SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                   FORM 10-KSB
       [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
                                       or
        [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                          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

Check  whether the issuer (1) 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 [ ]

Check if disclosure  of delinquent  filers in response to Item 405 of Regulation
S-B, is not contained in this form and no disclosure  will be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated  by reference  in Part III of this Form 10-KSB or any  amendment to
the Form 10-KSB. [ ]

The issuer's revenues for its most recent fiscal year were $6,165,664.

As of February 21, 1997,  Registrant had 8,357,427 shares of its $0.10 par value
Common  Stock and  141,822  shares of its  $0.01 par value  Series A  Cumulative
Convertible  Preferred Stock outstanding.  As of February 21, 1997 the aggregate
market value of the common stock, the  Registrant's  only class of voting stock,
held by  non-affiliates  was  $23,584,935.  This  calculation  is based upon the
closing sales price of $3.25 per share on February 21, 1997.


<PAGE>




                   TABLE OF CONTENTS AND CROSS REFERENCE SHEET


PART I

Item 1           Description of Business

Item 2           Description of Property

Item 3           Legal Proceedings

Item 4           Submission of Matters to a Vote of Security Holders

PART II

Item 5           Market for Common Equity and Related Stockholder Matters

Item 6           Management's Discussion and Analysis

Item 7           Financial Statements

Item 8           Changes  In  and  Disagreements  with Accountants on Accounting
                 and Financial Disclosure

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.

Item 13          Exhibits and Reports on Form 8-K



<PAGE>

                                     PART I

ITEM 1 - BUSINESS

GENERAL

Pease Oil and Gas Company  ("Company"),  was incorporated  under the laws of the
state of Nevada on September  11,  1968.  The  Company's  address is 751 Horizon
Court,  Suite 203, Grand  Junction,  Colorado 81506 and its telephone  number is
(970)  245-5917.  The  Company  is  engaged  in the  oil  and  gas  acquisition,
exploration,  development and production business.  Historically,  the Company's
operations were in the western United States,  primarily in Colorado,  Nebraska,
Utah,  and  Wyoming.  During  1996 and  early in 1997,  the  Company  has  taken
initiatives  to expand its  operations  in to the Gulf Coast  region of Alabama,
Southern Louisiana and Texas.

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  into providing 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.  This
acquisition was financed through: i) the issuance of 900,000 shares of preferred
stock in a public offering which  generated net proceeds of $7,965,000;  ii) the
issuance  of  restricted  common and  preferred  stock  with an agreed  value of
$1,900,000 to the sellers; and iii) a $2,400,000 loan from a bank.

RECENT ACQUISITIONS AND DEVELOPMENTS

As  discussed in the  following  paragraphs,  the  Company,  through a series of
acquisitions and the development of strategic alliances with several private and
public  exploration  companies,  has positioned  itself to expand its asset base
into the Gulf Coast Region of Alabama, Southern Louisiana and Texas.

On January  10,  1997,  the Company  acquired a 7.8125%  After  Prospect  Payout
Working  Interest in the East Bayou  Sorrel  Prospect  from third  parties for a
total  purchase  price of $1.75  million.  The purchase  price  consisted of the
issuance of 315,000  shares of the Company's  common stock and $875,000 cash. On
March 3, 1997 the Company  acquired an additional  10% working  interest in this
prospect  from  unrelated  third  parties for $2.5  million  cash.  The prospect
contains a  discovery  well,  the C.E.  Schwing #1,  which in February  1997 was
producing in excess of 1,400 barrels of oil per day and 1,300 MCF of natural gas
per day with a flowing  tubing  pressure  of 6,300 PSI on a 12/64"  choke from a
perforated  interval of 13,208 feet to 13,226 feet. The C.E.  Schwing #1 went on
production in December 1996. These  acquisitions  were funded with the Company's
existing working capital and the proceeds  generated from a private placement of
common stock during February and March 1997. In that placement, the Company sold
1,500,000  shares  of  the  Company's  restricted  common  stock  to  accredited
investors for $2.50 per share. The private  placement was completed on March 10,
1997 generating net proceeds of approximately $3.3 million.

On  February  4, 1997 the  Company  entered  into a  definitive  agreement  with
National Energy Group, Inc. ("NEGX"),  a publicly held company  headquartered in
Dallas,  Texas.  NEGX is the  operator of the East Bayou  Sorrel  Prospect.  The
Agreement provides the Company the right and obligation to participate with NEGX
in  various  oil and gas  exploration  projects  over the course of the next two
years. Essentially,  the agreement consists of three main elements. First, Pease
has the right and obligation to participate as a 12.5% working interest owner in
NEGX's  outlined  exploration  program.  Specifically,  there are 10  identified
projects including: Mustang Island located in Nueces County, Texas; Bayou Sorrel
located in  Iberville  Parish,  Louisiana;  and  Robertsdale  located in Baldwin
County, Alabama. Second, subject to certain conditions defined in the agreement,
Pease  has the right and  obligation  to  participate  in any  future  prospects
generated  under NEGX's  exclusive  arrangement  with Sandefer Oil and Gas, Inc.
("Sandefer"). Sandefer is a private corporation owned and operated by a group of
geologists and  geophysicists  who generate Gulf Coast,  Southern  Louisiana and
other  wildcat  prospects.  The East  Bayou  Sorrel  prospect  discussed  in the
previous  paragraph  was  generated  by  Sandefer.  Third,  Pease is entitled to
participate in any third party  generated  prospects that NEGX  participates  in
subject to certain conditions as defined in the Agreement.


                                        1

<PAGE>


BUSINESS STRATEGY

The recent acquisitions and developments are the first steps in transforming the
Company.  Its future  business  strategy is to expand its reserve  base and cash
flow by  utilizing  its  existing  asset base in the Rocky  Mountain  Region and
cultivating the recent  acquisitions,  strategic  alliances and opportunities in
the Gulf Coast Region of Alabama, Southern Louisiana and Texas. The Company will
attempt to execute this strategy through:

o    Raising  significant capital to take advantage of leading edge technologies
     such as horizontal drilling and 3-D seismic exploration projects;
o    Positioning  itself with strategic sources of capital and partners that can
     react  to  opportunities  in the oil and gas  business  when  they  present
     themselves;
o    Developing  alliances with major oil and gas finders that have been trained
     by major oil companies;  o Participating in exploration  projects that have
     opportunities  involving  relatively  small  amounts of capital  that could
     potentially  generate  significant rates of return.  These projects include
     areas with large field potentials in Alabama, Southern Louisiana, Texas and
     the Gulf of Mexico.  Generally, the exploration projects will target fields
     with potential reserves of 10 million barrels of oil or 100 Bcf of gas;
o    Implementing  the  Company's  investment  strategy to  carefully  consider,
     analyze,  and exploit the potential value of the Company's  existing assets
     to increase the rate of return to its shareholders;
o    Reinvesting operating cash flows into development drilling and recompletion
     activities;  o Continuing the expansion of the Company's operations outside
     the D-J Basin; o Continuing the implementation of asset rationalization and
     operating  efficiencies designed to improve operating margins and lower per
     unit operating cost;
o    Acquiring  properties  that build upon and enhance the  Company's  existing
     asset base;
o    Developing a long term track record regarding stock price performance and a
     reasonable rate of return to shareholders.

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,  1996,  the Company had varying  ownership  interests in 189
gross  productive  wells (174 net) located in five states.  The Company operates
179 of the 189 wells,  the other  wells are  operated by  independent  operators
under contracts that are standard in the industry.

 The following table presents information on the Company's major operating areas
as of December 31, 1996:
                                                           Net Proved Reserves
                                                           -------------------
    STATE                                REGION              Bbls        Mcf
    -----                                ------              ----        ---

CO, WY, NE ..........................   DJ Basin           996,000   3,950,000
Utah ................................   Greater Cisco
                                        and Four Corners  143,000     750,000
Wyoming .............................   Big Horn Basin      35,000        --
CO & AR .............................   Various              1,000     133,000
                                                         ---------   ---------
     Total ..........................                    1,175,000   4,833,000
                                                         =========   =========

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.

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


                                        2

<PAGE>

COMPETITION

The oil and gas  industry  is highly  competitive  in all  phases.  The  Company
encounters  strong  competition from other  independent oil and gas companies in
acquiring  economically  desirable prospects as well as in marketing  production
therefrom and obtaining external  financing.  Many of the Company's  competitors
may have financial resources,  personnel resources, and facilities substantially
greater than those of the Company.

Because there has been a decrease in exploration  for and development of oil and
gas properties in the United States,  there is increased  competition  for lower
risk  development  opportunities  and for  available  sources of  financing.  In
addition,  the marketing and sale of natural gas and processed gas are extremely
competitive.  Accordingly,  the  competitive  environment  in which the  Company
operates is unsettled.

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 to unaffiliated  third-party  purchasers at the prevailing  field price
("the posted price").  Currently,  the three primary purchasers of the Company's
crude oil are Total Petroleum, Inc., Texaco Trading and Transportation, Inc. and
Scurlock-Permian Corporation.  Together these three purchasers buy more than 80%
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
17-year  contract.  The gas to both  parties  is priced on an MMBtu  basis at an
index spot price.

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  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.

                                        3

<PAGE>


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 in the DJ Basin. 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
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.  A few
states  also  prorate  production  to the market  demand for oil and gas.  These
statutes and

                                        4

<PAGE>


regulations  limit the rate at which oil and gas could  otherwise be produced or
the prices obtained from the Company's properties.

During the 1993  session of the  Colorado  legislature,  a coalition  of surface
owner  organizations  attempted  to  persuade  the  legislators  to enact a bill
requiring  the  payment of damages to surface  owners.  Such  legislation  could
increase the cost of the Company's  operations and erode the traditional  rights
of the oil and gas industry in Colorado to make reasonable use of the surface to
conduct drilling and development activities.  Although the bill was withdrawn by
the surface owners after it was significantly  amended,  and no such legislation
has been presented since 1993 (to the Company's knowledge), surface owner groups
have indicated  they may seek a statewide  constitutional  ballot  initiative to
mandate  compensation to surface owners and will attempt to increase  regulation
of the oil and gas industry at the local  government  level.  The involvement of
such local  governments  could not prohibit  the conduct of drilling  activities
within their boundaries which were the subject of permits issued by the Colorado
Oil and Gas Conservation  Commission ("COGCC") but that they could regulate such
activities under their land use authority.  Accordingly,  under these decisions,
local  municipalities  and  counties  may take the  position  that they have the
authority to impose restrictions or conditions on the conduct of such operations
which could materially  increase the cost of such operations or even render them
entirely uneconomic.  In 1993 and 1991 the Cities of Thornton,  Broomfield,  and
Greeley, the Town of Frederick and Boulder County, enacted such ordinances.  The
Company does not have any properties within these boundaries. The Company is not
able to predict which  jurisdictions may adopt such regulations,  what form they
will take or the ultimate effects of such enactments on its operations. However,
in general these  ordinances  are 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,  the ordinances  have the potential to delay and increase the cost,
or even in some  cases  to  prohibit  entirely,  the  conduct  of the  Company's
drilling activities.

In  response  to the  concerns of surface  owner  groups,  the COGCC has adopted
regulations for the D-J Basin governing notices to and consultation with surface
owners  prior  to  the  conduct  of  drilling   operations,   imposing  specific
reclamation  requirements  on operators upon the  conclusion of operations,  and
containing  bonding  provisions to enforce these new requirements.  The COGCC in
1994 modified its rules to require the mandatory  installation of surface casing
to depths below known fresh water aquifers in the D-J Basin and is continuing to
consider  additional  measures  for  protection  of  surface  owners,   enhanced
financial  assurance  requirements,  and  modifications  to its rules concerning
safety and plugging and abandonment.  The rules adopted or modified by the COGCC
to date have not had a material  impact on the Company but it is not possible to
predict  what  additional  changes  will  be made or  what  their  financial  or
operational impact will be on the Company.

Under  the  sponsorship  of  the  Colorado   Department  of  Natural  Resources,
legislation  was  approved in the 1994 session of the  Colorado  legislature  to
enhance  the  authority  of the  COGCC  to  regulate  oil  and  gas  operations.
Representatives  of the oil and gas  industry  were  involved in the drafting of
this legislation, along with representatives of the agricultural industry, local
governments and environmental  groups, and are working closely with the COGCC on
the  consideration  and drafting of new rules to address the concerns  that have
been raised  about the effects of oil and gas  operations.  Although the Company
believes  that it  generally  conducts  its  operation  in  accordance  with the
procedures contemplated in the pending regulatory initiatives, management is not
able to  predict  the  final  form of the  initiatives  or their  impact  on the
Company.

Recently, Wyoming increased its bonding and financial requirements for operators
acquiring existing properties. These new requirements are not expected to have a
significant impact on the Company or its operations.

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

                                        5

<PAGE>


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.

Wyoming has recently  established  more stringent  environmental  regulations to
ensure  compliance  with  federal  regulations.  These new  regulations  are not
expected to have a significant impact on the Company or its operations.

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.

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 $31,440 per year through June 30, 2000.


                                        6

<PAGE>


Employees - As of February  21,  1997,  the Company had 35 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, 1996
are located in the following areas shown in the table below:
<TABLE>
<CAPTION>

                                                      OIL               GAS         Developed Acreage
                                                ---------------   ---------------   -----------------
                                                Gross     Net(2)  Gross     Net(2)   Gross    Net(2)
Fields                        State             Wells(1)  Wells   Wells(1)  Wells    Acreage  Acreage
------------------------      ------------      -----     -----   -----     -----    -------  -------
<S>                           <C>                 <C>       <C>   <C>       <C>       <C>      <C>  
Loveland Field                Colorado            88        87                        5,083    5,047
Lower Horse Draw Field        Colorado             2         1                          400      204
North Minto Field             Colorado             3         3                          440      432
Pod Field                     Colorado             6         6                          600      600
Yenter Field                  Colorado             6         6                        1,655    1,655
Johnson's Corner              Colorado             5         4                        1,122    1,122
West Peetz Field              Colorado             5         4                          785      785
Cisco Dome                    Utah                 1         1     38         31      8,877    8,267
Cowboy                        Utah                 4         4                        1,200    1,199
Enos Creek                    Wyoming              2         1                          280      215
Other Fields                  CO/NB/UT            25        23      4          3      6,443    4,543
                                              ------    ------  -----      -----     ------   ------
    Totals                                       147       140     42         34     26,885   24,069
                                              ======    ======  =====      =====     ======   ======
</TABLE>
------------------
Footnotes

     (1)  Wells which  produce  both gas and oil in  commercial  quantities  are
          classified as "oil" wells for disclosure purposes.

     (2)  "Net" wells and "net" acres refer to the Company's  fractional working
          interests multiplied by the number of wells or number of acres.

The majority 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, 1996 is 406
and 366 acres,  respectively.  All these  properties are located in Colorado and
will expire at various times in 1997 unless  production has been  obtained.  The
Company's  gross and net working  interests in leased and  developed  acreage in
Louisiana  as of  December  31,  1996 is 1600 and 100 acres  respectively.  This
consists of one  property  and will expire in 1998  unless  production  has been
obtained.

                                        7

<PAGE>


GULF COAST PROSPECTS

Overview - In 1997 and 1998, the Company will be directing a significant portion
of its  resources to the Gulf Coast  region,  which is currently one of the most
actively  explored  areas in the  United  States.  The  Company's  strategy  for
entering  the Gulf Coast area is to team up with the best oil and gas finders in
any specific  area.  The Company is focusing in South  Louisiana,  shallow Texas
State  waters and  specific  areas where the Company  believes it has  strategic
advantage  including Alabama and certain Texas areas., The parameters in general
are that the target reserves are 100 BCFG and/or 10 million bbls. oil. With this
strategy in mind,  the Company is typically  drilling to deeper  horizons  which
significant reserves have been found at shallower depths.

Currently,  three  prospects  are in the process of drilling or are  expected to
commence drilling in the first quarter of 1997. These include East Bayou Sorrel,
South Lake Arthur and Brazos Block 480. A brief  description of these  prospects
follows.

East Bayou Sorrel and Bayou Sorrel Area: This exploration prospect was generated
by Sandefer Oil and Gas. The initial exploratory  location was selected with the
use of  reprocessed  2D seismic data.  The well,  Schwing #1, was drilled in the
East Bayou Sorrel field,  Iberville  Parish,  LA, to a total depth of 13,200 ft.
Upon test it flowed at a sustained  rate of 1,026  barrels of oil and 980 Mcf of
gas per day with a flowing  tubing  pressure of 6,670 psi on an 8/64" choke.  In
February 1997,  the well was producing at or near the maximum  allowable rate of
1,400 barrels of oil per day on a restricted choke.

In January 1997, the Company  purchased a 7.8125% after prospect  payout working
interest  in the area of mutual  interest  (AMI) which  includes  the East Bayou
Sorrel Prospect. The Company acquired an additional 10% working interest in this
prospect in February 1997. The operator has identified seven productive zones in
the  Schwing  #1  well  of  which  only  one was  tested  and is on  production.
Additional pay sands may be discovered in the second well,  which is expected to
commence drilling operations in March 1997.

National Energy has planned a 33-square mile 3D seismic exploration program over
the Bayou Sorrel AMI area.  The seismic  program will  commence in 1997.  The 3D
data will  compliment an already  extensive  database of  reprocessed 2D seismic
data and a number of existing  well logs.  The  Company's  participation  in the
Bayou Sorrel drilling and 3D seismic exploration program are expected to provide
significant  exposure to potential  productive  drilling  opportunities.  The 3D
interpretation  should help define the  potential of the upper Marg vag pay zone
sandstone.  It is  believed  that a  productive  section  of a proven  producing
formation  will be found in Bayou  Sorrel  based on the existing 2D and well log
data. Because the formation is a profile producer in the region, Bayou Sorrel is
a potential  large  reserve  prospect.  Sandefer  Oil and Gas and NEGX have also
identified  two other fault blocks  suitable for drilling from existing data and
will focus on this area with the 3D seismic  exploration program which will give
the Company  additional  opportunities to participate in high potential  reserve
projects.

South Lake  Arthur - South Lake  Arthur is located in  Jefferson  Davis  Parish,
Louisiana.  It is a four-way  dip closure.  Sandefer Oil and Gas has  previously
drilled this prospect to 17,375 feet but the well was subsequently abandoned. In
reviewing the well data of this and other nearby wells,  it was determined  that
the well was most likely not tested  sufficiently  and  inadequately  completed.
Sandefer  geologists believe this well would have been found to be a producer if
it had been properly tested.  NEGX acquired this lease from Sandefer and planned
a well near the original Sandefer well. The well is currently being drilled. The
Company is  participating  at 1/16 of the working  interest  under its agreement
with NEGX. A very large gas field is in close proximity.  A productive sandstone
formation  underlies  the prospect at a depth of between  18,000 feet and 20,000
feet. A large multi-national natural resources firm has announced plans to drill
to the same  formation in the area,  which may reveal the potential of this deep
play and influence future participation in this prospect.

