<PAGE>
================================================================================

                                  UNITED STATES

                        SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                             --------------------
                                  FORM 10-K/A
                               (Amendment No. 1)

              [x]    Annual Report Pursuant to Section 13 or 15(d)
                        of the Securities Exchange Act of 1934
                      FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996

                                       or

              [ ]   Transition Report Pursuant to Section 13 or 15(d)
                        of the Securities Exchange Act of 1934
                   For the transition period from _______ to _______

                          COMMISSION FILE NO. 0-21411

                             --------------------

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

                             --------------------

            DELAWARE                                       75-2658940
   (State or other jurisdiction of                      (I.R.S. Employer
    incorporation or organization)                     Identification No.)

            400 WEST ILLINOIS, SUITE 1000 MIDLAND, TEXAS  79701
           (Address of principal executive offices)    (Zip code)

                                (915) 683-3092
            (Registrant's telephone number, including area code)

    Securities registered pursuant to Section 12(b) of the Act:  None

        Securities registered pursuant to Section 12(g) of the Act:

    COMMON STOCK, $0.10 PAR VALUE              10 1/4% SENIOR NOTES DUE 2006
         (Title of Class)                             (Title of Class)

                             --------------------

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         NO   X*
                                -------    -------

     *The Registrant's Form 8-A was declared effective with the Securities 
and Exchange Commission on October 2, 1996.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 
405 of Regulation S-K is not contained herein, and will not be contained, to 
the best of registrant's knowledge, in definitive proxy or information 
statements incorporated by reference in Part III of this Form 10-K or any 
amendment to this Form 10-K. [ ]

The aggregate market value of the Common Stock held by non-affiliates, based 
upon the last sale price as quoted on the Nasdaq Stock Market's National 
Market of $13.00 per share on March 21, 1997, was $79,887,340.

Number of shares of Common Stock outstanding as of March 21, 1997 ... 10,476,500

DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Form 10-K will be included in 
the registrant's definitive Proxy Statement, which will be filed with the 
Commission not later than April 30, 1997 and which is incorporated herein by 
reference.

================================================================================
<PAGE>

                            COSTILLA ENERGY, INC.

                              TABLE OF CONTENTS

                                                                         PAGE
                                                                         ----
PART II.

Item 8.      Financial Statements and Supplementary Data.                 3

PART IV

Item 14.     Exhibits, Financial Statement Schedules and Reports on
             Form 8-K.                                                    4

SIGNATURES                                                                6


                                      2

<PAGE>

                                    PART I


              SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Form 10-K under "Item 1. Business," "Item 3. Legal 
Proceedings," "Item 7. Management's Discussion and Analysis of Financial 
Condition and Results of Operations," and elsewhere in this Form 10-K 
constitute "forward-looking statements" within the meaning of the Private 
Securities Litigation Reform Act of 1995 (the "Reform Act").  Such 
forward-looking statements involve known and unknown risks, uncertainties, 
and other factors which may cause the actual results, performance, or 
achievements of Costilla Energy, Inc. ("Costilla" or the "Company") to be 
materially different from any future results, performance, or achievements 
expressed or implied by such forward-looking statements.  Such factors 
include, among others, the following:  the volatility of oil and gas prices, 
the Company's drilling results and ability to replace oil and gas reserves, 
the availability of capital resources, the reliance upon estimates of proved 
reserves, operating hazards and uninsured risks, competition, government 
regulation, and the ability of the Company to implement its business 
strategy, and other factors referenced in the Company's recent prospectus for 
its initial public offering of common stock.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

For the financial statements and supplementary data required by this Item 8,
see the Index to Consolidated Financial Statements on page F-1 in this Form 
10-K/A.

                                       3
<PAGE>
                                    PART IV


ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

FINANCIAL STATEMENTS

For a list of the consolidated financial statements filed as part of this
Form 10-K, see the Index to Consolidated Financial Statements on page F-1.

REPORTS ON FORM 8-K

No reports on Form 8-K were filed during the quarter ended December 31, 1996.

EXHIBITS

Exhibit
 Number         Description of Exhibit
-------         ----------------------
  *3.1      Certificate of Incorporation of the Company
  *3.2      Bylaws of the Company
  *4.1      Form of Notes or Global Certificate (included as Exhibit A to the
            Indenture)
  *4.2      Indenture dated as of October 1, 1996 by and between State Street
            Bank and Trust Company, as Trustee, and the Company, as Issuer
 **4.3      Form of Stock Certificate
***10.1     Credit Agreement dated October 10, 1996 between NationsBank of
            Texas, N.A., as agent, the Lenders named therein and the Company
  *10.2     Lease Agreement dated January 12, 1996 between Independence
            Plaza, Ltd. and Costilla Energy, L.L.C.
  *10.3     Concession Agreement dated July 6, 1995 between the Government of
            the Republic of Moldova and Resource Development Company Ltd.,
            L.L.C. (DE)
  *10.4     Consolidation Agreement dated October 8, 1996
  *10.5     1996 Stock Option Plan
  *10.6     Outside Directors Stock Option Plan
  *10.7     Employment Agreement between the Company and Bobby W. Page
            effective June 30, 1996
  *10.8     Employment Agreement between the Company and Cadell S. Liedtke
            effective October 8, 1996
  *10.9     Employment Agreement between the Company and Michael J. Grella
            effective October 8, 1996
  *10.10    Employment Agreement between the Company and Henry G. Musselman
            effective October 8, 1996
  *10.11    Purchase and Sale Agreement dated April 3, 1995 by and between
            Parker & Parsley Development L.P., Parker & Parsley Producing
            L.P. and Parker & Parsley Gas Processing Co., as Seller, and
            Costilla Petroleum Corporation and Costilla Energy, L.L.C., as
            Purchaser
  *10.12    Purchase and Sale Agreement dated March 8, 1996 by and between
            Parker & Parsley Development L.P., Parker & Parsley Producing
            L.P. and Parker & Parsley Gas Processing Co., as Seller, and
            Costilla Petroleum Corporation and Costilla Energy, L.L.C., as
            Purchaser
  *10.13    Bonus Incentive Plan

                                       4

<PAGE>

 ***10.14    Letter Agreement dated December 18, 1996 by and between Statewide
             Minerals, Inc., as Seller, Boldrick Partners, as Buyer
 ***10.15    Stock Purchase Agreement dated December 31, 1996 by and between ERI
             Investments, Inc. and the Company
 ***12.1     Computation of Ratio of Adjusted EBITDA to Interest Expense
  **16.1     Letter Regarding Change of Accountants
 ***21.1     Subsidiaries of the Registrant
 ***23.1     Consent of KPMG Peat Marwick LLP
 ***23.2     Consent of Williamson Petroleum Consultants, Inc.
 ***23.3     Consent of Elms, Faris & Co., P.C.
 ***24.1     Power of Attorney
 ***24.2     Certified copy of resolution of Board of Directors of Costilla
             Energy, Inc. authorizing signature by Power of Attorney
****27.1     Financial Data Schedule

 *   Incorporated by reference to Registration Statement on Form S-1, File
     No. 333-08909
 **  Incorporated by reference to Registration Statement on Form S-1, File
     No. 333-08913.
 *** Previously filed
**** Filed herewith

FINANCIAL STATEMENT SCHEDULES

     No Financial Statement Schedules are required with this report.  For a list
     of the consolidated financial statements filed as a part of this report,
     see the Index to Consolidated Financial Statements on page F-1.

REPORTS ON FORM 8-K

     The Company did not file a report on Form 8-K during the last quarter of
     the period covered by this report.

                                       5

<PAGE>

                             S I G N A T U R E S

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

                            COSTILLA ENERGY, INC.

Date:  November 10, 1997       By: */s/ MICHAEL J. GRELLA
                                --------------------------------
                                Michael J. Grella
                                President
                                and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.

Date:  November 10, 1997      */s/ CADELL S. LIEDTKE
                                   --------------------------------
                                   Cadell S. Liedtke
                                   Chairman of the Board

Date:  November 10, 1997      */s/ MICHAEL J. GRELLA
                                   --------------------------------
                                   Michael J. Grella
                                   President and Chief Executive Officer
                                   and Director

Date:  November 10, 1997      */s/ HENRY G. MUSSELMAN
                                   --------------------------------
                                   Henry G. Musselman
                                   Executive Vice President,
                                   Chief Operating Officer 
                                   and Director

Date:  November 10, 1997      */s/ W. D. KENNEDY
                                   --------------------------------
                                   W. D. Kennedy
                                   Director


Date:  November 10, 1997      */s/ JERRY J. LANGDON
                                   --------------------------------
                                   Jerry J. Langdon
                                   Director

Date:  November 10, 1997       /s/ BOBBY W. PAGE
                                   --------------------------------
                                   Bobby W. Page
                                   Senior Vice President and Chief Financial
                                   Officer (principal accounting officer)

Date:  November 10, 1997   *By: /s/ BOBBY W. PAGE
                                   --------------------------------
                                   Bobby W. Page
                                   Agent and Attorney in fact

                                       6

<PAGE>



                    INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<S>                                                                                <C>
Financial Statements of Costilla Energy, Inc.:
  Independent Auditors' Reports . . . . . . . . . . . . . . . . . . . . . . . .   F - 2
  Consolidated Balance Sheets as of December 31, 1996 and 1995. . . . . . . . .   F - 4
  Consolidated Statements of Operations for the years ended December31, 1996,
       1995 and 1994. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   F - 5
  Consolidated Statements of Stockholders' Equity for the years
  ended December 31, 1996, 1995 and 1994. . . . . . . . . . . . . . . . . . . .   F - 6
  Consolidated Statements of Cash Flows for the years ended December 31, 1996,
        1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   F - 7
  Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . . . .   F - 8
</TABLE>




























                                      F-1

<PAGE>

                          INDEPENDENT AUDITORS' REPORT



The Board of Directors and Stockholders
Costilla Energy, Inc.:

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

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

In our opinion, the consolidated financial statements referred to above 
present fairly, in all material respects, the financial position of Costilla 
Energy, Inc. and subsidiaries as of December 31, 1996 and 1995, and the 
results of their operations and their cash flows for the years then ended, in 
conformity with generally accepted accounting principles.


