# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

Ocean
Energy, Inc. (the Company, OEI, or Ocean) is an independent energy company engaged in the exploration, development
and production of crude oil and natural gas. North American operations are
focused in the shelf and deepwater areas of the Gulf of Mexico, the Rocky
Mountains, Permian Basin, Arklatex, Anadarko, East Texas and the Gulf Coast
regions. Internationally, Ocean holds a leading position among U.S. independents
in West Africa with oil and gas activities in Equatorial Guinea, Angola and
Côte dIvoire. The Company also conducts operations in Egypt, the
Russian Republic of Tatarstan, Brazil, Pakistan and Indonesia.

The
Companys accompanying Consolidated Financial Statements contain detailed
information that should be referred to in conjunction with the following
discussion.

Results
Of Operations

Ocean
achieved its best ever annual financial performance in 2001. Growth in
production volumes and higher commodity prices during the first half of the year
contributed to net income of $274 million, or $1.53 per diluted share, an
increase of 29% from 2000 net income of $213 million, or $1.22 per diluted
share. In 2001, revenues from sales of natural gas and crude oil were $1.3
billion, an increase of $182 million, or 17%, over 2000.

Other
accomplishments included a 10% yearoveryear production increase. The
Companys production averaged 149 MBOE per day for 2001 compared to
2000s rate of 135 MBOE per day. Ocean ended the year with a 387% reserve
replacement rate and a finding and development cost of $5.52 per BOE.

Oil and Gas Operations(Amounts in Thousands)

|                                         | Year Ended December 31,
|---------------------------------------- | -----------------------
|                                        
|
|                                        
|Oil and Gas Operations:                  |                        
|Revenues:                                |                        
|Natural gas                              |                        
|Crude oil                                |                        
|                                        
|                                         |                        
|Operating expenses                       |                        
|Depreciation, depletion and amortization |                        
|Impairment of oil and gas properties     |                        
|                                        
|Operating profit                         |                        
|Corporate                                |                        
|                                        
|Total Operating Profit                   |                        
|                                        

Revenues
 Ocean operates in highly competitive markets where energy prices
fluctuate significantly. As oil and gas prices fluctuate, so do the
Companys revenues, results of operations and cash flows. Natural gas
prices, which were at record levels at the beginning of 2001, declined steadily
throughout the year in response to the downturn in the economy, reduced
weatherrelated demand and record gas storage levels. Crude oil prices also
declined throughout 2001 as a result of the global economic downturn and
decreases in demand that were only partially offset by OPECs supply
constraints.

Natural
gas revenues increased $173 million, or 33%, to $699 million for the year ended
December 31, 2001, from $526 million for the year ended December 31, 2000. This
increase included

23

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

approximately
$53 million related to an increase in the average realized price for natural gas,
excluding the impact of financial derivatives. The average realized price for natural
gas, excluding the impact of financial derivatives, rose 9% to $4.18 per Mcf for 2001 as
compared to $3.85 for 2000. Although average realized gas prices were higher for 2001
than for 2000, the average realized price for natural gas, excluding the impact of
financial derivatives, was $2.32 for the fourth quarter of 2001. Since most of Oceans
gas reserves and production are in the United States, future natural gas prices will be
dependent primarily on the U.S. economic environment, weather patterns and other factors
affecting demand, and drilling levels related to supply enhancements.

Natural
gas revenues included an increase of $51 million due to an increase in
production. Daily natural gas production for 2001 was 443 MMcf, an increase of
9% from 2000 volumes. The increase was due primarily to successful results from
U.S. drilling activities and acquisitions of producing properties in Texas and
Louisiana during 2001. As drilling expenditures were curtailed in the second
half of the year in response to lower market prices for natural gas, gas
production rates declined in this period.

Gas
revenues were also positively impacted by the use of derivative financial
instruments that reduced the Companys exposure to declining gas prices.
Natural gas revenues for the year ended December 31, 2001, included a positive
net yearoveryear change of $69 million relating to the Companys use of derivative
financial instruments. The effect of derivative financial instruments on natural
gas revenues was $23 million for 2001 as compared to ($46) million for 2000.

Natural
gas revenues increased $182 million, or 53%, to $526 million for the year ended
December 31, 2000, from $344 million for the year ended December 31, 1999. This
increase was due to higher average natural gas prices. The average realized
price for natural gas, excluding the impact of financial derivatives, increased
74% to $3.85 per Mcf for 2000 as compared to $2.21 for 1999. Daily natural gas
production for 2000 was 407 MMcf, a decrease of 4% from 1999 volumes due
primarily to property sales. Natural gas revenues for 2000 included a reduction
of $46 million due to the impact of the use of derivative financial instruments.

