SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-KSB

         ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

                          Commission File Number 0-6580

                                [GRAPHIC OMITTED]






                            PEASE OIL AND GAS COMPANY
           (Name of small business issuer as specified in its charter)


               Nevada                                   87-0285520
   (State or other jurisdiction of                    (I.R.S. Employer
    incorporation or organization)                    Identification Number)
                          751 Horizon Court, Suite 203
                         Grand Junction, Colorado 81506
                    (Address of principal executive offices)
                                 (970) 245-5917
                (Issuer's telephone number, including area code)
Securities  registered  pursuant  to  Section  12(b) of the Act:  None
Securities  registered  pursuant to Section 12(g) of the Act:  Common Stock
(Par Value $.10 Per Share) Common Stock  Purchase  Warrants  (Expire August
13, 1999) Title of Class

    Indicate by check mark whether the issuer (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such  shorter  period  that the  registrant  was  required  to file such
reports),  and (2) has been subject to such filing  requirements for the past 90
days. Yes X No____

    The issuer's revenues for its most recent fiscal year were $2,916,982.

    As of March 23,1999 the issuer had  1,688,718  shares of its $0.10 par value
Common  Stock  issued  and  outstanding.  Based upon the  closing  sale price of
$0.4688 per share on March 23, 1999,  the  aggregate  market value of the common
stock, the Registrant's only class of voting stock,  held by non-affiliates  was
$774,044.

    Transitional Small Business Issuer Disclosure Format    Yes ____   No   X  






<PAGE>



                                TABLE OF CONTENTS

PART I                                                                 Page

ITEM 1.      BUSINESS. . . . . . . . . . . . . . . . . . . . . .         1
                      History and Overview . . . . . . . . . . .         1
                      Recent Developments. . . . . . . . . . . .         1
                      Business Strategy. . . . . . . . . . . . .         1
                      Operations. . . . . . . . . . . . . . . . .        2 
                      Competition. . . . . . . . . . . . . . . .         2
                      Markets. . . . . . . . . . . . . . . . . .         3
                      Regulations. . . . . . . . . . . . . . . .         3
                      Operational Hazards and Insurance. . . . .         5
                      Administration. . . . . . . . . . . . . . .        5 
ITEM 2.      PROPERTIES. . . . . . . . . . . . . . . . . . . . .         5
                      Principal Oil and Gas Interests. . . . . .         5
                      Gulf Coast Properties and Prospects. . . .         6
                      Rocky Mountain Properties. . . . . . . . .         7
                      Title to Properties. . . . . . . . . . . .         7
                      Estimated Proved Reserves. . . . . . . . .         7
                      Net Quantities of Oil and Gas Produced             8
                      Drilling Activity. . . . . . . . . . . . .         9
ITEM 3.      LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . .        9 
ITEM 4.      SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.        9

PART II

ITEM 5.      MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
             STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . . . .    9 
                      Market Information. . . . . . . . . . . . . . .    9 
                      Stockholders. . . . . . . . . . . . . . . . . .    10 
                      Dividends. . . . . . . . . . . . . . . . . . .     10 
                      Recent Sales of Unregistered Securities    . .     10 
ITEM 6.      MANAGEMENT'S DISCUSSION AND ANALYSIS. . . . . . . . . .     12
                      Liquidity and Capital Resources . . . . . . . . . .12
                               Results of Operations. . . . . . . . .    14
                               Other Matters. . . . . . . . . . . . .    20
ITEM 7.      FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . . .     22 
ITEM 8.      CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
             AND FINANCIAL DISCLOSURE. . . . . . . . . . . . . . . . . . 41

PART III

ITEM 9.      DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
             COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. . . . . .41
ITEM 10.     EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . . . .43
ITEM 11.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 45
ITEM 12.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . . . . . 46

PART IV

ITEM 13.     EXHIBITS AND REPORTS ON FORM 8-K. . . . . . . . . . . . . . 48



<PAGE>



                                     PART I

ITEM 1 - BUSINESS

HISTORY AND OVERVIEW

Pease Oil and Gas Company  ("Company"),  was incorporated  under the laws of the
state of Nevada on September 11, 1968 to  principally  engage in the oil and gas
acquisition, development and production business. Prior to 1993, the Company was
a relatively small operator  conducting  business  primarily in Western Colorado
and  Eastern  Utah.  However,  in  August,  1993,  the  Company  acquired  Skaer
Enterprises,  Inc., a Colorado  corporation,  its related businesses and related
oil and gas properties  (collectively  "Skaer").  Skaer was privately  owned and
operated,  and was considered one of the largest private independent oil and gas
companies in Colorado,  operating exclusively in the Denver-Julesburg Basin ("DJ
Basin") of northeastern  Colorado.  This acquisition  substantially expanded the
Company's  operations by increasing  the number of wells  operated and expanding
its  services to include oil field  services,  oil field  supplies,  natural gas
processing  and natural  gas  marketing.  Skaer was  acquired  for  $12,200,000,
including  $300,000 of various costs  associated  with the  acquisition.  In the
years following the acquisition, the Company invested several million dollars in
an  effort to  exploit  the  assets  acquired  from  Skaer  and,  unfortunately,
experienced marginal success.  Recognizing the limited upside potential of these
assets,  the Company  initiated  efforts in 1996 and 1997 to expand its resource
base through the acquisition  and exploration of properties  located in the Gulf
Coast region of Southern  Louisiana  and Texas.  During  1998,  the Company sold
substantially  all of its Rocky  Mountain  oil and gas assets,  including  those
acquired from Skaer, for approximately  $3.2 million.  Accordingly,  the Company
now maintains only non-operated  interests in 3 core areas in Southern Louisiana
and Texas.  These assets are  discussed  more  thoroughly  later in this section
under the caption "Properties and Prospects".

RECENT DEVELOPMENTS:

Restructuring and Pursuit of Merger Candidate

In response to the  historically  poor  financial  results and the depressed oil
commodity markets,  the Company initiated several steps to improve the corporate
governance and direction of the Company. These include:

    1.)      During the fourth quarter of 1998, the Board of Directors  accepted
             Mr. Willard H. Pease,  Jr.'s  resignation as President and CEO. Mr.
             Pease no longer works for the Company.  Mr. Patrick J. Duncan,  who
             has served the Company as CFO since 1994, was elected  President by
             the Board as President on an interim basis.

    2.)      During  1998  the  Company's  Board  of  Directors  established  an
             Executive Committee  currently  consisting of three voting members:
             Patrick J. Duncan, the Company's  President/CFO,  Steve A. Antry, a
             Director and consultant to the Company, and William F. Warnick, the
             Company's  Chairman  of  the  Board  of  Directors.  The  Executive
             Committee is designed to function as an ad hoc CEO, and manage,  on
             a  committee  basis,  the  significant  aspects  of  the  Company's
             business.  The  Executive  Committee has broad powers to act in the
             absence of the full Board of Directors.

    3.)      The Company is aggressively  pursuing a potential merger candidate.
             To  assist  in  this  venture,  the  Company  engaged  San  Jacinto
             Securities,  Inc.  ("SJS"),  an investment  banking firm located in
             Dallas, Texas. Although no formal agreements have been reached, the
             Company is engaged in an ongoing  dialogue  with several  potential
             candidates. However, no assurance can be given at this time whether
             or  not  a  merger   transaction   will  eventually   occur,   what
             consideration  may be offered to the Company in such a transaction,
             or whether an offer to merge will be accepted by the Company or its
             shareholders.

BUSINESS STRATEGY

The Company generally participates as a minority,  non-operating interest holder
in oil and natural gas drilling  projects with industry  partners.  Although the
Company  does  not  currently  operate  properties  or  originate  any of  these
exploration   prospects,   it  actively   participates   in  the  evaluation  of
opportunities presented by its industry

                                       -1-

<PAGE>



partners,  both  at the  time  of  its  initial  investment  in a  prospect  and
thereafter  during the  evaluation  and  selection  of drilling  locations.  The
Company's  current and future  business  strategy  will focus on  expanding  its
reserve  base and  future  cash  flows by  cultivating  the prior  acquisitions,
nurturing  the  strategic  alliances  and  exploiting  the existing  exploration
opportunities in the Gulf Coast Region.  Specifically,  the Company will attempt
to execute  this  strategy by focusing  its  immediate  exploration  efforts and
resources on what the Company  considers its three core areas in the Gulf Coast,
which are:

             1.       The East Bayou Sorrel Field in Iberville Parish,Louisiana,
                      operated by National Energy Group, Inc.;

             2.       The Maurice Field in Fayetteville Parish, Louisiana, 
                      operated by Amerada Hess; and

             3.       The Formosa, Texana and Ganado 3-D prospects, encompassing
                      130,000  acres  in  and  around  Jackson  County,   Texas,
                      operated by Parallel Petroleum.

In  addition,  the  Company  intends to  emphasize  the  following  precepts  in
implementing its strategy:

o   Make  disciplined  use of advanced  exploration  technologies -- such as 3-D
    seismic and computer-aided exploration ("CAEX") technology;
o   Mitigate  exploration risk by spreading investment over a significant number
    of prospects to improve the probability of success;
o   Developing alliances with experienced and competent technical personnel that
    have been trained by major oil  companies  and can  demonstrate a successful
    track record;
o   Reinvesting  future  operating  cash  flows  into  development  drilling  
    and recompletion activities; o Pursue the acquisition of properties and/or 
    potential merger candidates that could build upon and enhance the Company's
    existing asset base;

The Company recognizes that the ability to implement its business  strategies is
largely  dependent  on the ability to find a suitable  merger  candidate  and/or
raise additional debt or equity capital to fund future acquisition, exploration,
drilling  and  development  activities.  The  Company's  Capital  resources  are
discussed  more  thoroughly in Part II, Item 6, in  Management's  Discussion and
Analysis.

OPERATIONS

As of December 31, 1998, the Company had varying ownership interests in 10 gross
(.76 net) non-operated wells located in Southern Louisiana and Texas.

The  following  table  presents  oil  and gas  reserve  information  within  the
Company's major operating areas as of December 31, 1998:
                                                  Net Proved Reserves 
         REGION                              Bbls         Mcf        BOE (6:1)
         Gulf Coast -
          principally in S. Louisiana       275,00       1,368,000   503,000

At the present  time,  oil and natural gas  prospects  pursued in the Gulf Coast
region by the Company will be as a non- operator.

COMPETITION

The oil and gas  industry  is highly  competitive  in many  respects,  including
identification  of attractive oil and gas properties for  acquisition,  drilling
and  development,  securing  financing  for such  activities  and  obtaining the
necessary equipment and personnel to conduct such operations and activities.  In
seeking  suitable  opportunities,  the Company  competes  with a number of other
companies, including large oil and gas companies and other independent operators
with greater financial resources and, in some cases, with more experience.  Many
other oil and gas companies in the industry have financial resources, personnel,
and facilities  substantially greater than those of the Company. There can be no
assurance that the Company will be able to compete  effectively with these other
entities.

                                       -2-

<PAGE>



MARKETS

Overview - The three principal  products currently produced and marketed for the
Company (through its operating  partners) are crude oil, natural gas and natural
gas liquids  ("NGL's").  The Company does not currently  use  commodity  futures
contracts and price swaps in the sales or marketing of its natural gas and crude
oil.

Crude Oil - Oil produced from the Company's properties is generally  transported
by truck,  barge or  pipeline  to  unaffiliated  third-party  purchasers  at the
prevailing field price (the "posted price"). Currently, the primary purchaser of
the Company's  proportionate share of crude oil is Plains Marketing,  L.P. which
buys  approximately  80% of the  Company's  current  crude oil  production.  The
contracts are month-to-month and subject to change. The market for the Company's
crude oil is  competitive  and  therefore  the Company does not believe that the
loss of one of its primary  purchasers  would have a material  adverse effect on
the Company's  business because other  arrangements  could be made to market the
Company's  crude oil  products.  The  Company  does not  anticipate  problems in
selling future oil production  since  purchases are made based on current market
conditions  and  pricing.  Oil prices are subject to  volatility  due to several
factors beyond the Company's control including:  political turmoil; domestic and
foreign  production  levels;  OPEC's ability to adhere to production quotas; and
possible governmental control or regulation.

Natural Gas - The Company sells, through its operating partners, the natural gas
production  at the  wellhead  to various  pipeline  purchasers  or  natural  gas
marketing companies.  The operators sell the natural gas and pass the revenue on
to the Company once it is received.  Currently,  National Energy Group, Inc. and
Amerada Hess Corporation sell and distribute  substantially all of the Company's
natural gas and  corresponding  revenues.  The wellhead  contracts  have various
terms and conditions,  including contract duration. Under each wellhead contract
the purchaser is generally responsible for gathering,  transporting,  processing
and selling  the natural gas and natural gas liquids and the Company  receives a
net price at the wellhead.

REGULATIONS

General - All aspects of the oil and gas industry are  extensively  regulated by
federal,  state,  and local  governments  in all areas in which the  Company has
operations.  The following  discussion of regulation of the oil and gas industry
is necessarily brief and is not intended to constitute a complete  discussion of
the various  statutes,  rules,  regulations or governmental  orders to which the
Company's operations may be subject.

Price  Controls on Liquid  Hydrocarbons  - There are  currently no federal price
controls  on liquid  hydrocarbons  (including  oil,  natural gas and natural gas
liquids).  As a result,  the Company sells oil produced  from its  properties at
unregulated market prices which historically have been volatile.

Federal  Regulation of Sales and  Transportation  of Natural Gas - Historically,
the  transportation  and sale of natural gas in  interstate  commerce  have been
regulated pursuant to the Natural Gas Act ("NGA"), the Natural Gas Policy Act of
1978 ("NGPA") and regulations promulgated  thereunder.  The Natural Gas Wellhead
Decontrol Act of 1989  eliminated all regulation of wellhead gas sales effective
January 1, 1993. As a result, the Company's gas sales are no longer regulated.

The transportation and resale in interstate commerce of natural gas produced and
sold by the Company  continues to be subject to regulation by the Federal Energy
Regulatory  Commission  ("FERC") under the NGA. The transportation and resale of
natural gas transported and resold within the state of its production is usually
regulated by the state involved.  Although  federal and state  regulation of the
transportation  and resale of natural gas produced by the Company currently does
not have any material direct impact on the Company,  such regulation does have a
material  impact on the market for the Company's  natural gas production and the
price the Company  receives for its natural gas  production.  Adverse changes in
the regulation  affecting the Company's gas markets could have a material impact
on the Company.

Commencing  in the  mid-1980's  and  continuing  until  the  present,  the  FERC
promulgated  several orders  designed to correct market  distortions and to make
gas markets  more  flexible  and  competitive.  These orders have had a profound
influence  on natural  gas  markets in the United  States and have,  among other
things, increased the importance of interstate gas transportation and encouraged
development of a large spot market for gas.

                                       -3-

<PAGE>



In addition to FERC regulation of interstate  pipelines  under the NGA,  various
state  commissions  also  regulate  the rates and  services of  pipelines  whose
operations are purely intrastate in nature.  To the extent intrastate  pipelines
elect to transport gas in interstate  commerce  under certain  provisions of the
NGPA,  those  transactions are subject to limited FERC regulation under the NGPA
and may ultimately effect the price of natural gas sold by the Company.

There are many legislative proposals pending in Congress and in the legislatures
of various states that, if enacted,  might significantly  affect the oil and gas
industry.  The Company is not able to predict what will be enacted and thus what
effect, if any, such proposals would ultimately have on the Company.

State and  Local  Regulation  of  Drilling  and  Production  - State  regulatory
authorities  have  established  rules  and  regulations  requiring  permits  for
drilling, bonds for drilling,  reclamation and plugging operations,  limitations
on spacing and pooling of wells, and reports concerning operations,  among other
matters.  The states in which the  Company has oil and gas  interests  also have
statutes and regulations  governing a number of  environmental  and conservation
matters,  including the  unitization  and pooling of oil and gas  properties and
establishment  of  maximum  rates  of  production  from oil and gas  wells.  For
example, each well in the East Bayou Sorrell prospect is currently restricted to
approximately  1,400  Bbls  of oil  per  day  because  of  such  state  mandated
restriction.  A few states also prorate  production to the market demand for oil
and gas.  These  statutes  and  regulations  limit the rate at which oil and gas
could   otherwise  be  produced  or  the  prices  obtained  from  the  Company's
properties.

Also in recent years,  pressure has increased in states in which the Company has
been active to mandate compensation to surface owners for the effects of oil and
gas  operations  and to increase  regulation  of the oil and gas industry at the
local government  level. Such local regulation in general is aimed at increasing
the  involvement  of  local  governments  in  the  permitting  of  oil  and  gas
operations,  requiring  additional  restrictions or conditions on the conduct of
operations  to reduce the impact on the  surrounding  community  and  increasing
financial assurance requirements. Accordingly, such regulation has the potential
to delay and increase the cost, or even in some cases to prohibit entirely,  the
conduct of the Company's drilling activities.

Environmental  Regulations  -  The  production,  handling,   transportation  and
disposal of oil and gas and by-products are subject to regulation under federal,
state and local environmental laws. In most instances, the applicable regulatory
requirements  relate  to  water  and  air  pollution  control  and  solid  waste
management   measures  or  to  restrictions  of  operations  in  environmentally
sensitive  areas. In connection with its  acquisitions,  the Company attempts to
perform environmental assessments.  However,  environmental assessments have not
been performed on all of the Company's  properties.  To date,  expenditures  for
environmental  control  facilities and for remediation have not been significant
in relation to the Company's  results of operations.  However,  it is reasonably
likely that the trend in environmental legislation and regulations will continue
towards  stricter  standards and may result in  significant  future costs to the
Company. For instance,  efforts have been made in Congress to amend the Resource
Conservation  and Recovery Act to reclassify  oil and gas  production  wastes as
"Hazardous  Waste,"  the  effect  of which  would  be to  further  regulate  the
handling, transportation and disposal of such waste. If such legislation were to
pass, it could have a significant  adverse impact on the operating  costs of the
Company, as well as the oil and gas industry in general.

The Company believes that its operations comply with all applicable  legislation
and  regulations  in all  material  respects,  and  that the  existence  of such
regulations  has had no more  restrictive  effect  on the  Company's  method  of
operations  than other similar  companies in the industry.  Although the Company
does not believe its business operations presently impair environmental quality,
compliance with federal,  state and local regulations which have been enacted or
adopted regulating the discharge of materials into the environment could have an
adverse effect upon the capital expenditures,  earnings and competitive position
of the  Company,  the extent of which the Company  now is unable to assess.  The
Company  is not aware of any  environmental  degradation  which  exists,  or the
obligation  for  remediation  of which  would arise  under  applicable  state or
federal   environmental   laws.  The  Company  does  not  maintain  a  fund  for
environmental  or other similar costs.  Any such costs or expenses would be paid
by the Company out of operating capital.






                                       -4-

<PAGE>



OPERATIONAL HAZARDS AND INSURANCE

The  Company's  operations  are  subject to the usual  hazards  incident  to the
drilling and production of oil and gas, such as blowouts, cratering, explosions,
uncontrollable flows of oil, gas or well fluids, fires,  pollution,  releases of
toxic gas and other  environmental  hazards and risks.  These  hazards can cause
personal  injury and loss of life,  severe damage to and destruction of property
and equipment, pollution or environmental damage and suspension of operations.

The Company  maintains  insurance of various types to cover its operations.  The
Company's  insurance  does not cover every  potential risk  associated  with the
drilling  and  production  of  oil  and  gas.  In  particular,  coverage  is not
obtainable  for certain  types of  environmental  hazards.  The  occurrence of a
significant  adverse  event,  the  risks  of  which  are not  fully  covered  by
insurance,  could  have a material  adverse  effect on the  Company's  financial
condition and results of  operations.  Moreover,  no assurance can be given that
the Company will be able to maintain  adequate  insurance in the future at rates
it considers reasonable.

ADMINISTRATION

Office Facilities - The Company currently rents  approximately 4,000 square feet
in an office facility in Grand Junction,  Colorado owned by an unrelated  party.
The rental rate is $32,232 per year through June 30, 2000.

Employees  - As of March 23,  1999,  the Company had 6 full time and 1 part time
employees,  none of whom is covered by a collective  bargaining  agreement.  The
Company considers its relations with its employees satisfactory.