                                       /s/ KPMG PEAT MARWICK LLP
                                       ---------------------------------
                                       KPMG PEAT MARWICK LLP

Midland, Texas
March 10, 1997







                                      F-2

<PAGE>


                         INDEPENDENT AUDITORS' REPORT



The Board of Directors and Stockholders
Costilla Energy, Inc.:

We have audited the accompanying consolidated statement of operations, 
stockholders' equity, and cash flows of the predecessor entities of Costilla 
Energy, Inc. and subsidiaries, as detailed in Note 1 to the consolidated 
financial statements, for the year ended December 31, 1994.  These 
consolidated financial statements are the responsibility of the Company's 
management.  Our responsibility is to express an opinion on these financial 
statements based on our audit.

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

In our opinion, the consolidated financial statements referred to above 
present fairly, in all material respects, the results of operations and the 
cash flows of Costilla Energy, Inc. and subsidiaries for the year ended 
December 31, 1994, in conformity with generally accepted accounting 
principles.


                                       /s/ ELMS, FARIS & CO., P. C.
                                       ------------------------------------
                                       ELMS, FARIS & CO., P. C.


Midland, Texas
March 31, 1995

















                                      F-3

<PAGE>

                             COSTILLA ENERGY, INC.

                          CONSOLIDATED BALANCE SHEETS
                                 (IN THOUSANDS)

<TABLE>
                ASSETS
                                                                      DECEMBER 31,
                                                                 ---------------------
                                                                     1996       1995
                                                                 ---------    --------
<S>                                                              <C>           <C>
CURRENT ASSETS:
  Cash and cash equivalents                                      $  12,618    $  2,866 
  Accounts receivable:
    Trade, net                                                       6,675       3,154 
    Affiliates                                                         332         507 
    Oil and gas sales                                                9,031       3,915 
  Prepaid and other current assets                                   1,753         439 
                                                                 ---------    --------
          Total current assets                                      30,409      10,881
                                                                 ---------    --------

PROPERTY, PLANT AND EQUIPMENT, AT COST:
  Oil and gas properties, using the successful efforts
   method of accounting:
    Proved properties                                              140,477      79,897 
    Unproved properties                                              4,482       2,903 
  Accumulated depletion, depreciation and amortization             (20,435)     (9,413)
                                                                 ---------    --------
                                                                   124,524      73,387 
  Other property and equipment, net                                  2,420         679
                                                                 ---------    --------
          Total property, plant and equipment                      126,944      74,066
                                                                 ---------    --------

OTHER ASSETS:
  Deferred charges (Note 2)                                          4,503       1,736 
  Note receivable - other                                              250         - 
  Note receivable - affiliate                                          684         684 
                                                                 ---------    --------
          Total other assets                                         5,437       2,420
                                                                 ---------    --------
                                                                 $ 162,790    $ 87,367
                                                                 ---------    --------
                                                                 ---------    --------

              LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
  Current maturities of long-term debt                           $      98    $    -  
  Trade accounts payable                                            12,718       5,467 
  Undistributed revenue                                              3,517       1,227 
  Other current liabilities                                          3,756       1,533 
                                                                 ---------    --------
          Total current liabilities                                 20,089       8,227 
                                                                 ---------    --------

LONG-TERM DEBT, LESS CURRENT MATURITIES  (NOTE 7)                  100,262      71,494 
                                                                 ---------    --------
DEFERRED REVENUE                                                       -         3,319 
                                                                 ---------    --------
OTHER NONCURRENT LIABILITIES                                         1,870         196 
                                                                 ---------    --------
REDEEMABLE PREDECESSOR CAPITAL                                         -        11,576 
                                                                 ---------    --------
STOCKHOLDERS' EQUITY (DEFICIT):
  Predecessor capital                                                  -        (7,445)
  Preferred stock, $.10 par value (3,000,000 shares authorized;
   no shares outstanding                                               -           -
  Common stock, $.10 par value (20,000,000 shares authorized;
   10,475,000 shares outstanding at December 31, 1996)               1,047         - 
  Additional paid-in capital                                        41,081         -  
  Retained earnings (deficit)                                       (1,559)
                                                                 ---------    --------
          Total stockholders' equity (deficit)                      40,569      (7,445)
                                                                 ---------    --------
COMMITMENTS AND CONTINGENCIES (NOTE 9)                                 -           -
                                                                 ---------    --------

                                                                 $ 162,790    $ 87,367 
                                                                 ---------    --------
                                                                 ---------    --------
</TABLE>

See accompanying notes to consolidated financial statements.


                                     F-4

<PAGE>

                             COSTILLA ENERGY, INC.

                   CONSOLIDATED STATEMENTS OF OPERATIONS

                    (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
                                                           YEARS ENDED DECEMBER 31,
                                                      ---------------------------------
                                                         1996         1995       1994
                                                      --------     --------    --------
<S>                                                   <C>           <C>         <C>
REVENUES:
  Oil and gas sales                                   $ 53,919     $ 21,693    $  7,637 
  Interest and other                                        40          123          87 
  Gain on sale of assets                                 1,067          -           112 
                                                      --------     --------    --------
                                                        55,026       21,816       7,836 
                                                      --------     --------    --------

EXPENSES:
  Oil and gas production                                21,325       10,024       2,349 
  Oil and gas production - affiliates                      449          331           2 
  General and administrative                             4,682        2,910         634 
  General and administrative - affiliates                  556          661         550 
  Compensation related to option settlement                -            656         -
  Exploration and abandonments                           2,550        1,652         793
  Depreciation, depletion and amortization              12,430        5,958       1,847 
  Interest                                              11,281        4,591       1,458 
                                                      --------     --------    --------
                                                        53,273       26,783       7,633 
                                                      --------     --------    --------

    Income (loss) before federal income taxes and
     extraordinary item                                  1,753       (4,967)        203 

PROVISION FOR FEDERAL INCOME TAXES
  Current                                                  176            3           8 
  Deferred                                               1,042          -            32 
                                                      --------     --------    --------
    Income (loss) before extraordinary item                535       (4,970)        163 
    Extraordinary loss resulting from early
    extinguishment of debt, net of the related 
    deferred tax benefit of $1,042 (Notes 5 and 7)      (4,975)         -           -
                                                      --------     --------    --------

NET INCOME (LOSS)                                     $ (4,440)    $ (4,970)   $    163 
                                                      --------     --------    --------
                                                      --------     --------    --------

PREFERRED RETURN, ACCRETION AND REDEMPTION 
 PREMIUM ON REDEEMABLE MEMBERS' CAPITAL               $ (3,930)    $ (2,842)   $    -
                                                      --------     --------    --------
                                                      --------     --------    --------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM
 APPLICABLE TO COMMON EQUITY                          $ (3,395)    $ (7,812)   $    163
                                                      --------     --------    --------
                                                      --------     --------    --------
NET INCOME (LOSS) APPLICABLE TO
 COMMON EQUITY                                        $ (8,370)    $ (7,812)   $    163
                                                      --------     --------    --------
                                                      --------     --------    --------

INCOME (LOSS) PER SHARE:
  Income (loss) before extraordinary item             $  (0.52)    $  (1.50)   $   0.03 
  Extraordinary loss resulting from
   early extinguishment of debt, net of
   deferred tax benefit                                  (0.77)         -           -
                                                      --------     --------    --------
  Net income (loss)                                   $  (1.29)    $  (1.50)   $   0.03 
                                                      --------     --------    --------
                                                      --------     --------    --------

WEIGHTED AVERAGE SHARES OUTSTANDING                      6,473        5,200       5,200 
                                                      --------     --------    --------
                                                      --------     --------    --------
</TABLE>

See accompanying notes to consolidated financial statements.

                                     F-5
<PAGE>
                                       
                             COSTILLA ENERGY, INC.


          CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                (IN THOUSANDS)


<TABLE>
                                                                                                   TOTAL
                                                                                               STOCKHOLDERS'
                                                                      ADDITIONAL   RETAINED     EQUITY AND
                                               PREDECESSOR   COMMON    PAID-IN     EARNINGS    PREDECESSOR
                                                 CAPITAL     STOCK     CAPITAL     (DEFICIT)     CAPITAL
                                               -----------   ------   ----------   --------    -------------
<S>                                              <C>         <C>      <C>          <C>            <C>
BALANCE AT DECEMBER 31, 1993 (PREDECESSOR)       $    51     $    -   $      -     $     -        $    51 
  Net income                                         163          -          -           -            163 
  Withdrawals                                       (961)         -          -           -           (961)
                                                 -------     ------   --------     -------        -------

BALANCE AT DECEMBER 31, 1994 (PREDECESSOR)          (747)         -          -           -           (747)

  Issuance of predecessor interest                 1,266          -          -           -          1,266 
  Issuance costs                                    (753)         -          -           -           (753)
  Net loss                                        (4,970)         -          -           -         (4,970)
  Withdrawals                                        (55)         -          -           -            (55)
  Imputed capital contribution on 
    settlement of option                             656          -          -           -            656 
  Preferred return and accretion of  
    redeemable predecessor capital                (2,842)         -          -           -         (2,842)
                                                 -------     ------   --------     -------        -------

BALANCE AT DECEMBER 31, 1995 (PREDECESSOR)        (7,445)         -          -           -         (7,445)

  Net loss                                        (2,881)         -          -      (1,559)        (4,440)
  Preferred return and accretion of  
    redeemable predecessor capital                (3,930)         -          -           -         (3,930)
  Common stock issued, net                             -        527     60,052           -         60,579 
  Distributions to members                        (4,218)                4,218           -              -
  Transfer of predecessor capital and  
    issuance of common stock pursuant
    to the Offerings                              18,474        520    (23,189)          -         (4,195)
                                                 -------     ------   --------     -------        -------

BALANCE AT DECEMBER 31, 1996                     $     -     $1,047   $ 41,081     $(1,559)       $40,569 
                                                 -------     ------   --------     -------        -------
                                                 -------     ------   --------     -------        -------
</TABLE>



         See accompanying notes to consolidated financial statements. 



                                      F-6
<PAGE>
                                       
                              COSTILLA ENERGY, INC.


