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, 1997

                          Commission File Number 0-6580

                            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)                   (Zip code)

                                 (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)
   Series A Cumulative Convertible Preferred Stock (Par Value $0.01 Per Share)
             Common Stock Purchase Warrants (Expire August 13, 1998)
                                 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 $4,659,309.

     As of March 18,  1998 the  issuer  had  15,789,955  shares of its $0.10 par
value Common Stock issued and outstanding.  Based upon the closing sale price of
$1.06 per share on March 18,  1998.  the  aggregate  market  value of the common
stock, the Registrant's only class of voting stock,  held by non-affiliates  was
$15,836,000.

      Transitional Small Business Issuer Disclosure Format Yes [ ] No [X]





<PAGE>



                                TABLE OF CONTENTS

PART I                                                                      Page

ITEM 1.      BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . . . .  1
                      History and Overview  . . . . . . . . . . . . . . . . .  1
                      Gulf Coast Efforts  . . . . . . . . . . . . . . . . . .  1
                      Recent Developments . . . . . . . . . . . . . . . . . .  2
                      Business Strategy . . . . . . . . . . . . . . . . . . .  2
                      Operations. . . . . . . . . . . . . . . . . . . . . . .  3
                      Competition . . . . . . . . . . . . . . . . . . . . . .  4
                      Markets . . . . . . . . . . . . . . . . . . . . . . . .  4
                      Regulations . . . . . . . . . . . . . . . . . . . . . .  5
                      Operational Hazards and Insurance . . . . . . . . . . .  7
                      Administration. . . . . . . . . . . . . . . . . . . . .  7
ITEM 2.      PROPERTIES . . . . . . . . . . . . . . . . . . . . . . . . . . .  7
                      Principal Oil and Gas Interests . . . . . . . . . . . .  7
                      Gulf Coast Properties and Prospects . . . . . . . . . .  8
                      Colorado Properties . . . . . . . . . . . . . . . . . . 10
                      Utah Properties  . . . . . . . . . . . . . . . .  . . . 11
                      Title to Properties . . . . . . . . . . . . . . . . . . 11
                      Estimated Proved Reserves . . . . . . . . . . . . . . . 11
                      Net Quantities of Oil and Gas Produced  . . . . . . . . 12
                      Drilling Activity . . . . . . . . . . . . . . . . . . . 13
ITEM 3.      LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . . . 13
ITEM 4.      SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . . . 13

PART II

ITEM 5.      MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
             STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . . . . . . . . 13
                      Market Information. . . . . . . . . . . . . . . . . . . 13
                      Stockholders. . . . . . . . . . . . . . . . . . . . . . 14
                      Dividends . . . . . . . . . . . . . . . . . . . . . . . 14
                      Recent Sales of Unregistered Securities   . . . . . . . 14
ITEM 6.      MANAGEMENT'S DISCUSSION AND ANALYSIS . . . . . . . . . . . . . . 18
                      Liquidity and Capital Reserves. . . . . . . . . . . . . 19
                               Capital Expenditures . . . . . . . . . . . . . 20
                               Results of Operations. . . . . . . . . . . . . 21
                               Other Matters  . . . . . . . . . . . . . . . . 27
ITEM 7.      FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . 29
ITEM 8.      CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
             AND FINANCIAL DISCLOSURE . . . . . . . . . . . . . . . . . . . . 49

PART III

ITEM 9.      DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
             COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. . . . . . . . 49
ITEM 10.     EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . . . . . . 49
ITEM 11.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT . 49
ITEM 12.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS . . . . . . . . . 49

PART IV

ITEM 13.     EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . . 50



<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,  on August 23,  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  by  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.

GULF COAST EFFORTS

To  establish  an initial  foothold  in the Gulf Coast,  the Company  acquired a
7.8125% After  Prospect  Payout  Working  Interest and an additional 10% working
interest  in the  East  Bayou  Sorrel  Prospect  located  in  Iberville  Parish,
Louisiana. These transactions were closed during the first quarter of 1997 at an
aggregate  cost of $4.27  million  (including  $875,000 in common  stock).  This
prospect  contains two discovery  wells,  the C.E. Schwing #1 and #2, which have
historically  produced  at an  average  rate in excess of 2,300  barrels of oil,
2,400  Mcf of  natural  gas,  and 860  barrels  of  water  per day  representing
approximately 25% of the Company's current net average daily production. The 3-D
survey  discussed later in this section under the caption "Recent  Developments"
should greatly enhance the ultimate  development and exploration efforts of this
prospect.

On February 4, 1997 the Company entered into a definitive  exploration agreement
with National Energy Group, Inc. ("NEGX"), a publicly held company headquartered
in Dallas, Texas, the operator of the East Bayou Sorrel Prospect.  The Agreement
provided  the  Company  the right  and  obligation  to  participate  in  certain
exploration  projects  initiated  over the  course  of a  two-year  period.  The
Company's  obligation  under the Agreement ends on February 4, 1999. The working
interest percentage committed to under the Agreement was generally 12.5% but has
varied on a  prospect  by  prospect  basis,  ranging  from 9.375 to 20% to date.
During 1997 and through the date of this report, the Company participated in the
drilling of 10 wells under the terms of the Agreement with NEGX. Of the 10 wells
drilled,  7 were dry, 1 in East Bayou  Sorrell  has been  temporarily  abandoned
waiting on seismic  information,  and 2 resulted in modest discoveries.  Nine of
the ten wells that  commenced  drilling in 1997 were based on either 2-D data or
other  conventional  geologic  methods.  In order to increase the probability of
future success, most, if not all, of the remaining wells to be drilled under the
term of Agreement will be based on the  disciplined use of 3-D seismic and other
advanced exploration technology.

In  addition  to  the  agreement  with  NEGX,  the  Company  has  pursued  other
exploration  opportunities with various industry partners. For instance,  during
the third quarter of 1997,  the Company signed  various  exploration  agreements
regarding a joint venture with Parallel Petroleum  Corporation  ("Parallel"),  a
publicly held entity headquartered in Midland,  Texas.  Pursuant to the terms of
the agreements,  the Company owns a 12.5% working interest in three separate 3-D
seismic  exploratory  projects  covering  130,000  acres in and  around  Jackson
County,  Texas. The exploration efforts will focus within the  Yegua/Frio/Wilcox
geological  trend. The Company decided to pursue the joint venture with Parallel
based on  Parallel's  history of success in the  Yegua/Frio/Wilcox  Trend where,
between October 1994 and December 1997,  utilizing 3-D seismic imaging and other
new technologies,  Parallel  participated in drilling over 60 exploratory wells,
with a success rate of approximately  80%. Beginning with the seismic operations
which commenced in August 1997, the projects contemplated in the agreements with
Parallel  will span the  course  of the next two to three  years  with  drilling
expected to commence in the second quarter of 1998.

                                       -1-

<PAGE>



Contingent on the result of the seismic  surveys,  as many as 60 or 70 wells may
ultimately be drilled. The Company invested  approximately $3.2 million in these
projects in 1997.

During  1997,  the  Company  was also  successful  in  negotiating  the right to
participate in an exploration project operated by Amerada Hess Corporation. This
project,  known  as the  Maurice  Prospect,  is  located  in  Vermilion  Parish,
Louisiana,  and was purchased from Davis Petroleum  ("Davis"),  a privately held
corporation  located in Houston,  Texas, when Davis elected to sell a portion of
its interest in exchange for a farmout  agreement on another  property  owned by
the Company. During 1997, one successful well was drilled and is currently being
recompleted  with  production  expected to commence during the second quarter of
1998. In January 1998, a second well commenced  drilling  operations and reached
its proposed  target  depth of 16,300 feet in March 1998.  Based on the electric
logs, casing is currently being set and a production test is expected during the
second quarter of 1998. The Company anticipates one or two additional wells will
be drilled on this prospect in 1998.

RECENT DEVELOPMENTS:

Participation in Bayou Sorrel 3-D Area
On January 21, 1998, the Company  entered into a definitive  agreement with NEGX
to participate  as a 14.0625%  working  interest owner in a 3-D survey  covering
54-square  mile area  surrounding  the Bayou Sorrel  Field in Iberville  Parish,
Louisiana  (referred to herein as "Bayou  Sorrel 3-D Area").  The 3-D survey was
initiated in 1997 and the initial  cost of  $1,228,510  included  the  Company's
proportionate  share of the 3-D seismic survey and the existing land costs. This
Bayou Sorrel 3-D Area not only encompasses the Company's current interest in the
East Bayou  Sorrel  Prospect  where,  as  discussed  previously,  a 10%  working
interest and a 7.8125% After Prospect  Payout  Working  Interest was acquired by
the  Company in the first  quarter of 1997,  but greatly  increases  the area of
potential future prospects.  Although this participation in the Bayou Sorrel 3-D
Area  will  not  increase  the  Company's  ownership  in the East  Bayou  Sorrel
Prospect,  it will increase the ownership  percentage in any prospects generated
from the 3-D survey  outside of the East Bayou  Sorrel  Prospect  and within the
boundaries  of the  Bayou  Sorrel  3-D  Area.  The 3-D data is  currently  being
processed and the Company expects to independently participate in the processing
and  interpretation  of this data.  Based on the results of the  interpretation,
drilling could commence on new prospects as early as the second quarter of 1998.

Anticipated Sale of The Rocky Mountain Assets
In 1997,  the  Company's  Board of Directors  decided that the  Company's  Rocky
Mountain Assets, including the oil and gas properties, gas plant and service and
supply  operations should ultimately be sold. This decision was based on several
factors,  including  but not  limited  to,  the  declining  margins on the Rocky
Mountain  operations,  lack of success in  exploiting  the assets  acquired from
Skaer and the Company's most recent efforts to foster growth have been, and will
continue to be in the foreseeable future, focused in the Gulf Coast.

Although no formal  agreements  have been reached as of the date of this report,
the Company has been  conducting  on-going  negotiations  with  several  parties
interested  in  the  assets.   The  depressed  and  volatile   commodity  prices
experienced since November 1997 (and continuing through the date of this report)
have hindered the negotiations. However, the Company is committed to selling the
Rocky Mountain  Assets and  anticipates  most, if not all, of the related assets
will be sold sometime in 1998.

BUSINESS STRATEGY

To initiate the Gulf Coast  efforts,  the Company  sought out  opportunities  to
invest  in a  diversified  portfolio  of oil and gas  exploration  projects  and
attempted to mitigate risks of exploration drilling by taking minority interests
in projects with large potential reserves. The Company generally participates as
a minority,  non-operating interest holder 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  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:


                                       -2-

<PAGE>



          1.   The  54-square  mile Bayou Sorrel 3-D Area in  Iberville  Parish,
               Louisiana, operated by National Energy Group, Inc.;

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

          3.   The Maurice Prospect in Fayetteville Parish, Louisiana,  operated
               by Amerada Hess.

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;
o    Positioning  itself with strategic sources of capital and industry partners
     that can  react to  opportunities  in the oil and gas  business  when  they
     present themselves.

The Company currently employs the services of Baird Petrophysical Group, Inc., a
geophysical  and  petrophysical  consulting  firm headed by Ralph W. Baird.  Mr.
Baird has almost 30 years of experience providing specialized technical services
to the  petroleum  industry  around  the globe.  The  Company  uses Mr.  Baird's
services to screen, analyze,  advise, and otherwise assist in the interpretation
and evaluation of the Gulf Coast prospects.

The Company recognizes that the ability to implement its business  strategies is
largely  dependent on the ability to 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,  1997,  the Company had varying  ownership  interests in 185
gross  productive  wells (164 net) located in five states.  The Company operates
176 of the 185 wells,  the other  wells are  operated by  independent  operators
under contracts that are standard in the industry. As previously mentioned,  the
Company has  committed to selling its Rocky  Mountain  assets.  If and when this
occurs, the Company's  interest for producing  properties as of the date of this
report would be reduced to 3 gross (.40 net)  non-operated  wells located solely
in Southern  Louisiana.  This divestment would dramatically reduce the Company's
proved reserves, revenues and cash flows.

The  following  table  presents  oil  and gas  reserve  information  within  the
Company's major operating areas as of December 31, 1997:

                                                 Net Proved Reserves
       REGION                            Bbls          Mcf          BOE (6:1)
 --------------------                 ---------     ---------      ----------
 Rocky Mountains -
     principally in the DJ Basin        777,000     3,175,000       1,306,000
 Gulf Coast -
     principally in S. Louisiana        308,000     1,360,000         535,000
                                      ---------     ---------       ---------
          Total                       1,085,000     4,535,000       1,841,000
                                      =========     =========       =========

It is a primary  objective  of the  Company to  operate  most of the oil and gas
properties  located  in the Rocky  Mountain  Region in which it has an  economic
interest.  The  Company  believes,  with the  responsibility  and  authority  as
operator, it is in a better position to control costs, safety, and timeliness of
work as well as other critical factors affecting the economics of a well.

                                       -3-

<PAGE>


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.

MARKETS

Overview - The three principal  products  currently produced and marketed by the
Company  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 or pipeline to  unaffiliated  third-party  purchasers at the prevailing
field price (the "posted price").  Currently, the four primary purchasers of the
Company's  crude oil are Plains  Marketing &  Transportation,  Total  Petroleum,
Inc., Texaco Trading and Transportation,  Inc. and Scurlock-Permian Corporation.
Together these four  purchasers buy more than 90% of the Company's  annual 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 its natural  gas  production  in two  principal
ways:  a.) at the  wellhead  to  various  pipeline  purchasers  or  natural  gas
marketing  companies;  and b.) at the tailgate of its Gas Plant to either Public
Service Company of Colorado  ("PSCo") or  Hewlett-Packard  Company  ("HP").  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.

The  residue  gas sold at the  tailgate  of the  Company's  Gas Plant to PSCo is
subject  to a  month-to-month  contract  and the Gas sold to HP is  subject to a
contract  that  expires in 2013.  The gas to both  parties is priced on an MMBtu
basis at an index  spot  price.  It should be noted  that the sale of  processed
natural gas to PSCo is not directly  related to the Company's former natural gas
marketing and trading  contract  which  expired on July 1, 1996.  The market and
trading   activities  are  discussed  later  in  "Management's   Discussion  and
Analysis".

Natural Gas Liquids - The Company  produces  two natural gas liquid  products at
its Gas Plant,  butane-gasoline mix and propane. The butane gasoline mix is sold
to an unaffiliated party at prevailing market prices on a month-to-month  basis.
The propane is sold under a  month-to-month  arrangement  with one or more local
propane wholesalers for resale to the local propane market. The Company does not
believe that the loss of the current  purchasers of these  products would have a
material  adverse effect on the Company's  business  because it believes  other,
similar arrangements could be made to market the Company's natural gas liquids.

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

                                       -4-

<PAGE>


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.  In Colorado such regulation is by the Colorado
Public  Utility  Commission.  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.

