<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
                       ----------------------------------
                                   FORM 10-Q

    X    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
  -----  Exchange Act of 1934
         

         For quarterly period ended      September 30, 1996
                                   --------------------------------

                                       OR

  _____  Transition Report Pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934

         For the transition period from __________ to __________

                         Commission File No. 0-8232
                                             ------

                             MCFARLAND ENERGY, INC.
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)

           DELAWARE                                            95-2756635
----------------------------------                      ------------------------
 (State or other jurisdiction of                            (I.R.S. Employer
  incorporation or organization)                           Identification No.)
 
10425 SOUTH PAINTER AVENUE, SANTA FE SPRINGS, CALIFORNIA          90670
------------------------------------------------------------------------------- 
       (Address of principal executive offices)                 (Zip Code)
 
Registrant's telephone number, including area code    (310) 944-0181
                                                      --------------

                                     None
--------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last
report.

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 
                                 -----      -----       


APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

                                5,672,484 Shares

<PAGE>
 
                            McFarland Energy, Inc.        
                     Consolidated Statements of Operations
                                  (Unaudited)              

<TABLE>
<CAPTION>
                                             Three Months                  Nine Months       
                                            Ended Sept. 30,              Ended Sept. 30,     
                                        -----------------------     ------------------------- 
                                           1996         1995           1996           1995       
                                           ----         ----           ----           ---- 
<S>                                     <C>          <C>            <C>            <C>        
Revenues:                                                                                   
  Oil and gas                           $6,170,000   $5,003,000     $17,900,000    $14,333,000
  Interest and other                       126,000      101,000         343,000        343,000
  Gain on sale of assets                    89,000        5,000         683,000        124,000
                                        ----------   ----------     -----------    ----------- 
                                         6,385,000    5,109,000      18,926,000     14,800,000 
                                        ----------   ----------     -----------    ----------- 
Costs and expenses:
  Crude oil and gas production           2,023,000    1,710,000       5,571,000      5,195,000
  Exploration, including dry holes
     and abandonments                      304,000      291,000       1,042,000        974,000
  Depletion and depreciation             1,285,000    1,096,000       3,599,000      3,430,000
  General and administrative               542,000      496,000       1,913,000      1,660,000
  Litigation settlement                        ---          ---             ---    (17,158,000)
  Property impairments                         ---          ---             ---      5,515,000
  Interest                                  45,000      104,000         156,000        447,000
  Other                                        ---          ---          40,000        489,000
                                        ----------   ----------     -----------    -----------  
                                         4,199,000    3,697,000      12,321,000        552,000
                                        ----------   ----------     -----------    ----------- 
Income before income taxes               2,186,000    1,412,000       6,605,000     14,248,000
                                        ----------   ----------     -----------    ----------- 
Income taxes:
  Current                                  385,000          ---         455,000        212,000
  Deferred                                 315,000       86,000       1,531,000      1,796,000
                                        ----------   ----------     -----------    -----------
                                           700,000       86,000       1,986,000      2,008,000 
                                        ----------   ----------     -----------    ----------- 
Net income                              $1,486,000   $1,326,000     $ 4,619,000    $12,240,000
                                        ==========   ==========     ===========    ===========


Net income per common share             $     0.26   $     0.25     $      0.82    $      2.34
                                        ==========   ==========     ===========    ===========


Weighted average number of
  shares outstanding                     5,655,234    5,230,775       5,647,692      5,226,678
                                        ==========   ==========     ===========    ===========
</TABLE> 

                             (See notes following)

                                       2
<PAGE>
 
                             McFarland Energy, Inc.
                          Consolidated Balance Sheets
                                  (Unaudited)

<TABLE>                                                            
<CAPTION>                                                          
                                                          September 30,  December 31,
                                                          -------------  ------------
                                                              1996          1995     
                                                              ----          ----      
<S>                                                       <C>           <C>
ASSETS
------

Current Assets:
  Cash and short-term investments                         $ 7,944,000   $ 6,974,000
  Accounts receivable                                       4,152,000     4,026,000
  Crude oil inventory                                         260,000       259,000
  Materials and supplies inventory                            161,000       131,000
  Prepaids and other current assets                            86,000       610,000
  Deferred tax assets                                       1,588,000     1,588,000
                                                          -----------   ----------- 
         Total current assets                              14,191,000    13,588,000
                                                          -----------   ----------- 
 