                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (IN THOUSANDS)


<TABLE>
                                                           YEARS ENDED DECEMBER 31,
                                                      ---------------------------------
                                                        1996         1995        1994
                                                      ---------    --------    --------
<S>                                                   <C>          <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES: 

  NET INCOME (LOSS)                                   $  (4,440)   $ (4,970)   $    163

  ADJUSTMENTS TO RECONCILE NET INCOME 
    (LOSS) TO NET CASH PROVIDED BY 
    OPERATING ACTIVITIES:  
    Depreciation, depletion and amortization             12,430       5,958       1,847
    Exploration and abandonments                            491           -           -
    Amortization of deferred charges                      1,131         137           -
    Other noncash                                           103         (75)         35
    Compensation related to option settlement                 -         656           -
    Gain on sale of oil and gas properties               (1,067)          -        (112)
    Extraordinary loss resulting from early 
      extinguishment of debt                              6,017           -           -
                                                      ---------    --------    --------
                                                         14,665       1,706       1,933

    Changes in operating assets and liabilities: 
      Increase in accounts receivable                    (8,462)     (4,818)     (1,535)
      Decrease (increase) in other assets                (1,076)       (216)        301
      Increase in accounts payable                        6,067       3,745         723
      Increase in other liabilities                       4,475       2,655         102
      Increase (decrease) in deferred revenue            (3,319)      3,294           3
                                                      ---------    --------    --------
        Net cash provided by operating activities        12,350       6,366       1,527
                                                      ---------    --------    --------

CASH FLOWS FROM INVESTING ACTIVITIES:  

    Additions to oil and gas properties                 (67,010)    (61,500)    (11,819)
    Proceeds from sale of oil and gas properties          6,388           -         112
    Additions to other property and equipment            (3,007)       (720)        (49)
    Advances on notes receivable - other                   (500)          -           -
    Advances on affiliate notes receivable                    -        (247)       (390)
                                                      ---------    --------    --------
        Net cash used in investing activities           (64,129)    (62,467)    (12,146)
                                                      ---------    --------    --------

CASH FLOWS FROM FINANCING ACTIVITIES:  

    Borrowings under long-term debt                     228,707      62,704      11,579
    Payments of long-term debt                         (199,840)    (11,232)          -
    Proceeds from issuance of common stock, net          60,579           -           -
    Proceeds from redeemable predecessor capital              -      10,000           -
    Deferred loan and financing costs                    (8,191)     (2,587)          -
    Redemption of member's interest                     (15,506)          -           -
    Distributions to members and withdrawals             (4,218)        (55)       (961)
                                                      ---------    --------    --------
        Net cash provided by financing activities        61,531      58,830      10,618
                                                      ---------    --------    --------

NET INCREASE (DECREASE) IN CASH AND 
  CASH EQUIVALENTS                                        9,752       2,729          (1)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD            2,866         137         138
                                                      ---------    --------    --------
CASH AND CASH EQUIVALENTS, END OF PERIOD              $  12,618    $  2,866    $    137
                                                      ---------    --------    --------
                                                      ---------    --------    --------
</TABLE>


See accompanying notes to consolidated financial statements.    



                                      F-7
<PAGE>


                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1)  ORGANIZATION AND NATURE OF OPERATIONS

     Costilla was incorporated in Delaware in June 1996 to consolidate and 
continue the activities previously conducted by Costilla Energy, L.L.C., a 
Texas limited liability company (the "LLC"), and its wholly owned 
subsidiaries, to acquire the assets of CSL Management Corporation ("CSL") 
(which owns certain office equipment used by the Company), and to acquire the 
stock of Valley Gathering Company ("Valley").  Costilla was formed for the 
purpose of conducting a $60 million initial public offering of common stock 
and a $100 million senior notes offering (the "Offerings"), which Offerings 
were completed in early October 1996.

     At December 31, 1994, the financial statements of the LLC and its 
affiliates were combined.  The combining companies were owned by three 
individuals prior to the formation of the LLC.  Such individuals owned 
exactly the same proportionate interest in each of the combining companies 
prior to their combination into the LLC on February 14, 1995.  Each 
individual held exactly the same proportionate interest in the combining 
companies as was their proportionate interest in the LLC after its formation. 
Management believes, based on the exact same proportionate interests being 
held in the combining companies and the LLC before and after the date of its 
formation, that the combination lacks substance and is not the purchase of a 
minority interest.

     The LLC was formed on February 14, 1995 as the successor to CSL 
Partners, a Texas general partnership, which was organized on January 11, 
1989.  Subsequent to the formation of the LLC, NationsBank Capital 
Corporation ("NBCC") acquired a 30% interest in the LLC as described in Note 
12.  Contemporaneously with the closings of the Offerings: (1) the redeemable 
membership interests of NBCC in the LLC were redeemed for $15.5 million; (2) 
the LLC was merged into Costilla (the "Merger") and an aggregate of 5,200,000 
shares of Common Stock were issued to the members of the LLC; (3) Costilla 
acquired all of the issued and outstanding stock of Valley and the assets of 
CSL for $0.7 million; and (4) $4.2 million in distributions were made to the 
members of the LLC, $3.4 million of which was provided to former members for 
certain income tax effects of the Merger.  The LLC was an unincorporated 
association of several individuals and a corporation and ceased to exist on 
the date of the Offerings.

     The Company is an oil and gas exploration and production concern with 
properties located principally in West Texas, South Texas, and the Rocky 
Mountain regions of the United States.

(2)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     PRINCIPLES OF CONSOLIDATION

     As of December 31, 1996, the consolidated financial statements include 
the accounts of the Company and its wholly-owned subsidiaries.  The Company 
proportionately consolidates less than 100%-owned oil and gas partnerships 
and joint ventures in accordance with industry practice.  All significant 
accounts and transactions between the Company and its subsidiaries have been 
eliminated. 

     At December 31, 1996 Costilla had three wholly owned subsidiaries:  (i) 
Costilla Petroleum Corporation, a Texas corporation ("CPC"), which operated 
properties owned by Costilla and owned minor interests in the same 
properties, (ii)  Statewide Minerals, Inc., a Texas corporation 
("Statewide"), which had engaged in the purchase of small royalty and mineral 
interests; and (iii) Valley, which owns several small gas gathering systems, 
a small gas processing plant, certain salt water disposal systems and gas 
compressors.  Costilla and CPC were the sole members of two Texas limited 
liability companies through which the Company's Moldovan operations are 
conducted.


                                      F-8

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


USE OF ESTIMATES

     Preparation of the accompanying consolidated financial statements in 
conformity with generally accepted accounting principles requires management 
to make estimates and assumptions that affect the reported amounts of assets 
and liabilities and disclosure of contingent assets and liabilities at the 
date of the financial statements and the reported amounts of revenues and 
expenses during the reporting period.  Actual results could differ from those 
estimates.

     CASH AND CASH EQUIVALENTS

     For purposes of the statements of cash flows, cash and cash equivalents 
include cash on hand and depository accounts held by banks.

     CONCENTRATIONS OF CREDIT RISK

     Financial instruments that potentially expose the Company to 
concentrations of credit risk consist primarily of unsecured accounts 
receivable from unaffiliated working interest owners and crude oil and 
natural gas purchasers. During the year ended December 31, 1996, the Company 
had sales to one customer which accounted for 11.2% of total revenues.  
During the year ended December 31, 1995, the Company had sales to one 
customer which accounted for 17.7% of total revenues.

     TRADE RECEIVABLES

     Trade receivables generally consist of amounts due from outside working 
interest owners for their proportionate share of drilling and operating costs 
incurred by the Company, as operator of the related properties.

     HEDGING AND DERIVATIVE FINANCIAL INSTRUMENTS

     The financial instruments that the Company accounts for as hedging 
contracts must meet the following criteria:  the underlying asset or 
liability must expose the Company to price or interest rate risk that is not 
offset in another asset or liability, the hedging contract must reduce that 
price or interest rate risk, and the instrument must be designated as a hedge 
at the inception of the contract and throughout the contract period.  In 
order to qualify as a hedge, there must be clear correlation between changes 
in the fair value of the financial instrument and the fair value of the 
underlying asset or liability such that changes in the market value of the 
financial instrument will be offset by the effect of price or interest rate 
changes on the exposed items.

     Premiums paid for commodity option contracts and interest rate swap 
agreements which qualify as hedges are amortized to oil and gas sales and 
interest expense, respectively, over the terms of the agreements.  
Unamortized premiums are included in other assets in the consolidated balance 
sheet.  Amounts receivable under the commodity option contracts and interest 
rate swap agreements are accrued as an increase in oil and gas sales and a 
reduction of interest expense, respectively, for the applicable periods.  
When these derivative financial instruments cease to qualify as hedges, these 
instruments are classified as investments held for trading purposes.  
Investments held for trading purposes are marked to market at the end of each 
reporting period and the net balance change is recorded as other income in 
the consolidated statement of operations for the applicable period.

     OIL AND GAS PROPERTIES

     The Company uses the successful efforts method of accounting for oil and 
gas producing activities.  Costs to acquire mineral interests in oil and gas 
properties, to drill and equip exploratory wells that find proved reserves, 
and to drill and equip development wells are capitalized.  Costs to drill 
exploratory wells that do not find proved reserves, geological and 
geophysical costs, and costs of carrying and retaining unproved properties 
are expensed.


                                      F-9

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     Unproved oil and gas properties that are individually significant are 
periodically assessed for impairment of value, and a loss is recognized at 
the time of impairment by providing an impairment allowance.  Other unproved 
properties are amortized based on the Company's experience of successful 
drilling and average holding period.  Capitalized costs of producing oil and 
gas properties, after considering estimated dismantlement and abandonment 
costs and estimated salvage values, are depreciated and depleted by the 
unit-of-production method.  Support equipment and other property and 
equipment are depreciated over their estimated useful lives of the assets, 
which range from 5 to 7 years.

     Prior to the adoption of FAS 121 on January 1, 1995, the Company's 
aggregate oil and gas properties were carried at cost, not in excess of total 
estimated undiscounted future net revenues, on a worldwide basis.

     On sale or retirement of a complete unit of a proved property, the cost 
and related accumulated depreciation, depletion, and amortization are 
eliminated from the property accounts, and the resultant gain or loss is 
recognized.  On retirement or sale of a partial unit of proved property, the 
cost is charged to accumulated depreciation, depletion, and amortization with 
a resulting gain or loss recognized in income.

     On sale of an entire interest in an unproved property for cash or cash 
equivalent, gain or loss on the sale is recognized, taking into consideration 
the amount of any recorded impairment if the property had been assessed 
individually.  If a partial interest in an unproved property is sold, the 
amount received is treated as a reduction of the cost of the interest 
retained.

