SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                    FORM 10-K

[X]  ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE
     ACT OF 1934 For the fiscal year ended December 31, 1996

                                       or

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

                Commission File Number 0-19136 (Common Stock) and
                             333-9045(Senior Notes)

                           NATIONAL ENERGY GROUP, INC.
             (Exact name of registrant as specified in its charter)

              DELAWARE                                    58-1922764
   (State or other jurisdiction of             (IRS Employer Identification No.)
    incorporation or organization)

                       4925 Greenville Avenue, Suite 1400
                               Dallas, Texas 75206
               (Address of principal executive offices) (Zip Code)

       (Registrant's telephone number, including area code) (214) 692-9211

          Securities registered pursuant to Section 12(b) of the Act:
                                      None

           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $0.01 par value
                                (Title of Class)

            Securities registered pursuant to Securities Act of 1933:
                         Senior Notes, 10 3/4% due 2006

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

     Indicate by check mark if disclosure of delinquent  filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained,  to the
best  of  the  Registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendments hereto to this Form 10-K. [X]

     The  aggregate  market  value  of  the  shares  of  Common  Stock  held  by
non-affiliates  of the  Registrant,  as of March 25,  1997  (based upon the last
sales price of $3.6875 as reported by NASDAQ) was $101,743,147.


     36,145,359 shares of the Registrant's  common stock,  $0.01 par value, were
outstanding on March 25, 1997.

     The  information  required  by Part III of this Report is  incorporated  by
reference  from  Registrant's  definitive  proxy  statement  for its 1997 Annual
Meeting of  Stockholders  (to be filed with the  Commission not later than April
30, 1997).
<PAGE>



                                TABLE OF CONTENTS


                                     PART I
                                                                          Page

ITEMS 1 AND 2.  BUSINESS AND PROPERTIES...................................   2
           General........................................................   2
           Business Strategy..............................................   2
           Forward-Looking Statements.....................................   3
           Recent Developments............................................   4
           Oil and Natural Gas Properties.................................   6
           Principal Areas of Operation...................................   6
           Development and Exploitation...................................   7
           Exploration....................................................   9
           Oil and Natural Gas Production.................................  11
           Productive Well Summary........................................  11
           Production Economics...........................................  12
           Leasehold Acreage..............................................  12
           Drilling Activity..............................................  13
           Title to Oil and Natural Gas Properties........................  13
           Production and Sales Prices....................................  13
           Lease Interests................................................  13
           Control Over Production Activities.............................  14
           Factors Beyond the Company's Control...........................  14
           Markets and Customers..........................................  14
           Regulation.....................................................  14
           Operational Hazards and Insurance..............................  17
           Competition....................................................  17
           Office Space and Other.........................................  17
           Employees......................................................  17
ITEM 3.    LEGAL PROCEEDINGS..............................................  17
ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............  18

                                     PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
           STOCKHOLDER MATTERS............................................  18
           Market Information.............................................  18
           Holders........................................................  18
           Dividends on Common Stock......................................  18
ITEM 6.    SELECTED FINANCIAL DATA........................................  19
ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
           CONDITION AND RESULTS OF OPERATIONS............................  21
           Overview.......................................................  21
           Results of Operations..........................................  21
           Pro Forma Results of Operations................................  23
           Liquidity and Capital Resources................................  24
           Changes in Prices and Inflation................................  27
ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA ....................  27
ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
           AND FINANCIAL DISCLOSURE.......................................  27

                                    PART III

ITEM 10.   DIRECTORS AND EXECUIVE OFFICERS OF THE REGISTRANT..............  27
ITEM 11.   EXECUTIVE COMPENSATION.........................................  28
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
           MANAGEMENT.....................................................  28
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................  28

                                     PART IV

ITEM 14.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
           ON FORM 8-K....................................................  28
           Signatures.....................................................  35




                                       1
<PAGE>

                                     PART I

ITEMS 1 AND 2.  BUSINESS AND PROPERTIES.

General.

     National Energy Group, Inc. (the "Company") was incorporated under the laws
of the State of Delaware on November 20,  1990.  Effective  June 11,  1991,  Big
Piney Oil and Gas Company ("Big Piney") and VP Oil, Inc.  ("VP") merged with and
into the Company.  The principal executive offices of the Company are located at
4925 Greenville Avenue, Suite 1400, Dallas, Texas, 75206.

     The Company is an independent  energy company  engaged in the  acquisition,
exploitation,  development,  exploration  and production of oil and natural gas.
Through  the  acquisition  of oil and natural gas  properties  with  significant
reserve and production  enhancement potential,  and the subsequent  exploration,
exploitation and development of those properties,  the Company has substantially
increased its reserves and geographically  diversified its property holdings. In
its  acquisitions of oil and natural gas  properties,  the Company targets major
producing basins in Texas, Oklahoma, Arkansas, Louisiana,  Mississippi, Alabama,
and  offshore  in the Gulf of  Mexico,  and seeks to acquire  reserves  that are
balanced  between oil and natural gas with a mix of both short and long  reserve
lives.  While continuing to pursue  attractive  acquisition  opportunities,  the
Company has increased its focus upon  implementing a comprehensive  exploitation
and development program for its existing properties. This program is designed to
enhance proved  producing  reserves and convert proved  undeveloped  reserves to
proved producing reserves through development drilling, workovers, recompletions
and other production enhancement  activities.  As a complement to these efforts,
the Company recently initiated an exploration program concentrating primarily on
onshore Gulf of Mexico prospects in Texas, Louisiana,  Mississippi, and Alabama,
and offshore Gulf of Mexico prospects in shallow state waters in offshore Texas.

     As a result of its acquisition,  exploitation,  development and exploration
activities, the Company has substantially increased its reserves, production and
cash flow since 1991. The Company's estimated net proved reserves and PV10% have
grown from 6.8 Bcfe and $6.1  million,  respectively,  at December 31, 1991,  to
181.7  Bcfe  (71%  natural  gas) and  $291.7  million  (62%  proved  developed),
respectively,  at December 31, 1996 as determined from reserve reports  prepared
by Netherland,  Sewell & Associates,  Inc. ("Netherland & Sewell"),  independent
petroleum  engineers.  The Company's  average net daily production has increased
from 1.2  Mmcfe for 1991 to 41.4  Mmcfe for the  fourth  quarter  of 1996.  As a
result of increases in reserves and  production,  the Company has increased cash
flow from operations from $0.3 million for 1991 to $11.8 million for 1996.

     The Company  estimates it has a backlog of  approximately  206  development
opportunities   (including   recompletions,   drilling  locations  and  proposed
waterfloods) on its existing properties, which the Company believes will provide
at least a  three-year  inventory  of  development  projects.  The  Company  has
established  an aggregate  development  and  exploration  capital budget for its
existing  properties  of  approximately  $57  million  for  1997  consisting  of
approximately  $45  million  for  development  and  exploitation   projects  and
approximately $12 million for selective exploratory  activities primarily on its
onshore  Texas,  Louisiana,  Mississippi,  Alabama and  offshore  Gulf of Mexico
properties.   Actual  amounts  expended  by  the  Company  for  development  and
exploration  activities will be dependent on a number of factors,  including oil
and natural gas prices,  seismic and drilling costs, future drilling results and
the availability of capital.

Business Strategy.

     The Company  strives to increase  reserves,  production  and cash flow from
operations  through a strategy of (i) focusing on development  and  exploitation
activities to maximize production and ultimate reserve recovery,  (ii) acquiring
oil and natural gas properties with significant exploitation, development and/or
exploration  potential,  (iii) obtaining  operational control of its properties,
(iv) maintaining a low operating cost structure,  and (v) selectively  exploring
and developing properties with significant reserve potential.



                                       2
<PAGE>
     Development  and  Exploitation.   In  1994,  1995  and  1996,  the  Company
participated  in the drilling of 9 gross (6.4 net)  development  wells, 25 gross
(21.3  net)  development  wells  and 29  gross  (25.8  net)  development  wells,
respectively.  All but two of the development wells drilled since 1994 have been
commercially  productive.  The  Company  intends to  intensify  development  and
exploitation of its existing properties through development drilling, workovers,
redrills, recompletions, and other production enhancement techniques to maximize
its production and reserves. As of December 31, 1996, the Company has identified
approximately  206  development   opportunities   (including  recompletions  and
drilling  locations) on the  Company's  existing  properties.  The Company has a
development and exploitation  capital  expenditure  budget of approximately  $45
million  for 1997,  a major  portion  of which is  targeted  to  develop  proved
undeveloped reserves.

     Property  Acquisitions.  Acquisitions  of producing oil and gas  properties
have contributed  significantly to the Company's  historical growth in reserves.
During the period from  January 1, 1991 through  December 31, 1996,  the Company
has acquired,  through fifteen transactions,  202.1 Bcfe of estimated net proved
reserves.  While the Company  expects to generate  future growth in reserves and
production  through  its  increased  emphasis  on  development  and  exploratory
drilling,  the  Company  will  continue  to  seek to  opportunistically  acquire
properties   that   complement   and  enhance  its  inventory  of   development,
exploitation   and   exploration   projects.   Consistent  with  its  historical
acquisition   strategy,   the  Company   expects  to  focus  on   purchases   of
underdeveloped  properties  in  its  core  areas  of  expertise  either  through
negotiated  property  acquisitions  or  acquisitions  of companies  with oil and
natural gas properties.

     Operational  Control.  The Company generally prefers to operate and, except
for its exploratory prospects, to own a majority working interest in its oil and
natural gas properties. This operating philosophy enables the Company to control
the nature,  timing and costs of exploration  and development of its properties,
as well as the marketing of the resulting production.  At December 31, 1996, the
Company operated 506 of the 833 producing wells in which it owns an interest.

     Low Operating  Cost  Structure.  The Company seeks to increase cash flow by
maintaining a low unit operating cost structure  through its focus on increasing
production while limiting its field operating and corporate  overhead  expenses.
Through these efforts,  the Company has reduced  historical unit lease operating
expenses  40% from $0.70 per Mcfe in 1991 to $.42 per Mcfe during the year ended
December 31, 1996. During these same periods,  the Company decreased  historical
unit  general and  administrative  expenses  58% from $0.80 per Mcfe to $.34 per
Mcfe.

     Selective  Exploration  Program.  To  balance  its  relatively  lower  risk
development and  exploitation  activities,  the Company expects that exploration
drilling will become a more important aspect of its business in the future.  The
Company  also seeks to reduce the risks  normally  associated  with  exploratory
drilling by (i) allocating only a portion of its capital  expenditure  budget to
exploration  activities,  (ii)  limiting its working  interests  in  exploratory
prospects   through   participation  by  industry   partners,   (iii)  obtaining
operational control of its prospects,  and (iv) utilizing advanced technologies,
including 3-D seismic  surveys,  where  cost-effective.  The Company's  recently
initiated   exploration  program  targets  prospects  with  significant  reserve
potential,  focusing  primarily  on its  inventory of  exploratory  prospects in
onshore Texas,  Louisiana,  Mississippi and Alabama and offshore Gulf of Mexico,
including the Mustang Island Properties and Bayou Sorrel Properties.  To provide
additional  expertise in prospect  generation  and analysis for its  exploration
program and to control prospect  generation  costs, the Company has entered into
an agreement with Sandefer Oil and Gas, Inc.  ("Sandefer") under which prospects
in Louisiana,  Texas and Mississippi are generated exclusively for the Company's
consideration  and  Sandefer  participates  with the Company in the  evaluation,
marketing and sale of such prospects  (collectively,  the "Sandefer  Exploration
Venture"). The agreement with Sandefer also involves an arrangement with the two
geologists associated with Sandefer, who have substantial exploration experience
in  the  Gulf  Coast  region.  The  geologists  have  access  to  the  extensive
engineering and licensed  geological and  geophysical  data bases for Louisiana,
Texas and Mississippi owned or licensed by Sandefer.

Forward-Looking Statements.

     All  statements in this document  concerning  the Company other than purely
historical information (collectively  "Forward-Looking  Statements") reflect the
current  expectations  of management  and are based on the Company's  historical
operating trends, its proved reserve position as of December 31, 1996, and other
information  currently available to management.  These statements assume,  among
other  things,  (i) that no  significant  changes  will  occur in the  operating
environment for the Company's oil and gas  properties,  and (ii) that there will
be no material  acquisitions or  divestitures  except as disclosed  herein.  The
Company  cautions  that the  Forward-Looking  Statements  are subject to all the


                                       3
<PAGE>

risks and uncertainties  incident to the acquisition,  development and marketing
of, and exploration for, oil and gas reserves.  These risks include, but are not
limited to, commodity price risk, environmental risk, drilling risk, reserve and
operations  and  production  risk.  Many of these risks are described  elsewhere
herein.  See  "Management's  Discussion and Analysis of Financial  Condition and
Results of Operations".  Moreover, the Company may make material acquisitions or
enter into financing transactions. None of these can be predicted with certainty
and,  accordingly,  are not  taken  into  consideration  in the  Forward-Looking
Statements  made herein.  For all of the foregoing  reasons,  actual results may
vary  materially from the  Forward-Looking  Statements and there is no assurance
that the assumptions used are necessarily the most likely.

Recent Developments.

     In January 1996, the Company  completed the  acquisition of oil and natural
gas  properties  in offshore  Nueces  County,  Texas,  adjacent to the Company's
Mustang  Island  property,  from C/A  Limited,  Chartex  Petroleum  Company  and
Petrotex  Engineering Company (the "CA Acquisition").  The acquisition  included
interests in five wells, a pipeline and separation  facility  related to Mustang
Island.  The consideration  for this acquisition  consisted of 140,857 shares of
the Company's Common Stock and $675,000 in cash.

     In February  1996,  the Company  completed the  acquisition  of two oil and
natural  gas wells on one  offshore  block,  interests  in five  other  offshore
blocks,  and a related  production  platform and  equipment  in offshore  Nueces
County,  Texas,  adjacent to the Company's  Mustang  Island  property,  from UMC
Petroleum  Corporation (the "UMC  Acquisition").  The Company paid UMC Petroleum
Corporation  $1,500,000  in cash.  The  acquisition  was funded  primarily  from
borrowings under a credit facility.

     In April 1996,  the Company was awarded  exploration  rights on 16 offshore
tracts  (covering  7,765  acres) in the Mustang  Island area in offshore  Nueces
County,  Texas through  successful bids with the State of Texas ("Offshore Lease
Acquisition").  The Company  paid  $1,437,302  in cash for these  rights and the
purchase was funded by borrowings under a credit facility and available cash.

     On August 29, 1996,  the Company  completed  the  acquisition  of Alexander
Energy  Corporation  ("Alexander")  through a merger of Alexander  with and into
National Energy Group of Oklahoma, Inc. ("NEG-OK"), a wholly-owned subsidiary of
the Company,  (the "Merger").  Pursuant to the Merger (a) the separate corporate
existence of Alexander terminated, (b) each share of Alexander common stock, par
value $0.03 per share ("Alexander  Common Stock"),  together with certain rights
associated with the Alexander Common Stock  outstanding  immediately  before the
Merger,  were converted into 1.7 shares of the Company's common stock, par value
$0.01 per share ("Common Stock") and (c) all outstanding options and warrants to
purchase  Alexander  Common Stock were assumed by the Company and converted into
options and warrants to purchase  Common Stock.  In lieu of  fractional  shares,
Alexander shareholders otherwise entitled to receive fractional shares of Common
Stock were paid in cash an amount equal to $4.375  multiplied by the fraction of
a share of Common Stock to be received.  On December 31, 1996, NEG-OK was merged
into and with the Company and its separate corporate existence ceased to exist.

     On August 29, 1996,  the Company also closed the sale of 100,000  shares of
its Convertible  Preferred  Stock,  Series D, $1.00 par value per share ("Series
D"), the sale of 50,000 shares of its  Convertible  Preferred  Stock,  Series E,
$1.00 par value per share  ("Series  E"),  and  warrants to  purchase  1,050,000
shares of Common Stock. See Note 6 of Notes to Financial Statements.

     In September 1996, the Company completed the acquisition of oil and natural
gas  properties  located in the South  Lake Boeuf  Field,  La  Fourche,  Parish,
Louisiana  from  Araxas  Energy  Corporation,  Araxas  SPV-1,  Inc.  and  Araxas
Exploration,   Inc.  and  O'Sullivan  Oil  and  Gas  Company  (the  "Lake  Boeuf
Acquisition").  The consideration paid by the Company consisted of $1,500,000 in
cash and 1,758,460 shares of the Company's Common Stock. The cash portion of the
acquisition was funded from available cash.

     In October 1996, the Company acquired certain  leasehold  interests located
in the East Bayou Sorrel Field,  Iberville Parish,  Louisiana from W&T Offshore,
Inc. (the "W&T  Acquisition") The consideration paid by the Company consisted of
$3,300,000 in cash. The Company funded the acquisition with available cash.

     In November 1996, the Company  completed the acquisition of oil and natural
gas  properties  and  related  facilities  located  in the Bayou  Sorrel  Field,
Iberville Parish,  Louisiana from Panaco, Inc. (the "Bayou Sorrel Acquisition").
The  consideration  paid by the Company  consisted of $9,025,000  cash,  477,612
shares of the Company's  Common Stock and conveyance of a 3% overriding  royalty
interest in the property acquired,  limited to production below 11,000 feet. The
cash portion of the acquisition was funded from available cash.

                                       4
<PAGE>


     Also,  in November  1996,  the Company  completed  the sale of $100 million
principal amount of 10 3/4% Senior Notes due 2006 (the "Senior Notes"). In 1997,
the Senior Notes were exchanged for notes registered  pursuant to the Securities
Act of 1933 ("Exchange  Notes") which are substantially  identical to the Senior
Notes.

     In  December  1996,  the  Company  acquired  certain  oil and  natural  gas
properties located in the East Bayou Sorrel Field,  Iberville Parish,  Louisiana
from MCNIC Oil & Gas (the "MCNIC  Acquisition").  The consideration  paid by the
Company consisted of $7,000,000 in cash. The Company funded the acquisition from
available cash.


                                       5
<PAGE>

Oil and Natural Gas Properties.

     The  estimated  reserves  and related  future net  revenues  are based upon
reports  prepared  by  independent  petroleum  engineers.  For the  years  ended
December 31, 1995 and December 31, 1996 the reports were  prepared by Netherland
& Sewell, and for the year ended December 31, 1994, the reports were prepared by
other independent petroleum engineers. All of the Company's reserves are located
in the  continental  United  States.  Each of the reserve  reports were prepared
using constant prices and costs in accordance  with the published  guidelines of
the United States Securities & Exchange Commission ("SEC"). All of the Company's
reserves are pledged pursuant to the Company's credit facility.

     The  Company  has not filed any  estimates  of proved oil and  natural  gas
reserves with any federal authority or agency other than with the SEC.

     The net weighted  average prices used in the Company's  reserve  reports at
December  31, 1994,  1995 and 1996 were $16.59,  $18.71 and $25.36 per barrel of
oil,  respectively,  and  $1.62,  $1.91  and  $3.72  per  Mcf  of  natural  gas,
respectively.

     The following table sets forth certain  information for the Company's total
proved  oil and  natural  gas  reserves  and the PV10% of  estimated  future net
revenues from such  reserves,  at December 31, 1996, as prepared by Netherland &
Sewell. Also presented is the Standardized Measure of the Company's total proved
oil and natural gas reserves:

                              TOTAL PROVED RESERVES

                                         As of December 31, 1996,
                            ------------------------------------------------
                                                      Natural
                                          Natural       Gas
                               Oil          Gas      Equivalent     PV 10%
                             (Mbbls)       (Mmcf)     (Mmcfe)         (in
                                                                  thousands)
                            ----------- -----------  ----------- -----------

Proved developed reserves      4,384       77,497      103,801    $179,571
Proved undeveloped reserves    4,419       51,373       77,887     112,102
                            ----------- -----------  ----------- -----------
Total proved reserves          8,803      128,870      181,688    $291,673
                            =========== ===========  =========== ===========
Standardized Measure                                              $229,780
                                                                 ===========

Principal Areas of Operations.

The following  table sets forth for the Company's  principal areas of operation,
the  Company's  proved oil and natural gas reserves  and PV10% of the  estimated
future net revenue from such reserves at December 31, 1996.

<TABLE>
<CAPTION>
                                                              Natural
                              Oil and         Natural          Gas                               % of
                            Consensate          Gas          Equivalent          PV10%            Total
         Field               (Mbbls)          (Mmcf)          (Mmcfe)       (in thousands)        PV10%
-------------------------- --------------    ----------    -------------   ----------------    -----------
<S>                        <C>               <C>           <C>             <C>                  <C>
Onshore:
Anadarko Basin, OK             2,270            58,547         72,168         $111,214            38.13%
Cotton Valley Trend, TX          244            35,239         36,701           50,666            17.37
Goldsmith Adobe Unit, TX       3,538             3,804         25,035           34,575            11.85
Lake Boeuf, LA                 1,510             6,141         15,200           30,850            10.58
Arkoma Basin, OK and AR            -            14,894         14,894           25,016             8.58
Bayou Sorrel, LA                 573             1,848          5,288           13,899             4.77
Other Onshore                    495             4,433          7,399           16,727             5.73
                           --------------    ----------    -------------   ----------------    -----------
     Total Onshore             8,630           124,906        176,685          282,947            97.01
                           --------------    ----------    -------------   ----------------    -----------

Offshore:
Mustang Island                   173             3,964          5,003            8,726             2.99
                           --------------    ----------    -------------   ----------------    -----------
     Total                     8,803           128,870        181,688         $291,673           100.00%
                           ==============    ==========    =============   ================    ===========
</TABLE>

                                       6
<PAGE>

Development and Exploitation.

     While  acquisitions  historically  have  been  the  primary  focus  of  the
Company's   business   strategy,   recently  the  Company  has  accelerated  the
development and  exploitation of its existing  properties.  The Company develops
and exploits its  properties by drilling  development  wells,  including many on
infill locations,  engaging in increased density and forced pooling drilling and
recompleting  and reworking  existing wells and, where  appropriate,  intends to
develop and implement secondary recovery plans, including waterfloods.

     Anadarko  Basin.  Approximately  40% (72.2  Bcfe) of the  Company's  proved
reserves are located in the area of the Anadarko Basin in west central Oklahoma.
The Anadarko  Basin is considered a mature  natural gas  producing  area that is
characterized by multiple producing horizons and long reserve lives.  Drilling a
producing well on these  locations not only gives the Company the opportunity to
convert proved undeveloped  reserves to proved developed  producing reserves but
it also potentially provides additional proved undeveloped drilling locations on
the Company's leasehold acreage.

     The Company's Anadarko  properties  generally are 640 acre producing units.
The Company was successful in demonstrating to Oklahoma regulators that wells in
the  Anadarko  Basin  will  not   efficiently   drain  640  acres  and  obtained
authorization for increased density drilling on smaller acreage producing units.
Under the  forced  pooling  rules in  Oklahoma,  even if the  Company is not the
operator of the property for which increased density drilling has been approved,
the  Company  may  propose to drill and  operate  the wells,  which may  include
spacing  for up to  three  additional  wells.  Frequently  this  results  in the
proposing  party owning a larger  portion of the new wells due to other interest
owners declining to participate and occasionally  results in such party becoming
the  operator  of the new wells  proposed.  The  Company  intends to continue an
increased density drilling strategy in the Anadarko Basin.

     As of December  31,  1996,  the Company had  identified  34 PDNP and 55 PUD
locations in the Anadarko  Basin with  estimated  proved  reserves of 28.1 Bcfe.
These  locations  are well suited for  relatively  lower risk  exploitation  and
development   activities  that  should  significantly   increase  the  Company's
production and cash flow from its Anadarko Basin  properties in 1997. To develop
a portion of these  locations,  the Company  has  budgeted  approximately  $ 7.9
million to drill 23 gross  (12.3 net) wells in the  Anadarko  Basin for the year
ending  December 31, 1997.  Wells in the Anadarko  Basin are completed at depths
ranging from 2,000 to 25,000 feet,  although the Company's  wells  typically are
completed  between  7,000 and  15,000  feet in depth and cost  approximately  $1
million (gross) to drill and complete.

     Cotton Valley Trend.  Approximately 20% (36.7 Bcfe) of the Company's proved
reserves are located in the Cotton Valley Trend in Harrison and Rusk counties in
eastern  Texas.  The Cotton  Valley  producing  formation is 1,500 to 2,000 feet
thick and is located at depths of 8,500 to 10,500 feet. These properties produce
from low permeability reservoirs with long life natural gas reserves.

     In 1995 the  Company  initiated a major  development  program in the Cotton
Valley Trend.  The Company has performed  three  recompletions,  two  workovers,
completed  one well  that  had been  drilled  but not  completed  at time of the
purchase  of the  property  and  has  successfully  drilled  and  completed  two
development wells, which initially averaged 1,500 Mcf per day. In addition,  the
Company  spudded  four wells  during the  fourth  quarter  which were in various
stages of drilling and/or  completion at year end 1996 and will be on production
at the end of the first quarter or the beginning of the second  quarter of 1997.
Through these  development  activities  combined with the Merger,  average daily
production for the Cotton Valley  properties  has increased  from  approximately
3,400 Mcf per day in June 1995, when the Company  acquired its first interest in
the area, to an average of 9,300 Mcf per day during December 1996.

     The original development of the Cotton Valley Trend was based upon 640 acre
spacing, but production results have revealed that wells drilled on this spacing
are  insufficient to adequately  drain the reservoir due to the low permeability
of the  sandstones.  New studies  show  developing  these tight sands on 80 acre
spacing is necessary  to recover all  commercially  producible  reserves in this
formation.  The Cotton Valley Trend  properties are now subject to revised field
rules  established by the Texas Railroad  Commission that permit drilling on 160
acre or, alternatively,  on 80 acre spacing,  without obtaining a special ruling
from the Texas  Railroad  Commission  for each well.  The  Company has also been
successful in obtaining the Texas Railroad Commission's approval to indefinitely
suspend maximum production allowables.


                                       7
<PAGE>

     Due to incentives  created to drill on certain  leases of the Cotton Valley
Trend,  production from some of the Company's  Cotton Valley  properties  should
qualify for severance tax abatements.