On April 8, 1992, the FERC issued Order No. 636 requiring material restructuring
of  the  sales  and  transportation  service  provided  by  interstate  pipeline
companies.  The primary element of Order No. 636 was the mandatory unbundling of
interstate gas  transportation  services and storage  separately  from their gas
sales.  The  unbundled  transportation  and storage  was  required to be offered
without  favoring  gas bought from the  pipeline.  Order No. 636 did not require
pipelines  to stop buying and  reselling  gas;  to the  contrary,  it  contained
specific  provisions to allow  pipelines to continue  unbundled sales of natural
gas.  However,  after  Order No. 636 there was little  reason for a pipeline  to
continue selling natural gas and most pipelines moved all or almost all of their
gas purchases and sales to affiliated marketing companies.

Order No. 636 does not regulate  gas  producers  such as the  Company.  However,
Order No. 636 does  appear to have  achieved  FERC's  stated  goal of  fostering
increased  competition within all phases of the natural gas industry.  Generally
speaking,  this increased  competition has driven the price down for natural gas
produced by the Company and other  producers.  It is unclear what further impact
the increased  competition will have on the Company as a gas producer and seller
in the future.  Increased flexibility and competition provides greater assurance
of access to markets, but has consequently reduced or restrained prices.

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  operates  also  have  statutes  and

                                       -5-

<PAGE>


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 (especially  Colorado) 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.

New initiatives regulating the disposal of oil and gas waste are also pending in
certain states,  including states in which the Company conducts operations,  and
these various initiatives could have a similar impact on the Company.  The COGCC
has enacted  rules  regarding  the  regulation  of disposal of oil field  waste,
including  waste  currently  exempt  from  federal  regulation.  These rules may
require the termination of production from some of the Company's  marginal wells
for which the cost of compliance would exceed the value of remaining production.
In addition,  as indicated  above,  the COGCC has enacted  regulations  imposing
specific  reclamation  requirements  on  operators  upon the  conclusion  of the
operations,  and is currently chairing a group including  representatives of the
oil  and  gas  industry,   environmental  groups,   surface  owners,  and  local
governments to consider adopting statewide reclamation  requirements.  The COGCC
is also in the process of preparing new rules  governing  production  pits which
are intended to require  closure of unlined pits and certain steel,  fiberglass,
cement and other  vessels in  designated  sensitive  areas (which will  probably
include  most of the areas in Colorado  that the Company  operates)  or adequate
proof that such pits or vessels are not  leaking.  As  currently  drafted,  such
rules would permit  operators to comply over a period of at least two years. The
COGCC proposals will be subject to review and comment of water quality  agencies
and other  interested  parties and thus may change from the  approach  described
above.  Management  believes that  compliance  with current  applicable laws and
regulations  or with  proposals  in their  present  form could  possibly  have a
material adverse impact on the Company,  but management is unable to predict the
final form of the pending regulations or their potential impact on the Company.

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.

                                       -6-

<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 16, 1998, the Company had 25 full 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, 1997
are located in the following areas shown in the table below:

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

<S>                            <C>           <C>      <C>     <C>      <C>     <C>       <C>
Loveland Field .............   Colorado        81       81     --       --      5,083    5,047
Johnson's Corner ...........   Colorado         5        5     --       --      1,122    1,122
West Peetz Field ...........   Colorado         5        5     --       --        785      785
Yenter Field ...............   Colorado         6        6     --       --      1,655    1,655
Cisco Dome .................   Utah             1        1       38       31    8,877    8,267
All Other Fields ...........   CO/NB/UT        40       32        5        3    9,363    7,193
                                           ------   ------   ------   ------   ------   ------
Subtotal - .................   Rocky
   Mountains (rounded) .....                  138      130       43       34   26,885   24,069
East Bayou Sorrel ..........   Louisiana        2      .20     --       --        847       85
South Lake Arthur ..........   Louisiana     --       --          1      .20      349       73
                                           ------   ------   ------   ------   ------   ------
Subtotal - Gulf Coast ......                    2      .20        1     . 20    1,196      158
                                           ------   ------   ------   ------   ------   ------
Grand Total  (rounded
to nearest whole) ..........                  140      130       44       34   28,081   24,227
                                           ======   ======   ======   ======   ======   ======
</TABLE>


                                       -7-

<PAGE>

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.

Undeveloped  Acreage - The Company's  gross and net working  interests in leased
undeveloped  acreage in the Rocky Mountain Region as of December 31, 1997 is 406
and 366 acres,  respectively.  All these  properties are located in Colorado and
will expire at various times in 1998 unless production has been obtained.

The  Company's  gross and net working  interests in leased (or lease  options in
areas where 3-D seismic is being  conducted) on undeveloped  acreage in the Gulf
Coast Region as of December 31, 1997 is as follows:

                                                   Undeveloped Acreage
                                                  ----------------------
Prospect Description             State            Gross             Net
--------------------             -----            -----             ---
Bayou Sorrel 3-D Area            Louisiana         5,561            782(1)
Bayou Sorrel 3-D Area (Options)  Louisiana       121,121         17,033(2)
Maurice Prospect                 Louisiana         1,024             86(3)
Parallel 3-D Program             Texas            37,694          4,712(3)
Parallel 3-D Program (Options)   Texas            84,924         10,615(2)
Austin Bayou                     Texas             3,377             72(3)
                                                 -------         ------
    Totals:                                      253,701         33,300
                                                 =======         ======

     (1)  Substantially   all  of  these  leases  will  expire  in  1999  unless
          production has been obtained.
     (2)  Substantially  all of these lease  options  will expire in 1998 unless
          they are  exercised.  The total  acres  ultimately  exercised  will be
          contingent  on  the  interpretive  results  of the  corresponding  3-D
          seismic surveys. The Company estimates that between 20% and 60% of the
          options will  ultimately  be exercised at an  approximate  cost to the
          Company of $100.00 per net acre.
     (3)  Substantially   all  of  these  leases  will  expire  in  2000  unless
          production has been obtained.

GULF COAST PROPERTIES AND PROSPECTS

Overview - As stated earlier,  in 1996 and 1997 the Company  actively  initiated
efforts to transform itself into an aggressive Gulf Coast  exploration  company.
Historically,  the 30 year-old  company  focused on the U.S. Rocky Mountains for
acquisition  and  development  plays,  but  today it holds a  substantial  lease
position  onshore Texas and  Louisiana,  also known as the U.S. Gulf Coast.  The
Company  is  aggressively  acquiring  3-D  seismic  surveys  and  drilling  both
development and exploratory wells in the Gulf Coast.

In 1998 and  beyond,  the  Company  intends to  actively  pursue  the  drilling,
development,  and exploration  objectives  targeting known areas for oil and gas
reservoirs in the U.S.  Gulf Coast,  mainly Texas and  Louisiana.  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,  which the Company now owns. 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.

East Bayou Sorrel and Bayou Sorrel Area - 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. The acquisition included one discovery well that

                                       -8-
<PAGE>


was  drilled in 1996 and the  Company and NEGX  together  drilled an  additional
discovery  well  in 1997  on  this  prospect.  Together  these  two  wells  have
historically  produced  approximately  2,300 bbls of oil,  2,400 Mcf gas and 860
bbls of water per day. A new 3-D seismic survey  covering a much larger area (54
square  miles,  30,000  acres) than the  original  East Bayou  Sorrel  AMI,  was
completed in February 1998. The processing is complete and the data is now being
interpreted independently by the Company.  Preliminary results appear to confirm
the reservoir at East Bayou Sorrel,  and even more encouraging is the apparently
large number of potential  undrilled  targets  contained  within the 3-D volume.
Additional  development  drilling of the East Bayou  Sorrel  Field,  development
drilling of  undrilled  fault blocks near East Bayou  Sorrel  Field,  as well as
exploratory  drilling  based on images  from the 3-D  seismic is  expected to be
conducted during 1998 and beyond.

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 two of the projects are already  completed and the data is
currently being  interpreted by the Company and its partners.  The 3-D survey on
the third project is currently  being  conducted and is expected to be completed
late in 1998.  The Company  expects  that there may be as many as 60 to 70 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.

The typical Yegua well costs approximately  $800,000 to drill and complete,  and
if successful, has an average reservoir of 10 billion cubic feet of natural gas,
and begins to generate cash flow within 60 days from spud date. The typical Frio
well costs  approximately  $400,000 to drill and complete,  has a reservoir of 1
billion or more cubic feet of natural gas,  begins to generate cash flow 60 days
from spud date,  and return the original  investment in less than one year.  The
foregoing estimates naturally depend on flow rates and pricing.

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.

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.  The Trahan #1 is currently  being  completed in the bol mex
sands and is expected to be on production in April 1998. A second  Maurice Field
well, the Broussard #1, is currently being completed to produce the Marg tex and
will also test all  reservoirs  to the bol mex sands.  Additional  wells will be
drilled during 1998 and 1999 in order to develop the field. A 3-D seismic survey
is also being completed at this time. In addition,  the Company, along with AHC,
recently acquired its  proportionate  share of approximately 50% of the camerina
unit rights. Accordingly,  the Company will be able to pursue potential reserves
in the camerina sands in the future. The Company owns an 8.438% working interest
in this field.

                                       -9-

<PAGE>


Austin  Bayou Field - During  1997,  the Company  also  participated  with Davis
Petroleum and TransTexas in two (2) exploratory wells in Brazoria County, Texas,
located near  Danbury,  Texas.  Although no reserves have been assigned to these
wells as of the date of this report,  the first well,  the Zinn #1, is currently
being  completed for a test in the Oligocene Frio formation and the second well,
the Bennett #1,  indicated  the presence of gas during its drilling  operations.
This gas show is now  behind  pipe and will be  completed  and tested at a later
date.  Currently  the Company and its partners are  deepening the Bennett #1 and
drilling a third well,  the Kopplin #1. The three wells were  proposed  based on
newly  recorded  3-D seismic  data.  The Company owns a 2.129%  carried  working
interest in this field.  This carried  working  interest will revert to a paying
working interest basically once production has been obtained on any of the three
wells.

South Lake Arthur  Field - In 1997,  the Company and NEGX drilled the Edith Winn
#1 and discovered gas. The well,  located in Jefferson  Davis Parish,  Louisiana
was completed in a Camerina sand. It is currently producing  approximately 1,200
Mcf of gas per day. The Company owns a 20.83% working  interest in this well but
has no plans for further drilling on this prospect.

ROCKY MOUNTAIN PROPERTIES

Overview - Most of the  Company's  Rocky  Mountain  reserves  are located in the
Denver-Julesburg  ("DJ") Basin which encompasses most of northeast  Colorado and
parts of southeast  Wyoming,  southwest Nebraska and western Kansas. Oil and gas
are produced mainly from Cretaceous sandstones and limestones,  with the "D" and
the "J"  sandstones  being the most  prolific  producers  in the Basin at depths
ranging in general from  approximately  5,000 feet to approximately  7,500 feet.
The  Company's  activities  have focused on the  historically  better  producing
zones,  the "D" and the "J" sandstones and the Niobrara  formation.  At December
31, 1997,  approximately 70% of the Company's reserves were located in the Rocky
Mountains -- principally in the DJ Basin. A summary of the notable fields in the
DJ Basin, and other Rocky Mountain areas, are as follows:

Loveland  Field,  Larimer and Weld Counties - Loveland Field is located near the
City of Loveland, Colorado, 40 miles north of Denver. The area is producing both
oil and gas at an  average  rate in 1997 of  approximately  224  barrels  of oil
equivalent ("BOE") per day (185 BOE net to the Company).  Loveland Gas Plant and
associated Pease facilities are located near the center of the field.  Johnson's
Corner  Field is located  just 4 miles east of  Loveland  Field.  Together,  the
Loveland Field,  Johnson's  Corner Field and Loveland Gas Plant  constitute more
than half of Pease's total Rocky Mountain assets.

All of the  Company's  gas  production  from the Loveland and  Johnson's  Corner
fields is  processed  in the  Company's  Loveland  Gas Plant,  which has a rated
capacity of  approximately  6,000 Mcf per day.  Pipeline systems are in place to
gather gas from the Loveland and Johnson's  Corner fields.  Approximately  1,000
Mcf of gas per day from the Loveland and  Johnson's  Corner  fields is currently
processed  through the  Loveland gas plant.  The natural gas  produced  from the
Loveland  area is  extremely  rich in liquid  composition  with an average  heat
content  of 1,430 BTU per cubic  foot.  The  ability of the gas plant to recover
natural gas liquids,  such as propane and natural  gasolines (B-G Mix), from the
gas  enhances  the  value of gas  production  and  significantly  increases  the
economic  viability of  additional  development  in the  Loveland and  Johnson's
Corner fields.

Among the existing wells, numerous  opportunities exist to recomplete in certain
behind-pipe zones using newer stimulation  technologies.  In many wells,  Codell
sandstone and Timpas limestone  reserves remain  behind-pipe  which is available
for production upon  recompletion  of existing well bores.  Among the wells that
have  been  completed  in  these  zones,  the  Company  believes  that  original
completions were often inadequate because of limited  stimulation.  Of the three
benches (separate sedimentary levels) of the Niobrara Formation, the upper bench
has been  completed  in most wells  whereas  the middle  and lower  benches  are
available for production upon recompletion in many wells.

Johnson's Corner Field, Larimer County,  Colorado - Johnson's Corner Field is an
extension of the Wattenberg  Field with Muddy "J" Sandstone gas production.  The
wells  produce  approximately  25 BOE (net to the  Company) per day from the "J"
sand. One well has also been completed in the Codell and Niobrara formations and
oil  production  from all three  zones is  commingled.  Recently  two wells were
recompleted  in Codell  sandstone  and the  initial  results are  promising.  In
addition,  the Company believes there are several additional in-fill development
locations.


                                      -10-

<PAGE>


West Peetz Field,  Logan County,  Colorado - The Company operates 5 wells in two
leases in the West Peetz field.  The wells currently  produce about 22 BOPD (net
to  the  Company)  from  the J  sand.  A  detailed  geological  and  engineering
evaluation  of the field in early 1995  suggested  that West Peetz  field can be
produced  profitably  for  many  years to come and the  field  has an  excellent
potential for secondary  recovery.  A low-cost  simple water  injection plan was
evaluated in 1997 and is currently being implemented.

Yenter Field,  Logan County,  Colorado - Yenter Field is a structural trap which
has  produced  more than 10 MMBO and 24 BCFG  since the 1950s from the "J" sand.
Approximately  80% of wells in the field have been  plugged and  abandoned.  The
Company owns and  operates  five wells with  production  of about 25 BOE per day
(net to Company). Water produced with oil from these five wells is injected back
into  the  reservoir  to  help  maintain   reservoir   pressures  for  continued
production.  The Company has  conducted a complete  geological  and  engineering
study of Yenter Field, which has identified  undeveloped potential in additional
sandstone  reservoirs and  recommended  reworking "J" sandstone wells which have
been  shut in since  the mid  1970s,  and  upgrading  the  pressure  maintenance
program.  The  Company  desires  to acquire  additional  acreage in the field to
implement a secondary recovery program possibly with horizontal wells.

Cisco Dome Area,  Grand County,  Utah - In April 1995, the Company  purchased an
80% working interest in  approximately  8,877 acres in the Cisco Dome Field. The
Cisco Dome Field is located  adjacent to the Calf Canyon Field.  The property in
the Cisco Dome Field  contains 39 wells of which 21 are currently  producing gas
from  intervals  ranging  from  2,000  to  3,200  feet.  The  average  aggregate
production from these properties is approximately  310 Mcf and 6 bbls of oil per
day.