     IMPAIRMENT OF LONG-LIVED ASSETS

     As of January 1, 1995, the Company adopted the provisions of Statement 
of Financial Accounting Standards No. 121 - ACCOUNTING FOR THE IMPAIRMENT OF 
LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF ("FAS 121").  
Consequently, the Company reviews its long-lived assets to be held and used, 
including oil and gas properties accounted for under the successful efforts 
method of accounting, whenever events or circumstances indicate that the 
carrying value of those assets may not be recoverable.  An impairment loss is 
indicated if the sum of the expected future cash flows, on a depletable unit 
basis, is less than the carrying amount of such assets.  In this 
circumstance, the Company recognizes an impairment loss for the amount by 
which the carrying amount of the asset exceeds the fair value of the asset.

     DEFERRED CHARGES

     The Company capitalized certain costs incurred in connection with the 
issuance of $100 million of senior notes and with obtaining the 1996 Credit 
Facility (see Note 7 for definitions and descriptions of each).  These costs 
are being amortized over the lives of the related instruments.

     DEFERRED REVENUE

     In November 1995, the Company entered into gas sales agreements whereby 
it committed to delivery of a total of 2,379,000 MMbtu, from December 1, 1995 
through December 31, 1996, for a total fixed price of $3,429,610.  Income 
from such agreements is generally recognized in the period of delivery.

     REVENUE RECOGNITION

     The Company uses the sales method of accounting for crude oil revenues.  
Under this method, revenues are recognized based on actual volumes of oil 
sold to purchasers.

     The Company uses the entitlements method of accounting for natural gas 
revenues.  Under this method, revenues are recognized based on actual 
production of natural gas.  Natural gas revenues would not have been 
significantly altered in any period had the sales method of recognizing 
natural gas revenues been utilized.


                                      F-10

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     STOCK-BASED COMPENSATION

     The Company accounts for employee stock-based compensation using the 
intrinsic value method prescribed by Accounting Principles Board Opinion No. 
25, "Accounting for Stock Issued to Employees" ("APB 25").  Accordingly, the 
Company has only adopted the disclosure provisions of Statement of Financial 
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" 
("SFAS 123").  See Note 12 for the pro forma disclosures of compensation 
expense determined under the fair-value provisions of SFAS 123.

     INCOME TAXES

     The Company accounts for income taxes in accordance with the provisions 
of Statement of Financial Accounting Standards No. 109, "Accounting for 
Income Taxes" ("SFAS 109").  Under the asset and liability method of SFAS 
109, deferred tax assets and liabilities are recognized for the future tax 
consequences attributable to differences between the financial statement 
carrying amounts of existing assets and liabilities and their respective tax 
bases.  Deferred tax assets and liabilities are measured using enacted tax 
rates expected to apply to taxable income in the years in which those 
temporary differences are expected to be recovered or settled.  Under SFAS 
109, the effect on deferred tax assets and liabilities of a change in tax 
rate is recognized in income in the period that includes the enactment date.

     EARNINGS PER SHARE

     Primary net income (loss) per share is computed based on the weighted 
average number of shares of common stock and common stock equivalents 
outstanding during the period.  Primary net income (loss) per share is 
reduced by the preferred return, accretion and redemption premium on 
redeemable members' capital for the years ended December 31, 1996 and 1995.  
Common stock equivalent shares arising from stock options are computed using 
the treasury stock method.  There were no potentially dilutive securities, 
other than common stock equivalents.  Consequently, primary and fully diluted 
earnings per share do not differ.  For the periods prior to the Offerings, 
the weighted average shares outstanding attributable to predecessor capital 
are the 5,200,000 shares issued to the predecessor members upon conversion of 
the LLC.

     ENVIRONMENTAL

     The Company is subject to extensive Federal, state and local 
environmental laws and regulations.  These laws, which are constantly 
changing, regulate the discharge of materials into the environment and may 
require the Company to remove or mitigate the environmental effects of the 
disposal or release of petroleum or chemical substances at various sites.  
Environmental expenditures are expensed or capitalized depending on their 
future economic benefit.  Expenditures that relate to an existing condition 
caused by past operations and that have no future economic benefits are 
expensed.  Liabilities for expenditures of a noncapital nature are recorded 
when environmental assessment and/or remediation is probable, and the costs 
can be reasonably estimated.

     RECLASSIFICATIONS

     Certain reclassifications have been made to the 1995 and 1994 financial 
statements to conform to the 1996 presentation.

(3)  ACQUISITION OF OIL AND GAS PROPERTIES

     On June 14, 1996, the Company consummated the purchase from Parker and 
Parsley Petroleum Company of certain oil and gas properties for an estimated 
adjusted purchase price of approximately $38.7 million (the "1996 
Acquisition").  The properties are located primarily in south and west Texas. 
The transaction was accounted for using the purchase method.  The results of 
operations of the acquired properties are included in the Consolidated 
Statements of Operations as of the acquisition closing date, June 14, 1996.  
The Company sold for approximately $3.3 million its wholly-owned subsidiary, 
Costilla Pipeline Corporation, which owned the Three Rivers Pipeline 


                                      F-11

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


purchased in the 1996 Acquisition.  Certain other acquired properties, which 
were located outside the Company's areas of strategic focus, were sold in 
1996.  No gain or loss was recorded on these sales.

     In June 1995 the Company acquired a group of oil and gas properties from 
Parker and Parsley Petroleum Company for approximately $46.6 million (the 
"1995 Acquisition").  The properties are located in the Permian Basin, Gulf 
Coast and Rocky Mountain regions.  The transaction was accounted for using 
the purchase method.  The results of operations of the acquired properties 
are included in the Consolidated Statements of Operations as of the 
acquisition date of June 12, 1995. Certain other acquired properties, which 
were located outside the Company's areas of strategic focus, were sold in 
1995.  No gain or loss was recorded on these sales.

     PRO FORMA RESULTS OF OPERATIONS (UNAUDITED)

     The following table reflects the pro forma results of operations as 
though the 1995 Acquisition and 1996 Acquisition, net of the related 
properties sold, had occurred on January 1, 1995.  The pro forma amounts are 
not necessarily indicative of the results that may be reported in the future. 

                                                                YEARS ENDED
                                                                DECEMBER 31,
                                                              1996      1995
                                                            -------   --------
                                                              (IN THOUSANDS)
      Revenues. . . . . . . . . . . . . . . . . . . . . .   $64,251   $ 51,896
      Net loss before extraordinary item. . . . . . . . .    (4,830)   (14,227)
      Net loss per share before extraordinary item. . . .     (0.75)     (2.74)


(4)  IMPAIRMENT OF LONG-LIVED ASSETS

     The Company adopted FAS 121 effective as of January 1, 1995.  FAS 121 
requires that long-lived assets held and used by an entity, including oil and 
gas properties accounted for under the successful efforts method of 
accounting, be reviewed for impairment whenever events or changes in 
circumstances indicate that the carrying amount of an asset may not be 
recoverable. Long-lived assets to be disposed of are to be accounted for at 
the lower of carrying amount or fair value less cost to sell when management 
has committed to a plan to dispose of the assets.  All companies, including 
successful efforts oil and gas companies, are required to adopt FAS 121 for 
fiscal years beginning after December 15, 1995.

     In order to determine whether an impairment had occurred, the Company 
estimated the expected future cash flows of its oil and gas properties on a 
depletable unit basis and compared such future cash flows to the carrying 
amount of the related oil and gas properties to determine if the carrying 
amount was recoverable.  Based on this process, no writedown in the carrying 
amount of the Company's proved properties was necessary at December 31, 1996 
or 1995.

(5)  DERIVATIVE FINANCIAL INSTRUMENTS

     The Company utilizes derivative financial instruments to manage 
well-defined interest rate and commodity price risks.  The Company is exposed 
to credit losses in the event of nonperformance by the counterparties to its 
interest rate swap agreements and its commodity hedges.  The Company 
anticipates, however, that such counterparties will be able to fully satisfy 
their obligations under the contracts.  The Company does not obtain 
collateral or other security to support financial instruments subject to 
credit risk but monitors the credit standing of the counterparties.


                                      F-12

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

    COMMODITY HEDGES.  The Company utilizes option contracts to hedge the 
effect of price changes on future oil and gas production.  If market prices 
of oil and gas exceed the strike price of put options, the options will 
expire unexercised, therefore reducing the effective price received for oil 
and gas sales by the cost of the related option.

    The following table sets forth the future volumes hedged by year and the 
weighted-average strike price of the option contracts at December 31, 1996:

                                          OIL        GAS
                                         VOLUME     VOLUME      STRIKE PRICE
                                         (BBLS)    (MMBTU)      PER BBL/MMBTU
                                        ---------  ---------  ------------------
Oil:
  1997 . . . . . . . . . . . . . . . . .1,912,500          -  $16.52 - $20.65(a)
Gas:
  1997 . . . . . . . . . . . . . . . . .        -  1,500,000      $1.65(b)

-----------------------
(a) Represents the weighted-average price of a purchased put option contract 
    and of a collar established with the purchase of a put option contract and 
    the sale of a call option contract.
(b) Represents the strike price on a purchased put option contract.

    INTEREST RATE SWAP AGREEMENTS. Prior to the Offerings, the Company 
utilized two interest rate swap agreements to reduce the potential impact of 
increases in interest rates on floating-rate long-term debt.  Concurrent with 
the issuance of the $100 million of 10.25% fixed-rate senior notes in early 
October 1996, the two interest rate swap agreements ceased to be hedges.  
These interest rate swap agreements were marked-to-market and the related 
liability recorded.  The liability for the two interest rate swap agreements 
was $1,712,000 at December 31, 1996.  The average balance of this liability 
during the quarter ended December 31, 1996 was approximately $1,700,000.  
During the quarter ended December 31, 1996, the Company recorded investment 
losses of $207,300 on the interest rate swap agreements.  The following table 
sets forth the terms, fixed rates, and notional amounts of the interest rate 
swap agreements in place as of December 31, 1996:

                                   NOTIONAL
                                   PRINCIPAL          FIXED
            TERM                    AMOUNT        INTEREST RATE
--------------------------------   -----------    -------------
 Jan. 25, 1996 to Jan. 25, 1999    $24 million        7.50%
May 24, 1995 to May 27, 1997 (a)   $60 million        5.99%

-----------------------
(a)  Subject to extension until May 24, 1999 at the option of the
counterparty.