     As of December  31,  1996,  the Company  had  identified  4 PDNP and 19 PUD
locations in the Cotton Valley Trend.  The typical well in this area is expected
to cost approximately $1.1 million (gross) to drill and complete.  A significant
portion of the cost to complete  these wells is due to the low  permeability  of
the interbedded sandstones and shales, which requires massive hydraulic fracture
stimulation, typically of multiple zones of the producing formation, to fracture
the rock sufficient to obtain the increased  production levels necessary to make
such wells  commercially  viable. The Company has budgeted  approximately  $14.9
million to drill 12 gross (12 net) development  wells in the Cotton Valley Trend
for 1997. All of these wells will be drilled on PUD locations  where the Company
owns in excess of 95% of the interests.

     Goldsmith  Adobe  Unit  ("GAU").  Approximately  14%  (25.0  Bcfe)  of  the
Company's proved reserves are located in the Clearfork 5600 Reservoir,  which is
in the middle of the Permian Basin located in West Texas.  These reserves are in
the 7,880 acre Goldsmith Adobe Unit,  which the Company operates and in which it
now owns approximately a 95% working interest.

     Originally the unit was drilled on 40 acre spacing.  Previous operators had
drilled  several  wells on 20 acre  spacing  and,  based on the  results of this
drilling and 20 acre spacing  development on adjoining leases, the Company began
a  drilling  program in July 1994 to develop  the unit on 20 acre  spacing.  The
Company  drilled six wells  during  1994,  22 wells  during 1995 and 28 wells in
1996.  Of the 56 wells the  Company  has  drilled on the GAU,  53 are  currently
producing.  Through  the  Company's  acquisition  and  exploitation  activities,
average daily gross production from the GAU has increased from approximately 450
Boe in 1992 to 1,640 Boe during 1996.

     The Company has budgeted  approximately $7.6 million to drill an additional
29 gross (27.5 net) wells in the GAU in 1997.  The typical  well  drilled by the
Company  is  drilled  to  depths   between   5,600  and  6,000  feet  and  costs
approximately  $265,000 (gross) to drill and complete.  As of December 31, 1996,
the GAU had  approximately  100  infill  locations  left if the unit were  fully
developed  on 20  acre  spacing,  of  which  50 are  included  in the  Company's
undeveloped  proved  reserve  volumes as of  December  31,  1996.  Based on past
drilling results,  as the Company continues to drill producing wells in the GAU,
the Company  expects that  additional  reserves  will be proved on a substantial
number of the remaining infill locations of the GAU.

     Data  gained from the  drilling  and coring of new wells in the GAU suggest
that  the  reservoir  has  significant   secondary  recovery  potential  from  a
waterflood.  Waterflooding is one method of secondary recovery in which water is
injected  into  an oil  reservoir  for the  purpose  of  forcing  oil out of the
reservoir rock and into the bore of a producing  well.  The Company  anticipates
undertaking  a  waterflood  project  of the GAU in 1998 or 1999  from  which  it
expects to significantly  increase its recovery rate of the reserves in the GAU.
It has started a pilot  waterflood  project in the area and  currently is making
some  of the  necessary  expenditures  for  the  waterflood  project  by  adding
injection pumps and lines.

     Lake Boeuf.  Approximately  8% (15.2 Bcfe) of the Company's proved reserves
are located in Lafourche Parish, Louisiana,  which reserves were acquired by the
Company in September 1996. These reserves are principally proved undeveloped and
relate to nine different  horizons  ranging in depths from 9,500 to 15,000 feet,
estimated to contain approximately 1.5 Mmbbls of oil and 6.1 Bcf of natural gas.
The  Company  owns an  approximate  87.5%  working  interest  in the Lake  Boeuf
properties.

     The  Company  has  identified  two  PDNP  locations  which  it  intends  to
recomplete  during  1997 for  approximately  $250,000.  Additionally,  three PUD
locations  containing seven producing zones,  have been identified for which the
Company has  budgeted  approximately  $4.8 million to drill two gross (1.75 net)
wells as part of its 1997 capital expenditure program. The Lake Boeuf properties
are located in the parish adjacent to the Company's East Bayou Sorrel properties
in  Iberville  Parish on which it  recently  drilled  an  exploration  well that
represents a new field discovery.

     Arkoma Basin. Approximately 8% (14.9 Bcfe) of the Company's proved reserves
are located in the Arkoma Basin in eastern Oklahoma and western Arkansas,  which
reserves were acquired by the Company as a result of the Merger with  Alexander.
Most production comes from the Red Oak,  Cromwell,  Spiro and Wapanucka sands at
depths of 7,000 to 8,000 feet.  Most of these  channel  sands follow  structural
grain and are prolific  natural gas producers when the natural gas is trapped by
faults in the grain.



                                       8
<PAGE>

     As of December 31, 1996, the Company had  identified  three PDNP and eleven
PUD locations in the Arkoma Basin, and the Company expects that additional drill
sites will be developed  once it is able to more fully  evaluate the  additional
reserve potential identified during its acquisition analysis. The typical Arkoma
Basin  well is  drilled  to  approximately  7,500  feet and costs  approximately
$350,000  (gross)  to drill and  complete.  In 1996,  the  Company  successfully
drilled and completed  three wells and  participated  in two wells  successfully
drilled and completed by outside  operators in the Arkoma Basin. The Company has
budgeted  approximately  $1.2 million to drill eight gross (3.7 net) development
wells in the Arkoma Basin in 1997.

Exploration

     The Company  seeks to balance  its  strategy of  acquiring  and  exploiting
mature but  underdeveloped  reserves  by  dedicating  a portion  of its  capital
expenditure   budget  to  higher  risk  with   potentially  much  higher  reward
exploration opportunities. The Company expects to drill thirteen gross (3.7 net)
exploratory  wells in 1997. The Company has budgeted  approximately  $12 million
for its 1997  exploration  program,  $1.8  million on  prospects  on the Mustang
Island properties, including a 90 square mile 3-D seismic survey of the area, $6
million on  prospects  generated by the  Sandefer  Exploration  Venture and $4.7
million for other prospects.  The Company expects that its exploratory  projects
will be concentrated in Gulf Coast areas, both onshore and offshore.

     Sandefer  Exploration  Venture. To capitalize upon the extensive geological
and  geophysical  data  base for the  Upper  Texas  Gulf  Coast,  Louisiana  and
Mississippi  to which they have access,  on January 1, 1996 the Company  entered
into the  Sandefer  Exploration  Venture  to  develop  and  promote  exploration
prospects  for the Company in those  areas.  During the term of the  agreements,
which  initially  is two years,  the venture  will  generate oil and natural gas
prospects in those states and will submit leasing and drilling  proposals to the
Company for a monthly  retainer.  Through  1997,  the Company has budgeted  $9.0
million for the Sandefer Exploration Venture,  which includes amounts payable to
Sandefer,  the  geologists,  anticipated  leasing and other costs for  prospects
generated by the Sandefer Exploration Venture and the cost to drill and complete
seven  gross  (1.9 net)  exploratory  wells in 1997.  If the  Company  accepts a
drilling proposal generated by the Sandefer Exploration  Venture,  Sandefer will
receive an overriding  royalty interest in leases acquired by the Company in the
prospect  area and, upon payout of specified  costs on a prospect,  may have the
right to receive a deferred leasehold interest.

     At December 31, 1996,  one  exploratory  well has been drilled on prospects
generated by the Sandefer Exploration Venture. The first prospect drilled by the
Company  is the East Bayou  Sorrel  prospect  on which the  Schwing # 1 well was
drilled.  The Schwing #1 in Iberville Parish,  Louisiana  represents a new field
discovery in the Cib Haz  formation  at 13,200 feet and is  currently  producing
1,400 Bbls of oil and 1,200 Mcf of gas per day, on a 11.5/64 choke size in order
to maintain  production  at the 1,400 Bbls of oil per day  allowable  set by the
State of Louisiana.

     Although the leasing and drilling  costs are  generally  higher in southern
Louisiana  where the Schwing # 1 was drilled,  the Company  believes that due to
the higher porosity and permeability of the producing  formations,  the area has
significant  reserve  potential which could yield much higher  production  rates
than the Company's  Texas,  Oklahoma and Arkansas  properties.  The Company also
believes that the generally shorter life properties in southern  Louisiana would
add diversity to its  properties and provide  balance to its  relatively  longer
life, lower risk properties in the GAU, Cotton Valley, Anadarko Basin and Arkoma
Basin.

     Bayou Sorrel. The Bayou Sorrel area is located  approximately  eighty miles
west of New Orleans,  in Iberville  Parish,  Louisiana,  in the Atchaflaya River
Basin.  The  topography  of the surface is river swamp and all work must be done
with barge mounted drilling rigs and boats.  Production platforms are mounted on
pilings.  The Company became involved in this area in January 1996,  through the
Sandefer Exploration Venture, when it participated in the successful exploratory
test of the Schwing #1 well in the East Bayou Sorrel  prospect  which is drilled
on the  eastern  flank of the old Bayou  Sorrel  Field  discovered  by Shell Oil
Company in 1954.  The Shell  Bayou  Sorrel  Field was  drilled in the 1950's and
1960's, with a total of 87 wells drilled and produced in twenty-eight  different
horizons  ranging in depths  from 7,000' to 11,100' in  geological  age from the
Lower  Miocene  to the Upper  Oligocene.  The  target  depths  of the  Company's
exploration prospects in this area range from 11,000' to 14,000' and include the
Marg Vag, Marg Howeii,  Cib Haz, and Marg Tex zones in  geological  age from the
Upper Oligocene to the Lower Oligocene.


                                       9
<PAGE>

     After the successful test of the East Bayou Sorrel, Schwing #1, the Company
increased its original 17% working  interest in the well by acquiring  interests
from two other working interest owners.  In October 1996, the Company acquired a
14% working interest in the Schwing #1 from W&T Offshore, Inc. In December 1996,
the Company  acquired a 29% working  interest in the Schwing #1 from MCNIC Oil &
Gas, increasing the Company's working interest in such well to 60%.

     In November  1996,  the  Company  acquired  100% of the Shell Bayou  Sorrel
Field,  adjacent to the Schwing #1 discovery  well,  from Panaco,  Inc., who had
acquired  the field  from Shell a year  earlier.  The Bayou  Sorrel  Acquisition
included 10 wells producing approximately 325 barrels of oil per day and 18 shut
in wells along with 2,000  leasehold  acres held by  production  and  production
facilities  capable of handling 20,000 barrels of oil per day, 50,000 Mcf of gas
per day and salt water disposal of 30,000 barrels of water per day.

     In addition,  the Company has acquired  leases adjacent to the Bayou Sorrel
and East Bayou Fields which, in total,  give the Company 4,080 gross (3,979 net)
acres  in  the  area.  The  Company  has  undertaken  a  complete  geologic  and
engineering study of the Bayou Sorrel area, which will include a 3-D shoot of at
least thirty square miles  encompassing  the entire Bayou Sorrel lease position.
Additional deep Cib Haz prospects have been identified which the Company intends
to drill in late 1997 or 1998.  The Company has  budgeted in 1997  approximately
$5.1 million to drill two wells in the East Bayou Sorrel prospect offsetting the
Schwing #1 and one new exploratory well on the adjacent leases.

     Mustang Island.  The Mustang Island area located in shallow state waters in
offshore  Nueces  County,  Texas is the  other  principal  area of focus for the
Company's  exploration  program.  When  the  Company  decided  to  implement  an
exploration  program, it reviewed numerous prospects,  including Mustang Island.
The Company ultimately selected Mustang Island based on extensive geological and
geophysical studies that led the Company to conclude that there may be potential
for large reserves in the upper and lower Frio sands and in even lower depths in
the relatively  unexplored transition zone offshore in the Gulf of Mexico. After
a comprehensive  analysis,  including a review of capital expenditures,  markets
for production and the additional  infrastructure needed to explore, develop and
market the  reserves of the Mustang  Island  Properties,  a decision was made to
commence an exploration program off Mustang Island.

     In 1995 the Company  initially  acquired a 100%  interest in one  producing
well, one proved  undeveloped  drilling location and 770 acres of leases. In two
subsequent  transactions,  it acquired an approximate 72% working interest in an
additional  five wells and 1,440  acres of leases,  a 100%  working  interest in
approximately 11 miles of pipeline and a shore tank facility,  and a 50% working
interest  in two  other  wells,  which  wells  are  part of a  natural  gas unit
including  3,840 acres.  These  acquisitions  also included four  platforms (one
four-pile,  one  tripod  and two  monopods),  which the  Company  may use in its
exploratory  drilling  program.   Based  upon  the  Company's  reprocessing  and
extensive  analysis  of  approximately  500  square  miles of 2-D  seismic  data
purchased  by the  Company,  in April  1996 it bid upon and  acquired  five year
leases of 17  additional  tracts  from the State of Texas,  consisting  of 7,765
acres of leases.  All of such tracts are in close  geographic  proximity  to the
offshore  acreage the Company  previously had acquired and the total acreage now
leased by the Company in the Mustang  Island area is 13,810  gross  (11,295 net)
acres. The Mustang Island area contains complex  geological  structures in which
the Company  intends to principally  drill at depths of 15,000 to 17,000 feet in
the upper and lower Frio sands at a cost of  approximately  $3.0 million (gross)
to drill and complete each well.

     In 1996, the Company recompleted one well, which is currently producing 200
Mcf per day.  The Company has  budgeted  approximately  $4.6  million in 1997 to
recomplete  the three wells  acquired in 1996, to drill one PUD location and one
exploratory  well and to  commission a 3-D seismic  survey of the area.  The 3-D
seismic  survey will be used to evaluate its options for  improving the recovery
of the proved oil and natural gas reserves and to determine  possible  locations
for the exploratory  wells it intends to drill in the area in 1997 and 1998. The
Company intends to limit its working interests in its Mustang Island exploratory
prospects through participation by industry partners.

                                       10
<PAGE>

Oil and Natural Gas Production.

     The following table shows the  approximate  net production  attributable to
the Company's oil and natural gas interests for the periods indicated:

                         OIL AND NATURAL GAS PRODUCTION

                                          Year ended December 31,
                                ---------------------------------------------
                                    1994           1995            1996
                                -------------- --------------  --------------

Oil (Mbls)                            115,642        283,440         521,701
Natural gas (Mmcf)                    620,843      1,752,990       5,680,904
Natural gas equivalent (Mmcfe)      1,314,695      3,453,630       8,811,110


Productive Well Summary.

     The Company's  production of oil and natural gas is primarily  derived from
wells located in Texas,  Oklahoma and New Mexico. The following table sets forth
the Company's interests in productive wells, by state, as of December 31, 1996:

<TABLE>
<CAPTION>
                                PRODUCTIVE WELLS

                                       Oil                  Natural Gas                 Total
                              -----------------------  -----------------------  -----------------------
               Field             Gross        Net         Gross        Net         Gross        Net
----------------------------  ----------  -----------  ----------  -----------  ----------  -----------
<S>                           <C>         <C>          <C>         <C>          <C>         <C>
Onshore:
Anadarko Basin, OK                204         96.1         268        115.7          472       211.8
Cotton Valley Trend, TX             2          1.4          25         21.4           27        22.8
GAU, TX                           114        108.2           -          -            114       108.2
Lake Boeuf, LA                      1           .9           -          -              1          .9
Arkoma Basin, OK and AR             -          -           119         35.7          119        35.7
Bayou Sorrel, LA                   16         15.3           -          -             16        15.3
Other Onshore                      50         20.4          30          6.1           80        26.5
                              ----------  -----------  ----------  -----------  ----------  -----------
     Total Onshore                387        242.3         442        178.9          829       421.2
Offshore:
Mustang Island, TX                  1          1             3          1.7            4         2.7
                              ----------  -----------  ----------  -----------  ----------  -----------
     Total                        388        243.3         445        180.6          833       423.9
                              ==========  ===========  ==========  ===========  ==========  ===========

</TABLE>



                                       11
<PAGE>


Production Economics.

     The  following  table sets forth the average  sales price per barrel of oil
and Mcf of natural gas produced,  the average lease operating  expenses  ("LOE")
and depletion,  depreciation and amortization ("DD&A") rates and the general and
administrative  ("G&A") costs  attributable to the Company's oil and natural gas
production for the periods indicated.

                              PRODUCTION ECONOMICS

                                              Year ended December 31,
                                         --------------------------------
                                           1994        1995        1996
                                         ----------  ----------  --------
Average sales price:
     Oil (Bbl)                             $16.01       $17.22     $21.70
     Natural gas (Mcf)                       2.11         1.70       2.28
     Natural gas equivalent (Mcfe)           2.40         2.28       2.75
LOE per Mcfe                                  .92          .50        .42
G&A per Mcfe                                  .75          .51        .34
DD&A per Mcfe                                 .70          .91       1.11

Leasehold Acreage.

     The following table shows the approximate  gross and net acres in which the
Company had a leasehold interest as of December 31, 1996:

                                LEASEHOLD ACREAGE

                               Developed Acreage         Undeveloped Acreage
--------------------------- -------------------------  ------------------------
              Fields          Gross          Net         Gross         Net
--------------------------- -----------  ------------  -----------  -----------

Onshore:
Anadarko Basin, OK            106,771        42,622         8,990       4,935
Cotton Valley Trend, TX         4,761         4,410         1,567       1,455
GAU, TX                         4,720         4,482         3,160       3,007
Lake Boeuf, LA                    143           125           945         827
Arkoma Basin, OK and AR        43,365        14,576         1,144          72
Bayou Sorrel, LA                2,426         2,426         1,654       1,553
Other Onshore (1)              21,856         5,209        29,936      24,498
                            -----------  ------------  -----------  -----------
     Total Onshore            184,042        73,850        47,396      36,347
Offshore:
Mustang Island, TX              6,045         3,530         7,765       7,765
                            ===========  ============  ===========  ===========
      Total                   190,087        77,380        55,161      44,112
                            ===========  ============  ===========  ===========

(1)  Includes acreage in Colorado,  Kansas, Louisiana,  Oklahoma,  Nebraska, New
     Mexico, and Wyoming.

     Substantially all of the Company's producing oil and natural gas properties
are located on leases held by the Company for an  indeterminate  number of years
for so long as production  is  maintained.  All of the  Company's  non-producing
acreage is held under  leases from mineral  owners or a government  entity which
expire at varying dates. The Company is obligated to pay annual delay rentals to
the  lessors  of  certain  properties  in  order  to  prevent  the  leases  from
terminating.  Because substantially all of the Company's undeveloped acreage was
held by production,  annual delay rentals for 1996 were nominal;  however,  such
rentals are expected to increase in future periods.


                                       12
<PAGE>

Drilling Activity.

     The following table sets forth development and exploration drilling results
for the years ended December 31, 1994, 1995 and 1996.

                                DRILLING RESULTS
<TABLE>
<CAPTION>
                                                Years ended December 31,
                         -------------------------------------------------------------------------
                                  1994                     1995                     1996
                         -----------------------  -----------------------  -----------------------
                           Gross        Net         Gross        Net         Gross        Net
                         ----------  -----------  ----------  -----------  ----------  -----------
<S>                      <C>        <C>           <C>         <C>          <C>         <C>
DEVELOPMENT
     Productive                 9         6.4           24        20.7           28        25.6
     Non-productive             -           -            1          .6            1          .2
                         ----------  -----------  ----------  -----------  ----------  -----------
         Total                  9         6.4           25        21.3           29        25.8

EXPLORATORY
     Productive                 -          -             -         -              3         1.4
     Non-productive             2         1.0            2          .8            5         1.1
                         ----------  -----------  ----------  -----------  ----------  -----------
         Total                  2         1.0            2          .8            8         2.5
                         ----------  -----------  ----------  -----------  ----------  -----------

Combined Total                 11         7.4           27        22.1           37        28.3
                         ==========  ===========  ==========  ===========  ==========  ===========
</TABLE>

Title to Oil and Natural Gas Properties.

     The Company has acquired  interests in producing and non-producing  acreage
in the form of working  interests,  royalty  interests  and  overriding  royalty
interests.  To reduce the Company's  financial  exposure in any one  exploratory
prospect, the Company often acquires less than 100% of the working interest in a
prospect.  Working  interests held by the Company may, from time to time, become
subject to minor liens. Furthermore,  updated title opinions may not be received
prior to the  acquisition  of a producing  oil and natural gas  property.  It is
contemplated,  however,  that  investigations  will be made in  accordance  with
standard practices in the industry before the acquisition of such properties and
before drilling.

Production and Sales Prices.

     The Company's  production of oil and natural gas is derived solely from its
activities in the  continental  United  States.  The Company is not obligated to
provide a fixed and  determinable  quantity  of oil  and/or  natural  gas in the
future  under  existing  contracts or  agreements.  The Company does not plan to
refine or process  the oil and natural  gas it  produces,  but plans to sell the
production to unaffiliated oil and natural gas purchasing  companies in the area
in which it is produced. The Company expects to sell crude oil on a market price
basis and to sell natural gas under  contracts to both interstate and intrastate
gas pipeline companies. The Company currently sells a significant portion of its
oil  pursuant  to a contract  with Plains  Marketing  and  Transportation,  Inc.
("Plains"). See "Markets and Customers" below.

Lease Interests.

     The Company generally acquires a leasehold interest in the properties to be
explored.  The leases  grant the lessee the right to explore for and extract oil
and natural gas from a specified area.  Rentals usually consists of fixed annual
charges prior to production and, once production has been established, a royalty
based upon the gross  proceeds  from the sale of oil and natural gas. Once wells
are  drilled,  a lease  generally  continues  as long as  production  of oil and
natural gas continues.  In some cases,  leases may be acquired in exchange for a
commitment  to drill or finance the  drilling of a specified  number of wells to
predetermined depths.



                                       13
<PAGE>
Control Over Production Activities.

     The Company  operates  506 of the 833  producing  wells in which it owns an
interest as of December 31, 1996.  The  non-operated  properties are operated by
unrelated  third parties  pursuant to operating  agreements  which are generally
standard in the  industry.  Significant  decisions  about  operations  regarding
non-operated properties may be determined by the outside operator rather than by
the Company.  If the Company  declines to participate  in additional  activities
proposed by the outside operator under certain operating agreements, the Company
will not receive revenues from, and/or will lose its interest in the activity in
which it declined to participate.

Factors Beyond the Company's Control.

     Although  demand for oil is steady,  there are seasonal  variations  in the
demand for natural  gas.  The  Company's  oil and  natural gas  business is also
affected by factors  which are beyond its control and the exact effects of which
cannot be accurately predicted. These factors may include war in countries other
than the United States, the extent of domestic production, imports of crude oil,
production by and agreements  among OPEC members,  the  availability of adequate
pipeline and other transportation facilities, the marketing of competitive fuel,
government  regulation  of prices,  production,  transportation  and  marketing,
fluctuating  supply and  demand,  regulation  and other  matters  affecting  the
supply and demamd for crude oil and natural gas.

Markets and Customers.

     The  availability of a ready market for any oil and natural gas produced by
the Company and the prices  obtained  for such oil and natural gas depends  upon
numerous factors beyond its control,  including the demand for and supply of oil
and natural gas,  fluctuations in production and seasonal  demand,  proximity of
the wells to adequate  transmission  facilities,  weather  conditions,  economic
conditions, and the effects of state and federal governmental regulations on the
import,  production,  transportation  and  sale  of oil  and  natural  gas.  The
occurrence  of any factor which affects a ready market for the Company's oil and
natural gas or reduces  the price  obtained  for such oil and gas may  adversely
affect the Company.

     A large percentage of the Company's oil and natural gas sales are made to a
small  number of  purchasers.  During  the year ended  December  31,  1995,  two
suppliers, Plains and Energy Source, Inc. accounted for approximately 59% of the
Company's  oil sales and 11% of its  natural  gas  sales.  During  1996,  Plains
accounted for 83% of the Company's oil sales,  while Crosstex  Energy,  Inc. and
GPM Natural Gas  Corporation  accounted  for 23% and 22%,  respectively,  of the
Company's  natural gas sales.  The agreement with Plains,  entered into in 1993,
provides  for  Plains to  purchase  the  Company's  oil  pursuant  to West Texas
Intermediate  posted prices plus a small  premium.  The Company does not believe
that the loss of any customer  would have a material  and adverse  effect on its
business  because,  under prevailing market  conditions,  such customer could be
replaced.

Regulation.

     General.  The Company's  oil and natural gas  exploration,  production  and
related operations are subject to extensive rules and regulations promulgated by
federal and state  agencies.  Failure to comply with such rules and  regulations
can  result  in  substantial  penalties.  The  regulatory  burden on the oil and
natural gas industry  increases the Company's cost of doing business and affects
its profitability.  Because such rules and regulations are frequently amended or
interpreted,  the  Company  is unable to predict  the  future  cost or impact of
complying with such laws.

     Exploration  and  Production.  The Company's  exploration  and  development
operations are subject to various types of regulation at the federal,  state and
local levels.  Such regulation  includes  requiring  permits for the drilling of
wells;  maintaining bonding requirements in order to drill or operate wells; and
regulating the location of wells,  the method of drilling and casing wells,  the
surface use and  restoration of properties  upon which wells are drilled and the
plugging and abandoning of wells.  The Company's  operations are also subject to
various conservation  regulations and rules to protect the correlative rights of
subsurface  owners.  These  include the  regulation  of the size of drilling and
spacing  units or proration  units and the density of wells which may be drilled
and the  unitization  or  pooling of oil and  natural  gas  properties.  In this
regard,  some  states  allow the  forced  pooling  or  integration  of tracts to
facilitate  exploration while other states rely on voluntary pooling of land and
leases.  In  addition,  state  conservation  laws  establish  maximum  rates  of
production  from oil and natural gas wells,  generally  prohibit  the venting or
flaring of natural gas and impose certain requirements  regarding the ratability
of  production.  The effect of these  regulations is to limit the amounts of oil
and natural  gas the Company can produce  from its wells and to limit the number
of wells or the  locations  at which  the  Company  can  drill.  Legislation  in
Oklahoma and  regulatory  action in Texas governs the  methodology  by which the
regulatory agencies establish  permissible monthly production  allowables.  This
action has generated substantial  controversy,  especially at the federal level,
and has been labeled as an attempt to reduce the total production of natural gas
in order to increase  natural gas  prices.  A recent  attempt to enact a federal
prohibition of these recent state proration rule  initiatives was defeated,  but
various members of Congress and some federal  regulators have declared an intent


                                       14
<PAGE>


to monitor the states' actions very  carefully.  The Company cannot predict what
effect these new prorationing  regulations will have on its production and sales
of natural gas.

