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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q/A

Amendment No. 2



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(Mark one)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the Quarterly Period ended September 30, 2006

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
|- | --------------------------------------------------------------------------------

FOR THE TRANSITION PERIOD FROM  TO

COMMISSION FILE NUMBER: 0-10238



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U.S. ENERGY SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 52-1216347                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employee Identification No.)



|                                             |  |           
|-------------------------------------------- |  | ----------
|750 Lexington Avenue 15th Floor New York, NY |  | 10022     
|(Address of principal executive offices)     |  | (Zip Code)

212-588-8901

(Registrants telephone number, including area code)

545 Madison Avenue, Sixth Floor, New
York, New York 10022

(Former address)



---

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

Indicate by check mark the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated
filer ̈Accelerated filer ̈Non-accelerated filer   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES ̈NO  x

The number of shares
outstanding of U.S. Energy Systems, Inc.s common stock as of November 15, 2006: 17,370,360 shares



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##### Table of Contents

Explanatory Note:

We are
filing this amendment of our Form 10-Q for the quarterly period ended September 30, 2006, to amend and restate financial statements and other financial information with respect to a change in the interpretation and application of Statement of
Financial Accounting Standards No. 141, Business Combinations (FAS 141), pertaining to the computation and allocation of the purchase price for the acquisition of the UK assets as further described in Note D to the condensed
consolidated financial statements.

As discussed in the Form 10-Q for the quarter ended September 30, 2006 filed with the Securities and Exchange
Commission on November 21, 2006, U.S. Energy Systems, Inc. and its subsidiaries (the Company) allocated the cost of the UK Transaction to the assets acquired including the market value of the natural gas reserves based upon a
preliminary third party valuation obtained during the evaluation process and using the estimated fair value of the assets acquired. Based upon a comparison of the purchase price to the fair value of the assets acquired, an estimated Gain on
Acquisition of a Segment of $25 million, $38 million less $13 million of taxes, was included in the statement of operations for the period.

Originally,
the excess of the estimated fair value of the assets acquired over the acquisition price was recorded as a $25 million Extraordinary Gain on Acquisition of a Segment. Upon further review of FAS 141, it was subsequently determined that this excess
should first be allocated against the estimated fair value of the acquired assets on a prorated basis until such assets had been written down to zero, before any gain being recorded. Therefore, the estimated net gain of $25 million, net of taxes and
the allocation of $5,254,000 for minority interest, reported in the Form 10-Q for the quarter ended September 30, 2006 has been reversed.

In
addition, a change in the valuation of the various equity instruments provided to the sellers and lenders resulted in an increase in the acquisition and debt issuance costs associated with the issuance of the equity instruments. The valuation of the
equity instruments issued in connection with the purchase price and the debt financing, which included warrants of USEY and Class B membership interests in a USEY subsidiary, is based upon the average market price of the Companys stock for a
period including the closing date (August 7, 2006) and two days before the closing date for the warrants and a third party valuation for the Class B membership interests of the USEY subsidiary. The original valuation of the equity interests utilized
a stock price of $3.30 per share for the acquisition costs and $4.47 per share for the debt issuance costs. The valuation price was adjusted to $6.50 per share for both the acquisition costs and the debt issuance costs. The changes resulted in an
increase in the total acquisition price of $2,150,000 and an increase in debt issuance cost of $38,970,000, which is netted against the debt for presentation purposes. The value of the warrants issued in connection with the debt financing is based
upon the relative fair value of the debt and the warrants as of the issuance date.

The following table summarizes changes
in the purchase price of the net assets acquired and the allocation thereof:



|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  
|----------------------------------------------- |  | ---------------------- | ------- | - | ----------------------------- | - | ------ | -------------------- |  | -------------------------------- | ------ |  | ----------------------------- | ------- | - | ---------- | - | ------ | - |  | - | ------ | -
|As of August 7, 2006 (unaudited) (in thousands) |  | OriginalAmountReported |         |   | PurchasePriceAdjustment(1)(3) |   |        | RevisedPurchasePrice |  | Removal ofExtraordinary Gain (2) |        |  | RevisedValuationAllocation(3) |         |   | AsRestated |  
|Cash Paid for Acquisition                       |  | $                      | 72,634  |   |                               | $ |       |                      |  | $                                | 72,634 |  | $                             |        |   |            | $ |       |   |  | $ | 72,634 |  
|Equity Instruments Issued for Acquisition       |  |                        | 7,920   |   |                               |   | 7,513  |                      |  |                                  | 15,433 |  |                               |        |   |            |   |       |   |  |   | 15,433 |  
|Direct Acquisition Costs                        |  |                        | 12,042  |   |                               |   | (5,363 | )                    |  |                                  | 6,679  |  |                               |        |   |            |   |       |   |  |   | 6,679  |  
|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  
|Total Acquisition Price                         |  | $                      | 92,596  |   |                               | $ | 2,150  |                      |  | $                                | 94,746 |  | $                             |        |   |            | $ |       |   |  | $ | 94,746 |  
|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  
|                                                |  |                        |         |   |                               |  
|Property, Plant and Equipment                   |  | $                      | 12,862  |   |                               | $ |       |                      |  | $                                |       |  | $                             |        |   |            | $ | (2,310 | ) |  | $ | 10,552 |  
|Gas Property and Equipment, Depleting           |  |                        | 119,607 |   |                               |   |       |                      |  |                                  |       |  |                               | (38,494 | ) |            |   | 3,511  |   |  |   | 84,624 |  
|Long Term Power/Gas Contract                    |  |                        | 250     |   |                               |   |       |                      |  |                                  |       |  |                               |        |   |            |   | 1,986  |   |  |   | 2,236  |  
|Decommission Liabilities                        |  |                        | (1,629  | ) |                               |   |       |                      |  |                                  |       |  |                               |        |   |            |   | (1,037 | ) |  |   | (2,666 | )
|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  
|Totals                                          |  | $                      | 131,090 |   |                               | $ |       |                      |  | $                                |       |  | $                             | (38,494 | ) |            | $ | 2,150  |   |  | $ | 94,746 |  
|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  



|(1) |  | Purchase Price Adjustment column represents the correction to the original values ascribed to equity instruments and direct acquisition costs.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Represents the correction of the application of FAS 141 to limit the values ascribed to the purchased assets to the purchase price.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------

|(3) |  | These adjustments reflect the fair value of assets acquired (as adjusted for negative goodwill) and the equity instruments issued as provided by third party valuation reports.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The reversal of the previously recorded extraordinary gain and the resulting adjusted carrying values of the assets have no effect on the
cash flows or current loss from operations of the Company for the three and nine months ended September 30, 2006. The reduced carrying values of these assets will result in a decrease of future charges for depreciation, depletion and
amortization related to these assets. The changes in the valuation of the equity instruments issued in connection with the UK Transaction have no effect on the cash flows of the Company for the quarterly period ended September 30, 2006 but did
increase our operating loss for both the three and nine month periods by the amount of the amortization of the debt issuance costs, approximately $788,000.

The Company is currently working with an independent valuation company to verify the values utilized in the purchase price allocation for the UK Transaction. In accordance with FAS141, it has one year from the date of the acquisition to
finalize its allocation of the purchase price for the UK Transaction. Actual results may differ significantly from the estimates used thereby affecting the future valuation of these items.

This Form 10-Q/A includes updated certifications from the Companys chief executive officer and chief accounting officer in Exhibits 31.1, 31.2 and 32.1.



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS



|                              |  |                                                                                                                                                   |  |     
|----------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                                                                   |  | PAGE
|PART I: Financial Information |  |                                                                                                                                                  
|                              |  |                                                                                                                                                  
|Item 1:                       |  | Condensed Consolidated Financial StatementsUnaudited                                                                                             |  | 4   
|                              |  |                                                                                                                                                  
|                              |  | Condensed Consolidated Balance Sheets as of September 30, 2006 (Restated) and December 31, 2005                                                   |  | 4   
|                              |  |                                                                                                                                                  
|                              |  | Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and nine months ended September 30, 2006 (Restated) and 2005 |  | 6   
|                              |  |                                                                                                                                                  
|                              |  | Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 (Restated) and 2005                                  |  | 8   
|                              |  |                                                                                                                                                  
|                              |  | Notes to Condensed Consolidated Financial Statements                                                                                              |  | 10  
|                              |  |                                                                                                                                                  
|Item 2:                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                             |  | 31  
|                              |  |                                                                                                                                                  
|Item 3:                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                        |  | 37  
|                              |  |                                                                                                                                                  
|Item 4:                       |  | Controls and Procedures                                                                                                                           |  | 37  
|                              | 
|PART II: Other Information    |  |                                                                                                                                                  
|                              |  |                                                                                                                                                  
|Item 1A:                      |  | Risk Factors                                                                                                                                      |  | 37  
|                              |  |                                                                                                                                                  
|Item 6:                       |  | Exhibits                                                                                                                                          |  | 39  
|                              | 
|Signatures                    |  | 40                                                                                                                                               



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##### Table of Contents

U.S. ENERGY SYSTEMS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)



|                                                                                                                 |  |                      |         |                   |   |        
|---------------------------------------------------------------------------------------------------------------- |  | -------------------- | ------- | ----------------- | - | -------
|                                                                                                                 |  | September 30, 2006   |         | December 31, 2005
|                                                                                                                 |  | (Restated/Unaudited) |         |                  
|ASSETS                                                                                                           |  |                      |         |                   |   |        
|Current Assets:                                                                                                  |  |                      |         |                   |   |        
|Cash and Cash Equivalents                                                                                        |  | $                    | 4,446   |                   | $ | 11,301 
|Restricted Cash and Marketable Securities                                                                        |  |                      | 5,662   |                   |   | 5,501  
|Accounts Receivable Trade (less allowance for doubtful accounts of $159 and $888 in 2006 and 2005, respectively) |  |                      | 4,934   |                   |   | 2,198  
|Accounts Receivable Affiliates (less allowance for doubtful accounts of $511 in 2006 and 2005)                   |  |                      | 1,646   |                   |   | 2,789  
|Notes and Interest Receivable, Current Portion                                                                   |  |                      | 2,630   |                   |   | 1,976  
|Other Current Assets                                                                                             |  |                      | 2,625   |                   |   | 1,633  
|                                                                                                                 |  |                      |         |                   |   |        
|Total Current Assets                                                                                             |  |                      | 21,943  |                   |   | 25,398 
|                                                                                                                 |  |                     
|Restricted Cash and Marketable Securities                                                                        |  |                      | 93,434  |                   |   | 26,429 
|Property, Plant and Equipment, Net                                                                               |  |                      | 50,132  |                   |   | 40,306 
|Gas Property and Equipment, Depleting                                                                            |  |                      | 83,013  |                   |   |       
|Gas Property and Equipment, Non-Depleting                                                                        |  |                      | 2,787   |                   |   |       
|Long-Term Power / Gas Contract                                                                                   |  |                      | 2,193   |                   |   |       
|Construction in Progress                                                                                         |  |                      | 198     |                   |   | 198    
|Deferred CostsUK Acquisition                                                                                    |  |                      |        |                   |   | 261    
|Notes Receivable, less Current Portion                                                                           |  |                      | 20,570  |                   |   | 22,088 
|Investments                                                                                                      |  |                      | 1,381   |                   |   | 1,234  
|Debt Issuance Costs, Net of Accumulated Amortization                                                             |  |                      | 9,882   |                   |   | 10,476 
|Goodwill                                                                                                         |  |                      | 26,618  |                   |   | 26,618 
|Derivative Instruments                                                                                           |  |                      | 18,037  |                   |   | 1,860  
|Deferred Tax Asset (less valuation allowance of $14,405 in 2006 and $11,340 in 2005)                             |  |                      | 18,853  |                   |   | 13,878 
|Other Assets                                                                                                     |  |                      | 3,253   |                   |   | 283    
|                                                                                                                 |  |                      |         |                   |   |        
|TOTAL ASSETS                                                                                                     |  | $                    | 352,294 |                   | $ | 169,029
|                                                                                                                 |  |                      |         |                   |   |        
|                                                                                                                 |  |                     
|LIABILITIES                                                                                                      |  |                      |         |                   |   |        
|Current Liabilities:                                                                                             |  |                      |         |                   |   |        
|Current Portion of Long-Term Debt                                                                                |  | $                    | 1,987   |                   | $ | 1,879  
|Accounts Payable Trade and Accrued Expenses                                                                      |  |                      | 13,316  |                   |   | 4,083  
|Accounts Payable Affiliates                                                                                      |  |                      | 1,397   |                   |   | 1,091  
|Deferred Revenue                                                                                                 |  |                      | 272     |                   |   | 272    
|                                                                                                                 |  |                      |         |                   |   |        
|Total Current Liabilities                                                                                        |  |                      | 16,972  |                   |   | 7,325  
|                                                                                                                 |  |                     
|Long-Term Debt, less Current Portion                                                                             |  |                      | 218,615 |                   |   | 87,282 
|Deferred Revenue                                                                                                 |  |                      | 15,863  |                   |   | 16,224 
|Deferred Royalty                                                                                                 |  |                      | 5,072   |                   |   | 5,379  
|Illinois Subsidy Liability                                                                                       |  |                      | 36,126  |                   |   | 31,678 
|Decommissioning Liability                                                                                        |  |                      | 2,666   |                   |   |       
|                                                                                                                 |  |                      |         |                   |   |        
|Total Liabilities                                                                                                |  |                      | 295,314 |                   |   | 147,888
|                                                                                                                 |  |                      |         |                   |   |        
|Commitments and Contingencies                                                                                    |  |                      |         |                   |   |        
|Minority Interest                                                                                                |  |                      | 20,023  |                   |   | 4,968  
|                                                                                                                 |  |                      |         |                   |   |        

See notes to condensed consolidated financial statements

which are an integral part of the financial statements.

(continued)



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)



|                                                                                                                                                                                                             |  |                      |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                                                             |  | September 30, 2006   |         |   | December 31, 2005 |  
|                                                                                                                                                                                                             |  | (Restated/Unaudited) |         |   |                   |  
|STOCKHOLDERS EQUITY                                                                                                                                                                                         |  |                      |         |   |                   |   |         |  
|Preferred Stock, $.01 par value, Authorized 10,000,000 Shares:                                                                                                                                               |  |                      |         |   |                   |   |         |  
|Series B, Cumulative, Convertible, Issued and Outstanding, 368 Shares, Liquidation Preference, $1,000 per share                                                                                              |  | $                    |        |   |                   | $ |        |  
|Series C, Cumulative, Convertible, Issued and Outstanding, 38,809 Shares as of September 30, 2006 and 97,333 Shares as of
December 31, 2005, Liquidation Preference, $30 per share                           |  |                      |        |   |                   |   | 1       |  
|Series D, Cumulative, Convertible, Issued and Outstanding, 0 shares as of September 30, 2006 and 916,666 Shares as of December 31,
2005, Liquidation Preference, $9 per share                                |  |                      |        |   |                   |   | 9       |  
|                                                                                                                                                                                                             |  |                     
|Common Stock, $.01 par value, Authorized 50,000,000 Shares, Issued 17,816,290, Outstanding 17,370,360 at September 30, 2006 and Issued
13,490,098, Outstanding 13,044,109 at December 31, 2005, respectively |  |                      | 180     |   |                   |   | 135     |  
|Treasury Stock at Cost  445,930 Shares                                                                                                                                                                      |  |                      | (2,204  | ) |                   |   | (2,204  | )
|Additional Paid-In Capital                                                                                                                                                                                   |  |                      | 95,666  |   |                   |   | 62,583  |  
|Accumulated Deficit                                                                                                                                                                                          |  |                      | (59,522 | ) |                   |   | (46,528 | )
|Accumulated Other Comprehensive Income                                                                                                                                                                       |  |                      | 2,837   |   |                   |   | 2,177   |  
|                                                                                                                                                                                                             |  |                      |         |   |                   |   |         |  
|Total Stockholders Equity                                                                                                                                                                                   |  |                      | 36,957  |   |                   |   | 16,173  |  
|                                                                                                                                                                                                             |  |                      |         |   |                   |   |         |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                   |  | $                    | 352,294 |   |                   | $ | 169,029 |  
|                                                                                                                                                                                                             |  |                      |         |   |                   |   |         |  

See notes to condensed consolidated financial statements

which are an integral part of the financial statements.