Cowboy  Field,  San Juan County,  Utah - The Company has a 100% interest in four
oil wells in Cowboy  Field in  southeast  Utah.  The field is within the Paradox
Basin and production is from the Pennsylvanian Ismay Formation.
The Company has behind pipe potential and at least one development drillsite.

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 11 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 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
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.


                                      -11-
<PAGE>

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  discounted by
10 percent  per year using  prices  being  received by the Company at the end of
each of the last three fiscal years on a non-escalated basis. The prices used at
December 31, 1997 for the Rocky Mountain  properties  averaged $16.15 per barrel
of oil and $1.78 per Mcf of  natural  gas and $17.11 per barrel of oil and $2.61
per Mcf of natural gas for the Gulf Coast properties:

<TABLE>
<CAPTION>
                                                                  Rocky Mountain and Gulf Coast
                                              Gulf Coast             Reserves Combined as of
                                            Properties Only               December 31,
                                            At December 31,     --------------------------------
                                                 1997           1997          1996          1995
                                            ---------------     ----          ----          ----
<S>                                           <C>          <C>           <C>           <C>  
Estimated Proved Oil Reserves (Bbls) .....       308,000     1,085,000     1,175,000     1,294,000
Estimated Proved Gas Reserves (Mcf) ......     1,360,000     4,535,000     4,833,000     5,851,000

Estimated Future Net Revenues ............   $ 5,796,000   $14,371,000   $20,306,000   $13,680,000
Present Value of Estimated Future
    Net Revenues .........................   $ 4,460,000   $ 9,678,000   $11,980,000   $ 8,480,000
</TABLE>

As previously discussed,  it should be emphasized that the Company is attempting
to sell or otherwise monitize all the Rocky Moutain assets. Should this occur in
the future,  the Company's  only  remaining  reserves,  revenues and future cash
flows would be limited to those oil and gas properties located in the Gulf Coast
region.

NET QUANTITIES OF OIL AND GAS PRODUCED

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

                                    Year Ended December 31,
                              ----------------------------------
                              1997            1996          1995
                              ----            ----          ----
  Oil (Bbls)
      Rocky Mountains         80,000        100,000       121,000
      Gulf Coast              43,000           --            --
                             -------        -------       -------
            Total            123,000        100,000       121,000
                             =======        =======       =======
  Gas (Mcf)
      Rocky Mountains        392,000        412,000       497,000
      Gulf Coast              91,000           --            --
                             -------        -------       -------
             Total           483,000        412,000       497,000
                             =======        =======       =======

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:

                                      -12-

<PAGE>

                                     Average Sales Prices             Average
 Year Ended                   ---------------------------------     Production
 December 31                  Oil (Bbls)   Gas (Mcf)    Per BOE    Cost Per BOE
 -----------                  ---------    --------     -------    ------------
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

1996 ........................   $ 20.35     $ 1.26      $ 15.10      $ 8.46
1995 ........................   $ 16.77     $ 1.18      $ 12.85      $ 7.92

DRILLING ACTIVITY

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

                                       Year Ended December 31,
                           -----------------------------------------------
                              1997            1996                1995
                           -----------     ------------       ------------
Wells Drilled              Gross   Net     Gross    Net       Gross    Net
                           -----   ---     -----    ---       -----    ---
  Exploratory
      Oil                    1     .10       -       -           -      -
      Gas                    1     .08       -       -           -      -
      Non-productive         6     .77       1      .19          -      -
                           ----   -----    ----    ----        ----   ----
      Total                  8     .95       1      .19          -      -
                           ====   =====    ====    ====        ====   ====
  Development
      Oil                    -       -       1       1           -      -
      Gas                    -       -       -       -           -      -
      Non-productive         -       -       -       -           -      -
                           ----   -----    ----    -----       ----   ----
      Total                  -       -       1       1           -      -
                           ====   =====    ====    =====       ====   ====

At December 31, 1997 the Company was in the process of drilling or  completing 5
additional wells which are not included in the above schedule. Of these 5 wells,
as of the date of this report, one was dry, one (in East Bayou Sorrell) has been
temporarily  abandoned waiting on seismic  information,  two are being completed
and one is still drilling. In addition,  two additional wells commenced drilling
operations during the first quarter of 1998.

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,
1997 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, 1997.



                                      -13-

<PAGE>

                                     Part II

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

(a) Market  Information  - The  Company's  Common Stock has traded on the Nasdaq
SmallCap  Market,  under the symbol WPOG,  since July 1980.  Effective  June 11,
1997, in accordance with provisions of the Company's  Articles of Incorporation,
all outstanding $0.01 par value Series A Cumulative  Convertible Preferred Stock
were  automatically  converted  into  Common  Stock and  Common  Stock  Purchase
Warrants.  Other than the  foregoing,  there have been no  modifications  to any
instruments  defining  the  rights of the  holders  of any  class of  registered
securities  during the period  covered by this  report.  The Company  also has a
warrants  that are  publicly  traded on the Nasdaq  SmallCap  Market,  under the
symbol WPOGW.  There are approximately 3 million warrants  outstanding that give
the holders the right to purchase  one share of the  Company's  common  stock of
$6.00 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, 1996, 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.):

                                          Bid Prices
                              -------------------------------------
                                                      Series A
                                Common Stock       Preferred Stock
   Quarter Ended                High      Low       High      Low
   ------------------         -------   -------    ------    -------
   December 31, 1997           3 1/2     1 1/2       -          -
   September 30, 1997          3 1/16    2 7/16      -          -
   June 30, 1997               3 27/32   2 3/16    13 1/8    13 1/16  (6/11/97)
   March 31, 1997              3 9/16    2 1/2     10        10

   December 31, 1996           3 5/16    2 1/16    10 3/4     6
   September 30, 1996          2 1/8     1 7/32     6 3/4     5 1/4
   June 30, 1996               1 11/16   1 5/64     7         4 1/4
   March 31, 1996              1 3/8     1 9/32     5         3 1/2


(b)  Stockholders  - As of March 18, 1998 the Company had at least 350 round lot
shareholders of record for the Company's Common Stock. This does not include the
shareholders whose shares are held in a depository trust in "street" name. As of
March 18, 1998 at least 8,890,000  shares (or 56%) of the issued and outstanding
common stock (of which the number of beneficial round lot owners is not known by
the Company) were held in a depository trust in "street" name.

(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,

                                      -14-


<PAGE>


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, 1997:

    1.       Effective January 10, 1997 the Company issued 315,000 shares of its
             common stock to three unrelated entities, Atocha Exploration, Inc.,
             Potosky Oil and Gas,  Inc.,  and  Browning Oil  Company,  Inc.,  in
             exchange  for an  undivided  interest  in a  producing  oil and gas
             prospect  designated as the East Bayou Sorrel Prospect in Iberville
             Parish, Louisiana.

    2.       On January 31, 1997 the Company issued 250,000 shares of its common
             stock upon exercise of outstanding  purchase  warrants of $1.25 per
             share for a total proceeds of $312,500. The holders of the warrants
             received  them as part of a "unit" sold in a private  placement  in
             1995 that  consisted  of common  stock and  warrants.  The  Company
             relied  upon  Section  4(2) of the  Securities  Act and Rule 506 of
             Regulation D in claiming  exemption from registration  requirements
             of the  Securities  Act for  securities  sold. The shares of common
             stock issued upon  exercise of the  warrants  were  registered  for
             resale by the holders in Registration No. 33-94536.

    3.       Between  February 1, 1997 and March 10,  1997,  the Company  issued
             1,500,000  shares of its common stock for  $3,750,000 to a group of
             private investors each of whom qualified as an accredited  investor
             as such term is defined in  Regulation D adopted by the  Securities
             and  Exchange  Commission.  The Company  paid  selling  commissions
             totaling  $300,000 to various  participating  selling  agents.  The
             Company relied upon Section 4(2) of the Securities Act and Rule 506
             of  Regulation  D  in  claiming  exemption  from  the  registration
             requirements of the Securities Act for the securities sold.

    4.       Between March 14, 1997 and April 15, 1997,  the Company sold 52,000
             shares of its  common  stock  for  $130,000  to a group of  private
             investors each of whom qualified as an accredited  investor as such
             term is  defined in  Regulation  D adopted  by the  Securities  and
             Exchange Commission.  The Company paid selling commissions totaling
             $10,400 to various participating selling agents. The Company relied
             upon Section 4(2) of the  Securities Act and Rule 506 of Regulation
             D in claiming  exemption from the registration  requirements of the
             Securities Act for the securities sold.

    5.       During  1997 holders of  $1,025,000  of the  Company's  outstanding
             collateralized    convertible    10%    debentures   ("Debentures")
             surrendered   such  Debentures to the Company  for conversion  into
             341,665  shares of  the Company's  common stock in accordance  with
             conversion   provisions  of   the  Debentures.    The  Certificates
             representing the shares  issued upon conversion  bear a restrictive
             legend   prohibiting   transfer  without   registration  under  the


                                      -15-

<PAGE>

             Securities  Act  or   the   availability   of   an  exemption  from
             registration and  "stop transfer" instructions  have been issued to
             the  transfer  agent.   The  shares of  common  stock  issued  upon
             conversion  have  been  registered  for  resale by  the  holders on
             Registration  No. 333-19589.  The Company relied upon Section 3(a)9
             of the Securities Act for issuance of the securities.

    6.       On February 14, 1997, the Company issued 4,000 shares of its common
             stock  to two  consultants  of the  Company  in lieu  of  cash  for
             consulting  services  rendered to the Company  valued at $8,000 for
             financial  reporting  purposes.  The Certificates  representing the
             shares  issued  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.

    7.       Between  March 1,  1997  and  April 15,  1997  the  Company  issued
             2,482,500  shares  of  its  common  stock upon  exercise  of a like
             number of  warrants  at $1.25 per  warrant for a total  proceeds of
             $3,103,125. Holders of such  warrants acquired  the warrants in the
             Company's 1996 private  placement of Debentures and  Warrants.  The
             warrants would  have expired if  not previously  exercised on April
             15, 1997.  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.   The  shares  issued  upon
             exercise of warrants  were registered  by the Company for resale by
             the  holders in  Registration  No.  333-19589.  The  Company relied
             upon  Rule  506 of  Regulation  D  in  claiming  exemption  for the
             registration  requirements  of  the Securities Act  for issuance of
             the securities upon exercise of the warrants.

    8.       Between March 1, 1997 and June 3, 1997,  the Company issued 135,000
             shares of its  common  stock upon  exercise  of  outstanding  stock
             purchase warrants at $0.75 per share for total proceeds of $101,250
             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.  The holder of the warrants
             is an affiliate of Beta Capital  Group,  Inc. with whom the Company
             has a consulting  agreement  and  to whom the warrants were  issued
             in February 1996.  The shares of common stock  issued upon exercise
             of  the  warrants  were  registered  for  resale  by the  holder in
             Registration No. 333-19589.

    9.       Between  June 23, 1997  and September  30, 1997 the Company  issued
             116,250  shares  of its common  stock upon exercise of  outstanding
             stock purchase  warrants  at $0.75 per share  for total proceeds of
             $87,188 to  the Company.   The warrants were  originally  issued to
             Beta Capital  Group,  Inc. with  whom the Company  has a consulting
             agreement  and to whom the warrants  were issued in February  1996.
             Subsequent to  their  issuance,  Beta  re-assigned  the warrants to
             another holder.   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.  The shares
             of  common  stock  issued  upon  exercise  of  the   warrants  were
             registered  for  resale   by   the  holder  in   Registration   No.
             333-19589.


                                      -16-


<PAGE>


      10.      Between  January 1997 and December 17, 1997,  the Company  issued
               208,850  shares of its common stock upon exercise of  outstanding
               stock purchase  warrants  issued by the Company  between 1994 and
               1996  to  certain   broker/dealers  in  connection  with  private
               placements of Company  securities  during such time.  The Company
               received $308,150 of proceeds upon exercise of the warrants.  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.  The  shares of common  stock  issued  upon
               exercise were registered by the Company for resale by the holders
               under Registration Nos. 333-19589 and 33-94536.

      11.      On June 25, 1997 and  October 2, 1997 the Company  issued 670 and
               1,480 shares,  respectively,  of its common stock to three former
               directors.  The shares were issued for services to the Company as
               a  director  (in lieu of cash)  and were  valued  at  $6,851  for
               financial reporting purposes.  The Certificates  representing the
               shares  issued 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.

      12.      On July 14, 1997 the Company  issued  3,150  shares of its common
               stock to one  director  in  exchange  for an  overriding  royalty
               interest in the producing oil and gas prospect  designated as the
               East Bayou Sorrel  Prospect,  Iberville  Parish,  Louisiana.  The
               shares were valued at $10,000 for financial  reporting  purposes.
               The   Certificates   representing   the  shares   issued  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.

      13.      On July 18,  1997,  the Company  issued  2,240,000  shares of its
               common stock for $5,600,000 to a group of private  investors each
               of whom  qualified  as an  accredited  investor  as such  term is
               defined in  Regulation D adopted by the  Securities  and Exchange
               Commission. The principal underwriter was San Jacinto Securities,
               Inc. and the Company paid selling  commissions  of $560,000.  The
               Company  relied upon Section 4(2) of the  Securities Act and Rule
               506 of Regulation D in claiming  exemption from the  registration
               requirements  of the Securities Act for the securities  sold. The
               Certificates  representing the shares issued 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.

      14.      Between  August 29, 1997 and September 9, 1997 the Company issued
               42,675  shares  of  common  stock to two  former  directors  upon
               exercise of outstanding  options. The Company received $45,390 of
               proceeds  upon  exercise  of  the  warrants.   The   Certificates
               representing the shares issued 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.

      15.      On December  31, 1997,  the Company  issued  113,333  shares of a
               newly created  Series B Preferred  Stock.  The Series B Preferred
               Stock  is  convertible  into  the  Company's  common  stock  at a
               discount to the market as defined in the agreement.  The terms of

             
                                      -17-

<PAGE>


               the Series B Preferred  Stock are more  thoroughly  discussed  in
               Footnote 7 of the financial  statements  included under Item 7 of
               this report. The Company received $5,666,650 of proceeds upon the
               issuance of the preferred shares.  The principal  underwriter was
               San  Jacinto  Securities,  Inc.  and  the  Company  paid  selling
               commissions of $566,665. The Company is the acting transfer agent
               for the  preferred  shares  and the shares  are  prohibited  from
               transfer  without  registration  under the  Securities Act or the
               availability of exemption from registration. Should the preferred
               shares  ultimately  be converted  into common  stock,  the common
               stock  will  also  bear  a  restrictive  legend  prohibiting  the
               transfer  without  registration  under the  Securities Act or the
               availability  of  an  exemption  from   registration   and  "stop
               transfer" instructions will be issued to the transfer agent.

The  Company  relied  on  section  4(2) of The  Securities  Act in  issuing  the
securities described in paragraphs 1, 6, 8, 12, 14 and 15 without  registration.
Each of the persons who acquired the securities had full information  concerning
the  business of the  officers of the  Company,  certificates  representing  the
securities bear a restrictive  legend as described above and the securities were
acquired for investment.

ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS

Liquidity and Capital Resources
At December 31, 1997, the Company's cash balance was $6,547,804  with a positive
working capital position of $5,295,474, compared to a cash balance of $1,995,860
and a positive  working capital position of $1,907,694 of December 31, 1996. The
change in the Company's cash balance is summarized as follows:

Cash balance at December 31, 1996 .............................   $  1,995,860
Sources of Cash:
  Proceeds from the sale of common stock ......................      8,920,000
   Proceeds from sale of Series B Preferred Stock .............      5,099,985
  Proceeds from the exercise of common stock options
   and warrants ...............................................      3,957,604
  Proceeds from the sale of property and equipment ............         66,056
  Cash provided by operating activities .......................          6,314
                                                                  ------------
         Total Sources of Cash ................................     18,049,959
                                                                  ------------
Uses of Cash:
  Acquisition of oil and gas interests in East Bayou Sorrel ...     (3,431,955)
  Exploration Activities - Gulf Coast .........................     (7,915,522)
   Development Activities - Rocky Mountains ...................       (734,235)
  Other Capital Expenditures ..................................        (55,480)
  Costs associated with the sale of stock and
      exercise of common stock warrants .......................       (874,416)
  Payments on long term debt ..................................       (391,407)
  Purchase of certificate of deposit ..........................        (95,000)
                                                                  ------------
         Total uses of cash ...................................    (13,498,015)
                                                                  ------------
  Cash balance at December 31, 1997 ...........................   $  6,547,804
                                                                  ============

As noted,  most of the  Company's  sources of cash during 1997 were derived from
capital  raising  equity  transactions  (which were  discussed  more  thoroughly
previously in this report under Item 2(d) in Part II), and were  primarily  used
to fund the  Company's  exploration  activities  in the Gulf Coast.  The amounts
spent on specific  projects are discussed more thoroughly  later in this section
under the caption "Capital Expenditures".

                                      -18-

<PAGE>

As in 1997,  the  Company  will focus its future  activities  on  continuing  to
implement  an  aggressive   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  54-square  mile Bayou Sorrel 3-D Area in  Iberville  Parish,
               Louisiana, operated by National Energy Group, Inc. ("NEGX");

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

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

Under the existing commitments related to these three areas, the following table
summarizes the range of expected capital requirements for 1998 by program:

                                             Estimated Investment (in millions)
                                             ---------------------------------
Operator                                        Minimum            Maximum
--------                                        -------            -------
East Bayou Sorrel 3-D Area                      $ 4.3              $  6.3
Formosa, Texana, and Ganado Prospects             2.0                 3.2
Maurice Prospect                                  1.2                 1.5
                                                 ----                ----
          Total                                 $ 7.5              $ 11.0 

In  addition  to the  above  capital  requirements,  the  Company  may  incur an
additional  $2.0 million in  obligations  related to the  exploration  agreement
dated  February  4, 1997,  as amended on January  16,  1998,  by and between the
Company  and  NEGX.  That  agreement  provided  the  Company  with the right and
obligation to participate with NEGX in various exploration  projects,  including
the Bayou Sorrell 3-D Area, over a period of two years.  The agreement with NEGX
specifies  that the  Company's  minimum  obligation is at least $5.0 million per
year in dry hole, or drilling costs. Accordingly, this additional obligation may
be incurred for  exploration  projects  outside of the Bayou Sorrell 3-D Area or
for additional  costs which may be incurred for  completion  and  development of
successful  projects.  The obligation to  participate in additional  exploration
projects outside of the Bayou Sorrell 3-D Area ends on February 4, 1999.

The Company's  current and  anticipated  cash position will be  insufficient  to
cover the future working  capital and  exploration  obligations  and the Company
will  need to seek  additional  financing.  The  Company  is  exploring  various
alternatives and future sources of capital may include additional debt or equity
financings,  the sale of certain  existing  assets,  or a  combination  thereof.
However,  it  cannot  be  determined  at this  time,  what  alternatives  may be
available,   nor  to  what  extent  the  potential   dilution  to  the  existing
shareholders  may be. In addition,  if  additional  sources of financing are not
ultimately  available,  the  Company may have to  consider  other  alternatives,
including  cancellation  of existing  exploration  agreements,  farmouts,  joint
ventures, a merger, and/ or liquidation.

The Company is  currently  attempting  to sell or  otherwise  monitize its Rocky
Mountain assets.  Although no formal agreements have been reached as of the date
of this  report,  the Company has been  conducting  on-going  negotiations  with
several parties  interested in the assets.  The depressed and volatile commodity
prices  experienced since November 1997 (and continuing through the date of this
report) have  hindered the  negotiations.  However,  the Company is committed to
selling  the Rocky  Mountain  Assets and  anticipates  most,  if not all, of the
related assets will be sold sometime in 1998 assuming that acceptable  terms can
be negotiated  with a willing  purchaser.  The Company's  obligations  under its
outstanding  10%   Collateralized   Convertible   Debentures  (the  "Convertible
Debentures") in the principal  amount of $3.975 million,  together with interest
thereon,  is secured by a first priority  security interest in substantially all
of the oil and gas  reserves  in  Larimer  and Weld  Counties,  Colorado,  which
constituted  approximately  60% of all of the Company's  Rocky  Mountain  proved
reserves of oil and gas at December 31, 1997. A portion of any proceeds received
from the  Company  upon the sale of its Rocky  Mountain  oil and gas  properties
attributable to the properties which secure the Convertible  Debentures will not
be available to the Company,  as such proceeds must be set aside and reserved as
security for the Company's  obligations  under the Convertible  Debentures.  The
Company  intends to substitute  other oil and gas assets as  collateral  for the

                                      -19-

<PAGE>

Convertible  Debentures,  but such substitution requires the written approval of
the holders of at least two-thirds of the oustanding Convertible Debentures. The
Company intends to seek such approval for substitution at such time, if ever, as
an acceptable  sale of its Rocky  Mountain oil and gas  properties is negotiated
and placed under  contract.  However,  it cannot be  determined at this time the
amount of capital,  if any, that would be available for future  exploration  and
development activities should the Rocky Mountain assets be sold.

Capital Expenditures
During 1997,  the Company  incurred  $14,606,933  in property  and  equipment as
follows:

                                                          Total              %
                                                          -----             ---
Acquisitions of oil and gas interests in
    East Bayou Sorrel .............................   $ 4,266,955            29%
Exploration Activities -
    Discovery wells ...............................     2,100,510            14%
    Exploratory Dry Holes .........................     3,645,493            25%
    Land, Geologic and Geophysical Costs
      on Seismic Programs .........................     3,147,443            22%
    Other Exploration Costs .......................       606,126             4%
                                                      -----------          ----
        Total Exploration Activities ..............     9,499,572            65%
Workovers or Recompletions of Rocky
     Mountain properties ..........................       734,235             5%
                                                      -----------           ---
        Total Oil and Gas properties ..............    14,500,762            99%
Service and Other Field Equipment .................       102,341             1%
Office Equipment ..................................         3,830           Nil
                                                      -----------           ---
        Total Capital Expenditures ................   $14,606,933           100%
                                                      ===========           ===

The total costs incurred for exploration  activities of $9,499,572 is summarized
below by program operator:
<TABLE>
<CAPTION>
                                                          PROGRAM OPERATOR
                                         ---------------------------------------------------------
                                                                                The Co. &
                                         NEGX        Parallel        AHC          Other      Total             %
                                         ----        --------        ---        ---------    -----            ---
<S>                                   <C>          <C>          <C>          <C>          <C>                <C>
Category:
Discovery wells ...................   $1,542,431   $     --     $  558,079   $     --     $2,100,510           22%
Exploratory Dry Holes .............    3,518,690       36,197         --         90,606    3,645,493           38%
Land, G&G Costs on Seismic ........         --      3,119,939         --         27,504    3,147,443           33%
   Programs
Other Exploration Costs ...........         --           --          2,889      603,237      606,126            7%
                                      ----------   ----------   ----------   ----------   ----------          ---
       Total Exploration Costs .....  $5,061,121   $3,156,136   $  560,968   $  721,347   $9,499,572          100%
                                      ==========   ==========   ==========   ==========   ==========           ===
</TABLE>

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.


                                      -20-


<PAGE>

Change In Accounting Principle
During the fourth quarter of 1997, the Company  changed its method of accounting
for oil and gas producing  activities from the successful  efforts method to the
full cost  method.  The 1996  financial  statements  presented  herein have been
restated to reflect the change.

Through  December 31, 1995, the cumulative  effect of the change  resulted in an
increase  in  carrying  value  in oil and  gas  properties  and a  corresponding
decrease in the accumulated deficit of $3,068,165.  As a result of the change in
accounting method, the net loss applicable to common  shareholders  decreased by
$138,000  ($0.02 per share) in 1996,  and  increased  by  $1,970,500  ($0.15 per
share) in 1997.  The majority of the increased loss in 1997 is recognized in the
financial statements under the caption "Impairment Expense-Assets held For Sale"
which is discussed later in this section.

Management  believes the full cost method of accounting is preferable because it
will most accurately reflect the results of the Company's future operations.  In
connection  with the Company's  change in strategy from primarily an acquisition
and production  company to an  exploration  and  production  company,  it is now
focusing its efforts in the Gulf Coast region of the United States.  The Company
seeks  to  allocate  its  capital  resources  over a  diversified  portfolio  of
exploration  and  development  projects  within that area. It seeks to achieve a
balance  between the risks of exploratory  drilling and the return on investment
by investing in projects with large potential.  Dry holes,  abandoned properties
and seismic projects are an inherent part of the exploration  process.  However,
management believes that it is through  disciplined,  consistent  application of
this  balanced  portfolio  strategy  that  the  desired  return  on  its  entire
investment  will be achieved.  Management  believes that the full cost method of
accounting  is the method  used by many  independent  oil and gas  companies  of
comparable  size to the  Company  and allows  investors  to better  measure  the
performance  of the Company.  Management  further  believes that advanced  three
dimensional seismic and computer-aided  exploration technology has become a much
more  significant  factor in the success of an  exploration  program than in the
past.  Management  believes  that  expensing  these costs when  incurred,  as is
required under successful  efforts,  is inconsistent  with the value they add to
the exploration process.

Assets Held For Sale
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.  If and when these assets are sold, the revenue,  costs,
operating  margins and cash flows  currently  generated and discussed  under the
captions  "Gas  Plant  Processing",  "Oil  Field  Services  and  Supply",  "Well
Administration  and  Other  Income"  would no  longer  be part of the  Company's
operations.  Since these assets  include a significant  portion of the Company's
current  operations,  the sale of these assets, when and if it occurs, will have
an immediate and material negative impact on the Company's future cash flows and
results of operations.

Total Revenue
Total Revenue from all operations was as follows:

<TABLE>
<CAPTION>
                                                       For the Year Ended December 31,
                                               -----------------------------------------------
                                                       1997                        1996
                                                ---------------------       ------------------
                                                Amount            %         Amount           %

<S>                                          <C>                <C>     <C>                <C>
Oil and gas sales ........................   $3,168,042           68%   $2,546,676           41%
Natural gas marketing and trading ........         --           --       2,067,379           34%
Gas plant processing .....................      691,828           15%      818,356           13%
Oil field services and supply ............      707,060           15%      618,225           10%
Well administration and other income .....       92,379            2%      115,028            2%
                                             ----------   ----------    ----------   ----------
     Total revenue .......................   $4,659,309          100%   $6,165,664          100%
                                             ==========   ==========    ==========   ==========
</TABLE>


                                      -21-
<PAGE>

The decrease in total revenue is substantially attributable to the expiration of
the Company's  natural gas marketing  and trading  contract with Public  Service
Company of Colorado  effective July 1, 1996. This contract  provided the Company
the  opportunity  to market,  or broker,  third  party gas,  at an above  market
premium. This decrease in revenue was partially offset by an increase in oil and
gas revenue that has resulted from the Company's  Gulf Coast  activities.  These
circumstances,  along with any known trends or changes that effect  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 End
                                                            December 31,
                                                      1997               1996
                                                      ----               ----
Production:
   Oil (Bbls)
        Rocky Mtns .........................            80,000           100,000
        Gulf Coast .........................            43,000              --
                                                   -----------       -----------
             Combined Total ................           123,000           100,000
                                                   -----------       ===========
Gas (Mcf)
        Rocky Mtns .........................           392,000           412,000
        Gulf Coast .........................            91,000              --
                                                   -----------       -----------
              Combined Total ...............           483,000           412,000
                                                   ===========       ===========
BOE (6:1)
        Rocky Mtns .........................           145,000           169,000
        Gulf Coast .........................            59,000              --
                                                   -----------       -----------
              Combined Total ...............           204,000           169,000
                                                   ===========       ===========
Average Collected Price:
   Oil (per Bbl)
        Rocky Mtns .........................       $     18.75    $        20.35
        Gulf Coast .........................       $     19.15    $      --
                                                   -----------       -----------
              Combined Average .............       $     18.89    $        20.35
                                                   ===========       ===========
Gas (per Mcf)
         Rocky Mtns ........................       $      1.46    $         1.26
         Gulf Coast ........................       $      2.94    $      --
                                                   -----------       -----------
              Combined Average .............       $      1.74    $         1.26
                                                   ===========       ===========
Per BOE (6:1)
         Rocky Mtns ........................       $     14.25    $        15.10
         Gulf Coast ........................       $     18.76    $      --
                                                   -----------       -----------
              Combined Average .............       $     15.54    $        15.10
                                                   ===========       ===========

                                      -22-

<PAGE>


                                                      1997             1996
                                                      ----             ----
Operating Margins:
   Rocky Mtns:
       Revenue -
                Rocky Mtns. Oil ............     $ 1,498,800       $ 2,023,419
                Rocky Mtns. Gas ............         571,213           523,257
                                                 -----------       -----------
                                                 $ 2,070,013       $ 2,546,676
       Costs ...............................      (1,320,758)       (1,426,549)
                                                 -----------       -----------
               Operating Margin ............     $   749,255       $ 1,120,127
               Operating Margin Percent ....              36%               44%

Gulf Coast:
       Revenue -
               Gulf Coast - Oil ............     $   828,779       $      --
                                                                   -----------
               Gulf Coast - Gas ............         269,250              --
                                                 -----------       -----------
                                                 $ 1,098,029       $      --
       Costs ...............................        (165,980)             --
                                                 -----------       -----------
               Operating Margin ............     $   932,049       $      --
               Operating Margin Percent ....              85%             --

Combined Totals:
       Revenue .............................     $ 3,168,042       $ 2,546,676
       Costs ...............................      (1,486,738)       (1,426,549)
                                                 -----------       -----------
               Operating Margin ............     $ 1,681,304       $ 1,120,127
                                                 ===========       ===========
               Operating Margin Percent ....              53%               44%
Production Costs per BOE before
DD&A:
          Rocky Mtn Region .................     $      9.09       $      8.46
          Gulf Coast Region ................            2.84              --
                                                 -----------       -----------
              Combined Average .............     $      7.29       $      8.46
                                                 ===========       ===========
Change in Revenue Attributable
to:
          Production .......................     $   570,307
          Price ............................          51,059
                                                 -----------
  Total Increase in Revenue ................     $   621,366
                                                 ===========

Most of the decrease in oil and gas production for the Rocky Mountain region can
be attributed to the following: 1) the sale of several marginal,  uneconomic, or
nonstrategic  oil and gas  properties in the second  quarter 1996 that accounted
for 3,900 bbls of oil and 4,500 Mcf of gas in the prior year; and 2) the natural
decline  in  production  that  is  inherent  in oil and gas  wells.  Both  these
circumstances  were  largely  offset  by new  production  from  the  Gulf  Coast
acquisitions and discoveries.