ITEM 2 - PROPERTIES

PRINCIPAL OIL AND GAS INTERESTS

Developed Acreage - The Company's  producing  properties as of December 31, 1998
are located in the following areas shown in the table below:
<TABLE>

<CAPTION>
                                          OIL                 GAS
                                    Gross      Net(2)   Gross     Net(2)Developed Acreage
Fields ..............   State       Wells(1)   Wells    Wells(1)  Wells Gross     Net(2)
---------------------   ---------   --------   ------   -----     ---   -----     -----

<S>                                    <C>      <C>      <C>      <C>    <C>        <C>
East Bayou Sorrel ...   Louisiana       3       .27      --       --     368        33
South Lake Arthur ...   Louisiana       --       --       1      .21     349        73
Maurice .............   Louisiana       --       --       3      .21     196        14
Austin Bayou ........   Texas           --       --       3      .07     505        11
                                    --------   ------   -----     ---   -----     -----
Grand Total .........                   3       .27       7      .49   1,418       131
                                    ========   ======   =====     ===   =====     =====
</TABLE>

Footnotes

    (1)      Wells which produce both gas and oil in commercial  quantities  are
             classified as "oil" wells for disclosure purposes.
    (2)      "Net"  wells  and "net"  acres  refer to the  Company's  fractional
             working  interests  multiplied  by the number of wells or number of
             acres.

Substantially all of the Company's  producing oil and gas properties are located
on leases held by the Company for as long as production is maintained.




                                       -5-

<PAGE>



Undeveloped  Acreage - The Company's  gross and net working  interests in leased
(or lease  options  in areas  where 3-D  seismic  is or has been  conducted)  on
undeveloped  acreage  in the Gulf Coast  Region as of  December  31,  1998 is as
follows:

                                                  Undeveloped Acreage
Prospect Description            State            Gross             Net  

East Bayou Sorrel               Louisiana        1,110            111(1)
Maurice Prospect                Louisiana          843             76(2)
Parallel 3-D Program-Leases     Texas           18,797          2,350(2)
Parallel 3-D Program-Options    Texas           13,938          1,742(3)
Austin Bayou                    Texas              694             15(2)
                                               ----------      ---------
    Totals:                                     35,382          4,294
                                               ========          =======

(1)  Substantially all of these leases will expire in 2001 unless production has
been obtained.  (2) Substantially all of these leases will expire in 2000 unless
production has been obtained. (3) Substantially all of these leases/options will
expire in 1999 unless production has been obtained.

GULF COAST PROPERTIES AND PROSPECTS 

Overview - The U.S. Gulf Coast, although it has been actively explored,  remains
a prolific area with excellent  upside  potential for  exploration due to modern
proprietary 3-D seismic  surveys.  The Company  believes that the combination of
technology and the  availability  of leases to drill make this an opportune time
for an aggressive  exploration  program.  The three  significant areas where the
Company currently participates as a non-operating, minority interest partner are
described below.

East Bayou Sorrel - During 1997, the Company acquired a 10% working interest and
a 7.125% after prospect payout leasehold interest in the 1996 discovery of a new
oil and gas  field,  East  Bayou  Sorrel  Field  located  in  Iberville  Parish,
Louisiana.  Subsequently, this field has been explored with other well tests and
a 3-D seismic  survey was  completed  in February  1998.  As of the date of this
report,  the production from the three producing wells in this field  represents
approximately  50%  of  the  Company's  net  daily  production  (per  BOE).  The
production  is being  drawn from the Cibb haz 2 and Cibb haz 3 sand  formations.
Preliminary results of the 3-D survey appear to confirm the producing reservoirs
at East Bayou  Sorrel,  and a number of potential  undrilled  targets  contained
within the 3-D volume.  Additional development drilling of the East Bayou Sorrel
Field,  as well as exploratory  drilling based on images from the 3-D seismic is
expected to be conducted sometime in the future.

Maurice  Field - In 1997,  the Company  joined Davis  Petroleum and Amerada Hess
Corporation  ("AHC")  to drill a  discovery  well at  Maurice  Field,  Vermilion
Parish,  Louisiana.  Since  then two  additional  wells  have been  successfully
drilled  and  completed.  A  3-D  survey  is  currently  being  interpreted  and
additional  wells are  expected  to be drilled  during 1999 and 2000 in order to
develop the field. The three producing wells  representing  approximately 50% of
the  Company's net daily  production  (per BOE) and are being drawn from the Bol
mex, Marg tex and Camerina sand  formations.  The Company's  working interest in
this field ranges from 6.9% to 8.4%

Formosa,  Texana and Ganado 3-D Exploration Prospects - During 1997, the Company
secured a 12.5% working  interest in three  specific  on-shore  upper Gulf Coast
exploration projects located in and around Jackson County, Texas. The 3-D survey
will cover over 200 square miles (130,000  acres) in and around Jackson  County,
Texas. The surveys on the three projects are completed and the data is currently
being  interpreted and integrated  with known geology.  The Company expects that
there may be as many as 50 to 60 wells  ultimately  drilled  on these  prospects
based on our  preliminary  evaluation  of the 3-D  seismic  and  local  geology.
Parallel Petroleum of Midland, Texas is the designated operator for these wells.

The subject lands lie in close  proximity to productive oil and gas fields which
produce from the Miocene/Frio intervals. The subject acreage block is bounded by
fields that have  cumulatively  produced  in excess of 2 trillion  cubic feet of
natural gas and 500 million barrels of oil.


                                       -6-

<PAGE>



Within the project  areas,  there is an  extremely  high  potential  exploration
opportunity  that is being  defined  with the use of 3-D  seismic.  The  Jackson
County area has proven to be ideal for 3-D seismic as  faulting  and  structures
are easily  identified and many  stratigraphic  reservoirs  exhibit  hydrocarbon
indicators from the shallowest Miocene sands,  throughout the Frio, and into the
Vicksburg and Yegua  intervals.  The Formosa  Grande  Prospect Area has numerous
regional  down-to-the-coast  faults that are easily identified at the top of the
Frio, but also has deep seated  faulting that does not exhibit  displacement  at
the  shallower  horizons.  Very often,  these deep faults do create  hydrocarbon
traps. Most fields in this trend area exhibit multiple stacked reservoirs.

A Greta level structure map exhibits numerous large four-way closures, primarily
downthrown to regional growth  faulting.  These large  structures  have, for the
most part, been exploited,  some as early as the 1930s and 1940s. Although it is
not  readily  apparent  in  regional  mapping,  much of the Frio  production  is
stratigraphic  in  nature,  that is,  trapped in  channel  sands  that  traverse
structures,  or in sands  that  "pinch  out" up onto the  flanks of these  large
structures.  Significant  reserves  may remain in  similar  traps,  further  off
structure than has been developed to date.  Such traps should be readily defined
with 3-D seismic data.

The Company's  project area appears to be an excellent area to apply 3-D seismic
technology to exploit  reserves that have been passed over in existing fields as
well as to discover new reserves in deeper pools and undrained fault segments in
compartmentalized  fields.  Drilling will commence on these prospects during the
first quarter of 1999.

ROCKY MOUNTAIN PROPERTIES

During  1998,  the Company  sold all of its Rocky  Mountain  oil and gas assets.
Accordingly,  the Company's  only remaining  reserves,  revenues and future cash
flows are now limited to those oil and gas properties  located in the Gulf Coast
region.

TITLE TO PROPERTIES

As is  customary  in  the  oil  and  gas  industry,  only  a  perfunctory  title
examination  is  conducted  at the time oil and gas leases are  acquired  by the
Company.  Prior to the  commencement  of drilling  operations,  a thorough title
examination is conducted.  The Company  believes that title to its properties is
good and defensible in accordance with standards  generally  accepted in the oil
and gas industry,  subject to such exceptions,  which in the opinion of counsel,
are not so material as to detract substantially from the property economics.  In
addition,  some prospects may be burdened by customary royalty interests,  liens
incident to oil and gas  operations  and liens for taxes and other  governmental
charges as well as encumbrances,  easements and  restrictions.  The Company does
not believe that any of these burdens will materially  interfere with the use of
the property.

ESTIMATED PROVED RESERVES

The oil and gas reserve and reserve  value  information  is included in Part II,
Item 7 at footnote 10 of the consolidated financial statements,  titled "Oil and
Gas Producing Activities". This information is prepared pursuant to Statement of
Financial  Accounting  Standards  No.  69,  which  includes  the  estimated  net
quantities of the Company's  "proved" oil and gas reserves and the  standardized
measure of discounted  future net cash flows.  The 1997 reserve  information for
the  Rocky  Mountains  is based  upon an  engineering  evaluation  by  McCartney
Engineering,  Inc. The estimated proved reserves  information for the Gulf Coast
for both 1997 and 1998 is based upon an  engineering  evaluation by  Netherland,
Sewell  &   Associates,   Inc.   The   estimated   proved   reserves   represent
forward-looking  statements and should be read in connection with the disclosure
on  forward-looking  statements  included  herein  under Item 6 in  Managements'
Discussion and Analysis.

The Company has not filed any reports  containing oil and gas reserve  estimates
with any federal  authority  or agency  other than the  Securities  and Exchange
Commission  and the  Department  of  Energy.  There were no  differences  in the
reserve estimates reported to these two agencies.

All of the Company's oil and gas reserves are located in the Continental  United
States. The Table below sets forth the Company's estimated  quantities of proved
reserves, and the present value of estimated future net revenues

                                       -7-

<PAGE>



discounted by 10 percent per year using prices being  received by the Company at
the end of each of the last two fiscal years on a non-escalated basis.

<TABLE>
<CAPTION>
                                                           December 31,                                      
                                                   1998                      1997 
                                                --------  ----------------------------------------
                                                            Gulf Coast    Rocky Mtns       Total
<S>                                              <C>           <C>           <C>         <C>      
Estimated Proved Oil Reserves (Bbls) ......      275,000       308,000       777,000     1,085,000
Estimated Proved Gas Reserves (Mcf) .......    1,368,000     1,360,000     3,175,000     4,535,000
Estimated Future Net Revenues .............  $ 4,054,000   $ 5,796,000   $ 8,575,000   $14,371,000
Present Value of Estimated Future
    Net Revenues ..........................  $ 2,951,000   $ 4,460,000   $ 5,218,000   $ 9,678,000
Prices used to determined reserves:
     Oil (per Bbl) ........................                $     10.15   $     17.11   $     16.15
     Gas (per Mcf) ........................                $      2.43   $      2.61   $      1.78
</TABLE>

NET QUANTITIES OF OIL AND GAS PRODUCED

The Company's net oil and gas  production for each of the last two years (all of
which was from properties located in the United States) was as follows:

                                     Year Ended December 31,           
                                      1998               1997     
                                 ----------       --------------
             Oil (Bbls)
                 Gulf Coast         58,000             43,000
                 Rocky Mtns.        51,000             80,000
                                 ---------            --------
                      Total        109,000            123,000
                                   =======            =======
             Gas (Mcf)
                 Gulf Coast        320,000             91,000
                 Rocky Mtns        230,000            392,000
                                   -------            -------
                      Total        550,000            483,000
                                   =======            =======

The average sales price per barrel of oil and Mcf of gas, and average production
costs per barrel of oil equivalent ("BOE") excluding depreciation, depletion and
amortization were as follows:

                                                                   Average
   Year Ended                       Average Sales Prices         Production
  December 31            Oil (Bbls)    Gas (Mcf)     Per BOE    Cost Per BOE
  ------------          -----------   -----------    --------   ------------
      1998:
        Gulf Coast     $   12.19         $  2.22     $  12.73     $  2.17
        Rocky Mtns     $   12.11         $  1.39     $  10.50     $  9.04
       Combined Avg.   $   12.16         $  1.87     $  11.74     $  5.22
      1997:
        Gulf Coast      $  19.15         $  2.94     $  18.76     $  2.84
        Rocky Mtns      $  18.75         $  1.46     $  14.25     $  9.09
       Combined Avg.    $  18.89         $  1.74     $  15.54     $  7.29



                                       -8-

<PAGE>



DRILLING ACTIVITY

The following  table  summarizes  the Company's oil and gas drilling  activities
that were completed  during the last two fiscal years, all of which were located
in the continental United States:

                                        Year Ended December 31,       
                                      1998                       1997     
                                 ---------------           ---------------
    Wells Drilled                Gross      Net              Gross    Net
         Exploratory
             Oil                     1      .09                1     .10
             Gas                     4      .14                1     .08
             Non-productive          3      .32                6     .77  
                                 ------   ------             -----   -------
             Total                   8      .55                8     .95  
                                 ======   ======             ======  =======
         Development
             Oil                     -        -                 -      -
             Gas                     -        -                 -      -
             Non-productive          -        -                 -      -    
                                 -------- -------            ------  --------
             Total                   -        -                 -      -    
                                 ======== ========           ======  ========

During the first quarter of 1999, the Company  drilled a successful  development
well in the Maurice Prospect in which the Company owns a 6.9% working interest.
This well is not included in the above schedule.

ITEM 3 - LEGAL PROCEEDINGS

The  Company  may from time to time be  involved  in various  claims,  lawsuits,
disputes with third parties, actions involving allegations of discrimination, or
breach of contract incidental to the operation of its business.  At December 31,
1998 and as of the date of this  report,  the  Company  was not  involved in any
litigation  which it  believes  could have a  materially  adverse  effect on its
financial condition or results of operations.

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

No matter was submitted to a vote of the Company's  Security  holders during the
fourth quarter ended December 31, 1998.

                                     Part II

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

(a) Market  Information - On November 16, 1998, the Company's Board of Directors
approved a reverse  stock split of 1:10. No  shareholder  approval was necessary
and the Company proceeded with the administrative procedures necessary to effect
the reverse split. Accordingly,  the reverse split was effective at the close of
business on  December  1, 1998.  The  Company's  common  stock was traded on the
Nasdaq SmallCap  electronic  market system under the symbol "WPOG" until January
14, 1999 at which time the stock was  delisted by Nasdaq for failure to maintain
an average bid price of at least $1.00 per share. The stock is now listed on the
over-the-counter market on the NASD Bulletin Board (OTC BB). It is believed that
this delisting will have a material  negative impact on the Company's ability to
raise additional  equity capital.  In addition,  it may impair the ability for a
stockholder  to liquidate any  holdings.  The Company also has warrants that are
publicly traded on the Nasdaq "pink sheets" under the symbol "WPOGW".  There are
approximately 3 million warrants outstanding, each of which give the holders the
right to purchase  one share of the  Company's  common stock for ten warrants at
$60.00 per share. These warrants expire on August 13, 1999.

Bid  Quotations  - The  following  table  shows  the  range  of high and low bid
quotations for each  quarterly  period since January 1, 1997, as reported by the
National  Association of Securities  Dealers,  Inc. (such  quotations  represent
prices  between  dealers  and do  not  include  retail  markups,  markdowns,  or
commissions and do not necessarily represent actual transactions.):

                                       -9-

<PAGE>



                                 Bid Prices of
                                 Common Stock
       Quarter Ended             High      Low  
       March 31, 1997            35 5/8    25
       June 30, 1997             38 7/16   21 7/8
       September 30, 1997        30 5/8    24 3/8
       December 31, 1997         35        15

       March 31, 1998            19 11/16   8 7/16
       June 30, 1998             13 3/4     6 9/16
       September 30, 1998        7 1/2      1 1/4
       December 31, 1998         3 1/8     13/16

On December 1, 1998 the Company  effected a 1:10 reverse stock split.  The above
quotations have been retroactively adjusted to reflect the reverse split.

(b)  Stockholders - As of March 22,1999 the Company had at least 1,348 round lot
shareholders  holding 1,179,649 shares (or  approximately  70%) of the Company's
Common Stock.

(c ) Dividends - The Company has not paid cash  dividends on its Common Stock in
the past and does not anticipate doing so in the foreseeable future. The Company
is precluded from paying  dividends on its Common Stock so long as any dividends
on the Preferred Stock are in arrears.

Under the Company's  Articles of  Incorporation,  as amended  ("Articles"),  the
Board of Directors has the power,  without  further action by the holders of the
Common Stock,  to designate the relative rights and preferences of the Company's
Preferred Stock,  when and if issued.  Such rights and preferences could include
preferences as to liquidation,  redemption and conversion rights, voting rights,
dividends or other preferences,  any of which may be dilutive of the interest of
the  holders of the  Common  Stock.  The Board  previously  designated  Series A
Cumulative  Convertible Preferred Stock, none of which is outstanding and all of
which has been retired.

The  Company  has  designated  145,300  shares of Series B  Preferred,  of which
113,333  shares were issued on December 31,  1997,  and the balance are reserved
for  issuance  of payment in kind  ("PIK")  dividends  on  outstanding  Series B
Preferred.  The Series B Preferred  is entitled to a dividend of $2.50 per year,
payable  calendar  quarterly,  which amount may be paid,  at the election of the
Company, in cash or in kind. If a dividend is paid in kind, each share of Series
B Preferred  issued shall be valued at $50. The  dividend is  cumulative  to the
date of payment. The shares of Series B Preferred have a liquidation  preference
equal to $50 plus any unpaid  dividends.  The Series B Preferred was issued in a
private  placement and is not publicly  traded nor does the Company expect these
securities to be publicly traded in the future.

Additional  classes of Preferred Stock may be designated and issued from time to
time in one or more  series  with  such  designations,  voting  powers  or other
preferences  and relative  other rights or  qualifications  as are determined by
resolution  of the Board of Directors of the Company.  The issuance of Preferred
Stock may have the effect of delaying or  preventing  a change in control of the
Company  and may have an adverse  effect on the rights of the  holders of Common
Stock.

(d) Recent Sales of  Unregistered  Securities - The Company  issued and sold the
following  securities without  registration under the Securities Act of 1933, as
amended  ("Securities  Act"), during the fiscal year ended December 31, 1998 and
through the date of this report (all amounts have been retroactively adjusted to
reflect the 1:10 reverse stock split in December 1998):

    1.       On  February 2, 1998,  the Company  issued 125 shares of its common
             stock upon exercise of outstanding stock purchase warrants at $7.50
             per  share  for  total  proceeds  of  $938  to  the  Company.   The
             Certificates  representing  the shares  issued upon exercise bear a
             restrictive legend prohibiting  transfer without registration under
             the  Securities  Act  or  the  availability  of an  exemption  from
             registration and "stop transfer"  instructions  have been issued to
             the transfer agent. These warrants were issued in February

                                      -10-

<PAGE>



             1996 in connection with the Consulting  Agreement entered into with
             Beta  Capital  Group,  Inc.  The shares of common stock issued upon
             exercise of the warrants were  registered  for resale by the holder
             in Registration No. 333-19589.
    2.       On May 20, 1998 the Company issued 3,003 shares of its common stock
             upon  conversion  of 497 shares of Series B  Preferred  Stock.  The
             Certificates  representing the shares issued upon conversion bear a
             restrictive legend prohibiting  transfer without registration under
             the  Securities  Act  or  the  availability  of an  exemption  from
             registration.  The shares issued upon conversion were registered by
             the  Company  for  resale  by  the  holders  in  Registration   No.
             333-44305.   The  Company  relied  upon  Section   3(a)(9)  of  the
             Securities Act of 1933, as amended,  in claiming exemption from the
             registration requirements of the Securities Act for issuance of the
             securities upon conversion.
    3.       On July 17,  1998 the  Company  issued  6,354  shares of its common
             stock upon  conversion  of 500 shares of Series B Preferred  Stock.
             The  Certificates  representing  the shares issued upon  conversion
             bear a restrictive legend prohibiting transfer without registration
             under the Securities Act or the  availability  of an exemption from
             registration.  The shares issued upon conversion were registered by
             the  Company  for  resale  by  the  holders  in  Registration   No.
             333-44305.   The  Company  relied  upon  Section   3(a)(9)  of  the
             Securities Act of 1933, as amended,  in claiming exemption from the
             registration requirements of the Securities Act for issuance of the
             securities upon conversion.
    4.       On August 18, 1998 the Company  issued  12,227 shares of its common
             stock upon  conversion  of 500 shares of Series B Preferred  Stock.
             The  Certificates  representing  the shares issued upon  conversion
             bear a restrictive legend prohibiting transfer without registration
             under the Securities Act or the  availability  of an exemption from
             registration.  The shares issued upon conversion were registered by
             the  Company  for  resale  by  the  holders  in  Registration   No.
             333-44305.   The  Company  relied  upon  Section   3(a)(9)  of  the
             Securities Act of 1933, as amended,  in claiming exemption from the
             registration requirements of the Securities Act for issuance of the
             securities upon conversion.
    5.       On January 28, 1999 the Company  issued 16,209 shares of its common
             stock upon  conversion  of 200 shares of Series B Preferred  Stock.
             The  Certificates  representing  the shares issued upon  conversion
             bear a restrictive legend prohibiting transfer without registration
             under the Securities Act or the  availability  of an exemption from
             registration.  The shares issued upon conversion were registered by
             the  Company  for  resale  by  the  holders  in  Registration   No.
             333-44305.   The  Company  relied  upon  Section   3(a)(9)  of  the
             Securities Act of 1933, as amended,  in claiming exemption from the
             registration requirements of the Securities Act for issuance of the
             securities upon conversion.
    6.       On March 1, 1999 the  Company  issued  30,759  shares of its common
             stock upon  conversion  of 233 shares of Series B Preferred  Stock.
             The  Certificates  representing  the shares issued upon  conversion
             bear a restrictive legend prohibiting transfer without registration
             under the Securities Act or the  availability  of an exemption from
             registration.  The shares issued upon conversion were registered by
             the  Company  for  resale  by  the  holders  in  Registration   No.
             333-44305.   The  Company  relied  upon  Section   3(a)(9)  of  the
             Securities Act of 1933, as amended,  in claiming exemption from the
             registration requirements of the Securities Act for issuance of the
             securities upon conversion.
    7.       On March 23, 1999 the Company  issued  40,668  shares of its common
             stock upon  conversion  of 250 shares of Series B Preferred  Stock.
             The  Certificates  representing  the shares issued upon  conversion
             bear a restrictive legend prohibiting transfer without registration
             under the Securities Act or the  availability  of an exemption from
             registration.  The shares issued upon conversion were registered by
             the  Company  for  resale  by  the  holders  in  Registration   No.
             333-44305.   The  Company  relied  upon  Section   3(a)(9)  of  the
             Securities Act of 1933, as amended,  in claiming exemption from the
             registration requirements of the Securities Act for issuance of the
             securities upon conversion.

