common stock to
       officers and employees, net of notes receivable
       of $240,000                                                 --                  40              --                --
    Issuance of 1,533,000 shares of common stock                   --               1,533         7,911,657              --
    Payment for cancellation of warrant and
     options                                                       --                --            (975,000)             --
    Net income                                                     --                --                --             607,566
    Preferred stock dividends paid                                 --                --                --            (260,000)
    Common stock dividends paid                                    --                --                --             (31,506)
                                                           ------------      ------------      ------------      ------------
Balance, December 31, 1996                                    1,725,000             3,151        14,152,137         1,457,243
    Issuance of 54,162 shares of common stock pursuant
       to exercise of warrant                                      --                  54              --                --
    Redemption of 2,000 shares of preferred stock            (1,725,000)             --            (275,000)             --
    Issuance of 2,300,000 shares of common stock                   --               2,300        17,504,623              --
    Payment for cancellation of options                            --                --            (140,678)             --
    Net income                                                     --                --                --             907,607
    Preferred stock dividends paid                                 --                --                --             (57,055)
    Common stock dividends paid                                    --                --                --            (239,879)
                                                           ------------      ------------      ------------      ------------
Balance, December 31, 1997                                 $       --        $      5,505      $ 31,241,082      $  2,067,916
                                                           ------------      ------------      ------------      ------------
                                                           ------------      ------------      ------------      ------------
</TABLE>


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

                                       20
<PAGE>


                      Virginia Gas Company and Subsidiaries


                      Consolidated Statements of Cash Flows
                 For the Years Ended December 31, 1997 and 1996

<TABLE>
<CAPTION>
                                                                                 1997              1996
                                                                              ------------      ------------
<S>                                                                           <C>               <C>
Cash flows from operating activities:
    Net income                                                                $    907,607      $    607,566
    Adjustments to reconcile net income to net cash provided by operating
       activities:
         Depreciation, depletion, and amortization                                 806,469           387,116
         Undistributed earnings of affiliated companies                           (216,917)         (339,927)
         Deferred income taxes                                                     295,994           141,596
         Increase in accounts receivable                                        (1,608,542)         (180,903)
         (Increase) decrease in other current assets                              (170,361)           66,720
         Decrease in other assets                                                  278,971            20,477
         Decrease in notes payable                                                (250,000)         (332,212)
         Decrease in accounts payable                                             (104,709)         (978,177)
         (Decrease) increase in other current liabilities                         (155,974)          190,145
                                                                              ------------      ------------
                  Net cash used in operating activities                           (217,462)         (417,599)
                                                                              ------------      ------------
Cash flows from investing activities:
    Capital expenditures                                                        (6,097,356)       (9,803,768)
    Issuance of note receivable                                                 (3,650,000)             --
    Payments received on notes receivable                                          114,556           128,221
                                                                              ------------      ------------
                  Net cash used in investing activities                         (9,632,800)       (9,675,547)
                                                                              ------------      ------------
Cash flows from financing activities:
    Payment of loan principal                                                   (3,330,959)       (2,731,952)
    Proceeds from new loans                                                      9,100,000         1,100,000
    Proceeds from issuance of common stock, net                                 17,506,977        12,566,547
    Redemption of preferred stock                                               (2,000,000)             --
    Purchase of warrants and options                                              (140,678)         (975,000)
    Payment of debt issuance costs                                                (331,333)          (54,719)
    Establishment of financing reserve funds                                      (558,750)             --
    Dividends paid                                                                (296,934)         (291,506)
                                                                              ------------      ------------
                  Net cash provided by financing activities                     19,948,323         9,613,370
                                                                              ------------      ------------
Net increase (decrease) in cash                                                 10,098,061          (479,776)
Cash, beginning of year                                                          1,652,838         2,132,614
                                                                              ------------      ------------
Cash, end of year                                                             $ 11,750,899      $  1,652,838
                                                                              ------------      ------------
                                                                              ------------      ------------
Supplemental disclosure:
    Interest paid                                                             $  1,972,624      $  1,282,705
                                                                              ------------      ------------
                                                                              ------------      ------------
    Income taxes paid                                                         $     22,158      $     26,158
                                                                              ------------      ------------
                                                                              ------------      ------------

</TABLE>

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


                                       21

<PAGE>


                      Virginia Gas Company and Subsidiaries

                   Notes to Consolidated Financial Statements
                        As of December 31, 1997 and 1996


  1. Description of Operations:

Virginia Gas Company (the "Company") was organized in 1987 under the laws of the
state of Delaware. The Company, directly or through affiliated companies, is
primarily engaged in the storage, marketing, distribution, gathering,
exploration, and production of natural gas, and the distribution of propane gas,
principally in the southwestern counties of the Commonwealth of Virginia.

  2. Summary of Significant Accounting Policies:

Principles of Consolidation

The consolidated financial statements for 1997 include the accounts of four
wholly owned subsidiaries. The consolidated financial statements for 1996
include the accounts of three wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.

Cash and Cash Equivalents

Cash and cash equivalents consist of all cash balances and highly liquid
investments which have an original maturity at purchase of three months or less.

Investment in Affiliated Companies

The Company's investments in affiliated companies are accounted for using the
equity method. Investments carried at equity and the percentage interest owned
consist of Virginia Gas Storage Company (50 percent) and Virginia Gas
Distribution Company (50 percent).

Combined financial information as of December 31, 1997 and 1996, and for the
years then ended, for investments in affiliated companies accounted for by the
equity method is as follows.


