<PAGE>   1
 
================================================================================
 
                                 UNITED STATES
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
 
                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
 
                      THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997           COMMISSION FILE NO. 1-5591
 
                                PENNZOIL COMPANY
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                   DELAWARE                                      74-1597290
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)
 
        PENNZOIL PLACE, P.O. BOX 2967
                HOUSTON, TEXAS                                   77252-2967
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                      (ZIP CODE)
</TABLE>
 
       Registrant's telephone number, including area code: (713) 546-4000
 
          Securities registered pursuant to Section 12(b) of the Act:
 
<TABLE>
<CAPTION>
                                                                       NAME OF EACH EXCHANGE
                    TITLE OF EACH CLASS                                 ON WHICH REGISTERED
                    -------------------                                ---------------------
<S>                                                         <C>
Common Stock, par value $0.83 1/3 per share                 New York Stock Exchange
                                                            Pacific Stock Exchange
Rights to Purchase Preferred Stock                          New York Stock Exchange
                                                            Pacific Stock Exchange
Debentures                                                  New York Stock Exchange
</TABLE>
 
  6 1/2% Exchangeable Senior Debentures due January 15, 2003
  4 3/4% Exchangeable Senior Debentures due October 1, 2003
 
        Securities registered pursuant to Section 12(g) of the Act: None
                            ------------------------
 
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes   X    No ____
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ___
 
     Aggregate market value of the voting stock held by non-affiliates of the
registrant: $3.1 billion as of January 31, 1998.
 
     Number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date, January 31, 1998: Common Stock, par
value $0.83 1/3 per share -- 47,574,895.
 
     DOCUMENTS INCORPORATED BY REFERENCE: PORTIONS OF THE PROXY STATEMENT TO BE
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO REGULATION 14A
UNDER THE SECURITIES EXCHANGE ACT OF 1934 IN CONNECTION WITH THE COMPANY'S 1998
ANNUAL MEETING OF SHAREHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III
HEREOF (TO THE EXTENT SET FORTH IN ITEMS 10, 11, 12 AND 13 OF PART III OF THIS
ANNUAL REPORT ON FORM 10-K).
================================================================================
<PAGE>   2
 
FORWARD-LOOKING STATEMENTS -- SAFE HARBOR PROVISIONS
 
     This annual report on Form 10-K of Pennzoil Company for the year ended
December 31, 1997 contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which are intended to be covered by
the safe harbors created thereby. To the extent that such statements are not
recitations of historical fact, such statements constitute forward-looking
statements which, by definition, involve risks and uncertainties. In particular,
statements (i) under the captions (a) "Oil and Gas," (b) "Motor Oil & Refined
Products," and (c) "Franchise Operations" under "Item 1. Business and Item 2.
Properties" and (ii) under the captions (a) "Oil and Gas," (b) "Motor Oil &
Refined Products," (c) "Franchise Operations," (d) "Disclosures About Market
Risk" and (e) "Capital Resources and Liquidity" under "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations and
Item 7A. Quantitative and Qualitative Disclosures About Market Risk" contain
forward-looking statements. Where, in any forward-looking statement, Pennzoil
expresses an expectation or belief as to future results or events, such
expectation or belief is expressed in good faith and believed to have a
reasonable basis, but there can be no assurance that the statement of
expectation or belief will result or be achieved or accomplished.
 
     The following are factors that could cause actual results or events to
differ materially from those anticipated, and include but are not limited to:
general economic, financial and business conditions; commodity prices for
natural gas and crude oil; the effect of weather on natural gas demand and
consumption; competition for international drilling rights; the costs of
exploration and development of petroleum reserves; exploration risks; political
risks impacting exploration and development; competition in the motor oil
marketing business; base oil margins and supply and demand in the base oil
business; the success and costs of advertising and promotional efforts;
mechanical failure in refining operations; unanticipated environmental
liabilities; changes in and compliance with governmental regulations; changes in
tax laws; and the costs and effects of legal proceedings.
<PAGE>   3
 
                                     PART I
 
ITEM 1. BUSINESS AND ITEM 2. PROPERTIES.
 
     Pennzoil Company ("Pennzoil") is an energy company engaged primarily in oil
and gas exploration and production, in processing, refining and marketing of oil
and motor oil and refined products and in fast automotive oil change operations.
Pennzoil's operations are conducted primarily through subsidiaries. Pennzoil
Exploration and Production Company ("PEPCO") conducts the majority of Pennzoil's
oil and gas exploration and production operations. The refining of oil and the
processing and marketing of motor oil, refined products and industrial
specialties are conducted by Pennzoil Products Company ("PPC"). Jiffy Lube
International, Inc. ("Jiffy Lube") franchises, owns and operates automotive fast
lubrication and fluid maintenance service centers.
 
     As of December 31, 1997, Pennzoil beneficially owned approximately 17.8
million shares of common stock of Chevron Corporation ("Chevron"). At the
current dividend rate, Pennzoil receives approximately $43.4 million annually in
dividends on its current investment in Chevron stock. Reference is made to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources and Liquidity" and Note 1 of Notes to
Consolidated Financial Statements for additional information.
 
INDUSTRY SEGMENT FINANCIAL INFORMATION
 
     The tabular presentation below sets forth certain financial information
regarding Pennzoil's industry segments (i.e., oil and gas, motor oil and refined
products and franchise operations). Pennzoil's international operations
historically have not been material in relation to consolidated revenues,
operating income and identifiable assets.
 
<TABLE>
<CAPTION>
                                              1997         1996         1995
                                           ----------   ----------   ----------
                                                 (EXPRESSED IN THOUSANDS)
<S>                                        <C>          <C>          <C>
                REVENUES
Oil and Gas.............................   $  937,823   $  755,655   $  732,356
Motor Oil & Refined Products............    1,720,181    1,696,207    1,539,351
Franchise Operations....................      328,596      303,700      289,222
Other(1)................................       38,893      103,440       87,133
Intersegment sales(2)...................     (371,189)    (372,156)    (158,076)
                                           ----------   ----------   ----------
                                           $2,654,304   $2,486,846   $2,489,986
                                           ==========   ==========   ==========
        OPERATING INCOME (LOSS)
Oil and Gas.............................   $  395,691   $  239,658   $   91,967
Motor Oil & Refined Products............       95,835       53,327       12,044
Franchise Operations....................       24,492       21,383       13,188
Impairment of long-lived assets(3)......           --           --     (399,830)
Other(1)................................       43,486       87,333       74,024
                                           ----------   ----------   ----------
          Total operating income
            (loss)......................      559,504      401,701     (208,607)
Corporate administrative expense........       91,303       55,155       74,720
Interest expense, net...................      163,806      177,420      194,348
Income tax provision (benefit)..........      124,140       35,228     (172,533)
                                           ----------   ----------   ----------
Income (loss) before extraordinary
  items.................................   $  180,255   $  133,898   $ (305,142)
                                           ==========   ==========   ==========
</TABLE>
 
                                             (Table continued on following page)
 
                                        1
<PAGE>   4
 
<TABLE>
<CAPTION>
                                              1997         1996         1995
                                           ----------   ----------   ----------
                                                 (EXPRESSED IN THOUSANDS)
<S>                                        <C>          <C>          <C>
          IDENTIFIABLE ASSETS
Oil and Gas.............................   $1,837,367   $1,747,031   $1,991,895
Motor Oil & Refined Products............    1,128,099      908,389      871,506
Franchise Operations....................      348,764      339,293      339,968
Other...................................      123,971      148,940      160,979
Corporate...............................      967,746      980,671      943,483
Intersegment eliminations...............          (60)         (70)         (55)
                                           ----------   ----------   ----------
                                           $4,405,887   $4,124,254   $4,307,776
                                           ==========   ==========   ==========
DEPRECIATION, DEPLETION AND AMORTIZATION
                 EXPENSE
Oil and Gas.............................   $  220,525   $  216,857   $  270,792
Motor Oil & Refined Products............       43,038       32,063       30,458
Franchise Operations....................       21,439       19,840       18,086
Other...................................           13          329          695
Corporate...............................        3,833        4,848        5,088
                                           ----------   ----------   ----------
                                           $  288,848   $  273,937   $  325,119
                                           ==========   ==========   ==========
        CAPITAL EXPENDITURES(4)
Oil and Gas.............................   $  406,443   $  311,877   $  297,617
Motor Oil & Refined Products............      121,958      231,677      134,883
Franchise Operations....................       25,836       19,509       40,773
Other...................................           29          135          504
Corporate...............................        5,207        2,425        3,989
                                           ----------   ----------   ----------
                                           $  559,473   $  565,623   $  477,766
                                           ==========   ==========   ==========
</TABLE>
 
---------------
 
(1) For 1997, this amount primarily represents a $10.0 million pretax charge
    associated with Pennzoil's sale of PennUnion Energy Services, L.L.C.
    ("PennUnion"), a natural gas marketing subsidiary, and dividend income from
    Pennzoil's investment in Chevron common stock. For 1996, this amount
    primarily represents a $41.7 million pretax gain from Pennzoil's sale of
    Vermejo Park Ranch and dividend income from Pennzoil's investment in Chevron
    common stock. Reference is made to "Management's Discussion and Analysis of
    Financial Condition and Results of Operations -- Other" and Note 10 of Notes
    to Consolidated Financial Statements for additional information. For 1995,
    this amount primarily represents dividend income from Pennzoil's investment
    in Chevron common stock and a state franchise tax refund.
 
(2) Substantially all intersegment sales, which are priced at market, are from
    the oil and gas segment to the motor oil and refined products segment.
 
(3) Effective July 1, 1995, Pennzoil adopted the requirements of Statement of
    Financial Accounting Standards ("SFAS") No. 121, "Accounting for the
    Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
    Of." As a result, Pennzoil recorded a pretax charge of $399.8 million as of
    July 1, 1995 to reflect the impairment of long-lived assets. Included in the
    pretax charge of $399.8 million for the impairment of long-lived assets were
    charges related to the oil and gas, motor oil and refined products,
    franchise operations and corporate segments of $378.9 million, $3.5 million,
    $3.5 million and $13.9 million, respectively. Charges for the impairment of
    long-lived assets resulting from the adoption of SFAS No. 121 have not been
    included in depreciation, depletion and amortization expense ("DD&A") in the
    table above. Reference is made to "Management's Discussion and Analysis of
    Financial Condition and Results of Operations -- Oil and Gas" and Note 1 of
    Notes to Consolidated Financial Statements for additional information.
 
(4) Includes interest capitalized of $13.1 million, $10.7 million and $4.2
    million in 1997, 1996 and 1995, respectively.
 
                                        2
<PAGE>   5
 
     Narrative descriptions of these business segments follow, with emphasis on
1997 developments. Unless otherwise indicated by the context, references to
Pennzoil include its subsidiaries.
 
OIL AND GAS
 
     In the oil and gas segment, Pennzoil engages in the acquisition,
exploration, exploitation and development of prospective and proved oil and gas
properties, the production and sale of crude oil, condensate and natural gas
liquids and the production, treatment and sale of natural gas. The bulk of
Pennzoil's production is derived from established fields in Texas, Louisiana,
Mississippi, West Virginia, Utah and federal waters offshore Louisiana, Texas
and California.
 
     OIL AND GAS RESERVES. The following table sets forth information regarding
Pennzoil's net proved reserves and the present value (discounted at 10 percent)
of the estimated future net cash flows before deduction of income taxes from the
production and sale of those reserves. The reserves are reported by Ryder Scott
Company Petroleum Engineers, Houston, Texas ("Ryder Scott") and Outtrim Szabo
Associates Ltd., Calgary, Canada ("Outtrim Szabo") in accordance with criteria
prescribed by SFAS No. 69, "Disclosures About Oil and Gas Producing Activities."
The summary report of Ryder Scott on the reserve estimates as of December 31,
1997, is set forth as an exhibit to this Annual Report on Form 10-K and includes
reserve estimates of each of PEPCO, Pennzoil Caspian Corporation ("Pennzoil
Caspian"), Pennzoil Venezuela Inc., PPC and Pennzoil. The summary reports of
Ryder Scott on the reserve estimates as of December 31, 1996 and the summary
reports of Ryder Scott and Outtrim Szabo on the reserve estimates as of December
31, 1995 are included in Pennzoil's previously filed Annual Reports on Form
10-K.
 
     Information regarding ownership interests, prices, costs and other factual
data was furnished to Ryder Scott and Outtrim Szabo by Pennzoil. To facilitate
timely issuance of the reserve estimates, estimated production data were used
for the last few months of each year. Pennzoil believes that use of the actual
production data would not have resulted in a material change in the estimates of
reserves or pretax future net cash flows.
                                             -----------------------------------
<TABLE>
<CAPTION>
                                                                    TOTAL PROVED RESERVES
                                                                  --------------------------
                                                                         DECEMBER 31
                                                                  --------------------------
                                                                    1997      1996      1995
                                                                  ------    ------    ------
<S>                                                               <C>       <C>       <C>    
Crude oil, condensate and natural gas liquids
  (millions of barrels)
     United States.........................................          152       165       175
     International(1)(2)...................................           75        22        26
                                                                  ------    ------    ------
                                                                     227       187       201
                                                                  ======    ======    ======
Natural gas (billion cubic feet ("Bcf"))
     United States(3)......................................        1,054     1,187     1,255
     International(1)(2)...................................            5        90       214
                                                                  ------    ------    ------
                                                                   1,059     1,277     1,469
                                                                  ======    ======    ======
Present value (10 percent discount rate) of estimated
  future net cash flows before deduction of income taxes
  (in millions)(4)(5)
     United States.........................................       $1,791    $3,697    $2,587
     International.........................................          262       270       178
                                                                  ------    ------    ------
                                                                  $2,053    $3,967    $2,765
                                                                  ======    ======    ======
                                                                  ------------------------------
</TABLE>
 
                                             (Table continued on following page)
 
                                        3
<PAGE>   6
<TABLE>
<CAPTION>
                                                              PROVED DEVELOPED RESERVES
                                                              --------------------------
                                                                     DECEMBER 31
                                                              --------------------------
                                                               1997      1996      1995
                                                              ------    ------    ------
<S>                                                           <C>       <C>       <C>
Crude oil, condensate and natural gas liquids
  (millions of barrels)
  United States.............................................     128       141       151
  International(1) (2)......................................      14         1        11
                                                              ------    ------    ------
                                                                 142       142       162
                                                              ======    ======    ======
Natural gas (Bcf)
  United States(3)..........................................     964     1,070     1,132
  International(1) (2)......................................       4        90       202
                                                              ------    ------    ------
                                                                 968     1,160     1,334
                                                              ======    ======    ======
Present value (10 percent discount rate) of estimated future
  net cash flows before deduction of income taxes (in
  millions)(4)
  United States.............................................  $1,685    $3,329    $2,318
  International.............................................       7        58       138
                                                              ------    ------    ------
                                                              $1,692    $3,387    $2,456
                                                              ======    ======    ======
</TABLE>
 
---------------
 
 (1) Included in 1997 reserves are 21 million barrels of crude oil, condensate,
     and natural gas liquids (14 million barrels of which are proved developed
     reserves) and 4 Bcf of proved developed natural gas reserves attributable
     to three operating service agreements in Venezuela between Petroleos de
     Venezuela, S.A. ("PDVSA") and Pennzoil Venezuela Corporation, S.A., an
     indirect wholly owned subsidiary of Pennzoil. Under these agreements, all
     mineral rights are owned by the government of Venezuela. Reference is made
     to "Management's Discussion and Analysis of Financial Condition and Results
     of Operations -- Oil and Gas" for additional information.
 
 (2) In July 1996, Pennzoil sold its non-strategic Canadian oil and gas assets
     to Gulf Canada Resources Limited ("Gulf Canada"). In December 1997,
     Pennzoil sold the remainder of its Canadian oil and gas assets to Phillips
     Petroleum Company ("Phillips"). Reference is made to "Management's
     Discussion and Analysis of Financial Condition and Results of
     Operations -- Oil and Gas" and Note 10 of Notes to Consolidated Financial
     Statements for additional information.
 
 (3) United States natural gas reserves for 1997, 1996 and 1995 exclude 178 Bcf,
     182 Bcf and 156 Bcf, respectively, of carbon dioxide gas for sale or use in
     Pennzoil's operations.
 
 (4) Reference is made to "Supplemental Financial and Statistical
     Information -- Unaudited -- Oil and Gas Information" on pages F-33 through
     F-39 hereof for additional information regarding Pennzoil's proved reserves
     and estimated future net revenues therefrom, including presentation of
     Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves
     calculated in accordance with SFAS No. 69.
 
 (5) Increases (decreases) in the present value of future net cash flows
     attributable to net changes in prices, net of production costs, were
     ($1,707.0) million, $1,152.0 million, and $740.0 million for 1997, 1996 and
     1995, respectively. Reference is made to "Supplemental Financial and
     Statistical Information -- Unaudited -- Oil and Gas Information" on page
     F-39 for the presentation of "Changes in the Standardized Measure."
 
     No significant change in Pennzoil's proved reserves as set forth above has
occurred as a result of any major discovery or other event since December 31,
1997.
 
     No estimates of Pennzoil's total proved net oil or gas reserves have been
filed with or included in reports to any federal authority or agency other than
the Securities and Exchange Commission ("SEC") since January 1, 1997.
 
                                        4
<PAGE>   7
 
     OIL AND GAS PROPERTIES. The following table shows Pennzoil's developed and
undeveloped oil and gas acreage as of December 31, 1997.
 
<TABLE>
<CAPTION>
                                                 DEVELOPED             UNDEVELOPED
                                                 ACREAGE(1)             ACREAGE(2)
                                              ----------------      ------------------
                                              GROSS       NET       GROSS        NET
                                              -----      -----      ------      ------
                                                      (EXPRESSED IN THOUSANDS)
<S>                                           <C>        <C>        <C>         <C>
United States
  Alabama...................................      7          4          --          --
  Arkansas..................................     24          4           2          --
  Colorado..................................     --         --          35          35
  Kansas....................................     43         40           1          --
  Louisiana.................................    234        183          28          24
  Mississippi...............................     25         19          11           7
  Montana...................................     --         --         350         168
  New Mexico................................     14          9         694         691
  New York..................................     16         14           5           4
  Ohio......................................      6          6           1           1
  Pennsylvania..............................    179        149         145         124
  Texas.....................................    486        357          66          32
  Utah......................................    118         56          21          11
  West Virginia.............................    364        330          85          61
  United States Waters
     Offshore Alaska........................      7          1           3          --
     Offshore California....................      4          1          11           3
     Offshore Louisiana.....................    260        179         215         178
     Offshore Texas.........................     64         28         179         122
                                              -----      -----      ------      ------
Total United States.........................  1,851      1,380       1,852       1,461
International(3)
  Australia.................................     --         --         772         288
  Azerbaijan................................     --         --         212          39
  Egypt.....................................     --         --       9,111       8,928
  Qatar.....................................     --         --         675         506
  Venezuela.................................     23         13       1,434       1,004
                                              -----      -----      ------      ------
Total International.........................     23         13      12,204      10,765
                                              -----      -----      ------      ------
Total.......................................  1,874      1,393      14,056      12,226
                                              =====      =====      ======      ======
</TABLE>
 
---------------
 
(1) Developed acreage represents the spacing units or other acreage assignable
    to productive wells.
(2) Undeveloped acreage is acreage on which wells have not been drilled or
    completed to a point that would permit the production of commercial
    quantities of oil and gas, regardless of whether such acreage contains
    proved reserves.
(3) Acreage in international areas is operated under production sharing
    arrangements, service contracts or other contractual arrangements not
    involving lease or fee ownership.
 
                                        5
<PAGE>   8
 
     The following table shows the approximate number of Pennzoil's productive
oil and gas wells as of December 31 for the years shown. Productive wells
consist of producing wells and wells capable of production in commercial
quantities.
 
<TABLE>
<CAPTION>
                                           GROSS WELLS(1)             NET WELLS(1)
                                       ----------------------     ---------------------
                                       1997    1996     1995      1997    1996    1995
                                       -----   -----   ------     -----   -----   -----
<S>                                    <C>     <C>     <C>        <C>     <C>     <C>
Oil
  United States......................  6,532   6,637    6,892     3,617   3,725   3,977
  International......................     12       5      619         8       5     411
Natural gas
  United States......................  1,848   1,814    1,674     1,244   1,234   1,067
  International......................     --      46      369        --      42     239
                                       -----   -----   ------     -----   -----   -----
                                       8,392   8,502    9,554     4,869   5,006   5,694
                                       =====   =====   ======     =====   =====   =====
</TABLE>
 
---------------
 
 (1) "Gross Wells" includes all wells in which Pennzoil has an interest. "Net
     Wells" reflects Pennzoil's percentage ownership interest in each "Gross
     Well." One or more completions in the same bore hole are counted as one
     well. Any well in which one of multiple completions is an oil completion is
     classified as an oil well.
 
     PRODUCTION AND SALES. The following table summarizes the average daily
production of Pennzoil, net of all royalties, overriding royalties and other
outstanding interests for the periods indicated. Natural gas production refers
only to marketable production of natural gas on an "as sold" basis. The majority
of production in the following table categorized as "International" is
production in Canada.
 
<TABLE>
<CAPTION>
                                                                1997        1996        1995
                                                              --------    --------    --------
<S>                                                           <C>         <C>         <C>
Crude oil, condensate and natural gas liquids (barrels per
  day)
  United States.............................................   55,830      56,391      60,069
  International.............................................      964       3,213       7,074
                                                              -------     -------     -------
                                                               56,794      59,604      67,143
                                                              =======     =======     =======
 
Natural gas (thousand cubic feet ("Mcf") per day)
  United States.............................................  568,768     552,408     607,163
  International.............................................   20,724      36,803      55,148
                                                              -------     -------     -------
                                                              589,492     589,211     662,311
                                                              =======     =======     =======
</TABLE>
 
     The following table shows the weighted average sales prices received by
Pennzoil for its production and the average production (lifting) costs per unit
of production.
 
<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31, 1997
                                                              -------------------------------
                                                              UNITED
                                                              STATES   INTERNATIONAL   TOTAL
                                                              ------   -------------   ------
<S>                                                           <C>      <C>             <C>
Crude oil, condensate and natural gas liquids (per
  barrel)...................................................  $16.72      $13.48       $16.66
Natural gas (per Mcf).......................................  $ 2.43      $ 1.39       $ 2.40
Production (lifting) costs per equivalent barrel(1)(2)......  $ 3.40      $ 6.24       $ 3.48
</TABLE>
 
<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31, 1996
                                                              -------------------------------
                                                              UNITED
                                                              STATES   INTERNATIONAL   TOTAL
                                                              ------   -------------   ------
<S>                                                           <C>      <C>             <C>
Crude oil, condensate and natural gas liquids (per
  barrel)...................................................  $14.78      $18.70       $14.99
Natural gas (per Mcf).......................................  $ 1.92      $ 1.14       $ 1.87
Production (lifting) costs per equivalent barrel(1)(2)......  $ 3.31      $ 3.78       $ 3.34
</TABLE>
 
                                             (Table continued on following page)
 
                                        6
<PAGE>   9
 
<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31, 1995
                                                              -------------------------------
                                                              UNITED
                                                              STATES   INTERNATIONAL   TOTAL
                                                              ------   -------------   ------
<S>                                                           <C>      <C>             <C>
Crude oil, condensate and natural gas liquids (per
  barrel)...................................................  $14.15      $15.64       $14.31
Natural gas (per Mcf).......................................  $ 1.51      $  .92       $ 1.46
Production (lifting) costs per equivalent barrel(1)(2)......  $ 3.40      $ 3.32       $ 3.39
</TABLE>
 
---------------
 
 (1) For purposes of providing common units of measure, natural gas is converted
     to a Btu-equivalent barrel of liquid on the basis of relative energy
     content (6 Mcf per barrel).
 
 (2) Production (lifting) costs are costs incurred to operate and maintain wells
     and related equipment and facilities. They do not include depreciation,
     depletion and amortization of capitalized acquisition, exploration and
     development costs, exploration expenses, general and administrative
     expenses, interest expense or income tax. Differences between sales prices
     and production (lifting) costs do not represent profit.
 
     Pennzoil sells its crude oil and condensate production generally based on
posted field prices less any applicable transportation charges. Pennzoil sells
its natural gas liquids production at negotiated prices. Pennzoil sells most of
its U.S. natural gas production at market prices to Columbia Energy Services
Corp. ("Columbia") under a contract that terminates on June 30, 2001. Pennzoil's
natural gas marketing efforts are primarily constrained by regulatory
limitations described generally below under the caption "Government Regulation."
 
     Pennzoil has a price risk management program that permits utilization of
agreements and financial instruments (such as futures, forward and option
contracts and swaps and collars) to reduce the price risk associated with
fluctuations in crude oil and natural gas prices. Reference is made to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Disclosures about Market Risk" and "-- Capital Resources and
Liquidity" for additional information.
 
     DRILLING ACTIVITY. The following table shows Pennzoil's net productive and
dry exploratory and development wells completed for the periods shown.
Completion occurs upon the installation of permanent equipment for the
production of oil or gas, or, in the case of dry holes, upon reporting
abandonment to the appropriate regulatory agency.
 
<TABLE>
<CAPTION>
                                                             NET EXPLORATORY                    NET DEVELOPMENT
                                                                  WELLS                              WELLS
                                                      ------------------------------     ------------------------------
                                                        1997       1996       1995         1997       1996       1995
                                                      --------   --------   --------     --------   --------   --------
<S>                                                   <C>        <C>        <C>          <C>        <C>        <C>
Oil Wells(1)
  United States.....................................     --          --        6.5         32.8       22.6       45.1
  International.....................................    0.1          --        8.3           --        1.0        1.5
Gas Wells(1)
  United States.....................................    2.1         2.8        7.4         43.6       44.3       48.6
  International.....................................     --         1.0       11.7           --        3.0       21.1
Dry Holes(2)
  United States.....................................    1.7         2.7        1.5          2.6        3.8         --
  International.....................................    2.3         5.5        6.0           --         --        2.1
                                                        ---        ----       ----         ----       ----      -----
                                                        6.2        12.0       41.4         79.0       74.7      118.4
                                                        ===        ====       ====         ====       ====      =====
</TABLE>
 
------------
 
 (1) For purposes of this tabulation, a productive well is an exploratory or a
     development well that is not a dry hole. One or more completions in the
     same bore hole are counted as one well. Any well in which one of multiple
     completions is an oil completion is classified as an oil well.
 
 (2) A dry hole is an exploratory or development well found to be incapable of
     producing either oil or gas in sufficient quantities to justify completion
     as an oil or gas well.
 
     As of December 31, 1997, Pennzoil was participating in the drilling or
awaiting completion of 12 gross (10.6 net) wells onshore and 10 gross (4.5 net)
wells offshore the United States.
 
     OIL AND GAS SEGMENT RESTRUCTURING. During 1997, the oil and gas segment was
restructured around three key geographic divisions: domestic offshore, domestic
onshore and international. These three divisions are supported by the
centralized organizations of technology, planning and acquisitions,
administration, negotia-
 
                                        7
<PAGE>   10
 
tions and land. In addition, several recognized industry executives with proven
records of success joined the company in 1997. The principal purpose of the
reorganization is to increase accountability and to focus the oil and gas
segment on increasing both production and reserves. The cost of the
restructuring was included in 1997 operating expenses and was not material.
 
     VOLUMES AND PRODUCTION COSTS. Natural gas production for 1997 averaged 589
million cubic feet ("MMcf") per day, which was slightly higher than the prior
year. Liquids production for 1997 averaged 57 thousand barrels ("Mbbls") per
day, approximately 3 Mbbls per day lower than 1996. Year-over-year production
comparisons were negatively impacted by the sale of noncore producing properties
in the Gulf of Mexico and Canada in 1996. After adjusting for 1996 property
sales, year-over-year production increased approximately 3 percent from 1996 to
1997.
 
     The Sea Robin pipeline connected to Pennzoil's West Cameron 580 block was
damaged in late January 1998 when a third party offshore vessel dragged its
anchor across a 16-inch gathering line. The damage caused Pennzoil to shut in
production on the block. The pipeline repairs were completed in mid-February.
The shut-in reduced daily production volumes by approximately 22,000 barrels of
oil equivalent ("BOE"), net to Pennzoil, for the 25 day period the pipeline was
shut in.
 
     Total production costs and expenses per BOE, excluding exploration expense
and DD&A, were $4.49 in 1997, $4.41 in 1996 and $5.09 in 1995.
 
     DOMESTIC -- EXPLORATION, DEVELOPMENT AND PRODUCTION ACTIVITIES. During
1997, in the Gulf of Mexico, a discovery on South Marsh Island 23, where
Pennzoil has a 100 percent working interest, added net natural gas production of
6 MMcf per day. In addition, at West Cameron 537, where Pennzoil has a 95
percent working interest, another new discovery is producing a net 10 MMcf per
day. Other significant discoveries were made at East Cameron 334, where Pennzoil
has a 28 percent working interest, and at South Marsh Island 48, where Pennzoil
has a 100 percent working interest. Net natural gas production from these two
discoveries exceeds 20 MMcf per day. As part of the ongoing drilling program, at
least three additional development wells and one additional exploration well
will be drilled at South Marsh Island 48. At West Cameron 575, where Pennzoil
has a 76 percent working interest, and Ship Shoal 150, where Pennzoil has a 100
percent working interest, platforms will be installed in 1998 with production of
4,000 BOE per day expected to begin in the fourth quarter of 1998.
 
     Development of the deepwater Enchilada discovery operated by Shell Oil at
Garden Banks 127/128 is proceeding. Pennzoil has a 20 percent interest in this
field. First production is anticipated in the second quarter of 1998, and gross
production should reach an estimated 12 Mbbls per day by the end of 1998.
 
     In September 1996, Pennzoil and a subsidiary of Enterprise Oil plc
("Enterprise") agreed to form a strategic alliance to pursue certain exploration
opportunities on 102 leases in Pennzoil's Gulf of Mexico portfolio where
Pennzoil's working interest is 50 percent or more. Generally, Enterprise will
earn an interest equal to half of Pennzoil's working interest in a lease by
contributing funds toward the costs of drilling a jointly agreed upon
exploration well on the lease. On 59 of the 102 leases within the portfolio,
where Pennzoil's average working interest is 92 percent ("Category I"),
Enterprise has agreed to spend $100.0 million through 1998 to fund 100 percent
of such drilling costs. On the remaining 43 leases, where Pennzoil's average
working interest is 80 percent ("Category II"), Enterprise has the option,
through 1999, to earn an interest equal to half of Pennzoil's working interest
in a Category II individual exploration well by funding 67 percent of the
drilling costs. These periods may be extended by one year and two years,
respectively, if Enterprise elects to increase from $100.0 million to $150.0
million its commitment to fund 100 percent of Category I exploration drilling
costs. If Enterprise does elect to increase its commitment to funding
exploration drilling on Category I leases to $150.0 million, it will earn
one-half of Pennzoil's working interest in all the Category I leases, in
addition to the individual exploration leases drilled by the alliance.
 
     In December 1997, Pennzoil and Enterprise spudded a Category I exploration
well at West Cameron 581. The well, located 3 miles west of Pennzoil's recent
discovery at West Cameron 580, will be drilled to a target depth of 17,000 feet.
West Cameron 580 has produced over 6.5 million BOE, net to Pennzoil, since March
of 1997, and has reached a gross daily production rate of 42,000 BOE from two
wells.
 
                                        8
<PAGE>   11
 
     Pennzoil plans to drill nine additional exploration wells in the Gulf of
Mexico in 1998. Enterprise is expected to join the company as a 50 percent
working interest owner in several of these wells.
 
     At Eugene Island 330, Pennzoil plans to drill five new wells or sidetracks
and four recompletions in 1998. Pennzoil is the operator of this field with a 23
percent working interest.
 
     Pennzoil acquired 22 Gulf of Mexico blocks in federal offshore lease sales
during 1997, located in water depths ranging from 50 to 3,000 feet. Pennzoil has
a 100 percent interest in 11 of the blocks and a 50 percent interest in the
other 11 blocks bid jointly with Enterprise. Pennzoil's federal offshore lease
bonus payments totaled $7.0 million in 1997.
 
     During 1997, Pennzoil continued its onshore initiatives in northeast Texas,
West Texas and Mississippi. The company drilled 88 onshore wells and performed
300 workover and recompletion operations during 1997.
 
     In the Carthage-Bethany area of northeast Texas, Pennzoil drilled 35
development wells in 1997 and another 33 development wells are scheduled for
1998. In the West Texas (Permian) and Mid-Continent areas, Pennzoil completed 36
wells. At Tinsley Field in Mississippi, Pennzoil successfully completed a four-
well development program in the emerging Hosston play. These four wells should
add approximately 1 Mbbls per day of production beginning in early 1998.
 