(concluded)



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U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE LOSS

(Unaudited)

(In thousands, except Loss per share)



|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|---------------------------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------ | ----------------- |  | - | ----------------- | - |  | - | ------ | -
|                                                                       |  | THREE MONTHS ENDED |         |   | NINE MONTHS ENDED |  
|                                                                       |  | September 30,2006  |         |   | September 30,2005 |   |        | September 30,2006 |  |   | September 30,2005 |  
|                                                                       |  | (Restated)         |         |   |                   |   |        | (Restated)        |  |   |                   |  
|Revenues                                                               |  | $                  | 5,154   |   |                   | $ | 4,616  |                   |  | $ | 14,710            |   |  | $ | 14,116 |  
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Costs and Expenses:                                                    |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Operating Expenses                                                     |  |                    | 2,998   |   |                   |   | 2,126  |                   |  |   | 8,048             |   |  |   | 6,601  |  
|General and Administrative Expenses                                    |  |                    | 1,934   |   |                   |   | 1,393  |                   |  |   | 6,022             |   |  |   | 3,932  |  
|Depreciation and Amortization                                          |  |                    | 1,646   |   |                   |   | 1,095  |                   |  |   | 4,070             |   |  |   | 3,286  |  
|Income from Joint Ventures                                             |  |                    | (47     | ) |                   |   | (162   | )                 |  |   | (192              | ) |  |   | (271   | )
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Total Costs and Expenses                                               |  |                    | 6,531   |   |                   |   | 4,452  |                   |  |   | 17,948            |   |  |   | 13,548 |  
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|(Loss) Income from Operations                                          |  |                    | (1,377  | ) |                   |   | 164    |                   |  |   | (3,238            | ) |  |   | 568    |  
|                                                                       |  |                    |         |  
|Interest and Dividend Income                                           |  |                    | 1,003   |   |                   |   | 1,164  |                   |  |   | 3,246             |   |  |   | 3,023  |  
|Foreign Currency Transaction Expense                                   |  |                    | (847    | ) |                   |   | (4,039 | )                 |  |   | (4,276            | ) |  |   | (2,387 | )
|Unrealized Loss on Hedges                                              |  |                    | (3,779  | ) |                   |   |       |                   |  |   | (3,779            | ) |  |   |       |  
|Interest Expense                                                       |  |                    | (6,553  | ) |                   |   | (2,695 | )                 |  |   | (12,122           | ) |  |   | (8,115 | )
|Other Loss                                                             |  |                    | (9      | ) |                   |   | (50    | )                 |  |   | (51               | ) |  |   | (43    | )
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Loss before Taxes, Minority Interest and Disposal of Segment           |  |                    | (11,562 | ) |                   |   | (5,456 | )                 |  |   | (20,220           | ) |  |   | (6,954 | )
|Minority Interest                                                      |  |                    | 1,218   |   |                   |   | 1,014  |                   |  |   | 2,664             |   |  |   | 752    |  
|Income Tax Benefit (Expense)                                           |  |                    | 2,240   |   |                   |   | (1,826 | )                 |  |   | 4,561             |   |  |   | (1,740 | )
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Loss from Continuing Operations                                        |  |                    | (8,104  | ) |                   |   | (6,268 | )                 |  |   | (12,995           | ) |  |   | (7,942 | )
|                                                                       |  |                    |         |  
|Gain on Disposal of a Segment  Discontinued Operations (Net of taxes) |  |                    |        |   |                   |   |       |                   |  |   |                  |   |  |   | 150    |  
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Net Loss                                                               |  |                    | (8,104  | ) |                   |   | (6,268 | )                 |  |   | (12,995           | ) |  |   | (7,792 | )
|                                                                       |  |                    |         |  
|Dividends on Preferred Stock                                           |  |                    | (10     | ) |                   |   | (206   | )                 |  |   | (210              | ) |  |   | (619   | )
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Net Loss Applicable to Common Stockholders                             |  | $                  | (8,114  | ) |                   | $ | (6,474 | )                 |  | $ | (13,205           | ) |  | $ | (8,411 | )
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Other Comprehensive Loss:                                              |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Net Loss                                                               |  | $                  | (8,104  | ) |                   | $ | (6,268 | )                 |  | $ | (12,995           | ) |  | $ | (7,792 | )
|Other Comprehensive Income (Net of taxes)                              |  |                    | 390     |   |                   |   | 377    |                   |  |   | 96                |   |  |   | 121    |  
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Total Comprehensive Loss                                               |  | $                  | (7,714  | ) |                   | $ | (5,891 | )                 |  | $ | (12,899           | ) |  | $ | (7,671 | )
|                                                                       |  |                    |         |   |                   |   |        |                   |  |   |                   |   |  |   |        |  

See notes to condensed consolidated financial statements

which are an integral part of the financial statements.

(continued)



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND

COMPREHENSIVE LOSS

(Unaudited)

(In
thousands, except Loss per share)



|                                                                             |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|---------------------------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | ----------------- |  | - | ----------------- | - |  | - | ------ | -
|                                                                             |  | THREE MONTHS ENDED |        |   | NINE MONTHS ENDED |  
|                                                                             |  | September 30,2006  |        |   | September 30,2005 |   |        | September 30,2006 |  |   | September 30,2005 |  
|                                                                             |  | (Restated)         |        |   |                   |   |        | (Restated)        |  |   |                   |  
|NET INCOME (LOSS) PER SHARE OF COMMON STOCK:                                 |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|                                                                             |  |                    |        |  
|Loss per Share of Common Stock-Continuing Operations  Basic and Diluted     |  | $                  | (0.47  | ) |                   | $ | (0.52  | )                 |  | $ | (0.84             | ) |  | $ | (0.69  | )
|Income per Share of Common Stock-Discontinued Operations  Basic and Diluted |  |                    |       |   |                   |   |       |                   |  |   |                  |   |  | $ | 0.01   |  
|Net Loss per Share of Common Stock  Basic and Diluted                       |  | $                  | (0.47  | ) |                   | $ | (0.52  | )                 |  | $ | (0.84             | ) |  | $ | (0.68  | )
|                                                                             |  |                    |        |  
|Weighted Average Number of Common Shares Outstanding  Basic and Diluted     |  |                    | 17,350 |   |                   |   | 12,407 |                   |  |   | 15,736            |   |  |   | 12,407 |  

See notes to condensed consolidated financial statements

which are an integral part of the financial statements.

(concluded)



7



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)



|                                                                                         |  |                                |          |   |      |   |        |  
|---------------------------------------------------------------------------------------- |  | ------------------------------ | -------- | - | ---- | - | ------ | -
|                                                                                         |  | NINE MONTHS ENDEDSeptember 30, |         
|                                                                                         |  | 2006                           |          |   | 2005 |  
|                                                                                         |  | (Restated)                     |          |   |      |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                    |  |                                |          |   |      |   |        |  
|Net Loss                                                                                 |  | $                              | (12,995  | ) |      | $ | (7,792 | )
|Adjustments to Reconcile Net Loss to Net Cash Used in Operating Activities:              |  |                                |          |   |      |   |        |  
|Depreciation and Amortization                                                            |  |                                | 4,070    |   |      |   | 3,286  |  
|Minority Interest                                                                        |  |                                | (2,664   | ) |      |   | (2,964 | )
|Foreign Currency Transaction                                                             |  |                                | 4,276    |   |      |   | 2,387  |  
|Unrealized Gains                                                                         |  |                                |         |   |      |   | 129    |  
|Deferred Taxes                                                                           |  |                                | (4,637   | ) |      |   | 1,518  |  
|Unrealized Loss on Hedges                                                                |  |                                | 3,779    |   |      |   |       |  
|Equity Gains in Subsidiary                                                               |  |                                | (111     | ) |      |   |       |  
|Provision for Bad Debts                                                                  |  |                                | (715     | ) |      |   |       |  
|Stock Based Compensation                                                                 |  |                                | 1,727    |   |      |   |       |  
|Non-Cash Interest                                                                        |  |                                | 788      |   |      |   |       |  
|                                                                                         |  |                               
|Increase (Decrease) in Cash Attributable to Changes in Operating Assets and Liabilities: |  |                                |          |   |      |   |        |  
|Accounts Receivable                                                                      |  |                                | (878     | ) |      |   | 92     |  
|Foreign Currency Hedge                                                                   |  |                                |         |   |      |   | 136    |  
|Other Current Assets                                                                     |  |                                | (656     | ) |      |   | (670   | )
|Other Assets                                                                             |  |                                | (2,709   | ) |      |   | (45    | )
|Accounts Payable and Accrued Expenses                                                    |  |                                | 2,511    |   |      |   | 11     |  
|Decommissioning Liability                                                                |  |                                | 2,666    |   |      |   |       |  
|Deferred Royalty                                                                         |  |                                | (307     | ) |      |   | (193   | )
|Deferred Revenue                                                                         |  |                                | (361     | ) |      |   | (471   | )
|Deposits to Restricted Cash  Working Capital UK Transaction                             |  |                                | (1,316   | ) |      |   |       |  
|Illinois Subsidy Liability                                                               |  |                                | 4,448    |   |      |   | 4,184  |  
|                                                                                         |  |                                |          |   |      |   |        |  
|Net Cash Flows Used in Operating Activities                                              |  |                                | (3,084   | ) |      |   | (392   | )
|                                                                                         |  |                                |          |   |      |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                    |  |                                |          |   |      |   |        |  
|Restricted Cash                                                                          |  |                                | 4,409    |   |      |   | (1,367 | )
|Deposits to Restricted Cash  Capital Expansion UK Transaction                           |  |                                | (49,371  | ) |      |   |       |  
|Acquisition/Capital Improvements UK Operations                                           |  |                                | (76,563  | ) |      |   |       |  
|Payments of Notes Receivable                                                             |  |                                | 864      |   |      |   | 1,614  |  
|Purchase of Investments                                                                  |  |                                | (36      | ) |      |   | (405   | )
|Purchase of Derivatives                                                                  |  |                                | (21,057  | ) |      |   |       |  
|Debt Issuance Costs                                                                      |  |                                | (8,792   | ) |      |   |       |  
|Acquisition of Equipment and Leasehold Improvements                                      |  |                                | (2,787   | ) |      |   | (640   | )
|                                                                                         |  |                                |          |   |      |   |        |  
|Net Cash Used in Investing Activities                                                    |  |                                | (153,333 | ) |      |   | (798   | )
|                                                                                         |  |                                |          |   |      |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                    |  |                                |          |   |      |   |        |  
|Issuance of Long-Term Debt                                                               |  |                                | 166,335  |   |      |   |       |  
|Payments of Long-Term Debt                                                               |  |                                | (1,134   | ) |      |   | (1,015 | )
|Deposits to Restricted Cash  Debt Service UK Transaction                                |  |                                | (20,074  | ) |      |   |       |  
|Proceeds from Subsidiary Issuance of Ownership Interests                                 |  |                                | 3,743    |   |      |   |       |  
|Additional Paid in Capital                                                               |  |                                | 46       |   |      |   | 217    |  
|Dividends on Preferred Stock                                                             |  |                                | (210     | ) |      |   | (619   | )
|                                                                                         |  |                                |          |   |      |   |        |  
|Net Cash Provided by (Used in) Financing Activities                                      |  |                                | 148,706  |   |      |   | (1,417 | )
|                                                                                         |  |                                |          |   |      |   |        |  



8



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)



|                                                             |  |                                 |        |   |      |   |        |  
|------------------------------------------------------------ |  | ------------------------------- | ------ | - | ---- | - | ------ | -
|                                                             |  | NINE MONTHS ENDED September 30, |       
|                                                             |  | 2006                            |        |   | 2005 |  
|                                                             |  | (Restated)                      |        |   |      |  
|Effect of Exchange Rate Changes on Cash and Cash Equivalents |  | $                               | 856    |   |      | $ |       |  
|                                                             |  |                                 |        |   |      |   |        |  
|NET DECREASE IN CASH AND CASH EQUIVALENTS                    |  |                                 | (6,855 | ) |      |   | (2,607 | )
|                                                             |  |                                
|CASH AND CASH EQUIVALENTS  BEGINNING OF PERIOD              |  |                                 | 11,301 |   |      |   | 15,982 |  
|                                                             |  |                                 |        |   |      |   |        |  
|CASH AND CASH EQUIVALENTS  END OF PERIOD                    |  | $                               | 4,446  |   |      | $ | 13,375 |  
|                                                             |  |                                 |        |   |      |   |        |  
|Supplemental Disclosure of Cash Flow Information             |  |                                 |        |   |      |   |        |  
|Cash Paid for Interest                                       |  | $                               | 6,403  |   |      | $ | 6,521  |  
|Cash Paid For Taxes                                          |  | $                               | 183    |   |      | $ | 198    |  
|                                                             |  |                                
|Supplemental Schedule of Non-cash Investing & Financing      |  |                                 |        |   |      |   |        |  
|Conversion of Preferred Stock to Common Stock                |  | $                               | 10     |   |      | $ |       |  
|Non Cash Component of UK Acquisition Price                   |  | $                               | 15,433 |   |      | $ |       |  

See notes to consolidated financial statements

which are an integral part of the financial statements.

(concluded)



9



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

NOTE ABASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with instructions to Form 10-Q and Regulation S-X, and accordingly, do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of normal accruals) considered necessary for a fair presentation have been included. The results for the three and nine months ended September 30, 2006 are not necessarily
indicative of results for the full year or any other period (see particularly Note D). For a more complete discussion of significant accounting policies and certain other information, you should refer to the financial statements included in U.S.
Energy Systems, Inc.s (the Company) Annual Report on Form 10-K for the year ended December 31, 2005.

Certain reclassifications,
primarily pertaining to a regrouping of account totals, have been made to the prior years condensed consolidated financial statements to conform to the current years presentation.

The accompanying unaudited condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates
the realization of assets and the satisfaction of liabilities in the normal course of business. Based on the Companys estimates of cash requirements, the Company expects that the $703,000 of unrestricted cash held directly by the Company,
exclusive of cash held by the Companys subsidiaries, at September 30, 2006 is insufficient to fund the Companys operations for the next year and will necessitate additional cash funding no later than the first quarter of 2007 to
continue its operations. As discussed in Note U, during the first quarter of 2007, the Company completed the sale of 1,280,000 shares of its common stock at a price of $5.00 per share, exclusive of warrants, resulting in the Company having
sufficient cash available to fund the Companys operations for the upcoming year.

NOTE B  RESTATEMENT

The Company is amending its Form 10-Q for the quarterly period ended September 30, 2006, to amend and restate financial statements and other financial information
with respect to a change in the interpretation and application of Statement of Financial Accounting Standards No. 141, Business Combinations (FAS141), pertaining to the computation and allocation of the purchase price for the
acquisition of the UK assets as further described in Note D to the condensed consolidated financial statements.

As discussed in the Form 10-Q for the
quarter ended September 30, 2006 filed with the Securities and Exchange Commission on November 21, 2006, the Company allocated the cost of the UK Transaction to the assets acquired including the fair value of the natural gas reserves based
upon a preliminary third party valuation obtained during the evaluation process and using the estimated fair value of the assets acquired. Based upon a comparison of the purchase price to the estimated fair value of the assets acquired, an estimated
extraordinary gain of $25 million, $38 million less $13 million of taxes, was included in the statement of operations for the period.



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##### Table of Contents

Originally, the excess of the estimated fair value of the assets acquired over the acquisition price was recorded as a
$25 million Extraordinary Gain on Acquisition of a Segment. Upon further review of FAS 141, it was subsequently determined that this excess should first be allocated against the estimated fair value of the acquired assets on a prorated basis until
such assets had been written down to zero, before any gain being recorded. Therefore the estimated net gain of $25 million, net of taxes and the allocation of $5,254,000 for minority interest, reported in the Form 10-Q for the quarter ended
September 30, 2006 has been reversed.

In addition, a change in the valuation of the various equity instruments provided to the sellers and lenders
resulted in an increase in the acquisition and debt issuance costs associated with the issuance of the equity instruments. The valuation of the equity instruments issued in connection with the purchase price and the debt financing, which included
warrants of USEY and Class B membership interests of a USEY subsidiary, is based upon the average market price of the Companys stock for a period including the closing date (August 7, 2006) and two days before the closing date for the warrants
and a third party valuation for the Class B membership interests of the USEY subsidiary. The original valuation of the equity interests utilized a stock price of $3.30 per share for the acquisition costs and $4.47 per share for the debt issuance
costs. Utilizing the revised interpretation of FAS 141, the valuation price was adjusted to $6.50 per share for both the acquisition costs and the debt issuance costs. The changes resulted in an increase in the total acquisition price of $2,150,000
and an increase in debt issuance cost of $38,970,000, which is netted against the debt for presentation purposes. The value of the warrants issued in connection with the debt financing is based upon the relative fair value of the debt and the
warrants as of the issuance date.