                                       22
<PAGE>


<TABLE>
<CAPTION>

                                                     1997               1996
                                                 -----------         -----------
<S>                                              <C>                 <C>
Current assets                                   $ 2,352,128         $ 2,386,057
Property and equipment, net                       21,479,467          16,079,543
Other assets                                       5,318,164           4,917,958
                                                 -----------         -----------
                                                 $29,149,759         $23,383,558
                                                 -----------         -----------

Current liabilities                              $ 3,662,965         $ 2,941,557
Long-term debt payable to:
    Affiliated companies                          15,848,285          11,390,406
    Third parties                                      5,194              13,870
Other liabilities                                    713,441             551,686
Stockholders' equity                               8,919,874           8,486,039
                                                 -----------         -----------
                                                 $29,149,759         $23,383,558
                                                 -----------         -----------
</TABLE>

<TABLE>
<CAPTION>

                                                       For the Years Ended
                                                           December 31
                                                     1997               1996
                                                 -----------         -----------
<S>                                              <C>                 <C>
Revenues                                         $ 5,977,069         $ 5,008,509
Income before income taxes                           657,329           1,030,079
Net income                                           433,835             679,853
</TABLE>


The Company provides certain general and administrative services for Virginia
Gas Storage Company and Virginia Gas Distribution Company. These services
include professional services, insurance coverage and administrative services.
Other transactions include purchases and sales of natural gas, natural gas
storage, and technical services provided for the affiliated companies.

Use of Estimates

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

Revenue Recognition

The Company recognizes natural gas sales and gathering revenues upon delivery of
natural gas to the common pipeline carrier. Storage revenues are recognized
evenly throughout the contract terms with injection and withdrawal revenues
recognized as natural gas is injected or withdrawn from the storage facility.
Propane gas sales are recognized upon delivery of gas to the customer.



In January 1997, the Company's wholly owned subsidiary, Virginia Gas Marketing
Company, began marketing natural gas services. These services include the
marketing of natural gas and are later expected to include natural gas storage
services. The initial source of natural gas supply will be provided by
Company-operated wells and initial future storage services will be provided by
facilities operated by the Company and/or its affiliated companies. Revenues
attributable to the marketing operations totaled $3.6 million for the year ended
December 31, 1997.

                                       23
<PAGE>

Income Per Common Share

Income per common share is computed in accordance with SFAS No. 128, "Earnings
per Share," using the weighted-average shares of common stock and dilutive
common stock equivalents (options and warrants) outstanding during the
respective periods. Adoption of SFAS No. 128 in 1997 resulted in no change to
previously reported net income per share. Net income available to common
stockholders is net income less dividends on preferred stock. The number of
weighted-average shares used in calculating income per common share was
3,943,274 and 1,637,576 for the years ended December 31, 1997 and 1996,
respectively, after retroactive effect of a 103.1667 per share stock split, as
discussed in Note 9.

Property and Equipment

The Company follows the successful efforts method of accounting for its natural
gas exploration activities. Under this method, geological and geophysical costs
and costs of carrying and retaining undeveloped properties are expensed when
incurred. All direct and certain indirect costs relating to property
acquisition, successful exploratory wells, development costs, and support
equipment and facilities are capitalized as the properties are obtained or the
facilities are placed into service. Costs of exploratory wells are charged to
expense if it is determined that proven reserves are not found.

Unproved gas properties that are individually significant are periodically
assessed for impairment of value, with losses recognized at the time of
impairment. The Company provides for depreciation, depletion, and amortization
of its investment in producing gas properties on a units-of-production method.
The remaining property and equipment is depreciated using the straight-line
method over estimated useful lives, ranging from 5 to 30 years. Maintenance and
repairs are charged to expense as incurred. Improvements and betterments are
capitalized.

Capitalized Interest

The Company capitalizes interest on expenditures for significant projects while
activities are in progress to bring the assets to their intended use. Interest
capitalized totaled $328,011 and $290,398 for the years ended December 31, 1997
and 1996, respectively.

Other Assets

In conjunction with the 1997 issuance of the Russell County, the 1995 issuance
of the Buchanan County and the 1994 issuance of the Russell County and Buchanan
County, Virginia, Natural Gas Facilities Revenue Bonds by the Industrial
Development Authorities of the respective counties, reserve funds have been
established by the trustee for each issuance. Amounts in the reserve funds will
be used to make payments of principal and interest, whether at maturity, by
acceleration, call for redemption, or otherwise, where trust funds accumulated
by scheduled Company payments are insufficient to satisfy bond requirements.
Such amounts are invested in debt securities issued by the U.S. Treasury and
other U.S. government corporations and agencies. The Company records these
investments at cost and recognizes related interest as earned. The carrying
value of investments approximates market value.

Costs incurred in conjunction with financing transactions are amortized on a
basis that approximates the effective interest method.


                                       24
<PAGE>

Funds Held for Future Distribution

Revenues are collected by the Company as operator and marketer of the gas sold
on behalf of the working interest parties and held for final distribution to
them and to landowners. Until these funds are distributed, they are recorded as
funds held for future distribution.


Income Taxes

Income taxes are accounted for using the asset-and-liability method. Under the
asset-and-liability method, deferred income taxes reflect the temporary
differences between assets and liabilities recognized for financial reporting
purposes and amounts recognized for tax purposes.

Reclassifications

Certain reclassifications have been made in the 1996 balances to conform with
the 1997 presentation.

  3. Accounts Receivable:

<TABLE>
<CAPTION>
                                                       1997              1996
                                                    ----------        ----------
<S>                                                 <C>               <C>
Trade receivables                                   $  654,624        $  451,436
Lease operating expenses receivable                    130,294           145,528
Joint-interest receivables                              96,320            64,098
Due from affiliated companies                        1,800,580           412,214
                                                    ----------        ----------
                                                    $2,681,818        $1,073,276
                                                    ----------        ----------
                                                    ----------        ----------
</TABLE>

The majority of the Company's accounts receivable are due from companies
predominately involved in the marketing and distribution of oil and gas
products.

