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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K þ Annual Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2004 o Transition Report Pursuant to Section 13 of 15(d) of the
Securities Exchange Act of 1934 For the transition period from ________ to _________ Commission File Number: 0  13305 PARALLEL PETROLEUM CORPORATION  Delaware
    
    75-1971716(State or Other Jurisdiction of
Incorporation or Organization)
    
    (I.R.S. Employer
Identification No.)
 1004 N. Big Spring, Suite 400
Midland, Texas
    
    79701(Address of Principal Executive
Offices)
    
    (Zip Code)
 Registrants Telephone Number, Including Area Code: (432) 684-3727 Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $.01 par value
Common Stock Purchase Warrants
Rights to Purchase Series A Preferred Stock
(Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ
                   
      No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange
Act Rule 12b-2). Yes þ
                   
      No o The aggregate market value of voting and non-voting common equity held by non-affiliates of
the Registrant as of June 30, 2004 was approximately $116,087,075, based on the closing price of
the common stock on the same date. At March 1, 2005 there were 31,189,292 shares of common stock outstanding.




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FORM 10-K PARALLEL PETROLEUM CORPORATION  
 TABLE OF CONTENTS Item No.
    
    
    PagePART IItem 1. Business
    
    
    1Item 2. Properties
    
    
    33Item 3. Legal Proceedings
    
    
    36Item 4. Submission of Matters to a Vote of Security Holders
    
    
    36PART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
    
    
    37Item 6. Selected Financial Data
    
    
    39Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    41Item 7A. Quantitative and Qualitative Disclosures
About Market Risk
    
    
    63Item 8. Financial Statements and Supplementary Data
    
    
    65Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure
    
    
    66Item 9A. Controls and Procedures
    
    
    67Item 9B. Other Information
    
    
    69PART IIIItem 10. Directors and Executive Officers of the Registrant
    
    
    70Item 11. Executive Compensation
    
    
    75Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters
    
    
    88Item 13. Certain Relationships and Related Transactions
    
    
    91Item 14. Principal Accountant Fees and Services
    
    
    92PART IVItem 15. Exhibits and Financial Statement Schedules    
    
    94Warrant Purchase Agreement, Dated November 20, 2001Warrant Purchase Agreement, Dated December 23, 20031992 Stock Option PlanAgreement of Limited PartnershipConsent of KPMG LLPConsent of BDO Seidman, LLPConsent of Cawley Gillespie & Associates, Inc.Certification of Principal Executive Officer - Section 302Certification of Principal Financial Officer - Section 302Certification of CEO Pursuant to Section 18 U.S.C. Section 1350Certification of CFO Pursuant to Section 18 U.S.C. Section 1350
  (i)




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Cautionary Statement Regarding Forward Looking Statements Some statements contained in this Annual Report on Form 10-K are forward-looking statements.
These forward looking statements relate to, among others, the following:  
    our future financial and operating performance and results;
    our business strategy;
    market prices;
    sources of funds necessary to conduct operations and complete acquisitions;
    development costs;
    number and location of planned wells;
    our future commodity price risk management activities; and
    our plans and forecasts. We have based these forward-looking statements on our current assumptions, expectations and
projections about future events. We use the words may, will, expect, anticipate, estimate, believe, continue,
intend, plan, budget, present value, future or reserves and other similar words to
identify forward-looking statements. These statements also involve risks and uncertainties that
could cause our actual results or financial condition to materially differ from our expectations.
We believe the assumptions and expectations reflected in these forward-looking statements are
reasonable. However, we cannot give any assurance that our expectations will prove to be correct
or that we will be able to take any actions that are presently planned. All of these statements
involve assumptions of future events and risks and uncertainties. Risks and uncertainties
associated with forward-looking statements include, but are not limited to:  
    fluctuations in prices of oil and gas;
    demand for oil and natural gas;
    losses due to potential or future litigation;
    future capital requirements and availability of financing;
    geological concentration of our reserves;
    risks associated with drilling and operating wells;
    competition;
    general economic conditions; (ii)




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
    governmental regulations;  
    receipt of amounts owed to us by purchasers of our production and counterparties to
our hedging contracts;
    hedging decisions, including whether or not to hedge;
    events similar to 911;
    actions of third party co-owners of interests in properties in which we also own an
interest; and
    fluctuations in interest rates and availability of capital. For these and other reasons, actual results may differ materially from those projected or
implied. We believe it is important to communicate our expectations of future performance to our
investors. However, events may occur in the future that we are unable to accurately predict, or
over which we have not control. We caution you against putting undue reliance on forward-looking
statements or projecting any future results based on such statements. Before you invest in our common stock, you should be aware that there are various risks associated
with an investment. We have described some of these risks in other sections of this Annual Report
on Form 10-K and under Risks Related to Our Business beginning on page 20. (iii)




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PART I 
  ITEM 1. BUSINESS
 About Our Company Parallel Petroleum Corporation and its subsidiaries are engaged in the acquisition,
development and exploitation of long life oil and natural gas reserves and, to a lesser extent, the
exploration for new oil and natural gas reserves. Our current producing properties are in the:  
    Permian Basin of west Texas and New Mexico;
    Liberty County in east Texas; and
    the onshore Gulf Coast area of south Texas. In addition, we are actively evaluating, leasing, drilling and preparing to drill on new
projects located in the Abo gas trend of New Mexico, the Barnett Shale gas trend of the Fort Worth
Basin, the Cotton Valley Reef trend of east Texas and the Uinta Basin of Utah. In 2004, we spent approximately $67.9 million on oil and gas related capital expenditures, an
increase of approximately 348% over that expended in 2003 (See Note 3 to the consolidated
financial statements). This amount includes approximately $37.4 million of acquisition costs for
properties we acquired during the period from September, 2004 to December, 2004. In September and
October 2004, we acquired additional non-operated working interests in properties located in
Andrews County, Texas for a total of $20.9 million. In October and December 2004, we acquired
properties in Andrews and Gaines counties, Texas for approximately $16.5 million. In January 2005
we acquired additional interests in the Andrews and Gaines properties we acquired in October and
December 2004. The net purchase price for these additional interests was approximately $1.5
million. Throughout this report, we refer to some terms that are commonly used and understood in the
oil and gas industry. These terms are: 
    
    Bbls
    
    -
    
    barrels of oil or other liquid hydrocarbons;
    
    Bcf
    
    -
    
    billion cubic feet of natural gas;
    
    BOE
    
    -
    
    equivalent barrel of oil or 6 Mcf of natural gas for one barrel of oil;
    
    MBbl
    
    -
    
    thousand barrels of oil or other liquid hydrocarbons;
    
    MBOE
    
    -
    
    thousand barrels of oil equivalent;
    
    MMBbl
    
    -
    
    million barrels of oil or other liquid hydrocarbons;
 (1)




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
    
    MMBOE
    
    -
    
    million barrels of oil equivalent;
    
    Mcf
    
    -
    
    thousand cubic feet of natural gas; and
    
    MMcf
    
    -
    
    million cubic feet of natural gas.
 Parallel was incorporated in Texas on November 26, 1979, and reincorporated in the State of
Delaware on December 18, 1984. Our executive offices are located at 1004 N. Big Spring, Suite 400, Midland, Texas 79701. Our
telephone number is (432) 684-3727. Available Information You may read and copy any materials we file with, or furnish to, the Securities and Exchange
Commission at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549.
You may obtain information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The SEC maintains an Internet site (http://www.sec.gov) that contains
reports, proxy and information statements, and other information regarding issuers, including
Parallel, that file electronically with the SEC. Our
website address is http://www.plll.com. Information on our website or any other website
is not incorporated by reference into this Annual Report on Form 10-K and does not constitute a
part of this Annual Report on Form 10-K. We make available free of charge on our Internet website our annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as
reasonably practicable after we electronically file such material with, or furnish it to, the SEC. We will provide electronic or paper copies of our SEC filings free of charge upon request made
to: Cindy Thomason, Manager of Investor Relations, cindyt@plll.com, 1-800-299-3727. Recent Developments From September 2004 through January 18, 2005, we effected a series of oil and gas property
acquisitions in Andrews and Gaines counties, Texas for an aggregate net purchase price of
approximately $38.9 million. Cawley Gillespie & Associates, Inc., our independent petroleum
engineers, estimated that the recently acquired properties (excluding the properties acquired after
December 31, 2004) contain aggregate proved reserves of approximately 5.19 MMBoe with estimated
future net cash flows, discounted at an annual rate of 10%, of approximately $60.9 million at
December 31, 2004. Our 2005 capital investment budget for properties we owned at March 1, 2005 is estimated to be
approximately $43.7 million, which includes $7.0 million for the purchase of (2)




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leasehold and seismic in our areas of activity. The budget will be funded from our estimated
operating cash flows, which is based on anticipated commodity prices and forecasted production
volumes, bank borrowings and equity proceeds. The amount and timing of expenditures are subject to
change based upon market conditions, results of expenditures, new opportunities and other factors. On February 9, 2005, we sold 5,750,000 shares of common stock, $.01 par value per share, in a
public offering at a price of $5.27 per share. Gross proceeds were $30.3 million, and net proceeds
were approximately $28.0 million. The common shares were issued under our $100.0 million universal
shelf registration statement on Form S-3 which became effective in November 2004. Proved Reserves as of December 31, 2004 Cawley Gillespie & Associates, Inc. estimated the total proved reserves attributable to all of
our oil and gas properties to be 18.9 million Bbls of oil and 16.8 Bcf of natural gas as of
December 31, 2004. Based on oil and gas prices at December 31, 2004 and current operating and
development costs, the present value of our pretax future net revenues from these properties,
discounted at 10%, was estimated to be approximately $266.2 million as of December 31, 2004. Approximately 87% of our proved reserves are oil and approximately 86% are categorized as
proved developed reserves. About Our Strategy and Business From 1993 until mid 2002, our activities were concentrated in the onshore gulf coast area of
south Texas. In June, 2002 we reexamined and revised our business strategy. We shifted the
balance of our investments from properties having high rates of production in early years to
properties with more consistent production over a longer term. We now emphasize reducing drilling
risks by dedicating a smaller portion of our capital to high risk projects, while reserving the
majority of our available capital for exploitation, enhancement and development drilling
opportunities. Obtaining positions in long-lived oil and gas reserves is given priority over
properties that might provide more cash flow in the early years of production, but which have
shorter reserve lives. Our risk reduction efforts also include emphasizing acquisition
possibilities over high risk exploration projects. Since the latter part of 2002, we have reduced the emphasis on high risk exploration efforts
and we now focus on established geologic trends where we can utilize the engineering, operational,
financial and technical expertise of our entire staff. Although we will continue to participate in
exploratory drilling activities from time to time, reducing financial, reservoir, drilling and
geological risks and diversifying our property portfolio are the principal criteria in the
execution of our business plan. In summary, our current business plan:  
    focuses on projects having less geological risk;
    emphasizes exploitation and enhancement activities; (3)




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
    focuses on acquiring producing properties; and
    expands the scope of our operations by diversifying our exploratory and
development efforts, both in and outside of our current areas of operation. An integral part of our business strategy includes exploitation and enhancement activities.
Exploitation and enhancement activities include:  
    operational enhancements, such as surface facility reconfiguration, and the
installation of new or additional compression equipment;
    workovers;
    well recompletions;
    behind-pipe recompletions;
    refracing (restimulating a producing formation within an existing wellbore to
enhance production and add reserves);
    installation of injection wells and related facilities;
    development well drilling (infill drilling);
    cost reduction programs; and
    secondary recovery operations, including waterfloods. When we initiate exploitation and enhancement activities on our existing producing properties,
we first establish and maintain an ongoing program of oil and gas well reviews with the objective
of maximizing the output of existing wells. Oil and gas wells usually generate their highest
volumes during the earlier stages of production after which production begins to decline.
Enhancement and remedial work can be undertaken to restore varying amounts of the lost production
or reduce the rate of production decline. Our approach to producing property acquisitions, and the size and timing of any acquisition,
is dependent upon market conditions in the domestic oil and gas industry. Generally, during
periods of moderate to high prices for oil and gas, we believe that oil and gas acquisition
opportunities are not as favorable to a prospective purchaser as they are when market conditions
are depressed. Producing properties that we identify and attempt to acquire will include properties that have
proved undeveloped and behind-pipe reserves, operational enhancement potential, long-lived
reserves, multiple pay-zone exploitation and development drilling opportunities, and the potential
for operating control. Selecting and acquiring producing properties having these characteristics
will diversify and improve the quality of our property portfolio. (4)




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Although purchases of producing properties involve less risk than drilling, there is a risk
that estimates of future prices or costs, reserves, production rates or other criteria upon which
we have based our investment decision may prove to be inaccurate. In addition to acquisitions of producing properties, our business strategy also includes
seeking opportunities to negotiate and enter into work to earn, joint venture and similar
agreements with third parties for development operations on producing properties. Our sources for possible acquisitions of leases and prospects include independent landmen,
independent oil and gas operators, geologists and engineers. We also evaluate properties that
become available for purchase. If our review of an undeveloped lease or prospect or a producing
property indicates that it may have geological characteristics favorable for 3-D seismic analysis,
we may decide to acquire a working interest in the property or an option to acquire a working
interest. In the case of producing properties, we also seek properties that we believe are
underperforming relative to their potential. To reduce our financial exposure in any one prospect,
we may enter into co-ownership arrangements with third parties. These arrangements are common in
the industry and enable us to participate in more prospects and share the drilling and related
costs and dry-hole risks with other participants. From time to time, we sell prospects to third
parties or farm-out prospects and retain an interest in revenues from these prospects. As we have in the past, we will continue to: (1) Use Advanced Technologies. We believe the use of 3-D seismic surveys and other
advanced technologies provides us with a risk management tool. We believe that our use of these
technologies in exploring for and developing oil and gas properties can:  
    reduce drilling risks;
    lower finding costs;
    provide for more efficient production of oil and natural gas from our properties;
and
    increase the probability of locating reserves that might not otherwise be
discovered. Generally, 3-D seismic surveys provide more accurate and comprehensive information to evaluate
drilling prospects than conventional 2-D seismic technology. We evaluate substantially all of our
exploratory prospects using 3-D seismic technology. On some exploratory prospects, we also use
amplitude versus offset, or AVO analysis. AVO analysis shows the high contrast between sands and
shales and assists in determining the presence of natural gas in potential reservoir sands. We believe that using 3-D seismic, AVO and other technologies gives us a competitive advantage
because of the increased likelihood of successful drilling. When we evaluate exploratory prospects
in geographical areas where the use of 3-D seismic and other advanced technologies are not likely
to provide any advantages, we use traditional evaluation methods, such as 2-D seismic technology. (5)




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(2) Serve as Geophysical Operator. We prefer to serve as the geophysical operator on
projects located in areas where we have experience using 3-D seismic technology. By doing so, we
control the design, acquisition, processing and interpretation of 3-D surveys and, in most cases,
determine drilling locations and well depths. The integrity of 3-D seismic analysis in our
projects is enhanced by emphasizing quality controls throughout the data acquisition, processing
and interpretation phases. We retain experienced outside consultants and participate with knowledgeable joint working
interest owners when we acquire, process and interpret 3-D seismic surveys. When possible, we also
attempt to correlate or model the interpretations of 3-D seismic surveys with wells previously
drilled on or near the prospect being evaluated. (3) Conduct Exploratory Activities. Although we do not intend to emphasize
exploratory drilling to the extent we have in the past, when we do undertake exploratory projects,
we will continue to focus on prospects:  
    having known geological and reservoir characteristics;
    being in close proximity to existing wells so data from the existing wells
can be correlated with seismic data on or near the prospect being evaluated;
and
    having a potentially meaningful impact on our reserves. When economic conditions are favorable and when we have sufficient capital resources, we
believe we can maximize the value of our properties by accelerating drilling activities. This
provides us an opportunity to replace reserves at a more rapid pace than existing reserves are
produced. Drilling Activities in 2004 The following table shows our drilling activities, by geographic area, during 2004. Number of WellsNumber of
    
    
    Drilling or
    
    
    GrossDepth Range
    
    Gross
    
    
    Waiting on Completion
    
    
    Productive
    
    
    GrossArea
    
    (feet)
    
    Wells Drilled
    
    
    at December 31, 2004
    
    
    Wells
    
    
    Dry WellsNorth TexasBarnett Shale
    
    7,000 - 8,000
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    Permian BasinAbo Gas
    
    4,300 - 4,500
    
    
    5
    
    
    
    
    
    
    
    5
    
    
    
    Diamond M (Shallow)
    
    2,400 - 3,500
    
    
    30
    
    
    
    
    
    
    
    30
    
    
    
    Fullerton
    
    4,000 - 5,000
    
    
    8
    
    
    
    
    
    
    
    8
    
    
    
    East TexasCotton Valley
    
    16,000 - 18,000
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    Onshore Gulf Coast of TexasYegua
    
    6,300 - 13,000
    
    
    4
    
    
    
    
    
    
    
    4
    
    
    
    Shallow Frio
    
    3,000 - 6,300
    
    
    2
    
    
    
    
    
    
    
    1
    
    
    
    1Deep Frio
    
    8,000 - 11,000
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Cook Mountain
    
    11,000 - 15,000
    
    
    8
    
    
    
    
    
    
    
    6
    
    
    
    2Texas Panhandle
    
    6,000 - 6,000
    
    
    11
    
    
    
    2
    
    
    
    9
    
    
    
    71
    
    
    
    4
    
    
    
    63
    
    
    
    4
 (6)




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From 1993 until mid 2002, we concentrated our activities in the Yegua/Frio/Wilcox gas
trends in the onshore Gulf Coast area of south Texas in Dewitt, Jackson, Lavaca, Victoria and
Wharton Counties. Substantially all of our drilling success in south Texas has been in the
Yegua/Frio gas trend and we intend to continue drilling additional lower risk 3-D seismic
development wells in this trend. Although the successful wells we drilled in the Yegua/Frio trend
provided quick payouts of our drilling and completion costs, the reserve lives of the properties in
this area have proven to be very short as compared to our properties in the Permian Basin. As we announced in October 2003, consistent with our strategy of reducing geologic risk, we
began to diversify our exploration efforts into other oil and gas trends. However, and as planned,
the majority of our drilling in 2004 was in south and east Texas. We believe we can more fully develop our existing producing properties in the Permian Basin of
west Texas, which have been proven by previous drilling. Collectively, our Permian Basin
properties include approximately 39,000 gross (27,000 net) developed acres, which will provide
significant exploitation and development opportunities for both oil and gas. Additionally, our
Permian Basin properties have longer reserve lives than our South Texas properties. Our
exploitation and enhancement efforts are conducted primarily on our properties in the Permian Basin
of west Texas. We own working interests in these properties ranging from 6.25% to 100%. During 2004, our Permian Basin activities included:  
    producing property acquisitions;
    recompleting existing wellbores;
    restimulating producing reservoirs;
    identifying potential infill drilling locations;
    making mechanical improvements to surface facilities and downhole equipment; and
    reviewing the feasibility of applying new drilling and production technologies that
could either improve recovery potential or result in the discovery of a new reservoir. As part of our remedial and enhancement operations in the Permian Basin, we routinely review
the performance and economics of our oil and gas properties and, from time to time, we may also
renegotiate gas purchase contracts or reconfigure gathering lines. When necessary, we take
corrective action, such as:  
    shutting in temporarily uneconomic properties;
    plugging wells we believe to be permanently impaired or depleted;
    terminating oil and gas leases that are uneconomic under existing operating
conditions; and/or (7)




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
    selling properties to third parties. Drilling and Acquisition Costs The table below shows our oil and gas property acquisition, exploration and development costs
for the periods indicated. Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(in thousands)Transfers from (to) undeveloped
leases held for sale
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    2,128
    (1)Proved property acquisition costs
    
    
    39,763
    
    
    
    2,209
    
    
    
    48,044
    
    
    
    27
    
    
    
    23Unproved property acquisition costs
    
    
    7,400
    
    
    
    3,831
    
    
    
    2,295
    
    
    
    3,420
    
    
    
    3,372Exploration costs
    
    
    6,794
    
    
    
    3,240
    
    
    
    1,291
    
    
    
    6,820
    
    
    
    2,163Development costs
    
    
    13,954
    
    
    
    5,650
    
    
    
    9,308
    
    
    
    1,203
    
    
    
    1,087$
    67,911
    
    
    $
    14,930
    
    
    $
    60,938
    
    
    $
    11,470
    
    
    $
    8,773
   (1)
    
    Reflects costs associated with assets being held for sale in 1999 and transferred back to
oil and gas property in 2000. Actual capital expenditures during 2000, excluding transfers,
were approximately $6.6 million. Capital Investments for 2005 Our 2005 capital investment budget for properties we owned at March 1, 2005 is estimated to be
approximately $43.7 million, which includes $9.6 million for the purchase of leasehold, seismic and
other in our areas of activity. The budget will be funded from our estimated operating cash flows,
which is based on anticipated commodity prices and forecasted production volumes, bank borrowings
and equity proceeds. The amount and timing of expenditures are subject to change based upon market
conditions, results of expenditures, new opportunities and other factors. On a geographic basis, approximately 72.8% of our projected 2005 capital investment program
will be directed toward oil and gas reserves in the Permian Basin, 6.6% to gas reserves in east
Texas and in the onshore Gulf Coast area of south Texas, 17.4% for north Texas Barnett Shale gas
project, and 3.2% to other projects. Permian Basin of West Texas The Permian Basin of west Texas generated approximately 69% of our 2004 production and
represents approximately 90% of our reserve value as of December 31, 2004. Our significant
producing properties in the Permian Basin are described below. Fullerton San Andres Field, Andrews County, TexasThis property generates approximately
44% of our current daily production and represents approximately 48% of our total proved
reserve value as of December 31, 2004. This non-operated property was acquired in December 2002 for approximately $46.1 (8)




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million. During the fourth quarter of 2004, we acquired additional interests in the
property for approximately $20.9 million. Development since the initial acquisition in 2002
has primarily consisted of the re-stimulation of approximately 80 existing producing wells
and the drilling of six new producing wells. We have budgeted approximately $3.7 million to fund the drilling and completion of 13 new
infill wells in the field in 2005. Our average working interest in the Fullerton properties
is approximately 82%. Carm-Ann San Andres Field / N. Means Queen Unit, Andrews & Gaines Counties, TexasThese
properties generate approximately 5% of our current daily production and represent
approximately 11% of our total proved reserve value as of December 31, 2004. In the fourth
quarter 2004 and in 2005, we acquired producing properties in the
Carm-Ann Andres and North Queen Unit located in Andrews and Gaines
Counties, Texas. The combined aggregate net purchase price was
approximately $18.7 million. The properties include 25 leases covering 5,360 gross contiguous acres, with
67 gross producing oil and natural gas wells. This acquisition
established a new core operating area that is located within 50 miles of our Midland, Texas,
headquarters. We have budgeted approximately $4.1 million for the Carm-Ann / N. Means Queen properties in
2005 for 22 workovers and 13 new infill wells. Our average working interest in these
properties is approximately 77%. Diamond M Shallow Leases, Scurry County, TexasThis property generates approximately 4% of
our current daily production and represents approximately 13% of our total proved reserve
value as of December 31, 2004. Development activity on this project during 2004 consisted primarily of the drilling of 12
new producing wells and 18 new injection wells. We have budgeted a total of $5.0 million in 2005 to fund 16 workovers and well conversions
in this project throughout the year and for a 15-well development drilling program during
the fourth quarter of 2005, pending satisfactory waterflood response. Our average working
interest in these properties is approximately 66%. Diamond M Canyon Reef Unit, Scurry County, TexasThis property generates approximately 4%
of our current daily production and represents approximately 9% of our total proved reserve
value as of December 31, 2004. We assumed operations of this project in March 2003. Field activity has primarily consisted
of facility upgrades, geophysical testing, and the reactivation (workover) of two existing
wells during the fourth quarter of 2004. A total of $9.4 million has been budgeted in 2005 to fund the workover of 24 wells, the
drilling of 3 new wells, the acquisition of a new 3-D seismic survey and associated
equipment upgrades. Our average working interest in these properties is approximately 66%. (9)




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New Mexico Abo Gas Project This project generates less than 1% of our current daily
production and represents less than 1% of our total proved reserve value as of December 31,
2004. This project consists of two areas in which the primary target is the Abo formation at a
depth of approximately 5,000 feet. The Abo formation is a known natural gas-producing
reservoir but historically has been marginally economic due to low per-well producing rates
and low natural gas prices. We believe this projects reservoir can be more efficiently
exploited through the application of new horizontal drilling and hydraulic fracture
stimulation technologies. We have budgeted approximately $7.6 million for the New Mexico properties in 2005 for 3
re-entries, 6 new wells, and additional leasehold acquisitions. Area 1 of our Abo Gas Project consists of approximately 60,000 gross (4,800 net) acres. Our
base working interest in this area is approximately 8.5%. Since December 2003, we have
participated in the drilling of six non-operated Abo horizontal gas wells. Three wells are
currently producing to sales. One well, which went to sales in June 2004, is producing
approximately 1,000 gross Mcf of gas per day, and the other two wells are each producing
approximately 100 gross Mcf of gas per day. The other three wells are currently testing. We
believe the two lesser producing wells are performing in a manner similar to historical
vertical wells rather than efficiently completed horizontal wells. Refinement of the
completion process is ongoing. We also have, within Area 1, an approximate 20% working interest in one non-operated well.
The well has been drilled, fracture-stimulated and is currently producing. Area 2 of our Abo Gas Project consists of undeveloped leasehold interests in approximately
61,000 gross (25,500 net) acres, is contiguous to Area 1, and will be operated by Parallel.
We expect the commencement of drilling operations in Area 2 to begin in early 2005 and will
utilize well completion information gained from experience in Area 1. We own an 85.0%
working interest in this area. The estimated cost to drill and complete a horizontal well is approximately $1.6 million.
Based upon the results of the initial wells drilled, we believe this project has the
potential to become a multi-well, long-life gas project that will be developed over the next
three to five years. Other Permian Basin Projects Other Permian Basin projects generate approximately 12% of
our current daily production and represent approximately 9% of our total proved reserve
value as of December 31, 2004. We have budgeted approximately $2.0 million for other Permian Basin properties in 2005,
primarily for lease and well equipment and capitalized overhead. Onshore Gulf Coast of South Texas Yegua/Frio Gas Project, Jackson and Wharton Counties, Texas This project (10)




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generates approximately 23% of our current daily production and represents
approximately 9% of our total proved reserve value as of December 31, 2004. We have
budgeted approximately $0.9 million for the Yegua/Frio gas project in 2005, for the
drilling and completion of 3 wells. Cook Mountain Gas Project, Liberty County, TexasThis project generates approximately 8%
of our current daily production and represents approximately 1% of our total proved reserve
value as of December 31, 2004. We have
budgeted approximately $0.9 million for the Cook Mountain gas project in 2005 for the
drilling and completion of 3 wells. North Texas Barnett Shale Gas Project, Tarrant County, Texas Our development of this project is
expected to begin in the first quarter of 2005. This project does not yet contribute to our
current daily production or reserve value. Our Barnett Shale gas project is located east of downtown Ft. Worth, in Tarrant County,
Texas, between the Newark East Barnett Shale gas field to the north in Tarrant County and
the Cleburne Barnett Shale gas field to the south in Johnson County. Our current leasehold
position in the project is approximately 5,000 gross (1,400 net) acres. Having assembled pipeline right-of-way and permits necessary to complete a gas gathering
infrastructure, Parallel and a Dallas based operator spudded, on March 9, 2005, a horizontal
well, the Brentwood No. 1. Our working interest in this well is 40%. We are currently participating in the Parrot #1 horizontal well, which is operated by a Ft.
Worth based operator. This well is located on leasehold contiguous to our 5,000 gross-acre
leasehold position. The well is currently shut-in waiting on pipeline. Our working
interest in this well is 20%. The estimated cost to drill and complete a horizontal well is approximately $2.0 million.
Based upon the results of the initial wells drilled we believe this project has the
potential to become a multi-well, long-life gas project that will be developed over the next
three to five years. We have budgeted approximately $7.6 million for the Barnett Shale gas project in 2005 for
the drilling and completion of 7 new wells, pipeline construction and leasehold acquisition. Other Projects Utah/Colorado CBM (Coal Bed Methane) Gas/Conventional Oil and Gas Projects Our development
of this project is expected to begin in the first half of 2005. This project does not yet
contribute to our current daily production or reserve value. (11)




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We have increased our leasehold acreage position in this project to approximately 138,000
gross acres. It is a multiple zone project consisting of both oil and gas targets at a
depth of less than 6,000 feet. Seismic and geological data evaluation on this project
continues. We expect to drill a test well during the first half of 2005. We have budgeted approximately $1.4 million for the Utah/Colorado CBM gas project in 2005
for the drilling and completion of 1 well, seismic and leasehold acquisition, and multiple
core test holes for coal-bed methane potential. We own and operate 100% of this project. East Texas Cotton Valley Reef Gas Project This project does not yet contribute to our
current daily production or reserve value. This 3-D seismic gas project is a higher risk profile than our other projects. The
objective is the Cotton Valley barrier reef facies found between depths of 16,000 and 18,000
feet. The project consists of approximately 5,000 gross (650 net) acres. In 2004, the first well was drilled to a total depth of 18,100 feet, finding a non-porous
Cotton Valley Reef interval. The operator is currently attempting completion in shallower
zones. The operator is also re-evaluating seismic to help determine other drilling
locations with optimal porosity potential. We have budgeted approximately $1.1 million for the Cotton Valley Reef gas project in 2005
for the drilling of 1 well and additional leasehold acquisition. We own an approximate
13.125% working interest in this project. Oil and Natural Gas Prices Our revenues, profitability and cash flows are highly dependent on the prices we receive for
our oil and natural gas. Generally, oil and natural gas prices improved and stabilized during the
period from mid-2000 to the third quarter of 2001, when prices began to decline. During the first
quarter of 2002, prices began to increase again and this upward trend in price has continued. The average prices we received for the oil and natural gas we produced in 2004, 2003, and 2002
are shown in the table below. Average Price Received for theYear Ended December 31,2004
    
    
    2003
    
    
    2002Oil (Bbl)
    
    $
    39.05
    
    
    $
    29.11
    
    
    $
    24.59Natural gas (Mcf)
    
    $
    5.85
    
    
    $
    5.40
    
    
    $
    3.33
 (12)




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The average price we received for our oil sales at March 1, 2005 was approximately $40.69
per Bbl, excluding our hedging activities. At the same date, the average price we were receiving
for our natural gas was approximately $6.60 per Mcf, excluding our hedging activities. There is substantial uncertainty regarding future oil and gas prices and we can provide no
assurance that prices will remain at current levels. We have entered into hedge contracts in an
attempt to reduce the risk of fluctuating oil and gas prices and interest rates. In 2004, approximately 62% of our production was oil and 38% was natural gas. The majority of
the oil production is from our Permian Basin long life oil assets. The majority of the gas
production is from our Gulf coast short life assets. Employees In 2004, we added five new employees. At March 1, 2005, we had twenty-eight full time
employees. Mr. Cambridge serves in the capacity of a consultant and not as a full-time employee.
Parallel also retains independent land, geological, geophysical and engineering consultants and
expects to continue to do so in the future. Additionally, Parallel retains five contract pumpers
on a month-to-month basis. We consider our employee relations to be satisfactory. None of our employees are represented
by a union and we have not experienced work stoppages or strikes. Wells Drilled The following table shows certain information concerning the number of gross and net wells we
drilled during the three-year period ended December 31, 2004. Exploratory Wells (1)
    
    
    Development W ells (2)Year Ended
    
    Productive
    
    
    Dry
    
    
    Productive
    
    
    DryDecember 31,
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net2004
    
    
    17.0
    
    
    
    1.68
    
    
    
    4.0
    
    
    
    0.95
    
    
    
    50.0
    
    
    
    31.8
    
    
    
    
    
    
    
    2003
    
    
    15.0
    
    
    
    5.05
    
    
    
    8.0
    
    
    
    2.09
    
    
    
    3.0
    
    
    
    2.6
    
    
    
    1.0
    
    
    
    0.252002
    
    
    12.0
    
    
    
    3.10
    
    
    
    3.0
    
    
    
    0.70
    
    
    
    4.0
    
    
    
    2.3
    
    
    
    
    
    
    
    
   (1)
    
    An exploratory w ell is a well drilled to find and produce oil or natural gas in an
unp roved area, to find a new reservoir in a field previously found to be productive of oil or natural gas in
another reservoir, or to extend a known reservoir.(2)
    
    A development well is a well drilled within the p roved area of an oil or
natural gas reservoir to the
depth of a stratigraphic horizon known to be productive. All of our drilling is performed on a contract basis by third-party drilling contractors.
We do not own any drilling equipment. (13)




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At March 1, 2005, we were participating in the completion of 7 gross (.89 net) gas wells in
Hemphill, Jackson, Leon, Liberty and Tarrant Counties, Texas and Eddy County, New Mexico. Volumes, Prices and Lifting Costs The following table shows certain information about our oil and natural gas production,
average sales prices per Mcf of gas and Bbl of oil and the average lifting cost per BOE for the
three-year period ended December 31, 2004. Year Ended Dece mber 31,2004
    
    
    2003
    
    
    2002(in thousands except per unit data)Product ion, Prices and Lift ing Costs:Oil (Bbls)
    
    
    729
    
    
    
    629
    
    
    
    131Natural gas (Mcf)
    
    
    2,690
    
    
    
    3,356
    
    
    
    2,670BOE
    
    
    1,177
    
    
    
    1,188
    
    
    
    576Oil p rice (per Bbl) (1)
    
    $
    39.05
    
    
    $
    29.11
    
    
    $
    24.59Natural gas price (per Mcf)(1)
    
    $
    5.85
    
    
    $
    5.40
    
    
    $
    3.33BOE price (1)
    
    $
    37.55
    
    
    $
    30.66
    
    
    $
    21.03Average Production (lifting) Cost per BOE(2)
    
    $
    8.06
    
    
    $
    7.07
    
    
    $
    5.00
   (1)
    
    Average p rice received at th e wellhead for our oil and natural gas.(2)
    

    The increase in 2004 and 2003 is attributable to increased lifting costs associated
with our waterflood projects. The following summarizes our revenue for each of the three years ended December 31 by product
sold. 2004
    
    
    2003
    
    
    2002(in thousands)Oil revenue
    
    $
    28,455
    
    
    $
    18,300
    
    
    $
    3,217Oil hedge
    
    
    (7,458
    )
    
    
    (1,659
    )
    
    
    Gas revenue
    
    
    15,735
    
    
    
    18,121
    
    
    
    8,889Gas hedge
    
    
    (895
    )
    
    
    (907
    )
    
    
    $
    35,837
    
    
    $
    33,855
    
    
    $
    12,106
 Our oil sales in 2004 represented approximately 64% of our combined oil and gas sales for
the year ended December 31, 2004, as compared to 50% in 2003. Markets and Customers Our oil and natural gas production is sold at the well site on an as produced basis at market-
related prices in the areas where the producing properties are located. We do not refine or
process any of the oil or natural gas we produce and all of our production is sold to unaffiliated
purchasers on a month-to-month basis. (14)




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In the table below, we show the purchasers that accounted for 10% or more of our revenues
during the specified years. 2004
    
    
    2003
    
    
    2002Allegro Investments, Inc.
    
    
    22
    %
    
    
    30
    %
    
    
    31
    %Pure Resources, Inc.
    
    
    
    
    
    
    
    
    
    
    16
    %Sue Ann Production
    
    
    
    
    
    
    
    
    
    
    11
    %Texland Petroleum, Inc.
    