The following table summarizes changes in the purchase price of the net assets acquired
and the allocation thereof:



|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  
|----------------------------------------------- |  | ---------------------- | ------- | - | ----------------------------- | - | ------ | -------------------- |  | -------------------------------- | ------ |  | ----------------------------- | ------- | - | ---------- | - | ------ | - |  | - | ------ | -
|As of August 7, 2006 (unaudited) (in thousands) |  | OriginalAmountReported |         |   | PurchasePriceAdjustment(1)(3) |   |        | RevisedPurchasePrice |  | Removal ofExtraordinary Gain (2) |        |  | RevisedValuationAllocation(3) |         |   | AsRestated |  
|Cash Paid for Acquisition                       |  | $                      | 72,634  |   |                               | $ |       |                      |  | $                                | 72,634 |  | $                             |        |   |            | $ |       |   |  | $ | 72,634 |  
|Equity Instruments Issued for Acquisition       |  |                        | 7,920   |   |                               |   | 7,513  |                      |  |                                  | 15,433 |  |                               |        |   |            |   |       |   |  |   | 15,433 |  
|Direct Acquisition Costs                        |  |                        | 12,042  |   |                               |   | (5,363 | )                    |  |                                  | 6,679  |  |                               |        |   |            |   |       |   |  |   | 6,679  |  
|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  
|Total Acquisition Price                         |  | $                      | 92,596  |   |                               | $ | 2,150  |                      |  | $                                | 94,746 |  | $                             |        |   |            | $ |       |   |  | $ | 94,746 |  
|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  
|                                                |  |                        |         |   |                               |  
|Property, Plant and Equipment                   |  | $                      | 12,862  |   |                               | $ |       |                      |  | $                                |       |  | $                             |        |   |            | $ | (2,310 | ) |  | $ | 10,552 |  
|Gas Property and Equipment, Depleting           |  |                        | 119,607 |   |                               |   |       |                      |  |                                  |       |  |                               | (38,494 | ) |            |   | 3,511  |   |  |   | 84,624 |  
|Long Term Power/Gas Contract                    |  |                        | 250     |   |                               |   |       |                      |  |                                  |       |  |                               |        |   |            |   | 1,986  |   |  |   | 2,236  |  
|Decommission Liabilities                        |  |                        | (1,629  | ) |                               |   |       |                      |  |                                  |       |  |                               |        |   |            |   | (1,037 | ) |  |   | (2,666 | )
|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  
|Totals                                          |  | $                      | 131,090 |   |                               | $ |       |                      |  | $                                |       |  | $                             | (38,494 | ) |            | $ | 2,150  |   |  | $ | 94,746 |  
|                                                |  |                        |         |   |                               |   |        |                      |  |                                  |        |  |                               |         |   |            |   |        |   |  |   |        |  



|(1) |  | Purchase Price Adjustment column represents the correction to the original values ascribed to equity instruments and direct acquisition costs.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Represents the correction of the application of FAS 141 to limit the values ascribed to the purchased assets to the purchase price.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------

|(3) |  | These adjustments reflect the fair value of assets acquired (as adjusted for negative goodwill) and the equity instruments issued as provided by third party valuation reports.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The reversal of the previously recorded extraordinary gain and the resulting reduced carrying value of the assets have no effect on the cash
flows or current loss from operations of the Company for the three and nine months ended September 30, 2006. The reduced carrying values of these assets will result in a decrease in future charges for depreciation, depletion and amortization related
to these assets. The changes in the valuation of the equity instruments issued in connection with the UK Transaction have no effect on the cash flows of the Company for the quarterly period ended September 30, 2006 but did increase our
operating loss for the three and nine month periods by the amount of the amortization of the debt issuance costs, approximately $788,000.

The Company is
currently working with an independent valuation company to verify its estimates on the UK Transaction. In accordance with FAS141, it has one year from the date of the acquisition to finalize its allocation of the purchase price for the UK
Transaction. Actual results may differ significantly from the estimates used thereby affecting the future valuation of these items.



11



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The following tables isolate each of the restated amounts in the Companys consolidated balance sheet as of
September 30, 2006 and Statement of Operations and Comprehensive Income (Loss) for the three and nine months ended September 30, 2006.



|                                                 |  |                            |         |   |                       |   |         |  
|------------------------------------------------ |  | -------------------------- | ------- | - | --------------------- | - | ------- | -
|CONSOLIDATED BALANCE SHEET AT SEPTEMBER 30,
2006 |  | AFTERRESTATEMENT           |         |   | AS ORIGINALLYREPORTED |  
|                                                 |  | (unaudited  in thousands) |        
|Property, Plant and Equipment                    |  | $                          | 50,132  |   |                       | $ | 72,279  |  
|Gas Property and Equipment, Depleting            |  | $                          | 83,013  |   |                       | $ | 127,515 |  
|Long-Term Power / Gas Contract                   |  | $                          | 2,193   |   |                       |   |        |  
|Deferred Tax Asset                               |  | $                          | 18,853  |   |                       | $ | 5,380   |  
|Total Assets                                     |  | $                          | 352,294 |   |                       | $ | 403,277 |  
|Accounts Payable and Accrued Expenses            |  | $                          | 13,316  |   |                       | $ | 14,945  |  
|Decommissioning Liability                        |  | $                          | 2,666   |   |                       | $ |        |  
|Minority Interests                               |  | $                          | 20,023  |   |                       | $ | 11,777  |  
|Total Liabilities                                |  | $                          | 295,314 |   |                       | $ | 332,319 |  
|Accumulated Deficit                              |  | $                          | (59,522 | ) |                       | $ | (38,967 | )
|Total Stockholders Equity                       |  | $                          | 36,957  |   |                       | $ | 59,181  |  
|Total Liabilities and Stockholders Equity       |  | $                          | 352,294 |   |                       | $ | 403,277 |  



|                                                                      |  |                                                   |         |   |                       |   |         |  
|--------------------------------------------------------------------- |  | ------------------------------------------------- | ------- | - | --------------------- | - | ------- | -
|STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2006 |  | AFTERRESTATEMENT                                  |         |   | AS ORIGINALLYREPORTED |  
|                                                                      |  | (unaudited  in thousands, except per share data) |        
|Interest Expense                                                      |  | $                                                 | 6,553   |   |                       | $ | 5,765   |  
|Loss Before Taxes                                                     |  | $                                                 | (11,562 | ) |                       | $ | (10,774 | )
|Gain on Acquisition of a Segment                                      |  | $                                                 |        |   |                       | $ | 25,021  |  
|Minority Interest                                                     |  | $                                                 |        |   |                       | $ | (5,254  | )
|Net (Loss) Income                                                     |  | $                                                 | (8,104  | ) |                       | $ | 12,451  |  
|Net (Loss) Income Applicable to Common Stockholders                   |  | $                                                 | (8,114  | ) |                       | $ | 12,441  |  
|Total Comprehensive (Loss) Income                                     |  | $                                                 | (7,714  | ) |                       | $ | 12,841  |  
|(Loss) Income Per Share of Common Stock                               |  | $                                                 | (0.47   | ) |                       | $ | 0.72    |  



|                                                                     |  |                                                   |         |   |                       |   |         |  
|-------------------------------------------------------------------- |  | ------------------------------------------------- | ------- | - | --------------------- | - | ------- | -
|STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 |  | AFTERRESTATEMENT                                  |         |   | AS ORIGINALLYREPORTED |  
|                                                                     |  | (unaudited  in thousands, except per share data) |        
|Interest Expense                                                     |  | $                                                 | 12,122  |   |                       | $ | 11,334  |  
|Loss Before Taxes                                                    |  | $                                                 | (20,220 | ) |                       | $ | (19,432 | )
|Gain on Acquisition of a Segment                                     |  | $                                                 |        |   |                       | $ | 25,021  |  
|Minority Interest                                                    |  | $                                                 |        |   |                       | $ | (5,254  | )
|Net (Loss) Income                                                    |  | $                                                 | (12,995 | ) |                       | $ | 7,560   |  
|Net (Loss) Income Applicable to Common Stockholders                  |  | $                                                 | (13,205 | ) |                       | $ | 7,350   |  
|Total Comprehensive (Loss) Income                                    |  | $                                                 | (12,899 | ) |                       | $ | 7,656   |  
|(Loss) Income Per Share of Common Stock                              |  | $                                                 | (0.84   | ) |                       | $ | 0.47    |  

NOTE CBASIS OF REPORTING

The condensed consolidated financial statements of the Company include the accounts of the Company and its wholly owned and majority-owned subsidiaries. Investments in joint ventures are accounted for under the equity
method. Investments in partnerships, in which our ownership does not exceed 1% are unconsolidated and carried at cost. All inter-company accounts and transactions have been eliminated in consolidation.



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In preparing the condensed consolidated financial statements, management has made estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company made estimates in
computing the excess of fair value over costs on the UK Transaction and the application of FAS141, in accounting for the entire transaction. The Company is currently working with an independent valuation company to verify our estimates on the UK
Transaction. In accordance with FAS141, it has one year from the date of acquisition to finalize its allocation of the purchase price for the UK Transaction. The Company anticipates finalizing the purchase price allocation during 2007. Actual
results may differ significantly from the estimates used thereby affecting the future valuation of these items. See Note D for further discussion on the UK Transaction.

Gas Properties  The Company follows the full cost method of accounting for gas properties. Accordingly, all costs associated with acquisition, exploration and development of gas reserves, including
directly related overhead costs and related asset retirement costs, are capitalized.

All capitalized costs of gas properties are amortized on the
unit-of-production method using estimates of proved reserves. Investments in unproved properties and major development projects are not amortized until proved reserves that are associated with the projects can be determined or until impairment
occurs. Investments in unproved properties are carried on the Companys balance sheet as Gas Property and Equipment  Non-Depleting.

Recent
Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan
interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting and disclosure for uncertain tax positions, as defined. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the
recognition and measurement related to accounting for income taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company is assessing FIN 48 and has not yet determined the impact that the
adoption of FIN 48 will have on its result of operations or financial position.

In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosure requirements regarding fair value measurement. Where
applicable, this statement simplifies and codifies fair value related guidance previously issued within U.S. generally accepted accounting principles. SFAS 157 is effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The Company is currently reviewing SFAS 157 to determine its impact and any material effect of its adoption.

NOTE DACQUISITIONS

On August 7, 2006, the Company
completed its acquisition and financing of certain energy assets in the United Kingdom through certain of its subsidiaries (the UK Transaction). The assets (the UK Assets) acquired include (i) gas licenses for
approximately 100,000 acres of onshore natural gas properties and mineral rights in North Yorkshire, England (the Gas Licenses), containing significant proved reserves, (ii) the Knapton Generating Station, a 42 MW gas-fired power
plant associated with and located in the vicinity of the natural gas reserves in North Yorkshire, England, and (iii) certain related gas gathering and processing assets. As part of the UK Transaction, a subsidiary of the Company entered into a
power purchase agreement and a gas sales agreement with Scottish Power Energy Management (Scottish Power) under which Scottish Power is required to take all of the electricity generated by the Knapton Generating Station and all of the
natural gas produced from the associated reserves up to 100 bcf for a term of up to 12 years. The Company paid approximately $72.6 million and issued rights to acquire up to



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##### Table of Contents

8.1 million shares of its common stock, to acquire the UK Assets. The financing of the UK Transaction provided approximately $166.3 million for, among
other things, the acquisition of the UK Assets, for the funding of certain reserves required by the terms of the financing and for working capital to be used by the Companys subsidiaries for the operation and upgrading of the UK Assets
necessary to increase gas production. These loans mature in 2013 and 2014, subject to acceleration or mandatory prepayments upon the occurrence of certain events, and are currently secured by substantially all of the Companys and its
subsidiaries assets, other than U.S. Energy Biogas Corp.s (USEB) assets.

The Gas Licenses acquired represent the mineral rights of
the associated properties; the Company does not own the surface land. Individual land leases are negotiated with the surface rights landowners for fixed price and term contracts. The individuals do not receive royalties associated with extraction of
natural resources.

The Company, through GBGH, LLC (GBGH), owns a 79% interest in the UK Assets. GBGH intends to further develop the natural
gas fields subject to the Gas Licenses in a several phase process, expanding the gas collection system, constructing a pipeline and making modifications to the Knapton Generating Station (the Expansion).

As part of the transaction, various hedging and similar arrangements were entered into with respect to, among other things, gas and electricity prices, interest and
currency rates, and carbon emission allowances. The gas and electric hedges assures the Company that it will receive not less than specified prices for the sale of electricity from the Knapton Generating Station through August 2009 and for the sale
of gas from the facility in 2010 and 2011. The currency and interest rate hedges ensure that the results of operations with respect to our UK activities will not be adversely impacted, through August 2009, as a result of fluctuation in such rates.
The agreement with respect to carbon emission allowances requires that the Company purchase a specified amount of such allowances at fixed prices through December 31, 2007.

The financing arrangements entered into with respect to the UK Transaction require that GBGH set aside funds for various purposes, including maintenance and the Expansion. Management believes that such funds are
sufficient for such purposes, including the completion of the Expansion. Nonetheless, the Company agreed, pursuant to an equity support agreement, to provide additional funds to GBGH as follows: (i) £2.66 million (approximately $5
million based upon the exchange rate in effect on or about August 7, 2006) no later than September 7, 2007 to cover certain of GBGHs maintenance expenses; (ii) to cover certain shortfalls in the reserve account for Expansion;
(iii) $20 million, less specified amounts, upon default under specified financing arrangements; (iv) up to $4 million for certain breaches of warranties (or the discovery of certain negative information) arising with respect to the
agreements pursuant to which we acquired the UK Assets; (v) $20 million, if GBGH elects to extend the initial interest rate and currency hedge agreements which are due to expire on August 7, 2009; and (vi) if GBGH enters into one or
more replacement interest rate and currency hedge agreements, the amounts payable as an upfront fee or premium to the providers thereunder.

The Company is
in the process of reviewing the application of FAS141 including working with an independent valuation company to determine and verify the fair value of all assets acquired. In accordance with FAS141, we have one year from the acquisition date,
August 7, 2006, to finalize the allocation of the purchase price. As of September 30, 2006, we have allocated the cost of the UK Transaction to the assets acquired including the fair value of the natural gas reserves which is based on a
third party valuation obtained during the evaluation process and using the fair market price of natural gas in the UK market at closing. The allocation of purchase price is subject to revision based on the results of the independent valuation
company and our further evaluation.



14



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##### Table of Contents

The following table details the purchase price and the allocation for the UK Transaction through the application of
FAS141 as of September 30, 2006. This information, specifically the final amount of the fair value of the assets acquired over the acquisition price and the allocation of purchase price to the assets acquired, are subject to revision based on
the results of the independent valuation and our further evaluation.

The total fair value of the assets acquired was approximately $156,760,000 and the
total purchase price was $94,746,000. The difference of $62,014,000 has been allocated as a reduction to the long term assets in accordance with FAS 141.



|                                          |  |   |            |  
|----------------------------------------- |  | - | ---------- | -
|Cash Paid for Acquisition                 |  | $ | 72,634,000 |  
|Equity Instruments Issued for Acquisition |  |   | 15,433,000 |  
|Direct Acquisition Costs                  |  |   | 6,679,000  |  
|                                          |  |   |            |  
|Total Acquisition Price                   |  | $ | 94,746,000 |  
|                                          |  |   |            |  
|                                          | 
|Gas Property and Equipment, Depleting     |  | $ | 84,624,000 |  
|Property, Plant and Equipment             |  |   | 10,552,000 |  
|Decommissioning Liability                 |  |   | (2,666,000 | )
|Long Term Power /Gas Purchase Agreement   |  |   | 2,236,000  |  
|                                          |  |   |            |  
|Total Asset Acquired                      |  | $ | 94,746,000 |  
|                                          |  |   |            |  

Following are the Pro Forma Condensed Consolidated Statements of Operations for the Company for the nine months
ended September 30, 2005 and 2006. These Pro Forma Condensed Consolidated Statements of Operations estimate the operations of the Company as if the acquisition had occurred on January 1, 2005 and January 1, 2006, respectively.

The Pro Forma Condensed Consolidated Statement of Operations for 2005 includes the actual results of the Company combined with the historical results of
the entities acquired for the same periods. This statement also includes the estimated operations of the distressed power plant giving effect to the new power purchase agreement entered into as a result of the acquisition with production based on
actual historical operating results of the plant for the relevant period. Depletion charges have been calculated based on the new value assigned to the gas reserves. These statements also include the impact of the borrowing agreements entered into
by the Company reflecting the resulting interest expense on the debt that would have been outstanding and interest income from the reserve accounts established as a result of the acquisition.

The Pro Forma Condensed Consolidated Statement of Operations for 2006 includes the actual results of the Company through September 30, 2006, which includes the
actual results of entities acquired since the date of acquisition. The historical results of the entities acquired from January 1, 2006 through the date of acquisition are added to these actual results. The historical data for 2006 is prepared
on the same basis as the historical information for 2005.



