<PAGE>

                                                                  Exhibit 10.127

              Agreement To Exchange $0.9 Million Secured Notes Into
       Senior Preferred Stock of Penn Octane Corporation (the "Exchange")


Issuer:               Penn Octane Corporation ("POCC")

Purchaser:            Castle Energy Corporation (CEC), currently a holder of 
                      $1.0 Million Secured Notes of POCC (the "Notes") pursuant
                      to a Rollover and Assignment Agreement dated December 1,
                      1998.

The Transaction:      POCC will issue CEC 90,000 shares of its Senior Preferred 
                      Stock (the "Preferred Stock") at a price of $10.00 per
                      share (total value $0.9 million) in exchange for
                      cancellation of $0.9 Million of the Notes held by CEC.
                      After the transaction, CEC will still hold $.10 million of
                      the Notes, including any accrued and unpaid interest
                      thereon.

                      In addition to the issuance of the Preferred Stock, CEC
                      will also receive 50,000 shares of common stock of POCC.

                      In the event that POCC does not exercise its right to call
                      the Preferred Stock on or before September 3, 1999, then
                      CEC will be entitled to receive additional 50,000 shares
                      of common stock of POCC.

Dividend rate:        The holders of the Preferred Stock will receive a 12.0% 
                      annual cash or pay-in-kind dividend, payable
                      semi-annually.

Conversion Rate:      The holders of the Preferred Stock will be entitled at any
                      time to convert the Preferred Stock, all or in part,
                      including any accrued and unpaid dividends, into shares of
                      POCC Common Stock, at a conversion ratio of one share of
                      Preferred Stock for 4.0 shares of common stock of POCC.

Call Feature:         POCC may repurchases the Preferred Stock, all or in part, 
                      at any time, after providing 5 days written notice to CEC.
                      If during the 5 day period, CEC does not elect to convert
                      the Preferred Stock which is being called by POCC, all or
                      in part, then POCC may repurchase the requested amount of
                      Preferred Stock, for an amount equal to all principal and
                      accrued and unpaid dividends, less any portion which may
                      have been elected to be converted by CEC pursuant to
                      POCC's notice. POCC will be required to pay the amounts
                      required within 5 days from the expiration of the original
                      5 days written notice period provided to CEC. POCC is not
                      required to purchase any amount originally offered for
                      repurchase which subsequently is reduced due to CEC's
                      conversion of any portion of the Preferred Stock held by
                      CEC. In the event that POCC does not provide the funds as
                      prescribed herein, then POCC will be required to issue CEC
                      50,000 additional shares of common stock of POCC for each
                      month the payment is delayed.



<PAGE>


Term Sheet - Exchange Of Notes
Page 2 of 2
March 1, 1999


Collateral:           $0.9 Million of the Notes which are being exchanged shall
                      be released from any security and escrow agreements
                      previously entered into in connection with the Rollover
                      and Assignment Agreement.

Anti-Dilution:        Standard anti-dilution provision, including protection 
                      from stock splits, stock dividends and distribution of
                      assets.

Voting:               The Preferred Stock is non-voting.

Closing Date:         The exchange is effective as of March 3, 1999. Both 
                      parties agree to expedite the necessary paperwork related
                      to the issuance of the Preferred Stock and cancellation of
                      $0.9 million of the Notes.

Governing Law:        Should any portion of this agreement be deemed to be 
                      invalid, then the parties agree that the terms shall be
                      modified so that the intention of the parties is
                      maintained.


AGREED TO BY:
-------------

PENN OCTANE CORPORATION


---------------------------------------
Jerome B. Richter
Chairman of the Board,
  President and Chief Executive Officer


CASTLE ENERGY CORP.


---------------------------------------
Joseph Castle
Chairman of the Board,
  President and Chief Executive Officer