     Strategic workover programs were conducted in a number of areas. In East
Texas, a program consisting of 15 Travis Peak workover wells in the Carthage
Field developed a sustained gross production rate of 9 MMcf per day of natural
gas. The success of this program will lead to future workover and drilling
projects in the area. Waterflood, infill and new field management programs
consisting of both drilling and workovers are underway in the Permian Basin in
West Texas. These programs will be expanded over the next two years to fully
develop the upside potential of these fields.
 
     South Texas is a renewed area of strategic focus for the onshore division,
where a significant increase in drilling is planned for 1998. Pennzoil is
securing 3-D seismic coverage across all of its major acreage positions and is
expanding its exploration capabilities to pursue other opportunities in the
area. Pennzoil currently holds approximately 170,000 acres in South Texas.
 
     DOMESTIC -- ASSET HIGHGRADING PROGRAM. During 1996, Pennzoil completed its
assessment of its domestic oil and gas properties and its related asset
highgrading program which commenced in 1992. This assessment resulted in (i) the
categorization of Pennzoil's oil and gas properties into core and noncore
producing areas and core and noncore producing fields within core areas and (ii)
the disposition of substantially all properties and fields categorized as
noncore assets.
 
     From the beginning of 1992 through 1996, Pennzoil disposed of approximately
620 domestic producing oil and gas fields. The noncore assets disposed of over
the five-year period would have represented approximately 10 percent of the
reported value of Pennzoil's current proven oil and gas reserves and did not
factor into Pennzoil's future reserve development plans. Pennzoil currently has
approximately 100 core oil and gas properties in the United States. Reference is
made to "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Oil and Gas" for additional information.
 
     INTERNATIONAL -- CANADIAN PROPERTY SALES. In July 1996, Pennzoil completed
two related transactions with Gulf Canada: (i) the establishment of a joint
venture for the development of natural gas reserves in the Zama/Virgo region of
northwest Alberta and (ii) the sale by Pennzoil of its remaining, non-strategic
Canadian oil and gas assets to Gulf Canada. Including working capital and
closing adjustments of $3.5 million received in 1997, Pennzoil received net
proceeds of $196.3 million from the sale. Pennzoil recorded an after-tax gain of
$19.9 million on the sale, of which $19.1 million was due to the recognition of
certain tax benefits. Reference is made to Note 2 and Note 10 of Notes to
Consolidated Financial Statements for additional information.
 
     In December 1997, Pennzoil sold its 50 percent interest in the Zama/Virgo
joint venture to Phillips for net proceeds of $101.9 million and recorded an
after-tax gain of $24.6 million. The assets sold included 132 Bcf equivalent of
proved natural gas reserves. Included in Pennzoil's consolidated results of
operations for 1997 are revenues of $11.2 million and operating income of $3.3
million from these properties during 1997.
                                        9
<PAGE>   12
 
     INTERNATIONAL -- EXPLORATION, DEVELOPMENT AND PRODUCTION ACTIVITIES. In
October 1996, Pennzoil was awarded the drilling rights to the North July block
offshore Egypt in the Gulf of Suez. Pennzoil has a 100 percent working interest
in this block, which is bordered by a large oil field (July/North July). The
agreement for North July was signed during June 1997.
 
     In January 1997, Pennzoil was awarded the drilling rights to Block E, the
West Beni Suef exploration block, in Egypt's western desert. The agreement for
West Beni Suef was signed during June 1997. Pennzoil has a 100 percent working
interest and has committed to spend $7.0 million to acquire 2-D seismic on the
block and drill three exploration wells within three years of parliamentary
approval. West Beni Suef is located approximately 100 miles southwest of Cairo
and covers 8.7 million acres.
 
     Including the award of Block E, Pennzoil now has five exploration blocks in
Egypt covering a total of 9.2 million acres. Four blocks are located in the Gulf
of Suez. In the Southeast Gulf of Suez Block, where Pennzoil has a 50 percent
interest, Repsol Exploracion Egypto S.A. ("Repsol"), as operator, drilled an
exploratory well during 1997 which was found to be non-commercial. Pennzoil
plans to drill a total of four exploratory wells in Egypt in 1998. Pennzoil, as
operator, will drill two wells in the Southwest Gebel el Zeit concession (87.5
percent Pennzoil) and one well in the North July Field (100 percent Pennzoil).
Pennzoil's partner, IEOC, a subsidiary of Agip of Italy ("Agip"), will also
drill one well in the West Feiran Field (50 percent Pennzoil). All four wells
are offshore in the Gulf of Suez.
 
     In 1997, Pennzoil acquired two production permits, B2X-68/79 and B2X-70/80,
in Lake Maracaibo, Venezuela. Pennzoil will take over operation of the B2X-68/79
block (60 percent Pennzoil) in early 1998. The company is also working closely
with PanCanadian Petroleum Limited ("PanCanadian"), which will take over
operation of the B2X-70/80 block (50 percent Pennzoil) early in the year. In
late 1997, Pennzoil submitted a development plan for its B2X-68/79 contract to
PDVSA, the state oil company of Venezuela. The Company is also assisting
PanCanadian in preparing a development plan for the B2X-70/80 contract area for
submittal in the first quarter of 1998. Pennzoil should realize first production
from the B2X contract areas in the first half of 1998. These two blocks have
remaining gross reserves of between 100 and 200 MMbbls.
 
     In July 1996, Pennzoil completed the sale of approximately half of its 9.82
percent interest in the Azeri-Chirag-Gunashli ("ACG") joint development unit
offshore Azerbaijan in the Caspian Sea to affiliates of Exxon Corporation
("Exxon"), affiliates of ITOCHU Oil Exploration Co., Ltd. ("ITOCHU") and
affiliates of Unocal Corporation ("Unocal"). The three companies will pay
approximately $130.0 million to Pennzoil for a 5 percent working interest in the
ACG unit (3.00 percent to Exxon, 1.47 percent to ITOCHU and 0.53 percent to
Unocal) and the right to receive approximately 51 percent of the payments due
Pennzoil for reimbursement of costs incurred in developing a gas utilization
project for the Gunashli Field. Net cash payments to Pennzoil are scheduled in
three installments with the first installment having been made in two payments
consisting of approximately $83.0 million received at closing and another $5.0
million received in August 1996. A subsequent installment of $22.0 million was
received in January 1998 and a final payment of $20.0 million is due when the
unit reaches production of 200 Mbbls per day. Pennzoil has retained a 4.8175
percent working interest in the ACG unit. As part of the transaction, the three
companies will fund all of Pennzoil's future obligations in the ACG project,
retroactive to January 1, 1996, until all such expenditures and accrued interest
are recovered from Pennzoil's share of production from the ACG unit ("payout").
In addition, Pennzoil received a net cash payment of approximately $16.0 million
in August 1996 for reimbursement of Pennzoil's costs in the ACG unit incurred
from January 1996 through July 1996. Through 1997, no gains have been recorded
related to any of the above proceeds; instead, such receipts were applied to
reduce Pennzoil's net investment in the ACG unit and the gas utilization
project. Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Oil and Gas" for additional information.
 
     In September 1995, the consortium of foreign oil companies developing the
ACG unit elected to pursue dual export routes for transporting early oil
production from the Caspian Sea, one north through an existing pipeline system
to a Russian port on the Black Sea, and the second west through Azerbaijan and
Georgia to
 
                                       10
<PAGE>   13
 
the Black Sea. The western route will require replacing 150 miles of pipeline in
Azerbaijan and an additional 73 miles of pipeline to interconnect existing
lines. The northern route became operational in October 1997 with shipments of
oil from the State Oil Company of the Azerbaijan Republic ("SOCAR"). The western
route is expected to be completed in January 1999. Pennzoil has recorded 54
MMbbls of proved crude oil reserves relating to early oil from this project.
 
     First oil production started in November 1997 from the ACG joint
development area. The consortium plans to drill six wells in 1998. Year-end
production at ACG was 15 Mbbls per day. Total consortium project production by
the end of 1998 is expected to increase to an estimated 50 Mbbls per day. The
consortium expects daily production to reach 200 Mbbls per day by 2002. Peak
consortium project production of 800 Mbbls per day is expected to be reached by
2006. Based upon current projections of spending and production, Pennzoil
expects to achieve payout prior to the consortium project reaching peak
production.
 
     In November 1995, Pennzoil announced that its Pennzoil Caspian Development
Corporation ("PCDC") subsidiary had entered into a definitive exploration,
development and production sharing contract with SOCAR covering the Karabakh
prospect in the Caspian Sea offshore Azerbaijan. Participating in the project
with Pennzoil (30 percent) are units of LUKoil of Russia (7.5 percent), Agip (5
percent) and LUKAgip, a subsidiary of LUKoil and Agip (50 percent). In addition,
a commercial affiliate of SOCAR has a 7.5 percent interest as a contractor
party. The exploration, development and production sharing agreement was
ratified by the Azerbaijan Parliament in February 1996. The Karabakh prospect is
located north of the ACG deepwater unit and outside the Apsheron trend
approximately 50 miles offshore in approximately 600 feet of water. The work
commitment includes a seismic program and exploratory drilling over a period of
three years, which period may be extended an additional one-and-a-half years.
Should commercial hydrocarbons be discovered, the agreement will have a
development and production period of 25 years, which may be extended an
additional 5 years under certain conditions.
 
     In 1997, Caspian International Petroleum Company ("CIPCO"), the consortium
operating this block, encountered natural gas in its first well drilled. A full
assessment of the potential at Karabakh will depend on additional drilling and
evaluation. Two additional exploration wells are planned for the first half of
1998.
 
     In October 1996, Pennzoil signed a farm-in agreement with Amity Oil, N.L.
("Amity") to explore the Whicher Range concession in southwest Australia. In
1997, Pennzoil paid $9.5 million for its portion (88 percent) of the costs for
one recompletion and one well in exchange for a 44 percent interest in the
property. Amity is the operator during the exploration phase, and Pennzoil will
become operator for the development phase. In 1997, Pennzoil completed the WR-1
and WR-4 wells on the Whicher Range concession (44 percent Pennzoil). In 1998,
Pennzoil will perform extended production tests on both wells. These tests will
determine if commercial quantities of natural gas can be produced at Whicher
Range. Pennzoil has also reached an agreement with Amity for an option to
explore an area adjacent to Whicher Range on Exploration Permit 381. An
exploration well may be drilled in 1998, depending on the production test
results at Whicher Range.
 
     In 1997, Pennzoil sold a 25 percent working interest in Block 8 offshore
Qatar to Novus Petroleum Limited ("Novus"), of Sydney, Australia. Pennzoil now
has a 75 percent working interest in Block 8. As part of its buy-in, Novus
agreed to pay Pennzoil $9.7 million, which is expected to equal Pennzoil's share
of the dry-hole expenses for three wells drilled on Block 8. Two non-commercial
wells were subsequently drilled in 1997. The PQ-4 well, which reached total
depth in early 1998, was tested and also found to be non-commercial.
 
     Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Oil and Gas" for additional information.
 
     CAPITAL BUDGET. Pennzoil's capital budget, including interest capitalized,
for domestic and international oil and gas exploration and development during
1998 is currently estimated to be $447.3 million, compared to $406.4 million of
capital expenditures in 1997. The company's drilling program for 1998 includes
158 exploration and development wells worldwide, as well as substantial domestic
recompletion and workover activities.
 
                                       11
<PAGE>   14
 
     The domestic oil and gas capital budget is approximately $360.0 million and
includes 149 exploration and development wells. In the Gulf of Mexico, Pennzoil
plans to drill 10 exploration wells and 43 exploitation wells. Onshore,
primarily in South Texas, Carthage Field, the Permian Basin and SACROC in West
Texas, the company plans to drill 12 exploration wells and 84 exploitation
wells.
 
     Internationally, the company plans to drill nine exploration wells during
1998 in Australia, Azerbaijan, Egypt and Venezuela. International oil and gas
expenditures are expected to total approximately $87.4 million. Reference is
made to "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Capital Resources and Liquidity" for additional information.
 
     OPERATING RISKS. Pennzoil conducts or participates in certain offshore oil
and gas operations which are subject to the hazards of marine operations, such
as capsizing, collision and adverse weather and sea conditions, as well as risks
of blowouts and fires, which are generally present in all oil and gas drilling.
In the past, production from offshore operations has been delayed on several
occasions as a result of pipeline breaks, hurricanes, blowouts and other
unforeseen events. In addition, Pennzoil's foreign oil and gas operations are
subject to certain risks, such as nationalization, confiscation, renegotiation
of existing contracts and currency fluctuations. Pennzoil monitors political,
regulatory and economic developments in any foreign country in which it
operates.
 
MOTOR OIL & REFINED PRODUCTS
 
     Pennzoil's motor oil and refined products operations are conducted by PPC.
These operations include the procurement and refining of crude oil and the
blending, packaging and marketing of motor oil and refined products.
 
     MANUFACTURING. PPC owns and operates two lube oil and specialty refineries,
one located near Oil City, Pennsylvania ("Rouseville") and the other, located in
Shreveport, Louisiana. The paraffinic lube base stocks produced by these
refineries are used in the blending of motor oil and other lubricants by PPC's
marketing division and for sale to industrial customers. The lube oil and
specialty refineries also produce waxes, petrolatums, special cut kerosenes,
transformer oils, process oils and other naphthenic base oils for use in
producing industrial specialty products or for sale to industrial customers. Jet
fuel is also supplied by the Shreveport refinery to several commercial airlines.
 
     In December 1996, commercial production commenced at the new
state-of-the-art lube oil hydrocracker facility of Excel Paralubes ("Excel"), a
50-50 partnership between PPC and Conoco, Inc. ("Conoco") located at Conoco's
refinery in Lake Charles, Louisiana. The facility is capable of producing
approximately 18 Mbbls per day of high-quality base oils, the base ingredient in
finished lubricants. Conoco is acting as operator of the plant with support
positions staffed by both companies. The facility produces high-quality base
oils and has made PPC self-sufficient in high-quality lube base stocks.
 
                                       12
<PAGE>   15
 
     The following table sets forth information with respect to raw material
supplied and processed, refining capacity and utilization of PPC's refineries
during the years indicated.
 
<TABLE>
<CAPTION>
                                                                 1997          1996          1995
                                                               ---------     ---------     ---------
                                                               (BARRELS PER DAY EXCEPT PERCENTAGES)
<S>                                                            <C>           <C>           <C>
Raw Material
  Supplied
     Pennzoil's domestic crude oil and condensate
       production...........................................     45,160        42,246        21,695
     Raw materials purchased from others (including 50% of
       Excel)...............................................     20,353         9,015        28,381
     Net decrease (increase) in inventory...................        195         1,825        (2,110)
                                                                -------       -------       -------
                                                                 65,708        53,086        47,966
                                                                =======       =======       =======
  Processed(1)
     Oil City, Pennsylvania.................................     12,081        14,206        10,968
     Shreveport, Louisiana..................................     42,969        38,880        36,998
     Lake Charles, Louisiana (Pennzoil's 50% ownership in
       Excel)...............................................     10,658            --            --
                                                                -------       -------       -------
                                                                 65,708        53,086        47,966
                                                                =======       =======       =======
Refining capacity (at year end)
  Oil City, Pennsylvania....................................     16,500        16,500        16,500
  Shreveport, Louisiana(2)..................................     50,500        46,200        46,200
  Lake Charles, Louisiana (Pennzoil's 50% ownership in
     Excel).................................................     13,300            --            --
                                                                -------       -------       -------
                                                                 80,300        62,700        62,700
                                                                =======       =======       =======
Refinery utilization(1).....................................       83.0%         84.7%         76.5%
                                                                =======       =======       =======
</TABLE>
 
---------------
 
(1) Processed volumes and refinery utilization are lower in 1995 primarily due
    to the Rouseville refinery fire which occurred in the fourth quarter and to
    an extended maintenance turnaround at PPC's Shreveport refinery which also
    occurred in the fourth quarter of 1995.
 
(2) New capacity related to the residual catalytic cracking unit at the
    Shreveport refinery which came online in April 1997.
 
     PPC purchases from others the requirements of its marketing operations not
produced in its own refineries.
 
     Prior to October 1997, PPC owned and operated two specialty product plants
located in Karns City, Pennsylvania and Dickinson, Texas. These plants
manufactured petrolatums, white oils, ink solvents, sulfonates, waxes and other
specialty petroleum products using feedstocks from PPC's refineries. These
products were marketed by PPC's PENRECO(R) and MAGIE BROS(R) divisions directly
to manufacturers and end-users.
 
     In October 1997, PPC and Conoco formed a partnership called PENRECO(R). PPC
contributed its operations related to petrolatums, white oils, ink solvents,
sulfonates, waxes and other specialty products, including its two specialty
products plants located in Karns City, Pennsylvania and Dickinson, Texas. Conoco
contributed its solvents business, which sells products primarily into the
drilling fluids, mining, and cleaning products markets, and as carrier oils for
many consumer products. By combining the two companies' complementary
manufacturing, technical and marketing capabilities, PENRECO(R) will be able to
grow rapidly and remain a leader in the global industrial specialties markets.
 
     In April 1997, construction was completed on the residual catalytic
cracking unit at PPC's Shreveport refinery. This unit substantially lowers the
effective cost of base oils produced at the facility by converting low value
byproducts into higher value fuels.
 
     In April 1995, PPC and the Polymers Division of Petrolite Corporation
("Petrolite") formed a 50-50 partnership called BARECO(R) Products to market a
broad line of wax products to domestic and international purchasers of paraffin,
microcrystalline and related synthetic waxes. Pennzoil transports partially
refined feedstock from Utah to its Rouseville refinery, which produces
paraffinic and microcrystalline waxes and related products. These wax products,
along with certain waxes from Petrolite, existing wax products from PPC's
Shreveport refinery and waxes purchased from other suppliers, are marketed
through the partnership.
 
                                       13
<PAGE>   16
 
Pennzoil has invested approximately $28.0 million in its Rouseville refinery and
its packaging plant in nearby Reno, Pennsylvania in connection with this
venture. Production from these facilities began in September 1996.
 
     In July 1995, PPC and a partner formed Red River Terminals, L.L.C. to build
and operate a liquids terminal at the Port of Shreveport, Louisiana. The opening
of the Red River to navigation has provided the opportunity for PPC to use less
expensive waterborne freight for access to new feedstocks and markets for PPC's
Shreveport refinery and packaging facility. The project was completed in
February 1997.
 
     MARKETING. PENNZOIL(R) motor oil and lubricants are produced in five
domestic company-owned and operated blending and packaging plants (Portland,
Oregon; Shreveport, Louisiana; Rouseville, Pennsylvania; Vernon, California; and
St. Louis, Missouri). In addition, three industrial packaging plants (Mundy's
Corner, Pennsylvania; Marion, Illinois; and Alameda, California) produce
lubricants for the commercial and industrial markets and an aerosol filling
plant (Winter Haven, Florida) produces chemicals.
 
     PENNZOIL(R) products are sold in all 50 states through 162 independent
distributors and 53 company-owned distribution facilities. Additionally,
PENNZOIL(R) brand gasoline is marketed through approximately 450 retail outlets
located in Pennsylvania, Ohio, New York, Virginia, West Virginia, Tennessee,
Kentucky and Louisiana. Kerosenes, diesel oils, fuel oils and other distillates
are marketed at both the retail and wholesale levels through distributors.
 
     PPC competes with a number of other companies in the sale of motor oil and
refined products. Competition is based on price, service and quality, with
quality being of particular importance in the case of motor oils and other
petroleum specialty products.
 
     PPC is one of America's leading marketers of fuel injector and carburetor
cleaners and other car care products under the GUMOUT(R) name. These products
are sold primarily to the consumer through retail channels, but GUMOUT(R) has an
increasing presence in the installed market (fast lubes, service stations, auto
dealers, etc.). WOLF'S HEAD(R) lubricants are also marketed as a secondary
value-priced line throughout the U.S., alongside the PENNZOIL(R) lubricants
brand. In addition, PPC is a master distributor for GOJO(R) hand cleaner
products, PRESTONE(R) antifreeze and a distributor for FRIGC(R) FR-12TM
refrigerant.
 
     In September 1995, PPC acquired the assets of the Viscosity Oil division
("Viscosity Oil") of Case Corporation ("Case") for $33.6 million. Viscosity Oil
is a leading supplier of premium-quality lubricants to the North American
off-road industry, and it supplies lubricants to substantially all the Case
dealer network, with locations in all 50 states and Canada.
 
     In October 1997, PPC acquired the assets of Total Action Automotive
Products ("TAAP"). TAAP manufactures and markets premium-quality automotive
appearance products, including CLASSIC(R) car waxes and washes.
 
     In November 1997, PPC acquired the marketing and distribution assets of
Snap Automotive Products, Inc. ("Snap"). Snap products include FIX-A-FLAT(R),
the number one selling tire inflator in the U.S.; OUTLAW(R) fuel additives; and
SNAP(R) fuel additives and chemicals.
 
     PENNZOIL(R) motor oil and lubricants are marketed in 64 countries through
45 distributors, 4 licensees, 6 joint ventures and 9 majority owned business
entities.
 
     PPC considers the trademarks used in its motor oil and refined products
operations to have significant marketing value, primarily in identifying
Pennzoil and its products.
 
                                       14
<PAGE>   17
 
     The following table sets forth information with respect to quantities sold
externally by PPC's marketing and manufacturing operations during the years
indicated.
 
<TABLE>
<CAPTION>
                                             1997          1996          1995
                                           --------      --------      --------
                                                    (BARRELS PER DAY)
<S>                                        <C>           <C>           <C>
Gasoline and naphtha....................    19,192        21,551        20,618
Distillates and gas oils................    26,304        26,983        26,434
Lubricating oil and other specialty
  products..............................    30,721        23,812        22,966
Residual fuel oils......................     1,984         3,977         3,381
                                            ------        ------        ------
                                            78,201        76,323        73,399
                                            ======        ======        ======
</TABLE>
 
FRANCHISE OPERATIONS
 
     Jiffy Lube franchises, owns and operates automotive service centers. JIFFY
LUBE(R) service centers offer convenient automotive maintenance services. Jiffy
Lube's standard full service includes an oil change and filter replacement,
chassis lubrication, checking for proper tire inflation, window washing,
interior vacuuming, checking and topping off of transmission, differential,
windshield washer, battery and power steering fluid levels and air filter and
windshield wiper blade examination. JIFFY LUBE(R) service centers also provide
other authorized services and products at an additional cost.
 
     In March 1995, Jiffy Lube and the Sears Merchandise Group ("Sears") agreed
to open fast-oil change units in Sears Auto Centers over the next three years.
Under the agreement, Jiffy Lube remodels, equips and operates service areas
within Sears Auto Centers, while Sears continues to utilize the remaining bays
for its operations. Jiffy Lube had 165 fast-oil change units open at Sears Auto
Centers at the end of 1997, of which 133 are company-operated and 32 are
franchise-operated.
 
     At December 31, 1997, 1,516 JIFFY LUBE(R) service centers were open in the
United States. Franchisees operated 935 of the service centers and Jiffy Lube
owned and operated the remaining 581. The JIFFY LUBE(R) service centers
generally are clustered in metropolitan areas throughout the United States.
 
OTHER INTERESTS
 
     In September 1996, Pennzoil completed the sale of Vermejo Park Ranch to
Vermejo Park L.L.C., a Georgia limited liability company. The ranch is located
in northern New Mexico and southern Colorado and includes approximately 578,000
acres of surface properties. Reference is made to "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Other" and Note 10
of Notes to Consolidated Financial Statements for additional information.
 
     Pennzoil owns approximately 726,000 acres of certain mineral rights in the
Raton Basin area of New Mexico and Colorado. The table included under the
caption "Oil and Gas -- Oil and Gas Properties," showing Pennzoil's developed
and undeveloped oil and gas acreage, includes the mineral rights to 726,000
acres held in the Raton Basin.
 
EMPLOYEES
 
     The following table sets forth the number of Pennzoil employees by segment
at December 31 of each of the years indicated:
 
<TABLE>
<CAPTION>
                                             1997        1996        1995
                                           --------    --------    --------
<S>                                        <C>         <C>         <C>
Oil and Gas.............................       889         863       1,270
Motor Oil & Refined Products............     2,827       3,157       2,770
Franchise Operations....................     6,143       5,669       5,176
Corporate and Other.....................       355         347         542
                                            ------      ------      ------
          Total.........................    10,214      10,036       9,758
                                            ======      ======      ======
</TABLE>
 
                                       15
<PAGE>   18
 
     Approximately 6 percent of Pennzoil's employees are represented by various
labor unions. Collective bargaining agreements are in force with most of the
unions.
 
     Pennzoil is subject to various federal and state laws and regulations
governing employment practices and working conditions, including Title VII of
the Civil Rights Act of 1964, as amended, the Equal Pay Act of 1963, the Civil
Rights Act of 1991, the Americans with Disabilities Act of 1990, the Family and
Medical Leave Act of 1993, the Drug Free Workplace Act of 1989, the Age
Discrimination in Employment Act of 1967, as amended, the Rehabilitation Act of
1973, as amended, the Vietnam Era Veterans' Readjustment Assistance Act of 1974,
as amended, the Occupational Safety and Health Act of 1970, the Fair Labor
Standards Act of 1938, as amended, the National Labor Relations Act of 1935, as
amended, and Executive Order 11246.
 
GOVERNMENT REGULATION
 
     Pennzoil's operations are affected from time to time in varying degrees by
political developments and federal, state and local laws and regulations. In
particular, oil and gas operations and economics are affected by the imposition,
modification and removal of price controls, regulation of access to markets,
laws on taxation, fuel use restrictions and inducements, federal, state and
Indian land leasing policies and constantly changing administrative regulations
and interpretations of those regulations.
 
     REGULATION OF NATURAL GAS MARKETING. Until as late as January 1, 1993,
Pennzoil and other natural gas producers were subject to comprehensive natural
gas sales price and service regulation by the Federal Energy Regulatory
Commission ("FERC"). However, since that date, all sales of natural gas by
Pennzoil have been unregulated, subject to the terms and conditions of its
private contracts, and made at market prices. The FERC continues to have
jurisdiction over and actively regulates interstate and certain intrastate
natural gas transportation and storage rates and service conditions, which
affect the marketing of natural gas produced by Pennzoil, as well as the
revenues received by Pennzoil for sales of such production. Since the mid-1980s,
the FERC has issued a series of so called "open access" orders, culminating in
Order Nos. 636, 636-A and 636-B ("Order 636"), that have significantly altered
the marketing and transportation of gas. Order 636 mandated a fundamental
restructuring of interstate pipeline sales and transportation service, including
the unbundling by interstate pipelines of the sales, transportation, gathering,
storage and other components of wholesale gas marketing services such pipelines
previously performed. While the interstate pipelines may continue to sell gas in
the competitive marketplace, the FERC regulations require the full separation of
the pipelines' sales and transportation-related functions from its marketing
efforts, so that no undue advantage is gained over other merchants, such as
Pennzoil, which wish to secure transportation services and/or sell into these
newly available markets. As a result, virtually all interstate pipelines have
created separate marketing affiliates through which to sell gas. Order 636 and
subsequent FERC orders issued in individual pipeline restructuring proceedings
have been the subject of appeals, the results of which have generally been
supportive of the FERC's open-access policy. For example, in 1996, the United
States Court of Appeals for the District of Columbia Circuit largely upheld
Order 636. Because the FERC continues to review and revise its open-access
regulations, it is difficult to predict the ultimate impact of the orders on
Pennzoil and its gas marketing efforts. For example, the FERC has revised its
standards respecting what constitutes nonregulated gathering facilities and has
authorized a number of interstate pipelines to divest their gathering facilities
to unregulated affiliates or third parties. Concerns have been raised that such
unregulated gathering affiliates could increase gathering charges and thereby
increase the cost of doing business for those natural gas producers that lack
competitive gathering alternatives in a particular geographic area. While
sympathetic to these concerns, the FERC nevertheless has approved these
divestitures while encouraging greater state-level involvement in regulating
gathering. Several states, such as Texas, have become more active in reviewing
gathering activities to discourage abusive practices. The FERC also is
evaluating the use of alternative ratemaking procedures, including market-based
rates, for certain services. Gas storage services are an area where market-based
rates are prevalent. Notwithstanding these ongoing changes, Order 636 generally
has eliminated or substantially reduced the interstate pipelines' traditional
role as wholesalers of natural gas and has substantially increased competition
and volatility in natural gas markets. While significant regulatory uncertainty
remains, Order 636 may ultimately enhance Pennzoil's ability to market and
transport its gas, although it may also subject Pennzoil to greater competition.
 
                                       16
<PAGE>   19
 
     REGULATION OF PETROLEUM MARKETING. Sales of oil and natural gas liquids by
Pennzoil are not regulated and are made at market prices. The price Pennzoil
receives from the sale of these products is affected by the cost of transporting
the products to market. Much of that transportation is through interstate common
carrier pipelines. Effective as of January 1, 1995, the FERC implemented
regulations generally grandfathering all previously approved interstate
transportation rates and establishing an indexing system for those rates by
which adjustments are made annually based on the rate of inflation, subject to
certain conditions and limitations. These regulations may tend to increase the
cost of transporting oil and natural gas liquids by interstate pipeline,
although the annual adjustments may result in decreased rates in a given year.
These regulations have generally been approved on judicial review. Pennzoil is
not able to predict with certainty what effect, if any, these relatively new
federal regulations will have on it.
 
     FEDERAL AND STATE PRODUCTION REGULATIONS.  Pennzoil's oil and gas
exploration and production operations are subject to various types of regulation
at the federal, state and local levels. Federal regulation of Pennzoil's
offshore Gulf of Mexico leases is accomplished by the Minerals Management
Service of the Department of the Interior ("MMS"). The MMS has been particularly
active in recent years in evaluating and, in some cases, promulgating new rules
and regulations regarding competitive lease bidding and royalty payment
obligations for production from federal lands. The FERC also has jurisdiction
over certain offshore activities pursuant to the Outer Continental Shelf Lands
Act. State regulation typically includes requiring drilling permits and the
maintenance of bonds in order to drill or operate wells; the regulation of the
location of wells, the method of drilling and casing of wells and the surface
use and restoration of properties upon which wells are drilled; and the plugging
and abandoning of wells. Pennzoil's operations are also subject to various
conservation regulations, including regulation of the size of drilling and
spacing units or proration units, the density of wells that may be drilled in a
given area and the unitization or pooling of oil and gas properties. In this
regard, some states allow the forced pooling or integration of lands and leases.
In addition, state conservation laws establish maximum rates of production from
oil and gas wells, generally prohibit the venting or flaring of gas and impose
certain requirements regarding the ratability of production. The effect of these
regulations may be to limit the amounts of crude oil, condensate and natural gas
Pennzoil can produce from its wells and the number of wells or the locations at
which Pennzoil can drill.
 
     ENVIRONMENTAL MATTERS.  Pennzoil's operations in the United States are
subject to numerous federal, state and local laws and regulations controlling
the discharge of materials into the environment or otherwise relating to the
protection of the environment and human health and safety.
 
     Pennzoil is subject to a variety of state and federal Clean Air Act rules
requiring air emission reductions from its operating units and fuels. Currently,
the U.S. Environmental Protection Agency ("EPA"), the Ozone Transport Assessment
Group ("OTAG"), Ozone Transport Region ("OTR") and several states are examining
new standards and/or controls which could impose significant costs on Pennzoil.
The EPA has recently adopted new, more stringent national ambient air quality
standards for ozone and particulate matter. Under the new standards, many more
areas of the country will be considered high pollution areas and will be subject
to additional regulatory controls, including possible fuel specification
requirements. Control measures to implement these new standards will be adopted
over the next five to seven years. Similarly, the multi-state OTAG and OTR
groups are developing lists of suggested controls to limit interstate ozone
transport. The EPA has issued a proposal to require states to begin adopting
many of these suggested controls over the next few years.
 
     The precise effect of these actions on Pennzoil and other industrial
companies is uncertain because most of the requirements will be implemented
through EPA regulations to be issued over a period of years. For example, fuels
produced at one or both of Pennzoil's refineries will likely be required to be
reformulated to a composition significantly different from the fuels currently
produced. No detailed cost estimate has been prepared to date because it is also
likely that any reformulated fuel required by such future regulations will
differ significantly, but unpredictably, from the reformulated gasoline required
in some parts of the country today.
 
     Pennzoil is also subject to certain laws and regulations relating to
environmental remediation activities associated with past operations, such as
the Comprehensive Environmental Response, Compensation, and Liability Act
("CERCLA"), the Resource Conservation and Recovery Act and similar state
statutes. In
 
                                       17
<PAGE>   20
 
response to liabilities associated with these activities, accruals have been
established when reasonable estimates are possible. Pennzoil adjusts the
accruals when new remediation responsibilities are discovered and probable costs
become estimable, or when current remediation estimates must be adjusted to
reflect new information.
 