Total
revenues from sales of crude oil remained relatively flat at $556 million for
2001 as compared to $547 million for 2000. Crude oil revenues for 2001 included
a price decline of approximately $111 million due to reduced average realized
prices for oil, excluding the impact of financial derivatives. Average realized
crude oil prices decreased 16% to $21.48 for 2001 compared to $25.51 for 2000. The average realized price for crude oil,
excluding the impact of financial derivatives, was $17.03 for the fourth quarter of 2001.
Future crude oil prices will depend primarily on global economic conditions and
the ability of OPEC to constrain production levels.

Crude
oil revenues grew approximately $70 million due to an 11% yearoveryear
increase in crude oil production. Daily production averaged 75.3 MBbl for 2001
as compared to 67.6 MBbl for 2000. Higher production volumes were attributable
to increased exploration and exploitation success from the Gulf of Mexico shelf
properties and the Zafiro field in Equatorial Guinea.

24

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

Oil
revenues for 2001 also included a positive net yearoveryear change of $50 million relating to
the Companys use of derivative financial instruments. The effect of
derivative financial instruments on oil revenues was ($34) million for 2001 as compared to ($84) million for 2000.

Oil
revenues increased $133 million, or 32%, to $547 million for the year ended
December 31, 2000, from $414 million for 1999. This increase was the result of
higher crude oil prices partially offset by lower oil production. The average
realized price for oil, excluding the impact of financial derivatives, increased
47% to $25.51 during 2000 compared to $17.38 for 1999. Daily oil production
decreased 9% to 67.6 MBbl in 2000 as compared to 73.9 MBbl for 1999 primarily
due to property sales. Crude oil revenues for 2000 were reduced by $84 million
because of the impact of financial derivatives.

Operating
Data (*)

|                                            | Year Ended December 31,
|------------------------------------------- | -----------------------
|                                           
|
|                                           
|Net Daily Natural Gas Production (Mcf):     |                        
|Domestic                                    |                        
|Côte d'Ivoire                               |                        
|Other International                         |                        
|                                           
|Total                                       |                        
|                                           
|Average Natural Gas Prices ($ per Mcf):     |                        
|Domestic                                    |                        
|Côte d'Ivoire                               |                        
|Other International                         |                        
|Weighted Average                            |                        
|Average Natural Gas Prices Including the    |                        
|Impact of Financial Derivatives ($ per Mcf) |                        
|                                            |                        
|Net Daily Oil and NGL Production (Bbl):     |                        
|Domestic                                    |                        
|Equatorial Guinea                           |                        
|Côte d'Ivoire                               |                        
|Egypt                                       |                        
|Other International                         |                        
|                                           
|Total                                       |                        
|                                           
|Average Oil and NGL Prices ($ per Bbl):     |                        
|Domestic                                    |                        
|Equatorial Guinea                           |                        
|Côte d'Ivoire                               |                        
|Egypt                                       |                        
|Other International                         |                        
|Weighted Average                            |                        
|Average Oil Prices Including  the           |                        
|Impact of Financial Derivatives ($ per Bbl) |                        

|(*) |  | All
price information excludes the impact of financial derivatives, unless otherwise stated.
|--- |  | --------------------------------------------------------------------------------------------

Total
production for 2001 was 54 MMBOE, a 10% increase over 2000. Average daily production for
the full year was 443 MMcf of gas and 75.3 MBbl of oil, or 149 MBOE per day. The Company
expects its production to increase during 2002 as a result of new production from the
deepwater Nansen and Boomvang fields in the Gulf of Mexico and continued exploitation in
the Zafiro field in Equatorial Guinea, net of anticipated declines in areas where the
Company has reduced its budgeted capital expenditures, such as in the U.S. onshore and
Gulf of Mexico shelf properties.

Total
production for 2000 was 50 MMBOE as compared to 53 MMBOE for 1999 due to natural declines
and property sales. Average daily production for the full year was 407 MMcf of gas and
67.6 MBbl of oil, or 135 MBOE per day.

Operating
Expenses  Total operating expenses increased $50 million, or 19%, to $307 million for
2001 from $257 million for 2000. Lease operating expense increased $37 million due
primarily to the 10% increase in production and increased workover expense. Total
production and ad valorem taxes increased $11 million, or 26%, from $55 million for 2001
as compared to $44 million for 2000 primarily due to increased

25

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

production,
higher sales prices and an increase in the tax rate for the State of Louisiana.

Total
operating expense per BOE increased 9% to $5.64 per BOE for the year ended December 31,
2001, compared to $5.18 for 2000, primarily due to a 15% increase in production and ad valorem taxes per BOE and
additional workover expense.