In connection with the issuance of the above noted securities,  the Company also
relied upon Section 4(2) of the  Securities  Act in claiming  exemption  for the
registration  requirement of the Securities  Act. All of the persons to whom the
securities were issued had full information  concerning the business and affairs
of the Company and acquired  the shares for  investment  purposes.  Certificates
representing the securities  issued bear a restrictive  legend and stop transfer
instructions have been entered prohibiting  transfer of the securities except in
compliance with applicable securities law.

On March 23, 1999 there were  outstanding  106,153  shares of Series B Preferred
Stock held by 10  holders.  The Series B  Preferred  Stock is  convertible  into
common stock at a ratio dependent upon the reported closing market

                                      -11-

<PAGE>



price at the time of  conversion.  Based on such  price on March 23,  1999,  the
outstanding   Series  B  Preferred  Stock  would  have  been   convertible  into
approximately  15.1 million  shares.  The  Company's  Articles of  Incorporation
authorize a total of up to 4,000,000  shares of common stock, of which 1,688,718
were issued and  outstanding on March 23, 1999. The Company is obligated to take
appropriate  action and seek  stockholder  approval  to  increase  the number of
authorized  common stock at the next meeting of stockholders to provide for this
contingency.

ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS

Liquidity and Capital Resources
At December 31, 1998, the Company's cash balance was $1,049,582  with a positive
working capital position of $1,101,888, compared to a cash balance of $6,547,804
and a positive  working capital position of $5,295,474 of December 31, 1997. The
change in the Company's cash balance is summarized as follows:

    Cash balance at December 31, 1997                             $   6,547,804
    Sources of Cash:
      Proceeds from the sale of property and equipment                3,823,286
       Proceeds from long term debt                                      32,610
      Proceeds from the redemption of certificate of deposit             25,000
      Proceeds from the exercise of common stock warrants                   938
             Total Sources of Cash                                    3,881,834
                                                                 --------------
    Uses of Cash:
      Capital Expenditures for property, plant and equipment         (7,396,842)
       Repayment of long term debt                                   (1,207,805)
      Cash used in  operating  activities                              (211,453)
      Series B  Preferred  Stock dividends                             (210,941)
      Purchase and retirement of Series B Preferred  Stock             (206,250)
      Costs  associated  with the sale of  Series B  Preferred  Stock  (146,765)
                                                                ----------------
             Total uses of cash                                      (9,380,056)
                                                                 ---------------
      Cash balance at December 31, 1998                          $    1,049,582
                                                                 ==============

During 1998, the Company generated  approximately  $3.4 million from the sale of
existing assets consisting principally of its Rocky Mountain assets (certain oil
and gas properties,  the gas plant, service and supply businesses).  The Company
used  approximately  $1.2  million of these  proceeds  to pay down the  existing
convertible   debentures  in  connection  with  the  mortgage   release  of  the
corresponding oil and gas properties. The Company is currently under contract to
sell all of its remaining Rocky Mountain assets for $100,000 and is scheduled to
close in April, 1999. The proceeds will be available for working capital.

As noted,  most of the  Company's  uses of cash  were  deployed  in  exploration
activities  in the Gulf  Coast.  The costs  incurred in 1998 are  summarized  as
follows  (the  difference  between the total  incurred,  as  illustrated  in the
following  table,  and the total amount paid in 1998,  relates to the changes in
accounts  payable at December  31, 1997 and  December  31, 1998 as well as other
non-cash amounts capitalized in the full cost pool).

<TABLE>
<CAPTION>
                                                                      Total         %       
Exploration Activities -
<S>                                                                 <C>            <C>
    Land, Geologic and Geophysical Costs on Seismic Programs        2,976,835      43%
    Exploratory Dry Holes                                           1,539,464      22%
    Discovery wells                                                   937,273      14%
    Capitalized Interest Cost                                         852,980      12%
    Other Exploration Costs                                           492,830       7%  
                                                               ---------------  --------
        Total Exploration Activities                                6,799,382      98%
Workovers or Recompletions of Rocky Mountain properties                13,468       *     
        Total Oil and Gas properties                                6,812,850    
Service and Other Field Equipment                                      62,014       1%
Office Equipment                                                        5,159       *     
                                                               ---------------  --------
        Total Capital Expenditures                                  6,880,023     100%  
                                                               ==============   ========
* less than 1%
</TABLE>


                                      -12-

<PAGE>



The total costs incurred for exploration  activities of $6,799,382 is summarized
below by program operator:

<TABLE>
<CAPTION>
                                                                        PROGRAM OPERATOR
                                             NEGX        Parallel           AHC         Other         Total             %

Category:
<S>                                       <C>           <C>           <C>           <C>           <C>                   <C>
  Exploratory Dry Holes ................  $1,350,585    $  188,879    $     --      $     --      $1,539,464            23%
  Land, G&G Costs on Seismic
     Programs ..........................   1,283,521     1,557,698       135,616          --       2,976,835            44%
  Discovery wells ......................     362,254          --         575,019          --         937,273            14%
  Capitalized Interest .................     272,954       571,497         8,529          --         852,980            12%
  Other Exploration Costs ..............        --            --            --         492,830       492,830             7%
                                                        ----------    ----------    ----------    ----------    ----------
         Total Exploration Costs .......  $3,269,314    $2,318,074    $  719,164    $  492,830    $6,799,382           100%
                                                        ==========    ==========    ==========    ==========    ==========
         % of Exploration Costs ........          48%           34%           11%            7%          100%
</TABLE>

In 1999 the Company will focus its future activities on cultivating its existing
exploration  program in the Gulf Coast  region,  principally  in  Louisiana  and
Texas.  This  activity  will focus on what the Company  considers its three core
areas in the Gulf Coast, which are:

             1.       The East Bayou Sorrel  Area in Iberville Parish,Louisiana,
                      operated by National Energy Group, Inc. ("NEGX");

             2.       The Maurice Prospect in Fayetteville Parish, Louisiana, 
                      operated by Amerada Hess Corporation ("AHC"); and

             3.       The Formosa,  Texas and Ganado 3-D prospects  encompassing
                      130,000  acres  in  and  around  Jackson  County,   Texas,
                      operated by Parallel Petroleum ("Parallel").

In December 1998 National Energy Group,  Inc. filed an Involuntary  Petition for
an Order and Relief under Chapter 11 of Title 11 of the United States Bankruptcy
Code in United  States  Bankruptcy  Court for the  Northern  District  of Texas,
Dallas  Division.  As  operator of the East Bayou  Sorrel  field,  which  yields
approximately 50% of the Company's current  production,  the bankruptcy petition
might adversely  effect future  development or operation of the field;  however,
the Company  does not expect that its interest in the field or  production  from
currently existing wells will be affected.

The  Company  does have an  unsecured  claim in the  bankruptcy  proceeding  for
various  amounts which the Company  believes were paid to National Energy Group,
Inc. as operator in connection with the drilling of existing  wells.  Collection
of these  amounts  may be  delayed  or may not  occur,  pending  disposition  of
National  Energy Group,  Inc.'s  reorganization  proceeding.  The total claim is
approximately  $80,000.  However,  no amount has been  recorded in the financial
statements as of December 31, 1998.

Under the existing commitments related to these three areas, the following table
summarizes the range of expected capital requirements for 1999 by program:
                                             Estimated Investment (in millions)
Operator                                        Minimum           Maximum

East Bayou Sorrel Area                        $       -         $    400,000
Formosa, Texana, and Ganado Prospects            200,000             500,000
Maurice Prospect                                 350,000             600,000
                                              -----------        -------------
      Total                                   $  550,000         $ 1,500,000 
                                              ==========          ============

Given the range of  potential  capital  requirements  for  1999,  the  Company's
current and anticipated  cash position may not be sufficient to cover the future
working capital and exploration obligations. The Company has vigorously explored
various  alternatives  for  additional  sources of  capital.  However,  with the
hyper-dilutive potential of the outstanding Series B Preferred Stock (should the
holders elect to convert into common stock), the Company has

                                      -13-

<PAGE>



been  unable to  attract  additional  equity  capital.  For  example,  using the
Company's  recent  common  stock price of $0.47,  and  applying  the  applicable
discount of 25%, should all the holders of the Series B Preferred Stock elect to
convert into common stock, the Company would be required to issue  approximately
15.1 million shares in the conversion. This would represent approximately 90% of
the then outstanding common shares.  Presently, the Company has only 4.0 million
shares  of  common  stock  authorized  and is  obligated  under the terms of the
Preferred  Stock Agreement to seek approval of additional  authorized  shares at
its next meeting of  stockholders  to allow for conversion  should the Preferred
stockholders  choose to do so.  However,  it cannot be  determined  at this time
whether  or not  additional  common  shares  will be  authorized  by the  common
shareholders and, if not, what the consequences might be.

In September 1998, the Company engaged San Jacinto Securities,  Inc. ("SJS"), an
investment  banking  firm  located in Dallas,  Texas,  to assist the  Company in
pursuing various strategic alternatives. Their efforts have focused primarily on
seeking  a  potential  merger  candidate  for the  Company.  Although  no formal
agreement has been reached,  the Company is engaged in an ongoing  dialogue with
several potential  candidates.  However,  no assurance can be given at this time
whether or not a merger  transaction will eventually occur,  what  consideration
may be offered  to the  Company  in such a  transaction,  or whether an offer to
merge will be accepted by the Company or its shareholders. In exchange for their
services, SJS has been paid a $150,000  non-refundable cash fee and will receive
an additional 3% of the merger value in excess of $5.0 million should it occur.

The collapse of the oil market has significantly  impaired the marketability and
value of the Company's  existing assets,  hindered  negotiations for a potential
merger and limited the ability to raise additional capital. Therefore, it cannot
be  determined  at this time what courses of action will  ultimately be taken by
the Company.  If a merger cannot be  consummated  within a reasonable  period of
time and under  reasonable  terms,  then the Company may have to seek additional
financing.  However,  as previously  discussed,  the Company's  common stock was
delisted from the Nasdaq SmallCap  electronic  market system on January 14, 1999
for failure to  maintain  an average bid price of at least $1.00 per share.  The
stock is now listed on the  over-the-counter  market on the NASD Bulletin  Board
(OTC BB).  It is  believed  that this  delisting  will have a material  negative
impact on the Company's ability to raise additional  equity capital.  Therefore,
it is unclear at this time what  alternatives for future working capital will be
available, or to what extent the potential dilution to the existing shareholders
may be. If additional  sources of financing are not  ultimately  available,  the
company may have to consider other alternatives,  including the sale of existing
assets,  cancellation  of  existing  exploration  agreements,   farmouts,  joint
ventures,  restructuring  under the  protection of the Federal  Bankruptcy  Laws
and/or liquidation.

RESULTS OF OPERATIONS

Overview
The Company's  largest source of operating  revenue is from the sale of produced
oil, natural gas, and natural gas liquids. Therefore, the level of the Company's
revenues  and  earnings  are  affected by prices at which  natural  gas, oil and
natural gas liquids are sold. Therefore, the Company's operating results for any
prior period are not necessarily  indicative of future operating results because
of the  fluctuations  in natural gas, oil and natural gas liquid  prices and the
lack of  predictability  of those  fluctuations as well as changes in production
levels.

Divestment of Rocky Mountain Assets
During the fourth quarter of 1997, the Company's  Board of Directors  determined
that the Company's long-term strategy has shifted to exploration and development
activities  in the Gulf Coast region and that the Rocky  Mountain  assets should
ultimately be divested.  This  divestment was  substantially  completed in 1998.
Accordingly,  the revenue,  costs, operating margins and cash flows historically
generated and discussed  under the captions "Gas Plant  Processing",  "Oil Field
Services and Supply",  "Well  Administration and Other Income" will no longer be
part  of  the  Company's  future  operations.  Since  these  assets  included  a
significant portion of the Company's  historical  operations,  the sale of these
assets  has and will  have an  immediate  and  material  negative  impact on the
Company's future cash flows and results of operations.








                                      -14-

<PAGE>



Total Revenue
Total Revenue from all operations was as follows:

                                               For the Year Ended December 31,
                                           1998                      1997     
                                     ---------------------   -------------------
                                         Amount         %        Amount     % 

Oil and gas sales                        $ 2,359,905   81%    $ 3,168,042    68%
Gas plant processing                         256,174    9%        691,828    15%
Oil field services and supply                271,932    9%        707,060    15%
Well administration and other income          28,971    1%         92,379     2%
                                      --------------  ------  ------------ -----
     Total revenue                       $ 2,916,982  100%    $ 4,659,309   100%
                                         ===========  ====     ===========  ====

The decrease in total revenue is substantially  attributable to: 1.) the sale of
the Rocky  Mountain  assets in 1998;  and 2.) the  substantial  decrease  in oil
prices between the two periods. These circumstances, along with any known trends
or changes that affect  revenue on a  line-by-line  basis,  are discussed in the
following paragraphs under their respective captions.

Oil and Gas
Operating statistics for oil and gas production for the periods presented are as
follows:

                                             For the Year Ended
                                                  December 31,             
                                        1998                         1997   
                                   ---------------              -------------

Production:                                   
   Oil (Bbls)
        Rocky Mtns.                    51,000                      80,000
        Gulf Coast                     58,000                      43,000
                                     ----------                  ---------
             Combined Total           109,000                     123,000
                                      =========                  ========
Gas (Mcf)
        Rocky Mtns.                   230,000                     392,000
        Gulf Coast                    320,000                      91,000
                                      ---------                   -------
              Combined Total          550,000                     483,000
                                      =========                   =======
BOE (6:1)
        Rocky Mtns.                    89,000                     145,000
        Gulf Coast                    112,000                      59,000
                                      ---------                  ---------
              Combined Total          201,000                     204,000
                                      ========                   ========
Average Collected Price:
   Oil (per Bbl)
        Rocky Mtns.                 $          12.11       $           18.75
        Gulf Coast                  $          12.19       $           19.15
                                       --------------         ---------------
              Combined Average      $          12.16       $           18.89
                                       ==============         ===============
Gas (per Mcf)
         Rocky Mtns.               $            1.39      $             1.46
         Gulf Coast                $            2.22      $             2.94
                                      ---------------        ----------------
              Combined Average     $            1.87      $             1.74
                                      ===============        ================
Per BOE (6:1)
         Rocky Mtns.                $          10.50       $           14.25
         Gulf Coast                 $          12.73       $           18.76
                                      --------------         ---------------
              Combined Average      $          11.74       $           15.54
                                      ==============         ===============

                                           For the Year Ended December 31,

                                                  1998                   1997
                                            -----------------       -----------
Operating Margins:
   Rocky Mtns:                                                  
       Revenue -
                Rocky Mtns. Oil                $    612,370       $   1,498,800
                Rocky Mtns. Gas                     321,333             571,213
                                              ---------------     -------------
                                               $    933,703       $   2,070,013
       Costs                                       (806,224)         (1,320,758)
                                              ----------------      -----------
               Operating Margin                $    127,479       $     749,255
               Operating Margin Percent                  14%                 36%
Gulf Coast:                                                           
       Revenue -
               Gulf Coast - Oil                $    715,699       $     828,779
               Gulf Coast - Gas                     710,503             269,250
                                              ---------------     -------------
                                                  1,426,202       $   1,098,029
       Costs                                       (243,339)           (165,980)
                                              ----------------    -------------
               Operating Margin                $  1,182,863       $     932,049
               Operating Margin Percent                  83%                 85%
Combined Totals:                                                
       Revenue                                 $  2,359,905       $   3,168,042
       Costs                                     (1,049,563)         (1,486,738)
                                               ---------------     ------------
               Operating Margin                $  1,310,342       $   1,681,304
                                                -=============      --=========
               Operating Margin Percent                 56%                 53%
Production Costs per BOE before                                 
DD&A:
          Rocky Mtn Region                    $        9.04       $       9.09
          Gulf Coast Region                            2.17               2.84
                                               ---------------     -------------
              Combined Average                $        5.22       $       7.29
                                               ===============     =============
Change in Revenue Attributable
to:
          Production                              (143,959)
          Price                                   (661,732)
  Total Increase in Revenue                       (805,691)

Gas Plant Processing Revenues
This category accounts for the natural gas processed and the natural gas liquids
that were extracted and sold by the Gas Plant facility (which was sold in 1998).

Operating statistics for the periods presented are as follows:
                                               For the Year Ended December 31,
                                                     1998              1997
                                               ---------------    -------------
    Production:
          Natural Gas Processed (Mcf)              232,700            331,900  
                                               --------------    --------------
          Liquids Produced -
               B-G Mix (gallons)                   542,200            769,300
               Propane (gallons)                       404            642,500  
                                                 ----------      --------------
                      Total liquids produced           947          1,411,800   
                                                 ==========       =============
      Average Sales Price of Liquids (per gallon)$    0.27       $       0.41  
                                                 ==========      ==============

    Gross Margin:                                  Amount            Amount 
                                               ------------         -----------
               Revenue                           $ 256,174        $   691,828
               Costs                              (275,224)          (388,851) 
                                              ---------------       -----------
                      Gross Margin              $  (19,050)       $   302,977  
                                              ================     ============
                      Gross Margin Percent              -7%               44%


                                      -15-

<PAGE>



Oil Field Services and Oil Field Supply
Operating  statistics for the Company's oil field service and supply  operations
(which were sold in 1998) for the periods presented are as follows:

                                   For the Year Ended December 31, 
                                      1998                     1997     
                               ----------------         ----------------
    Revenue                    $    271,932              $   707,060
    Costs                          (295,789)                (651,458) 
                               --------------            -------------
    Net Operating Income       $    (23,857)            $     55,602  
                               ==============            =============

Well Administration and Other Income
This  revenue  primarily  represents  the revenue  generated  by the Company for
operating oil and gas properties.  The decrease in 1998 when compared to 1997 is
primarily attributed to the sale of the Rocky Mountain oil and gas properties in
1998. The Company expects very little other income in future periods.

Consulting Arrangement - Related Party
In March 1996 the Company  entered into a three-year  consulting  agreement with
Beta Capital Group, Inc. ("Beta").  Beta, located in Newport Beach,  California,
specializes  in emerging  companies  with both capital needs and market  support
requirements.  Beta's chairman,  Steve Antry, has been a director of the Company
since August  1996.  The  consulting  agreement  with Beta  provides for minimum
monthly cash payments of $17,500 plus reimbursement for out-of-pocket  expenses.
The contract ended in February 1999.  Accordingly,  the Company expects the cost
will be less than $40,000 in 1999.