     Certain of the  Company's  oil and  natural  gas leases are  granted by the
federal  government and  administered by various federal  agencies.  Such leases
require compliance with detailed federal  regulations and orders which regulate,
among other matters, drilling and operations on these leases and calculation and
disbursement of royalty  payments to the federal  government.  The Mineral Lands
Leasing Act of 1920  places  limitations  on the number of acres  under  federal
leases that may be owned in any one state.

     Environmental Protection and Occupational Safety. The Company is subject to
numerous federal,  state and local laws and regulations governing the release of
materials  into  the   environment  or  otherwise   relating  to   environmental
protection.  These laws and  regulations may require the acquisition of a permit
before drilling commences,  restrict the types,  quantities and concentration of
various  substances that can be released into the environment in connection with
drilling and production  activities,  limit or prohibit  drilling  activities on
certain lands lying within  wilderness,  wetlands and other  protected areas and
impose  substantial   liabilities  for  pollution   resulting  from  operations.
Moreover,   the  recent  trend  toward  stricter   standards  in   environmental
legislation and regulation is likely to continue. For instance,  legislation has
been  proposed in Congress from time to time that would  reclassify  certain oil
and natural gas production wastes as "hazardous wastes",  which reclassification
would make such wastes  subject to much more  stringent  handling,  disposal and
clean-up  requirements.  If such legislation were to be enacted, it could have a
significant impact on the operating costs of the Company, as well as the oil and
natural gas industry in general.  It is not anticipated that the Company will be
required in the near future to expend  amounts  that are material in relation to
its total  capital  expenditure  program  by reason  of  environmental  laws and
regulations,  but because such laws and regulations are frequently changed,  the
Company is unable to predict the ultimate cost and effects of such compliance.

     The Comprehensive  Environmental  Response,  Compensation and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without regard
to fault or the legality of the original conduct,  on certain classes of persons
who are considered to have contributed to the release of a "hazardous substance"
into the  environment.  These  persons  include  the  owner or  operator  of the
disposal site or sites where the release occurred and companies that disposed or
arranged for the disposal of the hazardous substances. Under CERCLA such persons
or  companies  may be subject to joint and  several  liability  for the costs of
cleaning  up  the  hazardous   substances  that  have  been  released  into  the
environment and for damages to natural  resources.  Also, it is not uncommon for
neighboring  landowners  and other  third  parties to file  claims for  personal
injury,  property damage and recovery of response costs allegedly  caused by the
hazardous substance released into the environment.

     In addition, the U.S. Oil Pollution Act of 1990 (the "OPA") and regulations
promulgated  pursuant  thereto  impose a variety of  regulations  on responsible
parties  related  to the  prevention  of oil spills and  liability  for  damages
resulting from such spills.  The OPA establishes  strict liability for owners of
facilities  that are the site of a release  of oil into  "waters  of the  United
States."  While  OPA  liability  more  typically   applies  to  facilities  near
substantial  bodies of  water,  at least  one  district  court has held that OPA
liability can attach if the contamination  could enter waters that may flow into
navigable waters.

     Stricter  standards in environmental  legislation may be imposed in the oil
and natural gas industry in the future,  such as proposals  made in Congress and
at the state  level from time to time,  that would  reclassify  certain  oil and
natural gas exploration and production wastes as "hazardous wastes" and make the
reclassified wastes subject to more stringent and costly handling,  disposal and
clean-up requirements. The impact of any such changes, however, would not likely
be any more  burdensome  to the  Company  than to any other  similarly  situated
company involved in oil and natural gas exploration and production.

     The  Resource  Conservation  and  Recovery  Act  ("RCRA")  and  regulations
promulgated thereunder govern the generation,  storage, transfer and disposal of
hazardous  wastes.  RCRA,  however,  excludes  from the  definition of hazardous
wastes "drilling fluids,  produced waters,  and other wastes associated with the
exploration,  development, or production of crude oil, natural gas or geothermal
energy." Because of this exclusion,  many of the Company's operations are exempt
from  RCRA  regulation.   Nevertheless,   the  Company  must  comply  with  RCRA
regulations for any of its operations that do not fall within the RCRA exclusion
(such as painting activities or use of solvents).

                                       15
<PAGE>

     The Company is also subject to laws and regulations concerning occupational
safety and health. While it is not anticipated that the Company will be required
in the near future to expend  amounts that are material in the  aggregate to the
Company's  overall  operations by reason of occupational  safety and health laws
and  regulations,  the  Company  is  unable  to  predict  the  ultimate  cost of
compliance.

     Marketing and  Transportation.  Federal legislation and regulatory controls
in the United  States have  historically  affected  the price of the natural gas
produced by the Company and the manner in which such production is marketed. The
transportation  and sales for resale of natural gas in  interstate  commerce are
regulated  pursuant  to the  Natural Gas Act of 1938 (the "NGA") and the Federal
Energy  Regulatory  Commission  ("FERC")  regulations   promulgated  thereunder.
Maximum  selling  prices of certain  categories of natural gas,  whether sold in
interstate or intrastate  commerce,  previously  were regulated  pursuant to The
Natural Gas Policy Act of 1978 ("NGPA"). The NGPA established various categories
of natural gas and  provided for  graduated  deregulation  of price  controls of
several  categories  of  natural  gas and the  deregulation  of sales of certain
categories of natural gas. All price  deregulation  contemplated  under the NGPA
has already taken place. Subsequently, the Natural Gas Wellhead Decontrol Act of
1989 (the  "Decontrol  Act")  terminated  all  remaining  NGA and NGPA price and
non-price controls on wellhead sales of domestic natural gas on January 1, 1993.
While  natural gas producers may  currently  make sales at  uncontrolled  market
prices, Congress could re-enact price controls in the future.

     Commencing in late 1985, the FERC issued a series of orders (Order No. 436,
Order No. 500 and related orders), which promulgated  regulations  significantly
altering the  transportation  and marketing of natural gas.  Among other things,
these  regulations  (a) required  interstate  pipelines  that elect to transport
natural   gas  for  others   under   self-implementing   authority   to  provide
transportation  services to all shippers on a non-discriminatory  basis, and (b)
permitted  each exiting firm sales  customer of any such pipeline to modify over
at least a five-year  period,  its existing purchase  obligations.  Although the
regulations do not directly  regulate natural gas producers such as the Company,
the availability of non-discriminatory  transportation  services and the ability
of pipeline customers to modify their existing purchase  obligations under these
regulations  has greatly  enhanced  the  ability of  producers  to market  their
natural gas  directly  to end users and local  distribution  companies.  In this
regard,  access to markets  through  interstate  pipelines  is  critical  to the
Company's marketing initiatives.

     In April 1992, the FERC issued its  restructuring  rule, known as Order No.
636  ("Order No.  636"),  that has had a major  impact on  pipeline  operations,
services  and rates.  The most  significant  provisions  of Order No.  636:  (a)
required interstate  pipelines to provide firm and interruptible  transportation
solely on an  "unbundled"  basis,  separate  from their  sales  service,  and to
convert  each  pipeline's   bundled  firm  sales  service  into  unbundled  firm
transportation service; (b) provided for the issuance of blanket certificates to
pipelines to provide  unbundled  sales  service  giving all utility  customers a
chance to purchase their firm supplies from non-pipeline merchants; (c) required
that pipelines provide firm and interruptible  transportation service on a basis
that is equal in quality for all natural gas supplies,  whether  purchased  from
the  pipeline  or  elsewhere;   (d)  required  that  pipelines  provide  a  new,
non-discriminatory  "no-notice"  transportation  service that largely replicates
the "bundled" sales service  previously  provided by pipelines;  (e) established
two new, generic programs for the  reallocation of firm pipeline  capacity;  (f)
required that all pipelines  offer access to their storage  facilities on a firm
and  interruptible  basis;  (g) provided for pregranted  abandonment of pipeline
sales  agreements,  interruptible  and firm  short-term  (defined as one year or
less) transportation  agreements and conditional  pregranted abandonment of firm
long-term  transportation  service;  (h) modified  transportation rate design by
requiring that all fixed costs related to  transportation  be recovered  through
the  reservation  charge;  and  (i)  provided  mechanisms  for the  recovery  by
pipelines of certain transition costs occurring from implementation of Order No.
636.

     The rules contained in Order No. 636, as amended by Order No. 636-A (issued
in August 1992) and Order No.  636-B  (issued in November  1992)  (collectively,
"Order No. 636") are far reaching  and complex.  In addition,  Order No. 636 and
individual  orders in restructuring  proceedings are currently  subject to court
challenges. While Order No. 636 does not directly regulate natural gas producers
such as the  Company,  the FERC has stated  that Order No.  636 is  intended  to
foster increased competition within the natural gas industry.



                                       16
<PAGE>


Operational Hazards and Insurance.

     The Company's  operations  are subject to all of the risks  inherent in oil
and natural gas exploration,  drilling and production.  These hazards can result
in  substantial  losses to the Company due to personal  injury and loss of life,
severe  damage to and  destruction  of  property  and  equipment,  pollution  or
environmental  damage  or  suspension  of  operations.   The  Company  maintains
insurance of various  types  customary in the industry to cover its  operations.
The Company believes it is insured  prudently against certain of these risks. In
addition,  the Company maintains operator's extra expense coverage that provides
coverage for the care, custody and control of wells drilled by the Company.  The
Company's  insurance  does not cover every  potential risk  associated  with the
drilling  and  production  of oil and natural gas.  The Company  does,  however,
maintain  levels of insurance  customary in the industry to limit its  financial
exposure in the event of a substantial environmental claim resulting from sudden
and  accidental  discharges;  however,  100%  coverage  is not  maintained.  The
occurrence  of a  significant  adverse  event,  the risks of which are not fully
covered by  insurance,  could have a material  adverse  effect on the  Company's
financial  condition and results of  operations.  Moreover,  no assurance can be
given that the Company will be able to maintain adequate insurance in the future
at rates it  considers  reasonable.  The  Company  believes  that it operates in
compliance with government  regulations and in accordance with safety  standards
which meet or exceed industry standards.

Competition.

     The oil and gas  industry is  intensely  competitive  in all of its phases,
particularly  with respect to the  acquisition  of desirable  producing  oil and
natural gas leases and oil and gas companies with production. The Company, which
is a small competitive  factor in the industry,  encounters  strong  competition
from major oil  companies,  independent  oil and gas  concerns,  and  individual
producers  and  operators,  many of  which  have  financial  resources,  staffs,
facilities  and  experience  substantially  greater  than those of the  Company.
Furthermore, in times of high drilling activity,  exploration for and production
of oil and natural gas may be affected by the availability of equipment,  labor,
supplies and by  competition  for drilling  rigs. The Company cannot predict the
effect these factors will have on its  operations.  The Company owns no drilling
rigs,  and it is  anticipated  that  its  drilling  will be  conducted  by third
parties.  Furthermore,  the  oil and  gas  industry  also  competes  with  other
industries  in  supplying  the  energy  and  fuel  requirements  of  industrial,
commercial and individual consumers.

Office Space and Other.

     The Company  leases  approximately  20,420  square feet of office  space in
Dallas,  Texas.  The  Company  also  leases a small  amount of  office  space in
Houston,  Texas for its  business  activities.  Other than oil and  natural  gas
properties and securities of oil and gas companies, it does not intend to invest
in real estate, real estate mortgages or securities of, or interests in, persons
primarily engaged in real estate activities for the foreseeable future.

Employees.

     At March 25, 1997,  the Company had 58 employees,  all but one of whom were
full-time. Of the 58 employees, 10 are field related personnel. The Company does
not have any collective  bargaining  agreements with employees and believes that
relations with its employees are generally satisfactory.

ITEM 3.    LEGAL PROCEEDINGS.

     On August 30, 1995,  the Company  filed a lawsuit in the District  Court of
Ector County,  Texas against R.E.  Steakley in which the Company seeks to enjoin
Mr.  Steakley  from  interfering  with its  operations  on the surface  property
controlled by Mr. Steakley.  The lawsuit alleges tortious  interference with the
Company's  access to its  facilities  and  wrongful  conduct with respect to the
Company's personnel.

     On August 31,  1995,  in a matter  involving  the same  property  described
above,  R.E. Steakley and N.M. Steakley filed a lawsuit in the District Court of
Harris  County,  Texas  against Amoco  Production  Company,  Phillips  Petroleum
Company,  the Company and others.  The  lawsuit  alleges  certain  environmental
claims and  related  tortious  and  contractual  claims  and sought  unspecified
damages. On December 19, 1996, the court in Harris County, Texas signed an order
transferring  the R. E. Steakley claim to the court in Ector County,  Texas as a
part of the Company's claim against R. E. Steakley. Subsequently, R. E. Steakley
filed a Fourth Amended  Original Answer and Original  Counterclaims  against the
Company in Ector County District Court in which he reasserts the claims filed in
the Harris County Court action. The Company intends to vigorously defend against
the suit and believes  that it is  operating  the  property in  compliance  with
applicable environmental laws and regulations and believes that, based on advice
from legal counsel,  that the ultimate resolution of the lawsuit will not have a
material or adverse  effect on the Company's  financial  condition or results of
operations.

                                       17
<PAGE>

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

No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter of the fiscal year ended December 31, 1996.



                                     PART II

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

Market Information.

     The Company's  Common Stock is traded on the NASDAQ National Market System.
The Company's symbol is "NEGX".

     The following  table shows the range of closing bid prices  through  August
31, 1995 and the range of closing sales prices  starting  September 1, 1995, for
the Company's  Common Stock,  as reported by NASDAQ.  The  quotations  represent
prices  between  dealers  in  securities  and may not  include  retail  mark-up,
mark-down or commission and may not represent actual transactions.

     Since  September 1, 1995, the prices reflect trading on the NASDAQ National
Market System and, for prior periods,  the prices reflect  trading on the NASDAQ
Small Cap Market.

                                      Common Stock Price
                               -------------------------------
Calendar Years by Quarter           High             Low
                               ---------------  --------------

1996
   First                            3 1/2            2 5/8
   Second                           3 7/8            2 1/2
   Third                            4 9/16           3 1/16
   Fourth                           4 3/4            3 1/4

1995
   First                            2 1/2            1 3/4
   Second                           3 3/8            2 9/16
   Third                            4                3
   Fourth                           4                3 1/16


     On  March  25,  1997,  the  latest   practical  date  for  providing  price
information, the last sales price for the Company's Common Stock was $3 11/16.

Holders.

     As of March 25, 1997, the Company had approximately 4,309 record holders of
its  shares  of  Common  Stock,   including   several  nominee  holders  for  an
undetermined number of beneficial owners.

Dividends on Common Stock.

     The Company has not paid cash  dividends  on its Common  Stock and does not
expect to declare cash dividends in the  foreseeable  future.  Furthermore,  any
future  dividends  on the  Common  Stock  will be  limited  by the  terms of the
Preferred  Stock,  which  prohibits  cash  dividends  on Common Stock unless all
accrued and unpaid  dividends  on the  Preferred  Stock have been paid,  and the
terms of the Company's  credit facility with Bank One, Texas,  N.A. ("Bank One")
and Credit Lyonnais New York Branch ("Credit  Facility"),  which does not permit
dividends on the Common Stock.

                                       18
<PAGE>


ITEM 6. SELECTED FINANCIAL DATA

                SELECTED HISTORICAL FINANCIAL AND OPERATING DATA
                      (in thousands, except per share data)

The following table sets forth selected historical  financial and operating data
with  respect to the  Company as of and for each of the five years in the period
ended  December 31, 1996,  The Company  acquired  significant  producing oil and
natural  gas  properties  in  all  the  periods   presented  which  affects  the
comparability  of the  historical  financial and operating  data for the periods
presented.  The  financial  data  was  derived  from  the  historical  financial
statements of the Company. This information is not necessarily indicative of the
Company's future  performance.  The Company has never declared or paid dividends
on its  Common  Stock.  The  financial  data set forth  below  should be read in
conjunction with  "Management's  Discussion and Analysis of Financial  Condition
and  Results of  Operations"  and the  Company's  financial  statements  and the
related notes thereto included elsewhere herein.

<TABLE>
<CAPTION>
                                                                            Year Ended December 31,
                                                             1992        1993         1994        1995         1996
                                                          ----------- -----------  ----------- -----------  -----------
<S>                                                       <C>         <C>          <C>         <C>          <C>
Statement of Operations Data: (1) (2)
Oil and natural gas sales..............................      $1,626     $1,803       $3,159      $7,858      $24,319
Well operating fees....................................         537        427          158         137          876
                                                          ----------- -----------  ----------- -----------  -----------
      Total revenues...................................       2,163      2,230        3,317       7,995       25,195
Cost and expenses:
    Lease operating expenses...........................         670        575        1,207       1,732        3,741
    Oil and natural gas production taxes...............         109        110          176         416        1,285
    General and administrative expenses................         964        994          985       1,772        3,034
    Writedown of oil and natural gas properties (3)....           -          -            -           -       43,497
    Depreciation, depletion and amortization...........         466        679        1,030       3,149        9,795
                                                          ----------- -----------  ----------- -----------  -----------
      Total costs and expenses.........................       2,209      2,358        3,398       7,069       61,352
                                                          ----------- -----------  ----------- -----------  -----------

Operating income (loss)................................         (46)      (128)         (81)        926      (36,157)
Interest expense.......................................        (175)      (188)        (517)     (1,032)      (4,213)
Other income (expenses)................................           -         17          109         312          309
                                                          ----------- -----------  ----------- -----------  -----------
Income (loss) before income taxes and extraordinary time       (221)      (299)        (489)        206      (40,061)
Income tax benefit.....................................           -          -            -           -       14,504
                                                          ----------- -----------  ----------- -----------  -----------
Income (loss) before extraordinary item................      $ (221)    $ (299)      $ (489)    $   206     $(25,557)
                                                          =========== ===========  =========== ===========  ===========
Net loss...............................................      $ (221)    $ (299)      $ (611)     $ (226)    $(25,849)
                                                          =========== ===========  =========== ===========  ===========

Loss per common share before extraordinary item........       $(0.05)   $(0.05)       $(0.09)     $(0.05)      $(1.33)
                                                          =========== ===========  =========== ===========  ===========

Net loss per common share                                     $(0.05)   $(0.05)       $(0.10)     $(0.09)      $(1.34)
                                                          =========== ===========  =========== ===========  ===========

Other Financial Data: (4)
    EBITDA.............................................        $419        $568      $1,058       $4,387     $17,444
                                                          ==========  ===========  =========== ===========  ===========
Balance Sheet Data (at period end): (1)
    Cash and cash equivalents..........................     $   366    $   161       $2,594      $6,076       14,182
    Working capital (deficit)..........................      (2,155)    (1,213)       3,561      (2,335)       2,582
    Total assets.......................................       8,742     12,710       18,746      43,491      212,035
    Long-term debt.....................................         120      3,799        6,000      13,475      100,000
    Stockholders' equity...............................       4,864      6,320       11,328      17,775       80,426
</TABLE>


                                       19
<PAGE>

-----------------

(1)  Reflects the revenues,  results of operations and production  subsequent to
     the dates of  acquisitions  of various oil and natural gas properties  that
     affect the comparability of the data presented.  In April 1992, the Company
     acquired  substantially  all of the assets of  TriSearch,  Inc. The Company
     acquired  a 63.8%  working  interest  in the GAU in  December  1993  and an
     additional interest of 17% in the GAU during 1994. During 1995, the Company
     acquired  interests  in  producing  oil and natural gas  properties  in the
     Mustang  Island area, the Oak Hill Field,  and in Eddy County,  New Mexico.
     During  1996,  the  Company  completed  the Merger with  Alexander  and the
     acquisition of Lake Boeuf.  See Note 2 of Notes to Financial  Statements of
     the Company.

(2)  Includes  extraordinary losses on early extinguishments of debt of $121,917
     for the year ended December 31, 1994,  $431,762 for the year ended December
     31, 1995 and $292,372 for the year ended December 31, 1996.

(3)  The  historical  results of operations for the year ended December 31, 1996
     include  a  noncash   writedown  of  oil  and  natural  gas  properties  of
     approximately $28.3 million (net of deferred taxes), in accordance with the
     full cost method of accounting,  which resulted from the Merger. See Note 2
     of Notes to Financial Statements.

(4)  See the Glossary included elsewhere in this Form 10-K for the definition of
     EBITDA.  EBITDA is not a measure of cash flow as  determined  by  generally
     accepted  accounting  principles.  The  Company  has  included  information
     concerning  EBITDA because EBITDA is a measure used by certain investors in
     determining the Company's  historical  ability to service its indebtedness;
     however, this measure may not be comparable to similarly titled measures of
     other  companies.  EBITDA should not be considered as an alternative to, or
     more  meaningful  than, net income or cash flow as determined in accordance
     with  generally  accepted  accounting  principles  as an  indicator  of the
     Company's operating performance or liquidity.

                                       20
<PAGE>

ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
     OF OPERATIONS.

Overview.

During 1995 and 1996, the Company acquired an estimated 26.9 Bcfe and 126.0 Bcfe
in proved  reserves,  respectively  (based on reserve  estimates  at the date of
acquisition).  As a result of  acquisitions  and efforts to increase  production
from  the  GAU and  Cotton  Valley  Trend,  proved  reserves,  as  estimated  by
Netherland & Sewell,  increased to 54.4 Bcfe and 181.7 Bcfe at December 31, 1995
and December 31, 1996,  respectively.  In August 1996, the Company completed the
Merger with Alexander whereby the Company acquired 102.1 Bcfe in proved reserves
and, in September 1996,  completed the Lake Boeuf  Acquisition  which added 17.5
Bcfe of proved reserves.

During 1995 and 1996, oil and natural gas sales, net of lease operating  expense
and  production  taxes,   increased  more  rapidly  than  G&A  and  DD&A.  As  a
consequence,  the Company  recognized net income of $2.4 million  (excluding the
$28.3 million  write-down of oil and natural gas  properties) for the year ended
December 31, 1996 and recognized  income from operations of $.9 million for 1995
after recording losses from operations in each year from 1992 through 1994.

Results of Operations.

The following  table sets forth  certain  information  regarding the  production
volumes,  oil and natural  gas sales,  average  sales  prices,  lease  operating
expenses ("LOE"),  general and administrative expenses ("G&A") and depreciation,
depletion  and  amortization  ("DD&A")  associated  with the  Company's  oil and
natural gas sales for the period indicated.
<TABLE>
<CAPTION>
                                                                     Year ended December 31,
                                                            1994              1995              1996
                                                            ----              ----              ----
<S>                                                    <C>               <C>                <C>
Net Production:
         Oil (Bbls)                                       115,642           283,440            521,701
         Natural gas (Mcf)                                620,843         1,752,990          5,680,904
         Natural gas equivalent (Mcfe)                  1,314,695         3,453,630          8,811,110
         Oil and natural gas sales:
                  Oil                                  $1,851,443        $4,880,313        $11,320,279
                  Natural gas                           1,307,273         2,978,003         12,999,119
                                                        ---------         ---------         ----------
                  Total                                $3,158,716        $7,858,316        $24,319,398
                                                       ==========        ==========        ===========
Average sales price:
         Oil (Bbls)                                        $16.01            $17.22             $21.70
         Natural gas (Mcf)                                   2.11              1.70               2.29
         Natural gas equivalent (Mcfe)                       2.40              2.28               2.75
LOE per Mcfe                                                  .92               .50                .42
G & A expenses per Mcfe                                       .75               .51                .34
DD&A per Mcfe                                                 .70               .91               1.11
</TABLE>

Year ended December 31, 1996 compared with year ended December 31, 1995.

Revenues.  Total revenues  increased by $17.2 million  (215.1%) to $25.2 million
for 1996 from $8.0  million in 1995.  The  increase  in  revenues  is due to the
increase in  production  from the  development  of the GAU,  and the increase in
production  due to the 1995  acquisitions  of Mustang  Island,  Oak Hill and the
Enron   Properties   (hereinafter   collectively   referred   to  as  the  "1995
Acquisitions").  The  increase  is  also  due to  the  UMC  Acquisition,  the CA
Acquisition,  the Lake Boeuf Acquisition,  the W&T Acquisition, the Bayou Sorrel
Acquisition  and the MCNIC  Acquisition  (hereinafter  referred  to as the "1996
Acquisitions")  completed  during 1996, and the Merger with Alexander  completed
August 29,  1996.  In 1996,  the  Company  produced  521,701  barrels of oil, an
increase of 84.1% over 283,440  barrels in 1995,  and  5,680,904  Mcf of natural
gas, an increase of 224.1% over 1,752,990 Mcf in 1995.

Also  contributing  to the  increase in revenues was the increase in average oil
prices of $4.48 per  barrel to $21.70  for 1996 from  $17.22  for 1995,  and the
increase in average natural gas prices of $.58 per Mcf to $2.28 per Mcf for 1996
from $1.70 for 1995.

                                       21
<PAGE>

Costs  and  Expenses.  Total  costs  and  expenses,  excluding  the  write-down,
increased $10.8 million (152.6%) to $17.9 million for 1996 from $7.1 million for
1995.  Lease  operating  expenses and  production  taxes  increased $2.9 million
(138.1%) to $5.0  million for 1996 from $2.1 million for 1995  primarily  due to
the development of the GAU, the 1995 Acquisitions, the 1996 Acquisitions and the
Merger. Lease operating expenses per Mcfe decreased by $.08 to $.42 per Mcfe for
1996  from  $.50 per Mcfe for  1995.  This  decrease  is a result  of the  lower
operating costs of the acquired  properties combined with reductions in costs at
the GAU obtained through  economies of scale resulting from the additional wells
drilled during 1995 and 1996.

DD&A increased  $6.6 million  (211.0%) to $9.8 million for 1996 compared to $3.1
million for 1995. This increase is due to the increased production from the GAU,
the 1995 Acquisitions,  the 1996 Acquisitions and the Merger. The depletion rate
per Mcfe was  $1.11 for 1996  compared  to .91 for 1995.  This  increase  in the
depletion  rate is  primarily  due to downward  revisions  in  estimated  proved
reserves at December  31, 1995 and the  acquisition  costs  associated  with the
Merger.

At August 29, 1996, as a result of allocating  the cost of acquiring  Alexander,
under the  purchase  method of  accounting,  to the proved oil and  natural  gas
properties  acquired in  connection  with the Merger,  the Company  recognized a
non-cash  write-down  of the oil and  natural  gas  properties,  net of  related
deferred income taxes of $28.3 million,  based on prices received in August 1996
of  $20.75  per  Bbl and  $2.21  per  Mcf.  See  Note 2 of  Notes  to  Financial
Statements.