Total
operating expenses increased $18 million, or 8%, to $257 million for the year ended
December 31, 2000, from $239 million for 1999. Operating expenses per BOE increased 14% to
$5.18 per BOE for the year ended December 31, 2000, compared to $4.54 per BOE in 1999.
Substantially all of the increase per BOE in 2000 was attributable to increases in
production taxes resulting from higher realized oil and gas prices.

Depreciation,
Depletion and Amortization Expense  Total depreciation, depletion and amortization ("DD&A") expense
for oil and gas operations increased $39 million, or 13%, to $344 million for 2001 from
$305 million for 2000 due primarily to increased production. DD&A expense per BOE related
to oil and gas operations increased 3% to $6.33 per BOE for 2001 as compared to $6.15 per
BOE for 2000 primarily due to the effects of property acquisitions, higher estimated
future development costs and the geographic mix of production.

Total
DD&A expense for oil and gas operations decreased $5 million to $305 million for the year
ended December 31, 2000, from $310 million for 1999 primarily due to decreased production.
DD&A expense per BOE related to oil and gas operations rose 5% to $6.15 per BOE for the
year ended December 31, 2000, from $5.88 per BOE for 1999 primarily due to the effects of
property sales, the geographic mix of production and increased estimates of future
development costs.

Impairment
of Oil and Gas Properties  During the fourth quarter of 2000, the Company recognized an
impairment in the amount of $20 million related to the
discontinuance of exploration activities in the Republic of Yemen. During 1999, the
Company recorded impairments of oil and gas properties of $46 million related primarily
to the sale of its Canadian subsidiary and to the discontinuance of exploration
activities in Bangladesh and other international locations. The Company had no ceiling
test limitations in 2001, 2000 or 1999.

Corporate

Corporate
expenditures comprise general and administrative expenses and DD&A expense for
nonoil and gas assets.

General
and Administrative Expenses  General and administrative expenses increased $2 million,
or 7%, to $31 million for the year ended December 31, 2001, compared to $29 million for
2000. This increase was due primarily to increases in compensation costs and increased
charitable contributions benefiting victims of a natural disaster in Houston and the
September 11 attacks on New York City. On a per BOE basis, general and administrative
expenses declined to $0.56 per BOE for 2001 from $0.58 per BOE for 2000.

General
and administrative expenses increased $7 million, or 32%, to $29 million for the year
ended December 31, 2000, compared to $22 million for 1999. This increase was due primarily
to an increase in expense relating to compensation plans that are tied directly to the
market price of the Companys common stock.

The
Company capitalizes certain employeerelated costs that are directly attributable to oil
and gas operations. The Company capitalized costs of $58 million, $45 million and $41
million in 2001, 2000 and 1999, respectively.

DD&A 
DD&A expense for nonoil and gas assets was approximately $6 million, $6 million and $8
million for the years 2001, 2000 and 1999, respectively.

Other

Interest
Expense  Interest expense decreased $12 million, or 16%, to $63 million for the year
ended December 31, 2001, from

26

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

$75 million in
2000. This decrease was primarily the result of lower average borrowing rates achieved on
the Companys outstanding debt due to a refinancing of fixedrate debt and to a lower
average rate applicable to the Companys credit facility during 2001. In addition,
interest rate swaps relating to the Companys 7 5/8% and 7 7/8% senior notes reduced
interest expense by approximately $3 million in 2001.

Interest
expense decreased $31 million, or 29%, to $75 million for the year ended December 31,
2000, from $106 million in 1999. This decrease was the result of the Companys debt
reduction program undertaken in 1999 and the increase in the amount of interest
capitalized during 2000 ($44 million in 2000 as opposed to $41 million in 1999) due to
the increase in the level of capital expenditures.

The
Company capitalized interest expense of $45 million, $44 million and $41 million in 2001,
2000 and 1999, respectively.

Merger
and Integration Costs  Merger and integration costs of $3 million associated with the
merger of Ocean and Seagull Energy Corporation were recorded in the first quarter of 2000
and related primarily to severance costs. Merger and integration costs of $50 million
were recorded for the year ended December 31, 1999, and consisted primarily of severance
costs, the writeoff of certain costs relating to an information technology system and
compensation expense related to the vesting of restricted stock.

Income
Tax Expense (Benefit)  Income tax expense of $226 million relating to continuing
operations was recognized for the year ended December 31, 2001, compared to expense of
$165 million for the year ended December 31, 2000. Total income tax expense increased
primarily due to higher revenues and operating profit recognized in 2001. The effective
income tax rate was 45% for 2001 and 44% for 2000.