    
    43
    %
    
    
    33
    %
    
    
    
 We do not believe the loss of any one of our purchasers would materially affect our
ability to sell the oil and natural gas we produce. Other purchasers are available in our areas of
operations. Our future ability to market our oil and natural gas production depends upon the availability
and capacity of gas gathering systems and pipelines and other transportation facilities. We do not
currently own or operate our own pipelines or transportation facilities. We are dependent on third
parties to transport our products. We are not obligated to provide a fixed and determinable quantity of oil or natural gas under
any existing arrangements or contracts. Our business does not require us to maintain a backlog of products, customer orders or
inventory. Office Facilities Our principal executive offices are located in Midland, Texas, where we lease approximately
21,640 square feet of office space at 1004 North Big Spring, Suite 400, Midland, Texas 79701. Our
current rental rate is $13,074 per month. The lease expires August 31, 2006. We have two field offices and storage facilities. These two offices are located in Andrews
and Snyder, Texas. The current monthly rental rate is $750 for the Andrews office and $1,200 for
the Snyder office. The Andrews office lease expires December 1, 2007. The Snyder office lease
expires upon the termination of our trade agreement with the prior operator. We are unable to
predict when this agreement will terminate, but we anticipate that it will remain in effect for the
life of the properties covered by the agreement. Competition The oil and natural gas industry is highly competitive, particularly in the areas of acquiring
exploration and development prospects and producing properties. The principal means of competing
for the acquisition of oil and natural gas properties are the amount and terms of the consideration
offered. Our competitors include major oil companies, independent oil and gas (15)




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firms and individual producers and operators. Many of our competitors have financial resources,
staffs and facilities much larger than ours. We are also affected by competition for drilling rigs and the availability of related
equipment. With relatively high oil and natural gas prices, the oil and gas industry typically
experiences shortages of drilling rigs, equipment, pipe and qualified field personnel. We are
unable to predict when or to what extent our exploration and development activities will be
affected by rig, equipment or personnel shortages. Intense competition among independent oil and natural gas producers requires us to react
quickly to available exploration and acquisition opportunities. We try to position for these
opportunities by maintaining:  
    adequate capital resources for projects in our primary areas of operations;
    the technological capabilities to conduct a thorough evaluation of a particular
project; and
    a small staff that can respond quickly to exploration and acquisition opportunities. The principal resources we need for acquiring, exploring, developing, producing and selling
oil and natural gas are:  
    leasehold prospects under which oil and natural gas reserves may be discovered;
    drilling rigs and related equipment to explore for such reserves; and
    knowledgeable and experienced personnel to conduct all phases of oil and natural gas
operations. Oil and Gas Regulations Our operations are regulated by certain federal and state agencies. Oil and natural gas
production and related operations are or have been subject to:  
    price controls;
    taxes; and
    environmental and other laws relating to the oil and gas industry. We cannot predict how existing laws and regulations may be interpreted by enforcement agencies
or court rulings, whether additional laws and regulations will be adopted, or the effect such
interpretations or new laws and regulations may have on our business, financial condition or
results of operations. Our oil and natural gas exploration, production and related operations are subject to
extensive rules and regulations that are enforced by federal, state and local agencies. Failure to (16)




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comply with these rules and regulations can result in substantial penalties. The regulatory burden
on the oil and natural gas industry increases our cost of doing business and affects our
profitability. Because these rules and regulations are frequently amended or reinterpreted, we are
not able to predict the future cost or impact of compliance with these laws. Texas and many other states require drilling permits, bonds and operating reports. Other
requirements relating to the exploration and production of oil and natural gas are also imposed.
These states also have statutes or regulations addressing conservation matters, including
provisions for:  
    the unitization or pooling of oil and gas properties;
    the establishment of maximum rates of production from oil and gas wells; and
    the regulation of spacing, plugging and abandonment of wells. Sales of natural gas we produce are not regulated and are made at market prices. However, the
Federal Energy Regulatory Commission regulates interstate and certain intrastate gas transportation
rates and services conditions, which affect the marketing of our natural gas, as well as the
revenues we receive for sales of our production. Since the mid-1980s, FERC has issued a series of
orders, culminating in Order Nos. 636, 636-A, 636-B and 636-C. These orders, commonly known as
Order 636, have significantly altered the marketing and transportation service, including the
unbundling by interstate pipelines of the sales, transportation, storage and other components of
the city-gate sales services these pipelines previously performed. One of FERCs purposes in issuing the orders was to increase competition in all phases
of the gas industry. Order 636 and subsequent FERC orders issued in individual pipeline
restructuring proceedings has been the subject of appeals, the results of which have generally been
supportive of the FERCs open-access policy. In 1996, the United States Court of Appeals for
the District of Columbia Circuit largely upheld Order No. 636. Because further review of certain
of these orders is still possible, and other appeals remain pending, it is difficult to predict the
ultimate impact of the orders on Parallel and our gas marketing efforts. Generally, Order 636 has
eliminated or substantially reduced the interstate pipelines traditional role as wholesalers
of gas, and has substantially increased competition and volatility in gas markets. While
significant regulatory uncertainty remains, Order 636 may ultimately enhance our ability to market
and transport our gas, although it may also subject us to greater competition. Sales of oil we produce are not regulated and are made at market prices. The price we receive
from the sale of oil is affected by the cost of transporting the product to market. Effective
January 1, 1995, FERC implemented regulations establishing an indexing system for transportation
rates for interstate common carrier oil pipelines, which, generally, would index such rates to
inflation, subject to certain conditions and limitations. These regulations could increase the
cost of transporting oil by interstate pipelines, although the most recent adjustment generally
decreased rates. These regulations have generally been approved on judicial review. We are unable
to predict with certainty what effect, if any, these regulations will have on us. The regulations
may, over time, tend to increase transportation costs or reduce wellhead prices for oil. (17)




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We are required to comply with various federal and state regulations regarding plugging and
abandonment of oil and gas wells. Environmental Regulations Various federal, state and local laws and regulations governing the discharge of materials
into the environment, or otherwise relating to the protection of the environment, health and
safety, affect our operations and costs. These laws and regulations sometimes:  
    require prior governmental authorization for certain activities;
    limit or prohibit activities because of protected areas or species;
    impose substantial liabilities for pollution related to our operations or
properties; and
    provide significant penalties for noncompliance. In particular, our exploration and production operations, our activities in connection with
storing and transporting oil and other liquid hydrocarbons, and our use of facilities for treating,
processing or otherwise handling hydrocarbons and related exploration and production wastes are
subject to stringent environmental regulations. As with the industry generally, compliance with
existing and anticipated regulations increases our overall cost of business. While these
regulations affect our capital expenditures and earnings, we believe that they do not affect our
competitive position in the industry because our competitors are also affected by environmental
regulatory programs. Since environmental regulations have historically been subject to frequent
change, we cannot predict with certainty the future costs or other future impacts of environmental
regulations on our future operations. A discharge of hydrocarbons or hazardous substances into the
environment could subject us to substantial expense, including the cost to comply with applicable
regulations that require a response to the discharge, such as claims by neighboring landowners,
regulatory agencies or other third parties for costs of:  
    containment or cleanup;
    personal injury;
    property damage; and
    penalties assessed or other claims sought for natural resource damages. The following are examples of some environmental laws that potentially impact our operations.  
    Water. The Oil Pollution Act, or OPA, was enacted in 1990 and amends
provisions of the Federal Water Pollution Control Act of 1972 and other statutes as
they pertain to prevention of and response to major oil spills. The OPA subjects
owners of facilities to strict, joint and potentially unlimited liability for removal
costs and certain other consequences of an oil spill, where such spill is into
navigable waters, or along shorelines. In the event of an oil spill into such waters,
substantial liabilities (18)




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could be imposed upon Parallel. States in which Parallel operates have also enacted
similar laws. Regulations are currently being developed under the OPA and similar state
laws that may also impose additional regulatory burdens on Parallel.The FWPCA imposes restrictions and strict controls regarding the discharge of produced
waters, other oil and gas wastes, any form of pollutant, and, in some instances, storm
water runoff, into waters of the United States. The FWPCA provides for civil, criminal
and administrative penalties for any unauthorized discharges and, along with the OPA,
imposes substantial potential liability for the costs of removal, remediation or damages
resulting from an unauthorized discharge and, along with the OPA, imposes substantial
potential liability for the costs of removal, remediation or damages resulting from an
unauthorized discharge. State laws for the control of water pollution also provide
civil, criminal and administrative penalties and liabilities in the case of an
unauthorized discharge into state waters. The cost of compliance with the OPA and the
FWPCA have not historically been material to our operations, but there can be no
assurance that changes in federal, state or local water pollution control programs will
not materially adversely affect us in the future. Although no assurances can be given,
we believe that compliance with existing permits and compliance with foreseeable new
permit requirements will not have a material adverse effect on our financial condition
or results of operations.
    Solid Waste. Parallel generates non-hazardous solid wastes that fall under
the requirements of the Federal Resource Conservation and Recovery Act and comparable
state statutes. The EPA and the states in which we operate are considering the
adoption of stricter disposal standards for the type of non-hazardous waste we
generate. The Resource Conservation and Recovery Act also govern the generation,
management, and disposal of hazardous wastes. At present, we are not required to comply
with a substantial portion of the Resource Conservation and Recovery Act requirements
because our operations generate minimal quantities of hazardous wastes. However, it is
anticipated that additional wastes, which could include wastes currently generated
during operations, could in the future be designated as hazardous wastes. Hazardous
wastes are subject to more rigorous and costly disposal and management requirements
than are non-hazardous wastes. Such changes in the regulations may result in Parallel
incurring additional capital expenditures or operating expenses.
    Superfund. The Comprehensive Environmental Response, Compensation, and
Liability Act, sometimes called CERCLA or Superfund, imposes liability, without regard
to fault or the legality of the original act, on certain classes of persons in
connection with the release of a hazardous substance into the environment. These
persons include the current owner or operator of any site where a release historically
occurred and companies that disposed or arranged for the disposal of the hazardous
substances found at the site. CERCLA also authorizes the EPA and, in some instances,
third parties to act in response to threats to the public health or the environment and
to seek to recover from the responsible classes of persons the costs they incur. In
the course of our ordinary operations, we may have managed substances that may fall
within CERCLAs definition of a hazardous substance. We may be jointly and
severally liable under CERCLA for all or part of the costs required (19)




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cleaning up sites where we disposed of or arranged for the disposal of these substances.
This potential liability extends to properties that we owned or operated, as well as to
properties owned and operated by others at which disposal of Parallels hazardous
substances occurred. Parallel may also fall into the category of a current owner or operator. We currently own or
lease numerous properties that for many years have been used for exploring and producing oil and
gas. Although we believe we use operating and disposal practices standard in the industry,
hydrocarbons or other wastes may have been disposed of or released by us on or under properties
that we have owned or leased. In addition, many of these properties have been previously owned or
operated by third parties who may have disposed of or released hydrocarbons or other wastes at
these properties. Under CERCLA, and analogous state laws, we could be required to remove or
remediate previously disposed wastes, including wastes disposed of or released by prior owners or
operators, to clean up contaminated property, including contaminated groundwater, or to perform
remedial plugging operations to prevent future contamination. Risks Related to Our Business The volatility of the oil and natural gas industry may have an adverse impact on our operations. Our revenues, cash flows and profitability are substantially dependent upon prevailing prices
for oil and natural gas. In recent years, oil and natural gas prices and, therefore, the level of
drilling, exploration, development and production, have been extremely volatile. Any significant
or extended decline in oil or natural gas prices will have a material adverse effect on our
business, financial condition and results of operations and could impair access to future sources
of capital. Volatility in the oil and natural gas industry results from numerous factors over which
we have no control, including;  
    the level of oil and natural gas prices, expectations about future oil and
natural gas prices and the ability of international cartels to set and maintain
production levels and prices;
    the cost of exploring for, producing and transporting oil and natural gas;
    the level and price of foreign oil and natural gas transportation;
    available pipeline and other oil and natural gas transportation capacity;
    weather conditions;
    international political, military, regulatory and economic conditions;
    the level of consumer demand;
    the price and the availability of alternative fuels;
    the effect of worldwide energy conservation measures; and (20)




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
    the ability of oil and natural gas companies to raise capital. Significant declines in oil and natural gas prices for an extended period may:  
    impair our financial condition, liquidity, ability to finance planned
capital expenditures and results of operations;
    reduce the amount of oil and natural gas that we can produce economically;
    cause us to delay or postpone some of our capital projects;
    reduce our revenues, operating income and cash flow; and
    reduce the carrying value of our oil and natural gas properties. No assurance can be given that current levels of oil and natural gas prices will continue. We
expect oil and natural gas prices, as well as the oil and natural gas industry generally, to
continue to be volatile. We must replace oil and natural gas reserves that we produce. Failure to replace reserves may
negatively affect our business. Our future performance depends in part upon our ability to find, develop and acquire
additional oil and natural gas reserves that are economically recoverable. Our proved reserves
decline as they are depleted and we must locate and develop or acquire new oil and natural gas
reserves to replace reserves being depleted by production. No assurance can be given that we will
be able to find and develop or acquire additional reserves on an economical basis. If we cannot
economically replace our reserves, our results of operations may be materially adversely affected. We are subject to uncertainties in reserve estimates and future net cash flows. There is substantial uncertainty in estimating quantities of proved reserves and projecting
future production rates and the timing of development expenditures. No one can measure underground
accumulations of oil and natural gas in an exact way. Accordingly, oil and natural gas reserve
engineering requires subjective estimations of those accumulations. Estimates of other engineers
might differ widely from those of our independent petroleum engineers, and our independent
petroleum engineers may make material changes to reserve estimates based on the results of actual
drilling, testing, and production. As a result, our reserve estimates often differ from the
quantities of oil and natural gas we ultimately recover. Also, we make certain assumptions
regarding future oil and natural gas prices, production levels, and operating and development costs
that may prove incorrect. Any significant variance from these assumptions could greatly affect our
estimates of reserves, the economically recoverable quantities of oil and natural gas attributable
to any particular group of properties, the classifications of reserves based on risk of recovery,
and estimates of the future net cash flows. Some of our reserve estimates are made without the
benefit of a lengthy production history and are calculated using volumetric analysis. Those
estimates are less reliable than estimates based on a lengthy production history. (21)




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Volumetric analysis involves estimating the volume of a reservoir based on the net feet of pay and
an estimation of the productive area. The present value of future net cash flows from our proved reserves is not necessarily the
same as the current market value of our estimated oil and natural gas reserves. We base the
estimated discounted future net cash flows from our proved reserves on prices and costs in effect
on the day of estimate. However, actual future net cash flows from our oil and natural gas
properties also will be affected by factors such as:  
    actual prices we receive for oil and natural gas;

    the amount and timing of actual production;
    supply and demand of oil and natural gas;
    limits of increases in consumption by natural gas purchasers; and
    changes in governmental regulations or taxation. The timing of both our production and our incurrence of expenses in connection with the
development and production of oil and natural gas properties will affect the timing of actual
future net cash flows from proved reserves, and thus their actual present value. In addition, the
10% discount factor we use when calculating discounted future net cash flows may not be the most
appropriate discount factor based on interest rates in effect from time to time and risks
associated with us or the oil and natural gas industry in general. Competition in the oil and natural gas industry is intense, and many of our competitors have
greater financial, technological and other resources than we do. We operate in the highly competitive areas of oil and natural gas acquisition, development,
exploitation, exploration and production. The oil and natural gas industry is characterized by
rapid and significant technological advancements and introductions of new products and services
using new technologies. We face intense competition from independent, technology-driven companies
as well as from both major and other independent oil and natural gas companies in each of the
following areas:  
    seeking to acquire desirable producing properties or new leases for future
exploration;
    marketing our oil and natural gas production;
    integrating new technologies; and
    seeking to acquire the equipment and expertise necessary to develop and
operate our properties. Many of our competitors have financial, technological and other resources substantially
greater than ours, and some of them are fully integrated oil and natural gas companies. These
companies may be able to pay more for development prospects and productive oil and natural (22)




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gas properties and may be able to define, evaluate, bid for and purchase a greater number of
properties and prospects than our financial or human resources permit. Further, these companies
may enjoy technological advantages and may be able to implement new technologies more rapidly than
we can. Our ability to develop and exploit our oil and natural gas properties and to acquire
additional properties in the future will depend upon our ability to successfully conduct
operations, implement advanced technologies, evaluate and select suitable properties and consummate
transactions in this highly competitive environment. We do not control all of our operations and development projects. Substantially all of our business activities are conducted through joint operating agreements
under which we own partial interests in oil and natural gas wells. At December 31, 2004, we owned interests in 218 gross (162.91 net) producing oil and natural
gas wells for which we were the operator and 451 gross (152.02 net) producing oil and natural gas
wells where we were not the operator. If we do not operate wells in which we own an interest, we do not have control over normal
operating procedures, expenditures or future development of underlying properties. The failure of
an operator of our wells to adequately perform operations, or an operators breach of the
applicable agreements, could reduce our production and revenues. The success and timing of our
drilling and development activities on properties operated by others therefore depends upon a
number of factors outside of our control, including the operators:  
    timing and amount of capital expenditures;
    expertise and financial resources;
    inclusion of other participants in drilling wells; and
    use of technology. Since we do not have a majority interest in most wells we do not operate, we may not be in a
position to remove the operator in the event of poor performance. Our business involves many operating risks, which may result in substantial losses, and insurance
may be unavailable or inadequate to protect us against these risks. Our operations are subject to hazards and risks inherent in drilling for, producing and
transporting oil and natural gas, such as:  
    fires;
    natural disasters;
    explosions; (23)




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
    pressure forcing oil or natural gas out of the wellbore at a dangerous
velocity coupled with the potential for fire or explosion;
    weather;
    failure of oilfield drilling and service tools;
    changes in underground pressure in a formation that causes the surface to
collapse or crater;
    pipeline ruptures or cement failures;
    environmental hazards such as natural gas leaks, oil spills and discharges
of toxic gases; and
    availability of needed equipment at acceptable prices, including steel
tubular products. Any of these risks can cause substantial losses resulting from:  
    injury or loss of life;
    damage to and destruction of property, natural resources and equipment;
    pollution and other environmental damage;
    regulatory investigations and penalties;
    suspension of our operations; and
    repair and remediation costs. We do not insure against the loss of oil or natural gas reserves as a result of operating
hazards or insure against business interruption. Losses could occur for uninsurable or uninsured
risks, or in amounts in excess of existing insurance coverage. The occurrence of an event that is
not fully covered by insurance could harm our financial condition and results of operations. The oil and natural gas industry is capital intensive. The oil and natural gas industry is capital intensive. We make substantial capital
expenditures for the acquisition, exploration for and development of oil and natural gas reserves. Historically, we have financed capital expenditures primarily with cash generated by
operations, proceeds from bank borrowings and sales of our equity securities. In addition, we may
consider selling non-core assets to raise additional operating capital. From time to time, we (24)




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may also reduce our ownership interests in 3-D seismic and other projects in order to reduce our
capital expenditure requirements, depending on our working capital needs. Our cash flow from operations and access to capital is subject to a number of variables,
including:  
    our proved reserves;
    the level of oil and natural gas we are able to produce from existing wells;
    the prices at which oil and natural gas are sold; and
    our ability to acquire, locate and produce new reserves. Any one of these variables can materially affect our ability to borrow under our revolving
credit facility. If our revenues or the borrowing base under our revolving credit facility decreases as a
result of lower oil and natural gas prices, operating difficulties, declines in reserves or for any
other reason, we may have limited ability to obtain the capital necessary to undertake or complete
future drilling projects. We may, from time to time, seek additional financing, either in the form
of increased bank borrowings, sales of debt or equity securities or other forms of financing and
there can be no assurance as to the availability or terms of any additional financing upon terms
acceptable to us. There are risks in acquiring producing properties, including difficulties in integrating acquired
properties into our business, additional liabilities and expenses associated with acquired
properties, diversion of management attention, increasing the scope, geographic diversity and
complexity of our operations and incurrence of additional debt. Our business strategy includes growing our reserve base through acquisitions. Our failure to
integrate acquired businesses successfully into our existing business, or the expense incurred in
consummating future acquisitions, could result in unanticipated expenses and losses. In addition,
we may assume cleanup or reclamation obligations or other unanticipated liabilities in connection
with these acquisitions. The scope and cost of these obligations may ultimately be materially
greater than estimated at the time of the acquisition. We are continually investigating opportunities for acquisitions. In connection with future
acquisitions, the process of integrating acquired operations into our existing operations may
result in unforeseen operating difficulties and may require significant management attention and
financial resources that would otherwise be available for the ongoing development or expansion of
existing operations. Our ability to make future acquisitions may be constrained by our ability to
obtain additional financing. Possible future acquisitions could result in our incurring additional debt, contingent
liabilities and expense, all of which could have a material adverse effect on our financial
condition and operating results. (25)




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The marketability of our natural gas production depends on facilities that we typically do not own
or control. The marketability of our natural gas production depends in part upon the availability,
proximity and capacity of natural gas gathering systems, pipelines and processing facilities. We
generally deliver natural gas through natural gas gathering systems and natural gas pipelines that
we do not own. Our ability to produce and market natural gas on a commercial basis could be harmed
by any significant change in the cost or availability of such systems and pipelines. We are subject to many restrictions under our revolving credit facility. We may depend on our revolving credit facility for future capital needs. As required by our
revolving credit facility with our bank lenders, we have pledged substantially all of our oil and
natural gas properties as collateral to secure the payment of our indebtedness. The revolving
credit facility restricts our ability to obtain additional financing, make investments, lease
equipment, sell assets and engage in business combinations. We are also required to comply with
certain financial covenants and ratios. The revolving credit facility prohibits us from declaring
or paying dividends on our common stock, but we are permitted to pay dividends on our outstanding
shares of 6% convertible preferred stock if we are not in default under the revolving credit
facility. Although we are currently in compliance with these covenants, in the past we have had to
request waivers from our banks because of our non-compliance with certain financial covenants and
ratios. Our ability to comply with these restrictions and covenants in the future is uncertain and
will be affected by the levels of cash flow from our operations and events or circumstances beyond
our control. Our failure to comply with any of the restrictions and covenants under the revolving
credit facility could result in a default under the revolving credit facility, which could cause
all of our existing indebtedness to be immediately due and payable. The revolving credit facility limits the amounts we can borrow to a borrowing base amount,
determined by the lenders, based upon projected revenues from the oil and natural gas properties
securing our loan. The lenders can adjust the borrowing base and the borrowings permitted to be
outstanding under the revolving credit facility. Any increase in the borrowing base requires the
consent of all lenders. If all lenders do not agree on an increase, then the borrowing base will
be the lowest borrowing base determined by each lender. Outstanding borrowings in excess of the
borrowing base must be repaid immediately, or we must pledge other oil and natural gas properties
as additional collateral. We do not currently have any substantial unpledged properties and no
assurance can be given that we would be able to make any mandatory principal prepayments required
under the revolving credit facility. If we default under our revolving credit facility, the lenders could foreclose on, and acquire
control of, substantially all of our assets. The lenders under our revolving credit facility have liens on substantially all of our assets.
As a result of the liens held by our revolving credit facility lenders, if we fail to meet our
payment or other obligations under the revolving credit facility, those lenders would be entitled
to foreclose on substantially all of our assets and liquidate those assets. (26)




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Our producing properties are geographically concentrated. A substantial portion of our proved oil and natural gas reserves are located in the Permian
Basin of west Texas and eastern New Mexico. Specifically, at December 31, 2004, approximately 90%
of the discounted present value of our proved reserves were located in the Permian Basin. As a
result, we may be disproportionately exposed to the impact of delays or interruptions of production
from these wells due to mechanical problems, damages to the current producing reservoirs,
significant governmental regulation, including any curtailment of production, or interruption of
transportation of oil or natural gas produced from the wells. Hedging activities create a risk of financial loss. In order to manage our exposure to price risks in the marketing of our oil and natural gas, we
have in the past and expect to continue to enter into oil and natural gas price risk management
arrangements with respect to a portion of our expected production. We use swap, floor, and collar
hedging arrangements that generally result in a fixed price or a range of minimum and maximum price
limits over a specified time period. Hedging contracts limit the benefits we will realize if
actual prices rise above the contract price. Our hedging arrangements may expose us to the risk of
financial loss in certain circumstances. In a typical hedge transaction, the hedging party will
have the right to receive from the counterparty to the hedge, the excess of the fixed price
specified in the hedge over a floating price based on a market index, multiplied by the quantity
hedged. If the floating price exceeds the fixed price, the hedging party is required to pay the

counterparty this difference multiplied by the quantity hedged. In this case, if we are the
hedging party we would be required to pay the difference regardless of whether we had sufficient
production to cover the quantities specified in the hedge. Significant reductions in production at
times when the floating price exceeds the fixed price could require us to make payments under the
hedge agreements even though the payments are not offset by sales of production. Hedging will also
prevent us from receiving the full advantage of increases in oil or natural gas prices above the
fixed amount specified in the hedge. In addition, these transactions may expose us to the risk of
financial loss in certain circumstances, including instances in which:  
    production is less than expected;
    there is a widening of price differentials between delivery points for our
production and the delivery point assumed in the arrangement which might result in
hedge ineffectiveness;
    the counterparties to our future contracts fail to perform under the contract; or
    a sudden, unexpected event materially impacts oil or natural gas prices. In the past, some of our hedging contracts required us to deliver cash collateral or other
assurances of performance to the counterparties in the event that our payment obligations exceeded
certain levels. Future collateral requirements are uncertain but will depend on arrangements with
our counterparties and highly volatile natural gas and oil prices. (27)




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We are subject to complex federal, state and local laws and regulations that could adversely affect
our business. Extensive federal, state and local regulation of the oil and natural gas industry
significantly affects our operations. In particular, our oil and natural gas exploration,
development and production, are subject to stringent environmental regulations. These regulations
have increased the costs of planning, designing, drilling, installing, operating and abandoning our
oil and natural gas wells and other related facilities. These regulations may become more
demanding in the future. Matters subject to regulation include:  
    discharge permits for drilling operations;
    drilling bonds;
    spacing of wells;
    unitization and pooling of properties;
    environmental protection;
    reports concerning operations; and
    taxation. Under these laws and regulations, we could be liable for:  
    personal injuries;
    property damage;
    oil spills;
    discharge of hazardous materials;
    reclamation costs;
    remediation and clean-up costs; and
    other environmental damages. Failure to comply with these laws and regulations also may result in the suspension or
termination of our operations and subject us to administrative, civil and criminal penalties.
Further, these laws and regulations could change in ways that substantially increase our costs.
Any of these liabilities, penalties, suspensions, terminations or regulatory changes could make it
more expensive for us to conduct our business or cause us to limit or curtail some of our
operations. (28)




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Declining oil and natural gas prices may cause us to record ceiling test write-downs. We use the full cost method of accounting to account for our oil and natural gas operations.
This means that we capitalize the costs to acquire, explore for and develop oil and natural gas
properties. Under full cost accounting rules, the capitalized costs of oil and natural gas
properties may not exceed a ceiling limit, which is based on the present value of estimated future
net revenues, net of income tax effects, from proved reserves, discounted at 10%, plus the lower of
cost or fair market value of unproved properties. These rules generally require pricing future oil
and natural gas production at unescalated oil and natural gas prices in effect at the end of each
fiscal quarter, with effect given to cash flow hedge positions. If capitalized costs of oil and
natural gas properties, as adjusted for asset retirement obligations, exceed the ceiling limit, we
must charge the amount of the excess against earnings. This is called a ceiling test write-down.
This non-cash impairment charge does not affect cash flow from operating activities, but it does
reduce stockholders equity. Impairment charges cannot be restored by subsequent increases
in the prices of oil and natural gas. The risk that we will be required to write down the carrying value of our oil and natural gas
properties increases when oil and natural gas prices decline. In addition, write-downs may occur
if we experience substantial downward adjustments to our estimated proved reserves. We did not recognize impairment in 2004. We cannot assure you that we will not experience
ceiling test write-downs in the future. Terrorist activities may adversely affect our business. Terrorist activities, including events similar to those of September 11, 2001, or armed
conflict involving the United States may adversely affect our business activities and financial
condition. If events of this nature occur and persist, the resulting political and social
instability could adversely affect prevailing oil and natural gas prices and cause a reduction in
our revenues. In addition, oil and natural gas production facilities, transportation systems and
storage facilities could be direct targets of terrorist attacks, and our operations could be
adversely impacted if infrastructure integral to our operations is destroyed or damaged. Costs
associated with insurance and other security measure may increase as a result of these threats, and
some insurance coverage may become more difficult to obtain, if available at all. We are highly dependent upon key personnel. Our success is highly dependent upon the services, efforts and abilities of key members of our
management team. Our operations could be materially and adversely affected if one or more of these
individuals become unavailable for any reason. We do not have employment agreements or long term contractual arrangements with any of our
officers or other key employees. In periods of improving market conditions, our ability to obtain
and retain qualified consultants on a timely basis may be adversely affected. Our future growth and profitability will also be dependent upon our ability to attract and
retain other qualified management personnel and to effectively manage our growth. There can be no
assurance that we will be successful in doing so. (29)




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Part of our business is seasonal in nature. Weather conditions affect the demand for and price of oil and natural gas and can also delay
drilling activities, temporarily disrupting our overall business plans. Demand for oil and natural
gas is typically higher during winter months than summer months. However, warm winters can also
lead to downward price trends. As a result, our results of operations may be adversely affected by
seasonal conditions. Our Oil and Natural gas Operations Are Subject to Many Inherent Risks Oil and natural gas drilling activities and production operations are highly speculative and
involve a high degree of risk. These operations are marked by unprofitable efforts because of dry
holes and wells that do not produce oil or natural gas in sufficient quantities to return a profit.
The success of our operations depends, in part, upon the ability of our management and technical
personnel. The cost of drilling, completing and operating wells is often uncertain. There is no
assurance that our oil and natural gas drilling or acquisition activities will be successful, that
any production will be obtained, or that any such production, if obtained, will be profitable. Our operations are subject to all of the operating hazards and risks normally incident to
drilling for and producing oil and natural gas. These hazards and risks include, but are not
limited to:  
    encountering unusual or unexpected formations and pressures;
    explosions, blowouts and fires;
    pipe and tubular failures and casing collapses;
    environmental pollution; and
    personal injuries. Any one of these potential hazards could result in accidents, environmental damage, personal
injury, property damage and other harm that could result in substantial liabilities to us. As is customary in the industry, we maintain insurance against some, but not all, of these
hazards. We maintain general liability insurance and obtain Operators Extra Expense insurance on
a well-by-well basis. We carry insurance against certain pollution hazards, subject to our
insurance policys terms, conditions and exclusions. If we sustain an uninsured loss or liability,
our ability to operate could be materially adversely affected. Our oil and natural gas operations are not subject to renegotiation of profits or termination
of contracts at the election of the federal government. (30)




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Restrictive debt covenants could limit our growth and our ability to finance our operations, fund
our capital needs, respond to changing conditions and engage in other business activities that may
be in our best interests. Our revolving credit facility contains a number of significant covenants that, among other
things, restrict our ability to:  
    dispose of assets;
    incur additional indebtedness;
    restrictions on all retained earnings and net income for payment of
dividends on our common stock;
    create liens on our assets;
    enter into specified investments or acquisitions;
    repurchase, redeem or retire our capital stock or other securities;
    merge or consolidate, or transfer all or substantially all of our assets
and the assets of our subsidiaries;
    engage in specified transactions with subsidiaries and affiliates; or
    engage in other specified corporate activities. Also, our revolving credit facility requires us to maintain compliance with specified
financial ratios and satisfy certain financial condition tests. Our ability to comply with these
ratios and financial condition tests may be affected by events beyond our control, and we cannot
assure you that we will meet these ratios and financial condition tests. These financial ratio
restrictions and financial condition tests could limit our ability to obtain future financings,
make needed capital expenditures, withstand a future downturn in our business or the economy in
general or otherwise conduct necessary corporate activities. We may also be prevented from taking
advantage of business opportunities that arise because of the limitations that the restrictive
covenants under the revolving credit facility impose on us. A breach of any of these covenants or
our inability to comply with the required financial ratios or financial condition tests could
result in a default under the revolving credit facility. A default, if not cured or waived, could
result in acceleration of all indebtedness outstanding under the revolving credit facility. The
accelerated debt would become immediately due and payable. If that should occur, we may not be
able to pay all such debt or to borrow sufficient funds to refinance it. Even if new financing
were then available, it may not be on terms that are acceptable to us. We do not pay dividends on our common stock. We have never paid dividends on our common stock, and do not intend to pay cash dividends on
the common stock in the foreseeable future. Net income from our operations, if any, will be used
for the development of our business, including capital expenditures, to retire (31)




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debt and to pay dividends on our outstanding shares of 6% convertible preferred stock. Any
decision to pay dividends on the common stock in the future will depend upon our profitability at
that time, the available cash and other factors. Our ability to pay dividends on our common stock
is further limited by the terms of our revolving credit facility and the terms of our preferred
stock. Changes in control may be discouraged. Our certificate of incorporation, our bylaws and the Delaware General Corporation Law contain
provisions that may discourage other persons from initiating a tender offer or takeover attempt
that a stockholder might consider to be in the best interests of all stockholders, including
takeover attempts that might result in a premium to be paid over the market price of our stock. On October 5, 2000, our Board of Directors adopted a stockholder rights plan. The plan is
designed to protect Parallel from unfair or coercive takeover attempts and to prevent a potential
acquirer from gaining control of Parallel without fairly compensating all of the stockholders. The
plan authorized 50,000 shares of $0.10 par Series A Preferred Stock Purchase Rights. A dividend of
one Right for each share of our outstanding common stock was distributed to stockholders of record
at the close of business on October 16, 2000. If a public announcement is made that a person has
acquired 15% or more of Parallels common stock or a tender or exchange offer is made for 15%
of more of the common stock, each Right entitles the holder to purchase from the company one
one-thousandth of a share of Series A Preferred Stock, at an exercise price of $26.00 per one
one-thousandth of a share, subject to adjustment. In addition, under certain circumstances, the
rights entitle the holders to buy Parallels stock at a 50% discount. See Note 9 to
consolidated financial statements. We are authorized to issue 10.0 million shares of preferred stock, 950,000 shares of which
were outstanding on March 1, 2005. Our Board of Directors has total discretion in the issuance and
the determination of the rights and privileges of any shares of preferred stock which might be
issued in the future, which rights and privileges may be detrimental to the holders of the common
stock. It is not possible to state the actual effect of the authorization and issuance of a new
series of preferred stock upon the rights of holders of the common stock and other series of
preferred stock unless and until the Board of Directors determines the attributes of any new series
of preferred stock and the specific rights of its holders. These effects might include:  
    restrictions on dividends on common stock and other series of preferred
stock if dividends on any new series of preferred stock have not been paid;
    dilution of the voting power of common stock and other series of preferred
stock to the extent that a new series of preferred stock has voting rights, or to the
extent that any new series of preferred stock is convertible into common stock;
    dilution of the equity interest of common stock and other series of
preferred stock; and
    limitation on the right of holders of common stock and other series of
preferred stock to share in Parallels assets upon liquidation until satisfaction
of any liquidation preference attributable to any new series of preferred stock. (32)




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The issuance of preferred stock in the future could discourage, delay or prevent a tender
offer, proxy contest or other similar transaction involving a potential change in control of
Parallel that might be viewed favorably by stockholders.  ITEM 2. PROPERTIES
 General Our principal properties consist of developed and undeveloped oil and natural gas leases and
the reserves associated with these leases. Generally, developed oil and natural gas leases remain
in force so long as production is maintained. Undeveloped oil and natural gas leaseholds are
generally for a primary term of five or ten years. In most cases, we can extend the term of our
undeveloped leases by paying delay rentals or by producing reserves that we discover under our
leases. Producing Wells and Acreage We have presented the following table to provide you with a summary of the producing oil and
natural gas wells and the developed and undeveloped acreage in which we owned an interest at
December 31, 2004. We have not included in the table acreage in which our interest is limited to
options to acquire leasehold interests, royalty or similar interests. Producing Wells
    
    
    AcreageOil(1)
    
    
    Gas
    
    
    Developed
    
    
    UndevelopedGross
    
    
    Net (2)
    
    
    Gross
    
    
    Net (2)
    
    
    Gross
    
    
    Net (3)
    
    
    Gross
    
    
    Net (3)Texas
    
    
    570
    
    
    
    280.4
    
    
    
    93
    
    
    
    34.02
    
    
    
    64,582
    
    
    
    36,126
    
    
    
    53,805
    
    
    
    5,820Colorado
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,080
    
    
    
    14,080New M exico
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    0.51
    
    
    
    1,277
    
    
    
    109
    
    
    
    121,222
    
    
    
    30,355Utah
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    123,864
    
    
    
    122,800Total
    
    
    570
    
    
    
    280.4
    
    
    
    99
    
    
    
    34.53
    
    
    
    65,859
    
    
    
    36,235
    
    
    
    312,971
    
    
    
    173,055
   (1)
    
    Does not include 356 wells that were shut in or temporarily abandoned as of December 31,
2004.(2)
    
    Net wells are computed by multiplying the number of gross wells by our working interest in the
gross wells.(3)
    
    Parallels net acres are computed by multiplying the number of lease net acres by our working
interest. At December 31, 2004, we owned interests in 218 gross (162.91 net) producing oil and
natural gas wells for which we were the operator and 451 gross (152.02 net) producing oil and
natural gas wells where we were not the operator. (33)




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The operator of a well has significant control over its location and the timing of its
drilling. In addition, the operator receives fees from other working interest owners as
reimbursement for general and administrative expenses for operating the wells. Except for our oil and natural gas leases, we do not own any patents, licenses, franchises or
concessions which are significant to our oil and natural gas operations. Title to Properties As is customary in the oil and natural gas industry, we make only a cursory review of title to
undeveloped oil and natural gas leases at the time they are acquired. These cursory title reviews,
while consistent with industry practices, are necessarily incomplete. We believe that it is not
economically feasible to review in depth every individual property we acquire, especially in the
case of producing property acquisitions covering a large number of leases. Ordinarily, when we
acquire producing properties, we focus our review efforts on properties believed to have higher
values and will sample the remainder. However, even an in-depth review of all properties and
records may not necessarily reveal existing or potential defects nor will it permit a buyer to
become sufficiently familiar with the properties to assess fully their deficiencies and
capabilities. In the case of producing property acquisitions, inspections may not always be
performed on every well, and environmental problems, such as ground water contamination, are not
necessarily observable even when an inspection is undertaken. In the case of undeveloped leases or
prospects we acquire, before any drilling commences, we will usually cause a more thorough title
search to be conducted, and any material defects in title that are found as a result of the title
search are generally remedied before drilling a well on the lease commences. We believe that we
have good title to our oil and natural gas properties, some of which are subject to immaterial
encumbrances, easements and restrictions. The oil and natural gas properties we own are also
typically subject to royalty and other similar non-cost bearing interests customary in the
industry. We do not believe that any of these encumbrances or burdens will materially affect our
ownership or the use of our properties. Oil and Natural Gas Reserves For the year ended December 31, 2004, our oil and natural gas reserves were estimated by
Cawley Gillespie & Associates, Inc., Fort Worth, Texas. At December 31, 2004, our total estimated proved reserves were approximately 18.9 MMBbls of
oil and 16.8 Bcf of gas, or 21.7 MMBOEs. (34)




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The information in this table provides you with certain information regarding the proved
reserves as estimated by Cawley Gillespie & Associates, Inc., at December 31, 2004. Proved
    
    
    ProvedDeveloped
    
    
    Undeveloped
    
    
    Total(in thousands)Oil (MBbls)
    
    
    13,210
    
    
    
    5,706
    
    
    
    18,916Gas (MMcf)
    
    
    13,158
    
    
    
    3,667
    
    
    
    16,825MBOE
    
    
    15,403
    
    
    
    6,317
    
    
    
    21,720Future Net Revenues (before income taxes)
    
    $
    402,085
    
    
    $
    175,417
    
    
    $
    577,502Present Value of Future Net Revenues
(before income taxes)
    
    $
    192,119
    
    
    $
    74,131
    
    
    $
    266,250
 Estimates of our proved reserves and future net revenues are made using sales prices and
costs, estimated to be in effect as of the date of such reserve estimates that are held constant
throughout the life of the properties, except to the extent a contract specifically provides for
escalation. The average realized prices for our reserves as of December 31, 2004 were $40.59 per
Bbl of oil and $5.65 per Mcf of natural gas. For additional information concerning our estimated proved oil and natural gas reserves, you
should read Note 15 to the consolidated financial statements. See also Item 8  Financial
Statements and Supplementary Data on page 65 of this Annual Report on Form 10-K. The reserve data in this report represent estimates only. Reservoir engineering is a
subjective process. There are numerous uncertainties inherent in estimating our oil and natural
gas reserves and their estimated values. Many factors are beyond our control. Estimating
underground accumulations of oil and natural gas cannot be measured in an exact manner. The
accuracy of any reserve estimate is a function of the quality of available data, engineering and
geological interpretation and judgment and the costs we actually incur in the development of our
reserves. As a result, estimates of different engineers often vary. In addition, estimates of
reserves are subject to revision by the results of drilling, testing and production after the date
of the estimates. Consequently, reserve estimates are often different from the quantities of oil
and natural gas that are ultimately recovered. The meaningfulness of estimates is highly dependent
upon the accuracy of the assumptions upon which they were based. The volume of production from oil and natural gas properties declines as reserves are produced
and depleted. Unless we acquire properties containing proved reserves or conduct successful
drilling activities, our proved reserves will decline as we produce our existing reserves. Our
future oil and natural gas production is highly dependent upon our level of success in acquiring or
finding additional reserves. We do not have any natural gas or oil reserves outside the United States. Our oil and natural
gas reserves and production are not subject to any long term supply or similar agreements with
foreign governments or authorities. (35)




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Our estimated reserves have not been filed with or included in reports to any federal agency
other than the SEC.  ITEM 3. LEGAL
PROCEEDINGS
 From time to time, we are a party to ordinary routine litigation incidental to our business.
As of March 1, 2005 we were not a party to any litigation. We are not aware of any threatened
litigation. No litigation proceedings were terminated during the fourth quarter of 2004. We have
not been a party to any bankruptcy, receivership, reorganization, adjustment or similar proceeding.  ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 We did not submit any matter to a vote of our stockholders during the fourth quarter of 2004. (36)




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PART II  ITEM 5.
    MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
   Market Information Our common stock trades on the Nasdaq National Market under the symbol PLLL. The following
table shows, for the periods indicated, the high and low closing sales prices for the common stock
as reported by Nasdaq. Price Per ShareHigh
    
    
    Low2002First Quarter
    
    $
    4.38
    
    
    $
    3.08Second Quarter
    
    $
    3.41
    
    
    $
    2.60Third Quarter
    
    $
    2.95
    
    
    $
    2.15Fourth Quarter
    
    $
    2.91
    
    
    $
    2.032003First Quarter
    
    $
    3.10
    
    
    $
    2.51Second Quarter
    
    $
    4.03
    
    
    $
    2.40Third Quarter
    
    $
    3.86
    
    
    $
    3.15Fourth Quarter
    
    $
    4.49
    
    
    $
    3.192004First Quarter
    
    $
    4.67
    
    
    $
    3.60Second Quarter
    
    $
    5.35
    
    
    $
    3.83Third Quarter
    
    $
    5.68
    
    
    $
    4.38Fourth Quarter
    
    $
    5.60
    
    
    $
    4.83
 The last sale price of our common stock on March 1, 2005 was $6.99 per share, as reported
on the Nasdaq National Market. As of March 1, 2005, there were approximately 1,569 stockholders of record. Dividends We have not paid, and do not intend to pay in the foreseeable future, cash dividends on our
common stock. The revolving credit facility we have with our bank lenders prohibits the payment of
dividends on the common stock. Our 6% convertible preferred stock also contains provisions that
restrict us from paying dividends or making distributions on our common stock if all dividends on
the preferred stock have not been paid in full. Any dividends on our preferred (37)