                                       25
<PAGE>



  4. Notes Receivable - Affiliated Companies:

<TABLE>
<CAPTION>
                                                                                        1997             1996
                                                                                    ------------      ------------
<S>                                                                                 <C>               <C>
Note receivable from Virginia Gas Distribution Company; interest receivable at
    9.5%; principal payable in maturities of $110,000 to
    $447,000 from 2002 to 2017                                                      $  3,650,000      $       --

Note receivable from Virginia Gas Distribution Company; interest receivable at
    9%; principal payable in maturities of $4,000 to
    $263,000 from 1999 to 2020                                                         2,879,214         2,879,214

Note receivable from Virginia Gas Storage Company; interest receivable at 8.88%;
    principal payable in maturities of $12,000 to $241,000
    from 1995 to 2017                                                                  2,504,839         2,567,837

Note receivable from Virginia Gas Distribution Company; interest receivable at
    7.35%; principal payable in maturities of $17,000 to
    $97,000 from 1996 to 2023                                                          1,268,288         1,284,833

Note receivable from Virginia Gas Storage Company; interest receivable at 7.35%;
    principal payable in maturities of $13,000 to $77,000
    from 1996 to 2023                                                                  1,005,462         1,018,580

Note receivable from Virginia Gas Distribution Company; interest receivable at
    8.88%; principal payable in maturities of $4,000 to
    $84,000 from 1995 to 2017                                                            870,562           892,457

Note receivable from Virginia Gas Storage Company; interest receivable at 9%;
    principal payable in maturities of $1,000 to $77,000 from
    1999 to 2020                                                                         842,697           842,697
                                                                                    ------------      ------------
                                                                                      13,021,062         9,485,618
Less- Current portion                                                                   (120,898)         (114,556)
                                                                                    ------------      ------------
                                                                                    $ 12,900,164      $  9,371,062
                                                                                    ------------      ------------
                                                                                    ------------      ------------
</TABLE>

  5. Property and Equipment:


<TABLE>
<CAPTION>
                                                                                            1997             1996
                                                                                    ------------      ------------
<S>                                                                                 <C>               <C>
Storage properties                                                                  $ 12,971,791      $  9,226,332
Pipelines                                                                              3,127,293         1,039,035
Producing properties                                                                   2,499,105         2,494,370
Propane facilities                                                                     1,658,805           165,756
Wells, pipelines, and storage properties in progress                                   3,300,630         3,973,172
Vehicles                                                                                 362,889           217,955
Building and improvements                                                                183,650           150,898
Office equipment                                                                         278,166           221,685
Well and pipeline equipment                                                               32,093            32,093
                                                                                    ------------      ------------
                                                                                      24,414,422        17,521,296
Less- Accumulated depreciation, depletion, and amortization                           (1,955,133)       (1,177,816)
                                                                                    ------------      ------------
                                                                                    $ 22,459,289      $ 16,343,480
                                                                                    ------------      ------------
                                                                                    ------------      ------------
</TABLE>

                                       26

<PAGE>


  6. Other Assets:

<TABLE>
<CAPTION>
                                                                                        1997             1996
                                                                                    ------------      ------------
<S>                                                                                 <C>               <C>
Restricted cash and investments - reserve funds                                     $    688,792      $    116,809
Deferred financing costs                                                                 455,116           455,350
Other                                                                                     15,364             5,150
                                                                                    ------------      ------------
                                                                                    $  1,159,272      $    577,309
                                                                                    ------------      ------------
                                                                                    ------------      ------------
</TABLE>

  7. Accounts Payable:

<TABLE>
<CAPTION>
                                                                                         1997             1996
                                                                                    ------------      ------------
<S>                                                                                 <C>               <C>
Trade payables                                                                      $    773,017      $    752,617
Payables to affiliated companies                                                         319,829           444,938
                                                                                    ------------      ------------
                                                                                    $  1,092,846      $  1,197,555
                                                                                    ------------      ------------
                                                                                    ------------      ------------
</TABLE>


  8. Long-Term Debt:

<TABLE>
<CAPTION>
                                                                                        1997             1996
                                                                                    ------------      ------------
<S>                                                                                 <C>               <C>
Note payable to the Industrial Development Authority of Russell County,
    Virginia; interest payable monthly at 9.5%, beginning in March 1997;
    principal payable in maturities of $275,000 to $1,115,000 from 2002 to 2017     $  9,100,000      $       --

Note payable to the Industrial Development Authority of Buchanan County,
    Virginia; interest payable monthly at 9%, beginning in February 1996;
    principal payable in maturities of $5,000 to $342,000 from 1999 to 2020            3,750,000         3,750,000

Note payable to the Industrial Development Authority of Buchanan County,
    Virginia; interest payable monthly at an effective rate of 8.88%, beginning
    in December 1994; principal payable in maturities of $20,000
    to $386,000 from 1995 to 2017                                                      4,009,167         4,110,000

Note payable to the Industrial Development Authority of Russell County,
    Virginia; interest payable monthly at an effective rate of 7.35%, beginning
    in February 1994; principal payable in maturities of $35,000
    to $205,000 from 1996 to 2023                                                      2,682,917         2,717,917

Note payable to Tenneco Energy Resources Corporation; interest at Morgan
    Guaranty prime rate plus 3%; payable in quarterly installments of
    principal plus interest through 1997                                                    --             975,000

Note payable with interest at 8%; payable in monthly installments of principal
    and interest of $1,802 through November 2007; secured by an asset with a
    book value of $172,335 as of December 31, 1997                                       147,688              --

Note payable with interest at 7%; payable in monthly installments of principal
    and interest of $1,099; maturing in February 1999, with a final payment of
    $95,336 secured by an asset with a book value of
    $146,224 as of December 31, 1997                                                     101,504           107,283
</TABLE>