     Pennzoil's assessment of the potential impact of these environmental laws
is subject to uncertainty due to the difficult process of estimating remediation
costs that are subject to ongoing and evolving change. Initial estimates of
remediation costs reflect a broad-based analysis of site conditions and
potential environmental and human health impacts derived from preliminary site
investigations (including soil and water analysis, migration pathways and
potential risk). Later changes in these initial estimates may be based on
additional site investigations, completion of feasibility studies (comparing and
selecting from among various remediation methods and technologies) and risk
assessments (determining the degree of current and future risk to the
environment and human health, based on current scientific and regulatory
criteria) and the actual implementation of the remediation plan. This process
occurs over relatively long periods of time and is influenced by regulatory and
community approval processes and is subject to the ongoing development of
remediation technologies. Pennzoil's assessment analysis takes into account the
condition of each site at the time of estimation, the degree of uncertainty
surrounding the estimates for each phase of remediation and other site-specific
factors.
 
     Capital outlays of approximately $96.0 million have been made by Pennzoil
since January 1995 with respect to environmental protection. Capital
expenditures for environmental control facilities are currently expected to be
approximately $41.0 million in 1998. Reference is made to "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Capital Resources and Liquidity -- Environmental Matters" for
additional information.
 
     FRANCHISE MATTERS. Jiffy Lube is subject to, and devotes substantial
efforts to compliance with, a variety of federal and state laws governing
franchise sales and marketing and franchise trade practices. Although the
regulatory environment differs by state, applicable laws and regulations
generally require disclosure of business information in connection with the sale
of franchises. Certain state regulations also affect the ability of the
franchisor to revoke or refuse to renew a franchise. Jiffy Lube seeks to comply
with applicable regulatory requirements. However, given the scope of Jiffy
Lube's business and the nature of franchise regulations, compliance problems can
be encountered from time to time.
 
ITEM 3. LEGAL PROCEEDINGS.
 
     (A) CLASS ACTION. Reference is made to Note 8 of Notes to Consolidated
Financial Statements for a description of Lazy Oil Co., John B. Andreassi and
Thomas A. Miller Oil Co. on behalf of themselves and other similarly situated
vs. Witco Corporation; Quaker State Corporation; Quaker State Oil Refining
Corp.; Pennzoil Company and Pennzoil Products Company.
 
     (B) RAMCO DISPUTE. In October 1995, PEPCO, Pennzoil International, Inc.,
Pennzoil Caspian and PCDC filed an action, styled Pennzoil Exploration and
Production Company, et al. v. Ramco Energy Limited and Ramco Hazar Energy
Limited, in the United States District Court for the Southern District of Texas,
Houston Division, against Ramco Hazar Energy Limited, formerly known as Ramco
Energy Limited (collectively "Ramco"). The federal suit seeks to compel Ramco to
arbitrate certain disputes that have arisen between it and the Pennzoil
plaintiffs pursuant to the Federal Arbitration Act and the Convention on the
Recognition and Enforcement of Foreign Arbitral Awards. The underlying dispute
involves Ramco's asserted claim to an interest in the Karabakh prospect, an oil
and gas field located in the territorial waters of the Azerbaijan Republic in
the Caspian Sea and which PCDC, SOCAR and other foreign oil companies have
agreed to explore and develop. After the filing of the federal action, the
Pennzoil plaintiffs filed an Original Petition for Declaration Relief in the
281st Judicial District Court of Harris County, Texas. The state suit, styled
Pennzoil Exploration and Production Company, et al. v. Ramco Energy Limited and
Ramco Hazar Energy Limited, which is expressly conditioned upon a determination
in the federal suit that the disputes between the Pennzoil plaintiffs and Ramco
are not subject to arbitration, seeks a declaration that the Pennzoil plaintiffs
have not breached any agreements with Ramco, and do not owe and/or have not
breached any fiduciary or other legal duty to Ramco including, without
limitation, a duty of good faith and fair dealing. In November 1995, Ramco
asserted a counterclaim in the state court action, asserting breach of contract
and
                                       18
<PAGE>   21
 
breach of fiduciary duties. The counterclaim seeks a declaratory judgment
granting Ramco a participation interest in the Karabakh prospect, compensatory
damages, exemplary damages, attorneys' fees, costs of court and other
unspecified relief. The judge in the federal suit granted in part the Pennzoil
plaintiffs' motion to compel arbitration and ordered arbitration to be held in
New York, New York. The Ramco defendants have appealed and the Pennzoil
plaintiffs have cross-appealed to the United States Court of Appeals for the
Fifth Circuit.
 
     (C) TEXAS FEDERAL COURT EMPLOYMENT ACTION. In August 1996, a lawsuit styled
Donna Alexander, et al. v. Pennzoil Company, et al.,was filed in the United
States District Court for the Southern District of Texas, Houston Division. The
amended complaint filed by eleven named plaintiffs alleges wrongful and illegal
discrimination by Pennzoil and subsidiaries against African-American employees
and seeks actual damages of $75.0 million and punitive damages of three times
that amount. Pennzoil vigorously denies these allegations and will oppose
plaintiffs' efforts to have the case certified as a class action by the Court.
 
     (D) LOUISIANA FEDERAL COURT EMPLOYMENT ACTION. In September 1997, a lawsuit
styled Kenneth Epperson, et al. v. Pennzoil Co., et al., was filed in the United
States District Court for the Western District of Louisiana, Shreveport
Division. The amended complaint filed by nine named plaintiffs alleges
discriminatory employment policies and practices against African-American and
other minority employees and seeks attorneys' fees and costs, various forms of
injunctive and equitable relief, $50.0 million in damages for back pay, front
pay and emotional distress, and a minimum of three times that amount in punitive
damages. Pennzoil vigorously denies these allegations and will oppose
plaintiffs' efforts to have the case certified as a class action by the Court.
 
     (E) STOCKHOLDER ACTION. Pennzoil and its directors have been named as
defendants in several purported class actions filed during 1997 on behalf of the
stockholders of Pennzoil in the Chancery Court of Delaware, all of which have
been consolidated into one proceeding (the "Stockholder Action"). The complaints
in the Stockholder Action allege breach of fiduciary duty on the part of the
Pennzoil Board of Directors arising out of the proposal by Union Pacific
Resources Group Inc. ("UPR") to acquire all outstanding shares of Pennzoil
common stock. The complaints seek similar relief, including declaratory and
injunctive relief barring defendants from breaching their fiduciary duties to
plaintiffs and the putative class members and from taking steps to impede any
offer to acquire Pennzoil, as well as damages in an unspecified amount.
Plaintiffs have taken no action to prosecute the Stockholder Action since UPR
terminated its tender offer for Pennzoil common stock in November 1997.
 
     (F) ROYALTY MATTERS. More than 30 oil companies, including Pennzoil, are
involved in disputes in which it is alleged that the oil companies and related
parties have underpaid holders of royalty interests, overriding royalty
interests and working interests in connection with the production of crude oil.
The pending proceedings include suits in federal court in Texas, Louisiana,
Mississippi and Wyoming (that have now been consolidated into one proceeding in
Texas) and in state court in Texas, Utah, Alabama and Louisiana. Certain parties
to the federal litigation have entered into a global settlement agreement, that
is subject to court approval, which would provide a conditional nationwide
settlement, subject to opt-outs, of the crude oil royalty, overriding royalty
and working interest claims of all members of the settlement class, including
claims in the federal litigation and in numerous other individual and class
action cases pending throughout the United States. Pennzoil is a party to the
settlement agreement, which explictly refutes an admission of liability, but was
entered into to avoid expensive and protracted litigation.
 
     Also pending is a separate suit in federal court in Texas alleging that
more than 30 major oil companies, including Pennzoil, underpaid royalties to the
United States in connection with crude oil produced from United States owned
and/or controlled lands since 1986. The claims were filed by private litigants
under the federal False Claims Act, and after investigation, the United States
served notice of its intent to intervene as to certain defendants. The United
States has not intervened with respect to claims against Pennzoil as of the date
of this report. Pennzoil has not been served in the case, but anticipates
defending vigorously against these claims. Pennzoil believes that it has acted
reasonably and paid royalties in good faith.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
     No matter was submitted during the fourth quarter of 1997 to a vote of
security holders.
 
                                       19
<PAGE>   22
 
ITEM S-K 401(B). EXECUTIVE OFFICERS OF THE REGISTRANT.
 
     (a) Set forth below are the names and ages of the executive officers of
Pennzoil (at February 28, 1998). Positions, unless otherwise specified, are with
Pennzoil.
 
<TABLE>
    <S>                                          <C>
    DAVID P. ALDERSON, II (48)                   BRUCE K. MISAMORE (47)
    Group Vice President -- Finance and          Vice President and Treasurer
      Accounting                                 JAMES L. PATE (62)(1)
    CLYDE W. BEAHM (60)                          Chairman of the Board and
    Group Vice President -- Products Marketing   Chief Executive Officer
    STEPHEN D. CHESEBRO (56)                     WILLIAM M. ROBB (53)
    President and Chief Operating Officer        Group Vice President -- Products
    LINDA F. CONDIT (50)                         Manufacturing
    Vice President and Corporate Secretary       JAMES W. SHADDIX (51)
    DONALD A. FREDERICK (52) Group Vice          General Counsel
    President -- Oil and Gas                     JAMES M. WHEAT (43)
    MICHAEL J. MARATEA (53)                      Group Vice President -- Franchise
    Vice President and Controller                Operations
</TABLE>
 
---------------
(1) Director of Pennzoil and member of Executive Committee.
 
     (b) Officers are appointed annually to serve for the ensuing year or until
their successors have been appointed. Officers listed above have held their
present offices for at least the past five years except for those named below,
who have had the business experience indicated during that period. Positions,
unless specified otherwise, are with Pennzoil.
 
DAVID P. ALDERSON, II -- Group Vice President -- Finance and Accounting since
  December 1995. Treasurer from August 1989 to June 1996. Group Vice
  President -- Finance from February 1992 to December 1995.
 
CLYDE W. BEAHM -- Group Vice President -- Products Marketing since January 1996.
  Group Vice President -- Franchise Operations from July 1992 to January 1996.
  Executive Vice President -- Franchise Operations prior thereto.
 
STEPHEN D. CHESEBRO -- President and Chief Operating Officer since December
  1997. Executive Vice President and President of Pennzoil Exploration and
  Production Company from February 1997 to December 1997. Chairman and Chief
  Executive Officer of Tenneco Energy from February 1993 to December 1996.
  President and Chief Operating Officer of Tenneco Energy prior thereto.
 
LINDA F. CONDIT -- Vice President since December 1995 and Corporate Secretary
  since March 1990.
 
DONALD A. FREDERICK -- Group Vice President -- Oil and Gas since December 1997.
  Executive Vice President of Pennzoil Exploration and Production Company from
  February 1997 to December 1997. Senior Vice President -- Exploration of
  Transworld Exploration and Production, Inc. from January 1994 to February
  1997. Consultant to Transworld Exploration and Production, Inc. from June 1993
  to December 1994. Vice President -- Exploration of Pecten International, the
  international exploration and production subsidiary of Shell Oil Company,
  prior to March 1993.
 
MICHAEL J. MARATEA -- Vice President since February 1996 and Controller since
  May 1995. Vice President -- Process Improvement of Pennzoil Exploration and
  Production Company from October 1993 to May 1995 and Assistant Controller
  prior thereto.
 
BRUCE K. MISAMORE -- Vice President and Treasurer since June 1996. Assistant
  Treasurer from July 1993 to June 1996. Director -- Corporate Finance of USX
  Corporation from May 1993 to July 1993. Manager -- Financial Planning of
  Marathon Oil Company prior thereto.
 
JAMES L. PATE -- Chairman of the Board since May 1994 and Chief Executive
  Officer since March 1990. President from March 1990 to December 1997.
 
JAMES M. WHEAT -- Group Vice President -- Franchise Operations since July 1996.
  Executive Vice President of Jiffy Lube International, Inc. from June 1995 to
  July 1996. Senior Vice President -- Marketing and Field Operations of Jiffy
  Lube International, Inc. from July 1992 to June 1995. Vice
  President -- Marketing and Field Operations of Jiffy Lube International, Inc.
  prior thereto.
 
                                       20
<PAGE>   23
 
                                    PART II
 
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
 
     The following table shows high and low sales prices for the common stock of
Pennzoil as reported on the New York Stock Exchange (consolidated transactions
reporting system), the principal market in which the common stock is traded, and
dividends paid per share for the calendar quarters indicated. The common stock
is also listed for trading on the Pacific Stock Exchange, as well as the
Toronto, London and Swiss stock exchanges.
 
<TABLE>
<CAPTION>
                                                        1997                                1996
                                           -------------------------------     -------------------------------
                                              MARKET PRICE                        MARKET PRICE
                                           -------------------                 -------------------
             QUARTER ENDED                   HIGH       LOW      DIVIDENDS       HIGH       LOW      DIVIDENDS
             -------------                 --------   --------   ---------     --------   --------   ---------
<S>                                        <C>        <C>        <C>           <C>        <C>        <C>
March 31................................    $63.50     $49.88      $.25         $43.63     $36.88      $.25
June 30.................................    $83.88     $45.00      $.25         $46.38     $39.63      $.25
September 30............................    $81.25     $72.25      $.25         $55.50     $45.63      $.25
December 31.............................    $82.69     $64.06      $.25         $58.75     $49.25      $.25
</TABLE>
 
     Pennzoil has paid quarterly dividends for 74 consecutive years.
 
     As of December 31, 1997, Pennzoil had 15,828 record holders of its common
stock.
 
ITEM 6. SELECTED FINANCIAL DATA.
 
     The following table contains selected financial data for the five years
indicated.
 
<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31
                                             ----------------------------------------------------
                                               1997       1996       1995       1994       1993
                                             --------   --------   --------   --------   --------
                                               (EXPRESSED IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<S>                                          <C>        <C>        <C>        <C>        <C>
Revenues...................................  $2,654.3   $2,486.8   $2,490.0   $2,562.9   $2,782.4
Income (loss) from
  Continuing operations (1)................  $  180.3   $  133.9   $ (305.1)  $ (283.8)  $  160.3
  Extraordinary items (2)..................      (5.2)     --         --         --         (18.4)
  Cumulative effect of changes in
     accounting principles (3).............     --         --         --          (4.9)     --
                                             --------   --------   --------   --------   --------
Net income (loss)..........................  $  175.1   $  133.9   $ (305.1)  $ (288.7)  $  141.9
Basic earnings (loss) per share
  Continuing operations (1)................  $   3.83   $   2.88   $  (6.60)  $  (6.16)  $   3.80
                                             --------   --------   --------   --------   --------
  Earnings (loss) per share before
     extraordinary items and cumulative
     effect of changes in accounting
     principles............................  $   3.83   $   2.88   $  (6.60)  $  (6.16)  $   3.80
  Extraordinary items (2)..................      (.11)     --         --         --          (.44)
  Cumulative effect of changes in
     accounting principles (3).............     --         --         --          (.11)     --
                                             --------   --------   --------   --------   --------
          Total............................  $   3.72   $   2.88   $  (6.60)  $  (6.27)  $   3.36
Diluted earnings (loss) per share..........  $   3.65   $   2.86   $  (6.60)  $  (6.27)  $   3.35
Dividends per common share.................  $   1.00   $   1.00   $   2.50   $   3.00   $   3.00
Total assets...............................  $4,405.9   $4,124.3   $4,307.8   $4,715.8   $4,886.2
Debt
  Notes payable (4)........................  $  --      $  --      $  468.9   $  337.2   $  433.0
  Exchangeable debentures..................     889.0      900.4      902.5      902.5      902.5
  Other long-term debt, including current
     maturities, and capital lease
     obligations...........................   1,381.2    1,391.4    1,214.3    1,352.1    1,175.3
                                             --------   --------   --------   --------   --------
Total debt and capital lease obligations...  $2,270.2   $2,291.8   $2,585.7   $2,591.8   $2,510.8
Total shareholders' equity.................  $1,138.5   $  969.1   $  836.2   $1,204.3   $1,505.8
</TABLE>
 
                                       21
<PAGE>   24
 
---------------
 
 (1) Reference is made to Note 1 of Notes to Consolidated Financial Statements.
     In October 1994, Pennzoil entered into a settlement with the Internal
     Revenue Service (the "IRS") relating to reporting positions taken by
     Pennzoil in its 1988 federal income tax return resulting in an aggregate
     payment by Pennzoil to the IRS of $556.0 million.
 
 (2) In 1997 and 1993, Pennzoil redeemed amounts outstanding under several debt
     facilities using proceeds from various sources. The premiums and related
     unamortized discount and debt issue costs relating to these redemptions
     resulted in extraordinary charges of $1.3 million and $18.4 million,
     respectively. During 1997, certain owners of Pennzoil's exchangeable
     debentures requested to exchange their debentures for Chevron common stock,
     in accordance with the respective supplemental indentures. Pennzoil
     recorded an extraordinary charge of $3.9 million, net of tax, associated
     with the exchanges based on the difference between the face value of the
     debt and the value of the Chevron common stock tendered for exchange.
     Reference is made to Note 3 of Notes to Consolidated Financial Statements
     for additional information.
 
 (3) Effective January 1, 1994, Pennzoil changed its method of accounting for
     postemployment benefit costs by adopting the new requirements of SFAS No.
     112, "Employers' Accounting for Postemployment Benefits." Pennzoil recorded
     a charge of $4.9 million ($7.6 million before tax), or $.11 per share, as
     of January 1, 1994 to reflect the cumulative effect of a change in
     accounting principle for periods prior to 1994.
 
 (4) As of May 1996, borrowings under Pennzoil's commercial paper and short-term
     variable-rate credit arrangements, beginning with the execution of a
     revolving credit facility with a group of banks, have been classified as
     long-term debt. Such debt classification is based upon the availability of
     committed long-term credit facilities to refinance such commercial paper
     and short-term borrowings and Pennzoil's intent to maintain such
     commitments in excess of one year. Reference is made to Note 3 of Notes to
     Consolidated Financial Statements for additional information.
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.
 
     Reference is made to Industry Segment Financial Information included in
Item 1, Business and Item 2, Properties and the Consolidated Financial
Statements beginning on page F-3 for additional information. (All earnings per
share presentations reflect basic earnings per share, unless otherwise noted.)
 
RESULTS OF OPERATIONS
 
     Net income of $175.1 million, or $3.72 per share, was recorded for 1997
compared to net income of $133.9 million, or $2.88 per share, for 1996 and a net
loss of $305.1 million, or $6.60 per share, for 1995.
 
     Results for 1997 include a gain of $24.6 million ($67.6 million before tax)
on the sale of Pennzoil's remaining Canadian oil and gas assets and a charge of
$6.5 million ($10.0 million before tax) associated with Pennzoil's sale of
PennUnion, a natural gas marketing subsidiary. Reference is made to Note 10 of
Notes to Consolidated Financial Statements for additional information.
 
     Results for 1996 include a gain of $25.6 million ($41.7 million before tax)
on the sale of Vermejo Park Ranch and a gain of $19.9 million ($1.2 million
before tax) on the sale of non-strategic Canadian oil and gas assets. Reference
is made to Note 2 and Note 10 of Notes to Consolidated Financial Statements for
additional information.
 
     Effective July 1, 1995, Pennzoil adopted the requirements of SFAS No. 121.
As a result, Pennzoil recorded a charge of $265.5 million ($399.8 million before
tax), or $5.74 per share, as of July 1, 1995 to reflect the impairment of
long-lived assets, which included charges of $378.9 million before tax related
to the impairment of certain proved oil and gas properties. Reference is made to
"-- Oil and Gas" and Note 1 of Notes to Consolidated Financial Statements for
additional information.
 
     In October 1995, Pennzoil announced a cost reduction program to reduce
general and administrative expenses. As a result of this program, Pennzoil
recorded a charge of $12.9 million ($19.9 million before tax) in December 1995
associated with a workforce reduction.
 
OIL AND GAS
 
     OPERATING RESULTS. The oil and gas segment recorded operating income of
$395.7 million in 1997 compared to operating income of $239.7 million in 1996
and $92.0 million in 1995. Operating income for 1995 excludes a charge of $378.9
million associated with the SFAS No. 121 impairment. Operating income
 
                                       22
<PAGE>   25
 
increased by $156.0 million in 1997 compared to 1996. The increase was primarily
due to a $109.4 million increase in aggregate natural gas realizations due to
higher realized natural gas prices, and a $30.8 million increase in aggregate
liquids price realizations due to higher liquids prices. Total production costs
and expenses per BOE, excluding exploration expense and DD&A, were $4.49 in
1997, $4.41 in 1996 and $5.09 in 1995.
 
     Effective July 1, 1995, Pennzoil adopted the requirements of SFAS No. 121,
which, for Pennzoil, resulted in write-downs of proved oil and gas properties
that were not required under its prior impairment policy. Certain proved oil and
gas fields in North America were deemed to be impaired because they were not
expected to individually recover their entire carrying value. The 1995 pretax
charge for the asset impairment of Pennzoil's proved oil and gas properties was
$378.9 million. Prior to the adoption of SFAS No. 121, Pennzoil periodically
reviewed the carrying amounts of proven properties and an impairment reserve was
provided as conditions warranted. There were no impairments recorded under SFAS
No. 121 in 1997 or 1996. Reference is made to "Supplemental Financial and
Statistical Information -- Unaudited -- Oil and Gas Information" for information
on the standardized measure of discounted future net cash flows relating to
proved oil and gas reserves.
 
     Oil and gas production volumes decreased approximately 2 percent for 1997
compared to 1996. Year-over-year production comparisons were negatively impacted
by the sale of noncore producing properties in the Gulf of Mexico and Canada in
1996. After adjusting for 1996 property sales, year-over-year production
increased approximately 3 percent from 1996 to 1997. Natural gas produced for
sale in 1997 was 589,492 Mcf per day, compared with 589,211 Mcf per day and
662,311 Mcf per day in 1996 and 1995, respectively. Realized natural gas prices
averaged $2.40 per Mcf in 1997 compared to $1.87 per Mcf in 1996 and $1.46 per
Mcf in 1995. Liquids volumes in 1997 were 56,794 barrels per day, compared to
59,604 and 67,143 barrels per day in 1996 and 1995, respectively. Liquids prices
received in 1997 averaged $16.66 per barrel, compared with $14.99 per barrel in
1996 and $14.31 per barrel in 1995.
 
     The results of operations from Pennzoil's oil and gas segment are subject
to volatility resulting from changes in crude oil and natural gas prices.
Pennzoil has a price risk management program that permits utilization of
agreements and financial instruments (such as futures, forward and option
contracts and swaps and collars) to reduce the price risk associated with
fluctuations in crude oil and natural gas prices. Reference is made to
"-- Disclosures about Market Risk" and "-- Capital Resources and Liquidity" for
additional information.
 
     During 1996, Pennzoil completed its assessment of its domestic oil and gas
properties and its related asset highgrading program commenced in 1992. This
assessment resulted in (i) the categorization of Pennzoil's oil and gas
properties into core and noncore producing areas and core and noncore producing
fields within core areas and (ii) the disposition of substantially all
properties and fields categorized as noncore assets. From the beginning of 1992
through 1996, Pennzoil disposed of approximately 620 producing oil and gas
fields. Proceeds from the sales of these domestic noncore assets in 1996 totaled
$89.2 million. There were no significant gains or losses on the sales of these
assets.
 
     Expenses associated with exploration activities in 1997 were $67.7 million
compared with $44.3 million in 1996 and $39.8 million in 1995. Exploration
expenses in 1997 increased $23.4 million compared to 1996 due to increased
offshore lease impairments and dry hole expenses.
 
     Operating results for 1995 include charges totaling $9.1 million for
workforce reduction expenses resulting from a general and administrative cost
reduction program announced in October 1995 and workforce reduction expenses
during 1995 that were identified prior to the October program.
 
     EXPLORATION, DEVELOPMENT AND PRODUCTION ACTIVITIES -- GULF OF MEXICO. In
September 1996, Pennzoil and a subsidiary of Enterprise agreed to form a
strategic alliance to pursue certain exploration opportunities on 102 leases in
Pennzoil's Gulf of Mexico portfolio where Pennzoil's working interest is 50
percent or more. Generally, Enterprise will earn an interest equal to half of
Pennzoil's working interest in a lease by contributing funds toward the costs of
drilling a jointly agreed upon exploration well on the lease. On the 59 Category
I leases within the portfolio, where Pennzoil's average working interest is 92
percent, Enterprise
 
                                       23
<PAGE>   26
 
has agreed to spend $100.0 million through 1998 to fund 100 percent of such
drilling costs. On the remaining 43 Category II leases, where Pennzoil's average
working interest is 80 percent, Enterprise has the option, through 1999, to earn
an interest equal to half of Pennzoil's working interest in a Category II
individual exploration well by funding 67 percent of the drilling costs. These
periods may be extended by one year and two years, respectively, if Enterprise
elects to increase from $100.0 million to $150.0 million its commitment to fund
100 percent of Category I exploration drilling costs. If Enterprise does elect
to increase its commitment to funding exploration drilling on Category I leases
to $150.0 million, it will earn one-half of Pennzoil's working interest in all
the Category I leases, in addition to the individual exploration leases drilled
by the alliance. Through 1997, Enterprise has incurred Category I costs of
approximately $33.6 million in drilling 5 wells. In December 1997, Pennzoil and
Enterprise spudded a Category I exploration well at West Cameron 581. The well,
located 3 miles west of Pennzoil's recent discovery at West Cameron 580, will be
drilled to a target depth of 17,000 feet. Pennzoil plans to drill nine
additional exploration wells in the Gulf of Mexico in 1998. Enterprise is
expected to join the company as a 50 percent working interest owner in several
of these wells.
 
     Pennzoil acquired 22 Gulf of Mexico blocks in federal offshore lease sales
during 1997, located in water depths ranging from 50 to 3,000 feet. Pennzoil has
a 100 percent interest in 11 of the blocks and a 50 percent interest in the
other 11 blocks bid jointly with Enterprise. Pennzoil's federal offshore lease
bonus payments totaled $7.0 million in 1997.
 
     CANADIAN PROPERTY SALES. During 1996, Pennzoil completed its assessment of
its Canadian oil and gas properties which resulted in the categorization of
Pennzoil Canada's oil and gas properties into strategic and non-strategic
properties. In July 1996, Pennzoil completed two related transactions with Gulf
Canada: (i) the establishment of a joint venture for the development of natural
gas reserves in the Zama/Virgo region of northwest Alberta and (ii) the sale by
Pennzoil of its remaining, non-strategic Canadian oil and gas assets to Gulf
Canada. Including working capital and closing adjustments of $3.5 million
received in 1997, Pennzoil received net proceeds of $196.3 million from the
sale. Pennzoil recorded an after-tax gain of $19.9 million on the sale, of which
$19.1 million was due to the recognition of certain tax benefits. Reference is
made to Note 2 and Note 10 of Notes to Consolidated Financial Statements for
additional information.
 
     In December 1997, Pennzoil sold its 50 percent interest in the Zama/Virgo
joint venture to Phillips for net proceeds of $101.9 million and recorded an
after tax gain of $24.6 million. The assets sold included 132 Bcf equivalent of
proved natural gas reserves. Included in Pennzoil's consolidated results of
operations for 1997 are revenues of $11.2 million and operating income of $3.3
million from these properties during 1997.
 
     EXPLORATION, DEVELOPMENT AND PRODUCTION ACTIVITIES -- EGYPT. In October
1996, Pennzoil was awarded the drilling rights to the North July block offshore
Egypt in the Gulf of Suez. Pennzoil has a 100 percent working interest in this
block, which is bordered by a large oil field (July/North July). The agreement
for North July was signed during June 1997.
 
     In January 1997, Pennzoil was awarded the drilling rights to Block E, the
West Beni Suef exploration block, in Egypt's western desert. The agreement for
West Beni Suef was signed during June 1997. Pennzoil has a 100 percent working
interest and has committed to spend $7.0 million to acquire 2-D seismic on the
block and drill three exploration wells within three years of parliamentary
approval. West Beni Suef is located approximately 100 miles southwest of Cairo
and covers 8.7 million acres.
 
     Including the award of Block E, Pennzoil now has five exploration blocks in
Egypt covering a total of 9.2 million acres. Four blocks are located in the Gulf
of Suez. In the Southeast Gulf of Suez Block, where Pennzoil has a 50 percent
interest, Repsol, as operator, drilled an exploratory well during 1997 which was
found to be non-commercial. Pennzoil plans to drill a total of four exploratory
wells in Egypt in 1998. Pennzoil, as operator, will drill two wells in the
Southwest Gebel el Zeit concession (87.5 percent Pennzoil) and one well in the
North July Field (100 percent Pennzoil). Pennzoil's partner, IEOC, a subsidiary
of Agip, will also drill one well in the West Feiran Field (50 percent
Pennzoil). All four wells are offshore in the Gulf of Suez.
 
                                       24
<PAGE>   27
 
     EXPLORATION, DEVELOPMENT AND PRODUCTION ACTIVITIES -- AZERBAIJAN. In July
1996, Pennzoil completed the sale of approximately half of its 9.82 percent
interest in the ACG joint development unit offshore Azerbaijan in the Caspian
Sea to affiliates of Exxon, affiliates of ITOCHU and affiliates of Unocal. The
three companies will pay approximately $130.0 million to Pennzoil for a 5
percent working interest in the ACG unit (3.00 percent to Exxon, 1.47 percent to
ITOCHU and 0.53 percent to Unocal) and the right to receive approximately 51
percent of the payments due Pennzoil for reimbursement of costs incurred in
developing a gas utilization project for the Gunashli Field. Net cash payments
to Pennzoil are scheduled in three installments with the first installment
having been made in two payments consisting of approximately $83.0 million
received at closing and another $5.0 million received in August 1996. A
subsequent installment of $22.0 million was received in January 1998 and a final
payment of $20.0 million is due when the unit reaches production of 200 Mbbls
per day. Pennzoil has retained a 4.8175 percent working interest in the ACG
unit. As part of the transaction, the three companies will fund all of
Pennzoil's future obligations in the ACG project, retroactive to January 1,
1996, until all such expenditures and accrued interest are recovered from
Pennzoil's share of production from the ACG unit. In addition, Pennzoil received
a net cash payment of approximately $16.0 million in August 1996 for
reimbursement of Pennzoil's costs in the ACG unit incurred from January 1996
through July 1996. Through 1997, no gains have been recorded related to any of
the above proceeds; instead, such receipts were applied to reduce Pennzoil's net
investment in the ACG unit and the gas utilization project.
 
     In September 1995, the consortium of foreign oil companies developing the
ACG unit elected to pursue dual export routes for transporting early oil
production from the Caspian Sea, one north through an existing pipeline system
to a Russian port on the Black Sea, and the second west through Azerbaijan and
Georgia to the Black Sea. The western route will require replacing 150 miles of
pipeline in Azerbaijan and an additional 73 miles of pipeline to interconnect
existing lines. The northern route became operational in October 1997 with
shipments of oil from SOCAR. The western route is expected to be completed in
January 1999. Pennzoil has recorded 54 MMbbls of proved crude oil reserves
relating to early oil from this project.
 
     First oil production started in November 1997 from the ACG joint
development area. The consortium plans to drill six wells in 1998. Year-end
production at ACG was 15 Mbbls per day. Total consortium project production by
the end of 1998 is expected to increase to an estimated 50 Mbbls per day. The
consortium expects daily production to reach 200 Mbbls per day by 2002. Peak
consortium project production of 800 Mbbls per day is expected to be reached by
2006. Based upon current projections of spending and production, Pennzoil
expects to achieve payout prior to the consortium project reaching peak
production.
 
     In November 1995, Pennzoil announced that its PCDC subsidiary had entered
into a definitive exploration, development and production sharing contract with
SOCAR covering the Karabakh prospect in the Caspian Sea offshore Azerbaijan.
Participating in the project with Pennzoil (30 percent) are units of LUKoil of
Russia (7.5 percent), Agip (5 percent) and LUKAgip, a subsidiary of LUKoil and
Agip (50 percent). In addition, a commercial affiliate of SOCAR has a 7.5
percent interest as a contractor party. The exploration, development and
production sharing agreement was ratified by the Azerbaijan Parliament in
February 1996. The Karabakh prospect is located north of the ACG deepwater unit
and outside the Apsheron trend approximately 50 miles offshore in approximately
600 feet of water. The work commitment includes a seismic program and
exploratory drilling over a period of three years, which period may be extended
an additional one-and-a-half years. Should commercial hydrocarbons be
discovered, the agreement will have a development and production period of 25
years, which may be extended an additional 5 years under certain conditions.
 
     In 1997, CIPCO, the consortium operating this block, encountered natural
gas in its first well drilled. A full assessment of the potential at Karabakh
will depend on additional drilling and evaluation. Two additional exploration
wells are planned for the first half of 1998.
 