Although  G&A  increased  $1.3  million to $3.0  million for 1996,  G&A per Mcfe
decreased  to $.34  (33.3%)  for 1996  from  $.51 for  1995.  This  decrease  is
attributable  to the  increase  in  production  from the GAU,  the 1995 and 1996
Acquisitions and to a lesser extent the Merger, without a proportionate increase
in the G&A costs to the Company.

Other Income and  Expenses.  The  increase of $3.2 million  (320.0%) in interest
expense to $4.2  million  for 1996 from $1.0  million  for 1995,  was due to the
increase in the amount of  outstanding  debt as a result of  borrowings  under a
prior credit facility and the Credit Facility to fund the 1996  Acquisitions and
the Merger  during  1996,  and was  partially  offset by the decline in weighted
average  interest rates.  Also  contributing to the increase was the issuance of
the Senior  Notes.  The average  debt  outstanding  for 1996 was $41.4  million,
including the Senior Notes,  as compared to $10.6 million for 1995. The weighted
average interest rate for 1996 was 8.64% compared to 9.66% for 1995.

Net Loss. A net loss of $25.8 million was  generated  for 1996,  compared with a
net loss of $.2 million for 1995.  The loss for 1995  includes an  extraordinary
charge resulting from the write-off of unamortized loan costs  attributable to a
prior  credit  facility  which  was paid  off out of  proceeds  from the  Credit
Facility.  The net loss for 1996  includes a net  non-cash  write-down  of $28.3
million to the Company's oil and natural gas properties, partially offset by the
increased operating income generated by the GAU, the 1995 Acquisitions, the 1996
Acquisitions and the Merger. Also included in the net loss was a loss on sale of
marketable securities of $118,000 for 1996 as compared to a gain of $221,000 for
1995.

Year ended December 31, 1995 compared with year ended December 31, 1994.

Revenues.  Total revenues increased by $4.7 million (141.0%) to $8.0 million for
1995 from $3.3 million for 1994. The increase in revenues is principally  due to
the continued  development  of the GAU and the increase in production due to the
1995  Acquisitions.  In 1995, the Company  produced  283,440  barrels of oil, an
increase of 145.1% over 115,642  barrels in 1994,  and  1,752,990 Mcf of natural
gas,  an  increase  of 182.4%  over  620,843  Mcf in 1994.  The  increase in oil
production is almost  entirely a result of the GAU's  increased  oil  production
resulting  from  the  development  since  August  1994.  The  1995  Acquisitions
accounted for the increased  natural gas  production.  Also  contributing to the
increase in revenues  was the increase in average oil prices of $1.21 per barrel
to $17.22 for 1995 from  $16.01 for 1994.  The  decline in average  natural  gas
prices of $.41 per Mcf to $1.70 for 1995 down from  $2.11 for 1994 was offset by
the 182.4% increase in natural gas production.

Costs and Expenses.  Total costs and expenses increased $3.7 million (108.0%) to
$7.1 million for 1995 from $3.4 million for 1994.  Lease operating  expenses and
production  taxes increased  $764,420 (55.3%) to $2.1 million for 1995 from $1.4
million  for  1994  primarily  due to the  development  of the GAU and the  1995
Acquisitions.  Lease operating expenses and production taxes attributable to the
GAU  increased  $284,687  from  1994 to 1995,  representing  37.2% of the  total


                                       22
<PAGE>

increase  for  the  Company.  Lease  operating  expenses  and  production  taxes
attributable to the 1995  Acquisitions  totaled $256,059 for 1995,  representing
33.5% of the total  increase  for the Company  since those  properties  were not
purchased until 1995.  Lease operating  expenses as a percent of oil and natural
gas sales  decreased to 22.0% for 1995 from 38.2% for 1994.  This  decrease is a
result of the lower  operating costs of the acquired  properties,  reductions in
costs  at the GAU  obtained  through  economies  of  scale  resulting  from  the
additional wells drilled since August 1994 and fewer workovers  performed during
1995 than during 1994.

DD&A increased  $2.1 million  (205.8%) to $3.1 million for 1995 compared to $1.0
million  for  1994.  This  increase,  was,  in part,  related  to the  increased
production from the GAU and the 1995  Acquisitions.  In addition,  the depletion
rate on oil and  natural  gas  properties  increased  to $1.05  per Mcfe for the
fourth quarter from $0.79 per Mcfe due to downward revisions in estimated proved
reserves at December 31, 1995.

Although G&A increased $787,068 to $1.8 million for 1995, G&A per Mcfe decreased
to $0.51 (32.0%) for 1995 from $0.75 for 1994.  This decrease is attributable to
the increase in  production  from the "GAU" and the 1995  Acquisitions,  without
proportionate increase in G&A costs to the Company.

Other Income and Expenses.  The increase of $515,010 (99.6%) in interest expense
to $1.0 million for 1995 from $517,086 for 1994,  was due to the increase in the
amount  of  outstanding  debt as a result  of  borrowings  under a prior  credit
facility  with  Bank One  obtained  by the  Company  in 1994 (the  "1994  Credit
Facility") and was partially  offset by a decline in weighted  average  interest
rates.  The average debt  outstanding  for 1995 was $10.6 million as compared to
only $5.2 million for 1994.  The  weighted  average  interest  rate for 1995 was
9.66% as compared to 11.24% for 1994.  During 1995, the Company  realized a gain
of $220,582 on the sale of marketable securities.

Net Loss. Income before  extraordinary  item of $205,793 was generated for 1995,
compared  with a loss  before  extraordinary  item of  $489,369  for 1994.  This
increase is directly the result of the  increased  production on the GAU and the
increase in production  resulting from the 1995 Acquisitions.  Also contributing
to this  increase  was a realized  gain of  $220,582  on the sale of  marketable
securities in 1995.

A net loss of $225,969, after an extraordinary charge of $431,762, was generated
for 1995, compared with a net loss of $611,286, after an extraordinary charge of
$121,917, in 1994. The extraordinary charge in 1995 resulting from the write-off
of  unamortized  loan  costs  attributable  to Texas Gas Fund I credit  facility
obtained by the Company in June 1994 ("Texas Gas Fund I"),which was paid off out
of proceeds from the 1994 Credit Facility.  The extraordinary charge in 1994 was
in connection with the write-off of unamortized  loan costs  attributable to the
Company's  credit facility with Bank One obtained in 1992, which was paid off in
1994 with proceeds from the credit facility with Texas Gas Fund I.

Pro Forma Results of Operations

The  following  table sets forth  certain  information  regarding  the pro forma
combined production volumes,  oil and gas sales,  average sales prices,  average
lease  operating  expenses and general and  administrative  expenses,  operating
income and EBITDA assuming the 1995 Acquisitions,  the Merger and the Lake Boeuf
Acquisition  had been  consummated  on January 1, 1995.  The pro forma  combined
information  does not purport to represent  the actual  results which would have
occurred had the Merger been consummated on such date.

                                       23
<PAGE>

<TABLE>
<CAPTION>
                                                                    Pro Forma
                                                                    Year ended
                                                                   December 31,
                                                              1995            1996
<S>                                                          <C>             <C>
Net production:
         Oil (Mmbls)                                             475             608
         Natural gas (Mmcf)                                   11,830          10,887
         Natural gas equivalent (Mmcfe)                       14,680          14,538

Oil and natural gas sales (in thousands):
         Oil                                                 $ 8,030         $12,959
         Natural gas                                          17,981          23,648
         Total                                               $26,011         $36,607

Average sale price:
         Oil (per Bbl)                                        $16.95          $21.30
         Natural gas (per  Mcf)                                 1.52            2.17
         Natural gas equivalent (per  Mcfe)                     1.77            2.52
LOE per Mcfe                                                     .49             .43
G&A expenses per Mcfe                                            .35             .32

Operating income (loss)                                      ($3,297)        $10,776
EBITDA                                                       $12,586         $26,767
</TABLE>

Liquidity and Capital Resources.

Year ended December 31, 1996 compared with year ended December 31, 1995.

Net cash provided by operating  activities  was $11.8 million for the year ended
December  31, 1996,  compared to $2.9  million for the same period in 1995.  The
increase  in  cash  flow  from  operating  activities  is  primarily  due to the
significant  increase in income from  operations  before DD&A resulting from the
1995 Acquisitions, the 1996 Acquisitions and the Merger discussed above.

Net cash used in investing  activities  was $49.3 million for 1996 compared with
$16.7  million  for  1995.  This  increase  was  principally  due  to  increased
expenditures   for  oil  and  natural  gas  property   acquisitions,   the  1996
Acquisitions, the Merger, and exploration and development costs.

Net cash  provided by financing  activities  was $45.6 million for 1996 compared
with $17.4 million for 1995.  The cash provided by financing  activities  during
1996 primarily consisted of borrowings under credit facilities of $69.0 million,
net proceeds  from issuance of the Senior Notes of $96.1  million,  and proceeds
from the  issuance of  preferred  stock of $15.0  million,  partially  offset by
repayments of borrowings under various credit facilities and debt assumed in the
Merger aggregating  $141.5 million.  Borrowings under credit facilities in 1995
were used to fund acquisitions, development of the GAU and working capital.

The Company's  working capital at December 31, 1996 was $2.6 million compared to
a  deficit  at  December  31,  1995 of $2.3  million.  The  improvement  was due
primarily to refinancing of borrowings under a credit facility.

                                       24
<PAGE>

Year ended December 31, 1995 compared with year ended December 31, 1994.

At December 31, 1995, the Company had existing cash and cash equivalents of $6.1
million.  Net cash provided by operating  activities  was $2.9 million for 1995,
compared  to  $373,292  for 1994.  The  increase  in cash  flow  from  operating
activities  is  primarily  due  to  the  significant  increase  in  income  from
operations before DDA.

Net cash used in investing  activities  was $16.7 million for 1995 compared with
$3.8 million for 1994. This increase was  principally  due to  expenditures  for
development of the GAU and the cash used in the 1995 Acquisitions.

Net cash  provided by financing  activities  was $17.4 million for 1995 compared
with $5.9 million for 1994.  The cash  provided by financing  activities  during
1995  primarily  consisted of increased  borrowings  under a credit  facility of
$21.0  million and the net proceeds  from the issuance of the Series C Preferred
Stock of $4.0 million.  Borrowings  under the credit facility were used to repay
outstanding  borrowings  under the Texas Gas Fund I of $6.0  million and to fund
acquisitions, development of the GAU and working capital.

The  Company's  working  capital  deficit at December 31, 1995 was $2.3 million.
This deficit was primarily attributable to the inclusion of then current portion
of the borrowings under a credit facility which totaled $6.5 million,  which was
offset in part by an  increased  cash and  accounts  receivable  position.  Also
contributing to the working capital deficit was the increase in accounts payable
resulting from the increased development activities during 1995.

Future Capital Requirements

The  Company  has  made,  and  will  continue  to  make,   substantial   capital
expenditures for acquisition,  development and production of oil and natural gas
reserves, particularly since a substantial portion of the proved reserves of the
Company consists of proved undeveloped reserves.

The Company has established an aggregate  development  and  exploration  capital
budget for its existing  properties  of  approximately  $57 million for the year
ended December 31,1997. The Company is not contractually committed to expend the
budgeted funds.  The Company  currently  expects that available cash, cash flows
from  operations  and available  borrowings  under the Credit  Facility shall be
sufficient  to fund planned  capital  expenditures  for its existing  properties
through 1997. However,  the Company may need to raise additional capital to fund
acquisitions and the development thereof.

For the periods  following  1997, the Company may seek  additional  capital,  if
required, from traditional reserve base borrowings, equity and debt offerings or
joint  ventures to further  develop and  explore its  properties  and to acquire
additional  properties.  The Company's ability to access additional capital will
be available to the Company from any source or that, if available, it will be at
prices or on terms  acceptable  to the Company.  Should the Company be unable to
access the capital markets or should  sufficient  capital not be available,  the
development  and  exploration  of the Company's  properties  could be delayed or
reduced and, accordingly, oil and natural gas revenues and operating results may
be adversely affected.

Notes.

On November  1, 1996,  the Company  closed the  offering of $100  million of its
Senior  Notes.  The net  proceeds  of the Senior  Notes of  approximately  $96.1
million were used to repay  approximately  $62.0 million of borrowings under the
Credit  Facility and to increase the Company's  working  capital.  In 1997,  the
Senior  Notes were  exchanged  for the  Exchange  Notes which are  substantially
identical to the Senior Notes. Collectively, the Senior Notes and Exchange Notes
are  referred to as the "Notes".  The Notes bear  interest at 10 3/4% per annum,
payable semi-annually on May 1 and November 1, commencing May 1, 1997. The Notes
mature  November 1, 2006,  but may be redeemed  after  November 1, 2001,  at the
Company's option. The Indenture  governing the Notes contains certain covenants,
including,  but not  limited  to,  covenants  restricting  the  Company  and its
Restricted  Subsidiaries,  as defined, ability to incur additional indebtedness.
See Note 4 of Notes to Financial Statements.

                                       25
<PAGE>

Credit Facilities.

In August 1996, the Company consummated a $100.0 million reducing revolving line
of credit,  with an initial  borrowing  base of $60.0 million and a $5.0 million
term loan. The proceeds from the initial  borrowings  were used to refinance the
existing  indebtedness  of the Company and  Alexander.  On November 1, 1996 this
facility  was  paid  off  with  a  portion  of  the  proceeds  from  the  Notes.
Simultaneously,  the Company  entered into amendments with respect to the Credit
Facility.  The Credit  Facility  is a  revolving  line of credit with an initial
borrowing base of $25.0 million, $10.0 million of which may only be used to make
acquisitions  of producing oil and natural gas  properties.  The Credit Facility
contains certain covenants, including maintenance of a minimum interest coverage
ratio, a current ratio and a minimum  tangible net worth. See Note 3 of Notes to
the Consolidated Financial Statements.

Preferred Stock.

In June  1994,  the  Company  consummated  the sale of $5.0  million of Series B
Preferred Stock.  Fifty thousand shares of Series B Preferred Stock were sold by
the Company at $100 per share.  The Series B Preferred Stock is convertible into
shares of Common Stock at a conversion price of $1.625 per share.

In June  1995,  the  Company  consummated  the sale of $4.0  million of Series C
Preferred Stock.  Fifty thousand shares of Series C Preferred Stock were sold by
the Company at $100 per share.  The Series C Preferred Stock is convertible into
shares of Common  Stock at a  conversion  rate of $2.00 per share.  The Series B
Preferred  Stock and Series C Preferred  Stock require that dividends be paid on
the Series B Preferred  Stock and Series C Preferred  Stock before any dividends
are paid on Common Stock.

In August 1996,  the Company  completed  the sale of 100,000  shares of Series D
Preferred  Stock for $10.0 million and 50,000 shares of Series E Preferred Stock
for $5.0 million.  The Series D Preferred Stock and Series E Preferred Stock are
convertible  into  shares of  Common  Stock at a  conversion  price of $2.25 per
share. In conjunction therewith,  the Company agreed to extend the date at which
it may first redeem its Series B and Series C convertible  Preferred Stocks from
June 14, 1997 to June 14, 1999.

See Note 6 of Notes to Consolidated Financial Statements.

Financial Reporting Impact of Full Cost Method of Accounting.

The Company  follows the full cost method of accounting  for oil and natural gas
properties.  Under  such  method,  the net book value of such  properties,  less
related  deferred  income  taxes,  may not exceed a  calculated  "ceiling."  The
ceiling is the  estimated  after-tax  future net  revenues  from  proved oil and
natural gas  properties,  discounted at 10% per year. In calculating  future net
revenues,  prices  and costs in effect at the time of the  calculation  are held
constant  indefinitely,  except for changes which are fixed and  determinable by
existing contracts. The net book value is compared to the ceiling on a quarterly
and yearly basis. The excess, if any, of the net book value above the ceiling is
required  to be written  off as a non-cash  expense.  As a result of  allocating
additional cost, under the purchase method of accounting, to the oil and natural
gas properties in connection with the Merger,  the Company  recognized a noncash
write down of its oil and natural gas properties of approximately $28.3 million,
net of  deferred  taxes.  The  amount of the actual  write  down was  charged to
expense  in the third  quarter  of 1996,  the  period in which  the  Merger  was
consummated.  At December 31, 1996,  the ceiling  exceeded the net book value of
the Company's  oil and natural gas  properties  by  approximately  $75.0 million
based on the weighted  average prices of crude oil and natural gas,  received by
the Company at that date, of $25.36 per barrel and $3.72 per mcf,  respectively.
At March 25, 1997, the price of crude oil and natural gas had declined to $20.99
per barrel and $1.88 per mcf as quoted on the  Mercantile  Exchange  for oil and
the New York Mercantile Exchange for natural gas. Sustained decreases in oil and
natural gas prices could result in additional  write downs during 1997 or future
periods.

                                       26
<PAGE>

Changes in Prices and Inflation.

The Company's revenues and value of its oil and natural gas properties have been
and will  continue to be affected by changes in oil and gas prices.  Oil and gas
prices  are  subject  to  seasonal  and other  fluctuations  that are beyond the
Company's ability to control or predict.

During  1995 and 1996,  the  Company  hedged  crude oil and  natural  gas prices
through the use of commodity swap  agreements in an effort to reduce the effects
of the  volatility  of the price of crude oil and natural  gas on the  Company's
operations.  These  agreements  involve  the receipt of  fixed-price  amounts in
exchange for variable  payments based on NYMEX prices and specific  volumes.  In
connection with the commodity swap  agreements,  the Company may also enter into
basis swap  agreements  to reduce the  effects of unusual  fluctuations  between
prices  actually  received at the wellhead and NYMEX prices.  Through the use of
commodity price and basis swap  agreements,  the Company can fix the price to be
received for specified  volumes of  production to the commodity  swap price less
the basis swap price.  The  differential to be paid or received,  under the swap
agreement, is accrued in the month of the related production and recognized as a
component of crude oil and natural gas sales. The Company does not hold or issue
financial instruments for trading purposes.

While the use of hedging  arrangements limits the downside risk of adverse price
movements, it may also limit future gains from favorable movements.  All hedging
is  accomplished  pursuant to swap  agreements  based upon standard  forms.  The
Company addresses market risk by selecting  instruments whose value fluctuations
correlate  strongly with the  underlying  commodity  being  hedged.  Credit risk
related to hedging  activities is managed by requiring  minimum credit standards
for counter parties, periodic settlements,  and market to market valuations. The
Company  has not  been  required  to  provide  collateral  relating  to  hedging
activities.  At  December  31,  1996,  the  Company had no hedging or basis swap
agreements  outstanding.  During  1996,  the  Company  recognized  a net gain of
$20,315 related to hedging transactions.

Although  certain of the Company's  costs and expenses are affected by the level
of  inflation,  inflation  has not had a  significant  effect  on the  Company's
results of operations during the years ended December 31, 1994, 1995 and 1996.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

     The  Financial  Statements  of the  Company  required  by  this  Item 8 are
included as part of Item 14(a)(1) hereof.


ITEM 9.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
     FINANCIAL DISCLOSURE.

     None.

PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information  required by this Item 10 is set forth in the sections  entitled
"Election of Directors" and "Certain  Relationships  and Related  Transactions -
Section 16 Reporting" in the Company's  definitive  proxy statement for its 1997
Annual Meeting of  Shareholders  (the "Proxy  Statement"),  and is  incorporated
herein by reference.


                                       27
<PAGE>

ITEM 11. EXECUTIVE COMPENSATION.

The  information  required by this Item 11 is set forth in the section  entitled
"Executive  Compensation" in the Company's Proxy Statement,  and is incorporated
herein by reference.


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The  information  required by this Item 12 is set forth in the section  entitled
"Security  Ownership  of  Certain  Beneficial  Owners  and  Management"  in  the
Company's Proxy Statement, and is incorporated herein by reference.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The  information  required by this Item 13 is set forth in the section  entitled
"Certain   Relationships  and  Related  Transactions"  in  the  Company's  Proxy
Statement, and is incorporated herein by reference.


PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(a)  The following documents are filed as part of this report.

1.   Financial  Statements:  See Index to  Financial  Statements  and  Financial
     Statement Schedules on page F-1 of this report .

2.   Financial Statement  Schedules:  See Index to Financial Statement Schedules
     on page F-1 of this report.

3.   Exhibits: The following documents are filed as exhibits to this report.

     2.1  Agreement and Plan of Merger,  dated June 6, 1996,  among the Company,
NEG-OK, Inc. ("NEG OK"), and Alexander Energy Corporation ("Alexander")(1)

     2.2 First  Amendment to Agreement and Plan of Merger,  dated as of June 20,
1996, among the Company, NEG-OK and Alexander(2)

     2.3 Mutual  Waiver  Agreement  dated as of August 29, 1996 by and among the
Company, NEG-OK and Alexander(3)

     3.1  Certificate  of  Incorporation  of the  Company,  which  includes  the
Certificate of Incorporation of the Company filed with the Secretary of State of
Delaware  on  November  20,  1990(4),  the  Certificate  of  Elimination  of the
Redeemable  Convertible Preferred Stock, Series A of the Company, filed with the
office of the  Secretary  of State of the State of Delaware on June 2,  1994(3),
the  Certificate of Amendment of Certificate  of  Incorporation  of the Company,
filed  with the office of the  Secretary  of State of the State of  Delaware  on
August 29,  1996(3),  the  Certificate  of  Designations  of the  Company of 10%
Cumulative   Convertible  Preferred  Stock,  Series  B(5),  the  Certificate  of
Designations of the Company of 10 1/2% Cumulative  Convertible  Preferred Stock,
Series C(6),  the  Certificate  of  Designations  of the Company of  Convertible
Preferred Stock, Series D(3), and the Certificate of Designations of the Company
of Convertible Preferred Stock, Series E(3)

     3.2 By-laws of the Company(4)

     4.1   Certificate  of   Designations  of  the  Company  of  10%  Cumulative
Convertible Preferred Stock, Series B(5)

     4.2  Certificate  of  Designations  of the  Company  of 10 1/2%  Cumulative
Convertible Preferred Stock, Series C(6)



                                       28
<PAGE>

     4.3  Certificate of  Designations  of the Company of Convertible  Preferred
Stock, Series D(3)

     4.4  Certificate of  Designations  of the Company of Convertible  Preferred
Stock, Series E(3)

     4.5 Note  Agreement  dated as of April 25,  1989,  by and  among  AEJH 1989
Limited  Partnership,  Alexander and John Hancock Mutual Life Insurance (10 1/2%
Senior Secured Notes)(8)

     4.6 Letter dated August 29, 1996 between  Alexander and John Hancock Mutual
Life Insurance Company relating to the payment of the 1989 Notes(3)

     4.7  Indenture  dated as of November 1, 1996,  among the Company,  National
Energy Group of Oklahoma, Inc. (the "Guarantor"), formerly NEG-OK, and Bank One,
Columbus, N.A.(9)

     10.1 Crude Oil Purchase  Contract,  dated  November  30, 1992,  between the
Company and Plains Liquids Transport Inc.(10)

     10.2  Amendment to Crude Oil Purchase  Contract,  dated  November 17, 1993,
between the Company and Plains Liquids Transport, Inc.(5)

     10.3 Crude Oil  Purchase  Contract,  dated  February  8, 1993,  between the
Company  and  Plains  Marketing  and  Transportation  Inc.  and the  predecessor
contract,  the Crude Oil Purchase  Contract,  dated  November 12, 1991,  between
Sunnybrook Transmission, Inc. and TriSearch Inc.(10)

     10.4 Stock Purchase Agreement, dated as of June 2, 1994, among the Company,
Arbco  Associates  L.P.,   Offense  Group  Associates  L.P.,   Kayne,   Anderson
Nontraditional Investments L.P., and Opportunity Associates L.P.(5)

     10.5 Gaines Berland, Inc. Warrant, dated January 27, 1995(1)

     10.11 Purchase and Sale Agreement,  dated as of March 29, 1995, between the
Company and Enron Oil and Gas Company(6)

     10.12  Agreement  for Purchase  and Sale (Oak Hill),  dated April 12, 1995,
between the Company and Sierra 1994 I Limited Partnership(6)

     10.13  Agreement  for Purchase and Sale (Mustang  Island),  dated April 20,
1995, between the Company and Sierra Mineral Development, L.C.(6)

     10.14  Stock  Purchase  Agreement,  dated as of June 14,  1995,  among  the
Company,  Arbco Associates L.P., Offense Group Associates L.P., Kayne,  Anderson
Nontraditional Investments L.P., and Opportunity Associates L.P.(6)

     10.15 Executive  Employment  Agreement,  dated January 1, 1996, between the
Company and Miles D. Bender(11)

     10.16 Executive  Employment  Agreement,  dated January 1, 1996, between the
Company and R. Thomas Fetters, Jr.(11)

     10.17 Agreement,  dated January 1, 1996, between the Company and Randall A.
Carter(11)

     10.18 Agreement,  dated January 1, 1996,  between the Company and Robert A.
Imel(11)

     10.19 Executive  Employment  Agreement,  dated January 1, 1996, between the
Company and Melissa Rutledge(11)

     10.20 Executive  Employment  Agreement,  dated January 1, 1996, between the
Company and William T. Jones(11)



                                       29
<PAGE>

     10.22  Executive  Employment  Agreement,  dated June 6, 1996,  between  the
Company and David E. Grose(1)

     10.23  Executive  Employment  Agreement,  dated June 5, 1996,  between  the
Company and Sue Barnard(1)

     10.24  Executive  Employment  Agreement,  dated June 6, 1996,  between  the
Company and Jim L. David(1)

     10.25 Employment Agreement, dated June 6, 1996, between the Company and Bob
G. Alexander(1)

     10.26  Employment  Agreement,  dated June 6, 1996,  between the Company and
Roger G. Alexander(1)

     10.29 Prudential Securities Incorporated Warrant to Purchase 100,000 Shares
of the Company's Common Stock(3)

     10.30  Gaines  Berland,  Inc.  Warrant to  Purchase  300,000  Shares of the
Company's Common Stock(3)

     10.31  Gaines  Berland,  Inc.  Warrant to  Purchase  700,000  Shares of the
Company's Common Stock(3)

     10.32  Agreement dated January 1, 1996 between the Company and Sandefer Oil
& Gas, Inc.(1)

     10.33 Consulting Agreement dated January 1, 1996 between the Sandefer Oil &
Gas, Inc. and Potosky Oil & Gas, Inc. and Atocha Exploration, Inc.(1)