15



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

AND COMPREHENSIVE
LOSS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005

(Unaudited)

(In thousands, except per share data)



|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|---------------------------------------------------- |  | ---------------------------------------------------------------------- | ------ | - | ------------------------------------ | - | ------- | --------------------------------------------------------------------- |  | - | ------- | -
|                                                     |  | U.S. EnergySystems, Inc.before givingconsiderationto the UKTransaction |        |   | Pro Formaimpact ofthe UK Transaction |   |         | U.S. EnergySystems, Inc.after givingconsiderationto the UKTransaction | 
|Revenue                                              |  | $                                                                      | 14,116 |   |                                      | $ | 3,681   |                                                                       |  | $ | 17,797  |  
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Costs and Expenses:                                  |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Operating Expenses                                   |  |                                                                        | 6,601  |   |                                      |   | 314     |                                                                       |  |   | 6,915   |  
|General, Administrative and Other Expenses           |  |                                                                        | 3,661  |   |                                      |   | 1,008   |                                                                       |  |   | 4,669   |  
|Depreciation, Depletion and Amortization             |  |                                                                        | 3,286  |   |                                      |   | 1,955   |                                                                       |  |   | 5,241   |  
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Total Costs and Expenses                             |  |                                                                        | 13,548 |   |                                      |   | 3,277   |                                                                       |  |   | 16,825  |  
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Income from Operations                               |  |                                                                        | 568    |   |                                      |   | 404     |                                                                       |  |   | 972     |  
|                                                     |  |                                                                        |       
|Interest and Dividend Income                         |  |                                                                        | 2,980  |   |                                      |   | 1,786   |                                                                       |  |   | 4,766   |  
|Foreign Currency Translation                         |  |                                                                        | (2,387 | ) |                                      |   |        |                                                                       |  |   | (2,387  | )
|Interest Expense                                     |  |                                                                        | (8,115 | ) |                                      |   | (10,923 | )                                                                     |  |   | (19,038 | )
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Loss before Provision of Taxes and Minority Interest |  |                                                                        | (6,954 | ) |                                      |   | (8,733  | )                                                                     |  |   | (15,687 | )
|                                                     |  |                                                                        |       
|Income Tax Expense                                   |  |                                                                        | (1,740 | ) |                                      |   |        |                                                                       |  |   | (1,740  | )
|Minority Interest                                    |  |                                                                        | 752    |   |                                      |   | 1,834   |                                                                       |  |   | 2,586   |  
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Loss from Continuing Operations                      |  |                                                                        | (7,942 | ) |                                      |   | (6,899  | )                                                                     |  |   | (14,841 | )
|                                                     |  |                                                                        |       
|Gain on Disposal of Segment (net of Income Tax)      |  |                                                                        | 150    |   |                                      |   |        |                                                                       |  |   | 150     |  
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Net Loss                                             |  |                                                                        | (7,792 | ) |                                      |   | (6,899  | )                                                                     |  |   | (14,691 | )
|                                                     |  |                                                                        |       
|Dividends on Preferred Stock                         |  |                                                                        | (619   | ) |                                      |   |        |                                                                       |  |   | (619    | )
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Net Loss Applicable to Common Stockholders           |  | $                                                                      | (8,411 | ) |                                      | $ | (6,899  | )                                                                     |  | $ | (15,310 | )
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Other Comprehensive Loss:                            |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Net Loss                                             |  | $                                                                      | (7,792 | ) |                                      | $ | (6,899  | )                                                                     |  | $ | (14,691 | )
|Unrealized Gain on Foreign Currency Translation      |  |                                                                        | 121    |   |                                      |   |        |                                                                       |  |   | 121     |  
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  
|Total Comprehensive Loss                             |  | $                                                                      | (7,671 | ) |                                      | $ | (6,899  | )                                                                     |  | $ | (14,570 | )
|                                                     |  |                                                                        |        |   |                                      |   |         |                                                                       |  |   |         |  



16



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

AND COMPREHENSIVE
LOSS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005

(Unaudited)

(In thousands, except per share data)



|                                                                  |  |                                                                        |            |   |                                     |   |            |                                                                       |  |   |            |  
|----------------------------------------------------------------- |  | ---------------------------------------------------------------------- | ---------- | - | ----------------------------------- | - | ---------- | --------------------------------------------------------------------- |  | - | ---------- | -
|                                                                  |  | U.S. EnergySystems, Inc.before givingconsiderationto the UKTransaction |            |   | Pro Formaimpact of theUKTransaction |   |            | U.S. EnergySystems, Inc.after givingconsiderationto the UKTransaction | 
|NET LOSS PER SHARE OF COMMON STOCK:                               |  |                                                                        |            |   |                                     |   |            |                                                                       |  |   |            |  
|Net Loss per share from Continuing Operations  Basic and Diluted |  | $                                                                      | (0.68      | ) |                                     | $ | (0.55      | )                                                                     |  | $ | (1.23      | )
|Weighted Average Number of Common Shares Outstanding  Basic      |  |                                                                        | 12,356,000 |   |                                     |   | 12,356,000 |                                                                       |  |   | 12,356,000 |  



17



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

AND COMPREHENSIVE
LOSS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006

(Unaudited)

(In thousands, except per share data)



|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|---------------------------------------------------- |  | ---------------------------------------------------------------------- | ------- | - | ----------------------------------- | - | ------ | --------------------------------------------------------------------- |  | - | ------- | -
|                                                     |  | U.S. EnergySystems, Inc.before givingconsiderationto the UKTransaction |         |   | Pro Formaimpact ofthe UKTransaction |   |        | U.S. EnergySystems, Inc.after givingconsiderationto the UKTransaction | 
|Revenue                                              |  | $                                                                      | 14,710  |   |                                     | $ | 1,537  |                                                                       |  | $ | 16,247  |  
|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Costs and Expenses:                                  |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Operating Expenses                                   |  |                                                                        | 8,048   |   |                                     |   | 897    |                                                                       |  |   | 8,945   |  
|General, Administrative and Other Expenses           |  |                                                                        | 5,830   |   |                                     |   | 338    |                                                                       |  |   | 6,168   |  
|Depreciation, Depletion and Amortization             |  |                                                                        | 4,070   |   |                                     |   | 1,286  |                                                                       |  |   | 5,356   |  
|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Total Costs and Expenses                             |  |                                                                        | 17,948  |   |                                     |   | 2,521  |                                                                       |  |   | 20,469  |  
|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Loss from Operations                                 |  |                                                                        | (3,238  | ) |                                     |   | (984   | )                                                                     |  |   | (4,222  | )
|Interest and Dividend Income                         |  |                                                                        | 3,195   |   |                                     |   | 1,236  |                                                                       |  |   | 4,431   |  
|Foreign Currency Translation                         |  |                                                                        | (4,276  | ) |                                     |   |       |                                                                       |  |   | (4,276  | )
|Unrealized Loss on Hedges                            |  |                                                                        | (3,779  | ) |                                     |   |       |                                                                       |  |   | (3,779  | )
|Interest Expense                                     |  |                                                                        | (12,122 | ) |                                     |   | (7,276 | )                                                                     |  |   | (19,398 | )
|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Loss before Provision of Taxes and Minority Interest |  |                                                                        | (20,220 | ) |                                     |   | (7,024 | )                                                                     |  |   | (27,244 | )
|                                                     |  |                                                                        |        
|Income Tax Expense                                   |  |                                                                        | 4,561   |   |                                     |   |       |                                                                       |  |   | 4,561   |  
|Minority Interest                                    |  |                                                                        | 2,664   |   |                                     |   | 1,475  |                                                                       |  |   | 4,139   |  
|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Net Loss                                             |  |                                                                        | (12,995 | ) |                                     |   | (5,549 | )                                                                     |  |   | (18,544 | )
|                                                     |  |                                                                        |        
|Dividends on Preferred Stock                         |  |                                                                        | (210    | ) |                                     |   |       |                                                                       |  |   | (210    | )
|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Net Loss Applicable to Common Stockholders           |  | $                                                                      | (13,205 | ) |                                     | $ | (5,549 | )                                                                     |  | $ | (18,754 | )
|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Other Comprehensive Loss:                            |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Net Loss                                             |  | $                                                                      | (12,995 | ) |                                     | $ | (5,549 | )                                                                     |  | $ | (18,544 | )
|Unrealized Gain on Investments (Net of Taxes)        |  |                                                                        | 96      |   |                                     |   |       |                                                                       |  |   | 96      |  
|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  
|Total Comprehensive Loss                             |  | $                                                                      | (12,899 | ) |                                     | $ | (5,549 | )                                                                     |  | $ | (18,448 | )
|                                                     |  |                                                                        |         |   |                                     |   |        |                                                                       |  |   |         |  



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##### Table of Contents

U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

AND COMPREHENSIVE
LOSS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006

(Unaudited)

(In thousands, except per share data)



|                                                                  |  |                                                                        |            |   |                                      |   |            |                                                                       |  |   |            |  
|----------------------------------------------------------------- |  | ---------------------------------------------------------------------- | ---------- | - | ------------------------------------ | - | ---------- | --------------------------------------------------------------------- |  | - | ---------- | -
|                                                                  |  | U.S. EnergySystems, Inc.before givingconsiderationto the UKTransaction |            |   | Pro Formaimpact of theUK Transaction |   |            | U.S. EnergySystems, Inc.after givingconsiderationto the UKTransaction | 
|NET LOSS PER SHARE OF COMMON STOCK:                               |  |                                                                        |            |   |                                      |   |            |                                                                       |  |   |            |  
|Net Loss per share from Continuing Operations  Basic and Diluted |  | $                                                                      | (0.84      | ) |                                      | $ | (0.35      | )                                                                     |  | $ | (1.19      | )
|Weighted Average Number of Common Shares Outstanding  Basic      |  |                                                                        | 15,736,000 |   |                                      |   | 15,736,000 |                                                                       |  |   | 15,736,000 |  

NOTE EREVENUE RECOGNITION

Revenues are recognized upon delivery of energy or service. The energy rates the Company or the Companys subsidiaries collect fluctuate with rates approved for use by utilities and municipalities local to the
respective projects. These rates may be estimates that are reconciled annually. Any difference between the estimated rate and the actual rate may apply to a previous period based on the effective date of the power purchase agreement. The adjustment,
if any, is booked in the period it is determined. Revenue related to the Illinois subsidy received by certain projects of USEB, our majority-owned subsidiary, is accounted for in a manner similar to an original issue discount whereby the amount to
be repaid in the future is discounted to its net present value and the discount is amortized as interest expense over the intervening period until repayment begins.

As of September 30, 2006, the Company was utilizing all of its natural gas production to fuel the Knapton Generating Station resulting in third party sales of electricity rather than natural gas. The Company
recognizes revenue upon delivery of the energy to Scottish Power Energy Management under a power purchase agreement. Revenue under this agreement is based on the day ahead energy rates for electricity in the UK market less a 7% discount.

NOTE F  LOSS PER SHARE DATA

Loss per share is computed by
dividing the loss applicable to common stockholders by the weighted average number of common shares outstanding during the periods. In arriving at the loss available to common stockholders, preferred stock dividends have been deducted. Potential
dilutive common shares amounting to 16,076,000 as of September 30, 2006 and 8,517,000 as of September 30, 2005. They have not been included in the calculation for the 2006 or 2005 periods due to their anti-dilutive effect. Potential
dilutive shares include all vested claims on shares regardless of the market price of the stock.



19



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##### Table of Contents

NOTE GSTOCK-BASED COMPENSATION

In December 2004, the Financial Accounting Standards Board revised Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123R), requiring
companies to record share-based payment transactions as compensation expense measured at fair value on the grant date. SFAS 123R further defines the concept of fair market value as it relates to such arrangements. Based on SEC guidance issued in
Staff Accounting Bulletin 107 in April 2005, the provisions of this statement are effective for the Company as of January 1, 2006.

The Company has
elected to implement SFAS 123R using the modified prospective transition method, which requires compensation costs be recorded as earned for all unvested stock options outstanding at the beginning of the first fiscal year of adoption of SFAS 123R
based on the grant date fair value estimated in accordance with the original provisions of SFAS 123 and for compensation costs for all share-based payments granted or modified subsequent to the adoption, based on fair value estimated in accordance
with the provisions of SFAS 123R. The impact of SFAS 123R is reflected in the Companys financial statements for the periods ended September 30, 2006. In accordance with the modified prospective transition method, the Company has not
restated the financial statements for prior periods and those statements do not include the impact of SFAS 123R. The Company recorded share-based compensation expense of $828,000 and $1,727,000 for the three and nine months ended September 30,
2006 and $180,000 for the three and nine months ended September 30, 2005.

The Companys 2000 Executive Incentive Compensation Plan (the
2000 Plan) provides for the granting of stock options, stock appreciation rights, restricted stock, deferred stock and other stock related awards and incentive awards that may be settled in cash, stock or property. A summary of the
Companys stock option activity as of September 30, 2006 is as follows:



|                                |  |           |   |  |                                 |      |                                                     |      |                           |   |          
|------------------------------- |  | --------- | - |  | ------------------------------- | ---- | --------------------------------------------------- | ---- | ------------------------- | - | ---------
|                                |  | Shares    |   |  | Weighted average exercise price |      | Weighted average remaining contractual term (years) |      | Aggregate intrinsic value
|Outstanding, January 1, 2006    |  | 7,156,425 |   |  | $                               | 3.67 |                                                     | 4.96 |                           |   |          
|Granted                         |  | 33,333    |   |  |                                 | 4.30 |                                                     | 9.70 |                           |   |          
|Exercised                       |  | (30,000   | ) |  |                                 | 1.50 |                                                     |     |                           |   |          
|Forfeited                       |  |          |   |  |                                 |     |                                                     |     |                           |   |          
|Expired                         |  |          |   |  |                                 |     |                                                     |     |                           |   |          
|                                |  |           |   |  |                                 |      |                                                     |      |                           |   |          
|Outstanding, September 30, 2006 |  | 7,159,758 |   |  | $                               | 3.68 |                                                     | 4.54 |                           | $ | 2,394,864
|                                |  |           |   |  |                                 |      |                                                     |      |                           |   |          
|Exercisable, September 30, 2006 |  | 5,999,758 |   |  | $                               | 3.77 |                                                     | 3.98 |                           | $ | 2,083,464
|                                |  |           |   |  |                                 |      |                                                     |      |                           |   |          

The Company estimates the fair value of stock options using a Black-Scholes valuation model, consistent with the
provisions of SFAS 123R, SEC Staff Accounting Bulletin 107 and the Companys prior pro-forma disclosures of net earnings, including the fair value of stock-based compensation. Key input assumptions used to estimate the fair value of stock
options include the expected term until the exercise of the option, expected volatility of the Companys stock, the risk free rate of return, option forfeiture rates, and dividends, if any. The expected volatility is derived from the historical
volatility of the Companys common stock on the NASDAQ market. The risk-free interest rate is the yield from a Treasury bond or note corresponding to the expected term of the option. Option forfeiture rates are based on the Companys
historical forfeiture rates. The Company has not paid dividends on its common stock and does not expect to pay dividends on its common stock in the near future.



20



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##### Table of Contents

The fair value of each option grant in 2006 was estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions:



|                                |  |      |  
|------------------------------- |  | ---- | -
|Risk-free Interest Rate         |  | 4.70 | %
|Expected Option Life in Years   |  | 5.00 |  
|Expected Stock Price Volatility |  | 0.68 |  
|Expected Dividend Yield         |  | 0.00 | %

Compensation costs for stock options with tiered vesting terms are recognized ratably over the vesting period. The
unrecognized compensation costs related to stock options are $1,506,000, $771,000 and $754,000 for the twelve months ending September 30, 2007, 2008 and 2009, respectively.

During the three-months ended September 30, 2006, restricted stock awards of 375,000 shares of common stock were granted as compensation to employees pursuant to the 2000 Plan. The shares vest as follows: one
third on December 13, 2007 if the Companys stock price is $15 per share, one third on December 13, 2008 if the Companys stock price is $20 per share and one third on December 13, 2009 if the Companys stock price is
$25 per share. In addition, previously issued restricted stock awards for rights to 117,754 shares of common stock vested valued at $104,000.

Also during
the three months ended September 30, 2006, warrants and convertible securities which can be converted into 8,074,000 shares of the Companys common stock, valued at $49,832,000, were issued in relation to the UK Transaction. The costs
associated with the issuance of these warrants are included as part of the acquisition price or the debt issuance costs for the UK Assets.

NOTE
HFOREIGN CURRENCY

The functional currency for USEBs foreign debt is denominated in the local currency, which is Canadian dollars. The
functional currency for the UK operations is the British pound. For the UK operations, assets and liabilities are translated in consolidation at the end-of-period exchange rates. The Company reports translation adjustments on foreign currency
transactions in Other Comprehensive Loss. Foreign currency translation gains or losses are recognized in the period incurred and are included in Foreign Currency Translation Expense in the condensed consolidated statement of operations.

NOTE IINVESTMENTS IN DERIVATIVES

The Company, through its
various subsidiaries, holds derivative financial instruments for the purpose of hedging the risks relating to (i) changes in foreign currency exchange rates, (ii) gas and electricity prices, (iii) interest rates, and (iv) the
price of carbon emission allowances, the volatility of which impact future earnings and cash flows.

The foreign currency exchange hedge related to
USEBs debt service payments to the Countryside Power Income Fund (the Countryside Fund) fixes the U.S. dollar to Canadian dollar exchange rate for debt service payments through March 2007. See Note U.

The hedges related to gas and electricity prices, interest rates, and the forward purchase agreement related to the carbon emission allowances and the remaining foreign
currency hedge, relate to the UK operations. The gas and electricity hedges assure that prices for the sale of electricity until August 2009 and the sale of gas in 2010 and 2011 will not fall below specified prices. The interest rates hedge and the
foreign currency hedge associated with the UK operations ensure that fluctuations in foreign currency exchange rates will not adversely affect the UK operations through August 2009. The carbon emission allowance agreement fixes the price for the
required purchase of such allowances through December 31, 2007.



21



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##### Table of Contents

Changes in the fair value of our hedge derivatives for the three and nine months ended September 30, 2006 are
recorded in unrealized gain (loss) on hedges.

NOTE JSUBSIDIARIES

On May 11, 2001, the Company, together with Cinergy Energy Solutions, Inc. (Cinergy Energy), acquired through a merger, Zahren Alternative Power Corporation, and renamed such entity U.S. Energy Biogas
Corp (USEB). The Company owns 54.26% and Cinergy Energy, a wholly owned subsidiary of Cinergy Corp. (Cinergy), owns 45.74% of USEB. See Note U.

On August 7, 2006, the Company, through U.S. Energy Overseas Investments LLC (Overseas) and together with Marathon Capital Holdings (UK), LLC (Marathon), acquired the ownership interests
of the newly formed GBGH, LLC. The Company owns 79% and Marathon owns 21% of GBGH, LLC.

NOTE KRESTRICTED CASH AND MARKETABLE SECURITIES

The various financing agreements for the Company and its subsidiaries require the establishment and maintenance of various reserve accounts, which are
also collateral for the financings. Access to the funds in the accounts is restricted by the terms of the loan agreements. The funds are invested in highly liquid assets approximating cash in accordance with the terms of the loan agreements.

USEBs financing arrangement with the Countryside Fund requires the maintenance of the Illinois Subsidy Liability Reserve Account (the Illinois
Accounts), a debt service reserve account and an improvement reserve account. The funds held in the improvement reserve account can be utilized to fund capital expenditures. The funds in the Illinois Accounts are to be utilized to retire the
Illinois subsidy liability as it becomes due.