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stock that are not declared and paid will accumulate. All accumulated dividends must be paid in
full before dividends may be paid to holders of common stock. The credit facility allows us to pay
dividends on our outstanding shares of preferred stock as long as we are not in default
under the terms of the credit facility. The holders of the preferred stock are entitled, as and
when declared by the Board of Directors, to receive an annual dividend of $.60 per share, payable
semi-annually on June 15 and December 15 of each year. See Risks Related to Our Business  We do
not pay dividends on our common stock on page 20 and Managements Discussion and Analysis
of Financial Condition and Results of Operations  Capital
Resources and Liquidity on page
55. Equity Compensation Plans At December 31, 2004, a total of 2,627,250 shares of common stock were authorized for issuance
under our equity compensation plans. In the table below, we describe certain information about
these shares and the equity compensation plans which provide for their authorization and issuance.
You can find descriptions of our stock grant and stock option plans beginning on page 78. Equity Compensation Plan Information (a)
    
    
    
    (b)
    
    
    
    (c)Plan category
    
    
    
    
    


    
    

    
    
    
    
    
    Number of securitiesNumber of
    
    
    
    
    
    
    
    
    remaining available forsecurities to be
    
    
    
    Weighted-average
    
    
    
    future issuance underissued upon exercise
    
    
    
    exercise price of
    
    
    
    equity compensationof outstanding
    
    
    
    outstanding
    
    
    
    plans (excludingoptions, warrants
    
    
    
    options, warrants
    
    
    
    securities reflected inand rights
    
    
    
    and rights
    
    
    
    column (a))Equity compensation
plans approved by
security holders (1)
    
    
    
    1,739,638
    
    
    
    $
    3.87
    
    
    
    
    312,612Equity compensation
plans not approved by
security holders
    
    
    
    575,000
    (2)
    
    
    $
    3.83
    
    
    
    
    Total
    
    
    
    2,314,638
    
    
    
    $
    3.85
    
    
    
    
    312,612
  (1)
    
    Includes the following plans: 2004 Non-Employee Director Stock Grant Plan; 1992 Stock
Option Plan; 1997 Non-employee Directors Stock Option Plan; 1998 Stock Option Plan; and
2001 Non-employee Directors Stock Option Plan.(2)
    
    These shares include an aggregate of 200,000 shares of common stock underlying stock
options granted in June, 2001 to non-officer employees pursuant to
Parallels
Employee Stock Option Plan. The Employee Stock Option Plan is the only equity compensation
plan in effect that was adopted without approval of our stockholders. Directors and
officers of Parallel are not eligible to participate in this plan. A description of the
material features of this plan can be found under the caption Employee Stock Option Plan
on page 86. The total number of shares shown also includes 275,000 shares of common stock
underlying a stock purchase warrant we issued to an investment banking firm in November,
2001 and 100,000 shares of common stock underlying a stock purchase warrant we issued to
the same investment banking firm in December, 2003. These warrants were issued under
financial advisory services agreements with the investment banking firm, and not under
employee or director compensation plans. The warrants issued in (38)




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November, 2001 are exercisable, in whole or in part, at an exercise price equal to $2.95 per
share, the fair market value of the common stock on the date of issuance of warrants, and
are exercisable at any time during the four-year period commencing on November 20, 2002.
The warrants issued in December, 2003 are exercisable, in whole or in part, at an exercise
price equal to $3.98 per share, the fair market value of the common stock on the date of
issuance of the warrants, and are exercisable at any time during the four-year period
commencing on December 23, 2004. All of the warrants contain customary provisions providing
for adjustment of the exercise price and the number and type of securities issuable upon
exercise of the warrants if any one or more of certain specified events occur. The warrants
also grant to the holder certain registration rights for the securities issuable upon
exercise of the warrants. Sale of Unregistered Securities At Parallels annual meeting of stockholders held on June 22, 2004, the stockholders approved
the Parallel Petroleum Corporation 2004 Non-Employee Director Stock Grant Plan. You can find a
description of this plan on page 82. Historically, Directors fees had been paid solely in cash.
However, upon approval of the plan by the stockholders, we began paying an annual retainer fee to
each non-employee Director in the form of common stock having a value of $25,000. Only Directors of
Parallel who are not employees of Parallel or any of its subsidiaries are eligible to participate
in the Plan. Under the plan, each non-employee Director is entitled to receive an annual retainer
fee consisting of shares of common stock that will be automatically granted on the first day of
July in each year. The actual number of shares received is determined by dividing $25,000 by the
average daily closing price of the common stock on the Nasdaq Stock Market for the ten consecutive
trading days commencing fifteen trading days before the first day of July of each year. On July 1,
2004, and in accordance with the terms of the plan, we issued a total of 20,888 shares of common
stock to four non-employee Directors as follows: Jeffrey G. Shrader  5,222 shares; Dewayne E.
Chitwood  5,222 shares; Martin B. Oring  5,222 shares; and Ray M. Poage  5,222 shares. The
shares of common stock were issued without registration under the Securities Act of 1933, as
amended, in reliance on the exemption provided by Section 4(2) of the Securities Act. Generally,
shares issued under this plan are not transferable as long as the non-employee Director holding the
shares remains a Director of the Company. Certificates evidencing the shares bear restrictive
legends. Repurchase of Equity Securities Neither we nor any affiliated purchaser repurchased any of our equity securities during the
fourth quarter of the fiscal year ended December 31, 2004.  ITEM 6. SELECTED FINANCIAL DATA
 In the table below, we provide you with selected historical financial data. We have prepared
this information using the audited consolidated financial statements for the five-year period ended
December 31, 2004. It is important that you read this data along with our consolidated financial
statements and related notes, and Managements Discussion and Analysis of Financial Condition and
Results of Operations under Item 7 below. The selected financial data provided are not
necessarily indicative of our future results of operations or financial performance. (39)




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Year Ended December 31,2004
    
    
    2003
    
    
    2002(1)
    
    
    2001(2)
    
    
    2000(in thousands, except per share and per unit data)Consolidated Income Statements Data:Operating revenues
    
    $
    35,837
    
    
    $
    33,855
    
    
    $
    12,106
    
    
    $
    17,840
    
    
    $
    17,134Operating expenses
    
    $
    23,571
    
    
    $
    21,138
    
    
    $
    11,250
    
    
    $
    28,405
    
    
    $
    9,530Income (loss) before cumulative effect
of change in accounting principle
    
    $
    5,585
    
    
    $
    7,664
    
    
    $
    18,701
    
    
    $
    (4,708
    )
    
    $
    5,977Net income (loss)
    
    $
    5,585
    
    
    $
    7,602
    
    
    $
    18,701
    
    
    $
    (4,708
    )
    
    $
    5,977Cumulative preferred stock dividend
    
    $
    (572
    )
    
    $
    (580
    )
    
    $
    (585
    )
    
    $
    (585
    )
    
    $
    (585
    )Net income (loss) available to common stockholders
    
    $
    5,013
    
    
    $
    7,022
    
    
    $
    18,116
    
    
    $
    (5,292
    )
    
    $
    5,393Net income (loss) per common share before cumulative
effect of change in accounting principleBasic
    
    $
    0.20
    
    
    $
    0.33
    
    
    $
    0.88
    
    
    $
    (0.26
    )
    
    $
    0.26Diluted
    
    $
    0.20
    
    
    $
    0.31
    
    
    $
    0.79
    
    
    $
    (0.26
    )
    
    $
    0.25Weighted average common stock and common stock
equivalents outstandingBasic
    
    
    25,323
    
    
    
    21,264
    
    
    
    20,680
    
    
    
    20,458
    
    
    
    20,332Diluted
    
    
    28,402
    
    
    
    24,175
    
    
    
    23,549
    
    
    
    20,458
    
    
    
    23,465Cash
dividends - common stock
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Consolidated Balance Sheet Data:Total assets
    
    $
    170,671
    
    
    $
    118,343
    
    
    $
    102,351
    
    
    $
    41,760
    
    
    $
    46,456Total liabilities
    
    $
    110,677
    
    
    $
    57,111
    
    
    $
    56,852
    
    
    $
    15,446
    
    
    $
    15,288Long-term debt, less current maturities
    
    $
    79,000
    
    
    $
    39,750
    
    
    $
    45,604
    
    
    $
    9,600
    
    
    $
    11,624Total stockholders equity
    
    $
    59,994
    
    
    $
    61,232
    
    
    $
    45,499
    
    
    $
    26,314
    
    
    $
    31,168Consolidated Statement of Cash Flow Data:Cash provided (used) byOperating activities
    
    $
    17,727
    
    
    $
    19,465
    
    
    $
    1,528
    
    
    $
    13,383
    
    
    $
    10,694Investing activities
    
    $
    (69,518
    )
    
    $
    (15,494
    )
    
    $
    (30,277
    )
    
    $
    (11,357
    )
    
    $
    (5,846
    )Financing activities
    
    $
    39,194
    
    
    $
    1,595
    
    
    $
    37,210
    
    
    $
    (676
    )
    
    $
    (4,123
    )Operating Data:Product SalesOil (Bbls)
    
    
    729
    
    
    
    629
    
    
    
    131
    
    
    
    138
    
    
    
    165Gas (Mcf)
    
    
    2,690
    
    
    
    3,356
    
    
    
    2,670
    
    
    
    3,266
    
    
    
    2,822BOE
    
    
    1,177
    
    
    
    1,188
    
    
    
    576
    
    
    
    682
    
    
    
    635Average sales priceOil (per Bbl)
    
    $
    39.05
    
    
    $
    29.11
    
    
    $
    24.59
    
    
    $
    24.80
    
    
    $
    28.88Gas (per Mcf)
    
    $
    5.85
    
    
    $
    5.40
    
    
    $
    3.33
    
    
    $
    4.41
    
    
    $
    4.38Proved reservesOil (Bbls)
    
    
    18,916
    
    
    
    12,084
    
    
    
    10,271
    
    
    
    916
    
    
    
    974Gas (Mcf)
    
    
    16,825
    
    
    
    16,271
    
    
    
    15,633
    
    
    
    13,947
    
    
    
    15,686Present value of proved oil and gas reserves discounted
at 10% (before estimated federal income taxes)
    
    $
    266,250
    
    
    $
    147,789
    
    
    $
    122,934
    
    
    $
    17,074
    
    
    $
    90,950Other Data:Long-term leases (3)
    
    $
    127,087
    
    
    $
    130,043
    
    
    $
    84,046
    
    
    $
    53,851
    
    
    $
    51,064Operating cash flow (4)
    
    $
    18,471
    
    
    $
    19,310
    
    
    $
    5,225
    
    
    $
    11,569
    
    
    $
    11,718
 (40)




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(1)
    
    Results include a $31.0 million gain attributable to equity in income of First Permian,
L.P. See Note 6 to the consolidated financial statements. Results also include noncash
charges of $717,000 on the sale of Energen stock, $509,000 for the change in fair value of
derivatives and $440,000 for the change in fair market value of our crude oil swaps.(2)
    
    Results include noncash charges of $2.2 million in the fiscal quarter ended September 30,
2001 and $14.6 million in the fourth quarter ended December 31, 2001, in each case related to
the impairment of oil and natural gas properties incurred in 2001 and primarily a result of a
decrease in year-end reserves and lower oil and natural gas prices.(3)
    
    Excludes our two field offices in Andrews and Snyder, Texas as the lease costs for these
office facilities are billed to nonaffiliated third party working interest owners under our
joint operating agreements with these third parties.(4)
    
    Defined as cash provided by operating activities before changes in operating assets and
liabilities. Because of the exclusion of changes in assets and liabilities, this cash flow
statistic is different from cash provided (used) by operating activities, as is disclosed
under generally accepted accounting principles and is reconciled to operating cash flow as
follows: 2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(in thousands)Cash provided by operating activities
    
    $
    17,727
    
    
    $
    19,465
    
    
    $
    1,528
    
    
    
    13,383
    
    
    $
    10,694Changes in operating assets and liabilities
    
    
    744
    
    
    
    (155
    )
    
    
    3,697
    
    
    
    (1,814
    )
    
    
    1,024Operating cash flow
    
    $
    18,471
    
    
    $
    19,310
    
    
    $
    5,225
    
    
    $
    11,569
    
    
    $
    11,718
 As compared to cash provided by operating activities, we believe operating cash flow is a
better liquidity indicator for oil and natural gas producers because changes in assets and
liabilities eliminates fluctuations related to the timing of cash receipts and disbursements
which can vary from period-to-period because of conditions we cannot control.  ITEM 7.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
   The following discussion is intended to assist you in understanding our financial position and
results of operations for each year in the three-year period ended December 31, 2004. You should
read the following discussion and analysis in conjunction with our consolidated financial
statements and the related notes. The following discussion contains forward-looking statements. For a description of
limitations inherent in forward-looking statements, see Cautionary Statement Regarding Forward
Looking Statements on page (ii). Overview and Strategy Our primary objective is to increase stockholder value of our common stock through increasing
reserves, production, cash flow and earnings. We have shifted the balance of our investments from
properties having high rates of production in early years to properties expected to produce more
consistently over a longer term. We attempt to reduce our financial risks by dedicating a smaller
portion of our capital to high risk projects, while reserving the majority of our available capital
for exploitation and development drilling opportunities. Obtaining positions in long-lived oil and
natural gas reserves will be given priority over properties that might provide (41)




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more cash flow in the early years of production, but which have shorter reserve lives. We also
attempt to further reduce risk by emphasizing acquisition possibilities over high risk exploration
projects. During the latter part of 2002, we reduced our emphasis on high risk exploration efforts and
started focusing on established geologic trends where we can utilize the engineering, operational,
financial and technical expertise of our entire staff. Although we anticipate participating in
exploratory drilling activities in the future, reducing financial, reservoir, drilling and
geological risks and diversifying our property portfolio are important criteria in the execution of
our business plan. In summary, our current business plan:  
    focuses on projects having less geological risk;
    emphasizes exploitation and enhancement activities;
    focuses on acquiring producing properties; and
    expands the scope of operations by diversifying our exploratory and development
efforts, both in and outside of our current areas of operation. Although the direction of our exploration and development activities has shifted from high
risk exploratory activities to lower risk development opportunities, we will continue our efforts,
as we have in the past, to maintain low general and administrative expenses relative to the size of
our overall operations, utilize advanced technologies, serve as operator in appropriate
circumstances, and reduce operating costs. The extent to which we are able to implement and follow through with our business plan will be
influenced by:  
    the prices we receive for the oil and natural gas we produce;
    the results of reprocessing and reinterpreting our 3-D seismic data;
    the results of our drilling activities;
    the costs of obtaining high quality field services;
    our ability to find and consummate acquisition opportunities; and
    our ability to negotiate and enter into work to earn arrangements, joint venture or
other similar agreements on terms acceptable to us. Significant changes in the prices we receive for our oil and natural gas, or the occurrence of
unanticipated events beyond our control may cause us to defer or deviate from our business plan,
including the amounts we have budgeted for our activities. (42)




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Operating Performance Our operating performance is influenced by several factors, the most significant of which are
the prices we receive for our oil and natural gas and our production volumes. The world price for
oil has overall influence on the prices that we receive for our oil production. The prices
received for different grades of oil are based upon the world price for oil, which is then adjusted
based upon the particular grade. Typically, light oil is sold at a premium, while heavy grades of
crude are discounted. Natural gas prices we receive are influenced by:  
    seasonal demand;
    weather;
    hurricane conditions in the Gulf of Mexico;
    availability of pipeline transportation to end users;
    proximity of our wells to major transportation pipeline infrastructures; and
    world oil prices. Additional factors influencing our overall operating performance include:  
    production expenses;
    overhead requirements; and
    costs of capital. Our oil and natural gas exploration, development and acquisition activities require
substantial and continuing capital expenditures. Historically, the sources of financing to fund
our capital expenditures have included:  
    cash flow from operations;
    sales of our equity securities;
    bank borrowings; and
    industry joint ventures. Depletion per BOE in 2004 was $7.05 versus $6.83 in 2003 and $10.52 in 2002. The increase per
BOE in 2004 was a result of increased drilling costs and producing property acquisitions. Our oil and natural gas producing activities are accounted for using the full cost method of
accounting. Under this accounting method, we capitalize all costs incurred in connection with the
acquisition of oil and natural gas properties and the exploration for and development of oil (43)




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and natural gas reserves. See Note 3 to the consolidated financial statements. These costs
include lease acquisition costs, geological and geophysical expenditures, costs of drilling
productive and non-productive wells, and overhead expenses directly related to land and property
acquisition and exploration and development activities. Proceeds from the disposition of oil and
natural gas properties are accounted for as a reduction in capitalized costs, with no gain or loss
recognized unless a disposition involves a material change in reserves, in which case the gain or
loss is recognized. Depletion of the capitalized costs of oil and natural gas properties, including estimated
future development costs, is provided using the equivalent unit-of-production method based upon
estimates of proved oil and natural gas reserves and production, which are converted to a common
unit of measure based upon their relative energy content. Unproved oil and natural gas properties
are not amortized, but are individually assessed for impairment. The cost of any impaired property
is transferred to the balance of oil and natural gas properties being depleted. Results of Operations We changed our business model in 2002 from exploration on the Gulf Coast to acquisition and
exploitation of long life assets in the Permian Basin. At the beginning of 2002, our reserves were
approximately 3.2 million barrels of oil equivalent with a reserves to production ratio of
approximately 4 to 1. Through the execution of this business model, our reserves at the end of
2004 were approximately 21.7 million barrels of oil equivalent with a reserves to production ratio
of approximately 18.3 to 1. At the end of 2002, our production was 77% natural gas and 23% oil
compared to 38% natural gas and 62% oil at the end of 2004. The production stream changed from
short life Gulf coast natural gas to long life Permian Basin oil and has increased our lease
operating expense primarily due to increased utilities and chemicals associated with the oil
properties. (44)




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The following table show selected data and operating income comparison for each of the three
years ended December 31, 2004. Years Ended December 31,2004
    
    
    2003
    
    
    2002(in thousands except per unit data)Production
VolumesOil (Bbls)
    
    
    729
    
    
    
    629
    
    
    
    131Natural gas (Mcf)
    
    
    2,690
    
    
    
    3,356
    
    
    
    2,670BOE
    
    
    1,177
    
    
    
    1,188
    
    
    
    576Sales
PriceOil (per Bbl) (1)
    
    $
    39.05
    
    
    $
    29.11
    
    
    $
    24.59Natural gas (per Mcf)(1)
    
    $
    5.85
    
    
    $
    5.40
    
    
    $
    3.33BOE Price(1)
    
    $
    37.55
    
    
    $
    30.66
    
    
    $
    21.03BOE Price(2)
    
    $
    30.45
    
    
    $
    28.50
    
    
    $
    21.03Operating
RevenuesOil
    
    $
    28,455
    
    
    $
    18,300
    
    
    $
    3,217Oil hedges
    
    
    (7,458
    )
    
    
    (1,659
    )
    
    
    Natural gas
    
    
    15,735
    
    
    
    18,121
    
    
    
    8,889Natural gas hedge
    
    
    (895
    )
    
    
    (907
    )
    
    
    $
    35,837
    
    
    $
    33,855
    
    
    $
    12,106Operating
ExpensesLease operating expense
    
    $
    7,373
    
    
    $
    6,458
    
    
    $
    2,081Production taxes
    
    
    2,108
    
    
    
    1,946
    
    
    
    796General and administrative:General and administrative
    
    
    3,123
    
    
    
    3,019
    
    
    
    1,287Public report ing
    
    
    2,255
    
    
    
    1,325
    
    
    
    866Depreciation and Depletion
    
    
    8,712
    
    
    
    8,390
    
    
    
    6,220$
    23,571
    
    
    $
    21,138
    
    
    $
    11,250Operating income
    
    $
    12,266
    
    
    $
    12,717
    
    
    $
    856
   (1)
    
    Excludes hedge transactions.(2)
    
    Includes hedge transactions. Critical Accounting Policies and Practices Full Cost and Impairment of Assets.We account for our oil and natural gas
exploration and development activities using the full cost method of accounting. Under this
method, all costs incurred in the acquisition, exploration and development of oil and natural gas
properties are capitalized. Costs of non-producing properties, wells in process of being drilled
and significant development projects are excluded from depletion until such time as the related
project is developed and proved reserves are established or impairment is determined. At the end
of each quarter, the net capitalized costs of our oil and natural gas properties, as adjusted for
asset retirement obligations, is limited to the lower of unamortized cost or a ceiling, based on
the present value of estimated future net revenues, net of income tax effects, discounted at 10%,
plus the lower of cost of fair market value of our unproved properties. Revenues are measured at
unescalated oil and natural gas prices at the end of each quarter, with effect given to our cash (45)




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flow hedge positions. If the net capitalized costs of our oil and natural gas properties exceed the
ceiling, we are subject to a ceiling test write-down to the extent of the excess. A ceiling test
write-down is a non-cash charge to earnings. It reduces earnings and
impacts stockholders
equity in the period of occurrence and results in lower depreciation, depletion and amortization
expense in future periods. The risk that we will be required to write down the carrying value of oil and natural gas
properties increases when oil and natural gas prices decline. If commodity prices deteriorate, it
is possible that we could incur an impairment in future periods. Depletion. Provision for depletion of oil and natural gas properties, under the full
cost method, is calculated using the unit of production method based upon estimates of proved oil
and natural gas reserves with oil and natural gas production being converted to a common unit of
measure based upon their relative energy content. Investments in unproved properties and major
development projects are not amortized until proved reserves associated with the projects can be
determined or until impairment occurs. Oil and natural gas properties included $9.5 million and
$2.3 million for 2004 and 2003, respectively, for unproved properties not included in depletion.
The cost of any impaired property is transferred to the balance of oil and natural gas properties
being depleted. Proved Reserve Estimates.Our discounted present value of proved oil and natural gas
reserves is a major component of the ceiling calculation, and represents the component that
requires the most subjective judgments. Estimates of reserves are forecasts based on engineering
data, projected future rates of production and the timing of future expenditures. The process of
estimating oil and natural gas reserves requires substantial judgment, resulting in imprecise
determinations, particularly for new discoveries. Different reserve engineers may make different
estimates of reserve quantities based on the same data. Our reserve estimates are prepared by
outside consultants. The passage of time provides more qualitative information regarding estimates of reserves, and
revisions are made to prior estimates to reflect updated information. However, there can be no
assurance that more significant revisions will not be necessary in the future. If future
significant revisions are necessary that reduce previously estimated reserve quantities, it could
result in a full cost ceiling writedown. At December 31, 2004, the excess of the ceiling over our
capitalized costs was approximately $84.0 million. In addition to the impact of these estimates
of proved reserves on calculation of the ceiling, estimates of proved reserves are also a
significant component of the calculation of depreciation, depletion and amortization. While the quantities of proved reserves require substantial judgment, the associated prices of
oil and natural gas reserves that are included in the discounted present value of the reserves do
not require judgment. Accounting principles generally accepted in the United States require that
prices and costs in effect as of the last day of the period are held constant indefinitely.
Accordingly, the resulting value is not indicative of the true fair value of the reserves. Oil and
natural gas prices have historically been cyclical and, on any particular day at the end of a
quarter, can be either substantially higher or lower than prices we actually receive in the
long-term, which are a barometer for true fair value. (46)




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##### Table of Contents



Use of Estimates. The preparation of consolidated financial statements in accordance
with accounting principles generally accepted in the United States of America requires management
to make estimates and assumptions that affect reported assets, liabilities, expenses, and some
narrative disclosures. Hydrocarbon reserves, future development costs and certain hydrocarbon
production expense are the most critical estimates to our consolidated financial statements. Derivatives. The Financial Accounting Standards Board issued SFAS No. 133 and SFAS
No. 138 requiring that all derivative instruments be recorded on the balance sheet at their
respective fair values. We adopted SFAS No. 133 and SFAS No. 138 on January 1, 2001. For the
periods prior to January 1, 2003, derivative contracts were not designated as hedges. Accordingly,
the unrealized gains or losses were recorded in income. As of January 1, 2003 we designated
costless collars, oil and gas swaps, and interest rate swaps as cash flow hedges. Accordingly, the
effective portion of the unrealized gain or loss on cash flow hedges is recorded in other
comprehensive income until the forecasted transaction occurs. We continued to record the unrealized
loss on put positions outstanding in income during 2003. The purpose of our hedges is to provide a
measure of stability in our oil and natural gas prices and interest rate payments and to manage
exposure to commodity price and interest rate risk under existing sales contracts. Overhead Reimbursement  Joint Operations. As compensation for administration,
supervision office services and warehousing cost, an operator may charge drilling and producing
overhead costs based upon rates negotiated in the joint operating agreement. Overhead reimbursements charged to working interest owners for properties that we operate are
treated as reductions in general and administrative expense for producing overhead. Capital costs
were reduced by approximately $19,000 and $34,000 for 2004 and 2003, respectfully. General and
administrative costs were reduced by approximately $324,000 and $123,000 for drilling and producing
overhead reimbursements for 2004 and 2003, respectfully. Prior to 2003, overhead was recorded as other income. The amounts reimbursed to us for 2002
were $20,000. Incentive and Retention Plan. Parallel will account for the Plan under the provisions
of Statement of Financial Accounting Standards No. 5, Accounting for Contingencies(SFAS No. 5).
Parallel has determined that the likelihood of the occurrence of a corporate transaction or change
of control, as defined in the Plan, is possible, however, the ultimate liability to Parallel is not
readily determinable because of the inability to predict Parallels stock price on the future date
of any corporate transaction or change of control. Therefore, the terms and conditions of the Plan
will be disclosed in Parallels consolidated financial statements, but no liability will be
recorded until such time as a corporate transaction or a change of control occurs. Years Ended December 31, 2004 and December 31, 2003 Our oil and natural gas revenues and production product mix are displayed in the following
table for the years ended December 31, 2004 and 2003. (47)




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##### Table of Contents



Oil and Gas Revenues Revenues(1)
    
    
    Production2004
    
    
    2003
    
    
    2004
    
    
    2003Oil (Bbls)
    
    
    59
    %
    
    
    49
    %
    
    
    62
    %
    
    
    53
    %Natural gas (Mcf)
    
    
    41
    %
    

    
    51
    %
    
    
    38
    %
    
    
    47
    %Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    The following table outlines the detail of our operating revenues for the following periods. Year Ended December 31
    
    
    Increase
    
    
    % Increase2004
    
    
    2003
    
    
    (Decrease)
    
    
    (Decrease)(in thousands except per unit data)Production
VolumesOil (Bbls)
    
    
    729
    
    
    
    629
    
    
    
    100
    
    
    
    16
    %Natural gas (Mcf)
    
    
    2,690
    
    
    
    3,356
    
    
    
    (666
    )
    
    
    (20
    )%BOE
    
    
    1,177
    
    
    
    1,188
    
    
    
    (11
    )
    
    
    (1
    )%Sales
PriceOil (per Bbl)(1)
    
    $
    39.05
    
    
    $
    29.11
    
    
    $
    9.94
    
    
    
    34
    %Natural gas (per Mcf)(1)
    
    $
    5.85
    
    
    $
    5.40
    
    
    $
    0.45
    
    
    
    8
    %BOE price(1)
    
    $
    37.55
    
    
    $
    30.66
    
    
    $
    6.89
    
    
    
    22
    %BOE price(2)
    
    $
    30.45
    
    
    $
    28.50
    
    
    $
    1.95
    
    
    
    7
    %Operating
RevenuesOil
    
    $
    28,455
    
    
    $
    18,300
    
    
    $
    10,155
    
    
    
    55
    %Oil hedges
    
    $
    (7,458
    )
    
    $
    (1,659
    )
    
    $
    (5,799
    )
    
    
    (350
    )%Natural gas
    
    $
    15,735
    
    
    $
    18,121
    
    
    $
    (2,386
    )
    
    
    (13
    )%Natural gas hedges
    
    $
    (895
    )
    
    $
    (907
    )
    
    $
    12
    
    
    
    1
    %Total
    
    $
    35,837
    
    
    $
    33,855
    
    
    $
    1,982
    
    
    
    6
    %
   (1)
    
    Excludes hedge transactions.(2)
    
    Includes hedge transactions. Oil revenues, excluding hedges, increased $10.2 million or 55% for the year ended 2004
compared to 2003. Oil production volumes increased 16% attributable to re-stimulations and
additional acquisitions in the Fullerton San Andres Field, acquisitions in the Carm-Ann San Andres
Field/N. Means Queen Unit and the drilling of producing and injection wells on our Diamond M
Property. The increase in oil production increased revenue approximately $3.9 million for 2004.
Wellhead average realized crude oil prices increased $9.94 per Bbl or 34% to $39.05 per Bbl for
2004 compared to 2003. The increase in oil price increased revenue approximately $6.3 million for
2004. (48)




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##### Table of Contents



Natural gas revenues, excluding hedges, decreased $2.4 million or 13% for the year ended
2004 compared to 2003. Natural gas production volumes decreased 20% due to natural production
declines in our south Texas Yegua/Frio and Cook Mountain projects. The decline in natural gas
volumes decreased revenue approximately $3.6 million for 2004. Average realized wellhead natural
gas prices increased 8% or $0.45 per Mcf to $5.85 per Mcf. The increase in natural gas prices had
a positive effect on revenues of approximately $1.2 million for the period ending 2004. Losses on oil hedges increased $5.8 million or 350% for 2004 compared to 2003 due to the
increase in oil prices. Natural gas hedge losses were $895,000 in 2004 compared to $907,000 in
2003. Although natural gas prices increased 8% in 2004, we had less natural gas volumes hedged for
2004. On a BOE basis, hedges accounted for a realized loss of $7.10 per BOE in 2004 compared to
$2.16 per BOE in 2003. We have hedged certain oil and natural gas volumes (see Note 5 to Consolidated financial
statements) to try and mitigate price changes in our oil and natural gas movements and to meet the
requirements under our loan facility. Based upon our 2005 hedges currently in effect and if 2004
prices and volumes are held constant, a 10% increase in oil prices would have the effect of
increasing oil revenues in fiscal 2005 by $1.9 million. Using the same parameters, a 10% decrease
in oil prices would have an effect of an increase of approximately $1.6 million for 2005. At the
end of 2004, in association with our property acquisitions, we hedged additional oil volumes for
2005 thru 2008, thereby increasing the average price hedged over 2004. This is the reason a
decrease in oil prices can have a positive effect on this comparison. Based upon our 2005 hedges
currently in effect and if 2004 prices and volumes are held constant, a 10% increase in gas prices
would have the effect of increasing gas revenues in fiscal 2005 by $2.2 million. Using the same
parameters, a 10% decrease in gas prices would have an effect of a decrease of approximately
$765,000 for 2005. Cost and Expenses Year Ended December 31,
    
    
    Increase
    
    
    % Increase2004
    
    
    2003
    
    
    (Decrease)
    
    
    (Decrease)(dollars in thousands)Lease operating expense
    
    $
    7,373
    
    
    $
    6,458
    
    
    $
    915
    
    
    
    14
    %Production taxes
    
    
    2,108
    
    
    
    1,946
    
    
    
    162
    
    
    
    8
    %General and administrative:General and administrative
    
    
    3,123
    
    
    
    3,019
    
    
    
    104
    
    
    
    3
    %Public reporting
    
    
    2,255
    
    
    
    1,325
    
    
    
    930
    
    
    
    70
    %Total general and administrative
    
    
    5,378
    
    
    
    4,344
    
    
    
    1,034
    
    
    
    24
    %Depreciation and depletion
    
    
    8,712
    
    
    
    8,390
    
    
    
    322
    
    
    
    4
    %Total
    
    $
    23,571
    
    
    $
    21,138
    
    
    $
    2,433
    
    
    
    12
    %
 Lease operating expense increased 14% or $915,000 compared to 2003. During 2004, 62% of
our production was crude oil compared to 53% in 2003. The change in our business plan to long-life
assets which influenced our purchase of assets in the west Texas Fullerton, Carm-Ann and
work-to-earn agreement at Diamond M has shifted our production and reserves away
from a natural gas base to a crude oil base. This shift has increased the lease operating expense
due to the mechanical operations and utilities required to produce oil properties compared to (49)




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natural gas properties. Lifting costs were $8.06 per BOE in 2004 compared to $7.07 per BOE in 2003
on a BOE basis. As we continue to exploit and develop our long-life Permian Basin oil properties
(Fullerton, Carm-Ann and Diamond M), we expect that lifting costs will continue around the same
level or decline due to increased activity. The lifting costs are also expected to be reduced by
the development of natural gas properties in south Texas, Barnett Shale and New Mexico. Production taxes increased 8% or $162,000 in 2004, associated with a net wellhead increase in
revenues of $7.8 million. Production taxes in future periods will be a function of product mix,
production volumes and product prices. General and administrative in total increased 24% or $1.0 million in 2004 compared to 2003.
Included in our total general and administrative costs is public reporting cost which increased 70%
or $930,000 for 2004. The increase in public reporting cost was attributable to audit costs
associated with the change of auditors at the end of 2003 and increased legal costs and costs
attributable to the work on our internal control over financial reporting under Section 404 of the
Sarbanes-Oxley Act of 2002 or SOX 404. The SOX 404 costs have been a significant portion of the
increase in our public reporting costs and we expect SOX 404 costs to continue into 2005. General
and administrative expenses capitalized to the full cost pool were $1.1 million for 2004 compared
to $900,000 for 2003. On a BOE basis, general and administrative costs were $2.65 per BOE in 2004
compared to $2.54 per BOE in 2003, while public reporting costs were $1.92 per BOE and $1.12 per
BOE for the same period. General and administrative expenses will increase in 2005 in association
with reporting requirements and operational support of current and new acquisitions. Depreciation and depletion expense increased 4% or $322,000 for 2004 compared to 2003.
Depletion per BOE was $7.05 for 2004 and $6.83 for 2003. This increase is attributable to
increased drilling costs and producing property purchases. Depreciation expense increased with the
cost of a new accounting and production system in 2004. Depletion costs are highly correlated with
production volumes and capital expenditures. Fiscal year 2005 depletion costs will increase with
increased production volumes. Other income (expense) Year Ended December 31,
    
    
    Increase
    
    
    % Increase2004
    
    
    2003
    
    
    (Decrease)
    
    
    (Decrease)(dollars in thousands)Change in fair market
value of derivatives
    
    $
    
    
    
    $
    (22
    )
    
    $
    22
    
    
    
    Gain (loss) on ineffective
portion of hedges
    
    
    (945
    )
    
    
    191
    
    
    
    (1,136
    )
    
    
    (595
    )%Interest and other income
    
    
    189
    
    
    
    116
    
    
    
    73
    
    
    
    63
    %Interest expense
    
    
    (2,732
    )
    
    
    (2,048
    )
    
    
    (684
    )
    
    
    (33
    )%Other expense
    
    
    (324
    )
    
    
    (259
    )
    
    
    (65
    )
    
    
    (25
    )%Total
    
    $
    (3,812
    )
    
    $
    (2,022
    )
    
    $
    (1,790
    )
    
    
    (89
    )%
 The loss associated with the ineffective portion of our hedges increased $1.1 million or
595% for 2004 compared to 2003. Additional crude oil hedge positions were added following our
Fullerton acquisition of additional interest and the Carm-Ann acquisition. After entering into (50)




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##### Table of Contents



these additional hedge positions, commodity prices increased dramatically and resulted in an
ineffective portion to be recorded in other expense. The ineffective gain or loss may increase or
decrease until settlement of these contracts. Interest and other income increased with increased
interest income and other non-recurring income. Interest expense increased with the increase of
debt from approximately $40.0 million to $79.0 million in 2004 along with an increase of our loan
interest rate from 4.50% to 7.25% later in 2004. Other expense increased in 2004 associated with
legal, accounting and related costs associated with an aborted high yield debt offering. If
interest rates remain at current levels, interest expense will decrease for 2005 as a result of
applying the $28.0 million in net proceeds from our February 2005 equity offering to the repayment
of a portion of our existing bank debt. Income tax expense was $2.9 million in 2004 compared to $3.0 million in 2003. 2003 included a
reduction of $900,000 for state income tax. Income tax expense for 2005 will be dependent on our
earnings and is expected to be approximately 35% of income before income taxes. We had basic net earnings per share of $.20 and $.33 and diluted earnings per share of $.20
and $.31 for 2004 and 2003, respectively. Basic weighted average common shares outstanding
increased from 21.3 million shares in 2003 to 25.3 million shares in 2004. Diluted weighted
average common shares increased from 24.2 million shares in 2003 to 28.4 million shares in 2004.
The increase in common shares is due to the private placement of 4.0 million shares in late
December 2003 and stock option exercised in 2004. Years Ended December 31, 2003 and December 31, 2002 Our oil and natural gas revenues and production mix are displayed in the following table for
the years ended December 31, 2003 and 2002. Oil
and Gas Revenues Revenues (1)
    
    
    Production2003
    
    
    2002
    
    
    2003
    
    
    2002Oil (Bbls)
    
    
    49
    %
    
    
    27
    %
    
    
    53
    %
    
    
    23
    %Natural gas (Mcf)
    
    
    51
    %
    
    
    73
    %
    
    
    47
    %
    
    
    77
    %Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
   (1)
    
    Includes hedge transactions (51)




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##### Table of Contents



The following table summarizes, on a per unit basis, our production volumes and sales
prices for the fiscal years ended December 31, 2003 and 2002, and our total operating revenues for
these same periods. Year Ended December 31,
    
    
    Increase
    
    
    % Increase2003
    
    
    2002
    
    
    (Decrease)
    
    
    (Decrease)(in thousands except per unit data)Production
VolumesOil (Bbls )
    
    
    629
    
    
    
    131
    
    
    
    498
    
    
    
    380
    %Natural gas (Mcf)
    
    
    3,356
    
    
    
    2,670
    
    
    
    686
    
    
    
    26
    %BOE
    
    
    1,188
    
    
    
    576
    
    
    
    612
    
    
    
    106
    %Sales
PriceOil (per Bbl)(1)
    
    $
    29.11
    
    
    $
    24.59
    
    
    $
    4.52
    
    
    
    18
    %Natural gas (per Mcf) (1)
    
    $
    5.40
    
    
    $
    3.33
    
    
    $
    2.07
    
    
    
    62
    %BOE price (1)
    
    $
    30.66
    
    
    $
    21.03
    
    
    $
    9.63
    
    
    
    46
    %BOE price (2)
    
    $
    28.50
    
    
    $
    21.03
    
    
    $
    7.47
    
    
    
    36
    %Operating
RevenuesOil
    
    $
    18,300
    
    
    $
    3,217
    
    
    $
    15,083
    
    
    
    469
    %Oil hedges
    
    $
    (1,659
    )
    
    $
    
    
    
    $
    (1,659
    )
    
    
    Natural gas
    
    $
    18,121
    
    
    $
    8,889
    
    
    $
    9,232
    
    
    
    104
    %Natural gas hedges
    
    $
    (907
    )
    
    $
    
    
    
    $
    (907
    )
    
    
    Total
    
    $
    33,855
    
    
    $
    12,106
    
    
    $
    21,749
    
    
    
    180
    %
   (1) Excludes hedge transactions.(2) Includes hedge transactions. We did not apply hedge accounting in 2002. Oil revenues, excluding hedges, increased $15.1 million or 469% for the year ended 2003
compared to 2002. Oil production volumes increased 380% attributable to the Fullerton producing
property purchase in December 2002. The increase in oil production increased revenue approximately
$12.3 million or 469% for 2003. Realized crude oil prices increased $4.52 or 18% to $29.11 for
2003 compared to 2002. The increase in oil price increased revenue approximately $2.8 million for
2003. Natural gas revenues, excluding hedges, increased $9.2 million or 104% for the year ended 2003
compared to 2002. Natural gas production volumes increased 26% due to two additional wells drilled
in 2003 in the Cook Mountain along with a full years production on the Murphy #1. The increase in
natural gas volumes increased revenues approximately $2.3 million for 2003. Average realized
wellhead natural gas prices increased 62% or $2.07 to $5.40 per Mcf. The increase in natural gas
prices had a positive effect on revenues of approximately $6.9 million for the period ending 2003. Losses on oil and natural gas hedges were $1.7 million and $900,000 respectively for 2003. In
2003, we adopted cash flow hedge accounting which allows us to record changes in fair value of
contracts designated as cash flow hedges through other comprehensive income until realized. When
realized, we reflect the gain or loss on commodity derivatives designed as cash flow hedges in oil
and gas revenue. On a BOE basis, hedges accounted for a realized loss of $2.16 per BOE in 2003. (52)




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##### Table of Contents



Cost and Expenses Year Ended December 31,
    
    
    Increase
    
    
    % Increase2003
    
    
    2002
    
    
    (Decrease)
    
    
    (Decrease)(dollars in thousands)Lease operating expense
    
    $
    6,458
    
    
    $
    2,081
    
    
    $
    4,377
    
    
    
    210
    %Production taxes
    
    
    1,946
    
    
    
    796
    
    
    
    1,150
    
    
    
    144
    %General and administrative:General and administrative
    
    
    3,019
    
    
    
    1,287
    
    
    
    1,732
    
    
    
    135
    %Public reporting
    
    
    1,325
    
    
    
    866
    
    
    
    459
    
    
    
    53
    %Total general and administrative
    
    
    4,344
    
    
    
    2,153
    
    
    
    2,191
    
    
    
    102
    %Depreciation and depletion
    
    
    8,390
    
    
    
    6,220
    
    
    
    2,170
    
    
    
    35
    %Total
    
    $
    21,138
    
    
    $
    11,250
    
    
    $
    9,888
    
    
    
    88
    %
 Lease operating expense increased 210% or $4.4 million in 2003 compared to 2002. Fiscal
year 2003 was the first full year of our new business plan of long life oil assets compared to
short-life natural gas projects. The oil production percentage increased from 23% in 2002 to 53%
in 2003. Our lease operating expense increased with increased costs on mechanical operations and
utilities on the waterfloods on the Fullerton and Diamond M properties. Lifting costs were $7.07
per BOE in 2003 compared to $5.00 per BOE in 2002. Production taxes increased $1.2 million or 144% associated with a wellhead increase in revenue
of $24.3 million. General and administrative in total increased 102% or $2.2 million in 2003 compared to 2002.
Our new business plan was implemented in June 2002. Fiscal year 2003 was the first full year with
the general and administrative costs, primarily personnel and office space, required for our
business plan implementation. Public reporting cost increased $459,000 or 53% with increased legal
expense, audit expense related to property acquisitions, increased expenses associated with our
recent equity offering and attendance at industry conferences. General and administrative expenses
associated with capital projects was $900,000 for 2003 compared to $1.3 million for 2002. On a BOE
basis, general and administrative costs were $2.54 per BOE and $2.23 per BOE for 2003 and 2002,
respectively. Public reporting costs were $1.12 per BOE for 2003 and $1.50 per BOE for 2002. Depreciation and depletion expense increased 35% or $2.2 million for 2003 compared to 2002.
Our depletion rate decreased $3.69 per BOE to $6.83 in 2003. The rate decrease was attributable to
the calculated depletion rate derived from the reserves and purchase price of the Fullerton assets
being less than our prevailing rate prior to the purchase. Although the total depletion rate
declined, depletion expense increased with a 106% increase in BOE production volumes. (53)




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##### Table of Contents



Other income
(expense) Year Ended December 31,
    
    
    Increase
    
    
    % Increase2003
    
    
    2002
    
    
    (Decrease)
    
    
    (Decrease)(dollars in thousands)Equity in income of
First Permian, L.P.
    