  Property and Equipment                                   87,384,000    89,099,000
         Less accumulated depletion and depreciation       52,642,000    55,266,000
                                                          -----------   ----------- 
                                                           34,742,000    33,833,000
                                                          -----------   ----------- 
  Other Assets                                                155,000       272,000
                                                          -----------   ----------- 
                                                          $49,088,000   $47,693,000
                                                          ===========   ===========

LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
  Accounts payable                                       $ 2,047,000    $2,170,000
  Royalties and revenue payable                            1,613,000     1,345,000
  Income taxes payable                                           ---       283,000
  Other accrued liabilities                                  645,000     4,997,000
                                                         -----------   ----------- 
         Total current liabilities                         4,305,000     8,795,000
                                                         -----------   ----------- 
Convertible Note                                                 ---     2,600,000
                                                         -----------   ----------- 
Production Payment Notes                                   2,752,000     3,139,000
                                                         -----------   ----------- 
Deferred Income Taxes                                      2,295,000       764,000
                                                         -----------   ----------- 
Stockholders' Equity:
  Common stock, $1.00 par value                            5,665,000     5,239,000
  Additional paid-in capital                              21,228,000    18,932,000
  Retained earnings                                       12,843,000     8,224,000
                                                         -----------   -----------  
                                                          39,736,000    32,395,000
                                                         -----------   ----------- 

                                                         $49,088,000   $47,693,000
                                                         ===========   ===========
</TABLE> 

                             (See notes following)

                                       3
<PAGE>
 
                             McFarland Energy, Inc.
                     Consolidated Statements of Cash Flows
                                  (Unaudited)
                                        

<TABLE>
<CAPTION>
                                                           Nine Months Ended September 30,     
                                                           -------------------------------     
                                                                 1996           1995           
                                                                 ----           ----           
<S>                                                          <C>            <C>                 
CASH FLOWS FROM OPERATING ACTIVITIES:                                                          
 Net income                                                  $ 4,619,000     $ 12,240,000         
 Adjustments to reconcile net income to                                                        
  net cash provided by operating activities:                                                  
   Depletion and depreciation                                  3,599,000        3,430,000
   Dry holes, abandonments and impairments                       797,000        6,428,000         
   Deferred income taxes                                       1,531,000        1,796,000         
   Gain on sale of assets                                       (683,000)        (124,000)        
   Other                                                             ---          428,000         
   Change in assets and liabilities:                                                            
    Decrease (increase) in:                                                                        
     Receivables                                                (126,000)       1,110,000         
     Inventory                                                   (31,000)         (79,000)        
     Prepaids and other current assets                           524,000          631,000         
    Increase (decrease) in:                                                                        
     Accounts payable                                           (123,000)        (932,000)        
     Royalties and revenue payable                               268,000         (355,000)        
     Taxes payable                                              (283,000)             ---         
     Other accrued expenses                                       27,000         (674,000)        
                                                             -----------     ------------
                                                                                               
 NET CASH PROVIDED BY OPERATING ACTIVITIES                    10,119,000       23,899,000          
                                                             -----------     ------------

CASH FLOWS (USED IN) FROM INVESTING ACTIVITIES:
 Purchase of property and equipment, including dry holes      (5,515,000)      (6,650,000)
 Amounts included in accrued liabilities                      (4,379,000)             ---
 Proceeds from sales of property and equipment                   893,000          142,000
 Other                                                           117,000           44,000
                                                             -----------     ------------
 
 NET CASH USED IN INVESTING ACTIVITIES                        (8,884,000)      (6,464,000)
                                                             -----------     ------------

CASH FLOWS (USED IN) FROM FINANCING ACTIVITIES:
 Payments on debt                                               (387,000)     (13,645,000)
 Exercise of stock options                                       122,000           94,000
                                                             -----------     ------------

 NET CASH USED IN FINANCING ACTIVITIES                          (265,000)     (13,551,000)
                                                             -----------     ------------

 NET INCREASE IN CASH AND CASH EQUIVALENTS                       970,000        3,884,000

 Cash and cash equivalents at the beginning of the year        6,974,000        1,864,000
                                                             -----------     ------------