Income
tax expense of $165 million was recognized for the year ended December 31, 2000, compared
to a benefit of $0.1 million for the year ended December 31, 1999. The change in the
income tax provision is primarily the result of three factors: (i) significant
improvement in operating results; (ii) changes in the nature of deferred tax assets and
liabilities due to the Seagull merger and subsequent asset sales; and (iii) the relative
significance of international operating results and taxes to the Companys total results
of operations.

Dividends
 Quarterly stock dividends, which were first declared in December 2000, continued for
each quarter of 2001. The Company declared cash dividends on common stock totaling
approximately $27 million during 2001. The amount of future dividends for OEI common
stock will be determined on a quarterly basis and will depend on earnings, financial
condition, capital requirements and other factors.

Liquidity
and Capital Resources

Liquidity
 One of managements goals has been to reduce the Companys longterm debt levels,
resulting in a lower debt to capitalization ratio and reduced interest expense. The
Company has lowered its debt to total capitalization ratio significantly since 1999 and
has maintained that lower ratio during 2001 even with increased capital spending. The
Companys debt to total capitalization ratio was 47% at both December 31, 2001, and
December 31, 2000, 58% at December 31, 1999, and 68% at the date of the Seagull merger.
With cash flows attributable to asset sales, prepaid oil and gas sales, higher commodity
prices and disciplined capital spending, the Company has reduced its longterm debt from
a total of nearly $2 billion to $1.3 billion at December 31, 2001. The Company achieved
investment grade status from Standard & Poors and from Moodys Investor Services during
2000 and early 2001, respectively.

In
addition, the Company has successfully taken advantage of favorable market conditions to
repurchase some of its higher interest rate debt and replace it with lower rate debt,
thereby achieving a lower average interest rate for its longterm debt.

Debt
Issuances and Repurchases  During 2001, the Company publicly issued $350 million of 71⁄4%
senior notes due 2011 pursuant to a shelf registration statement. The proceeds

27

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

were used to
repay amounts outstanding under the Companys credit facility and to retire existing
higher interest rate debt by exercising call provisions for the Companys 8 5/8% senior
subordinated notes due 2005, in the amount of $100 million, and 93⁄4% senior
subordinated notes due 2006, in the amount of $1.8 million.

Also
during 2001, the Company repurchased on the open market approximately $22 million of its
8 3/8% senior subordinated notes due July 2008 and $25 million of its 8 7/8% senior
subordinated notes due July 2007. The repurchase of these notes was funded with available
cash balances and borrowings under the Companys existing credit facility.

In
connection with the repurchase and the exercise of call provisions, the Company recorded
a total aftertax extraordinary loss of approximately $4 million, or ($0.02) per basic
and diluted share. The extraordinary loss is net of a current tax benefit of
approximately $2 million.

During
1999, the Company repurchased $150 million of its outstanding 10 3/8% senior subordinated
notes due 2005 and $158 million of its outstanding 93⁄4% senior subordinated notes due
2006. The repurchase of these notes was funded with available cash balances and
borrowings under the credit facility. In connection with this repurchase, the Company
recorded an aftertax extraordinary loss of $23 million, or ($0.16) per basic and diluted
share. The extraordinary item is net of a current tax benefit of approximately $13
million.

Credit
Facility  As of December 31, 2001, the Companys credit facility consisted of a $500
million revolving facility due in 2004. The credit facility bears interest, at the
Companys option, at LIBOR or prime rates plus applicable margins ranging from zero to
1.7% or at a competitive bid. The average interest rate on the credit facility during
2001 was 5.2%. As of December 31, 2001, borrowings outstanding against the credit
facility totaled $50 million. The Company also maintains letters of credit, which totaled
$31 million at December 31, 2001. The Companys available borrowing capacity under the
credit facility as of December 31, 2001, was $419 million.

Operating
Leases  At December 31, 2001, the Company was a party to lease agreements (Nansen and
Boomvang ConstructionPeriod Leases) in which the lessors agreed to construct and lease
to the Company two spars that would be used in the development of the Nansen and Boomvang
fields in the Gulf of Mexico. The lessors share of the estimated construction and
related costs for the two spars is approximately $170 million. The agreements provided
that lease payments were to begin upon completion of construction and continue for a
period of three years, subject to certain renewal options. Upon expiration of each lease
term, including any renewals, the Company had the option to purchase the leased property
for a specified price or to arrange for the sale of the lessors interest in the spars to
a third party. No rental expense was recorded pursuant to these leases for the year ended
December 31, 2001, as the spars were still under construction at December 31, 2001.