During 1997, the Company granted Beta warrants for an additional  100,000 shares
of common stock which after the reverse stock split  translates to 10,000 shares
of common stock. These warrants are exercisable for a period of four years at an
exercise  price of $37.50 per share.  The  Company has  determined  the value of
these options using the Black Scholes model and has recognized the fair value of
approximately  $60,000 as consulting  expense in the accompanying  statements of
operations for the year ended  December 31, 1997. An independent  contractor for
Beta is also a member of the Company's Board of Directors.

General and Administrative
General and Administrative ("G&A") expenses increased  approximately $100,000 in
1998  when  compared  to 1997.  However,  the  totals  in 1998  include  several
non-recurring expenses as follows:

    $ 150,000   -     Severance for Willard H. Pease, Jr., the Company's former
                      President and CEO
      150,000   -     Fee paid to San Jacinto Securities in connection with
                      seeking a merger candidate
      100,000   -     Costs  associated with the corporate  restructuring  and
                      divestment of Rocky Mountain assets.
    ----------
    $ 400,000

The Company has and will take steps to  significantly  reduce  future G&A costs,
and expects G&A costs in 1999 to be approximately  $60,000 to $80,000 per month.
The Company capitalized $236,931 and $280,000 in 1998 and 1997, respectively, of
G&A costs associated with the Gulf Coast exploration activities.

Depreciation, Depletion and Amortization
Depreciation,  Depletion and Amortization  ("DD&A") for the periods presented by
cost center consisted of the following:
                                                For the Year Ended December 31
                                                    1998                 1997   
                                              -------------       --------------
    Oil and Gas Properties - Rocky Mountains   $    275,137        $  1,176,865
    Oil and Gas Properties - Gulf Coast           1,639,125           1,018,499
    Gas Plant Operations                            164,881             232,304
    Service and Supply Operations                   108,464             146,436
    Furniture and Fixtures                           53,485              49,219
    Non-Compete Agreements                             -                 45,996
                                             ----------------       -----------
      Total                                    $  2,241,092        $  2,669,319
                                                ===========         ===========


                                      -16-

<PAGE>



DD&A  associated  with the Rocky Mountain  assets (oil and gas  properties,  gas
plant and  service  and  supply)  decreased  in 1998 when  compared to 1997 as a
result of the sale of those  assets  in 1998 and the  impairment  recognized  in
1997. The DD&A for the Gulf Coast oil and gas properties  increased in 1998 as a
result of increased production and lower commodity prices.

Interest Expense
Total interest  incurred,  and its allocation,  for the periods  presented is as
follows:

                                              For the Year Ended December 31,
                                                     1998               1997
                                              ----------------   ---------------
   Interest paid or accrued                   $     399,218       $    448,705
   Amortization of debt discount                    367,443            353,310
   Amortization of debt issuance costs              485,535            223,003
                                                --------------    -------------
            Total interest incurred               1,252,196          1,025,018
   Interest capitalized                            (852,978)          (323,641)
                                                ---------------   --------------
                 Interest expense             $     399,218       $    701,377
                                                  =============     ============

The higher interest  incurred in 1998 is attributed to a $396,792 charge for the
early  retirement  of  approximately   $1.2  million  of  the  1996  convertible
debentures. The $1.2 million payment was made in connection with the sale of the
Rocky Mountain assets and the corresponding  deferred charges (debt discount and
issuance costs) were reduced proportionately by charging that amount to expense.

Impairment - Oil and Gas Properties
The Company uses the full cost method of accounting for oil and gas  activities.
The full  cost  method  regards  all  costs  of  acquisition,  exploration,  and
development  activities  as  being  necessary  for the  ultimate  production  of
reserves.  All of those costs are incurred with the knowledge  that many of them
relate to  activities  that do not result  directly  in finding  and  developing
reserves.  However,  the  benefits  obtained  from the  prospects  that do prove
successful, together with benefits from past discoveries, may ultimately recover
the costs of all activities,  both successful and unsuccessful.  Thus, all costs
incurred in those  activities  are  regarded  as  integral  to the  acquisition,
discovery,  and development of reserves that ultimately  result from the efforts
as a whole  and are  thereby  associated  with the  Company's  proved  reserves.
Establishing a direct  cause-and-effect  relationship between costs incurred and
specific reserves discovered,  which is the premise under successful efforts, is
not relevant to the full cost concept.  However,  the costs  accumulated  in the
Company's full cost pool are subject to a "ceiling", as defined by Regulation SX
Rule 4-10(e)(4).  As prescribed by the  corresponding  accounting  standards for
full  cost,  all the  accumulated  costs in  excess  of the  ceiling,  are to be
expensed by a charge to  impairment.  Accordingly,  at December  31,  1997,  the
Company  incurred an impairment  charge of $3,946,733  related to its Gulf Coast
oil and gas  properties.  The majority of this charged was the result of the dry
holes  drilled in 1997. In 1998 the Company  incurred an  additional  impairment
charge of $7,278,818  which can be attributed  to: a.)  $3,292,324 in dry holes;
b.)  $2,971,309  related to the  expiration of leases in the acreage  associated
with Parallel  Petroleum's  3-D program in S. Texas;  and c.)  $1,015,185 to the
continuing collapse of oil prices.

Impairment - Assets Held For Sale
In 1997 when the  Company's  Board of  Directors  decided  to  divest  its Rocky
Mountain  assets,   the  Company  evaluated  these  assets  for  impairment  and
recognized an impairment charge of $8,965,972. This charge was recognized during
the  fourth  quarter of 1997 in order to reduce  the net  carrying  value of the
assets to the estimated net realizable value ("NRV") of $4,048,000.

The Company  recognized an additional  charge of $313,953 during 1998 to account
for the  difference  between the estimated  NRV in 1997 and the amount  actually
received in 1998.

Dividends and Net Loss Per Common Share
Net loss per common  share is computed by dividing  the net loss  applicable  to
common  stockholders by the weighted average number of common shares outstanding
during  the year.  All  potential  common  shares  have been  excluded  from the
computations because their effect would be antidilutive.


                                      -17-

<PAGE>



The net loss  applicable  to common  stockholders  is  determined  by adding any
dividends accruing to the benefit of the preferred stockholders to the net loss.
The dividends  included for this  calculation  include:  1) paid  dividends;  2)
accrued but unpaid dividends;  and 3) any imputed dividends  attributable to the
beneficial  conversion  feature.  During 1997, the net loss applicable to common
stockholders  includes  $89,969 for the year ended  December 31, 1997 of accrued
but  unpaid  dividends  related to the Series A  Preferred  Stock.  The Series A
Preferred  Stock  automatically  converted into common on June 11, 1997.  During
1998,  the net loss  applicable  to common  stockholders  includes the following
charges associated with the Series B Preferred Stock that was issued on December
31, 1997:


    Dividends declared                   $    278,026
    Imputed non-cash dividend               1,789,468
                                          ------------
             Total                        $ 2,067,494
                                          ===========

The Series B Preferred  Stock became  convertible  into common stock on April 1,
1998 at a conversion  price equal to a 12% discount to the average trading price
of the common stock prior to conversion. This discount increases monthly through
March 1999 when the  discount  tops out at 25% (this  discount is  considered  a
"beneficial  conversion  feature"  and at  December  31,  1998 was at 24%).  The
additional  non-cash imputed dividend charge included in the net loss applicable
to common stockholders represents the intrinsic value of the discount applicable
through  December  31,  1998.  As  long  as any  Series  B  Preferred  Stock  is
outstanding,  additional  non-cash  imputed dividend charges will be incurred in
future periods as the conversion  discount increases until the discount tops out
at 25%.  The holders of the Series B Preferred  Stock are  entitled to dividends
equal to $2.50 per annum,  payable  quarterly  in cash or  additional  shares of
Series B Preferred Stock at the option of the Company.



                                      -18-

<PAGE>



OTHER MATTERS

Disclosure Regarding Forward-Looking Statements
This  report on Form 10-KSB  includes  "forward-looking  statements"  within the
meaning  of  Section  27A of  the  Securities  Act  of  1933,  as  amended  (the
"Securities  Act"),  and Section 21E of the Securities  Exchange Act of 1934, as
amended (the "Exchange Act"). All statements other than statements of historical
facts included in this report, including,  without limitation,  statements under
"Business and Properties" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" regarding the Company's financial position,
reserve  quantities  and  net  present  values,  business  strategy,  plans  and
objectives  of  management  of the  Company  for future  operations  and capital
expenditures, are forward-looking statements and the assumptions upon which such
forward- looking statements are based are believed to be reasonable. The Company
can give no assurance that such  expectations  and assumptions  will prove to be
correct.  Reserve  estimates of oil and gas properties  are generally  different
from the  quantities  of oil and natural gas that are  ultimately  recovered  or
found. This is particularly true for estimates applied to exploratory prospects.
Additionally, any statements contained in this report regarding forward- looking
statements  are subject to various known and unknown  risks,  uncertainties  and
contingencies,  many of which are beyond the control of the Company. Such things
may cause actual  results,  performance,  achievements or expectations to differ
materially  from  the   anticipated   results,   performance,   achievements  or
expectations.  Factors that may affect such forward-looking  statements include,
but are not limited to: the Company's ability to generate  additional capital to
complete its planned drilling and exploration activities;  risks inherent in oil
and gas acquisitions,  exploration,  drilling, development and production; price
volatility of oil and gas;  competition;  shortages of  equipment,  services and
supplies;  government regulation;  environmental matters; financial condition of
the other companies participating in the exploration, development and production
of oil and gas programs;  and other matters  beyond the  Company's  control.  In
addition, since all of the prospects in the Gulf Coast are currently operated by
another party, the Company may not be in a position to control costs, safety and
timeliness of work as well as other critical factors  affecting a producing well
or exploration and development activities.  All written and oral forward-looking
statements  attributable  to  the  Company  or  persons  acting  on  its  behalf
subsequent to the date of this report are expressly  qualified in their entirety
by this disclosure.

Year 2000 Issue
The  Company  has  conducted a review of its  computer  systems to identify  the
systems that could be affected by the "Year 2000"  issue.  The Year 2000 problem
is the result of computer  programs  being  written using two digits rather than
four to define the  applicable  year.  Any of the  Company's  programs that have
time-sensitive  software may recognize a date using '00' as the year 1900 rather
than  the  year  2000.   This  could  result  in  a  major  system   failure  or
miscalculations.

The Company  does not believe  that the Year 2000  problem  will pose a material
operations  problem for the Company.  The Company's  computer software providers
have assured the Company that all of the  Company's  software is or will be Year
2000 compliant  (i.e. will function  properly in the year 2000 and beyond).  The
Company's  accounting software providers have asserted they will provide written
assurance that its products are or will be Year 2000 compliant. To the Company's
knowledge, after investigation,  no "imbedded technology" (such as microchips in
an electronic control system) of the Company poses a material Year 2000 problem.

Because  the  Company  believes  that  it has no  material  internal  Year  2000
problems,  the  Company  has not  expended  and  does  not  expect  to  expend a
significant amount of funds to address Year 2000 issues. It is Company policy to
continue to review its suppliers' Year 2000 compliance and require  assurance of
Year 2000  compliance  from new suppliers;  however,  such  monitoring  does not
involve a significant cost to the Company.

The  Company is  materially  dependent  on Plains  Marketing,  L.P.  ("Plains"),
National Energy Group, Inc. ("NEG") and Amerada Hess Corporation ("AHC") for the
delivery and payment of the  Company's oil and natural gas.  These  companies in
turn are dependent on various third party vendors for delivery and payment.  The
Company has or will request  written  assurances  from Plains,  NEG and AHC that
they have  examined  their  Year 2000  issues.  However,  as of the date of this
report,  the Company has not received a response.  The Company will  continue to
request such  assurance  but it should be  emphasized  that no assurance  can be
given at this time that Plains,  NEG or AHC, or their third party vendors are or
will be Year 2000 compliant.


                                      -19-

<PAGE>



In the event that one or more of the Company's vendors,  including Plains,  NEG,
AHC and their respective vendors, were to have a material Year 2000 problem, the
Company believes that the foreseeable consequences would be a temporary delay in
revenue collection caused by an interruption in computerized billing (and not an
interruption in the actual flow of the Company's oil or natural gas),  which may
have a substantial  impact on the Company's ability to conduct  operations.  The
Company does not have any contingency plan to address this possibility.



                                      -20-

<PAGE>



ITEM 7.   FINANCIAL STATEMENTS



                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                           Page

Independent Auditor's Report. . . . . . . . . . . . . . . .  . . . . . . .   23

Consolidated Balance Sheet - December 31, 1998  . . . . . . . . . . . . . .  24

Consolidated Statements of Operations - 
For the Years Ended December 31, 1998 and 1997. . . . . . . . . . . . . . .  25

Consolidated Statements of Stockholders' Equity - 
For the Years Ended December 31,1998 and 1997. . . . . . . . . . . . . . . . 26

Consolidated Statements of Cash Flows - For the Years Ended 
December 31, 1998 and 1997. . . . . . . . . . . . . . . . . . . . . . .   27-28

Notes to Consolidated Financial Statements. . . . . . . . . . . . . . .   29-40



                                      -21-

<PAGE>



                          INDEPENDENT AUDITOR'S REPORT




Board of Directors
Pease Oil and Gas Company
Grand Junction, Colorado

We have audited the accompanying consolidated balance sheet of Pease Oil and Gas
Company and  subsidiaries as of December 31, 1998, and the related  consolidated
statements  of  operations,  stockholders'  equity  and cash flows for the years
ended  December  31,  1998  and  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 consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of Pease Oil and Gas
Company and  subsidiaries  as of  December  31,  1998,  and the results of their
operations  and their cash flows for the years ended  December 31, 1998 and 1997
in conformity with generally accepted accounting principles.

The accompanying  consolidated  financial statements have been prepared assuming
that the  Company  will  continue as a going  concern,  which  contemplates  the
realization  of assets and  liquidation  of  liabilities in the normal course of
business.  As discussed in Note 1 to the Financial  Statements,  the Company has
incurred net losses of $10.6  million in 1998 and $15.9  million in 1997.  These
conditions and others matters  discussed in Note 1 raise substantial doubt about
the  Company's  ability to continue as a going  concern.  Management's  plans in
regard to these matters are also  discussed in Note 1. The Financial  Statements
do not  include  any  adjustments  that might  result  from the  outcome of this
uncertainty.


/s/ HEIN + ASSOCIATES LLP

Denver, Colorado
March 5, 1999

                                      -22-

<PAGE>



                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET
                                December 31, 1998

                                     ASSETS
<TABLE>
<CAPTION>

CURRENT ASSETS:
<S>                                                                                <C>         
      Cash and equivalents .....................................................   $  1,049,582
      Trade receivables, net of allowance for bad debts of $13,645 .............        420,460
      Assets held for sale .....................................................        100,000
      Prepaid expenses and other ...............................................        170,687
                                                                                   ------------
                        Total current assets ...................................      1,740,729
OIL AND GAS PROPERTIES, at cost (full cost method):
      Unevaluated properties ...................................................      2,816,475
      Costs being amortized ....................................................     16,834,274
                   Total oil and gas properties ................................     19,650,749
      Less accumulated amortization ............................................    (13,883,174)
                   Net oil and gas properties ..................................      5,767,575
OTHER ASSETS:
      Debt issuance costs, net of accumulated amortization of $326,610 .........        322,551
      Office equipment and vehicles, net of accumulated depreciation of $156,124         74,623
      Deposits and other .......................................................          7,493
                                                                                   ------------
                   Total other assets ..........................................        404,667
                                                                                   ------------
TOTAL ASSETS ...................................................................   $  7,912,971
                                                                                   ============
</TABLE>

                      LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>

CURRENT LIABILITIES:
<S>                                                                              <C>         
      Current maturities of long-term debt ...................................   $      5,825
                                                                                -------------------
      Accounts payable, trade ................................................        310,447
                                                                                -------------------
      Accrued expenses .......................................................        322,569
                                                                                -------------------
                   Total current liabilities .................................        638,841
LONG-TERM DEBT, less current maturities: .....................................      2,293,261
COMMITMENTS AND CONTINGENCIES (Notes 3, 5, and 9)
STOCKHOLDERS' EQUITY:
      Preferred Stock, par value $.01 per share, 2,000,000 shares authorized,
           107,336 shares of Series B 5% PIK Cumulative Convertible Preferred
           Stock issued and outstanding (liquidation preference of $5,366,800)          1,073
      Common Stock, par value $.10 per share, 4,000,000 shares authorized,
          1,601,062 shares issued and outstanding ............................        160,106
      Additional paid-in capital .............................................     37,811,006
      Accumulated deficit ....................................................    (32,991,316)
                                                                             -------------------
                   Total stockholders' equity ................................      4,980,869
                                                                             -------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ...................................   $  7,912,971

                                                                              ===================
</TABLE>

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



                                      -23-

<PAGE>



                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                 For the Years Ended December 31, 1998 and 1997



                                                      1998             1997
                                                --------------    -------------
REVENUE:
      Oil and gas sales ......................   $  2,359,905    $  3,168,042
      Gas plant processing ...................        256,174         691,828
      Oilfield services and supply ...........        271,932         707,060
      Well administration and other ..........         28,971          92,379
                                                 ------------    ------------
                   Total revenue .............      2,916,982       4,659,309
                                                 ------------    ------------
EXPENSES:
      Oil and gas production costs ...........      1,049,563       1,486,738
      Gas plant ..............................        275,224         388,851
      Oilfield services and supply ...........        295,789         651,458
      Consulting expense-related party .......        247,123         437,236
      General and administrative .............      1,587,013       1,487,236
      Depreciation, depletion and amortization      2,241,092       2,669,319
      Impairment expense:
              Oil and gas properties .........      7,278,818       3,946,733
              Assets held for sale ...........        313,953       8,965,972
                                                 ------------    ------------
                   Total expenses ............     13.288,575      20,033,543
                                                 ------------    ------------
LOSS FROM OPERATIONS .........................    (10,371,593)    (15,374,234)
OTHER INCOME (EXPENSES):
      Interest expense .......................       (399,218)       (701,377)
      Interest and other income ..............        139,785         180,774
      Gain (Loss) on sale of assets ..........          3,555            (230)
                                                 ------------    ------------
NET LOSS .....................................   $(10,627,471)   $(15,895,067)
                                                 ============    ============
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS ...   $(12,694,965)   $(15,985,036)
                                                 ============    ============
NET LOSS PER COMMON SHARE ....................   $      (7.99)   $     (12.21)
                                                 ============    ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
      OUTSTANDING ............................      1,588,000       1,309,000
                                                 ============    ============

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


                                      -24-

<PAGE>



                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 For the Years Ended December 31, 1998 and 1997


<TABLE>
<CAPTION>

                                                                                            Additional                     Total
                                                      Preferred  Stock     Common Stock      Paid-in     Accumulated   Stockholders'
                                                       Shares   Amount   Shares   Amount     Capital       Deficit         Equity
                                                   -----------  ------- -------- --------   ------------ ------------  ------------

<S>                                                      <C>      <C>     <C>       <C>      <C>          <C>            <C>      
BALANCES, December 31, 1996 .......................    179,938  $1,799  753,039   $75,304  $ 19,789,707 $ (6,468,778)  $ 13,398,032
   Fair value of warrants granted for services ....       --       --      --        --         240,000       --            240,000
   Issuance of common stock for:
      Acquisition of oil and gas properties .......       --       --     31,815    3,182       881,818      --             885,000
      Exercise of stock options ...................       --       --      4,268      427        44,964      --              45,391
      Exercise of warrants ........................       --       --    319,260   31,926     3,880,287      --           3,912,213
      Services ....................................       --       --        615       61        14,790      --              14,851
      Cash in private placements ..................       --       --    379,200   37,920     9,442,080      --           9,480,000
      Conversion of 10% collateralized convertible
         debentures, net of discount ..............       --       --     34,166    3,417       488,637      --             492,054
      Conversion of Series A preferred stock ......   (179,938) (1,799)   56,990    5,699        (3,900)     --                --
   Issuance of Series B preferred stock ...........    113,333   1,133      --        --      5,665,517      --           5,666,650
   Offering costs .................................       --       --       --        --     (2,147,446)     --          (2,147,446)
   Net loss .......................................       --       --       --        --           --     (15,895,067)  (15,895,067)
                                                     --------- ------- ---------  -------     ----------  ------------  ------------
BALANCES, December 31, 1997 .......................    113,333   1,133 1,579,353  157,936    38,296,454   (22,363,845)   16,091,678
Purchase and retirement of Series B preferred stock     (4,500)    (45)     --        --       (206,205)      --           (206,250)
Issuance of common stock for:
    Exercise of warrants ..........................       --       --        125       12           926       --                938
    Conversion of Series B preferred stock ........     (1,497)    (15)   21,584    2,158        (2,143)      --                --
Series B preferred stock dividends ................       --       --       --        --       (278,026)      --           (278,026)
Net Loss ..........................................       --       --       --        --           --     (10,627,471)  (10,627,471)
                                                   -----------  ------ ---------  --------   ------------ ------------  ------------
BALANCES, December 31, 1998 .......................    107,336  $1,073 1,601,062 $160,106  $ 37,811,006  $(32,991,316) $  4,980,869
                                                   ===========  ====== ========= ========   ============  ============  ============
</TABLE>