 CASH AND CASH EQUIVALENTS AT
  SEPTEMBER 30, 1996 AND 1995                                $ 7,944,000     $  5,748,000
                                                             ===========     ============

</TABLE> 

                             (See notes following)

                                       4
<PAGE>
 
                            McFarland Energy, Inc.
                    Notes to Unaudited Financial Statements
                              September 30, 1996

Note 1.  Statement from Management
-------  -------------------------

     The information furnished in this report reflects all adjustments which, in
the opinion of management, are necessary to present fairly the financial
position at September 30, 1996 and December 31, 1995 and the results of
operations for the three and nine months ended September 30, 1996 and 1995.


Note 2.  Principles of Consolidation
-------  ---------------------------

     The consolidated financial statements include the accounts of McFarland
Energy, Inc. and its wholly-owned subsidiary, Carl Oil & Gas Co. ("Company").
All intercompany accounts and transactions have been eliminated in
consolidation.  In December 1995, Carl Oil & Gas Co. was merged into McFarland
and all of the operational and administrative functions of Carl were assumed by
McFarland.


Note 3.  Settlement of Chevron Lawsuit
-------  -----------------------------

     On January 16, 1995, the Company announced that it had settled with Chevron
the lawsuit of McFarland Energy, Inc. v. Chevron U.S.A., Inc. (Case No.
               ----------------------------------------------          
BC023747) for the sum of $25,673,000. In September 1994, a Los Angeles Superior
Court jury trial awarded the Company compensatory and punitive damages totaling
$47,300,000.  On January 13, 1995, the Company and Chevron entered into a final
settlement agreement and funds in the amount of $25,673,000 were wired to the
Company on January 17, 1995.  Of the total settlement amount, $8,292,000 was
paid to the Company's outside attorneys and the Company incurred various other
costs totalling $223,000.  The net settlement amount of $17,158,000 was
recognized as a gain in the first quarter of 1995.


Note 4.  Property Impairments
-------  --------------------

     In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." This statement requires that long-lived assets be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. It establishes guidelines for determining
recoverability based on future net cash flows from the use of the asset and for
the measurement of the impairment loss. Impairment loss under SFAS No. 121 is
calculated as the difference between the carrying amount of the asset and its
fair value. Any impairment loss is recorded in the current period in which the
recognition criteria are first applied and met.

     Under the successful efforts method of accounting for oil and gas
operations, the Company periodically assessed its proved properties for
impairments by comparing the aggregate net book carrying

                                       5
<PAGE>
 
                            McFarland Energy, Inc.
                    Notes to Unaudited Financial Statements
                              September 30, 1996
                                  (Continued)

amount of all proved properties with their aggregate future net cash flows.  The
new statement requires that the impairment review be performed on the lowest
level of asset groupings for which there are identifiable cash flows.  In the
case of the Company, this results in a property by property impairment review.

     The Company adopted SFAS No. 121 in the first quarter of 1995, and
primarily as a result of significantly lower natural gas prices, recorded an
impairment loss on certain oil and gas properties totalling $4,765,000. In
addition, the Company wrote-off its investment in a natural gas marketing and
gas gathering company in the amount of $750,000. The impairment loss on the oil
and gas properties was calculated as the difference between the asset book
carrying amounts and future net cash flow projections, giving consideration to
recent prices, pricing trends and discount rates. These projections represented
the Company's best estimate of fair value based on the information available.

Note 5.  Credit Agreement
-------  ----------------

     On April 20, 1994, the Company entered into a new credit agreement with its
bank ("Credit Agreement") which consisted of a $5,000,000 unsecured revolving
line of credit facility and a $6,000,000 seven-year term loan facility.  On
September 20, 1994, the Company amended the Credit Agreement in order to finance
its acquisition of the Oak Hill Field, Rusk County, Texas properties.  The
amendment increased the revolving line of credit facility to $10,000,000 and
replaced the bank's offshore interest rate option with a LIBOR plus 1.5%
optional rate.  At the option of the Company, the interest rate on borrowed
funds is either the reference rate, a rate of interest publicly announced by the
bank; the fixed rate, the rate agreed upon between the Company and the bank; or
LIBOR plus 1.5%.  In January 1995, the Company repaid all of the outstanding
borrowing on the revolving line of credit.  At September 30, 1996, there was no
outstanding borrowing under this facility.