The
Nansen spar was completed and installed in January 2002. In accordance with the terms of
the Nansen ConstructionPeriod Lease, the Company arranged for the sale of the lessors
interest in the spar to a thirdparty purchaser. The Company has entered into a 20year
operating lease (Nansen Operating Lease) with the purchaser. The Nansen Operating Lease
contains various options whereby the Company may purchase the lessors interest in the
spar. Future cash payments under the Nansen Operating Lease will total $2 million, $7
million, $8 million, $11 million and $11 million for the years 2002, 2003, 2004, 2005 and
2006, respectively, and $194 million total for all years thereafter.

The
Boomvang spar is scheduled for completion during the third quarter of 2002. The Company
has arranged to replace the Boomvang ConstructionPeriod Lease with a 20year operating
lease that is expected to have terms similar to the Nansen Operating Lease and rental payments of
less than $1 million in 2002, approximately $3 million in 2003 and averaging
approximately $4 million annually thereafter. The Boomvang Operating Lease is also expected
to contain an option whereby

28

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

the Company may purchase the lessors
interest in the spar. The estimated total construction cost for the lessors share of the
Boomvang spar is approximately $45 million.

Other
Financing Transactions  During 2000, the Company entered into a marketsensitive prepaid
natural gas sales contract to deliver approximately 53,500 MMBtu per day of natural gas for
the period January 2002 through December 2003. In exchange for the natural gas to be
provided, the Company received an advance payment of approximately $75 million. The
contract has been amended to provide for delivery beginning in January 2003 at a rate of
53,500 MMBtu per day for 2003 and 55,600 MMBtu per day for 2004. To the extent that the Henry
Hub price exceeds a stated amount per MMBtu for any delivery month ($2.50 for 2003 and
$3.00 for 2004), the purchaser will make payments to the Company equal to the difference
between the index price and the stated amount times the delivery quantity for that month.

In
1999, the Company entered into a prepaid crude oil sales contract to deliver
approximately 5.6 MBbl per day of crude oil for the period February 2000 through May 2003.
In exchange for the crude oil to be provided, the Company received an advance payment of
approximately $100 million.

The
obligations associated with the future delivery of the natural gas and crude oil have
been recorded as deferred revenue. The contracts are amortized into revenue as scheduled
deliveries of natural gas and crude oil are made.

Also
during 2000, the Company conveyed certain Internal Revenue Code Section 29 Tax
Creditbearing properties to a trust for approximately $70 million, which was recorded in
other noncurrent liabilities. The trust receives the operating cash flow from the
properties until the investor recoups its investment plus a required aftertax rate of
return. The transaction is determined to have an embedded derivative financial instrument
as described in Note 12 to the Companys Consolidated Financial Statements.

Capital
Expenditures and Acquisitions(Amounts in Thousands)

|                            | Year Ended December 31,
|--------------------------- | -----------------------
|                           
|
|                           
|Oil and Gas Operations:     |                        
|Leasehold acquisitions      |                        
|Exploration costs           |                        
|Development costs           |                        
|                           
|                            |                        
|Corporate                   |                        
|                           
|Total Continuing Operations |                        
|Discontinued Operations     |                        
|                           
|Total Capital Expenditures  |                        
|                           
|Acquisitions                |                        
|                           

At
December 31, 2001, the Company had increased its estimated proved reserves to 601 MMBOE from 460
MMBOE at December 31, 2000. The increase was the result of a successful drilling program
and strategic property acquisitions. The Company replaced 387% of its 2001 production at
a finding and development cost of $5.52 per BOE. Excluding acquisitions, the Company
experienced a 308% reserve replacement, and a finding and development cost of $5.11 per BOE. The
Companys threeyear average total finding and development cost including acquisitions is
$5.08 per BOE.

Capital
expenditures from oil and gas operations, excluding acquisitions, totaled $858 million in
2001, an increase of 52% over amounts spent in 2000. Oil and gas expenditures, excluding
acquisitions, totaled $634 million for domestic operations and $224 million for
international operations. During 2001, the Company completed a total of 315 gross wells
(128 net wells), with an 87% success rate. Of that number, 40 were exploratory
wells and 275 were development wells. The success rate for exploratory

29

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

wells was 60%.

Acquisitions
in 2001 totaled $305 million and included the purchase of all outstanding shares of stock
of Texoil, Inc., an independent oil and gas company, for a cash purchase price of
approximately $115 million plus assumed bank debt of $15 million. The Company also
purchased oil and gas assets located primarily in East Texas and North Louisiana from
Ensight Resources, L.L.C. for a purchase price of approximately $118 million. In
addition, the Company recognized a deferred tax liability of approximately $50 million
due to the excess of book over tax basis of the oil and gas properties acquired in the
purchase of Texoil.