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


                                      -25-

<PAGE>



                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 For the Years Ended December 31, 1998 and 1997

<TABLE>
<CAPTION>

                                                                                 1998            1997
                                                                          ---------------    -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                         <C>             <C>          
      Net loss ..........................................................   $(10,627,471)   $(15,895,067)
      Adjustments to  reconcile  net loss to net  cash  provided  by  (used  in)
                  operating activities:
                   Depreciation, depletion and amortization .............      2,241,092       2,623,323
                   Amortization of debt discount and issuance costs .....        396,742         576,313
                   Amortization of non-compete agreements ...............           --            45,996
                   Impairment expense:
                          Assets held for sale ..........................        313,953       8,965,972
                          Oil and gas properties ........................      7,278,818       3,946,733
                   Loss (Gain) on sale of assets ........................         (3,555)            230
                   Issuance of common stock and warrants for services ...           --            74,851
                   Other ................................................        175,682            --
                   Changes in operating assets and liabilities:
                         (Increase) decrease in:
                            Trade receivables ...........................        336,974        (157,786)
                             Inventory ..................................           --          (156,822)
                             Prepaid expenses and other .................          8,292          14,685
                         Increase (decrease) in:
                             Accounts payable ...........................        (40,673)          9,068
                             Accrued expenses ...........................       (291,307)        (41,182)
                                                                            ------------    ------------
                   Net cash provided by (used in) operating activities ..       (211,453)          6,314
                                                                            ------------    ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital expenditures for property, plant and equipment ............     (7,396,842)    (12,137,192)
      Change in other assets ............................................         25,000         (95,000)
      Proceeds from sale of property, plant and equipment ...............      3,823,286          66,056
                                                                            ------------    ------------
                   Net cash used in investing activities ................     (3,548,556)    (12,166,136)
                                                                            ------------    ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from sale of Series B preferred stock ....................           --         5,099,985
      Proceeds from exercise of stock options and warrants ..............            938       3,957,604
      Series B preferred stock dividends ................................       (210,941)           --
      Proceeds from long-term debt ......................................         32,610            --
      Repayment of long-term debt .......................................     (1,207,805)       (391,407)
      Proceeds from sale of common stock ................................           --         8,920,000
      Offering costs ....................................................       (146,765)       (874,416)
      Purchase and retirement of Series B preferred stock ...............       (206,250)           --   
                                                                            ------------    ------------
                   Net cash provided by (used in) financing activities ..     (1,738,213)     16,711,766
                                                                            ------------    ------------

NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS .........................     (5,498,222)      4,551,944

CASH AND EQUIVALENTS, beginning of year .................................      6,547,804       1,995,860
                                                                            ------------    ------------

CASH AND EQUIVALENTS, end of year .......................................   $  1,049,582    $  6,547,804
                                                                            ============    ============
</TABLE>

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


                                      -26-

<PAGE>


                      PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF CASH FLOWS
                    For the Years Ended December 31, 1998 and 1997


<TABLE>
<CAPTION>

                                                                              1998             1997
                                                                          -------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
<S>                                                                        <C>            <C>        
    Cash paid for interest .............................................   $   400,309    $   505,523
                                                                           ===========    ===========

    Cash paid for income taxes .........................................   $      --      $      --
                                                                                          ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
   FINANCING ACTIVITIES:
     Fair value of warrants granted for oil and gas exploration services   $      --      $   180,000
     Conversion of long-term debt, net of discount, to common stock ....          --          492,054
     Debt incurred for purchase of vehicles ............................          --           50,691
     Increase (decrease) in payables for:
          Oil and gas properties .......................................    (1,002,353)     1,077,266
          Offering costs ...............................................      (146,765)       146,765
          Series B preferred stock dividends ...........................        67,085           --
     Issuance of common stock for oil and gas properties ...............          --          885,000
     Capitalized portion of amortized debt issuance/discount costs .....       485,534           --
</TABLE>



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



                                      -27-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

     Nature of Operations - At December 31, 1998 the principal business of Pease
Oil and Gas  Company  (the  "Company")  is to  participate  as a  non-operating,
minority interest owner in exploration, development, production and sale of oil,
natural gas and natural gas liquids.  The Company was previously  engaged in the
processing and marketing of natural gas at a gas processing  plant,  the sale of
oil and gas  production  equipment and oilfield  supplies,  and oil and gas well
completion and  operational  services.  However,  as discussed in Note 2, during
1998 the  Company's  gas  processing  plant and the oilfield  service and supply
businesses were sold. The Company conducts its operations  through the following
wholly-owned subsidiaries: Loveland Gas Processing Company, Ltd. ("LGPCo); Pease
Oil Field  Services,  Inc.;  Pease Oil Field Supply,  Inc.; and Pease  Operating
Company, Inc.. All the subsidiaries are currently inactive.

     Continuing  Operations  - The  Company  has  incurred  net  losses of $10.6
million in 1998 and $15.9 million in 1997. As a result of continuing losses, the
Company's  working capital has been reduced to $1.1 million at December 31, 1998
and  stockholders'  equity is less than $5 million.  At December 31,  1998,  the
liquidation  preference  of the Series B  Preferred  stock is in excess of total
stockholders'  equity and the hyperdilutive  potential of the conversion feature
has resulted in the Company's inability to raise additional equity capital which
is critical to carry out development and exploration activities that are planned
for the next several  years.  The Company may be required to redeem the Series B
Preferred  stock  on  December  31,  2002 at a price  equal  to the  liquidation
preference.  Alternatively,  the  Company  can force the  holders  to convert to
common stock which would result in ownership by the Preferred  holders in excess
of 90% (based on the current  trading price of the common stock).  However,  the
Company does not currently have a sufficient  number of common shares authorized
to convert all of the Preferred  stock.  Under the terms of the Preferred  Stock
Agreement,  the Company is obligated to take the  appropriate  steps to increase
the number of  authorized  shares in the future.  However,  no assurance  can be
given at this time whether or not  additional  shares can or will be authorized.

     In April  2001,  the Company  will also be required to pay off  convertible
debentures with a current  outstanding  balance of $2,782,500.  During 1998, the
Company has taken several steps to reduce general and  administrative  costs and
management believes the Company will be able to generate positive operating cash
flows in 1999. Management believes capital requirements for 1999 will be between
$550,000 and $1,500,000.  Accordingly, management believes that existing working
capital at December 31, 1998 plus cash expected to be generated  from  operating
activities will be sufficient to meet  commitments for capital  expenditures and
other  obligations  of the Company  through at least 1999.  However,  should the
existing  working  capital not be  sufficient  to meet future  obligations,  the
Company may have to consider other alternatives,  including the sale of existing
assets,  cancellation  of  existing  exploration  agreements,   farmouts,  joint
ventures,  restructuring  under the  protection of the Federal  Bankruptcy  Laws
and/or liquidation.

     In response to  historically  poor  financial  results  and  depressed  oil
commodity markets, the Company is also aggressively pursuing a merger candidate.
To this end,  the Company  engaged  San Jacinto  Securities,  Inc.  ("SJS"),  an
investment  banking firm located in Dallas,  Texas to assist the Company in this
venture. Although no formal agreements have been reached, the Company is engaged
in ongoing dialogue with several potential candidates. However, no assurance can
be given at this time whether or not a merger transaction will eventually occur,
what  consideration  may be offered to the  Company  in such a  transaction,  or
whether an offer to merge will be accepted by the Company or its shareholders.

     Principles of Consolidation - The accompanying financial statements include
the  accounts of the Company and its  wholly-owned  subsidiaries.  All  material
intercompany transactions and accounts have been eliminated in consolidation.

    Cash and Equivalents - The Company  considers all highly liquid  investments
purchased  with  an  original  maturity  of  three  months  or  less  to be cash
equivalents.

    Oil and Gas Properties - The Company's oil and gas producing  activities are
accounted for using the full cost method of accounting. The Company has one cost
center (full cost pool) since all of its oil and gas  producing  activities  are
conducted in the United States. Under the full cost method, all costs associated
with the acquisition,  development and exploration of oil and gas properties are
capitalized,  including  payroll  and other  internal  costs  that are  directly
attributable  to these  activities.  For the years ended  December  31, 1998 and
1997,  capital  expenditures  include  internal  costs of $236,931 and $280,000,
respectively.  Proceeds from sales of oil and gas properties are credited to the
full cost pool with no gain or lost  recognized  unless such  adjustments  would
significantly  alter the relationship  between  capitalized costs and proved oil
and gas reserves.

    Acquisition  costs of unproved  properties  and costs related to exploratory
drilling and seismic activities are initially excluded from amortization.  These
costs are  periodically  evaluated for impairment and  transferred to properties
being  amortized  when either proved  reserves are  established or the costs are
determined to be impaired.

    The  capitalized  costs related to all evaluated oil and gas  properties are
amortized  using  the units of  production  method  based  upon  production  and
estimates of proved reserve quantities. Future costs to develop proved reserves,
as well as site restoration,  dismantlement and abandonment costs, are estimated
based on current  costs and are also  amortized  to  expense  using the units of
production method.

    The  capitalized   costs  of  evaluated  oil  and  gas  properties  (net  of
accumulated amortization and related deferred income taxes) are not permitted to
exceed  the full  cost  ceiling.  The full cost  ceiling  involves  a  quarterly
calculation  of the  estimated  future net cash  flows  from  proved oil and gas
properties, using current prices and costs and an annual discount factor of 10%.
Accordingly,  the full cost  ceiling may be  particularly  sensitive in the near
term due to changes in oil and gas prices or production rates.

    Impairment of  Long-Lived  Assets - The Company  performs an assessment  for
impairment  whenever  events  or  changes  in  circumstances  indicate  that the
carrying  amount  of a  long-lived  asset  may  not be  recoverable.  If the net
carrying  value  exceeds  estimated  undiscounted  future net cash  flows,  then
impairment  is recognized  to reduce the carrying  value to the  estimated  fair
value.

    Property,  Plant and Equipment - Property,  plant and equipment is stated at
cost.  Depreciation  of property,  plant and equipment was calculated  using the
straight-line method over the estimated useful lives of the assets, as follows:

                                                    Years
             Gas plant                                 17
             Service equipment and vehicles           4-7
             Buildings and office equipment          7-15


                                      -28-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



    Depreciation  expense related to property,  plant and equipment  amounted to
$328,164  and  $429,012  for  the  years  ended  December  31,  1998  and  1997,
respectively.

    The costs of  normal  maintenance  and  repairs  are  charged  to  operating
expenses as incurred.  Material expenditures which increase the life of an asset
are capitalized and depreciated over the estimated  remaining useful life of the
asset.  The cost of properties  sold, or otherwise  disposed of, and the related
accumulated  depreciation or amortization are removed from the accounts, and any
gains or losses are reflected in current operations.

    Non-compete  Agreements - The costs of non-compete  agreements were incurred
in connection with the 1993  acquisition of  substantially  all of the Company's
Rocky Mountain  assets.  These costs were being  amortized over the terms of the
two to ten-year  agreements on a straight-line  basis. At December 31, 1997, the
remaining  net book  value of  $260,682  was  charged to  impairment  expense in
connection with the sale of assets discussed in Note 2.

    Debt Issuance Costs - Debt issuance  costs relate to the $5 million  private
placement of convertible  debentures  discussed in Note 3. These costs are being
amortized using the interest method.

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

    The  Company's  financial  statements  are based on a number of  significant
estimates including the allowance for doubtful accounts,  assumptions  affecting
the fair value of stock options and warrants, and oil and gas reserve quantities
which are the basis for the  calculation of  amortization  and impairment of oil
and gas properties.  Management emphasizes that reserve estimates are inherently
imprecise and that estimates of more recent  discoveries are more imprecise than
those for properties with long production histories.

    Income Taxes - Deferred tax assets and  liabilities  are  recognized for the
future tax consequences  attributable to differences between financial statement
carrying  amounts of existing assets and  liabilities  and their  respective tax
bases.  Deferred tax assets and liabilities are measured using enacted tax rates
expected  to apply to  taxable  income  in the  years in which  those  temporary
differences  are expected to be recovered or settled.  The effect on  previously
recorded  deferred  tax assets and  liabilities  resulting  from a change in tax
rates is recognized in earnings in the period in which the change is enacted.

    Revenue  Recognition - The Company recognizes gas plant revenues and oil and
gas sales upon delivery to the  purchaser.  Revenues from oil field services are
recognized as the services are performed.  Oil field supply and equipment  sales
are recognized when the goods are shipped to the customer.

    Net Loss Per  Common  Share  -Net  loss per  common  share is  presented  in
accordance  with the provisions of Statement of Financial  Accounting  Standards
No. 128,  Earnings Per Share (FAS 128),  which requires  disclosure of basic and
diluted  earnings per share (EPS).  Basic EPS  excludes  dilution for  potential
common  shares and is computed by dividing  income or loss  applicable to common
shareholders by the weighted average number of common shares outstanding for the
period.  Diluted  EPS  reflects  the  potential  dilution  that  could  occur if
securities or other  contracts to issue common stock were exercised or converted
into common  stock and  resulted  in the  issuance  of common  stock.  Basic and
diluted EPS are the same in 1998 and 1997 as all  potential  common  shares were
antidilutive.

    Stock Split - Effective  December 1, 1998, the Board of Directors declared a
1 for 10 reverse stock split related to the  Company's  common stock.  All share
and per share amounts in the  accompanying  financial  statements and notes have
been retroactively restated for this stock split.

    Stock-Based Compensation - The Company accounts for stock-based compensation
using the  intrinsic  value method  prescribed in  Accounting  Principles  Board
Opinion  No.  25,  "Accounting  for Stock  Issued  to  Employees,"  and  related
interpretations.  Accordingly,  compensation  cost for stock options  granted to
employees is measured as the

                                      -29-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

excess,  if any, of the quoted market price of the Company's common stock at the
measurement date (generally, the date of grant) over the amount an employee must
pay to acquire the stock.

    In October  1995,  the  Financial  Accounting  Standards  Board issued a new
statement titled  "Accounting for Stock- Based  Compensation" (FAS 123). FAS 123
requires that options,  warrants,  and similar  instruments which are granted to
non-employees  for goods and  services  be  recorded  at fair value on the grant
date. Fair value is generally determined under an option pricing model using the
criteria set forth in FAS 123.

2.  ASSETS HELD FOR SALE:

    During  the  fourth  quarter  of 1997,  the  Company's  Board  of  Directors
determined that the Company's  long-term strategy had shifted to exploration and
development  activities  in the Gulf Coast  region  and that the Rocky  Mountain
assets should be divested.  Accordingly,  the Company evaluated these assets for
impairment  and  recognized  a charge of  $8,965,972  in 1997 to reduce  the net
carrying value of the assets to the estimated  fair value of  $4,048,000.  These
assets were sold during 1998 for cash proceeds of  $3,054,000  and an additional
payment of $100,000 is due by April 1999.

    The results of operations,  exclusive of the impairment  charge,  related to
the Rocky Mountain  assets for the years ended December 31, 1998 and 1997 are as
follows:

                                                    1998                1997   
                                               --------------   ---------------
             Revenues                          $  1,488,843       $   3,683,000
             Operating costs and expenses        (1,394,141)         (2,368,000)
             Depreciation and amortization         (549,816)         (1,606,000)
                                               ---------------  ---------------
                      Loss from operations     $   (455,114)     $     (291,000)
                                               ==============   ===============

     The Company recognized an additional impairment charge in 1997 of $313,953,
to account for the difference between the net realizable value estimated in 1997
and the actual amount realized in 1998.

3.  DEBT FINANCING ARRANGEMENTS:

    Long-Term  Debt -  Long-term  debt at  December  31,  1998  consists  of the
following:

  Convertible debentures, interest at 10%,
       due April 2001, unsecured,                                $   2,782,500
  Less unamortized discount                                           (511,787)
                                                               ----------------
           Net carrying value                                        2,270,713

  Note payable to bank, interest at 8.5%,
       monthly payments of $669, due March 2003,
       collateralized by vehicle                                        28,373

           Total long-term debt                                      2,299,086
           Less current maturities                                      (5,825)
                   Long-term debt, less current maturities       $   2,293,261
                                                                  =============



    Aggregate maturities of long-term debt are as follows:

             Year Ending December 31:

                      1999                 $      5,825
                      2000                        6,340
                      2001                    2,277,613
                      2002                        7,510
                      2003                        1,798
                                       ----------------
                                           $  2,299,086

                                      -30-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     Convertible  Debentures  and  Consulting  Agreement  - In March  1996,  the
Company  entered into a consulting  agreement with a company (the  "Consultant")
that specializes in developing and implementing  capitalization plans, including
the utilization of debt capital in business operations. The agreement expired in
February  1999,  and provides for minimum  monthly cash payments of $17,500.  In
addition to cash compensation,  the Company agreed to grant warrants to purchase
100,000 shares of the Company's common stock. The exercise price of the warrants
is $7.50 per share and they expire in March 2001.

     In  April  1996,  the  Company,  with  the  assistance  of the  Consultant,
initiated  a  private  placement  to sell  up to  $5,000,000  of  collateralized
convertible debentures in the form of "Units". Each Unit consists of one $50,000
five-year 10% collateralized  convertible  debenture and detachable  warrants to
purchase  2,500  shares of the  Company's  common stock at $12.50 per share (see
Note 7 for additional  information  with respect to the  warrants).  In November
1996,  the offering was completed and the Company was  successful in selling the
entire $5,000,000 generating net cash proceeds of $4,300,000. The estimated fair
value of the  detachable  warrants of $1,829,000 is treated as a discount and is
being  amortized  using the  interest  method.  The  debentures  were  initially
collateralized  by a first  priority  interest in certain Rocky Mountain oil and
gas properties owned and operated by the Company.

    The debentures are convertible,  at the holder's option,  into the Company's
common stock for $30.00 per share and may be redeemed by the  Company,  in whole
or in part,  beginning  at a premium of 110% of the  original  principal  amount
subject  to  adjustment  beginning  on April 25,  1999.  During  the year  ended
December 31, 1997, the holders of $1,025,000 of debentures elected to convert to
341,665  shares of common stock.  Effective  October 1, 1998, the holders of the
debentures  voted to amend the  debentures to release the oil and gas properties
which  previously  collateralized  this debt. In exchange for this release,  the
Company agreed to retire 30% of the outstanding principal balance which amounted
to an aggregate of $1,192,500.  Interest on the debentures is payable  quarterly
and the principal balance is due on April 15, 2001.

    The Company  also agreed to pay the  Consultant a fee equal to 2% of the net
proceeds  from the private  placement  and up to 7% of the net proceeds from any
warrants  which are  exercised  during  the term of the  agreement  or up to six
months after termination in certain circumstances.  All of the compensation paid
to the  Consultant is limited to 15% of the gross  proceeds  generated  from the
private placement, exercise of warrants, or other debt or equity financings that
may be  consummated  during the term of the  agreement.  In August 1996, a major
shareholder of the Consultant was elected to the Company's Board of Directors.