(6)  FAIR VALUE OF FINANCIAL INSTRUMENTS

     The following table presents the carrying amounts and estimated fair 
values of the Company's financial instruments at December 31, 1996 and 1995.  
FASB Statement No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL 
INSTRUMENTS, defines the fair value of a financial instrument as the amount 
at which the instrument could be exchanged in a current transaction between 
willing parties.

                                       F-13

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
                                                         1996                 1995
                                                 -------------------   ----------------
                                                 CARRYING    FAIR      CARRYING   FAIR
                                                  AMOUNT     VALUE      AMOUNT    VALUE
                                                 --------   --------   -------    -----
<S>                                              <C>        <C>        <C>        <C>
Financial Assets:                                             (IN THOUSANDS)
  Cash, cash equivalents and restricted cash. . .$ 12,618   $ 12,618   $ 2,866   $ 2,866
  Receivables (trade) . . . . . . . . . . . . . .   6,675      6,675     3,154     3,154
  Receivables (oil and gas sales) . . . . . . . .   9,031      9,031     3,915     3,915 
  Commodity option contracts. . . . . . . . . . .     592     (2,172)      165       555 
  Notes receivable -- affiliate . . . . . . . . .     684        542       684       684 
  Notes receivable -- other . . . . . . . . . . .     500        500         0         0
Financial liablilites:
  Payables (trade). . . . . . . . . . . . . . . .  12,718     12,718     5,467     5,467 
  Deferred revenue. . . . . . . . . . . . . . . .       -          -     3,319     2,950 
  Long-term debt. . . . . . . . . . . . . . . . . 100,262    105,512    71,494    71,494 
  Interest rate swap and option agreements. . . .   1,712      1,712       146    (2,970)
</TABLE>

    The carrying amounts shown in the table are included in the statement of 
financial position under the indicated captions.

    The following methods and assumptions were used to estimate the fair 
value of each class of financial instruments:

    CASH, TRADE RECEIVABLES, NOTES RECEIVABLE-OTHER AND TRADE PAYABLES:  The 
carrying amounts approximate fair value because of the short maturity of 
those instruments.

    COMMODITY OPTION CONTRACTS: The carrying amount comprises the unamortized 
premiums paid for the option contracts.  The fair value is estimated using 
option pricing models and essentially values the potential for the option 
contracts to become in-the-money through changes in commodity prices during 
the remaining terms.

    NOTES RECEIVABLE-AFFILIATE:  The amounts reported relate to notes 
receivable from an affiliated company.  The carrying amount reflects an 
estimate of net present value using an assumed annual interest rate of 9% 
based upon the anticipated note payment schedule.

    DEFERRED REVENUE:  The amounts reported relate to the gas purchase 
agreements described in Note 2.  The carrying amount represents the payments 
received under the agreements for which subsequent delivery is required.  The 
fair value is estimated based upon the commodity price at December 31, 1995 
for a similar agreement.

    LONG-TERM DEBT:  The fair value of the Corporation's long-term debt is 
based upon the quoted market price for this issue at December 31, 1996.

    INTEREST RATE SWAP AGREEMENTS:  At December 31, 1996, the Company had two 
interest rate swap agreements outstanding with an aggregate notional amount 
of $84 million.  These agreements are more fully described in Note 5.  The 
carrying amount is equal to the sum of the unamortized premiums paid for the 
agreements and the fair value.  The fair values of each of the open interest 
rate swap agreements were obtained from bank quotes and represent the 
estimated amount the Company would pay upon termination of the agreements at 
December 31, 1996, taking into consideration interest rates at that date. 

                                       F-14

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(7)  LONG-TERM DEBT

Long-term debt consists of the following (thousands):

                                               DECEMBER 31,
                                            -------------------
                                              1996       1995  
                                            --------   -------
     10 1/4% Senior Notes due 2006 . . . . .$100,000   $     - 
     Revolver Note . . . . . . . . . . . . .     100    59,824 
     Term notes. . . . . . . . . . . . . . .       -    11,670 
     Other notes payable . . . . . . . . . .     260         - 
                                            --------  -------- 
                                             100,360    71,494 
            Less current maturities. . . . .      98         - 
                                            --------  -------- 
                                            $100,262  $ 71,494 
                                            --------  -------- 
                                            --------  -------- 

    In October 1996, the Company issued $100 million aggregate principal 
amount of 10.25% Senior Notes due October 1, 2006 (the "Notes").  The notes 
were sold at par and interest is payable April 1 and October 1, commencing 
April 1, 1997.  The Notes may not be redeemed prior to October 1, 2001, and 
thereafter at a premium reducing to par, plus interest, by maturity.  There 
is no mandatory redemption of the Notes required prior to maturity. The notes 
are general unsecured senior obligations of the Company and rank equally in 
right of payment with all other senior indebtedness of the Company and senior 
in right of payment of all existing future subordinated indebtedness of the 
Company. The Notes are subject to an Indenture between the Company and a 
trustee.  The Indenture restricts, among other things, the Company's ability 
to incur additional indebtedness, pay dividends or make certain other 
restricted payments, incur liens, engage in any sale and leaseback 
transaction, sell stock of subsidiaries, apply net proceeds from certain 
assets sales, merge or consolidate with any other person, sell, assign, 
transfer, lease, convey or otherwise dispose of substantially all of the 
assets of the company, or enter into certain transactions with affiliates. 
Net proceeds from the sale of the Notes of approximately $96.1 million were 
used to repay existing indebtedness.

    In October 1996, the Company entered into a credit agreement (the "1996 
Credit Facility") with NationsBank of Texas, N.A. (the "Bank").  The 1996 
Credit Facility provides a revolving line of credit with the availability of 
funds and letters of credit being subject to a borrowing base determination 
at least semiannually. The borrowing base provides a maximum availability of 
$50.0 million (which amount is also the initial borrowing base), $100,000 of 
which was outstanding at December 31, 1996. Availability under the borrowing 
base is initially limited to $20.0 million for working capital and $30.0 
million for acquisitions of oil and gas properties meeting certain criteria 
established by the Bank.  Borrowings under the 1996 Credit Facility bear 
interest, at the Company's option, at a floating rate which is at or above 
the NationsBank, N.A. prime rate or the LIBOR rate, depending on the 
percentage of committed funds which have been borrowed.  Interest is payable 
quarterly and principal will be amortized in twelve equal installments 
commencing two years from the date of the credit agreement.  Under the 1996 
Credit Facility, the Company is obligated to pay certain fees to the Bank, 
including a commitment fee which ranges from 0.30% to 0.40% based on 
the unused portion of the commitment. The 1996 Credit Facility contains 
customary restrictive covenants (including restrictions on the payment of 
dividends and the incurrence of additional indebtedness) and requires the 
Company to maintain a current ratio of not less than 1.0 to 1.0, a ratio of 
Adjusted EBITDA to interest expense of not less than 2.0 to 1.0 and a minimum 
tangible net worth.  Borrowings under the 1996 Credit Facility are secured by 
substantially all of the assets of the Company and any subsidiary of the 
Company that guarantees the Company's obligations under the 1996 Credit 
Facility.  Initially, none of the Company's subsidiaries have guaranteed the 
Company's obligations under the 1996 Credit Facility.

    In June, 1996, the Company entered into a loan agreement with 
NationsBridge, L.L.C. to provide financing of up to $125 million ("Bridge 
Loan").  The proceeds of this Bridge Loan were used to finance the 1996 
Acquisition, to refinance the 1995 Credit Facility and for other general 
corporate purposes.  The Company 



                                      F-15

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


capitalized certain costs incurred in obtaining the Bridge Loan and amortized 
these costs over the estimated life of the Bridge Loan.  Concurrent with the 
Offerings, the $2,665,000 remaining unamortized balance of these deferred 
charges were expensed as an extraordinary item.

    In June, 1995, the Company entered into a Credit Agreement ("1995 Credit 
Facility") with a syndicate of banks to provide financing for an aggregate 
$185 million senior secured revolving line of credit ("Revolver Notes") and 
an aggregate $15 million in senior secured term notes ("Term Notes").  In 
June 1996, these notes in a total amount of $71,494,000 were paid off with a 
portion of the proceeds of the Bridge Loan.  The Company capitalized certain 
costs incurred in obtaining the 1995 Credit Facility and amortized these 
costs over the lives of the notes.  Concurrent with the Bridge Loan, the 
$1,640,000 remaining unamortized balance of these deferred charges were 
expensed as an extraordinary item.

    Maturities of long-term debt at December 31, 1996 are as follows 
(thousands):

     1997 . . . . . . . . . . . . . . . . . . $     98 
     1998 . . . . . . . . . . . . . . . . . .       62 
     1999 . . . . . . . . . . . . . . . . . .      101 
     2000 . . . . . . . . . . . . . . . . . .        - 
     2001 . . . . . . . . . . . . . . . . . .      100 
     Thereafter  . . . . . . . . . . . . . . . 100,000 

    The Company paid interest on long-term debt of $8,838,971, $4,453,684 and 
$1,356,604 in 1996, 1995 and 1994, respectively.

(8) INCOME TAXES

    Concurrent with the Offerings and upon consummation of the Corporate 
Reorganization, the Company became a tax paying entity for U.S. Federal 
income tax purposes.  At that date, the tax basis of the Company's assets and 
liabilities exceeded the book basis by approximately $3,500,000, resulting in 
a deferred tax asset of approximately $1,200,000.  A valuation allowance was 
provided for 100% of this deferred tax asset.

    Income tax provision (benefit), generated from $2,978,000 of net income 
before extraordinary item from the date of the Corporate Reorganization 
through December 31, 1996, and amounts separately allocated were 
as follows (thousands):

         Income (loss) before extraordinary item   $  1,218 
         Extraordinary loss resulting from early
           extinguishment of debt                    (1,042)
                                                   --------
                                                   $    176 
                                                   --------
                                                   --------

    The Company's effective tax rate does not differ materially from the U.S. 
Federal statutory rate.