Standardized Measure of
Discounted Future Net Cash Flows  The
standardized measure of discounted future net cash flows before taxes for the Companys
proved oil and gas reserves decreased to $3.4 billion at December 31, 2001, compared with
$8.5 billion at the end of 2000. These amounts are calculated based on Securities and
Exchange Commission (SEC) criteria. The decrease was due to reduced price assumptions
partially offset by reserve additions. Yearend calculations were made using weighted
average yearend prices of $2.64 and $8.81 per Mcf for gas and $17.23 and $22.97 per Bbl
for oil for 2001 and 2000, respectively. The Companys average realized prices, excluding
the impact of financial derivatives, were $4.18 and $3.85 per Mcf for gas and $21.48 and
$25.51 per Bbl for oil for 2001 and 2000, respectively. Significant changes can occur in these estimates based
upon oil and gas prices in effect at year end. The above estimates should not be viewed
as an estimate of fair market value. See Note 19 to the Companys Consolidated Financial
Statements.

2002
Capital Expenditure Budget  The Companys capital expenditure budget for the year 2002
is approximately $650 million. The reduction from the prior years expenditures reflects
the Companys desire to manage expenditures in relation to expected cash flows from
operations at a time when the Company is operating in an environment of economic
recession and lower commodity prices.

Approximately
$300 to $350 million of the 2002 capital expenditure budget will be spent in the Gulf of
Mexico where the Company plans to grow its reserve base through the delineation of recent
discoveries and additional deepwater exploration. Plans include development activities in
five new deepwater fields and further development of the Nansen and Boomvang deepwater
fields as well as Gulf of Mexico shelf properties.

Approximately
$250 to $275 million of the 2002 capital expenditure budget is allocated to international
operations with nearly half of the international budget to be spent in Equatorial Guinea
on continued development of the Zafiro field. Additionally, the budget includes plans for
development in Egypt and exploration activities in Angola.

Approximately
$50 to $75 million of the 2002 capital expenditure budget is allocated to the Companys
domestic onshore properties. The Company plans additional development in the Bear Paw
field in Montana and in the Arklatex region.

Actual
capital spending may vary from the capital expenditure budget and is subject to change if
market conditions shift or new opportunities are identified. The 2002 capital expenditure
budget was developed using certain assumed price levels for the sales of natural gas and
crude oil. Changes in commodity prices could impact the Companys cash flow from
operations and funds available for reinvestment. For example, shortfalls in budgeted cash
flows from operations could result in the reduction of the Companys capital spending
program, increases in borrowing under the cred

30

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

it facility or divestments of properties.
The Company will evaluate its level of capital spending throughout the year based upon
drilling results, commodity prices, cash flows from operations and property acquisitions.
In general, the Companys strategy is to maintain capital
spending, excluding acquisitions and/or divestments, at levels near discretionary cash
flow (income from continuing operations before DD&A,impairments, deferred taxes and
other noncash operating activities).

The
Company makes, and will continue to make, substantial capital expenditures for the
acquisition, exploration, development and production of its oil and gas reserves. The
Company has historically funded its expenditures from cash flow from operating
activities, bank borrowings, sales of equity and debt securities, sales of nonstrategic
oil and gas properties, sales of partial interests in exploration concessions and project
finance borrowings. The Company intends to finance capital expenditures for the year 2002
primarily with cash flow provided by operations.

The
ability of the Company to satisfy its obligations and fund planned capital expenditures
will be dependent upon its future performance. Such future performance is subject to many
conditions that are beyond the Companys control, particularly oil and gas prices, and
the Companys ability to obtain additional debt and equity financing, if necessary. In addition,
where the Company is not the majority owner and/or operator of the venture, it may have limited
control over the timing or amount of capital expenditures associated with the particular project. The
Company currently expects that its cash flow from operations and availability under the
credit facility will be adequate to execute its business plan for the year 2002. No
assurance can be given that the Company will not experience liquidity problems from time
to time or on a longterm basis. If the Companys cash flow from operations and
availability under the credit facility are not sufficient to satisfy its cash
requirements, there can be no assurance that additional debt or equity financing will be
available to meet its requirements.

Commodity
Pricing  Changes in commodity prices significantly affect the Companys capital
resources, liquidity and expected operating results. Price changes directly affect
revenues and can indirectly impact expected production by changing the amount of funds
available to reinvest in exploration and development activities. The prices the Company
receives for its crude oil production are based on global market conditions. The prices
the Company receives for its natural gas production are primarily driven by North
American market forces. Oil and gas prices have fluctuated significantly in recent years
in response to numerous economic, political and environmental factors. During the second
half of 2001, prices declined due to a weakening commodity environment in the midst of a
global recession. Prices are also affected by weather, factors of supply and demand, and
commodity inventory levels. The Company expects that commodity prices will continue to
fluctuate significantly in the future.