    $
    
    
    
    $
    31,044
    
    
    
    (31,044
    )
    
    
    Incentive awards attributable to
the sale of First Permian, L.P.
    
    
    
    
    
    
    (1,382
    )
    
    
    1,382
    
    
    
    Loss on sale of marketable securities
    
    
    
    
    
    
    (717
    )
    
    
    717
    
    
    
    Change in
fair market value of derivatives
    
    
    (22
    )
    
    
    (948
    )
    
    
    926
    
    
    
    98
    %Gain (loss) on ineffective
portion of hedges
    
    
    191
    
    
    
    
    
    
    
    191
    
    
    
    Interest and other income
    
    
    116
    
    
    
    93
    
    
    
    23
    
    
    
    25
    %Dividend income
    
    
    
    
    
    
    371
    
    
    
    (371
    )
    
    
    Interest expense
    
    
    (2,048
    )
    
    
    (601
    )
    
    
    (1,447
    )
    
    
    (241
    )%Other expense
    
    
    (259
    )
    
    
    (332
    )
    
    
    73
    
    
    
    22
    %Total
    
    $
    (2,022
    )
    
    $
    27,528
    
    
    $
    (29,550
    )
    
    
    (107
    )%
 The equity in income of First Permian, L.P., (see Note 6 to the consolidated financial
statements) is where First Permian, L.P. sold all of its oil and gas properties on April 8, 2002.
Parallel was the owner of a 30.675% in First Permian, we received our prorata share of the net
sales proceeds, or $5.5 million in cash and 933,589 shares of common stock of Energen Corporation.
Our prorata share of the net income and distributions for 2002 was $31.0 million. The incentive
awards attributable to the sale of First Permian, L.P. of $1.4 million reflects bonus payments made
to certain officers and employees in 2002 as a result of First Permians sale of all of its assets.
We recognized a loss on sale of marketable securities for 2002 in the amount of $717,000, which
resulted from our sales of 933,589 shares, all our investment of Energen common stock. The loss
represents the difference in Energens stock price of $27.40 per share at the time of the First
Permian sale and our realized net price of approximately $26.63 per share. We recognized a loss of approximately $22,000 in the change in fair market value of
derivatives for 2003 compared to a loss of $948,000 for 2002. The $22,000 loss in 2003 was
attributable to the expiration of put options not designated as cash flow hedges. The decrease
from 2002 to 2003 is primarily due to our adopting cash flow hedge accounting which allows us to
record changes in fair value of contracts designated as cash flow hedges through other
comprehensive income until realized. When realized, we reflect the gain or loss on commodity
derivatives designated as cash flow hedges in revenue (see Note 5 to the consolidated financial
statements). The gain on the ineffective portion of the hedges was $191,000 in 2003. We did not have any
gain or loss on ineffective portion of the hedges in 2002 since we did not use hedge accounting. Dividend income in 2002 included dividends received by Parallel for the Energen stock held
during the year. All of our Energen stock was sold in 2002; therefore no dividends were received
in 2003. (54)




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##### Table of Contents



Interest expense increased $1.4 million or 241% in 2003. Our outstanding debt increased with
the Fullerton acquisition in December 2002 requiring larger interest payments during 2003. Income tax expense was $3.0 million in 2003 compared to $9.7 million in 2002. Income before
taxes was $10.7 million in 2003 compared to $28.4 million in 2002 which correlates with the
reduction in income tax expense. We had basic net earnings per share of $.33 and $.88 and diluted earnings per share of $.31
and $.79 for 2003 and 2002 respectively. Basic weighted average common shares outstanding
increased from 20.7 million shares in 2002 to 21.3 million shares in 2003. Diluted weighted
average common shares increased from 23.5 million shares in 2002 to 24.2 million shares in 2003.
The increase in average common shares is due to the 454,545 common shares issued in conjunction
with the Fullerton acquisition and stock options exercised for 2003. Capital Resources and Liquidity Our capital resources consist primarily of cash flows from our oil and natural gas properties,
bank borrowings supported by our oil and natural gas reserves and completed equity offerings. Our
level of earnings and cash flows depends on many factors, including the prices we receive for oil
and natural gas we produce. Working capital decreased 95% or $15.6 million as of December 31, 2004 compared with December
31, 2003. Current assets exceeded current liabilities by $800,000 at December 31, 2004. The
working capital decrease was primarily due to the decrease in available cash used for debt
reduction and capital requirements, increased accounts payable and the increase in derivative
obligations. The following table summarizes our cash flows from operating, investing and financing
activities: Year ended December 31,2004
    
    
    2003
    
    
    2002(in thousands)Operating activities
    
    $
    17,727
    
    
    $
    19,465
    
    
    $
    1,528Investing activities
    
    $
    (69,518
    )
    
    $
    (15,494
    )
    
    $
    (30,277
    )Financing activities
    
    $
    39,194
    
    
    $
    1,595
    
    
    $
    37,210
 Cash from operating activities in 2004 decreased $2.0 million over 2003 due to natural
production declines in our south Texas gas properties and increased hedge losses with increased
commodity prices. These movements are partially offset by oil production in our Permian Basin
properties and in commodity prices. Investing and financing activities increased in 2004 compared
to 2003 primarily as a result of additional interests acquired in our Fullerton property and the
Carm-Ann acquisition in 2004. (55)




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##### Table of Contents



Cash provided from operating activities in 2003 increased $17.9 million over 2002 largely due
to increased operating income from the Fullerton acquisition, increased production in the Cook
Mountain Gas project and increased sales prices in 2003. Investing and financing activities
decreased in 2003 compared to 2002 primarily as a result of the Fullerton acquisition in 2002.
These declines were partially offset by proceeds from the First Permian asset sale also recorded in
2002. We incurred property additions of $67.9 million for the period ended December 31, 2004,
primarily due to our net property acquisitions of $37.4 million, leasehold acquisition,
development, and enhancement activities. Also added to our property basis were asset retirement
costs of $338,000 for SFAS 143 (see Note 4). The property acquisitions, development and
enhancement activities were financed by the utilization of cash flows provided by operations and
our credit facility. As of March 1, 2005 the amount available under our universal shelf registration statement
filed with the Securities and Exchange Commission for the offer and sale, from time to time, of
Parallel debt and equity securities totaled approximately $69.7 million. Based on our projected oil and natural gas revenues and related expenses, available bank
borrowings and completed equity offering, we believe that we will have sufficient capital resources
to fund normal operations and capital requirements, interest expense and principal reduction
payments on bank debt, if required, and preferred stock dividends. We continually review and
consider alternative methods of funding. Bank Borrowings On September 27, 2004, we entered into a Second Amended and Restated Credit Agreement (or the
Credit Agreement) with First American Bank, SSB, BNP Paribas, Citibank, F.S.B. and Western
National Bank. The Credit Agreement provides for a revolving credit facility which means that we can borrow,
repay and reborrow funds drawn under the credit facility. The total amount that we can borrow and
have outstanding at any one time is limited to the lesser of $200.0 million or the borrowing base
established by our lenders. At March 1, 2005 our borrowing base was $89.3 million. The principal
amount outstanding under the credit facility at December 31, 2004 was $79.0 million, excluding
$350,000 reserved for our letters of credit. The amount of the borrowing base is based primarily
upon the estimated value of our oil and gas reserves. The borrowing base amount is redetermined by
the lenders semi-annually on or about April 1 and October 1 of each year or at other times required
by the lenders or at our request. If, as a result of the lenders redetermination of the borrowing
base, the outstanding principal amount of our loan exceeds the borrowing base, we must either
provide additional collateral to the lenders or repay the principal of the note in an amount equal
to the excess. Except for the principal payments that may be required because of our outstanding
loans being in excess of the borrowing base, interest only is payable monthly. Loans made to us under this credit facility bears interest at First American Banks base rate
or the LIBOR rate, at our election. Generally, First American Banks base rate is equal to the sum
of (a) the prime rate published in the Wall Street Journal, and (b) if the principal amount (56)




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##### Table of Contents



outstanding is equal to or greater than 85% of the borrowing base established by the lenders, a
margin of 2.00%. The LIBOR rate is generally equal to the sum of (a) the rate designated as British Bankers
Association Interest Settlement Rates and offered on one, two, three, six or twelve month interest
periods for deposits of $1.0 million, and (b) a margin ranging from 2.25% to 4.75%, depending upon
the outstanding principal amount of the loans. If the principal amount outstanding is equal to or
greater than 85% of the borrowing base established by the lenders, the margin is 4.75%. If the
principal amount outstanding is equal to or greater than 75% of the borrowing base, but less than
85% of the borrowing base, the margin is 2.75%. If the principal amount outstanding is equal to or
greater than 50%, but less than 75% of the borrowing base, the margin is 2.50%. If the principal
amount outstanding is less than 50% of the borrowing base, the margin is 2.25%. The interest rate we are required to pay on our borrowings, including the applicable margin,
may never be less than 4.50%. At December 31, 2004, our interest rate was 7.25% on $5.0 million;
6.73% on $55.0 million; and 7.29% on $19.0 million. We obtain different interest rates on bank
base rates and on each LIBOR tranche. In the case of base rate loans, interest is payable on the last day of each month. In the case
of LIBOR loans, interest is payable on the last day of each applicable interest period. If the total outstanding borrowings under the credit facility are less than the borrowing
base, an unused commitment fee is required to be paid to the lenders. The amount of the fee is .25%
of the daily average of the unadvanced amount of the borrowing base. The fee is payable quarterly. If the borrowing base is increased, we are required to pay a fee of .375% on the amount of any
increase in the borrowing base. Parallel, L.L.C., a subsidiary of Parallel Petroleum Corporation, guaranteed payment of the
loans. Parallels obligations to the lenders are secured by substantially all of its oil and gas
properties. All outstanding principal under the revolving credit facility is due and payable on December
20, 2008. The maturity date of our outstanding loans may be accelerated by the lenders upon the
occurrence of an event of default under the Credit Agreement. The Credit Agreement contains various restrictive covenants and compliance requirements as
follows:  
    at the end of each quarter, a current ratio (as defined in the credit agreement) of
at least 1.1 to 1.0;
    for each period (as calculated in the Credit Agreement) ending on December 31, March
31, June 30 and September 30, a funded debt ratio (as defined in the Credit (57)




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Agreement) of not more than 3.70, 3.60 and 3.50, respectively, for December 31, 2004, 2005,
2006 and 2007; and  
    at all times, adjusted consolidated net worth (as defined in the Credit Agreement)
of at least (a) $50.0 million, plus (b) seventy-five percent (75%) of the net proceeds
from any equity securities issued by Parallel, plus (c) fifty percent (50%) of
consolidated net income for each fiscal quarter, if positive, and zero percent (0%) if
negative. As of December 31, 2004, we were in compliance with our bank covenants. The Credit Agreement also contains restrictions on all retained earnings and net income for
payment of dividends on common stock. Under the Credit Agreement, Parallel and its subsidiaries also entered into a separate
commitment letter with the lenders. Under the commitment letter, the lenders made available an
additional $20.5 million under the Credit Agreement for Parallels completion of the purchase of
oil and gas properties from third parties. If we have borrowing capacity under our Credit Agreement, we intend to borrow, repay and
reborrow under the revolving credit facility from time to time as necessary, subject to borrowing
base limitations, to fund:  
    interpretation and processing of 3-D seismic survey data;
    lease acquisitions and drilling activities;
    acquisitions of producing properties or companies owning producing
properties; and,
    general corporate purposes. Preferred Stock At December 31, 2004 we had 950,000 shares of 6% convertible preferred stock outstanding. The
preferred stock:  
    required us to pay dividends of $.60 per annum, semi-annually on June 15
and December 15 of each year;
    is convertible into common stock at any time, at the option of the holder,
into 2.8751 shares of common stock at an initial conversion price of $3.50 per share,
subject to adjustment in certain events;
    is redeemable at our option, in whole in part, for $10 per share, plus
accrued dividends;
    has no voting rights, except as required by applicable law, and except
that as long as any shares of preferred stock remain outstanding, the holders of a
majority of the (58)




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outstanding shares of the preferred stock may vote on any proposal to change any
provision of the preferred stock which materially and adversely affects the rights,
preferences or privileges of the preferred stock;  
    is senior to the common stock with respect to dividends and on
liquidation, dissolution or winding up of Parallel;
    has a liquidation value of $10 per share, plus accrued and unpaid
dividends. Commodity Price Risk Management Transactions For the year ended December 31, 2002, we used mark-to-market accounting for all our derivative
contracts. As of January 1, 2003 we designated the costless collars, oil and natural gas swaps and
interest rate swaps as cash flow hedges under the provisions of SFAS 133, as amended. We continued
mark-to-market accounting for our put positions. The purpose of our hedges is to provide a measure
of stability in our oil and natural gas prices and interest rate payments and to manage exposure to
commodity price and interest rate risk. Our objective is to lock in a range of oil and natural gas
prices and a fixed interest rate for certain notional amounts. Under cash flow hedge accounting, the quarterly change in the fair value of the commodity
derivatives is recorded in stockholders equity as other comprehensive income (loss) and then
transferred to revenue in the period the production is sold. Ineffective portions of cash flow
hedges (changes in realized prices that do not match the changes in the hedge price) are recognized
in other expense as they occur. While the cash flow hedge contract is open, the ineffective gain
or loss many increase or decrease until settlement of the contract. Under cash flow hedge accounting for interest rate, the quarterly change in the fair value of
the derivative is recorded in stockholders equity as other comprehensive income (loss). The gain
or loss is transferred, on a contract basis, to interest expense as the interest accrues.
Ineffective portions of cash flow hedges are recognized in other expense as they occur. We are exposed to credit risk in the event of nonperformance by the counterparty in its
derivative instruments. However, we periodically assess the creditworthiness of the counterparty
to mitigate this credit risk. Certain of our commodity price risk management arrangements have required us to deliver cash
collateral or other assurances of performance to the counterparties in the event that our payment
obligations with respect to our commodity price risk management transactions exceed certain levels. For additional information about our price risk management transactions, see Item 7A of this
Annual Report on Form 10-K, beginning on page 63. Future Capital Requirements Our capital expenditure budget for 2005 is approximately $43.7 million and is highly dependent
on future oil and natural gas prices and the availability of funding. These expenditures will be
governed by the following factors: (59)




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
    internally generated cash flows;
    availability of borrowing under our revolving credit facility;
    additional sources of funding; and
    future drilling successes. In 2004, we have focused on drilling lower risk natural gas prospects that could have a
meaningful effect on our reserve base and cash flows. In selected cases, we may elect to reduce
our interest in higher risk, higher impact projects. We may also sell certain non-core producing
properties to raise funds for capital expenditures. Contractual Obligations, Commitments and Off-Balance Sheet Arrangements We have contractual obligations and commitments that may affect our financial position.
However, based on our assessment of the provisions and circumstances of our contractual obligation
and commitments, we do not feel there would be an adverse effect on our consolidated results of
operations, financial condition or liquidity. The following table is a summary of significant contractual obligations: Obligation Due in PeriodAfter 5Contractual Cash Obligations
    
    2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    years
    
    
    Total(in thousands)Revolving Credit Facility (secured)
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    79,000
    
    
    $
    
    
    
    $
    
    
    
    $
    79,000Office Lease (Dinero Plaza)
    
    
    157
    
    
    
    105
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    262Andrews and Snyder Field Offices
    
    
    23
    
    
    
    23
    
    
    
    23
    
    
    
    14
    
    
    
    14
    
    
    
    (1)
    
    
    
    97Preferred Stock Dividend
    
    
    570
    
    
    
    570
    
    
    
    570
    
    
    
    570
    
    
    
    570
    
    
    
    (2)
    
    
    
    2,850Asset retirement obligations(3)
    
    
    150
    
    
    
    58
    
    
    
    222
    
    
    
    41
    
    
    
    146
    
    
    
    1,515
    
    
    
    2,132Derivative Obligations
    
    
    7,965
    
    
    
    5,270
    
    
    
    2,208
    
    
    
    2,048
    
    
    
    
    
    
    
    
    
    
    
    17,491Total
    
    $
    8,865
    
    
    $
    6,026
    
    
    $
    3,023
    
    
    $
    81,673
    
    
    $
    730
    
    
    $
    998
    
    
    $
    101,832
   (1)
    
    The Snyder field office lease remains in effect until the termination of our trade
agreement with a third party working interest owner in the Diamond M project. The Andrews
field office lease expires in December 2007. The lease cost for these two office facilities
are billed to nonaffiliated third party working interest owners under our joint operating
agreements with these third parties.(2)
    
    Payments of preferred dividends so long as preferred stock remains outstanding and not
converted.(3)
    
    Assets retirement obligations of oil and natural gas assets, excluding salvage value and
accretion. (60)




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##### Table of Contents



Deferred taxes are not included in the table above. The utilization of net operating
loss carryforwards combined with our plans for development and acquisitions may offset any major
cash outflows. However, the ultimate timing of the settlements cannot be precisely determined. In addition to our principal payment obligations under the revolving credit facility payment
noted in the table above, we are subject to interest payments on such indebtedness. See Note 7 to
the consolidated financial statements. We have no off-balance sheet financing arrangements or any unconsolidated special purpose
entities. Outlook The oil and natural gas industry is capital intensive. We make, and anticipate that we will
continue to make, substantial capital expenditures in the exploration for, development and
acquisition of oil and natural gas reserves. Historically, our capital expenditures have been
financed primarily with:  
    internally generated cash from operations;
    proceeds from bank borrowings; and
    proceeds from sales of equity securities. The continued availability of these capital sources depends upon a number of variables,
including:  
    our proved reserves;
    the volumes of oil and natural gas we produce
from existing wells;
    the prices at which we sell oil and natural gas; and
    our ability to acquire, locate and produce new reserves. Each of these variables materially affects our borrowing capacity. We may from time to time
seek additional financing in the form of:  
    increased bank borrowings;
    sales of Parallels securities;
    sales of non-core properties; or
    other forms of financing. (61)




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We do not have agreements for any future financing and there can be no assurance as to the
availability or terms of any such financing. Inflation Our drilling costs have escalated and we would expect this trend to continue, but our
commodity prices have also increased at the same time. Recent Accounting Pronouncements In September 2004, the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 106(SAB No. 106). SAB No. 106 applies to companies using the full cost method of accounting
for oil and gas properties and equipment costs, such as Parallel. SAB No. 106 affected the way in
which we calculate our full cost ceiling limitation (Parallel excluded asset retirement costs
related to proved developed properties in the calculation of the ceiling) and the way we calculated
depletion on our gas properties (only asset retirement costs for new recompletions and new wells
will be included in calculating depletion rates). Parallel adopted SAB No. 106 on October 1, 2004. In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment(SFAS No. 123(R)).
SFAS No. 123(R) requires an entity to recognize the grant-date fair value of stock options and
other equity-based compensation issued to employees in the income statement. SFAS No. 123(R) will
be effective for Parallel beginning July 1, 2005. We do not expect SFAS No. 123(R) to have a
material impact on its results of operations. In December 2004, the FASB issued FASB Staff Position FAS 109-1, Application on FASB
Statement No. 109, Accounting for Income Taxes, for the Tax Deduction Provided to U.S. Based
Manufacturers by the American Jobs Creation Act of 2004(FSP 109-1). FSP 109-1 clarifies how to
apply Statement No. 109 to the new laws tax deduction for income attributable to Domestic
production activities. We are currently evaluating the impact of the new law. Effects of Derivative Instruments For the year ended December 31, 2002, we used mark-to-market accounting for all our derivative
contracts. As of January 1, 2003 we designated the costless collars, oil and natural gas swaps and
interest rate swaps as cash flow hedges under the provisions of SFAS 133, as amended. We continued
mark-to-market accounting for our put positions. The purpose of our hedges is to provide a measure
of stability in our oil and natural gas prices and interest rate payments and to manage exposure to
commodity price and interest rate risk. Our objective is to lock in a range of oil and natural gas
prices and fixed interest rates. Under cash flow hedge accounting, the quarterly change in the fair value of the derivatives is
recorded in stockholders equity as other comprehensive income (loss) and then transferred to
earnings when the production is sold. Ineffective portions of cash flow hedges (changes in
realized prices that do not match the changes in the hedge price) are recognized in other expense
as they occur. While the cash flow hedge contract is open, the ineffective gain or loss many
increase or decrease until settlement of the contract. (62)




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##### Table of Contents



We are exposed to credit risk in the event of nonperformance by the counterparty in its
derivative instruments. However, we periodically assess the creditworthiness of the counterparty
to mitigate this credit risk. 
  ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 The following quantitative and qualitative information is provided about market risks and
derivative instruments to which Parallel was a party at December 31, 2004, and from which Parallel
may incur future earnings, gains or losses from changes in market interest rates and oil and
natural gas prices. Interest Rate Sensitivity as of December 31, 2004 Our only financial instrument sensitive to changes in interest rates is our bank debt. As the
interest rate is variable and reflects current market conditions, the carrying value approximates
the fair value. The table below shows principal cash flows and related weighted average interest
rates by expected maturity dates. Weighted average interest rates were determined using weighted
average interest paid and accrued in December, 2004. You should read Note 7 to the consolidated
financial statements for further discussion of our debt that is sensitive to interest rates. 2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Total(dollars in thousands)Variable rate debt
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    79,000
    
    
    $
    
    
    
    $
    79,000Revolving Facility (secured)
    
    
    7.25
    %
    
    
    7.25
    %
    
    
    7.25
    %
    
    
    7.25
    %
    
    
    
    
    
    
    Average interest rate
 At December 31, 2004, we had bank loans in the amount of approximately $79.0 million
outstanding at an average interest rate of 7.25%. Borrowings under our credit facility bear
interest, at our election, at (i) the banks base rate or (ii) the libor rate, plus libor
margin, but in no event less than 4.50%. As a result, our annual interest cost in 2004 will
fluctuate based on short-term interest rates. As the interest rate is variable and is reflective
of current market conditions, the carrying value approximates the fair value. Under our credit facility, we may elect an interest rate based upon the agent lenders base
lending rate, or the libor rate, plus a margin ranging from 2.25% to 2.75% per annum, depending on
our borrowing base usage. The interest rate we are required to pay, including the applicable
margin, may never be less than 4.50%. (63)




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As of December 31, 2004, we had entered into fixed interest rate swap contracts with BNP
Paribas based on the 90-day LIBOR rates at the time of the contract. The effect of the swap is
that we converted our variable rate debt into fixed rate debt. We will receive variable interest
rates as described previously and pay fixed rates as shown in the table below. NotionalPeriod of Time
    
    Amounts
    
    
    Fixed Interest Rates$ in millionsJanuary 1, 2005 thru December 31, 2005
    
    $
    50
    
    
    
    3.36
    %January 1, 2006 thru December 31, 2006
    
    $
    50
    
    
    
    3.82
    %January 1, 2007 thru December 31, 2007
    
    $
    50
    
    
    
    4.30
    %January 1, 2008 thru December 30, 2008
    
    $
    50
    
    
    
    4.74
    %
 Commodity Price Sensitivity as of December 31, 2004 Our major market risk exposure is in the pricing applicable to our oil and natural gas
production. Market risk refers to the risk of loss from adverse changes in oil and natural gas
prices. Realized pricing is primarily driven by the prevailing domestic price for crude oil and
spot prices applicable to the region in which we produce natural gas. Historically, prices
received for oil and natural gas production have been volatile and unpredictable. We expect
pricing volatility to continue. Oil prices ranged from a low of $26.76 per barrel to a high of
$52.82 per barrel during 2004. Natural gas prices we received during 2004 ranged from a low of
$2.31 per Mcf to a high of $8.79 per Mcf. A significant decline in the prices of oil or natural
gas could have a material adverse effect on our financial condition and results of operations. Put Options. On May 24, 2002 we purchased put floors on volumes of 100,000 Mcf per
month for a total of 700,000 Mcf during the seven month period from April 2003 through October 2003
at a floor price of $3.00 per Mcf for a total consideration of $139,500. These derivatives were
not held for trading purposes. A decrease in fair value of the put floors of approximately $22,000 was recognized for the
period ended December 31, 2003 in our consolidated statements of operations. Costless Collar. Collars are created by purchasing puts to establish a floor price
and then selling a call which establishes a maximum amount we will receive for the oil or natural
gas hedged. Calls are sold to offset or reduce the premium paid for buying the put. We have
entered into costless Houston ship channel gas collars and west Texas intermediate light sweet
crude oil collars. (64)




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##### Table of Contents



A recap for the period of time, number of MMBtus and natural gas prices is as follows: Houston Ship ChannelBarrels of
    
    
    Ny Mex oil prices
    
    
    MMBtu of
    
    
    gas pricesPeriod of Time
    
    Oil
    
    
    Floor
    
    
    Cap
    
    
    Natural Gas
    
    
    Floor
    
    
    CapApril 1, 2005 thru October 31, 2005
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    428,000
    
    
    $
    5.00
    
    
    $
    7.26January 1, 2005 thru December 31,
2005
    
    
    73,000
    
    
    $
    36.00
    
    
    $
    49.60
    
    
    
    
    
    
    $
    
    
    
    $
    January 1, 2006 thru December 31,
2006
    
    
    70,800
    
    
    $
    35.00
    
    
    $
    44.00
    
    
    
    
    
    
    $
    
    
    
    $
    
 Swaps. Generally, swaps are an agreement to buy or sell a specified commodity
for delivery in the future, but at an agreed fixed price. Swap transactions convert a floating
price into a fixed price. For any particular swap transaction, the counterparty is required to
make a payment to the hedge party if the reference price for any settlement period is less than the
swap price for such hedge, and the hedge party is required to make a payment to the counterparty if
the reference price for any settlement period is greater than the swap price for such hedge. We have entered into oil and gas swap contracts with BNP Paribas. A recap for the period of
time, number of MMBtus, number of barrels, and swap prices are as follows: Barrels
    
    
    
    
    
    
    
    
    
    
    Houston Shipof
    
    
    Nymex Oil
    
    
    MMBtu of
    
    
    ChannelPeriod of Time
    
    Oil
    
    
    Swap Price
    
    
    Natural Gas
    
    
    Gas Swap PriceJanuary 1, 2005 thru December 31, 2005
    
    
    620,500
    
    
    $
    30.19
    
    
    
    
    
    
    $
    January 1, 2005 thru March 31, 2005
    
    
    
    
    
    $
    
    
    
    
    180,000
    
    
    $
    4.705January 1, 2006 thru December 20, 2006
    
    
    448,000
    
    
    $
    28.46
    
    
    
    
    
    
    $
    January 1, 2007 thru December 31, 2007
    
    
    474,500
    
    
    $
    34.36
    
    
    
    
    
    
    $
    January 1, 2008 thru December 31, 2008
    
    
    439,200
    
    
    $
    33.37
    
    
    
    
    
    
    $
    
 
  ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 Parallels consolidated financial statements and supplementary financial data are included in
this report beginning on page F-1. (65)




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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 Resignation of KPMG LLP On December 4, 2003, we received written notice from KPMG LLP confirming that the
client-auditor relationship between Parallel and KPMG had ceased as of December 2, 2003. KPMG
resigned due to an independence issue arising from retirement benefits paid to Ray M. Poage, a
former partner of KPMG who is also a director of Parallel. For the period from April 28, 2003 to
December 2, 2003, Mr. Poage received eight monthly retirement payments from KPMG, each in the
amount of $856.26. KPMGs audit reports on our consolidated financial statements for the two fiscal years ended
December 31, 2001 and December 31, 2002 did not contain an adverse opinion or disclaimer of opinion
and were not qualified or modified as to uncertainty, audit scope or accounting principles. During the two fiscal years ended December 31, 2001 and December 31, 2002 and the period from
January 1, 2003 through December 2, 2003, there were no disagreements between Parallel and KPMG on
any matter of accounting principles or practices, financial statement disclosure, or auditing scope
or procedure, which, if not resolved to the satisfaction of KPMG would have caused it to make
reference to the subject matter of the disagreement in connection with its report on the
consolidated financial statements for that period, nor have there been any reportable events as
defined under Item 304(a)(1)(v) of regulation S-K during such period. We provided KPMG with a copy of our Current Report on Form 8-K, dated December 2, 2003 and
filed with the SEC on December 9, 2003, reporting KPMGs resignation. We requested that KPMG
furnish us with a letter addressed to the Securities and Exchange Commission stating whether it
agreed with the statements we made in our Form 8-K Report and, if not, stating the respects in
which it did not agree. KPMGs letter, filed as an exhibit to the Form 8-K Report, expressed
agreement with our statements. Engagement of BDO Seidman, LLP Effective January 20, 2004, we engaged BDO Seidman, LLP as the principal accountant to audit
our consolidated financial statements. The decision to engage BDO Seidman was recommended and
approved by the Audit Committee of our Board of Directors. During the two fiscal years ended December 31, 2001 and December 31, 2002 and during any
subsequent interim period, BDO Seidman was not engaged as either the principal accountant to audit
our consolidated financial statements or as an independent accountant to audit a significant
subsidiary and on whom the principal accountant was expected to express reliance on its report. In
addition, during the two most recent fiscal years and during any subsequent interim period prior to
engaging BDO Seidman, neither we, nor anyone on our behalf consulted BDO Seidman regarding (a)
either the application of accounting principles to a specified transaction, (66)




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either completed or proposed, or the type of audit opinion that might be rendered on our
consolidated financial statements, and no written report was provided to us and no oral advice was
provided to us by BDO Seidman which was considered by us in reaching a decision as to the
accounting, auditing or financial reporting issues; and (b) there was no matter that was a subject
of disagreement as defined in paragraph 304(a)(1)(iv) of Regulation S-K, or a reportable event, as
described in paragraph 304(a)(1)(v) of Regulation S-K.  ITEM 9A. CONTROLS AND
PROCEDURES
 Disclosure Controls and Procedures We use certain disclosure controls and procedures to help ensure that information we are
required to disclose in reports that we file with the Securities and Exchange Commission is
accumulated and communicated to our management and recorded, processed, summarized and reported
within the time periods specified by the SEC. As of the end of the period covered by this Annual
Report on Form 10-K, the effectiveness of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934) was evaluated
by Larry C. Oldham, our President and Chief Executive Officer (principal executive officer), and
Steven D. Foster, our Chief Financial Officer (principal financial officer). Mr. Oldham and Mr.
Foster have concluded that our disclosure controls and procedures are effective, as of the end of
the period covered by this Annual Report on Form 10-K, for their intended purposes. There were no changes in our internal control over financial reporting that occurred during
our last fiscal quarter (the quarter ended December 31, 2004) that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting. Managements Report on Internal Control Over Financial Reporting Management of Parallel is responsible for establishing and maintaining effective internal
control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of
1934. Parallels internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
consolidated financial statements for external purposes in accordance with generally accepted
accounting principles. Parallels internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of Parallel; (2)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of
consolidated financial statements in accordance with generally accepted accounting principles, and
that receipts and expenditures of Parallel are being made only in accordance with authorizations of
management and Board of Directors of Parallel and, (3) provide reasonable assurance regarding (67)




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prevention or timely detection of unauthorized acquisition, use, or disposition of Parallels assets that could have a material effect on the consolidated financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and presentation. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies and procedures may deteriorate. Management assessed the effectiveness of Parallels internal control over financial reporting
as of December 31, 2004. In making this assessment, management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control
Integrated Framework.As a result of this assessment, management determined that Parallels
internal control over financial reporting as of December 31, 2004 is effective, based on those
criteria. BDO Seidman, LLP, the independent registered public accounting firm who also audited
Parallels consolidated financial statements, has issued an attestation report on managements
assessment of the effectiveness of internal control over financial reporting as of December 31,
2004. Report of Independent Registered Public Accounting Firm on Internal Control over Financial
Reporting The Board of Directors and Stockholders of
Parallel Petroleum Corporation We have audited managements assessment, included in the accompanying Managements Report on
Internal Control Over Financial Reporting, that Parallel Petroleum Corporation and subsidiaries
(the Company) maintained effective internal control over financial reporting as of December 31,
2004, based on criteria established in Internal Control  Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The
Companys management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on managements assessment and an opinion on the
effectiveness of the Companys internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion. (68)




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A companys internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the
financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that the Company maintained effective internal control over
financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on
the COSO criteria. Also, in our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2004, based on the COSO
criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets as of December 31, 2004 and 2003 and the
related consolidated statements of income, comprehensive income (loss), stockholders equity and
cash flows for each of the years then ended of the Company and our report dated February 28, 2005
expressed an unqualified opinion thereon. /s/ BDO Seidman, LLPHouston, TexasFebruary 28, 2005
 
  ITEM 9B. OTHER INFORMATION
 None. (69)




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PART III 
  ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT
 The Directors and executive officers of Parallel at March 1, 2005 are as follows: Name
    
    Age
    
    Since
    
    Position with CompanyThomas R. Cambridge(1)
    
    69
    
    1985
    
    Chairman of the Board of DirectorsLarry C. Oldham(1)
    
    51
    
    1979
    
    Director, President and Chief Executive OfficerDewayne E.
Chitwood (2)(3)(4)
    
    68
    
    2000
    
    DirectorMartin B. Oring(1)(2)(3)(4)
    
    59
    
    2001
    
    DirectorRay M. Poage(1)(2)(3)(4)
    
    57
    
    2003
    
    DirectorJeffrey G. Shrader(1)(2)(4)
    
    54
    
    2001
    
    DirectorDonald E. Tiffin
    
    47
    
    
    
    Chief Operating OfficerEric A. Bayley
    
    56
    
    
    
    Vice President of Corporate EngineeringJohn S. Rutherford
    
    45
    
    
    
    Vice President of Land and AdministrationSteven D. Foster
    
    49
    
    
    
    Chief Financial Officer
   (1)
    
    Member of Hedging and Acquisition Committee(2)
    
    Member of Compensation Committee(3)
    
    Member of Audit Committee(4)
    
    Member of Corporate Governance and Nominating Committee Thomas R. Cambridge, age 69, is the Chairman of the Board of Directors of Parallel. He
is an independent petroleum geologist engaged in the exploration for, development and production of
oil and natural gas. From 1970 until 1990, such activities were carried out primarily through
Cambridge & Nail Partnership, a Texas general partnership. Since 1990, such activities have been
carried out through Cambridge Production, Inc., a Texas corporation, and Cambridge Partnership,
Ltd., a Texas limited partnership. Mr. Cambridge has served as a Director of Parallel since
February 1985 and as Chairman of the Board since October, 1985; as President during the period from
October, 1985 to October, 1994 and as Chief Executive Officer from October, 1985 to January, 2004.
He received a Bachelors degree in geology from the University of Nebraska in 1958 and a Masters of
Science degree in 1960. Mr. Oldham is a founder of Parallel and has served as an officer and Director since its
formation in 1979. Mr. Oldham became President of Parallel in October, 1994, and served as
Executive Vice President before becoming President. Effective January 1, 2004, Mr. Oldham replaced
Mr. Cambridge as Chief Executive Officer. Mr. Oldham received a Bachelor of Business
Administration degree from West Texas State University in 1975. (70)