The operating costs per BOE for the Rocky Mountain properties  increased in 1997
when compared to the same period in 1996,  primarily as a result of  maintenance
and stimulation procedures that were needed to maintain production.  Most of the
wells in the  Rocky  Mountain  region  are  between  10 and 30 years old and the
Company  expects to incur higher costs from time to time since the  equipment is

                                      -23-

<PAGE>

aging and the reservoirs  are on the latter part of the decline curve.  Although
the Company does not expect  future costs of the Rocky  Mountain  properties  to
increase, and anticipates that they may even be lower, future costs of the Rocky
Mountain  properties  are not  accurately  determinable  based on the age of the
wells and corresponding equipment.

Natural Gas Marketing and Trading
The Company had a "take-or-pay" contract with Public Service Company of Colorado
("PSCo")  which  called for PSCo to purchase  from the Company a minimum of 2.92
billion cubic feet ("BCF") of natural gas  annually.  The price paid the Company
by PSCo was based on the Colorado Interstate Gas Commission's "spot" price, plus
a fixed price bonus. The natural gas marketing and trading activities  represent
natural  gas that was  purchased  from third  parties and sold to PSCo under the
terms of the contract.

Operating  statistics for the Company's Marketing and Trading Activities for the
periods presented are as follows:

                                        For the Year Ended December 31,
                                           1997                 1996
                                      -------------         ----------
    Total Volume Sold (Mcf)                                  1,223,855
    Average Price                     $     -               $     1.69
                                        -----------          ---------
             Total Revenue            $     -               $2,067,379
    Costs                                   -               (1,745,446)
                                        -----------          ----------
             Gross Margin             $     -               $   321,933
                                        ============         ==========

The contract with PSCo expired on June 30, 1996. Historically, the price paid by
PSCo under that contract was at a premium above the market and therefore allowed
for the marketing and trading activities. No marketing and trading revenues have
been  generated  subsequent  to June 30,  1996  and  considering  the  increased
competition  fostering  within all phases of the  natural  gas  industry,  it is
unlikely that the Company will resume  marketing  and trading  activities in the
future. The loss of this premium contract was the single largest item decreasing
the  Company's  total  revenue  in 1997.  In  addition,  since the gross  margin
represented the net cash flow and income generated from this activity,  the loss
of this  premium  contract  price had a negative  impact on the  Company's  1997
results of operations and cash flows.

Gas Plant Processing Revenues
This category accounts for the natural gas processed and the natural gas liquids
extracted and sold by the Gas Plant facility.








                                      -24-
<PAGE>


Operating statistics for the periods presented are as follows:

                                                 For the Year Ended December 31,
                                                 -------------------------------
                                                        1997            1996
                                                        ----            ----
    Production:
      Natural Gas Processed (Mcf) ...............       331,900        363,000
                                                    -----------    -----------
      Liquids Produced -
           B-G Mix (gallons) ....................       769,300        894,000
           Propane (gallons) ....................       642,500        694,000
                                                    -----------    -----------
                  Total liquids produced ........     1,411,800      1,588,000
                                                    ===========    ===========
  Average Sales Price of Liquids (per gallon) ...   $      0.41    $      0.45
                                                    ===========    ===========

Gross Margin: ...................................        Amount         Amount
                                                    -----------    -----------
           Revenue ..............................   $   691,828    $   818,356
           Costs ................................      (388,851)      (464,512)
                                                    -----------    -----------
                  Gross Margin ..................   $   302,977    $   353,844
                                                    ===========    ===========
                  Gross Margin Percent ..........          44 %             43%

The  decrease  in natural  gas  processing  volumes  (per Mcf)  during 1997 when
compared  to 1996,  can be  substantially  attributed  to the normal  decline in
production from the two fields owned and operated by the Company that supply the
gas plant with the natural gas.  The change in revenue in 1997 when  compared to
1996  is a  direct  result  of the  volume  of  natural  gas  processed  and the
corresponding changes in liquid prices.

Costs  associated with the Gas Plant  operations  consist of both semi-fixed and
variable  costs.  The  semi-fixed  costs consist of direct  payroll,  utilities,
operating supplies,  general and administrative costs, and other items necessary
in the day-to-day  operations.  The semi-fixed  costs are not expected to change
significantly  regardless of the volume processed by the Gas Plant. The variable
costs consist  primarily of purchased  gas,  plant fuel and shrink,  lubricants,
repair and  maintenance.  These  costs are  generally  a direct  function of the
volume  processed  by the Gas  Plant and are  expected  to  either  increase  or
decrease proportionately with the corresponding plant production.

Oil Field Services and Oil Field Supply
Operating  statistics for the Company's oil field service and supply  operations
for the periods presented are as follows:

                                   For the Year Ended December 31,
                                   -------------------------------
                                     1997                     1996
                                    -----                     ----
    Revenue                     $   707,060              $   618,225
    Costs                          (651,458)                (553,343)
                                  ----------             ------------
    Net Operating Income        $    55,602              $     64,882
                                  ===========             ===========

Although revenue in these operations increased $88,835, or 14%, in 1997, the net
operating  income was not materially  different due to additional costs incurred
for repairs and maintenance and low margins realized on supply sales.


                                       -25-
<PAGE>
Well Administration and Other Income
This  revenue  primarily  represents  the revenue  generated  by the Company for
operating oil and gas properties.  The decrease in 1997 when compared to 1996 is
primarily  attributed to several  marginal wells that the Company  operated were
sold in 1996.

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.

During 1997, the Company granted Beta warrants for an additional  100,000 shares
of common stock. These warrants are exercisable for a period of four years at an
exercise price of $3.75 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 who
works for Beta is also a member of the Company's Board of Directors.

General and Administrative
The increase in general and  administrative  ("G&A")  expenses of  approximately
$405,000 in 1997 when compared to 1996 is summarized as follows:

$    132,000 - Severance  to the  Company's  V.P. of  Production  and
               Engineering  who  retired in light of the  Company's  anticipated
               divestment of its Rocky Mountain assets.
      70,000 - Travel and entertainment  costs associated with the Company's
               expansion into the Gulf Coast.  
      62,000 - Payroll  costs  associated  with an  increase in base pay and
               insurance  premiums for virtually all the Company's  officers and
               employees.
      37,000 - For consulting services  (principally  legal,  accounting and
               land)  associated  with  the  Company's  expansion  into the Gulf
               Coast.
      37,000 - Recovery  of Bad Debt in 1996 (this  reduced  G&A  expense in
               1996 - no such amounts were recovered in 1997)
      25,000 - A Directors and Officers Liability Insurance Policy purchased
               on July 1, 1996.
      12,000 - Directors' compensation.
      30,000 - All other, net.
     -------
   $ 405,000
     =======

Although  the Company has and will take steps to maintain or monitor  future G&A
costs, the Company expects future G&A costs to be at those levels experienced in
1996.  Even if the Rocky Mountain  assets are ultimately  sold, the Company does
not expect any  significant  reductions in future G&A expenses,  at least in the
near term.  This is primarily due to any reductions  that may be made due to the
divestment will likely be offset by additional  administrative  costs associated
with the Gulf Coast exploration activities. Accordingly, future G&A costs can be
expected to be approximately  $120,000 to $130,000 per month. In connection with
the  Company's  accounting  change  from  successful  efforts to full cost,  the
Company  capitalized  $280,000  and  $138,000  in 1997 and  1996,  respectively,
certain costs associated with the Gulf Coast  exploration  activities that would
have been expensed as G&A under successful efforts.

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
                                                    1997                 1996
                                                -------------       ---------
 Oil and Gas Properties - Rocky Mountains       $ 1,176,865      $ 1,017,859
 Oil and Gas Properties - Gulf Coast              1,018,499              -
 Gas Plant Operations                               232,304          234,534
 Service and Supply Operations                      146,436          140,132
 Furniture and Fixtures                              49,219           45,124
 Non-Compete Agreements                              45,996           45,996
                                                 ------------     ----------
   Total                                         $ 2,669,319      $1,483,645
                                                  ==========       =========
                                       -26-
<PAGE>

As  illustrated,  the  increase  in the DD&A in 1997  when  compared  to 1996 is
substantially attributed to the Gulf Coast oil and gas properties.

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

                                                    For the Year
                                                 Ended December 31,
                                               1997              1996
                                               ----              ----
Interest paid or accrued                $    448,705        $  311,461
Amortization of debt discount                353,310            97,107
Amortization of debt issuance costs          223,003            93,860
                                         -----------         ---------
         Total interest incurred        $  1,025,018        $  502,428
Interest capitalized                        (323,641)            -
                                          ----------         ---------
              Interest expense          $    701,377        $  502,428
                                         ===========          ========

The higher  interest  incurred  in 1997 is  reflective  of the  increase  in the
average  long-term debt outstanding and amortization of the  corresponding  debt
issuance/discount costs. Both of these circumstances are directly related to the
convertible  debentures sold by the Company  pursuant to a private  placement of
convertible debentures completed in November 1996.

Impairment - Oil and Gas Properties
As previously discussed, the Company decided to change its accounting method for
oil and gas activities  from  successful  efforts to full cost during the fourth
quarter  of  1997.  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 Company expects that the benefits  obtained
from the prospects  that do prove  successful,  together with benefits from past
discoveries,   will  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.
In light of the transformation  from Rocky Mountain  acquisition and development
to Gulf Coast exploration, the Company believes this method will be a preferable
method of accounting.  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). At
December  31,  1997,  the  Company's  full cost pool  consisted  of those  costs
associated  with the Gulf Coast  exploration  activities.  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.

The oil and gas prices as of the date of this  report were lower than those used
to estimate the reserves at December 31, 1997 by approximately  $2.10 per bbl of
oil and $0.35 per Mcf of gas.  The prices  used for the Gulf Coast  reserves  at
December  31, 1997  averaged  $17.11 per bbl of oil and $2.61 per Mcf of natural
gas. If commodity  prices do not recover,  at least to the extent being received
as of December 31, 1997, the Company could incur additional  impairment  charges
during the first  quarter of 1998,  the extent of which cannot be  determined at
this time.



                                       -27-
<PAGE>

Impairment - Assets Held For Sale
As previously  discussed,  the Company has decided to divest its Rocky  Mountain
assets.  At the time  this  decision  was made by the  Board of  Directors,  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 of  $4,048,000.  This charge was larger  than  previously
announced  on December 24, 1997 in Form 8-K because of the  Company's  change in
accounting  method from successful  efforts to full cost. As discussed in Note 2
to the Financial Statements,  the cumulative effect of the change resulted in an
increase in the oil and gas  properties  held for sale of $3,068,165 at December
31, 1995. This cumulative effect increased the impairment recognized in 1997 and
is summarized as follows:

 $2,554,861     -   Impairment related to the cumulative effect of change in 
                    accounting method ($3,068,165 net of $513,304 in DD&A for
                    1996 and 1997).
  6,411,111     -   Remaining impairment related to the assets held for sale.
 $8,965,972     -   Total Impairment on the Assets Held For Sale.

Dividends and Net Loss Per Common Share
Net loss per common  share is computed by dividing  the net loss  applicable  to
common stockholders  (which includes accrued but unpaid preferred  dividends) by
the weighted  average number of common shares  outstanding  during the year. All
common stock equivalents have been excluded from the computations  because their
effect would be anti-dilutive.

The net loss  applicable  to common  stockholders,  is  determined by adding any
dividends enuring to the benefit of the preferred  stockholders to the net loss.
In 1997, the dividends of $89,969  related to the Series A Preferred  Stock that
automatically  converted into common on June 11, 1997. On December 31, 1997, the
Company issued 113,333 shares of the newly designated 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 holders of the Series B Preferred  Stock are  entitled to  dividends
equal to $2.50 per annum (currently $283,333 per year) payable quarterly in cash
or additional  shares of Series B Preferred  Stock at the option of the Company.
This 5% dividend  will be charged to the future  earnings  applicable  to common
stockholders. In addition, the Series B Preferred Stock becomes convertible into
common stock after 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 will also be accounted for as an additional  dividend on the Series
B Preferred Stock which will be recognized as a charge to earnings applicable to
common  stockholders in the future.  Other terms of the Series B Preferred Stock
are more thoroughly discussed in Footnote 7 of the Financial Statements included
under Item 7 of this report.

OTHER MATTERS

Recently Issued Financial Accounting Standards
In June 1997, the FASB issued  Statement of Financial  Accounting  Standards No.
130, "Reporting  Comprehensive Income" ("SFAS 130"), which establishes standards
for  reporting  and  display of  comprehensive  income and its  components.  The
components of comprehensive income refer to revenues, expenses, gains and losses
that are excluded from net income under current accounting standards,  including
foreign currency  translation items,  minimum pension liability  adjustments and
unrealized  gains  and  losses  on  certain   investments  in  debt  and  equity
securities.  SFAS  130  requires  that  all  items  that  are  recognized  under
accounting  standards as  components  of  comprehensive  income be reported in a
financial  statement  displayed  in equal  prominence  with the other  financial
statements;  the total of other comprehensive income for a period is required to


                                       -28-
<PAGE>


be  transferred  to a component  of equity  that is  separately  displayed  in a
statement of financial position at the end of an accounting period.  SFAS 130 is
effective for both interim and annual periods beginning after December 15, 1997.
The Company does not believe that this SFAS will have any significant  impact on
its financial statements.

In June 1997, the FASB issued  Statement of Financial  Accounting  Standards No.
131,  "Disclosures  about  Segments of an  Enterprise  and Related  Information"
("SFAS 131"). SFAS 131 establishes  standards for the way public enterprises are
to report  information about operating  segments in annual financial  statements
and requires the reporting of selected  information about operating  segments in
interim financial reports issued to shareholders.  It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers.  SFAS 131 is effective for periods beginning after December 15, 1997.
The  Company  does not  believe  that  this SFAS  will  currently  result in any
significant new disclosures in its financial statements.

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 begun to address  possible  remedial  efforts in connection with
computer software that could be affected by the Year 2000 problem. The Year 2000
problem is the result of computer programs being written using two digits rather
than four to define the applicable  year. Any 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 has been informed by the suppliers of substantially all of the Company's
software  that all of those  suppliers'  software that is used by the Company is
Year 2000 compliant.  The Company has no internally  generated  software.  After
reasonable  investigation,  the  Company  has not yet  identified  any Year 2000
problems  but will  continue  to  monitor  the issue.  However,  there can be no
assurances  that Year 2000 problems will not occur with respect to the company's
computer systems. The Year 2000 problem may impact other entities with which the
Company  transacts  business,  and the Company  cannot predict the effect of the
Year 2000 problem on such entities.