Brazos Block 480 Prospect - Brazos  Block 480 is the only  offshore  prospect in
which the Company is presently  participating.  This prospect,  located within a
prolific  gas  producing  geologic  trend of offshore  Texas,  is believed to be
analogous to Amoco's Matagorda Block 519 Field which produced over 120 BCFG from
November 1985 through  September 1995. A well is scheduled to commence  drilling
operations in April 1997,  at a site located  adjacent to Cove Field about eight
miles  offshore  in  approximately  60 feet of water.  The  prospect  is tightly
controlled by numerous 2D seismic  lines.  A nine-square  mile 3D seismic survey
has also been shot and interpreted.

                                        8

<PAGE>


COLORADO PROPERTIES

Overview - The  Denver-Julesburg  ("DJ")  Basin  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, 1996,  84% of the Company's  reserves were in the DJ Basin. A summary of the
notable fields in the DJ Basin 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 1996 of  approximately  248  barrels  of oil
equivalent ("BOE") per day (205 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.  There is also an
interconnect into the Wattenberg pipeline system of K N Energy,  which gives the
gas plant access to third-party gas from the extensive Wattenberg field complex.
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.
Currently, a program is being implemented to recomplete several selected 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 40 BOE 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.

West Peetz Field,  Logan County,  Colorado - The Company operates 5 wells in two
leases in the West Peetz field.  The wells currently  produce about 20 BOPD 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 has been recommended and is currently under
consideration.

Pod Field,  Washington  County,  Colorado - In Pod Field, the Company has a 100%
working  interest  and  operates  five wells which  produce from the "J" sand. A
geological and  engineering  evaluation of the field conducted in 1995 indicates
the potential  presence of undeveloped  gas reserves in the Niobrara  Formation.
However, further study will be necessary before any action will be taken.

                                        9

<PAGE>


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 35 barrels of oil
per day ("BOPD"). 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.

North Minto Field, Logan County, Colorado - North Minto is a "J" Sandstone field
and was  unitized  for  secondary  recovery  in 1989.  One  well  was  producing
approximately  8 BOPD during 1993.  The injection  well had been shut-in  during
October 1992.  The Company  completed  geologic and  engineering  reviews of the
field  after the  acquisition  and  consequently  re-established  the  injection
program which increased production to 32 BOPD. In 1996, the Company restored one
well back into production to benefit from the waterflood. Additional leases have
been  acquired  as a result of this study and two  additional  drill  sites have
reserve potential in the North Minto Unit.

Lower Horse Draw Field, Rio Blanco County,  Colorado - The Company has interests
in two wells that  produce  gas from the Mancos B  fractured  silty shale in the
Lower Horse Draw Field. Proved developed reserves include 162,000 Mcf of gas net
to the Company.

UTAH PROPERTIES

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  400 Mcf and 7 bbls of oil per
day. The Company is presently working to recomplete several wells in behind-pipe
zones  to take  advantage  of  current  gas  prices  in the  market.  Among  the
recompleted  wells,  one is producing 250 Mcf per day. The company  expects that
after  finishing  the  recompletion   program,   daily  gas  production  can  be
significantly  increased.  Management of the Company has extensive knowledge and
experience with operations in and near this field. Cisco Dome field is large and
geologically  complex.  There are numerous  locations on the  Company's  acreage
available  for  additional  drilling.  A  geological  and  engineering  study is
currently  being  conducted to seek  further  development  opportunities  in the
existing wells as well as to delineate optimal drilling locations.

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.

WYOMING PROPERTIES

Enos Creek Field,  Hot Springs County,  Wyoming - Enos Creek Field is located in
the southwestern  Big Horn Basin of central Wyoming.  In early 1992, the Company
entered into a farmout  agreement  with an industry  partner to co-develop  Enos
Creek Prospect.  During the summer of 1992, the Company and its partners drilled
a side track well from an existing  wellbore  targeted at a separate fault block
in the geologic  structure.  The well penetrated three oil zones while drilling,
one in the Curtis Formation and two in the Phosphoria Formation.

The well is  currently  producing  from the  Phosphoria  Formation.  The Company
intends to recomplete a well adjacent to existing well in the Tensleep Formation
sometime in the future.

                                       10

<PAGE>

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  12  of  the  consolidated  financial  statements,  titled
Supplemental Oil and Gas Disclosures.  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  is based upon an engineering  evaluation by McCartney  Engineering,
Inc. The estimated  proved  reserves  represent  forward-looking  statements and
should be read in connection with the disclosure on  forward-looking  statements
included herein under Item 6 in Managements' Discussion and Analysis.

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

All of the Company's oil and gas reserves are located in the Continental  United
States. The Table below sets forth the Company's estimated  quantities of proved
reserves,  and the present value of estimated future net revenues  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,  1996 were  $24.43  per barrel of oil and $3.73 per MCF of natural
gas:
<TABLE>
<CAPTION>
                                                             December 31,
                                                 --------------------------------------
                                                     1996          1995         1994
                                                     ----          ----         ----
<S>                                               <C>           <C>           <C>      
  Estimated Proved Oil Reserves (Bbls) ......     1,175,000     1,294,000     1,352,000
  Estimated Proved Gas Reserves (Mcf) .......     4,833,000     5,851,000     5,724,000

  Estimated Future Net Revenues (before the
       estimated future income taxes) .......   $26,506,000   $15,480,000   $14,016,000
  Present Value of Estimated Future
      Net Revenues (before the estimated
      future income tax expenses) ...........   $15,641,000   $ 9,616,000   $ 8,519,000
</TABLE>

The table  above does not include the  reserve  values  associated  with the Gas
Plant.  The Gas Plant  reserves are disclosed in Part II, Item 7 of footnote 12.
No reserves have been  estimated  for the  Company's  interest in the East Bayou
Sorrel Prospect which was acquired  subsequent to the Company's last fiscal year
end and will not be estimated until at least a developmental  well is drilled on
the  property in 1997.  Other than that,  there has been no major  discovery  or
other  favorable or adverse  event that is believed to have caused a significant
change in the estimated quantities of proved reserves subsequent to December 31,
1996. However,  the prices for oil and gas have decreased as of the date of this
report below those used for the reserve  estimates.  The Company's  reserves for
its oil and gas  properties at December 31, 1996,  discounted at 10%,  using the
average  sales  prices in 1996 ($20.35 per bbl. of oil and $1.26 per Mcf of gas)
are approximately 47% lower, or $7.3 million dollars.

                                       11

<PAGE>

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,
                                       -----------------------------------------
                                         1996             1995             1994
                                       -------          -------          -------
Oil (Bbls) ..................          100,000          121,000          155,000
Gas (Mcf) ...................          412,000          497,000          543,000

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

                                      Average Sales Prices              Average
           Year Ended     ---------------------------------------    Production
          December 31     Oil (Bbls)      Gas (Mcf)      Per BOE    Cost Per BOE
          -----------     -----------    -----------     --------   ------------
             1996         $   20.35      $   1.26      $   15.10      $   8.46
             1995         $   16.77      $   1.18          12.85      $   7.92
             1994         $   15.94      $   1.36          13.09      $   8.90

The above table represents activities related only to oil and gas production. It
does not include any value from the  natural  gas liquids  extracted  by the Gas
Plant.

DRILLING ACTIVITY

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

                                                                                     Year Ended December 31,
                                                     ---------------------------------------------------------------------------
                                                            1996                        1995                         1994
                                                     ------------------           -----------------           ------------------
    Wells Drilled                                    Gross          Net           Gross         Net           Gross          Net
                                                     -----          ---           -----         ---           -----          ---
    Exploratory
<S>                                                   <C>           <C>            <C>         <C>            <C>           <C>
     Oil ....................................           --            --             --          --             --            --
     Gas ....................................           --            --             --          --             --            --
     Non-productive .........................            1            .19            --          --               1           .25
                                                        --           ----           ---         ---            ----          ----
         Total ..............................            1            .19            --          --               1           .25
                                                                     ====           ===         ===            ====          ====

Development
     Oil ....................................            1              1            --          --               4          3.92
     Gas ....................................           --            --             --          --            --            --
     Non-productive .........................           --            --             --          --            --            --
                                                        --           ----           ---         ---            ----          ----
         Total ..............................            1              1            --          --               4          3.92
                                                        ==           ====           ===         ===            ====          ====
</TABLE>

The Company was not participating in any drilling activity at December 31, 1996.
However,  the Company is participating to the extent of a 6.25% working interest
in the E. Winn #1 well, a 17,375 foot Miogyp Sand test, in the South Lake Arthur
Prospect,  located in Jefferson Davis Parish, Louisiana, that commenced drilling
operations on January 9, 1997. Total depth is expected to be reached sometime in
April 1997. This prospect consists of approximately 1,600 gross acres.

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,
1996 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.

                                       12
<PAGE>


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 ending December 31, 1996.

                                     Part II

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

(a) Market  Information  - The  Company's  Common  Stock has been  quoted on the
NASDAQ Small-cap  Market,  under the symbol WPOG, since July 1980. The Company's
Preferred  Stock,  has traded on the NASDAQ  Small-cap  Market  under the symbol
WPOGP since August 1993.

Bid  Quotations  - The  following  table  shows  the  range  of high and low bid
quotations for each  quarterly  period since January 1, 1995, 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
                                 -----------------------------------------
                                    Common Stock           Preferred Stock
                                 -----------------        ----------------
Quarter Ended                    High         Low          High       Low
-------------                    ----         ---          ----       ---
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         19/32        5         3 1/2

December 31, 1995 ...........     9/16        13/32        4 5/8     3 7/8
September 30, 1995 ..........      7/8          1/2        4 5/8     4 5/8
June 30, 1995 ...............    31/32          5/8        5 7/8     4 3/4
March 31, 1995 ..............   2 3/32        1 3/4        5 7/8     3 5/8


(b) Stockholders - As of February 21, 1997 the Company had 978 holders of record
of the  Company's  Common  Stock  and 17  holders  of  record  of the  Company's
Preferred  Stock.  This does not include the holders  whose shares are held in a
depository  trust in "street"  name. As of February 21, 1997 at least  5,306,000
shares (or 62%) of the issued and outstanding  common stock and at least 134,000
shares  (or 95%) of the  issued and  outstanding  preferred  stock was 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.

Holders of shares of Preferred  Stock are entitled to receive,  when,  as and if
declared by the Board of Directors  out of funds at the time  legally  available
therefor,  cash  dividends  at an annual  rate of 10%  (equal to $1.00 per share
annually),  payable  quarterly in arrears.  Cumulative  dividends accrue and are
payable to holders of record as they appear on the stock books of the Company on
such record dates as are fixed by the Board of Directors.

The Preferred Stock was issued in August 1993 and the Company  declared and paid
five  consecutive  dividends for the quarters  ended  September 30, 1993 through
September  30,  1994.  In December  1994,  the Board of  Directors  voted not to
declare the quarterly cash dividend to holders of the Company's  Preferred Stock
for the fourth quarter of 1994.  The decision to not pay the quarterly  dividend
was a result of the Company's  continuing operating losses, the cash and working
capital  position,  and the Company's  belief that its primary  lender would not
approve the payment  thereof.  In March 1995,  the Board of  Directors  voted to
suspend payment on any future Preferred Stock dividends  indefinitely.  However,
pursuant to the terms of the Preferred Stock,  dividends will continue to accrue

                                       13

<PAGE>

on a quarterly  basis.  Dividends  paid in the future,  if any, on the Preferred
Stock will be contingent on many factors including,  but not limited to, whether
or not a dividend can be justified through the cash flow and earnings  generated
from future operations.

The Preferred Stock will have priority as to dividends over the Common Stock and
any series or class of the Company's  stock  hereafter  issued,  and no dividend
(other than dividends payable solely in Common Stock or any

other series or class of the Company's stock hereafter  issued that ranks junior
as to dividends to the Preferred  Stock) may be declared,  paid or set apart for
payment on, and no purchase,  redemption or other acquisition may be made by the
Company  of, any Common  Stock or other  stock  unless  all  accrued  and unpaid
dividends  on the  Preferred  Stock have been paid or declared and set apart for
payment.

(d) Recent  Sales of  Unregistered  Securities  - During  the fiscal  year ended
December 31, 1996, the Company issued and sold the following  securities without
registration under the Securities Act of 1933, as amended.

             1. Between June 1996 and  November  15,  1996,  the Company  issued
    $5,000,000 in  collateralized  convertible  10%  debentures  and warrants to
    purchase up to 2,500,000  shares of the Company's  common stock at $1.25 per
    share.  The  securities  were  offered  and sold as  units,  with  each unit
    consisting of $50,000 in debentures and warrants to purchase  25,000 shares.
    The securities were sold by the Company and by 12 broker\dealers  registered
    as such with the Securities  and Exchange  Commission and who are members of
    the National  Association of Securities  Dealers,  Inc. The securities  were
    sold  to 105  private  investors  each of whom  qualified  as an  accredited
    investors as such term is defined in Regulation D adopted by the  Securities
    and Exchange  Commission under the Securities Act. The Company received $5.0
    million  for the  securities  and  paid  total  underwriting  discounts  and
    commissions of $547,000.  The debentures sold by the Company are convertible
    into common  stock of the Company at the  election of the holder at the rate
    of one  share  of  common  stock  for  each  $3.00 in  principal  amount  of
    debenture,  or a total of 1,666,666 shares upon conversion of all debentures
    issued.  The warrants  included in the units are  exercisable at any time by
    the  holder  and may be called for  redemption  by the  Company at $0.10 per
    share upon 45 days notice if the  reported  market price for common stock of
    the  Company  is at least  $3.00 per  share  for a period of 10  consecutive
    trading days or more. 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 issued.

             2. On March 9, 1996, the Company issued 38,050 shares of its common
    stock to 22 persons who were  employees  or directors of the Company in lieu
    of cash  for  services  to the  Company  valued  at  $35,050  for  financial
    reporting purposes.

             3.  Effective  February  12,  1996,  the  Company  issued  warrants
    entitling  the holders to purchase up to 1,000,000  shares of the  Company's
    common  stock  at  $0.75  per  share  to 14  persons  in  connection  with a
    consulting  agreement  between the Company and Beta Capital Corp., with whom
    the  Company  has a  consulting  agreement.  Issuance  of the  warrants  was
    required by the consulting  agreement and the exercise price of the warrants
    was equal to the reported market price for the Company's common stock at the
    time the Company  became  obligated  to issue the  warrants.  For  financial
    reporting purposes, these warrants were valued at $192,300. The warrants are
    exercisable for five years from the date of issuance.

             4. On May 13, 1996,  the Company issued 82,353 shares of its common
    stock to three holders who elected to convert $70,000 in principal amount of
    outstanding  convertible debentures originally issued in a private placement
    in 1991.

             5. On August 13,  1996,  the Company  issued  15,000  shares of its
    common stock to a consultant  of the Company in lieu of cash for  consulting
    services to the Company valued at $22,977 for financial reporting purposes.

             6. On December 16, 1996,  the Company  issued  60,000 shares of its
    common stock to Willard H. Pease,  Jr., the  President of the Company,  upon
    conversion of a promissory  note of the Company in the  principal  amount of
    $60,000 issued to Mr. Pease in 1994 in payment of certain obligations.

                                       14

<PAGE>

             7. Between  November  22, 1996 and  December 13, 1996,  the Company
    issued  50,000  shares of its common stock upon  exercise of three  warrants
    held by two  persons.  The  warrants  were  exercised at $0.85 per share for
    total proceeds to the Company of $42,500.  The warrants had been issued in a
    private transaction in 1995 as compensation to a consultant.

             8. On December 16 and 17, 1996, the Company issued 17,500 shares of
    its common  stock upon  exercise of two warrants  held by two  persons.  The
    warrants had been issued in the private placement of securities described in
    subparagraph 1 above. The Company received proceeds of $21,875 upon exercise
    of the warrant.

             9. On December 16, 1996,  13,440 shares of common stock were issued
    to eight  nonemployee-directors  of the Company in lieu of cash for services
    to the  Company  valued at $24,261 by the Company  for  financial  reporting
    purposes.

             10.  Effective  November 15, 1996, the Company  issued  warrants to
    purchase  up to  223,500  shares  of  common  stock at $2.00 per share to 12
    broker\dealers  as  partial  compensation  to such  persons  for sale of the
    securities in the private  offering  described in subparagraph 1 above.  The
    warrants are  exercisable  upon issuance and expire if not  exercised  three
    years after issuance.

             11. On March 9, 1996,  the  Company  issued  warrants  to  purchase
    40,000  shares of common  stock at $0.75 per share to one  person in lieu of
    cash for  consulting  services  provided to the Company valued at $7,700 for
    financial  reporting  purposes.  The  warrants  may be exercised at any time
    before March 9, 2001.

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

ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS

SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
  Statement of Operations Data:                                                     Year Ended December 31,
                                                                                 1996                    1995
                                                                                 ----                    ----
<S>                                                                          <C>                    <C>        
Oil and gas sales ......................................                     $ 2,546,676            $ 2,623,782
Natural gas marketing and trading ......................                       2,067,379              3,872,565
Gas plant processing revenue ...........................                         818,356              1,135,050
Total revenue ..........................................                       6,165,664              9,031,816
   Net loss ............................................                      (1,411,582)              (765,436)
Preferred Stock Dividends:
   Declared ............................................                            --                     --
   Converted ...........................................                         (22,750)              (117,000)
   In arrears ..........................................                        (179,938)              (202,688)
Non-cash inducement ....................................                            --               (1,523,906)
                                                                             -----------            -----------
Net loss applicable
   to common stockholders ..............................                     $(1,614,270)           $(2,609,030)
                                                                             ===========            ===========
<CAPTION>

Per Share Data: ........................................                         1996                   1995
                                                                                 ----                   ----
<S>                                                                          <C>                    <C>         
Before non-cash inducement charge ......................                     $     (0.22)           $     (0.18)
Effect of non-cash inducement charge ...................                            --                    (0.24)
                                                                             -----------            -----------
   Net loss per
    common share .......................................                     $     (0.22)           $     (0.42)
                                                                             ===========            ===========
Cash dividends declared per common share ...............                     $      --              $      --
                                                                             ===========            ===========

                                       15

<PAGE>
<CAPTION>

Balance Sheet Data:                                                                  As of December 31,
                                                                               --------------------------------
                                                                                 1996                    1995
                                                                                 ----                    ----
<S>                                                                          <C>                    <C>          
Working capital (deficit) ..............................                     $  1,907,694           $   (500,180)
Total assets ...........................................                     $ 14,901,149           $ 13,439,726
Long-term liabilities ..................................                     $  5,276,033           $  1,602,811
Stockholder's equity ...................................                     $  8,472,188           $  9,017,262
</TABLE>

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 have
been  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,  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.  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.