     EXPLORATION, DEVELOPMENT AND PRODUCTION ACTIVITIES -- OTHER
INTERNATIONAL. In October 1996, Pennzoil signed a farm-in agreement with Amity
to explore the Whicher Range concession in southwest Australia. In 1997,
Pennzoil paid $9.5 million for its portion (88 percent), of the costs for one
recompletion and one well in exchange for a 44 percent interest in the property.
Amity is the operator during the exploration phase, and
 
                                       25
<PAGE>   28
 
Pennzoil will become operator for the development phase. In 1997, Pennzoil
completed the WR-1 and WR-4 wells on the Whicher Range concession (44 percent
Pennzoil). In 1998, Pennzoil will perform extended production tests on both
wells. These tests will determine if commercial quantities of natural gas can be
produced at Whicher Ranger. Pennzoil has also reached an agreement with Amity
for an option to explore an area adjacent to Whicher Range on Exploration Permit
381. An exploration well may be drilled in 1998, depending on the production
test results at Whicher Range.
 
     In July 1995, a joint venture between Pennzoil Venezuela Corporation, S.A.,
an indirect wholly owned subsidiary of Pennzoil, and Vinccler S.A. entered into
an operating service agreement with PDVSA to operate the East Falcon Unit in
northwestern Venezuela. This unit includes an oil field in which production
operations were suspended in 1968, two undeveloped gas fields and several
prospects. Under this service agreement, Pennzoil is required to incur all costs
attributable to exploration, development and production activities. The service
agreement allows for Pennzoil to recover such costs through a per-barrel fee for
operating this unit. Production began in mid-1996.
 
     In 1997, Pennzoil acquired two production permits, B2X-68/79 and B2X-70/80,
in Lake Maracaibo, Venezuela. Pennzoil will take over operation of the B2X-68/79
block (60 percent Pennzoil) in early 1998. The company is also working closely
with PanCanadian, which will take over operation of the B2X-70/80 block (50
percent Pennzoil) early in the year. In late 1997, Pennzoil submitted a
development plan for its B2X-68/79 contract to PDVSA, the state oil company of
Venezuela. The company is also assisting PanCanadian in preparing a development
plan for the B2X-70/80 contract area for submittal in the first quarter of 1998.
Pennzoil should realize first production from the B2X contract areas in the
first half of 1998. These two blocks have remaining gross reserves of between
100 and 200 MMbbls.
 
     In 1997, Pennzoil sold a 25 percent working interest in Block 8 offshore
Qatar to Novus. Pennzoil now has a 75 percent working interest in Block 8. As
part of its buy-in, Novus agreed to pay Pennzoil $9.7 million, which is expected
to equal Pennzoil's share of the dry-hole expenses for three wells to be drilled
on Block 8. Two non-commercial wells were drilled in 1997. The PQ-4 well, which
reached total depth in early 1998, was tested and also found to be
non-commercial.
 
     CAPITAL EXPENDITURES. Capital expenditures for the oil and gas segment in
1997 were $406.4 million compared to $311.9 million in 1996 and $297.6 million
in 1995. Total capital expenditures for this segment in 1998 are budgeted at
$447.3 million. Reference is made to "-- Capital Resources and Liquidity" for
additional information.
 
MOTOR OIL & REFINED PRODUCTS
 
     OPERATING RESULTS. Operating income in 1997 for the motor oil and refined
products segment was $95.8 million compared with operating income of $53.3
million in 1996 and $12.0 million in 1995. The increase in earnings in 1997
compared to 1996 was due mainly to the successful startup of two major refining
projects -- the Excel Paralubes lubricating base oil plant, which started
operations in December of 1996, and the Shreveport refinery upgrade. Higher
domestic marketing results in 1997 also contributed to the increase. Higher
earnings in 1996 compared to 1995 were primarily due to nonrecurring charges
recorded in 1995 associated with a fire at the Rouseville refinery, costs
associated with the shutdown of The Eureka Pipe Line Company ("Eureka"), costs
associated with restructuring European marketing operations and litigation
settlement expenses. Also contributing to the improvement in 1996 compared to
1995 were higher lubricating product margins and lower expenses. Weak industry
refining margins in 1996 partially offset the improvement.
 
     Excluding charges for the fire at the Rouseville refinery in 1995, the
manufacturing division reported lower earnings in 1996 compared to 1995. The
decrease in earnings was primarily due to lower refinery product margins and
higher pre-operating expenses at the Excel facility. Base oil margins declined
during 1996 as the market reacted to new capacity anticipated from Excel and
other producers. Commercial production commenced at the Excel facility in late
December 1996.
 
     Total processed volume at the Shreveport and Rouseville refineries of
55,050 barrels per day was 1,964 barrels per day higher than in 1996 and 7,084
barrels per day higher than in 1995. The higher volume as
 
                                       26
<PAGE>   29
 
compared to 1996 was due to the startup of the residual catalytic cracking unit
at the Shreveport refinery, partially offset by the increase in non-crude
feedstocks at the Rouseville refinery for use in wax production. The higher
volume as compared to 1995 was also due in part to the 1995 Rouseville refinery
fire.
 
     Higher earnings in the domestic marketing division, excluding nonrecurring
charges, were the result of higher lubricating product margins and higher other
product sales volumes. Domestic motor oil volumes were about 1 percent lower
than 1996 and 2 percent lower than 1995 levels. Filter sales increased by 10
percent over 1996 and were up 24 percent from 1995. Sales of WOLF'S HEAD(R)
lubricating products also increased substantially, up 45 percent and 77 percent
over 1996 and 1995, respectively. Total international motor oil and other
lubricating product volumes, including those sold through licensees and joint
ventures, increased 20 percent when compared to 1996 and 28 percent when
compared to 1995.
 
     In October 1995, an explosion and fire occurred at PPC's Rouseville
refinery. Two PPC employees and three contractor employees were killed and
others were injured. Occupational Safety and Health Administration
investigations resulted in a fine of $1.5 million. A charge of $20.0 million was
taken in 1995 for losses related to the fire.
 
     In November 1995, PPC sold the assets of Eureka, a wholly owned subsidiary
that operated a crude oil gathering system in West Virginia. PPC recorded a
charge of $5.7 million for estimated costs associated with the disposal of the
facility.
 
     BUSINESS ACTIVITIES. In December 1996, commercial production commenced at
the new state-of-the-art lube oil hydrocracker facility of Excel, a 50-50
partnership between PPC and Conoco, located at Conoco's refinery in Lake
Charles, Louisiana. The facility is capable of producing approximately 18,000
barrels per day of high-quality base oils, the base ingredient in finished
lubricants. Conoco is acting as operator of the plant with support positions
staffed by both companies. The facility produces high-quality base oils and has
made PPC self-sufficient in high-quality lube base stocks.
 
     Construction of a residual catalytic cracking unit at PPC's Shreveport
refinery was completed in April 1997. This upgrade project allows PPC's
Shreveport refinery to significantly diversify its production capabilities and
to realize higher profits from by-products, which were being sold at low values,
by converting them into clean burning gasoline and diesel fuels.
 
     In October 1997, PPC and Conoco formed a partnership called PENRECO(R). PPC
contributed its operations related to petrolatums, white oils, ink solvents,
sulfonates, waxes and other specialty products. Conoco contributed its solvents
business, which sells products primarily into the drilling fluids, mining and
cleaning products markets, and as carrier oils for many products. By combining
the two companies' complementary manufacturing, technical and marketing
capabilities, PENRECO(R) will be able to grow rapidly and remain a leader in the
global industrial specialties markets.
 
     In October 1997, PPC acquired the assets of TAAP. TAAP manufactures and
markets premium-quality automotive appearance products, including CLASSIC(R) car
waxes and washes.
 
     In November 1997, PPC acquired the marketing and distribution assets of
Snap. Snap products include FIX-A-FLAT(R), the number one selling tire inflator
in the U.S.; OUTLAW(R) fuel additives; and SNAP(R) fuel additives and chemicals.
 
     These acquisitions add successful brands to PPC's portfolio and are an
important part of the strategy to grow the consumer products business. These new
products further extend PPC's portfolio into the attractive automotive chemicals
and appearance products markets.
 
     In September 1995, PPC acquired the assets of the Viscosity Oil division of
Case for $33.6 million. Viscosity Oil is a leading supplier of premium-quality
lubricants to the North American off-road industry and it supplies lubricants to
substantially all the Case dealer network, with locations in all 50 states and
Canada.
 
     In July 1995, PPC and a partner formed Red River Terminals, L.L.C. to build
and operate a liquids terminal at the Port of Shreveport, Louisiana. The opening
of the Red River to navigation has provided the
 
                                       27
<PAGE>   30
 
opportunity for PPC to use less expensive waterborne freight for access to new
feedstocks and markets for PPC's Shreveport refinery and packaging facility. The
project was completed in February 1997.
 
     In April 1995, PPC and the Polymers Division of Petrolite formed a 50-50
partnership called BARECO(R) Products to market a broad line of wax products to
domestic and international purchasers of paraffin, microcrystalline and related
synthetic waxes. Pennzoil transports partially refined feedstock from Utah to
its Rouseville refinery, which produces paraffinic and microcrystalline waxes
and related products. These wax products, along with certain waxes from
Petrolite, existing wax products from Pennzoil's Shreveport refinery and waxes
purchased from other suppliers, are marketed through the partnership. Pennzoil
has invested approximately $28.0 million in its Rouseville refinery and its
packaging plant in nearby Reno, Pennsylvania in connection with this venture.
Production from these facilities began in September 1996. As a result, the
Rouseville refinery has been processing various high-wax content feedstocks, the
use of which has reduced some of the crude oil processed volumes while
maintaining full unit utilization of the refinery's processing capabilities.
 
     CAPITAL EXPENDITURES. Capital expenditures for the motor oil and refined
products segments were $122.0 million in 1997, $231.7 million in 1996 and $134.9
million in 1995. Capital expenditures in 1997, 1996 and 1995 included $42.0
million, $147.3 million and $52.3 million, respectively, for the upgrade of
PPC's Shreveport refinery. Also included in 1995 capital expenditures was $19.2
million in expenditures for facilities at the Rouseville refinery to enable
production of additional waxes in connection with the previously announced
Petrolite joint venture. Capital expenditures for 1996 also included $8.6
million for completion of the Rouseville refinery wax project mentioned earlier.
The 1998 capital budget is $60.6 million. Reference is made to "-- Capital
Resources and Liquidity" for additional information.
 
FRANCHISE OPERATIONS
 
     OPERATING RESULTS. The franchise operations segment, operating through
Jiffy Lube, recorded operating income of $24.5 million during 1997, compared to
operating income of $21.4 million in 1996 and operating income of $13.2 million
in 1995. The improvement in 1997 results is due primarily to higher company
center sales, lower operating expenses resulting from fewer new store openings
and increased royalty income. Operating results for 1995 include nonrecurring
charges of $6.0 million for a litigation settlement and $0.3 million for
severance charges associated with a general and administrative cost reduction
program. Excluding these nonrecurring charges, operating income in 1997
increased $3.1 million over 1996 and operating income in 1996 increased $1.9
million over 1995. The increase in income from 1995 to 1996 was primarily due to
lower selling, general and administrative expenses in 1996. The lower expenses
in 1996 were partially offset by higher start-up expenses associated with the
large number of new centers added in 1996. Domestic service centers open at
December 31, 1997 increased by 136 stores compared to December 31, 1996. As of
December 31, 1997, Jiffy Lube operated 581 company-owned service centers and had
935 domestic franchise service centers open.
 
     Systemwide service center sales reported to Jiffy Lube for the year ended
December 31, 1997 increased $63.6 million, or approximately 9 percent, to $765.0
million, compared with the prior year, and increased $108.4 million, or
approximately 17 percent, compared with 1995. Average ticket prices increased to
$35.87 for the year ended December 31, 1997, compared with $35.27 and $34.71 for
the years ended December 31, 1996 and 1995, respectively.
 
     BUSINESS ACTIVITIES. In March 1995, Jiffy Lube and Sears agreed to open
fast-oil change units in Sears Auto Centers over the next three years. Under the
agreement, Jiffy Lube remodels, equips and operates service areas within the
Sears Auto Centers, while Sears continues to utilize the remaining bays for its
operations. Jiffy Lube had 165 fast-oil change units open at Sears Auto Centers
at the end of 1997, of which 133 are company-operated and 32 are
franchise-operated.
 
     During the year ended December 31, 1997, Jiffy Lube acquired 35 centers
along with related real estate in exchange for cash of $17.8 million and
liabilities and debt assumed of $2.5 million. Also, during the year ended
December 31, 1997, 24 centers were sold for $3.1 million in cash and $0.4
million in forgiveness of debt. Also during 1997, 6 company-owned stores were
exchanged for 6 franchised stores.
                                       28
<PAGE>   31
 
     During the year ended December 31, 1996, Jiffy Lube acquired 16 centers and
real estate in exchange for cash of $4.7 million and liabilities and debt
assumed of $2.8 million. Also, during the year ended December 31, 1996, 36
centers were sold for $4.4 million in cash and $0.6 million in forgiveness of
debt.
 
     During the year ended December 31, 1995, Jiffy Lube acquired 52 centers and
real estate in exchange for cash of $35.3 million, liabilities and debt assumed
of $1.3 million and 4 centers with a net book value of $0.4 million. Also,
during the year ended December 31, 1995, 19 centers were sold for $2.6 million
in cash and $0.3 million in forgiveness of debt.
 
     CAPITAL EXPENDITURES. Capital expenditures for the franchise operations
segment were $25.9 million in 1997, compared to $19.5 million and $40.8 million
in 1996 and 1995, respectively. Capital expenditures for 1998 are estimated to
be approximately $33.6 million primarily for the expansion of additional
company-owned service centers and the refurbishing of existing company-owned
service centers. Reference is made to "-- Capital Resources and Liquidity" for
additional information.
 
OTHER
 
     Other operating income in 1997 was $43.5 million, compared to $87.3 million
in 1996 and $74.0 million in 1995. Other operating income decreased in 1997
compared to 1996 and 1995 levels primarily as a result of a $41.7 million pretax
gain on the sale of Vermejo Park Ranch in 1996 and a favorable resolution of a
Texas franchise tax issue, which resulted in Pennzoil's receiving a $23.2
million refund in 1995. Reference is made to Note 10 to Consolidated Financial
Statements for additional information. As of December 31, 1997, Pennzoil
beneficially owned approximately 17.8 million shares of Chevron common stock.
The shares of Chevron common stock beneficially owned by Pennzoil are classified
as non-current marketable securities and other investments in the accompanying
consolidated balance sheet. Reference is made to "-- Capital Resources and
Liquidity" for additional information. Dividend income on the Chevron common
stock was $41.0 million for 1997, $37.6 million for 1996 and $34.8 million for
1995.
 
     Other revenues, net of related expenses, are included in the consolidated
statement of income under "Investment and other income, net" which consists of
the following:
 
<TABLE>
<CAPTION>
                                                       1997        1996        1995
                                                     --------    --------    --------
                                                         (EXPRESSED IN THOUSANDS)
<S>                                                  <C>         <C>         <C>
Interest income....................................  $  7,867    $  7,043    $  9,411
Dividend income....................................    41,094      37,835      34,850
Realized gains on sales of marketable securities
  and other investments............................    12,066         306          --
Net gains on sales of assets.......................    66,665      61,508       7,739
Settlements and refunds............................    11,282      (3,391)     25,913
Other income (expense), net........................     4,083      18,813      26,786
                                                     --------    --------    --------
                                                     $143,057    $122,114    $104,699
                                                     ========    ========    ========
</TABLE>
 
     Substantially all interest and dividend income is from marketable
securities and other cash investments.
 
DISCLOSURES ABOUT MARKET RISK
 
     Pennzoil is exposed to market risk, including adverse changes in commodity
prices, foreign currency exchange rates, marketable equity security prices, and
interest rates as discussed below.
 
  HEDGING ACTIVITIES. Pennzoil has a price risk management program that permits
utilization of agreements and financial instruments (such as futures, forward
and option contracts and swaps and collars) to reduce the price risks associated
with fluctuations in crude oil and natural gas prices as they relate to
Pennzoil's anticipated production. These financial instruments are designated as
hedges and accounted for on the accrual basis with gains and losses being
recognized based on the type of contract and exposure being hedged. Realized
gains or losses on crude oil and natural gas financial instruments designated as
hedges of anticipated transactions are treated as deferred credits or charges
and are included in other current liabilities or other
                                       29
<PAGE>   32
 
current assets, as applicable, on the balance sheet. Net gains and losses on
such financial instruments, including accrued gains or losses upon maturity or
termination of the contract, are deferred and recognized in income when the
associated hedged commodities are produced. Pennzoil did not materially hedge
crude oil or natural gas prices in 1997. Pennzoil will constantly review and may
alter its hedged positions.
 
     Pennzoil also enters into short-term forward exchange contracts to hedge
the impact of foreign currency fluctuations on certain monetary liabilities and
commitments denominated in foreign currencies. The purpose of entering into
these hedges is to minimize the impact of foreign currency fluctuations on the
results of operations. These contracts have maturity dates that do not exceed
twelve months. The unrealized gains and losses on these contracts are deferred
and recognized in the results of operations in the period in which the hedged
transaction is consummated. Pursuant to this strategy, Pennzoil hedged against
the foreign currency risk associated with its $42.2 million Canadian tax
liability due in early 1998 that resulted from the 1997 sale of its remaining
Canadian investment. To accomplish this, in 1997, Pennzoil entered into a series
of forward contracts at an average exchange rate of 1.412 Cdn.$/U.S.$, whereby
the counterparties would pay Pennzoil Cdn.$57.3 million in 1998, and Pennzoil
would concurrently pay the counterparties U.S.$40.6 million. Unrealized losses
at December 31, 1997 totaling $0.5 million on these contracts were substantially
offset by corresponding foreign currency translation gains on the tax liability.
 
     MARKETABLE EQUITY SECURITIES AND EXCHANGEABLE DEBENTURES. At December 31,
1997, Pennzoil's marketable equity securities were recorded at their fair value
of $946.0 million, including net unrealized gains of $186.3 million. For
accounting purposes, at December 31, 1997, in determining the fair value of
Pennzoil's investment in Chevron common stock, Pennzoil limited its fair value
estimation of Chevron common stock to its net realizable value of $889.0 million
under the terms of Pennzoil's exchangeable debentures. A hypothetical 10 percent
adverse change in prices quoted by stock exchanges or provided by other sources
for Chevron common stock or other marketable securities held by Pennzoil would
not have had a material effect on the Company's results of operations for the
fiscal year ended December 31, 1997. At December 31, 1997, Pennzoil's
exchangeable debentures were recorded at their face amount of $889.0 million,
with fixed interest rates ranging from 4.75% to 6.50%. With respect to the
exchangeable debentures, a hypothetical 10 percent adverse change in market
interest rates would have had no effect on the Company's results of operations
for the fiscal year ended December 31, 1997. Reference is made to Notes 1 and 3
of the Notes to Consolidated Financial Statements for additional information.
 
     INTEREST. At December 31, 1997, the fair value of Pennzoil's long-term
debt, excluding the exchangeable debentures, commercial paper and short-term
variable rate credit agreements, is projected to be $1.1 billion using quoted
market prices or, where such prices are not available, on estimated year-end
interest rates of debt with the same remaining average maturities and credit
quality. Such fair value exceeded the long-term debt carrying value by $124.7
million. Pennzoil's long-term debt obligations have fixed interest rates.
Because Pennzoil has no current plans to redeem these obligations before their
stated maturity or call date, Pennzoil is not exposed to cash flow or fair value
risk from market interest rate changes. The fair value of commercial paper and
short-term variable rate credit agreements is considered to be the same as the
carrying amount. Reference is made to Note 3 of Notes to Consolidated Financial
Statements for additional information. A hypothetical 10 percent adverse change
in market interest rates relative to the aforementioned securities would not
have had a material effect on Pennzoil's results of operations for the fiscal
year ending December 31, 1997.
 
                                       30
<PAGE>   33
 
INTEREST CHARGES, NET
 
     During 1997, Pennzoil's interest charges, net of interest capitalized,
decreased $13.6 million from 1996 levels. The decrease in interest charges, net
of capitalized interest, is due primarily to lower average borrowings and higher
capitalized interest.
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31
                                                 ------------------------------------
                                                   1997          1996          1995
                                                 --------      --------      --------
                                                       (EXPRESSED IN THOUSANDS)
<S>                                              <C>           <C>           <C>
Interest expense...............................  $176,891      $188,155      $198,579
Less: Interest capitalized.....................    13,085        10,735         4,231
                                                 --------      --------      --------
                                                 $163,806      $177,420      $194,348
                                                 ========      ========      ========
</TABLE>
 
CAPITAL RESOURCES AND LIQUIDITY
 
     CASH FLOW. Pennzoil had cash and cash equivalents of $18.6 million and
$34.4 million at December 31, 1997 and 1996, respectively. Cash flow generated
from operating activities and proceeds from the sales of assets in 1997 totaled
approximately $623.4 million. These funds were used primarily for capital
expenditures ($559.5 million), for the net payment of debt ($18.8 million) and
for payment of cash dividends ($47.1 million).
 
     INVESTMENT IN CHEVRON CORPORATION. As of December 31, 1997, Pennzoil
beneficially owned approximately 17.8 million shares of Chevron common stock
that have been deposited with exchange agents for possible exchange for $397.2
million and $491.8 million principal amount of exchangeable debentures of
Pennzoil due January 15, 2003 and October 1, 2003, respectively, at exchange
rates equivalent to $42 1/16 and $58 13/16 per share of Chevron common stock,
respectively. Reference is made to Note 3 of Notes to Consolidated Financial
Statements for additional information. The quarterly dividend rate on Chevron
common stock for the first quarter 1997 was $.54 per share. In the second
quarter of 1997, Chevron increased its quarterly dividend rate to $.58 per
share. Pennzoil received approximately $41.0 million in dividends on its
investment in Chevron stock in 1997. In the first quarter of 1998, Chevron
increased its quarterly dividend rate to $.61 per share.
 
     EXCHANGEABLE DEBENTURES. Included in Pennzoil's long-term indebtedness as
of December 31, 1997 is an aggregate of $889.0 million principal amount of
exchangeable debentures. These debentures are exchangeable at the option of the
holders thereof at any time prior to maturity, unless previously redeemed, into
approximately 17.8 million shares of Chevron common stock beneficially owned by
Pennzoil. The exchangeable debentures were issued in two series. The 6 1/2%
Exchangeable Senior Debentures (the "6 1/2% Debentures"), $397.2 million
principal amount outstanding, and the 4 3/4% Exchangeable Senior Debentures (the
"4 3/4% Debentures"), $491.8 million principal amount outstanding, are
exchangeable into shares of Chevron common stock at exchange rates of 23.774
shares and 17.004 shares, respectively, per $1,000 principal amount of
debentures (the equivalent of $42 1/16 per share and $58 13/16 per share,
respectively). The closing transactions price for Chevron common stock reported
on the New York Stock Exchange on December 31, 1997 was $77.00 per share.
Through December 31, 1997, $8.2 million of the 4 3/4% Debentures and $3.2
million of the 6 1/2% Debentures had been tendered for exchange. The 6 1/2%
Debentures and the 4 3/4% Debentures can be called at Pennzoil's option
beginning in January 1998 and October 1998, respectively.
 
     On December 23, 1997, Pennzoil filed a registration statement on Form S-4
with the SEC proposing to issue up to $889.1 million principal amount of new
exchangeable debentures ("New Debentures") in exchange (the "Exchange Offer")
for a portion of its 6 1/2% Debentures and its 4 3/4% Debentures. The New
Debentures would have terms substantially similar to the existing debentures
except for the maturity date, call date, coupon and the number of Chevron shares
into which the New Debentures are exchangeable.
 
     Pursuant to the Exchange Offer as currently proposed, the New Debentures
would mature in 2008, with an option to call the debentures by Pennzoil
beginning in 2000; the coupon for the New Debentures would be determined through
a modified "Dutch Auction" process. Existing holders of exchangeable debentures
accepted in the exchange would be given New Debentures with par amounts equal to
103 percent of the
                                       31
<PAGE>   34
 
market value of the debentures submitted. Cash would be paid for any equivalent
fractional New Debentures. The number of Chevron shares which the New Debentures
are expected to be exchangeable into is 82.3 percent of the number of shares
that the submitted debentures were exchangeable into.
 
     Pennzoil currently intends to periodically sell the Chevron shares that
would no longer be required to be deposited with exchange agents as a result of
the Exchange Offer. Pennzoil has also announced that it currently intends to
call the remaining exchangeable debentures that are not accepted in the Exchange
Offer.
 
     If the Exchange Offer is completed as currently proposed, Pennzoil expects
to record an extraordinary after-tax loss in 1998 of approximately $191 million
as a result of these transactions; this extraordinary loss is expected to be
partially offset by an after-tax gain of approximately $130 million resulting
from gains on the shares of Chevron stock assumed to be delivered in exchange
for existing exchangeable debentures under current exchange rights and gains on
shares of Chevron stock assumed to be sold. Shareholders' equity would be
increased by approximately $60 million of after-tax unrealized holding gain on
Chevron common stock beneficially owned by Pennzoil, reflecting the adjustment
to market value from net realizable value prior to the Exchange Offer of the
remaining shares of Chevron common stock held by Pennzoil, reduced by liquidated
holding gains on the shares of Chevron stock assumed to be delivered in exchange
for existing exchangeable debentures under current exchange rights and the
shares of Chevron stock assumed to be sold. The net change to shareholders'
equity is estimated to be a reduction of approximately $1 million. The impact of
the proposed Exchange Offer on long-term debt would be a net decrease of
approximately $223 million due to an approximately $85 million reduction in the
amount of exchangeable debt and an approximately $138 million reduction in
variable-rate credit arrangements as a result of the use of the proceeds of the
proposed sale of Chevron shares.
 
     PRO FORMA EFFECT OF EXCHANGE OF OUTSTANDING EXCHANGEABLE DEBENTURES FOR
CHEVRON COMMON STOCK.  If the Exchange Offer is not completed and the holders of
all currently outstanding exchangeable debentures were to exchange their
debentures for shares of Chevron common stock, Pennzoil would realize a taxable
gain. The following table presents the calculation of Pennzoil's actual debt to
capital ratio as of December 31, 1997 and its unaudited pro forma debt to
capital ratio as of December 31, 1997, assuming (i) all exchangeable debentures
are exchanged for shares of Chevron common stock, (ii) Pennzoil borrows an
amount equal to the cash taxes to be owed due to the realization of the capital
gain, and (iii) the full statutory federal tax rate of 35 percent would apply to
the resulting taxable gain. Currently, Pennzoil would be subject to a 20 percent
cash tax rate, with the balance of 15 percent payable when Pennzoil is no longer
subject to alternative minimum tax.
 
<TABLE>
<CAPTION>
                                                                      EFFECT OF EXCHANGE OF
                                                                    ALL CURRENTLY OUTSTANDING
                                                                     EXCHANGEABLE DEBENTURES
                                                              -------------------------------------
                                                                   ACTUAL             PRO FORMA
                                                              DECEMBER 31, 1997   DECEMBER 31, 1997
                                                              -----------------   -----------------
                                                                     (EXPRESSED IN MILLIONS)
<S>                                                           <C>                 <C>
Total debt, including current maturities....................      $2,199.9            $2,199.9
Exchange of debentures......................................            --              (889.0)
Borrowings to fund taxes due on realized gain...............            --               152.8
                                                                  --------            --------
                                                                   2,199.9             1,463.7
Shareholders' equity........................................       1,138.5             1,138.5
                                                                  --------            --------
Total capital...............................................      $3,338.4            $2,602.2
                                                                  ========            ========
Debt-to-capital ratio.......................................          65.9%               56.2%
</TABLE>
 
     ACCOUNTS RECEIVABLE. At December 31, 1997 and 1996, current receivables
included notes receivable of $12.4 million and $11.9 million, respectively.
Other assets included long-term notes receivable of $41.4 million and $39.3
million at December 31, 1997 and 1996, respectively.
 
     In September 1996, Pennzoil Receivables Company, a wholly owned special
purpose subsidiary of Pennzoil, entered into a one-year receivables sales
facility, which provided for the ongoing sales of up to
 
                                       32
<PAGE>   35
 
$135.0 million of accounts receivable of certain Pennzoil subsidiaries. In
September 1997, the facility was amended to extend the expiration date of the
facility to September 1998. Total accounts sold under this agreement were $135.0
million as of December 31, 1997. Pennzoil used the initial proceeds from this
arrangement to reduce outstanding debt. Fees associated with these transactions
totaled $8.1 million and $1.9 million in 1997 and 1996, respectively, and are
netted against other income.
 
     CREDIT FACILITIES. Pennzoil has currently limited aggregate borrowings
under its commercial paper programs to $500.0 million. Borrowings under
Pennzoil's commercial paper facilities totaled $162.5 and $198.2 million at
December 31, 1997 and December 31, 1996, respectively. The average interest
rates applicable to outstanding commercial paper were 5.85 percent and 5.74
percent during 1997 and 1996, respectively.
 
     Pennzoil has several short-term variable-rate credit arrangements with
certain banks. Pennzoil has currently limited its aggregate borrowings under
these credit arrangements to $300.0 million. Outstanding borrowings totaled
$185.0 million and $129.9 million at December 31, 1997 and 1996, respectively.
The average interest rates applicable to amounts outstanding under these
arrangements were 5.71 percent and 5.53 percent during 1997 and 1996,
respectively. None of the banks under these credit arrangements has any
obligation to continue to extend credit after the maturities of outstanding
borrowings or to extend the maturities of any borrowings.
 
     Pennzoil's current revolving credit facility (the "Revolving Credit
Facility") with a group of banks provides for up to $600.0 million of unsecured
revolving credit borrowings through May 26, 1998, with any outstanding
borrowings on such date being converted into a term credit facility terminating
on May 30, 1999. Pennzoil has the option, subject to the extension of additional
credit by new or existing banks, of increasing the size of the facility by
$100.0 million. Outstanding borrowings under Pennzoil's revolving credit
facilities totaled $108.0 million and $99.0 million at December 31, 1997 and
1996, respectively. The average interest rate applicable to amounts outstanding
under Pennzoil's revolving credit facilities was 5.79 percent and 5.67 percent
during 1997 and 1996, respectively.
 
     Reference is made to Note 3 of Notes to Consolidated Financial Statements
for additional information regarding Pennzoil's credit facilities.
 
     DISPOSITION OF ASSETS. During 1996, Pennzoil completed its assessment of
its domestic oil and gas properties and its related asset highgrading program
commenced in 1992. This assessment resulted in (i) the categorization of
Pennzoil's oil and gas properties into core and noncore producing areas and core
and noncore producing fields within core areas and (ii) the disposition of
substantially all properties and fields categorized as noncore assets. From the
beginning of 1992 through 1996, Pennzoil disposed of approximately 620 producing
oil and gas fields, including approximately 20 fields in 1996. The fields
disposed of in 1996 primarily consisted of noncore properties in the Gulf of
Mexico. Proceeds from the sales of these domestic noncore assets in 1996 totaled
$89.2 million. There were no significant gains or losses on the sale of these
assets.
 
     In July 1996, Pennzoil completed the sale of its non-strategic Canadian oil
and gas assets to Gulf Canada. Including working capital and closing adjustments
of $3.5 million received in 1997, Pennzoil received net proceeds of $196.3
million from the sale. Proceeds from the sale were primarily used to reduce
outstanding debt. Reference is made to Note 10 of Notes to Consolidated
Financial Statements for additional information.
 
     In late 1997, Pennzoil sold its 50 percent interest in a natural gas joint
venture in the Zama/Virgo region of northwest Alberta to Phillips and received
net proceeds of $101.9 million and recorded an after tax gain of $24.6 million.
The assets sold included 132 Bcf equivalent of proved natural gas reserves.
Included in Pennzoil's consolidated results for 1997 are revenues of $11.2
million and operating income of $3.3 million from these properties during 1997.
 
     In July 1996, Pennzoil completed the sale of approximately half of its
interest in the ACG joint development unit offshore Azerbaijan in the Caspian
Sea, and in September 1996, completed the sale of Vermejo Park Ranch. Pennzoil
used the proceeds from both of these sales to partially fund its 1996 capital
spending program and to reduce outstanding debt. Reference is made to Note 10 of
Notes to Consolidated Financial Statements for additional information.
                                       33
<PAGE>   36
 
     In June 1997, Pennzoil sold its PennUnion natural gas marketing subsidiary
to Columbia and recorded a pretax charge of $10.0 million.
 
     CLASSIFICATION OF BORROWINGS UNDER CREDIT FACILITIES. As of December 31,
1997, borrowings under Pennzoil's commercial paper and short-term variable-rate
credit arrangements (the commercial paper programs and the short-term variable
rate credit arrangements, collectively, the "short-term facilities") totaled
$347.5 million, all of which, beginning with the execution of the Revolving
Credit Facility in May 1996, has been classified as long-term debt. Such debt
classification is based upon the availability of committed long-term credit
facilities to refinance such short-term facilities and Pennzoil's intent to
maintain such commitments in excess of one year subject to overall reductions in
debt levels. Prior to the execution of the Revolving Credit Facility, borrowings
under the short-term facilities were classified as short-term debt, and
borrowings under the previous revolving credit facility were classified as
long-term debt.
 