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Mr. Chitwood is president, chief executive officer and a manager of Wes-Tex Holdings, LLC, the
general partner of Wes-Tex Drilling Company, L.P., a partnership engaged in oil and natural gas
exploration and production. During the five-year period preceding
Mr. Chitwoods association
with Wes-Tex in 1997, he was an owner and founder of CBS Insurance L.P., a general insurance
agency. Mr. Oring is the owner of Wealth Preservation, LLC, a financial counseling firm founded by Mr.
Oring in January, 2001. From 1998 to December, 2000, Mr. Oring was Managing Director Executive
Services of Prudential Securities Incorporated, and from 1996 to 1998, Mr. Oring was Managing
Director Capital Markets of Prudential Securities Incorporated. From 1989 to 1996, Mr. Oring was
Manager of Capital Planning for The Chase Manhattan Corporation. Mr. Poage was employed by KPMG LLP from 1972 until June 2002 when he retired. Mr. Poages
responsibilities included supervising and managing both audit and tax professionals and providing
services, primarily in the area of taxation, to private and publicly held companies engaged in the
oil and natural gas industry. He is a Certified Financial Planner and member of the American
Institute of Certified Public Accountants and the Texas Society of Certified Public Accountants.
At March 1, 2004 Mr. Poage was Chairman of the Audit Committee of the Board of Directors of
Parallel. Mr. Shrader has been a shareholder in the law firm of Sprouse Shrader Smith, Amarillo, Texas,
since January, 1993. He has also served as a director of Hastings Entertainment, Inc. since 1992.
At March 1, 2004 Mr. Shrader was Chairman of the Compensation Committee of the Board of Directors
of Parallel. Mr. Tiffin served as Vice President of Business Development from June, 2002 until January 1,
2004 when he became the Chief Operating Officer. From August, 1999 until May, 2002, Mr. Tiffin
served as General Manager of First Permian, L.P. and from July, 1993 to July, 1999, Mr. Tiffin was
the Drilling and Production Manager in the Midland, Texas office of Fina Oil and Chemical Company.
Mr. Tiffin graduated from the University of Oklahoma in 1979 with a Bachelor of Science degree in
Petroleum Engineering. Mr. Bayley has been Vice President of Corporate Engineering since July, 2001. From October,
1993 until July, 2001, Mr. Bayley was employed by Parallel as Manager of Engineering. From
December, 1990 to October, 1993, Mr. Bayley was an independent consulting engineer and devoted
substantially all of his time to Parallel. Mr. Bayley graduated from Texas A&M University in 1978
with a Bachelor of Science degree in Petroleum Engineering. He graduated from the University of
Texas of the Permian Basin in 1984 with a Masters of Business Administration degree. Mr. Rutherford has been Vice President of Land and Administration of Parallel since July,
2001. From October 1993 until July, 2001, Mr. Rutherford was employed as Manager of
Land/Administration. From May, 1991 to October, 1993, Mr. Rutherford served as a consultant to
Parallel, devoting substantially all of his time to Parallels business. Mr. Rutherford graduated
from Oral Roberts University in 1982 with a degree in Education, and in 1986 he graduated from
Baylor University with a Masters degree in Business Administration. (71)




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Mr. Foster has been the Chief Financial Officer of Parallel since June, 2002. From November,
2000 to May, 2002, Mr. Foster was the Controller and Assistant Secretary of First Permian, L.P. and
from September, 1997 to November 2000, he was employed by Pioneer Natural Resources, USA in the
capacities of Director of Revenue Accounting and Manager of Joint Interest Accounting. Mr. Foster
graduated from Texas Tech University in 1977 with a Bachelor of Business Administration degree in
accounting. He is a certified public accountant. Directors hold office until the annual meeting of stockholders following their election or
appointment and until their respective successors have been duly elected or appointed. Officers are appointed annually by the Board of Directors to serve at the Boards discretion
and until their respective successors in office are duly appointed. There are no family relationships between any of Parallels directors or officers. Consulting Arrangements As part of our overall business strategy, we continually monitor our general and
administrative expenses. Decisions regarding our general and administrative expenses are made
within parameters we believe to be compatible with our size, the level of our activities and
projected future activities. Our goal is to keep general and administrative expenses at acceptable
levels, without impairing the quality of services and organizational structure necessary for
conducting our business. In this regard, we retain outside advisors and consultants from time to
time to provide technical and administrative support services in the operation of our business. Corporate Governance Under the Delaware General Corporation Law and Parallels bylaws, our business, property and
affairs are managed by or under the direction of the Board of Directors. Members of the Board are
kept informed of Parallels business through discussions with the Chairman of the Board, the Chief
Executive Officer and other officers, by reviewing materials provided to them and by participating
in meetings of the Board and its committees. We currently have six members of the Board. The
Board has determined that all of the Directors, other than Mr. Cambridge and Mr. Oldham, are
independent for the purposes of NASD Rule 4200(a)(15). The Board based these determinations
primarily on responses of the Directors and executive officers to questions regarding employment
and compensation history, affiliations and family and other relationships and on discussions among
the Directors. The Board has four standing committees:  
    The Audit Committee;
    The Corporate Governance and Nominating Committee;
    The Compensation Committee; and
    The Hedging and Acquisitions Committee. (72)




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Audit Committee The Audit Committee reviews the results of the annual audit of our consolidated financial
statements and recommendations of the independent auditors with respect to our accounting
practices, policies and procedures. As prescribed by our Audit Committee charter, the Audit
Committee also assists the Board of Directors in fulfilling its oversight responsibilities,
reviewing our systems of internal accounting and financial controls, and the independent audit of
our consolidated financial statements. The Audit Committee of the Board of Directors consists of three directors, all of whom have no
financial or personal ties to Parallel (other than director compensation and equity ownership as
described in this Annual Report on Form 10-K) and meet the Nasdaq standards for independence. The
Board of Directors has determined that at least one member of the Audit Committee, Ray M. Poage,
meets the criteria of an audit committee financial expert as that term is defined in Item 401(h)
of Regulation S-K, and is independent for purposes of Nasdaq listing standards and Section 10A
(m)(3) of the Securities Exchange Act of 1934, as amended. Mr. Poages background and experience
includes service as a partner of KPMG LLP where Mr. Poage participated extensively in accounting,
auditing and tax matters related to the oil and natural gas business. The Audit Committee operates
under a charter, which was revised in March 2004. The charter can be viewed in our website on
www.parallel-petro.com. Since October 2003, the members of the Audit Committee have been and continue to be Messrs.
Poage (Chairman), Chitwood and Oring. Corporate Governance and Nominating Committee At its March 15, 2004 meeting, the Board formed a Corporate Governance and Nominating
Committee and adopted a charter for this new committee. The functions of the Corporate Governance
and Nominating Committee will include: recommending to the Board of Directors nominees for election
as directors of Parallel, and making recommendations to the Board of Directors from time to time as
to matters of corporate governance. Upon formation of the Corporate Governance and Nominating
Committee, the Board of Directors appointed Dewayne E. Chitwood, Martin B. Oring, Charles R.
Pannill, Ray M. Poage and Jeffrey G. Shrader to serve as members. These Directors continue to
serve on the Corporate Governance and Nominating Committee, except that Mr. Pannill ceased to be a
member of the committee upon his retirement from the Board of Directors in June 2004. The Corporate
Governance and Nominating Committee will operate under the charter setting out the functions and
responsibilities of this committee. A copy of the charter can be viewed in our website at
www.parallel-petro.com. The committee will consider candidates for Director suggested by stockholders. Stockholders
wishing to suggest a candidate for Director should write to any one of the members of the committee
at his address shown under Item 12 of this Annual Report on Form 10-K. Suggestions should include:  
    a statement that the writer is a stockholder and is proposing a candidate

for consideration by the committee; (73)




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
    the name of and contact information for the candidate;
    a statement of the candidates age, business and educational experience;
    information sufficient to enable the committee to evaluate the candidate;
    a statement detailing any relationship between the candidate and any joint
interest owners, customer, supplier or competitor of Parallel;
    detailed information about any relationship or understanding between the
proposing stockholder and the candidate; and
    a statement that the candidate is willing to be considered and willing to
serve as a Director if nominated and elected. Compensation Committee The members of the Compensation Committee during 2004 were Dewayne E. Chitwood, Martin B.
Oring, Ray M. Poage and Jeffrey G. Shrader and Charles R. Pannill, until his retirement from the
Board of Directors in June 2004. Messrs. Chitwood, Oring, Poage and Shrader continue to serve as
members of the Compensation Committee. Mr. Shrader presently acts as the Chairman of the
Compensation Committee. The Compensation Committees responsibilities include reviewing and
recommending to the Board the compensation and terms of benefit arrangements with Parallels
officers, and the making of awards under such arrangements. Hedging and Acquisitions Committee The Hedging and Acquisitions Committee presently consists of four Directors, including Messrs.
Oring, Shrader, Oldham and Cambridge. With respect to hedging, the committee reviews, assists, and
advises management on overall risk management strategies and techniques. The committee strives to
implement prudent commodity and interest rate hedging arrangements, and monitors our compliance
with certain covenants in our revolving credit facility. The Hedging and Acquisitions Committee
also reviews with management oil and gas acquisition opportunities, and consults with members of
management to review plans and strategies for pursing acquisitions. Code of Ethics On March 15, 2004, the Board adopted a code of ethics as part of our efforts to comply with
the Sarbanes-Oxley Act of 2002 and rule changes made by the Securities and Exchange Commission and
Nasdaq. Our code of ethics applies to all of our directors, officers and employees, including our
chief executive officer, chief financial officer and all other financial officers and executives.
You may review the code of ethics on our website at www.parallel-petro.com. A copy of our code of
ethics has also been filed with the Securities and Exchange Commission and is incorporated by
reference as an exhibit to this Annual Report on Form 10-K. We will provide without charge to each
person, upon written or oral request, a copy of our code of ethics. (74)




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Requests should be directed to: Manager of Investor RelationsParallel Petroleum Corporation1004 N. Big Spring, Suite 400Midland, Texas 79701Telephone: (432) 684-3727
 Stockholder Communications with Directors Parallel stockholders who want to communicate with any individual Director can write to that
Director at his address shown under Item 12 of this Annual Report on Form 10-K. Your letter should indicate that you are a Parallel stockholder. Depending on the subject
matter, the Director will:  
    if you request, forward the communication to the other Directors;
    request that management handle the inquiry directly, for example where
it is a request for information about the company or it is a stock-related matter;
or
    not forward the communication to the other Directors or management if
it is primarily commercial in nature or if it relates to an improper or irrelevant
topic. Director Attendance at Annual Meetings We typically schedule a Board meeting in conjunction with our annual meeting of stockholders
and expect that our Directors will attend, absent a valid reason, such as illness or a schedule
conflict. Last year, all seven of the individuals then serving as Directors attended our annual
meeting of stockholders. 
  ITEM 11. EXECUTIVE COMPENSATION
 Summary of Annual Compensation The table below shows a summary of the types and amounts of compensation paid for the last
three fiscal years to Mr. Cambridge, our Chairman of the Board, and to Mr. Oldham, our President
and Chief Executive Officer. The table also includes a summary of the types and amounts of
compensation paid to our other four executive officers for the years indicated. (75)




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Compensation TableLong-Term CompensationAnnual Compensation
    
    
    Awards
    
    PayoutsOther
    
    
    Restricted
    
    Securities
    
    
    
    AllAnnual
    
    
    Stock
    
    Underlying
    
    LTIP
    
    OtherName and
    
    
    
    Salary
    
    
    Bonus
    
    
    Compensation
    
    
    Awards
    
    Options/
    
    Payouts
    
    CompensationPrincipal Position(1)
    
    Year
    
    ($)
    
    
    ($)(2)
    
    
    ($)(3)
    
    
    ($)
    
    SAR (#)
    
    ($)
    
    ($)T. R. Cambridge
    
    2004
    
    $
    110,000
    
    
    $
    10,000
    
    
    $
    
    
    
    0
    
    0
    
    0
    
    
    0Chairman of the Board
    
    2003
    
    $
    110,000
    
    
    $
    25,000
    
    
    $
    
    
    
    0
    
    0
    
    0
    
    
    02002
    
    $
    106,284
    
    
    $
    158,888
    
    
    $
    450
    
    
    0
    
    0
    
    0
    
    

    0L. C. Oldham
    
    2004
    
    $
    250,000
    
    
    $
    11,019
    
    
    $
    27,183
    (4)
    
    0
    
    0
    
    0
    
    $
    15,000
    (5)President , Chief Executive
    
    2003
    
    $
    191,000
    
    
    $
    61,391
    
    
    $
    22,802
    
    
    0
    
    0
    
    0
    
    $
    11,460Officer and Director
    
    2002
    
    $
    187,316
    
    
    $
    555,674
    
    
    $
    22,474
    
    
    0
    
    0
    
    0
    
    $
    11,113D. E. Tiffin
    
    2004
    
    $
    220,000
    
    
    $
    10,015
    
    
    $
    23,560
    (6)
    
    0
    
    0
    
    0
    
    $
    13,560
    (7)Chief Operating Officer
    
    2003
    
    $
    171,140
    
    
    $
    44,391
    
    
    $
    17,464
    
    
    0
    
    0
    
    0
    
    $
    10,2682002
    
    $
    99,832
    
    
    $
    47,421
    
    
    $
    8,257
    
    
    0
    
    50,000
    
    0
    
    $
    5,990E. A. Bayley
    
    2004
    
    $
    140,000
    
    
    $
    7,101
    
    
    $
    24,500
    (8)
    
    0
    
    0
    
    0
    
    $
    8,400

    (9)Vice President
    
    2003
    
    $
    110,000
    
    
    $
    23,391
    
    
    $
    16,470
    
    
    0
    
    0
    
    0
    
    $
    6,6002002
    
    $
    111,792
    
    
    $
    172,178
    
    
    $
    16,127
    
    
    0
    
    0
    
    0
    
    $
    6,303J. S. Rutherford
    
    2004
    
    $
    140,000
    
    
    $
    7,062
    
    
    $
    23,357
    (10)
    
    0
    
    0
    
    0
    
    $
    8,400
    (11)Vice President
    
    2003
    
    $
    110,000
    
    
    $
    23,391
    
    
    $
    15,763
    
    
    0
    
    0
    
    0
    
    $
    6,6002002
    
    $
    110,384
    
    
    $
    410,352
    
    
    $
    16,540
    
    
    0
    
    0
    
    0
    
    $
    6,488S. D. Foster
    
    2004
    
    $
    140,000
    
    
    $
    7,033
    
    
    
    27,983
    (12)
    
    0
    
    0
    
    0
    
    $
    8,760
    (13)Chief Financial Officer
   (1)
    
    Mr. Cambridges position as Chief Executive Officer ceased on January 1, 2004 when Mr.
Oldham became Chief Executive Officer.(2)
    
    The bonuses paid to Messrs. Cambridge, Oldham, Bayley and Rutherford during 2002 includes
payments made to them under Incentive Award Agreements as a result of the sale of First
Permians assets. Parallel entered into these Incentive Award Agreements with Messrs.
Cambridge, Oldham, Bayley, Rutherford and four other employees in December 2001 to provide an
incentive to the participants and to reward outstanding efforts and achievements by them when
a material contribution to Parallels success resulted from an Award Event. An Award Event
generally meant an acquisition of First Permian, a sale of substantially all of First
Permians assets, or Parallels sale or other disposition of its 30.675% ownership interest in
First Permian. The agreements awarded Unit Equivalent Rights to the recipients. A Unit
Equivalent Right was essentially equivalent to a Common Unit of common membership interest in
First Permian. At March 1, 2002, First Permian had outstanding 1,140,992 Common Units and
1,350,000 Preferred Units. Parallel owned 350,000 Common Units of First Permian. The Unit
Equivalent Rights entitled the recipient to a one-time cash bonus. Payment of the bonus was
triggered by the occurrence of an Award Event. The amount of a bonus payment was defined as
the difference between $30.00 per Common Unit and the price per Common Unit received by First
Permians holders of Common Units in a transaction constituting an Award Event, multiplied by
the number of Unit Equivalent Rights granted to the recipient. To illustrate, assuming the
holders of First Permians Common Units received $100.00 per Common Unit from a sale of
assets, a recipient of 1,000 Unit Equivalent Rights would be entitled to receive a cash
payment equal to $70.00 ($100.00 minus $30.00) multiplied by 1,000, or $70,000. Under these
Incentive Award Agreements, 9,565 Unit Equivalent Rights were granted to Mr. Oldham; 2,394
were granted to Mr. Cambridge; 2,869 to Mr. Bayley; and 7,173 to Mr. Rutherford. In April,
2002 an Award Event occurred when First Permian sold all of its oil and gas properties to
Energen Corporation. Because shares of Energen Corporations common stock were a component of
the total purchase price for First Permians properties, the portion of the bonus payments
attributable to the Energen stock was based upon the price at which we sold our shares of
Energen stock. Under these agreements, Mr. Cambridge received $132,480; Mr. Oldham -
$529,266; Mr. Bayley - $158,770; and Mr. Rutherford - $396,944. The Incentive Award
Agreements automatically terminated upon payment of the bonuses. Mr. Tiffin received a
signing and inducement bonus in the amount of $46,013 when he joined Parallel in June 2002.(3)
    
    Under rules of the Securities and Exchange Commission, the dollar value of perquisites and
personal benefits may be excluded from this column if the aggregate amount of such
compensation is the lesser of either $50,000 or 10% of the total (76)




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annual salary and bonus reported for the named executive officers. However, for 2004 we have
identified the following amounts: Mr.
    
    
    Mr.
    
    
    Mr.
    
    
    Mr.
    
    
    Mr.
    
    
    Mr.Cambridge
    
    
    Oldham
    
    
    Tiffin
    
    
    Bayley
    
    
    Rutherford
    
    
    FosterPersonal use of club memberships (a)
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    113
    
    
    $
    3,672
    
    
    $
    4,407Personal use of company car(b)
    
    $
    
    
    
    $
    2,507
    
    
    $
    
    
    
    $
    6,189
    
    
    $
    3,107
    
    
    $
    Car allowance
    
    $
    
    
    
    $
    
    
    
    $
    6,000
    
    
    $
    
    
    
    $
    
    
    
    $
    6,000Personal income tax preparation
and financial planning services
    
    $
    
    
    
    $
    3,588
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
  (a)
    
    The value of personal use of club memberships was determined by multiplying monthly
dues by a fraction equal to actual personal expenses divided by total expenses. All
employees reimbursed us for their personal expenses.(b)
    
    Personal use of a company car is based on the lease value method published by the
Internal Revenue Service for fringe benefits.
  (4)
    
    These amounts include insurance premiums for nondiscriminatory group life, medical,
disability, long-term care and dental insurance as follows: $21,088 for 2004; $19,697 for
2003; and $17,647 for 2002.(5)
    
    This amount represents Parallels contribution to Mr. Oldhams individual retirement account
maintained under the 408(k) simplified employee pension plan/individual retirement account.(6)
    
    This amount includes insurance premiums for nondiscriminatory group life, medical, disability
and dental insurance as follows: $17,560 for 2004; $16,964 for 2003; and $8,150 for 2002.(7)
    
    This amount represents Parallels contribution to Mr. Tiffins individual retirement account
maintained under the 408(K) simplified employee premium plan/individual retirement account.(8)
    
    This amount includes insurance premiums for nondiscriminatory group life, medical,
disability, long-term care and dental insurance as follows: $18,198 for 2004; $16,470 for
2003; and $15,150 for 2002.(9)
    
    This amount represents Parallels contribution to Mr. Bayleys individual
retirement account maintained under the 408(k) simplified employee pension plan/individual
retirement account.(10)
    
    This amount includes insurance premiums for nondiscriminatory group life, medical, disability
and dental insurance as follows: $16,578 for 2004; $15,763 for 2003; and $14,221 for 2002.(11)
    
    This amount represents Parallels contribution to Mr. Rutherfords individual
retirement account maintained under the 408(k) simplified employee premium plan/individual
retirement account.(12)
    
    This amount includes insurance premiums for nondiscriminatory group life, medical,
disability, long-term care and dental insurance as follows: $17,576 for 2004.(13)
    
    This amount represents Parallels contribution to Mr. Fosters individual retirement account
maintained under the 408(k) simplified employee premium plan/individual retirement account.
 Stock Options We use stock options as part of the overall compensation of directors, officers and employees.
However, we did not grant any stock options in 2004 to any of the executive officers named in the
Summary Compensation Table. Summary descriptions of our stock option plans are included in this
report so you can review the types of options we have granted in the past and the significant
features of our stock options. (77)




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In the table below, we show certain information about the exercise of stock options in 2004
and the value of unexercised stock options held by the named executive officers at December 31,
2004. Aggregated Option/SAR Exercises in
Last Fiscal Year and Fiscal Year-End Option/SAR Values Value ofNumber of Securities Underlying
    
    
    UnexercisedShares Acquired
    
    Value
    
    Unexercised Options at Fiscal
    
    
    in-the-Money Optionson
    
    Realized
    
    Year-End (#)
    
    
    at Fiscal Year-End ($)(2)Name
    
    Exercise
    
    ($)(1)
    
    Exercisable
    
    
    Unexercisable
    
    
    Exercisable
    
    
    UnexercisableT.R. Cambridge
    
    0
    
    0
    
    
    300,000
    
    
    
    0
    
    
    
    440,000
    
    
    
    0L.C. Oldham
    
    0
    
    0
    
    
    347,500
    
    
    
    52,500
    
    
    
    613,650
    
    
    
    22,050E. A. Bayley
    
    0
    
    0
    
    
    165,000
    
    
    
    0
    
    
    
    230,330
    (3)
    
    
    0J.S. Rutherford
    
    0
    
    0
    
    
    158,750
    
    
    
    0
    
    
    
    230,330
    (4)
    
    
    0D.E. Tiffin
    
    0
    
    0
    
    
    50,000
    
    
    
    0
    
    
    
    160,500
    
    
    
    0S.D. Foster
    
    0
    
    0
    
    
    35,000
    
    
    
    0
    
    
    
    112,350
    
    
    
    0
   (1)
    
    The value realized is equal to the fair market value of a share of common stock on
the date of exercise, less the exercise price of the stock options exercised.(2)
    
    The value of unexercised in-the-money options is equal to the fair market value of a
share of common stock at fiscal year-end ($5.39 per share), based on the last sale price
of Parallels common stock, less the exercise price.(3)
    
    At December 31, 2004, the exercise prices of exercisable options to purchase a total of
25,000 shares of common stock held by Mr. Bayley exceeded $5.39, the fair market value of
our common stock on that date.(4)
    
    At December 31, 2004, the exercise prices of exercisable options to purchase a total of
18,750 shares of common stock held by Mr. Rutherford exceeded $5.39, the fair market value
of our common stock on that date. Change of Control Arrangements Stock Option Plans Parallels outstanding stock options and stock option plans contain certain change of
control provisions which are applicable to Parallels outstanding stock options, including the
options held by our officers and Directors. For purposes of our options, a change of control
occurs if:  
    Parallel is not the surviving entity in a merger or consolidation;
    Parallel sells, leases or exchanges all or substantially all of its assets;
    Parallel is to be dissolved and liquidated;
    any person or group acquires beneficial ownership of more than 50% of
Parallels common stock; or (78)




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
    in connection with a contested election of directors, the persons who were
directors of Parallel before the election cease to constitute a majority of the Board of
Directors. If a change of control occurs, the Compensation Committee of the Board of Directors can:  
    accelerate the time at which options may be exercised;
    require optionees to surrender some or all of their options and pay to
each optionee the change of control value;
    make adjustments to the options to reflect the change of control; or
    permit the holder of the option to purchase, instead of the shares of
common stock as to which the option is then exercisable, the number and class of shares
of stock or other securities or property which the optionee would acquire under the
terms of the merger, consolidation or sale of assets and dissolution if, immediately
before the merger, consolidation or sale of assets or dissolution, the optionee had
been the holder of record of the shares of common stock as to which the option is then
exercisable. The change of control value is an amount equal to, whichever is applicable:  
    the per share price offered to Parallels stockholders in a merger,
consolidation, sale of assets or dissolution transaction;
    the price per share offered to Parallels stockholders in a tender offer
or exchange offer where a change of control takes place; or
    if a change of control occurs, other than from a tender or exchange offer,
the fair market value per share of the shares into which the options being surrendered
are exercisable, as determined by the Committee. Incentive and Retention Plan On September 22, 2004, the Compensation Committee of the Board of Directors approved and
adopted an incentive and retention plan for Parallels officers and employees. On September 24,
2004, the Board of Directors adopted the plan upon recommendation by the Compensation Committee. The purpose of the plan is to advance the interests of Parallel and its stockholders by
providing officers and employees with incentive bonus compensation which is linked to a corporate
transaction. As defined in the plan, a corporate transaction means:  
    an acquisition of Parallel by way of purchase, merger, consolidation,
reorganization or other business combination, whether by way of tender offer or
negotiated (79)




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transaction, as a result of which Parallels outstanding securities are exchanged or
converted into cash, property and/or securities not issued by Parallel;
    a sale, lease, exchange or other disposition by Parallel of all or
substantially all of its assets;
    the stockholders of Parallel approving a plan or proposal for the
liquidation or dissolution of Parallel; or
    any combination of any of the foregoing. The plan also recognizes the possibility of a proposed or threatened transaction and the need
to be able to rely upon officers and employees continuing their employment, and that Parallel be
able to receive and rely upon their advice as to the best interests of Parallel and its
stockholders without concern that they might be distracted by the personal uncertainties and risks
created by any such transaction. In this regard, the plan also provides for a retention payment
upon the occurrence of a change of control, as defined below. All members of Parallels executive group are participants in the plan. For purposes of the
plan, the executive group includes all executive officers of Parallel and any other officer
employee of Parallel selected by the Compensation Committee in its sole discretion. In addition,
the Committee may designate other non-officer employees of Parallel as participants in the plan who
will also be eligible to receive a performance bonus upon the occurrence of a corporate transaction
or a retention payment upon the occurrence of a change of control. Generally, the plan provides for:  
    the payment of a one-time performance bonus to eligible officers and
employees upon the occurrence of a corporate transaction; or
    a one time retention payment upon a change of control of Parallel. A
change of control is generally defined as the acquisition of beneficial ownership of
60% or more of the voting power of Parallels outstanding voting securities by any
person or group of persons, or a change in the composition of the Board of Directors of
Parallel such that the individuals who, at the effective date of the plan, constitute
the Board of Directors cease for any reason to constitute at least a majority of the
Board of Directors. In the case of a corporate transaction, the total amount of cash available for performance
bonuses is equal to the per share price received by all stockholders minus a base price of $3.73
per share, multiplied by 1,080,362 shares. The $3.73 base price represents the volume weighted
average closing price per share of Parallels common stock for the fiscal quarter ended December
31, 2003 and the 1,080,362 shares represents 5% of the weighted average number of shares of common
stock (basic) outstanding for the same period. As an example, if the stockholders of the company
received a per share price of $6.00 in a merger, tender offer or other corporate transaction, the
total amount of cash available for payment to all plan participants would be [$6.00 - $3.73] x
1,080,362, or $2,452,422. If a change of control occurs, the total amount of cash available for
retention payments to all plan participants is equal to the per share closing (80)




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price of Parallels common stock on the day immediately preceding the change of control minus the
base price of $3.73 per share, multiplied by 1,080,362. If a corporate transaction or change of control occurs, the Compensation Committee will
allocate for payment to each member of the executive group such portion of the total performance
bonus or retention payment as the Compensation Committee determines in its sole discretion. After
making these allocations, if any part of the total performance bonus or retention payment amount
remains unallocated, the Compensation Committee may allocate any remaining portion of the
performance bonus or retention payment among all other participants in the plan. After all
allocations of the performance bonus have been made, each participants proportionate share of the
performance bonus or retention payment will be paid in a cash lump sum. The plan is entirely unfunded and the plan makes no provision for segregating any of
Parallels assets for payment of any amounts under the plan. A participants rights under the plan are not transferable. The plan is administered by the Compensation Committee of the Board of Directors of Parallel.
The Compensation Committee has the power, in its sole discretion, to take such actions as may be
necessary to carry out the provisions and purposes of the plan. The Compensation Committee has the
authority to control and manage the operation and administration of the plan and has the power to:  
    designate the officers and employees of Parallel and its subsidiaries who
participate in the plan, in addition to the Executive Group;
    maintain records and data necessary for proper administration of the plan;
    adopt rules of procedure and regulations necessary for the proper and
efficient administration of the plan;
    enforce the terms of the plan and the rules and regulations it adopts;
    employ agents, attorneys, accountants or other persons; and
    perform any other acts necessary or appropriate for the proper management
and administration of the plan. The plan automatically terminates and expires on the date participants receive a performance
bonus or retention payment. Compensation of Directors Stock Effective July 1, 2004, we began paying an annual retainer fee to each non-employee Director
in the form of shares of our common stock. Under the 2004 Non-Employee Director Stock Grant Plan,
which is described below in more detail, each non-employee Director is (81)




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entitled to receive an annual retainer fee in the form of shares of common stock having a value of
$25,000. The shares of stock are automatically granted on the first day of July in each year. The
actual number of shares received is determined by dividing $25,000 by the average daily closing
price of the common stock on the Nasdaq Stock Market for the ten consecutive trading days
commencing fifteen trading days before the first day of July of each year. On July 1, 2004, and in
accordance with the terms of the plan, we issued a total of 20,888 shares of common stock to four
non-employee Directors as follows: Jeffrey G. Shrader  5,222 shares; Dewayne E. Chitwood  5,222
shares; Martin B. Oring  5,222 shares; and Ray M. Poage  5,222 shares. Cash Following stockholder approval of the 2004 Non-Employee Director Stock Grant Plan in June
2004, we reduced by one-half the per meeting and annual cash fees we had been paying to our
non-employee Directors. We now pay each non-employee Director a cash fee of $750 for attendance at
each meeting of the Board of Directors and each non-employee Director who is a member of a Board
committee also receives:  
    $375 per meeting for service on the Compensation Committee, with the
Chairman of the Compensation Committee being entitled to receive an additional fee of
$2,500 per year;
    $375 per meeting for service on the Audit Committee, with the Chairman of
the Audit Committee being entitled to receive an additional fee of $5,000 per year and
each other Audit Committee member receiving $2,500 per year;
    $375 per meeting for service on the Corporate Governance and Nominating
Committee, with the Chairman of the Corporate Governance and Nominating Committee being
entitled to receive an additional fee of $2,500 per year; and
    $375 per meeting for service on the Hedging and Acquisitions Committee. The cash fees paid to our non-employee Directors for their services in 2004 are as follows:
Mr. Pannill received $21,000; Mr. Chitwood - $49,875; Mr. Shrader - $42,750; Mr. Poage - $52,125;
and Mr. Oring - $49,500. All Directors are reimbursed for expenses incurred in connection with
attending meetings. Options Directors who are not employees of Parallel are also eligible to participate in
Parallels 1997 Nonemployee Directors Stock Option Plan and the 2001 Nonemployee Directors
Stock Option Plan. No options were granted to any of the non-employee Directors in 2004. 2004 Non-Employee Director Stock Grant Plan On April 29, 2004, upon recommendation of the Boards Compensation Committee, our Directors
approved the 2004 Non-Employee Director Stock Grant Plan, and the plan was later approved by the
stockholders at our annual meeting held on June 22, 2004. Directors of Parallel who are not
employees of Parallel or any of its subsidiaries are eligible to participate in the Plan. (82)




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Under the Plan, each non-employee Director is entitled to receive an annual retainer fee consisting
of shares of common stock that will be automatically granted on the first day of July in each year.
The actual number of shares received is determined by dividing $25,000 by the average daily closing
price of the common stock on the Nasdaq Stock Market for the ten consecutive trading days
commencing fifteen trading days before the first day of July of each year. Historically, Directors
fees had been paid solely in cash. However, in accordance with this plan and following approval by
our stockholders, we commenced paying an annual retainer fee in July 2004 to each non-employee
Director in the form of common stock having a value of $25,000. The Plan is administered by the Compensation Committee. Although the Compensation Committee
has authority to adopt such rules and regulations for carrying out the Plan as it may deem proper
and in the best interests of Parallel, the Committees administrative functions are largely
ministerial in view of the Plans explicit provisions described below, including those related to
eligibility and predetermination of the timing, pricing and amount of grants. The interpretation by
the Compensation Committee of any provision of the Plan is final. The total number of shares available for grant is 116,000 shares of common stock, subject to
adjustment as described below. If there is a change in the common stock by reason of a merger,
consolidation, reorganization, recapitalization, stock dividend, stock split, combination of
shares, exchange of shares, change in corporate structure or otherwise, the aggregate number of
shares available under the Plan will be appropriately adjusted in order to avoid dilution or
enlargement of the rights intended to be made available under the Plan. The Board may suspend, terminate or amend the Plan at any time or from time to time in any
manner that the Board may deem appropriate; provided that, without approval of the stockholders, no
revision or amendment shall change the eligibility of Directors to receive stock grants, the number
of shares of common stock subject to any grants or the Plan itself, or materially increase the
benefits accruing to participants under the Plan, and Plan provisions relating to the amount, price
and timing of grants of stock may not be amended. Shares acquired under the Plan are non-assignable and non-transferable other than by will or
the laws of descent and distribution and may not be sold, pledged, hypothecated, assigned or
transferred until the non-employee Director holding such Stock ceases to be a Director, except that
the Compensation Committee may permit a transfer of stock subject to the condition that the
Compensation Committee receive evidence satisfactory to it that the transfer is being made for
essentially estate and/or tax planning purposes or a gratuitous or donative purpose and without
consideration. The Plan will remain in effect until terminated by the Board, although no additional shares of
common stock may be issued after the 116,000 shares subject to the Plan have been issued. Stock Option Plans 1992 Stock Option Plan. In May, 1992, our stockholders approved and adopted the 1992
Stock Option Plan. The 1992 Plan expired by its own terms on March 1, 2002, but remains effective
only for purposes of outstanding options. The 1992 Plan provided for granting to key (83)




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employees, including officers and Directors who were also key employees of Parallel, and Directors
who were not employees, options to purchase up to an aggregate of 750,000 shares of common stock.
Options granted under the 1992 Plan to employees are either incentive stock options or options
which do not constitute incentive stock options. Options granted to nonemployee Directors are not
incentive stock options. The 1992 Plan is administered by the Boards Compensation Committee, none of whom were
eligible to participate in the 1992 Plan, except to receive a one-time option to purchase 25,000
shares at the time he or she became a Director. The Compensation Committee selected the employees
who were granted options and established the number of shares issuable under each option and other
terms and conditions approved by the Compensation Committee. The purchase price of common stock
issued under each option is the fair market value of the common stock at the time of grant. The 1992 Plan provided for the granting of an option to purchase 25,000 shares of common stock
to each individual who was a nonemployee Director of Parallel on March 1, 1992 and to each
individual who became a nonemployee Director following March 1, 1992. Members of the Compensation
Committee were not eligible to participate in the 1992 Plan other than to receive a nonqualified
stock option to purchase 25,000 shares of common stock as described above. An option may be granted in exchange for an individuals right and option to purchase shares
of common stock pursuant to the terms of a prior option agreement. An agreement that grants an
option in exchange for a prior option must provide for the surrender and cancellation of the prior
option. The purchase price of common stock issued under an option granted in exchange for a prior
option is determined by the Compensation Committee and may be equal to the price for which the
optionee could have purchased common stock under the prior option. At March 1, 2002, 65,000 shares of common stock remained authorized for issuance under the
1992 Plan. However, the 1992 Plan prohibited the grant of options after March 1, 2002.
Consequently, no additional options are available for grant under the 1992 Plan. At March 1, 2005, options to purchase a total of 278,750 shares of common stock were
outstanding under the 1992 Plan. 1997 Nonemployee Directors Stock Option Plan. The Parallel Petroleum 1997
Non-Employee Directors Stock Option Plan was approved by our stockholders at the annual meeting of
stockholders held in May, 1997. This plan provides for granting to Directors who are not employees
of Parallel options to purchase up to an aggregate of 500,000 shares of common stock. Options
granted under the plan will not be incentive stock options within the meaning of the Internal
Revenue Code. This Plan is administered by the Compensation Committee of the Board of Directors. The
Compensation Committee has sole authority to select the nonemployee Directors who are to be granted
options; to establish the number of shares which may be issued to nonemployee Directors under each
option; and to prescribe the terms and conditions of the options in accordance with the plan.
Under provisions of the plan, the option exercise price must be the fair market value of the stock
subject to the option on the grant date. Options are not transferable (84)




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other than by will or the laws of descent and distribution and are not exercisable after ten years
from the date of grant. The purchase price of shares as to which an option is exercised must be paid in full at the
time of exercise in cash, by delivering to Parallel shares of stock having a fair market value
equal to the purchase price, or a combination of cash or stock, as established by the Compensation
Committee. Options may not be granted under this plan after March 27, 2007. At March 1, 2005, options to
purchase a total of 235,000 shares of common stock were outstanding under this plan. At March 1, 2005, options to purchase 142,500 shares of common stock were available for future
grants under this plan. 1998 Stock Option Plan. In June, 1998, our stockholders adopted the 1998 Stock Option
Plan. The 1998 Plan provides for the granting of options to purchase up to 850,000 shares of
common stock. Stock options granted under the 1998 Plan may be either incentive stock options or
stock options which do not constitute incentive stock options. The 1998 Plan is administered by the Compensation Committee of the Board of Directors.
Members of the Compensation Committee are not eligible to participate in the 1998 Plan. Only
employees are eligible to receive options under the 1998 Plan. The Compensation Committee selects
the employees who are granted options and establishes the number of shares issuable under each
option. Options granted to employees contain terms and conditions that are approved by the
Compensation Committee. The Compensation Committee is empowered and authorized, but is not
required, to provide for the exercise of options by payment in cash or by delivering to Parallel
shares of common stock having a fair market value equal to the purchase price, or any combination
of cash or common stock. The purchase price of common stock issued under each option must not be
less than the fair market value of the common stock at the time of grant. Options granted under
the 1998 Plan are not transferable other than by will or the laws of descent and distribution and
are not exercisable after ten years from the date of grant. Options may not be granted under the 1998 Plan after March 11, 2008. At March 1, 2005,
options to purchase a total of 785,000 shares of common stock were outstanding under this plan. At March 1, 2005, there were no available options to purchase shares of common stock for
future grant under the 1998 Stock Option Plan. 2001 Nonemployee Directors Stock Option Plan. The Parallel Petroleum 2001
Non-employee Directors Stock Option Plan was approved by our stockholders at the annual meeting of
stockholders held in June, 2001. This plan provides for granting to Directors who are not
employees of Parallel options to purchase up to an aggregate of 500,000 shares of common stock.
Options granted under the plan will not be incentive stock options within the meaning of the
Internal Revenue Code. (85)




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This Plan is administered by the Compensation Committee of the Board of Directors. The
Compensation Committee has sole authority to select the nonemployee Directors who are to be granted
options; to establish the number of shares which may be issued to nonemployee Directors under each
option; and to prescribe such terms and conditions as the Committee prescribes from time to time in
accordance with the plan. Under provisions of the plan, the option exercise price must be the fair
market value of the stock subject to the option on the grant date. Options are not transferable
other than by will or the laws of descent and distribution and are not exercisable after ten years
from the date of grant. The purchase price of shares as to which an option is exercised must be paid in full at the
time of exercise in cash, by delivering to Parallel shares of stock having a fair market value
equal to the purchase price, or a combination of cash or stock, as established by the Compensation
Committee. Options may not be granted under this plan after May 2, 2011. At March 1, 2005, options to
purchase 375,000 shares of common stock were outstanding under this plan. At March 1, 2005, there were available for future grant under this plan options to purchase
75,000 shares of common stock. Employee Stock Option Plan. In June, 2001, our Board of Directors adopted the
Parallel Petroleum Employee Stock Option Plan. This plan authorized the grant of options to
purchase up to 200,000 shares of common stock, or less than 1.00% of our outstanding shares of
common stock. Directors and officers are not eligible to receive options under this plan. Only
employees are eligible to receive options. Stock options granted under this plan are not incentive
stock options. This plan was implemented without stockholder approval. The Employee Stock Option Plan is administered by the Compensation Committee of the Board of
Directors. The Compensation Committee selects the employees who are granted options and
establishes the number of shares issuable under each option. Options granted to employees contain terms and conditions that are approved by the
Compensation Committee. The Compensation Committee is empowered and authorized, but is not
required, to provide for the exercise of options by payment in cash or by delivering to Parallel
shares of common stock having a fair market value equal to the purchase price, or any combination
of cash or common stock. The purchase price of common stock issued under each option must not be
less than the fair market value of the common stock at the time of grant. Options granted under
this plan are not transferable other than by will or the laws of descent and distribution. The Employee Stock Option Plan will expire on June 20, 2011. Unless some of the options that
have been granted under the plan are forfeited and again become available for future grant, no
additional options may be granted under this plan. At March 1, 2005, options to purchase 200,000 shares of common stock were outstanding under
this plan. (86)




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Section 408(k) Retirement Plan Until December 31, 2004, Parallel maintained under Section 408(k) of the Internal Revenue Code
a combination simplified employee pension and individual retirement account plan for eligible
employees. Generally, eligible employees included all employees who were at least twenty-one years
of age. Effective January 1, 2005, the 408 (k) plan was terminated and replaced with a new retirement
plan under Section 401(k) of the Internal Revenue Code, as described below. Contributions to employee SEP accounts were made at the discretion of Parallel, as authorized
by the Compensation Committee of the Board of Directors. Although the percentage of contributions
were permitted to vary from time to time, the same percentage contribution was required to be made
for all participating employees. Parallel was not required to make annual contributions to the SEP
accounts. Under the prototype plan adopted by Parallel, all of the SEP contributions were required
to be made to SEP/IRAs maintained with the sponsor of the plan, a national investment banking firm.
All contributions to employees accounts vested immediately and became the property of each
employee at the time of contribution, including employer contributions, income-deferral
contributions and IRA contributions. Generally, earnings on contributions to an employees SEP/IRA
account are not subject to federal income tax until withdrawn. In addition to receiving SEP contributions made by Parallel, employees were permitted to make
individual annual IRA contributions of up to the maximum of $13,000. Maximum total contribution for
Parallel and Parallels employees can be no more than $41,000. In addition to the annual salary
deferral limit stated above, employees who reach age 50 or older during a calendar year can elect
to take advantage of a catch-up salary deferral contribution; eligible participants can increase
their salary deferral by $3,000 for the year 2004. Each employee is responsible for the investment
of funds in his or her own SEP/IRA and can select investments offered through the sponsor of the
plan. Distributions could be taken by employees at any time and must commence by April 1st following
the year in which the employee attains age 70 1/2 Parallel made matching contributions to employee accounts in an amount equal to the
contribution made by each employee, subject to a maximum of 6% of each employees salary during any
calendar year. During 2004, Parallel contributed an aggregate of $132,618 to the accounts of 28
employee participants. Of this amount, $15,000 was allocated to Mr. Oldhams account; $8,400 was
allocated to Mr. Bayleys account; $8,400 was allocated to Mr. Rutherfords account;
$13,560 to Mr. Tiffins account; and $8,760 to Mr. Fosters account. Section 401(k) Retirement Plan Effective January 1, 2005, Parallel adopted a retirement plan (the Plan) which qualifies
under Section 401(k) of the Internal Revenue Code. The Plan is designed to provide eligible
employees with an opportunity to save for retirement on a tax-deferred basis. A third party acts
as the Plans administrator and is responsible for the day-to-day administration and operation of (87)




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the Plan. The Plan is maintained on a yearly basis beginning on January 1 and ending on December
31 of each year. Each employee is eligible to participate in the Plan as of the date of his or her employment.
An employee may elect to have his or her compensation reduced by a specific percentage or dollar
amount and have that amount contributed to the Plan as a salary deferred contribution. A Plan
participants aggregate salary deferred contributions for a plan year may not exceed certain
statutory dollar limits, which for 2005 is $14,000. The amount deferred by a Plan participant, and
any earnings on that amount, will not be subject to income tax until actually distributed to such
participant. Each year, in addition to salary deferrals made by a participant, Parallel may contribute to
the Plan matching contributions and discretionary profit sharing contributions. Matching
contributions, if made, will equal a uniform percentage of a participants salary deferrals. For
2005, the Compensation Committee established an annual profit sharing contribution of 3% and a
matching contribution in an amount not to exceed 3% of a participants annual salary. Each
participant will share in discretionary profit sharing contributions, if any, regardless of the
amount of service completed by the participant during the applicable plan year. Each participant may direct the investment of his or her interest in the Plan under
established investment direction procedures setting forth the investment choices available to the
participants. Each participant will be entitled to all of the participants account under the Plan
upon retirement after age 65. Each participant is at all times 100% vested in amounts attributed
to the participants salary deferrals and to matching contributions and discretionary profit
sharing contributions made by Parallel. The Plan contains special provisions relating to
disability and death benefits. Participants may borrow from their respective Plan accounts, subject to the Plan
administrators determination that the participant submitting an application for a loan meets the
rules and requirements set forth in the written loan program established by Parallel. Parallel has
the right to amend the Plan at any time. However, no amendment may authorize or permit any part of
the Plan assets to be used for purposes other than the exclusive benefit of participants or their
beneficiaries. 
  ITEM 12.
    