                                       -29-
<PAGE>

ITEM 7.   FINANCIAL STATEMENTS


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                           Page

Independent Auditor's Report. . . . . . . . . . . . . . . . . . . . . . .  30

Consolidated Balance Sheets - December 31, 1997 . . . . . . . . . . . . .  31

Consolidated Statements of Operations - For the Years Ended December
 31, 1997 and 1996. . . . . . . . . . . . . . . . . . . . . . . . . . . .  32

Consolidated Statements of Stockholders' Equity - For the Years Ended
 December 31, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . .  33

Consolidated Statements of Cash Flows - For the Years Ended 
 December 31, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . .  34-35

Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . .  36-48


                                       -30-
<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, 1997, and the related  consolidated
statements  of  operations,  stockholders'  equity  and cash flows for the years
ended  December  31,  1997  and  1996.   These  financial   statements  are  the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the 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,  1997,  and the results of their
operations  and their cash flows for the years ended  December 31, 1997 and 1996
in conformity with generally accepted accounting principles.

As discussed in Note 2 to the financial statements, the Company adopted the full
cost method of accounting for oil and gas  properties  during the fourth quarter
of 1997.



/s/ HEIN + ASSOCIATES LLP


Denver, Colorado
March 18, 1998

                                       -31-
<PAGE>

<TABLE>
<CAPTION>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET
                                December 31, 1997

                                     ASSETS

<S>                                                                                <C>         
CURRENT ASSETS:
      Cash and equivalents .....................................................   $  6,547,804
      Trade receivables, net of allowance for bad debts of $24,395 .............        757,434
      Prepaid expenses and other ...............................................         43,979
                                                                                      ---------
                        Total current assets ...................................      7,349,217
                                                                                      ---------
ASSETS HELD FOR SALE ...........................................................      4,048,000
                                                                                      ---------
OIL AND GAS PROPERTIES, at cost (full cost method):
      Unevaluated properties ...................................................      4,522,917
      Costs being amortized ....................................................      9,424,932
                                                                                      ---------
                   Total oil and gas properties ................................     13,947,849
      Less accumulated amortization ............................................     (4,965,232)
                                                                                      ---------
                   Net oil and gas properties ..................................      8,982,617
                                                                                      ---------
OTHER ASSETS:
      Debt issuance costs, net of accumulated amortization of $263,055 .........        664,318
      Deposits and other .......................................................        167,493
      Office equipment and vehicles, net of accumulated depreciation of $176,027         82,498
                                                                                     ----------
                   Total other assets ..........................................        914,309
                                                                                     ----------
TOTAL ASSETS ...................................................................   $ 21,294,143
                                                                                     ==========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
      Accounts payable, trade ..................................................   $  1,500,239
      Accrued production taxes .................................................        204,108
      Other accrued expenses ...................................................        349,396
                                                                                      ---------
                   Total current liabilities ...................................      2,053,743
                                                                                      ---------
LONG-TERM LIABILITIES:
      Convertible debentures, net of discount of $1,052,297 ....................      2,922,703
      Accrued production taxes .................................................        226,019
                                                                                      ---------
                   Total long-term liabilities .................................      3,148,722
                                                                                      ---------
COMMITMENTS AND CONTINGENCIES (Notes 4, 6, and 11) STOCKHOLDERS' EQUITY:
      Preferred Stock, par value $.01 per share, 2,000,000 shares authorized,
           113,333 shares of Series B 5% PIK Cumulative Convertible Preferred
           Stock issued and outstanding (liquidation preference of $5,666,650)..          1,133
      Common Stock, par value $.10 per share, 40,000,000 shares authorized,
           issued and outstanding 15,789,955 shares ............................      1,578,996
      Additional paid-in capital ...............................................     36,875,394
      Accumulated deficit ......................................................    (22,363,845)
                                                                                     ----------
                   Total stockholders' equity ..................................     16,091,678
                                                                                     ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .....................................   $ 21,294,143
                                                                                     ==========
</TABLE>

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

                                       -32-
<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                 For the Years Ended December 31, 1997 and 1996



                                                      1997            1996
                                                      ----            ----

REVENUE:
      Oil and gas sales ......................   $  3,168,042    $  2,546,676
      Gas plant processing ...................        691,828         818,356
      Oilfield services and supply ...........        707,060         618,225
      Natural gas marketing ..................           --         2,067,379
      Well administration and other ..........         92,379         115,028
                                                 ------------    ------------
                   Total revenue .............      4,659,309       6,165,664
                                                 ------------    ------------
EXPENSES:
      Oil and gas production costs ...........      1,486,738       1,426,549
      Gas plant ..............................        388,851         464,512
      Oilfield services and supply ...........        651,458         553,343
      Natural gas marketing ..................           --         1,745,446
      Consulting expense-related party .......        437,236         257,199
      General and administrative .............      1,487,236       1,082,342
      Depreciation, depletion and amortization      2,669,319       1,483,645
      Impairment expense:
              Oil and gas properties .........      3,946,733            --
              Assets held for sale ...........      8,965,972            --
                                                 ------------    ------------
                   Total expenses ............     20,033,543       7,013,036
                                                 ------------    ------------
LOSS FROM OPERATIONS .........................    (15,374,234)       (847,372)
OTHER INCOME (EXPENSES):
      Interest expense .......................       (701,377)       (502,428)
      Interest and other income ..............        180,774          82,557
      Loss on sale of assets .................           (230)         (6,660)
                                                 ------------    ------------
NET LOSS .....................................   $(15,895,067)   $ (1,273,903)
                                                 ============    ============
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS ...   $(15,985,036)   $ (1,476,591)
                                                 ============    ============
NET LOSS PER COMMON SHARE ....................   $      (1.22)   $      (0.20)
                                                 ============    ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
      OUTSTANDING ............................     13,090,000       7,278,000
                                                 ============    ============

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


                                       -33-
<PAGE>
<TABLE>
<CAPTION>
                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 For the Years Ended December 31, 1997 and 1996
                                                                         Preferred Stock                 Common Stock
                                                                      ---------------------         ------------------------
                                                                      Shares          Amount         Shares           Amount 
                                                                      ------          ------         ------           ------
<S>                                                                   <C>        <C>                <C>         <C>    
BALANCES, January 1, 1996, as previously reported ............        202,688    $      2,027       7,180,804   $    718,081
   Adjustment for the cumulative effect on prior
          years of applying retroactively the new method
          of accounting for oil and gas properties ...........           --              --              --             --   
                                                                     --------          ------       ---------       --------
BALANCES, January 1, 1996, as adjusted .......................        202,688           2,027       7,180,804        718,081
   Issuance of common stock to officers, directors, and
           employees for compensation ........................           --              --            51,490          5,149
   Fair value of warrants granted for debt discount and
           issuance costs ....................................           --              --              --             --   
   Conversion of debentures into common stock ................           --              --            82,353          8,235
   Issuance of common stock for engineering services .........           --              --            15,000          1,500
   Exercise of options and warrants to purchase common stock .           --              --            67,500          6,750
   Conversion of note payable to director into common stock ..           --              --            60,000          6,000
   Conversion of Series A preferred stock to common stock ....        (22,750)           (228)         69,670          6,967
   Offering costs ............................................           --              --              --             --   
   Net loss ..................................................           --              --              --             --   
                                                                     --------          ------       ---------       --------
BALANCES, December 31, 1996 ..................................        179,938           1,799       7,526,817        752,682
   Fair value of warrants granted for services ...............           --              --              --             --   
   Issuance of common stock for:
      Acquisition of oil and gas properties ..................           --              --           318,150         31,815
      Exercise of stock options ..............................           --              --            42,675          4,268
      Exercise of warrants ...................................           --              --         3,192,600        319,260
      Services ...............................................           --              --             6,150            615
      Cash in private placements .............................           --              --         3,792,000        379,200
      Conversion of 10% collateralized convertible debentures,
         net of discount .....................................           --              --           341,665         34,166
      Conversion of Series A preferred stock .................       (179,938)         (1,799)        569,898         56,990
   Issuance of Series B preferred stock ......................        113,333           1,133            --             --   
   Offering costs ............................................           --              --              --             --   
   Net loss ..................................................           --              --              --             --   
                                                                     --------          ------      ----------      ---------
BALANCES, December 31, 1997 ..................................        113,333    $      1,133      15,789,955   $  1,578,996
                                                                     ========          ======      ==========      =========
<CAPTION>
                                                                  Additional      Accumulated          Total
                                                                    Paid-In          Deficit        Stockholders'
                                                                    Capital          (Note 2)         Equity
                                                                  ----------      -----------       ------------
<S>                                                              <C>             <C>             <C>       
BALANCES, January 1, 1996, as previously reported ............   $ 16,560,194    $ (8,263,040)   $  9,017,262
   Adjustment for the cumulative effect on prior
          years of applying retroactively the new method
          of accounting for oil and gas properties ...........           --         3,068,165       3,068,165

                                                                 ------------    ------------    ------------
BALANCES, January 1, 1996, as adjusted .......................     16,560,194      (5,194,875)     12,085,427
   Issuance of common stock to officers, directors, and
           employees for compensation ........................         57,162            --            62,311
   Fair value of warrants granted for debt discount and
           issuance costs ....................................      2,320,000            --         2,320,000
   Conversion of debentures into common stock ................         61,765            --            70,000
   Issuance of common stock for engineering services .........         21,477            --            22,977
   Exercise of options and warrants to purchase common stock .         57,625            --            64,375
   Conversion of note payable to director into common stock ..         54,000            --            60,000
   Conversion of Series A preferred stock to common stock ....         (6,739)           --              --
   Offering costs ............................................        (13,155)           --           (13,155)
   Net loss ..................................................           --        (1,273,903)     (1,273,903)
                                                                  ------------    ------------    ------------
BALANCES, December 31, 1996 ..................................     19,112,329      (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 ..................        853,185            --           885,000
      Exercise of stock options ..............................         41,123            --            45,391
      Exercise of warrants ...................................      3,592,953            --         3,912,213
      Services ...............................................         14,236            --            14,851
      Cash in private placements .............................      9,100,800            --         9,480,000
      Conversion of 10% collateralized convertible debentures,
         net of discount .....................................        457,888            --           492,054
      Conversion of Series A preferred stock .................        (55,191)           --              --
   Issuance of Series B preferred stock ......................      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 ..................................   $ 36,875,394    $(22,363,845)   $ 16,091,678
                                                                 ============    ============    ============
</TABLE>
              The accompanying notes are an integral part of these
                       consolidated financial statements.
                                       -34-
<PAGE>

<TABLE>
<CAPTION>
                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 For the Years Ended December 31, 1997 and 1996


                                                                                1997             1996
                                                                                ----             ----
                                                                                               (Note 2)
<S>                                                                         <C>             <C>          
CASH FLOWS FROM OPERATING ACTIVITIES:
      Net loss ..........................................................   $(15,895,067)   $ (1,273,903)
      Adjustments to reconcile net loss to net cash provided by (used in)
               operating activities:
                   Depreciation, depletion and amortization .............      2,623,323       1,437,651
                   Amortization of debt discount and issuance costs .....        576,313         190,967
                   Amortization of non-compete agreements ...............         45,996          45,996
                   Impairment expense:
                          Assets held for sale ..........................      8,965,972            --
                          Oil and gas properties ........................      3,946,733            --
                   Loss on sale of assets ...............................            230           6,660
                   Issuance of common stock and warrants for services ...         74,851          85,288
                   Other ................................................           --           (54,942)
                   Changes in operating assets and liabilities:
                         (Increase) decrease in:
                            Trade receivables ...........................       (157,786)        363,667
                             Inventory ..................................       (156,822)        124,502
                             Prepaid expenses and other .................         14,685         (14,316)
                         Increase (decrease) in:
                             Accounts payable ...........................          9,068        (905,027)
                             Accrued expenses ...........................        (41,182)       (109,473)
                                                                            ------------    ------------
                   Net cash provided by (used in) operating activities ..          6,314        (102,930)
                                                                            ------------    ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
      Capital expenditures for property, plant and equipment ............    (12,137,192)     (1,444,098)
      Change in other assets ............................................        (95,000)         53,500
      Proceeds from sale of property and equipment ......................         66,056         163,821
                                                                            ------------    ------------
                   Net cash used in investing activities ................    (12,166,136)     (1,226,777)
                                                                            ------------    ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
      Proceeds from sale of Series B preferred stock ....................      5,099,985            --
      Proceeds from exercise of stock options and warrants ..............      3,957,604            --
      Proceeds from issuance of convertible debentures ..................           --         5,000,000
      Repayment of long-term debt .......................................       (391,407)     (1,795,670)
      Proceeds from sale of common stock ................................      8,920,000         133,125
      Offering costs ....................................................       (874,416)        (13,155)
      Debt issuance costs ...............................................           --          (676,008)
                                                                            ------------    ------------
                   Net cash provided by financing activities ............     16,711,766       2,648,292
                                                                            ------------    ------------
NET INCREASE IN CASH AND EQUIVALENTS ....................................      4,551,944       1,318,585

CASH AND EQUIVALENTS, beginning of year .................................      1,995,860         677,275
                                                                            ------------    ------------
CASH AND EQUIVALENTS, end of year .......................................   $  6,547,804    $  1,995,860
                                                                            ============    ------------
</TABLE>

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


                                       -35-
<PAGE>

<TABLE>
<CAPTION>
                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 For the Years Ended December 31, 1997 and 1996



                                                                          1997        1996
                                                                          ----        ----
<S>                                                                   <C>          <C>       
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
    Cash paid for interest ........................................   $  505,523   $  192,502
                                                                      ==========   ==========

    Cash paid for income taxes ....................................   $     --     $     --
                                                                      ==========   ==========
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
   FINANCING ACTIVITIES:
     Fair value of warrants granted for:
          Debt issuance costs .....................................   $     --     $  491,000
          Discount on convertible debentures ......................         --      1,829,000
          Oil and gas exploration services ........................      180,000         --
     Conversion of long-term debt, net of discount, to common stock      492,054      130,000
     Debt incurred for purchase of vehicles .......................       50,691         --
     Payables for:
          Oil and gas properties ..................................    1,077,266         --
          Offering costs ..........................................      146,765         --
     Issuance of common stock for oil and gas properties ..........      885,000         --

</TABLE>



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





                                       -36-
<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 - Pease Oil and Gas Company (the  "Company")  explores
for, develops,  produces and sells oil and natural gas;  transports,  processes,
sells and markets natural gas and natural gas liquids at a gas processing plant;
performs oil and gas well  completion and operational  services;  and sells new,
used and reconditioned oil and gas production  equipment and oil field supplies.
As discussed in Note 3, the Company  intends to divest its gas processing  plant
and oil field service and supply  businesses.  The Company conducts its business
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.

    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, 1997 and
1996,  capital  expenditures  include  internal  costs of $75,000  and  $10,000,
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



                                       -37-
<PAGE>

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


    Depreciation  expense related to property,  plant and equipment  amounted to
$429,012  and  $419,792  for  the  years  ended  December  31,  1997  and  1996,
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 anticipated sale of assets discussed in Note 3.

    Debt Issuance Costs - Debt issuance  costs relate to the $5 million  private
placement of convertible  debentures  discussed in Note 4. These costs are being
amortized using the interest method.