Liquidity and Capital Resources
At December 31, 1996, the Company's cash balance was $1,995,860  with a positive
working capital  position of $1,907,694,  compared to a cash balance of $677,275
and a working  capital  deficit of $500,180 at December 31, 1995.  The change in
the Company's cash balance is summarized as follows:

Cash balance at December 31, 1995 ............................      $   677,275
Cash used in operating activities ............................         (143,615)
Capital expenditures .........................................       (1,403,413)
Proceeds from the sale of property
  and equipment ..............................................          163,821
Redemption of certificate of deposit .........................           53,500
Payments on long-term debt ...................................       (1,795,670)
Net proceeds from issuance of
  convertible debt ...........................................        4,323,992
Proceeds from common stock
  subscription receivable and warrant exercises, net .........          119,970
                                                                    -----------
Cash balance at December 31, 1996 ............................      $ 1,995,860
                                                                    ===========

The  significant  improvement in the Company's cash balance and working  capital
position  is  directly  related to: a) the  proceeds  received  from the private
placement of convertible debentures;  and b) the repayment of the entire balance
of outstanding debt with Colorado  National Bank ("CNB").  In November 1996, the
Company   completed  a  private   placement  of  $5,000,000  of   collateralized
convertible debentures and warrants to purchase up to 2,500,000 shares of stock,
sold in "Units", which generated net cash proceeds of $4,300,000. Each Unit sold
for  $50,000  and  consisted  of  one  $50,000   five-year  10%   collateralized
convertible  debenture  and warrants to purchase  25,000 shares of the Company's
common stock at $1.25 per share.  The debentures are  collateralized  by a first
priority interest in certain

                                       16

<PAGE>

oil and gas  properties  owned and operated by the Company.  The  debentures are
convertible,  at the holders 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 and are subject to adjustment
beginning on April 25, 1999. Interest on the debentures is payable quarterly and
the entire  principal  balance will be due on April 15,  2001.  The warrants are
currently  exercisable and will expire on July 31, 2001. The Company is entitled
to call the warrants at any time after February 15, 1997 at a price of $0.10 per
warrant.  (As discussed later in this section,  the Company  initiated a call on
these  warrants on February 28,  1997.) In a  registration  statement  effective
February 10, 1997, the Company  registered for resale:  (1) the shares of common
stock into which the debentures  may be converted;  and (2) the shares of common
stock issuable upon exercise of the warrants.

The completion of that private  placement and repayment of the entire balance of
outstanding debt with CNB with a portion of the proceeds thereof,  significantly
improved the Company's working capital position and provided the funds necessary
to pursue  additional  acquisition,  drilling and  development  activities  on a
limited basis.  Recently, the Company has charted a course of action to maintain
its existing  asset base in the Rocky  Mountain  region and expand into the Gulf
Coast  region of  Alabama,  Southern  Louisiana  and  Texas  through a series of
acquisitions  and strategic  alliances which is discussed more thoroughly in the
following  paragraphs.  However,  this new  course of action  will  require  the
Company to seek a  significant  amount of  additional  capital to fully fund and
implement that plan.

On February 4, 1997,  the Company  signed a definitive  agreement  with National
Energy Group, Inc. ("NEGX"),  a publicly held Company,  headquartered in Dallas,
Texas.  The  agreement   provides  the  Company  the  right  and  obligation  to
participate  with NEGX in  various  oil and gas  exploration  projects  over the
course of next two years.  Essentially,  the  agreement  consists  of three main
elements.  First,  the Company has the right and  obligation to participate as a
12.5% working  interest  owner in NEGX's  outlined  program which consists of 10
identified projects in Alabama,  Southern Louisiana,  and Texas. Second, subject
to certain  conditions  defined in the agreement,  the Company has the right and
obligation  to  participate  in  any  future  projects  generated  under  NEGX's
exclusive  arrangement  with  Sandefer Oil and Gas Company,  Inc.  ("Sandefer").
Sandefer is a private  corporation  owned and operated by a group of  geologists
and geophysicists who generate Gulf Coast,  Southern Louisiana and other wildcat
prospects.  Third,  the Company is entitled  to  participate  in any other third
party  generated   prospects  that  NEGX  participates  in  subject  to  certain
conditions as defined in the agreement.

Pursuant  to the  terms  of the  agreement  with  NEGX,  the  Company's  minimum
obligation  is at least $5.0 million per year in dry hole,  or drilling,  costs.
Additional  costs will be incurred for completion and  development of successful
projects.  Accordingly,  the Company  anticipates the actual  obligation will be
higher  assuming  that a  reasonable  amount of  success  is  achieved  with the
underlying  prospects.  If all the prospects  prove to be productive  (which the
Company  believes is unlikely as the drilling  program is a wildcat  exploration
program),  the total  obligation  to the  Company for 1997 could be in excess of
$20.0 million.

If all the contemplated  exploratory prospects are successful and the properties
are eventually fully developed,  the net reserves  attributable to the Company's
interest would be several times the Company's  present  reserves.  The Company's
current  reserves are  approximately 2 million  barrels of oil (or  equivalent).
Accordingly,  the agreement  with NEGX provides the Company with an  exploration
program that has the potential to significantly  increase its existing  reserves
and future cash flow.

In order to fund the obligation with NEGX the Company intends to seek additional
financing.  The Company intends to pursue  additional equity through exercise of
outstanding  warrants,   private  equity  placements,   and/or  other  potential
financing  vehicles.  Specifically,  in December 1996,  the Company  initiated a
warrant call  underlying  warrants to purchase  250,000  shares of the Company's
common stock held by 11 persons that were exercisable at $1.25 per share.  These
warrants were issued as part of a "Unit" of common stock and warrants  issued in
a private  placement  during 1995.  All the holders of the  warrants  elected to
exercise  their  warrants  prior to redemption  by the Company.  Exercise of the
warrants generated net cash proceeds of $290,000 in January 1997.

Also,  during  February and early March,  1997, the Company  completed a private
placement of 1,500,000  shares of common stock for proceeds of $3.75  million as
described  below.  On February  28,  1997,  the Company  initiated a call of the
warrants that were attached to the convertible  debentures issued in the private
placement which was

                                       17

<PAGE>

completed in 1996. The warrants were held by  approximately  105 persons and are
exercisable  for $1.25 per  share.  Pursuant  to the terms of the  warrant,  the
holders have  forty-five days after the call notice (or until April 15, 1997) to
exercise  their  warrants  or they will be  redeemed by the Company for $.10 per
warrant. If all the warrants are exercised (which the Company believes is likely
based on the market price of the  Company's  common stock as of the date of this
report),  it will  generate  net proceeds to the Company of  approximately  $2.9
million.  The  proceeds  generated  from these  warrant  calls  should cover the
Company's  working capital needs,  including the anticipated  exploration  costs
associated  with the letter  agreement  with NEGX,  at least  through the second
quarter of 1997. After that, the Company will need to seek additional financing.

Anticipating  the need for  additional  financing,  in February 1997 the Company
signed a  non-binding  letter of intent with a brokerage  firm setting forth the
terms and  conditions  under which the broker will attempt to assist the Company
with a future private  placement.  The letter  agreement with the brokerage firm
contemplates a future placement of at least $6.0 million dollars in common stock
in the second or third  quarter  of 1997.  The  agreement  is subject to several
contingencies  including, but not limited to, due diligence and the execution of
formal agreement.

If the  Company is  unsuccessful  in  completing  the private  placement,  or if
additional funds are necessary either before or after such a transaction,  it is
uncertain at this time what actions the Company will take. Possibilities include
other debt or equity financings or the sale of existing assets.

In March 1996 the  Company  retained  Beta  Capital  Group,  Inc.  ("Beta") as a
consultant  to the Company.  Beta is located in Newport  Beach,  California  and
specializes in emerging oil and gas companies that have capital  resources needs
and market  support  requirements.  Beta has worked  closely with the Company to
structure  its  financings  and meet the  Company's  expected  cash and  capital
resources requirements.  Beta's President, Steve Antry, was an officer of Benton
Oil and Gas  Company  between  1989 and 1992.  During that time,  Mr.  Antry was
instrumental  in  obtaining  various  sources of capital that Benton Oil and Gas
required  during  a  very  significant  growth  period.  Based  on  Mr.  Antry's
background,  the  Company  believes  that  Beta adds a  tremendous  value to the
Company because of their network of financial resources.  Therefore, the Company
will attempt to utilize Beta's syndication of financial resources to fund future
capital requirements.

In addition to the  identified  exploration  program with NEGX,  the Company has
pursued the  acquisition  of an oil and gas property in Southern  Louisiana.  On
January 10, 1996, the Company  acquired a 7.8125% After Prospect  Payout Working
Interest  ("APPO WI") in the East Bayou Sorrel Prospect from third parties for a
total  purchase  price of $1.75  million.  The purchase  price  consisted of the
issuance of 315,000  shares of the Company's  common stock and $875,000 in cash.
On March 3, 1997 the Company  acquired an additional 10% working interest in the
same prospect for $2.5 million cash from third parties.  The prospect includes a
discovery  well, the C.E.  Schwing #1, which in February 1997 produced at a rate
in excess of 1,400  barrels of oil per day and 1,300 Mcf of natural  gas per day
with a flowing tubing  pressure of 6,300 PSI on a 12/64" choke from a perforated
interval of 13,208 feet to 13,226 feet.  If that  production  rate is sustained,
this  acquisition  will increase the Company's net  production  (per BOE) by 25%
(based on 1996's average net daily production.  An offset  developmental well to
the C.E.  Schwing #1 is expected to commence  drilling  operations in the second
quarter of 1997.

These  acquisitions were funded with the Company's  existing working capital and
the proceeds  generated from a private placement of common stock during February
and March 1997.  In that  placement,  the Company sold  1,500,000  shares of the
Company's  restricted common stock to accredited  investors for $2.50 per share.
The private placement was completed on March 10, 1997 generating net proceeds of
approximately  $3.3  million.  The Company has agreed to use its best efforts to
register the shares sold in this private  placement for resale on or before July
10, 1997.

                                       18

<PAGE>


Capital Expenditures

During 1996,  the Company  capitalized  or invested  $1,403,413  in property and
equipment as follows:

    Oil and Gas Properties:
         Drilling Costs -
     Exploratory Dry Holes .....................................      $  525,000
     Developmental well ........................................         435,647
                                                                      ----------
         Total Drilling Costs ..................................         960,647
     Workovers or Recompletions of existing properties .........         206,627
     Deposit on future exploratory well ........................         181,312
                                                                      ----------
         Total Oil and Gas properties ..........................       1,348,586
Service Equipment and Rolling Stock ............................          27,777
Office Equipment ...............................................          19,930
Gas Plant facility .............................................           7,120
                                                                      ----------
                                                                      $1,403,413
                                                                      ==========

During  1996  the  Company  drilled  two  new  wells.   The  first  well  was  a
"double-stacked"  horizontal - the first of its kind in  Colorado.  The well was
drilled  in   Loveland   Field,   located  in  Larimer   County,   Colorado.   A
"double-stacked"  horizontal  well consists of drilling two separate  horizontal
wells,  or legs, in two different  geologic  formations from a single well bore.
This technology has been used extensively in the Austin Chalk Formation in Texas
and  Pease Oil and Gas was the first  company  to  attempt  this  technology  in
Colorado. The geologic formations targeted during this well were the Niobrara, a
proved zone, and the Timpas,  an unproved zone.  Unfortunately,  the Timpas zone
was found to be  unproductive  and the  Company  wrote-off  $450,000 to dry hole
costs (this  represents the estimated costs  attributable to drilling the Timpas
leg). The remaining  costs  associated  with this well for the Niobrara leg were
capitalized as developmental costs.

The second  well was a deep  wildcat  prospect in  Southern  Louisiana  that was
generated  by NEGX.  The well was drilled in excess of 14,000 feet and  although
the logs  indicated  some  excellent  shows,  it appears the targeted  formation
either  did not  receive a  hydrocarbon  charge  or it had  passed  through  the
formation and the well was plugged and  abandoned.  The Company's  cost for this
dry hole was $75,000.

In 1996, the Company spent $206,627 for workovers,  recompletions  and equipment
acquisitions  related to maintaining or enhancing the current  production of its
producing oil and gas properties.

In November 1996, the Company also paid $181,312 for a deposit on an exploratory
well which commenced  drilling  operations on January 9, 1997. This well, the E.
Winn #1, is a 17,375 foot Miogyp Sand test,  in the South Lake Arthur  prospect,
located in  Jefferson  Davis  Parish,  Louisiana.  Total depth is expected to be
reached  sometime in April 1997. The deposit has been capitalized as of December
31,  1996 and will  remain  that  way,  along  with the  future  drilling  costs
incurred, until the outcome of the exploratory well is known.

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. As a result,  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.

Early in 1995, the Company initiated a corporate  restructuring that focused on:
eliminating  areas of its business  that were losing money,  reducing  operating
costs, increasing efficiencies,  and generating funds for working capital. These
initiatives  included but were not limited to  downsizing  of the  Company's oil
field service and supply  operations  and closing the  administrative  office in
Denver, Colorado. As is more fully discussed later in this section under their

                                       19

<PAGE>

respective  captions,  the Company's oil field service supply operating  margins
have  been  historically  low and even  unprofitable.  The  burden  of these low
margins or  operating  losses have been  compounded  with the risks  inherent in
these  operations and the capital  investment  required to maintain and operate.
Accordingly, the decision was made to downsize these operations in May 1995. The
administrative office was closed because the Company could not afford the luxury
and expense of two administrative offices.

In December 1994 the Company's  Board of Directors did not declare the quarterly
cash  dividend  to  holders of the  Company's  Series A  Cumulative  Convertible
Preferred  Stock  ("Preferred  Stock") for the fourth  quarter of 1994. In March
1995, the Board of Directors  voted to suspend  payment on any future  Preferred
Stock  dividends  indefinitely.  These  decisions  were  based on the  Company's
working capital position at that time, and the belief that the Company's primary
lender  would not  approve a dividend  payment.  However,  pursuant to the terms
underlying  the  Preferred  Stock,  dividends  continue to accrue on a quarterly
basis and will  increase  the number of common  shares  that will be issued upon
conversion  of the  preferred  stock  pursuant  to the  terms  of the  Company's
Articles  of  Incorporation.  Whether  dividends  are paid in the  future on the
Preferred  stock will be contingent  on many factors,  including but not limited
to,  whether  or not a  dividend  can be  justified  through  the cash  flow and
earnings generated from future operations.

In  January  1995,  the  Company  extended  a  tender  offer  to  the  Preferred
stockholders.  On February 28, 1995,  the Company  completed the tender offer to
its Preferred  Stockholders whereby the holders of the Company's Preferred Stock
were given the opportunity to convert each share of Preferred Stock and all then
accrued and undeclared  dividends  (including the full dividend for the quarters
ended  December  31, 1995 and March 31,  1995) into 4.5 shares of the  Company's
Common Stock and warrants to purchase  2.625 shares of Common Stock at $5.00 per
share through December 31, 1996 and $6.00 per share through August 13, 1998 (the
date the warrants expire). As a result of the tender offer 933,492 shares of the
Preferred  stock converted into 4,200,716  shares of the Company's  Common Stock
and warrants to purchase  2,450,417 shares of Common stock. In addition,  21,600
shares of Preferred  Stock converted into 56,739 shares of Common Stock prior to
the tender offer.  In 1996, an additional  22,750 shares of the Preferred  Stock
converted into 69,670 shares of common  pursuant to terms of such conversion set
forth in the Company's  Articles of Incorporation.  Accordingly,  as of December
31, 1996 there remained  179,938 shares of Preferred  Stock  outstanding.  These
conversions substantially changed the capital structure of the Company.

Consideration of the  restructuring  initiatives is an important  component when
comparing the results of operations between the two periods presented.

Total Revenue
Total Revenue from all operations was as follows:
<TABLE>
<CAPTION>
                                                              Year Ended December 31,
                                              --------------------------------------------------------
                                                         1996                              1995
                                              -----------------------           ----------------------
                                                Amount              %              Amount             %
                                                ------            --               ------           --

<S>                                          <C>                  <C>           <C>                 <C>
Oil and gas sales ................           $2,546,676           41%           $2,623,782          29%
Natural gas marketing
  and trading ....................            2,067,379           34%            3,872,565          43%
Gas plant processing .............              818,356           13%            1,135,050          13%
Oil field services
  and supply .....................              618,225           10%            1,302,741          14%
Well administration
  and other income ...............              115,028            2%               97,678           1%
                                             ----------         -----           ----------         ----
      Total revenue ..............           $6,165,664          100%           $9,031,816         100%
                                             ==========         =====           ==========         ====
</TABLE>

The decrease in total revenue is a result of: a) the expiration of the Company's
natural gas  marketing  and trading  contract  with  Public  Service  Company of
Colorado  effective  July 1, 1996;  b) no third party gas was  processed  by the
Company's gas plant  facility in 1996; c) a decrease in oil and gas  production;
and  d)  downsizing  of the  Company's  service  and  supply  operations.  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.

                                       20

<PAGE>

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

                                            For the Year Ended December 31,
                                            ------------------------------
                                                 1996            1995
                                             -----------     -----------
Production:
    Oil (bbls) ...........................       100,000         121,500
    Gas (Mcf) ............................       412,000         496,500
    BOE (6:1) ............................       168,700         204,000
Average Collected Price:
    Oil (per bbl) ........................   $     20.35     $     16.77
    Gas (per Mcf) ........................   $      1.26     $      1.18
    Per BOE (6:1) ........................   $     15.10     $     12.85
Gross Margin:
    Revenue ..............................   $ 2,546,676     $ 2,623,782
    Operating costs ......................    (1,426,549)     (1,617,318)
                                             -----------     -----------
      Gross Margin .......................   $ 1,120,127     $ 1,006,464
                                             ===========     ===========
      Gross Margin Percent ...............            44%             38%
                                             ===========     ===========
Average Production Costs per
  BOE before DD&A ........................   $      8.46     $      7.92
DD&A per BOE .............................          3.50            3.63
                                             -----------     -----------
    Total Costs of Production
      per BOE ............................   $     11.96     $     11.55
                                             ===========     ===========

Change in oil and gas revenue
  attributed to:
    Production ...........................   $  (465,388)
    Price ................................       388,282
                                             -----------
     Net change between 1995 and 1996 ....   $   (77,106)
                                             ===========

Most  of the  decrease  in oil  and  gas  production  can be  attributed  to the
following: 1) the sale of several marginal,  uneconomic, or nonstrategic oil and
gas properties in 1996 (see divested  production table below);  and 2) to a much
lesser extent the natural  decline in production that is inherent in oil and gas
wells. Both these circumstances were largely offset by an increase in price.

The production  included in the above tables and associated  with the wells sold
during 1996 is as follows:

                                              For the Year Ended December 31,
                                              -------------------------------
Divested Production                               1996                 1995
-------------------                               ----                 ----
Oil (bbls) .............................          3,900              16,700
Gas (Mcf) ..............................          4,500              23,000
BOE (6:1) ..............................          4,650              20,500

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.

                                       21

<PAGE>

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

                                               For the Year Ended December 31,
                                              ---------------------------------
                                                   1996                   1995
                                                   ----                   ----
Total Volume Sold (Mcf) ..............           1,223,855            2,586,205
Average Price ........................         $      1.69          $      1.50
                                               -----------          -----------
         Total Revenue ...............         $ 2,067,379          $ 3,872,565
Costs ................................          (1,745,446)          (3,404,169)
                                               -----------          -----------
         Gross Margin ................         $   321,933          $   468,396
                                               ===========          ===========

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.  Although  the  Company  has  been
negotiating  with  PSCo to renew the  contract,  no  formal  agreement  has been
reached as of the date of this report.  Consequently,  no marketing  and trading
revenues have been  generated  subsequent to June 30, 1996.  With the increasing
competition  fostering  within all phases of the  natural  gas  industry,  it is
unlikely  that the contract  will be renewed at an above market  premium,  if at
all,  and the Company is unlikely to resume  marketing  and trading  activities.
Since the gross margin  represents  the net cash flow and income  generated from
this  activity,  the loss of this  premium  contract  price  has and will have a
material and negative impact on the Company's current and future operations.