GBGHs financing agreements with Credit Suisse provide for the maintenance of debt service reserve
accounts, an interest during construction reserve account, a major maintenance reserve account and capital improvement reserve accounts. The funds held in the interest during construction reserve account can be utilized to satisfy the interest
payment obligations as they come due. The capital improvement reserve accounts will be utilized to fund improvements to and expansion of the existing well fields and gas collection systems as well as exploratory work to identify and establish new
reserves. The major maintenance reserve account will be used to cover any major unforeseen repairs necessary to the gas collection and power generation systems.

Restricted cash and marketable securities were as follows:



|                                                 |  |            |  |                   |            |                  |   |           
|------------------------------------------------ |  | ---------- |  | ----------------- | ---------- | ---------------- | - | ----------
|                                                 |  | Subsidiary |  | September 30,2006 |            | December 31,2005
|Illinois Subsidy Liability Reserve Accounts (**) |  | USEB       |  | $                 | 27,866,000 |                  | $ | 26,429,000
|Improvement Reserve                              |  | USEB       |  |                   | 3,472,000  |                  |   | 3,367,000 
|Debt Service Reserve                             |  | USEB       |  |                   | 2,160,000  |                  |   | 2,104,000 
|Project Contract Reserve                         |  | USEB       |  |                   | 30,000     |                  |   | 30,000    
|                                                 |  |            | 
|Debt Service Reserve (*)                         |  | GBGH       |  |                   | 11,448,000 |                  |   |          
|Interest During Construction Reserve (*)         |  | GBGH       |  |                   | 8,738,000  |                  |   |          
|Capital Expenditure Reserve (*)                  |  | GBGH       |  |                   | 21,117,000 |                  |   |          
|                                                 |  |            | 
|Expansion (*)                                    |  | UKES       |  |                   | 21,931,000 |                  |   |          
|Major Maintenance (*)                            |  | UKES       |  |                   | 2,334,000  |                  |   |          
|                                                 |  |            |  |                   |            |                  |   |           
|Totals                                           |  |            |  | $                 | 99,096,000 |                  | $ | 31,930,000
|                                                 |  |            |  |                   |            |                  |   |           

---

|(*) |  |   associated with the UK Acquisition
|--- |  | -------------------------------------

|(**) |  |   includes marketable securities
|---- |  | ---------------------------------



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Included in the Illinois Accounts at September 30, 2006 is $25,859,000 that is managed by a professional investment
manager under investment allocation parameters established by the Company. Of such sum, $16,879,000 is invested in equity fund accounts, $7,893,000 is invested in debt accounts, and $1,087,000 is held in cash or cash equivalent accounts. These
investments, which are classified as available for sale, are carried at fair value, with unrealized gains and losses, net of any tax effects, reported in Stockholders Equity as Accumulated Other Comprehensive Income. The original cost of these
investments, which has been invested since July 2004, is $21,417,000.

The reserve accounts held for the UK Transaction are deposited in money market
accounts with a triple-A rated financial institution. The accounts at GBGH are held in U.S. dollars while the accounts at UK Energy Systems Limited (UKES) are held in British Pounds.

NOTE L  LONG TERM DEBT

The Companys consolidated debt is
summarized as follows:



|                                   |  |                     |   |  |          |  |                                     |             |   |                                    |   |           
|---------------------------------- |  | ------------------- | - |  | -------- |  | ----------------------------------- | ----------- | - | ---------------------------------- | - | ----------
|Borrowing Entity                   |  | CurrentInterestRate |   |  | Maturity |  | Principal BalanceSeptember 30, 2006 |             |   | Principal BalanceDecember 31, 2005
|U.S. Energy Biogas Corp.           |  | 11.00               | % |  | 2019     |  | $                                   | 91,952,000  |   |                                    | $ | 89,161,000
|                                   |  |                     |   | 
|US Energy Overseas Investments LLC |  | 10.50               | % |  | 2014     |  |                                     | 23,692,000  |   |                                    |   |          
|                                   |  |                     |   | 
|GBGH, LLC  1stLien Debt           |  | 11.25               | % |  | 2013     |  |                                     | 113,500,000 |   |                                    |   |          
|                                   |  |                     |   | 
|GBGH, LLC  2ndLien Debt           |  | 14.00               | % |  | 2014     |  |                                     | 29,500,000  |   |                                    |   |          
|                                   |  |                     |   | 
|Unamortized Debt Issuance Costs    |  |                     |   |  |          |  |                                     | (38,042,000 | ) |                                    |   |           
|                                   |  |                     |   |  |          |  |                                     |             |   |                                    |   |           
|Totals                             |  |                     |   |  |          |  | $                                   | 220,602,000 |   |                                    | $ | 89,161,000
|                                   |  |                     |   |  |          |  |                                     |             |   |                                    |   |           

Additional information pertaining to the components of the Companys debt
follows:

U.S. Energy Biogas Corp.  USEBs debt is payable to Countryside Canada Power Inc. (Countryside). The debt is denominated
in Canadian dollars with the exchange rate on debt service payments fixed through a swap agreement through March 2007. Due to fluctuations in the foreign currency exchange rate, the change in outstanding principal for the comparative periods is
comprised of $1,134,000 of principal payments made offset by $3,925,000 of additional principal due resulting from changes in the foreign currency exchange rate. Principal payments on the debt are made monthly. The debt is collateralized by
substantially all of USEBs assets.

On October 3, 2006 and October 12, 2006, USEB received notices from Countryside claiming that USEB had
failed to provide certain financial reporting documentation to Countryside as required by Section 5 of the loan agreement and claiming that, as a result, an event of default exists under the loan agreement. Though USEB is current in its payment
of principal and interest and no monetary default exists or is alleged by Countryside, the loan agreement provides that upon an event of default under the circumstances alleged by Countryside the lender may, upon written notice to USEB, declare the
entire



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unpaid principal and all accrued interest due and payable. USEB has responded to Countrysides notices and takes the position that no event of default
exists. As of November 21, 2006, Countryside has not indicated that it intends to seek to accelerate the loan. Were the debt to be accelerated, USEBs assets and cash flow would not be sufficient to repay the amounts outstanding under
the loan agreement, and it is not certain that USEB would be able to replace or restructure the debt under such circumstances. USEB is also engaged in negotiations with Countryside regarding a potential restructuring of the loan
agreement. USEBs inability to replace or restructure the debt or an acceleration of the debt by Countryside, would have a material adverse effect upon USEBs financial condition and continued operations. As discussed in Note U, the
settlement agreement reached with Countryside in January 2007, allows for the restructuring of the Countryside debt by May 31, 2007.

The loan agreement
with Countryside contains covenants that require USEB to set aside significant amounts from cash flow in various reserve accounts. Access to the funds in these accounts is restricted by the terms of the loan agreement. When the swap agreement
expires in March 2007, USEB may not have sufficient funds available to satisfy debt service payments without access to a portion of the funds held in the reserve accounts. As discussed in Note U, the settlement agreement reached with Countyside in
January 2007 eliminates USEBs obligation to fund the various reserves and denominates future payment obligation in U.S. dollars.

US Energy Overseas
Investments LLC  Overseas debt is payable to Silver Point Finance, LLC. The interest rate on the debt is adjusted periodically based upon market conditions. All interest is accrued and added to the outstanding principal balance. As of
September 30, 2006, the outstanding principal balance consists of $23,335,000 in original principal and $357,000 of accrued interest. Principal payments on the debt are required from cash receipts received by Overseas or the raising of equity
by the Company. The debt is collateralized by the UK Assets. The financing arrangements require that the Company obtain USEBs guarantee of this debt by December 31, 2006. Should USEBs guarantee not be obtained, Silver Point Finance,
LLC will receive the rights to acquire 3,998,000 shares of the Companys common stock. See Note U.

GBGH, LLC  GBGH, LLCs debt is payable
to Credit Suisse, as collateral agent. The interest rate on the debt is adjusted periodically based upon market conditions. Principal payments on the debt are payable from excess cash flows generated by GBGH, LLC and its subsidiaries. The debt is
collateralized by the UK Assets.

The debt arrangements generally restrict the Companys and its subsidiaries ability to sell assets, incur additional
indebtedness and may limit equity distributions.

NOTE MILLINOIS RETAIL RATE PROGRAM

USEB has ten operating projects in the State of Illinois (Illinois), which are receiving a subsidy for each kilowatt/hour (kwh) of electricity
sold to the local utility under the Illinois Retail Rate Program. In accordance with the Illinois Retail Rate Program, the utility has contracted, for a ten-year period, with each project to purchase electricity for an amount that exceeds the
utilitys avoided cost (what it would otherwise pay for the generation of electricity). The excess paid above avoided cost is the subsidy. The utility then receives a tax credit from Illinois equal to the amount of that excess. Each
project is obligated to begin to repay the subsidy to Illinois after the project has recouped its capital investment and retired all debt associated with the financing and construction of the project but, in any case, no later than ten years from
the date the project commenced commercial operations. All subsidy liabilities must be fully repaid to Illinois (without interest) by the end of the actual useful life of the project but no later than 20 years from the date the project commenced
commercial operations.

This subsidy is accounted for reporting purposes in a manner similar to an original issue discount whereby the amount to be repaid
in the future is discounted to its net present value and the discount is amortized (as interest expense) over the ten-year period until repayment begins. The amount of power generation revenue recognized each period is equal to the avoided cost plus
the difference between the subsidy received by the project and the net present value of the subsidy. This unamortized discount and the liability are shown net on the consolidated balance sheet as Illinois Subsidy Liability.



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USEB is required by the Countryside Fund to deposit funds into the Illinois Accounts for repayment of the Illinois
subsidy liability. The Illinois Accounts are classified as restricted cash and marketable securities in non-current assets on the Companys balance sheet. The amount deposited into the Illinois Accounts is based upon the amount of subsidy
received and contemplates an annual return sufficient to fund the current period subsidy liability repayment as it becomes due. Regular deposits combined with actual and expected returns on those deposits may not be sufficient to fully repay the
respective liabilities as they become due. Should the amounts in the Illinois Accounts be insufficient to fully repay the obligations, any shortfall would have to be funded from the projects operations.

The following is a summary of significant dates pertaining to each projects participation in the Illinois Retail Rate Program.



|             |  |                                       |  |                                            |  |                                                            
|------------ |  | ------------------------------------- |  | ------------------------------------------ |  | -----------------------------------------------------------
|Project      |  | Commencement of Commercial Operations |  | Expiration of Illinois Retail Rate Program |  | Estimated Commencement ofRepayment of Subsidy Liability (1)
|Countryside  |  | April, 2001                           |  | April, 2011                                |  | May, 2011                                                  
|Dolton       |  | May, 1998                             |  | May, 2008                                  |  | September, 2008                                            
|Dixon Lee    |  | July, 1999                            |  | July, 2009                                 |  | August, 2009                                               
|Morris       |  | December, 2000                        |  | December, 2010                             |  | January, 2011                                              
|Roxanna      |  | November, 1999                        |  | November, 2009                             |  | December, 2009                                             
|Upper Rock   |  | April, 2000                           |  | April, 2010                                |  | May, 2010                                                  
|122ndStreet  |  | July, 1998                            |  | July, 2008                                 |  | August, 2008                                               
|Brickyard    |  | September, 1999                       |  | September, 2009                            |  | October, 2009                                              
|Streator     |  | January, 2000                         |  | January, 2010                              |  | February, 2010                                             
|Willow Ranch |  | January, 1998                         |  | January, 2008                              |  | February, 2008                                             

---

|(1) |  | The estimated commencement of the repayment of the liability is based upon managements
assumptions. One year before a projects eligibility for participation in the program terminates, a proposed repayment schedule must be presented to the Illinois Commerce Commission for their approval. Until any repayment schedule is approved
by the Illinois Commerce Commission, it will continue to be an estimated schedule.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The funds held in the Illinois Accounts are currently
invested in equities and fixed income securities. These investments are being managed by a third-party professional money manager with the investment allocations being approved by the management of the Company and USEB. The amount held in the
Illinois Accounts as of September 30, 2006 was $27,866,000. The amount of the subsidy liability owed to Illinois as of September 30, 2006 was $61,967,000, before the unamortized discount. It is anticipated that repayments of the incentive
will begin in 2008 and continue through 2021.

Under the terms of the Illinois Retail Rate Program, estimated rates are paid for production sold to the
utility with that rate being trued up annually, on the anniversary date of the commencement of commercial operations of the applicable project, to the actual rates paid for electricity by the local municipality. After the actual rate is determined,
sales for the preceding calendar year, retroactive to the last anniversary date, are adjusted based upon the actual rate. If the actual rate is greater than the estimated rate, additional sales proceeds are paid to the project. If the actual rate is
less than the estimated rate, then prior sales proceeds received, equal to the excess amounts paid, must be refunded to the utility. This actual rate then becomes the estimated rate for the subsequent year.

In the past, the annual reconciliation of estimated rates to the actual rates has resulted in both increases and decreases in retroactive revenue. USEB cannot predict
whether any changes in future rates will result in increases or decreases in revenues from the Illinois projects. For the three and nine months ended September 30, 2006, the Company received approximately 20% and 22%, respectively, of its
revenues from the subsidy paid under the Illinois Retail Rate Program.

As discussed in Note U, the settlement agreement between the Illinois Commerce
Commission and USEB stipulates that a payment of $5,250,000, if made before May 31, 2007, would fully satisfy USEBs obligations for all subsidy liability owed and also requires that USEB withdraw from the Illinois Retail Rate Program by May
31, 2007.



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NOTE NTRANSACTIONS WITH AFFILIATES

USEB is a general partner in related unconsolidated limited partnerships and collects management fees from the partnerships. Fees earned from such general partner undertakings for the three and nine months ended
September 30, 2006 were $60,000 and $181,000, respectively, compared with $62,000 and $185,000 for the comparable 2005 periods.

USEB reimburses its
stockholders, including the Company, for a majority of the costs incurred by them for the benefit of USEB. These costs include management and accounting salary and benefit costs, office expenses associated with the accounting services and an
allocation of rent expenses. The total reimbursements for the three and nine months ended September 30, 2006 were $22,000 and $74,000, respectively, compared with $74,000 and $251,000 for the comparable 2005 periods. These items are eliminated
in the consolidated financial statements of the Company.

NOTE OFOREIGN CURRENCY TRANSACTIONS

USEBs debt obligation to Countryside requires that debt service payments be made in Canadian dollars. USEB has entered into a cash flow foreign currency hedge
agreement with financial institutions fixing the Canadian dollar to U.S. dollar exchange rate at $1.331 Canadian dollar per U.S. dollar. This hedge agreement, in an amount equal to the debt service payments, expires on March 31, 2007.
Subsequent to the expiration of the hedge agreement, USEBs debt service payments to Countryside are subject to fluctuations in the currency exchange rate. When the swap agreement expires in March 2007, USEB may not have sufficient funds
available to satisfy debt service payments without access to a portion of the funds held in the various reserve accounts required by the agreement with Countryside Fund. See Note U.

As required by Statement of Financial Accounting Standards No. 52Foreign Currency Translation (SFAS 52) and Statement of Financial Accounting Standards
No. 133Accounting for Derivative Instruments and Hedging Activities, USEB has adjusted the outstanding principal on the debt owed to Countryside to reflect the currency exchange rate as of the end of the financial reporting
period. The gain or loss resulting from the adjustment of the outstanding principal from that recorded in the previous reporting periods is recorded as Foreign Currency Transaction Expense.

Following is a summary of the Foreign Currency Translation account as of September 30, 2006 as it relates to the USEB debt (the exchange rates are Canadian dollars
per one U.S. dollar and are stated whole dollars):



|                                                                      |  |                                       |            |                                     |   |           
|--------------------------------------------------------------------- |  | ------------------------------------- | ---------- | ----------------------------------- | - | ----------
|                                                                      |  | Three Months Ended September 30, 2006 |            | Nine Months EndedSeptember 30, 2006
|Currency Exchange Rate at Loan Origination, April 8, 2004             |  | $                                     | 1.3310     |                                     | $ | 1.3310    
|Currency Exchange Rate at December 31, 2005                           |  | $                                     | 1.1660     |                                     | $ | 1.1660    
|Currency Exchange Rate as of June 30, 2006                            |  | $                                     | 1.1201     |                                     | $ | 1.1201    
|Currency Exchange Rate as of September 30, 2006                       |  | $                                     | 1.1142     |                                     | $ | 1.1142    
|Cumulative Translation Adjustments Beginning of Reporting Period      |  | $                                     | 13,193,000 |                                     | $ | 9,764,000 
|Cumulative Translation Adjustments End of Reporting Period            |  | $                                     | 13,816,000 |                                     | $ | 13,816,000
|Aggregate Adjustment for the Current Reporting Period                 |  | $                                     | 623,000    |                                     | $ | 4,052,000 
|Deferred Income Taxes Allocated to Adjustment in the Reporting Period |  | $                                     | 237,000    |                                     | $ | 1,565,000 

In addition, the foreign currency transaction expense related to the UK operations was $244,000.