                                       27
<PAGE>

<TABLE>
<S>                                                                                 <C>               <C>
Note payable with interest at 9%; interest payable in semiannual installments,
    maturing October 2024                                                                   --             100,000

Note payable to the Industrial Development Authority of Washington County,
    Virginia with interest at 9.25%; payable in monthly installments of
    principal and interest of $2,872 through October 1999; secured by an asset
    with a book value of $101,932 as of December 31, 1997                                 57,922            85,626


Note payable to Virginia Gas Distribution Company; interest payable at 9%;
    principal payable in maturities of $1,000 to $91,000 from 1999 to 2020                  --           1,000,000

Note payable to Virginia Gas Distribution Company; interest payable at 7.35%;
    principal payable in maturities of $5,000 to $30,000 from 1996 to 2023                  --             395,333

Note payable to Virginia Gas Storage Company; interest payable at 8%;
    balance due December 1997                                                               --              70,000

Notes payable through 2001 with interest from 9% to 10.75%; secured by assets
    with a book value of $97,166 as of December 31, 1997                                  97,835            71,060
                                                                                    ------------      ------------
                                                                                      19,947,033        13,382,219
Less- Current portion                                                                   (218,611)       (1,244,490)
                                                                                    ------------      ------------
Long-term debt                                                                      $ 19,728,422      $ 12,137,729
                                                                                    ------------      ------------
                                                                                    ------------      ------------
</TABLE>


In February 1997, the Industrial Development Authority of Russell County,
Virginia (the "Russell County Authority"), issued its Subordinated Natural Gas
Facilities Revenue Bonds Series 1997 with principal of $9,100,000. The bonds are
payable from and are secured by a promissory note issued by the Company to the
Russell County Authority. A portion of the proceeds was loaned to an affiliated
company and is being used to construct a natural gas distribution facility in
and around the town of Lebanon, Virginia, and for related storage and pipeline
facilities.

In December 1995, the Industrial Development Authority of Buchanan County,
Virginia (the "Buchanan County Authority"), issued its Senior Subordinated
Natural Gas Facilities Revenue Bonds Series 1995 with principal of $3,750,000.
The bonds are payable from and are secured by a promissory note issued by the
Company to the Buchanan County Authority. A portion of the proceeds was loaned
to affiliated companies and is being used to extend existing natural gas
distribution facilities in and around the town of Grundy, Virginia, and for
related supporting pipeline gathering and storage facilities.

In January 1994, the Russell County Authority issued its Natural Gas Revenue
Bond Series A and B with combined principal of $3,000,000. The bonds are payable
from and are secured by a promissory note issued by the Company to the Russell
County Authority. The proceeds were loaned by the Company to affiliated
companies to construct a natural gas distribution facility in and around the
town of Castlewood, Virginia, and for related supporting exploration and
production, pipeline and storage facilities in the amount of $2,630,000 and to
retire $370,000 of long-term debt.


                                       28
<PAGE>


In November 1994, the Buchanan County Authority issued its Natural Gas Revenue
Bond Series A with principal of $4,250,000. The bonds are payable from and are
secured by a promissory note issued by the Company to the Buchanan County
Authority. The bonds were also issued in parity with the Russell County Bonds
discussed above. A portion of the proceeds was loaned to affiliated companies
and is being used to construct a natural gas distribution facility in and around
the town of Grundy, Virginia, and for related supporting exploration and
production, pipeline, and storage facilities.

On February 29, 1996, the Company purchased the interest of its joint venture
partner in the development of the Saltville, Virginia, natural gas storage
facility. The purchase price of the interest was $2,225,000, with consideration
consisting of a $500,000 payment in March 1996 and the issuance of a promissory
note for $1,725,000. The former joint venture partner retains the option to
jointly develop with the Company on a 50-50 percent basis any additional storage
caverns on the Saltville property.

As of December 31, 1997, principal payments on long-term debt for the next five
years are as follows:

<TABLE>
<S>                                                                <C>
          1998                                                     $     218,611
          1999                                                           362,241
          2000                                                           188,853
          2001                                                           255,317
          2002                                                           514,793
</TABLE>

Based upon the borrowing rates currently available to the Company for loans with
similar terms and remaining maturities, the approximate fair value of long-term
debt at December 31, 1997 and 1996, is approximately $20,201,000 and $12,972,000
respectively.

  9. Stockholders' Equity:

References to the common stock of the Company in these financial statements and
in the accompanying notes reflect retroactive application of an increase in the
number of authorized shares from 20,000 to 10,000,000 and a 103.1667 per share
stock split, effected June 1996, by the shareholders of the Company. In
conjunction with the stock split, the shareholders also implemented a super
majority provision requiring the vote of 75 percent of the issued and
outstanding shares entitled to vote on any matters involving an amendment to the
certificate of incorporation or the bylaws; the merger, dissolution,
reorganization, or recapitalization of the Company; or the sale of all or
substantially all of the assets of the Company.

In September 1997, the Company completed a secondary offering of its common
stock. The offering resulted in the issuance of an additional 2,300,000 common
shares of the Company at $8.50 per share.

In October 1996, the Company completed an initial public offering of its common
stock. The offering resulted in the issuance of an additional 1,533,000 common
shares of the Company at $6 per share. In connection with the offering, the
Company granted warrants to the underwriter to purchase, on a post-offering
basis, 153,300 shares of the Company's common stock at a purchase price equal to
165 percent of the public offering price, or $9.90 per share.


                                       29
<PAGE>

In August 1996, the company sold 42,000 shares of common stock to an officer of
the Company for $252,000 and made loans to eight employees totaling $240,000
related to the purchase of 40,000 shares of the Company's common stock.