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.

Operating statistics for the periods presented are as follows:

                                               For the Year Ended December 31,
                                               -------------------------------
                                                     1996            1995
                                                     ----            ----
    Production:
      Natural Gas Processed (Mcf) -
           From Company owned wells .........       363,000         424,600
           Third party gas ..................          --           228,000
                                                -----------     -----------
                  Total gas processed .......       363,000         653,400
      Liquids Produced -
           B-G Mix (gallons) ................       907,600       1,314,900
           Propane (gallons) ................       694,000       1,053,900

  Average Sales Price of Liquids (per gallon)   $      0.45     $      0.34
                                                ===========     ===========

Gross Margin: ...............................        Amount          Amount
                                                -----------     -----------
           Revenue ..........................   $   818,356     $ 1,135,050
           Costs ............................      (464,512)       (942,867)
                                                -----------     -----------
                  Gross Margin ..............   $   353,844     $   192,183
                                                ===========     ===========
                  Gross Margin Percent ......            43%             17%

The decrease in  processing  volumes and revenue  during 1996 as compared to the
same periods in 1995, can be substantially  attributed to the Company  purchased
and  processed  third party gas between  February  1995 and  September  1995. In
October  1995 the Company  stopped  processing  third party gas to correct  some
operational problems. The operational problems have been corrected and the plant
is now  running  more  efficiently  and  effectively  than  it has in the  past.
However,  with  the  increased  competition  to  process  natural  gas  and  the
historically low gas prices prevalent in the Rocky Mountain Region,  the Company
has not been able to  purchase  third  party gas at an  economical  rate.  These
factors along with the  increasing  competitive  environment  in the natural gas
market, it is uncertain at this time if the Company will be able to compete with
other gas plants and purchasers of natural gas in its market area.  Accordingly,
it cannot be  determined  at this time when, or if, the Company will process any
additional third party gas.
                                       22

<PAGE>


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  average  approximately
$435,000 annually and 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,  and
costs of gas marketing and buying.  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.  When compared
to 1996,  the costs in 1995 were higher in amount and as a percentage of revenue
as a result of the Company  purchasing  and  processing  third party gas between
February 1995 and September 1995. Currently,  the gas processed by the Gas Plant
facility  is  from  wells  the  Company  owned.  Accordingly,  the  costs,  as a
percentage of revenue, have decreased in 1996.

As stated above, the Company  currently  processes  natural gas exclusively from
wells  owned  or  operated  by the  Company.  Given  the  extremely  competitive
environment in the DJ Basin where the gas plant facility is located,  management
is exploring  the  possibility  of  increasing  the  Company's  net cash flow by
entering  into  a gas  processing  agreement  with a  third  party.  Under  this
scenario,  the current  operations at the gas plant  facility would be shut down
and the gas  currently  processed  by the plant would be sold to a third  party.
Although no formal decision has been made,  this  possibility is being disclosed
since such a decision may ultimately  impact the carrying value of the gas plant
facility under Statement of Financial  Accounting Standards No. 121, "Accounting
for the  Impairment  of  Long-Lived  Assets."  As of  December  31, 1996 the net
carrying value of the gas plant facility was approximately  $3.34 million. It is
not certain at this time if a decision of this nature will  ultimately  be made,
and if so, if that decision would ultimate  impact the carrying value of the gas
plant facility.  However,  should a determination be made in the future that the
carrying  value of the gas  plant  facility  will not be  realized,  a  non-cash
impairment  charge may need to be recognized  as prescribed  under SFAS No. 121,
which could have a material  negative impact on the Company's  future results of
operations and balance sheet.

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:

                                           Service and Supply Operations
                                           For the Year Ended December 31,
                                           -------------------------------
                                                   1996        1995
                                                   ----        ----
Revenue ..................................   $   618,225   $ 1,302,741
Costs ....................................       553,343    (1,391,588)
                                             -----------   -----------
Net Operating Income (Loss) ..............   $    64,882   $   (88,847)
                                             ===========   ===========

The  decrease  in revenue  from the service  and supply  operations  is directly
related to the  restructuring  initiatives  conducted  in 1995. A summary of the
restructuring for both operations is discussed in the following paragraphs.

Service Operations
Historically,  the Company's  service  business  operated out of two locations -
Loveland and Sterling Colorado. The services provided included:  servicing rigs,
vacuum trucks,  roustabout  services,  and hot oiling  services.  The operations
serviced both the Company's needs and those of third parties.  The restructuring
was focused on reducing the service rig, vacuum truck, and roustabout operations
to a point where the Company can service its own oil and natural gas  operations
efficiently  and at the lowest  possible  cost,  while  performing  only limited
services for third  parties.  Any services of this type to third parties will be
limited to those circumstances when the equipment and man power is not needed in
the Company's operations. The Company did retain its hot oiler fleet (consisting
of three trucks) and intends to continue providing this service to third parties
on a full time basis.

Supply Operations
Historically,  the Company's supply business has operated out of two locations -
Loveland and Sterling,  Colorado. The restructuring was focused on consolidating
the operations to one location (Loveland, Colorado), eliminating duplicate costs
and ultimately reducing the amount of inventory.


                                       23

<PAGE>


Although  total  revenues  from the  service  and  supply  operations  decreased
approximately  53%  from  1995 to 1996 as a  result  of the  restructuring,  the
margins improved since the operations ran more efficiently on the smaller scale.

Well Administration and Other Income
This  revenue  primarily  represents  the revenue  generated  by the Company for
operating oil and gas  properties.  There has been no significant  change in the
average monthly revenue between 1996 and 1995 and Management does not expect any
significant change in the future.

Consulting Arrangement - Related Party
The Company  entered into a consulting  agreement with Beta in March 1996.  Fees
and  reimbursed  expenses  incurred  by the  Company in  connection  with Beta's
contract  were  $257,199  for the year ended  December  31, 1996 with no similar
expenditures in 1995.

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
                                   ------------------------------
                                           1996        1995
                                           ----        ----
Oil and Gas Properties ............   $  589,853   $  741,924
Gas Plant Operations ..............      234,534      245,953
Service and Supply Operations .....      140,132      166,173
Furniture and Fixtures ............       45,126       46,437
Non-Compete Agreements ............       45,994       91,827
                                      ----------   ----------
  Total ...........................   $1,055,639   $1,292,314
                                      ==========   ==========

As discussed  above under the caption Oil and Gas,  DD&A per BOE for oil and gas
properties  has  remained  relatively  constant for the periods  presented.  The
decrease in DD&A for the Service and Supply  Operations can be attributed to the
disposition of the  corresponding  assets during the  restructuring  initiatives
conducted  in  1995.  The  decrease  in  the  amortization  of  the  Non-compete
Agreements  can be attributed to one agreement  which became fully  amortized in
1995. That  particular  agreement had an original cost basis of $100,000 and was
amortized over a 24 month period.

Dry Hole, Plugging and Abandonment
As previously  discussed  under the caption  Capital  Expenditures,  the Company
charged  $450,000  to dry hole costs for the  estimated  costs  attributable  to
drilling the Timpas leg  attempted  on the  horizontal  well in Loveland  Field,
Colorado  and another  $75,000 for a dry hole on a wildcat  prospect in Southern
Louisiana that was generated by NEGX. The remaining costs in 1996 as well as all
the costs in 1995 relate to plugging and  abandonment of a few depleted wells in
the Rocky Mountain Region.

Restructuring Charges
The  restructuring  charges  incurred  in  1995  were  directly  related  to the
initiatives  discussed above under the caption Overview and consisted  primarily
of  severance  pay,  relocation  costs  and a  loss  on the  abandonment  of the
administrative office lease in Denver,  Colorado.  The Company did not incur any
such costs in 1996.

Interest Expense
The higher  interest  expense  incurred in 1996 is reflective of the increase in
the average  long-term debt  outstanding and  amortization of the  corresponding
debt issuance costs.  Both of these  circumstances  are directly  related to the
convertible  debentures  sold by the Company  pursuant to the private  placement
completed in November 1996 and previously  discussed under the caption Liquidity
and Capital Resources.

(Loss) Gain on Sale of Assets
The gain on sale of assets in 1995 is primarily related to the sale of oil field
service equipment in connection with the Company's restructuring initiatives and
the sale of various oil and gas  properties.  The loss on sale of assets in 1996
is  primarily  related to the sale of  certain  oil and gas  properties  and the
abandonment of obsolete or unusable office equipment, furniture and fixtures.

                                       24

<PAGE>

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 Company completed a tender offer to the Company's preferred  stockholders in
February  1995.  In  connection  therewith,  the Company  offered the  preferred
holders  4.5  common  shares  for each  preferred  share  owned.  The 4.5 shares
represented  an increase from the original  terms of the  preferred  stock which
provided for 2.625 common shares for each  preferred  share.  In order to comply
with an accounting  pronouncement,  the Company was required to reduce  earnings
available to common  stockholders  to convert  their  shares.  Since the Company
issued an additional 1,750,000 common shares in the tender offer compared to the
shares that would have been issued  under the  original  terms of the  preferred
stock,  the  Company was  required to deduct the fair value of these  additional
shares of  $1,523,906  from  earnings  available  to common  stockholders.  This
non-cash  charge resulted in the reduction of earnings per share by $.24 for the
year ended December 31, 1995.

While this charge is intended to show the cost of the  inducement  to the owners
of the Company's common shares immediately  before the tender offer,  management
does not believe that it  accurately  reflects the impact of the tender offer on
the Company's common stockholders. As disclosed to the preferred stockholders in
connection  with the  tender  offer,  the book  value per share of common  stock
increased from a negative amount to approximately $1.00 per share as a result of
the tender offer.  Therefore,  management believes that, even though the current
accounting  rules  require  the $.24  charge per common  share,  there are other
significant  offsetting factors by which the common shareholders  benefited from
this  conversion  which  are  not  reflected  in the  1995  earnings  per  share
presentation.



                                       25

<PAGE>


PART II - OTHER INFORMATION

ITEM 7.   FINANCIAL STATEMENTS

The Consolidated Financial Statements that constitute Item 7 are included at the
end of this report beginning on Page F-1.

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

This item is not applicable to the Registrant.

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

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

The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
                                                                                       Served as
         Name                 Age      Position With the Company                    Director Since
--------------------          ---      -------------------------                   ---------------
<S>                            <C>     <C>                                                <C> 
Willard H. Pease, Jr. (1)      37      President, Chief Executive Officer                  1983
                                         and Director (Term Expires 1999)

James N. Burkhalter            61      Vice President of Engineering and                   1993
                                         Production and Director
                                         (Term Expires 1997)

Patrick J. Duncan (1)          34      Chief Financial Officer, Treasurer,                 1995
                                         Corporate Secretary and Director
                                         (Term Expires 1997)

Steve A. Antry                 41      Director (Term Expires 1997)                        1996

Richard A. Houlihan (1)        57      Director (Term Expires 1998)                        1996

Homer C. Osborne (2)           68      Director (Term Expires 1998)                        1994

James C. Ruane (2)             63      Director (Term Expires 1998)                        1980

Leroy W. Smith                 68      Director (Term Expires 1997)                        1996

Robert V. Timlin               66      Director (Term Expires 1997)                        1981

Clemons F. Walker (2)          58      Director (Term Expires 1999)                        1996

William F. Warnick (2)         50      Director (Term Expires 1999)                        1988
</TABLE>

                                       26

<PAGE>


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

    Willard H. Pease, Jr. has been President and Chief Executive  Officer of the
Company since 1990. Mr. Pease was Executive  Vice President and Chief  Operating
Officer of the  Company  from 1983 to 1990.  Mr.  Pease is  responsible  for the
Company's corporate finance,  managing the day-to-day  operations of the Company
and is principally  responsible  for the Company's oil and gas  exploration  and
production  activities.  Mr. Pease has worked in the oil field business for over
17 years.  Mr.  Pease  received  a B.A.  degree in  management  with  additional
educational focuses in geology in 1983.

    James N. Burkhalter has been Vice President of Engineering and Production of
the Company  since  1993,  and is  responsible  for the  Company's  engineering,
production,  regulatory compliance,  and gas plant operations.  Prior to joining
the Company Mr. Burkhalter was owner and president of Burkhalter Engineering, an
engineering  firm which he formed in 1975.  Mr.  Burkhalter has been Chairman of
the Colorado Board of  Registration  for  Professional  Engineers and Surveyors,
serving eight years. From 1959 to 1975 Mr. Burkhalter worked for Amoco and Rocky
Mountain Natural Gas as a petroleum  engineer.  Mr.  Burkhalter  received a B.S.
degree in petroleum engineering in 1959 from the Colorado School of Mines.

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

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

    Richard A. Houlihan is a Certified Public  Accountant,  Senior Member of the
American Society of Appraisers and a Certified  General  Appraiser in Nevada and
Utah. He has been a principal of Houlihan  Valuation  Advisors  since 1986,  Mr.
Houlihan  also was founder and  president  of Solitude  Ski Resort,  founder and
president of Houlihan,  Lokey, Howard & Zukin, Inc., one of the largest business
valuation  firms  in  the  United  States,   was  financial  vice  president  of
Carr-Sigoloff  Industries Corporation  specializing in mergers and acquisitions,
and MAS Manager at Price Waterhouse & Company Management Advisory Services.  Mr.
Houlihan has a B.S.  degree from Brigham Young  University  and a M.V.S.  degree
from Lindenwood College.

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

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

    Leroy W. Smith was president and owner of Doctors' Financial Management Co.,
Inc.  from 1956 through 1994 with offices in Burbank and Santa Ana,  California,
which provided  accounting and business  management  services for professionals.
Since  retiring  in 1994 Mr.  Smith has  served as  trustee  and  managed  three
retirement  trusts with total market value of  approximately  $5.5 million.  Mr.
Smith is also an Enrolled Agent before the Internal Revenue Service.

                                       27

<PAGE>


    Robert V. Timlin has been  self-employed as a consulting  petroleum engineer
since 1989. Mr. Timlin has been involved in the oil and gas industry for over 30
years and has served in a managerial capacity with several companies,  including
HMT  Management  Inc., an oil and gas  management  firm,  from 1983 to 1988; T&M
Casing  Service,  Inc.,  from 1975 to 1983;  Dowell Studer,  Inc., and Husky Oil
Company.  Mr. Timlin received an Associates  Degree in petroleum  engineering in
1957.

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

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

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

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

The following  disclosure is based solely upon a review of the Forms 3 and 4 and
any amendments thereto furnished to the Company during the Company's fiscal year
ended  December 31, 1996, and Forms 5 and  amendments  thereto  furnished to the
Company  with respect to such fiscal year,  or written  representations  that no
Forms 5 were  required  to be filed by such  persons.  Based on this  review the
following  persons who were  directors,  officers and beneficial  owners of more
than 10% of the Company's outstanding Common Stock during such fiscal year filed
late reports on Forms 3 and 4.

James C. Ruane filed one late report on Form 4 reporting one transaction.  LeRoy
W. Smith filed one late report on Form 4 reporting two transactions.

ITEM 10-EXECUTIVE COMPENSATION

Summary Compensation Table
The  Summary  Compensation  Table shows  certain  compensation  information  for
services  rendered in all capacities  during each of the last three fiscal years
by the Chief Executive  Officer.  No executive officer received salary and bonus
in excess of $100,000 in 1996. The following information for the Chief Executive
Officer includes the dollar value of base salaries,  bonus awards, the number of
stock options granted and certain other  compensation,  if any,  whether paid or
deferred.

                                       28

<PAGE>
<TABLE>
<CAPTION>
                                                SUMMARY COMPENSATION TABLE

                                         Annual Compensation               Long-Term Compensation Awards
                           ---------------------------------------------   -----------------------------
                                                                              Restricted   Securities
Name and Principal                                          Other Annual      Stock        Underlying
Position                   Year    Salary       Bonus       Compensation      Awards     Options/SARs(#)
--------                   ----    --------     -----       ------------      -------    --------------
<S>                         <C>    <C>          <C>         <C>                <C>           <C>    
Willard H. Pease, Jr ....   1996   $78,530(1)   $5,000(3)   $101,250 (2)       None          110,400
   President and Chief      1995   $75,240(1)   None        None               None          139,600
   Executive Officer        1994   $75,240(1)   None        None               None           None
</TABLE>

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

     (2)  At December  31, 1995 the  Company  owed  $60,000 to Willard H. Pease,
          Jr., the Company's  President and CEO. This loan was  unsecured,  bore
          interest at 8% per annum and was  originally  cue on January 31, 1996.
          On March 9, 1996 the Board of Directors  agreed to change the terms of
          the note to allow the note to be convertible into the Company's common
          stock at $1.00 per share,  the then current  market rate,  in exchange
          for a one-year  extension on the note.  On December 16, 1996 Mr. Pease
          elected to convert the note in its entirety, the note was canceled and
          Mr. Pease was issued 60,000 shares of the Company's  restricted common
          stock. The $101,250 shown as other annual compensation  represents the
          difference  between the  closing  sales price as reported by NASDAQ on
          December  16,  1996 and the  conversion  price of $1.00 per share.  No
          additional  amounts  have  been  shown  as Other  Annual  Compensation
          because  the  aggregate  incremental  cost to the  Company of personal
          benefits provided to Mr. Pease did not exceed the lesser of $50,000 or
          10% of his annual salary in any given year.

     (3)  On March 9, 1996 the Board of Directors granted Mr. Pease 5,000 shares
          of the  Company's  common  stock for prior  services.  The shares were
          valued at $5,000 or $1.00 per share which represented the market price
          of the  Company's  common  stock on the date of grant.  The shares are
          fully vested.

Option Grants in the Last Fiscal Year
Set forth below is information  relating to grants of stock options to the Chief
Executive Officer pursuant to the Company's Stock Option Plans during the fiscal
year ended December 31, 1996.
<TABLE>
<CAPTION>

                          Option/SAR Grants in Last Fiscal Year

                                                           Individual Grants
-------------------------------------------------------------------------------------------------------
                                       Number of
                                       Securities       % of Total
                                       Underlying       Options/SARs
                                       Options/         Granted to          Exercise or
                                       SARs             Employees in        Base Price      Expiration
 Name                                  Granted (#)      Fiscal Year           ($/Sh)           Date
 ----                                  ----------       ------------        -----------     ----------
<S>                                   <C>                  <C>               <C>             <C>   <C>
Willard H. Pease, Jr................. 110,400 (1)          33.9%             $1.00(3)        03/08/01
      President and Chief              60,000 (2)          18.4%             $1.00(3)        01/31/97
      Executive Officer
</TABLE>

(1)  Consists  of  8,900  shares  underlying  options  issued  under  one of the
     Company's  qualified  stock  option  plans and  101,500  shares  underlying
     warrants to purchase  common stock.  All these Options and Warrants  became
     exercisable on September 8, 1996.
(2)  At December 31, 1995 the Company owed $60,000 to Willard H. Pease, Jr., the
     Company's  President and CEO. This loan was unsecured,  bore interest at 8%
     per annum and was  originally cue on January 31, 1996. On March 9, 1996 the
     Board of Directors agreed to change the terms of the note to allow the note
     to be convertible  into the Company's  common stock at $1.00 per share, the
     then current  market  price,  in exchange  for a one-year  extension on the
     note.
(3)  The exercise  price listed above was 100% of the market price of the Common
     Stock on the date the options,  warrants or convertible  notes were granted
     or approved by the Company's Board of Directors.