    Inventory - Inventory consists primarily of oil and gas production equipment
and oil field supplies.  These items are generally held for resale.  At December
31, 1997,  inventory  also  includes  $99,000 of crude oil,  fuel,  and propane.
Inventory  is  carried at the lower of cost or  market,  cost  being  determined
generally under the first-in,  first-out  (FIFO) method of accounting,  or where
possible, by specific identification.

    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,  fair value of assets
held for  sale,  assumptions  affecting  the fair  value  of stock  options  and
warrants,  selection of the useful lives for property,  plant and equipment, 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).  FAS 128 replaces  the  presentation  of
primary and fully diluted earnings per share (EPS), with a presentation of basic
EPS and diluted EPS.  Under FAS 128,  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 1997 and 1996 as all  potential  common  shares were
antidilutive.


                                       -38-
<PAGE>

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


    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 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.  CHANGE IN ACCOUNTING PRINCIPLE:

    During  the  fourth  quarter  of 1997,  the  Company  changed  its method of
accounting  for oil and gas producing  activities  from the  successful  efforts
method to the full cost method. The 1996 financial  statements  presented herein
have been restated to reflect the change.

    Through  December 31, 1995, the cumulative  effect of the change resulted in
an increase in oil and gas properties and a decrease in the accumulated  deficit
of  $3,068,165.  As a result of the change in  accounting  method,  the net loss
applicable  to common  shareholders  decreased  by $138,000  ($.02 per share) in
1996, and increased by $1,970,500 ($.15 per share) in 1997.

    Management believes the full cost method of accounting is preferable because
it will more accurately  reflect the results of the Company's future operations.
In  connection  with  the  Company's   change  in  strategy  from  primarily  an
acquisition and production company to an exploration and production  company, it
is now focusing its efforts in the Gulf Coast region of the United  States.  The
Company seeks to allocate its capital resources over a diversified  portfolio of
exploration  and  development  projects  within that area. It seeks to achieve a
balance  between the risks of exploratory  drilling and the return on investment
by investing in projects with large potential.  Dry holes,  abandoned properties
and seismic projects are an inherent part of the exploration  process.  However,
management believes that it is through  disciplined,  consistent  application of
this  balanced  portfolio  strategy  that  the  desired  return  on  its  entire
investment  will be achieved.  Management  believes that the full cost method of
accounting  is the method  used by many  independent  oil and gas  companies  of
comparable  size to the  Company  and allows  investors  to better  measure  the
performance  of the Company.  Management  further  believes that advanced  three
dimensional seismic and computer-aided  exploration technology has become a much
more  significant  factor in the success of an  exploration  program than in the
past.  Management  believes  that  expensing  these costs when  incurred,  as is
required under successful  efforts,  is inconsistent  with the value they add to
the exploration process.

3.  ASSETS HELD FOR SALE:

    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.  Accordingly,  the Company evaluated these
assets for  impairment  and  recognized a charge of $8,965,972 to reduce the net
carrying value of the assets to the estimated fair value of $4,048,000.  Some of
the  properties  that will be divested  are  collateralized  by the  convertible
debentures  discussed in Note 4. Consequently,  a substantial portion of the net
proceeds  would  be  required  to be  deposited  in an  account  restricted  for
repayment of the  debentures.  Therefore,  the assets held for sale are excluded
from current assets in the accompanying balance sheet.

    Management  expects the  divestiture  of the  majority of these  assets will
occur  sometime in 1998. The following is a summary of the net carrying value of
assets held for sale at December 31, 1997:


                                       -39-
<PAGE>

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


  Oil and gas properties                                  $   3,089,081
  Gas plant                                                     250,000
  Service and supply buildings and equipment,
       including inventory of $278,272                          708,919
                                                          -------------
           Total                                          $   4,048,000
                                                          =============

    For the year ended  December  31,  1996,  all of the  Company's  assets were
located in the Rocky Mountain region and, accordingly, all of the 1996 operating
resulting were attributable these assets.  The results of operations,  exclusive
of the  impairment  charge,  related to assets  held for sale for the year ended
December 31, 1997 are as follows:

    Revenues                                              $   3,683,000
    Operating costs and expenses                             (2,368,000)
    Depreciation and amortization                            (1,606,000)
                                                          -------------
              Loss from operations                        $    (291,000)
                                                          =============

4.  DEBT FINANCING ARRANGEMENTS:

    Long-Term  Debt -  Long-term  debt at  December  31,  1997  consists  of the
following:

    Convertible debentures, interest at 10%,
       collateralized by certain oil and gas properties,
       due April 2001                                           $   3,975,000
    Less unamortized discount                                      (1,052,297)
                                                                -------------
             Net carrying value                                 $   2,922,703
                                                                =============

    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  expires in
March 1999,  and  provides  for minimum  monthly  cash  payments of $17,500.  In
addition to cash compensation,  the Company agreed to grant warrants to purchase
1,000,000  shares of the  Company's  common  stock.  The  exercise  price of the
warrants is $0.75 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
25,000 shares of the  Company's  common stock at $1.25 per share (see Note 8 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 are  collateralized  by a
first priority  interest in certain 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 $3.00 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.  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



                                       -40-
<PAGE>

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


Consultant was elected to the Company's Board of Directors.

    Notes Payable - Related  Parties - In March 1996,  the  Company's  president
agreed to extend the due date of a  delinquent  $60,000  note payable to him. As
consideration  for the  extension,  the  Company's  Board of Directors  approved
amending the note to provide for  conversion to common stock at $1.00 per share.
In December 1996, the president exercised the conversion  feature.  During 1997,
the Company repaid other outstanding notes payable to the Company's president of
$246,719 plus accrued interest of $42,417.

5.   INCOME TAXES:

    Deferred  tax assets  (liabilities)  as of  December  31,  1997 and 1996 are
comprised of the following:

                                                     1997                1996
                                                     ----                ----
        Long-term Assets:
Net operating loss carryforwards ...........      $ 5,816,000       $ 3,616,000
Property, plant  and equipment .............          229,000        (3,358,000)
Tax credit carryforwards ...................          294,000           294,000
Percentage depletion carryforwards .........          120,000            58,000
Other ......................................           41,000            25,000
                                                  -----------       -----------
         Total .............................        6,500,000           635,000
Less valuation allowance ...................       (6,500,000)         (635,000)
                                                  -----------       -----------
         Net long-term asset ...............      $      --         $      --
                                                  ===========       ===========

    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.

    During the year ended December 31, 1997, the Company increased the
valuation  allowance  by  $5,865,000  primarily  due to an  increase  in the net
operating loss carryforwards which are not considered to be realizable.

    At December 31, 1997, the Company had net operating loss  carryforwards  for
income tax purposes of  approximately  $15.5 million,  which expire primarily in
2008 through 2012. Some of these net operating losses are subject to limitations
under  IRS  Sections  382 and 384.  Additionally,  the  Company  has tax  credit
carryforwards  at December 31, 1997, of  approximately  $294,000 and  percentage
depletion carryforwards of approximately $320,000.

6.  COMMITMENTS AND CONTINGENCIES:

    Gas  Contracts - The Company  operates a natural gas  processing  plant (the
"Gas  Plant").  The Company had a contract with a major utility which called for
the major utility to purchase a minimum of 2.92 billion cubic feet ("BCF") and a
maximum of 3.65 BCF of natural gas annually. The price paid by the major utility
was on an MMBTU basis  above the  Colorado  Interstate  Gas  Company's  Northern
Pipeline "spot" price. The contract expired on June 30, 1996.

    Historically,  the price paid under this contract was at a premium above the
market  which   allowed  the  Company  to  conduct  its  marketing  and  trading
activities.  The expiration of this contract and the  corresponding  loss of the
market  premium  resulted in the  elimination  of the  Company's  marketing  and
trading activities beginning in July 1996.

    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.


                                       -41-
<PAGE>


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


    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 $5,668 and $8,926 for the years
ended December 31, 1997 and 1996, 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 begun to address possible remedial efforts
in  connection  with  computer  software that could be affected by the Year 2000
problem.  The Year 2000 problem is the result of computer programs being written
using two digits rather than four to define the  applicable  year.  Any 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 has been informed by the suppliers of substantially
all of the Company's software that all of those suppliers' software that is used
by the Company is Year 2000 compliant.  The Company has no internally  generated
software. After reasonable investigation, the Company has not yet identified any
Year 2000 problem but will continue to monitor the issue. However,  there can be
no  assurances  that  Year 2000  problems  will not occur  with  respect  to the
company's computer systems. The Year 2000 problem may impact other entities with
which the Company transacts business,  and the Company cannot predict the effect
of the Year 2000 problem on such entities.

    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.

7.  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 569,898  shares of common stock  pursuant to the original  conversion
terms.  Upon conversion,  the holders also received warrants to purchase 569,898
shares of common  stock at $6.00 per share  through  August 13,  1998,  when the
warrants expire.

    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 will be accounted for
as an  additional  dividend  on the  Series  B  Preferred  Stock  which  will be
recognized as a charge to earnings applicable to common stockholders.

    Beginning  on a date that is 540 days after the issuance  date,  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.


                                       -42-
<PAGE>


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


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 the preferred
stock,  the Company  agreed to issue the  placement  agent  warrants to purchase
323,800 shares of the common stock at $1.75 per share.

8.  STOCK BASED COMPENSATION:

    Stock Option Plans - The Company's  shareholders have approved the following
stock  option plans that  authorize  an aggregate of 1,900,000  shares for stock
options that may be granted to officers, directors,  employees, and consultants:
100,000 shares in June 1991; 300,000 shares in June 1993; 150,000 shares in June
1994; 350,000 shares in August 1996; and 1,000,000 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:

<TABLE>
<CAPTION>
                                                                                  1997                             1996
                                                                     -----------------------------      ----------------------------
                                                                                         Weighted                          Weighted
                                                                                         Average                           Average
                                                                     Number              Exercise          Number          Exercise
                                                                    Of Shares              Price         Of Shares           Price
                                                                    ---------            --------        ---------         --------
<S>                                                                   <C>                <C>                <C>             <C>   
Outstanding, beginning of year .........................              621,300            $   1.02           459,600         $  .94

         Canceled ......................................              (24,825)               2.16              --               --
         Expired .......................................               (5,000)               3.44            (4,000)          7.19
         Granted .......................................              640,000                2.83              --             1.39
         Exercised .....................................              (42,675)               1.06           165,700             --
                                                                   ----------                             ---------               
Outstanding, end of year ...............................            1,188,800                1.96           621,300           1.02
                                                                   ==========                             =========                
</TABLE>

    For all options  granted during 1997 and 1996,  the weighted  average market
price of the Company's common stock on the grant date was approximately equal to
the weighted average  exercise price. At December 31, 1997,  options for 788,800
shares were exercisable and options for the remaining 400,000 shares will become
exercisable in May 1998. If not  previously  exercised,  options  outstanding at
December 31, 1997, will expire as follows:

                                      Weighted
                                      Average
                                       Number        Exercise
                                      Of Shares       Price
                                      ---------      ---------
Year Ending December 31,
-----------------------
             1998                       15,000        $ 2.94
             2000                      403,925           .78
             2001                       85,400          1.00
             2001                       51,975          1.81
             2002 or thereafter        632,500          2.83
                                     ---------       -------
                                     1,188,800        $ 1.96
                                     =========       =======


                                       -43-
<PAGE>
                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

    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, 1997 and 1996:
<TABLE>
<CAPTION>
                                                                                           1997                         1996
                                                                                 --------------------------    --------------------
                                                                               Weighted                        Weighted
                                                                                Average                        Average
                                                                                 Number           Exercise      Number     Exercise
                                                                               Of Shares           Price       Of Shares     Price
                                                                               ---------          --------     ---------   --------
<S>                                                                             <C>              <C>          <C>            <C>    
Outstanding, beginning of year .........................................        7,216,585        $   2.95     3,359,418      $  5.00
    Granted to:
       Beta Capital Group, Inc. (Note 4) ...............................          100,000            3.75     1,000,000          .75
       Consultants .....................................................           50,000            3.00        90,000          .75
       Directors for services ..........................................           50,000            3.00       101,500         1.00
       Investors in private placement of debentures ....................             --               --      2,500,000         1.25
       Brokers and underwriter in private placements ...................          622,750            2.26       223,500         2.00
    Issued to underwriter and former holders of preferred
       stock upon conversion ...........................................        1,031,159            5.71        69,670         6.00
    Expired ............................................................           (5,000)           1.25       (60,000)        6.00
    Exercised ..........................................................       (3,187,600)           1.22       (67,500)         .95
                                                                               ----------                    ---------- 

Outstanding, end of year ...............................................        5,877,894            4.31     7,216,588         2.94
                                                                               ==========                    ========== 
</TABLE>

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

                                                                Weighted
                                                                 Average
                                                  Number         Exercise
    Year Ending December 31,                      Of Shares       Price
    -----------------------                       ---------     ---------

             1998                                    574,436   $    4.58
             1999                                  3,395,458        5.76
             2000                                    269,950        2.40
             2001                                    990,250        1.08
             2002                                    647,800        2.20
                                                  ----------      ------
                                                   5,877,894        4.31
                                                  ==========

    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,
                                                       -------------------------
                                                         1997            1996
                                                         ----            ----
Net loss applicable to common stockholders:
             As reported                           $ (15,985,036)  $ (1,614,270)
             Pro forma                               (16,507,036)    (1,764,270)
Net loss per common share:
             As reported                           $       (1.22)  $       (.20)
             Pro forma                                     (1.26)          (.22)

                                       -44-
<PAGE>



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


    The weighted average fair value of options and warrants granted to employees
for the years ended December 31, 1997 and 1996 was $1.63 and $.65, respectively.
The fair value of each employee  option and warrant granted in 1997 and 1996 was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted average assumptions:
                                                      Year Ended December 31,
                                                     -------------------------
                                                          1997         1996
                                                          ----         ----

             Expected volatility                         63.7%         64.0%
             Risk-free interest rate                      6.0%          6.5%
             Expected dividends                            -             -
             Expected terms (in years)                    4.0           3.4

9.  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, 1997,  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.

10.          SIGNIFICANT CONCENTRATIONS:

    Substantially all of the Company's accounts receivable at December 31, 1997,
result  from crude  oil,  natural  gas sales,  and joint  interest  billings  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.

    The  Company's  Rocky  Mountain  oil and gas  properties  are  predominantly
located in a single basin in which the gas marketing arrangements are influenced
by local supply and demand. Accordingly, in comparison to the net price received
by gas  producers in many other areas of the United  States,  the Company  often
realizes a lower net sales price. Additionally, since the Company's gas plant is
located  in this  basin and its oil field  service  and  supply  operations  are
conducted in this basin,  the Company is vulnerable to a curtailment in drilling
activity  in order to realize  the value of oil field  inventories  and  related
operating  assets.  As  discussed  in Note 3, the  Company is in the  process of
divesting these assets and recognized an impairment  charge of $8,965,972 in the
fourth quarter of 1997.

     For the year ended  December 31, 1996, the Company had natural gas sales to
the major utility discussed in Note 6 which accounted for 34% of total revenues.
For the years ended  December 31, 1997 and 1996,  the Company also had oil sales
to a single  customer which  accounted for 20% and 11%,  respectively,  of total
revenues.