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 This table shows information as of March 1, 2005 about the beneficial ownership of common
stock by: (1) each person known by us to own beneficially more than five percent of our
outstanding common stock; (2) the executive officers named in the Summary Compensation Table in
this report; (3) each director of Parallel; and (4) all of Parallels executive officers and
directors as a group. (88)




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Name and Address
    
    Amount and Nature

    
    Percentof
    

    of
    
    ofBeneficial Owner
    

    Beneficial Ownership(1)
    
    Class(2)Thomas R. Cambridge
2201 Civic Circle, Suite 216
Amarillo, Texas 79109
    
    

    1,057,045(3)
    

    
    
    3.36
    %Dewayne E. Chitwood
400 Pine St., Suite 700
Abilene, Texas 79601
    
    

    1,686,279(4)
    

    
    
    5.28
    %Larry C. Oldham
1004 N. Big Spring, Suite 400
Midland, Texas 79701
    
    

    892,090(5)
    

    
    
    2.83
    %Martin B. Oring
706 Cinnamon Lane
Franklin Lakes, New Jersey 07417
    
    

    220,888(6)
    

    
    
    *Ray M. Poage
4711 Meandering Way
Colleyville, Texas 76034
    
    

    61,690(7)
    

    
    
    *Jeffrey G. Shrader
801 S. Filmore, Suite 600
Amarillo, Texas 79105
    
    

    130,222(8)
    

    
    
    *Eric A. Bayley
1004 N. Big Spring, Suite 400
Midland, Texas 79701
    
    

    203,490(9)
    

    
    
    *John S. Rutherford
1004 N. Big Spring, Suite 400
Midland, Texas 79701
    
    

    166,300(10)
    
    

    
    *Donald E. Tiffin
1004 N. Big Spring, Suite 400
Midland, Texas 79701
    
    

    60,415(11)
    

    
    
    *Steven D. Foster
1004 N. Big Spring, Suite 400
Midland, Texas 79701
    
    

    43,000(12)
    

    
    
    *Wellington Management Company, LLP
75 State Street
Boston, Massachusetts 02109
    
    

    3,555,800(13)
    

    
    
    11.40
    %All Executive Officers and Directors
as a Group (10 persons)
    
    

    4,521,419(14)
    

    
    
    13.57
    %
   *
    
    Less than one percent.(1)
    
    Unless otherwise indicated, all shares of common stock are held directly with sole voting
and investment powers.(2)
    
    Securities not outstanding, but included in the beneficial ownership of each such
person, are deemed to be outstanding for the purpose of computing the percentage of
outstanding securities of the class owned by such person, but are not deemed to be
outstanding for the purpose of computing the percentage of the class owned by any other
person. Shares of common stock that may be acquired within sixty days upon exercise of
outstanding stock options and warrants or upon conversion of preferred stock are deemed
to be outstanding. (89)




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(3)
    
    Includes 757,045 shares of common stock held indirectly through Cambridge
Collateral Services, Ltd., a limited partnership of which Mr. Cambridge and his wife are
the general partners. Also included are 300,000 shares of common stock underlying
presently exercisable stock options held by Mr. Cambridge.(4)
    
    Includes 932,488 shares of common stock held directly by Wes-Tex Drilling Company,
L.P., a limited partnership, and 314,285 shares of common stock that may be acquired by
Wes-Tex Drilling Company, L.P. upon conversion of 110,000 shares of preferred stock. In
his capacity as president, chief executive officer and a manager of Wes-Tex Holdings,
LLC, the general partner of Wes-Tex Drilling Company, L.P., Mr. Chitwood may be deemed to
have shared voting and investment powers with respect to such shares. See note 13 below.
Also included are 20,000 shares of common stock held by the Estate of Myrle Greathouse
(the Estate); 157,142 shares that may be acquired by the Greathouse Charitable
Remainder Trust (the Trust) upon conversion of 55,000 shares of preferred stock; and
157,142 shares of common stock that may be acquired by the Greathouse Foundation (the
Foundation) upon conversion of 55,000 shares of preferred stock. Mr. Chitwood is the
executor (but not a beneficiary) of the Estate, the trustee (but not a beneficiary) of
the Trust and the executive director and a director of the Foundation. In these
capacities, Mr. Chitwood may also be deemed to have shared voting and investment powers
with respect to the shares of common stock beneficially owned by the Estate, the Trust
and the Foundation. However, Mr. Chitwood disclaims beneficial ownership of all shares of
common stock held by Wes-Tex Drilling Company, L.P., the Estate, Trust and Foundation.
Also included are 100,000 shares of common stock underlying presently exercisable stock
options held by Mr. Chitwood.(5)
    
    Includes 200,000 shares of common stock held indirectly through Oldham Properties,
Ltd., a limited partnership of which Mr. Oldham is the general partner and he and his
wife are the limited partners. Also included are 355,000 shares of common stock
underlying presently exercisable stock options held by Mr. Oldham.(6)
    
    Of the total number of shares shown, 24,000 shares are held directly by Mr.
Orings wife; 100,000 shares may be acquired by Mr. Oring upon exercise of stock
options held by Mr. Oring; and 91,666 shares may be acquired upon exercise of a stock
purchase warrant.(7)
    
    Includes 25,000 shares that may be acquired upon exercise of a presently
exercisable stock option and an additional 25,000 shares with respect to which such stock
option will become exercisable within the next sixty days.(8)
    
    Includes 100,000 shares of common stock underlying presently exercisable stock
options.(9)
    
    Includes 165,000 shares of common stock underlying presently exercisable stock
options. A total of 6,790 shares of common stock are held indirectly by Mr. Bayley
through individual retirement accounts and Parallels 408(K) Plan.(10)
    
    Includes 158,750 shares of common stock underlying presently exercisable stock
options. Also included are 7,550 shares held indirectly by Mr. Rutherford through his
408(k) Plan.(11)
    
    Of the total number of shares shown 6,500 shares are held indirectly through Mr.
Tiffins individual retirement account. Includes 50,000 shares of common stock
underlying presently exercisable stock options.(12)
    
    Includes 35,000 shares of common stock underlying presently exercisable stock
options.(13)
    
    The number of shares reported is based on information, as of December 31, 2004,
contained in Schedule 13G filed by Wellington Management Company LLP (Wellington) with
the Securities and Exchange Commission on February 14, 2005. Wellington reported that, in
its capacity as investment advisor, it may be deemed to beneficially own such shares
which are held of record by clients of Wellington; that those clients have the right to
receive, or the power to direct the receipt of, dividends from, or the proceeds from the
sale of, such securities; and that no such client is known to have such right or power
with respect to more than five percent of this class of securities. Wellington reported
shared dispositive power with respect to all of such shares and shared voting power with
respect to 2,951,300 shares.(14)
    
    Includes 1,505,416 shares of common stock underlying stock options and warrants
that are presently exercisable or that become exercisable within sixty days and 628,569
shares of common stock that may be acquired upon conversion of 220,000 shares of
preferred stock. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires Parallels Directors and
officers to file periodic reports with the Securities and Exchange Commission. These reports show
the Directors and officers ownership and the changes in ownership, of Parallels common stock and
other equity securities. To our knowledge, all Section 16(a) filing requirements were complied
with during 2004. (90)




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##### Table of Contents



ITEM 13.
    CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS
 Mr. Chitwood, a director of Parallel, has been the Chief Executive Officer of Wes-Tex Drilling
Company, L.P. since January 30, 2001. He was appointed to Parallels Board on December 19,
2000 to fill a vacancy created by the death of a former director of Parallel. The former director
was also the sole owner of Wes-Tex Drilling Company, L.P. In 1994, the predecessor of Wes-Tex
Drilling Company, L.P. acquired an undivided working interest from Parallel in an oil and gas
prospect located in Howard County, Texas. Since then, Wes-Tex has participated with us and other
interest owners in the drilling and development of this prospect. Wes-Tex has participated in
these operations under standard form operating agreements on the same or similar terms afforded by
Parallel to nonaffiliated third parties. We invoice all working interest owners, including
Wes-Tex, on a monthly basis, without interest, for their pro rata share of lease acquisition,
drilling and operating expenses. During 2004, we billed Wes-Tex $14,493 for its proportionate
share of lease operating expenses incurred on properties we operate. The largest amount owed to us
by Wes-Tex at any one time during 2004 for its share of lease operating expenses was $3,099. At
December 31, 2004, Wes-Tex owed us $3,099 for these expenses. During 2004, we disbursed $48,102 to
Wes-Tex in payment of revenues attributable to Wes-Texs pro rata share of the proceeds from sales
of oil and gas produced from properties in which Wes-Tex and Parallel owned interests. Mr.
Chitwood is not an owner of Wes-Tex and has no interest in these transactions other than in his
capacity as an officer of Wes-Tex. During 2004, Cambridge Production, Inc., a corporation owned by Mr. Cambridge, served as
operator of 2 wells on oil and gas leases in which we acquired a working interest in 1984.
Generally, the operator of a well is responsible for the day to day operations on the lease,
overseeing production, employing field personnel, maintaining production and other records,
determining the location and timing of drilling of wells, administering gas contracts, joint
interest billings, revenue distribution, making various regulatory filings, reporting to working
interest owners and other matters. During 2004, Cambridge Production billed us $15,246 for our pro
rata share of lease operating expenses and drilling and workover expenses. The largest amount we
owed Cambridge Production at any one time during 2004 was $9,214. At December 31, 2004, we owed
Cambridge Production $1,014 for these expenses. Our pro rata share of oil and gas sales during 2004
from the wells operated by Cambridge Production was $165,122. Cambridge Productions billings to
Parallel are made monthly on the same basis as all other working interest owners in the wells. Cambridge Partnership, Ltd., a limited partnership controlled by Mr. Cambridge, acquired an
undivided working interest in 1999 from Parallel in an oil and gas prospect located in south Texas.
The interest was acquired on the same terms as all other unaffiliated working interest owners.
Since then, Cambridge Partnership, Ltd. has participated with us in the drilling and development of
this prospect. Cambridge Partnership, Ltd. has participated in these operations under standard
form operating agreements on the same or similar terms afforded by Parallel to nonaffiliated third
parties. Although Parallel is not the operator of this project, we invoice Cambridge Partnership,
Ltd., on a monthly basis, without interest, for its pro rata share of (91)




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operating expenses. During 2004, we billed Cambridge Partnership, Ltd. $4,316 for its
proportionate share of lease operating expenses incurred on properties we administer. The largest
amount owed to us by Cambridge Partnership, Ltd. at any one time during 2004 for its share of lease
operating expenses was $1,045. At December 31, 2004, Cambridge Partnership, Ltd. owed us $851 for
these expenses. During 2004, we disbursed $3,028 to Cambridge Partnership, Ltd. in payment of
revenues attributable to its pro rata share of the proceeds from sales of oil and gas produced from
properties in which Cambridge Partnership, Ltd. and Parallel owned interests. Cambridge Production, Inc. maintains an office in Amarillo, Texas from which Mr. Cambridge
performs his duties and services as Chairman of the Board and as geological consultant to Parallel.
We reimburse Cambridge Production, Inc. $3,000 per month for office and administrative expenses
incurred on behalf of Parallel. During 2004 we reimbursed Cambridge Production, Inc. a total of
$36,000. In December, 2001, and prior to his employment with Parallel, Donald E. Tiffin, our Chief
Operating Officer, received from an unaffiliated third party a 3% working interest in the Diamond M
Project in Scurry County, Texas for services rendered in connection with assembling the project. In
August, 2002, shortly after his employment with Parallel, and due to the personal financial
exposure in the Diamond M Project and to prevent the interest from being acquired by a third party,
Mr. Tiffin assigned two-thirds of his ownership interest in the project to Parallel at no cost,
leaving him with a 1% working interest. Parallel acquired its initial interest in the Diamond M
Project from the same third party in December, 2001, but did not become operator of the project
until March 1, 2003. As with other nonaffiliated interest owners, we invoice Mr. Tiffin on a
monthly basis, without interest, for his share of drilling, development and lease operating
expenses. During 2004, we billed Mr. Tiffin a total of $115,311 for his proportionate share of
capital expenditures and lease operating expenses, and Mr. Tiffin paid us $117,836 for these
drilling and development expenses, which included $5,284 attributable to expenses billed to Mr.
Tiffin in 2003. During 2004, we disbursed to Mr. Tiffin $29,332 in oil and gas revenues related to
his interest in this project. The largest aggregate amount outstanding and owed to us by Mr. Tiffin
at any one time during 2004 was $29,134. At December 31, 2004, Mr. Tiffin owed us approximately
$2,800. We believe the transactions described above were made on terms no less favorable than if we
had entered into the transactions with an unrelated party.  ITEM 14.
    PRINCIPAL ACCOUNTANT FEES AND
SERVICES
 KPMG LLP audited our consolidated financial statements for the year ended December 31, 2002
and for the prior eighteen years. However, as described under Item 9 of this Annual Report on Form
10-K, KPMG resigned in December 2003. Prior to KPMGs resignation, KPMG provided audit and tax
services in 2003. In January 2004, we engaged BDO Seidman, LLP as our independent auditors. (92)




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The audit committee had not, as of the time of filing this Annual Report on Form 10-K with the
Securities and Exchange Commission, adopted policies and procedures for pre-approving audit or
permissible non-audit services performed by our independent auditors. Instead, the audit committee
as a whole has pre-approved all such services. In the future, our audit committee may approve the
services of our independent auditors pursuant to pre-approval policies and procedures adopted by
the Audit Committee, provided the policies and procedures are detailed as to the particular
service, the Audit Committee is informed of each service, and such policies and procedures do not
include delegation of the Audit Committees responsibilities to Parallels management. The aggregate fees for professional services rendered by BDO and KPMG in 2004 and 2003 were: BDO
    
    
    KPMGTypes of Fees
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003(dollars in thousands)Audit fees
    
    $
    551
    (1)
    
    $
    140
    
    
    $
    
    
    
    $
    120Audit-related fees
    
    
    9
    (2)
    
    
    
    
    
    
    23
    
    
    
    61Tax fees
    
    
    
    
    
    
    
    
    
    
    48
    
    
    
    28All other fees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    560
    
    
    $
    140
    
    
    $
    71
    
    
    $
    209
   (1)
    
    Such amount includes $320,000 for professional services in
connection with the audit of the internal control over financial
reporting under Section 404 of the Sarbanes-Oxley of 2002. This
amount includes associated expenses in the amount of approximately
$40,000.(2)
    
    Includes fees associated with our abandoned senior debt
offering and our incentive and retention plan. We retained a third party to assist Parallels management in their Sarbanes-Oxley 404
readiness and assessment of internal control over financial reporting. Their aggregate fees for
services provided in connection with the internal control over financial reporting were
approximately $252,000, including associated expenses of approximately $47,000. We also retained another third party to assist us with our information technology portion of
the Sarbanes-Oxley Section 404 work. Their fee was approximately $25,000, including
associated expenses of approximately $4,000. In the above table, audit fees are fees we paid for professional services for the audit of
our consolidated financial statements included in Form 10-K and review of consolidated financial
statements included in Form 10-Qs, or for services that are normally provided by the accountant in
connection with statutory and regulatory filings or engagements and fees for Sarbanes-Oxley 404
audit work; audit-related fees are fees billed for assurance and related services (such as due
diligence services) that are reasonably related to the performance of the audit or review of our
consolidated financial statements; tax fees are fees for tax compliance, advice and planning; and
all other fees are fees billed to Parallel for any services not included (93)




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in the first three categories. It is estimated that personnel, other than full time permanent employees of BDO performed 65%
of the total hours expended to audit Parallels consolidated financial statements. 
 PART IV  ITEM 15.
    EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES
 The following documents are filed as part of this report: (a)(1) and (a)(2) Financial Statement and Financial Statement Schedules  For a list of Consolidated Financial Statements and Schedules, see Index to
the Consolidated Financial Statements on page F-1, and incorporated herein
by reference.(a)(3)
    ExhibitsSee Item 15(b) below.(b)
    Exhibits:A list of exhibits to this Annual Report on Form 10-K is set forth below. No.
    
    Description of Exhibit3.1
    
    Certificate of Incorporation of Registrant (Incorporated by reference to Exhibit 3.1
to Form 10-Q of the Registrant for the fiscal quarter ended June 30, 2004)3.2
    
    Bylaws of Registrant (Incorporated by reference to Exhibit 3 of the Registrants
Form 8-K, dated October 9, 2000, as filed with the Securities and Exchange Commission on
October 10, 2000)3.3
    
    Certificate of Formation of Parallel, L.L.C. (Incorporated by reference to Exhibit
No. 3.3 of the Registrants Registration Statement on Form S-3, No. 333-119725 filed on
October 13, 2004)3.4
    
    Limited Liability Company Agreement of Parallel, L.L.C. (Incorporated by reference to
Exhibit No. 3.4 of the Registrants Statement on Form S-3, No. 333-119725 filed on October
13, 2004)
 (94)




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No.
    
    Description of Exhibit3.5
    
    Certificate of Limited Partnership of Parallel, L.P. (Incorporated by reference to
Exhibit No. 3.5 of the Registrants Registration Statement on Form S-3, No. 333-119725
filed on October 13, 2004)3.6
    
    Agreement of Limited Partnership of Parallel, L.P. (Incorporated by reference to
Exhibit No. 3.6 of the Registrants Registration Statement on Form S-3, No. 333-119725
filed on October 13, 2004)4.1
    
    Certificate of Designations, Preferences and Rights of Serial Preferred Stock  6%
Convertible Preferred Stock (Incorporated by reference to Exhibit 4.1 of Form 10-Q of the
Registrant for the fiscal quarter ended June 30, 2004)4.2
    
    Certificate of Designation, Preferences and Rights of Series A Preferred Stock
(Incorporated by reference to Exhibit 4.2 of Form 10-K of the Registrant for the fiscal
year ended December 31, 2000)4.3
    
    Rights Agreement, dated as of October 5, 2000, between the Registrant and
Computershare Trust Company, Inc., as Rights Agent (Incorporated by reference to Exhibit
4.3 of Form 10-K of the Registrant for the fiscal year ended December 31, 2000)4.4
    
    Form of Indenture relating to senior debt securities of the Registrant (Incorporated by
reference to Exhibit No. 4.4 of the Registrants Statement on Form S-3, No. 333-119725
filed on October 13, 2004)4.5
    
    Form of Indenture relating to subordinated debt securities of the Registrant
(Incorporated by reference to Exhibit No. 4.5 of the Registrants Registration Statement
on Form S-3, No. 333-119725 filed on October 13, 2004)4.6
    
    Form of common stock certificate of the Registrant (Incorporated by reference to
Exhibit No. 4.6 of the Registrants Registration Statement on Form S-3, No. 333-119725
filed on October 13, 2004)*4.7
    
    Warrant Purchase Agreement, dated November 20, 2001, between the
Registrant and Stonington Corporation*4.8
    
    Warrant Purchase Agreement, dated December 23, 2003, between the
Registrant and Stonington CorporationExecutive Compensation Plans and Arrangements (Exhibit No.s 10.1 through
10.8):*10.1
    
    1992 Stock Option Plan
 (95)




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No.
    
    Description of Exhibit10.2
    
    Merrill Lynch, Pierce, Fenner & Smith Incorporated Prototype Simplified Employee
Pension Plan (Incorporated by reference to Exhibit 10.6 of the
Registrants Form 10-K
for the fiscal year ended December 31, 1995)10.3
    
    Non-Employee Directors Stock Option Plan (Incorporated by reference to Exhibit 10.6 of
the Registrants Form 10-K Report for the fiscal year ended December 31, 1997)10.4
    
    1998 Stock Option Plan (Incorporated by reference to Exhibit 10.7 of Form 10-K of the
Registrant for the fiscal year ended December 31, 1998)10.5
    
    Form of Incentive Award Agreements, dated December 12, 2001, between the Registrant and
Thomas R. Cambridge, Larry C. Oldham, Eric A. Bayley and John S. Rutherford granting 2,394
Unit Equivalent Rights to Mr. Cambridge; 9,564 Unit Equivalent Rights to Mr. Oldham; 2,869
Unit Equivalent Rights to Mr. Bayley; and 7,173 Unit Equivalent Rights to Mr. Rutherford
(Incorporated by reference to Exhibit 10.8 of Form 10-K of the Registrant for the fiscal
year ended December 31, 2001)10.6
    
    2001 Non-Employee Directors Stock Option Plan (Incorporated by reference to Exhibit
10.7 of the Registrants Form 10-Q Report for the first fiscal quarter ended March 31,
2004)10.7
    
    2004 Non-Employee Director Stock Grant Plan (Incorporated by reference to Exhibit 10.1
of the Registrants Form 8-K Report dated September 22, 2004)10.8
    
    Incentive and Retention Plan (Incorporated by reference to Exhibit 10.1 of the
Registrants Form 8-K Report dated September 23, 2004 and filed with the Securities and
Exchange Commission on September 29, 2004)10.9
    
    Certificate of Formation of First Permian, L.L.C. (Incorporated by reference to Exhibit
10.1 of the Registrants Form 8-K Report dated June 30, 1999)10.10
    
    Limited Liability Company Agreement of First Permian, L.L.C. (Incorporated by reference to
Exhibit 10.2 of the Registrants Form 8-K Report dated June 30, 1999)10.11
    
    Amended and Restated Limited Liability Company Agreement of First Permian, L.L.C. dated as
of May 31, 2000 (Incorporated by reference to Exhibit 10.16 of Form 10-K of the Registrant
for the fiscal year ended December 31, 2000)10.12
    
    Credit Agreement, dated June 30, 1999, by and among First Permian, L.L.C., Parallel
Petroleum Corporation, Baytech, Inc., and Bank One, Texas, N.A.
 (96)




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No.
    
    Description of Exhibit(Incorporated by reference to Exhibit 10.6 of the Registrants Form 8-K Report dated
June 30, 1999)10.13
    
    Limited Guaranty, dated June 30, 1999, by and among First Permian, L.L.C., parallel
Petroleum Corporation and Bank One, Texas, N.A. (Incorporated by reference to Exhibit 10.7 of
the Registrants Form 8-K Report dated June 30, 1999)10.14
    
    Second Restated Credit Agreement, dated October 25, 2000, among First Permian, L.L.C.,
Bank One, Texas, N.A., and Bank One Capital Markets, Inc. (Incorporated by reference to
Exhibit 10.22 of Form 10-K of the Registrant for the fiscal year ended December 31, 2000)10.15
    
    Loan Agreement, dated as of January 25, 2002, between the Registrant and First American
Bank, SSB (Incorporated by reference to Exhibit 10.25 of Form 10-K of the Registrant for the
fiscal year ended December 31, 2001)10.16
    
    Purchase and Sale Agreement, dated as of November 27, 2002, among JMC Exploration, Inc.,
Arkoma Star L.L.C., Parallel, L.P. and Texland Petroleum, Inc. (Incorporated by reference to
Exhibit 10.1 of Form 8-K of the Registrant, dated December 20, 2002)10.17
    
    First Amended and Restated Credit Agreement, dated December 20, 2002, by and among
Parallel Petroleum Corporation, Parallel, L.P., Parallel, L.L.C., First American Bank, SSB,
Western National Bank and BNP Paribas (Incorporated by reference to Exhibit 10.2 of Form 8-K
of the Registrant, dated December 20, 2002)10.18
    
    Guaranty dated December 20, 2002, between Parallel, L.L.C. and First American Bank, SSB,
as Agent (Incorporated by reference to Exhibit 10.3 of Form 8-K of the Registrant, dated
December 20, 2002)10.19
    
    First Amendment to First Amended and Restated Credit Agreement, dated as of September 12,
2003, by and among Parallel Petroleum Corporation, Parallel, L.P., Parallel, L.L.C., First
American Bank, SSB, Western National Bank, and BNP Paribas (Incorporated by reference to
Exhibit 10.29 of Form 10-Q of the Registrant for the quarter ended September 30, 2003)10.20
    
    Second Amended and Restated Credit Agreement, dated September 27, 2004, by and among
Parallel Petroleum Corporation, Parallel, L.P., Parallel, L.L.C., First American Bank, SSB,
BNP Paribas, Citibank, F.S.B. and Western National Bank (Incorporated by reference to Exhibit
10.1 of the Registrants Form 8-K Report dated September 27, 2004 and filed with the
Securities and Exchange Commission on October 1, 2004)*10.21
    
    Agreement of Limited Partnership of West Fork Pipeline Company LP
 (97)




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##### Table of Contents



No.
    
    Description of Exhibit14
    
    Code of Ethics (Incorporated by reference to Exhibit No. 14 of the Registrants
Form 10-K Report for the fiscal year ended December 31, 2003 and filed with the
Securities and Exchange Commission on March 22, 2004)21
    
    Subsidiaries (Incorporated by reference to Exhibit No. 21 of the Registrants Form
10-K Report for the fiscal year ended December 31, 2003 and filed with the Securities and
Exchange Commission on March 22, 2004)*23.1
    
    Consent of KPMG LLP*23.2
    
    Consent of BDO Seidman, LLP*23.3
    
    Consent of Cawley Gillespie & Associates, Inc. Independent Petroleum
Engineers*31.1
    
    Certification of Principal Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes -
Oxley Act of 2002*31.2
    
    Certification of Principal Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes -
Oxley Act of 2002*32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes -
Oxley Act of 2002.*32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes -
Oxley Act of 2002.
   * Filed herewith. (98)




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION Index to the Consolidated Financial Statements PageReport of Independent Registered Public Accounting Firm  BDO Seidman, LLP
    
    F-2Report of Independent Registered Public Accounting Firm  KPMG LLP
    
    F-3Financial Statements:Consolidated Balance Sheets at December 31, 2004 and 2003
    
    F-4Consolidated Statements of Income for the years ended December 31, 2004, 2003, and 2002
    
    F-5Consolidated Statements of Stockholders Equity for the years ended December 31,
2004, 2003, and 2002
    
    F-6Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003, and
2002
    
    F-7Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 2004, 2003, and 2002
    
    F-8Notes to Consolidated Financial Statements
    
    F-9
 All schedules are omitted, as the required information is inapplicable or the information is
presented in the Consolidated Financial Statements or related notes. F-1




---



##### Table of Contents



Report of Independent Registered Public Accounting Firm We have audited the accompanying consolidated balance sheets of Parallel Petroleum Corporation as
of December 31, 2004 and 2003, and the related statements of income, comprehensive income (loss),
stockholders equity, and cash flows for each of 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 the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the Consolidated Financial Statements referred to above present fairly, in all
material respects, the financial position of the Company as of December 31, 2004 and 2003, and the
results of its operations and its cash flows for the years then ended, in conformity with U.S.
generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of Parallel Petroleum Corporations internal control over
financial reporting as of December 31, 2004, based on criteria established in Internal Control 
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) and our report dated February 28, 2005 expressed an unqualified opinion thereon. /s/ BDO Seidman, LLP
 Houston, Texas
February 28, 2005 F-2




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##### Table of Contents



Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders
Parallel Petroleum Corporation: We have audited the accompanying consolidated statements of operations, stockholders equity, cash
flows and comprehensive income (loss) of Parallel Petroleum Corporation (the Company) and
subsidiaries for the year ended December 31, 2002. These Consolidated Financial Statements are the
responsibility of the Companys management. Our responsibility is to express an opinion on these
Consolidated Financial Statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the Consolidated Financial Statements referred to above present fairly, in all
material respects, the results of Parallel Petroleum Corporations operations and their cash flows
for the year ended December 31, 2002, in conformity with U.S. generally accepted accounting
principles. /s/ KPMG LLP
 Midland, Texas
March 14, 2003 F-3




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION 
 Consolidated Balance Sheets
December 31, 2004 and 2003  (dollars in thousands)
 2004
    
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    4,781
    
    
    $
    17,378Accounts receivable:Oil and gas
    
    
    6,642
    
    
    
    4,610Other, net of allowance for doubtful account of $9
    
    
    389
    
    
    
    316Affiliates
    
    
    7
    
    
    
    7,038
    
    
    
    4,926Other current assets
    
    
    179
    
    
    
    210Deferred tax asset
    
    
    2,531
    
    
    
    1,098Total current assets
    
    
    14,529
    
    
    
    23,612Property and equipment, at cost:Oil and gas properties, full cost method
    
    
    229,245
    
    
    
    162,621Other
    
    
    2,062
    
    
    
    1,414231,307
    
    
    
    164,035Less accumulated depreciation, depletion and amortization
    
    
    (78,782
    )
    
    
    (70,070
    )Net property and equipment
    
    
    152,525
    
    
    
    93,965Restricted cash
    
    
    2,287
    
    
    
    Investment in Westfork Pipeline
    
    
    595
    
    
    
    297Other assets, net of accumulated amortization of $581 and $182
    
    
    735
    
    
    
    469$
    170,671
    
    
    $
    118,343Liabilities and Stockholders EquityCurrent liabilities:Accounts payable and accrued liabilities
    
    $
    5,568
    
    
    $
    3,965Asset retirement obligations
    
    
    150
    
    
    
    Derivative obligations
    
    
    7,965
    
    
    
    3,231Total current liabilities
    
    
    13,683
    
    
    
    7,196Revolving Credit Facility
    
    
    79,000
    
    
    
    39,750Asset retirement obligations
    
    
    1,982
    
    
    
    1,701Derivative obligations
    
    
    9,525
    
    
    
    2,655Deferred tax liability
    
    
    6,487
    
    
    
    5,809Total long-term liabilities
    
    
    96,994
    
    
    
    49,915Commitments and contingenciesStockholders equity:Series A preferred stock  par value $0.10 per share, authorized 50,000 shares
    
    
    
    
    
    
    Preferred stock  $0.60 cumulative convertible preferred stock  par value
of $0.10 per share, (liquidation preference of
$10 per share) authorized
10,000,000 shares, issued and outstanding 950,000 and 959,500
    
    
    95
    
    
    
    96Common stock  par value $0.01 per share, authorized 60,000,000
shares, issued and outstanding 25,439,292 and 25,216,863
    
    
    254
    
    
    
    253Additional paid-in capital
    
    
    48,328
    
    
    
    47,544Retained earnings
    
    
    22,073
    
    
    
    17,060Accumulated other comprehensive loss
    
    
    (10,756
    )
    
    
    (3,721
    )Total stockholders equity
    
    
    59,994
    
    
    
    61,232$
    170,671
    
    
    $
    118,343
 See accompanying Notes to Consolidated Financial Statements. F-4




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION 
 Consolidated Statements of Income
Years ended December 31, 2004, 2003, 2002  (dollars in thousands, except per share data)
 2004
    
    
    2003
    
    
    2002Oil and gas revenues
    
    $
    35,837
    
    
    $
    33,855
    
    
    $
    12,106Cost and expenses:Lease operating expense
    
    
    7,373
    
    
    
    6,458
    
    
    
    2,081Production taxes
    
    
    2,108
    
    
    
    1,946
    
    
    
    796General and administrative
    
    
    5,378
    
    
    
    4,344
    
    
    
    2,153Depreciation, depletion and amortization
    
    
    8,712
    
    
    
    8,390
    
    
    
    6,220Total costs and expenses
    
    
    23,571
    
    
    
    21,138
    
    
    
    11,250Operating income
    
    
    12,266
    
    
    
    12,717
    
    
    
    856Other income (expense), net:Equity in income of First Permian, L.P.
    
    
    
    
    
    
    
    
    
    
    31,044Incentive awards attributable to the sale of First Permian, L.P.
    
    
    
    
    
    
    
    
    
    
    (1,382
    )Loss on sale of marketable securities
    
    
    
    
    
    
    
    
    
    
    (717
    )Change in fair market value of derivatives
    
    
    
    
    
    
    (22
    )
    
    
    (948
    )Gain (loss) on ineffective portion of hedges
    
    
    (945
    )
    
    
    191
    
    
    
    Interest and other income
    
    
    189
    
    
    
    116
    
    
    
    93Dividend income
    
    
    
    
    
    
    
    
    
    
    371Interest expense
    
    
    (2,732
    )
    
    
    (2,048
    )
    
    
    (601
    )Other expense
    
    
    (324
    )
    
    
    (259
    )
    
    
    (332
    )Total other income (expense), net
    
    
    (3,812
    )
    
    
    (2,022
    )
    
    
    27,528Income before income taxes
    
    
    8,454
    
    
    
    10,695
    
    
    
    28,384Income tax expense, deferred
    
    
    (2,869
    )
    
    
    (3,031
    )
    
    
    (9,683
    )Income before cumulative effect of change in accounting principle
    
    
    5,585
    
    
    
    7,664
    
    
    
    18,701Cumulative effect on prior years of a change in accounting principle,
net of tax of $32
    
    
    
    
    
    
    (62
    )
    
    
    Net income
    
    
    5,585
    
    
    
    7,602
    
    
    
    18,701Cumulative preferred stock dividend
    
    
    (572
    )
    
    
    (580
    )
    
    
    (585
    )Net income available to common stockholders
    
    $
    5,013
    
    
    $
    7,022
    
    
    $
    18,116Net income per common share:Basic  before cumulative effect of a change in accounting principle
    
    $
    0.20
    
    
    $
    0.33
    
    
    $
    0.88Cumulative effect of a change in accounting principle, net of tax
    
    
    
    
    
    
    
    
    
    
    Basic  after cumulative effect of a change in accounting principle
    
    $
    0.20
    
    
    $
    0.33
    
    
    $
    0.88Diluted  before cumulative effect of a change in accounting principle
    
    $
    0.20
    
    
    $
    0.31
    
    
    $
    0.79Cumulative effect of a change in accounting principle, net of tax
    
    
    
    
    
    
    
    
    
    
    Diluted  after cumulative effect of a change in accounting principle
    
    $
    0.20
    
    
    $
    0.31
    
    
    $
    0.79
 See accompanying Notes to Consolidated Financial Statements. F-5




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION 
 Consolidated Statements of StockholdersEquity
Years ended December 31, 2004, 2003 and 2002  (amounts in thousands)
 Preferred stock
    
    
    Common stock
    
    
    Additional
    
    
    
    
    
    
    Accumulated
    
    
    TotalNumber of
    
    
    
    
    
    
    Number of
    
    
    
    
    
    
    paid-in
    
    
    Retained
    
    
    Comprehensive
    
    
    stockholdersshares
    
    
    Amount
    
    
    shares
    
    
    Amount
    
    
    capital
    
    
    earnings (deficit)
    
    
    Loss
    
    
    equityBalanceJanuary 1, 2002
    
    
    975
    
    
    $
    97
    
    
    
    20,664
    
    
    $
    207
    
    
    $
    34,111
    
    
    $
    (8,078
    )
    
    $
    
    
    
    $
    26,337Common stock issued as
part of asset purchase
    
    
    
    
    
    
    
    
    
    
    454
    
    
    
    5
    
    
    
    995
    
    
    
    
    
    
    
    
    
    
    
    1,000Options exercised,
including income tax benefit of $16
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    
    
    
    
    46
    
    
    
    
    
    
    
    
    
    
    
    46Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,701
    
    
    
    
    
    
    
    18,701Dividends on preferred stock
($0.60 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (585
    )
    
    
    
    
    
    
    (585
    )Balance,December 31, 2002
    
    
    975
    
    
    
    97
    
    
    
    21,143
    
    
    
    212
    
    
    
    35,152
    
    
    
    10,038
    
    
    
    
    
    
    
    45,499Common stock issued for cash
    
    
    
    
    
    
    
    
    
    
    4,000
    
    
    
    40
    
    
    
    12,080
    
    
    
    
    
    
    
    
    
    
    
    12,120Preferred stock converted
    
    
    (15
    )
    
    
    (1
    )
    
    
    43
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Warrants issued for services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    157
    
    
    
    
    
    
    
    
    
    
    
    157Options exercised,
including income tax benefit of $19
    
    
    
    
    
    
    
    
    
    
    31
    
    
    
    
    
    
    
    57
    
    
    
    
    
    
    
    
    
    
    
    57Stock option expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    98
    
    
    
    
    
    
    
    
    
    
    
    98Decrease in value of cash flow hedges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,721
    )
    
    
    (3,721
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,602
    
    
    
    
    
    
    
    7,602Dividends on preferred stock($0.60 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (580
    )
    
    
    
    
    
    
    (580
    )BalanceDecember 31, 2003
    
    
    960
    
    
    
    96
    
    
    
    25,217
    
    
    
    253
    
    
    
    47,544
    
    
    
    17,060
    
    
    
    (3,721
    )
    
    
    61,232Common stock issued for services
    
    
    
    
    
    
    
    
    
    
    21
    
    
    
    
    
    
    
    99
    
    
    
    
    
    
    
    
    
    
    
    99Preferred stock converted
    
    
    (10
    )
    
    
    (1
    )
    
    
    27
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    Options
exercised, including income tax benefit of $177
    
    
    
    
    
    
    
    
    
    
    174
    
    
    
    1
    
    
    
    522
    
    
    
    
    
    
    
    
    
    
    
    523Deferred stock offering costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7
    )
    
    
    
    
    
    
    
    
    
    
    (7
    )Stock option expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    169
    
    
    
    
    
    
    
    
    
    
    
    169Decrease in value of cash flow hedges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,035
    )
    
    
    (7,035
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,585
    
    
    
    
    
    
    
    5,585Dividends on preferred stock
($0.60 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (572
    )
    
    
    
    
    
    
    (572
    )BalanceDecember 31, 2004
    
    
    950
    
    
    $
    95
    
    
    
    25,439
    
    
    $
    254
    
    
    $
    48,328
    
    
    $
    22,073
    
    
    $
    (10,756
    )
    
    $
    59,994
 See accompanying Notes to Consolidated Financial Statements. F-6




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION 
 Consolidated Statements of Cash Flows
Years ended December 31, 2004, 2003 and 2002 (in thousands)
 2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net income
    
    $
    5,585
    
    
    $
    7,602
    
    
    $
    18,701Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation, depletion and amortization
    
    
    8,712
    
    
    
    8,390
    
    
    
    6,220Accretion of asset retirement obligation
    
    
    92
    
    
    
    139
    
    
    
    Equity in income of First Permian, L.P.
    