     The term loan credit facility consisted of a seven-year term loan up to
$6,000,000 and repayable over twenty-four successive quarterly equal
installments commencing on June 1, 1995.  The interest rate on borrowed funds
was either the bank's reference rate plus .5%, a negotiated fixed rate or LIBOR
plus 2%.  In conjunction with the acquisition of the Star Fee property, the
Company borrowed $6,000,000 under the term loan facility.  The term loan was
collateralized by two of the Company's principal crude oil producing properties.
In March 1995, the Company repaid all the outstanding borrowing under the term
loan facility.

     The Credit Agreement contains certain covenants which require maintenance
of minimum levels of net worth and working capital, maintenance of minimum or
maximum financial ratios, and certain limitations on the incurrence of liens or
encumbrances on the Company's assets.  The Company is required to pay a
quarterly commitment fee of .25% per annum on the unused portion of the
revolving credit.  There are no compensating balance requirements.

                                       6
<PAGE>
 
                            McFarland Energy, Inc.
                    Notes to Unaudited Financial Statements
                              September 30, 1996
                                  (Continued)

Note 6.  Production Payment Notes
-------  ------------------------

     On April 22, 1994, the Company issued $3,624,000 of 5% seven-year
production payment notes ("Notes") in conjunction with the Star Fee property
acquisition.  Interest payments are due quarterly, while monthly principal
payments occur when the average monthly crude oil selling price of the
property's production exceeds $12.00 per barrel.  When the monthly average
selling price is between $12.00 and $15.01 per barrel, the sum of the principal
payments will be equal to $1.00 per each net revenue barrel produced from the
property in that month.  When the monthly average selling price exceeds $15.00
per barrel, the sum of the principal payments will be equal to $2.00 per each
net revenue barrel produced from the property in that month.

     The Notes are due February 1, 2001.  The Company has the option to make the
final payment of the outstanding balance in either cash, Company common stock,
or a combination of both. The market value per share of common stock delivered
will be based on the average quoted closing price on the National Association of
Securities Dealers Stock Market System for the twenty trading days prior to
January 20, 2001.  The Notes are collateralized by one of the Company's
principal crude oil properties.

Note 7.  Convertible Note
-------  ----------------

     On January 4, 1993, the Company refinanced its previously issued
convertible notes with the issuance of a single $2,600,000 convertible note to
its largest institutional shareholder.  The note bore interest at 8% per annum
and was due January 4, 2003.  The terms of the new note called for quarterly
interest payments through January 4, 2003, or up to the date of conversion.  The
Company had the option of converting the note to its common stock at any time
after January 4, 1996 provided that the Company's common stock has been quoted
by the National Association of Securities Dealers at a weighted average price of
$6.50 per share, or higher, for at least nineteen out of twenty consecutive
business days.  This note was also convertible at the option of the note holder
at any time after January 4, 1994 at the rate of one share of the Company's
common stock for each $6.50 principal amount.  On January 29, 1996, the Company
converted the note into 400,000 shares of the Company's common stock.  Following
the conversion, the Company had a total of 5,639,234 common shares outstanding.

     The note was subordinate to any senior indebtedness incurred by the Company
and restricted the payment of dividends on common stock if there existed any
unpaid accrued interest.

Note 8.  Commitments and Contingencies
-------  -----------------------------

     The Company has certain contingent liabilities with respect to litigation,
claims, taxes, government regulations, and contractual agreements arising from
the ordinary course of business.  While there are always risks inherent in the
resolution of any contingency, it is the opinion of management that such
contingent liabilities will not result in any loss which would have an adverse
material effect on the Company's financial position.

     The Company is subject to other possible loss contingencies pursuant to
federal, state and local environmental laws and regulations.  These include
existing and potential obligations to investigate the

                                       7
<PAGE>
 
                            McFarland Energy, Inc.
                    Notes to Unaudited Financial Statements
                              September 30, 1996
                                  (Continued)

effects of the release of certain hydrocarbons or other substances at various
sites; to remediate or restore these sites; and to compensate others for damages
and to make other payments as required by law or regulation.  These obligations
relate to sites owned by the Company or others, and are associated with past and
present oil and gas operations.  The amount of such obligations is indeterminate
and will depend on such factors as the unknown nature and extent of
contamination, the unknown timing, extent and method of remedial actions which
may be required, the determination of the Company's liability in proportion to
other responsible parties, and the state of the law.