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NOTE POTHER COMPREHENSIVE INCOME/(LOSS)

Other Comprehensive Income (Loss) for the three and nine months ended September 30, 2006 and 2005 is comprised of the following:



|                                                   |  |                                 |          |                                |      |   |         |  |   |          |   |  |   |         |  
|-------------------------------------------------- |  | ------------------------------- | -------- | ------------------------------ | ---- | - | ------- |  | - | -------- | - |  | - | ------- | -
|                                                   |  | Three Months EndedSeptember 30, |          | Nine Months EndedSeptember 30, |     
|                                                   |  | 2006                            |          |                                | 2005 |   | 2006    |  |   | 2005     |  
|Unrealized gains on investments available for sale |  | $                               | 561,000  |                                |      | $ | 219,000 |  | $ | 441,000  |   |  | $ | 130,000 |  
|Foreign currency translation (see Note H)          |  |                                 | (171,000 | )                              |      |   | 158,000 |  |   | (345,000 | ) |  |   | (9,000  | )
|                                                   |  |                                 |          |                                |      |   |         |  |   |          |   |  |   |         |  
|Total                                              |  | $                               | 390,000  |                                |      | $ | 377,000 |  | $ | 96,000   |   |  | $ | 121,000 |  
|                                                   |  |                                 |          |                                |      |   |         |  |   |          |   |  |   |         |  

Accumulated Other Comprehensive Income, as reflected in the accompanying balance sheet, was $2,837,000 at
September 30, 2006 consisting of $2,421,000 of unrealized gains on investments available for sale, $148,000 of foreign currency translation losses and $564,000 from the effect of foreign currency translations from the conversion of the UK
statement of operations. As of December 31, 2005, Accumulated Other Comprehensive Income of $2,177,000 was comprised of $1,980,000 of unrealized gains on investments available for sale and $197,000 of gains from foreign currency translations.

NOTE QDEFERRED INCOME TAXES

In accordance with
Statement of Financial Accounting Standards 109Accounting for Income Taxes (SFAS 109), the Company evaluates the likelihood of the near term future realization of the value of the net deferred tax assets. Such an
evaluation includes an analysis of the anticipated near term generation of taxable income and the implementation of tax planning strategies. Potential future taxable income from projects yet to be acquired or developed is not included in the
evaluation.

Based on this analysis and to comply with SFAS No. 109, an increase in the valuation allowance of $2,045,000 and $3,065,000 was recorded
against the net deferred tax assets for the three and nine months ended September 30, 2006, respectively, increasing the total valuation allowance to $14,405,000. The increase to the valuation allowance for the three and nine months ended
September 30, 2005 was $4,165,000.

The establishment of the additional valuation allowance against the deferred tax asset will not have any effect on
the Companys ability to utilize existing net operating losses to offset future taxable income and will not have any effect on the Companys cash flows. As of December 31, 2005, the Company has approximately $71,003,000 of Net
Operating Losses being carried forward, expiring between 2006 and 2025.

NOTE RCOMMITMENTS AND CONTINGENCIES

The Company and its subsidiaries have various financial commitments under office and equipment leases and under the Development Agreement with Countryside. The office and
equipment leases expire on various dates. The $288,000 obligation under the Development Agreement with the Countryside Fund expires in March 2009. (See Note U.)

Financial commitments for the next five years are:



|                    |  |             |          
|------------------- |  | ----------- | ---------
|Year                |  | Commitments
|2006                |  | $           | 178,000  
|2007                |  |             | 700,000  
|2008                |  |             | 700,000  
|2009                |  |             | 451,000  
|2010                |  |             | 346,000  
|2011 and thereafter |  |             | 2,015,000
|                    |  |             |          
|Total               |  | $           | 4,390,000
|                    |  |             |          



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Lease expenses for the Company were $28,000 and $212,000 for the three and nine months ended September 30, 2006 and
$65,000 and $187,000 for the three and nine months ended September 30, 2005, respectively.

In April 2001, USEB acquired its Brookhaven, Countryside
and Morris project entities from Yankee Energy Services Company (YESCO). Two of the projects, Countryside and Morris, produce electricity from landfill gas and participate in the Illinois Retail Rate Program. As part of the transaction,
the acquired entities entered into a secured, contingent acquisition consideration agreement with YESCO. The agreement stipulates that additional acquisition consideration will be due and payable should, for the Countryside and Morris projects,
actual electricity rates received exceed established levels and should actual operation and maintenance expenses be beneath established amounts. The contingent obligation has a face amount of $4,700,000, accrues interest at a rate of 9.5% per
annum and is secured by the assets of the entities. The amount of payment due, if any, is calculated and paid on a quarterly basis. The contingent obligation terminates on March 31, 2011 when all unpaid balances remaining are forgiven and all
security interests in the associated collateral will be released. For the nine months ended September 30, 2006 and 2005, USEB paid $41,000 and $28,000, respectively, on this obligation. This amount has not been reflected in the accompanying balance
sheet as a liability. All payments on the obligation are recorded as operating expenses in the related entities.

USEB had provided the buyers related to
certain installment sale notes with tax indemnifications related to the validity of the Section 29 tax credits generated by the assets sold to the buyers. To date, there have not been any claims made on these indemnifications. The Company will
accrue any amounts related to these issues as they become quantifiable.

On June 13, 2006, an affiliate of the Countryside Fund filed a lawsuit
against the Company in the Supreme Court of the State of New York, New York County, entitled Countryside U.S. Power Inc. v. U.S. Energy Systems, Inc. (Index No. 602079/2006). Countryside asserts two causes of action for breach of contract
relating to the Development Agreement by and among Countryside, the Company and Cinergy Solutions, Inc., dated April 8, 2004. Countryside alleges that the Company breached the Development Agreement by failing to pay monthly fees (first cause of
action) and failing to provide certain office services to Countryside (second cause of action). Countryside seeks damages in the amount of $1,163,244 on the first cause of action, $745,152 on the second cause of action, and unspecified
attorneys fees pursuant to a third cause of action based on an indemnification provision in the Development Agreement, together with interest and costs. The lawsuit is in its early stages and the Company has not yet answered the complaint. See
Note U.

NOTE SCONVERSION OF PREFERRED STOCK

Effective on March 31, 2006, the Company caused the conversion of each share of its Series D Convertible Preferred Stock into four shares of common stock. A total of 916,666 shares of the Series D Convertible Preferred Stock were
converted into 3,666,664 shares of common stock. This conversion will reduce preferred dividends by approximately $495,000 per year. The conversion resulted in a decrease in preferred stock equity of $9,000, a decrease in additional paid in capital
of $28,000 and an increase in common stock equity of $37,000.

Effective on June 26, 2006, stockholders owning 58,524 of the Companys Series C
Convertible Preferred Stock exchanged such shares for 468,192 shares of common stock. This conversion will reduce preferred dividends by approximately $105,000 per year. This conversion resulted in a decrease in preferred stock equity of $1,000, a
decrease in additional paid in capital of $3,600 and an increase in common equity of $4,600.



28



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##### Table of Contents

NOTE TSEGMENT INFORMATION

The Companys results by operating segment were as follows:



|                    |  |                                 |            |   |                                |   |            |            |  |   |             |   |  |   |            |  
|------------------- |  | ------------------------------- | ---------- | - | ------------------------------ | - | ---------- | ---------- |  | - | ----------- | - |  | - | ---------- | -
|                    |  | Three Months EndedSeptember 30, |            |   | Nine Months EndedSeptember 30, |  
|                    |  | 2006                            |            |   | 2005                           |   |            | 2006       |  |   | 2005        |  
|                    |  | (restated)                      |            |   |                                |   |            | (restated) |  |   |             |  
|Operating Revenues: |  |                                 |            |   |                                |   |            |            |  |   |             |   |  |   |            |  
|USEB                |  | $                               | 4,719,000  |   |                                | $ | 4,616,000  |            |  | $ | 14,275,000  |   |  | $ | 14,116,000 |  
|UK Operations       |  |                                 | 435,000    |   |                                |   |           |            |  |   | 435,000     |   |  |   |           |  
|Corporate           |  |                                 |           |   |                                |   |           |            |  |   |            |   |  |   |           |  
|                    |  |                                 |            |   |                                |   |            |            |  |   |             |   |  |   |            |  
|Total               |  | $                               | 5,154,000  |   |                                | $ | 4,616,000  |            |  | $ | 14,710,000  |   |  | $ | 14,116,000 |  
|                    |  |                                 |            |   |                                |   |            |            |  |   |             |   |  |   |            |  
|Net (Loss):         |  |                                 |            |   |                                |   |            |            |  |   |             |   |  |   |            |  
|USEB                |  | $                               | (269,000   | ) |                                | $ | (1,435,000 | )          |  | $ | (2,371,000  | ) |  | $ | (1,821,000 | )
|UK Operations       |  |                                 | (5,891,000 | ) |                                |   |           |            |  |   | (5,891,000  | ) |  |   |           |  
|Corporate           |  |                                 | (1,954,000 | ) |                                |   | (5,039,000 | )          |  |   | (4,943,000  | ) |  |   | (6,590,000 | )
|                    |  |                                 |            |   |                                |   |            |            |  |   |             |   |  |   |            |  
|Total               |  | $                               | (8,114,000 | ) |                                | $ | (6,474,000 | )          |  | $ | (13,205,000 | ) |  | $ | (8,411,000 | )
|                    |  |                                 |            |   |                                |   |            |            |  |   |             |   |  |   |            |  



|                    |  |                   |             |                  |   |            
|------------------- |  | ----------------- | ----------- | ---------------- | - | -----------
|                    |  | September 30,2006 |             | December 31,2005
|                    |  | (restated)        |             |                 
|Identifiable Assets |  |                   |             |                  |   |            
|USEB                |  | $                 | 161,185,000 |                  | $ | 157,597,000
|UK Operations       |  |                   | 185,577,000 |                  |   |           
|Corporate           |  |                   | 5,532,000   |                  |   | 11,432,000 
|                    |  |                   |             |                  |   |            
|Total               |  | $                 | 352,294,000 |                  | $ | 169,029,000
|                    |  |                   |             |                  |   |            

The USEB segment is comprised of the operations of USEBs landfill gas to energy projects. The UK segment
relates to the natural gas project described in Note D. Currently, the Company treats the UK operations as one segment. The Company may, in the future, based upon changes in the operating structure, create an additional segment related to the UK
operations. The Corporate segment relates to the executive management of the Company.

NOTE USUBSEQUENT EVENTS

Annual MeetingOn November 6, 2006, the Company held its annual meeting of stockholders in which the stockholders approved the issuance of 8,074,000
shares of common stock upon the exercise of certain warrants and the conversion of certain securities related to the UK Transaction. The stockholders also approved an amendment to the Companys Amended and Restated Certificate of Incorporation
to increase the number of authorized shares of common stock from 50,000,000 shares to 75,000,000 shares.



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USEB Chapter 11 FilingOn November 29, 2006, USEB and certain of its subsidiaries filed for
reorganization under Chapter 11 of the U.S. Bankruptcy Code in the Southern District of New York in order to facilitate the restructuring of its capital structure particularly related to its debt with Countryside Power Income Fund
(Countryside). USEB, which was current in its payment of all principal and interest and did not have any monetary defaults under the loan agreements, continues to operate all projects as Debtor in Possession. The USEB Chapter 11 case
number is 06-12827(RDD).

On January 16, 2007, USEB announced that it reached an agreement with Countryside concerning the principal issue in the
case, the restructuring of the Countryside debt obligations. The agreement, which has been subsequently approved by the Court, allows Countryside a US$99,000,000 secured claim. The claim is the only allowed claim that Countryside will have in the
Chapter 11 case and Countryside has agreed to forgo any claims related to USEBs April 8, 2004 Royalty Agreement with Countryside, any fees incurred by Countryside pertaining to the case, all accrued but unpaid interest through
January 31, 2007 and any claims against the Company under the April 8, 2004 Development Agreement between USEY and Countryside. The Company made a US$3,000,000 payment against the secured claim in January, 2007 and a US$30,000,000 payment
in March, 2007. The remaining outstanding principal of US$66,000,000 was deemed over secured for purposes of adequate protection and the use of cash collateral in the bankruptcy case and shall bear interest at a rate of 10% per annum (down from
11% per the original loan agreement) payable monthly in US dollars to Countryside. The final installment against the secured claim is due on May 31, 2007. Mutual general releases have been exchanged among the parties involved and will
cover certain individuals affiliated with Countryside who have been threatened with lawsuits arising out of their prior employment by the Company.

On
March 19, 2007, USEB announced that it reached an agreement with the State of Illinois and the Illinois Commerce Commission (the ICC) resolving the principal remaining outstanding issue in the Chapter 11 case. The agreement, which
is subject to Court approval, provides that the ICC will not pursue repayment of approximately $63,000,000 in interest-free loans provided to certain of USEBs landfill gas to energy projects under the Illinois Retail Rate Program. In return,
USEB or its subsidiaries will pay the ICC $5,000,000 on the effective date of USEBs Plan of Reorganization but no later than May 31, 2007 and will withdraw its 10 operating projects from participation in the program by the effective date
but no later than May 31, 2007. The funds to be paid to the ICC will include the establishment of a $250,000 reserve account that will be utilized to pay any and all rate adjustment claims, up to a $250,000 limit, for a period of six months
immediately following effective date. USEB is currently executing plans to sell its electricity output from the 10 Illinois projects to other customers outside of the Illinois Retail Rate Program. The Company is working with energy brokers and
consultants to identify the optimum market for the energy and to execute power sales contracts. It is not anticipated that changes in rates from the exiting of the Illinois Retail Rate Program and the entering into of new contracts will have a
significant adverse effect on the Companys revenues.

USEB expects to be able to file a Plan of Reorganization with the Court that will have the
support of its creditors and would enable USEB to exit Chapter 11 in the first half of 2007.

Acquisition of U.S. Energy Biogas Corp. StockOn
November 28, 2006, the Company entered into a Stock Purchase Agreement with DEGS Biogas, Inc. (formerly Cinergy Energy Solutions, Inc., DEGS) pursuant to which the Company acquired 4,574 shares of the Class B Common Stock of USEB from
DEGS (the DEGS Shares). The Company now owns 100% of the outstanding stock of USEB.

In consideration for the DEGS Shares, the Company agreed
to: (i) assume two promissory notes, payable to BMC Energy LLC, a subsidiary of USEB, each dated May 1, 2001, (a) one note is a fixed obligation with remaining payments aggregating $430,000 and (b) the other note is a contingent obligation, based on
the value of Section 29 tax credits generated by the Company and its subsidiaries, the face amount of which is $4.3 million, (ii) assume DEGS GASCO LLCs obligations to fund operating and capital expenses of certain limited partnerships or
limited liability companies that own and operate landfill gas collection systems and related assets in an amount not to exceed $1 million, and (iii) subject to execution of definitive documentation, appoint a broker in connection with sales of
greenhouse gas emission credits by the Company or its subsidiaries. Management currently anticipates that the operating and capital expense funding obligations and payments on the contingent note will not exceed an aggregate of $1 million.

Equity IssuanceIn the first quarter of 2007, the Company sold 1,280,000 shares of its common stock for $5.00 per share and issued 652,000
warrants, with each warrant exercisable in whole or in part at any time for a period of five years following the date of issuance at an exercise price of $0.01 per share.

Legal ProceedingsOn or about March 20, 2007, Marathon Capital Holdings(UK), LLC (Marathon) and Richard T. Brandt II as director, filed suit in the Supreme Court of the State of New York
against the Company, one of its subsidiaries and certain officers and directors of the Company. The suit asserts causes of action seeking permanent injunctive relief directing the defendants to provide the plaintiffs with access to the books and
records of the Company and to allow the plaintiffs to more fully participate in the management and affairs of the Company. The suit seeks an award of attorneys fees and costs in connection with the litigation, but does not otherwise seek
monetary damages. The defendants intend to vigorously defend against the suit.



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|ITEM 2: | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

RECENT DEVELOPMENTS

On August 7, 2006, the Company completed the acquisition and financing of certain energy assets in the United Kingdom through certain of its
subsidiaries. Please refer to Note D of the condensed consolidated financial statements for a description of the transaction.

RESULTS OF OPERATIONS

The net loss applicable to common stockholders of $8,114,000 for the three months ended September 30, 2006, represents an increase of $1,640,000
from the $6,474,000 net loss for the three months ended September 30, 2005. The increase in 2006 is primarily due to a $3,192,000 decrease in foreign currency translation expense and $4,066,000 increase income tax benefits, offset by an
increase in the loss from operations of $1,541,000, a $3,858,000 increase in interest expense and a $3,779,000 increase in expenses related to the various hedge arrangements. The change in the foreign currency translation expense is primarily due to
changes related to USEBs Canadian dollar denominated Countryside debt. The increase in interest expense is due to $3,784,000 of interest associated with the UK operations which closed on August 7, 2006. The decrease in income tax expense
is the result of the recording of a valuation reserve against the deferred tax assets during the three months ended September 2005. The expense related to the various hedges is primarily associated with the UK operations represents the mark to
market of the value of the hedges purchased. The amount is comprised of $2,740,000 related to the interest rate hedge and $1,250,000 related to the gas and electricity hedge offset by $211,000 in gains associated with USEBs foreign currency
hedge.

The net loss applicable to common stockholders of $13,205,000 for the nine months ended September 30, 2006, represents an increase of
$4,794,000 from the $8,411,000 net loss for the nine months ended September 30, 2005. The increase is primarily the result of an increase in the loss from operations of $3,806,000 (including a $1,281,000 increase in expenses related to the UK
operations which commenced operations on August 7, 2006), a $4,007,000 increase in interest expense, a $1,889,000 increase in foreign currency transaction expenses primarily related to USEBs Countryside debt and a $3,779,000 increase in
expense related to the mark to market of the various hedge arrangements offset by a $6,301,000 increase in income tax benefits and a $1,912,000 increase in benefits related to minority interest allocations. The increase in interest expense is
primarily due to the $3,306,000 of interest expense related to the UK operations.