In June 1996 the Company issued warrants on a pro rata basis to shareholders of
record of the Company as of May 17, 1996, to purchase an aggregate of 735,686
shares of the Company's common stock at a purchase price equal to 165 percent of
the planned public offering price per share of $6, or $9.90 per share. In
conjunction with the terms of the agreement under which the preferred stock and
warrants were sold, the Company issued, in June 1996, warrants to the preferred
stockholder to purchase an aggregate of 54,163 shares of the Company's common
stock at a purchase price equal to 165 percent of the planned public offering
price per share of $6, or $9.90 per share. At December 31, 1997, the Company had
a total of 943,149 shares reserved pursuant to the warrants discussed above.

In May 1996, the Company completed a private placement for 800,058 shares of the
Company's common stock, resulting in net proceeds to the Company of $4,401,317.
All shares were sold to a single investor.

In September 1995, the Company issued for $2,000,000 cash consideration 2,000
shares of its Series A nonvoting preferred stock and warrants to purchase common
stock equal to 6 percent of the then outstanding common stock of the Company
(increasing 1 percent per year until September 29, 2000) all to one investment
corporation. In February 1997, the Company redeemed the outstanding 2,000 shares
of preferred stock for the liquidation price of $2,000,000 plus unpaid
dividends.

In conjunction with the issuance of the subordinated indebtedness in April 1993,
the Company issued a warrant entitling the lender to purchase 76,756 shares of
the Company's common stock at $6.46 per share. Concurrent with the issuance of
the warrant, the Company issued stock options to the lender to purchase a number
of common shares sufficient for the lender to maintain 14 percent of the
ownership of the Company's common stock on a fully diluted basis. The options
granted the lender the right to purchase the common stock at 66 percent of the
issue price of any proposed common stock offerings. In July 1996, the Company
negotiated a release with the lender and paid $975,000 to the lender in exchange
for the cancellation of the lender's warrant and options.

10.  Stock Options:

The Company has granted certain management and directors stock options that
allow the individual to purchase previously unissued common shares at a set
price. The exercise prices of options granted approximate the estimated fair
market value, as determined by the Board of Directors, of the Company's common
stock as of the grant date. At December 31, 1996, the Company was also obligated
to grant options to certain members of management upon issuance of additional
shares of the Company's common stock to ensure that these employees' portion of
the Company's outstanding common stock will not become diluted. The Company's
obligation was cancelled during 1997.

On July 1, 1997, the Company issued to certain of its officers and employees
options to purchase 120,000 shares of the Company's common stock at an exercise
price of $10 per share. The options are subject to a three-year vesting period
from July 1, 1997 until June 30, 2000. The options expire on June 30, 2002. None
of the options outstanding at December 31, 1997 are currently exercisable.


                                       30
<PAGE>


Changes in the options outstanding during the years ended December 31, 1997 and
1996, were as follows:

<TABLE>
<CAPTION>
                                                                      Weighted-Average
                                                                           Exercise
                                                                           Price Per
                                                        Shares               Share
                                                       --------             --------
<S>                                                    <C>            <C>
Outstanding, December 31, 1995                           14,650               $8.72
    Granted                                              70,004               $8.72
                                                       --------
Outstanding, December 31, 1996                           84,654               $8.72
    Granted                                              43,266               $8.72
    Granted                                             120,000              $10.00
    Cancelled                                          (137,920)              $8.81
                                                       --------
Outstanding, December 31, 1997                          110,000              $10.00
                                                       --------
                                                       --------
</TABLE>

In 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," and elected to account for its stock options under APB Opinion
No. 25, under which no compensation cost has been recognized. Had compensation
cost for these stock options been determined in accordance with SFAS No. 123,
the Company's net income and earnings per share would have been reduced by
approximately $28,000 ($.01 per share) in 1997, and would not have been
materially different from amounts reported for 1996. The weighted average fair
value of options granted during 1997 and 1996 was approximately $3.80 and $1.00,
respectively.

The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option-pricing model. The following weighted average
assumptions were used for grants in 1997 and 1996, respectively: risk-free rate
of return of 6.3% and 6.0%; expected dividend yield of .71% and .67%; expected
time of exercise of five and three years; expected volatility of 34% in both
years.

11.  Commitments and Contingent Liabilities:

Certain of the Company's leases require the Company to pay minimum royalties or
rentals. The aggregate minimum royalty and rental payments on leases for the
next five years are as follows.


<TABLE>
<S>                                                              <C>
          1998                                                   $  38,746
          1999                                                      34,278
          2000                                                      30,728
          2001                                                      29,828
          2002                                                      26,886
</TABLE>

The Company is subject to various Federal, state, and local laws and regulations
relating to the protection of the environment. The Company believes that it is
in compliance with these laws and regulations and does not expect to incur
significant capital expenditures in future years to maintain compliance.


                                       31
<PAGE>

12.  Sales to Major Customers:

One of the Company's customers accounted for 22 percent and 31 percent of
consolidated operating revenue for the years ended December 31, 1997 and 1996.
One customer accounted for 16 percent, one customer accounted for 14 percent,
while another customer accounted for 13 percent, respectively, of 1997
consolidated operating revenue.

13.  Income Taxes:

The components of the provision for income taxes are as follows:

<TABLE>
<CAPTION>
                                                   1997                  1996
                                                ---------              ---------
<S>                                             <C>                    <C>
Current:
    Federal                                     $   2,669              $  10,231
    State                                            --                     --
                                                ---------              ---------
                                                    2,669                 10,231
                                                ---------              ---------
Deferred:
    Federal                                       305,082                124,985
    State                                          (9,088)                16,611
                                                ---------              ---------
                                                  295,994                141,596
                                                ---------              ---------
                                                $ 298,663              $ 151,827
                                                ---------              ---------
</TABLE>


The components of deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                          1997           1996
                                                       ----------     ----------
<S>                                                    <C>            <C>
Deferred tax assets:
    Minimum tax credit carryforwards                   $  111,615     $  104,609
    Net operating loss carryforward                       146,456         86,910
                                                       ----------     ----------
                  Total                                   258,071        191,519
                                                       ----------     ----------
Deferred tax liabilities:
    Capital assets                                      1,183,979        821,433
                                                       ----------     ----------
                  Net deferred tax liabilities         $  925,908     $  629,914
                                                       ----------     ----------
                                                       ----------     ----------
</TABLE>


The Company has no valuation allowances as of December 31, 1997 and there were
no changes in the valuation allowance during the years ended December 31, 1997
or 1996.