                                       8
<PAGE>
 
                            McFarland Energy, Inc.
                     Management's Discussion and Analysis
               of Financial Condition and Results of Operations

                        Liquidity and Capital Resources
                        -------------------------------

Liquidity
---------

     For the nine months ended September 30, 1996, net cash provided by
operating activities before changes in current assets and liabilities totalled
$9,863,000. This represented a 39% increase over the prior year after adjusting
for nonrecurring items in 1995. Significantly higher cash flow in 1996 reflects
record oil production, lower per unit lifting costs and higher oil and gas
prices.

     Companywide crude oil production for the nine month period in 1996 totalled
1,025,000 barrels, a 15% increase above the prior year. The continued growth in
oil production reflects the success of the Company's development drilling
program in the Midway Sunset field and the producing property acquisitions made
at the end of 1995. The Company completed a twenty-one (21) well development
drilling program in the second quarter of this year. The full benefit of this
program should continue to be realized over the remainder of the year.

     On April 17, 1996, the Company announced that the petroleum engineering and
consulting firm of Degolyer & MacNaughton ("D&M") had issued its report on an
evaluation of the Company's two core Midway Sunset field properties. D&M
estimated the proved reserves at these two properties to be 4.8 million net
barrels higher than previously estimated at December 31, 1995. After reflecting
these revised reserve estimates, the Company's barrel of oil equivalents ("BOE")
and pretax "SEC 10" value as of January 1, 1996 were 16.4 million BOE and $71
million, respectively. The adjustments to the year end 1995 figures represented
a 42% increase in quantities and a 19% increase in "SEC 10" value.

     Year to date natural gas production was 12% lower in 1996 at 1,476,000 mcf.
Lower gas production was primarily attributable to declining production at the
Company's California gas wells in the Northern San Joaquin Valley. In 1996, the
Company has drilled four (4) exploratory wells in the San Joaquin Valley, three
(3) of which were dry holes. The fourth well presently awaits hook-up. The
Company expects to drill at least two (2) more exploratory wells in this area in
the fourth quarter.

     The fundamentals of the West Coast crude oil market remain strong. The
posted price for the Company's predominate Midway Sunset field crude has risen
steadily throughout the third quarter to its current price level of $16.25 per
barrel. The higher prices will have a favorable impact on the fourth quarter;
however, it is uncertain just how long prices will remain at their present 
levels.

     The Company maintains a hedging arrangement with a local refiner that
covers approximately one-half of the Company's daily crude oil production. The
objective of the hedge is to ensure the Company an acceptable level of cash flow
from the sale of its crude oil. The hedge is a cost free "collar" based on
Midway Sunset field posted prices. In October of this year, the Company entered
into a new hedging agreement that reflected relatively higher prevailing Midway
Sunset field posted prices. All other terms were basically unchanged from the
previous agreement which expired on November 1, 1996. The new agreement extends
into the fourth quarter of 1997. Through the first nine months of 1996, the
hedging arrangement reduced the Company's revenues by $963,000.

                                       9
<PAGE>
 
                            McFarland Energy, Inc.
                     Management's Discussion and Analysis
               of Financial Condition and Results of Operations

                        Liquidity and Capital Resources
                        -------------------------------
                                  (Continued)

     Natural gas prices have remained well above 1995 levels. During the first
nine months of 1996, the Company's average natural gas selling price was $1.73
per mcf, or 44% higher than the 1995 average of $1.20 per mcf. While natural gas
prices throughout most parts of the country have been relatively strong, gas
prices in California have remained depressed for most of the year. However,
since the end of the third quarter, there has been a recent sharp increase in
California natural gas prices reflecting rising demand and tighter supplies.
Whether this condition will continue for an extended period, remains uncertain.