     10.34 Stock Purchase Agreement dated August 7, 1996 between the Company and
High River Limited Partnership(2)

     10.35 High River Limited  Partnership Warrant to purchase 700,000 Shares of
Common Stock, dated August 29, 1996(3)

     10.36 Stock  Purchase  Agreement  dated as of August 26, 1996,  between the
Company and Foremost Insurance Company, Arbco Associates,  L.P., Kayne, Anderson
Nontraditional Investments L.P., Offense Group Associates,  L.P., Topa Insurance
Company and Kayne, Anderson Offshore Limited (the "Series E Investors")(3)

     10.37 Form of Series E Investors' Warrants to purchase an aggregate 350,000
Shares of Common Stock, dated August 29, 1996(3)

     10.38  Agreement dated as of August 29, 1996 by and between the Company and
Prudential Securities Incorporated(3)

     10.40  Restated  Loan  Agreement  dated  August 29, 1996 among Bank One and
Credit Lyonnais New York Branch ("Credit Lyonnais") and the Company,  NEG-OK and
Boomer Marketing Corporation ("Boomer")(3)

     10.41  $50,000,000  Revolving  Note dated  August 29, 1996  payable to Bank
One(3)

     10.42  $50,000,000  Revolving  Note dated August 29, 1996 payable to Credit
Lyonnais(3)

     10.43 $2,500,000 Term Note dated August 29, 1996 payable to Bank One(3)

     10.44  $2,500,000  Term  Note  dated  August  29,  1996  payable  to Credit
Lyonnais(3)

     10.45 Unlimited Guaranty of NEG-OK dated August 29, 1996 for the benefit of
Bank One(3)

     10.46 Unlimited  Guaranty of NEG-OK,  dated August 29, 1996 for the benefit
of Credit Lyonnais(3)

     10.47 Unlimited Guaranty of Boomer dated August 29, 1996 for the benefit of
Bank One(3)



                                       30
<PAGE>

     10.48 Unlimited Guaranty of Boomer dated August 29, 1996 for the benefit of
Credit Lyonnais(3)

     10.49 Form of Deeds of Trust, Mortgages,  Security Agreements,  Assignments
of Production  and Financing  Statements  covering oil and gas properties of the
Company and NEG-OK, dated August 29, 1996(3)

     10.50 Sale and Purchase Agreement dated September 26, 1994 by and among JMC
Exploration, Inc., Ted Bowman, Chris Webb and John Abrahamson and Alexander(12)

     10.51 First Amendment to Sale and Purchase Agreement dated October 26, 1994
by and among JMC Exploration,  Inc., Ted Bowman,  Chris Webb and John Abrahamson
and Alexander(12)

     10.52  Alexander  Energy  Corporation  1986 Incentive Stock Option Plan, as
amended(13)

     10.53 Alexander Energy Corporation 1993 Stock Option Plan(14)

     10.54 Agreement of Limited  Partnership of AEJH 1985 Limited Partnership by
and between Alexander and John Hancock Mutual Life Insurance  Company,  together
with all amendments thereto(15)

     10.55 Agreement of Limited  Partnership of AEJH 1987 Limited Partnership by
and between Alexander and John Hancock Mutual Life Insurance  Company,  together
with all amendments thereto(15)

     10.56 Agreement of Limited  Partnership of AEJH 1989 Limited Partnership by
and between Alexander and John Hancock Mutual Life Insurance Company dated April
25, 1989(8)

     10.57 Limited  Partnership  Agreement of Energy and Environmental  Services
Limited  Partnership  dated May 15, 1991 by and between Energy and Environmental
Services,  Inc., as general partner,  and Alexander Energy  Corporation and REP,
Inc., as limited partners(15)

     10.58 Warrant Purchase Agreement among Alexander,  Hanifen, Imhoff Inc. and
The Principal/Eppler, Guerin & Turner, Inc.(16)

     10.59 Purchase Option Agreement (warrants) between American National Energy
Corporation and Gaines, Berland, Inc. dated September 14, 1993(8)

     10.60  Form of  Special  Severance  Agreements  between  Alexander  and the
technical  support staff of Alexander,  between NEG-OK and Cyndy Burris and John
Christofferson, respectively(8)

     10.61 Separation Policy of Alexander dated December 8, 1994(8)

     10.62 Asset  Purchase and Sale  Agreement  dated  September 30, 1996 by and
between the Company and Araxas Energy  Corporation,  Araxas SPV-1,  Inc., Araxas
Exploration, Inc. and O'Sullivan Oil and Gas Company, Inc.(9)

     10.63 Purchase  Agreement dated October 29, 1996, by and among the Company,
Guarantor  and Bear,  Stearns & Co.  Inc.,  Smith  Barney Inc.  and  Jefferies &
Company, Inc. (the "Initial Purchasers")(9)

     10.64  Registration  Rights  Agreement dated October 29, 1996, by and among
the Company, Guarantor and the Initial Purchasers(9)

     10.65 First  Amendment to Restated  Loan  Agreement  dated October 31, 1996
among Bank One and Credit Lyonnais and the Company, Guarantor and Boomer (9)

     23.1 Consent of Ernst & Young LLP, Independent Auditors (18)

     23.2  Consent  of  Netherland,   Sewell  &  Associates,  Inc.,  Independent
Petroleum Engineers (18)

     27.1 Financial Data Schedule(17)

                                       31
<PAGE>

     99.39  Certificate  of Merger with respect to the merger of Alexander  with
and into NEG-OK,  filed with the offices of the  Secretary of State of the State
of Delaware  and the  Secretary  of State of the State of Oklahoma on August 29,
1996(3)

         ---------------

(1)  Incorporated by reference to the Company's  Registration  Statement on Form
     S-4 (No. 333-9045), dated July 29, 1996.

(2)  Incorporated by reference to Amendment No. 1 to the Company's  Registration
     Statement on Form S-4 (No. 333-9045), dated August 7, 1996.

(3)  Incorporated  by reference  to the  Company's  Current  Report on Form 8-K,
     dated August 29, 1996.

(4)  Incorporated by reference to the Company's  Registration  Statement on Form
     S-4 (No. 33-38331), dated April 23, 1991.

(5)  Incorporated  by reference  to the  Company's  Current  Report on Form 8-K,
     dated June 17, 1994.

(6)  Incorporated  by reference  to the  Company's  Current  Report on Form 8-K,
     dated July 17, 1995.

(7)  Incorporated by reference to the Company's  Registration  Statement on Form
     S-3 (No. 33-81172), dated July 27, 1994.

(8)  Incorporated  by  reference  to  Alexander's  Form 10-K for the fiscal year
     ended December 31, 1994.

(9)  Incorporated  by reference to the Company's  Quarterly  Report on Form 10-Q
     for the quarter ended September 30, 1996.

(10) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
     the year ended December 31, 1992.

(11) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
     the year ended December 31, 1995.

(12) Incorporated by reference to Alexander's  Current Report on Form 8-K, dated
     November 14, 1994.

(13) Incorporated  by  reference  to  Alexander's  Registration  Statement  (No.
     33-20425), dated March 22, 1988.

(14) Incorporated  by  reference to  Alexander's  Proxy  Statement  for the 1993
     Annual Meeting of Stockholders.

(15) Incorporated  by  reference  to  Alexander's  Form 10-K for the fiscal year
     ended December 31, 1991.

(16) Incorporated  by reference to Alexander's  Amendment No. 1 to  Registration
     Statement (No. 33-57142), dated February 26, 1993.

(17) The Financial Data Schedule, for the year ended December 31, 1996, is filed
     herewith for EDGAR filings only.

(18) Filed herewith.

     -------------


(b)  No reports on Form 8-K were filed dring the last quarter of 1996.

                                       32
<PAGE>

GLOSSARY


Wherever used herein, the following terms shall have the meanings specified.

     Bbl - One stock tank barrel, or 42 US gallons liquid volume, used herein in
reference to crude oil or other liquid hydrocarbons.

     Bcf - One billion cubic feet.

     Bcfe - One billion cubic feet of natural gas equivalent.

     Behind  the  Pipe  -  Hydrocarbons  in  a  potentially   producing  horizon
penetrated by a well bore the production of which has been postponed pending the
production of hydrocarbons from another  formation  penetrated by the well bore.
The hydrocarbons are classified as proved but non-producing reserves.

     Boe - Barrels of oil equivalent  (converting  six Mcf of natural gas to one
Bbf of oil).

     Developed  Acreage - Acres which are  allocated or  assignable to producing
wells or wells capable of production.

     Development  Well - A well  drilled  within  the  proved  are of an oil and
natural  gas  reservoir  to the  depth of a  stratigraphic  horizon  known to be
productive.

     Dry Well - A well found to be incapable of producing  either oil or natural
gas in  sufficient  quantities  to justify  completion  as an oil or natural gas
well.

     EBITDA - Earnings (excluding discontinued operations,  extraordinary items,
charges  resulting  from  changes in  accounting  and  significant  nonrecurring
revenues  and  expenses)  before  interest  expense,  income  taxes,  depletion,
depreciation  and  amortization,  and the  provision  for  impairment of oil and
natural gas  properties.  EBITDA is not a measure of cash flow as  determined my
generally accepted accounting  principles.  EBITDA information has been included
in this  Prospectus  because  EBITDA is a measure  used by certain  investors in
determining  historical  ability to service  indebtedness.  EBITDA should not be
considered as an  alternative  to, or more  meaningful  than, net income or cash
flows as determined in accordance with generally accepted accounting  principles
as an indicator of operating performance or liquidity.

     Exploratory Well - A well drilled to find and produce oil or natural gas in
an unproved  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 know
reservoir.

     Gross Acres or Gross Wells - The total acres or wells,  as the case may be,
in which a working interest is owned.

     Infill Well - A well drilled  between known producing wells to better wells
to better exploit the reservoir.

     Mbbl - One thousand Bbl.

     Mmbbl - One million Bbl.

     Mboe - One thousand barrels of oil equivalent.

     Mcf - One thousand cubic feet.

     Mcfe - One thousand cubic feet of natural gas  equivalent,  using the ratio
of one Bbl of crude oil to six Mcf of natural gas.

     Mmcf - One million cubic feet of natural gas equivalent.



                                       33
<PAGE>

     Net Acres or Net Wells - The sum of the fractional  working interests owned
in gross acres or gross wells.

     NYMEX - New York Mercantile Exchange.

     Oil and  Natural  Gas Lease - An  instrument  by which a mineral  fee owner
grants to a lessee  the right for a specific  period of time to explore  for oil
and  natural  gas  underlying  the lands  covered  by the lease and the right to
product any oil and natural gas so discovered  generally for so long as there is
production in economic quantities from such lands.

     Overriding Royalty Interest - A fractional undivided interest in an oil and
natural  gas  property  entitling  the owner to a share of oil and  natural  gas
production, in addition to the usual royalty paid to the owner, free of costs of
production.

     PDNP - Proved developed, nonproducing or behind the pipe reserves.

     Productive  Well - A well that is  producing  oil or natural gas or that is
capable of production.

     Proved  Developed  Reserves - Reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods.

     Proved  Reserves - The estimated  quantities of crude oil,  natural gas and
natural gas liquids 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  Undeveloped  Reserves  or PUD - Reserves  that are  expected  to be
recovered  from new wells on undrilled  acreage,  or from existing wells where a
relatively major expenditure is required for completion.

     PV 10% - The  discounted  future net cash flows for proved oil and  natural
gas reserves computed on the same basis as the Standardized Measure, but without
deducting  income taxes,  which is not in  accordance  with  generally  accepted
accounting  principles.  PV 10% is an important financial measure for evaluating
the relative  significance  of oil and natural gas properties and  acquisitions,
but should not be construed as an  alternative to the  Standardized  Measure (as
determined in accordance with generally accepted accounting principles).

     Royalty Interest - An interest in an oil and natural gas property entitling
the  owner  to a share  of oil and  natural  gas  production  free of  costs  of
production.

     SEC - Securities and Exchange Commission.

     Secondary  Recovery - A method of oil and natural gas  extraction  in which
energy sources extrinsic to the reservoir are utilized.

     Standardized  Measure - The estimated future net cash flows from proved oil
and natural gas reserves computed using prices and costs, at the date indicated,
after income taxes and discounted at 10%.

     Undeveloped Acreage - Lease acreage on which wells have not been drilled or
completed to a point that would permit the  production of commercial  quantities
of oil and  natural gas  regardless  of whether  such  acreage  contains  proved
reserves.

     Working  Interest - The operating  interest which gives the owner the right
to drill,  produce and conduct operating  activities on the property and a share
of production, subject to all royalties,  overriding royalties and other burdens
and to all costs of  exploration,  development  and  operations and all risks in
connection therewith.



                                       34
<PAGE>
SIGNATURES

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

NATIONAL ENERGY GROUP, INC.

By:               /s/ Miles D. Bender                       March 31, 1997
                  -------------------
                  Miles D. Bender
                  President and Chief Executive Officer

By:               /s/ Robert A. Imel                        March 31, 1997
                  ------------------
                  Robert A. Imel
                  Chief Financial Officer and
                  Senior Vice President

By:               /s/ Melissa H. Rutledge                   March 31, 1997
                  -----------------------
                  Melissa H. Rutledge
                  Controller and Chief Accounting Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following  persons on behalf of the registrant and in the
capacities on March 31, 1997

By:               /s/Miles D. Bender
                  ------------------
                  Miles D. Bender
                  President,
                  Chief Executive Officer
                  and Director

By:               /s/George B. McCullough
                  -----------------------
                  George B. McCullough
                  Chairman of the Board
                  and Director

By:               /s/Norman C. Miller
                  -------------------
                  Norman C. Miller
                  Chairman, Executive
                  Committee and Director

By:               /s/ Robert H. Kite
                  ------------------
                  Robert H. Kite
                  Director

By:               /s/George M. McDonald
                  ---------------------
                  George M. McDonald
                  Director

By:               /s/Robert V. Sinnott
                  --------------------
                  Robert V. Sinnott
                  Director

By:               /s/Elwood W. Schafer
                  --------------------
                  Elwood W. Schafer
                  Director

By:               /s/Bob G. Alexander
                  -------------------
                  Bob G. Alexander
                  Director

By:               /s/Jim L. David
                  ---------------
                  Jim L. David
                  Vice President -
                  Exploitation and Director

By:               /s/Robert A. West
                  -----------------
                  Robert A. West
                  Director

By:               /s/Robert J. Mitchell
                  ---------------------
                  Robert J. Mitchell
                  Director
                                       35
<PAGE>


         INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

FINANCIAL STATEMENTS                                                       Page
                                                                          ------

Report of Independent Auditors........................................       F-2
Balance Sheets at December 31, 1995 and 1996..........................       F-3
Statements of Operations for the years ended December 31, 1994,
   1995 and 1996......................................................       F-4
Statements of Cash Flows for the years ended December 31, 1994,
   1995 and 1996......................................................       F-5
Statements of Changes in Stockholders' Equity for the years
   ended December 31, 1994, 1995 and 1996.............................       F-6
Notes to Financial Statements.........................................       F-8


FINANCIAL STATEMENT SCHEDULES

     All  schedules  for which  provision is made in the  applicable  accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.



                                      F-1
<PAGE>

                         REPORT OF INDEPENDENT AUDITORS

The Board of Directors
National Energy Group, Inc.

     We have audited the  accompanying  balance sheets of National Energy Group,
Inc.,  as of  December  31,  1995  and  1996,  and  the  related  statements  of
operations,  changes  in  stockholders'  equity,  and cash flows for each of the
three years in the period ended December 31, 1996.  These  financial  statements
are the  responsibility of the Company's  management.  Our  responsibility is to
express an opinion on these financial statements based on our audits.

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

     In our opinion,  the financial statements referred to above present fairly,
in all material respects, the financial position of National Energy Group, Inc.,
at December 31, 1995 and 1996,  and the results of its  operations  and its cash
flows for each of the three years in the period  ended  December  31,  1996,  in
conformity with generally accepted accounting principles.



                                                               ERNST & YOUNG LLP


Dallas, Texas
March 18, 1997




                                      F-2
<PAGE>

                           NATIONAL ENERGY GROUP, INC.

                                 BALANCE SHEETS
<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                                         1995             1996
                                                                                     ------------    ------------
<S>                                                                                   <C>             <C>
                                      ASSETS
Current assets:
   Cash and cash equivalents....................................................      $ 6,076,199     $14,182,246
   Marketable securities........................................................        1,824,724              --
   Accounts receivable-- oil and gas sales......................................        1,407,349       6,812,358
   Accounts receivable-- joint interest and other...............................          262,619       3,003,661
   Other........................................................................          335,751       1,131,736
                                                                                     ------------    ------------
Total current assets............................................................        9,906,642      25,130,001

Oil and gas properties, at cost (full cost method):
   Proved oil and gas properties................................................       37,493,394     169,863,109
   Unproved oil and gas properties..............................................          707,913      24,682,425
                                                                                     ------------    ------------
                                                                                       38,201,307     194,545,534
Accumulated depreciation, depletion, and amortization...........................        5,366,293      15,039,999
                                                                                     ------------    ------------
Net oil and gas properties......................................................       32,835,014     179,505,535

Other property and equipment....................................................          372,395       2,869,227
Accumulated depreciation........................................................          236,278         347,841
                                                                                     ------------    ------------
Net other property and equipment................................................          136,117       2,521,386

Other assets, net...............................................................          613,593       4,878,234
                                                                                     ------------    ------------
Total assets....................................................................      $43,491,366    $212,035,156
                                                                                     ============    ============
                        LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable-- trade.....................................................      $ 3,649,906    $ 12,012,655
   Accounts payable-- revenue and other.........................................          984,299       7,281,271
   Accounts payable-- broker margin.............................................          978,656              --
   Accrued merger costs.........................................................               --       1,462,724
   Accrued interest.............................................................          128,938       1,791,667
   Note payable and current portion of long-term debt...........................        6,500,000              --
                                                                                     ------------    ------------
Total current liabilities.......................................................       12,241,799      22,548,317

Other long-term liabilities.....................................................               --       1,786,813
Long-term debt, less current portion............................................       13,475,000              --
10 3/4% Senior Notes due 2006...................................................               --     100,000,000
Deferred income taxes...........................................................               --       7,273,829

Stockholders' equity:
   Convertible preferred stock, $1.00 par:
     Authorized shares 1,000,000
     Issued and outstanding shares -- 92,500 and 242,500 at December 31, 1995 and
       1996, respectively
     Aggregate liquidation preference -- $9,250,000 and $24,250,000 at December 31,
       1995 and 1996, respectively..............................................           92,500         242,500
   Common stock, $.01 par value:
     Authorized shares -- 50,000,000 and 100,000,000 at December 31, 1995 and 1996,
       respectively
     Issued and outstanding shares -- 11,880,125 and 35,977,140 at December 31,
       1995 and 1996, respectively..............................................          118,801         359,771

   Additional paid-in capital...................................................       21,485,224     110,293,386
   Unrealized loss on marketable securities, net................................         (247,492)             --
   Deficit......................................................................       (3,674,466)    (30,469,460)
                                                                                     ------------    ------------
Total stockholders' equity......................................................       17,774,567      80,426,197
                                                                                     ------------    ------------
Total liabilities and stockholders' equity......................................      $43,491,366    $212,035,156
                                                                                     ============    ============
</TABLE>
                             See accompanying notes.

                                      F-3
<PAGE>


                           NATIONAL ENERGY GROUP, INC.

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                                 Year ended December 31,
                                                                             1994         1995           1996
                                                                        ------------  ------------  -----------
<S>                                                                     <C>           <C>           <C>
Revenue:
   Oil and gas sales...............................................      $3,158,716   $  7,858,316  $24,319,398
   Well operator fees..............................................         157,845        136,943      876,247
                                                                        -----------   ------------  -----------
                                                                          3,316,561      7,995,259   25,195,645

Costs and expenses:
   Lease operating.................................................       1,207,251      1,732,124    3,740,525
   Oil and gas production taxes....................................         176,320        415,867    1,285,410
   Depreciation, depletion, and amortization.......................       1,029,986      3,149,464    9,795,283
   Writedown of oil and gas properties.............................              --             --   43,497,000
   General and administrative......................................         984,304      1,771,372    3,034,146
                                                                        -----------   ------------  -----------
                                                                          3,397,861      7,068,827   61,352,364
                                                                        -----------   ------------  -----------
Operating income (loss)............................................         (81,300)       926,432  (36,156,719)
Interest expense...................................................        (517,086)    (1,032,096)  (4,212,564)
Interest income and other, net.....................................         109,017         90,875      426,021
Gain (loss) on sale of marketable securities.......................              --        220,582     (117,955)
                                                                        -----------   ------------  -----------
Income (loss) before income taxes..................................        (489,369)       205,793  (40,061,217)
Benefit for income taxes...........................................              --             --  (14,503,595)
                                                                        -----------   ------------  ------------
Income (loss) before extraordinary item............................        (489,369)       205,793  (25,557,622)
Extraordinary loss on early extinguishments of debt................        (121,917)      (431,762)    (292,372)
                                                                        -----------   ------------  -----------
Net loss...........................................................       $(611,286)  $   (225,969)$(25,849,994)
                                                                        ============  ============= ============

Loss per common share:
   Loss before extraordinary item..................................       $    (.09)  $       (.05) $     (1.33)
                                                                        ============  ============= ============
   Net loss........................................................       $    (.10)  $       (.09) $     (1.34)
                                                                        ============  ============= ============
Weighted average number of common and common equivalent
   shares outstanding..............................................       8,476,821     10,701,635   19,939,975
                                                                        ============  ============= ============
</TABLE>

                             See accompanying notes.


                                       F-4
<PAGE>

                           NATIONAL ENERGY GROUP, INC.

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                   Year ended December 31,
                                                                              1994          1995           1996
                                                                         ------------- -------------  --------------
<S>                                                                      <C>           <C>            <C>
Operating Activities
Net loss.............................................................      $ (611,286) $   (225,969)   $(25,849,994)
Adjustments to reconcile net loss to net cash provided by
   operating activities:
     Depreciation, depletion, and amortization.......................       1,029,986     3,149,464       9,795,283
     Writedown of oil and gas properties.............................              --            --      43,497,000
     Amortization of loan costs......................................          19,114        21,060         151,063
     Amortization of deferred compensation...........................          41,694        39,809          36,083
     Benefit for deferred income taxes...............................              --            --     (14,503,595)
     Extraordinary loss on early extinguishment of debt..............         121,917       431,762         292,372
     Common stock, options, and warrants issued for services.........          64,290       104,614         216,206
     Loss (gain) on sale of marketable securities....................              --      (220,582)        117,955
     Changes in operating assets and liabilities  excluding
       effects of business acquisitions:
         Accounts receivable.........................................        (217,192)     (784,668)     (4,729,262)
         Accounts receivable from related parties....................              --        23,999              --
         Other current assets........................................        (101,530)     (108,615)       (320,601)
         Accounts payable and accrued liabilities....................          26,299       425,626       3,085,455
                                                                         ------------  ------------   -------------
Net cash provided by operating activities............................         373,292     2,856,500      11,787,965
                                                                         ------------  ------------   -------------

Investing Activities
Purchases of marketable securities...................................      (1,081,041)   (2,917,659)         (9,008)
Proceeds from sale of marketable securities..........................          35,176     2,111,890       1,675,669
Proceeds from broker margin..........................................              --       978,656              --
Purchases of other property and equipment............................         (48,632)      (42,950)     (1,553,355)
Oil and gas acquisition, exploration, and development expenditures...      (2,849,508)  (16,912,919)    (46,945,872)
Acquisition of Alexander Energy Corporation, net of cash acquired of               --            --      (2,455,993)
   $1,332,444........................................................
Proceeds from sales of oil and gas properties........................          90,500        69,306              --
Other ...............................................................          41,471       (11,963)         11,638
                                                                         ------------  -------------  -------------
Net cash used in investing activities................................      (3,812,034)  (16,725,639)    (49,276,921)
                                                                         ------------  ------------   -------------

Financing Activities
Proceeds from issuance of 10 3/4% Notes due 2006, net................              --            --      96,059,119
Proceeds from issuance of long-term debt, net........................       5,691,366    17,514,077      69,026,613
Proceeds from issuance of note payable...............................              --     3,000,000       8,000,000
Repayments of long-term debt.........................................      (4,200,000)   (6,875,000)   (130,510,233)
Repayments of note payable...........................................              --            --     (11,000,000)
Repayments of other long-term liabilities............................         (77,571)           --        (534,815)
Proceeds from exercise of stock options and warrants.................          35,938       467,987         499,704
Proceeds from issuance of convertible preferred stock, net...........       4,436,372     3,980,343      15,000,000
Preferred stock dividends............................................         (14,705)     (735,000)       (945,000)
Payments for redemption of fractional shares.........................            (477)         (714)           (385)
                                                                         ------------  ------------   -------------
Net cash provided by financing activities............................       5,870,923    17,351,693      45,595,003
                                                                         ------------  ------------   -------------

Increase in cash and cash equivalents................................       2,432,181     3,482,554       8,106,047
Cash and cash equivalents at beginning of period.....................         161,464     2,593,645       6,076,199
                                                                         ------------  ------------   -------------
Cash and cash equivalents at end of period...........................      $2,593,645  $  6,076,199    $ 14,182,246
                                                                         ============  ============   =============

Supplemental Cash Flow Information
Interest paid in cash................................................      $  457,949  $    983,075    $  2,549,835
                                                                         ============  ============   =============
</TABLE>
                             See accompanying notes.


                                      F-5
<PAGE>

                           NATIONAL ENERGY GROUP, INC.