A reconciliation of the tax provision at the statutory Federal income tax rate
and the Company's actual provision for income tax is as follows:

<TABLE>
<CAPTION>
                                                         1997           1996
                                                       ---------      ---------
<S>                                                    <C>            <C>
Tax at statutory rate of 34%                           $ 410,132      $ 258,194
Equity in earnings of affiliated companies               (73,752)      (115,576)
State income taxes, less Federal benefit                  (5,998)        10,963
Statutory depletion in excess of cost depletion          (27,670)       (26,693)
Other, net                                                (4,049)        24,939
                                                       ---------      ---------
                                                       $ 298,663      $ 151,827
                                                       ---------      ---------
                                                       ---------      ---------
</TABLE>

                                       32
<PAGE>

In addition, the Company has minimum tax credits that can be carried forward
indefinitely to offset future regular tax. The aggregate amount of minimum tax
credits available at December 31, 1997, is $111,615.

14.  Employment Commitments:

On May 23, 1996, the Company entered into a ten-year employment contract with
its President and CEO (the "President"), which provides for an annual salary of
$155,000. The contract provides for a bonus to be paid based upon 10 percent of
the Company's pretax earnings on all amounts from $1,000,000 to $1,999,999 and
15 percent of the Company's pretax earnings on all amounts in excess of
$2,000,000. The President's bonus for 1996 was $50,000. If the President is
terminated by the Company for any reason other than for cause during the term of
the employment contract, at the President's election, the Company would be
obligated to purchase all or a portion of the shares held by him and his family
(382,563 shares as of December 31, 1997 and 1996) at a price equal to 150
percent of the market value of the Company's shares on the date of termination.
In addition, the Company would be obligated to pay the President in a lump sum
all salary amounts owed through the term of the employment agreement plus an
additional $2,000,000.

15.  Subsequent Event:

On March 19, 1998, the Company completed a significant financing arrangement
with the John Hancock Mutual Life Insurance Companies. Under the terms of the
arrangement, Virginia Gas Company issued to John Hancock $24 million of 8.5%
senior notes due 2012. With the proceeds, the Company retired approximately
$19.5 million of industrial revenue bonds which had an average interest rate of
9%. The remaining proceeds will be used to develop segments of the Company's
pipeline expansion projects and to fund other planned corporate expansions. In
addition, the retirement of the industrial revenue bonds released, for the
Company's use, another $2.1 million (including interest earned through March 19,
1998) of reserve funds associated with the issuance of the bonds. These funds
will also be used to fund planned corporate expansions.

As a result of the refinancing described above, the Company will incur, during
the first quarter of 1998, a one time after tax charge to earnings of
approximately $815,000. This is due to accelerated amortization of issue costs
previously expensed over the term of the industrial revenue bonds, and
defeasement premiums, interest, and fees associated with the 1994 Russell
County bond issue.

                                       33
<PAGE>



Item 8. Changes in and Disagreements with Accountants on Accounting and
        Financial Disclosure

         In January, 1996 the Company retained Arthur Andersen LLP as its
independent public accountants. Another auditor had served in this capacity
since 1992. There were no disagreements with the former auditors on any matter
of accounting principles or practices, financial statement disclosure or
auditing scope or procedures at the time of the change with respect to the
Company's financial statements which, if not resolved to the former auditors'
satisfaction, would have caused them to make reference to the subject matter of
the disagreement in connection with their reports. The former auditors' reports
did not contain an adverse opinion or disclaimer of opinion and were not
modified as to uncertainty, audit scope or accounting principles. Prior to
retaining Arthur Andersen LLP, the Company had not consulted with Arthur
Andersen LLP regarding accounting principles.

                                    Part III

Item 9.  Directors and Executive Officers of the Company

         Information required by this item is omitted pursuant to Instruction E
of Form 10-KSB as the Company's definitive proxy statement for the Annual
Meeting of Stockholders will be filed with the Securities and Exchange
Commission ("SEC") not later than 120 days after December 31, 1997. The
information provided in the definitive proxy statement is incorporated herein by
reference.

Item 10. Executive Compensation

         Information required by this item is omitted pursuant to Instruction E
of Form 10-KSB as the Company's definitive proxy statement for the Annual
Meeting of Stockholders will be filed with the Securities and Exchange
Commission ("SEC") not later than 120 days after December 31, 1997. The
information provided in the definitive proxy statement is incorporated herein by
reference.

Item 11. Security Ownership of Certain Beneficial Owners and Management

         Information required by this item is omitted pursuant to Instruction E
of Form 10-KSB as the Company's definitive proxy statement for the Annual
Meeting of Stockholders will be filed with the Securities and Exchange
Commission ("SEC") not later than 120 days after December 31, 1997. The
information provided in the definitive proxy statement is incorporated herein by
reference.

Item 12. Certain Relationships and Related Transactions

         Information required by this item is omitted pursuant to Instruction E
of Form 10-KSB as the Company's definitive proxy statement for the Annual
Meeting of Stockholders will be filed with the Securities and Exchange
Commission ("SEC") not later than 120 days after December 31, 1997. The
information provided in the definitive proxy statement is incorporated herein by
reference.