4.  INCOME TAXES:
    Deferred  tax assets  (liabilities)  as of  December  31,  1998 and 1997 are
comprised of the following:

                                                 1998                 1997     
                                            ---------------      --------------
Long-term Assets:
      Net operating loss carryforwards       $ 7,897,000          $5,816,000
      Property, plant  and equipment           1,178,000             229,000
      Tax credit carryforwards                   294,000             294,000
      Percentage depletion carryforwards         160,000             120,000
      Other                                       21,000              41,000
                                             --------------      ------------
               Total                           9,550,000           6,500,000
      Less valuation allowance                (9,550,000)         (6,500,000)
                                             -------------       -----------
               Net long-term asset           $      -            $      -      
                                             =============       ============

     During the years ended  December 31, 1998 and 1997,  the Company  increased
the valuation  allowance by $3,050,000 and $5,865,000,  respectively,  primarily
due to an  increase  in the  net  operating  loss  carryforwards  which  are not
considered to be realizable.  The Company has provided a valuation allowance for
the  net  operating  loss  and  credit  carryforwards  based  upon  the  various
expiration dates and the limitations which exist under IRS Sections 382 and 384.

    
    At December 31, 1998, the Company had net operating loss  carryforwards  for
income tax purposes of approximately $20 million, which expire primarily in 2008
through 2018. Some of these net operating losses are subject

                                      -31-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

to limitations under IRS Sections 382 and 384, particularly should a significant
number of Series B Preferred  stock  convert  into  common  stock in the future.
Additionally,  the Company has tax credit carryforwards at December 31, 1998, of
approximately  $294,000 and percentage depletion  carryforwards of approximately
$429,000.

5.  COMMITMENTS AND CONTINGENCIES:

    Employment  Agreements  -  During  1994,  the  Board of  Directors  approved
employment agreements with the Company's executive officers.  The agreements may
be  terminated  by the  officers  upon 90 days notice or by the Company  without
cause upon 30 days notice.  In the event of a termination by the Company without
cause,  the  Company  would be  required to pay the  officers  their  respective
salaries for one to three years. If the termination occurs following a change in
control,  the Company would be required to make lump sum payments  equivalent to
two to three years salary for each of the officers.

    Profit  Sharing Plan - The Company has  established a 401(k) profit  sharing
plan  that  covers  all  employees  with six  months  of  service  who  elect to
participate  in the Plan.  The Plan  provides  that the  employees  may elect to
contribute  up to  15%  of  their  salary  to the  Plan.  All  of the  Company's
contributions  are discretionary and amounted to $5,401 and $5,669 for the years
ended December 31, 1998 and 1997, respectively.

    Environmental - The Company is subject to extensive Federal, state and local
environmental laws and regulations.  These laws, which are constantly  changing,
regulate the  discharge of materials  into the  environment  and may require the
Company to remove or  mitigate  the  environmental  effects of the  disposal  or
release of  petroleum or chemical  substances  at various  sites.  Environmental
expenditures  are expensed or  capitalized  depending  on their future  economic
benefit.  Expenditures  that  relate  to an  existing  condition  caused by past
operations and that have no future economic  benefits are expensed.  Liabilities
for  expenditures  of  a  noncapital  nature  are  recorded  when  environmental
assessment  and/or  remediation  is  probable,  and the costs can be  reasonably
estimated.

    Year 2000 Issue - The Company has conducted a review of its computer systems
to identify  the systems  that could be affected by the "Year 2000"  issue.  The
Year 2000 problem is the result of computer  programs  being  written  using two
digits  rather than four to define the  applicable  year.  Any of the  Company's
programs  that have  time-sensitive  software may recognize a date using '00' as
the year 1900 rather  than the year 2000.  This could  result in a major  system
failure or miscalculations.

    The Company does not believe that the Year 2000 problem will pose a material
operations  problem for the Company.  The Company's  computer software providers
have assured the Company that all of the  Company's  software is or will be Year
2000 compliant  (i.e. will function  properly in the year 2000 and beyond).  The
Company's  accounting software providers have asserted they will provide written
assurance that its products are or will be Year 2000 compliant. To the Company's
knowledge, after investigation,  no "imbedded technology" (such as microchips in
an electronic control system) of the Company poses a material Year 2000 problem.

    Because the Company  believes  that it has no  material  internal  Year 2000
problems,  the  Company  has not  expended  and  does  not  expect  to  expend a
significant amount of funds to address Year 2000 issues. It is Company policy to
continue to review its suppliers' Year 2000 compliance and require  assurance of
Year 2000  compliance  from new suppliers;  however,  such  monitoring  does not
involve a significant cost to the Company.

    The Company is materially  dependent on Plains Marketing,  L.P.  ("Plains"),
National Energy Group, Inc. ("NEG") and Amerada Hess Corporation ("AHC") for the
delivery and payment of the  Company's oil and natural gas.  These  companies in
turn are dependent on various third party vendors for delivery and payment.  The
Company has or will request  written  assurances  from Plains,  NEG and AHC that
they have  examined  their  Year 2000  issues.  However,  as of the date of this
report,  the Company has not received a response.  The Company will  continue to
request such  assurance  but it should be  emphasized  that no assurance  can be
given at this time that Plains,  NEG or AHC, or their third party vendors are or
will be Year 2000 compliant.

    In the event that one or more of the Company's  vendors,  including  Plains,
NEG,  AHC and  their  respective  vendors,  were to have a  material  Year  2000
problem,  the Company  believes  that the  foreseeable  consequences  would be a
temporary delay in revenue  collection caused by an interruption in computerized
billing (and not an interruption in the

                                      -32-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

actual flow of the Company's  oil or natural gas),  which may have a substantial
impact on the Company's ability to conduct operations. The Company does not have
any contingency plan to address this possibility.

    Bankruptcy of Third Party Operator - In December 1998 National Energy Group,
Inc. filed an  Involuntary  Petition for an Order and Relief under Chapter 11 of
Title 11 of the United States  Bankruptcy Code in United States Bankruptcy Court
for the Northern  District of Texas,  Dallas  Division.  As operator of the East
Bayou Sorrel field, which represents  approximately 50% of the Company's current
production, the bankruptcy petition might adversely effect future development or
operation of the field;  however,  the Company does not expect that its interest
in the field or production from currently existing wells will be affected.

    The Company does have an unsecured  claim in the  bankruptcy  proceeding for
various  amounts which the Company  believes were paid to National Energy Group,
Inc. as operator in connection with the drilling of existing  wells.  Collection
of these  amounts  may be  delayed  or may not  occur,  pending  disposition  of
National  Energy Group,  Inc.'s  reorganization  proceeding.  The total claim is
approximately  $80,000.  However,  no amount has been  recorded in the financial
statements as of December 31, 1998.

    Contingencies  - The  Company  may from time to time be  involved in various
claims, lawsuits,  disputes with third parties, actions involving allegations of
discrimination,  or breach  of  contract  incidental  to the  operations  of its
business.  The  Company  is  not  currently  involved  in  any  such  incidental
litigation  which it  believes  could have a  materially  adverse  effect on its
financial conditions or results of operations.

6.  PREFERRED STOCK

    The Company has the  authority to issue up to 2,000,000  shares of Preferred
Stock,  which  may be  issued  in such  series  and  with  such  preferences  as
determined by the Board of Directors.  During 1993, the Company issued 1,170,000
shares  of  Series A  Cumulative  Convertible  Preferred  Stock  (the  "Series A
Preferred  Stock").  Each  share of Series A  Preferred  Stock was  entitled  to
receive  dividends  at 10% per annum when,  as and if declared by the  Company's
Board of Directors.  Unpaid dividends accrued and were cumulative.  During 1997,
the  holders of all  remaining  shares of Series A  Preferred  Stock  elected to
convert to 56,990  shares of common stock  pursuant to the  original  conversion
terms.  Upon conversion,  the holders also received  warrants to purchase 56,990
shares of common stock at $60.00 per share through  August 13, 1998. On March 4,
1998, the expiration date of these warrants was extended for one year.

    In  December  1997,  the  Board of  Directors  authorized  a new  series  of
preferred  stock  which  was  designated  as  the  Series  B 5%  PIK  Cumulative
Convertible  Preferred Stock (the "Series B Preferred  Stock").  The Company has
authority to issue up to 145,300 shares of Series B Preferred  Stock. The Series
B Preferred Stock provides for a liquidation preference of $50 per share and the
holders are entitled to dividends at 5% per annum,  payable quarterly in cash or
additional shares of Series B Preferred Stock at the option of the Company.  The
Series B Preferred Stock became  convertible into common stock on March 31, 1998
at a conversion  price equal to a 12% discount to the average  trading  price of
the common stock prior to conversion.  This discount  increases  monthly through
March 1999 when the discount  tops out at 25%.  The discount is being  accounted
for  as an  additional  dividend  on the  Series  B  Preferred  Stock  which  is
recognized as a charge to earnings applicable to common stockholders.

    Beginning  in June 1999,  the  Company  may force the  holders to convert to
common stock at a conversion price that generally represents a 25% discount from
the fair value of the common stock.

    If not previously converted,  the Company is required to redeem the Series B
Preferred  Stock  on  December  31,  2002 at a price  equal  to the  Liquidation
Preference.  On December 31, 1997, the Company issued 113,333 shares of Series B
Preferred Stock for $5,666,650.

    In connection with the issuance of this preferred  stock, the Company agreed
to issue  warrants to the  placement  agent for 32,380 shares of common stock at
$17.50 per share.




                                      -33-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.  STOCK BASED COMPENSATION:

    Stock Option Plans - The Company's  shareholders have approved the following
stock  option plans that  authorize  an  aggregate  of 185,732  shares for stock
options that may be granted to officers, directors,  employees, and consultants:
9,000 shares in June 1991;  27,732  shares in June 1993;  15,000  shares in June
1994; 34,000 shares in August 1996; and 100,000 shares in May 1997.

    The plans  permit the  issuance of incentive  and  nonstatutory  options and
provide for a minimum  exercise  price equal to 100% of the fair market value of
the  Company's  common  stock on the date of grant.  The maximum term of options
granted under the plan is 10 years and options granted to employees expire three
months after the termination of employment. None of the options may be exercised
during the first six months of the option term.

    No options  may be granted  after 10 years  from the  adoption  date of each
plan.  The following is a summary of activity under these stock option plans for
the years ended December 31, 1997 and 1996:

                                              1998                  1997     
                                   -----------------------  ------------------
                                                  Weighted             Weighted
                                                   Average              Average
                                      Number      Exercise   Number    Exercise
                                    Of Shares      Price    Of Shares   Price

Outstanding, beginning of year ...   118,880    $   19.61     62,130   $  10.20

         Canceled ................   (46,350)       21.36     (2,483)     21.60
         Expired .................    (1,500)       29.40       (500)     34.40
         Repriced ................   (20,000)       26.90        --        --
         Granted .................    20,000        11.25     64,000      28.30
         Exercised ...............      --                       --       10.60
                                    ------                   --------

Outstanding, end of year .........    71,030    $   13.85     118,800  $  19.60
                                    ======                   ========

     For all  options  granted  during  1998 and 1997,  the market  price of the
Company's common stock on the grant date was approximately equal to the exercise
price.  All options are currently  exercisable and if not previously  exercised,
will expire as follows:

                                                    Weighted
                                 Range of           Average
                              Exercise Prices       Exercise          Number
                              Low        High        Price           Of Shares
Year Ending December 31,
             2000           $  7.00    $  8.30     $   7.84            25,432
             2001             10.00      18.10        13.41            12,348
             2002              5.00       5.00         5.00            10,000
             2002             17.50      29.70        24.45            23,250
                                                                     ---------
                                                   $  13.85            71,030
                                                                     =========

    Warrants  and  Non-Qualified  Stock  Options - The Company has also  granted
warrants and non-qualified options which are summarized as follows for the years
ended December 31, 1998 and 1997:







                                      -34-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>

<CAPTION>    
                                                                     1998                    1997
                                                                   --------                 ------
                                                                          Weighted                Weighted
                                                                          Average                  Average
                                                              Number      Exercise    Number      Exercise
                                                             Of Shares      Price    Of Shares     Price

<S>                                                            <C>          <C>      <C>        <C>      
Outstanding, beginning of year ............................    587,790      $ 43.11  721,659    $   29.50
    Granted to:
       Beta Capital Group, Inc. (Note 4) ..................       --           --     10,000        37.50
           Consultants ....................................       --                   5,000        15.00
       Directors for services .............................       --          30.30
       Former officers and directors for severance ........     39,850        14.88     --            --
       Brokers and underwriter in private placements ......       --                  62,275        22.60
    Issued to underwriter and former holders of preferred
       stock upon conversion ..............................       --                 103,116        57.10
    Expired ...............................................    (57,444)       45.81     (500)       12.50
    Exercised .............................................       (125)        7.50 (318,760)       12.20
                                                                --------              ------

Outstanding, end of year ..................................    570,071      $ 40.87  587,790    $   43.11
                                                                ========              ======
</TABLE>

    If not previously exercised,  warrants and non-qualified options will expire
as follows:

                                                          Weighted
                                      Range of            Average
                                  Exercise Prices         Exercise       Number
    Year Ending December 31,       Low         High          Price    Of Shares

             1999               $ 20.00     $ 60.00        $ 57.61      339,546
             2000                  5.00       71.90          18.58       66,845
             2001                  7.50       37.50          10.79       98,900
             2002                 17.50       30.30          22.05       64,780
                                                                       ---------
                                                           $ 40.87      570,071
                                                                        ========

    Pro Forma  Stock-Based  Compensation  Disclosures - The Company  applies APB
Opinion 25 and  related  interpretations  in  accounting  for stock  options and
warrants which are granted to employees.  Accordingly,  no compensation cost has
been  recognized  for grants of options  and  warrants  to  employees  since the
exercise prices were not less than the fair value of the Company's  common stock
on the grant dates.  Had  compensation  cost been  determined  based on the fair
value at the grant dates for awards under those plans consistent with the method
of FAS 123, the Company's net loss and loss per share would have been changed to
the pro forma amounts indicated below.

                                                   Year Ended December 31,
                                                   1998               1997
                                               --------------   ---------------
Net loss applicable to common stockholders:
             As reported                       $ (12,694,965)   $ (15,985,036)
             Pro forma                           (13,171,965)     (16,507,036)
Net loss per common share:
             As reported                       $       (7.99)   $      (12.20)
             Pro forma                                 (8.29)          (12.60)

    The weighted average fair value of options and warrants granted to employees
for  the  years  ended  December  31,  1998  and  1997  was  $2.24  and  $16.30,
respectively. The fair value of each employee option and warrant granted in 1998
and  1997  was   estimated  on  the  date  of  grant  using  the   Black-Scholes
option-pricing model with the following weighted average assumptions:



                                      -35-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                                     Year Ended December 31,
                                                   1998                1997     
                                             ----------------    ---------------

             Expected volatility                   80.0%            63.7%
             Risk-free interest rate                5.6%             6.0%
             Expected dividends                      -                 -
             Expected terms (in years)              2.2              4.0

8.  FINANCIAL INSTRUMENTS

    Statement of Financial Accounting Standards No. 107 requires all entities to
disclose  the fair value of certain  financial  instruments  in their  financial
statements.  Accordingly,  at December 31, 1998,  management's  best estimate is
that the carrying  amount of cash,  receivables,  notes payable to  unaffiliated
parties,  accounts payable, and accrued expenses  approximates fair value due to
the short maturity of these instruments. Management estimates that fair value is
approximately equal to carrying value of the convertible debentures since market
interest rates have not changed significantly since the offering commenced.

9.  SIGNIFICANT CONCENTRATIONS:

    Substantially all of the Company's accounts receivable at December 31, 1998,
result  from crude oil and  natural  gas sales to  companies  in the oil and gas
industry.  This  concentration of customers and joint interest owners may impact
the Company's overall credit risk, either positively or negatively,  since these
entities may be similarly  affected by changes in economic or other  conditions.
In  determining  whether to require  collateral  from a significant  customer or
joint interest owner, the Company  analyzes the entity's net worth,  cash flows,
earnings,  and/or credit ratings.  Receivables are generally not collateralized;
however,  receivables from joint interest owners are subject to collection under
operating  agreements  which generally  provide lien rights.  Historical  credit
losses incurred on trade receivables by the Company have been insignificant.

     For the years ended  December 31, 1998 and 1997,  the Company had oil sales
to a single customer which accounted for 20% of total revenues.

    At December 31, 1998,  substantially all of the Company's cash and temporary
cash investments were held at a single financial  institution.  The Company does
not  maintain  insurance to cover the risk that cash and  temporary  investments
with a single  financial  institution  may be in excess of  amounts  insured  by
federal deposit insurance.

10.          OIL AND GAS PRODUCING ACTIVITIES:

    Property   Acquisitions  -  In  January  1997,  the  Company  completed  the
acquisition of a 7.8125% after prospect  payout working  interest in a producing
oil and gas prospect in Louisiana.  The prospect is operated by National  Energy
Group, Inc. (NEGX), an independent oil and gas producer.  The purchase price was
$1,750,000 which consisted of $875,000 in cash and the issuance of 31,500 shares
of the Company's  common stock with a fair value of $875,000.  In February 1997,
the Company entered into agreements with  unaffiliated  parties for the purchase
of a 10% working interest in this prospect for $2.5 million.

    Full Cost Amortization Expense - Amortization expense amounted to $1,914,262
and  $2,195,364  for the years ended  December 31, 1998 and 1997,  respectively.
Amortization  expense per equivalent  units of oil and gas produced  amounted to
$9.52 and $10.77 for the years ended  December 31, 1998 and 1997,  respectively.
Natural gas is converted to  equivalent  units of oil on the basis of six Mcf of
gas to one equivalent barrel of oil.







                                      -36-

<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

    Unevaluated  Oil and Gas Properties - At December 31, 1998,  unevaluated oil
and gas properties consist of the following:

    Unproved property acquisition costs     $ 1,096,030
    Seismic and lease option costs            1,320,735
    Interest costs                              399,710
                                            -------------
                                            $ 2,816,475

     All  unevaluated  costs were incurred  during 1997 and 1998 and  management
expects that planned  activities will enable the evaluation of substantially all
of these costs by the end of 2000.

    Capitalization of Interest - For the years ended December 31, 1998 and 1997,
the Company capitalized  interest costs of $854,483 and $323,642,  respectively,
related to unevaluated oil and gas properties and other exploration activities.

     Full Cost  Ceiling - During  1998,  the Company  recognized  an  impairment
charge of $7,278,818 due to the full cost ceiling limitation of which $4,739,775
was recognized in the fourth quarter.  The fourth quarter  impairment  charge is
substantially  attributed to the  expiration of certain  previously  unevaluated
leases, the continuing collapse of oil prices and one dry hole.

    Costs  Incurred in Oil and Gas  Producing  Activities  - The  following is a
summary of costs  incurred  in oil and gas  producing  activities  for the years
ended December 31, 1998 and 1997:

                                                  1998               1997      
                                            -----------------  ----------------
             Property acquisition costs     $       -            $    4,266,955
             Development costs                     13,468               734,235
             Exploration costs                  6,799,382             9,499,572 
                                            -----------------    --------------
                      Total                 $   6,812,850        $   14,500,762 
                                            ================    ===============

    Results of  Operations  from Oil and Gas  Producing  Activities - Results of
operations  from  oil  and  gas  producing  activities  (excluding  natural  gas
marketing and trading,  well  administration  fees,  general and  administrative
expenses,  and interest  expense) for the years ended December 31, 1998 and 1997
are presented below.

                                                 1998                  1997     
                                         ------------------     ---------------
   Oil and gas sales                      $   2,360,000         $     3,168,000
   Production costs                          (1,050,000)             (1,487,000)
   Amortization expense                      (1,914,000)             (2,195,000)
   Impairment expense                        (7,279,000)             (9,506,000)
                                         -------------------    ----------------
      Results of operations from oil and
      gas producing activities            $  (7,883,000)        $   (10,020,000)
                                         ==================     -===============

    Oil and Gas Reserve Quantities (Unaudited) - Proved oil and gas reserves are
the  estimated  quantities  of crude oil,  natural  gas, and natural gas liquids
which geological and engineering  data demonstrate with reasonable  certainty to
be recoverable in future years from known reservoirs under existing economic and
operating  conditions.  Proved developed oil and gas reserves are those reserves
expected to be recovered  through  existing  wells with  existing  equipment and
operating  methods.  The  reserve  data is  based  on  studies  prepared  by the
Company's consulting petroleum engineers.  Reserve estimates require substantial
judgment  on  the  part  of   petroleum   engineers   resulting   in   imprecise
determinations, particularly with respect to new discoveries. Accordingly, it is
expected  that the estimates of reserves  will change as future  production  and
development  information becomes available.  All proved oil and gas reserves are
located in the United  States.  At December 31, 1997,  approximately  70% of the
Company's  proved  oil and gas  reserve  quantities  were  located  in the Rocky
Mountain  Region.  As  discussed  in Note 2,  the  Company  has  divested  these
properties.  The following table presents  estimates of the Company's net proved
oil and gas reserves,  and changes therein for the years ended December 31, 1998
and 1997.