                  STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                                                       Common Stock
                                                                                        Issuable
                                          Convertible                                  Under Asset
                                        Preferred Stock            Common Stock        Acquisition
                                       Shares       Amount      Shares       Amount     Agreement
                                       ------       ------      ------       ------     ---------
<S>                                   <C>         <C>        <C>           <C>         <C>
Balance at December 31, 1993......         --     $     --    7,844,732    $ 78,447    $  97,910
   Common stock issued upon
     exercise of options...........        --           --       62,500         625           --
   Common stock issued or issuable
     under asset acquisition
     agreements...................         --           --      200,000       2,000       38,125
   Issuance of Series B Preferred
     Stock........................     50,000       50,000           --          --           --
   Common stock issued for services        --           --       60,250         602           --
   Common stock issued upon
     conversion
     of Series A Preferred Stock..         --           --      425,000       4,250           --
   Common stock issued on
     conversion of long-term debt          --           --      415,054       4,151           --
   Unrealized gain on marketable
     securities...................         --           --           --          --           --
   Preferred stock dividends......      2,500        2,500           --          --           --
   Net loss.......................         --           --           --          --           --
                                   ----------   ----------  -----------  ----------  -----------
Balance at December 31, 1994......     52,500       52,500    9,007,536      90,075      136,035
   Common stock issued upon
     exercise of options and warrants      --           --      327,992       3,280           --
   Common stock issued under asset
     acquisition agreement........         --           --      300,000       3,000     (136,035)
   Common stock and warrants
     issued for services..........         --           --       13,000         130           --
   Common stock issued upon
     conversion of Class B Common
     Stock........................         --           --    1,166,796      11,668           --
   Common stock and warrants
     issued to acquire interests
     in oil and gas properties             --           --    1,064,801      10,648           --
   Issuance of Series C Preferred
     Stock........................     40,000       40,000           --          --           --
   Preferred stock dividends......         --           --           --          --           --
   Unrealized loss on marketable
     securities...................         --           --           --          --           --
   Net loss.......................         --           --           --          --           --
                                   ----------   ----------  -----------  ----------  -----------
Balance at December 31, 1995......     92,500       92,500   11,880,125     118,801           --
</TABLE>


<TABLE>
<CAPTION>
                                                       Gain (Loss)
                                         Additional    on Available                  Total
                                          Paid-In       for-Sale                  Stockholders'
                                          Capital      Securities      Deficit       Equity
                                          -------      ----------      -------       ------
<S>                                    <C>             <C>          <C>           <C>
Balance at December 31, 1993......     $  7,980,992    $      --    $(1,837,506)  $ 6,319,843
   Common stock issued upon
     exercise of options..........           35,313           --             --        35,938
   Common stock issued or issuable
     under asset acquisition
     agreements...................          123,000           --             --       163,125
   Issuance of Series B Preferred
     Stock........................        4,386,372           --             --     4,436,372
   Common stock issued for services          51,908           --             --        52,510
   Common stock issued upon
     conversion...................
     of Series A Preferred Stock..          420,720           --             --       424,970
   Common stock issued on
     conversion of long-term debt.          380,311           --             --       384,462
   Unrealized gain on marketable
     securities...................               --      136,285             --       136,285
   Preferred stock dividends......          247,500           --       (264,705)      (14,705)
   Net loss.......................               --           --       (611,286)     (611,286)
                                      -------------  -----------   ------------- -------------
Balance at December 31, 1994......       13,626,116      136,285     (2,713,497)   11,327,514

                                       F-6
<PAGE>


   Common stock issued upon
     exercise of options and warrants       464,707           --             --       467,987
   Common stock issued under asset
     acquisition agreement........          133,035           --             --            --
   Common stock and warrants
     issued for services..........           79,203           --             --        79,333
   Common stock issued upon
     conversion of Class B Common
     Stock........................          (11,668)          --             --            --
   Common stock and warrants
     issued to acquire interests
     in oil and gas properties....        3,269,003           --             --     3,279,651
   Issuance of Series C Preferred
     Stock........................        3,924,828           --             --     3,964,828
   Preferred stock dividends......               --           --       (735,000)     (735,000)
   Unrealized loss on marketable
     securities...................               --     (383,777)            --      (383,777)
   Net loss.......................               --           --       (225,969)     (225,969)
                                      -------------  -----------   ------------- -------------
Balance at December 31, 1995......       21,485,224     (247,492)    (3,674,466)   17,774,567
</TABLE>




                                      F-7
<PAGE>

                           NATIONAL ENERGY GROUP, INC.

            STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)
<TABLE>
<CAPTION>
                                                                                              Common Stock
                                                                                                Issuable
                                             Convertible                                       Under Asset
                                           Preferred Stock              Common Stock           Acquisition
                                         Shares        Amount        Shares       Amount        Agreement
                                         ------        ------        ------       ------        ---------
   <S>                                  <C>          <C>           <C>          <C>            <C>
   Common stock issued upon
     exercise  of options and warrants        --     $      --        351,242    $  3,513       $      --
   Common stock, options, and
     warrants issued for services.....        --            --         50,000         500              --
   Common stock issued to acquire
     interests in oil and gas
     properties.......................        --            --      2,416,332      24,163              --
   Issuance of Series D and E
     Convertible Preferred Stock
     and related warrants to
     purchase common stock............   150,000       150,000            --          --               --
   Common stock, stock options,
     and warrants issued or assumed
     in acquisition of Alexander
     Energy Corporation...............        --            --     21,279,441     212,794              --

   Preferred stock dividends..........        --            --            --          --               --
   Change in unrealized gain on
     marketable securities............        --            --            --          --               --
   Net loss...........................        --            --            --          --               --
                                         -------      --------     ----------   ---------        ---------
Balance at December 31, 1996..........   242,500      $242,500     35,977,140    $359,771        $     --
                                         =======      ========     ==========   =========        =========
</TABLE>

<TABLE>
<CAPTION>
                                                       Unrealized
                                                       Gain (Loss)
                                          Additional  on Available                     Total
                                           Paid-In      for-Sale                   Stockholders'
                                           Capital     Securities       Deficit       Equity
                                           -------     ----------       -------       ------
   <S>                                  <C>             <C>          <C>           <C>
   Common stock issued upon
     exercise of options and warrants   $    496,191    $      --    $        --   $   499,704
   Common stock, options, and
     warrants issued for services.....       215,706           --             --       216,206
   Common stock issued to acquire
     interests in oil and gas
     properties.......................     8,319,203           --             --     8,343,366
   Issuance of Series D and E
     Convertible Preferred Stock
     and related warrants to
     purchase common stock............    14,850,000           --             --    15,000,000
   Common stock, stock options,
     and warrants issued or assumed
     in acquisition of Alexander
     Energy Corporation...............    64,927,062           --             --    65,139,856
   Preferred stock dividends..........            --           --       (945,000)     (945,000)
   Change in unrealized gain on
     marketable securities............            --      247,492             --       247,492
   Net loss...........................            --           --    (25,849,994)  (25,849,994)
                                       -------------  -----------   ------------- ------------
Balance at December 31, 1996..........  $110,293,386    $      --   $(30,469,460)  $80,426,197
                                       =============  ===========   ============= ============

</TABLE>

                             See accompanying notes.


                                      F-8
<PAGE>


                           NATIONAL ENERGY GROUP, INC.

                          NOTES TO FINANCIAL STATEMENTS
                                December 31, 1996


1. Significant Accounting Policies

  Organization and Business

     National Energy Group, Inc. (the "Company") was incorporated under the laws
of the State of  Delaware on November  20,  1990.  The Company is engaged in the
acquisition, development, and production of crude oil and natural gas.

  Accounting Estimates

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

  Cash and Cash Equivalents

     Cash  and  cash  equivalents   include  demand  deposits  and  money-market
investments with maturities of three months or less when purchased.  At December
31, 1995 and 1996,  all cash and cash  equivalents  were invested with Bank One,
Texas, N.A. ("Bank One").

  Marketable Securities

    The Company's  marketable  securities are classified as  available-for-sale.
Available-for-sale  securities  are carried at fair value,  with the  unrealized
gains and losses,  net of tax, reported as a separate component of stockholders'
equity.   Realized  gains  and  losses  and  declines  in  value  judged  to  be
other-than-temporary  are included in interest  income.  The cost of  securities
sold is based on the specific identification method.

     The following is a summary of available-for-sale securities at December 31,
1995 (none in 1996):
<TABLE>
<CAPTION>
                                                                      Gross             Gross
                                                                   Unrealized        Unrealized         Estimated
                                                     Cost             Gains            Losses          Fair Value
                                                     ----             -----            ------          ----------
     <S>                                         <C>                <C>             <C>               <C>
     Common stocks...........................    $ 2,072,216        $1,026           $ 248,518        $ 1,824,724
                                                 ===========        ======           =========        ===========
</TABLE>

     The marketable securities were comprised of securities of other independent
oil and gas companies. The common stock of one oil and gas company accounted for
62% of the estimated fair market value of the total  marketable  securities held
at December 31, 1995.

    During  the years  ended  December  31,  1995 and  1996,  the  Company  sold
available-for-sale  securities  with a  fair  value  at  the  date  of  sale  of
$2,111,890 and $1,675,669,  respectively. The gross realized gains on such sales
totaled  $224,443 in 1995 and $9,765 in 1996. The gross realized  losses on such
sales totaled $3,861 and $127,720 during 1995 and 1996, respectively.

  Accounts Receivable

    The  Company  sells  crude oil and  natural  gas to  various  customers.  In
addition,  the Company participates with other parties in the operation of crude
oil  and  natural  gas  wells.  Substantially  all  of  the  Company's  accounts
receivable  are due from  either  purchasers  of crude  oil and  natural  gas or
participants in crude oil and natural gas





                                      F-9
<PAGE>



                           NATIONAL ENERGY GROUP, INC.

                    NOTES TO FINANCIAL STATEMENTS (continued)
                                December 31, 1996


wells for which the Company  serves as the  operator.  Generally,  operators  of
crude oil and natural gas  properties  have the right to offset future  revenues
against  unpaid  charges  related to operated  wells.  Crude oil and natural gas
sales are generally unsecured.

  Natural Gas Production Imbalances

    The Company  accounts for natural gas production  imbalances using the sales
method,  whereby the Company  recognizes  revenue on all natural gas sold to its
customers  notwithstanding  the fact that its ownership may be less than 100% of
the natural gas sold.

 Oil and Gas Properties

    The Company  utilizes the full cost method of  accounting  for its crude oil
and natural gas  properties.  Under the full cost  method,  all  productive  and
nonproductive  costs incurred in connection with the  acquisition,  exploration,
and  development  of crude oil and  natural gas  reserves  are  capitalized  and
amortized on the  units-of-production  method based upon total proved  reserves.
The costs of unproven properties are excluded from the amortization  calculation
until the individual  properties are evaluated and a determination is made as to
whether  reserves exist.  Capitalized  costs are limited to the aggregate of the
present value of future net reserves plus the lower of cost or fair market value
of unproved properties.  Conveyances of properties, including gains or losses on
abandonments of properties,  are treated as adjustments to the cost of crude oil
and natural gas properties,  with no gain or loss  recognized.  The Company does
not believe that future costs related to dismantlement,  site  restoration,  and
abandonment  costs,  net of estimated  salvage  values,  will have a significant
effect on its results of  operations or financial  position  because the salvage
value of  equipment  and related  facilities  should  approximate  or exceed any
future expenditures for dismantlement,  restoration, or abandonment. The Company
has not incurred any net  expenditures  for costs of this nature during the last
two years.

    The  Company has  capitalized  internal  costs of  $158,961,  $141,516,  and
$487,835 for the years ended December 31, 1994,  1995,  and 1996,  respectively.
Such  capitalized  costs include  salaries and related  benefits of  individuals
directly  involved in the Company's  acquisition,  exploration,  and development
activities based on the percentage of their time devoted to such activities.

  Other Property and Equipment

    Other property and equipment  includes gas  processing and field  production
facilities,  furniture,  fixtures, and other equipment. Such assets are recorded
at cost  and are  depreciated  over  their  estimated  useful  lives  using  the
straight-line method.

    Maintenance  and repairs  are charged  against  income  when  incurred;  and
renewals  and  betterments,  which  extend  the  useful  lives of  property  and
equipment, are capitalized.

  Income Taxes

    The Company uses the liability method in accounting for income taxes.  Under
the liability  method,  deferred tax assets and liabilities are determined based
on  differences  between  financial  reporting  and  tax  bases  of  assets  and
liabilities  and are measured  using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.

  Natural Gas Hedging Activities

    In 1995 and 1996,  the Company  hedged natural gas prices through the use of
commodity  price  swap  agreements  in an effort to reduce  the  effects  of the
volatility  of the  price of  natural  gas on the  Company's

                                      F-10
<PAGE>

operations.  These  agreements  involve  the receipt of  fixed-price  amounts in
exchange for variable  payments based on NYMEX prices and specific  volumes.  In
connection with the commodity price swap agreements,  the Company may also enter
into basis swap agreements to reduce the effects of unusual fluctuations between
prices  actually  received at the wellhead and NYMEX prices.  Through the use of
commodity price and basis swap  agreements,  the Company can fix the price to be
received for specified  volumes of  production to the commodity  swap price less
the basis swap price.  The  differential  to be paid or received  under the swap
agreement is accrued in the month of the related production and recognized as an
adjustment  to oil and gas sales.  The Company does not hold or issue  financial
instruments for trading purposes.

  Stock Options

    The Company has elected to follow  Accounting  Principles  Board Opinion No.
25,  "Accounting  for Stock Issued to Employees"  (APB 25) in accounting for its
employee  stock  options.  Under APB 25, if the exercise  price of an employee's
stock options equals or exceeds the market price of the underlying  stock on the
date of grant, no compensation expense is recognized.

  Earnings (Loss) Per Share

    Primary  earnings  (loss) per common  and  common  equivalent  share data is
computed by dividing net income  (loss),  adjusted for preferred  stock dividend
requirements  of $264,705,  $735,000,  and $945,000  for 1994,  1995,  and 1996,
respectively,  by the weighted  average  number of common and common  equivalent
shares outstanding during each period.  Shares issuable upon exercise of options
and warrants are included in the  computation  of earnings per common and common
equivalent  share to the extent that they are dilutive.  Fully diluted  earnings
(loss) per share  computations  also  assume  the  conversion  of the  Company's
preferred stock (Note 5) if such conversion has a dilutive effect.

    For the years ended December 31, 1994,  1995,  and 1996,  neither the common
equivalent  shares  nor the  assumed  conversion  of the  preferred  stock had a
dilutive effect on the loss per share  calculations.  Accordingly,  the loss per
share  calculations for such periods are based on the weighted average number of
common shares outstanding during each year.

  Reclassifications

    Certain  previously  reported amounts have been reclassified to conform with
the current presentation.

2. Acquisitions

     During 1994, the Company  acquired an additional  17.0% working interest in
the  Goldsmith  Adobe Unit  ("GAU").  Such interest was acquired for $584,095 in
cash. The Company is the operator of the GAU and holds a 91.8% working  interest
in the GAU.

    In April  1995,  the  Company  purchased a 100%  working  interest  (77% net
revenue  interest)  in State of Texas Lease No.  69153 and the State Tract 901-S
Field, Nueces County,  Texas ("Mustang Island") for $900,000 in cash and 352,500
shares of Common  Stock.  The cash  portion of the  acquisition  was funded from
available cash.

    In June 1995,  the  Company  completed  the  acquisition  of  producing  gas
properties in the Oak Hill Field ("Oak Hill") in Rusk County,  Texas, which is a
component of the Cotton Valley Trend. The consideration  paid by the Company for
Oak Hill  consisted of  $7,200,000 in cash,  612,301  shares of Common Stock and
warrants  to  purchase  200,000  shares of Common  Stock at a price per share of
$2.00.  The cash portion of the acquisition  was funded  primarily by borrowings
under a credit facility with Bank One.

                                      F-11
<PAGE>

    In  addition,  in June  1995,  the  Company  completed  the  acquisition  of
producing oil and gas  properties in Eddy County,  New Mexico from Enron Oil and
Gas Company (the "Enron  Properties")  for $2,119,295 in cash. This  acquisition
was funded by  borrowings  under a credit  facility  with Bank One and available
cash.

    The  following  pro forma data  presents  the results of the Company for the
years ended December 31, 1994 and 1995, as if the acquisition of Mustang Island,
Oak Hill,  and the Enron  Properties  had  occurred on January 1, 1994.  The pro
forma results of operations are presented for comparative  purposes only and are
not necessarily indicative of the results which would have been obtained had the
acquisitions been consummated as presented. The following data reflect pro forma
adjustments for the oil and gas revenues, production costs, and depreciation and
depletion  related to the properties  and additional  interest on borrowed funds
(in thousands, except per share amounts).
<TABLE>
<CAPTION>
                                                                                     Pro Forma
                                                                              Year ended December 31,
                                                                               1994                   1995
                                                                       ----------------      -------------
<S>                                                                    <C>                   <C>
                                                                                       (Unaudited)
Revenues...........................................................     $        5,051       $       $9,254
                                                                       ===============       ==============
Loss before extraordinary item.....................................     $         (573)      $           --
                                                                       ===============       ==============
Loss before extraordinary item per common share....................     $         (.06)      $         (.06)
                                                                       ===============       ==============
</TABLE>

    In January  1996,  the  Company  completed  the  acquisition  of oil and gas
properties in offshore Nueces County,  Texas,  adjacent to the Company's Mustang
Island  property,  from C/A Limited,  Chartex  Petroleum  Company,  and Petrotex
Engineering  Company.  The  acquisition  includes  interests  in five  wells,  a
pipeline and separation  facility related to Mustang Island.  The  consideration
for this  acquisition  consisted of 140,857 shares of the Company's Common Stock
and $675,000 in cash.

     In February 1996, the Company  completed the acquisition of two oil and gas
wells on one offshore  block,  interests in five other  offshore  blocks,  and a
related  production  platform and equipment in offshore  Nueces  County,  Texas,
adjacent  to  the  Company's   Mustang  Island  property,   from  UMC  Petroleum
Corporation  (the "UMC  Acquisition").  The  consideration  for this acquisition
consisted of $1.5 million in cash,  which was funded  primarily from  borrowings
under a credit agreement with Bank One.

    In April  1996,  the Company won  exploration  rights on 16 offshore  tracts
(covering  7,765 acres) in the Mustang  Island area in offshore  Nueces  County,
Texas  through  successful  bids  with  the  State  of  Texas  ("Offshore  Lease
Acquisition").  The Company paid  $1,437,302 in cash for these  rights,  and the
purchase  was funded by  borrowings  under a credit  facility  with  BankOne and
available cash.

    On August 29,  1996,  the Company  completed  the  acquisition  of Alexander
Energy  Corporation  ("Alexander").  The transaction  consisted of a merger (the
"Merger") of Alexander  with and into National  Energy Group of Oklahoma,  Inc.,
formerly  known as  NEG-OK,  Inc.,  a  wholly-owned  subsidiary  of the  Company
("NEG-OK").  Pursuant to the Merger,  (a) the  separate  corporate  existence of
Alexander  terminated,  (b) each share of Alexander common stock, par value $.03
per share  ("Alexander  Common Stock"),  together with certain rights associated
with the Alexander Common Stock outstanding  immediately before the Merger, were
converted into 1.7 shares of the Company's Common Stock, and (c) all outstanding
options and  warrants to purchase  Alexander  Common  Stock were  assumed by the
Company and converted  into options and warrants to purchase  Common  Stock.  In
lieu of fractional shares,  Alexander shareholders otherwise entitled to receive
fractional  shares of Common  Stock were paid in cash an amount  equal to $4.375
multiplied  by the  fraction  of a share  of  Common  Stock to be  received.  On
December 31, 1996,  NEG-OK was merged into and with the Company and its separate
corporate existence ceased to exist.

                                      F-12
<PAGE>

    In connection with the Merger, on August 29, 1996, the Company,  NEG-OK, and
Boomer Marketing Corporation ("Boomer Marketing"),  a wholly-owned subsidiary of
NEG-OK,  entered into a new credit facility. See Note 3. On August 29, 1996, the
Company  also  closed the sale of 100,000  shares of its  Convertible  Preferred
Stock,  Series D,  $1.00 par value per share,  the sale of 50,000  shares of its
Convertible  Preferred Stock,  Series E, $1.00 par value per share, and warrants
to purchase 1,050,000 shares of Common Stock. See Note 6.

    The cost of acquiring Alexander was approximately $69.4 million,  consisting
of the following (in thousands):

Fair value of 21.1 million shares of the Company's Common
  Stock issued........................................................   $63,404
Cost of 105,740 shares of NEG-OK common stock owned by the
  Company.............................................................       288
Alexander stock options and warrants assumed..........................       340
Fair value of 122,324 shares of the Company's
  Common Stock and 800,000 warrants issued for services
  provided by investment advisors.....................................     1,322
Other investment advisor, legal, and accounting professional
  fees and other Merger related costs.................................     4,009
                                                                           -----
                                                                         $69,363
                                                                         =======

     The fair value of the securities  issued in connection  with the Merger was
calculated  using the price of the Company's Common Stock at the time the Merger
was announced to the public of $3.00 per share.

    The Company's  purchase price has been allocated to the consolidated  assets
and liabilities of NEG-OK based on preliminary estimates of fair values with the
remaining purchase price allocated to proved oil and gas properties. No goodwill
has been recorded in this transaction.

    The  preliminary  allocation of the purchase  price is summarized as follows
(in thousands):

Working capital (deficit) assumed, excluding current portion
  of long-term debt.................................................$       (87)
Oil and gas properties:
  Proved............................................................    132,756
  Unproved..........................................................      6,319
Other property and equipment........................................        970
Other non-current assets............................................        198
Long-term debt assumed..............................................    (45,853)
Other non-current liabilities assumed...............................     (3,163)
Deferred income taxes...............................................    (21,777)
                                                                       ---------
                                                                      $  69,363
                                                                      ==========


    Under the full cost method of accounting,  the carrying value of oil and gas
properties (net of related  deferred taxes) is generally not permitted to exceed
the sum of the present  value (10% discount  rate) of estimated  future net cash
flows, after tax, from proved reserves,  based on current prices and costs, plus
the lower of cost or  estimated  fair value of  unproved  properties  (the "cost
center  ceiling").  Based upon the  combined  cost center  ceiling at August 29,
1996,  and the  preliminary  allocation of the  Company's  purchase  price,  the
purchase  price  allocated to oil and gas  properties  was in excess of the cost
center  ceiling  using oil and natural gas prices being  received by the Company
and NEG-OK in August  1996 of $20.75 per Bbl and $2.21 per Mcf.  Such excess was
written off at the date of  acquisition,  resulting in a charge to the Company's
results of operations of $28.3 million as follows (in thousands):

Writedown of oil and gas properties...................................$  43,497
Deferred income tax benefit...........................................  (15,224)
                                                                      ----------
                                                                      $  28,273
                                                                      ==========

                                      F-13
<PAGE>

    In  September  1996,  the Company  acquired  an  approximate  87.5%  working
interest in two wells and certain proved undeveloped  reserves in the South Lake
Boeuf Field, La Fourche  Parish,  Louisiana (the "Lake Boeuf  Acquisition")  for
approximately  $7.2  million,  consisting  of $1.5 million in cash and 1,758,460
shares of Common Stock.

    The  following  pro forma data  presents  the results of the Company for the
years  ended  December  31,  1995 and 1996,  as if the  acquisitions  of Mustang
Island,  Oak Hill, the Enron Properties,  NEG-OK, and the Lake Boeuf Acquisition
had occurred on January 1, 1995.  The  historical  results of the CA Acquisition
and  the  UMC  Acquisition  were  not  significant.  The pro  forma  results  of
operations are presented for  comparative  purposes only and are not necessarily
indicative of the results  which would have been  obtained had the  acquisitions
been consummated as presented.  The following data reflect pro forma adjustments
for oil and gas revenues, production costs, depreciation,  and depletion related
to  the  properties  and  businesses  acquired,   interest  on  borrowed  funds,
additional  preferred  stock dividend  requirements,  and the related income tax
effects (in thousands, except per share amounts).

                                                               Pro Forma
                                                         Year ended December 31,
                                                           1995          1996
                                                        ----------  ------------
                                                              (Unaudited)
Total revenues.........................................$   28,790   $    38,818
                                                       ===========  ============
Income (loss) before extraordinary item................$   (6,131)  $     3,652
                                                       ===========  ============
Income (loss) before extraordinary item per share......$     (.20)  $       .06
                                                       ===========  ============


In October 1996, the Company acquired certain leasehold interests located in the
Easy Bayou Sorrel Field, Iberville Parish, Louisiana from W&T Offshore, Inc. The
consideration  paid by the Company  consisted of $3,300,000 in cash. In November
1996,  the Company  completed the  acquisition of oil and natural gas properties
and related  facilities  located in the Bayou Sorrel  Field,  Iberville  Parish,
Louisiana.  The consideration  paid by the Company consisted of $9,025,000 cash,
477,612  shares of the  Company's  Common Stock and  conveyance of 3% overriding
royalty  interest in the property  acquired,  limited to production below 11,000
feet.  In  December  1996,  the  Company  acquired  certain  oil and natural gas
properties located in the East Bayou Sorrel Field, Iberville Parish,  Louisiana.
The  consideration  paid by the Company  consisted of  $7,000,000  in cash.  The
Company funded the cash portion of these acquisitions from available cash. These
acquisitions consisted principally of proved developed nonproducing and unproved
properties and, accordingly,  did not have a significant impact on the Company's
results of operations for 1996.

3. Credit Facilities

    Borrowings  of $6,000,000  were  outstanding  at December 31, 1994,  under a
credit  facility with Texas Gas Fund I. A portion of the proceeds from the Texas
Gas Fund I facility were used to repay the Company's previous loan with Bank One
which resulted in an extraordinary charge of $121,917, or $.01 per common share.

    In June 1995, the Company consummated a $33,000,000  reducing revolving line
of credit  facility  (the "Prior  Credit  Facility")  with Bank One. The initial
advance  under the  Facility of  $12,500,000  was used to pay off the  Company's
credit  facility  with  Texas  Gas Fund I, to  purchase  Oak Hill and the  Enron
Properties (Note 2), and for closing fees. The repayment of borrowings under the
Texas Gas Fund I facility  resulted  in an  extraordinary  charge of $431,762 or
$.04 per common share.

    At December 31, 1995,  the Prior  Credit  Facility  consisted of a revolving
note of up to  $30,000,000,  subject to a borrowing base, and an advance note of
up to  $3,000,000  (primarily  for the  development  of  GAU).  Interest  on the


                                      F-14
<PAGE>


revolving  note was at a rate of prime plus 1% (subject to  reduction in certain
circumstances)   or  LIBOR  plus  3.75%   (subject  to   reduction   in  certain
circumstances),  at the Company's option.  Interest on the advance note was at a
rate of prime plus 4%. Payments of interest and principal were made monthly. The
Facility was secured by all of the Company's  principal  oil and gas  properties
and  related  equipment,   oil  and  gas  inventory,  and  related  receivables.
Prepayments  were allowed at any time.  At December  31,  1995,  the Company had
$16,975,000  outstanding  under the revolving  note and  $3,000,000  outstanding
under the advance note.