                                       F-16


<PAGE>

                       COSTILLA ENERGY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     The tax effects of temporary differences that give rise to significant 
portions of deferred tax assets and deferred tax liabilities were as follows 
at December 31, 1996:

     Deferred tax assets:
       Net operating loss carryforwards                     $ 2,805 
       Interest rate swap agreements held
        for trading purposes                                    599 
                                                            -------
         Total gross deferred tax asset                       3,404 
                                                            -------
     Deferred tax liabilities:
       Oil and gas properties, principally due
        to differences in depletion and the 
        deduction of intangible drilling costs
        for tax purposes                                      1,692 
                                                            -------

     Net deferred tax asset                                   1,712 
     Valuation allowance of net deferred tax asset           (1,712)
                                                            -------
     Net deferred tax asset, net of valuation allowance     $     - 
                                                            -------
                                                            -------

     A valuation is provided for when it is more likely than not that some 
portion of the deferred tax assets will not be realized.  Due to uncertainties 
arising from a lack of earnings history and based on management's intentions 
to continue an aggressive drilling program (generating intangible drilling 
costs which are projected to create future losses for tax purposes), it does 
not appear more likely than not that the Company will be able to utilize all 
the available carryforwards prior to their ultimate expiration.

     At December 31, 1996, the Company had net operating loss carryforwards of 
approximately $8 million, which are available to offset future regular taxable 
income, if any.  The carryforwards expire December 31, 2011.

(9)  COMMITMENTS AND CONTINGENCIES

     LEASES

     The Company leases equipment and office facilities under operating leases 
on which rental expense for the years ended December 31, 1996, 1995 and 1994 
was $416,442, $311,221, and $197,533, respectively. Future minimum lease 
commitments under noncancellable operating leases at December 31, 1996 are as 
follows (thousands):

     1997...................................   $  275,695 
     1998...................................      273,943 
     1999...................................      260,324 
     2000...................................      233,880 
     2001...................................      286,850 
     Thereafter.............................    1,395,886 

     EMPLOYMENT AGREEMENTS

     During the period from June through October, 1996, the Company entered 
into employment agreements with four of its executive officers.  The 
employment agreements are each for three years and each will automatically 
renew for successive one-year periods thereafter unless the employee is 
notified to the contrary. These employment agreements provide for base annual 
salary levels totaling $990,000 for 1997.

                                     F-17
<PAGE>

                       COSTILLA ENERGY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     Each employee would receive his salary for the remaining term of the 
applicable employment agreement if the Company were to terminate such person's 
employment other than for cause.  If such person were to voluntarily leave his 
employment with the Company prior to the second anniversary of the employment 
agreement no further payments would be required.  With the exception of one of 
the Company's executive officers, if a voluntary termination were to occur 
after the second anniversary of the employee agreement, such person would be 
entitled to one year's salary from the date of termination. With the exception 
of one of the Company's executive officers, the employee agreements provide 
that the covered employee will not compete with the Company for a one year 
period following his voluntary cessation of employment or termination of 
employment for cause, in either case if such event occurs within the initial 
three-year term of the employee agreement.

EXPLORATION AND DEVELOPMENT

     In July 1995, the Republic of Moldova (located in Eastern Europe between 
Romania and the Ukraine) granted a Concession Agreement to Resource 
Development Company Limited, L.L.C. ("Redeco"), an entity not affiliated with 
the Company.  The Company paid Redeco $90,000 and agreed to bear the first 
$2.0 million of Concession expenses in return for a 50.0% interest in Redeco.  
Upon reaching the $2.0 million in 1996, Redeco elected, according to the 
agreement, to pay the Company for half of all amounts expended in excess of 
$750,000 plus interest.  The Concession Agreement covers the entire country 
with respect to oil and gas and other minerals and continues for various time 
periods depending on the nature of the activity conducted.  The Company has no 
material fixed financial commitments with respect to the Concession.  As of 
December 31, 1996, the Company's share of costs expended was $1,909,349.

     LETTERS OF CREDIT

     As a result of certain bonding and trade creditor requirements, the 
Company has caused irrevocable letters of credit to be issued by a bank 
totaling $96,000.  As of December 31, 1996, no amounts had been drawn on these 
letters of credit.

(10) 401(k) PLAN

     The Company has established a qualified cash or deferred arrangement 
under IRS code section 401(k) covering substantially all employees.  Under the 
plan, the employees have an option to make elective contributions of a portion 
of their eligible compensation, not to exceed specified annual limitations, to 
the plan and the Company has an option to match a percentage of the employee's 
contribution.  The Company has made matching contributions to the plan 
totaling  $58,713, $22,531, and $8,921 in 1996, 1995 and 1994, respectively.

(11) REDEEMABLE PREDECESSOR CAPITAL AND PREDECESSOR CAPITAL

     During 1995, NationsBanc Capital Corporation ("NBCC") contributed $10 
million in exchange for a 30% ownership interest in the Company including the 
preferential return described below.  Of this amount $1,266,000 was attributed 
to the non-redeemable portion of predecessor capital and $8,734,000 was 
attributed to redeemable predecessor capital.  Preferred return and accretion 
of predecessor capital included in the consolidated statements of operations 
and the consolidated statements of stockholders' equity includes accretion of 
the amount attributable to redeemable predecessor capital to $10,000,000 over 
a two year period beginning February 17, 1995.  As described below, the 
redemption amount was ultimately to be equal to $10,000,000 plus a preferred 
return and an additional redemption amount related to NBCC's redeemable 
interest not subject to preferential return.

     Concurrent with the Offerings, NBCC's membership interest was redeemed 
for a total of $15,506,614 and 936,000 common shares were issued to NBCC.  
After accounting for the Underwriter's exercise of its over-

                                     F-18
<PAGE>

                            COSTILLA ENERGY, INC.

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

allotment option in November 1996, NBCC owns 8.94% of the 10,475,000 common 
shares outstanding at December 31, 1996.  The following table details the 
redemption price paid to NBCC:

     NBCC Preferred Capital Contribution.................   $10,000,000 
     Preferred Return....................................     2,732,376 
                                                            -----------
     Adjusted NBCC Preferred Capital Contribution........    12,732,376 
     
     PLUS: 10% Redemption Premium........................     1,273,238 
     PLUS: Aggregate Redemption Price of NBCC's   
           Redeemable Unrestricted Common Units..........     1,500,000 
                                                            -----------
     Total Redemption Price Paid NBCC....................   $15,505,614 
                                                            -----------
                                                            -----------

     Redeemable predecessor capital was subject to a preferential return of 
15% per annum and was redeemable at any time at the Company's option, subject 
to a redemption premium as described below, or at NBCC's option on February 
17, 2003 or at an earlier date upon occurrence of certain events including a 
change in control, certain changes in management, a change in the Company's 
status as a limited liability company for tax purposes, or violation of any of 
various other restrictive provisions contained in the Regulations of Costilla 
Energy, Inc. (the "Regulations").  The 15% preferred return was treated as a 
reduction of predecessor capital.  The redemption price to be paid by the 
Company was equal to the initial amount received for the preferred units plus 
a premium, determined in the year the units are purchased, as follows:

       Year after               Premium
   February 17, 1995          Percentage
   -----------------          ----------
           1                      10%
           2                      10%
           3                      8%
           4                      6%
           5                      4%
           6                      2%
           7                      0%
           8                      0%

     In addition, a portion of NBCC's interest not subject to preferential 
return was classified as redeemable predecessor capital as the Company could 
have been be required to repurchase such interest upon the occurrence of 
certain events similar to those events requiring redemption of the redeemable 
predecessor capital described above and, in any event, on or after February 
17, 2000.  Such interest could have, at the Company's option, been repurchased 
to the extent the Company has exercised its right to redeem all or a portion 
of the redeemable members' interest subject to the preferential return.  The 
redemption price the Company would have paid in either instance would be 
determined by the year in which the predecessor capital was repurchased as 
follows:

                   Before                Aggregate 
                 February 17           Redemption Price
                 -----------           ----------------
                    1996                 $        1 
                    1997                  1,500,000 
                    1998                  3,000,000 
                    1999                  4,500,000 
                    2000                  5,500,000 

                                     F-19
<PAGE>

                            COSTILLA ENERGY, INC.

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     Prior to the Offerings in October 1996, the ultimate redemption price of 
$5,500,000 was being accrued ratably over the period from February 17, 1995 
through February 17, 2000 and was treated as a reduction of predecessor 
capital.

(12) STOCK-BASED COMPENSATION

     OUTSIDE DIRECTORS STOCK OPTION PLAN

     The Outside Directors Stock Option Plan provides for the issuance of 
stock options to the outside directors of the Company.  A total of 50,000 
shares has been authorized and reserved for issuance under the plan, subject 
to adjustments to reflect changes in the Company's capitalization resulting 
from stock splits, stock dividends and similar events.  Only outside directors 
are eligible to participate in the plan.  Outside directors are those 
directors of the Company who are not executive officers or regular salaried 
employees of the Company as of the date the Option is granted.  Under the 
plan, an option for 1,000 shares of Common Stock will be granted to each 
person who qualifies as an outside director each year that such person is 
elected as a director of the Company.  The exercise price of each option 
granted under the plan will be the fair market value (as reported on the 
Nasdaq National Market) of the Common Stock at the time the option is granted 
and may be paid either in cash, shares of Common Stock or a broker-assisted 
cashless transaction.  Each option will be exercisable immediately, and will 
expire ten years from the date of grant.  As of December 31, 1996, no options 
had been granted under this plan. 

     BONUS INCENTIVE PLAN

     The Company has adopted the Bonus Incentive Plan, concurrent with the 
Offerings.  The plan provides that the Board of Directors each year may award 
bonuses in cash, Common Stock, or some combination thereof, to those officers, 
directors, employees and advisors of the Company or a subsidiary of the 
Company, who the Board of Directors determines have contributed to the success 
of the Company.  A total of 150,000 shares of Common Stock has been authorized 
and reserved for issuance under the plan, subject to adjustments to reflect 
changes in the Company's capitalization resulting from stock splits, stock 
dividends and similar events.  All officers, directors, employees and advisors 
of the Company or a subsidiary of the Company who have completed a minimum of 
180 days of service and are employed or retained by the Company or such 
subsidiary on the last day of the plan year, other than such persons who own 
ten percent or more of the outstanding shares of the Common Stock during that 
year, are eligible to participate in the plan.  Bonus awards will be 
determined based upon a number of factors, including performance and salary 
level of the participant and the financial performance of the Company and its 
subsidiaries.  Bonuses will be awarded after review and upon approval of the 
Board of Directors, subject to the terms and conditions of the plan.  As of 
December 31, 1996, no shares of Common Stock have been issued pursuant to this 
plan.