                                      -37-

<PAGE>



<TABLE>
<CAPTION>
                                                           1998                        1997                    
                                                ------------------------   --------------------------
                                                  Oil            Gas           Oil           Gas
                                                 (Bbls)         (Mcf)         (Bbls)        (Mcf)      

<S>                                             <C>           <C>           <C>           <C>      
Proved reserves, beginning of year .........    1,085,000     4,535,000     1,175,000     4,833,000
   Purchase of minerals in place ...........         --            --         165,000       209,000
   Sale of minerals in place ...............     (725,000)   (2,848,000)      (16,000)      (45,000)
   Extensions, discoveries, and
        other additions ....................      129,000       517,000       229,000     1,295,000
   Revisions of previous estimates .........     (105,000)     (286,000)     (345,000)   (1,274,000)
   Production ..............................     (109,000)     (550,000)     (123,000)     (483,000)
                                               ----------    ----------    ----------    ----------
Proved reserves, end of year ...............      275,000     1,368,000     1,085,000     4,535,000
                                               ==========    ==========    ==========    ==========
Proved developed reserves, beginning of year      930,000     3,833,000     1,034,000     4,078,000
                                               ==========    ==========    ==========    ==========
Proved developed reserves, end of year .....      261,000       920,000       930,000     3,833,000
                                               ==========    ==========    ==========    ==========
</TABLE>

     The downward  revisions in both 1997 and 1998 were  primarily  attributable
to: a.)  substantially  lower oil and gas  prices in effect at their  respective
year  ends  when  compared  to the  prior  year;  and  b.)  previously  recorded
undeveloped reserves were removed as a result of drilling dry holes.

    Standardized  Measure  of  Discounted  Future  Net  Cash  Flows  (Unaudited)
Statement of Financial  Accounting  Standards No. 69 prescribes  guidelines  for
computing a  standardized  measure of future net cash flows and changes  therein
relating to estimated proved reserves. The Company has followed these guidelines
which are briefly discussed below.

    Future  cash  inflows  and  future  production  and  development  costs  are
determined by applying year-end prices and costs to the estimated  quantities of
oil and gas to be produced.  Estimated  future  income taxes are computed  using
current statutory income tax rates including  consideration for estimated future
statutory  depletion and tax credits.  The  resulting  future net cash flows are
reduced to present value amounts by applying a 10% annual discount factor.

    The  assumptions  used  to  compute  the  standardized   measure  are  those
prescribed  by the  Financial  Accounting  Standards  Board and, as such, do not
necessarily reflect the Company's expectations for actual revenues to be derived
from those reserves nor their present  worth.  The  limitations  inherent in the
reserve  quantity  estimation  process,  as  discussed  previously,  are equally
applicable to the standardized  measure  computations  since these estimates are
the basis for the valuation process.

    The  following  summary  sets  forth the  Company's  future  net cash  flows
relating to proved oil and gas  reserves as of December  31, 1998 and 1997 based
on the  standardized  measure  prescribed  in Statement of Financial  Accounting
Standards No. 69.
 <TABLE>
 <CAPTION>
                                         1998                             1997                                    
                                    --------------  ----------------------------------------------
                                                         Gulf              Rocky
                                                        Coast            Mountain        Total
<S>                                  <C>             <C>             <C>             <C>         
Future cash inflows ..............   $  6,117,000    $  8,560,000    $ 18,202,000    $ 26,762,000
Future production costs ..........     (1,519,000)     (1,237,000)     (7,947,000)     (9,184,000)
Future development costs .........       (544,000)     (1,527,000)     (1,680,000)     (3,207,000)
Future income tax expense ........           --              --              --              --
                                                                                     ------------
         Future net cash flows ...      4,054,000       5,796,000       8,575,000      14,371,000
10% annual discount for estimated
    timing of cash flow ..........     (1,103,000)     (1,336,000)     (3,357,000)     (4,693,000)
                                     ------------    ------------    ------------    ------------
Standardized Measure of Discounted
   Future Net Cash Flows .........   $  2,951,000    $  4,460,000    $  5,218,000    $  9,678,000
                                     ============    ============    ============    ============
</TABLE>

    Changes  in  Standardized  Measure  (Unaudited)  -  The  following  are  the
principal sources of change in the standardized measure of discounted future net
cash flows for the years ended December 31, 1998 and 1997:

                                                    1998               1997    
                                               ----------------  ---------------

Standardized measure, beginning of year           $  9,678,000    $  11,980,000
Sale of oil and gas produced, net of
    production costs                                (1,310,000)      (1,681,000)
Purchase of minerals in place                            -            2,231,000
Sale of minerals in place                           (5,109,000)        (121,000)
Net changes in prices and production costs          (1,031,000)      (8,437,000)
Net changes in estimated development costs             907,000         (185,000)
Revisions of previous quantity estimates            (2,874,000)      (2,179,000)
Discoveries, extensions, and other additions         1,722,000        3,214,000
Accretion of discount                                  968,000        1,198,000
Changes in income taxes, net                             -            3,658,000
                                                ----------------  -------------

Standardized Measure, end of year                 $  2,951,000    $   9,678,000
                                                  =============  ===============







                                      -38-

<PAGE>



                               PART II (Continued)

ITEM 8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
FINANCIAL DISCLOSURE

This item is not applicable to the Registrant.

                                    PART III


ITEM 9.     DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; 
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

Directors and Executive Officers
The following  table sets forth the names and ages of the current  directors and
executive officers of the Company,  the principal offices and positions with the
Company  held by each  person  and the date such  person  became a  director  or
executive  officer of the  Company.  The  executive  officers of the Company are
elected  annually by the Board of  Directors.  The Board of Directors is divided
into three approximately equal classes. The directors serve three year terms and
until their successors are elected.  Each year the stockholders  elect one class
of  directors.  The  executive  officers  serve terms of one year or until their
death,  resignation  or removal by the Board of  Directors.  There are no family
relationships  between any of the directors and executive officers. In addition,
there was no arrangement or understanding  between any executive officer and any
other person pursuant to which any person was selected as an executive officer.

The directors and executive officers of the Company are as follows:
                                                                      Served as
         Name           Age  Position With the Company            Director Since
Patrick J. Duncan        36  President, Chief Financial Officer,       1995
                               and Director  (Term Expires 2000)

Steve A. Antry           43  Director (Term Expires 2001)              1996

Stephen L. Fischer       40  Director (Term Expires 2001)              1997

Homer C. Osborne (2)     69  Director (Term Expires 2001)              1994

James C. Ruane (1)(2)    64  Director (Term Expires 2001)              1980

Clemons F. Walker (2)    59  Director (Term Expires 1999)              1996

William F. Warnick (1)(2)51  Chairman of the Board and
                             Director (Term Expires 1999)              1988

    (1) Member of the Audit Committee of the Board of Directors.
    (2) Member of the Compensation Committee.

    The Company's  Board of Directors held 12 meetings  during 1998. One meeting
was held by unanimous  written consent signed by all directors without an actual
meeting and eleven were actual  meetings at which all directors  attended except
for Steve A. Antry who missed two meetings.

    The Company has an audit committee, consisting of James C. Ruane and William
F. Warnick which met once in 1998.  The functions of the audit  committee are to
review financial  statements,  meet with the Company's  independent auditors and
address accounting matters or questions raised by the auditors.

     The  Company has a  compensation  committee  consisting  of James C. Ruane,
Homer C. Osborne,  Clemons F. Walker and William F.  Warnick,  which met once in
1998. The functions of the compensation  committee are to review compensation of
officers and employees and  administer  and award options under all stock option
plans of the Company.


                                      -39-

<PAGE>



      Patrick J. Duncan has been the  President  of the Company  since  November
1998 and Chief  Financial  Officer of the  Company  since  September  1994,  the
Company's Corporate Secretary since April 1995 and the Company's Treasurer since
March 1996.  In addition to managing the  day-do-day  activities of the Company,
Mr. Duncan is responsible for all the financial,  accounting and  administrative
reporting and compliance  required by his individual job titles.  Mr. Duncan was
an Audit Manager with HEIN + ASSOCIATES LLP, Certified Public Accountants,  from
1991 until joining the Company as the Company's  Controller in April 1994.  From
1988 until 1991,  Mr.  Duncan was an Audit  Supervisor  with  Coopers & Lybrand,
Certified  Public  Accountants.  Mr.  Duncan  received  a B.S.  degree  from the
University of Wyoming in 1985.

    Steve A. Antry is founder and  president  of Beta  Capital  Group,  Inc.,  a
financial consulting firm located in Newport Beach, California. Beta specializes
in advising  emerging oil and gas  exploration  companies that have both capital
needs and market support requirements.  Prior to forming Beta in 1992, Mr. Antry
was an  executive  officer of Benton Oil & Gas  Company  from 1989 to 1992 and a
Marketing  Director for Swift Energy's income funds from 1987 to 1989. Mr. Antry
is also a registered  representative with Signal Securities,  Inc., a registered
broker/dealer,   and  has  B.B.A.  and  M.B.A.   degrees  from  Texas  Christian
University.

    Stephen L. Fischer joined Beta Capital Group,  Inc., a financial  consulting
firm  located in Newport  Beach,  California,  in March 1996 as Vice  President.
Between  1991 and prior to joining  Beta in 1996,  Mr.  Fischer was a Registered
Representative of Peacock,  Hislop,  Staley & Given, an Arizona based investment
banking  firm.  Since  1983,  Mr.  Fischer  has held  various  positions  in the
financial  services industry in investment  banking,  retail,  and institutional
sales,  with a  special  emphasis  on the oil and gas  exploration  sector.  Mr.
Fischer  has been a  private  investor  in the oil and gas  industry  for over a
decade.

    Homer C.  Osborne was an officer and director of Garrett  Computing  System,
Inc., a petroleum engineering and computing firm, from 1967 until 1976, at which
time he organized  Osborne Oil Company as a  wholly-owned  subsidiary of Garrett
Computing  Systems,  Inc. Mr. Osborne operated Osborne Oil Company as a separate
entity from 1976 until 1998, when he sold the Company.  Mr. Osborne is currently
enjoying retirement.

    James C. Ruane has owned and operated Goodall's Charter Bus Service, Inc., a
bus  chartering  business  representing  Grey Line in the San Diego area,  since
1958. Mr. Ruane has been an oil and gas investor for over 20 years.

    Clemons F. Walker has been an independent  financial consultant since August
of 1996. Prior to that he was employed as an investment  banker and stockbroker.
Between  1978 and August 1995 Mr.  Walker  worked for Wilson Davis in Las Vegas,
Nevada when  Presidential  Brokerage  purchased  the Wilson  Davis office in Las
Vegas and he  continued to work for the  surviving  entity until August of 1996.
Since  1978 Mr.  Walker  has  focused  his  efforts  in  investment  banking  by
supporting small-cap companies through assistance in private placements,  public
offerings and other capital raising efforts.  During his career,  Mr. Walker has
organized,  advised,  facilitated,  sold and  participated  in numerous debt and
equity  transactions  (both  public and  private)  in a variety  of  industries,
including the oil and gas industry.  Mr. Walker has a bachelor of arts degree in
Business  Administration  from Brigham Young  University with a concentration in
Finance.

    William F.  Warnick has been a practicing  attorney in Lubbock,  Texas since
1971.  He was elected as Chairman of the Board of  Directors  in July 1998.  Mr.
Warnick  serves as the Texas  Attorney  General's  appointee to the Texas School
Board Land  Commission and is a member of the American,  Texas,  and Lubbock Bar
Associations. He is an oil and gas investor and has served in various management
positions of private independent oil and gas companies.
Mr. Warnick received a B.A. degree in finance and a J.D. degree in 1971.

COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934

Section  16(a) of the  Securities  Exchange Act of 1934  requires the  Company's
officers  and  directors,  and  persons  who own more  than ten  percent  of the
Company's  Common  Stock,  to file reports of ownership and changes in ownership
with the Securities and Exchange  Commission  ("SEC").  Officers,  directors and
greater than ten percent stockholders are required by SEC regulations to furnish
the Company with copies of all Section 16(a) forms they file.

The following  disclosure is based solely upon a review of the Forms 3 and 4 and
any amendments thereto furnished to the Company during the Company's fiscal year
ended December 31, 1998, and Forms 5 and amendments thereto

                                      -40-

<PAGE>



furnished  to  the  Company  with  respect  to  such  fiscal  year,  or  written
representations that no Forms 5 were required to be filed by such persons. Based
on this review the following  person who was a director and beneficial  owner of
more than 10% of the Company's  outstanding Common Stock during such fiscal year
filed late reports on Forms 3 and 4.

Mr. Willard H. Pease, Jr., Mr. Patrick J. Duncan, and Mr. Clemons F. Walker each
filed one late report on Form 4 reporting one transaction.  All of the directors
filed a late Form 4 at the end of the year reporting the Company's reverse stock
split.

ITEM 10-EXECUTIVE COMPENSATION

Summary Compensation Table
The  Summary  Compensation  Table shows  certain  compensation  information  for
services  rendered in all capacities  during each of the last three fiscal years
by the Chief Executive Officer and those executive officers who received salary,
bonus or other  compensation  in  excess  of  $100,000  (these  individuals  are
collectively  referred  to  herein  as  the  "Named  Executive  Officers").  The
following information for the Named Executive Officers includes the dollar value
of base salaries,  bonus awards, the number of stock options granted and certain
other compensation, if any, whether paid or deferred.

<TABLE>
<CAPTION>
                                        SUMMARY COMPENSATION TABLE
                                                                                  Long-Term
                               Annual Compensation                          Compensation Awards     
                                                                          Restricted   Securities
Name and Principal                                                 Other     Stock      Underlying
Position                         Year  Salary (1)       Bonus   Compensation Awards    Options/SARs(#)
------------------------------  -----  ----------       -----     -------    -------   -------------

<S>                              <C>    <C>                                                   
Patrick J. Duncan ............   1998   $104,370          None      None       None       None
    President and CFO (6) ....   1997   $ 79,791      $  5,000      None       None     24,500
                                 1996   $ 65,548      $  5,000(3)   None       None      2,900
Willard H. Pease, Jr .........   1998   $108,303      $ 25,000    $150,000(4)  None       None
    Former President and .....   1997   $ 93,270      $  5,000      None       None     25,000
    Chief Executive Officer(4)   1996   $ 78,530      $  5,000(3) $101,250(2)  None     11,040
J.N. Burkhalter ..............   1998       None          None      None       None       None
    Former V.P. Engineering ..   1997   $ 84,790          None    $138,050(5)  None      3,500
    and Production (5) .......   1996   $ 68,690      $  5,000(3)   None       None      2,700
</TABLE>

     (1)  Includes  $240  contributed  by the  Company  each year to a qualified
401(k) retirement plan.

     (2) At December 31, 1995 the Company owed $60,000 to Mr.  Pease.  This loan
was  unsecured,  bore interest at 8% per annum and was originally due on January
31, 1996. On March 9, 1996 the Board of Directors  agreed to change the terms of
the note to allow the note to be convertible  into the Company's common stock at
$10.00 per share,  the then  current  market  rate,  in exchange  for a one-year
extension on the note.  On December  16, 1996 Mr.  Pease  elected to convert the
note in its  entirety,  the note was  canceled  and Mr.  Pease was issued  6,000
shares of the Company's  restricted  common stock.  The $101,250  shown as other
annual compensation represents the difference between the closing sales price as
reported by NASDAQ on December 16, 1996 and the  conversion  price of $10.00 per
share.  No  additional  amounts  have been  shown as Other  Annual  Compensation
because the  aggregate  incremental  cost to the  Company of  personal  benefits
provided to Mr.  Pease did not exceed the lesser of $50,000 or 10% of his annual
salary in any given year.

     (3) On March 9, 1996 the Board of Directors  granted Mr. Duncan,  Mr. Pease
and Mr.  Burkhalter  500 shares  each of the  Company's  common  stock for prior
services.  The  shares  were  valued at  $5,000,  or  $10.00  per  share,  which
represented the market price of the Company's common stock on the date of grant.
The shares are fully vested.

     (4)  In  December  1998  Mr.  Pease's   employment  with  the  Company  was
terminated.  In  accordance  with his amended  employment  agreement,  Mr. Pease
received a cash payment of $150,000 for severance.

     (5) Effective January 1, 1998, Mr. Burkhalter  resigned his position as the
Company's  V.P.  of  Engineering  and  Production  in  light  of  the  Company's
anticipated  sale  of  the  Rocky  Mountain  assets.   In  connection  with  his
resignation,  Mr. Burkhalter  received total severance of $138,050 consisting of
office equipment and one vehicle valued at $5,850,  and a future cash obligation
of $132,200. The cash obligation will be paid

                                      -41-

<PAGE>



in monthly  installments  through August 2000. This severance was granted by the
Company,  in part,  pursuant  to the  terms  of an  employment  agreement  dated
December 27, 1994.

     (6) Mr.  Duncan was  appointed by the Board of  Directors as the  Company's
President on an interim basis to succeed Mr. Pease.  No additional  amounts have
been shown as Other Annual Compensation  because the aggregate  incremental cost
to the Company for personal  benefits  provided to Mr. Duncan did not exceed the
lesser of $50,000 or 10% of his annual salary in any given year.

Option Grants in the Last Fiscal Year
There were no grants of stock options to the Named Executive  Officers  pursuant
to the  Company's  Stock Option Plans during the fiscal year ended  December 31,
1998.

Aggregated Option Exercises in the Last Fiscal Year and the Fiscal Year-End 
Option Values

Set forth  below is  information  with  respect  to the  unexercised  options to
purchase the Company's Common Stock held by Named Executive Officers at December
31, 1998. No options were exercised during fiscal 1998.

<TABLE>
<CAPTION>
                       Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values
                                                                 Number of
                                                                 Securities        Value of
                                                                 Underlying        Unexercised
                                                                 Unexercised       In-the-Money
                                                                 Options/SARs      Options/SARs
                                                                 at FY-End (#)     at FY-End ($)
                           Shares Acquired    Value Realized     Exercisable/      Exercisable/
 Name                        on Exercise (#)                   ($Unexercisable     Unexercisable
<S>                                                              <C>    <C>         <C> <C> 
Patrick J. Duncan ...........   None             None            35,000/35,000      $ 0/0(1)
      President and
      Chief Financial Officer
Willard H. Pease, Jr ........   None             None            50,000/50,000      $0/0
      Former President and
      Chief Executive Officer
</TABLE>

    (1) The value of the  unexercised  In-the-Money  Options was  determined  by
multiplying  the number of  unexercised  options  (that  were in other  money on
December  31,  1998) by the  closing  sales  of the  Company's  common  stock on
December  31,1998 (as reported by NASDAQ) and from that total,  subtracting  the
total exercise price. No options were in-the-money at December 31, 1998.

Option and Warrant Repricing
In February 1998 the Board of Directors  repriced  20,000  options that had been
previously granted to Mr. Duncan from $27.50 to $17.50 per share. In November of
1998 the Board of Directors  repriced  10,000 options that had  previously  been
granted to Mr. Duncan from $17.50 to $5.00 per share.

In connection  with the  termination  agreement with Willard H. Pease,  Jr., the
Board of  Directors  repriced  20,000  warrants  previously  granted to him from
$27.50 to $5.00 per share.

Employment  Contract
Mr. Willard Pease,  Jr.'s  employment  with the Company was terminated on 
December 7, 1998.  Mr. Pease had been the Company's  President and Chief 
Executive Officer. Pursuant to his amended employment agreement, Mr. Pease
was paid $150,000 for severance  and signed a formal  Severance and  Termination
Agreement which canceled any further committment.

The Company  reaffirmed  the  Employment  Agreement  of Patrick J. Duncan as the
Company's  President and Chief  Financial  Officer dated  December 27, 1994 by a
letter dated January 11, 1999 at an annual salary of $97,500.  Upon  termination
or change of control,  the  Company is  obligated  to pay Mr.  Duncan one to two
year's salary.