     On August 29, 1996, the Company, NEG-OK and Boomer Marketing,  entered into
a  credit  facility  (the  "Credit   Facility")  with  Bank  One,  as  Bank  and
Administrative  Agent,  and the Credit  Lyonnais  New York  Branch,  as Bank and
Syndication Agent (collectively,  the "Banks"). The Credit Facility consisted of
a $100.0 million reducing  revolving line of credit,  with an initial  borrowing
base of $60.0 million and a $5.0 million term loan.  Interest under the reducing
revolving  line of credit was  payable  monthly  at the Bank One base rate.  The
proceeds from the Credit  Facility were used to repay the Prior Credit  Facility
and the existing indebtedness of NEG-OK, resulting in an extraordinary charge of
$292,372 or $.01 per common share.

     On November 1, 1996, the Company repaid the  outstanding  borrowings  under
the Credit  Facility  with a portion of  proceeds  from the  issuance  of $100.0
million  principal amount of 10 3/4% Senior Notes due 2006 (the "Senior Notes").
See Note 4.

     In connection  with the issuance of the Senior Notes,  the Company  amended
the  Credit  Facility.  The  borrowing  base,  pursuant  to the  amended  Credit
Facility,  was reduced to $25.0  million,  limited to $15.0  million for general
corporate  purposes and $10.0 million for  acquisitions of producing oil and gas
properties.  The borrowing base will be redetermined at least  semiannually  and
may require mandated monthly principal reductions by an amount determined by the
Banks from time to time.  No principal  reductions  will be required  before the
next borrowing base  redetermination  scheduled for April 1, 1997. The principal
is due at  maturity,  August  29,  2000.  Interest  is  payable  monthly  and is
calculated at the Bank One base rate,  as  determined  from time to time by Bank
One (which increases by .25% if the outstanding loan balance is greater than 75%
of the borrowing  base).  The Company may elect to calculate  interest under the
EuroDollar  Rate, as defined in the Credit  Facility.  At December 31, 1996, the
Company had no outstanding indebtedness under the amended Credit Facility.

     The Company is required to pay a  commitment  fee on the unused  portion of
the  borrowing  base equal to this of 1% per annum and paid a facility fee equal
to 3/4% of the initial borrowing base under the Credit Facility.

    The Company granted to the Banks liens on substantially all of the Company's
oil and natural gas properties,  whether currently owned or hereafter  acquired,
and a negative  pledge on all other oil and natural gas  properties.  The Credit
Facility requires,  among other things,  semiannual engineering reports covering
oil and natural gas  properties,  and maintenance of certain  financial  ratios,
including the maintenance of a minimum interest coverage, a current ratio, and a
minimum tangible net worth.

    The Credit  Facility  includes other covenants  prohibiting  cash dividends,
distributions,  loans, or advances to third parties,  except that cash dividends
on  preferred  stock will be  allowed  so long as no event of default  exists or
would exist as result of the payment  thereof.  In  addition,  if the Company is
required to  purchase  or redeem any portion of the Notes,  or if any portion of
the Notes become due, the borrowing  base is subject to  reduction.  At December
31,  1996,  the  Company was not in  violation  of any  covenants  of the Credit
Facility.

4. 10 3/4% Senior Notes due 2006


     On  November  1, 1996,  the Company  completed  the sale of $100.0  million
principal  amount of Senior  Notes.  The net  proceeds  of the  Senior  Notes of
approximately  $96.0  million  were used to repay  approximately  $62 million of
borrowings  outstanding  under the Credit Facility and to increase the Company's
working capital. In 1997, the Senior Notes were exchanged for an equal principal
amount of the Company's 10 3/4% Senior Notes due 2006  ("Exchange  Notes") which
are substantially identical to the Senior Notes. Collectively,  the Senior Notes
and the Exchange Note are referred to as the "Notes." The Notes bear interest at
an annual rate of 10 3/4%, payable

                                      F-15
<PAGE>

semiannually  in  arrears on May 1 and  November  1 of each year.  The Notes are
senior,  unsecured  obligations  of the  Company,  ranking  pari  passu with all
existing and future senior  indebtedness of the Company,  and senior in right of
payment to all  future  subordinated  indebtedness  of the  Company.  Subject to
certain  limitations  set  forth  in  the  indenture  covering  the  Notes  (the
"Indenture"),  the  Company and its  subsidiaries  may incur  additional  senior
indebtedness and other indebtedness.

     The Indenture  provides that the Notes will be  unconditionally  guaranteed
(the  "Guarantee")  by any subsidiary  designated by the Company as a Restricted
Subsidiary (a "Guarantor"). As a result of the merger of NEG-OK into the Company
on December 31, 1996, the Company has no Restricted Subsidiaries.

    The  Indenture  contains  certain  covenants  limiting  the  Company and any
Restricted  Subsidiaries,  with respect to the following: (i) assets sales; (ii)
restricted  payments;  (iii) the incurrence of additional  indebtedness  and the
issuance  of  certain  redeemable  preferred  stock;  (iv)  liens;  (v) sale and
leaseback transactions; (vi) lines of business; (vii) dividend and other payment
restrictions affecting subsidiaries; (viii) mergers and consolidations; and (ix)
transactions with affiliates.

    At any time on or after  November 1, 2001,  the Company  may, at its option,
redeem all or any portion of the Notes at the  redemption  prices  expressed  as
percentages of the principal amount of the Notes set forth below,  plus, in each
case, accrued and unpaid interest thereon to the applicable  redemption date, if
redeemed during the 12-month period beginning  November 1 of the years indicated
below:

                  Year                                          Percentage
             --------------                                    ------------
            2001..................................................105.375%
            2002..................................................102.688%
            2003 and thereafter...................................100.000%

    Notwithstanding  the  foregoing,  at any time prior to November 1, 2001, the
Company  may,  at its  option,  redeem  all or any  portion  of the Notes at the
Make-Whole  Price,  as defined,  plus accrued and unpaid interest to the date of
redemption. In addition, in the event the Company consummates one or more Equity
Offerings,  as defined,  on or prior to November 1, 1999,  the  Company,  at its
option, may redeem up to $35.0 million of the aggregate  principal amount of the
Notes  with all or a portion  of the  aggregate  net  proceeds  received  by the
Company from such Equity Offering or Equity  Offerings at a redemption  price of
110.75% of the aggregate principal amount of the Notes so redeemed, plus accrued
and unpaid interest  thereon to the redemption  date;  provided,  however,  that
following  such  redemption,  at least $65.0 million of the aggregate  principal
amount of the Notes remains outstanding.

     Upon a Change of Control, as defined, the Company will be required, subject
to certain conditions, to offer to repurchase all Notes at 101% of the principal
amount thereof, plus accrued and unpaid interest to the date of purchase.

    The carrying value of the Notes approximates their fair value.

5. Commitments and Contingencies

    The Company  leases office space under an operating  lease.  Rental  expense
charged to operations was approximately  $80,000,  $101,000, and $117,000 during
the years ended December 31, 1994, 1995, and 1996,  respectively.  Minimum lease
payments under future  operating lease  commitments at December 31, 1996, are as
follows:

                    1997...............................          $  269,164
                    1998...............................             317,089
                    1999...............................             317,723
                    Thereafter.........................              14,660
                                                                  ----------
                                                                  $ 918,636
                                                                  ==========

                                      F-16
<PAGE>


    On August 30, 1995,  the Company  filed a lawsuit in the  District  Court of
Ector County,  Texas against R.E.  Steakley in which the Company seeks to enjoin
Mr.  Steakley  from  interfering  with its  operations  on the surface  property
controlled by Mr. Steakley.  The lawsuit alleges tortuous  interference with the
Company's  access to its  facilities  and  wrongful  conduct with respect to the
Company's personnel.

     On August 31, 1995, R.E.  Steakley and N.M. Steakley filed a lawsuit in the
District  Court of Harris  County,  Texas,  against  Amoco  Production  Company,
Phillips Petroleum Company, the Company, and others. The lawsuit alleges certain
environmental  claims and  related  tortuous  and  contractual  claims and seeks
unspecified  damages.  On December 19, 1996, the Court in Harris  County,  Texas
signed  and order  transferring  the R.E.  Steakley  claim to the court in Ector
County,  Texas  as  a  part  of  the  Company's  claim  against  R.E.  Steakley.
Subsequently,  R.E. Steakley filed a Fourth Amended Original Answer and Original
Counterclaims  against the Company in Ector  County  District  Court in which he
reasserts the claims filed in the Harris  County  action.  The Company  believes
that it is  operating  in  compliance  with  applicable  environmental  laws and
regulations  and  believes,  based on the advice of counsel,  that the  ultimate
resolution  of the  lawsuit  will not have a  material  effect on the  Company's
financial condition or results of operations.

    The Company is not a defendant in any additional  pending legal  proceedings
other than routine  litigation  incidental to its  business.  While the ultimate
results of these  proceedings  cannot be predicted with  certainty,  the Company
does not believe that the outcome of these matters will have a material  adverse
effect on the Company.

6. Stockholders' Equity

  Capital Stock

    In  connection  with the  Merger,  the  Company's  shareholders  approved an
amendment  to the  Company's  Certificate  of  Incorporation  to  eliminate  the
authorization  of the Class B Common Stock, to change the name of Class A Common
Stock to "Common  Stock," and to  increase  the number of  authorized  shares of
Common Stock from 50,000,000 to 100,000,000 shares.

Preferred Stock

    At December 31, 1996, the Company has authorized 330,000 shares of $1.00 par
value convertible preferred stock designated in four series B through E:
<TABLE>
<CAPTION>
<S>                                                <C>              <C>              <C>             <C>
                                                   Series B          Series C        Series D        Series E
                                                   --------          --------        --------        --------
Number of authorized shares................          100,000         80,000          100,000          50,000
Number of shares issued and
  outstanding:
  December 31, 1994........................           52,500             --               --              --
  December 31, 1995........................           52,500         40,000               --              --
  December 31, 1996........................           52,500         40,000          100,000          50,000
Conversion price per common share..........          $ 1.625         $ 2.00           $ 2.25          $ 2.25
Liquidation preference value per
  share....................................          $ 100.00      $ 100.00         $ 100.00        $ 100.00
Dividend rights............................            10%           10 1/2%        Participation    Participation
                                                     payable         payable           with             with
                                                     semi-           semi-           common           common
                                                    annually         annually          stock            stock
                                                  (cumulative)     (cumulative)

</TABLE>
                                      F-17
<PAGE>

    In connection  with the  acquisition  of certain oil and gas assets in 1992,
the Company's  Board of Directors  authorized the issuance of up to 5,000 shares
of  redeemable   convertible   preferred  stock   designated  as  5%  Redeemable
Convertible  Preferred  Stock,  Series A, par value,  $1.00 per share ("Series A
Preferred  Stock").  The Series A Preferred  Stock was  converted  into  425,000
shares of Common Stock during 1994.

    On June 3, 1994,  the  Company  consummated  the sale of  $5,000,000  of the
Company's 10% Cumulative  Convertible  Preferred  Stock,  Series B ("Series B").
Fifty thousand shares of Series B were sold by the Company at $100.00 per share.
The Series B is convertible into shares of Common Stock at a conversion price of
$1.625 per share.  The Series B has a liquidation  and dividend  preference over
the Common Stock. The Series B has a 10% dividend,  payable  semi-annually.  The
Company  has the  option to make six  dividend  payments  in shares of Series B;
after the sixth such payment, the holders of Series B have the option to receive
additional  dividends in shares of Series B or to accrue such dividends in cash.
If the Company makes four  dividend  payments in shares of Series B, the holders
of Series B have the right to appoint  one-third of the members of the Company's
Board of Directors.  As of December 31, 1996 all dividend payments were current.
The Series B is  redeemable by the Company  beginning  June 14, 1999, at $100.00
per share,  plus  accrued  and unpaid  dividends;  provided,  however,  that the
Company  cannot  redeem any shares of Series B unless and until all  outstanding
shares of the Series C have been redeemed by the Company.  The holders of Series
B  currently  have the right to  appoint  one member to the  Company's  Board of
Directors.  The Series B requires that  dividends be paid on the Series B before
any dividends are paid on Common Stock.

    The  holders  of  Series B are  entitled  to one  vote for each  share as to
matters upon which by law they are entitled to vote as a class, and the approval
of a majority of the Series B, voting separately as a class, is required to make
changes to the Company's Certificate of Incorporation or By-Laws which adversely
affect the Series B, to authorize or issue  additional  shares of Series B or to
issue  preferred  stock  equal to or senior to the Series B as to  dividends  or
liquidation,  or,  subject to  certain  exceptions,  to effect an  extraordinary
transaction that requires a vote of the Company's  stockholders.  As a result, a
class vote of the holders of Series B would be required for the Company to merge
or be acquired and may therefore delay, deter, or prevent a change in control of
the Company.

    In  June  1995,  the  Company  consummated  the  sale of  $4,000,000  of the
Company's 10 1/2% Cumulative Convertible Preferred Stock, Series C ("Series C").
Forty thousand shares of Series C were sold by the Company at $100.00 per share.
The Series C is convertible into shares of Common Stock at a conversion price of
$2.00 per share.

    The Series C has a liquidation and dividend preference over the Common Stock
and is parity  stock to the  previously  issued  Series B. The Series C has a 10
1/2%  dividend,  payable  semi-annually.  The Company has the option to make six
dividend  payments  in shares of Series C;  after the sixth  such  payment,  the
holders of Series C have the option to receive additional dividends in shares of
Series C or to accrue such dividends in cash.

    If the  Company  makes  four  dividend  payments  in shares of Series C, the
holders of Series C (voting as a class with other  affected  series of preferred
stock with similar  voting  rights)  have the right to appoint  one-third of the
members of the Company's  Board of  Directors;  provided,  however,  that if the
holders of Series B are presently  entitled to a similar right, then the holders
of Series C shall have no such right  until the right of the holders of Series B
terminates.  As of December 31, 1996, all dividend payments are current and have
been made in cash. The Series C is redeemable by the Company  beginning June 14,
1999, at $100.00 per share,  plus accrued and unpaid  dividends.  The holders of
the Series C  currently  have the right to appoint  one member to the  Company's
Board of  Directors.  The holders of Series C are  entitled to one vote for each
share as to matters upon which by law they are entitled to vote as a class,  and
the  approval of a majority of the Series C, voting  separately  as a class,  is
required  to make  changes to the  Company's  Certificate  of  Incorporation  or
By-Laws which  adversely  affect the Series C, to authorize or issue  additional
shares of Series C or to issue  preferred stock equal to or senior to the Series
C as to dividends or liquidation,  or, subject to certain exceptions,  to effect
an extraordinary  transaction that requires a vote of the Company  stockholders.
As a result,  a class vote of the  holders of Series C, as well as the

                                      F-18
<PAGE>

Series B, would be  required  for the  Company to merge or be  acquired  and may
therefore delay, deter, or prevent a change in control of the Company.

    On August 29, 1996,  the Company  closed the sale for $10.0  million to High
River Limited  Partnership  ("High River") of 100,000 shares of its  Convertible
Preferred  Stock,  Series D, $1.00 par value per share ("Series D") and warrants
to purchase 700,000 shares of Common Stock exercisable  immediately at $2.50 per
share, which warrants expire five years from their date of issuance.  The rights
and preferences of the Series D are described in the Certificate of Designations
of the Series D and include the immediate right to convert all the shares of the
Series  D into  4,444,444  shares  of  Common  Stock,  based  upon  the  initial
conversion price of $2.25 per share.

    The  holders  of the Series D are  entitled  to one vote for each share when
entitled to vote as described below and as to matters upon which by law they are
entitled  to vote as a class.  The  holders  of  Series D will have the right to
appoint one member to the Board of Directors.  The Company may not,  without the
consent of the director  appointed by the holders of Series D,  voluntarily file
for protection under federal or other bankruptcy laws. In addition,  the holders
of Series D will have the right to choose to appoint  one-half of the members of
the Board of Directors plus one member  (including  the member  appointed by the
Series D) if the Series D contingent voting rights are triggered and the holders
of the Series D exercise their rights.

    On August 29,  1996,  simultaneously  with the closing of the sale for $10.0
million of the Series D to High River, the Company also closed the sale for $5.0
million  to two  insurance  companies  and four  affiliates  of Kayne,  Anderson
Investment Management, Inc. ("KAIM"), a registered investment adviser, of 50,000
shares of  Convertible  Preferred  Stock,  Series  E,  $1.00 par value per share
("Series  E") and  warrants  to  purchase  350,000  shares of the  Common  Stock
exercisable  immediately at $2.50 per share,  which  warrants  expire five years
from  their  date of  issuance.  The  Series E has the  rights  and  preferences
described in the  Certificate of  Designations of the Series E which include the
immediate  right to convert  all of the  shares of the  Series E into  2,222,222
shares of the Common Stock, based upon the initial conversion price of $2.25 per
share.  The Series E will vote  together  with the Common  Stock on all  matters
submitted to the holders of Common Stock and shall have that number of votes per
share  equal to the  number of shares of Common  Stock  into which such share is
convertible as of the record date for the vote.

Common Stock

    Holders  of Common  Stock are  entitled  to one vote for each  share held of
record on all matters voted on by  stockholders.  The shares of the Common Stock
do not have cumulative voting rights,  which means that the holders of more than
50% of the shares of the Common Stock  voting for the election of the  directors
can elect all of the directors to be elected by holders of the Common Stock,  in
which event the holders of the remaining shares of Common Stock will not be able
to elect any director. Upon any liquidation,  dissolution,  or winding-up of the
affairs of the  Company,  holders  of the  Common  Stock  would be  entitled  to
receive,  pro rata, all of the assets of the Company  available for distribution
to  stockholders,  after payment of any liquidation  preference of any Preferred
Stock  that may be issued  and  outstanding  at the time.  Holders of the Common
Stock have no subscription, redemption, sinking fund, or preemptive rights.

    The Class B Common  Stock  ("Class B") was  entitled  to special  conversion
rights.  In June 1995, as a result of the Company's proven crude oil and natural
gas reserves  reaching a value in excess of  $25,000,000,  the 129,644 shares of
Class B common stock which were outstanding at December 31, 1994, were converted
into 1,296,440 shares of Common Stock, in accordance with the terms of the Class
B. Under the terms of the Class B, such shares cannot be reissued.

                                      F-19
<PAGE>

  Warrants

    In June 1994, in connection  with the sale of the Series B Preferred  Stock,
the Company  issued  warrants to purchase  307,692  shares of Common  Stock at a
price of $1.625 per share. During 1995, 255,492 of these warrants were exercised
and the remainder were exercised in 1996. In 1995, the Company granted  warrants
to  purchase  300,000  shares of Common  Stock at a price of $1.625  per  share,
pursuant to a consulting agreement. The estimated fair value of the warrants was
deferred at the date of grant and charged to general and administrative expenses
over the vesting period. In June 1995, in connection with the acquisition of Oak
Hill (Note 2), the Company issued warrants to purchase  200,000 shares of Common
Stock at a price of $2.00 per share. During 1996, 100,000 of these warrants were
exercised.

    During 1996, the Company  issued  warrants to purchase  1,050,000  shares of
Common Stock with  exercise  prices of $2.50 per share to the  purchasers of the
Series D and Series E and issued  warrants to purchase  300,000 shares of Common
Stock  with  exercise  prices  of  $2.875  per share to  financial  advisors  in
connection with this  transaction.  In connection  with the Merger,  the Company
issued  warrants to purchase  800,000  shares of Common  Stock to two  financial
advisors.  Warrants to purchase 700,000 shares have an exercise prices of $2.875
per share while warrants to purchase  100,000 shares have an exercise  prices of
$4.09 per share.  In the Merger,  the Company also assumed  396,015  warrants to
purchase Common Stock at prices ranging from $2.07 to $3.00 in the Merger.

    The following table summarizes warrants outstanding at December 31, 1996:
<TABLE>
<CAPTION>
 Number of Shares                                                    Expiration         Warrants       Exercise
   Under Warrant                                                        Date           Exercisable      Prices
   -------------                                                        ----           -----------      ------
<S>                                                                 <C>                 <C>             <C>
      100,000......................................................  July 31, 1997          100,000    $ 1.625
      100,000......................................................  July 31, 1998          100,000      1.625
      100,000......................................................  July 31, 1999          100,000      1.625
      100,000......................................................  June 30, 1998          100,000       2.00
    1,050,000...................................................... August 29, 2001       1,050,000       2.50
      300,000...................................................... August 29, 2001         300,000      2.875
      700,000...................................................... August 29, 2001         700,000      2.875
      100,000...................................................... August 29, 2001         100,000       4.09
      127,500...................................................... March 10, 1998          127,500       3.00
      268,515...................................................... September 14, 1998      268,515       2.07
   ----------                                                                            -----------
    2,946,015                                                                             2,946,015
    =========                                                                            ===========
</TABLE>


  Stock Options

     During 1992, the Company's Board of Directors and stockholders approved the
Company's 1992 Stock Option Plan (the "1992 Plan"). At December 31, 1996, 15,000
options had been granted pursuant to the 1992 Plan. At present, the Company does
not plan to issue further options under the 1992 Plan.

    During 1994,  1995,  and 1996,  the  Company's  Board of  Directors  granted
options  to  purchase  40,000,  765,000,  and  5,000  shares  of  Common  Stock,
respectively,  to certain  officers  and  directors.  These  options were issued
outside of the 1992 Plan.

    As a result of the Merger,  the Company  assumed 135,028  outstanding  stock
options previously issued pursuant to three stock option plans of Alexander.  No
additional  stock  options  will be granted  pursuant to such  plans.  The stock
options  assumed may be exercised  to purchase  shares of Common Stock at prices
ranging from $0.88 to $2.94 per share.

                                      F-20
<PAGE>

    A summary of the Company's stock option  activity,  and related  information
for the years ended December 31, 1994, 1995, and 1996, follows:
<TABLE>
<CAPTION>
                                     1994                           1995                           1996
                         ----------------------------  ----------------------------  -------------------------------
                                          Weighted                      Weighted                        Weighted
                                           Average                       Average                        Average
                                          Exercise                      Exercise                        Exercise
                            Options         Price         Options         Price         Options          Price
                         -------------- -------------- -------------- -------------- --------------- ---------------
<S>                         <C>          <C>           <C>             <C>           <C>             <C>
Outstanding at
   beginning of year          297,500    $      .64         240,000      $     .79         932,500      $    2.02
     Granted                   40,000          1.62         765,000           1.93           5,000           3.00
     Assumed in merger
       with Alexander
                                   --             --             --             --         135,028           2.25
     Exercised                (62,500)          .58         (72,500)           .72        (199,042)          1.08
     Cancelled                (35,000)          .81              --             --              --             --
                                                       --------------                ---------------
                         ==============
Outstanding at end of
   year                       240,000           .79         932,500           2.02         873,486           2.28
                         ==============                ==============                ===============
Exercisable at end of
   year                       200,000           .63         347,500           1.24         503,484           2.24
                         ==============                ==============                ===============

Weighted-average fair
   value of options
   granted or assumed
   during the year                                     $                             $
                                                               1.31                          2.15
                                                       ==============                ===============
</TABLE>

     At December 31, 1996,  the exercise  prices of  outstanding  options ranged
from $0.625 to $3.00 per share. The weighted average remaining  contractual life
of such options was 3.4 years.

    On August 30, 1996 the Board of Directors  approved the isssuance of options
to purchase  700,000  shares of Common Stock to the  Company's  chief  executive
officer.  The options have an exercise  price of $4.0625 per share.  The options
become  exercisable when the price of the Common Stock reaches and remains at or
above $8.125 for a period of 30 days. If the price target is not met within five
years,  the options  expire.  In December 1996, the Company's Board of Directors
approved grants of options to purchase  966,500 shares of Common Stock for $3.75
per share. Both grants are subject to approval of a new stock option plan by the
stockholders of the Company and, therefore, are not included in the above table.

   Statement of Financial  Accounting  Standards No. 123,  "Accounting for Stock
Based  Compensation," (SFAS 123) requires the disclosure of pro forma net income
and earnings per share information  computed as if the Company had accounted for
its employee stock options  granted  subsequent to December 31, 1994,  under the
fair value  method set forth in SFAS 123.  The fair value for these  options was
estimated at the date of grant using a  Black-Scholes  option pricing model with
the following  weighted-average  assumptions for 1995 and 1996, respectively:  a
risk-free  interest rate of 6%, a dividend yield of 0%, and a volatility  factor
of .54. In addition,  the fair value of these options was estimated  based on an
expected life of three years for options granted by the Company and one year for
the options assumed in the merger with Alexander.

   The Black-Scholes  option valuation model was developed for use in estimating
the fair value of traded  options  which have no  vesting  restrictions  and are
fully  transferable.  In addition,  option valuation models require the input of
highly  subjective  assumptions  including the expected stock price  volatility.
Because the Company's employee stock options have characteristics  significantly
different from those of traded  options,  and because  changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion,  the  existing  models do not  necessarily  provide a  reliable  single
measure of the fair value of its employee  stock options.  In addition,  because
SFAS 123 is applicable only to options granted  subsequent to December 31, 1994,
the pro forma  information does not reflect the pro forma effect of all previous
stock option grants of the Company,  and thus the pro forma  information  is not
necessarily  indicative  of future  amounts  until  SFAS 123 is  applied  to all
outstanding stock options.