The
Company has utilized and expects to continue to utilize derivative financial instruments
with respect to a portion of its oil and gas production to achieve a more predictable
cash flow by reducing its exposure to price fluctuations. Cash flow hedges are maintained
at levels which management considers necessary to manage its cash flow in support of the
2002 capital expenditure budget. See Notes 2 and 13 to the Companys Consolidated
Financial Statements.

Disclosures
About Contractual Obligations and Commercial Commitments  The following table sets
forth the Companys obligations and commitments to make future payments under its debt
agreements, lease agreements, transportation agreements and
other longterm obligations as of December 31, 2001:

31

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

|                              | Payments due by Period (in thousands)
|----------------------------- | -------------------------------------
|                             
|
|
|                             
|Principal Payments on         |                                      
|LongTerm Debt                |                                      
|Interest Payments on          |                                      
|LongTerm Debt                |                                      
|Operating Leases:             |                                      
|Office space and equipment    |                                      
|Nansen Operating Lease (1)    |                                      
|Boomvang Construction         |                                      
|Period Lease                  |                                      
|Future Minimum Transportation |                                      
|Payments                      |                                      
|                             
|Total Contractual Cash        |                                      
|Obligations                   |                                      
|Other Long-Term Obligations:  |                                      
|Deferred Revenue (2)          |                                      
|Conveyance of Section 29      |                                      
|Properties (3)                |                                      
|                             
|Total Contractual             |                                      
|Obligations                   |                                      
|                             

|(1) |  | The Nansen Operating Lease
 became effective in January 2002.
|--- |  | -------------------------------------------------------------

|(2) |  | Represents
amortization of forward sales as product is delivered.
|--- |  | -----------------------------------------------------------------

|(3) |  | Represents
estimates of proceeds from related trust properties as payments for obligation.
|--- |  | ------------------------------------------------------------------------------------------

|                          | Amount of Commitment Expiration Per Period (in thousands)
|------------------------- | ---------------------------------------------------------
|                         
|
|
|
|                         
|Standby Letters of Credit |                                                          
|Guarantees                |                                                          
|                         
|Total Commercial          |                                                          
|Commitments               |                                                          
|                         

Under
the terms of certain joint venture agreements, international production sharing contracts
or concession agreements, the Company has commitments to conduct seismic activity or to
participate in other exploratory or development activities. Certain agreements are backed
by letters of credit or parent company guarantees.

Under
certain conditions relating to a change of control, the Companys longterm
debt may be subject to a mandatory repurchase offer. In addition, under the
terms of the Nansen Operating Lease, the Company would be required to provide a
letter of credit or other comparable credit support up to a maximum amount of
approximately $36 million if the Companys senior debt credit rating were
to be downgraded below investment grade by both Moodys and Standard &
Poors. The amount required to be provided decreases as lease payments are
made.

Critical
Accounting Policies

Application
of generally accepted accounting principles requires the use of estimates,
judgments and assumptions that affect the reported amounts of assets and
liabilities as of the date of the financial statements and revenues and expenses
during the reporting period. In addition,

32

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

alternatives
can exist among various accounting methods. In such cases, the choice of accounting
method can also have a significant impact on reported amounts.

The
Companys estimates of its proved oil and gas reserve quantities, the application of
the full cost method of accounting for the Companys exploration and production activities, the application of standards of
accounting for derivative instruments and hedging activities, and the
Companys accounting method used for revenue recognition require management
to make numerous estimates and judgments.

Full
Cost Method of Accounting for Oil and Gas Properties  The Companys exploration
and production activities are accounted for using the full cost method. The Company
believes that the full cost method is the most appropriate method to use to account for
its oil and gas production activities. The Company is conducting significant exploration
programs in the Gulf of Mexico and in certain international regions. The full cost method
more appropriately treats the costs of entering these ventures as part of an overall
investment in discovering and developing proved reserves and allows for comparable
analysis with our peers.

Under
the full cost method, all acquisition, exploration and development costs,
including certain related employee costs and a portion of interest expense,
incurred for the purpose of finding oil and gas are capitalized. These
capitalized costs are accumulated in pools on a countrybycountry basis.
Capitalized costs include the cost of drilling and equipping productive wells,
dry hole costs, lease acquisition costs, delay rentals and costs related to such
activities. Employee costs associated with production operations and general
corporate activities are expensed in the period incurred. Transactions involving
sales of reserves in place, unless significant, are recorded as adjustments to
oil and gas properties.