     1996 STOCK OPTION PLAN

     The 1996 Stock Option Plan provides for the grant of both incentive stock 
options and non-qualifying stock options, as well as limited stock 
appreciation rights and supplemental bonuses, to the employees of the Company 
and its subsidiaries, including officers and  directors who are salaried 
employees. A total of 850,000 shares of Common Stock has been authorized and 
reserved for issuance under the plan, subject to adjustments to reflect 
changes in the Company's capitalization resulting from stock splits, stock 
dividends and similar events.  The plan is administered by the Board of 
Directors.  The Board of Directors has the sole authority to interpret the 
plan, to determine the persons to whom the options will be granted, to 
determine the basis upon which the options will be granted, and to determine 
the exercise price, duration and other terms of the options to be granted 
under the plan; provided that (a) the exercise price of each option granted 
under the plan may not be less than the fair market value of the Common Stock 
on the date the option is granted (and for incentive stock options, 110% of 
fair market value if the employee is the beneficial owner of 10% or more the 
Company's voting securities), (b) the exercise price must be paid in cash, by 
surrendering previously owned shares of Common Stock upon the exercise of the 
option or by a

                                     F-20

<PAGE>

                            COSTILLA ENERGY, INC.

                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

promissory note or broker-assisted cashless exercise approved by the Board of 
Directors, (c) the term of the option may not exceed ten years, and (d) no 
option is transferable other than by will, the laws of descent and 
distribution or pursuant to a qualified domestic relations order.  Limited 
stock appreciation rights may be granted under the plan with respect to 
specified options, allowing the option holder to receive, in cash, the 
difference between the exercise price and the market value in the event of a 
change in control of the Company.  The Board of Directors may also grant 
supplemental bonuses under the plan which are cash bonuses not to exceed the 
amount of income tax liability incurred by a plan participant upon the 
exercise of a non-qualifying stock option or a limited stock appreciation 
right with respect to which the bonus was granted.  The Board of Directors may 
amend without stockholder approval, in any respect other than any amendment 
that requires stockholder approval by law, and may modify any outstanding 
option, including the repricing of non-qualifying options, with the consent of 
the option holder.  There are currently approximately 100 employees who are 
eligible to participate in the plan.

     During 1996, the Company granted 711,750 stock options pursuant to the 
1996 Stock Option Plan, leaving 138,250 options available for future grant 
under the plan as of December 31, 1996.  The options granted during the year 
have a term of ten (10) years and an exercise price of $12.50 per share, a 
price equal to the market price on the date of the grant.  The fair value, as 
calculated under the provision of SFAS 123, of the options granted in 1996 was 
$6.73 per share.

     The Company applies APB 25 and related Interpretations in accounting for 
its stock option awards.  Accordingly, no compensation expense has been 
recognized for its stock option awards.  If compensation expense for the stock 
option awards had been determined consistent with SFAS 123, the Company's net 
loss and net loss per share, for the year ended December 31, 1996 would have 
been adjusted to the following pro forma amounts:

                     Net loss                  $(6,285,276)

                     Net loss per share        $     (1.58)

     The pro forma net loss and pro forma net loss per share amounts noted 
above are not likely to be representative of the pro forma amounts to be 
reported in future years.  Pro forma adjustments in future years will include 
compensation expense associated with the options granted in 1996 plus 
compensation expense associated with any options awarded in future years.  As 
a result, such pro forma compensation expense is likely to be higher than the 
levels reflected for 1996 if any options are awarded in future years.

     Under SFAS 123, the fair value of each stock option grant is estimated on 
the date of grant using the Black-Scholes option pricing model with the 
following weighted average assumptions used for grants in 1996:

       Risk-free interest rate           6.25%
       Expected life                   5 years
       Expected volatility                 54%
       Expected dividend yield              0%

(13) RELATED PARTY TRANSACTIONS

     Certain members and officers of the Company own interests in and hold 
positions with A&P Meter Service and Supply, Inc. ("A&P"), CSL, 511 Tex L.C. 
("511 Tex"), and Valley.

     Advances from the Company to A&P have been consolidated into two 
promissory notes.  The first note, which was originally executed December 31, 
1994, totals $390,000, including accrued interest of $20,000 at December 31, 
1996.  The note bears interest at a floating rate equal to the "prime rate" 
plus 1.0%.  No principal or interest payments are due until the maturity of 
the note at December 31, 2004.  The note is secured by a second lien on A&P's 
accounts receivable, inventory and equipment.  The second note is in the 
amount of $294,000,

                                     F-21

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


including accrued interest of $47,000, and is dated May 22, 1996.  The note 
bears interest at 6.0% per annum, is unsecured and is payable upon demand.  
During 1996, the Company paid $520,519 to A&P for goods and services 
provided. During 1995, the Company paid $612,139 to A&P for goods and 
services provided.

     During 1996, 1995 and 1994, the Company paid $517,352, $592,920 and 
$549,620, respectively, to CSL for management fees and lease payments on 
equipment.

     During 1996, the Company paid $50,742 to 511 Tex for office rent. During 
1995, the Company paid $67,896 to 511 Tex for office rent.

     During 1996, 1995 and 1994 the Company paid $484,000, $440,884 and 
$2,458, respectively, to Valley for gas compression and salt water disposal 
charges.  During 1996, Valley paid the Company $383,139 for operating costs 
of its salt water disposal wells and gas compressors.  During 1995, Valley 
paid the Company $109,399 for operating costs of its salt water disposal 
wells and gas compressors.

     On December 31, 1996, certain officers and related party entities owed 
the Company $321,310 plus accrued interest of $1,431. During March 
1997, the Company has received full payment for these amounts. 


     During 1996 and 1995 the LLC paid $75,000 each year to NationsBank 
Capital Corp. for management fees.  No management fees are due to NationsBank 
Capital Corp. for any period subsequent to the Offerings.

(14) SUBSEQUENT EVENTS

     On January 1, 1997 Costilla Petroleum Corporation was merged into its 
parent, Costilla Energy, Inc. and Costilla Energy, Inc. assumed the business, 
assets and liabilities of Costilla Petroleum Corporation.  The merger was 
effected for administrative purposes and to further reflect the Corporate 
Reorganization whereby business will be conducted through the Company rather 
than its predecessor, Costilla Energy, L.L.C.

     On March 1, 1997 Valley Gathering Company was merged into its parent, 
Costilla Energy, Inc. and Costilla Energy, Inc. assumed the business, assets 
and liabilities of Valley Gathering Company.  The merger was effected for 
administrative purposes and to further reflect the Corporate Reorganization 
whereby business will be conducted through the Company rather than its 
predecessor, Costilla Energy, L.L.C.

     On March 5, 1997 Statewide was dissolved.  This dissolution was effected 
for administrative purposes subsequent to the sale on December 31, 1996 of 
substantially all of the assets of Statewide for net proceeds of 
approximately $3.0 million.  The remaining unsold producing oil and gas 
property was transferred to its parent, Costilla Energy, Inc., on December 
31, 1996.

     On March 6, 1997, the Company sold its 40.5% interest in a Delaware 
limited liability company which owns and operates a gas pipeline and 
associated facilities in Louisiana.  This membership interest had been held 
for resale.  The Company sold its interest to another member of the limited 
liability company for $1,071,150.  This amount represented the Company's 
actual investment of $1,019,771 plus interest of $51,379 since the date of 
the Company's original investment in April, 1996.  The effective date of the 
sale was the date of the Company's original investment in April, 1996.  The 
Company received a cash payment of $918,184 on March 6, 1997.  In addition, 
the Company received a $152,966 note due in full on July 1, 1997 plus 
interest at 5.62%.


                                     F-22

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(15)  OIL AND GAS EXPENDITURES

     The following table reflects costs incurred in oil and gas property 
acquisition, exploration and development activities:

                                            YEARS ENDED DECEMBER 31,
                                         ------------------------------
                                           1996       1995        1994
                                         -------    -------     -------
                                                  (THOUSANDS)
    Property acquisition costs:
      Proved                             $39,505    $52,470     $ 9,649
      Unproved                               721      1,742       1,232
    Exploration                            6,760      5,627       2,167
    Development                           17,723        158           -
                                         -------    -------     -------

                                         $64,709    $59,997     $13,048
                                         -------    -------     -------
                                         -------    -------     -------



(16) SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED)

     The estimates of proved oil and gas reserves, which are located 
principally in the United States, were prepared by the Company as of December 
31, 1995 and 1994 and by Williamson Petroleum Consultants as of December 31, 
1996.  Reserves were estimated in accordance with guidelines established by 
the SEC and FASB which require that reserve estimates be prepared under 
existing economic and operating conditions with no provision for price and 
cost escalations except by contractual arrangements.  The Company has 
presented the reserve estimates utilizing an oil price of $24.17 per Bbl and 
a gas price of $3.96 per Mcf as of December 31, 1996 and an oil price of 
$17.79 per Bbl and a gas price of $2.03 per Mcf as of December 31, 1995.

     OIL AND GAS PRODUCING ACTIVITIES

     Oil and gas reserve quantity estimates are subject to numerous 
uncertainties inherent in the estimation of quantities of proved reserves and 
in the projection of future rates of production and the timing of development 
expenditures.  The accuracy of such estimates is a function of the quality of 
available data and of engineering and geological interpretation and judgment. 
Results of subsequent drilling, testing and production may cause either 
upward or downward revision of previous estimates.  Further, the volumes 
considered to be commercially recoverable fluctuate with changes in prices 
and operating costs.  The Company emphasizes that reserve estimates are 
inherently imprecise and that estimates of new discoveries are more imprecise 
than those of currently producing oil and gas properties.  Accordingly, these 
estimates are expected to change as additional information becomes available 
in the future.