                                       29

<PAGE>


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

Set forth  below is  information  with  respect  to the  unexercised  options to
purchase the  Company's  Common Stock held by Willard H. Pease,  Jr. at December
31, 1996. No options were exercised during fiscal 1996.
<TABLE>
<CAPTION>

               Aggregated Option/SAR Exercises in Last Fiscal Year
                          and FY-End Option/SAR Values
                                                                      Number of
                                                                      Securities           Value of
                                                                      Underlying           Unexercised
                                                                      Unexercised          In-the-Money
                                                                      Options/SARs         Options/SARs
                                                                      at FY-End (#)        at FY-End ($)
                           Shares Acquired     Value Realized         Exercisable/         Exercisable/
 Name                      on Exercise (#)          ($)               Unexercisable        Unexercisable
--------                   --------------      --------------         -------------        -------------
<S>                            <C>    <C>        <C>      <C>          <C>      <C>       <C>       <C>   
Willard H. Pease, Jr.          60,000 (1)        $101,250 (1)          250,000/-0-        $544,557/-0- (2)
    President and Chief
    Executive Officer
</TABLE>

     (1)  On December 16, 1996, Mr. Pease  converted a $60,000  promissory  note
          into 60,000 shares of the Company's common stock pursuant to the terms
          of the underlying  promissory note. The $101,250 shown as other annual
          compensation represents the difference between the closing sales price
          as reported by NASDAQ on December 16, 1996 and the conversion price of
          $1.00 per share.

     (2)  The value of the unexercised  In-the-Money Options 1996 was determined
          by multiplying the number of unexercised  options by the closing sales
          of the  Company's  common  stock on  December  31,1996 as  reported by
          NASDAQ and from that total, subtracting the total exercise price.

Employment Contract
The Company has entered into an employment  agreement  with a Director,  Willard
Pease, Jr., who is also the Company's President and Chief Executive Officer. The
employment  agreement  was  entered  into in 1993 and may be  terminated  by the
Company  without cause on 30 days notice  provided the Company  continues to pay
the salary of Mr. Pease for 36 months.  The salary must be paid in a lump sum if
the  termination  occurs  after a change in control of the Company as defined in
the employment agreement. Mr. Pease may terminate the employment agreement on 90
days written notice. The base salary of Mr. Pease under the employment agreement
was increased to a base salary of $95,000 per year effective October 1, 1996.

Compensation of Directors
Directors who are employees do not receive  additional  compensation for service
as directors.  Other  directors each receive a $1,000 annual  retainer fee, $750
per meeting  attended and $100 per meeting  conducted via telephone  conference.
Directors may elect to receive the compensation either in cash or stock. All the
compensation  paid to the outside  directors in 1995 and 1996 was in the form of
stock.

ITEM 11-  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following  table sets forth  certain  information  regarding the  beneficial
ownership of the Company's  Common Stock,  its only class of outstanding  voting
securities  as of  February  21,  1997,  by (i) each  person who is known to the
Company to own  beneficially  more than 5% of the outstanding  Common Stock with
the  address  of each such  person,  (ii) each of the  Company's  directors  and
officers, and (iii) all officers and directors as a group:

                                       30

<PAGE>

<TABLE>
<CAPTION>

  Name and Address of
   Beneficial Owner or                     Amount and Nature of
Name of Officer or Director               Beneficial Ownership(1)   Percent of Class
---------------------------               ----------------------    ----------------
<S>                                         <C>            <C>         <C> 
Steve Allen Antry
   901 Dove Street, Suite 230
   Newport Beach, CA 92660 ..............   671,832 Shares (2)         7.4%
James N. Burkhalter
   P.O. Box 60219
   Grand Junction, CO 81506 .............   165,710 Shares (3)         2.0%
Patrick J. Duncan
   P.O. Box 60219
   Grand Junction, CO 81506 .............   170,625 Shares (4)         2.0%
Richard A. Houlihan
   650 Town Center Drive, Suite 550
   Costa Mesa, CA 92625 .................   288,983 Shares (5)         3.4%
Homer C. Osborne
   1200 Preston Road #900
   Dallas, TX 75230 .....................   49,407 Shares (6)          0.6%
Willard H. Pease, Jr ....................
   P.O. Box 60219
   Grand Junction, CO 81506 .............   786,139 Shares (7)         9.2%
James C. Ruane
   5010 Market St.
   San Diego, CA 92102 ..................   281,838 Shares (8)         3.3%
Leroy W. Smith
   P.O. Box 10040
   Santa Ana, CA 92711-0040 .............   181,280 Shares (9)         1.8%
Robert V. Timlin
   1989 South Balsam
   Lakewood, CO 80277 ...................   63,490 Shares (10)         0.8%
Clemons F. Walker
   748 Rising Star Drive
   Henderson, NV 89104 ..................   362,763 Shares (11)        4.2%
William F. Warnick
   2022 Broadway
   Lubbock, TX 79401 ....................   84,193 Shares (12)         1.0%

  All Officers and Directors as a
  group (eleven persons) ................   3,106,260 Shares (13)     29.8%
</TABLE>

(1)  Beneficial owners listed have sole voting and investment power with respect
     to the shares unless otherwise  indicated.  On December 18, 1996, Mr. Pease
     converted a $60,000  promissory  note into 60,000  shares of the  Company's
     common stock pursuant to the terms of the underlying  promissory  note. The
     $101,250  shown as other  annual  compensation  represents  the  difference
     between the closing  sales price as reported by NASDAQ on December 16, 1996
     and the conversion price of $1.00 per share.

(2)  Includes  2,680 shares that are owned  directly by Mr. Antry,  7,500 shares
     underlying  options that become exercisable on July 27, 1997, 61,137 shares
     underlying   presently   exercisable   warrants,   515  shares   underlying
     convertible   preferred  stock  and  600,000  shares  underlying  presently
     exercisable warrants that are held by Mr. Antry's wife.

(3)  Includes  15,710 shares owned  directly by Mr.  Burkhalter,  115,000 shares
     underlying  presently  exercisable  options,  and 35,000 shares  underlying
     options that become exercisable on July 27, 1997.

                                       31

<PAGE>


(4)  Includes  20,625  shares  owned  directly  by Mr.  Duncan,  105,000  shares
     underlying  presently  exercisable  options,  and 45,000 shares  underlying
     options that become exercisable on July 27, 1997.

(5)  Includes  151,150  shares  owned  directly by Mr.  Houlihan,  7,500  shares
     underlying  options that become exercisable on July 27, 1997, 97,500 shares
     underlying  presently  exercisable  options,   8,333  shares  underlying  a
     convertible debenture, and 24,500 shares owned by a trust that Mr. Houlihan
     has sole voting and investment power.

(6)  Includes  6,607  shares  owned  directly  by  Mr.  Osborne,  35,300  shares
     underlying  presently  exercisable  options,  and 7,500  shares  underlying
     options that become exercisable on July 27, 1997.

(7)  Includes  121,173  shares  that are owned  directly by Mr.  Pease,  364,966
     shares are owned by entities  affiliated  with Mr.  Pease over which shares
     Mr. Pease has sole voting and investment  power,  148,500 shares underlying
     presently exercisable options, 50,000 shares underlying options that become
     exercisable  on July 24,  1997,  and 101,500  shares  underlying  presently
     exercisable warrants.

(8)  Includes  107,528 shares owned directly by Mr. Ruane,  4,560 shares held by
     Mr.  Ruane as trustee for two trusts,  over which  shares Mr.  Ruane may be
     deemed to have shared voting and investment power, 12,500 shares underlying
     presently   exercisable   warrants,   70,000  shares  underlying  presently
     exercisable  options,  and 7,500  shares  underlying  options  that  become
     exercisable on July 27, 1997.

(9)  Includes 1,280 shares owned directly by Mr. Smith, 10,000 shares owned by a
     trust that Mr.  Smith acts as the Trustee and is  therefore  deemed to have
     beneficial  ownership,  5,000  shares  owned  by his  wife,  10,000  shares
     underlying presently  exercisable options,  7,500 shares underlying options
     that  become  exercisable  on July  27,  1997,  100,000  shares  underlying
     presently  exercisable  warrants that are owned by two separate trusts that
     Mr.  Smith acts as the Trustee and is therefore  deemed to have  beneficial
     ownership,  12,500  shares  underlying  convertible  preferred  stock owned
     directly by Mr. Smith; 12,500 shares underlying convertible preferred stock
     held by his wife, and 22,500 shares underlying  convertible preferred stock
     that are owned by two  separate  trusts that Mr.  Smith acts as the Trustee
     and is therefore deemed to have beneficial ownership.

(10) Includes  5,990  shares  owned  directly  by  Mr.  Timlin,   26,693  shares
     underlying  presently  exercisable  options,  and 7,500  shares  underlying
     options that become exercisable on July 27, 1997.

(11) Includes 142,062  shares  owned  directly  by Mr.  Walker,  212,686  shares
     underlying presently exercisable warrants,  7,500 shares underlying options
     that  become  exercisable  on July  27,  1997,  and 515  shares  underlying
     convertible preferred stock.

(12) Includes  26,693  shares  owned  directly  by Mr.  Warnick,  50,000  shares
     underlying  presently  exercisable  options,  and 7,500  shares  underlying
     options that become exercisable on July 27, 1997.

(13) Includes 583.800 shares underlying presently  exercisable options,  190,000
     shares  underlying  options  that  become  exercisable  on July  27,  1997,
     1,185,073 shares underlying presently exercisable  warrants,  48,530 shares
     underlying  convertible  preferred  stock,  and 8,333  shares  underlying a
     convertible note.

ITEM 12-CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

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


                                       32

<PAGE>


In August  1996,  Richard A.  Houlihan,  a director of the  Company  purchased a
$25,000 10%  collateralized  debenture that included warrants to purchase 25,000
shares  of  Common  Stock  at  $1.25  per  share  on the  same  terms  as  other
nonaffiliated purchasers.

At December 31, 1996 the Company owed  certain  affiliates  of Willard H. Pease,
Jr.  $116,719  principal,  plus  $31,398  in accrued  interest,  for oil and gas
revenue  attributable  to  interests  in wells  operated by the Company that are
owned by the individuals and related entities.  Of the principal amount,  $2,877
was incurred in 1994, $4,603 was incurred in 1993, $20,992 was incurred in 1992,
$85,518 was incurred in 1991 and $2,729 was incurred in 1990.

At December  31, 1995 the Company  owed  $60,000 to Willard H. Pease,  Jr.,  the
Company's  President and CEO. This loan was unsecured,  bears interest at 8% per
annum  and was  originally  due in  January  1996.  In March  1996 the  Board of
Directors  agreed  to  change  the  terms of the  note to  allow  the note to be
convertible into the Company's common stock at $1.00 per share, the then current
market price, in exchange for a one-year extension of the note. In December 1996
Mr. Pease elected to convert the note in its entirety, the note was canceled and
Mr. Pease was issued 60,000 shares of the Company's restricted common stock.

Until June 1993,  Willard H. Pease,  Jr. owned an oil well  servicing  business,
Grand  Junction Well  Services,  Inc.  ("GJWS"),  which  operated a workover and
completion  rig.  In June 1993,  the  Company  acquired  GJWS from Mr.  Pease by
merging GJWS into a newly-formed  subsidiary of the Company.  In the merger, the
Company  issued Mr.  Pease 46,667  shares of Common  Stock and the  Company's 6%
secured convertible  promissory note in the principal amount of $175,000,  for a
total value of $350,000,  which was the estimated  fair market value of the GJWS
assets and business.  The note was originally  payable in three annual principal
installments of $45,000 on October 1, 1994, $65,000 on April 1, 1995 and $65,000
on April 1, 1996. The October 1, 1994 principal  payment of $45,000 was paid and
the remaining installments were extended to October 1, 1997 and October 1, 1998,
respectively.  The unpaid  principal  portion of $130,000 is  convertible at the
election of Mr. Pease into Common Stock at $5.00 per share.  The transaction was
approved unanimously by the disinterested directors of the Company.

In March 1996 the Company  entered into a three-year  consulting  agreement with
Beta Capital Group, Inc.  ("Beta").  Beta's  president,  Steve Antry, has been a
director of the Company since August 1996.  The  consulting  agreement with Beta
provides for minimum  monthly cash  payments of $17,500 plus  reimbursement  for
out-of-pocket  expenses. The Company also agreed to pay Beta additional fees, as
defined in the  agreement,  that are based on a percentage of the gross proceeds
generated from any public financing, private financing or from any warrants that
are  exercised  during the term of the  agreement.  During 1996 the Company paid
Beta, or its agents,  a total of $424,706 under the terms of the agreement.  The
total amount paid  consisted of: a.) $162,500 for monthly  consulting  fees; b.)
$94,700 for the reimbursement of out-of-pocket  expenses;  c.) $163,000 for fees
related to funds  generated  from  private  placements;  and d.) $4,506 for fees
related to funds  generated  from the exercise of  warrants.  In addition to the
cash  compensation,  the Company  granted Beta  warrants to purchase 1.0 million
shares of the  Company's  common stock for $.75 per share.  As allowed under the
terms  of the  agreement,  Beta  assigned  400,000  of those  warrants  to other
parties, including 100,000 to a Mr. Richard Houlihan, a director of the Company.
All these warrants expire in April 2001.

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


                                       33

<PAGE>


                                     PART IV


ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K

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) 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 January 5, 1995. (2)
(4.4) Certificate  of Designation  of Series A Cumulative Convertible  Preferred
      Stock. (1)
(4.5) Certificate of Amendment  of  Certificate  of  Designation  of  Series  A
      Cumulative Convertible Preferred Stock filed on August 16, 1993. (2)
(4.6) Second Certificate  of Amendment of Certificate of Designation of Series A
      Cumulative Convertible Preferred Stock filed on November 1, 1994. (2)
(10.1) Residue Gas Sales and Purchase  Agreement  dated June 22,  1986,  between
       Western  Gas  Supply Company  and  Loveland  Gas Processing,   Ltd.,  and
       Amendments  dated  July  30,  1986,  August 12, 1986, September 11, 1986,
       April 16, 1987, April 1, 1988, January 2, 1992, March 26, 1992 and May 1,
       1992. (1)
(10.2) Amendment  dated  December 1, 1993,  between  Public  Service  Company of
       Colorado and Loveland Gas  Processing Co., Ltd., to Residue Gas Sales and
       Purchase  Agreement  dated  June  22,  1986,  between  Western Gas Supply
       Company and Loveland Gas Processing, Ltd. (2)
(10.3) Gas  Purchase  and Sale  Contract  dated  November 1, 1988,  between Fuel
       Resources  Development  Co.  as seller  and  Loveland Gas Processing Co.,
       Ltd., as buyer,  pertaining to the  purchase of gas, and Amendments dated
       November  1, 1990, January 24, 1991, May 1, 1991, July 5, 1991, August 1,
       1991, April 1, 1992 and August 1, 1992. (1)
(10.4) Purchase  Order No. 5 dated January 1, 1994 from Loveland Gas  Processing
       Co., Ltd. to Fuel Resources  Development Co. that amends the Gas Purchase
       and  Sale  Contract  dated   November 1,  1988,  between  Fuel  Resources
       Development Co. and Loveland Gas Processing, Ltd. (2)
(10.5) Form of Warrants  issued to Ronin  Group Ltd.,  and Clemons F. Walker for
       the purchase of an aggregate of 240,000 shares of Common Stock. (3)
(10.6) 1990 Stock Option Plan. (1)
(10.7) 1993 Stock Option Plan (1)
(10.8) 1994 Employee Stock Option Plan. (2)
(10.9) Form of 12% Convertible  Unsecured  Promissory  Notes issued by Pease Oil
       and Gas Company in 1994 Private Placement. (2)
(10.10) Form of  Warrants  issued  to  brokers  Sales  Agents  in 1994  Private
        Placements. (2)
(10.11) Employment  Agreement effective September 16, 1994 between Pease Oil and
        Gas Company and Willard H. Pease, Jr. (2)
(10.12) Employment  Agreement  effective December 27, 1994 between Pease Oil and
        Gas Company and Patrick J. Duncan. (2)
(10.13) Employment  Agreement  effective December 27, 1994 between Pease Oil and
        Gas Company and James N. Burkhalter. (2)
(10.18)  Interconnect  Agreement  dated January 1, 1995,  between KN Front Range
        Gathering Company and Loveland Gas Processing Co., Ltd.(2)
(10.19) Gas Gathering  Agreement dated February 1, 1995,  between KN Front Range
        Gathering Company and Loveland Gas Processing Co., Ltd. (2)

                                       34

<PAGE>



(10.20) Agreement  dated  August  15,  1994,  between  Hewlett-Packard  Company,
        Loveland Gas Processing Co.,  Ltd.,  Pease Oil and Gas Company and Pease
        Operating Company. (2)
(10.21) Purchase and Sale Agreement dated April 24, 1995 among Pease Oil and Gas
        Company,  Thermo  Cogeneration Partnership, L.P and Seahawk Energy, Inc.
        (3)
(10.22) Agreement  between   Beta  Capital  Group,  Inc.,  and Pease Oil and Gas
        Company dated March 9, 1996. (4)
(10.24) Form of Warrant issued to Beta Capital Group, Inc.
(10.25) 1996 Stock Option Plan.
(10.26) 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.
(10.27) 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)
(10.28) Letter  Agreement dated February 4, 1997 by and between  National Energy
        Group, Inc. and Pease Oil and Gas Company. (6)
(10.29) Purchase  and Sale  Agreement  dated  February  26, 1997 by and between
        Transworld Exploration & Production, Inc. (7)
(21)    List of Subsidiaries. (3)
(23)    Consents of Experts
(23.1)  Consent of McCartney Engineering, LLC Consulting Petroleum Engineers
(23.2)  Consent of Hein + Associates LLP, Certified Public Accountants
(27)    Financial Data Schedule.

Footnotes:

     (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.