    
    
    
    
    
    
    
    
    
    (31,044
    )Loss on sale of marketable securities
    
    
    
    
    
    
    
    
    
    
    717Deferred income taxes
    
    
    2,869
    
    
    
    3,031
    
    
    
    9,683Change in fair value of derivative instruments
    
    
    
    
    
    
    22
    
    
    
    508(Gain) loss on ineffective portion of hedges
    
    
    945
    
    
    
    (191
    )
    
    
    440Common stock issued in lieu of cash for directors fees
    
    
    99
    
    
    
    
    
    
    
    Stock option expense
    
    
    169
    
    
    
    98
    
    
    
    Stock-based financial advisory services
    
    
    
    
    
    
    157
    
    
    
    Cumulative effect on prior years of a change in accounting principle, net of tax
    
    
    
    
    
    
    62
    
    
    
    Changes in assets and liabilities:Other, net
    
    
    (266
    )
    
    
    139
    
    
    
    (549
    )Increase in accounts receivable
    
    
    (2,112
    )
    
    
    (783
    )
    
    
    (1,608
    )(Increase) decrease in other current assets
    
    
    31
    
    
    
    (132
    )
    
    
    (621
    )Increase (decrease) in accounts payable and accrued liabilities
    
    
    1,603
    
    
    
    931
    
    
    
    (388
    )Purchase of derivative instruments
    
    
    
    
    
    
    
    
    
    
    (531
    )Net cash provided by operating activities
    
    
    17,727
    
    
    
    19,465
    
    
    
    1,528Cash flows from investing activities:Additions to oil and gas properties
    
    
    (67,911
    )
    
    
    (14,930
    )
    
    
    (61,240
    )Restricted cash
    
    
    (2,287
    )
    
    
    
    
    
    
    Proceeds from disposition of oil and gas properties
    
    
    1,625
    
    
    
    64
    
    
    
    693Proceeds from disposition of Energen Stock
    
    
    
    
    
    
    
    
    
    
    24,863Additions to other property and equipment
    
    
    (647
    )
    
    
    (331
    )
    
    
    (531
    )Distribution received from investment of First Permian, LLC
    
    
    
    
    
    
    
    
    
    
    5,938Investment in Westfork Pipeline
    
    
    (298
    )
    
    
    (297
    )
    
    
    Net cash used in investing activities
    
    
    (69,518
    )
    
    
    (15,494
    )
    
    
    (30,277
    )Cash flows from financing activities:Net borrowing (payments) on revolving line of credit
    
    
    39,250
    
    
    
    (10,000
    )
    
    
    37,750Proceeds from exercise of stock options
    
    
    523
    
    
    
    55
    
    
    
    45Proceeds (net) from common stock issued
    
    
    
    
    
    
    12,120
    
    
    
    Payment of preferred stock dividend
    
    
    (572
    )
    
    
    (580
    )
    
    
    (585
    )Deferred stock offering costs
    
    
    (7
    )
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    39,194
    
    
    
    1,595
    
    
    
    37,210Net increase (decrease) in cash and cash equivalents
    
    
    (12,597
    )
    
    
    5,566
    
    
    
    8,461Cash and cash equivalents at beginning of year
    
    
    17,378
    
    
    
    11,812
    
    
    
    3,351Cash and cash equivalents at end of year
    
    $
    4,781
    
    
    $
    17,378
    
    
    $
    11,812Non-cash financing and investing activities:Oil and gas properties asset retirement obligation
    
    $
    338
    
    
    $
    1,075
    
    
    $
    (Non-cash) proceeds from sale of investment of First Permian, L.P.
    
    $
    
    
    
    $
    
    
    
    $
    (25,580
    )Accrued preferred stock dividend
    
    $
    
    
    
    $
    
    
    
    $
    24Issuance of stock for purchase of oil and gas property
    
    $
    
    
    
    $
    
    
    
    $
    1,000
 See accompanying Notes to Consolidated Financial Statements. F-7




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION 
 Consolidated Statements of Comprehensive Income (Loss)
Years ended December 31, 2004, 2003 and 2002  (dollars in thousands)
 2004
    
    
    2003
    
    
    2002Net income
    
    $
    5,585
    
    
    $
    7,602
    
    
    $
    18,701Other comprehensive loss:Unrealized losses on derivatives
    
    
    (19,378
    )
    
    
    (8,336
    )
    
    
    Reclassification adjustment for losses
on derivatives included in net income
    
    
    8,719
    
    
    
    2,699
    
    
    
    Change in fair value of derivatives
    
    
    (10,659
    )
    
    
    (5,637
    )
    
    
    Income tax benefit
    
    
    3,624
    
    
    
    1,916
    
    
    
    Total other comprehensive loss
    
    
    (7,035
    )
    
    
    (3,721
    )
    
    
    Total comprehensive income (loss)
    
    $
    (1,450
    )
    
    $
    3,881
    
    
    $
    18,701
 See accompanying notes to Consolidated Financial Statements F-8




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION 
 
 (1) Organization, Business and Summary of Significant Accounting Policies  (a)
    Basis of Consolidation The accompanying financial statements present the consolidated results of Parallel
Petroleum Corporation, a Delaware Corporation, and its wholly owned subsidiaries,
Parallel L.P. and Parallel, L.L.C (collectively the Company or Parallel). All
significant inter-company account balances and transactions have been eliminated.  (b)
    Nature of Operations The Companys focus is on the acquisition, development and exploitation of long-lived
oil and natural gas reserves and, to a lesser extent, exploration for new oil and
natural gas reserves. The Companys business activities are carried out primarily in
Texas. The Companys activities are focused in the Permian Basin of west Texas and New
Mexico, Liberty County in east Texas and the onshore Gulf Coast area of south Texas.
The Company is actively evaluating, leasing, drilling and preparing to drill
new projects located in New Mexico, the Fort Worth Basin of Texas, the Cotton Valley
Reef trend of east Texas and the Uinta Basin of Utah.  (c)
    Concentration of Credit Risk Financial instruments that potentially expose the Company to concentrations of credit
risk consist primarily of unsecured accounts receivable from unaffiliated working
interest owners and crude oil and natural gas purchasers. A substantial portion of
Parallels oil and natural gas reserves are located in the Permian Basin and the
Company may be disproportionally exposed to the impact of delays or interruptions of
production from these wells due to mechanical problems, damages to the current
producing reservoirs and significant governmental regulation, including any curtailment
of production or interruption of transportation of oil or gas produced from the wells.  (d)
    Property and EquipmentOil and gas properties: The Company uses the full cost method of accounting for its oil and gas producing
activities. Accordingly, all costs associated with acquisition, exploration, and
development of oil and gas reserves, including directly related overhead costs, are
capitalized. Management and service fees received for contractual arrangements, if any, are treated
as reimbursement of costs, offsetting the costs incurred to provide those services. Depletion is provided using the unit-of-production method based upon estimates of
proved oil and gas reserves with oil and gas production being converted to a common
unit of measure based upon their relative energy content. Investments in unproved
properties and major development projects are not amortized until proved reserves
associated with the projects can be determined or until impairment occurs. If the
results of an assessment indicate that the properties are impaired, the amount of the
impairment is added to the capitalized costs to be amortized. There was no impairment
recorded for 2004, 2003 and 2002. If the net investment in oil and gas properties in a cost center, as adjusted for
asset retirement obligations, exceeds an amount equal to the sum of (1) the
standardized measure of discounted future net cash flows from proved reserves (see Note
15) and (2) the lower of cost or fair market value of F-9




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 properties in process of development and unexplored acreage, the excess is charged
to expense as additional depletion. The standardized measure is calculated using a 10%
discount rate and is based on unescalated prices in effect at year-end with effect
given to the Companys cash flow hedge positions. Sales of proved and unproved properties are accounted for as adjustments of capitalized
costs with no gain or loss recognized, unless such adjustments would significantly
alter the relationship between capitalized costs and proved oil and gas reserves, in
which case the gain or loss is recognized in income. Abandonments of properties are
accounted for as adjustments of capitalized costs subject to amortization. Other: Maintenance and repairs are charged to operations. Renewals and betterments are
capitalized to the appropriate property and equipment accounts. Upon retirement or disposition of assets other than oil and gas properties, the cost
and related accumulated depreciation are removed from the accounts with the resulting
gains or losses, if any, recognized in income. Depreciation of other property and
equipment is computed using the straightline method based on the estimated useful
lives of the property and equipment.  (e)
    Income Taxes The Company accounts for federal income taxes using the liability method. Under the
liability method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying amounts
of existing assets and liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be recovered
or settled. Under the liability method, the effect on previously recorded deferred tax
assets and liabilities resulting from a change in tax rates is recognized in earnings
in the period in which the change is enacted.  (f)
    Investments Investments in affiliated companies with a 20% to 50% ownership interest are accounted
for on the equity basis and, accordingly, net income includes the Companys share of
their income or loss.  (g)
    Stock-Based Compensation Prior to 2003, Parallel accounted for stock-based compensation utilizing the
intrinsic value method prescribed by Accounting Principles Board Opinion No. 25
Accounting for Stock Issued to Employees(APB 25) and related interpretations. In
September, 2003, Parallel
adopted the provisions of Statement of Financial Accounting Standards No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure,an amendment to SFAS No. 123, whereby certain transitional
alternatives are available for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. Parallel used the prospective method
which applied prospectively the fair value recognition method to all employee and
director awards granted, modified or settled after the beginning of the fiscal year in
which the fair value based method of accounting for stock-based compensation was
adopted. The potential impact of using the fair value method for all options, on a pro
forma basis, is presented in the table that follows. As Parallel adopted the fair
value recognition F-10




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 provisions of SFAS No. 123 prospectively for all employee awards granted, modified or
settled after January 1, 2003, the charge for stock-based compensation included in the
determination of income in 2003 and 2002 is less than that which would have been
recognized if the fair value method had been applied to all awards since the original
effective date of SFAS No. 123. Parallel recognized compensation expense of $169,000 in 2004 and $98,000 in 2003
associated with its stock option grants in 2003. The total number of options granted
during 2003 was 180,000. There were no options granted during 2004. The following table illustrates the effect on net income and earnings per share as if
the fair value based method had been applied to all outstanding and unvested awards in
each period. The fair value of each grant is estimated on the date of grant using the
Black-Scholes option-pricing model. 2004
    
    
    2003
    
    
    2002(in thousands, except per share data)Net income as reported
    
    $
    5,585
    
    
    $
    7,602
    
    
    $
    18,701Add:Expense recorded in 2004 and 2003
    
    
    169
    
    
    
    98
    
    
    
    Deduct:Total stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects
    
    
    (360
    )
    
    
    (587
    )
    
    
    (757
    )Pro forma net income
    
    $
    5,394
    
    
    $
    7,113
    
    
    $
    17,944Earnings per share:Basic  as reported
    
    $
    0.20
    
    
    $
    0.33
    
    
    $
    0.88Basic  pro forma
    
    $
    0.20
    
    
    $
    0.33
    
    
    $
    0.87Diluted  as reported
    
    $
    0.20
    
    
    $
    0.31
    
    
    $
    0.79Diluted  pro forma
    
    $
    0.20
    
    
    $
    0.29
    
    
    $
    0.74
  (h)
    Environmental Expenditures The Company is subject to extensive federal, state and local environmental laws and
regulations. These laws regulate the discharge of materials into the environment and
may require the Company to remove or mitigate the environmental effects of the disposal
or release of petroleum or chemical substances at various sites. Environmental
expenditures are expensed or capitalized depending on their future economic benefit.
Expenditures that relate to an existing condition caused by past operations and that
have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are recorded when
environmental assessment and/or remediation is probable, and the costs can be
reasonably estimated. Such liabilities are generally F-11




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 undiscounted unless the timing of cash payments for the liability or component are
fixed or reliably determinable.  (i)
    Earnings Per Share Basic earnings per share excludes any dilutive effects of option, warrants and
convertible securities and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period. Diluted earnings per share are computed similar to basic earnings per share;
however, diluted earnings per share reflect the assumed conversion of all potentially
dilutive securities. The following table provides the computation of basic and diluted earnings per share
for the year ended December 31: 2004
    
    
    2003
    
    
    2002(in thousands except per share data)Basic EPS Computation:Numerator-Net income before cumulative effect of a change in accounting principle
    
    $
    5,585
    
    
    $
    7,664
    
    
    $
    18,701Cumulative effect of a change in accounting principle, net of tax
    
    
    
    
    
    
    (62
    )
    
    
    5,585
    
    
    
    7,602
    
    
    
    18,701Preferred stock dividend
    
    
    (572
    )
    
    
    (580
    )
    
    
    (585
    )Net income available to common stockholders
    
    $
    5,013
    
    
    $
    7,022
    
    
    $
    18,116Denominator-Weighted average common shares outstanding
    
    
    25,323
    
    
    
    21,264
    
    
    
    20,680Basic EPS:Net income before cumulative effect of a change in accounting principle
    
    $
    0.20
    
    
    $
    0.33
    
    
    $
    0.88Cumulative effect of a change in accounting principle, net of tax
    
    
    
    
    
    
    
    
    
    
    Basic net earnings per share
    
    $
    0.20
    
    
    $
    0.33
    
    
    $
    0.88Diluted EPS Computation:Numerator-Net income before cumulative effect of a change in accounting principle
    
    $
    5,585
    
    
    $
    7,664
    
    
    $
    18,701Cumulative effect of a change in accounting principle, net of tax
    
    
    
    
    
    
    (62
    )
    
    
    5,585
    
    
    
    7,602
    
    
    
    18,701Preferred stock dividend
    
    
    
    
    
    
    
    
    
    
    Net income available to common stockholders
    
    $
    5,585
    
    
    $
    7,602
    
    
    $
    18,701Denominator -Weighted average common shares outstanding
    
    
    25,323
    
    
    
    21,264
    
    
    
    20,680Employee stock options
    
    
    289
    
    
    
    150
    
    
    
    85Warrants
    
    
    76
    
    
    
    20
    
    
    
    Preferred stock
    
    
    2,714
    
    
    
    2,741
    
    
    
    2,784Weighted average common shares for diluted
earnings per share assuming conversion
    
    
    28,402
    
    
    
    24,175
    
    
    
    23,549Diluted EPS:Net income before cumulative effect of a change in accounting principle
    
    $
    0.20
    
    
    $
    0.31
    
    
    $
    0.79Cumulative effect of a change in accounting principle, net of tax
    
    
    
    
    
    
    
    
    
    
    Diluted net earnings per share
    
    $
    0.20
    
    
    $
    0.31
    
    
    $
    0.79
 F-12




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 Some stock options and warrants during 2004, 2003 and 2002, approximately 664,000, 1.4
million and 1.9 million shares, respectively, were not included in the computation of
diluted net earnings per share because the stock options exercise price was greater
than the average market price of common stock of the Company.  (j)
    Use of Estimates in the Preparation of Consolidated Financial Statements Preparation of the accompanying Consolidated Financial Statements in conformity with
accounting principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the
Consolidated Financial Statements and the reported amounts of revenues and expenses
during the reporting period. The oil and gas reserve estimates, and the related future
net cash flows derived from those reserves, are used in the determination of depletion
expense and the full-cost ceiling test and are inherently imprecise. Actual results
could differ from those estimates.  (k)
    Cash Equivalents For purposes of the statements of cash flows, the Company considers all demand
deposits, money market accounts and certificates of deposit purchased with an original
maturity of three months or less to be cash equivalents.  (l)
    Restricted Cash Restricted cash includes cash held in escrow for the purchase of producing properties
(see Note 3).  (m)
    Reclassifications Certain reclassifications have been made to 2003 amounts to conform to the 2004
presentation.  (n)
    Derivative Financial Instruments Derivative financial instruments, utilized to manage or reduce commodity price risk related to
the Companys production and interest rate risk related to the Companys long-term debt, are
accounted for under the provisions of Statement of Financial Accounting Standards No. 133(SFAS No.
133), Accounting for Derivative Instruments and for Hedging Activities, and related
interpretations. Under this statement, all derivatives are carried on the balance sheet at fair
value. If the derivative is designated as a fair value hedge, the changes in the fair value of the
derivative and of the hedged item attributable to the
hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the
effective portions of changes in the fair value of the derivative are recorded in other
comprehensive income (OCI) and are recognized in the statement of operations when the hedged item
affects earnings. If the derivative is not designated as a hedge, changes in the fair value are
recognized in other expense. Ineffective portions of changes in the fair value of cash flow hedges
are also recognized in other expense. F-13




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PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002  (o)
    Revenue RecognitionOil and natural gas revenues are recorded using the sales method, whereby the Company recognizes
oil and natural gas revenue based on the amount of oil and gas sold to purchasers.The following summarizes revenue for each of the three years ended December 31 by product sold. 2004
    
    
    2003
    
    
    2002(in thousands)Oil revenue
    
    $
    28,455
    
    
    $
    18,300
    
    
    $
    3,217Oil hedge
    
    
    (7,458
    )
    
    
    (1,659
    )
    
    
    Gas revenue
    
    
    15,735
    
    
    
    18,121
    
    
    
    8,889Gas hedge
    
    
    (895
    )
    
    
    (907
    )
    
    
    $
    35,837
    
    
    $
    33,855
    
    
    $
    12,106
  (p)
    Recent Accounting PronouncementsIn September 2004, the Securities and Exchange Commission issued Staff Accounting Bulletin No.
106(SAB No. 106). SAB No. 106 applies to companies using the full cost method of accounting
for oil and gas properties and equipment costs. SAB No. 106 affected the way in which the Company
calculates its full cost ceiling limitation (the Company excluded asset retirement costs related to
proved developed properties in the calculation of the ceiling) and the way the Company calculated
depletion on its gas properties (only asset retirement costs for new recompletions and new wells will
be included in future development costs in calculating depletion rates). The Company adopted SAB
No. 106 on October 1, 2004.In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 123 (revised 2004), Share- Based Payment(SFAS No.
123(R)) . SFAS No. 123(R) requires an entity to recognize the grant-date fair value of stock options
and other equity-based compensation issued to employees in the income statement. SFAS No.
123(R) will be effective for the Company beginning July 1, 2005. The Company does not expect
SFAS No. 123(R) to have a material impact on its results of operations.In December 2004, the FASB issued FASB Staff Position FAS 109-1, Application on FASB
Statement No. 109, Accounting for Income Taxes, for the Tax Deduction Provided to U.S. Based
Manufacturers by the American Jobs Creation Act of 2004(FSP 109-1). FSP 109-1 clarifies how to
apply Statement No. 109 to the new laws tax deduction for income attributable to Domestic
production activities. The Company is currently evaluating the impact of the new law.  (2)
    Fair Value of Financial InstrumentsThe carrying amount of cash, accounts receivable, accounts payable, and accrued liabilities approximates
fair value because of the short maturity of these instruments. F-14




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 The carrying amount of long-term debt approximates fair value because the Companys current borrowing
rate is based on a variable market rate of interest. The Company also has derivative instruments which
are
described in Footnote 5.  (3)
    Oil and Gas PropertiesThe following table reflects capitalized costs related to the oil and gas properties as of December 31: 2004
    
    
    2003(in thousands)Proved properties
    
    $
    219,719
    
    
    $
    160,287Unproved properties , not subject to depletion
    
    
    9,526
    
    
    
    2,334229,245
    
    
    
    162,621Accumulated depletion
    
    
    (77,623
    )
    
    
    (69,726
    )$
    151,622
    
    
    $
    92,895
 Certain directly identifiable internal costs of property acquisition, exploration, and
development activities are capitalized. Such costs capitalized in 2004, 2003 and 2002 totaled $1.0
million, $0.9 million and $1.3 million, respectively. Depletion per equivalent unit of production (BOE) was $7.05, $6.83 and $10.52 for 2004, 2003, and
2002, respectively. The following table reflects costs incurred in oil and gas property acquisition, exploration, and
development activities for each of the years in the three year period ended December 31: 2004
    
    
    2003
    
    
    2002(in thousands)Proved property acquisition costs
    
    $
    39,763
    
    
    $
    2,209
    
    
    $
    48,044Unproved
property acquisitions costs
    
    
    7,400
    
    
    
    3,831
    
    
    
    2,295Exploration
    
    
    6,794
    
    
    
    3,240
    
    
    
    1,291Development
    
    
    13,954
    
    
    
    5,650
    
    
    
    9,308$
    67,911
    
    
    $
    14,930
    
    
    $
    60,938
 On December 20, 2002, Parallel purchased a majority non-operated interest in producing oil and
gas properties located in the Fullerton Field of Andrews County, Texas in the Permian Basin of west
Texas. The total purchase price for this interest in the Fullerton properties was $46.0 million. In September and October 2004, in two separate transactions, Parallel purchased additional
non-operated working interests in the Fullerton Field properties. The net purchase price for these
two transactions was approximately $20.9 million. F-15




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 In October and December 2004, Parallel purchased producing properties in the Carm-Ann San Andres
and North Means Queen Unit located in Andrews and Gaines counties, Texas. The combined net purchase
price was approximately $16.5 million. In January 2005, Parallel acquired additional interest, in
these properties for a net purchase price of approximately $1.5 million. The 2005 purchase was made
out of restricted cash.  (4)
    Asset Retirement Obligation On January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 143,
Accounting for Asset Retirement Obligations(SFAS 143). SFAS 143 requires companies to recognize
a liability for the present value of all legal obligations associated with the retirement of
tangible long-lived assets and to capitalize an equal amount as part of the cost of the related oil
and gas properties. The adoption of SFAS 143 required the Company to record a non-cash expense, net of tax, of
approximately $62,000 as a cumulative effect of change in accounting principle in the first quarter
of 2003, as well as a non-current liability of approximately $1.5 million and an addition to oil and
gas properties of approximately $1.5 million. The following table summarizes the Companys asset
retirement obligation transactions as if SFAS No. 143 had been applied during all periods
presented. 2004
    
    
    2003
    
    
    2002(in thousands)Pro FormaBeginning asset retirement obligation
    
    $
    1,701
    
    
    $
    1,469
    
    
    $
    897Additions related to new properties
    
    
    886
    
    
    
    345
    
    
    
    498Deletions related to property disposals
    
    
    (547
    )
    
    
    (252
    )
    
    
    Accretion expense
    
    
    92
    
    
    
    139
    
    
    
    74Ending asset retirement obligation
    
    $
    2,132
    
    
    $
    1,701
    
    
    $
    1,469
 The table below reflects, on a pro forma basis, the net income and net income per share
amounts as if the provisions of SFAS No. 143 had been applied during all the periods presented. 2004
    
    
    2003
    
    
    2002(dollars in thousands except per share data)Pro FormaNet income, as reported
    
    $
    5,585
    
    
    $
    7,602
    
    
    $
    18,701Accretion of asset retirement obligation, net of tax
    
    
    
    
    
    
    
    
    
    
    (39
    )Cumulative effect of change in
accounting principle, net of tax
    
    
    
    
    
    
    62
    
    
    
    Pro forma net income
    
    $
    5,585
    
    
    $
    7,664
    
    
    $
    18,662Basic net income per share, as reported
    
    $
    0.20
    
    
    $
    0.33
    
    
    $
    0.88Basic net income per share, pro forma
    
    $
    0.20
    
    
    $
    0.33
    
    
    $
    0.88Diluted net income per share, as reported
    
    $
    0.20
    
    
    $
    0.31
    
    
    $
    0.79Diluted net income per share, pro forma
    
    $
    0.20
    
    
    $
    0.31
    
    
    $
    0.79
 F-16




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002  (5)
    Derivative Instruments The Company enters into derivative contracts to provide a measure of stability in the Companys oil
and gas revenues and interest rate payments and to manage exposure to commodity price and interest
rate risk. The Companys objective is to lock in a range of oil and gas prices and fixed interest
rate.. The Companys line of credit agreement as of December 31, 2004 required at least 50% of the
Companys estimated monthly crude oil produced from proved producing oil and gas properties during
2005 calendar year and thereafter until the maturity date to be hedged. The Company designates its
interest rate swaps, costless collars and commodity swaps as cash flow hedges. The effective
portion of the unrealized gain or loss on cash flow hedges is recorded in other comprehensive
income until the forecasted transaction occurs. During the term of a cash flow hedge, the effective portion of the change in the fair value of the
derivatives is recorded in stockholders equity as other comprehensive income (loss) and then
transferred to oil and gas revenues when the production is sold and interest expense as the
interest accrues. Ineffective portions of hedges (changes in realized prices that do not match the
changes in the hedge price) are recognized in other expense as they occur. While the hedge contract
is open, the ineffective gain or loss may increase or decrease until settlement of the contract. As of December 31, 2004 and 2003, the Company had recorded unrealized losses of $16.3 million and
$5.9 million, respectively, related to its derivative instruments, which represented the estimated
aggregate fair values of the Companys open derivative contracts as of that date. In addition, the
Company recorded realized losses related to the ineffective portion of derivative instruments
aggregating approximately $1.2 million for December 31, 2004, and a gain or reversal of
ineffectiveness, of $0.2 million at December 31, 2003. These unrealized and realized losses are
presented on the Consolidated Balance Sheet ending December 31, 2004 and 2003, as a current liability of $8.0 million and $3.2 million and long-term
liabilities of $9.5 million and $2.7 million, respectively. The unrealized losses are presented in
stockholders equity in the Consolidated Balance Sheets as accumulated other comprehensive loss of
$10.8 million, net of income taxes of $5.5 million for December 31, 2004 and $3.7 million, net of
income taxes of $1.9 million for December 31, 2003. During the twelve month period ending December
31, 2005, the Company expects approximately $4.9 million, net of
income taxes, to be transferred out of accumulated comprehensive loss and charged to earnings. The Company is exposed to credit risk in the event of nonperformance by BNP Paribas, a
counterparty, in its derivative instruments. However, the Company periodically assesses its credit
worthiness to mitigate this credit risk. Interest Rate Sensitivity Swaps.The Company entered into 48-month LIBOR fixed interest rate swap contracts with BNP Paribas.
The Company will pay a fixed interest rate, as noted in the table below, for the 48-month period
beginning January 1, 2005 through December 30, 2008. Under the Companys revolving credit facility, the Company may elect an interest rate based upon
the agent banks base lending rate plus a base rate margin of up to 2.00%, or the LIBOR rate, plus
a margin ranging from 2.25% to 4.75% per annum, depending on the Companys borrowing base usage.
The interest rate the Company is required to pay, including the applicable margin, may never be
less than 4.50%. The Company entered into fixed rate swap contracts with BNP Paribas based on the 90-day LIBOR rates
at the time of the contract. The effect of the Swap is that the Company converted its variable rate
debt into F-17




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 fixed rate debt. The Company will receive variable interest rates as previously described and pay
fixed rates as shown in the table below. NotionalPeriod of Time
    
    Amounts
    
    
    Fixed Interest Rates$ in millionsJanuary 1, 2005 thru December 31, 2005
    
    $
    50
    
    
    
    3.36
    %January 1, 2006 thru December 31, 2006
    
    $
    50
    
    
    
    3.82
    %January 1, 2007 thru December 31, 2007
    
    $
    50
    
    
    
    4.30
    %January 1, 2008 thru December 30, 2008
    
    $
    50
    
    
    
    4.74
    %
 Commodity Price Sensitivity Puts.On May 24, 2002 the Company purchased put floors on volumes of 100,000 Mcf per month for a
total of 700,000 Mcf during the seven month period from April, 2003 through October, 2003 at a
floor price of $3.00 per Mcf for a total consideration of approximately $139,500. These derivatives
were not held for trading purposes. A decrease in fair value of the put floors of $22,000 and $508,000 was recognized in the
Consolidated Statements of Operations for the years ended 2003 and 2002, respectively. Costless
Collars.Collars are created by purchasing puts to establish a floor price and then
selling a call which establishes a maximum amount the Company will receive for the oil or gas hedged. Calls
are sold to offset the premium paid for buying the put. The Company has entered into costless gas
collars and light sweet crude oil collars. A recap for the period of time, number of MMBtus, number of barrels, and oil and gas prices is as
follows: Houston Ship ChannelBarrels of
    
    
    NyMex oil prices
    
    
    M M Btu of
    
    
    gas pricesPeriod of Time
    
    Oil
    
    
    Floor
    
    
    Cap
    
    
    Natural Gas
    
    
    Floor
    
    
    CapApril 1, 2005 thru October 31, 2005
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    
    428,000
    
    
    $
    5.00
    
    
    $
    7.26January 1, 2005 thru December 31, 2005
    
    
    73,000
    
    
    $
    36.00
    
    
    $
    49.60
    
    
    
    
    
    
    $
    
    
    
    $
    January 1, 2006 thru December 31, 2006
    
    
    70,800
    
    
    $
    35.00
    
    
    $
    44.00
    
    
    
    
    
    
    $
    
    
    
    $
    
 Swaps.Generally, swaps are an agreement to buy or sell a specified commodity for delivery in
the future, but at an agreed fixed price. Swap transactions convert a floating price into a fixed
price. For any particular swap transaction, the counterparty is required to make a payment to the
hedge party if the reference price for any settlement period is less than the swap price for such
hedge, and the hedge party is required to make a payment to the counterparty if the reference price
for any settlement period is greater than the swap price for such hedge. F-18




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 The Company has entered into oil and gas swap contracts with BNP Paribas. A recap for the period of
time, number of MMBtus, number of barrels, and swap prices is as follows: Barrels
    
    
    
    
    
    
    
    
    
    
    Houston Shipof
    
    
    Nymex Oil
    
    
    M MBtu of
    
    
    ChannelPeriod of Time
    
    Oil
    
    
    Swap Price
    
    
    Natural Gas
    
    
Gas Swap PriceJanuary 1, 2005 thru Dece mber 31, 2005
    
    
    620,500
    
    
    $
    30.19
    
    
    
    
    
    
    $
    January 1, 2005 thru March 31, 2005
    
    
    
    
    
    $
    
    
    
    
    180,000
    
    
    $
    4.705January 1, 2006 thru Dece mber 20, 2006
    
    
    448,000
    
    
    $
    28.46
    
    
    
    
    
    
    $
    January 1, 2007 thru Dece mber 31, 2007
    
    
    474,500
    
    
    $
    34.36
    
    
    
    
    
    
    $
    January 1, 2008 thru Dece mber 31, 2008
    
    
    439,200
    
    
    $
    33.37
    
    
    
    
    
    
    $
    
  (6)
    Equity Investments and Property Acquisitions On March 7, 2002, First Permian entered into an Agreement of Sale and Purchase with Energen
Resources Corporation, a wholly owned subsidiary of Energen Corporation (Energen), to sell all of
First Permians oil and gas properties for a gross consideration
of $120.0 million in cash and 3.0 million shares in Energen stock approximating $70.0 million in value. Energen is a publicly
traded company listed on the NYSE. The transaction closed on April 8, 2002. As a 30.675% interest
owner in First Permian, the Company received its prorata share of the net proceeds, $5.5 million in
cash and 933,589 shares of Energen common stock. All shares of Energen stock were sold prior to
December 31, 2002 for $24.9 million; resulting in the total proceeds from the sale of First Permian
in the amount of $30.4 million. Through 2004, the Company has invested $595,000 in a partnership to construct the Westfork Pipeline
on its leaseholds in the Barnett Shale area, which is recorded as an equity investment in the
accompanying consolidated balance sheet. The Company has budgeted expenditures of approximately
$420,000 for 2005, resulting in a 28% interest in the partnership, which mirrors the Companys
working interest in the leaseholds in the area. The Company intends to develop those leaseholds and
utilize the pipeline to transport the resulting production to market. The partnership is currently
acquiring the necessary easements and permits for the pipeline. Upon successful completion of the
acquisition of the easements, construction of the pipeline and development of the leasehold will
commence. In September and October 2004, with two separate transactions, Parallel purchased additional
non-operated working interest in the Fullerton Field properties. The net purchase price for these
transactions was approximately $20.9 million. In October and December 2004, Parallel purchased properties in the Carm-Ann San Andres and North
Means Queen Unit located in Andrews and Gaines counties, Texas. The combined net purchase price was
approximately $16.5 million. In January 2005, Parallel acquired additional interest in these
properties for a net purchase price of approximately $1.5 million. F-19




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 The following table presents unaudited, pro forma operating results as if the 2004 property
purchases were effective on January 1, 2004 and 2003. This pro forma information does not reflect
the effects of the January 2005 purchase. 2004
    
    
    2003Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    TotalPLLL
    
    
    Fullerton
    
    
    Carm Ann
    
    
    Pro Forma
    
    
    PLLL
    
    
    Fullerton
    
    
    Carm Ann
    
    
    Pro Forma(in thousands, except per share data)
    
    
    (in thousands, except per share data)Oil and gas revenue
    
    $
    35,837
    
    
    $
    3,484
    
    
    $
    2,311
    
    
    $
    41,632
    
    
    $
    33,855
    
    
    $
    3,320
    
    
    $
    2,473
    
    
    $
    39,648Operating income
    
    $
    12,266
    
    
    $
    1,876
    
    
    $
    587
    
    
    $
    14,729
    
    
    $
    12,717
    
    
    $
    1,228
    
    
    $
    933
    
    
    $
    14,878Net income available
to common stockholders
    
    $
    5,013
    
    
    $
    785
    
    
    $
    (28
    )
    
    $
    5,770
    
    
    $
    7,022
    
    
    $
    207
    
    
    $
    138
    
    
    $
    7,367Net income
per common share:Basic
    
    $
    0.20
    
    
    $
    0.03
    
    
    $
    
    
    
    $
    0.23
    
    
    $
    0.33
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.35Diluted
    
    $
    0.20
    
    
    $
    0.02
    
    
    $
    
    
    
    $
    0.22
    
    
    $
    0.31
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.33
 The pro forma results have been prepared for comparative purposes only. The Company does not
purport to present actual results that would have been achieved or to be indicative of future
results.  (7)
    Revolving Credit Facility The Company has a revolving credit facility with a bank under which borrowings totaling $79.0
million and $39.8 million were outstanding as of December 31, 2004 and 2003, respectively. The revolving credit facility has varying interest rates and consists of the following banks base
rate and LIBOR tranches at December 31: 2004
    
    
    2003(in thousands)Revolving Facility note payable to banks ,Agent banks base lending rate of 7.25% and 4.50%
    
    $
    5,000
    
    
    $
    39,750Libor No . 1 at 6.73% (maturing January 3, 2005)
    
    
    55,000
    
    
    
    Libor No . 2 at 7.29% (maturing May 23, 2005)
    
    
    19,000
    
    
    
    Total note payable to banks
    
    $
    79,000
    
    
    $
    39,750
 On September 27, 2004, the Company entered into a Second Amended and Restated Credit Agreement
(or the Credit Agreement) with a syndication of banks. The Credit Agreement provides for a revolving credit facility which means that the Company can
borrow, repay and reborrow funds drawn under the credit facility. The total amount that the Company
can borrow and have outstanding at any one time is limited to the lesser of $200.0 million or the
borrowing base established by their lenders. As of December 31, 2004, the Companys borrowing
base was $85.8 million. The principal amount outstanding under the credit facility at December 31,
2004 was $79.0 million, excluding $350,000 reserved for the Companys letters of credit. The amount
of the borrowing base is F-20




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 based primarily upon the estimated value of the Companys oil and gas reserves. The borrowing base
amount is redetermined by the lenders semi-annually on or about April 1 and October 1 of each year
or at other times required by the lenders or at the Companys request. If, as a result of the
lenders redetermination of the borrowing base, the outstanding principal amount of the Companys
loan exceeds the borrowing base, the Company must either provide additional collateral to the
lenders or repay the principal of the note in an amount equal to the excess. Except for the
principal payments that may be required because of the Companys outstanding loans being in excess
of the borrowing base, interest only is payable monthly. Loans made to the Company under this credit facility bear interest at the banks base rate or the
LIBOR rate, at the Companys election. Generally, the banks base rate is equal to the sum of (a)
the prime rate published in the Wall Street Journal, and (b) if the principal amount outstanding is
equal to or greater than 85% of the borrowing base established by the lenders, a margin of 2.00%. The LIBOR rate is generally equal to the sum of (a) the rate designated as British Bankers
Association Interest Settlement Rates and offered on one, two, three, six or twelve month
interest periods for deposits of $1.0 million, and (b) a margin ranging from 2.25% to 4.75%,
depending upon the outstanding principal amount of the loans. If the principal amount outstanding
is equal to or greater than 85% of the borrowing base established by the lenders, the margin is
4.75%. If the principal amount outstanding is equal to or greater than 75% of the borrowing base,
but less than 85% of the borrowing base, the margin is 2.75%. If the principal amount outstanding
is equal to or greater than 50%, but less than 75% of the borrowing base, the margin is 2.50%. If
the principal amount outstanding is less than 50% of the borrowing base, the margin is 2.25%. The interest rate the Company is required to pay, including the applicable margin, may never be
less than 4.50%. At December 31, 2004, the Companys interest rate was 7.25%. In the case of base rate loans, interest is payable on the last day of each month. In the case of
LIBOR loans, interest is payable on the last day of each applicable interest period. If the total outstanding borrowings under the credit facility are less than the borrowing base, an
unused commitment fee is required to be paid to the lenders. The amount of the fee is .25% of the
daily average of the unadvanced amount of the borrowing base. The fee is payable quarterly. If the borrowing base is increased, the Company is required to pay a fee of .375% on the amount of
any increase in the borrowing base. All outstanding principal under the revolving credit facility is due and payable on December 20,
2008. The maturity date of the Companys outstanding loans may be accelerated by the lenders upon
the occurrence of an event of default under the Credit Agreement. Parallel, L.L.C., a subsidiary of Parallel Petroleum Corporation, guaranteed payment of the loans. The Companys obligations to the lenders are secured by substantially all of its oil and gas
properties. F-21