     In January 1996, the Company elected to convert its $2,600,000 8%
convertible note, which was held by a large public company, into 400,000 shares
of McFarland Energy, Inc. common stock. The conversion of the note will save the
Company $208,000 of interest expense annually.

     The Company maintains an unsecured $10,000,000 revolving line of credit
facility for producing property acquisitions. At September 30, 1996, there was
no outstanding borrowing. The Company believes that it has substantially greater
borrowing capacity in order to make a significant producing property
acquisition.

Capital Resources
-----------------

     Net working capital at September 30, 1996 totalled $9,886,000, up 106% from
the end of 1995. In addition, the current ratio has more than doubled during the
same period to 3.3 to 1. The sharp rise in these two key fundamental measures of
financial condition reflects the Company's strong 1996 operating performance.

     Capital expenditures in 1996 totalled $5,515,000. Producing property
acquisitions totalled $1,724,000 and consisted principally of the recent
acquisition of a non-operated working interest in the Rio Vista gas unit in
Sacramento Valley, California. Development activities totalled $2,418,000, while
exploration related activities totalled $939,000. Various other projects
accounted for $434,000.

     Development activities consisted primarily of the 1996 development drilling
program at the Midway Sunset field and surface facility enhancements. For 1996,
the Company's development program called for the drilling of twenty-one (21)
wells at a total cost of approximately $1,900,000. Drilling was completed in the
second quarter of the year.

     In 1996, exploration activities consisted of the drilling of four (4) wells
in the California San Joaquin Valley. Three (3) wells were dry holes, while the
fourth well was a discovery gas well that is presently awaiting hook-up. The
Company plans to drill at least two (2) additional exploratory wells in the
fourth quarter.

     The Company believes that it will be able to fund its remaining 1996
capital expenditure projects with its internally generated cash flow and
existing cash balances. However, should the need arise, it could utilize its
available revolving line of credit facility to fund its commitments.

                                       10
<PAGE>
 
                            McFarland Energy, Inc.
                     Management's Discussion and Analysis
               of Financial Condition and Results of Operations

                             Results of Operations
                             ---------------------
                 Nine Months Ended September 30, 1996 and 1995
                 --------------------------------------------- 

     For the nine months ended September 30, 1996, oil and gas revenues
increased 25% to $17.9 million from $14.3 million in the prior year. This
significant increase was primarily due to higher crude oil production and higher
crude oil and natural gas prices in 1996.

     Crude oil production for 1996 totalled 1,025,000 barrels, an increase of
15% over 1995. This significant increase was attributable to the success of the
Company's ongoing development drilling program in the Midway Sunset field of
California. Natural gas production decreased 12% to 1,476,000 mcf, reflecting
lower production from the Company's gas wells in the California Northern San
Joaquin Valley.

     The average crude oil price received in 1996, excluding the effects of the
hedge, increased 11% to $15.75 per barrel. In 1996, the hedge program decreased
revenues by $963,000 or $0.94 per barrel. In 1995, the hedge program decreased
revenues by $482,000 or $0.54 per barrel. Natural gas prices averaged $1.73 per
mcf in 1996, a 44% increase over the $1.20 per mcf received in 1995.

     Oil and gas production costs for 1996 totalled $5,571,000, which was 7%
higher than 1995. However, on a barrel of oil equivalent basis ("BOE"), the
average lifting cost dropped from $4.43 per BOE in 1995 to $4.38 per BOE in
1996.

     In May 1996, the Company sold its interest in a marginally economic oil
property in the Midway Sunset field to a third party for $543,500. As a result,
a gain on the sale of $525,000 was recognized in the second quarter of 1996.

     Exploration, dry holes and abandonment costs in 1996 totalled $1,042,000,
reflecting three dry holes drilled in the Northern San Joaquin Valley and
related leasehold write-offs. General and administrative expense increased 15%
to $1,913,000 in 1996 as a result of increased salaries and wages, higher
general corporate expense and higher costs related to the Company's ongoing
producing property acquisition efforts. Interest expense for 1996 declined to
$156,000 as a result of the conversion of the convertible note in January 1996
(See Note 7 of Notes to Unaudited Financial Statements).

     Higher income tax expense in 1996 reflects an effective tax rate of 30%.
This significant increase in the Company's tax provision was due primarily to
lower available levels of net operating loss and percentage depletion carryovers
in 1996.