                                       35

<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 27, 1997                  By:/s/ Willard H. Pease, Jr.
                                       ----------------------------
                                       Willard H. Pease, Jr.
                                       President and Chief Executive Officer

Date:  March 27, 1997                  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 27, 1997                  By:/s/ Willard H. Pease, Jr.
                                       ----------------------------
                                       Willard H. Pease, Jr., President
                                       and Chairman of the Board

Date:  March 27, 1997                  By: /s/ Patrick J. Duncan
                                       -------------------------
                                       Patrick J. Duncan
                                       Chief Financial Officer,
                                       Treasurer, and Director

Date:  March 27, 1997                  By:/s/ James N. Burkhalter
                                       --------------------------
                                       James N. Burkhalter, Vice-President
                                       Engineering and Production, and Director

Date: March 27, 1997                   By:/s/ Steve A. Antry
                                       ---------------------------
                                       Steve A. Antry, Director

Date: March 27, 1997                   By:/s/ Richard A. Houlihan
                                       ----------------------------
                                       Richard A. Houlihan, Director

Date:  March 27, 1997                  By:/s/ Homer C. Osborne
                                       ----------------------------
                                       Homer C. Osborne, Director

Date:  March 27, 1997                  By:/s/ James C. Ruane
                                       ----------------------------
                                       James C. Ruane, Director

Date: March 27, 1997                   By:/s/ Leroy W. Smith
                                       -----------------------------
                                       Leroy W. Smith, Director

Date:  March 27, 1997                  By:/s/ Robert V. Timlin
                                       ------------------------------
                                       Robert V. Timlin, Director

Date: March 27, 1997                   By:/s/ Clemons F. Walker
                                       ------------------------------
                                       Clemons F. Walker, Director

Date:  March 27, 1997                  By:/s/ William F. Warnick
                                       ------------------------------
                                       William F. Warnick, Director

                                       36

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                            Page


Independent Auditor's Report.................................................F-2

Consolidated Balance Sheets - December 31, 1996 and 1995 ....................F-3

Consolidated Statements of Operations - For the Years Ended December 31, 1996
     and 1995................................................................F-5

Consolidated Statements of Stockholders' Equity - For the Years Ended
     December 31, 1996 and 1995..............................................F-6

Consolidated Statements of Cash Flows - For the Years Ended December 31,
     1996 and 1995...........................................................F-7

Notes to Consolidated Financial Statements...................................F-8





                                       F-1

<PAGE>



                          INDEPENDENT AUDITOR'S REPORT






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



We have audited the  accompanying  consolidated  balance sheets of Pease Oil and
Gas Company and  subsidiaries  as of December 31, 1996 and 1995, and the related
consolidated  statements of operations,  stockholders' equity and cash flows for
the years then ended.  These financial  statements are the responsibility of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  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, 1996 and 1995,  and the results of
their  operations  and their cash  flows for the years then ended in  conformity
with generally accepted accounting principles.



/s/ HEIN + ASSOCIATES LLP
HEIN + ASSOCIATES LLP


Denver, Colorado
February 21, 1997

                                       F-2

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>

                                                                                  DECEMBER 31,
                                                                         ---------------------------
                                                                             1996             1995
                                                                             ----             ----
                                     ASSETS
<S>                                                                     <C>             <C>   
CURRENT ASSETS:
     Cash and equivalents ...........................................   $  1,995,860    $    677,275
     Trade receivables, net of allowance for bad debts of $25,000 and
          $51,000, respectively .....................................        599,648         963,315
     Inventory ......................................................        408,787         532,289
     Prepaid expenses and other .....................................         56,327          77,844
     Common stock subscription receivable, 91,667 shares ............           --            68,750
                                                                        ------------    ------------
               Total current assets .................................      3,060,622       2,319,473
                                                                        ------------    ------------

OIL AND GAS PROPERTIES, at cost (successful efforts method):
     Undeveloped properties .........................................        351,727         377,606
     Wells in progress ..............................................        181,312            --
     Developed properties ...........................................      9,505,408       9,149,516
                                                                        ------------    ------------
               Total oil and gas properties .........................     10,038,447       9,527,122
     Less accumulated depreciation and depletion ....................     (3,946,974)     (3,608,917)
                                                                        ------------    ------------

               Net oil and gas properties ...........................      6,091,473       5,918,205
                                                                        ------------    ------------
PROPERTY, PLANT AND EQUIPMENT, at cost:
     Gas plant ......................................................      4,099,285       4,095,227
     Service equipment and vehicles .................................        879,313         855,025
     Buildings and office equipment .................................        459,228         529,703
                                                                        ------------    ------------
               Total property, plant and equipment ..................      5,437,826       5,479,955
     Less accumulated depreciation ..................................     (1,376,154)     (1,034,731)
                                                                        ------------    ------------
               Net property, plant and equipment ....................      4,061,672       4,445,224
                                                                        ------------    ------------
OTHER ASSETS:
     Debt issuance costs, net of accumulated amortization of $170,134
          and $29,167, respectively .................................      1,105,874          20,833
     Non-compete agreements, net of accumulated amortization
          of $253,322 ...............................................        306,678         352,674
     Other ..........................................................        274,830         383,317
                                                                        ------------    ------------
               Total other assets ...................................      1,687,382         756,824
                                                                        ------------    ------------
TOTAL ASSETS ........................................................   $ 14,901,149    $ 13,439,726
                                                                        ============    ============

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

                                       F-3

<PAGE>
                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                                   (continued)

<CAPTION>
                                                                             DECEMBER 31,
                                                                    ----------------------------
                                                                         1996             1995
                                                                         ----             ----
                      LIABILITIES AND STOCKHOLDERS' EQUITY

<S>                                                                 <C>             <C>       
CURRENT LIABILITIES:
     Current maturities of long-term debt:
          Related parties .......................................   $    285,895    $       --
          Other .................................................         45,944       1,100,474
     Accounts payable, trade ....................................        267,540       1,172,567
     Accrued production taxes ...................................        288,122         303,287
     Other accrued expenses .....................................        265,427         243,325
                                                                    ------------    ------------
               Total current liabilities ........................      1,152,928       2,819,653
                                                                    ------------    ------------
LONG-TERM LIABILITIES:
     Long-term debt, less current maturities:
          Convertible debentures ................................      5,000,000            --
          Other .................................................         19,945       1,223,159
     Accrued production taxes ...................................        256,088         379,652
                                                                    ------------    ------------
               Total long-term liabilities ......................      5,276,033       1,602,811
                                                                    ------------    ------------
COMMITMENTS AND CONTINGENCIES (Notes 3, 5, 6, and 11)

STOCKHOLDERS' EQUITY:
     Preferred Stock, par value $.01 per share, 2,000,000 shares
          authorized, 179,938 and 202,688 shares of Series A
          Cumulative Convertible Preferred Stock issued and
          outstanding (liquidation preference of $2,204,000 and
          $2,280,000, respectively) .............................          1,799           2,027
     Common Stock, par value $.10 per share, 25,000,000 shares
          authorized, issued and outstanding 7,526,817 shares and
          7,180,804 shares, respectively ........................        752,682         718,081
     Additional paid-in capital .................................     17,392,329      16,560,194
     Accumulated deficit ........................................     (9,674,622)     (8,263,040)
                                                                    ------------    ------------
               Total stockholders' equity .......................      8,472,188       9,017,262
                                                                    ------------    ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ......................   $ 14,901,149    $ 13,439,726
                                                                    ============    ============
</TABLE>
     The accompanying notes are an integral part of these consolidated financial
statements.

                                       F-4

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                           FOR THE YEARS ENDED
                                                                DECEMBER 31,
                                                       --------------------------
                                                           1996           1995
                                                           ----           ----
<S>                                                    <C>            <C>        
REVENUE:
      Oil and gas sales .............................  $ 2,546,676    $ 2,623,782
      Natural gas marketing and trading .............    2,067,379      3,872,565
      Gas plant processing ..........................      818,356      1,135,050
      Oil field services and supply .................      618,225      1,302,741
      Well administration and other income ..........      115,028         97,678
                                                       -----------    -----------
             Total revenue ..........................    6,165,664      9,031,816
                                                       -----------    -----------
OPERATING COSTS AND EXPENSES:
      Oil and gas production ........................    1,426,549      1,617,318
      Natural gas marketing and trading .............    1,745,446      3,404,169
      Gas plant processing ..........................      464,512        942,867
      Oil field services and supply .................      553,343      1,391,588
      General and administrative ....................    1,092,342      1,059,306
      Consulting arrangement - related party ........      257,199           --
      Depreciation, depletion and amortization ......    1,055,639      1,292,314
      Dry holes, plugging, and abandonments .........      555,685         18,786
      Restructuring costs ...........................         --          226,986
                                                       -----------    -----------
             Total operating costs and expenses .....    7,150,715      9,953,334
                                                       -----------    -----------
LOSS FROM OPERATIONS ................................     (985,051)      (921,518)
                                                       -----------    -----------
OTHER INCOME (EXPENSES):
      Interest income ...............................       41,148          8,444
      Interest expense:
             Amortization of debt issuance costs ....     (190,967)       (17,554)
             Other ..................................     (311,461)      (288,881)
      Gain (loss) on sale of assets .................       (6,660)        75,073
                                                       -----------    -----------
             Net ....................................     (467,940)      (222,918)
                                                       -----------    -----------
LOSS BEFORE INCOME TAXES ............................   (1,452,991)    (1,144,436)
      Income tax benefit ............................       41,409        379,000
                                                       -----------    -----------
NET LOSS ............................................   (1,411,582)      (765,436)
      Preferred stock dividends:
             Converted ..............................      (22,750)      (117,000)
             In arrears .............................     (179,938)      (202,688)
                                                       -----------    -----------
                   Total preferred stock dividends...     (202,688)      (319,688)
                                                       -----------    -----------
                   Loss before non-cash inducement...   (1,614,270)    (1,085,124)

      Non-cash inducement in tender offer (Note 1)...         --       (1,523,906)
                                                       -----------    -----------
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS ..........  $(1,614,270)   $(2,609,030)
                                                       ===========    ===========
NET LOSS PER COMMON SHARE:
      Before non-cash inducement ....................  $      (.22)   $      (.18)
      Non-cash inducement (Note 1) ..................         --             (.24)
                                                       -----------    -----------
                                                       $      (.22)   $      (.42)
                                                       ===========    ===========
WEIGHTED AVERAGE NUMBER OF COMMON 
  SHARES OUTSTANDING.................................    7,278,000      6,190,000
                                                        ===========    ===========
</TABLE>

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

                                       F-5

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995

<TABLE>
<CAPTION>
                                                             Preferred Stock                  Common Stock        Additional 
                                                       -------------------------        ------------------------    Paid-in   
                                                       Shares            Amount         Shares           Amount     Capital 
                                                       ------            ------         ------           ------   ----------
<S>                                                   <C>          <C>                <C>          <C>             <C>         
BALANCES January 1, 1995 .......................      1,157,780    $     11,578       2,286,028    $    228,603    $ 16,744,348

     Conversion of preferred stock to
       common stock:
          In tender offer ......................       (933,492)         (9,335)      4,200,716         420,072        (410,737)
          Other ................................        (21,600)           (216)         56,739           5,673          (5,457)
     Acquisition of oil and gas properties for
          common stock .........................           --              --            65,000           6,500          53,422
     Sale of common stock in private placement .           --              --           500,000          50,000         325,000
     Offering costs ............................           --              --              --              --           (77,953)
     Issuance of common stock to directors and
          employees for services and other .....           --              --            21,036           2,104          11,327
     Settlement of trade payable for common
          stock ................................           --              --            63,206           6,321         (30,948)
     Cancellation of trestury shares ...........           --              --           (11,921)         (1,192)        (48,808)
     Net loss ..................................           --              --              --              --              --
                                                   ------------    ------------    ------------    ------------    ------------
BALANCES December 31, 1995 .....................        202,688           2,027       7,180,804         718,081      16,560,194

     Issuance of common stock to officers,
          directors, and employees for
          compensation .........................           --              --            51,490           5,149          57,162
     Fair value of warrants granted for debt
          issuance costs .......................           --              --              --              --           600,000
     Conversion of debentures into common
          stock ................................           --              --            82,353           8,235          61,765
     Issuance of common stock for engineering
          services .............................           --              --            15,000           1,500          21,477
     Exercise of options and warrants to
          purchase common stock ................           --              --            67,500           6,750          57,625
     Conversion of note payable to director into
          common stock .........................           --              --            60,000           6,000          54,000
     Conversion of preferred stock to common
          stock ................................        (22,750)           (228)         69,670           6,967          (6,739)
     Offering costs ............................           --              --              --              --           (13,155)
     Net loss ..................................           --              --              --              --              --
                                                   ------------    ------------    ------------    ------------    ------------
BALANCES, December 31, 1996 ....................        179,938    $      1,799       7,526,817    $    752,682    $ 17,392,329
                                                   ============    ============    ============    ============    ============

<PAGE>

<CAPTION>
                                                                            Tresury Stock              Total
                                                    Accumulated      ---------------------------    Stockholders'
                                                      Deficit            Shares         Amount         Equity
                                                    -----------          ------         ------      -------------
<S>                                                <C>                   <C>       <C>                <C>    
BALANCES January 1, 1995 .......................   $ (7,497,604)         28,715    $   (132,588)   $  9,354,337

     Conversion of preferred stock to              
       common stock:                               
          In tender offer ......................           --              --              --              --
          Other ................................           --              --              --              --
     Acquisition of oil and gas properties for     
          common stock .........................           --              --              --            59,922
     Sale of common stock in private placement .           --              --              --           375,000
     Offering costs ............................           --              --              --           (77,935)
     Issuance of common stock to directors and     
          employees for services and other .....           --              --              --            13,431
     Settlement of trade payable for common        
          stock ................................           --           (16,794)         82,588          57,961
     Cancellation of trestury shares ...........           --           (11,921)         50,000            -- 
     Net loss ..................................       (765,436)           --              --          (765,436)
                                                     ----------      -----------       ----------    ---------- 
BALANCES December 31, 1995 .....................     (8,263,040)           --              --         9,017,262

     Issuance of common stock to officers,         
          directors, and employees for             
          compensation .........................           --              --              --            62,311
     Fair value of warrants granted for debt       
          issuance costs .......................           --              --              --           600,000
     Conversion of debentures into common          
          stock ................................           --              --              --            70,000
     Issuance of common stock for engineering
          services .............................           --              --              --            22,977
     Exercise of options and warrants to           
          purchase common stock ................           --              --              --            64,375
     Conversion of note payable to director into   
          common stock .........................           --              --              --            60,000
     Conversion of preferred stock to common                                    
          stock ................................           --              --              --              --
     Offering costs ............................           --              --              --           (13,155)
     Net loss ..................................     (1,411,582)           --              --        (1,411,582)
                                                     ----------      -----------       ----------    ----------      
BALANCES, December 31, 1996 ....................   $ (9,674,622)           --          $   --       $ 8,472,188
                                                     ==========      ===========       ==========    ==========
</TABLE>


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


                                       F-6
<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                            FOR THE YEARS ENDED
                                                                                DECEMBER 31,
                                                                      ------------------------------
                                                                         1996                1995
                                                                         ----                ---- 
<S>                                                                  <C>                <C>         
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss ....................................................       $(1,411,582)       $  (765,436)
  Adjustments to reconcile net loss to net cash provided by
     operating activities:
  Provision for depreciation and depletion ....................         1,009,645          1,200,487
  Amortization of intangible assets ...........................           236,963            109,381
  Deferred income taxes .......................................              --             (400,000)
  Loss (gain) on sale of property and equipment ...............             6,660            (75,073)
  Provision for bad debts .....................................            21,497             35,176
  Dry holes and abandonments ..................................           525,000               --
  Issuance of common stock for services .......................            85,288             71,392
  Other .......................................................           (54,942)           (41,770)
  Changes in operating assets and liabilities:
   (Increase) decrease in:
     Trade receivables ........................................           342,170            625,286
     Inventory ................................................           124,502            296,824
     Prepaid expenses and other ...............................           (14,316)            14,001
  Increase (decrease) in:
     Accounts payable .........................................          (905,027)          (529,581)
     Accrued expenses .........................................          (109,473)          (160,512)
                                                                      -----------        -----------
  Net cash provided by (used in) operating activities .........          (143,615)           380,175
                                                                      -----------        -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Capital expenditures for property, plant and equipment ......        (1,403,413)          (387,403)
  Proceeds from redemption of certificate of deposit ..........            53,500             43,000
  Proceeds from sale of property and equipment ................           163,821            823,631
                                                                      -----------        -----------
     Net cash provided by (used in) investing activities ......        (1,186,092)           479,228
                                                                      -----------        -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from issuance of convertible debentures ............         5,000,000               --
  Repayment of long-term debt .................................        (1,795,670)          (943,341)
  Proceeds from sale of common stock ..........................           133,125            281,250
  Offering costs ..............................................           (13,155)           (52,953)
  Debt issuance costs .........................................          (676,008)              --
                                                                      -----------        -----------
     Net cash provided by (used in) financing activities ......         2,648,292           (715,044)
                                                                      -----------        -----------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS ...................         1,318,585            144,359

CASH AND EQUIVALENTS, beginning of year .......................           677,275            532,916
                                                                      -----------        -----------
CASH AND EQUIVALENTS, end of year .............................       $ 1,995,860        $   677,275
                                                                      ===========        ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
  INFORMATION:
  Cash paid for interest ......................................       $   192,502        $   273,735
                                                                      ===========        ===========
  Cash received (paid) for income taxes .......................       $    41,409        $   (21,000)
                                                                      ===========        ===========

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES:
  Fair value of warrants granted for debt issuance costs ......       $   600,000        $      --
  Conversion of long-term debt to common stock ................           130,000               --
  Long-term debt incurred for purchase of vehicles ............              --               24,992
  Acquisition of oil and gas properties for common stock ......              --               59,922
  Common stock subscription receivable ........................              --               68,750
</TABLE>
     The accompanying notes are an integral part of these consolidated financial
statements.
                                       F-7

<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, markets and trades 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.  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 - For purposes of the  statements of cash flows,  the
     Company considers all highly liquid investments  purchased with an original
     maturity of three months or less to be cash equivalents.

     Oil and Gas  Producing  Activities  - The Company  follows the  "successful
     efforts"  method of accounting for its oil and gas  properties.  Under this
     method  of  accounting,   all  property  acquisition  costs  and  costs  of
     exploratory and development  wells are capitalized  when incurred,  pending
     determination  of  whether  the  well  has  found  proved  reserves.  If an
     exploratory well has not found proved  reserves,  the costs of drilling the
     well are charged to expense. The costs of development wells are capitalized
     whether  productive or nonproductive.  Geological and geophysical costs and
     the costs of carrying and retaining undeveloped  properties are expensed as
     incurred.  Management  estimates  that the salvage  value of lease and well
     equipment will  approximately  offset the future liability for plugging and
     abandonment  of the related wells.  Accordingly,  no accrual for such costs
     has been recorded.

     Depletion and  depreciation of capitalized  costs for producing oil and gas
     properties  is provided  using the  units-of-production  method  based upon
     proved reserves.  Depletion and depreciation  expense for the Company's oil
     and gas  properties  amounted to $589,853  and $741,924 for the years ended
     December 31, 1996 and 1995, respectively.

     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.  When an
     assessment  for  impairment of oil and gas  properties  is  performed,  the
     Company compares the net carrying value of proved oil and gas properties on
     a  lease-by-lease  basis  (the  lowest  level at which  cash  flows  can be
     determined on a consistent  basis) to the related estimates of undiscounted
     future  net cash  flows  for such  properties.  If the net  carrying  value
     exceeds the net cash flows,  then  impairment  is  recognized to reduce the
     carrying value to the estimated fair value. The allowance for impairment is
     included in  accumulated  depreciation  and  depletion in the  accompanying
     balance sheets.