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 The Credit Agreement contains various restrictive covenants and compliance requirements as follows:  
    at the end of each quarter, a current ratio (as
defined in the credit agreement) of at least 1.1 to 1.0;
    for each period (as calculated in the Credit
Agreement) ending on December 31, March 31,
June 30 and September 30, a funded debt ratio (as defined
in the Credit Agreement) of not
more than 3.70, 3.60 and 3.50 respectively for December
31, 2004, 2005, 2006 and 2007; and
    at all times, adjusted consolidated net worth (as
defined in the Credit Agreement) of at least
(a) $50.0 million, plus (b) seventy-five percent (75%) of
the net proceeds from any equity
securities issued by the Company, plus (c) fifty percent
(50%) of the Companys consolidated
net income for each fiscal quarter, if positive, and zero
percent (0%) if negative. As of December 31, 2004, the Company was in compliance with its bank covenants. The Credit Agreement also contains restrictions on all retained earnings and net income for payment
of dividends on common stock. Under the Credit Agreement, Parallel also entered into a separate commitment letter with the
lenders. The lenders under the Credit Agreement temporarily made an additional $20.5 million
available which we borrowed to fund property acquisitions in 2004 and early 2005. This amount was
repaid with a portion of the proceeds from the public offering of common stock completed in
February 2005 discussed in Note 9. If the Company has borrowing capacity under the Credit Agreement, the Company intends to borrow,
repay and reborrow under the revolving credit facility from time to time as necessary, subject to
borrowing base limitations, to fund:  
    interpretation and processing of 3-D seismic survey data;
    lease acquisitions and drilling activities;
    acquisitions of producing properties or companies owning producing properties; and,
    general corporate purposes.  (8)
    Income TaxesThe Companys income tax provision is classified as follows: Years ended December 31,2004
    
    
    2003
    
    
    2002(dollars in thousands)Income tax expense, all deferred
    
    $
    2,869
    
    
    $
    3,031
    
    
    $
    9,683Cumulative effect of change in accounting principle
    
    
    
    
    
    
    (32
    )
    
    
    Losses on derivatives recognized in other
comprehensive income
    
    
    (3,624
    )
    
    
    (1,916
    )
    
    
    Total income tax provision (benefit), all deferred
    
    $
    (755
    )
    
    $
    1,083
    
    
    $
    9,683
 F-22




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 Federal income tax expense differs from the amount computed at the Federal statutory rate as
follows: Year ended December 31,2004
    
    
    2003
    
    
    2002(in thousands)Income tax expense at statutory rate
    
    $
    2,874
    
    
    $
    3,700
    
    
    $
    9,651Statutory depletion
    
    
    (29
    )
    
    
    (96
    )
    
    
    (360
    )State tax, net of federal benefit(1)
    
    
    6
    
    
    
    (594
    )
    
    
    370Nondeductible expenses and other
    
    
    18
    
    
    
    21
    
    
    
    22Income tax expense
    
    $
    2,869
    
    
    $
    3,031
    
    
    $
    9,683
   (1)
    
    The state tax benefit in 2003 resulted from a reversal of a prior year estimate. The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and
deferred tax liabilities at December 31 are as follows: 2004
    
    
    2003(in thousands)Current:Deferred tax assets:Losses on derivatives recognized in other comprehensive income
    
    $
    2,531
    
    
    $
    1,098Noncurrent:Deferred tax assets:Net operating loss carryforwards, state and federal
    
    $
    4,196
    
    
    $
    3,104Statutory depletion carryforwards
    
    
    2,019
    
    
    
    1,724Alternative minimum tax credit carryforward
    
    
    118
    
    
    
    118Equity investment in First Permian, LLC
    
    
    
    
    
    
    16Losses on derivatives recognized in other comprehensive income
    
    
    3,010
    
    
    
    818Crude oil mark-to-market
    
    
    407
    
    
    
    85Asset retirement obligations
    
    
    110
    
    
    
    79Other
    
    
    39
    
    
    
    5Total noncurrent deferred tax assets
    
    
    9,899
    
    
    
    5,949Deferred tax liabilities:Property and equipment, principally due to differences in
basis, expensing of intangible drilling costs for tax
purposes and depletion
    
    
    (16,386
    )
    
    
    (11,758
    )Total deferred tax liabilities
    
    
    (16,386
    )
    
    
    (11,758
    )Net noncurrent deferred income tax liability
    
    $
    (6,487
    )
    
    $
    (5,809
    )
 F-23




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 As of December 31, 2004, the Company had net operating loss carryforwards for regular tax and
alternative minimum taxable income (AMT) purposes available to reduce future taxable income. These
carryforwards expire as follows: Net operating
    
    
    A M Tloss
    
    
    operating loss(in thousands)2019
    
    $
    4,435
    
    
    $
    4,8692021
    
    
    4,576
    
    
    
    4,4982022
    
    
    44
    
    
    
    442023
    
    
    7
    
    
    
    3322024
    
    
    3,089
    
    
    
    3,118$
    12,151
    
    
    $
    12,861
 As of December 31, 2004, the Company had approximately $118,000 of alternative minimum
tax credit carryover that does not expire.  (9)
    Equity Transactions Preferred Stock As of December 31, 2004 the Company had outstanding 950,000 shares of 6% Convertible Preferred
Stock, $0.10 par value per share. Cumulative annual dividends of $0.60 per share are payable
semi-annually on June 15 and December 15 of each year. Each share of Convertible Preferred Stock
may be converted, at the option of the holder, into 2.8571 shares of common stock at an initial
conversion price of $3.50 per share, subject to adjustment in certain events. The Convertible
Preferred Stock has a liquidation preference of $10 per share and has no voting rights, except as
required by law. The Company may redeem the preferred stock, in whole or part, for $10 per share
plus accrued and unpaid dividends. On October 5, 2000, the Company authorized 50,000 shares of $0.10 par Series A Preferred Stock.
These shares will be issued upon the exercise of the Companys Preferred Stock Purchase Rights.
Subject to the rights of the holders of any series of preferred stock ranking prior and superior to
the Series A preferred stock with respect to dividends, the holders of shares of the Series A
Preferred Stock shall be entitled to receive, when, and if declared by the board of directors,
quarterly dividends payable in cash on the first day of July, October, January and April, in each
year, commencing on the first quarterly dividend payment Date after the first issuance of a
fraction of a share of Series A Preferred Stock. Each share of Series A Preferred Stock shall
entitle the holder to one one-thousandth of a vote on all matters submitted to a vote of the
stockholders of the Company. Sale of Equity Securities On December 23, 2003, the Company privately placed a total of 4.0 million shares of common stock,
$.01 par value per share, at a price of $3.25 per share. Gross cash proceeds from the placement
were $13.0 million, and net proceeds were $12.1 million. The shares were subsequently registered
for resale under the Securities Act of 1933, as amended. F-24




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 On February 9, 2005, the Company sold 5,750,000 shares of its common stock, $.01 par value per
share, pursuant to a public offering at a price of $5.27 per share. Gross cash proceeds were $30.3
million, and net proceeds were approximately $28.0 million. The common shares were issued under
Parallels $100.0 million Universal Shelf Registration Statement on Form S-3 which became effective
in November 2004. The proceeds were used to reduce the revolving credit facility.  (10)
    Stock Options, Warrants and Rights The Company awards both incentive stock options and nonqualified stock options to selected key
employees, officers and directors. The options are awarded at an exercise price equal to the
closing price of the Companys common stock on the date of grant. These options vest over a period
of two to ten years with a ten-year exercise period. As of December 31, 2004, options expire
beginning in 2006 and extending through 2013. Options to purchase a total of 217,500 shares of
common stock remain available for grant. The Company has reserved 95,112 of shares of common stock
to issue for director fees. Under FAS 123, the fair value of each stock option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average assumptions used for
grants in 2003 and 2002. No options were granted during 2004. 2003
    
    
    2002Risk-free interest rate
    
    
    3.7
    %
    
    
    2.5
    %Expected life
    
    
    8 years
    
    
    
    8 yearsExpected volatility
    
    
    45.3
    %
    
    
    45.2
    %
 A summary of the Companys employee stock options as of December 31, 2004, 2003 and 2002, and
changes during the years ended on those dates is presented below: Year ended
    
    
    Year ended
    
    
    Year endedDecember 31, 2004
    
    
    December 31, 2003
    
    
    December 31, 2002Number of
    
    
    Weighted
    
    
    Number of
    
    
    Weighted
    
    
    Number of
    
    
    Weightedshares
    
    
    average price
    
    
    shares
    
    
    average price
    
    
    shares
    
    
    average priceStock options:Outstanding at beginning of year
    
    
    2,138,150
    
    
    $
    3.65
    
    
    
    2,338,750
    
    
    $
    2.71
    
    
    
    2,103,750
    
    
    $
    3.74Options granted
    
    
    
    
    
    
    
    
    
    
    180,000
    
    
    
    2.96
    
    
    
    345,000
    
    
    
    2.54Options exercised
    
    
    (174,400
    )
    
    
    (3.00
    )
    
    
    (30,600
    )
    
    
    (1.82
    )
    
    
    (25,000
    )
    
    
    (1.82
    )Options cancelled
    
    
    
    
    
    
    
    
    
    
    (100,000
    )
    
    
    (4.97
    )
    
    
    
    
    
    
    Options expired
    
    
    (45,000
    )
    
    
    (4.29
    )
    
    
    (250,000
    )
    
    
    (3.94
    )
    
    
    (85,000
    )
    
    
    (1.75
    )Outstanding at end of year
    
    
    1,918,750
    
    
    $
    3.71
    
    
    
    2,138,150
    
    
    $
    3.65
    
    
    
    2,338,750
    
    
    $
    2.71Exercisable at end of year
    
    
    1,776,250
    
    
    $
    3.50
    
    
    
    1,785,650
    
    
    $
    3.85
    
    
    
    1,656,250
    
    
    $
    2.82Weighted average fair value of
options granted during the year
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    1.64
    
    
    
    
    
    
    $
    1.66
 F-25




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 The following table summarizes information about the Companys employee stock options
outstanding and exercisable at December 31, 2004: Options outstanding
    
    
    Options exercisableNumber
    
    
    Weighted
    
    
    
    
    
    
    NumberOutstanding at
    
    
    average
    
    
    Weighted
    
    
    exercisable at
    
    
    WeightedRange of
    
    December 31,
    
    
    remaining
    
    
    average
    
    
    December 31,
    
    
    averageexercise prices
    
    2004
    
    
    contractual life
    
    
    exercise price
    
    
    2004
    
    
    exercise price$1.81 - $3.60
    
    
    990,000
    
    
    7 years
    
    $
    2.67
    
    
    
    900,000
    
    
    $
    2.64$4.09 - $5.40
    
    
    928,750
    
    
    5 years
    
    $
    4.83
    
    
    
    876,250
    
    
    $
    4.821,918,750
    
    
    
    
    
    
    
    
    
    
    
    1,776,250
 (a) Stock Warrants The Company has outstanding at December 31, 2004, 2003 and 2002; 300,000, warrants which were
issued as part of the Companys initial public offering in 1980. Each warrant allows the
holder to buy one share of common stock for $6.00. The warrants are exercisable for a 30 day
period commencing on the date a registration statement covering exercise is declared
effective. The warrants contain antidilution provisions and in the event of liquidation,
dissolution, or winding up of the Company, the holders are not entitled to participate in the
assets of the Company. The Company also has outstanding at December 31, 2004, 2003 and 2002 an additional 275,000
warrants issued as partial payment for services rendered for financial and investment advice
in 2001. The warrants have an exercise price equal to the average of the last bid and asked
price of the Companys common stock on the effective date of the issuance of the warrants and
have a term of five years from date of issuance and a vesting period of one year. The exercise
price for the warrants is $2.95. The expense related to these warrants in the amount of
$99,000 was recorded in other expenses in 2001 and is based on the estimated fair value on the
date of grant using the Black-Scholes option pricing model. The Company has outstanding at December 31, 2004 and 2003, 100,000 warrants which were issued
as partial payment for services rendered for financial and investment advice for the Companys
private placement offering in December, 2003. The warrants have an exercise price equal to
the average of the last bid and asked price of the Companys common stock on the effective
date of the issuance of the warrants and have a term of five years from date of issuance and a
vesting period of one year. The exercise price for the warrants is $3.98. The fair value
related to these warrants in the amount of $157,000 was recorded in other expenses in 2003 and
is based on the estimated fair value on the date of grant using the Black-Scholes option
pricing model. (b) Stock Rights On October 5, 2000, the board of directors declared a dividend of one Right for each
outstanding share of the Companys common stock. If a public announcement that a person has
acquired 15% or more of the Companys common stock or a tender offer or exchange offer is made
for 15% or more of the common stock, each Right will entitle the holder to purchase from the
Company one one-thousandth of a share of F-26




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 Series A Preferred Stock, par value $0.10 per share, at an exercise price of $26.00 per one
one-thousandth of a share, subject to adjustment. Initially, the Rights attach to all common stock certificates representing shares then
outstanding, and no separate Rights certificates will be distributed. The Rights separate from
the common stock upon the earlier of (1) ten business days following a public announcement
that a person or group of affiliated or associated persons has acquired or obtained the right
to acquire, beneficial ownership of 15% or more of the outstanding shares of common stock or
(2) ten business days (or such later date as the board of directors shall determine) following
the commencement of a tender or exchange offer that would result in a person or group
beneficially owning 15% or more of such outstanding shares of common stock. The date the
Rights separate is referred to as the distribution date. Under certain circumstances the Rights entitle the holders to buy the Companys stock at a 50%
discount. In the event that (1) the Company is the surviving corporation in a merger or other
business combination with an entity that owns 15% or more of the Companys outstanding stock;
(2) any person shall acquire beneficial ownership of 15% of the Companys outstanding stock;
or, (3) there is any type of recapitalization of the Company that results in an increase by
more than 1% the proportionate share of equity securities of the Company owned by a person who
owns 15% or more of the Companys outstanding stock, each Right holder will have the
option to buy for the purchase price common stock of the Company having a value equal to two
times the purchase price of the Right. Under certain circumstances the Rights entitle the holders to buy shares of the acquirers
common stock at a 50% discount. In the event that, at any time after a person has acquired 15%
or more of the Companys common stock, (1) the Company enters into a merger or other business
combination transaction in which the Company is not the surviving corporation; (2) the Company
is the surviving corporation in a transaction in which all or part of the common stock is
exchanged for cash, property or securities of any other person; or, (3) more than 50% of the
assets, cash flow or earning power of the Company is sold, each right holder will have the
option to buy for the purchase price stock of the acquiring company having a value equal to
two times the purchase price of the Right. The Rights are not exercisable until the distribution date and will expire at the close of
business on October 5, 2010, unless earlier redeemed by the Company for $0.001 per Right. (11) Related Party Transactions An entity owned by Thomas R. Cambridge, the Companys Chairman of the board of directors, is
the owner and acted as the Companys agent in performing the routine day to day operations on
2 wells. In 2004, 2003 and 2002 the Company was billed approximately $15,000, $51,000 and
$85,000, respectively, for the Companys pro rata share of lease operating and drilling
expenses and received approximately $165,000, $198,000 and $187,000 in 2004, 2003, and 2002,
respectively, in oil and gas revenues related to these wells. These 2 wells were acquired in
1984. An entity, in which Mr. Cambridge is the President, owned interests in certain wells that are
administered by the Company. During 2004 the Company charged approximately $4,000 for lease
operating expense and paid approximately $3,000 in oil and gas revenues related to these
wells. Dewayne E. Chitwood, a Director of the Company, also serves as director of an entity which
owns 110,000 shares of preferred stock of the Company. In addition, a Foundation, where Mr.
Chitwood is the Chairman of the board of directors of the Foundation; and a Trust, where he is
Trustee, owns a total of F-27




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 55,000 shares each of preferred stock of the Company. These shares of preferred stock of the
Company were purchased in 1998 at a price of $10 per share on the same terms as all other
unaffiliated purchasers. An entity, in which Mr. Chitwood is an officer of the managing general partner, owned
interests in certain wells that are operated by the Company. During 2004, 2003 and 2002 the
Company charged approximately $14,000, $23,000 and $34,000, respectively, for lease operating
expenses and paid approximately $48,000, $74,000, and $69,000, respectively, in oil and gas
revenues related to these wells. In December, 2001, and prior to his employment with Parallel, Donald E. Tiffin, our Chief
Operating Officer, received a 3% working interest from an unaffiliated third party in the
Diamond M Project in Scurry County, Texas for services rendered in connection with assembling
the project. In August, 2002, shortly after his employment with Parallel, and due to the
personal financial exposure in the Diamond M Project and to prevent the interest from being
acquired by a third party, Mr. Tiffin assigned two-thirds of his ownership interest in the
project to Parallel at no cost, leaving him with a 1% working interest. Parallel acquired its
initial interest in the Diamond M Project in December, 2001. During 2004, the Company charged
approximately $115,000 for capital expenditures and lease operating expenses and paid
approximately $29,000 in oil and gas revenues related to this project. (12) Statements of Cash Flows No Federal income taxes were paid in 2004, 2003 and 2002. The Company made interest payments of approximately $2.7 million, $2.0 million, and $601,000
in 2004, 2003 and 2002, respectively. At December 31, 2004, 2003 and 2002, there were $741,000, $600,000 and $301,000,
respectively, of property additions accrued in accounts payable. (13) Major Customers The following purchasers accounted for 10% or more of the Companys oil and gas sales for the
years ended December 31: 2004
    
    
    2003
    
    
    2002Company A
    
    
    22
    %
    
    
    30
    %
    
    
    31
    %Company B
    
    
    
    
    
    
    
    
    
    
    16
    %Company C
    
    
    
    
    
    
    
    
    
    
    11
    %Company D
    
    
    43
    %
    
    
    33
    %
    
    
    
 (14) Commitments and Contingencies From time to time, the Company is a party to ordinary routine litigation incidental to its
business. The Company is not currently a party to any pending litigation, and is not aware of
any threatened litigation. The Company has not been a party to any bankruptcy, receivership,
reorganization, adjustment or similar proceeding. The Company established a simplified employee pension plan (SEP) covering all salaried
employees of the Company. The employees voluntarily contribute a portion of their eligible
compensation, not to exceed $13,000, to the SEP. In addition to this annual salary deferral
limit, employees who reach age 50 or older F-28




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PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 during a calendar year can elect to take advantage of a catch-up salary deferral contribution.
Eligible participants can increase their salary deferral by $3,000 for the year 2004. The
Company may make discretionary contributions to the SEP; however, total contributions cannot
exceed $41,000 per employee. During 2004, 2003 and 2002, the Company contributed an aggregate
of approximately $133,000, $106,000, and $56,000, respectively, to the SEP. On January 1, 2005 the Company established a 401(k) Plan and Trust for eligible employees.
Employees may not participate in the SEP with the establishment of the 401(k) Plan and Trust. The Company leases office space under a non-cancelable operating lease expiring in 2006.
Future annual payments under this operating lease are $157,000 and $105,000 for the years
ended December 31, 2005 and 2006, respectively. Rental expense under our current and former
lease totaled approximately $127,000, $130,000, and $84,000 for the years ended December 31,
2004, 2003 and 2002, respectively. The Company leases two field offices and storage facilities. These two facilities are located
in Andrews and Snyder, Texas. The Andrews office is under a non-cancelable commercial lease
expiring in 2007 and the Snyder office ends upon the expiration or termination a trade
agreement with the prior operator. Future annual payments under these lease agreements total
approximately $23,000 for 2005, 2006 and 2007 and $14,000 for 2008 and 2009. Rental expense
under these two leases totaled approximately $15,000 and $2,400 for the year ended December
31, 2004 and 2003, respectively. The Company has an Incentive and Retention Plan which provides for the payment to eligible
officers and employees a one time performance bonus and retention payment upon the occurrence
of a change of control as defined in the Plan. Because of the uncertainty of the occurrence
of a change of control or corporate transaction within the meaning of the plan, the amount of
these bonuses is undeterminable. (15) Supplemental Oil and Gas Reserve Data (Unaudited) The Company has presented the reserve estimates utilizing an oil price of $40.59, $30.63 and
$29.21 per Bbl and a gas price of $5.65, $5.45 and $4.40 per Mcf as of December 31, 2004, 2003
and 2002, respectively. Information for oil is presented in barrels (Bbl) and for gas in
thousands of cubic feet (Mcf). The estimates of the Companys proved natural gas reserves and related future net cash flows
that are presented in the following tables are based upon estimates made by independent
petroleum engineering consultants. The Companys reserve information was prepared as of December 31, 2004, 2003 and 2002. The
Company cautions that there are many inherent uncertainties in estimating proved reserve
quantities, projecting future production rates, and timing of development expenditures.
Accordingly, these estimates are likely to change as future information becomes available.
Proved oil and gas reserves are the estimated quantities of crude oil and natural gas which
geological and engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic and operating conditions. Proved
developed reserves are those reserves expected to be recovered through existing wells, with
existing equipment and operating methods. F-29




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 A summary of changes in reserve balances is presented below: Total proved
    
    
    Proved developedBBL
    
    
    MCF
    
    
    BBL
    
    
    MCF(in thousands)Reserves as of December 31, 2001
    
    
    916
    
    
    
    13,947
    
    
    
    490
    
    
    
    9,574Purchase of reserve s in p lace
    
    
    9,119
    
    
    
    1,931
    
    
    
    7,513
    
    
    
    1,609Extensions and discoveries
    
    
    323
    
    
    
    2,048
    
    
    
    323
    
    
    
    2,048Revisions of previous estimates
    
    
    44
    
    
    
    377
    
    
    
    67
    
    
    
    640Production
    
    
    (131
    )
    
    
    (2,670
    )
    
    
    (130
    )
    
    
    (2,669
    )Reserves as of December 31, 2002
    
    
    10,271
    
    
    
    15,633
    
    
    
    8,263
    
    
    
    11,202Extensions and discoveries
    
    
    1,412
    
    
    
    1,811
    
    
    
    283
    
    
    
    1,811Revisions of previous estimates
    
    
    1,030
    
    
    
    2,183
    
    
    
    1,027
    
    
    
    2,409Production
    
    
    (629
    )
    
    
    (3,356
    )
    
    
    (629
    )
    
    
    (3,356
    )Reserves as of December 31, 2003
    
    
    12,084
    
    
    
    16,271
    
    
    
    8,944
    
    
    
    12,066Purchase of reserve s in p lace
    
    
    4,982
    
    
    
    1,432
    
    
    
    3,057
    
    
    
    733Sale of reserves in place
    
    
    (18
    )
    
    
    (467
    )
    
    
    (18
    )
    
    
    (468
    )Extensions and discoveries
    
    
    1,159
    
    
    
    4,661
    
    
    
    338
    
    
    
    3,840Revisions of previous estimates
    
    
    1,438
    
    
    
    (2,382
    )
    
    
    1,618
    
    
    
    (323
    )Production
    
    
    (729
    )
    
    
    (2,690
    )
    
    
    (729
    )
    
    
    (2,690
    )Reserves as of December 31, 2004
    
    
    18,916
    
    
    
    16,825
    
    
    
    13,210
    
    
    
    13,158
 The following is a standardized measure of the discounted net future cash flows and
changes applicable to proved oil and gas reserves required by Statement of Financial
Accounting Standards No. 69 Disclosures about Oil and Gas Producing Activities(SFAS No. 69).
The future cash flows are based on estimated oil and gas reserves utilizing prices and costs
in effect as of year end, discounted at 10% per year and assuming continuation of existing
economic conditions. During 2004, the average sales price received by the Company for its oil was approximately
$39.05 (unhedged) per Bbl, as compared to $29.11 in 2003; while the average sales price for
the Companys gas was approximately $5.85 (unhedged) per Mcf in 2004, as compared to $5.40
per Mcf in 2003. The standardized measure of discounted future net cash flows, in managements opinion, should
be examined with caution. The basis for this table is the reserve studies prepared by
independent petroleum consultants, which contain imprecise estimates of quantities and rates
of production of reserves. Revisions of previous year estimates can have a significant impact
on these results. Also, exploration costs in one year may lead to significant discoveries in
later years and may significantly change previous estimates of proved reserves and their
valuation. Therefore, the standardized measure of discounted future net cash flow is not
necessarily indicative of the fair value of the Companys proved oil and gas properties. Future income tax expense was computed by applying statutory rates less the effects of tax
credits for each period presented to the difference between pre-tax net cash flows relating to
the Companys proved reserves and the tax basis of proved properties and available net
operating loss and percentage depletion carryovers. F-30




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PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 Standardized Measure of Discounted Future Net Cash Flows
Relating to Proved Oil and Gas Reserves(in thousands) December 31,2004
    
    
    2003
    
    
    2002Future cash inflows
    
    $
    862,945
    
    
    $
    458,723
    
    
    $
    368,835Future costs:Production
    
    
    (260,312
    )
    
    
    (149,548
    )
    
    
    (103,924
    )Development
    
    
    (25,131
    )
    
    
    (15,485
    )
    
    
    (9,440
    )Future net cash flows before income taxes
    
    
    577,502
    
    
    
    293,690
    
    
    
    255,471Future income taxes
    
    
    (137,765
    )
    
    
    (66,757
    )
    
    
    (58,622
    )Future net cash flows
    
    
    439,737
    
    
    
    226,933
    
    
    
    196,85010% annual discount for estimated timing of cash flows
    
    
    (233,328
    )
    
    
    (110,667
    )
    
    
    (97,233
    )Standardized measure of discounted future net
cash flows
    
    $
    206,409
    
    
    $
    116,266
    
    
    $
    99,616
 Changes in Standardized Measure of
Discounted Future Net Cash Flows From Proved Reserves(in thousands) December 31,2004
    
    
2003
    
    
2002Increase (decrease):Purchases of minerals in place
    
    $
    47,727
    
    
    $
    
    
    
    $
    85,075Extensions and discoveries and improved recovery,
net of future production and development costs
    
    
    18,984
    
    
    
    9,556
    
    
    
    10,790Accretion of discount
    
    
    14,779
    
    
    
    12,293
    
    
    
    1,707Net change in sales prices net of production costs
    
    
    45,572
    
    
    
    10,832
    
    
    
    16,619Changes in estimated future development costs
    
    
    (8,641
    )
    
    
    (6,948
    )
    
    
    (512
    )Revisions of quantity estimates
    
    
    13,022
    
    
    
    13,520
    
    
    
    1,218Net change in income taxes
    
    
    (28,319
    )
    
    
    (8,204
    )
    
    
    (23,318
    )Sales, net of production costs
    
    
    (26,356
    )
    
    
    (25,451
    )
    
    
    (9,170
    )Changes of production rates (timing) and other
    
    
    13,375
    
    
    
    11,052
    
    
    
    132Net increase (decrease)
    
    
    90,143
    
    
    
    16,650
    
    
    
    82,541Standardized measure of discounted future net cash flows:Beginning of year
    
    
    116,266
    
    
    
    99,616
    
    
    
    17,075End of year
    
    $
    206,409
    
    
    $
    116,266
    
    
    $
    99,616
 F-31




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##### Table of Contents



PARALLEL PETROLEUM CORPORATION
Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002 (16) Selected Quarterly Financial Data (Unaudited) QuarterFirst
    
    
    Second
    
    
    Third
    
    
    Fourth(in thousands, except per share data)2004Oil and gas revenues
    
    $
    8,001
    
    
    $
    7,917
    
    
    $
    7,745
    
    
    $
    12,174Total costs and expenses
    
    
    5,306
    
    
    
    5,675
    
    
    
    5,774
    
    
    
    6,816Operating income
    
    
    2,695
    
    
    
    2,242
    
    
    
    1,971
    
    
    
    5,358Net income
    
    $
    1,482
    
    
    $
    1,103
    
    
    $
    1,047
    
    
    $
    1,953Net income available to common stockholders
    
    $
    1,339
    
    
    $
    959
    
    
    $
    905
    
    
    $
    1,810Net income per common share -basic
    
    $
    0.05
    
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.07Net income per common share -diluted
    
    $
    0.05
    
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.072003Oil and gas revenues
    
    $
    8,493
    
    
    $
    8,532
    
    
    $
    8,732
    
    
    $
    8,098Total costs and expenses
    
    
    4,323
    
    
    
    5,143
    
    
    
    5,329
    
    
    
    6,343Operating income
    
    
    4,170
    
    
    
    3,389
    
    
    
    3,403
    
    
    
    1,755Income before cumulative effect of change
in accounting principle
    
    
    2,313
    
    
    
    2,671
    
    
    
    1,695
    
    
    
    985Cumulative effect of change in accounting
principle, net of tax
    
    
    (62
    )
    
    
    
    
    
    
    
    
    
    
    Net income
    
    $
    2,251
    
    
    $
    2,671
    
    
    $
    1,695
    
    
    $
    985Net income after preferred stock dividend
    
    $
    2,105
    
    
    $
    2,525
    
    
    $
    1,549
    
    
    $
    843Net income per share:Basic:Income before cumulative effect of change
in accounting principle
    
    $
    0.10
    
    
    $
    0.12
    
    
    $
    0.07
    
    
    $
    0.04Cumulative effect of change in accounting
principle, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income per common share
    
    $
    0.10
    
    
    $
    0.12
    
    
    $
    0.07
    
    
    $
    0.04Diluted:Income before cumulative effect of change
in accounting principle
    
    $
    0.09
    
    
    $
    0.11
    
    
    $
    0.07
    
    
    $
    0.04Cumulative effect of change in accounting
principle, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income per common share
    
    $
    0.09
    
    
    $
    0.11
    
    
    $
    0.07
    
    
    $
    0.04
 During the fourth quarter of 2003, the Company reduced its estimate of State income tax liability by $907,000. F-32




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##### Table of Contents



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. PARALLEL PETROLEUM CORPORATIONMarch 15, 2005
    
    By: /s/ Larry C. OldhamLarry C. Oldham,
President and Chief Executive Officer
 S-1




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##### Table of Contents



Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the capacities and on the
dates indicated. /s/ Thomas R. Cambridge
    
    Chairman of the Board of Directors
    
    March 15, 2005Thomas R. Cambridge/s/ Larry C. Oldham
    
    President and Chief Executive Officer(Principal Executive Officer)
    
    March 15, 2005Larry C. Oldham/s/ Steven D. Foster
    
    Chief Financial Officer(Principal Financial and
Accounting Officer)
    
    March 15, 2005Steven D. Foster/s/ Dewayne E. Chitwood
    
    Director
    
    March 15, 2005Dewayne E. Chitwood/s/ Martin B. Oring
    
    Director
    
    March 15, 2005Martin B. Oring/s/ Ray M. Poage
    
    Director
    
    March 15, 2005Ray M. Poage/s/ Jeffrey G. Shrader
    
    Director
    
    March 15, 2005Jeffrey G. Shrader
 S-2




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##### Table of Contents



INDEX TO EXHIBITS (a) Exhibits No.
    
    Description of Exhibit3.1
    
    Certificate of Incorporation of Registrant (Incorporated by reference to Exhibit 3.1 to Form
10-Q of the Registrant for the fiscal quarter ended June 30, 2004)3.2
    
    Bylaws of Registrant (Incorporated
by reference to Exhibit 3 of the Registrants Form
8-K, dated October 9, 2000, as filed with the Securities and Exchange Commission on October
10, 2000)3.3
    
    Certificate of Formation of Parallel, L.L.C. (Incorporated by reference to Exhibit No. 3.3 of
the Registrants Registration Statement on Form S-3, No. 333-119725 filed on October 13, 2004)3.4
    
    Limited Liability Company Agreement of Parallel, L.L.C. (Incorporated by reference to Exhibit
No. 3.4 of the Registrants Statement on Form S-3, No. 333-119725 filed on October 13, 2004)3.5
    
    Certificate of Limited Partnership of Parallel, L.P. (Incorporated by reference to Exhibit
No. 3.5 of the Registrants Registration Statement on Form S-3, No. 333-119725 filed on
October 13, 2004)3.6
    
    Agreement of Limited Partnership of Parallel, L.P. (Incorporated by reference to Exhibit No.
3.6 of the Registrants Registration Statement on Form S-3, No. 333-119725 filed on October
13, 2004)4.1
    
    Certificate of Designations, Preferences and Rights of Serial Preferred Stock  6%
Convertible Preferred Stock (Incorporated by reference to Exhibit 4.1 of Form 10-Q of the
Registrant for the fiscal quarter ended June 30, 2004)4.2
    
    Certificate of Designation, Preferences and Rights of Series A Preferred Stock (Incorporated
by reference to Exhibit 4.2 of Form 10-K of the Registrant for the fiscal year ended December
31, 2000)4.3
    
    Rights Agreement, dated as of October 5, 2000, between the Registrant and Computershare Trust
Company, Inc., as Rights Agent (Incorporated by reference to Exhibit 4.3 of Form 10-K of the
Registrant for the fiscal year ended December 31, 2000)4.4
    
    Form of Indenture relating to senior debt securities of the Registrant (Incorporated by
reference to Exhibit No. 4.4 of the Registrants Statement on Form S-3, No. 333-119725 filed
on October 13, 2004)




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##### Table of Contents



No.
    
    Description of Exhibit4.5
    
    Form of Indenture relating to subordinated debt securities of the Registrant
(Incorporated by reference to Exhibit No. 4.5 of the Registrants Registration Statement on
Form S-3, No. 333-119725 filed on October 13, 2004)4.6
    
    Form of common stock certificate of the Registrant (Incorporated by reference to Exhibit
No. 4.6 of the Registrants Registration Statement on Form S-3, No. 333-119725 filed on
October 13, 2004)*4.7
    
    Warrant Purchase Agreement, dated November 20, 2001, between the Registrant and Stonington Corporation*4.8
    
    Warrant Purchase Agreement, dated December 23, 2003, between the Registrant and Stonington CorporationExecutive Compensation Plans and Arrangements (Exhibit No.s 10.1 through 10.8):*10.1
    
    1992 Stock Option Plan10.2
    
    Merrill Lynch, Pierce, Fenner & Smith Incorporated Prototype Simplified Employee Pension
Plan (Incorporated by reference to Exhibit 10.6 of the Registrant=s Form 10-K for the
fiscal year ended December 31, 1995)10.3
    
    Non-Employee Directors Stock Option Plan (Incorporated by reference to Exhibit 10.6 of the
Registrants Form 10-K Report for the fiscal year ended December 31, 1997)10.4
    
    1998 Stock Option Plan (Incorporated by reference to Exhibit 10.7 of Form 10-K of the
Registrant for the fiscal year ended December 31, 1998)10.5
    
    Form of Incentive Award Agreements, dated December 12, 2001, between the Registrant and
Thomas R. Cambridge, Larry C. Oldham, Eric A. Bayley and John S. Rutherford granting 2,394
Unit Equivalent Rights to Mr. Cambridge; 9,564 Unit Equivalent Rights to Mr. Oldham; 2,869
Unit Equivalent Rights to Mr. Bayley; and 7,173 Unit Equivalent Rights to Mr. Rutherford
(Incorporated by reference to Exhibit 10.8 of Form 10-K of the Registrant for the fiscal year
ended December 31, 2001)10.6
    
    2001 Non-Employee Directors Stock Option Plan (Incorporated by reference to Exhibit 10.7 of
the Registrants Form 10-Q Report for the first fiscal quarter ended March 31, 2004)10.7
    
    2004 Non-Employee Director Stock Grant Plan (Incorporated by reference to Exhibit 10.1 of
the Registrants Form 8-K Report dated September 22, 2004)10.8
    
    Incentive and Retention Plan (Incorporated by reference to Exhibit 10.1 of the Registrants
Form 8-K Report dated September 23, 2004 and filed with the Securities and Exchange
Commission on September 29, 2004)10.9
    
    Certificate of Formation of First Permian, L.L.C. (Incorporated by reference to Exhibit
10.1 of the Registrants Form 8-K Report dated June 30, 1999)




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##### Table of Contents



No.
    
    Description of Exhibit10.10
    
    Limited Liability Company Agreement of First Permian, L.L.C. (Incorporated by reference to
Exhibit 10.2 of the Registrants Form 8-K Report dated June 30, 1999)10.11
    
    Amended and Restated Limited Liability Company Agreement of First Permian, L.L.C. dated as
of May 31, 2000 (Incorporated by reference to Exhibit 10.16 of Form 10-K of the Registrant for
the fiscal year ended December 31, 2000)10.12
    
    Credit Agreement, dated June 30, 1999, by and among First Permian, L.L.C., Parallel
Petroleum Corporation, Baytech, Inc., and Bank One, Texas, N.A. (Incorporated by reference to
Exhibit 10.6 of the Registrants Form 8-K Report dated June 30, 1999)10.13
    
    Limited Guaranty, dated June 30, 1999, by and among First Permian, L.L.C., parallel
Petroleum Corporation and Bank One, Texas, N.A. (Incorporated by reference to Exhibit 10.7 of
the Registrants Form 8-K Report dated June 30, 1999)10.14
    
    Second Restated Credit Agreement, dated October 25, 2000, among First Permian, L.L.C., Bank
One, Texas, N.A., and Bank One Capital Markets, Inc. (Incorporated by reference to Exhibit
10.22 of Form 10-K of the Registrant for the fiscal year ended December 31, 2000)10.15
    
    Loan Agreement, dated as of January 25, 2002, between the Registrant and First American
Bank, SSB (Incorporated by reference to Exhibit 10.25 of Form 10-K of the Registrant for the
fiscal year ended December 31, 2001)10.16
    
    Purchase and Sale Agreement, dated as of November 27, 2002, among JMC Exploration, Inc.,
Arkoma Star L.L.C., Parallel, L.P. and Texland Petroleum, Inc. (Incorporated by reference to
Exhibit 10.1 of Form 8-K of the Registrant, dated December 20, 2002)10.17
    
    First Amended and Restated Credit Agreement, dated December 20, 2002, by and among Parallel
Petroleum Corporation, Parallel, L.P., Parallel, L.L.C., First American Bank, SSB, Western
National Bank and BNP Paribas (Incorporated by reference to Exhibit 10.2 of Form 8-K of the
Registrant, dated December 20, 2002)10.18
    
    Guaranty dated December 20, 2002, between Parallel, L.L.C. and First American Bank, SSB, as
Agent (Incorporated by reference to Exhibit 10.3 of Form 8-K of the Registrant, dated
December 20, 2002)10.19
    
    First Amendment to First Amended and Restated Credit Agreement, dated as of September 12,
2003, by and among Parallel Petroleum Corporation, Parallel, L.P., Parallel, L.L.C., First
American Bank, SSB, Western National Bank, and BNP Paribas (Incorporated by reference to
Exhibit 10.29 of Form 10-Q of the Registrant for the quarter ended September 30, 2003)10.20
    
    Second Amended and Restated Credit Agreement, dated September 27, 2004, by and among
Parallel Petroleum Corporation, Parallel, L.P., Parallel, L.L.C., First American Bank, SSB,
BNP Paribas, Citibank, F.S.B. and Western National Bank (Incorporated by reference to Exhibit
10.1 of the Registrants Form 8-K Report dated September 27, 2004 and filed with the
Securities and Exchange Commission on October 1, 2004)*10.21
    
    Agreement of Limited Partnership of West Fork Pipeline Company LP




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##### Table of Contents



No.
    
    Description of Exhibit14
    
    Code of Ethics (Incorporated by reference to Exhibit No. 14 of the Registrants Form
10-K Report for the fiscal year ended December 31, 2003 and filed with the Securities and
Exchange Commission on March 22, 2004)21
    
    Subsidiaries (Incorporated by reference to Exhibit No. 21 of the Registrants Form 10-K
Report for the fiscal year ended December 31, 2003 and filed with the Securities and
Exchange Commission on March 22, 2004)*23.1
    
    Consent of KPMG LLP*23.2
    
    Consent of BDO Seidman, LLP*23.3
    
    Consent of Cawley Gillespie & Associates, Inc. Independent Petroleum Engineers*31.1
    
    Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes  Oxley Act of 2002*31.2
    
    Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes  Oxley Act of 2002*32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes  Oxley Act of 2002.*32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes  Oxley Act of 2002.
   * Filed herewith.