                                      F-23

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


                                                      OIL AND         NATURAL 
                                                CONDENSATE (MBBLS)   GAS (MMCF)
                                                ------------------   ----------
Total Proved Reserves:
Balance, January 1, 1993 . . . . . . . . . . . .      1,985            16,418
  Revisions of previous estimates  . . . . . . .         57             1,160
  Extensions and discoveries . . . . . . . . . .        380               591
  Production . . . . . . . . . . . . . . . . . .       (158)             (865)
  Purchases of minerals-in-place . . . . . . . .        101             4,315 
                                                     ------           -------

Balance, December 31, 1993 . . . . . . . . . . .      2,365            21,619 
  Revisions of previous estimates  . . . . . . .       (460)           (5,424)
  Extensions and discoveries . . . . . . . . . .        761             1,520 
  Production . . . . . . . . . . . . . . . . . .       (330)           (1,600)
  Purchases of minerals-in-place . . . . . . . .      1,673            11,397 
                                                     ------           -------
                                                                  
Balance, December 31, 1994 . . . . . . . . . . .      4,009            27,512 
  Revisions of previous estimates  . . . . . . .       (570)              425 
  Extensions and discoveries . . . . . . . . . .        605             8,922 
  Production . . . . . . . . . . . . . . . . . .       (950)           (4,806)
  Purchases of minerals-in-place . . . . . . . .      7,694            46,099 
                                                     ------           -------
                                                                  
Balance, December 31, 1995 . . . . . . . . . . .     10,788            78,152 
  Revisions of previous estimates  . . . . . . .      1,782             5,440 
  Extensions and discoveries . . . . . . . . . .      1,169            13,581 
  Production . . . . . . . . . . . . . . . . . .     (1,726)           (9,205)
  Sales of minerals-in-place . . . . . . . . . .       (119)             (482)
  Purchases of minerals-in-place . . . . . . . .      5,106            32,786 
                                                     ------           -------

Balance, December 31, 1996   . . . . . . . . . .     17,000           120,272 
                                                     ------           -------
                                                     ------           -------
Proved Developed Reserves:
  January 1, 1993. . . . . . . . . . . . . . . .      1,488            10,055 
  December 31, 1993. . . . . . . . . . . . . . .      1,785            13,268 
  December 31, 1994. . . . . . . . . . . . . . .      2,632            16,340 
  December 31, 1995. . . . . . . . . . . . . . .      8,566            57,393 
  December 31, 1996. . . . . . . . . . . . . . .     14,018            90,023 



                                       F-24

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING
      TO PROVED OIL AND GAS RESERVES

     The standardized measure of discounted future net cash flows is computed 
by applying year-end prices of oil and gas (with consideration of price 
changes only to the extent provided by contractual arrangements) to the 
estimated future production of proved oil and gas reserves less estimated 
future expenditures (based on year-end costs) to be incurred in developing 
and producing the proved reserves, less estimated future income tax expenses 
(based on year-end statutory tax rates, with consideration of future tax 
rates already legislated) to be incurred on pretax net cash flows less tax 
basis of the properties and available credits, and assuming continuation of 
existing economic conditions.  The estimated future net cash flows are then 
discounted using a rate of 10% per year to reflect the estimated timing of 
the future cash flows.

     Discounted future cash flow estimates like those shows below are not 
intended to represent estimates of the fair value of oil and gas properties.  
Estimates of fair value should also consider probable reserves, anticipated 
future oil and gas prices, interest rates, changes in development and 
production costs and risks associated with future production.  Because of 
these and other considerations, any estimate of fair value is necessarily 
subjective and imprecise.

<TABLE>
                                                                    YEARS ENDED DECEMBER 31,
                                                              -----------------------------------
                                                                 1996         1995         1994
                                                              ---------    ---------     --------
                                                                          (THOUSANDS)
        <S>                                                     <C>            <C>         <C>
     Future cash flows . . . . . . . . . . . . . . . . . . .  $ 887,100    $ 350,653     $122,098
     Future costs:
       Production. . . . . . . . . . . . . . . . . . . . . .   (323,288)    (145,510)     (46,345)
       Development . . . . . . . . . . . . . . . . . . . . .    (25,469)     (16,806)      (7,157)
                                                              ---------    ---------     --------

     Future net cash flows before income taxes . . . . . . .    538,343      188,337       68,596
     Future income taxes . . . . . . . . . . . . . . . . . .    144,836            -            -
                                                              ---------    ---------     --------
     Future net cash flows . . . . . . . . . . . . . . . . .    393,507      188,337       68,596
     10% annual discount for estimated timing of 
      cash flows . . . . . . . . . . . . . . . . . . . . . .   (165,273)     (75,041)     (31,817)
                                                              ---------    ---------     --------
     Standardized measure of discounted net cash 
      flows. . . . . . . . . . . . . . . . . . . . . . . . .  $ 228,234    $ 113,296     $ 36,779
                                                              ---------    ---------     --------
                                                              ---------    ---------     --------
</TABLE>





                                       F-25

<PAGE>

                            COSTILLA ENERGY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


     CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS FROM 
      PROVED RESERVES (IN THOUSANDS)

<TABLE>
                                                                 YEARS ENDED DECEMBER 31,
                                                              -----------------------------
                                                                1996       1995       1994
                                                              --------   --------   -------
                                                                        (THOUSANDS)
        <S>                                                     <C>         <C>       <C>
     Increase (decrease):
       Purchase of minerals-in place . . . . . . . . . . . .  $ 49,966   $ 77,343   $15,231 
       Extensions and discoveries and improved
        recovery, net of future production and
        development costs. . . . . . . . . . . . . . . . . .    25,910      9,799     4,072 
       Accretion of discount . . . . . . . . . . . . . . . .    11,330      3,678     2,638 
       Net change in sales prices net of production
        costs. . . . . . . . . . . . . . . . . . . . . . . .   108,160     (3,422)      503 
       Changes in estimated future
        development costs. . . . . . . . . . . . . . . . . .     4,187     (2,419)      940 

       Revisions of quantity estimates . . . . . . . . . . .    29,485     (2,855)   (7,248)
       Net change in income taxes. . . . . . . . . . . . . .   (83,570)         -         - 
       Sales, net of production costs. . . . . . . . . . . .   (32,146)   (11,338)   (5,286)
       Sales of minerals in place. . . . . . . . . . . . . .    (1,330)         -         - 
       Changes of production rates (timing) and
        other. . . . . . . . . . . . . . . . . . . . . . . .     2,946      5,731      (448)
                                                              --------   --------   -------

         Net increase. . . . . . . . . . . . . . . . . . . .   114,938     76,517    10,402 

       Standardized measure of discounted future
        net cash flows:
          Beginning of period. . . . . . . . . . . . . . . .   113,296     36,779    26,377 
                                                              --------   --------   -------
          End of period. . . . . . . . . . . . . . . . . . .  $228,234   $113,296   $36,779 
                                                              --------   --------   -------
                                                              --------   --------   -------
</TABLE>


     The 1996 future cash flows shown above include amounts attributable to 
proved undeveloped reserves requiring approximately $24.6 million of future 
development costs.  If these reserves are not developed, the standardized 
measure of discounted future net cash flows for 1996 shown above would be 
reduced by approximately $44.4 million.






                                      F-26



<PAGE>

                               EXHIBIT INDEX

Exhibit
 Number         Description of Exhibit
-------         ----------------------
  *3.1      Certificate of Incorporation of the Company
  *3.2      Bylaws of the Company
  *4.1      Form of Notes or Global Certificate (included as Exhibit A to the
            Indenture)
  *4.2      Indenture dated as of October 1, 1996 by and between State Street
            Bank and Trust Company, as Trustee, and the Company, as Issuer
 **4.3      Form of Stock Certificate
***10.1     Credit Agreement dated October 10, 1996 between NationsBank of
            Texas, N.A., as agent, the Lenders named therein and the Company
  *10.2     Lease Agreement dated January 12, 1996 between Independence
            Plaza, Ltd. and Costilla Energy, L.L.C.
  *10.3     Concession Agreement dated July 6, 1995 between the Government of
            the Republic of Moldova and Resource Development Company Ltd.,
            L.L.C. (DE)
  *10.4     Consolidation Agreement dated October 8, 1996
  *10.5     1996 Stock Option Plan
  *10.6     Outside Directors Stock Option Plan
  *10.7     Employment Agreement between the Company and Bobby W. Page
            effective June 30, 1996
  *10.8     Employment Agreement between the Company and Cadell S. Liedtke
            effective October 8, 1996
  *10.9     Employment Agreement between the Company and Michael J. Grella
            effective October 8, 1996
  *10.10    Employment Agreement between the Company and Henry G. Musselman
            effective October 8, 1996
  *10.11    Purchase and Sale Agreement dated April 3, 1995 by and between
            Parker & Parsley Development L.P., Parker & Parsley Producing
            L.P. and Parker & Parsley Gas Processing Co., as Seller, and
            Costilla Petroleum Corporation and Costilla Energy, L.L.C., as
            Purchaser
  *10.12    Purchase and Sale Agreement dated March 8, 1996 by and between
            Parker & Parsley Development L.P., Parker & Parsley Producing
            L.P. and Parker & Parsley Gas Processing Co., as Seller, and
            Costilla Petroleum Corporation and Costilla Energy, L.L.C., as
            Purchaser
  *10.13    Bonus Incentive Plan
***10.14    Letter Agreement dated December 18, 1996 by and between Statewide
            Minerals, Inc., as Seller, Boldrick Partners, as Buyer

<PAGE>

 Exhibit
  Number         Description of Exhibit
 -------         ----------------------
 ***10.15    Stock Purchase Agreement dated December 31, 1996 by and between ERI
             Investments, Inc. and the Company
 ***12.1     Computation of Ratio of Adjusted EBITDA to Interest Expense
  **16.1     Letter Regarding Change of Accountants
 ***21.1     Subsidiaries of the Registrant
 ***23.1     Consent of KPMG Peat Marwick LLP
 ***23.2     Consent of Williamson Petroleum Consultants, Inc.
 ***23.3     Consent of Elms, Faris & Co., P.C.
 ***24.1     Power of Attorney
 ***24.2     Certified copy of resolution of Board of Directors of Costilla
             Energy, Inc. authorizing signature by Power of Attorney
****27.1     Financial Data Schedule

-------------------
 *   Incorporated by reference to Registration Statement on Form S-1, File
     No. 333-08909
 **  Incorporated by reference to Registration Statement on Form S-1, File
     No. 333-08913.
 *** Previously filed
**** Filed herewith