                                       F-8

<PAGE>
                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     Property, Plant and Equipment - Property, plant, and equipment is stated at
     cost. Depreciation of property, plant and equipment is 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

     Depreciation  expense related to property,  plant and equipment amounted to
     $419,792  and  $458,563  for the years  ended  December  31, 1996 and 1995,
     respectively.

     The cost of normal maintenance and repairs is 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 assets. These costs are being amortized over the terms of the two
     to ten-year  agreements  on a  straight-line  basis.  Amortization  expense
     related to the non-compete agreements was $45,994 and $91,827 for the years
     ended December 31, 1996 and 1995, respectively.

     Debt Issuance Costs - Debt issuance costs relate to the $5 million  private
     placement of  convertible  debentures  discussed in Note 3. These costs are
     being  amortized using the  straight-line  method (which  approximates  the
     interest method) over the 5-year term of the debentures.

     Inventory  -  Inventory  consists  primarily  of  oil  and  gas  production
     equipment  and oil  field  supplies.  These  items are  generally  held for
     resale.   At  December  31,  1996  and  1995,   inventory   also   includes
     approximately $72,000 and $100,000,  respectively,  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.  At December 31,
     1996 and  1995,  the  Company  has  classified  $200,000  of used oil field
     equipment inventory as long-term (included in other assets) because,  based
     on current  inventory  usage, it is not expected to be sold within the next
     year.

     Accounting   Estimates  -  The  preparation  of  financial   statements  in
     conformity  with  generally   accepted   accounting   principles   requires
     management  to make  estimates  and  assumptions  that  affect the  amounts
     reported in the financial statements and the accompanying notes. The actual
     results could differ from those estimates.


                                      F-9

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     The Company's  financial  statements  are based on a number of  significant
     estimates including the allowance for doubtful accounts, accrued production
     taxes,  realizability of intangible assets,  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 depreciation, depletion, 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.  At
     December 31, 1996,  approximately 35% of the Company's oil and gas reserves
     are attributable to non-producing  properties.  Accordingly,  the Company's
     estimates are expected to change as future information becomes available.

     The  Company is  required  under  certain  circumstances  to  evaluate  the
     possible  impairment of the carrying  value of its long-lived  assets.  For
     proved oil and gas properties,  this involves a comparison to the estimated
     future  undiscounted cash flows, which is the primary basis for determining
     the  related  fair  values  for  such   properties.   In  addition  to  the
     uncertainties inherent in the reserve estimation process, these amounts are
     affected by historical  and projected  prices for oil and natural gas which
     have typically been volatile.  It is reasonably possible that the Company's
     oil and gas reserve  estimates will  materially  change in the  forthcoming
     year.

     At December 31, 1996,  the Company's gas plant had a net carrying  value of
     approximately $3,340,000.  The determination of impairment of the gas plant
     may change in the future  based on the  Company's  ability to  continue  to
     develop its  properties  whereby  sufficient  quantities of natural gas and
     liquids are available to operate the plant profitably.

     Income Taxes - Income taxes are provided for in accordance  with  Statement
     of Financial  Accounting  Standards No. 109, "Accounting for Income Taxes."
     SFAS No. 109 requires an asset and liability approach in the recognition of
     deferred  tax   liabilities   and  assets  for  the  expected   future  tax
     consequences of temporary  differences between the carrying amounts and the
     tax bases of the Company's assets and liabilities.

     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  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.

     In connection  with the 1995  conversion of preferred stock to common stock
     discussed in Note 6, the Company  experienced a  significant  change in its
     capital  structure.  The pro  forma  effect  of  these  changes,  as if the
     conversions occurred on January 1, 1995, would have resulted in a reduction
     in  the  1995  loss  applicable  to  common  stockholders  before  non-cash
     inducement  from $.18 per share to $.14 per  share.  The pro forma loss per
  
                                      F-10

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     share calculations give effect to 4,257,455 common shares which were issued
     in the conversion and the elimination of dividends related to the converted
     preferred shares of approximately $117,000 for 1995. However, the pro forma
     information  does  not  give  effect  to the  inducement  discussed  in the
     following paragraph.

     The  Company   completed  a  tender  offer  to  the   Company's   preferred
     stockholders in February 1995. In connection therewith, the Company offered
     the preferred holders 4.5 common shares for each preferred share owned. The
     4.5 shares represented an increase from the original terms of the preferred
     stock which  provided for 2.625  common  shares for each  preferred  share.
     Under a recently issued accounting pronouncement,  the Company was required
     to reduce  earnings  available to common  stockholders by the fair value of
     the   additional   shares  which  were  issued  to  induce  the   preferred
     stockholders  to  convert  their  shares.   Since  the  Company  issued  an
     additional  1,750,000  common  shares in the tender  offer  compared to the
     shares  that  would  have  been  issued  under  the  original  terms of the
     preferred stock, the Company was required to deduct the fair value of these
     additional   shares  of  $1,523,906  from  earnings   available  to  common
     stockholders.  This non-cash  charge  resulted in the reduction of earnings
     per share by $.24 for the year ended December 31, 1995.

     While this  charge is intended  to show the cost of the  inducement  to the
     owners of the Company's common shares  immediately before the tender offer,
     management  does not believe that it accurately  reflects the impact of the
     tender  offer on the  Company's  common  stockholders.  As disclosed to the
     preferred  stockholders in connection with the tender offer, the book value
     per share of common stock increased from a negative amount to approximately
     $1.00 per  share as a result of the  tender  offer.  Therefore,  management
     believes that,  even though the current  accounting  rules require the $.24
     charge per common share, there are other significant  offsetting factors by
     which the common shareholders  benefited from this conversion which are not
     reflected in the 1995 earnings per share presentation.

     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.

     Reclassifications  - Certain  reclassifications  have been made to the 1995
     financial   statements  to  conform  to  the   presentation  in  1996.  The
     reclassifications had no effect on the 1995 net loss.


2.   RESTRUCTURING:

     During  1995,  in light of  declining  natural  gas prices,  declining  rig
     counts,  lackluster margins and the competitive environment inherent in the

                                      F-11

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     oil and gas  industry,  the  Company  undertook  steps to reduce  operating
     costs,   increase   efficiencies,   reduce  operating  risks  and  generate
     additional working capital.  During the second quarter of 1995, the Company
     announced a restructuring  program that included  substantially  downsizing
     its service and supply businesses and closing its administrative  office in
     Denver, Colorado. As a result of this restructuring, 35 of the Company's 70
     employees were terminated,  and service equipment,  land and buildings were
     sold.

     As of December 31, 1995, the Company recognized  $226,986 of costs incurred
     in  connection  with both the  tender  offer  discussed  in Note 6, and the
     restructuring  discussed above.  The costs recognized in the  restructuring
     consist primarily of severance pay, a loss on the abandonment of the office
     lease, and a $90,000 loss from the liquidation of inventory at an auction.

     For the year ended  December  31,  1995,  the  operating  revenues  and net
     operating  loss  of  the  service  and  supply  businesses,   exclusive  of
     restructuring charges and gains on sales of assets, were as follows:

          Revenues                             $1,302,741
          Operating costs                      (1,391,588)
          Depreciation                           (157,380)
                                               ----------
              Net operating loss                $(246,227)
                                               ==========

     Substantially, all of the 1995 net operating loss from these operations was
     incurred prior to completion of the restructuring discussed above.


3.   DEBT FINANCING ARRANGEMENTS:

     Long-Term Debt - Long-term debt at December 31, 1996 and 1995,  consists of
     the following:
<TABLE>
<CAPTION>
                                                                                  1996           1995
                                                                                 -----           ----
<S>                                                                            <C>           <C>     
     Unaffiliated Parties:

     Collateralized convertible 10% debentures due April 2001  .............   $5,000,000    $     --

     Other installment notes.  Interest at 6.9% to 9.75%, monthly principal
     and interest payments of approximately $3,440 through 1998. All of
     the notes are  collateralized by vehicles .............................       52,555        85,423

     Contract payable, $4,444 credited monthly against gas purchases, due
     July 1997, collateralized by certificate of deposit ...................       13,334        66,667

     Note payabel to a bank, interest at prime plus 3% .....................         --        1,762,802

                                      F-12
<PAGE>


                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<CAPTION>
                                                                                  1996           1995
                                                                                 -----           ----
<S>                                                                            <C>           <C>     
     Convertible 12% debentures, due May 1996, convertible into
     82,353 share of common stock ..........................................         --           70,000
                                                                                ----------     ---------
           Total unaffiliated parties ......................................    5,065,889      1,984,892
                                                                                ----------     ---------
     Related Parties:

     Note payable to the Company's president and CEO.  Interest at 6%
     annual principal payments of $65,000 due January 1997 and 1998.
     note is convertible into common stock at $5.00 per share and is
     collateralized by equipment ...........................................      130,000        130,000

     Unsecured notes payable to the Company's president and CEO and
     various entities controlled by him.  Interest at 8% to 10% with
     principal and interest due January 1, 1997 ............................      116,719        176,717

     Accrued interest ......................................................       39,177         32,024
                                                                                ---------      ---------
         Total related parties .............................................      285,896        338,741
                                                                                ---------      ---------
     Total long-term debt ..................................................    5,351,785      2,323,633

     Less current maturities:
        Related parties ....................................................     (285,896)           --
        Other ..............................................................      (45,944)    (1,100,474)
                                                                                ---------      ---------
         Total long-term debt, less current maturities .....................   $5,019,945     $1,223,159
                                                                                =========     ==========
</TABLE>

     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.   The  Company's  Board  of
     Directors has resolved to repay all outstanding  loans from related parties
     during  1997.  Accordingly,  all  such  amounts  are  included  in  current
     liabilities in the 1996 balance sheet.

                                      F-13

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     Aggregate Debt Maturities - The aggregate  maturities of long-term debt are
     as follows:

         Year Ending     Related
         December 31,    Parties           Others              Total
         ------------    -------           ------              -----

           1997         $285,896         $   45,944         $  331,840
           1998             --               19,945             19,945
           2001             --            5,000,000          5,000,000
                        --------          ---------          ---------
                        $285,896         $5,065,889         $5,351,785
                        ========         ==========         ==========

     Convertible  Debt 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 initial term of
     the  agreement  is for two years and  provides  for  minimum  monthly  cash
     payments of $17,500.  The  Consultant can elect to extend the agreement for
     an  additional  period of one year. 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 $.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 warrants to
     purchase  25,000  shares of the  Company's  common stock at $1.25 per share
     (see Note 7 for additional  information  with respect to the warrants).  In
     November 1996, the offering was completed and the Company was successful in
     selling the entire  $5,000,000  generating net cash proceeds of $4,300,000.
     The 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 holders 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 and are subject to adjustment  beginning on April 25, 1999. Interest
     on the debentures is payable quarterly commencing on September 30, 1996 and
     the entire 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% from the net proceeds from
     any warrants which are exercised  during the term of the agreement or up to
     six  months  after  termination  in  certain  circumstances.   All  of  the
     compensation paid to the Consultant is limited to 15% of the gross proceeds
     generated from the private placement,  exercise of warrants,  or other debt
     or  equity  financings  that  may be  consummated  during  the  term of the
     agreement.  In August  1996,  a major  shareholder  of the  Consultant  was
     elected to the Company's Board of Directors.

                                      F-14

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


4.   INCOME TAXES:

     The Company's  income tax benefit for the years ended December 31, 1996 and
     1995 consists of the following:
<TABLE>
<CAPTION>

                                                                       1996            1995
                                                                       ----            ----

<S>                                                                <C>              <C>         
         Current benefit (provision)                               $    41,409      $   (21,000)
         Deferred benefit                                                 --            400,000
                                                                     ---------       ----------
           Total                                                   $    41,409      $   379,000
                                                                     =========       ==========
</TABLE>

     A  reconciliation  of the income tax benefit at the  statutory  rate to the
     income tax benefit reported in the accompanying  financial statements is as
     follows:
<TABLE>
<CAPTION>

                                                                       1996            1995
                                                                       ----            ----

<S>                                                                <C>              <C>         
         Computed tax benefit at the expected statutory rate       $   494,000       $   389,100
         State income taxes and other                                   39,000            10,900
         Federal income taxes assessed in audit                          --              (21,000)
         Increase in valuation allowance                              (533,000)             --
         Federal income tax refund                                      41,409              --
                                                                     ---------        ----------
                          Total                                     $   41,409       $   379,000
                                                                     =========        ==========
</TABLE>

     Deferred  tax assets  (liabilities)  as of  December  31, 1996 and 1995 are
     comprised of the following:
<TABLE>
<CAPTION>

                                                                       1996            1995
                                                                       ----            ----

<S>                                                                <C>              <C>         
     Long-term Assets:
          Net operating loss carryforwards                          $ 3,616,000      $ 3,050,000
          Tax credit carryforwards                                      294,000          294,000
          Percentage depletion carryforwards                             58,000           58,000
          Other                                                          25,000           45,000
                                                                      ---------       ----------
               Total                                                  3,993,000        3,447,000
          Less valuation allowance                                   (1,770,000)      (1,237,000)
                                                                      ---------       ----------
                                                                      2,223,000        2,210,000
     Long-term liability for property and equipment                  (2,223,000)      (2,210,000)
                                                                      ---------       ----------
              Net long-term liability                              $      --         $      --
                                                                      =========       ==========
</TABLE>

                                      F-15

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     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,  1996,  the  Company  increased  the
     valuation  allowance  by $533,000  primarily  due to an increase in the net
     operating loss carryforwards which are not considered to be realizable.

     At December 31, 1996, the Company has net operating loss  carryforwards for
     income tax purposes of approximately $9,600,000,  which expire primarily in
     2008 through 2011.  Approximately  $2,880,000 of these net operating losses
     are subject to limitations under IRS Sections 382 and 384. These losses may
     only offset future taxable income to the extent of  approximately  $335,000
     per year  and  generally  may not  offset  any  gain on the sale of  assets
     acquired in the acquisition of Skaer Enterprises,  Inc.  Additionally,  the
     Company has tax credit carryforwards at December 31, 1996, of approximately
     $294,000 and percentage depletion carryforwards of approximately $150,000.


5.   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.  Management is continuing to
     explore alternatives with the major utility and other purchasers of natural
     gas in order to maximize the Company's natural gas revenue.

     The Company also had a contract with an independent  producer that required
     purchases of gas  quantities at a fixed margin per MMBTU for any difference
     between  plant  sales  and the  contract  volumes  with the  utility.  This
     contract  also expired in June 1996.  The revenue and  corresponding  costs
     incurred  pursuant to these  contracts have been reflected as Gas Marketing
     and Trading in the consolidated statements of operations.

     Leases - The  Company  leases its office  facilities  under  noncancellable
     operating leases. The total minimum commitments under these leases amounted
     to approximately $100,000 as of December 31, 1996. Total rent expense under
     all operating  leases for the years ended  December 31, 1996 and 1995,  was
     $26,807 and $90,569, respectively.

                                      F-16

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


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

     Profit  Sharing Plan - The Company has  established a 401(k) profit sharing
     plan that  covers  all  employees  with one month 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 $8,926 and $2,996 for the
     years ended December 31, 1996 and 1995, respectively.

     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 condition or results of operations.


6.   PREFERRED STOCK:

     The Company has the authority to issue up to 2,000,000  shares of Preferred
     Stock,  which may be issued in such  series  and with such  preferences  as
     determined  by the Board of  Directors.  During  1993,  the Company  issued
     1,170,000  shares of Series A Cumulative  Convertible  Preferred Stock (the
     "Preferred Stock").

     At December 31, 1996, the Preferred  Stock had a liquidation  preference of
     $12.25  per  share  ($10  liquidation  value  plus  $2.25 of  dividends  in
     arrears),  and each share of Preferred  Stock was  convertible  into 3.0625
     shares of common stock and warrants to purchase 3.0625 common shares.  Each
     warrant  entitles the holder to purchase one share of common stock at $6.00
     per share through August 13, 1998, when the warrants expire.  The Preferred
     Stock will automatically  convert into common stock if the reported sale of
     Preferred  Stock  equals or exceeds  $13.00  per share for ten  consecutive
     days.  The Company may redeem the Preferred  Stock at $10.00 per share plus
     any  dividends  in arrears.  Each share of  Preferred  Stock is entitled to
     receive  dividends  at 10%  per  annum  when,  as and  if  declared  by the
     Company's Board of Directors. Unpaid dividends accrue and are cumulative.

     In February  1995,  the Company  completed a tender offer to the  preferred
     stockholders  whereby  the  holders of the  Preferred  Stock were given the
     opportunity  to convert each share of  Preferred  Stock and all accrued and
     undeclared  dividends  (including  the full dividend for the quarters ended
     December  31,  1994 and March 31,  1995) into 4.5  shares of the  Company's
     common  stock.  As a result of this  tender  offer,  933,492  shares of the
     preferred  stock  converted into 4,200,716  shares of the Company's  common
     stock.  In  connection  with the  tender  offer  and other  conversions  of
     preferred  stock  through  December 31, 1996,  warrants for an aggregate of
     2,605,900 shares are outstanding.

                                      F-17

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     Through December 31, 1996, the Board of Directors has elected to forego the
     declaration of the regular quarterly dividend for five consecutive quarters
     resulting  in  dividends in arrears of  approximately  $405,000  ($2.25 per
     share)  related to  179,938  outstanding  shares of  Preferred  Stock.  The
     Company is precluded  from paying  dividends on its common stock so long as
     any  dividends  on the  Preferred  Stock are in  arrears.  The terms of the
     Preferred   Stock   prohibited  the  Company  from  entering  into  certain
     transactions  without an  affirmative  vote of the preferred  stockholders.
     Otherwise, the preferred stockholders have no voting rights.

     In connection with the Company's 1993 preferred stock offering, the Company
     issued  warrants to the  underwriter to purchase 90,000 shares of preferred
     stock at $12.00 per share. If not previously exercised, these warrants will
     expire in August 1998.  In 1993,  the Company  also  granted  warrants to a
     consultant for the purchase of 60,000 shares of common stock.  The warrants
     are exercisable for $6.00 per share and expired in November 1996.