     CAPITAL EXPENDITURES. Total capital expenditures for 1997 were $559.5
million, including $13.1 million of interest capitalized, a decrease of $6.1
million from comparable 1996 capital expenditure levels.
 
     The table below summarizes the current 1998 capital budget by segment
compared with 1997 and 1996 capital expenditures. The capital budget is
reassessed from time to time, and could, for example, be adjusted to reflect
changes in oil and gas prices and other economic factors.
 
<TABLE>
<CAPTION>
                                                  1998
                                                 BUDGET      1997       1996
                                                 ------     ------     ------
                                                   (EXPRESSED IN MILLIONS)
<S>                                              <C>        <C>        <C>
Oil and Gas....................................  $447.3     $406.4     $311.9
Motor Oil & Refined Products...................    60.6      122.0      231.7
Franchise Operations...........................    33.6       25.9       19.5
Corporate and Other............................    13.7        5.2        2.5
                                                 ------     ------     ------
                                                 $555.2     $559.5     $565.6
                                                 ======     ======     ======
</TABLE>
 
     Pennzoil currently expects to generate funds for its budgeted 1998 capital
expenditures from a combination of some, or all, of the following: cash flows
from operations, borrowings under its short-term facilities and revolving credit
facility and available cash.
 
     ENVIRONMENTAL MATTERS. Pennzoil continues to make capital and operating
expenditures relating to the environment, including expenditures associated with
its compliance with federal, state and local environmental regulations. As they
continue to evolve, environmental protection laws are expected to have an
increasing impact on Pennzoil's operations. In connection with pollution
abatement efforts related to current operations, Pennzoil made capital
expenditures of approximately $34.0 million in 1997 and $33.0 million in 1996.
Capital expenditures for environmental control facilities are currently expected
to be approximately $41.0 million in 1998. Pennzoil's recurring operating
expenditures relating to environmental compliance activities are not material.
 
     Pennzoil is subject to certain laws and regulations relating to
environmental remediation activities associated with past operations, such as
CERCLA, the Resource Conservation and Recovery Act and similar state statutes.
In response to liabilities associated with these activities, accruals have been
established when reasonable estimates are possible. Such accruals primarily
include estimated costs associated with remediation. Pennzoil has not used
discounting in determining its accrued liabilities for environmental
remediation, and no claims for possible recovery from third-party insurers or
other parties related to environmental costs have been recognized in Pennzoil's
consolidated financial statements. Pennzoil adjusts the accruals when new
remediation responsibilities are discovered and probable costs become estimable,
or when current remediation estimates must be adjusted to reflect new
information.
 
     Pennzoil's assessment of the potential impact of these environmental laws
is subject to uncertainty due to the difficult process of estimating remediation
costs that are subject to ongoing and evolving change. Initial estimates of
remediation costs reflect a broad-based analysis of site conditions and
potential environmental and human health impacts derived from preliminary site
investigations (including soil and water analysis,
                                       34
<PAGE>   37
 
migration pathways and potential risk). Later changes in these initial estimates
may be based on additional site investigations, completion of feasibility
studies (comparing and selecting from among various remediation methods and
technologies) and risk assessments (determining the degree of current and future
risk to the environment and human health, based on current scientific and
regulatory criteria) and the actual implementation of the remediation plan. This
process occurs over relatively long periods of time, is influenced by regulatory
and community approval processes and is subject to the ongoing development of
remediation technologies. Pennzoil's assessment analysis takes into account the
condition of each site at the time of estimation, the degree of uncertainty
surrounding the estimates for each phase of remediation and other site specific
factors.
 
     Certain of Pennzoil's subsidiaries are involved in matters in which it has
been alleged that such subsidiaries are potentially responsible parties ("PRPs")
under CERCLA or similar state legislation with respect to various waste disposal
areas owned or operated by third parties. In addition, certain of Pennzoil's
subsidiaries are involved in other environmental remediation activities,
including the removal, inspection and replacement, as necessary, of underground
storage tanks. As of December 31, 1997 and 1996, Pennzoil's consolidated balance
sheet included accrued liabilities for environmental remediation of $20.6
million and $30.4 million, respectively. Of these reserves, $2.4 million and
$2.1 million are reflected in the consolidated balance sheet as current
liabilities as of December 31, 1997 and 1996, respectively, and $18.2 million
and $28.3 million are reflected as other liabilities as of December 31, 1997 and
1996, respectively. Pennzoil does not currently believe there is a reasonable
possibility of incurring additional material costs in excess of the current
accruals recognized for such environmental remediation activities. With respect
to the sites in which Pennzoil subsidiaries are PRPs, Pennzoil's conclusion is
based in large part on (i) the availability of defenses to liability, including
the availability of the "petroleum exclusion" under CERCLA and similar state
laws, and/or (ii) Pennzoil's current belief that its share of wastes at a
particular site is or will be viewed by the EPA or other PRPs as being de
minimis. As a result, Pennzoil's monetary exposure is not expected to be
material.
 
     YEAR 2000. Pennzoil has begun the process of identifying, evaluating and
implementing new operating computer systems necessary to address potential year
2000 compliance issues. Many of Pennzoil's operating and financial systems are
already compliant. Pennzoil's remaining operating and financial systems are
scheduled for compliance in phases and will be compliant by the year 2000.
Pennzoil is communicating with software vendors, business partners and others
with which it conducts business to provide written assurances that their systems
will be year 2000 compliant. The total future cost associated with potential
year 2000 compliance issues has not been determined, but is not expected to have
a material adverse effect on the consolidated financial position or results of
operations of Pennzoil.
 
     OTHER MATTERS. Pennzoil does not currently consider the impact of inflation
to be significant in the businesses in which Pennzoil operates.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
     The information required by Item 305 of Regulation S-K is included under
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations."
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
     The consolidated financial statements of Pennzoil, together with the report
thereon of Arthur Andersen LLP dated February 27, 1998 and the supplementary
financial data specified by Item 302 of Regulation S-K, are set forth on pages
F-1 through F-39 hereof. (See Item 14 for Index.)
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.
 
     Not Applicable.
 
                                       35
<PAGE>   38
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
 
     The information appearing under the captions "Nominees," "Directors with
Terms Expiring in 1999 and 2000" and "Compliance with Section 16(a) of the
Exchange Act" set forth within the section entitled "Election of Directors" in
Pennzoil's definitive Proxy Statement to be filed pursuant to Regulation 14A
under the Securities Exchange Act of 1934 is incorporated herein by reference.
See also Item S-K 401(b) appearing in Part I of this Annual Report on Form 10-K.
 
ITEM 11. EXECUTIVE COMPENSATION.
 
     The information appearing under the captions "Director Remuneration" set
forth within the section entitled "Election of Directors" and under the captions
"Executive Compensation" and "Compensation Committee Interlocks and Insider
Participation" in Pennzoil's definitive Proxy Statement to be filed pursuant to
Regulation 14A under the Securities Exchange Act of 1934 is incorporated herein
by reference.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
     The information appearing under the caption "Security Ownership of
Directors and Officers" set forth within the section entitled "Election of
Directors" and under the caption "Security Ownership of Certain Shareholders"
set forth within the section entitled "Additional Information" in Pennzoil's
definitive Proxy Statement to be filed pursuant to Regulation 14A under the
Securities Exchange Act of 1934 is incorporated herein by reference.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
     The information appearing under the captions "Director Remuneration" and
"Certain Transactions" set forth within the section entitled "Election of
Directors" and under the caption "Security Ownership of Certain Shareholders"
set forth within the section entitled "Additional Information" and under the
caption "Compensation Committee Interlocks and Insider Participation" in
Pennzoil's definitive Proxy Statement to be filed pursuant to Regulation 14A
under the Securities Exchange Act of 1934 is incorporated herein by reference.
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
 
(A)(1) FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
<TABLE>
<CAPTION>
                                                                PAGE
                                                                ----
<S>                                                           <C>
Report of Independent Public Accountants....................    F-1
Consolidated Statement of Income............................    F-3
Consolidated Balance Sheet..................................    F-4
Consolidated Statement of Shareholders' Equity..............    F-6
Consolidated Statement of Cash Flows........................    F-7
Notes to Consolidated Financial Statements..................    F-8
</TABLE>
 
     The supplementary financial data specified by Item 302 of Regulation S-K
are included in "Supplemental Financial and Statistical
Information -- Unaudited" beginning on page F-33.
 
(A)(2) FINANCIAL STATEMENT SCHEDULES.
 
     Schedules of Pennzoil and its subsidiaries are omitted because of the
absence of the conditions under which they are required or because the required
information is included in the financial statements or notes thereto.
 
                                       36
<PAGE>   39
 
(A)(3) EXHIBITS.
 
<TABLE>
<S>                       <C>
          *3(a)           -- Restated Certificate of Incorporation of Pennzoil
                             Company, as amended through May 10, 1996 (Pennzoil
                             Company 10-Q (March 31, 1997), SEC File No. 1-5591,
                             Exhibit 3).
          *3(b)           -- By-laws of Pennzoil Company, as amended through July 1,
                             1997 (Pennzoil Company 8-K (July 11, 1997), SEC File No.
                             1-5591, Exhibit 1).
          *4(a)           -- Indenture dated as of February 15, 1986 (the "1986
                             Indenture") between Pennzoil Company and Mellon Bank,
                             N.A., Trustee (Pennzoil Company 10-Q (June 30, 1986), SEC
                             File No. 1-5591, Exhibit 4(a)).
          *4(b)           -- Officer's Certificate dated as of March 16, 1987
                             delivered pursuant to the terms of the 1986 Indenture
                             setting forth the terms of Pennzoil Company's 9%
                             Debentures due April 1, 2017 (Pennzoil Company 10-Q
                             (March 31, 1987), SEC File
                             No. 1-5591, Exhibit 4(a)).
          *4(c)           -- Officer's Certificate dated as of April 14, 1989
                             delivered pursuant to the terms of the 1986 Indenture
                             setting forth the terms of Pennzoil Company's 10 5/8%
                             Debentures due June 1, 2001 (Pennzoil Company 10-Q (March
                             31, 1989), SEC File No. 1-5591, Exhibit 4(a)).
          *4(d)           -- Officer's Certificate dated as of November 14, 1989
                             delivered pursuant to the terms of the 1986 Indenture
                             setting forth the terms of Pennzoil Company's 10 1/8%
                             Debentures due November 15, 2009 and 9 5/8% Notes due
                             November 15, 1999 (Pennzoil Company 10-K (1989), SEC File
                             No. 1-5591, Exhibit 4(n)).
          *4(e)           -- Officer's Certificate dated as of November 19, 1990
                             delivered pursuant to the terms of the 1986 Indenture
                             setting forth the terms of Pennzoil Company's 10 1/4%
                             Debentures due November 1, 2005 (Pennzoil Company 10-K
                             (1990), SEC File No. 1-5591, Exhibit 4(n)).
          *4(f)           -- Instrument of Resignation, Appointment and Acceptance
                             dated as of April 1, 1991 among Pennzoil Company, Mellon
                             Bank, N.A., as Retiring Trustee, and Texas Commerce Bank
                             National Association, as Successor Trustee, under the
                             1986 Indenture (Pennzoil Company 10-K (1991), SEC File
                             No. 1-5591, Exhibit 4(p)).
          *4(g)           -- Indenture dated as of December 15, 1992 (the "1992
                             Indenture") between Pennzoil Company and Texas Commerce
                             Bank National Association, Trustee (Pennzoil Company 10-K
                             (1992), SEC File No. 1-5591, Exhibit 4(o)).
          *4(h)           -- First Supplemental Indenture dated as of January 13, 1993
                             to the 1992 Indenture (Pennzoil Company 10-K (1992), SEC
                             File No. 1-5591, Exhibit 4(p)).
          *4(i)           -- Second Supplemental Indenture dated as of October 12,
                             1993 to the 1992 Indenture (Pennzoil Company 10-K (1993),
                             SEC File No. 1-5591, Exhibit 4(i)).
          *4(j)           -- Rights Agreement dated as of October 28, 1994 between
                             Pennzoil Company and Chemical Bank, as Rights Agent
                             (Pennzoil Company 8-K (October 28, 1994), SEC File No.
                             1-5591, Exhibit 1).
                             Pennzoil Company agrees to furnish to the Commission upon
                             request a copy of any agreement defining the rights of
                             holders of long-term debt of Pennzoil Company and all its
                             subsidiaries for which consolidated or unconsolidated
                             financial statements are required to be filed, under
                             which the total amount of securities authorized does not
                             exceed 10% of the total assets of Pennzoil Company and
                             its subsidiaries on a consolidated basis.
       +*10(a)            -- 1981 Stock Option Plan of Pennzoil Company (Registration
                             No. 2-76935, Exhibit 4(a)).
       +*10(b)            -- 1982 Stock Option Plan of Pennzoil Company (Pennzoil
                             Company 10-K (1982), SEC File No. 1-5591, Exhibit 10(e)).
       +*10(c)            -- Pennzoil Company Salary Continuation Plan (Pennzoil
                             Company 10-K (1982), SEC File No. 1-5591, Exhibit 10(g)).
</TABLE>
 
                                       37
<PAGE>   40
<TABLE>
<S>                       <C>
       +*10(d)            -- Pennzoil Company Supplemental Disability Plan effective
                             January 1, 1978 (Pennzoil Company 10-K(1977), SEC File
                             No. 1-5591, Exhibit 5(y)).
       +*10(e)            -- Pennzoil Company Supplemental Life Insurance Plan
                             effective January 1, 1978, as amended (Pennzoil Company
                             10-K (1980), SEC File No. 1-5591, Exhibit 10(g)).
       +*10(f)            -- Pennzoil Company Deferred Compensation Plan (Pennzoil
                             Company 10-K (1981), SEC File No. 1-5591, Exhibit 10(i)).
       +*10(g)            -- Specimen of Pennzoil Company Deferred Compensation
                             Agreement (Pennzoil Company 10-K (1982), SEC File No.
                             1-5591, Exhibit 10(j)(1)).
       +*10(h)            -- Specimen of Pennzoil Company agreements regarding certain
                             benefits payable in the event of a change in control
                             (Pennzoil 10-Q (September 30, 1982), SEC File
                             No. 1-5591, Exhibit 28).
       +*10(i)            -- Pennzoil Company Section 415 Excess Benefit Agreements
                             (Pennzoil Company 10-Q (March 31, 1980), SEC File No.
                             1-5591, Exhibit 5).
       +*10(j)            -- Pennzoil Company Medical Expenses Reimbursement Plan
                             effective January 1, 1978 (Pennzoil Company 10-K(1977),
                             SEC File No. 1-5591, Exhibit 5(v)).
       +*10(k)            -- Pennzoil Company 1985 Conditional Stock Award Program
                             (Pennzoil Company definitive proxy material (April 25,
                             1985), SEC File No. 1-5591, Exhibit B).
       +*10(l)            -- Pennzoil Company Executive Severance Plan (Pennzoil
                             Company 10-K (1987), SEC File No. 1-5591, Exhibit 10(t)).
       +*10(m)            -- 1990 Stock Option Plan of Pennzoil Company (Pennzoil
                             Company definitive proxy material (April 26, 1990), SEC
                             File No. 1-5591, Exhibit A).
       +*10(n)            -- Pennzoil Company 1990 Conditional Stock Award Program
                             (Pennzoil Company definitive proxy material (April 26,
                             1990), SEC File No. 1-5591, Exhibit B).
       +*10(o)            -- 1992 Stock Option Plan of Pennzoil Company (Pennzoil
                             Company definitive proxy material (April 13, 1993), SEC
                             File No. 1-5591, Exhibit A).
       +*10(p)            -- Pennzoil Company 1993 Conditional Stock Award Program
                             (Pennzoil Company definitive proxy material (April 13,
                             1993), SEC File No. 1-5591, Exhibit B).
       +*10(q)            -- Employment Agreement between Pennzoil Company and Stephen
                             D. Chesebro' dated as of February 10, 1997 (Pennzoil
                             Company 10-K (1996), SEC File No. 1-5591, Exhibit 10(r)).
       +*10(r)            -- Employment Agreement between Pennzoil Company and Donald
                             A. Frederick dated February 10, 1997 (Pennzoil Company
                             10-K (1996), SEC File No. 1-5591, Exhibit 10(s)).
          12              -- Computation of Ratio of Earnings to Fixed Charges for the
                             years ended December 31, 1997, 1996, 1995, 1994 and 1993.
          21              -- List of Subsidiaries of Pennzoil Company.
          23(a)           -- Consent of Arthur Andersen LLP.
          23(b)           -- Consent of Ryder Scott Company Petroleum Engineers.
          24              -- Powers of Attorney.
          27              -- Financial Data Schedule.
          99(a)           -- Summary of Reserve Report of Ryder Scott Company
                             Petroleum Engineers as of December 31, 1997 relating to
                             oil and gas reserves.
</TABLE>
 
---------------
 
 * Incorporated by reference.
 
 + Management contract or compensatory plan or arrangement required to be filed
   as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.
 
(B) REPORTS ON FORM 8-K.
 
     No reports on Form 8-K were filed during the quarter ended December 31,
1997.
 
                                       38
<PAGE>   41
 
                                   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.
 
                                                   PENNZOIL COMPANY
 
                                        By:          JAMES L. PATE
                                           -------------------------------------
                                           (JAMES L. PATE, CHAIRMAN OF THE BOARD
                                                AND CHIEF EXECUTIVE OFFICER)
 
                                          Date: March 5, 1998
 
     PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
 
<TABLE>
<CAPTION>
                      SIGNATURE                                      TITLE
                      ---------                                      -----                        DATE
<C>                                                    <S>                                <C>
 
                   JAMES L. PATE                       Principal Executive Officer               March 5, 1998
-----------------------------------------------------  and Director
      (JAMES L. PATE, CHAIRMAN OF THE BOARD AND
              CHIEF EXECUTIVE OFFICER)
 
               DAVID P. ALDERSON, II                   Principal Financial and                   March 5, 1998
-----------------------------------------------------  Accounting Officer
   (DAVID P. ALDERSON, II, GROUP VICE PRESIDENT --
               FINANCE AND ACCOUNTING)

                HOWARD H. BAKER, JR.*
                   W. J. BOVAIRD*
               W. L. LYONS BROWN, JR.*
                 ERNEST H. COCKRELL*
                  HARRY H. CULLEN*                     A majority of the Directors               March 5, 1998
                   ALFONSO FANJUL*                        of the Registrant
              CHARLES BERDON LAWRENCE*
                  BRENT SCOWCROFT*
                  GERALD B. SMITH*
                 CYRIL WAGNER, JR.*
 
*By:            DAVID P. ALDERSON, II
-----------------------------------------------------
      (DAVID P. ALDERSON, II, ATTORNEY-IN-FACT)
</TABLE>
 


 
                                       39

<PAGE>   42
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Pennzoil Company:
 
     We have audited the accompanying consolidated balance sheet of Pennzoil
Company (a Delaware corporation) and subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1997. 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 Pennzoil Company and
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
 
     As discussed in Note 1 to the Consolidated Financial Statements, effective
July 1, 1995, the Company changed its method of accounting for the impairment of
long-lived assets.
 
                                          ARTHUR ANDERSEN LLP
 
Houston, Texas
February 27, 1998
 
                                       F-1
<PAGE>   43
 
                      [THIS PAGE INTENTIONALLY LEFT BLANK]
 
                                       F-2
<PAGE>   44
 
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
                        CONSOLIDATED STATEMENT OF INCOME
 
<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31
                                                       ----------------------------------------
                                                          1997           1996           1995
                                                       ----------     ----------     ----------
                                                            (EXPRESSED IN THOUSANDS EXCEPT
                                                                  PER SHARE AMOUNTS)
<S>                                                    <C>            <C>            <C>
REVENUES
  Net sales..........................................  $2,511,247     $2,364,732     $2,385,287
  Investment and other income, net...................     143,057        122,114        104,699
                                                       ----------     ----------     ----------
                                                        2,654,304      2,486,846      2,489,986
COSTS AND EXPENSES
  Cost of sales......................................   1,391,772      1,421,731      1,537,737
  Selling, general and administrative expenses.......     387,964        349,019        419,530
  Depreciation, depletion and amortization...........     288,848        273,937        325,119
  Impairment of long-lived assets (Note 1)...........      --             --            399,830
  Exploration expenses...............................      67,664         44,271         39,782
  Taxes, other than income...........................      49,855         51,342         51,315
  Interest charges...................................     176,891        188,155        198,579
  Interest capitalized...............................     (13,085)       (10,735)        (4,231)
                                                       ----------     ----------     ----------
INCOME (LOSS) BEFORE INCOME TAX......................     304,395        169,126       (477,675)
Income tax provision (benefit).......................     124,140         35,228       (172,533)
                                                       ----------     ----------     ----------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEMS.............     180,255        133,898       (305,142)
Extraordinary items (Note 3).........................      (5,188)        --             --
                                                       ----------     ----------     ----------
NET INCOME (LOSS)....................................  $  175,067     $  133,898     $ (305,142)
                                                       ==========     ==========     ==========
BASIC EARNINGS (LOSS) PER SHARE
  Total before extraordinary items...................  $     3.83     $     2.88     $    (6.60)
  Extraordinary items................................        (.11)        --             --
                                                       ----------     ----------     ----------
          TOTAL BASIC................................  $     3.72     $     2.88     $    (6.60)
                                                       ==========     ==========     ==========
DILUTED EARNINGS (LOSS) PER SHARE
  Total before extraordinary items...................  $     3.76     $     2.86     $    (6.60)
  Extraordinary items................................        (.11)        --             --
                                                       ----------     ----------     ----------
          TOTAL DILUTED..............................  $     3.65     $     2.86     $    (6.60)
                                                       ==========     ==========     ==========
DIVIDENDS PER COMMON SHARE...........................  $     1.00     $     1.00     $     2.50
                                                       ==========     ==========     ==========
</TABLE>
 
See Notes to Consolidated Financial Statements.
 
                                       F-3
<PAGE>   45
 
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
                           CONSOLIDATED BALANCE SHEET
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                     DECEMBER 31
                                                              -------------------------
                                                                 1997           1996
                                                              ----------     ----------
                                                              (EXPRESSED IN THOUSANDS)
<S>                                                           <C>            <C>
CURRENT ASSETS
  Cash and cash equivalents.................................  $   18,594     $   34,383
  Receivables (Note 1)......................................     234,282        250,328
  Inventories
     Crude oil and natural gas..............................      20,883         24,365
     Motor oil and refined products.........................     184,027        147,554
  Materials and supplies, at average cost...................      20,772         22,083
  Deferred income tax.......................................      19,479         20,834
  Other current assets (Note 4).............................      96,677         38,045
                                                              ----------     ----------
          TOTAL CURRENT ASSETS..............................     594,714        537,592
                                                              ----------     ----------
PROPERTY, PLANT AND EQUIPMENT, at cost
  Oil and Gas, successful efforts method of accounting......   4,604,674      4,387,277
  Motor Oil & Refined Products..............................   1,182,930      1,170,259
  Franchise Operations......................................     228,048        206,100
  Other.....................................................     104,054        100,679
                                                              ----------     ----------
          TOTAL PROPERTY, PLANT AND EQUIPMENT...............   6,119,706      5,864,315
  Less accumulated depreciation, depletion and
     amortization...........................................   3,621,109      3,546,231
                                                              ----------     ----------
          NET PROPERTY, PLANT AND EQUIPMENT.................   2,498,597      2,318,084
                                                              ----------     ----------
OTHER ASSETS
  Marketable securities and other investments (Note 1)......     945,995        955,182
  Other.....................................................     366,581        313,396
                                                              ----------     ----------
          TOTAL OTHER ASSETS................................   1,312,576      1,268,578
                                                              ----------     ----------
TOTAL ASSETS................................................  $4,405,887     $4,124,254
                                                              ==========     ==========
</TABLE>
 
See Notes to Consolidated Financial Statements.
 
                                       F-4
<PAGE>   46
 
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
                           CONSOLIDATED BALANCE SHEET
 
                      LIABILITIES AND SHAREHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                  DECEMBER 31
                                           -------------------------
                                              1997           1996
                                           ----------     ----------
                                           (EXPRESSED IN THOUSANDS)
<S>                                        <C>            <C>
CURRENT LIABILITIES
  Current maturities of long-term
     debt...............................   $    2,363     $    1,181
  Accounts payable (Note 4).............      297,205        246,277
  Taxes accrued.........................       38,909          2,811
  Interest accrued......................       30,016         30,827
  Payroll accrued.......................       27,135         25,530
  Other current liabilities.............       90,367         86,321
                                           ----------     ----------
          TOTAL CURRENT LIABILITIES.....      485,995        392,947
LONG-TERM DEBT, less current maturities
  (Note 3)
  Exchangeable debentures...............      889,027        900,397
  Other long-term debt..................    1,308,520      1,317,409
                                           ----------     ----------
          TOTAL LONG-TERM DEBT, less
             current maturities.........    2,197,547      2,217,806
DEFERRED INCOME TAX.....................      288,677        241,791
OTHER LIABILITIES.......................      295,129        302,635
                                           ----------     ----------
          TOTAL LIABILITIES.............    3,267,348      3,155,179
                                           ----------     ----------
 
COMMITMENTS AND CONTINGENCIES (Note 8)
 
SHAREHOLDERS' EQUITY
  Common stock, $0.83 1/3
     par -- authorized 100,000,000
     shares, issued 52,208,888 shares...       43,507         43,507
  Additional capital....................      325,460        323,209
  Retained earnings.....................      842,597        714,676
  Net unrealized holding gain on
     marketable securities (Note 1).....      186,325        191,803
  Cumulative foreign currency
     translation adjustment and other...       (9,427)        (3,450)
  Common stock in treasury, at cost,
     4,663,080 shares in 1997
     and 5,609,926 shares in 1996.......     (249,923)      (300,670)
                                           ----------     ----------
          TOTAL SHAREHOLDERS' EQUITY....    1,138,539        969,075
                                           ----------     ----------
TOTAL LIABILITIES AND SHAREHOLDERS'
  EQUITY................................   $4,405,887     $4,124,254
                                           ==========     ==========
</TABLE>
 
See Notes to Consolidated Financial Statements.
 
                                       F-5
<PAGE>   47
 
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
                 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31
                                       ---------------------------------------------------------------------
                                               1997                    1996                    1995
                                       ---------------------   ---------------------   ---------------------
                                        SHARES      AMOUNT      SHARES      AMOUNT      SHARES      AMOUNT
                                       --------   ----------   --------   ----------   --------   ----------
                                                             (EXPRESSED IN THOUSANDS)
<S>                                    <C>        <C>          <C>        <C>          <C>        <C>
COMMON STOCK, $0.83 1/3 par --
  Authorized 100,000,000 shares
  Balance January 1 and December
     31..............................   52,209    $   43,507    52,209    $   43,507    52,209    $   43,507
                                       -------    ----------   -------    ----------   -------    ----------
ADDITIONAL CAPITAL
  Balance January 1..................                323,209                 324,812                 326,862
     Shares reissued.................                  2,251                  (1,603)                 (2,050)
                                                  ----------              ----------              ----------
  Balance December 31................                325,460                 323,209                 324,812
                                                  ----------              ----------              ----------
RETAINED EARNINGS
  Balance January 1..................                714,676                 627,257               1,047,993
     Net income (loss)...............                175,067                 133,898                (305,142)
     Dividends on common stock.......                (47,146)                (46,479)               (115,594)
                                                  ----------              ----------              ----------
  Balance December 31................                842,597                 714,676                 627,257
                                                  ----------              ----------              ----------
NET UNREALIZED HOLDING GAIN ON
  MARKETABLE SECURITIES (Note 1)
  Balance January 1..................                191,803                 155,629                 112,668
     Change in net unrealized holding
       gain..........................                 (5,478)                 36,174                  42,961
                                                  ----------              ----------              ----------
  Balance December 31................                186,325                 191,803                 155,629
                                                  ----------              ----------              ----------
CUMULATIVE FOREIGN CURRENCY
  TRANSLATION ADJUSTMENT AND OTHER
  Balance January 1..................                 (3,450)                 (2,036)                   (848)
     Translation adjustment..........                 (5,982)                 (1,429)                 (1,176)
     Change in additional minimum
       pension liability.............                      5                      15                     (12)
                                                  ----------              ----------              ----------
  Balance December 31................                 (9,427)                 (3,450)                 (2,036)
                                                  ----------              ----------              ----------
COMMON STOCK IN TREASURY, at cost
  Balance January 1..................   (5,610)     (300,670)   (5,839)     (312,937)   (6,082)     (325,918)
     Shares reissued.................      947        50,747       229        12,267       243        12,981
                                       -------    ----------   -------    ----------   -------    ----------
  Balance December 31................   (4,663)     (249,923)   (5,610)     (300,670)   (5,839)     (312,937)
                                       -------    ----------   -------    ----------   -------    ----------
TOTAL SHAREHOLDERS' EQUITY...........   47,546    $1,138,539    46,599    $  969,075    46,370    $  836,232
                                       =======    ==========   =======    ==========   =======    ==========
</TABLE>
 
See Notes to Consolidated Financial Statements.
 
                                       F-6
<PAGE>   48
 
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
                      CONSOLIDATED STATEMENT OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31
                                           ----------------------------------------
                                              1997           1996           1995
                                           -----------    -----------    ----------
                                                   (EXPRESSED IN THOUSANDS)
<S>                                        <C>            <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES
  Net income (loss).....................   $   175,067    $   133,898    $ (305,142)
  Adjustments to reconcile net income
     (loss) to net cash
     provided by operating activities:
       Depreciation, depletion and
          amortization..................       288,848        273,937       325,119
       Impairment of long-lived assets
          (Note 1)......................       --             --            399,830
       Dry holes and impairments........        31,441         11,587        11,448
       Deferred income tax..............        59,034         20,914      (175,446)
       Gains on sales of assets.........       (66,665)       (61,508)       (7,739)
       Partnership distributions in
          excess of earnings............        23,774        --             --
       Non-cash and other nonoperating
          items (Note 1)................        47,898         53,635        52,153
       Change in operating assets and 
          liabilities (Note 1)..........       (67,314)       (21,915)      146,813
                                           -----------    -----------    ----------
          Net cash provided by operating
            activities..................       492,083        410,548       447,036
                                           -----------    -----------    ----------
CASH FLOWS FROM INVESTING ACTIVITIES
  Capital expenditures..................      (559,473)      (565,623)     (473,360)
  Acquisition of Viscosity Oil (Note
     10)................................       --             --            (33,642)
  Acquisition of Snap (Note 10).........       (41,000)       --             --
  Purchases of marketable securities and
     other investments..................      (585,279)      (572,836)     (664,553)
  Proceeds from sales of marketable
     securities and other investments...       590,396        578,871       655,482
  Proceeds from sales of assets (Note
     10)................................       131,326        480,284       192,316
  Other investing activities............       (24,867)        12,660        (7,368)
                                           -----------    -----------    ----------
          Net cash used in investing
            activities..................      (488,897)       (66,644)     (331,125)
                                           -----------    -----------    ----------
CASH FLOWS FROM FINANCING ACTIVITIES
  Issuance (repayments) of notes
     payable, net.......................        19,380       (139,165)      131,722
  Debt repayments.......................    (1,694,680)    (1,583,659)     (210,906)
  Proceeds from issuances of debt.......     1,656,500      1,435,679        77,598
  Dividends paid........................       (47,146)       (46,479)     (115,594)
  Proceeds from exercise of stock
     options (Note 7)...................        46,971            488        --
                                           -----------    -----------    ----------
          Net cash used in financing
            activities..................       (18,975)      (333,136)     (117,180)
                                           -----------    -----------    ----------
NET INCREASE (DECREASE) IN CASH AND CASH
  EQUIVALENTS...........................       (15,789)        10,768        (1,269)
CASH AND CASH EQUIVALENTS,
  beginning of period...................        34,383         23,615        24,884
                                           -----------    -----------    ----------
CASH AND CASH EQUIVALENTS, end of
  period................................   $    18,594    $    34,383    $   23,615
                                           ===========    ===========    ==========
</TABLE>
 
See Notes to Consolidated Financial Statements.
 
                                       F-7
<PAGE>   49
 
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --
 
  General Policies --
 
     The accompanying consolidated financial statements include all
majority-owned subsidiaries of Pennzoil Company ("Pennzoil" or the "Company").
All significant intercompany accounts and transactions have been eliminated.
 
     Certain prior period items have been reclassified in the consolidated
financial statements in order to conform with the current year presentation.
 
     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, the
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 those estimates.
 