Revenues for the three and nine months ended September 30, 2006
were $5,154,000 and $14,710,000, respectively, compared with $4,616,000 and $14,116,000 for the corresponding 2005 periods, representing increases of $538,000, or 12%, and $594,000, or 4% from the prior corresponding period. For the three months
ended September 30, 2006, the increase was primarily due to $435,000 of revenues associated with the UK operations which began operations on August 7, 2006 and a $104,000, or 2%, increase in USEB revenues from energy sales. For the nine
months ended September 30, 2006, the increase was primarily due to the revenues associated with the UK operations plus a $160,000, or 1%, increase in USEB revenues from energy sales.

Operating expenses for the three and nine months ended September 30, 2006 were $2,998,000 and $8,048,000, respectively, compared with $2,126,000 and $6,601,000 for
the corresponding 2005 periods, representing increases of $872,000, or 41%, and $1,447,000, or 22%, from the prior corresponding periods. For the three month periods, the increase was primarily due to $605,000 of operating expenses related to the UK
operations which began operations on August 7, 2006 and a $275,000 increase in expenses for two third party operated projects due to changes in the operating agreements. For the nine



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month period, the increase was primarily due to $605,000 of operating expenses related to the UK operations, a $164,000 increase in production rental
payments due to increase in associated sales volumes, and a $247,000 increase in third party operating and maintenance costs due to rate increases.

General and administrative expenses were $1,934,000 and $6,022,000 for the three and nine months ended September 30, 2006, respectively, resulting in an increase of $541,000 or 39% and $2,090,000 or 53% from $1,393,000 and $3,932,000
for the corresponding 2005 periods. The increase for the three month period was primarily due to $197,000 of expenses related to the vesting of previously granted options as required by the SFAS 123R, $511,000 in expenses related to the settlement
of the Zahren/Rose lawsuit and $242,000 of general and administrative expenses related to the UK operations which began on August 7, 2006. The increase for the nine month period was primarily due to $1,080,000 of expenses related to SFAS 123R,
$511,000 in expenses related to the settlement of the Zahren/Rose lawsuit and $242,000 of general and administrative expenses related to the UK operations. As of September 30, 2006, the total unrecognized compensation costs related to granted
stock options is $3,031,000. These costs will be recognized over the next 39 months.

Depreciation and amortization expenses were $1,646,000 and $4,070,000
for the three and nine months ended September 30, 2006 compared with $1,095,000 and $3,286,000 for the corresponding 2005 periods representing an increase of $551,000 or 50% and $784,000 or 24% for each period. The increase is related to
depreciation associated with capital improvements on the USEB assets completed in 2005 and the addition of depreciation related to the UK operations beginning in August 2006. We anticipate that such expenses will increase in the future as a result
of the amortization of debt issuance and other costs associated with the UK Transaction and the depreciation associated with the UK assets.

Interest and
dividend income was $1,003,000 and $3,246,000 for the three and nine months ended September 30, 2006 compared with $1,164,000 and $3,023,000 reported for the corresponding 2005 periods, as follows:



|                 |  |                                 |           |                                |   |           |  |      |           |  |   |          
|---------------- |  | ------------------------------- | --------- | ------------------------------ | - | --------- |  | ---- | --------- |  | - | ---------
|                 |  | Three Months EndedSeptember 30, |           | Nine Months EndedSeptember 30,
|                 |  | 2006                            |           | 2005                           |   | 2006      |  | 2005
|Notes Receivable |  | $                               | 631,000   |                                | $ | 676,000   |  | $    | 1,897,000 |  | $ | 2,050,000
|Investments      |  |                                 | 372,000   |                                |   | 488,000   |  |      | 1,349,000 |  |   | 973,000  
|                 |  |                                 |           |                                |   |           |  |      |           |  |   |          
|Total:           |  | $                               | 1,003,000 |                                | $ | 1,164,000 |  | $    | 3,246,000 |  | $ | 3,023,000
|                 |  |                                 |           |                                |   |           |  |      |           |  |   |          

Unrealized Loss on Hedges was $3,779,000 for the three and nine months ended September 30, 2006. The loss
represents the mark to market value of the various hedges associated with the UK operations. The loss is comprised of the following:



|                                   |  |                                 |            |                                |      |   |      |  |   |            |   |  |   |  
|---------------------------------- |  | ------------------------------- | ---------- | ------------------------------ | ---- | - | ---- |  | - | ---------- | - |  | - | -
|                                   |  | Three Months EndedSeptember 30, |            | Nine Months EndedSeptember 30,
|                                   |  | 2006                            |            |                                | 2005 |   | 2006 |  |   | 2005      
|Gas and Electricity UK            |  | $                               | (1,250,000 | )                              |      | $ |     |  | $ | (1,250,000 | ) |  | $ | 
|Interest Rate/Foreign Currency -UK |  |                                 | (2,740,000 | )                              |      |   |     |  |   | (2,740,000 | ) |  |   | 
|USEB Foreign Currency              |  |                                 | 211,000    |                                |      |   |     |  |   | 211,000    |   |  |   | 
|                                   |  |                                 |            |                                |      |   |      |  |   |            |   |  |   |  
|Total:                             |  | $                               | (3,779,000 | )                              |      | $ |     |  | $ | (3,779,000 | ) |  | $ | 
|                                   |  |                                 |            |                                |      |   |      |  |   |            |   |  |   |  



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Interest expense was $6,553,000 and $12,122,000 for the three and nine months ended September 30, 2006, representing
an increase of $3,858,000 or 143% and $4,007,000 or 49% from the $2,695,000 and $8,115,000 reported for the corresponding 2005 periods. Interest expense is comprised of interest paid by USEB on the Countryside debt, the amortization of the discount
associated with the accounting treatment of the Illinois subsidy and interest related to the UK operations. The interest expense associated with the Illinois subsidy does not have any effect on the Companys cash flows. The financing related to
the UK operations closed on August 7, 2006 resulting in partial period interest being recorded for this reporting period.

A comparison of the
components of interest expense follows:



|                              |  |                                |           |                               |   |           |  |      |            |  |   |          
|----------------------------- |  | ------------------------------ | --------- | ----------------------------- | - | --------- |  | ---- | ---------- |  | - | ---------
|                              |  | Three Months EndedSeptember 30 |           | Nine Months EndedSeptember 30
|                              |  | 2006                           |           | 2005                          |   | 2006      |  | 2005
|USEB Interest                 |  | $                              | 2,124,000 |                               | $ | 2,164,000 |  | $    | 6,403,000  |  | $ | 6,522,000
|Illinois Subsidy Amortization |  |                                | 645,000   |                               |   | 531,000   |  |      | 1,935,000  |  |   | 1,593,000
|UK Transaction Interest       |  |                                | 3,784,000 |                               |   |          |  |      | 3,784,000  |  |   |         
|                              |  |                                |           |                               |   |           |  |      |            |  |   |          
|Total:                        |  | $                              | 6,553,000 |                               | $ | 2,695,000 |  | $    | 12,122,000 |  | $ | 8,115,000
|                              |  |                                |           |                               |   |           |  |      |            |  |   |          

We anticipate that interest expense will increase significantly in the future as a result of the $166.3 million of
debt incurred in the financing associated with the UK Transaction.

Foreign currency translation expense primarily pertains to USEBs debt obligations
to Countryside. Foreign currency translation expense for the three and nine months ended September 30, 2006 was $847,000 and $4,276,000, respectively, compared to $4,039,000 and $2,387,000 for the corresponding periods in 2005. These amounts
represent the adjustments, as required by SFAS 52, Foreign Currency Translations, to the outstanding principal owed to Countryside to reflect the change in the currency exchange rate from the start of the reporting periods to the end of
the reporting periods plus $244,000 of expense related to the UK operations. The Canadian dollar to U.S. dollar exchange rate decreased to $1.1142 as of September 30, 2006 from $1.1201 as of June 30, 2006 and from $1.1660 as of
December 31, 2005. See Note O to the condensed consolidated financial statements. The Canadian dollar to U.S. dollar exchange rate was $1.1713 as of September 30, 2005, $1.2287 as of June 30, 2005 and $1.2047 as of December 31,
2004.

The provision for income taxes for the three and nine months ended September 30, 2006 and 2005 was a benefit of $2,240,000 and an expense of
$1,826,000 for the three months, respectively, and a benefit of $4,561,000 and an expense of $1,740,000 for the nine months, respectively. During the three months ended September 30, 2005, the Company recorded a valuation allowance of
$4,165,000 against the deferred tax asset. The provisions for taxes are based on an effective tax rate of 38% and for the three and nine month periods ended September 30, 2006 are net of a $2,045,000 and $3,065,000 increase in the valuation
allowance against the deferred tax asset, respectively.

Gain on disposal of a segment of $150,000 for the nine months ended September 30, 2005
represents residual income from the operations of USE Canada Energy Corp which was sold in 2004.

SUBSEQUENT EVENTS

Annual MeetingOn November 6, 2006, the Company held its annual meeting of stockholders in which the stockholders approved the issuance of 8,074,000
shares of common stock upon the exercise of certain warrants and the conversion of certain securities related to the UK Transaction (or 12,072,000 shares if the Company does not obtain the USEB guaranty to a portion of the debt related to the UK
acquisition). The stockholders also approved an amendment to the Companys Amended and Restated Certificate of Incorporation to increase the number of authorized shares of common stock from 50,000,000 shares to 75,000,000 shares.

USEB Chapter 11 FilingOn November 29, 2006, USEB and certain of its subsidiaries filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code
in the Southern District of New York in order to facilitate the restructuring of its capital structure particularly related to its debt with Countryside Power Income Fund (Countryside). USEB, which was current in its payment of all
principal and interest and did not have any monetary defaults under the loan agreements, continues to operate all projects as Debtor in Possession. The USEB Chapter 11 case number is 06-12827(RDD).

On January 16, 2007, USEB announced that it reached an agreement with Countryside concerning the principal issue in the case, the restructuring of the Countryside
debt obligations. The agreement, which has been subsequently approved by the Court, allows Countryside a US$99,000,000 secured claim. The claim is the only allowed claim that Countryside will have in the Chapter 11 case and Countryside has agreed to
forgo any claims related to USEBs April 8, 2004 Royalty Agreement with Countryside, any fees incurred by Countryside pertaining the case, all accrued but unpaid interest through January 31, 2007 and any claims against the Company
under the April 8, 2004 Development Agreement between USEY and Countryside. The Company made a US$3,000,000 payment against the secured claim in January, 2007 and a US$30,000,000 payment in March, 2007. The remaining outstanding principal of
US$66,000,000 was deemed over secured for purposes of adequate protection and the use of cash collateral in the bankruptcy case and shall bear interest at a rate of 10% per annum (down from 11% per the original loan agreement) payable
monthly in US dollars to Countryside. The final installment against the secured claim is due on May 31, 2007. Mutual general releases have been exchanged among the parties involved and will cover certain individuals affiliated with Countryside
who have been threatened with lawsuits arising out of their prior employment by the Company.

On March 19, 2007, USEB announced that it reached an
agreement with the State of Illinois and the Illinois Commerce Commission (the ICC) resolving the principal remaining outstanding issue in the Chapter 11 case. The agreement, which is subject to Court approval, provides that the ICC will
not pursue repayment of approximately $63,000,000 in interest-free loans provided to certain of USEBs landfill gas to energy projects under the Illinois Retail Rate Program. In return, USEB or its subsidiaries will pay the ICC $5,000,000 on
the effective date of USEBs Plan of Reorganization but no later than May 31, 2007 and will withdraw its 10 operating projects from participation in the program by the effective date but no later than May 31, 2007. The funds to be
paid to the ICC will include the establishment of a $250,000 reserve account that will be utilized to pay any and all rate adjustment claims, up to a $250,000 limit, for a period of six months immediately following effective date. USEB is currently
executing plans to sell its electricity output from the 10 Illinois projects to other customers outside of the Illinois Retail Rate Program.

USEB expects
to be able to file a Plan of Reorganization with the Court that will have the support of its creditors and would enable USEB to exit Chapter 11 in the first half of 2007.

Acquisition of U.S. Energy Biogas Corp. StockOn November 28, 2006, the Company entered into a Stock Purchase Agreement with DEGS Biogas, Inc. (formerly Cinergy Energy Solutions, Inc., DEGS)
pursuant to which the Company acquired 4,574 shares of the Class B Common Stock of USEB from DEGS (the DEGS Shares). The Company now owns 100% of the outstanding stock of USEB.

In consideration for the DEGS Shares, the Company agreed to: (i) assume two promissory notes, payable to BMC Energy LLC, a subsidiary of USEB, each dated May 1, 2001,
(a) one note is a fixed obligation with remaining payments aggregating $430,000 and (b) the other note is a contingent obligation, based on the value of Section 29 tax credits generated by the Company and its subsidiaries, the face amount of which
is $4.3 million, (ii) assume DEGS GASCO LLCs obligations to fund operating and capital expenses of certain limited partnerships or limited liability companies that own and operate landfill gas collection systems and related assets in an amount
not to exceed $1 million, and (iii) subject to execution of definitive documentation, appoint DEGS or its designee as the Companys broker in connection with sales of greenhouse gas emission credits by the Company or its subsidiaries.
Management currently anticipates that the operating and capital expense funding obligations and payments on the contingent note will not exceed an aggregate of $1 million.

Equity IssuanceIn the first quarter of 2007, the Company sold 1,280,000 shares of its common stock for $5.00 per share and issued 652,000 warrants, with each warrant exercisable in whole or in part at any
time for a period of five years following the date of issuance at an exercise price of $0.01 per share.

Legal ProceedingsOn or about March
20, 2007, Marathon Capital Holdings(UK), LLC (Marathon) and Richard T. Brandt II as director, filed suit in the Supreme Court of the State of New York against the Company, one of its subsidiaries and certain officers and directors of the
Company. The suit asserts causes of action seeking permanent injunctive relief directing the defendants to provide the plaintiffs with access to the books and records of the Company and to allow the plaintiffs to more fully participate in the
management and affairs of the Company. The suit seeks an award of attorneys fees and costs in connection with the litigation, but does not otherwise seek monetary damages. The defendants intend to vigorously defend against the suit.



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LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2006, consolidated unrestricted cash amounted to $4,446,000 compared with $11,301,000 of unrestricted cash at December 31, 2005, a reduction of $6,855,000.

Of the $4,446,000 of consolidated unrestricted cash, $703,000 was held directly by the Company with the balance being held in the accounts of the Companys
subsidiaries. The $703,000 compares with $10,528,000 in unrestricted cash held directly by the Company as of December 31, 2005. Of the $9,825,000 decrease during the first nine months of 2006, $7,960,000 is directly related to the
Companys equity investment in the UK acquisition. The balance of the decrease principally relates to the Companys general and administrative expenses and preferred dividends. The impact of future dividends on preferred stock has been
mitigated by actions in 2006 reducing the outstanding preferred stock, including the conversion of the Companys series D preferred stock and the voluntary conversion of most of the Companys series C preferred stock into common stock.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course of business. Based on the Companys estimates of cash requirements, the Company expects that the $703,000 of unrestricted cash held directly by the Company at
September 30, 2006 is insufficient to fund the Companys operations for the next year and will necessitate additional cash funding no later than the first quarter of 2007 to continue its operations. As discussed in Note U to the condensed
consolidated financial statements, during the first quarter of 2007, the Company completed the sale of 1,280,000 shares of its common stock at a price of $5.00 per share, exclusive of warrants, resulting in the Company having sufficient cash
available to fund the Companys operations for the upcoming year.

Cash flows from the UK operations are sufficient to support their operations, but
restrictions under their financing arrangements limit or prohibit the distribution of cash to the Company.

While USEB has positive cash flows that enable
it to meet its normal operating needs, USEBs loan agreement with Countryside contains covenants that require USEB to set aside significant amounts from cash flow in various reserve accounts. Access to the funds in these accounts is restricted
by the terms of the loan agreement.

Effective on April 1, 2007, USEBs foreign currency hedge agreement which fixes the Canadian dollar to U.S.
dollar exchange rate expires. As USEB is required to make payments to Countryside in Canadian dollars, USEB will be subject to adjustments in debt service payments made to Countryside to reflect existing exchange rates upon the expiration of the
existing hedging arrangement. While USEB is required to hedge at least 75% of its future debt service payments to Countryside, any new hedging arrangement will result in an adjustment to the amount of U.S. dollar debt service payments made by USEB.
Based upon the exchange rate existing as of September 30, 2006, USEBs debt service payments to Countryside will increase by approximately $163,000 per month, to approximately $1,000,000 per month, beginning in April of 2007. This amount
is subject to fluctuations in the exchange rate. When the foreign currency hedge agreement expires at the end of March 2007, USEB may not have sufficient cash to satisfy its debt service payment obligations and to continue its operations without
access to a portion of the funds held in the various restricted cash accounts that are required by the financing arrangements with Countryside. Management is actively engaged in negotiations with USEBs lender to restructure their loan
arrangements but no assurance can be made that they will be successful. See Note U.

The financing arrangements between Countryside and the USEB projects
require these projects to maintain various restricted cash accounts, which, as of September 30, 2006, amounted to $33,498,000 including $27,866,000 classified as a long-term asset. These funds are presented as a long-term asset as they are
being reserved to retire the long-term Illinois Subsidy Liabilities as they become due. See Note U.