                                       34
<PAGE>


Item 13. Exhibits and Reports on Form 8-K

The following exhibits are included:


        Exhibit                  Description of Exhibit
       --------                  ----------------------
         3.1      Amended and Restated Certificate of Incorporation
                  (incorporated by reference to Exhibit 3.1 to Virginia Gas
                  Company's Registration Statement, Registration No.
                  333-5362-NY).
         3.2      Bylaws (incorporated by reference to Exhibit 3.2 to Virginia
                  Gas Company's Registration Statement, Registration No.
                  333-5362-NY).
         4.1      Specimen Common Stock Certificate (incorporated by reference
                  to Exhibit 4.1 to Virginia Gas Company's Registration
                  Statement, Registration No. 333-5362-NY).
         4.2      Loan Agreement between Industrial Development Authority of
                  Russell County, Virginia and Virginia Gas Company
                  (incorporated by reference to Exhibit 4.2 to Virginia Gas
                  Company's Form SB-2 Registration No. 333-32009)
         4.3      Promissory Note between Industrial Development Authority of
                  Russell County, Virginia and Virginia Gas Company
                  (incorporated by reference to Exhibit 4.3 to Virginia Gas
                  Company's Form SB-2 Registration No. 333-32009)
         4.4      Loan Agreement between Industrial Development Authority of
                  Buchanan County, Virginia and Virginia Gas Company
                  (incorporated by reference to Exhibit 4.4 to Virginia Gas
                  Company's Form SB-2 Registration No. 333-32009)
         4.5      Promissory Note between Industrial Development Authority of
                  Buchanan County, Virginia and Virginia Gas Company
                  (incorporated by reference to Exhibit 4.5 to Virginia Gas
                  Company's Form SB-2 Registration No. 333-32009)
         9.1      Shareholders' Agreement and Voting Trust (incorporated by
                  reference to Exhibit 9.1 to Virginia Gas Company's
                  Registration Statement, Registration No. 333-5362-NY).
         10.1     Series A Preferred Stock Securities Purchase Agreement by and
                  between Virginia Gas Company and Sirrom Capital Corporation
                  (incorporated by reference to Exhibit 10.1 to Virginia Gas
                  Company's Registration Statement, Registration No.
                  333-5362-NY).
         10.2     Stock Purchase Warrant issued by Virginia Gas Company to
                  Sirrom Capital Corporation (incorporated by reference to
                  Exhibit 10.2 to Virginia Gas Company's Registration Statement,
                  Registration No. 333-5362-NY).
         10.3     Placement Agreement between Virginia Gas Company and Anderson
                  & Strudwick, Incorporated (incorporated by reference to
                  Exhibit 10.3 to Virginia Gas Company's Registration Statement,
                  Registration No. 333-5362-NY).
         10.4     Warrant to Anderson & Strudwick Incorporated (incorporated by
                  reference to Exhibit 4.2 to Virginia Gas Company's Form SB-2
                  Registration No. 333-5362-NY)
         10.5     Employment Agreement between Virginia Gas Company and Michael
                  L. Edwards (incorporated by reference to Exhibit 10.6 to
                  Virginia Gas Company's Registration Statement, Registration
                  No. 333-5362-NY).


                                       35
<PAGE>


        Exhibit                  Description of Exhibit
       --------                  ----------------------

         10.6     Lease Agreement between J.D. Morefield, et.al. and Virginia
                  Gas Company (incorporated by reference to Exhibit 10.7 to
                  Virginia Gas Company's Registration Statement, Registration
                  No. 333-5362-NY).
         10.7     Firm Gas Storage Agreement between Virginia Gas Storage
                  Company and Roanoke Gas Company (incorporated by reference to
                  Exhibit 10.8 to Virginia Gas Company's Form SB-2 Registration
                  No. 333-32009).
         10.8     Firm Storage Service Agreement between Virginia Gas Storage
                  Company and Powell-Clinch Utility District (incorporated by
                  reference to Exhibit 10.9 to Virginia Gas Company's
                  Registration Statement, Registration No. 333-5362-NY).
         10.9     Firm Storage Service Agreement between Virginia Gas Storage
                  Company and the Public Utility District of Jefferson and Cocke
                  Counties, Tennessee (incorporated by reference to Exhibit
                  10.10 to Virginia Gas Company's Registration Statement,
                  Registration No. 333-5362-NY).
         10.10    Gas Storage Agreement between Virginia Gas Storage Company and
                  United Cities Gas Company (incorporated by reference to
                  Exhibit 10.11 to Virginia Gas Company's Registration
                  Statement, Registration No. 333-5362-NY).
         10.11    Firm Gas Storage Agreement between Virginia Gas Storage
                  Company and Knoxville Utilities Board (incorporated by
                  reference to Exhibit 10.12 to Virginia Gas Company's
                  Registration Statement, Registration No. 333-5362-NY).
         10.12    Winter Service Firm Natural Gas Sales Agreement between
                  Virginia Gas Storage Company and Knoxville Utilities Board
                  (incorporated by reference to Exhibit 10.13 to Virginia Gas
                  Company's Registration Statement, Registration No.
                  333-5362-NY).
         10.13    Agreement for Construction, Ownership and Operation of the
                  Haysi Gathering System between Virginia Gas Storage Company
                  and Penn Virginia Resources Corporation (incorporated by
                  reference to Exhibit 10.14 to Virginia Gas Company's
                  Registration Statement, Registration No. 333-5362-NY).
         10.14    Interruptible Gathering Service Agreement between Columbia Gas
                  Transmission Corporation and Virginia Gas Storage Company
                  (incorporated by reference to Exhibit 10.15 to Virginia Gas
                  Company's Registration Statement, Registration No.
                  333-5362-NY).
         10.15    Transfer Agreement between Virginia Gas Company and Tenneco
                  Energy Resources Corporation (incorporated by reference to
                  Exhibit 10.16 to Virginia Gas Company's Registration
                  Statement, Registration No. 333-5362-NY).
         10.16    Amendment to Transfer Agreement between Virginia Gas Company
                  and Tenneco Energy Marketing Company, successor-in-interest to
                  Tenneco Energy Resources Corporation (incorporated by
                  reference to Exhibit 10.17 to Virginia Gas Company's Form
                  10-KSB for the fiscal year ended December 31, 1996)
         10.17    Promissory Note in principal amount of $1,725,000 in favor of
                  Tenneco Energy Resources Corporation (incorporated by
                  reference to Exhibit 10.17 to Virginia Gas Company's
                  Registration Statement, Registration No. 333-5362-NY).
         10.18    United Cities Contract (incorporated by reference to Exhibit
                  10.18 to Virginia Gas Company's Registration Statement,
                  Registration No. 333-5362-NY).
         10.19    Pipeline Balancing Agreement between East Tennessee Natural
                  Gas Company and Virginia Gas Pipeline Company (incorporated by
                  reference to Exhibit 10.19 to Virginia Gas Company's
                  Registration Statement, Registration No. 333-5362-NY).