  Principles of Consolidation --
 
     The consolidated financial statements include the accounts of those
subsidiaries that are more than 50 percent owned directly or indirectly, after
elimination of intercompany balances and transactions. Pennzoil also
consolidates its proportionate share of assets, liabilities, and results of
operations of oil and gas joint ventures and partnerships.
 
     Amounts representing Pennzoil's percentage interest in the underlying net
assets of less than majority owned companies in which a significant equity
ownership interest is held are included in other assets. Pennzoil's equity
earnings and losses from these investments are included in other income.
 
     Pennzoil's investment in Chevron Corporation ("Chevron") common stock is
included in marketable securities and other investments at fair value. For
accounting purposes, Pennzoil limits its fair value estimation of Chevron common
stock to its net realizable value. Reference is made to Notes 3 and 5 for
additional information. Investments in all other marketable securities are
included in other assets at cost, which approximates fair value. Dividends from
these companies are included in other income as received.
 
  Marketable Securities and Other Investments --
 
     Pennzoil accounts for certain investments in debt and equity securities by
following the requirements of Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." This standard requires that, except for debt securities classified
as "held-to-maturity," investments in debt and equity securities must be
reported at fair value. As a result, Pennzoil's investment in Chevron common
stock, which shares are classified as "available for sale," is reported at fair
value, determined as described above under "-- Principles of Consolidation,"
with the unrealized gain excluded from earnings and reported as a separate
component of shareholders' equity. As of December 31, 1997, Pennzoil
beneficially owned approximately 17.8 million shares of Chevron common stock,
acquired at an average cost of approximately $33.68 per share.
 
     Unrealized gains on Pennzoil's investment in Chevron common stock are
subject to the exchange rights of holders of Pennzoil's $397.2 million
outstanding principal amount of 6 1/2% Exchangeable Senior Debentures due
January 15, 2003 (the "6 1/2% Debentures") and $491.8 million outstanding
principal amount of 4 3/4% Exchangeable Senior Debentures due October 1, 2003
(the "4 3/4% Debentures"), all of which are exchangeable at the option of the
holders thereof for shares of Chevron common stock owned by Pennzoil. Reference
is made to Note 3 for additional information. The fair value of the shares of
Chevron common stock held by Pennzoil, determined as described above under
"-- Principles of Consolidation," as of December 31, 1997 and 1996 was $49.93
and $50.00, respectively, per share, based on the closing transaction price for
Chevron
 
                                       F-8
<PAGE>   50
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
common stock reported on the New York Stock Exchange on December 31, 1997 and
December 31, 1996 of $77.00 and $65.00 per share, reduced by a reserve for
certain exchange rights relating to Pennzoil's outstanding 6 1/2% Debentures and
4 3/4% Debentures. As of December 31, 1997 and December 31, 1996, the net
unrealized after-tax gain included in shareholders' equity related to Pennzoil's
investment in Chevron common stock was $188.1 million and $191.8 million,
respectively.
 
     The cost, fair value (which, in the case of Chevron common stock, is
determined as described above under "-- Principles of Consolidation") and
unrealized gains related to Pennzoil's marketable securities are as follows:
 
<TABLE>
<CAPTION>
                                                       ESTIMATED     UNREALIZED
             AT DECEMBER 31                  COST      FAIR VALUE      GAINS
             --------------                --------    ----------    ----------
                                                 (EXPRESSED IN THOUSANDS)
<S>                                        <C>         <C>           <C>
1997
  Non-current marketable securities and
     other investments:
     Chevron common stock...............   $599,652     $889,027      $289,375
     Other marketable securities and
       investments......................     56,968       56,968            --
                                           --------     --------      --------
  Total non-current marketable
     securities
     and other investments..............   $656,620     $945,995      $289,375
                                           ========     ========      ========
1996
  Non-current marketable securities and
     other investments:
     Chevron common stock...............   $608,565     $903,647      $295,082
     Other marketable securities and
       investments......................     51,535       51,535            --
                                           --------     --------      --------
  Total non-current marketable
     securities
     and other investments..............   $660,100     $955,182      $295,082
                                           ========     ========      ========
</TABLE>
 
     Pennzoil's investments in debt securities are classified as
"held-to-maturity" based on Pennzoil's ability and intent to hold those
securities to maturity. Such securities are carried at cost, net of unamortized
premium or discount, if any, and consist primarily of domestic commercial paper.
All of Pennzoil's "held-to-maturity" securities approximate their fair values
based on the relatively short maturities of those investments.
 
     Income effects from marketable securities and other investments are
discussed below.
 
  Investment and Other Income, Net --
 
     Other revenues, net of related expenses, are included in "Investment and
Other Income, Net," which consists of the following:
 
<TABLE>
<CAPTION>
                                             1997         1996         1995
                                           --------     --------     --------
                                                (EXPRESSED IN THOUSANDS)
<S>                                        <C>          <C>          <C>
Interest income.........................   $  7,867     $  7,043     $  9,411
Dividend income.........................     41,094       37,835       34,850
Realized gains on sales of marketable
  securities and other investments......     12,066          306           --
Net gains on sales of assets............     66,665       61,508        7,739
Settlements and refunds.................     11,282       (3,391)      25,913
Other income (expense), net.............      4,083       18,813       26,786
                                           --------     --------     --------
                                           $143,057     $122,114     $104,699
                                           ========     ========     ========
</TABLE>
 
     Substantially all interest and dividend income is from marketable
securities and other cash investments.
 
                                       F-9
<PAGE>   51
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
  Receivables --
 
     Current receivables include trade accounts and notes receivable and are net
of allowances for doubtful accounts of $18.1 million in 1997 and $9.7 million in
1996. Long-term receivables consist of notes receivable and are net of
allowances for doubtful accounts of $0.9 million in 1997 and 1996.
 
     At December 31, 1997 and 1996, current receivables included notes
receivable of $12.4 million and $11.9 million, respectively. Other assets
included long-term notes receivable of $41.4 million and $39.3 million at
December 31, 1997 and 1996, respectively.
 
     In September 1996, Pennzoil Receivables Company, a wholly owned special
purpose subsidiary of Pennzoil, entered into a one-year receivables sales
facility, which provided for the ongoing sales of up to $135.0 million of
accounts receivable of certain Pennzoil subsidiaries. In September 1997, the
facility was amended to extend the expiration date of the facility to September
1998. Receivables sold under this agreement totaled $135.0 million as of
December 31, 1997. Pennzoil used the initial proceeds from this arrangement to
reduce outstanding debt. Fees associated with these transactions totaled $8.1
million and $1.9 million in 1997 and 1996, respectively, and are netted against
other income.
 
  Inventories --
 
     A majority of inventories is reported at cost using the last-in, first-out
("LIFO") method, which is lower than market. Substantially all other inventories
are reported at cost using the first-in, first-out method. Inventories valued on
the LIFO method totaled $146.4 million at December 31, 1997 and $116.2 million
at December 31, 1996. The current cost of LIFO inventories was approximately
$170.7 million and $187.1 million at December 31, 1997 and 1996, respectively.
 
  Oil and Gas Producing Activities --
 
     Pennzoil follows the successful efforts method of accounting for oil and
gas operations. Under the successful efforts method, lease acquisition costs are
capitalized. Significant unproved properties are reviewed periodically on a
property-by-property basis to determine if there has been impairment of the
carrying value, with any such impairment charged currently to exploration
expense. All other unproved properties are generally aggregated and a portion of
such costs estimated to be nonproductive, based on historical experience, is
amortized on an average holding period basis.
 
     Exploratory drilling costs are capitalized pending determination of proved
reserves. If proved reserves are not discovered, the exploratory drilling costs
are expensed. Other exploration costs are also expensed. All development costs
are capitalized. Provision for depreciation, depletion and amortization expense
("DD&A") is determined on a field-by-field basis using the unit-of-production
method. Estimated costs of future dismantlement and abandonment of wells and
production platforms, net of salvage values, are accrued as part of DD&A using
the unit-of-production method; actual costs are charged to accumulated
depreciation, depletion and amortization.
 
  Mineral Property Conveyances and Related Transactions --
 
     Pennzoil's mineral interests in oil and gas properties are frequently
conveyed to others for a variety of reasons, including the desire to spread
risks, to improve operating efficiencies, and to achieve tax benefits. The
Company complies with SFAS No. 19, "Financial Accounting and Reporting by Oil
and Gas Producing Companies," in accounting for such conveyances.
 
     Pennzoil recognizes gains and losses when an oil and gas mineral interest
is sold, either partially or in its entirety, based on the difference between
the amount of sales proceeds received and the unamortized cost of the mineral
interest sold. When a partial interest is retained, an allocation based on fair
value is applied to the
 
                                      F-10
<PAGE>   52
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
interest sold and to the partial interest retained for purposes of the gain or
loss calculation. However, normal retirement treatment of the partial interest
sold, without any recognition of a gain or loss, is used if the amortization
basis of the assets retained is not significantly affected by the sale.
 
     In addition, gains or losses are not recognized when: (i) a transfer of
assets used in oil and gas producing activities is exchanged for other assets
also used in oil and gas producing activities, (ii) a pooling of assets in a
joint undertaking intended to find, develop, or produce oil and gas from a
particular property or group of properties occurs, or (iii) a partial interest
in an unproved property is sold and substantial uncertainty exists as to
recovery of the cost applicable to the interest retained. Under these
circumstances, amounts received are treated as a recovery of prior costs
incurred.
 
  Property, Plant and Equipment and Depreciation, Depletion and Amortization --
 
     Effective July 1, 1995, Pennzoil adopted the requirements of SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," which resulted in write-downs of proved oil and gas properties
that were not required under its prior impairment policy. Certain proved oil and
gas fields in North America were deemed to be impaired because they were not
expected to individually recover their entire carrying value. The 1995 pretax
charge was $399.8 million for asset impairments, of which $378.9 million was
attributable to the impairment of Pennzoil's proved oil and gas properties.
Prior to the adoption of SFAS No. 121, Pennzoil periodically reviewed the
carrying amounts of proven properties and an impairment reserve was provided as
conditions warranted. There were no impairments recorded under SFAS No. 121 in
1997 or 1996.
 
     All other properties are depreciated on straight-line or accelerated
methods in amounts calculated to allocate the cost of properties over their
estimated useful lives.
 
     The estimated costs of major maintenance, including turnarounds at
refineries, are accrued. Other expenditures for maintenance and repairs are
charged against income as incurred. Renewals and improvements are treated as
additions to property, plant and equipment, and items replaced are treated as
retirements.
 
  Revenue Recognition --
 
     Oil and gas revenues are recognized when produced. For production from
properties with natural gas imbalances, Pennzoil uses the sales method of
accounting. Under the sales method, revenue is recognized based on actual
volumes of gas sold to purchasers. The volume of gas sold may differ from
volumes to which Pennzoil is entitled based on its interest in the properties.
Differences between volumes sold and volumes based on entitlements create gas
imbalances, which are monitored over the life of the reservoir. At December 31,
1997, Pennzoil's gas imbalance reflects a net underproduced position of 1.2
billion cubic feet ("Bcf") of gas. Pennzoil expects to correct this imbalance
with co-owners through future production or alternative arrangements generally
accepted by the industry depending on the specific circumstances involved.
 
     All other significant revenues are recognized when title passes to the
customer or when the service is performed.
 
  Derivative Instruments --
 
     Pennzoil has a price risk management program that utilizes financial
instruments, principally crude oil and natural gas swaps, to reduce the price
risks associated with fluctuations in crude oil and natural gas prices. These
financial instruments are designated as hedges and accounted for on the accrual
basis with gains and losses being recognized based on the type of contract and
exposure being hedged. Realized gains or losses on crude oil and natural gas
swaps designated as hedges of anticipated transactions related to anticipated
production are treated as deferred credits or charges and are included in other
current liabilities or other current assets on the balance sheet. Net gains and
losses on crude oil and natural gas swaps designated as
                                      F-11
<PAGE>   53
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
hedges of anticipated transactions, including accrued gains or losses upon
maturity or termination of the contract, are deferred and recognized in income
when the associated hedged commodities are produced.
 
     In order for crude oil and natural gas swaps to qualify as a hedge of an
anticipated transaction, the derivative contract must identify the expected date
of the transaction, the commodity involved, and the expected quantity to be
purchased or sold. In the event that a hedged transaction does not occur, future
gains and losses, including termination gains or losses, are recognized in other
income when incurred.
 
     Pennzoil also periodically enters into forward exchange contracts to hedge
some of its monetary liabilities and commitments denominated in foreign
currencies. Forward exchange contracts are used to manage exposure to adverse
fluctuations in foreign currency exchange rates. Gains and losses related to
these qualifying hedges are deferred and recognized in operating income when the
hedged transaction occurs. Foreign currency transactions which do not qualify as
hedges are marked-to-market and gains and losses are recognized through other
income.
 
     In the statement of cash flows, cash receipts or payments related to
financial instruments are classified consistent with the cash flows from the
transaction being hedged.
 
  Environmental Expenditures --
 
     Environmental expenditures are expensed or capitalized in accordance with
generally accepted accounting principles. Liabilities for these expenditures are
recorded when it is probable that obligations have been incurred and the amounts
can be reasonably estimated. Reference is made to Note 8 for a discussion of
amounts recorded for these liabilities.
 
  Intangible Assets --
 
     Substantially all intangible assets, included in other assets in the
accompanying consolidated balance sheet, relate to goodwill recognized in
business combinations accounted for as purchases. Goodwill included in other
assets in the accompanying consolidated balance sheet was $158.5 million at
December 31, 1997 and $114.7 million at December 31, 1996, net of accumulated
amortization of $39.1 million and $33.2 million, respectively. Goodwill is being
amortized on a straight-line basis over periods ranging from 20 to 40 years.
Amortization expense recorded during 1997 and 1996 was $13.1 million and $10.6
million, respectively.
 
  Cash Flow Information --
 
     For purposes of the consolidated statement of cash flows, all highly liquid
investments purchased with a maturity of three months or less are considered to
be cash equivalents. The effect of changes in foreign exchange rates on cash
balances has been immaterial.
 
     Non-cash and other nonoperating items consist of the following:
 
<TABLE>
<CAPTION>
                                                                  YEAR ENDED DECEMBER 31
                                                             --------------------------------
                                                               1997        1996        1995
                                                             --------    --------    --------
                                                                 (EXPRESSED IN THOUSANDS)
<S>                                                          <C>         <C>         <C>
Non-cash accruals........................................    $ 52,518    $ 39,954    $ 48,326
Undistributed (earnings) losses from equity in
  unconsolidated subsidiaries............................        (312)      6,844      (3,283)
Gain on sale of marketable securities....................     (12,066)         --          --
Other non-cash and nonoperating items....................       7,758       6,837       7,110
                                                             --------    --------    --------
                                                             $ 47,898    $ 53,635    $ 52,153
                                                             ========    ========    ========
</TABLE>
 
                                      F-12
<PAGE>   54
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     Changes in operating assets and liabilities, net of effects from the
purchase of equity interests in certain businesses acquired, consist of the
following:
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31
                                           ----------------------------------------
                                              1997           1996           1995
                                           ----------     ----------     ----------
                                                   (EXPRESSED IN THOUSANDS)
<S>                                        <C>            <C>            <C>
Receivables
  Current federal income taxes
     receivable.........................   $   (5,492)    $       --     $   (5,958)
  Other receivables.....................       12,316         80,798          2,680
Inventories.............................      (54,453)        (7,302)        10,923
Payables
  Current federal income taxes
     payable............................       (5,492)         5,958        101,446
  Accounts payable and accrued
     liabilities(1)(2)..................       90,659        (91,248)        73,725
Other assets and liabilities(2).........     (104,852)       (10,121)       (36,003)
                                           ----------     ----------     ----------
(Increase) decrease in operating assets
  and liabilities.......................   $  (67,314)    $  (21,915)    $  146,813
                                           ==========     ==========     ==========
Cash paid during the period for:
  Interest (net of amount
     capitalized).......................   $  162,257     $  179,490     $  188,886
  Income taxes(3).......................   $   30,625     $   13,441     $ (107,167)
</TABLE>
 
---------------
(1) Included in 1997 accrued liabilities is $42.2 million associated with
    foreign taxes payable resulting from the December 1997 gain on the sale of
    Canadian oil and gas properties. Current accounting guidelines require that
    gains on sales of certain oil and gas reserves and related assets be removed
    from net income when determining net operating cash inflows while the
    related current federal income tax is required to be included in determining
    operating cash flows. Pennzoil believes that the income tax effect should be
    treated consistently with the associated gain when analyzing the elements of
    operating cash flows.
 
(2) Included in 1997 accounts payable and accrued liabilities and other assets
    are $40.6 million and $40.1 million, respectively, associated with a series
    of forward contracts entered into to hedge against the foreign currency risk
    associated with Pennzoil's $42.2 million Canadian tax liability. See
    footnote 1 above and Note 4 for additional information.
 
(3) 1995 income taxes include cash tax refunds of $122.1 million.
 
                                      F-13
<PAGE>   55
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
  Earnings Per Share --
 
     Pennzoil has adopted SFAS No. 128, "Earnings Per Share," which requires
restatement of all comparative per share amounts. Under the provisions of SFAS
No. 128, the presentation of primary earnings per share has been replaced with
basic earnings per share, and fully diluted earnings per share presentations
have been replaced with diluted earnings per share for potentially dilutive
securities such as outstanding options, convertible debt and preferred stock.
All prior period earnings per share data have been restated.
 
     Basic earnings per share are computed based on the weighted average shares
of common stock outstanding. Earnings per share computations to reconcile basic
and diluted income from continuing operations for the years 1997, 1996 and 1995
consist of the following:
 
<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31
                                                            ---------------------------------
                                                              1997        1996        1995
                                                            --------    --------    ---------
                                                             (EXPRESSED IN THOUSANDS EXCEPT
                                                                   PER SHARE AMOUNTS)
<S>                                                         <C>         <C>         <C>
Income from continuing operations.......................    $180,255    $133,898    $(305,142)
Basic weighted average shares...........................      47,119      46,473       46,245
Effect of dilutive securities(1):
  Options...............................................         688         183           --
  Awards................................................         116         102           --
Diluted weighted average shares.........................      47,923      46,758       46,245
Per share income from continuing operations:
  Basic.................................................    $   3.83    $   2.88    $   (6.60)
  Diluted...............................................    $   3.76    $   2.86    $   (6.60)
</TABLE>
 
---------------
 
(1) A weighted average year-to-date number of options to purchase 713,369 and
    1,982,107 shares of common stock were outstanding during 1997 and 1996,
    respectively, but were not included in the computation of diluted per share
    income from continuing operations because the options' exercise prices were
    greater than the average market price of the common shares. A weighted
    average year-to-date number of options to purchase 2,603,332 shares of
    common stock and awards of 82,675 shares of common stock were outstanding
    during 1995, but were not included in the computation of diluted per share
    income from continuing operations because these options and awards would
    result in an antidilutive per share amount.
 
  International Operations --
 
     Consolidated income (loss) from continuing operations before income tax
includes income (losses) from international operations of $39.4 million, ($37.2)
million and ($99.8) million in 1997, 1996 and 1995, respectively.
 
  Recent Accounting Pronouncements --
 
     In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income." The Statement establishes standards
for reporting and display of comprehensive income and its components in a full
set of general-purpose financial statements. The statement requires (a)
classification of items of other comprehensive income by their nature in a
financial statement and (b) display of the accumulated balance of other
comprehensive income separate from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. SFAS No. 130
is effective for fiscal years beginning after December 15, 1997 and
reclassification of financial statements for earlier periods provided for
comparative purposes is required.
 
     In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." Under the new standard, companies will
be required to report certain information about operating segments in
consolidated statements. Operating segments will be determined based on the
method
 
                                      F-14
<PAGE>   56
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
by which management organizes its business for making operating decisions and
assessing performance. The standard also requires that companies report certain
information about their products and services, the geographic areas in which
they operate, and their major customers. SFAS No. 131 is effective for financial
statements for periods beginning after December 15, 1997.
 
(2) INCOME TAXES --
 
  Accounting for Income Taxes --
 
     Pennzoil accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes." SFAS No. 109 requires recognition of deferred tax
liabilities and assets for the expected future tax consequences of events that
have been included in the financial statements or tax returns. Under this
method, deferred tax liabilities and assets are determined based on the
difference between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
 
  Federal, State and Foreign --
 
     Federal, state and foreign income tax expense (benefit) for continuing
operations consists of the following:
 
<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31
                                                          -----------------------------------
                                                            1997         1996         1995
                                                          --------     --------     ---------
                                                               (EXPRESSED IN THOUSANDS)
<S>                                                       <C>          <C>          <C>
Current
  United States.........................................  $ 28,285     $ 11,994     $   1,800
  Foreign...............................................    37,359          485           741
  State.................................................      (538)       1,835           372
Deferred
  United States.........................................    58,140       12,356      (142,627)
  Foreign...............................................    (6,044)       2,728       (24,039)
  State.................................................     6,938        5,830        (8,780)
                                                          --------     --------     ---------
                                                          $124,140     $ 35,228     $(172,533)
                                                          ========     ========     =========
</TABLE>
 
     Pennzoil's net deferred tax liability is as follows:
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31
                                                              ------------------------
                                                                 1997          1996
                                                              ----------    ----------
                                                              (EXPRESSED IN THOUSANDS)
<S>                                                           <C>           <C>
Deferred tax liability......................................  $ 551,826     $ 478,342
Deferred tax asset..........................................   (312,905)     (280,631)
Valuation allowance.........................................     30,277        23,246
                                                              ---------     ---------
          Net deferred tax liability........................  $ 269,198     $ 220,957
                                                              =========     =========
</TABLE>
 
                                      F-15
<PAGE>   57
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     Temporary differences and carryforwards which gave rise to significant
portions of deferred tax assets and liabilities are as follows:
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31
                                                              ------------------------
                                                                 1997          1996
                                                              ----------    ----------
                                                              (EXPRESSED IN THOUSANDS)
<S>                                                           <C>           <C>
Investment in equity securities.............................  $ 138,808     $ 143,117
Property, plant and equipment...............................    335,088       284,221
Proceeds from issuance of exchangeable debentures
  treated as option proceeds................................     40,855        40,953
Original issue discount on exchangeable debentures..........    (26,763)      (29,880)
Alternative minimum tax credit carryforward.................   (101,719)      (92,499)
Net operating loss carryforwards............................    (38,037)      (32,898)
Other, net..................................................   (109,311)     (115,303)
Valuation allowance.........................................     30,277        23,246
                                                              ---------     ---------
          Net deferred tax liability........................  $ 269,198     $ 220,957
                                                              =========     =========
</TABLE>
 
     The principal items accounting for the difference in income taxes on income
(loss) from continuing operations computed at the federal statutory rate and
income taxes as recorded are as follows:
 
<TABLE>
<CAPTION>
                                                YEAR ENDED DECEMBER 31
                                           ---------------------------------
                                             1997        1996        1995
                                           --------    --------    ---------
                                               (EXPRESSED IN THOUSANDS)
<S>                                        <C>         <C>         <C>
Income tax provision (benefit) at
  statutory rate........................   $106,538    $ 59,194    $(167,187)
Increases (reductions) resulting from:
  Dividends received deduction..........    (10,068)     (9,272)      (8,535)
  State income taxes, net...............      4,160       4,982       (5,465)
  Sale of foreign subsidiary(1).........         --     (19,094)          --
  Taxes on foreign income in excess of
     statutory rate(2)..................     20,355        (509)        (618)
  Nondeductible goodwill................      2,429       2,303       11,815
  Other, net............................        726      (2,376)      (2,543)
                                           --------    --------    ---------
Income tax provision (benefit)..........   $124,140    $ 35,228    $(172,533)
                                           ========    ========    =========
</TABLE>
 
---------------
 
(1) In 1996 Pennzoil recognized a tax benefit from the sale of stock of Pennzoil
    Canada, Inc. ("Pennzoil Canada"), an indirect wholly owned subsidiary of
    Pennzoil. The benefit was attributable to prior foreign losses and asset
    write-downs that had not previously been recognized for tax purposes.
    Reference is made to Note 10 for additional information on the sale of
    Pennzoil Canada.
 
(2) In December 1997, Pennzoil received net proceeds of $101.9 million from the
    sale of its remaining Canadian oil and gas assets. A pretax gain of $67.6
    million and Canadian income taxes of $29.6 million were recorded in
    connection with the sale. The $29.6 million has been deducted in calculating
    the U.S. income tax liability.
 
     The Internal Revenue Service is currently reviewing Pennzoil's 1993, 1994
and 1995 federal income tax returns.
 
     As of December 31, 1997, Pennzoil had a United States net operating loss
carryforward of approximately $4.5 million, which is available to reduce future
regular federal income taxes payable. Additionally, for purposes of determining
alternative minimum tax, an approximate $3.1 million net operating loss is
available to offset future alternative minimum taxable income. Utilization of
these regular and alternative minimum tax net operating losses, to the extent
generated in separate return years, is limited based on the separate taxable
income of the subsidiary, or its successor, generating the loss. If not used,
these carryovers will expire in the years 2000 to 2006. In addition, Pennzoil
has approximately $101.7 million of alternative minimum tax credits indefinitely
available to reduce future regular tax liability to the extent it exceeds the
related alternative
 
                                      F-16
<PAGE>   58
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
minimum tax otherwise due. All net operating loss and credit carryover amounts
are subject to examination by the tax authorities.
 
     Pennzoil also has state net operating loss carryforwards, the tax effect of
which was approximately $38.0 million as of December 31, 1997. A valuation
allowance of approximately $28.6 million has been established to offset the
portion of the deferred tax asset related to state tax loss carryforwards
expected to expire before their utilization.
 
(3) DEBT --
 
     Debt outstanding was as follows:
 
<TABLE>
<CAPTION>
                                                 DECEMBER 31
                                           ------------------------
                                              1997          1996
                                           ----------    ----------
                                           (EXPRESSED IN THOUSANDS)
<S>                                        <C>           <C>
Exchangeable debentures
  6 1/2% due 2003.......................   $  397,247    $  400,397
  4 3/4% due 2003.......................      491,780       500,000
Other debentures and notes
  9 5/8% due 1999.......................      200,000       200,000
  10 5/8% due 2001......................      150,000       150,000
  10 1/4% due 2005......................      250,000       250,000
  10 1/8% due 2009......................      200,000       200,000
  9% due 2017...........................           --        38,500
Revolving credit facilities with
  banks.................................      108,000        99,000
Commercial paper........................      162,475       198,176
Variable-rate credit arrangements.......      185,000       129,920
Other (including debenture premiums and
  discounts)............................       55,408        52,994
                                           ----------    ----------
  Total debt, including current
     maturities.........................    2,199,910     2,218,987
Less amounts classified as
  short-term:...........................        2,363         1,181
                                           ----------    ----------
  Total long-term amount................   $2,197,547    $2,217,806
                                           ==========    ==========
</TABLE>
 
     Pennzoil's current revolving credit facility (the "Revolving Credit
Facility") with a group of banks provides for up to $600 million of unsecured
revolving credit borrowings through May 26, 1998, with any outstanding
borrowings on such date being converted into a term credit facility terminating
on May 30, 1999. Pennzoil has the option, subject to the extension of additional
credit by new or existing banks, of increasing the size of the facility by $100
million. Outstanding borrowings under Pennzoil's revolving credit facilities
totaled $108.0 million and $99.0 million at December 31, 1997 and 1996,
respectively. The average interest rate applicable to amounts outstanding under
Pennzoil's revolving credit facilities was 5.79% and 5.67% during 1997 and 1996,
respectively.
 
     Pennzoil has currently limited aggregate borrowings under its commercial
paper programs to $500.0 million. Borrowings under Pennzoil's commercial paper
facilities totaled $162.5 and $198.2 million at December 31, 1997 and December
31, 1996, respectively. The average interest rates applicable to outstanding
commercial paper were 5.85% and 5.74% during 1997 and 1996, respectively.
 
     Pennzoil has several short-term variable-rate credit arrangements with
certain banks. Pennzoil has currently limited its aggregate borrowings under
these credit arrangements to $300.0 million. Outstanding borrowings totaled
$185.0 million and $129.9 million at December 31, 1997 and 1996, respectively.
The average interest rates applicable to amounts outstanding under these
arrangements were 5.71% and 5.53% during 1997 and 1996, respectively. None of
the banks under these credit arrangements has any obligation to
 
                                      F-17
<PAGE>   59
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
continue to extend credit after the maturities of outstanding borrowings or to
extend the maturities of any borrowings.
 
     As of December 31, 1997, borrowings under Pennzoil's commercial paper and
short-term variable-rate credit arrangements (the commercial paper programs and
the short-term variable rate credit arrangements, collectively, the "short-term
facilities") totaled $347.5 million, all of which, beginning with the execution
of the Revolving Credit Facility in May 1996, has been classified as long-term
debt. Such debt classification is based upon the availability of committed
long-term credit facilities to refinance such short-term facilities and
Pennzoil's intent to maintain such commitments in excess of one year. Prior to
the execution of the Revolving Credit Facility, borrowings under the short-term
facilities were classified as short-term debt, and borrowings under the previous
revolving credit facility were classified as long-term debt.
 
     In April 1997, Pennzoil redeemed $38.5 million principal amount of
indebtedness consisting of all of Pennzoil's outstanding 9% debentures due 2017.
The purchase premium and related unamortized discount and debt issue costs
relating to the redemption resulted in an extraordinary charge of $1.3 million,
net of tax.
 
     During 1997 certain owners of Pennzoil's exchangeable debentures requested
to exchange their debentures for Chevron common stock, in accordance with the
respective supplemental indentures. Pennzoil recorded an extraordinary charge of
$3.9 million, net of tax associated with the exchanges based on the difference
between the carrying amount of the debt and the value tendered for exchange.
 
     The 6 1/2% Exchangeable Senior Debentures (the "6 1/2% Debentures") and the
4 3/4% Exchangeable Senior Debentures (the "4 3/4% Debentures") are exchangeable
at the option of the holders thereof at any time prior to maturity, unless
previously redeemed, for shares of Chevron common stock beneficially owned by
Pennzoil at exchange rates of 23.774 shares and 17.004 shares, respectively, per
$1,000 principal amount of the 6 1/2% Debentures and the 4 3/4% Debentures (the
equivalent of $42 1/16 per share and $58 13/16 per share, respectively), subject
to adjustment in certain events. In lieu of delivering certificates representing
shares of Chevron common stock in exchange for the 6 1/2% Debentures and the
4 3/4% Debentures, Pennzoil may, at its option, pay to any holder surrendering
the 6 1/2% Debentures and the 4 3/4% Debentures an amount in cash equal to the
market price of the shares for which the 6 1/2% Debentures and the 4 3/4%
Debentures are exchangeable. Pennzoil has deposited a sufficient number of
shares of Chevron common stock with exchange agents for possible exchange for
the 6 1/2% Debentures and the 4 3/4% Debentures. Under the instruments governing
the 6 1/2% Debentures and the 4 3/4% Debentures, Pennzoil may not pledge,
mortgage, hypothecate or grant a security interest in, or permit any mortgage,
pledge, security interest or other lien upon, the shares of Chevron common stock
deposited with exchange agents and deliverable in exchange for the 6 1/2%
Debentures and the 4 3/4% Debentures. Pennzoil may at any time obtain from the
exchange agents or otherwise authorize or direct the exchange agents to release
all or part of the approximately 17.8 million shares of Chevron common stock
deposited with the exchange agents. However, in the event Pennzoil obtains or
otherwise releases any shares of Chevron common stock subject to exchange, each
holder of a 6 1/2% Debenture or a 4 3/4% Debenture will generally have the
right, at such holder's option, to require Pennzoil to repurchase all or a
portion of such holder's debentures at a premium.
 
     On December 23, 1997, Pennzoil filed a registration statement on Form S-4
with the Securities and Exchange Commission proposing to issue up to $889.1
million principal amount of new exchangeable senior debentures ("New
Debentures") in exchange for a portion of its 6 1/2% Debentures and its 4 3/4%
Debentures. The New Debentures would have terms substantially similar to the
existing debentures except for the maturity date, call date, coupon and the
number of Chevron shares into which the New Debentures are exchangeable.
 
     At December 31, 1997, aggregate maturities of long-term debt, excluding
commercial paper and short-term variable rate credit arrangements, for the years
ending December 31, 1998 through 2002 were $2.4 million, $308.2 million, $.4
million, $150.2 million and $.1 million, respectively. These maturities include
$108.0 million in 1999 related to maturities of borrowings under Pennzoil's
Revolving Credit Facility.
 
                                      F-18
<PAGE>   60
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
(4) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF
    CREDIT RISK --
 
  Financial Instruments With Off-Balance-Sheet Risk --
 
     Pennzoil is a party to various financial instruments with off-balance-sheet
risk as part of its normal course of business, including financial guarantees
and contractual commitments to extend financial guarantees, credit and other
assistance to customers, franchisees and other third parties. These financial
instruments involve, to varying degrees, elements of credit risk which are not
recognized in Pennzoil's consolidated balance sheet.
 