The financing arrangement we entered into with respect
to the UK Transaction requires that GBGH set aside funds for various purposes, including maintenance and the Expansion. See Note D to the condensed



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consolidated financial statements. Management believes that the funds provided by the financing arrangements are sufficient for such purposes, including the
completion of the Expansion. Nonetheless, we agreed, pursuant to an equity support agreement, to provide additional funds to GBGH as follows: (i) £2.66 million (approximately $5 million based upon the exchange rate in effect on or
about August 7, 2006) no later than September 7, 2007 to cover certain of GBGHs maintenance expenses; (ii) to cover certain shortfalls in the reserve account for the Expansion; (iii) $20 million, less specified amounts,
upon default under specified financing arrangements; (iv) up to $4 million for certain breaches of warranties (or the discovery of certain negative information) arising with respect to the agreements pursuant to which we acquired the UK Assets;
(v) $20 million, if GBGH elects to extend the initial interest rate and currency hedge agreements which is due to expire on August 7, 2009; and (vi) if GBGH enters into one or more replacement interest rate and currency hedge
agreements, the amounts payable as an upfront fee or premium to the providers thereunder. The Companys ability to provide any such additional funds to GBGH is dependent on the Companys ability to raise additional capital.

The Countryside and UK Transaction financing arrangements generally limit or prohibit our principal cash generating subsidiaries from (i) making improvements or
expanding certain projects unless specified conditions are satisfied; and/or (ii) distributing funds to U.S. Energy Systems, Inc., at the parent company level. As a result of these limitations and the expenditures incurred in connection with,
among other things, the UK Transaction, we estimate that, at the parent company level, U.S. Energy Systems, Inc. will require additional funds for general corporate and working capital purposes no later than the first quarter of 2007. As discussed
in Note U to the condensed consolidated financial statements, during the first quarter of 2007, the Company completed the sale of 1,280,000 shares of its common stock at a price of $5.00 per share, exclusive of warrants, resulting in the Company
having sufficient cash available to fund the Companys operations for the upcoming year.

We anticipate that the funds required will be generated by
the raising of additional capital. However, as previously noted, our ability to raise additional capital is restricted by these financing arrangements which, among other things, limit our and our subsidiaries ability to issue equity, incur
debt or sell assets. In particular, the Silver Point financing arrangement prohibits the Company and its subsidiaries from incurring any further debt and requires U.S. Energy Systems, Inc., with certain exceptions, to prepay the Silver Point loan,
among other things, if we or our subsidiaries issue equity (provided that only 50% of the net proceeds in excess of the first $3 million from issuances of our equity is to be applied to reduce such loan). Further, Silver Point has the exclusive
right to arrange financing for us through December 2006. No assurance can be given that we will be able to obtain the necessary funding on acceptable terms.

Management has been actively seeking to raise additional capital. The Company has initiated discussions with potential participants but as of November 21, 2006, no commitments have been obtained nor can the obtaining of funding be
guaranteed. Management is also seeking bridge financing should working capital requirements necessitate such financing prior to obtaining additional capital. Our ability to raise additional funds is restricted by our financing arrangements. No
assurances can be given that the Company will be able to obtain the necessary funding on acceptable terms. If the Company is not successful in obtaining such funding, it would be required to curtail its corporate operations and there would be
substantial doubt about its ability to continue as a going concern. See Note U.

During the nine months ended September 30, 2006, cash used in
operating activities was $3,084,000, an increase of $2,692,000 from the $392,000 used in operating activities for the nine months ended September 30, 2005. The increase was due primarily to an increase in cash utilized in the UK operations.

Cash used in investing activities increased to $153,333,000 for the nine months ended September 30, 2006, compared to $798,000 of cash used in
investing activities for the nine months ended September 30, 2005, an increase of $152,535,000. This increase was primarily the result of expenditures related to the UK Transaction including $49,371,000 of deposits into restricted cash
accounts, the acquisition of $21,057,000 of various hedge agreements, $8,792,000 of debt issuance costs and $79,350,000 of gas field and power generation assets.



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Cash provided by (used in) financing activities increased to $148,706,000 for the nine months ended September 30,
2006, an increase of $150,123,000 from the $1,417,000 used in financing activities for the nine months ended September 30, 2005. The increase is primarily due to the financing of the UK acquisition offset by principal payments made on long term
debt and the payment of minority interest distributions related to the ownership of certain USEB projects.

CAUTIONARY STATEMENT RELATING TO FORWARD
LOOKING STATEMENTS

We may from time to time make written or oral forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements contained in our filings with the Securities and Exchange Commission and in our press releases. Forward-looking statements relate
to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by terms such as
anticipate, believe, could, estimate, expect, intend, may, plan, potential, should, strategy, will and
other words of similar meaning. The forward-looking statements are based on our beliefs, assumptions and expectations of future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations
can change as a result of many possible events or factors, not all of which are known to us or are within our control. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those
expressed in our forward-looking statements. In connection with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, we are hereby identifying important factors that could cause actual results and outcomes
to differ materially from those contained in any forward-looking statement made by or on our behalf. Such factors include, but are not limited to:



| |  |  | access to needed financing or refinancing on acceptable terms,
| | - |  | --------------------------------------------------------------



| |  |  | our ability to continue as a going concern,
| | - |  | -------------------------------------------



| |  |  | revisions in the initial estimates in the fair market value of the acquired assets,
| | - |  | -----------------------------------------------------------------------------------



| |  |  | failure to realize the estimated savings or operating results of the acquisition, and other risks associated with acquisitions generally, including risks relating
to managing and integrating acquired businesses,
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in market conditions,
| | - |  | -----------------------------



| |  |  | the impact of competition,
| | - |  | --------------------------



| |  |  | changes in local or regional economic conditions, and the amount and rate of growth in expenses,
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | dependence on management and key personnel,
| | - |  | -------------------------------------------



| |  |  | changes in federal or state laws and their interpretation with respect to regulation, energy policy and other business issues,
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | the inability to commence planned projects in a timely manner,
| | - |  | --------------------------------------------------------------



| |  |  | our ability to continue our growth strategy, and
| | - |  | ------------------------------------------------



| |  |  | the ability to complete acquisitions
| | - |  | ------------------------------------

Additional
factors which may impact our business, prospects, operating results and financial condition are described under the caption Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2005. Any forward-looking
statement speaks only as of its date. We do not undertake to update any forward-looking statement that we may make from time to time.



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|ITEM 3: | Quantitative and Qualitative Disclosures about Market Risk
|------- | ----------------------------------------------------------

We are exposed to various types of market risk in the
normal course of our business, including the impact of interest rate changes, foreign currency exchange rate fluctuations, changes in equity investment prices and corporate tax rates and fluctuations in energy prices.

The Company has entered into derivative transactions as a hedge against these market risks. USEB has entered into a foreign currency hedge, as discussed in Note O to the
condensed consolidated financial statements to eliminate the impact of fluctuations in exchange rates on our Countryside debt service payments through March 31, 2007. GBGH has entered into various hedging and similar arrangements with respect
to gas and electricity prices, interest and currency rates and the price of carbon emission allowances. These hedging arrangements are further described in Note D to the condensed consolidated financial statements.



|ITEM 4: | Controls and Procedures
|------- | -----------------------

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined under Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) that
are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is
accumulated and communicated to our management, including our Chief Executive Officer and Chief Accounting Officer (the person who performs the functions of the Chief Financial Officer), as appropriate, to allow timely decisions regarding required
disclosure.

Pursuant to Rule 13a-15(b) under the Exchange Act, management, including our Chief Executive Officer and our Chief Accounting Officer, have
performed an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Accounting Officer concluded that our
disclosure controls and procedures remain effective. It has been determined by management that even though we are presenting unaudited restated consolidated financial statements for the quarter ended September 30, 2006, that the control procedures
were not deficient. The basis of the restatement is the result of a change in our interpretation and application of FASB 141 pertaining to a complex acquisition and not by a failure to follow any internal accounting policy. However, the Company is
aware that the restatement has not been made as promptly as it should have been. In order to improve the timeliness of its disclosure filings, the Company has and will continue to improve its disclosure controls and procedures through (i) the
ongoing installation of new, updated accounting software, (ii) the recently completed hiring of additional accounting staff, (iii) the planned hiring of additional internal staff and (iv) the execution of arrangements with independent specialists.

There have been no changes in our Companys internal controls or in other factors, which could significantly affect internal controls subsequent to
the date we carried out our evaluation.

Changes in Internal Controls

There has been no change in our internal control over financial reporting during the quarter ended September 30, 2006, that has materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.

PART IIOther Information

Item 1A:
Risk Factors

In addition to the information set forth in this report, and the risk factors discussed below, you should
carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The
risks described in our Annual Report on Form 10-K are not the only risks facing our Company.



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If we do not obtain USEBs guaranty of the Silver Point financing arrangements by December 31, 2006, an
event of default will occur under the financing agreements and we may be required to issue Rights to acquire 3,998,000 shares.

Our financing
arrangements with Silver Point provide that USEB, by December 31, 2006, must guaranty (the USEB Guaranty) the $23.3 million Silver Point financing. Otherwise, an event of default will occur under the terms of those financing
arrangements. Upon an event of default, Silver Point has the right to accelerate the payment of principal and interest under the agreements. In addition, if the guaranty is not timely provided, we are required to issue to Silver Point Rights to
acquire 3,998,000 shares (the Silver Point Shares). We need the consent of Cinergy Energy Solutions, Inc., our minority partner in USEB, and the Countryside Power Income Fund or its affiliates, to obtain this guaranty. We are involved in
litigation with the Countryside Fund and no assurance can be given that Cinergy or the Countryside Fund will consent to the issuance of the USEB Guaranty. The obligation to provide the guaranty was eliminated in December 2006 in connection with the
issuance of rights to acquire 1,100,000 shares of the Companys common stock.

Our stockholders may be diluted as a result of the issuance of
the Rights.

In connection with the UK Transaction and the related financing arrangements, we issued Rights allowing the issuance of up to 8,074,000
shares (subject to increase for the Silver Point Shares). Of these Rights (as well as the Rights to acquire the Silver Point Shares): (i) Rights to acquire 5,074,000 Shares are exercisable at an exercise price of $0.01 per share; and
(ii) the $0.01 exercise price of Rights to acquire 4,488,780 of these Shares will be reduced (and the number of shares to be issued will increase) on a weighted average basis if we issue common stock or rights to acquire common stock at a price
per share (the Trigger Price) below the greater of $3.00 or fair market value (as determined pursuant to the applicable Right). Your equity interests in U.S. Energy Systems, Inc. may be diluted as a result of these issuances and as a
result of the application of these anti-dilution adjustments. In the first quarter of 2007, the Company sold 1,280,000 shares of its common stock for $5.00 per share and issued 652,000 warrants, with each warrant exercisable in whole or in part at
any time for a period of five years following the date of issuance at an exercise price of $0.01 per share.

We require additional capital to fund
our general corporate and working capital requirements.

We estimate that at the parent company level, U.S. Energy Systems, Inc. will require
additional funds for general corporate and working capital purposes no later than the first quarter of 2007. As a result of limitations imposed by our various financing arrangements, funds for such purposes are generally not available from cash
flows generated by our subsidiaries, as such subsidiaries are restricted in their ability to make distributions to us. Our ability to raise additional funds is restricted by our financing arrangements which, among other things, limit our and our
subsidiaries ability to issue equity, incur debt or sell assets. In particular, the Silver Point financing arrangements prohibit U.S. Energy Systems, Inc. and its subsidiaries from incurring any additional debt and require us, with certain
exceptions, to prepay the Silver Point loan if, among other things, we or our subsidiaries issue equity (provided that only 50% of the net proceeds in excess of the first $3 million from issuances of equity by U.S. Energy Systems, Inc. is to be
applied to reduce such loan). Further, Silver Point has the exclusive right to arrange financing for us through December 2006. No assurance can be given that we will be able to obtain the necessary funding on acceptable terms. If the Company is not
successful in obtaining such funding, it would be required to curtail its corporate operations and there would be substantial doubt about its ability to continue as a going concern. In the first quarter of 2007, the Company sold 1,280,000 shares of
its common stock for $5.00 per share and issued 652,000 warrants, with each warrant exercisable in whole or in part at any time for a period of five years following the date of issuance at an exercise price of $0.01 per share.

The actual natural gas reserve acquired in the UK transaction may be below estimated quantities and the actual costs associated with location and extraction of the
gas may exceed current estimates.

The actual quantities of natural gas reserves acquired in the UK transaction and the costs associated with the
location and extraction of the natural gas, while based upon professional, third party engineering studies, may vary from estimates as they constitute future events which cannot be predicted with certainty. In the event the actual amounts of natural
gas fall below estimated quantities or the cost associated with the exploration and extraction of the gas exceed estimated costs, the net cash flow derived from the UK operations may be adversely affected.

Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may materially adversely affect our business, financial condition
and/or operating results.



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|Item 6: | Exhibits
|------- | --------



|              |  |   |  |                                                                                                                                                                                                                                                                                                  
|------------- |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  |   |  | Description                                                                                                                                                                                                                                                                                      
|3.1           |  | * |  | Second Amended and Restated Bylaws of U.S. Energy Systems, Inc.                                                                                                                                                                                                                                  
|              |  |  
|4.1           |  | * |  | Form of Series D Common Stock Purchase Warrant                                                                                                                                                                                                                                                   
|              |  |  
|4.2           |  | * |  | Form of Series E Common Stock Purchase Warrant                                                                                                                                                                                                                                                   
|              |  |  
|4.3           |  | * |  | Form of Series F Common Stock Purchase Warrant                                                                                                                                                                                                                                                   
|              |  |  
|4.4           |  | * |  | Form of Series G Common Stock Purchase Warrant                                                                                                                                                                                                                                                   
|              |  |  
|4.5           |  | * |  | Form of Series H Common Stock Purchase Warrant                                                                                                                                                                                                                                                   
|              |  |  
|4.6           |  | * |  | Form of Series I Common Stock Purchase Warrant                                                                                                                                                                                                                                                   
|              |  |  
|10.1          |  | * |  | First Lien Credit Agreement, dated as of August 7, 2006, among GBGH, LLC, the lenders party thereto, Credit Suisse, Cayman Islands Branch, as First Lien Collateral Agent and First Lien
Administrative Agent, and Credit Suisse Securities (USA) LLC, as Sole Lead Arranger and Sole Bookrunner.
|              |  |  
|10.2          |  | * |  | Second Lien Credit Agreement, dated as of August 7, 2006, among GBGH, LLC, the lenders party thereto, Credit Suisse, Cayman Islands Branch, as Second Lien Collateral Agent and Second Lien
Administrative Agent, Credit Suisse Securities (USA) LLC, as Sole Lead Arranger and Sole Bookrunner. 
|              |  |  
|10.3          |  | * |  | Equity Support Agreement, dated as of August 7, 2006, among U.S. Energy Systems, Inc., GBGH, LLC and Credit Suisse.                                                                                                                                                                              
|              |  |  
|10.4          |  | * |  | Credit and Guaranty Agreement, dated as of August 7, 2006, among US Energy Overseas Investments LLC, U.S. Energy Systems, Inc., various lenders and Silver Point Finance, LLC, as
Administrative Agent, Collateral Agent, Syndication Agent and Lead Arranger.                                   
|              |  |  
|10.5          |  | * |  | Second Amended and Restated Limited Liability Company Agreement, dated August 3, 2006, with respect to GBGH, LLC between US Energy Overseas Investments LLC and Marathon Capital Holdings (UK),
LLC.                                                                                             
|              |  |  
|10.6          |  | * |  | Amended and Restated Limited Liability Company Agreement, dated May 22, 2006, with respect to US Energy Overseas Investments LLC between U.S. Energy Systems, Inc. and VTEX Energy
Inc.                                                                                                          
|              |  |  
|10.7          |  | * |  | Amendment No. 1 to the Amended and Restated Limited Liability Company Agreement, dated as of August 1, 2006, with respect to US Energy Overseas Investments LLC, between U.S. Energy Systems,
Inc. and VTEX Energy Inc.                                                                          
|              |  |  
|31.1          |  |   |  | Rule 13a-14(a)/15d-14(a) certifications                                                                                                                                                                                                                                                          
|              |  |  
|31.2          |  |   |  | Rule 13a-14(a)/15d-14(a) certifications                                                                                                                                                                                                                                                          
|              |  |  
|32.1          |  |   |  | Section 1350 certification                                                                                                                                                                                                                                                                       

---

|* | Previously filed with the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed on November 21, 2006.
|- | --------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.

U.S. ENERGY SYSTEMS, INC.



|    |  |                                              |  |  |  |                   
|--- |  | -------------------------------------------- |  |  |  | ------------------
|By: |  | /s/ Asher E. Fogel                           |  |  |  |                   
|    |  | Asher E. Fogel                               |  |  |  | Dated: May 7, 2007
|    |  | Chief Executive Officer                      |  |  |  |                   
|    |  | (Principal Executive Officer)                |  |  |  |                   
|    |  |                                              | 
|By: |  | /s/ Richard J. Augustine                     |  |  |  |                   
|    |  | Richard J. Augustine                         |  |  |  | Dated: May 7, 2007
|    |  | Chief Accounting Officer                     |  |  |  |                   
|    |  | (Principal Accounting and Financial Officer) |  |  |  |                   



40