7.   STOCK BASED COMPENSATION:

     Stock Option Plans - The  Company's  shareholders  have approved four stock
     option  plans that  authorize  an  aggregate  of  900,000  shares for stock
     options  that  may  be  granted  to  officers,  directors,  employees,  and
     consultants.  The plans permit the issuance of incentive and  non-statutory
     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 plans 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, 1996 and 1995:
<TABLE>
<CAPTION>
                                                  1996                           1995
                                       --------------------------     ---------------------------
                                                        Weighted                          Weighted
                                                        Average                           Average
                                        Number          Exercise       Number             Exercise
                                       of Shares        Price         of Shares           Price
                                       ---------        ---------     ---------           ---------
<S>                                    <C>                <C>           <C>               <C>  
     Outstanding, beginning of year    459,600            $.94          347,000           $3.53

        Canceled                         -               -             (224,000)           3.43
        Expired                         (4,000)           7.19          (99,000)           3.70
        Granted                        165,700            1.39          435,600             .79
                                       -------                          -------
     Outstanding, end of year          621,300            1.02          459,600            .94
                                       =======                          =======
</TABLE>

                                      F-18

<PAGE>
                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     For all options  granted during 1996 and 1995, 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, 1996, options
     for 542,000 shares were  exercisable  and options for the remaining  79,300
     shares became  exercisable in February  1997. If not previously  exercised,
     options outstanding at December 31, 1996, will expire as follows:

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

                          1997                          5,000           $3.44
                          1998                         15,000            2.94
                          2000                        295,600             .83
                          2000                        140,000             .70
                          2001                         86,400            1.00
                          2001                         79,300            1.81
                                                      -------
                                                      621,300
                                                      =======

     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, 1996 and 1995:
<TABLE>
<CAPTION>
                                                                     1996                        1995
                                                           -----------------------    ---------------------------
                                                                         Weighted                        Weighted
                                                                          Average                         Average
                                                             Number      Exercise        Number          Exercise
                                                            of Shares      Price        of Shares          Price
                                                            ---------    --------       ---------        --------
<S>                                                       <C>              <C>          <C>               <C>  
     Outstanding, beginning of year                       3,359,418        $5.00        232,302           $4.05
        Granted to:
             Officer and director                           101,500         1.00          --                --
             Consultants                                  1,090,000          .75        358,000             .97
             Former officer and director                      --             --          77,000            3.61
             Investors in private placements of:
                  Common stock                                --             --         250,000            1.25
                  Convertible debentures                  2,500,000         1.25          --                --
             Brokers in private placement of convertible
                  debentures                                223,500         2.00          --                --
        Issued to former holders of preferred stock
             upon conversion                                 69,670         6.00      2,507,116            6.00
        Repriced                                              --             --         (15,000)           6.00
        Expired                                             (60,000)        6.00        (50,000)            .85
        Exercised                                           (67,500)         .95          --                --
                                                          ---------                   ---------
     Outstanding, end of year                             7,216,588         2.94      3,359,418            5.00
                                                          =========                   =========
</TABLE>

                                      F-19

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     All  outstanding  warrants and  non-qualified  options were  exercisable at
     December 31, 1996. If not previously exercised,  warrants and non-qualified
     options outstanding at December 31, 1996, will expire as follows:

                                                              Weighted
                                                               Average
                                              Number          Exercise
        Year Ending December 31,             of Shares          Price
        ------------------------             ---------        --------
               1997                            400,000           $1.25
               1998                          2,605,900            6.00
               1998                            118,188            1.51
               1999                            223,500            2.00
               1999                             50,000            3.34
               2000                            118,000             .76
               2000                             77,000            3.61
               2001                          1,040,000             .75
               2001                            101,500            1.00
               2001                          2,482,500            1.25
                                             ---------
               Total                         7,216,588
                                             =========

     Presented below is a comparison of the weighted  average exercise price and
     market price of the Company's  common stock on the measurement date for all
     warrants and stock options granted to non-employees during 1996 and 1995:
<TABLE>
<CAPTION>

                                                     1996                                1995
                                       --------------------------------    -------------------------------
                                       Number of    Exercise     Market    Number of    Exercise    Market
                                        Shares       Price        Price     Shares        Price      Price
                                       ---------    --------     ------    ---------    --------    ------
<S>                                    <C>           <C>          <C>       <C>          <C>         <C>  
        Market price equal to
              exercise price           101,500       $1.00        $1.00     118,000      $ .76       $ .76
        Market price greater than
              exercise price            50,000         .85         1.00        --          --          --
        Exercise price greater than
              market price           3,763,500        1.16          .69     567,000       1.50         .79
</TABLE>

     Fair value of all  warrants  and stock  options  granted  to  non-employees
     during  the  year  ended  December  31,  1996,  was  determined  using  the
     Black-Scholes  option pricing  model.  Significant  assumptions  included a
     risk-free  interest rate of 6.5%,  expected  volatility of 63%, and that no
     dividends  would be declared  during the expected term of the options.  The

                                      F-20

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     weighted  average  contractual  term of the options was  approximately  4.8
     years  compared  to a weighted  average  expected  term of 1.9  years.  The
     estimated fair value of warrants  granted to non-employees in 1996 amounted
     to $600,000,  which is recorded as a debt issuance cost in the 1996 balance
     sheet.

     In connection with private  placements of debt and equity  securities,  the
     Company  granted common stock purchase  warrants that are redeemable at the
     option of the Company. Presented below is a summary of these warrants:

                                                                     Redemption
       Year          Expiration         Exercise      Number of       Price Per
     Granted            Date             Price          Shares          Share
     -------         ----------         --------      ---------      ----------
       1994         August 1998          $1.92          83,188            $.25
       1995         April 1997            1.25         250,000             .25
       1996         July 2001             1.25       2,500,000             .10

     In December 1996, the Company  provided notice of redemption to the holders
     of the warrants  granted in 1995.  Accordingly,  the holders must  exercise
     their warrants by January 31, 1997 or accept the redemption price (see Note
     11).

     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,
                                                      ------------------------
                                                         1996            1995
                                                         ----            ----
       Net loss applicable to common stockholders:
           As reported                               $(1,614,270)   $(2,609,030)
           Pro forma                                  (1,764,270)    (2,772,030)
       Net loss per common share:
           As reported                               $      (.22)   $      (.42)
           Pro forma                                        (.24)          (.45)


                                      F-21

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     The fair value of each employee option and warrant granted in 1996 and 1995
     was estimated on the date of grant using the  Black-Scholes  option-pricing
     model with the following weighted average assumptions:

                                                    Year Ended December 31,
                                                    -----------------------
                                                     1996             1995
                                                     ----             ----

           Expected volatility                         64%             61%
           Risk-free interest rate                    6.5%            6.5%
           Expected dividends                          --              --
           Expected terms (in years)                  3.4             3.3


8.   FINANCIAL INSTRUMENTS:

     Statement of Financial  Accounting  Standards No. 107 requires all entities
     to  disclose  the fair  value of  certain  financial  instruments  in their
     financial statements.  Accordingly, at December 31, 1996, 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.  Management estimates that fair
     value  differs from  carrying  value for the  following  instruments  as of
     December 31, 1996 and 1995:
<TABLE>
<CAPTION>
                                                 1996                        1995
                                         ---------------------     ------------------------
                                         Carrying       Fair        Carrying         Fair
                                           Value        Value        Value           Value

<S>                                      <C>          <C>           <C>            <C>     
     Long-term portion of accrued        $256,088     $225,000      $379,652       $335,000
        production taxes

     Notes payable to related parties     285,896      271,000       338,741        300,000
</TABLE>

     Fair  value of the  above  debt  instruments  was  estimated  using  market
     interest rates at December 31, 1996 for debt with comparable terms.


9.   SIGNIFICANT CONCENTRATIONS:

     Substantially all of the Company's accounts receivable at December 31, 1996
     and 1995,  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 or not to require  collateral from a customer or joint
  
                                      F-22

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     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 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.

     At December 31, 1996, the Company had a receivable  from a single  customer
     for  $67,718,  which was  collected  in January  1997.  For the years ended
     December 31, 1996 and 1995,  the Company had natural gas sales to the major
     utility  discussed  in Note 5  which  accounted  for  34% and 46% of  total
     revenues,  respectively.  For the year ended December 31, 1996, the Company
     also had oil sales to a single  customer  which  accounted for 11% of total
     revenues.

     At December  31,  1996,  the  Company has  temporary  cash  investments  of
     $1,941,550 with a single financial institution.


10.  FOURTH QUARTER ADJUSTMENTS:

     During  the fourth  quarter of 1996,  the  Company  recognized  a charge of
     $450,000 for drilling costs related to an unsuccessful well. This charge is
     included in dry holes,  plugging and  abandonments in the 1996 statement of
     operations.


11.  SUBSEQUENT EVENTS (UNAUDITED):

     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
     Natural Energy Group, Inc. (NEGX), an independent oil and gas producer. The
     purchase price was $1,750,000  which  consisted of $875,000 in cash and the
     issuance of 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. The purchase price totals $2.5 million and the agreements provide
     for an effective  date of October 16,  1996.  NEGX is the operator of these
     properties.

                                      F-23

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     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 $5 million  and $20  million for the year ending
     December 31, 1997.

     Financing  Arrangements - In January 1997, the Company  commenced a private
     placement of up to 1,500,000 shares of common stock for $2.50 per share. In
     connection with the private  placement,  the Company agreed to use its best
     efforts to register the shares for sale by including  such  securities in a
     registration  statement.  As of March 10,  1997,  the Company had  received
     subscriptions  for the entire  1,500,000 shares resulting in total proceeds
     of $3,750,000. Commissions and other costs of the offering are estimated to
     be approximately 10% of the gross proceeds.

     Through  March  25,  1997,  options  and  warrants  were  exercised  for an
     aggregate  of  1.65  million  shares,  resulting  in net  proceeds  of $1.9
     million.

     In  February  1997,  the  Company  entered  into a letter of intent with an
     underwriter for a proposed private placement of the Company's common stock.
     The  aggregate  gross  proceeds of the offering will be at least $6 million
     unless  otherwise  agreed by the parties.  The  underwriter  would  receive
     commissions equal to 10% of the gross proceeds and warrants to purchase the
     Company's common stock.

     In January 1997,  options for 190,000 shares of the Company's  common stock
     were  granted to officers and  directors.  The options are  exercisable  at
     $2.97 per share and expire in January 2002.


12.  SUPPLEMENTAL OIL AND GAS DISCLOSURES:

     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, 1996 and 1995:

                                                     1996                 1995
                                                     ----                 ----

           Property acquisition costs            $   16,022           $  60,000
           Development costs                        806,564             161,000
           Exploration costs                        555,685                --
                                                  ---------            -------- 
                Total                            $1,378,271           $ 221,000
                                                  =========            ========

                                      F-24

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     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, 1996 and
     1995 are presented below.

                                                      1996             1995
                                                      ----             ----
         Oil and gas sales:
              LGPCo                            $    340,000       $   373,000
              Unaffiliated entities               2,207,000         2,251,000
                                                  ---------         ---------
                   Total oil and gas sales        2,547,000         2,624,000
         Exploration and abandonment expenses      (556,000)          (19,000)
         Production costs                        (1,427,000)       (1,617,000)
         Depletion, depreciation and impairment    (590,000)         (742,000)
         Imputed income tax benefit (provision)      10,000           (91,000)
                                                  ---------         ---------
         Results of operations from oil and gas
           producing activities                 $   (16,000)      $   155,000
                                                  =========         =========

     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 25% of the Company's proved developed reserves are
     currently non-producing as certain wells require workovers,  recompletions,
     or  construction  of a gathering  system to an existing  gas pipeline at an
     estimated  total cost of $1.4 million.  All proved oil and gas reserves are
     located in the United States. The following table presents estimates of the
     Company's  net proved oil and gas  reserves,  and  changes  therein for the
     years ended December 31, 1996 and 1995.


                                      F-25

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     Changes in Net Quantities of Proved Reserves (Unaudited)
<TABLE>
<CAPTION>

                                                       1996                              1995
                                             -------------------------        ---------------------------
                                                Oil            Gas               Oil             Gas
                                               (Bbls)         (Mcf)             (Bbls)          (Mcf)

<S>                                          <C>             <C>              <C>              <C>      
     Proved reserves, beginning of year      1,294,000       5,851,000        1,352,000        5,724,000
          Purchase of minerals in place          7,000           -               38,000          447,000
          Sale of minerals in place            (27,000)        (26,000)         (14,000)        (107,000)
          Extensions, discoveries
              other additions                   72,000         455,000           82,000          382,000
          Revisions of previous estimates      (71,000)     (1,035,000)         (43,000)         (98,000)
          Production                          (100,000)       (412,000)        (121,000)        (497,000)
                                             ---------       ----------       ---------        ---------
     Proved reserves, end of year            1,175,000       4,833,000        1,294,000        5,851,000
                                             =========       ==========       =========        =========

     Proved developed reserves, end of year  1,034,000       4,078,000        1,014,000        4,302,000
                                             =========       ==========       =========        ---------
</TABLE>

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

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

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


                                      F-26

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     The  following  summary  sets  forth the  Company's  future  net cash flows
     relating to proved oil and gas  reserves  as of December  31, 1996 and 1995
     based on the  standardized  measure  prescribed  in  Statement of Financial
     Accounting Standards No. 69.
                                                      1996            1995
                                                      ----            ----

        Future cash inflows                     $  46,727,000     $  32,620,000
        Future production costs                   (17,220,000)      (13,871,000)
        Future development costs                   (3,001,000)       (3,269,000)
        Future income tax expense                  (6,200,000)       (1,800,000)
                                                  -----------       -----------
             Future net cash flows                 20,306,000        13,680,000
        10% annual discount for estimated
             timing of cash flow                   (8,326,000)       (5,200,000)
                                                  -----------        ----------
        Standardized Measure of Discounted 
             Future Net Cash Flows               $ 11,980,000      $  8,480,000
                                                   ==========        ==========
                                           
     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, 1996 and 1995:
<TABLE>
<CAPTION>

                                                               1996               1995
                                                               ----               ----

<S>                                                       <C>               <C>         
         Standardized measure, beginning of year          $  8,480,000      $  6,500,000
         Sale of oil and gas produced, net of
              production costs                              (1,120,000)       (1,006,000)
         Purchase of minerals in place                          45,000           228,000
         Sale of minerals in place                             (45,000)          (80,000)
         Net changes in prices and production costs          8,815,000           617,000
         Net changes in estimated development costs            233,000           785,000
         Revisions of previous quantity estimates           (3,769,000)         (803,000)
         Discoveries, extensions, and other additions        1,089,000           620,000
         Accretion of discount                                 848,000           650,000
         Changes in income taxes, net                       (2,596,000)          969,000
                                                           -----------        ----------
         Standardized Measure, end of year                $ 11,980,000      $  8,480,000
                                                            ==========        ==========
</TABLE>

                                      F-27

<PAGE>

                   PEASE OIL AND GAS COMPANY AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     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.

     The Company's reserve engineer has prepared the following estimates for the
     reserves related to these activities as of December 31, 1996.

          Future net revenues, discounted at 10%           $   537,000
                                                             =========

             Net quantities:
                Natural gas (mcf)                            1,514,000
                                                             =========

                Liquids (bbls)                                 237,000
                                                             =========

                                      F-28

<PAGE>


                                 EXHIBIT INDEX

Exhibit      Description                                                Page No.
-------      -----------                                                --------

(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)   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 January 5, 1995. (2)
(4.4)   Certificate  of  Designation  of Series A Cumulative  Convertible
        Preferred Stock. (1)
(4.5)   Certificate  of Amendment of Certificate of Designation of Series
        A  Cumulative  Convertible  Preferred  Stock  filed on August 16,
        1993. (2)
(4.6)   Second  Certificate of Amendment of Certificate of Designation of
        Series A Cumulative Convertible Preferred Stock filed on November
        1, 1994. (2)
(10.1)  Residue Gas Sales and Purchase  Agreement  dated June 22, 1986,
        between  Western Gas Supply Company and Loveland Gas  Processing,
        Ltd.,  and  Amendments  dated July 30,  1986,  August  12,  1986,
        September  11, 1986,  April 16, 1987,  April 1, 1988,  January 2,
        1992, March 26, 1992 and May 1, 1992. (1)
(10.2)  Amendment  dated  December  1, 1993,  between  Public  Service
        Company of Colorado and Loveland Gas  Processing  Co.,  Ltd.,  to
        Residue Gas Sales and  Purchase  Agreement  dated June 22,  1986,
        between  Western Gas Supply Company and Loveland Gas  Processing,
        Ltd. (2)
(10.3)  Gas Purchase and Sale Contract dated November 1, 1988,  between
        Fuel  Resources  Development  Co.  as  seller  and  Loveland  Gas
        Processing  Co.,  Ltd.,  as buyer,  pertaining to the purchase of
        gas, and Amendments dated November 1, 1990, January 24, 1991, May 
        1, 1991, July 5, 1991,  August 1, 1991,  April 1, 1992 and August
        1, 1992. (1)
(10.4)  Purchase  Order No. 5 dated  January 1, 1994 from  Loveland Gas
        Processing  Co.,  Ltd.  to Fuel  Resources  Development  Co. that
        amends the Gas Purchase and Sale Contract dated November 1, 1988,
        between  Fuel   Resources   Development   Co.  and  Loveland  Gas
        Processing, Ltd. (2)
(10.5)  Form of Warrants  issued to Ronin  Group  Ltd.,  and Clemons F.
        Walker for the  purchase  of an  aggregate  of 240,000  shares of
        Common Stock. (3)
(10.6)  1990 Stock Option Plan. (1)
(10.7)  1993 Stock Option Plan (1)
(10.8)  1994 Employee Stock Option Plan. (2)
(10.9)  Form of 12% Convertible  Unsecured  Promissory  Notes issued by
        Pease Oil and Gas Company in 1994 Private Placement. (2)
(10.10) Form of  Warrants  issued  to  brokers  Sales  Agents  in 1994
        Private Placements. (2)
(10.11) Employment  Agreement  effective  September  16, 1994 between
        Pease Oil and Gas Company and Willard H. Pease, Jr. (2)
(10.12) Employment Agreement effective December 27, 1994 between Pease
        Oil and Gas Company and Patrick J. Duncan. (2)
(10.13) Employment Agreement effective December 27, 1994 between Pease
        Oil and Gas Company and James N. Burkhalter. (2)

<PAGE>

Exhibit      Description                                                Page No.
-------      -----------                                                --------

(10.18) Interconnect Agreement dated January 1, 1995, between KN Front
        Range Gathering Company and Loveland Gas Processing Co., Ltd.(2)
(10.19) Gas Gathering  Agreement  dated  February 1, 1995,  between KN
        Front Range  Gathering  Company and Loveland Gas Processing  Co.,
        Ltd. (2)
(10.20) Agreement  dated  August 15,  1994,  between  Hewlett-Packard
        Company,  Loveland Gas Processing  Co.,  Ltd.,  Pease Oil and Gas
        Company and Pease Operating Company. (2)
(10.21) Purchase and Sale  Agreement  dated April 24, 1995 among Pease
        Oil and Gas Company,  Thermo  Cogeneration  Partnership,  L.P and
        Seahawk Energy, Inc. (3)
(10.22) Agreement between Beta Capital Group,  Inc., and Pease Oil and
        Gas Company dated March 9, 1996. (4)
(10.24) Form of Warrant issued to Beta Capital Group, Inc.
(10.25) 1996 Stock Option Plan.
(10.26) 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.
(10.27) 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)
(10.28) Letter  Agreement  dated  February  4,  1997  by and  between
        National Energy Group, Inc. and Pease Oil and Gas Company. (6)
(10.29) Purchase  and Sale  Agreement  dated  February 26, 1997 by and
        between Transworld Exploration & Production, Inc. (7)
(21)    List of Subsidiaries. (3)
(23)    Consents of Experts
(23.1)  Consent of  McCartney  Engineering,  LLC  Consulting  Petroleum
        Engineers
(23.2)  Consent of Hein + Associates LLP, Certified Public Accountants
(27)    Financial Data Schedule.

     (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.