     Other financial guarantees include debt and lease obligation guarantees
with expiration dates of up to twenty years issued to third parties to guarantee
the performance of customers and franchisees in the fast-lube industry.
Commitments to extend credit are also provided to fast lube industry
participants to finance equipment purchases, working capital needs and, in some
cases, the acquisition of land and construction of improvements. Contractual
commitments to extend credit and other assistance are in effect as long as
certain conditions established in the respective contracts are met. Contractual
commitments to extend financial guarantees are conditioned on the occurrence of
specified events. The largest of these commitments is to provide a guarantee for
letters of credit issued by third parties to meet the reinsurance requirements
of Pennzoil's captive insurance subsidiary. This commitment has no stated
maturity and is expected to vary in amount from year to year to meet the
reinsurance requirements. Reserves established for reported and incurred but not
reported insurance losses in the amount of $39.5 million and $39.7 million have
been recognized in Pennzoil's consolidated balance sheet as of December 31, 1997
and 1996, respectively. The credit risk to Pennzoil is mitigated by the
insurance subsidiary's portfolio of high-quality, short-term investments used to
collateralize the letters of credit. At December 31, 1997, the market value of
the collateral represented approximately 122% of the estimated credit risk.
 
     Pennzoil has a price risk management program that permits the utilization
of agreements and financial instruments (such as futures, forward and option
contracts and swaps and collars) to reduce the price risks associated with
fluctuations in crude oil and natural gas prices as they relate to Pennzoil's
anticipated production of its crude oil and natural gas reserves of Pennzoil's
marketing. The estimated value of amounts owed to Pennzoil under open commodity
price hedges was $0.7 million as of December 31, 1997 and $1.2 million as of
December 31, 1996; such amounts (to the extent realized) are expected to be
substantially offset by corresponding decreases in the market price of
underlying commodities.
 
     In connection with Pennzoil's disposition of Pennzoil Resources Canada
Ltd., in 1997, Pennzoil entered into a series of forward contracts at an average
exchange rate of 1.412 Cdn.$/U.S.$ to hedge against the foreign currency risk
associated with its $42.2 million Canadian tax liability due in early 1998.
Under these contracts, the counterparties would pay Pennzoil Cdn.$57.3 million
in 1998, and Pennzoil would concurrently pay the counterparties U.S.$40.6
million. In connection with these forward contracts, at December 31, 1997,
Pennzoil has recorded a liability of $40.6 million, included in accounts
payable, and an asset of $40.1 million, included in other current assets.
Unrealized losses at December 31, 1997 totaling $0.5 million are deferred and
any unrealized gains or losses will be recognized in income upon the settlement
of the forward contracts.
 
     Pennzoil conducts its price risk management program with major financial
institutions and industry partners which the company believes present a minimal
credit risk. Pennzoil is exposed to potential market risks if its physical
markets for delivery do not substantially correlate with markets designated as
indices in the financial instruments used for price risk management.
 
                                      F-19
<PAGE>   61
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     Following are the amounts related to Pennzoil's financial guarantees and
contractual commitments to extend financial guarantees, credit and other
assistance and forward foreign currency exchange contracts as of December 31,
1997 and 1996.
 
<TABLE>
<CAPTION>
                                                                    CONTRACT OR
                                                                  NOTIONAL AMOUNTS
                                                              ------------------------
                                                                1997           1996
                                                              ---------      ---------
                                                              (EXPRESSED IN THOUSANDS)
<S>                                                           <C>            <C>
Financial guarantees relating to Excel Paralubes............  $ 16,790       $255,900
Natural gas volume delivery guarantees......................     9,102         22,838
Other financial guarantees..................................     5,159          8,305
Commitments to extend financial guarantees
  Guarantees of letters of credit...........................    32,525         24,388
  Other guarantees..........................................     9,557         14,383
Forward foreign currency exchange contracts.................    40,576             --
                                                              --------       --------
     Total..................................................  $113,709       $325,814
                                                              ========       ========
</TABLE>
 
     Pennzoil has agreed to sell most of its U.S. natural gas production at
market prices to Columbia Energy Services Corp. ("Columbia") under a contract
that terminates on June 30, 2001.
 
     Pennzoil's exposure to credit losses in the event of nonperformance by the
other parties to these financial instruments is represented by the contractual
or notional amounts. Decisions to extend financial guarantees and commitments
and the amount of remuneration and collateral required are based on management's
credit evaluation of the counterparties on a case-by-case basis. The collateral
held varies but may include accounts receivable, inventory, equipment, real
property, securities and personal assets. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.
 
  Concentrations of Credit Risk --
 
     Pennzoil extends credit to various companies in the oil and gas, motor oil
and refined products and fast lube industries in the normal course of business.
Within these industries, certain concentrations of credit risk exist. These
concentrations of credit risk may be similarly affected by changes in economic
or other conditions and may, accordingly, impact Pennzoil's overall credit risk.
However, management believes that consolidated receivables are well diversified,
thereby reducing potential credit risk to Pennzoil, and that allowances for
doubtful accounts are adequate to absorb estimated losses as of December 31,
1997. Pennzoil's policies concerning collateral requirements and the types of
collateral obtained for on-balance-sheet financial instruments are the same as
those described above under "Financial Instruments With Off-Balance-Sheet Risk."
 
     At December 31, 1997, receivables related to these group concentrations in
the oil and gas, motor oil and refined products and fast lube industries were
$94.4 million, $160.0 million, and $31.5 million, respectively, compared with
$128.4 million, $137.9 million and $29.1 million, respectively, at December 31,
1996.
 
(5) FAIR VALUE OF FINANCIAL INSTRUMENTS --
 
  Balance Sheet Financial Instruments --
 
     The carrying amounts of Pennzoil's short-term financial instruments,
including cash equivalents, current marketable securities and other investments,
trade accounts receivable, trade accounts payable and notes payable, approximate
their fair values based on the short maturities of those instruments and on
quoted market prices, where such prices are available.
 
                                      F-20
<PAGE>   62
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     The following table summarizes the carrying amounts and estimated fair
values of Pennzoil's other balance sheet financial instruments.
 
<TABLE>
<CAPTION>
                                               DECEMBER 31, 1997           DECEMBER 31, 1996
                                            ------------------------    ------------------------
                                                          ESTIMATED                   ESTIMATED
                                             CARRYING       MARKET       CARRYING       MARKET
                                              AMOUNT        VALUE         AMOUNT        VALUE
                                            ----------    ----------    ----------    ----------
                                                          (EXPRESSED IN THOUSANDS)
<S>                                         <C>           <C>           <C>           <C>
Notes receivable..........................  $   52,610    $   51,314    $   50,299    $   48,893
Long-term investments.....................     945,995     1,428,059       956,122     1,227,092
Exchangeable debentures...................     889,027     1,382,596       900,396     1,193,614
Other long-term debt......................   1,310,883     1,435,564     1,318,591     1,448,652
</TABLE>
 
     The following methods and assumptions were used to estimate the market
value of each class of financial instrument included above:
 
          Notes Receivable. The estimated market value of notes receivable is
     based on discounting future cash flows using estimated year-end interest
     rates at which similar loans have been made to borrowers with similar
     credit ratings for the same remaining maturities.
 
          Long-Term Investments. The estimated market value of long-term
     investments is based on quoted market prices at year end for those
     investments. The carrying amount of the investment in Chevron common stock
     beneficially owned by Pennzoil is limited to the carrying amount of the
     exchangeable debentures of $889.0 million on the balance sheet. Reference
     is made to Note 1 for additional information.
 
          Long-Term Debt. The estimated market value of Pennzoil's long-term
     debt is based on quoted market prices or, where such prices are not
     available, on estimated year-end interest rates of debt with the same
     remaining average maturities and credit quality.
 
          Exchangeable Debentures. The estimated market value of the
     exchangeable debt reflected above is based on quoted market prices which
     are driven by the price of the Chevron shares into which the debt is
     exchangeable. The debentures are exchangeable at the option of the holders
     thereof into approximately 17.8 million shares of Chevron common stock
     beneficially owned by Pennzoil. Pennzoil's liability for the debentures is
     effectively limited to the face value of the exchangeable debt of $889.0
     million. Reference is made to Note 3 for additional information.
 
  Off-Balance-Sheet Financial Instruments --
 
     The estimated fair value of certain financial guarantees written and
commitments to extend financial guarantees was $3.4 million and $6.1 million as
of December 31, 1997 and December 31, 1996, respectively. The estimated fair
value of certain financial guarantees written and commitments to extend
financial guarantees is based on the estimated cost to Pennzoil to obtain third
party letters of credit to relieve Pennzoil of its obligations under such
guarantees or, in the case of certain lease guarantees related to Jiffy Lube
International, Inc. ("Jiffy Lube") franchisees, the present value of expected
future cash flows using a discount rate commensurate with the risks involved.
 
     The estimated value of amounts owed to Pennzoil under its open commodity
price hedges was $0.7 million as of December 31, 1997 and $1.2 million as of
December 31, 1996. The estimated value of Pennzoil's open commodity price hedges
is the amount that Pennzoil would receive or pay to terminate its hedge
agreements, taking into account the creditworthiness of the hedge
counterparties.
 
     The estimated value of amounts owed by Pennzoil under its foreign currency
exchange contracts was $40.6 million as of December 31, 1997. Pennzoil did not
have any open foreign currency exchange contracts as of December 31, 1996. The
estimated value of Pennzoil's foreign currency exchange contracts represents the
 
                                      F-21
<PAGE>   63
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
original contract amount adjusted using the year-end closing spot exchange rate.
Reference is made to Note 4 for further information regarding off-balance sheet
financial instruments.
 
(6) BENEFIT PLANS --
 
  Retirement Plans --
 
     Substantially all employees are covered by non-contributory retirement
plans which provide benefits based on the participants' years of service and
compensation or stated amounts for each year of service. Annual contributions to
the plans are made in accordance with the minimum funding provisions of ERISA
where applicable, but not in excess of the maximum amount that can be deducted
for federal income tax purposes.
 
     Net periodic pension cost for 1997, 1996 and 1995 included the following
components:
 
<TABLE>
<CAPTION>
                                                   1997          1996          1995
                                                 --------      --------      --------
                                                       (EXPRESSED IN THOUSANDS)
<S>                                              <C>           <C>           <C>
Service cost -- benefits earned during the
  year.........................................  $  8,506      $  8,510      $  8,190
Interest cost on projected benefit
  obligations..................................    15,127        13,760        12,743
Expected return on plan assets.................   (23,557)      (18,195)      (11,846)
Net amortization and deferral..................    (1,063)        1,500         1,723
                                                 --------      --------      --------
          Net periodic pension cost............      (987)     $  5,575      $ 10,810
                                                 ========      ========      ========
</TABLE>
 
     Actual return on plans' assets was $64.8 million, $46.3 million and $47.6
million in 1997, 1996 and 1995, respectively.
 
     Assumptions used were:
 
<TABLE>
<CAPTION>
                                                              AS OF DECEMBER 31
                                                          --------------------------
                                                          1997       1996       1995
                                                          -----      -----      ----
<S>                                                       <C>        <C>        <C>
Discount rates..........................................   7.25%      7.50%     7.50%
Weighted average rates of increase in compensation
  levels................................................   4.60%      4.60%     4.60%
Expected long-term rate of return on assets.............  10.50%     10.50%     9.00%
</TABLE>
 
                                      F-22
<PAGE>   64
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     The following table sets forth the plans' funded status and amounts
recognized in the consolidated balance sheet:
 
<TABLE>
<CAPTION>
                                        DECEMBER 31, 1997                          DECEMBER 31, 1996
                             ----------------------------------------   ----------------------------------------
                              PLANS WHERE     PLANS WHERE                PLANS WHERE     PLANS WHERE
                             ASSETS EXCEED    ACCUMULATED               ASSETS EXCEED    ACCUMULATED
                              ACCUMULATED      BENEFITS       TOTAL      ACCUMULATED      BENEFITS       TOTAL
                               BENEFITS      EXCEED ASSETS    PLANS       BENEFITS      EXCEED ASSETS    PLANS
                             -------------   -------------   --------   -------------   -------------   --------
                                                          (EXPRESSED IN THOUSANDS)
<S>                          <C>             <C>             <C>        <C>             <C>             <C>
Actuarial present value of
  benefit obligations:
  Vested benefit
     obligation............    $183,342         $ 6,312      $189,654     $157,852         $ 5,045      $162,897
                               ========         =======      ========     ========         =======      ========
  Accumulated benefit
     obligation............    $205,281         $ 6,504      $211,785     $178,008         $ 5,153      $183,161
                               ========         =======      ========     ========         =======      ========
  Projected benefit
     obligation............     226,054           8,714       234,768      194,544           6,567       201,111
Plan assets at fair
  value....................     273,422             308       273,730      217,552             802       218,354
                               --------         -------      --------     --------         -------      --------
Projected benefit
  obligation (in excess of)
  less than plan assets....      47,368          (8,406)       38,962       23,008          (5,765)       17,243
Unrecognized net (gain)
  loss.....................     (88,899)          2,035       (86,864)     (53,457)          1,287       (52,170)
Prior service cost not
  yet recognized in net
  periodic pension cost....      29,590           3,742        33,332       16,542           2,871        19,413
Unrecognized net
  obligation (asset).......        (889)              1          (888)      (1,121)             28        (1,093)
Minimum liability
  adjustment...............          --          (3,568)       (3,568)          --          (2,810)       (2,810)
                               --------         -------      --------     --------         -------      --------
Pension liability
  recognized in the
  consolidated
  balance sheet............    $(12,830)        $(6,196)     $(19,026)    $(15,028)        $(4,389)     $(19,417)
                               ========         =======      ========     ========         =======      ========
</TABLE>
 
     The plans' assets include equity securities, common trust funds and various
debt securities.
 
     Unrecognized prior service cost is amortized on a straight-line basis over
a period equal to the average of the expected future service of active employees
expected to receive benefits under the respective plans.
 
  Postretirement Health Care and Life Insurance Benefits --
 
     Pennzoil sponsors several unfunded defined benefit postretirement plans
covering most salaried and hourly employees. The plans provide medical and life
insurance benefits and are, depending on the type of plan, either contributory
or non-contributory. The accounting for the health care plans anticipates future
cost-sharing changes that are consistent with Pennzoil's expressed intent to
increase, where possible, contributions from future retirees to a minimum of 30%
of the total annual cost. Furthermore, Pennzoil's future contributions for both
current and future retirees have been limited, where possible, to 200% of the
average 1992 benefit cost.
 
                                      F-23
<PAGE>   65
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     Net periodic postretirement benefit cost for 1997, 1996 and 1995 included
the following components:
 
<TABLE>
<CAPTION>
                                                      1997     1996     1995
                                                     ------   ------   ------
                                                     (EXPRESSED IN THOUSANDS)
<S>                                                  <C>      <C>      <C>
Service cost -- benefits attributed to service
  during the period................................  $1,162   $1,283   $1,217
Interest cost on accumulated postretirement benefit
  obligation.......................................   4,491    5,015    5,795
Amortization of unrecognized net losses............      --       --       81
                                                     ------   ------   ------
Net periodic postretirement benefit cost...........  $5,653   $6,298   $7,093
                                                     ======   ======   ======
</TABLE>
 
     The following table sets forth the plans' combined status reconciled with
the amount included in the consolidated balance sheet at December 31, 1997 and
1996:
 
<TABLE>
<CAPTION>
                                                           1997           1996
                                                         ---------      ---------
                                                         (EXPRESSED IN THOUSANDS)
<S>                                                      <C>            <C>
Accumulated postretirement benefit obligation:
  Retirees.............................................   $43,255        $46,685
  Fully eligible active plan participants..............     5,253          8,048
  Other active plan participants.......................    15,947         15,664
                                                          -------        -------
Total accumulated postretirement benefit obligation....    64,455         70,397
Unrecognized net gain (loss) from changes in
  assumptions..........................................     4,232         (2,480)
                                                          -------        -------
Accrued postretirement benefit cost....................   $68,687        $67,917
                                                          =======        =======
</TABLE>
 
     For measurement purposes, a 7% annual rate of increase in the per capita
cost of covered health care benefits was assumed for 1998; the rate was assumed
to decrease gradually to 5% through the year 2002 and remain at that level
thereafter. The health care cost trend rate assumption has a significant effect
on the amount of the obligation and periodic cost reported. An increase in the
assumed health care cost trend rates by 1% in each year would increase the
accumulated postretirement benefit obligation as of December 31, 1997 by $3.3
million and the aggregate of the service and interest cost components of net
periodic postretirement benefit cost for the year then ended by $0.3 million.
 
     The weighted-average discount rate used in determining the accumulated
postretirement benefit obligation as of December 31, 1997 and 1996 were 7.25%
and 7.50%, respectively.
 
  Contribution Plans --
 
     Pennzoil has defined contribution plans covering substantially all
employees who have completed one year of service. Employee contributions of not
less than 1% to not more than 6% of each covered employee's compensation are
matched between 50% and 100% by Pennzoil. The cost of such company contributions
totaled $9.0 million in 1997, $9.0 million in 1996 and $10.7 million in 1995.
 
(7) CAPITAL STOCK AND STOCK OPTIONS --
 
     Pennzoil's Restated Certificate of Incorporation authorizes the issuance of
up to 9,747,720 shares of preferred stock. None of these shares were issued or
outstanding at December 31, 1997. Pursuant to its authority to divide the
preferred stock into a series, the Board of Directors in October 1994 designated
750,000 shares of preferred stock as a series of "Series A Junior Participating
Preferred Stock." The Series A Junior Participating Preferred Stock is issuable
upon the exercise of certain rights to purchase the Series A Junior
Participating Preferred Stock ("Rights"). One Right was distributed with respect
to each share of Pennzoil
 
                                      F-24
<PAGE>   66
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
common stock outstanding at the close of business on November 11, 1994, and
Rights are issuable with all subsequently issued shares of Pennzoil common stock
prior to the date the Rights become exercisable or expire. The Rights are not
currently exercisable or transferable apart from the Pennzoil common stock. Each
Right entitles the holder to purchase from Pennzoil a unit consisting of one
one-hundredth of a share of Series A Junior Participating Preferred Stock at
$140 per share upon the occurrence of certain specified events.
 
     Pennzoil's Restated Certificate of Incorporation authorizes the issuance of
up to 27,862,924 shares of preference common stock. None of these shares were
issued or outstanding at December 31, 1997. Dividend rights on any preference
common stock are junior to the rights of any Pennzoil preferred stock and senior
to the rights of Pennzoil common stock.
 
     In 1997, Pennzoil adopted two new incentive plans and reserved an
additional 1,350,000 shares of common stock for issuance pursuant to such
incentive plans. At December 31, 1997, Pennzoil had 3,829,185 shares of common
stock reserved for issuance under all employee benefit plans.
 
     At December 31, 1997, Pennzoil had nonqualified stock option plans covering
a total of 3,695,413 shares of Pennzoil common stock (compared to 3,400,304
shares at December 31, 1996), of which 726,457 shares were available for
granting of options. Options granted under the plans have a maximum term of ten
years and are exercisable under the terms of the respective option agreements at
the market price of the common stock at the date of grant, subject to
antidilution adjustments in certain circumstances. At December 31, 1997,
expiration dates for the outstanding options ranged from December 1998 to
December 2007 and the average exercise price per share was $52.19. Payment of
the exercise price may be made in cash or in shares of Pennzoil common stock
previously owned by the optionee, valued at the then-current market value.
 
     Additional information with respect to the stock option activity during
1997, 1996, and 1995 is summarized in the following table:
 
<TABLE>
<CAPTION>
                                          1997                    1996                    1995
                                  ---------------------   ---------------------   ---------------------
                                              WTD. AVG.               WTD. AVG.               WTD. AVG.
                                              EXERCISE                EXERCISE                EXERCISE
         STOCK OPTIONS             SHARES       PRICE      SHARES       PRICE      SHARES       PRICE
         -------------            ---------   ---------   ---------   ---------   ---------   ---------
<S>                               <C>         <C>         <C>         <C>         <C>         <C>
Outstanding at beginning of
  year..........................  3,311,921    $54.20     2,587,740    $58.75     1,980,349    $63.75
  Granted.......................    827,441    $52.70       872,570    $39.64       745,272    $45.19
  Exercised.....................    786,843    $54.77        35,838    $46.76            --        --
  Lapsed........................    115,515    $43.09       112,551    $48.46       125,916    $57.24
  Expired.......................    268,048    $74.88            --        --        11,965    $57.24
                                  ---------    ------     ---------               ---------
Outstanding at end of year......  2,968,956    $52.19     3,311,921    $54.20     2,587,740    $58.75
                                  =========               =========               =========
Options exercisable at
  year-end......................  1,511,084               2,072,538               1,749,921
                                  =========               =========               =========
</TABLE>
 
     The following table summarizes information about fixed stock options
outstanding at December 31, 1997.
 
<TABLE>
<CAPTION>
                                                   OPTIONS OUTSTANDING                   OPTIONS EXERCISABLE
                                       -------------------------------------------   ---------------------------
                                          NUMBER OF         WEIGHTED      WEIGHTED      NUMBER OF       WEIGHTED
                                           OPTIONS           AVERAGE      AVERAGE        OPTIONS        AVERAGE
                                         OUTSTANDING       CONTRACTUAL    EXERCISE     EXERCISABLE      EXERCISE
      RANGE OF EXERCISE PRICES         AT DEC. 31, 1997   LIFE IN YEARS    PRICE     AT DEC. 31, 1997    PRICE
      ------------------------         ----------------   -------------   --------   ----------------   --------
<S>                                    <C>                <C>             <C>        <C>                <C>
  $39.06 -$50.00.....................     1,125,044            7.8         $41.90         467,853        $43.03
  $50.01 -$65.00.....................     1,376,381            7.4         $52.94         605,250        $53.95
  $65.01 -$80.81.....................       467,531            3.1         $74.74         437,981        $75.17
                                          ---------                        ------       ---------        ------
  $39.06 -$80.81.....................     2,968,956                        $52.19       1,511,084        $56.72
</TABLE>
 
                                      F-25
<PAGE>   67
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     In 1997, there were 51,341 units of common stock granted to selected
employees under Pennzoil's conditional stock award programs. Awards under the
programs are made in the form of units which entitle the recipient to receive,
at the end of a specified period, subject to certain conditions of continued
employment, a number of shares of Pennzoil common stock equal to the number of
units granted. At December 31, 1997, units covering 105,332 shares of Pennzoil
common stock were outstanding (compared to 88,746 shares at December 31, 1996).
In 1997, 13,210 shares of Pennzoil common stock were distributed to selected
employees upon maturity of awards granted under Pennzoil's conditional stock
award programs. During 1997, units covering 21,545 shares of Pennzoil's common
stock lapsed. These units had been granted in previous years under Pennzoil's
conditional stock award programs.
 
     Pennzoil applies Accounting Principles Board ("APB") Opinion 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for its stock-based compensation plans. APB Opinion 25 does not
require compensation costs to be recorded on options which have exercise prices
at least equal to the market price of the stock on the date of grant.
Accordingly, no compensation cost has been recognized for Pennzoil's stock-based
plans. Had compensation cost for Pennzoil's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the optional accounting method prescribed by SFAS No. 123,
"Accounting for Stock-Based Compensation," Pennzoil's net income and earnings
per share would have been reduced to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                               1997        1996        1995
                                                             --------    --------    ---------
                                                              (EXPRESSED IN THOUSANDS EXCEPT
                                                                    PER SHARE AMOUNTS)
<S>                                           <C>            <C>         <C>         <C>
Net income (loss)...........................  As reported    $175,067    $133,898    $(305,142)
                                                Pro forma    $164,989    $130,121    $(308,886)
Basic earnings (loss) per share.............  As reported    $   3.72    $   2.88    $   (6.60)
                                                Pro forma    $   3.50    $   2.80    $   (6.68)
Diluted earnings (loss) per share...........  As reported    $   3.65    $   2.86    $   (6.60)
                                                Pro forma    $   3.44    $   2.78    $   (6.68)
</TABLE>
 
     The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions for
1997, 1996 and 1995, respectively: risk-free interest rates of 6.63%, 6.25% and
7.91%; dividend yield of 1.67%, 5.45% and 6.80%; stock price volatility factor
of .2053, .2079 and .2368; and expected option lives of 10 years for each of the
respective three years. The weighted average fair value of options granted
during 1997, 1996 and 1995 was $18.74, $6.66 and $7.73 per option, respectively.
 
(8) COMMITMENTS AND CONTINGENCIES --
 
  Environmental Matters --
 
     Pennzoil is subject to certain laws and regulations relating to
environmental remediation activities associated with past operations, such as
the Comprehensive Environmental Response, Compensation, and Liability Act
("CERCLA"), the Resource Conservation and Recovery Act and similar state
statutes. In response to liabilities associated with these activities, accruals
have been established when reasonable estimates are possible. Such accruals
primarily include estimated costs associated with remediation. Pennzoil has not
used discounting in determining its accrued liabilities for environmental
remediation, and no claims for possible recovery from third party insurers or
other parties related to environmental costs have been recognized in Pennzoil's
consolidated financial statements. Pennzoil adjusts the accruals when new
remediation responsibilities are discovered and probable costs become estimable,
or when current remediation estimates must be adjusted to reflect new
information.
 
     Certain of Pennzoil's subsidiaries are involved in matters in which it has
been alleged that such subsidiaries are potentially responsible parties ("PRPs")
under CERCLA or similar state legislation with
 
                                      F-26
<PAGE>   68
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
respect to various waste disposal areas owned or operated by third parties. In
addition, certain of Pennzoil's subsidiaries are involved in other environmental
remediation activities, including the removal, inspection and replacement, as
necessary, of underground storage tanks. As of December 31, 1997 and 1996,
Pennzoil's consolidated balance sheet included accrued liabilities for
environmental remediation of $20.6 million and $30.4 million, respectively. Of
these reserves, $2.4 million and $2.1 million are reflected on the consolidated
balance sheet as current liabilities as of December 31, 1997 and 1996,
respectively, and $18.2 million and $28.3 million are reflected as other
liabilities as of December 31, 1997 and 1996, respectively. Pennzoil does not
currently believe there is a reasonable possibility of incurring additional
material costs in excess of the current accruals recognized for such
environmental remediation activities. With respect to the sites in which
Pennzoil subsidiaries are PRPs, Pennzoil's conclusion is based in large part on
(i) the availability of defenses to liability, including the availability of the
"petroleum exclusion" under CERCLA and similar state laws, and/or (ii)
Pennzoil's current belief that its share of wastes at a particular site is or
will be viewed by the Environmental Protection Agency or other PRPs as being de
minimis. As a result, Pennzoil's monetary exposure is not expected to be
material.
 
  Class Action --
 
     In April 1994, a lawsuit styled Lazy Oil, Inc. vs. Witco Corporation;
Quaker State Corporation; and Pennzoil Company, was filed in the United States
District Court for the Western District of Pennsylvania. Three other suits,
Andreassi vs. Witco Corporation; Quaker State Corporation; and Pennzoil Company
and Thomas A. Miller Oil vs. Witco Corporation; Quaker State Corporation; and
Pennzoil Company, and Wynnewood Drilling Associates v. Witco Corporation; Quaker
State Corporation; Quaker State Oil Refining Corporation; Pennzoil Company; and
Pennzoil Products Company were also filed in 1994, containing allegations
substantially identical to those in the Lazy Oil case. All four suits have been
consolidated for discovery and trial. The consolidated case, styled Lazy Oil
Co., John B. Andreassi and Thomas A. Miller Oil Co. on behalf of themselves and
others similarly situated vs. Witco Corporation; Quaker State Corporation;
Quaker State Oil Refining Corp.; Pennzoil Company and Pennzoil Products Company
is currently pending in the United States District Court for the Western
District of Pennsylvania, Erie Division. On December 31, 1997, the Court entered
an order approving a settlement, over the objection of three of the four class
representatives and certain other class members. Under the settlement, Pennzoil
paid $9.7 million plus administrative costs. The objecting class representatives
have given notice that they intend to appeal the approval of the settlement to
the United States Court of Appeals for the Third Circuit. This class action suit
brought by purchasers of "Penn Grade crude" alleged that, from 1981 to 1995, the
defendants engaged in a combination and conspiracy in unreasonable restraint of
trade in violation of Section 1 of the Sherman Act, by allegedly acting to fix,
lower, maintain and stabilize the purchase price of "Penn Grade crude" sold by
the plaintiffs and the other class members to the defendants. The plaintiffs
also alleged that the defendants have fraudulently concealed their alleged
combination and conspiracy. Plaintiffs' motion for class certification was not
opposed by defendants, and the Court certified a class of plaintiffs consisting
of all persons who sold "Penn Grade crude" to any of the defendants between 1981
and June 30, 1995. Pennzoil believes that the final outcome of these matters
will not have a material adverse effect on its consolidated financial condition
or results of operations.
 
  Ramco Dispute --
 
     In October 1995, PEPCO, Pennzoil International, Inc., Pennzoil Caspian
Corporation and Pennzoil Caspian Development Corporation filed an action, styled
Pennzoil Exploration and Production Company, et al. v. Ramco Energy Limited and
Ramco Hazar Energy Limited, in the United States District Court for the Southern
District of Texas, Houston Division, against Ramco Hazar Energy Limited,
formerly known as Ramco Energy Limited (collectively "Ramco"). The federal suit
seeks to compel Ramco to arbitrate certain disputes that have arisen between it
and the Pennzoil plaintiffs pursuant to the Federal Arbitration Act and the
 
                                      F-27
<PAGE>   69
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Convention on the Recognition and Enforcement of Foreign Arbitral Awards. The
underlying dispute involves Ramco's asserted claim to an interest in the
Karabakh prospect, an oil and gas field located in the territorial waters of the
Azerbaijan Republic in the Caspian Sea and which Pennzoil Caspian Development
Corporation, the State Oil Company of the Azerbaijan Republic and other foreign
oil companies have agreed to explore and develop. After the filing of the
federal action, the Pennzoil plaintiffs filed an Original Petition for
Declaration Relief in the 281st Judicial District Court of Harris County, Texas.
The state suit, styled Pennzoil Exploration and Production Company, et al. v.
Ramco Energy Limited and Ramco Hazar Energy Limited, which is expressly
conditioned upon a determination in the federal suit that the disputes between
the Pennzoil plaintiffs and Ramco are not subject to arbitration, seeks a
declaration that the Pennzoil plaintiffs have not breached any agreements with
Ramco, and do not owe and/or have not breached any fiduciary or other legal duty
to Ramco including, without limitation, a duty of good faith and fair dealing.
In November 1995, Ramco asserted a counterclaim in the state court action,
asserting breach of contract and breach of fiduciary duties. The counterclaim
seeks a declaratory judgment granting Ramco a participation interest in the
Karabakh prospect, compensatory damages, exemplary damages, attorneys' fees,
costs of court and other unspecified relief. The judge in the federal suit
granted in part the Pennzoil plaintiffs' motion to compel arbitration and
ordered arbitration to be held in New York, New York. The Ramco defendants have
appealed and the Pennzoil plaintiffs have cross-appealed to the United States
Court of Appeals for the Fifth Circuit. Pennzoil believes that the final outcome
of these matters will not have a material adverse effect on its consolidated
financial condition or results of operations.
 
  Texas Federal Court Employment Action --
 
     In August 1996, a lawsuit styled Donna Alexander, et al. v. Pennzoil
Company, et al., was filed in the United States District Court for the Southern
District of Texas, Houston Division. The amended complaint filed by eleven named
plaintiffs alleges wrongful and illegal discrimination by Pennzoil and
subsidiaries against African-American employees and seeks actual damages of
$75.0 million and punitive damages of three times that amount. Pennzoil
vigorously denies these allegations and will oppose plaintiffs' efforts to have
the case certified as a class action by the Court. Pennzoil believes that the
final outcome of the case will not have a material effect on its consolidated
financial condition or results of operations.
 
  Louisiana Federal Court Employment Action --
 
     In September 1997, a lawsuit styled Kenneth Epperson, et al. v. Pennzoil
Co., et al., was filed in the United States District Court for the Western
District of Louisiana, Shreveport Division. The amended complaint filed by nine
named plaintiffs alleges discriminatory employment policies and practices
against African-American and other minority employees and seeks attorneys' fees
and costs, various forms of injunctive and equitable relief, $50.0 million in
damages for back pay, front pay and emotional distress, and a minimum of three
times that amount in punitive damages. Pennzoil vigorously denies these
allegations and will oppose plaintiffs' efforts to have the case certified as a
class action by the Court. Pennzoil believes that the final outcome of the case
will not have a material effect on its consolidated financial condition or
results of operations.
 