     In the first quarter of 1995, the Company adopted the Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to be Disposed Of," which requires that
long-lived assets be reviewed for impairment on a property by property basis
(See Note 4 of Notes to Unaudited Financial Statements). In 1995, the Company
recorded an impairment loss of $4,765,000 on certain oil and gas properties and
a write-down of $750,000 on its investment in a natural gas marketing and gas
gathering company.

                                       11
<PAGE>
 
                            McFarland Energy, Inc.
                     Management's Discussion and Analysis
               of Financial Condition and Results of Operations

                             Results of Operations
                             ---------------------
                 Nine Months Ended September 30, 1996 and 1995
                 ---------------------------------------------
                                  (Continued)

  The litigation settlement in 1995 reflected the net proceeds of $17,158,000
received from the settlement of the Company's lawsuit with Chevron U.S.A., Inc.
in January 1995 (See Note 3 of Notes to Unaudited Financial Statements).

                                       12
<PAGE>
 
                            McFarland Energy, Inc.
                     Management's Discussion and Analysis
               of Financial Condition and Results of Operations

                             Results of Operations
                             ---------------------
                Three Months Ended September 30, 1996 and 1995
                ----------------------------------------------

  For the three months ended September 30, 1996, oil and gas revenues increased
23% to $6.2 million,  reflecting higher crude oil production and higher crude
oil and natural gas prices in 1996.

  Crude oil production in the third quarter of 1996 increased 10% to 346,000
barrels.  Higher crude production was attributable to the Company's continuing
successful development activities at its core properties in the Midway Sunset
field.  Natural gas production in the third quarter of 1996 was 563,000 mcf,
which was 9% lower than the same period in 1995.  This decrease was primarily
attributable to the declining production from the Northern San Joaquin Valley
and Oak Hill field operations.

  The average crude oil price received in the current quarter, excluding the
effects of the hedge, was $15.65 per barrel, or 12% higher than 1995.  The
effect of the hedge program in the current quarter decreased revenues by
$312,000 or $0.90 per barrel.  In 1995, the hedge program decreased revenues by
$133,000 or $0.42 per barrel.  Natural gas prices in 1996 increased 51% to $1.76
per mcf, as compared to $1.16 per mcf in the same quarter of 1995.

  Production costs in the third quarter of 1996 totalled $2,023,000, or an 18%
increase from 1995. On a barrel of oil equivalent basis, lifting costs
averaged $4.60 per BOE as compared to $4.10 per BOE in 1995. In 1996, production
costs reflected the producing property acquisition in Santa Barbara County, 
California at the end of 1995 and the Sacramento Valley, California acquisition 
in 1996.
 
  Higher depletion expense in the third quarter of 1996 reflected the
incremental depletion related to the 1995 and 1996 producing property
acquisitions in Santa Barbara County, California and in Sacramento Valley,
California.  Exploration costs of $304,000 in 1996 represented one dry hole
drilled in Kern County, California and various leasehold write-offs in the
Northern San Joaquin Valley and Sacramento Valley, California.  Interest expense
for the quarter dropped to $45,000 due to the conversion of the convertible note
in January 1996 (See Note 7 of Notes to Unaudited Financial Statements).

  Income tax expense in the current quarter reflects an effective rate of 32%.
This significant increase in the Company's tax provision was due primarily to
lower available levels of net operating loss and percentage depletion carryovers
in 1996.

                                       13
<PAGE>
 
                            McFarland Energy, Inc.
                                   Form 10-Q
                              September 30, 1996

                                    Part II


Item 6. Exhibits and Reports on Form 8-K
----------------------------------------

   (a)  Exhibits:             27      Financial Data Schedule



   (b)  Reports on Form 8-K:  none

                                       14
<PAGE>
 
                                  SIGNATURES


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

                                        McFARLAND ENERGY, INC.


Date:  November 12, 1996                /s/Ronald T Yoshihara
                                        ---------------------
                                        Ronald T Yoshihara
                                        Treasurer
                                        (Chief Financial Officer)



                                        /s/Eileen C. Sugita
                                        ---------------------
                                        Eileen C. Sugita
                                        Controller
                                        (Chief Accounting Officer)

                                       15