                                      F-21
<PAGE>

   For  purposes  of pro forma  disclosures,  the  estimated  fair  value of the
options is amortized to expense over the options' vesting period.  The Company's
pro forma  information  follows  (in  thousands  except for  earnings  per share
information):

                                                   Year ended December 31,
                                                    1995              1996
                                                --------------    ----------

  Pro forma net loss........................    $  (321,559)     $ (26,380,771)
                                                ============     ==============
  Pro forma net loss per common share.......    $      (.10)     $       (1.37)
                                                ============     ==============

7. Income Taxes

     The  reconciliation  of income taxes computed at the U.S. federal statutory
tax  rates  to the  benefit  for  income  taxes  on  the  income  (loss)  before
extraordinary item is as follows:
<TABLE>
<CAPTION>
                                                                                Year ended December 31,
                                                                                -----------------------
                                                                        1994           1995             1996
                                                                    -----------    ----------     ---------------
<S>                                                                 <C>             <C>           <C>
Income tax (benefit) at statutory rate............................  $  (166,385)     $ 69,970       $(14,021,426)
Utilization of net operating loss carryforward....................           --       (69,970)          (414,177)
Benefit of net operating loss not recognized......................      166,385            --                  --
Other.............................................................           --            --            (67,992)
                                                                    -----------    ----------     ---------------
                                                                    $        --      $     --       $(14,503,595)
                                                                    ===========    ==========       ============


    The computation of the net deferred tax asset (liability) follows:

                                                                                             December 31,
                                                                                          1995          1996
                                                                                    -------------  ---------
Deferred tax liabilities:
  Property and equipment.........................................................   $(1,778,045)   $(19,948,392)
  Other..........................................................................        (8,378)        (38,549)
Deferred tax assets:
  Net operating loss carryforwards...............................................      2,402,574     14,564,346
  Statutory depletion carryforwards..............................................             --      1,340,763
  Other..........................................................................             --      1,812,635
                                                                                        --------      ---------
                                                                                         616,151     (2,269,197)
Less valuation allowance.........................................................       (616,151)    (5,004,632)
                                                                                    -------------     ---------
                                                                                   $         --   $  (7,273,829)
                                                                                    ============   ==============
</TABLE>


    At December  31,  1996,  the Company had net  operating  loss  carryforwards
available  for federal  income tax purposes of  approximately  $42 million which
expire beginning in 1997.  Utilization of substantially all of the net operating
loss carryforwards is subject to various limitations because of previous changes
in stock ownership (as defined in the Internal  Revenue Code) of the Company and
Alexander.  Additional net operating loss limitations may be imposed as a result
of subsequent changes in stock ownership of the Company.  For federal income tax
purposes,  the  Company  also  has  statutory  depletion  carryforwards  of $3.8
million,  which do not expire. As a result



                                      F-22
<PAGE>


of the limitations on the utilization of net operating loss  carryforwards,  the
Company has  established a valuation  allowance to reduce deferred tax assets to
amounts that are more likely than not to be realized.

8. Gas Hedging Activities and Commitments

    While the use of hedging  arrangements  limits the downside  risk of adverse
price movements,  it may also limit future gains from favorable  movements.  All
hedging is accomplished  pursuant to swap agreements  based upon standard forms.
The  Company  addresses  market  risk  by  selecting   instruments  whose  value
fluctuations  correlate  strongly with the  underlying  commodity  being hedged.
Credit risk related to hedging activities is managed by requiring minimum credit
standards  for  counterparties,   periodic  settlements,   and  mark  to  market
valuations.  The Company has not been required to provide collateral relating to
its hedging activities.

    In December  1995,  the Company had entered into various swap  agreements to
fix the  selling  prices for natural  gas at a weighted  average  NYMEX price of
$2.805 per Mcf for 225,000 Mcf of natural gas to be produced  during  1996.  The
Company closed the positions prior to December 31, 1995, resulting in a deferred
gain of approximately $70,875 which was recognized in 1996.

     During the year ended December 31, 1996, the Company  recognized a net gain
of $20,315  related to hedging  transactions.  At December 31, 1996, the Company
has no hedging agreements outstanding.

9. Crude Oil and Natural Gas Producing Activities

    The unproven  properties are excluded from the amortization base and consist
primarily of acreage,  acquisition costs, and related geological and geophysical
costs.  These costs are expected to be evaluated  during the Company's  drilling
program during the next three to five years.

    Costs incurred in connection with acquisition, development, exploitation and
exploration of crude oil and natural gas properties for the years ended December
31, 1994, 1995, and 1996, are as follows:
<TABLE>
<CAPTION>
                                                                        Year ended December 31,
                                                                          1994           1995            1996
                                                                    ------------     ---------      ------------
<S>                                                                 <C>              <C>            <C>
Acquisitions of properties:
  Proved.......................................................       $ 1,153,548    $ 13,657,383   $151,511,108
  Unproved.....................................................           134,512         707,913     24,534,610
Exploration costs..............................................           130,182          73,034      4,406,015
Development costs..............................................         2,006,183       8,595,363     19,389,494
Amortization rate per Mcfe.....................................               .70          .91              1.11
</TABLE>

     The  acquisitions  of properties in 1996 include  $132.8  million of proved
properties and $6.3 million of unproved  properties  acquired in the Merger. See
Note 2.

    Depletion,  depreciation, and amortization increased $351,964 for the fourth
quarter of 1995 due to  downward  revisions  in  estimated  proved  reserves  at
December 31, 1995.

                                      F-23
<PAGE>

    Revenues from  individual  customers  that exceed 10% of total crude oil and
natural gas sales are as follows:
<TABLE>
<CAPTION>

                                                                   Year ended December 31,
                                                         -------------------------------------------
<S>                                                      <C>              <C>             <C>
                                                            1994            1995            1996
                                                         ------------     -----------     ----------
Plains Marketing and Transportation................      $  1,614,711     $ 4,618,136     $9,382,466
Crosstex Energy....................................                --              --      2,919,944
GPM Natural Gas Corporation........................           553,613              --      2,832,049
Energy Source, Inc.................................                --         870,285             --
</TABLE>


    The  Company  believes  that the loss of these  customers  would  not have a
significant   impact  on  the  Company's  results  of  operations  or  financial
condition.

10. Supplementary Crude Oil and Natural Gas Reserve Information (Unaudited)

    The Company has interests in crude oil and natural gas  properties  that are
principally located in Texas, Oklahoma, New Mexico, Wyoming, and offshore Texas.
The  Company  does not own or lease  any crude oil and  natural  gas  properties
outside the United States.

    The Company retains independent engineering firms to provide annual year-end
estimates of the Company's  future net recoverable  crude oil,  natural gas, and
natural gas liquids reserves. Estimated proved net recoverable reserves as shown
below  include  only those  quantities  that can be expected to be  commercially
recoverable  at prices  and costs in effect at the  balance  sheet  dates  under
existing  regulatory  practices  and with  conventional  equipment and operating
methods.

    Proved  developed  reserves  represent  only those  reserves  expected to be
recovered  through  existing wells.  Proved  undeveloped  reserves include those
reserves  expected to be recovered  from new wells on undrilled  acreage or from
existing  wells  on  which  a  relatively  major  expenditure  is  required  for
recompletion.

    Net quantities of proved  developed and undeveloped  reserves of natural gas
and crude oil, including  condensate and natural gas liquids,  are summarized as
follows:

                                                            Natural Gas
                                            Crude Oil        (Thousand
                                            (Barrels)       Cubic Feet)
                                            ---------       -----------
December 31, 1993.........................  3,721,084        11,047,393
  Purchase of reserves in place...........  1,035,137         1,858,271
  Extensions and discoveries..............    906,526         1,996,771
  Revisions of previous estimates.........   (387,840)         (879,838)
  Production..............................   (115,642)         (620,843)
  Sales of reserves in place..............     (3,524)          (21,280)
                                          ------------    --------------
December 31, 1994.........................  5,155,741        13,380,474
  Purchase of reserves in place...........    190,063        25,785,458
  Revisions of previous estimates......... (1,141,288)       (6,453,623)
  Production..............................   (283,440)       (1,752,990)
  Sales of reserves in place..............         --           (90,207)
                                          -----------     --------------
December 31, 1995.........................  3,921,076        30,869,112
  Purchase of reserves in place...........  4,691,982        97,840,796
  Extensions and discoveries..............     37,800           371,062
  Revisions of previous estimates.........    703,594         6,104,198
  Production..............................   (521,701)       (5,680,904)
  Sales of reserves in place..............    (29,880)         (634,386)
                                          -----------     -------------
December 31, 1996.........................  8,802,871       128,869,878
                                          ===========     =============

                                      F-24
<PAGE>


Proved developed reserves:
  December 31, 1993.......................  1,641,800         8,781,785
  December 31, 1994.......................  1,532,470         9,205,784
  December 31, 1995.......................  1,632,404        13,304,031
  December 31, 1996.......................  4,383,926        77,496,645

    The Company's principal  individual  properties are the GAU, located onshore
in  Texas,  and the  South  Lake  Boeuf  Field  located  in La  Fourche  Parish,
Louisiana.  As of December 31, 1994, 1995, and 1996, the Company's net interests
in the proved reserves of the GAU was approximately  32,532 Mmcfe, 25,002 Mmcfe,
and 25,035  Mmcfe,  respectively.  As of December 31, 1996,  the  Company's  net
interest in the South Lake Boeuf Field was 15,200 Mmcfe.

    The following is a summary of a standardized  measure of discounted net cash
flows  related to the Company's  proved crude oil and natural gas reserves.  For
these calculations, estimated future cash flows from estimated future production
of proved  reserves were  computed  using crude oil and natural gas prices as of
the end of each  period  presented.  Future  development  and  production  costs
attributable  to the proved  reserves  were  estimated  assuming  that  existing
conditions  would continue over the economic lives of the individual  leases and
costs were not  escalated for the future.  Estimated  future income tax expenses
were calculated by applying future statutory tax rates (based on the current tax
law adjusted for permanent  differences and tax credits) to the estimated future
pretax net cash flows related to proved crude oil and natural gas reserves, less
the tax basis of the properties involved.

    The Company  cautions against using this data to determine the fair value of
its crude oil and natural gas  properties.  To obtain the best  estimate of fair
value of the crude oil and natural gas properties,  forecasts of future economic
conditions,  varying  discount  rates,  and  consideration  of other than proved
reserves would have to be incorporated into the calculation.  In addition, there
are  significant  uncertainties  inherent  in  estimating  quantities  of proved
reserves and in projecting rates of production that impair the usefulness of the
data.

    The  standardized  measure of discounted  future net cash flows  relating to
proved crude oil and natural gas reserves are summarized as follows:
<TABLE>
<CAPTION>

                                                                                          December 31,
                                                                              -----------------------------------
                                                                                   1995                   1996
                                                                              --------------         ------------
<S>                                                                           <C>                   <C>
Future cash inflows......................................................     $  132,218,400        $ 702,089,600
Future production and development costs..................................        (71,109,500)        (220,155,000)
Future income tax expenses...............................................         (7,123,405)        (105,547,035)
                                                                              --------------         -------------
Future net cash flows....................................................         53,985,495          376,387,565
10% annual discount for estimated timing of cash flows...................        (21,858,394)        (146,607,933)
                                                                              ---------------      ---------------
Standardized measure of discounted future net cash
  flows..................................................................     $   32,127,101         $229,779,632
                                                                              ==============        =============
</TABLE>

                                      F-25
<PAGE>



    The  following  are the  principal  sources  of change  in the  standardized
measure of discounted future net cash flows:
<TABLE>
<CAPTION>

                                                                          Year ended December 31,
                                                             ------------------------------------------------
                                                                  1994             1995               1996
                                                             -------------    -------------      ------------
<S>                                                          <C>                <C>              <C>
Sales and transfers of crude oil and natural
  gas produced, net of production costs................        $(1,775,145)     $ (5,710,325)    $(19,293,463)
Net changes in prices and production costs.............         14,785,630        14,654,096      131,330,518
Development costs incurred during the period
  and changes in estimated future development
  costs................................................           (119,443)      (11,886,400)       4,884,876
Purchases of reserves in place.........................          3,414,926        15,455,400      117,893,900
Sales of reserves in place.............................            (30,585)          (97,210)        (450,300)
Extensions and discoveries, less related
  costs................................................          4,605,206                --          850,200
Revisions of previous quantity estimates...............         (1,985,978)       (8,871,208)      16,576,531
Accretion of discount..................................          1,439,950         2,744,504        3,627,860
Net change in income taxes.............................         (6,952,217)        2,590,707      (57,743,416)
Changes in production rates (timing) and other.........         (4,221,647)        2,408,034          (24,175)
                                                             -------------      ------------     ------------
Net change.............................................      $   9,160,697      $ 11,287,598     $197,652,531
                                                             =============      ============     ============
</TABLE>

    During recent years, there have been significant  fluctuations in the prices
paid for crude oil in the world markets.  This situation has had a destabilizing
effect on crude oil posted  prices in the United  States,  including  the posted
prices paid by purchasers of the Company's  crude oil. The net weighted  average
prices of crude oil and natural gas at December 31, 1994,  1995, and 1996,  used
in the above  table  were  $16.59,  $18.71,  and $25.36 per barrel of crude oil,
respectively,  and $1.62,  $1.91,  and $3.72 per thousand  cubic feet of natural
gas, respectively.



                                      F-26
<PAGE>

                               INDEX TO EXHIBITS

2.1  Agreement  and Plan of  Merger,  dated  June 6,  1996,  among the  Company,
     NEG-OK, Inc. ("NEG OK"), and Alexander Energy Corporation ("Alexander")(1)

2.2  First Amendment to Agreement and Plan of Merger, dated as of June 20, 1996,
     among the Company, NEG-OK and Alexander(2)

2.3  Mutual  Waiver  Agreement  dated as of  August  29,  1996 by and  among the
     Company, NEG-OK and Alexander(3)

3.1  Certificate of Incorporation of the Company, which includes the Certificate
     of  Incorporation  of the  Company  filed  with the  Secretary  of State of
     Delaware on November 20,  1990(4),  the  Certificate  of Elimination of the
     Redeemable Convertible Preferred Stock, Series A of the Company, filed with
     the office of the  Secretary  of State of the State of  Delaware on June 2,
     1994(3),  the Certificate of Amendment of Certificate of  Incorporation  of
     the Company,  filed with the office of the  Secretary of State of the State
     of Delaware on August 29,  1996(3),  the Certificate of Designations of the
     Company of 10% Cumulative  Convertible  Preferred  Stock,  Series B(5), the
     Certificate  of   Designations   of  the  Company  of  10  1/2%  Cumulative
     Convertible  Preferred Stock,  Series C(6), the Certificate of Designations
     of the  Company  of  Convertible  Preferred  Stock,  Series  D(3),  and the
     Certificate of Designations of the Company of Convertible  Preferred Stock,
     Series E(3)

3.2  By-laws of the Company(4)

4.1  Certificate of  Designations  of the Company of 10% Cumulative  Convertible
     Preferred Stock, Series B(5)

4.2  Certificate  of   Designations   of  the  Company  of  10  1/2%  Cumulative
     Convertible Preferred Stock, Series C(6)

4.3  Certificate of Designations of the Company of Convertible  Preferred Stock,
     Series D(3)

4.4  Certificate of Designations of the Company of Convertible  Preferred Stock,
     Series E(3)

4.5  Note  Agreement  dated as of April 25, 1989, by and among AEJH 1989 Limited
     Partnership,  Alexander  and John Hancock  Mutual Life  Insurance  (10 1/2%
     Senior Secured Notes)(8)

4.6  Letter dated August 29, 1996 between Alexander and John Hancock Mutual Life
     Insurance Company relating to the payment of the 1989 Notes(3)

4.7  Indenture dated as of November 1, 1996, among the Company,  National Energy
     Group of Oklahoma,  Inc. (the "Guarantor"),  formerly NEG-OK, and Bank One,
     Columbus, N.A.(9)

10.1 Crude Oil Purchase  Contract,  dated November 30, 1992, between the Company
     and Plains Liquids Transport Inc.(10)

10.2 Amendment to Crude Oil Purchase Contract,  dated November 17, 1993, between
     the Company and Plains Liquids Transport, Inc.(5)

10.3 Crude Oil Purchase  Contract,  dated February 8, 1993,  between the Company
     and Plains Marketing and Transportation Inc. and the predecessor  contract,
     the  Crude  Oil  Purchase  Contract,   dated  November  12,  1991,  between
     Sunnybrook Transmission, Inc. and TriSearch Inc.(10)

10.4 Stock  Purchase  Agreement,  dated as of June 2, 1994,  among the  Company,
     Arbco Associates  L.P.,  Offense Group  Associates  L.P.,  Kayne,  Anderson
     Nontraditional Investments L.P., and Opportunity Associates L.P.(5)

10.5 Gaines Berland, Inc. Warrant, dated January 27, 1995(1)

<PAGE>

10.11 Purchase and Sale  Agreement,  dated as of March  29,  1995,  between  the
      Company and Enron Oil and Gas Company(6)

10.12 Agreement for Purchase and Sale (Oak Hill), dated April 12, 1995,  between
      the Company and Sierra 1994 I Limited Partnership(6)

10.13 Agreement for Purchase and Sale  (Mustang  Island),  dated April 20, 1995,
      between the Company and Sierra Mineral Development, L.C.(6)

10.14 Stock Purchase  Agreement,  dated as of June 14, 1995,  among the Company,
      Arbco Associates L.P.,  Offense Group  Associates  L.P.,  Kayne,  Anderson
      Nontraditional Investments L.P., and Opportunity Associates L.P.(6)

10.15 Executive Employment Agreement, dated January 1, 1996, between the Company
      and Miles D. Bender(11)

10.16 Executive Employment Agreement, dated January 1, 1996, between the Company
      and R. Thomas Fetters, Jr.(11)

10.17 Agreement, dated  January 1, 1996,  between  the  Company  and  Randall A.
      Carter(11)

10.18 Agreement, dated  January  1,  1996,  between  the  Company  and Robert A.
      Imel(11)

10.19 Executive Employment Agreement, dated January 1, 1996, between the Company
      and Melissa Rutledge(11)

10.20 Executive Employment Agreement, dated January 1, 1996, between the Company
      and William T. Jones(11)

10.22 Executive Employment  Agreement,  dated June 6, 1996,  between the Company
      and David E. Grose(1)

10.23 Executive  Employment  Agreement, dated June 5, 1996,  between the Company
      and Sue Barnard(1)

10.24 Executive  Employment  Agreement, dated June 6, 1996,  between the Company
      and Jim L. David(1)

10.25 Employment  Agreement, dated June 6, 1996,  between the Company and Bob G.
      Alexander(1)

10.26 Employment Agreement, dated June 6, 1996, between the Company and Roger G.
      Alexander(1)

10.29 Prudential Securities  Incorporated  Warrant to Purchase 100,000 Shares of
      the Company's Common Stock(3)

10.30 Gaines Berland,  Inc. Warrant to Purchase  300,000 Shares of the Company's
      Common Stock(3)

10.31 Gaines Berland,  Inc. Warrant to Purchase  700,000 Shares of the Company's
      Common Stock(3)

10.32 Agreement  dated January 1, 1996  between the Company and  Sandefer  Oil &
      Gas, Inc.(1)

<PAGE>

10.33 Consulting Agreement dated January 1, 1996 between the Sandefer Oil & Gas,
      Inc. and Potosky Oil & Gas, Inc. and Atocha Exploration, Inc.(1)

10.34 Stock Purchase Agreement dated August 7, 1996 between the Company and High
      River Limited Partnership(2)

10.35 High River Limited  Partnership  Warrant  to  purchase  700,000  Shares of
      Common Stock, dated August 29, 1996(3)

10.36 Stock Purchase Agreement dated as of August 26, 1996,  between the Company
      and Foremost Insurance  Company, Arbco Associates,  L.P., Kayne,  Anderson
      Nontraditional  Investments  L.P., Offense Group  Associates,  L.P.,  Topa
      Insurance  Company and Kayne,  Anderson  Offshore  Limited (the  "Series E
      Investors")(3)

10.37 Form of Series E  Investors'  Warrants  to purchase an  aggregate  350,000
      Shares of Common Stock, dated August 29, 1996(3)

10.38 Agreement  dated as of August  29, 1996 by and  between  the  Company  and
      Prudential Securities Incorporated(3)

10.40 Restated  Loan  Agreement dated  August 29, 1996 among Bank One and Credit
      Lyonnais New York Branch ("Credit  Lyonnais") and the Company,  NEG-OK and
      Boomer Marketing Corporation ("Boomer")(3)

10.41 $50,000,000 Revolving Note dated August 29, 1996 payable to Bank One(3)

10.42 $50,000,000  Revolving  Note  dated August  29,  1996  payable  to  Credit
      Lyonnais(3)

10.43 $2,500,000 Term Note dated August 29, 1996 payable to Bank One(3)

10.44 $2,500,000 Term Note dated August 29, 1996 payable to Credit Lyonnais(3)

10.45 Unlimited Guaranty of NEG-OK dated August 29, 1996 for the benefit of Bank
      One(3)

10.46 Unlimited  Guaranty of NEG-OK,  dated  August 29,  1996 for the benefit of
      Credit Lyonnais(3)

10.47 Unlimited Guaranty of Boomer dated August 29, 1996 for the benefit of Bank
      One(3)

10.48 Unlimited  Guaranty of Boomer  dated  August 29,  1996 for the  benefit of
      Credit Lyonnais(3)

10.49 Form of Deeds of Trust, Mortgages,  Security  Agreements,  Assignments  of
      Production and Financing Statements covering oil and gas properties of the
      Company and NEG-OK, dated August 29, 1996(3)

10.50 Sale and  Purchase  Agreement  dated  September 26,  1994 by and among JMC
      Exploration,  Inc.,  Ted  Bowman,  Chris  Webb  and  John  Abrahamson  and
      Alexander(12)

10.51 First  Amendment to Sale and Purchase Agreement dated  October 26, 1994 by
      and  among  JMC  Exploration,  Inc.,  Ted  Bowman,  Chris  Webb  and  John
      Abrahamson and Alexander(12)

10.52 Alexander   Energy  Corporation  1986  Incentive  Stock  Option  Plan,  as
      amended(13)

10.53 Alexander Energy Corporation 1993 Stock Option Plan(14)

10.54 Agreement of Limited  Partnership of AEJH 1985 Limited  Partnership by and
      between Alexander and John Hancock Mutual Life Insurance Company, together
      with all amendments thereto(15)

10.55 Agreement of Limited Partnership  of AEJH 1987 Limited  Partnership by and
      between Alexander and John Hancock Mutual Life Insurance Company, together
      with all amendments thereto(15)

10.56 Agreement of Limited Partnership  of AEJH 1989 Limited  Partnership by and
      between  Alexander and John Hancock  Mutual Life  Insurance  Company dated
      April 25, 1989(8)

10.57 Limited Partnership Agreement of Energy and Environmental Services Limited
      Partnership  dated May 15,  1991 by and between  Energy and  Environmental
      Services,  Inc., as general partner, and Alexander Energy  Corporation and
      REP, Inc., as limited partners(15)

10.58 Warrant Purchase Agreement among Alexander,  Hanifen,  Imhoff Inc. and The
      Principal/Eppler, Guerin & Turner, Inc.(16)

10.59 Purchase Option  Agreement  (warrants)  between  American  National Energy
      Corporation and Gaines, Berland, Inc. dated September 14, 1993(8)

<PAGE>

10.60 Form of Special  Severance Agreements  between Alexander and the technical
      support  staff of  Alexander,  between NEG-OK  and Cyndy  Burris  and John
      Christofferson, respectively(8)

10.61 Separation Policy of Alexander dated December 8, 1994(8)

10.62 Asset Purchase and Sale Agreement  dated September 30, 1996 by and between
      the Company and Araxas  Energy Corporation,  Araxas  SPV-1,  Inc.,  Araxas
      Exploration, Inc. and O'Sullivan Oil and Gas Company, Inc.(9)

10.63 Purchase  Agreement dated  October  29,  1996,  by and among the  Company,
      Guarantor and Bear,  Stearns & Co. Inc., Smith Barney Inc. and Jefferies &
      Company, Inc. (the "Initial Purchasers")(9)

10.64 Registration Rights  Agreement  dated  October 29, 1996,  by and among the
      Company, Guarantor and the Initial Purchasers(9)

10.65 First  Amendment to Restated  Loan Agreement  dated October 31, 1996 among
      Bank One and Credit Lyonnais and the Company, Guarantor and Boomer (9)

23.1 Consent of Ernst & Young LLP, Independent Auditors (18)

23.2 Consent of Netherland,  Sewell & Associates,  Inc.,  Independent  Petroleum
     Engineers (18)

27.1 Financial Data Schedule(17)

99.39 Certificate  of Merger  with respect to the merger of  Alexander  with and
      into NEG-OK, filed with the offices of the Secretary of State of the State
      of Delaware  and the Secretary of State of the State of Oklahoma on August
      29, 1996(3)

<PAGE>

         ---------------

(1)  Incorporated by reference to the Company's  Registration  Statement on Form
     S-4 (No. 333-9045), dated July 29, 1996.

(2)  Incorporated by reference to Amendment No. 1 to the Company's  Registration
     Statement on Form S-4 (No. 333-9045), dated August 7, 1996.

(3)  Incorporated  by reference  to the  Company's  Current  Report on Form 8-K,
     dated August 29, 1996.

(4)  Incorporated by reference to the Company's  Registration  Statement on Form
     S-4 (No. 33-38331), dated April 23, 1991.

(5)  Incorporated  by reference  to the  Company's  Current  Report on Form 8-K,
     dated June 17, 1994.

(6)  Incorporated  by reference  to the  Company's  Current  Report on Form 8-K,
     dated July 17, 1995.

(7)  Incorporated by reference to the Company's  Registration  Statement on Form
     S-3 (No. 33-81172), dated July 27, 1994.

(8)  Incorporated  by  reference  to  Alexander's  Form 10-K for the fiscal year
     ended December 31, 1994.

(9)  Incorporated  by reference to the Company's  Quarterly  Report on Form 10-Q
     for the quarter ended September 30, 1996.

(10) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
     the year ended December 31, 1992.

(11) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
     the year ended December 31, 1995.

(12) Incorporated by reference to Alexander's  Current Report on Form 8-K, dated
     November 14, 1994.

(13) Incorporated  by  reference  to  Alexander's  Registration  Statement  (No.
     33-20425), dated March 22, 1988.

(14) Incorporated  by  reference to  Alexander's  Proxy  Statement  for the 1993
     Annual Meeting of Stockholders.

(15) Incorporated  by  reference  to  Alexander's  Form 10-K for the fiscal year
     ended December 31, 1991.

(16) Incorporated  by reference to Alexander's  Amendment No. 1 to  Registration
     Statement (No. 33-57142), dated February 26, 1993.

(17) The Financial Data Schedule, for the year ended December 31, 1996, is filed
     herewith for EDGAR filings only.

(18) Filed herewith.