  Stockholder Action --
 
     Pennzoil and its directors have been named as defendants in several
purported class actions filed during 1997 on behalf of the stockholders of
Pennzoil in the Chancery Court of Delaware, all of which have been consolidated
into one proceeding (the "Stockholder Action"). The complaints in the
Stockholder Action allege breach of fiduciary duty on the part of the Pennzoil
Board of Directors arising out of the proposal by Union Pacific Resources Group
Inc. ("UPR") to acquire all outstanding shares of Pennzoil common stock. The
complaints seek similar relief, including declaratory and injunctive relief
barring defendants from breaching their fiduciary duties to plaintiffs and the
putative class members and from taking steps to impede
                                      F-28
<PAGE>   70
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
any offer to acquire Pennzoil, as well as damages in an unspecified amount.
Plaintiffs have taken no action to prosecute the Stockholder Action since UPR
terminated its tender offer for Pennzoil common stock in November 1997. Pennzoil
believes that the final outcome of this case will not have a material effect on
its consolidated financial condition or results of operations.
 
  Royalty Matters --
 
     More than 30 oil companies, including Pennzoil, are involved in disputes in
which it is alleged that the oil companies and related parties have underpaid
holders of royalty interests, overriding royalty interests and working interests
in connection with the production of crude oil. The pending proceedings include
suits in federal court in Texas, Louisiana, Mississippi and Wyoming (that have
now been consolidated into one proceeding in Texas) and in state court in Texas,
Utah, Alabama and Louisiana. Certain parties to the federal litigation have
entered into a global settlement agreement, that is subject to court approval,
which would provide a conditional nationwide settlement, subject to opt-outs, of
the crude oil royalty, overriding royalty and working interest claims of all
members of the settlement class, including claims in the federal litigation and
in numerous other individual and class action cases pending throughout the
United States. Pennzoil is a party to the settlement agreement, which explicitly
refutes an admission of liability, but was entered into to avoid expensive and
protracted litigation.
 
     Also pending is a separate suit in federal court in Texas alleging that
more than 30 major oil companies, including Pennzoil, underpaid royalties to the
Untied States in connection with crude oil produced from United States owned
and/or controlled lands since 1986. The claims were filed by private litigants
under the federal False Claims Act, and after investigation, the United States
served notice of its intent to intervene as to certain defendants. The United
States has not intervened with respect to claims against Pennzoil as of the date
of this report. Pennzoil has not been served in the case, but anticipates
defending vigorously against these claims. Pennzoil believes that it has acted
reasonably and paid royalties in good faith.
 
     Pennzoil believes that the final outcome of these disputes will not have a
material adverse effect on its consolidated financial condition or results of
operations.
 
  Other --
 
     Pennzoil and its subsidiaries are involved in various other claims,
lawsuits and other proceedings relating to a wide variety of matters. While
uncertainties are inherent in the final outcome of such matters and it is
presently impossible to determine the actual costs that ultimately may be
incurred, management currently believes that the resolution of such
uncertainties and the incurrence of such costs should not have a material
adverse effect on Pennzoil's consolidated financial condition or results of
operations.
 
(9) LEASES --
 
  As Lessee --
 
     Pennzoil leases various assets and office space with lease periods of 1 to
20 years. Additionally, Jiffy Lube leases sites and equipment which are
subleased to franchisees or used in the operation of automotive fast lubrication
and fluid maintenance service centers operated by Jiffy Lube. The typical lease
period for the service centers is 20 years with escalation clauses generally
increasing the lease payments by 9% every third year, with some leases
containing renewal options generally for periods of five years. These leases,
excluding leases for land that are classified as operating leases, are accounted
for as capital leases and are capitalized using interest rates appropriate at
the inception of each lease.
 
     Certain operating and capital lease payments are contingent upon such
factors as the consumer price index or the prime interest rate with any future
changes reflected in income as accruable. The effects of these changes are not
considered material.
 
                                      F-29
<PAGE>   71
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     Total operating lease rental expenses for Pennzoil (exclusive of oil and
gas lease rentals) were $70.4 million, $68.0 million and $70.0 million for 1997,
1996 and 1995, respectively. Non-current capital lease obligations are
classified as other liabilities in the accompanying consolidated balance sheet.
 
     Future minimum commitments under noncancellable leasing arrangements as of
December 31, 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                                  AMOUNTS PAYABLE
                                                                     AS LESSEE
                                                              ------------------------
                                                              CAPITAL        OPERATING
                                                               LEASES         LEASES
                                                              --------       ---------
                                                              (EXPRESSED IN THOUSANDS)
<S>                                                           <C>            <C>
YEAR ENDING DECEMBER 31:
1998........................................................  $ 11,454       $ 61,439
1999........................................................    11,541         54,882
2000........................................................    11,675         49,917
2001........................................................    11,727         44,542
2002........................................................    11,606         42,058
Thereafter..................................................    67,717        302,953
                                                              --------       --------
Net minimum future lease payments...........................  $125,720       $555,791
                                                                             ========
Less interest...............................................    55,440
                                                              --------
Present value of net minimum lease payments at December 31,
  1997......................................................  $ 70,280
                                                              ========
</TABLE>
 
     Assets recorded under capital lease obligations of $58.2 million and $44.1
million at December 31, 1997 are classified as property, plant and equipment and
other assets, respectively, in the accompanying consolidated balance sheet.
 
  As Lessor --
 
     Pennzoil, through Jiffy Lube, owns or leases numerous service center sites
which are leased or subleased to franchisees. Buildings owned or leased that
meet the criteria for direct financing leases are carried at the gross
investment in the lease less unearned income. Unearned income is recognized in
such a manner as to produce a constant periodic rate of return on the net
investment in the direct financing lease. Any buildings leased or subleased that
do not meet the criteria for a direct financing lease and any land leased or
subleased are accounted for as operating leases. The typical lease period is 20
years and some leases contain renewal options. The franchisee is responsible for
the payment of property taxes, insurance and maintenance costs related to the
leased property. The net investment in direct financing leases is classified as
other assets in the accompanying consolidated balance sheet.
 
                                      F-30
<PAGE>   72
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
     Future minimum lease payment receivables under noncancellable leasing
arrangements as of December 31, 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                                 AMOUNTS RECEIVABLE
                                                                      AS LESSOR
                                                              -------------------------
                                                               DIRECT
                                                              FINANCING       OPERATING
                                                               LEASES          LEASES
                                                              ---------       ---------
                                                              (EXPRESSED IN THOUSANDS)
<S>                                                           <C>             <C>
YEAR ENDING DECEMBER 31:
1998........................................................   $ 4,593        $ 11,996
1999........................................................     4,651          11,542
2000........................................................     4,723          11,347
2001........................................................     4,781          10,532
2002........................................................     4,814          10,063
Thereafter..................................................    28,648          56,026
                                                               -------        --------
Net minimum future lease receipts...........................   $52,210        $111,506
                                                                              ========
Less unearned income........................................    22,626
                                                               -------
Net investment in direct financing leases at December 31,
  1997......................................................   $29,584
                                                               =======
</TABLE>
 
(10) ACQUISITIONS AND DIVESTITURES --
 
  Sale of Interest in Azeri-Chirag-Gunashli Unit-
 
     In July 1996, Pennzoil completed the sale of approximately half of its 9.82
percent interest in the Azeri-Chirag-Gunashli ("ACG") joint development unit
offshore Azerbaijan in the Caspian Sea to affiliates of Exxon Corporation
("Exxon"), affiliates of ITOCHU Oil Exploration Co. Ltd. ("ITOCHU") and
affiliates of Unocal Corporation ("Unocal"). The three companies will pay
approximately $130.0 million to Pennzoil for a 5 percent working interest in the
ACG unit (3.00 percent to Exxon, 1.47 percent to ITOCHU and 0.53 percent to
Unocal) and the right to receive 51 percent of the payments due Pennzoil for
reimbursement of costs incurred in developing a gas utilization project for the
Gunashli Field. Net cash payments to Pennzoil are scheduled in three
installments with the first installment having been made in two payments
consisting of approximately $83.0 million received at closing and another $5.0
million received in August 1996. A subsequent installment of $22.0 million was
received in January 1998 and a final payment of $20.0 million is due when the
unit reaches production of 200,000 barrels per day. Pennzoil retains a 4.8175
percent working interest in the ACG unit. As part of the transaction, the three
companies will fund all of Pennzoil's future obligations in the ACG project,
retroactive to January 1, 1996, until all such expenditures and accrued interest
are recovered from Pennzoil's share of production from the ACG unit. In
addition, Pennzoil received a net cash payment of approximately $16.0 million in
August 1996 for reimbursement of Pennzoil's costs in the ACG unit incurred from
January 1996 through July 1996. Through 1997, no gains have been recorded
related to any of the above proceeds; instead, such receipts were applied to
reduce Pennzoil's net investment in the ACG unit and gas utilization project.
 
  Joint Venture with Gulf Canada; Sale of Noncore Canadian Assets --
 
     In July 1996, Pennzoil completed two related transactions with Gulf Canada:
(i) the establishment of a joint venture for the development of natural gas
reserves in the Zama/Virgo region of northwest Alberta and (ii) the sale by
Pennzoil of its remaining, non-strategic Canadian oil and gas assets to Gulf
Canada. Including working capital and closing adjustments of $3.5 million
received in 1997, Pennzoil received net proceeds of $196.3 million from the
sale. Pennzoil recorded an after-tax gain of $19.9 million on the sale, of which
$19.1
 
                                      F-31
<PAGE>   73
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
million was due to the recognition of certain tax benefits. Reference is made to
Note 2 of Notes to Consolidated Financial Statements for additional information.
 
     In December 1997, Pennzoil sold its 50 percent interest in the Zama/Virgo
joint venture to Phillips Petroleum Company ("Phillips") and received net
proceeds of $101.9 million and recorded an after tax gain of $24.6 million. The
assets sold included 132 Bcf equivalent of proved natural gas reserves. Included
in Pennzoil's consolidated results for 1997 are revenues of $11.2 million and
operating income of $3.3 million from these properties during 1997.
 
  Sale of Vermejo Park Ranch --
 
     In September 1996, Pennzoil completed the sale of Vermejo Park Ranch to
Vermejo Park, L.L.C., a Georgia limited liability company. The ranch is located
in northern New Mexico and southern Colorado and is approximately 578,000 acres.
Pennzoil recorded a gain of $25.6 million ($41.7 million before tax) from the
sale.
 
  Acquisition of Snap Automotive Products --
 
     In November 1997, PPC acquired the marketing and distribution assets of
Snap Automotive Products, Inc. ("Snap") for $41.0 million. The acquisition was
accounted for using the purchase method of accounting, and the results of
operations of Snap subsequent to November 1997 have been included in Pennzoil's
consolidated statement of income.
 
  Acquisition of Total Action Automotive Products --
 
     In October 1997, PPC acquired the assets of Total Action Automotive
Products ("TAAP") for $3.5 million. The acquisition was accounted for using the
purchase method of accounting, and the results of operations of TAAP subsequent
to October 1997 have been included in Pennzoil's consolidated statement of
income.
 
  Acquisition of Viscosity Oil --
 
     In September 1995, PPC acquired the assets of the Viscosity Oil division
("Viscosity Oil") of Case Corporation for $33.6 million. The acquisition was
accounted for using the purchase method of accounting, and the results of
operations of Viscosity Oil subsequent to September 1995 have been included in
Pennzoil's consolidated statement of income.
 
  Sale of PennUnion --
 
     In June 1997, Pennzoil sold its natural gas marketing subsidiary, PennUnion
Energy Services, L.L.C., to Columbia and recorded a pretax charge of $10.0
million.
 
(11) MAJOR CUSTOMERS --
 
     In June 1997, Pennzoil agreed to sell most of its U.S. natural gas
production at market prices to Columbia under a contract that terminates on June
30, 2001. Columbia's purchases accounted for 9% of Pennzoil's revenues for 1997.
 
(12) SEGMENT FINANCIAL INFORMATION --
 
     Information with respect to revenues, operating income and other data by
industry segment is presented in Item 1, Business and Item 2, Properties of this
Annual Report on Form 10-K.
 
                                      F-32
<PAGE>   74
 
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
        SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED
QUARTERLY RESULTS --
 
<TABLE>
<CAPTION>
                                                                                INCOME
                                                                                BEFORE
                                                                 OPERATING   EXTRAORDINARY     NET
                                                     REVENUES    INCOME(1)       ITEMS        INCOME
                                                    ----------   ---------   -------------   --------
                                                                (EXPRESSED IN THOUSANDS)
<S>                                                 <C>          <C>         <C>             <C>
1997
--------------------------------------------------
First Quarter.....................................  $  649,000   $140,388      $ 57,551      $ 57,551
Second Quarter....................................     648,357     98,044        23,877        23,877
Third Quarter.....................................     658,939    121,965        37,824        35,249
Fourth Quarter....................................     698,008    199,107        61,003        58,390
                                                    ----------   --------      --------      --------
                                                    $2,654,304   $559,504      $180,255      $175,067
                                                    ==========   ========      ========      ========
1996
--------------------------------------------------
First Quarter.....................................  $  587,341   $ 83,763      $ 15,769      $ 15,769
Second Quarter....................................     636,580     96,890        24,543        24,543
Third Quarter.....................................     653,688    127,935        65,125        65,125
Fourth Quarter....................................     609,237     93,113        28,461        28,461
                                                    ----------   --------      --------      --------
                                                    $2,486,846   $401,701      $133,898      $133,898
                                                    ==========   ========      ========      ========
</TABLE>
 
<TABLE>
<CAPTION>
                                                          BASIC EARNINGS
                                                            PER SHARE
                                                      ----------------------
                                                         BEFORE                   BEFORE
                                                      EXTRAORDINARY    NET     EXTRAORDINARY    NET
                                                          ITEMS       INCOME       ITEMS       INCOME
                                                      -------------   ------   -------------   ------
A4DILUTED EARNINGS PER SHARE
<S>                                                   <C>             <C>      <C>             <C>
1997
----------------------------------------------------
First Quarter.......................................      $1.23       $1.23        $1.21       $1.21
Second Quarter......................................       0.51        0.51         0.50        0.50
Third Quarter.......................................       0.80        0.75         0.78        0.73
Fourth Quarter......................................       1.29        1.23         1.27        1.21
                                                          -----       -----        -----       -----
                                                          $3.83       $3.72        $3.76       $3.65
                                                          =====       =====        =====       =====
1996
----------------------------------------------------
First Quarter.......................................      $0.34       $0.34        $0.34       $0.34
Second Quarter......................................       0.53        0.53         0.53        0.53
Third Quarter.......................................       1.40        1.40         1.39        1.39
Fourth Quarter......................................       0.61        0.61         0.60        0.60
                                                          -----       -----        -----       -----
                                                          $2.88       $2.88        $2.86       $2.86
                                                          =====       =====        =====       =====
</TABLE>
 
---------------
 
(1) Operating income is defined as net revenues less costs and operating
    expenses.
 
OIL AND GAS INFORMATION
 
  Estimated Quantities of Proved Oil and Gas Reserves
 
     Presented on the following page are Pennzoil's estimated net proved oil and
gas reserves as of December 31, 1997, 1996 and 1995. Reserves in the United
States are located onshore in all the main producing states (except Alaska) and
offshore California, Louisiana and Texas. International reserves are located in
Azerbaijan, Canada and Venezuela.
 
                                      F-33
<PAGE>   75
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
  SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
 
OIL AND GAS INFORMATION (CONTINUED)
 
     The estimates of proved oil and gas reserves have been prepared by Ryder
Scott Company Petroleum Engineers ("Ryder Scott") and Outtrim Szabo Associates,
Ltd. ("Outtrim Szabo") and are based on data supplied by Pennzoil. The reports
of Ryder Scott and Outtrim Szabo, which include a description of the basis used
in preparing the estimated reserves, are included as exhibits to Pennzoil's
Annual Reports on Form 10-K for the respective years. Oil includes crude oil,
condensate and natural gas liquids.
 
<TABLE>
<CAPTION>
                                              1997                             1996                             1995
                                 ------------------------------   ------------------------------   ------------------------------
                                 UNITED                           UNITED                           UNITED
      PROVED OIL RESERVES        STATES   INTERNATIONAL   TOTAL   STATES   INTERNATIONAL   TOTAL   STATES   INTERNATIONAL   TOTAL
     (MILLIONS OF BARRELS)       ------   -------------   -----   ------   -------------   -----   ------   -------------   -----
<S>                              <C>      <C>             <C>     <C>      <C>             <C>     <C>      <C>             <C>
Proved developed and
  undeveloped
  reserves(1)
  Beginning of year............    165           22         187     175           26         201     205           15         220
    Revisions of previous
      estimates
      -- economics.............     (7)           4          (3)      8            1           9       4           --           4
      -- performance and
         other.................      6           --           6      --            3           3     (18)          (2)        (20)
    Extensions and
      discoveries..............     13           30          43      12           13          25      21            3          24
    Estimated production.......    (20)          --         (20)    (20)          (1)        (21)    (22)          (2)        (24)
    Purchases of minerals in
      place(2).................     --           20          20       7            1           8       8           15          23
    Sales of minerals in
      place(2)(3)..............     (5)          (1)         (6)    (17)         (21)        (38)    (23)          (3)        (26)
                                 -----        -----       -----   -----        -----       -----   -----        -----       -----
  End of year..................    152           75         227     165           22         187     175           26         201
                                 =====        =====       =====   =====        =====       =====   =====        =====       =====
Proved developed reserves
  Beginning of year............    141            1         142     151           11         162     176           15         191
  End of year..................    128           14         142     141            1         142     151           11         162
 
PROVED NATURAL GAS RESERVES
(BILLIONS OF CUBIC FEET)
Proved developed and
  undeveloped reserves(1)(4)
  Beginning of year............  1,187           90       1,277   1,255          214       1,469   1,341          204       1,545
    Revisions of previous
      estimates
      -- economics.............    (24)          --         (24)     19           --          19      21           (3)         18
      -- performance and
         other.................     (2)          28          26      20           22          42      33            8          41
    Extensions and
      discoveries..............    104           23         127     145           29         174     212           30         242
    Estimated production.......   (206)          (8)       (214)   (202)         (17)       (219)   (218)         (20)       (238)
    Purchases of minerals in
      place(2).................     --           --          --       8           28          36      26            6          32
    Sales of minerals in
      place(2)(3)..............     (5)        (128)       (133)    (58)        (186)       (244)   (160)         (11)       (171)
                                 -----        -----       -----   -----        -----       -----   -----        -----       -----
End of year....................  1,054            5       1,059   1,187           90       1,277   1,255          214       1,469
                                 =====        =====       =====   =====        =====       =====   =====        =====       =====
Proved developed reserves(4)
  Beginning of year............  1,070           90       1,160   1,132          202       1,334   1,242          192       1,434
  End of year..................    964            4         968   1,070           90       1,160   1,132          202       1,334
</TABLE>
 
---------------
 
(1) Included in 1997 reserves are 21 million barrels of crude oil, condensate,
    and natural gas liquids (14 million barrels of which are proved developed
    reserves) and 4 Bcf of proved developed natural gas reserves attributable to
    three operating service agreements in Venezuela between Petroleos de
    Venezuela, S.A. and Pennzoil Venezuela Corporation, S.A., an indirect wholly
    owned subsidiary of Pennzoil. Under these agreements, all mineral rights are
    owned by the government of Venezuela. Reference is made to "Management's
    Discussion and Analysis of Financial Condition and Results of
    Operations -- Oil and Gas" for additional information.
 
(2) There were no asset exchanges reported as purchases and sales of minerals in
    place for 1997. Purchases and sales of minerals in place for 1996 include 7
    million barrels of oil and 33 Bcf of natural gas and 12 million barrels of
    oil and 37 Bcf of natural gas, respectively, associated with asset
    exchanges. Purchases and sales of minerals in place for 1995 include 2
    million barrels of oil and 16 Bcf of natural gas and 2 million barrels of
    oil and 54 Bcf of natural gas, respectively, associated with asset
    exchanges.
 
(3) In July 1996, Pennzoil sold its non-strategic Canadian oil and gas assets to
    Gulf Canada. In December 1997, Pennzoil sold its remaining Canadian oil and
    gas assets, a 50 percent interest in a natural gas joint venture in the
    Zama/Virgo region of northwest Alberta, to Phillips. Reference is made to
    Note 10 and to "Management's Discussion and Analysis of Financial Condition
    and Results of Operations -- Oil and Gas" for additional information on
    sales of oil and gas reserves.
 
(4) United States natural gas reserves for 1997, 1996 and 1995 exclude 178 Bcf,
    182 Bcf and 156 Bcf, respectively, of carbon dioxide gas for sale or use in
    company operations.
 
                                      F-34
<PAGE>   76
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
  SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
 
OIL AND GAS INFORMATION (CONTINUED)
 
  Capitalized Costs and Costs Incurred Relating to Oil and Gas Producing
Activities
 
     The following table shows the aggregate capitalized costs related to oil
and gas producing activities and related accumulated depreciation, depletion and
amortization and valuation allowances.
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31
                                                              -------------------
                                                               1997        1996
                                                              -------    --------
                                                                 (EXPRESSED IN
                                                                   MILLIONS)
<S>                                                           <C>        <C>
Capitalized costs
  Proved properties.........................................  $ 4,345    $  4,128
  Unproved properties.......................................      260         260
                                                              -------    --------
                                                                4,605       4,388
  Accumulated depreciation, depletion and amortization......   (2,923)     (2,839)
                                                              -------    --------
                                                              $ 1,682    $  1,549
                                                              =======    ========
</TABLE>
 
     The following table shows costs incurred in oil and gas producing
activities (whether charged to expense or capitalized).
 
<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31
                               ------------------------------------------------------------------------------------------
                                           1997                           1996                           1995
                               ----------------------------   ----------------------------   ----------------------------
                               UNITED     INTER-              UNITED     INTER-              UNITED     INTER-
                               STATES   NATIONAL(1)   TOTAL   STATES   NATIONAL(1)   TOTAL   STATES   NATIONAL(1)   TOTAL
                               ------   -----------   -----   ------   -----------   -----   ------   -----------   -----
                                                                (EXPRESSED IN MILLIONS)
<S>                            <C>      <C>           <C>     <C>      <C>           <C>     <C>      <C>           <C>
Costs incurred in oil and gas
  producing activities
     Property acquisition
       Unproved..............   $  9       $  2       $ 11     $ 10       $ (7)      $  3     $  6       $  6       $ 12
       Proved................      1         28         29        2          1          3       22          4         26
     Exploration.............     73         44        117      104         27        131       86         41        127
     Development.............    262         24        286      181         27        208      139         22        161
                                ----       ----       ----     ----       ----       ----     ----       ----       ----
                                $345       $ 98       $443     $297       $ 48       $345     $253       $ 73       $326
                                ====       ====       ====     ====       ====       ====     ====       ====       ====
</TABLE>
 
---------------
 
 (1) Total costs incurred (reimbursed) during 1997, 1996 and 1995 include $19.0
     million, ($4.0) million and $13.0 million, respectively, related to
     Pennzoil's Azerbaijan activities. Net reimbursements for unproved property
     acquisition related to the gas utilization project in Azerbaijan during
     1997, 1996 and 1995 totaled approximately $4.0 million, $7.0 million and
     $36.0 million, respectively.
 
                                      F-35
<PAGE>   77
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
  SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
 
OIL AND GAS INFORMATION (CONTINUED)
 
  Results of Operations From Oil and Gas Producing Activities
 
     This information is similar to the disclosures set forth in the "Industry
Segment Financial Information" set forth on pages 1 and 2 herein but differs in
several respects as to the level of detail, geographic presentation and income
taxes. Income taxes were determined by applying the applicable statutory rates
to pretax income with adjustment for tax credits and other allowances. Income
tax provisions involved certain allocations among geographic areas based on
management's assessment of the principal factors giving rise to the tax
obligation.
 
<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31
                            -------------------------------------------------------------------------------------------------
                                         1997                             1996                             1995
                            ------------------------------   ------------------------------   -------------------------------
                            UNITED                           UNITED                           UNITED
                            STATES   INTERNATIONAL   TOTAL   STATES   INTERNATIONAL   TOTAL   STATES   INTERNATIONAL   TOTAL
                            ------   -------------   -----   ------   -------------   -----   ------   -------------   ------
                                                                 (EXPRESSED IN MILLIONS)
<S>                         <C>      <C>             <C>     <C>      <C>             <C>     <C>      <C>             <C>
Sales
  Outside customers.......   $523        $ 77        $600     $373        $ 41        $414    $ 543        $ 58        $  601
  Other segments, at
    market................    338          --         338      342          --         342      131          --           131
                             ----        ----        ----     ----        ----        ----    -----        ----        ------
                              861          77         938      715          41         756      674          58           732
                             ----        ----        ----     ----        ----        ----    -----        ----        ------
Costs and expenses
  Production costs
    Operating expenses....    156          10         166      148          13         161      168          20           188
    Production, severance
      and property
      taxes...............     33          --          33       35          --          35       34          --            34
  Technical support and
    other(1)..............     36          18          54       38          21          59       86          21           107
  Exploration expenses,
    including dry holes...     53          15          68       31          13          44       20          20            40
  Depreciation, depletion,
    amortization and
    impairment
    provisions(2).........    216           5         221      195          22         217      564          86           650
                             ----        ----        ----     ----        ----        ----    -----        ----        ------
                              494          48         542      447          69         516      872         147         1,019
                             ----        ----        ----     ----        ----        ----    -----        ----        ------
Pretax results of
  operations..............    367          29         396      268         (28)        240     (198)        (89)         (287)
Income tax expense
  (benefit)...............    128          31         159       97         (29)         68      (73)        (27)         (100)
                             ----        ----        ----     ----        ----        ----    -----        ----        ------
Results of operations.....   $239        $ (2)       $237     $171        $  1        $172    $(125)       $(62)       $ (187)
                             ====        ====        ====     ====        ====        ====    =====        ====        ======
</TABLE>
 
---------------
 
(1) International technical support and other during 1997, 1996 and 1995
    includes approximately $7.0 million, $13.0 million and $4.0 million,
    respectively, related to Pennzoil's Azerbaijan activities.
 
(2) Effective July 1, 1995, Pennzoil adopted the requirements of SFAS No. 121,
    "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
    Assets to Be Disposed Of." As a result, Pennzoil recorded a pretax charge of
    $378.9 million as of July 1, 1995, to reflect the impairment of long-lived
    oil and gas assets. Reference is made to "Management's Discussion and
    Analysis of Financial Condition and Results of Operations -- Oil and Gas"
    and Note 1 of Notes to Consolidated Financial Statements for additional
    information.
 
                                      F-36
<PAGE>   78
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
  SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
 
OIL AND GAS INFORMATION (CONTINUED)
 
 Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil
 and Gas Reserves (Standardized Measure)
 
     The Standardized Measure is determined on a basis which presumes that
year-end economic and operating conditions will continue over the periods during
which year-end proved reserves would be produced. Neither the effects of future
inflation nor expected future changes in technology and operating practices have
been considered.
 
     The Standardized Measure is determined as the excess of future cash inflows
from proved reserves less future costs of producing and developing the reserves,
future income taxes and a discount factor. Future cash inflows represent the
revenues that would be received from production of year-end proved reserve
quantities assuming the future production would be sold at year-end prices plus
any fixed and determinable future escalations (but not escalations based on
inflation) of natural gas prices provided by existing contracts. As a result of
the continued volatility in oil and natural gas markets, future prices received
from oil, condensate and natural gas sales may be higher or lower than current
levels.
 
     Future production costs include the estimated expenditures related to
production of the proved reserves plus any production taxes without
consideration of inflation. Future development costs include the estimated costs
of drilling development wells and installation of production facilities, plus
the net costs associated with dismantlement and abandonment of wells and
production platforms, assuming year-end costs continue without inflation. Future
income taxes were determined by applying current legislated statutory rates to
the excess of (a) future cash inflows, less future production and development
costs, over (b) the tax basis in the properties involved plus existing net
operating loss carryforwards. Tax credits are considered in the computation of
future income tax expenses. The discount was determined by applying a discount
rate of 10% per year to the annual future net cash flows.
 
                                      F-37
<PAGE>   79
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
  SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
 
OIL AND GAS INFORMATION (CONTINUED)
 
     The Standardized Measure does not purport to be an estimate of the fair
market value of Pennzoil's proved reserves. An estimate of fair market value
would also take into account, among other things, the expected recovery of
reserves in excess of proved reserves, anticipated changes in future prices and
costs and a discount factor more representative of the time value of money and
the risks inherent in producing oil and gas. In the opinion of Pennzoil's
management, the estimated fair value of Pennzoil's oil and gas properties is in
excess of the amounts set forth below.
 
<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31
                                  ---------------------------------------------------------------------
                                                1997                                1996
                                  ---------------------------------   ---------------------------------
                                  UNITED                              UNITED
                                  STATES    INTERNATIONAL    TOTAL    STATES    INTERNATIONAL    TOTAL
                                  -------   -------------   -------   -------   -------------   -------
                                                         (EXPRESSED IN MILLIONS)
<S>                               <C>       <C>             <C>       <C>       <C>             <C>
Future cash inflows.............  $ 4,847       $ 961       $ 5,808   $ 8,270       $ 688       $ 8,958
Future production costs.........   (1,621)       (305)       (1,926)   (2,055)       (212)       (2,267)
Future development costs(1).....     (458)        (86)         (544)     (445)        (45)         (490)
                                  -------       -----       -------   -------       -----       -------
Future net cash flows before
  income taxes..................    2,768         570         3,338     5,770         431         6,201
10% annual discount for
  estimated timing of net cash
  flows before income taxes.....     (977)       (308)       (1,285)   (2,073)       (161)       (2,234)
                                  -------       -----       -------   -------       -----       -------
Present value of future net cash
  flows before income taxes.....    1,791         262         2,053     3,697         270         3,967
Future income tax expense
  discounted at 10%(2)..........     (433)       (134)         (567)   (1,090)       (122)       (1,212)
                                  -------       -----       -------   -------       -----       -------
Standardized measure of
  discounted future net cash
  flows relating to proved oil
  and gas reserves..............  $ 1,358       $ 128       $ 1,486   $ 2,607       $ 148       $ 2,755
                                  =======       =====       =======   =======       =====       =======
</TABLE>
 
---------------
 
(1) Includes future dismantlement and abandonment costs, net of salvage values.
 
(2) Future income taxes before discount were $710.0 million (U.S.) and $232.0
    million (foreign) and $1,755.0 million (U.S.) and $183.0 million (foreign)
    for 1997 and 1996, respectively.
 
                                      F-38
<PAGE>   80
                       PENNZOIL COMPANY AND SUBSIDIARIES
 
  SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
 
OIL AND GAS INFORMATION (CONTINUED)
 
  Changes in the Standardized Measure
 
     The following table sets forth the principal elements of the changes in the
Standardized Measure for the years presented. All amounts are reflected on a
discounted basis.
 
<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31
                                                              -----------------------------
                                                               1997        1996       1995
                                                              -------     ------     ------
                                                                 (EXPRESSED IN MILLIONS)
<S>                                                           <C>         <C>        <C>
Standardized measure -- beginning of period.................  $ 2,755     $2,065     $1,534
Revisions --
  Net changes in prices, net of production costs............   (1,707)     1,152        740
  Revisions of quantity estimates...........................       17        165        (88)
  Changes in estimated future development costs.............     (160)       (62)       (46)
  Accretion of discount.....................................      397        276        195
  Changes in production rates (timing) and other............     (302)      (189)      (111)
                                                              -------     ------     ------
          Net Revisions.....................................   (1,755)     1,342        690
                                                              -------     ------     ------
Extensions, discoveries and improved recovery, net of future
  production and development costs..........................      366        651        550
Sales and transfers, net of production costs................     (657)      (674)      (469)
Development costs incurred during the period that reduced
  future development costs..................................      222        145        117
Net change in estimated future income taxes.................      645       (512)      (276)
Purchases of reserves in place..............................        1         42         68
Sales of reserves in place..................................      (91)      (304)      (149)
                                                              -------     ------     ------
Standardized measure -- end of period.......................  $ 1,486     $2,755     $2,065
                                                              =======     ======     ======
</TABLE>
 
                                      F-39
<PAGE>   81
 
                                 EXHIBIT INDEX
 
<TABLE>
<S>                       <C>
          12              -- Computation of Ratio of Earnings to Fixed Charges for the
                             years ended December 31, 1997, 1996, 1995, 1994 and 1993.
          21              -- List of Subsidiaries of Pennzoil Company.
          23(a)           -- Consent of Arthur Andersen LLP.
          23(b)           -- Consent of Ryder Scott Company Petroleum Engineers.
          24              -- Powers of Attorney.
          27              -- Financial Data Schedule.
          99(a)           -- Summary of Reserve Report of Ryder Scott Company
                             Petroleum Engineers as of December 31, 1997 relating to
                             oil and gas reserves.
</TABLE>