                                       36
<PAGE>


        Exhibit                  Description of Exhibit
       --------                  ----------------------

         10.20    Warrant to Shareholders (incorporated by reference to Exhibit
                  10.20 to Virginia Gas Company's Registration Statement,
                  Registration No. 333-5362-NY).
         10.21    Firm Storage Service Agreement between Virginia Gas Storage
                  Company and Sevier County Utility District (incorporated by
                  reference to Exhibit 10.22 to Virginia Gas Company's Form
                  10-KSB for the fiscal year ended December 31, 1996)
         10.22    Firm Storage Service Agreement between Virginia Gas Storage
                  Company and Natural Gas Utility District of Hawkins County
                  (incorporated by reference to Exhibit 10.23 to Virginia Gas
                  Company's Form 10-KSB for the fiscal year ended December 31,
                  1996)
         10.23    Firm Storage Service Agreement between Virginia Gas Pipeline
                  Company and Citizens Gas Utility District (incorporated by
                  reference to Exhibit 10.24 to Virginia Gas Company's Form
                  10-KSB for the fiscal year ended December 31, 1996)
         10.24    Firm Gas Storage Agreement between Virginia Gas Pipeline
                  Company and Knoxville Utilities Board (incorporated by
                  reference to Exhibit 10.25 to Virginia Gas Company's Form
                  10-KSB for the fiscal year ended December 31, 1996)
         10.25    Underwriting Agreement between Virginia Gas Company and
                  Anderson & Strudwick, Incorporated (incorporated by reference
                  to Exhibit 1.1 to Virginia Gas Company's Form SB-2
                  Registration No. 333-5362-NY)
         10.26    Description of Stock Options issued to named executive
                  officers (incorporated by reference to Exhibit 10.27 to
                  Virginia Gas Company's Form SB-2 Registration No. 333-32009)
         10.27    Amendment to the Firm Storage Service Agreement between
                  Virginia Gas Storage Company and Powell-Clinch Utility
                  District (incorporated by reference to Exhibit 10.28 to
                  Virginia Gas Company's Form SB-2 Registration No. 333-32009)
         10.28    Firm Storage Service Contract between Virginia Gas Pipeline
                  Company and Hawkins County Utility District (incorporated by
                  reference to Exhibit 10.29 to Virginia Gas Company's Form SB-2
                  Registration No. 333-32009)
         10.29    Firm Storage Service Contract between Virginia Gas Pipeline
                  Company and ALCOA (incorporated by reference to Exhibit 10.30
                  to Virginia Gas Company's Form SB-2 Registration No.
                  333-32009)
         10.30    Gas Transportation Agreement between Virginia Gas Distribution
                  Company and East Tennessee Gas Company (incorporated by
                  reference to Exhibit 10.31 to Virginia Gas Company's Form SB-2
                  Registration No. 333-32009)
         10.31    Underwriting Agreement between Virginia Gas Company and
                  Ferris, Baker Watts, Incorporated (incorporated by reference
                  to Exhibit 1.1 to Virginia Gas Company's Form SB-2
                  Registration No. 333-32009)
         21.1     Subsidiaries and Affiliates of Virginia Gas Company
                  (incorporated by reference to Exhibit 21.1 to Virginia Gas
                  Company's Form 10-KSB for the fiscal year ended December 31,
                  1996)
*        27.1     Financial Data Schedule
*        99.1     Financial Statements of Virginia Gas Storage Company
                      Report of Independent Public Accountants
                      Balance Sheets
                      Statements of Income
                      Statements of Stockholders' Equity
                      Statements of Cash Flows
                      Notes to Financial Statements


                                       37
<PAGE>

        Exhibit                  Description of Exhibit
       --------                  ----------------------

*        99.2     Financial Statements of Virginia Gas Distribution Company
                      Report of Independent Public Accountants
                      Balance Sheets
                      Statements of Income
                      Statements of Stockholders' Equity
                      Statements of Cash Flows
                      Notes to Financial Statements

------------
*   Filed herewith

(b)  Reports on Form 8-K

       No reports on Form 8-K were filed in the fourth quarter of 1997.


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<PAGE>


                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 24, 1998.


VIRGINIA GAS COMPANY
(Registrant)



By  /s/  MICHAEL L. EDWARDS
    ----------------------------
    Michael L. Edwards
    President, Chief Executive Officer, Director,
    and acting Chief Financial Officer



         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 23, 1998.


/s/  EVERETTE G. ALLEN, JR.
    ----------------------------        Director
          EVERETTE G. ALLEN, JR.


/s/  KAREN K. EDWARDS                   Vice President and Director
    ----------------------------
         Karen K. Edwards



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