    At December 31, 1997,  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.

11.          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

                                       -45-
<PAGE>

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


$875,000 in cash and the  issuance  of 315,000  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.

    In February  1997,  the Company  entered  into an  agreement  with NEGX that
provides the Company with the right and the obligation to participate as a 12.5%
working  interest  owner in  NEGX's  defined  drilling  program.  The  agreement
provides that the Company will be required to pay 16.7% of the costs to earn its
12.5% interest,  under certain  circumstances.  The Company is also committed to
participate in other prospects  operated by NEGX through  February 1999 when the
initial term of the agreement expires.  Management  estimates that the Company's
capital  requirements  under this  agreement  will be between $4 million  and $6
million for the year ending December 31, 1998.

    Full Cost Amortization Expense - Amortization expense amounted to $2,195,364
and  $1,017,859  for the years ended  December 31, 1997 and 1996,  respectively.
Amortization  expense per equivalent  units of oil and gas produced  amounted to
$10.95 and $6.03 for the years ended  December 31, 1997 and 1996,  respectively.
Natural gas is converted to  equivalent  units of oil on the basis of six MCF of
gas to one equivalent barrel of oil.

    Unevaluated  Oil and Gas Properties - At December 31, 1997,  unevaluated oil
and gas properties consist of the following:

    Unproved property acquisition costs                $ 1,303,821
    Seismic and lease option costs                       3,219,096
                                                         ---------
                                                       $ 4,522,917
                                                         =========

    All unevaluated costs were incurred during 1997 and management  expects that
planned  activities  for 1998 will  enable the  evaluation  of over 50% of these
costs. Evaluation of the remaining costs is expected to occur primarily in 1999.

    Capitalization  of  Interest - For the year ended  December  31,  1997,  the
Company  capitalized  interest costs of $323,642  related to unevaluated oil and
gas  properties  and  other  exploration  activities.  No  interest  costs  were
capitalized in 1996.

    Full  Cost  Ceiling  -  During  the  fourth  quarter  of 1997,  the  Company
recognized  an  impairment  charge of  $3,946,733  due to the full cost  ceiling
limitation.

    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, 1997 and 1996:

                                         1997                    1996
                                  ------------------         --------------
     Property acquisition costs   $    4,266,955        $        16,022
     Development costs                   734,235                806,564
     Exploration costs                 9,499,572                555,685
                                     -----------           ------------
                      Total       $   14,500,762          $   1,378,271
                                   ==============          ============

    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, 1997 and 1996
are presented below.

                                       -46-
<PAGE>

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

                                                           1997         1996
                                                           ----         ----

             Oil and gas sales                      $  3,168,000    $ 2,547,000
             Production costs                         (1,487,000)    (1,427,000)
             Amortization expense                     (2,195,000)    (1,018,000)
             Impairment expense                       (9,506,000)          -
                                                      ----------      ----------
            Results of operations from oil and
            gas producing activities                $(10,020,000)   $  (102,000)
                                                     ===========      =========

    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.  Approximately 33% of the Company's
proved developed  reserves are currently  non-producing as certain wells require
workovers,  and recompletions,  at an estimated total cost of $1.8 million.  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
are located in the Rocky Mountain Region. As discussed in Note 3, the Company is
in the process of divesting  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, 1997 and 1996.

<TABLE>
<CAPTION>
                                                                               1997                               1996
                                                                     ----------------------------     ------------------------------
                                                                       Oil               Gas              Oil                Gas
                                                                      (Bbls)            (Mcf)            (Bbls)             (Mcf)
                                                                 
<S>                                                                 <C>               <C>               <C>               <C>      
Proved reserves, beginning of year .........................        1,175,000         4,833,000         1,294,000         5,851,000
   Purchase of minerals in place ...........................          165,000           209,000             7,000              --
   Sale of minerals in place ...............................          (16,000)          (45,000)          (27,000)          (26,000)
   Extensions, discoveries, and
        other additions ....................................          229,000         1,295,000            72,000           455,000
   Revisions of previous estimates .........................         (345,000)       (1,274,000)          (71,000)       (1,035,000)
   Production ..............................................         (123,000)         (483,000)         (100,000)         (412,000)
                                                                   ----------        ----------        ----------        ----------
Proved reserves, end of year ...............................        1,085,000         4,535,000         1,175,000         4,833,000
                                                                   ==========        ==========        ==========        ==========
Proved developed reserves, beginning of year ...............        1,034,000         4,078,000         1,014,000         4,302,000
                                                                   ==========        ==========        ==========        ==========
Proved developed reserves, end of year .....................          930,000         3,833,000         1,034,000         4,078,000
                                                                   ==========        ==========        ==========        ==========
</TABLE>

    During  1996,  the  Company  recognized  downward  revisions  in oil and gas
reserves due to disappointing results from a development well drilled that year.
During 1997,  downward  revisions were primarily  attributable to  substantially
lower oil and gas prices in effect at December 31, 1997.

    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.


                                       -47-
<PAGE>


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


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,  1997 and 1996  based on the
standardized  measure prescribed in Statement of Financial  Accounting Standards
No. 69.
<TABLE>
<CAPTION>
                                                    1997                                  1996
                                      --------------------------------------------        ----   
                                         Gulf              Rocky
                                         Coast            Mountain        Total
<S>                                  <C>             <C>             <C>             <C>         
Future cash inflows ..............   $  8,560,000    $ 18,202,000    $ 26,762,000    $ 46,727,000
Future production costs ..........     (1,237,000)     (7,947,000)     (9,184,000)    (17,220,000)
Future development costs .........     (1,527,000)     (1,680,000)     (3,207,000)     (3,001,000)
Future income tax expense ........           --              --              --        (6,200,000)
                                     -------------   ------------    ------------    ------------
         Future net cash flows ...      5,796,000       8,575,000      14,371,000      20,306,000
10% annual discount for estimated
    timing of cash flow ..........     (1,336,000)     (3,357,000)     (4,693,000)     (8,326,000)
                                     ------------    ------------    ------------    ------------
Standardized Measure of Discounted
   Future Net Cash Flows .........   $  4,460,000    $  5,218,000    $  9,678,000    $ 11,980,000
                                     ============    ============    ============    ============
</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, 1997 and 1996:

                                                    1997            1996
                                                    ----            ----

Standardized measure, beginning of year ....   $ 11,980,000    $  8,480,000
Sale of oil and gas produced, net of
    production costs .......................     (1,681,000)     (1,120,000)
Purchase of minerals in place ..............      2,231,000          45,000
Sale of minerals in place ..................       (121,000)        (45,000)
Net changes in prices and production costs .     (8,437,000)      8,815,000
Net changes in estimated development costs .       (185,000)        233,000
Revisions of previous quantity estimates ...     (2,179,000)     (3,769,000)
Discoveries, extensions, and other additions      3,214,000       1,089,000
Accretion of discount ......................      1,198,000         848,000
Changes in income taxes, net ...............      3,658,000      (2,596,000)
                                               ------------    ------------
Standardized Measure, end of year ..........   $  9,678,000    $ 11,980,000
                                               ============    ============

    Gas Plant  (Unaudited) - The Company  processes most of the natural gas from
its properties in a gas plant owned by the Company.  Since the revenues from the
Company's  properties are subject to agreements with royalty owners and, in some
cases,  other working  interest  owners,  gas  processing  agreements  have been
entered into to set forth the contractual  arrangements for processing  charges.
Generally, the Company's processing fee consists of ownership of the natural gas
liquids and a portion of the  residue  gas that  results  from  processing.  The
Standardized  Measure of Discounted  Future Net Cash Flows shown above  excludes
the  Company's  share of the  natural gas liquids and residue gas related to the
Company's  gas  processing   activities,   as  well  as  marketing  and  trading
activities.


                                       -48-
<PAGE>

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


    The Company's reserve engineer has prepared the following  estimates for the
reserves related to these activities as of December 31, 1997.

           Future net revenues, discounted at 10%                  $  791,250

  Net quantities:
           Natural gas (mcf)                                        1,183,000
           Liquids (bbls)                                             184,000



                                       -49-
<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

ITEM 10 EXECUTIVE COMPENSATION

ITEM 11 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 .

ITEM 12 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The  information  required  by Items 9, 10, 11 and 12 are  omitted  because  the
Company will file a definitive Proxy Statement  pursuant to Regulation 14A under
the  Securities  Exchange  Act of 1934  not  later  than  April  30,  1998.  The
information  required  by such items will be included  in the  definitive  Proxy
Statement  to be so filed  for the  Company's  Annual  Meeting  of  Stockholders
scheduled for June 13, 1998 and is hereby incorporated by reference.


                                       -50-
<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. (1)
(3.2)     Plan of Recapitalization. (1)
(3.3)     Certificate  of Amendment to the  Articles of  Incorporation  filed on
          July 6, 1994. (2)
(3.4)     Certificate  of Amendment to the  Articles of  Incorporation  filed on
          December 19, 1994. (2)
(3.5)     Certificate   of   Amendment   to  Article  IV  of  the   Articles  of
          Incorporation as filed with the Nevada Secretary of State,  increasing
          the  authorized  shares of common stock of  Registrant  to  40,000,000
          shares, $0.10 par value,  incorporated by reference to Exhibit 3(i) of
          the Registrant's Form 8-K dated June 11, 1997.(8)
(3.6)     Bylaws, as amended and restated May 11, 1993. (1)
(4.1)     Representative's Preferred Stock Purchase Warrant. (1)
(4.2)     Warrant Agency Agreement between Willard Pease Oil and Gas Company and
          American Securities Transfer, Inc. dated August 23, 1993. (1)
(4.3)     Amendment  to  Warrant  Agency  Agreement  dated as of March 3,  1998,
          incorporated by reference to Exhibit 10.1 of the Registrant's Form 8-K
          dated March 9, 1998.(11)
(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.(10)
(10.1)    Form of Warrants  issued to Clemons F.  Walker for the  purchase of an
          aggregate of 98,000 shares of Common Stock. (3)
(10.2)    1990 Stock Option Plan. (1)
(10.3)    1993 Stock Option Plan (1)
(10.4)    1994 Employee Stock Option Plan. (2)
(10.5)    Employment  Agreement  effective  September 16, 1994 between Pease Oil
          and Gas Company and Willard H. Pease, Jr. (2)
(10.6)    Employment Agreement effective December 27, 1994 between Pease Oil and
          Gas Company and Patrick J. Duncan. (2)
(10.7)    Employment Agreement effective December 27, 1994 between Pease Oil and
          Gas Company and James N. Burkhalter. (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. (4)
(10.10)   Form of Warrants issued to Beta Capital Group, Inc.(12)
(10.11)   1996 Stock Option Plan.(12)
(10.12)   Mortgage,  Assignment  of Proceeds,  Security  Agreement and Financing
          Statement   from  Pease  Oil  and  Gas  Company  to  Holders  of  1996
          Collateralized   Subordinated   Convertible  Debentures  dated  as  of
          November 15, 1996.(12)
(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. (5)
(10.14)   Letter Agreement dated February 4, 1997 by and between National Energy
          Group, Inc. and Pease Oil and Gas Company. (6)
(10.15)   Purchase  and Sale  Agreement  dated  February 26, 1997 by and between
          Transworld Exploration & Production, Inc. (7)
(10.16)   1997 Long Term Incentive Option Plan
(10.17)   Preferred Stock Investment Agreement dated December 31, 1997.(10)
(10.18)   Letter Agreement dated 1/16/98 between National Energy Group, Inc. and
          Pease Oil and Gas Company.



                                       -51-
<PAGE>


(10.19)   Letter  Agreement dated 7/22/97 between  National Energy Group,  Inc.,
          Sullivan & Company 3-D Program 1, LLC and Willisco, Inc.
(10.20)   Agreement between National Energy Group, Inc. and Acadian  Geophysical
          Services, Inc.
(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
(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
(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
(10.24)   Retirement,  Severance and  Termination  of Employment  Agreement from
          James N. Burkhalter dated 1/1/98.
(18)      Letter  dated  March 18,  1998 from Hein +  Associates  LLP  regarding
          preferability  of  full  cost  accounting   method  for  oil  and  gas
          activities.

(21)      List of Subsidiaries. (3)

(23.1)    Consent of McCartney Engineering, LLC, Consulting Petroleum Engineers

(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  Registration  Statement No. 33-94536 on
          Form SB-2.
     (4)  Incorporated  by reference to the  Registrant's  Annual Report on Form
          10-KSB for the fiscal year ended December 31, 1995.
     (5)  Incorporated by reference to Form 8-K filed January 10, 1997.
     (6)  Incorporated by reference to Form 8-K filed February 19, 1997.
     (7)  Incorporated by reference to Form 8-K filed March 17, 1997.
     (8)  Incorporated by reference to Form 8-K filed June 11, 1997.
     (9)  Incorporated by referenced to form 8-K filed December 24, 1997.
     (10) Incorporated by reference to Form 8-K filed January 13, 1998.
     (11) Incorporated by reference to Form 8-K filed March 9, 1998.
     (12) Incorporated  by reference to the  Registrant's  Annual Report on Form
          10-KSB for the fiscal year ended December 31, 1996.

(b) Reports on Form 8-K: The Company filed the following reports on Form 8-K for
the period October 1, 1997 through the date of this report:

       Item Reported                   Date               Financial Statements
       -------------        ------------------------      ---------------------
(1)             5              December 24, 1997           None - Not Applicable
(2)           5,7              January 13, 1998            None - Not Applicable
(3)           5,7              March 9, 1998               None - Not Applicable



                                       -52-
<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 30, 1998                   By:/s/ Willard H. Pease, Jr.
                                       ----------------------------
                                       Willard H. Pease, Jr.
                                       President and Chief Executive Officer

Date: March 30, 1998                   By: /s/ Patrick J. Duncan
                                       -------------------------
                                       Patrick J. Duncan
                                       Chief Financial Officer, Treasurer,
                                       and Principal Accounting Officer

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 30, 1998                   By:/s/ Willard H. Pease, Jr.
                                       ----------------------------
                                       Willard H. Pease, Jr., President
                                       and Chairman of the Board

Date: March 30, 1998                   By: /s/ Patrick J. Duncan
                                       -------------------------
                                       Patrick J. Duncan
                                       Chief Financial Officer,
                                       Treasurer, and Director

Date: March 30, 1998                   By:/s/ Steve A. Antry
                                       ---------------------
                                       Steve A. Antry, Director

Date: March 30, 1998                   By:/s/ R. Thomas Fetters, Jr.
                                       -----------------------------
                                       R. Thomas Fetters, Jr., Director

Date: March 30, 1998                   By:/s/ Stephen L. Fischer
                                       -------------------------
                                       Stephen L. Fischer

Date: March 30, 1998                   By:/s/ Homer C. Osborne
                                       -----------------------
                                       Homer C. Osborne, Director

Date: March 30, 1998                   By:/s/ James C. Ruane
                                       ---------------------
                                       James C. Ruane, Director

Date: March 30, 1998                   By:/s/ Clemons F. Walker
                                       ------------------------
                                       Clemons F. Walker, Director

Date: March 30, 1998                   By:/s/ William F. Warnick
                                       -------------------------
                                       William F. Warnick, Director

                                       -53-