Compensation of Directors
Directors who are employees or otherwise  receive  compensation from the Company
do not  receive  additional  compensation  for  service  as  directors.  Outside
directors each receive a $2,500 annual  retainer fee, $750 per meeting  attended
and $100 per meeting conducted via telephone conference plus options to purchase
5,000  shares of the  Company's  common  stock at the current  market price each
January 1st. All fees are paid in the form of Company

                                      -42-

<PAGE>



restricted common stock.  Outside  directors serving on the Executive  Committee
receive a cash fee for the lessor of $75 per hour or $600 per day.

ITEM 11-  SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS

The following  table sets forth  certain  information  regarding the  beneficial
ownership of the Company's  Common Stock,  its only class of outstanding  voting
securities  as of April 15, 1998,  by (i) each of the  Company's  directors  and
officers,  and (ii) each  person or entity  who is known to the  Company  to own
beneficially  more than 5% of the  outstanding  Common Stock with the address of
each such person or entity:

                        SECURITY OWNERSHIP OF MANAGEMENT

     Name and Address of          Amount and Nature of
       Officer or Director        Beneficial Ownership(1)     Percent of Class
-----------------------------     -----------------------     ----------------
Steve Allen Antry ..........        52,695 Shares    (2)           3.04%
Patrick J. Duncan ..........        36,563 Shares    (3)           2.62%
Stephen L. Fischer .........        21,965 Shares    (4)           1.28%
Homer C. Osborne ...........         5,256 Shares    (5)           0.31%
James C. Ruane .............        27,684 Shares    (6)           1.63%
Clemons F. Walker ..........        25,934 Shares    (7)           1.52%
William F. Warnick .........         8,919 Shares    (8)           0.53%
                                                     --             ----
  All Officers and Directors as a
  group (seven persons) .........   179,016 Shares   (9)           9.58%

                     SECURITY OWNERSHIP OF BENEFICIAL OWNERS

       Name and Address of                 Amount and Nature of      Percent
           Beneficial Owner               Beneficial Ownership(1)    of Class
Kayne Anderson, et al .................
   1800 Avenue of the Stars
   Second Floor
   Los Angeles, CA 90067 ..............   8,462,649 Shares(10)(11)    83.36%
State Street, et al
   Chase/Chemical Bank
   A/C State Street Bank & Trust Co. ..
   4 New York Plaza
   Ground Floor/Receive Window
   New York, NY 10004 .................   5,688,889 Shares(10)(12)    77.11%
Howard Amster IRA
   111 East Kilbourn Ave ..............
   Milwaukee, WI 53202 ................   142,222 Shares(10)           7.77%
The Madav IX Foundation
   1750 Euclid Avenue
   Cleveland, OH 44115 ................   284,444 Shares(10)          14.42%
Ramat Securities, Ltd. ................
   23811 Chagrin Blvd., Suite 200
   Beachwood, OH 44122 ................   92,444 Shares(10)            5.19%
Tamar Securities, Inc. ................
   23811 Chagrin Blvd., Suite 200
   Beachwood, OH 44122 ................   426,667 Shares(10)          20.17%

Security Ownership of Beneficial Owners
    as a Group (10 entities) ..........   15,097,315 Shares(10)(13)   89.94%(13)

(1) Beneficial  owners listed have sole voting and investment power with respect
to the shares unless otherwise indicated.


                                      -43-

<PAGE>



(2)  Includes  300  shares  that are owned  directly  by Mr.  Antry,  750 shares
underlying  presently  exercisable  options,  6,146 shares underlying  presently
exercisable  warrants,   and  45,500  shares  underlying  presently  exercisable
warrants that are held by Mr. Antry's wife.

(3) Includes 1,563 shares owned directly by Mr. Duncan, 35,000 shares underlying
presently exercisable options.

(4) Includes 895 shares owned directly by Mr.  Fischer,  400 shares owned by his
wife, and 20,670 shares underlying presently exercisable warrants.

(5)  Includes  976  shares  owned  directly  by Mr.  Osborne  and  4,280  shares
underlying  presently  exercisable  options.  

(6) Includes  18,753 shares owned directly by Mr. Ruane,  456 shares held by Mr.
Ruane as trustee for two trusts,  over which  shares Mr.  Ruane may be deemed to
have shared  voting and  investment  power,  1,225 shares  underlying  presently
exercisable warrants, 7,250 shares underlying presently exercisable options.

(7)  Includes  10,913  shares  owned  directly  by  Mr.  Walker,  14,271  shares
underlying presently exercisable  warrants,  and 750 shares underlying presently
exercisable options.

(8) Includes 3,169 shares owned directly by Mr. Warnick, 5,750 shares underlying
presently exercisable options.

(9)  Includes  37,424  shares  owned,  directly  or  indirectly,  53,780  shares
underlying  presently  exercisable  options,  87,812 shares underlying presently
exercisable warrants.

(10) Includes the number of shares of Common Stock  issuable upon  conversion of
outstanding  Series B preferred stock at an assumed  Conversion  Price of $0.35.
The Conversion  Price of the Series B preferred  stock is based on a discount to
market,  at the time of  conversion,  as defined in the amended  Certificate  of
Designation (which is currently 25%).  Accordingly,  the number of shares issued
upon  conversion  could  be  larger  or  smaller,  depending  on the  applicable
Conversion  Price at the time of conversion.  Also,  this table does not include
shares of Common Stock which would be issuable  upon  conversion  of  additional
Series B Preferred  Stock which might be issued to holders  from time to time as
payment in kind for dividends on outstanding Series B Preferred.

(11)  The  preferred  stock  is held  by four  entities  which  are  effectively
controlled by Kayne Anderson Investment Management,  Inc., a Nevada corporation.
The entities  include  Arbco  Associates,  L.P.,  Kayne  Anderson  Non-Tradition
Investments,  L.P., Offense Group Associates,  L.P. and Opportunity  Associates,
L.P.

(12)  The  preferred  stock  is  held by two  entities,  Marine  Crew & Co,  and
Sandpiper & Co. that are  effectively  controlled  by State Street  Research and
Management Company, a registered investment advisor.

(13) As of the date of this  report,  the  Company  does  not have a  sufficient
number of  authorized  shares of common stock  necessary  for  conversion of all
outstanding  Series B  Preferred  stock.  Information  set  forth in this  table
assumes that the Company duly  authorizes the issuance of additional  shares and
is based on the reported  closing price of the  Company's  common stock on March
23, 1999.

ITEM 12-CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

General and Overview -
From time to time,  various  officers  and  directors  of the  Company and their
affiliates  have  participated  in the  drilling of oil and gas wells which were
drilled and  operated by the Company.  All such persons and entities  have taken
working  interests  in the  wells  and have paid the  drilling,  completion  and
related  costs of the  wells on the same  basis  as the  Company  and all  other
working interest owners. On occasions of such participation the Company retained
the  maximum  interest  in the  well  that it  could  justify,  given  its  cash
availability and the risk involved.

All existing loans or similar advances to, and transactions  with,  officers and
their affiliates were approved or ratified by the independent and  disinterested
directors. Any future material transactions with officers,  directors and owners
of 5% or more of the Company's  outstanding Common Stock or any affiliate of any
such person  shall be on terms no less  favorable  to the Company  than could be
obtained from independent  unaffiliated  third parties and must be approved by a
majority of the independent disinterested directors.


                                      -44-

<PAGE>



Transactions with Beta Capital Group, Inc.-

In March 1996 the Company  entered into a three-year  consulting  agreement with
Beta Capital Group, Inc.  ("Beta").  Beta's  president,  Steve Antry, has been a
director of the Company since August 1996.  The  consulting  agreement with Beta
provides for minimum  monthly cash  payments of $17,500 plus  reimbursement  for
out-of-pocket  expenses. The Company also agreed to pay Beta additional fees, as
defined in the  agreement,  that are based on a percentage of the gross proceeds
generated from any public financing, private financing or from any warrants that
are exercised  during the term of the  agreement.  The following is a summary of
amounts  paid by the  Company  to Beta,  or its  agents,  during the term of the
agreement:

<TABLE>
<CAPTION>
                                                                1998         1997         1996        Total
                                                          ----------   ----------   ----------   ----------
<S>                                                       <C>          <C>          <C>          <C>       
Monthly consulting fees ...............................   $  210,000   $  210,000   $  162,500   $  582,500
Reimbursement of out-of-pocket expenses ...............       37,123      167,236       94,700      299,059
Fees related to funds generated from private placements         --        320,933      163,000      483,933
Fees related to funds generated from warrant exercises          --        273,855        4,506      278,361
                                                          ----------   ----------   ----------   ----------
    Total .............................................   $  247,123   $  972,024   $  424,706   $1,643,853
                                                          ==========   ==========   ==========   ==========
</TABLE>

In addition to the cash compensation,  in 1996 the Company granted Beta warrants
to purchase  100,000  shares of the Company's  common stock for $7.50 per share.
For  financial  statement  reporting  purposes,  these  warrants  were valued at
$294,000.  As  allowed  under  the  terms of the  agreement,  Beta  subsequently
assigned  40,000 of those warrants to other parties,  including  10,000 to a Mr.
Richard  Houlihan,  a former  director of the Company and 20,670 to Mr.  Stephen
Fischer,  a current  director of the Company (Mr. Fischer is also a principal of
Beta).  In March  1997,  the  Company  granted  Beta  warrants  to  purchase  an
additional  10,000 shares of the Company's common stock at $37.50 per share. For
financial statement reporting purposes, these warrants were valued at $60,000.
All the warrants granted Beta expire in April 2001.

Transactions with Other Directors-

In July 1998 the Company's Board of Directors established an Executive Committee
designed  to manage the  significant  aspects  of the  Company's  business  on a
committee basis. Mr. William F. Warnick, a director,  was elected as Chairman of
the Committee.  In exchange for his services in 1998, Mr. Warnick  received cash
compensation  of  $44,010  plus  $17,966  for   reimbursement  of  out-of-pocket
expenses.

In May 1997 the  Company  entered  into a  consulting  agreement  with R. Thomas
Fetters,  Jr., who also became a director of the Company in May 1997.  The terms
of the  consulting  agreement  provide for monthly cash  payments of $4,000 plus
reimbursement for out-of-pocket  expenses.  Total amounts paid to Mr. Fetters in
1997 were $74,610 and $43,112 in 1998. In addition to the cash  compensation Mr.
Fetters also received  warrants to purchase 1,500 shares of the Company's common
stock at $12.50 per share and warrants to purchase an  additional  10,000 shares
at $30.00 per share.  The contract was terminated in August 1998 and Mr. Fetters
resigned as a Director in November 1998.

In July 1997, the Company acquired a .1% overriding royalty interest in the East
Bayou Sorrel Field from an entity that Homer Osborne, a director of the Company,
was a principal.  The interest was acquired for $50,000,  consisting  of $40,000
cash and 315 shares of common stock valued at $10,000.  Mr. Osborne received all
of the common shares and $7,000 cash in the transaction.

Transactions  with Former  Officers- 

On December 7, 1998,  Mr. Willard H. Pease, Jr.'s  employment  with the company 
was  terminated.  Mr. Pease was formerly the President,  Chairman and CEO. In 
connection with his termination and pursuant to the terms of his amended 
employment agreement, Mr. Pease received a cash payment of $150,000 for 
severance.

Effective  January 1, 1998, Mr. J. N. Burkhalter  resigned as the Company's V.P.
of Engineering and Production in light of the Company's  anticipated sale of the
Rocky Mountain assets. In connection with this resignation,  the Company entered
into a Retirement,  Severance and  Termination of Employment  Agreement with Mr.
Burkhalter  that  provided  for  total  severance  of  $138,050.  The  severance
consisted  of office  equipment  and one  vehicle  valued  at $5,850  and a cash
obligation  of  $132,200,  which  will be paid in monthly  installments  through
August 2000.




                                      -45-

<PAGE>



                                     PART IV


ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

Exhibit No.                   Description and Method of Filing

(3.1)                 Articles of Incorporation, as amended. 
(3.2)                 Certificate of Amendment to the Articles of Incorporation
                      filed on June 23, 1993.
(3.3)                 Certificate of Amendment to the Articles of Incorporation 
                      filed on June 29, 1993.
(3.4)                 Plan of Recapitalization 
(3.5)                 Certificate of Amendment to the Articles of Incorporation 
                      filed on July 5, 1994.  
(3.6)                 Certificate of Amendment to the Articles of Incorporation 
                      filed on December 19, 1994. (2)
(3.7)                 Certificate of Amendment to Article IV of the Articles of 
                      Incorporation incorporated  by  reference to Exhibit 3(i) 
                      of the Registrant's Form 8-K dated June 11, 1997.(7)
(3.8)                 Certificate of Change in Number of Authorized Shares of  
                      Common Stock dated November 18, 1998 
(3.9)                 Bylaws, as amended and restated May 11, 1993. 
(4.4)                 Amendment to the Certificate of Designation of Series B 5%
                      PIK Cumulative  Convertible Preferred Stock,  incorporated
                      by reference to Exhibit 3.2 of Registrant's Form 8-K dated
                      December 31,1997.(8)
(10.2)                1990 Stock Option Plan. 
(10.3)                1993 Stock Option Plan 
(10.4)                1994 Employee Stock Option Plan. (2)
(10.6)                Employment Agreement effective December 27, 1994 between 
                      Pease Oil and Gas Company and Patrick J. Duncan. (2)
(10.8)                Agreement dated August 15, 1994, between Hewlett-Packard 
                      Company, Loveland Gas Processing Co., Ltd., Pease Oil and 
                      Gas Company and Pease Operating Company. (2)
(10.9)                Agreement between Beta Capital Group, Inc., and Pease Oil 
                      and Gas Company dated  March 9, 1996. (3)
(10.10)               Form of Warrants issued to Beta Capital Group, Inc.(11)
(10.11)               1996 Stock Option Plan.(11)
(10.13)               Purchase and Sale Agreement dated December 31, 1996 by and
                      between Atocha Exploration, Inc., Browning Oil Company, 
                      Inc., Potosky Oil and Gas, Inc. and Pease Oil and Gas 
                      Company. (4)
(10.14)               Letter Agreement dated February 4, 1997 by and between 
                      National Energy Group, Inc. and Pease Oil and Gas 
                      Company. (5)
(10.15)               Purchase and Sale Agreement dated February 26, 1997 with
                      Transworld Exploration & Production, Inc. (6)
(10.16)               1997 Long Term Incentive Option Plan (12)
(10.17)               Preferred Stock Investment Agreement dated December 31, 
                      1997.(9)
(10.18)               Letter Agreement dated 1/16/98 between National Energy 
                      Group, Inc. and Pease Oil and Gas Company.(12)
(10.19)               Letter Agreement dated 7/22/97 between National Energy 
                      Group, Inc., Sullivan & Company 3-D Program 1, LLC and 
                      Willisco, Inc.(12)
(10.20)               Agreement between National Energy Group, Inc. and Acadian
                      Geophysical Services, Inc.(12)
(10.21)               Exploration Agreement dated 8/1/97 between Parallel 
                      Petroleum Corporation, TAC Resources, Inc., Allegro 
                      Investments, Inc., Beta Oil and Gas Company, Pease Oil 
                      and Gas Company, Four-Way Texas, LLC, Meyer Financial 
                      Services, inc. and Wes-Tex Drilling Corporation regarding
                      the Texana Prospect (12)
(10.22)               Exploration Agreement dated 8/1/97 between Parallel 
                      Petroleum Corporation, TAC Resources, Inc., Allegro 
                      Investments, Inc., Beta Oil and Gas Company, Pease Oil and
                      Gas Company, Four-Way Texas, LLC, Meyer Financial 
                      Services, inc. and Wes-Tex Drilling Corporation regarding
                      the Formosa Prospect (12)

                                      -46-

<PAGE>



(10.23)               Exploration Agreement dated 1/1/97 between Parallel 
                      Petroleum Corporation, Sue-Ann Production Company, TAC 
                      Resources, Inc., Allegro Investments, Inc., Beta Oil and 
                      Gas Company, Pease Oil and Gas Company, Meyer Financial 
                      Services, Inc., Four-Way Texas, LLC regarding the
                      Ganado Prospect (12)
(10.24)               Retirement, Severance and Termination of Employment 
                      Agreement from James N. Burkhalter dated 1/1/98. (12)
(10.25)               Letter Agreement dated May 20, 1998 between National 
                      Energy Group, Inc. and Pease Oil and Gas Company
(10.26)               Amended  Employment  Agreement  effective November 1, 1998
                      between Willard H. Pease,Jr.and Pease Oil and Gas 
                      Company
(10.27)               Severance and Termination of Employment Agreement 
                      effective December 7, 1998 between Willard H. Pease, Jr. 
                      and Pease Oil and Gas Company
(10.28)               Confirmation of Employment Contract effective January 11, 
                      1998 between Patrick J. Duncan and Pease Oil and Gas 
                      Company
(10.29)               Engagement Letter of San Jacinto Securities, Inc. dated 
                      September 4, 1998 with Pease Oil and Gas Company
(21)                  List of Subsidiaries
(23.2)                Consent of Netherland, Sewell & Associates, Inc., 
                      Consulting Petroleum Engineers
(23.3)                Consent of Hein + Associates LLP, Certified Public 
                      Accountants
(27)                  Financial Data Schedule.

Footnotes for Exhibits:
    (1)  Incorporated by reference to Registration Statement No. 33-64448 on 
         Form SB-2.
    (2) Incorporated by reference to the Registrant's 1994 Annual Report on Form
        10-KSB for the fiscal year ended December 31, 1994.
    (3) Incorporated  by reference  to the  Registrant's  Annual  Report on Form
        10-KSB for the fiscal year ended December 31, 1995.
    (4) Incorporated  by  reference  to Form 8-K filed  January 10,  1997.  
    (5) Incorporated  by  reference  to  Form  8-K  filed  February  19,  1997. 
    (6) Incorporated by reference to Form 8-K filed March 17, 1997. 
    (7) Incorporated by reference to Form 8-K filed June 11, 1997. 
    (8) Incorporated by reference to Form 8-K filed December 24, 1997. 
    (9) Incorporated  by reference to Form 8-K filed January 13, 1998.  
    (10)Incorporated by reference to Form 8-K filed March 9, 1998.  
    (11)Incorporated  by  reference to the  Registrant's  Annual Report on Form
        10-KSB for the fiscal year ended December 31, 1996.
    (12)Incorporated by reference to the Registrant's Annual Report on Form
        10-KSB for the fiscal year ended December 31, 1997. 
 
(b) Reports on Form 8-K: The Company filed the following reports on Form 8-K for
the period October 1, 1998 through the date of this report:

         Item Reported               Date                Financial Statements  
         -------------    ----------------------       ----------------------
    (1)        5,7        September 30, 1998             None - Not Applicable
    (2)        5          December 1, 1998               None - Not Applicable
    (3)        5          December 12, 1998              None - Not Applicable












                                      -47-

<PAGE>


                                   SIGNATURES

In  accordance  with  Section 13 or 15 (d) of the Exchange  Act, the  Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

                                       PEASE OIL AND GAS COMPANY

Date: March 31, 1999                By:/s/ Patrick J. Duncan   .         
                                       -------------------------------------
                                       Patrick J. Duncan
                                       President, Chief Financial Officer
                                       And Principal Accounting Officer

Date: March 31, 1999                By: /s/ William F. Warnick            
                                       --------------------------------------
                                       William F. Warnick
                                       Chairman of the Board

In  accordance  with the Exchange  Act, this report has been signed below by the
following  persons on behalf of the  Registrant and in the capacities and on the
dates indicated.


Date: March 31, 1999                By:/s/ Patrick J. Duncan   .         
                                       -------------------------------------
                                       Patrick J. Duncan
                                       President, Chief Financial Officer

Date: March 31, 1999                By:/s/ Steve A. Antry                   
                                       ----------------------------------------
                                       Steve A. Antry, Director

Date: March 31, 1999                By:/s/ Stephen L. Fischer            
                                       -------------------------------------
                                       Stephen L. Fischer

Date: March 31, 1999                By:/s/ Homer C. Osborne            
                                       -----------------------------------
                                       Homer C. Osborne, Director

Date: March 31, 1999                By:/s/ James C. Ruane                
                                       -------------------------------------
                                       James C. Ruane, Director

Date: March 31, 1999                By:/s/ Clemons F. Walker           
                                       -----------------------------------
                                       Clemons F. Walker, Director

Date: March 31, 1999                By: /s/ William F. Warnick            
                                       --------------------------------------
                                       William F. Warnick, Director
                                       Chairman of the Board

                                      -48-

<PAGE>