Where
proved reserves are established, capitalized costs are limited on a
countrybycountry basis to the sum of the present value of future net cash
flows using current unescalated pricing discounted at 10%, related to estimated
production of proved reserves and the lower of cost or estimated fair value of
unproved properties, all net of expected income tax effects (ceiling
limitation). To the extent the full cost pool exceeds the ceiling
limitation, an impairment is made and additional depreciation, depletion and
amortization expense is recorded. The Company did not
have any writedowns related to full cost ceiling limitations in 2001, 2000 or
1999. Significant declines in prices, downward revisions in reserves or
increases in finding and development costs could result in a ceiling test
writedown. Leasehold costs, seismic costs and other costs incurred during the
exploration phase are capitalized as unproved property costs. Upon evaluation,
these costs are moved to the related full cost pool. Unproved properties whose
acquisition costs are not individually significant are aggregated, and the
portion of such costs estimated to be ultimately nonproductive, based on
experience, is amortized to the full cost pool over an average holding period.
Depreciation, depletion and amortization of oil and gas properties is computed
on a countrybycountry basis using a unitofproduction method based on
estimated proved reserves. All costs associated with proved oil and gas
properties, including an estimate of future development, restoration,
dismantlement and abandonment costs associated therewith, are included in the
computation base. The costs of investments in unproved properties and major
development projects are excluded from this calculation until the project is
evaluated and proved reserves are established or impaired.

In
countries where the existence of proved reserves has not yet been determined, leasehold
costs, seismic costs and other costs incurred during the exploration phase remain
capitalized as unproved property costs until proved reserves have been established or
until exploration activities cease. If exploration activities result in the establishment
of a proved reserve base, amounts in the unproved property account are reclassified as
proved properties and become subject to depreciation, depletion and amortization and the
application of the ceiling test. If exploration efforts in a country are unsuccessful in
establishing proved reserves and exploration activities cease, the
amounts accumulated as unproved costs are charged against earnings as impairments.

33

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

Reserves
 Estimates of the Companys proved oil and gas reserves are prepared
by the Companys engineers in accordance with guidelines established by the
SEC. Those guidelines require that reserve estimates be prepared under existing
economic and operating conditions with no provisions for increases in commodity
prices except by contractual arrangement and assuming continuation of existing
operating conditions. Estimation of oil and gas reserve quantities is inherently
difficult and is subject to numerous uncertainties. Such uncertainties include
the projection of future rates of production and the timing of development
expenditures. The accuracy of the estimates depends on the quality of available
geological and geophysical data and requires interpretation and judgment.
Estimates may be revised either upward or downward by results of future
drilling, testing or production. In addition, estimates of volumes considered to
be commercially recoverable fluctuate with changes in commodity prices and
operating costs. The Companys estimates of its reserves are expected to
change as additional information becomes available. An independent petroleum
engineering firm reviews at least 80% of the Companys yearend estimates
of proved reserves. These reserve estimates have a significant effect on
DD&A expense and on the ceiling limitation.

Capitalized
Interest and Employee Costs The Company capitalizes a portion of
interest expense on borrowed funds and certain employeerelated costs incurred
for the purpose of finding and developing oil and gas reserves. This practice is
in accordance with the full cost method, which requires that all costs
associated with property acquisition, exploration and development activities be
capitalized. The Company capitalizes interest cost in accordance with Statement
of Financial Accounting Standards (SFAS) No. 34,
Capitalization of Interest Cost, and SFAS Interpretation No. 33, Applying
FASB Statement No. 34 to Oil and Gas Producing Operations Accounted for by the
Full Cost Method. Employeerelated costs, which are directly attributable to
exploration and development are also capitalized, based on analysis of time
spent on these activities. Amounts capitalized can be significant with
increasing exploration and major development activities particularly in
deepwater areas.

Revenue
Recognition  The Company records revenues from the sales of crude oil
and natural gas when delivery to the customer has occurred and title has
transferred. This occurs when production has been delivered to a pipeline or a tanker
lifting has occurred. The Company may have an interest with other
producers in certain properties. In this case the Company uses the entitlements
method to account for sales of production. Under the entitlements method the
Company may receive more or less than its entitled share of production. If the
Company receives more than its entitled share of production, the imbalance is
treated as a liability. If the Company receives less than its entitled share,
the imbalance is recorded as an asset.

Derivative
Financial Instruments and Hedging Activities  The Company accounts for its investment
in derivative financial instruments in accordance with SFAS No. 133, Accounting for
Derivative Financial Instruments and Hedging Activities, as amended. As a result,
derivative financial instruments are marked to market quarterly. For derivative
instruments designated as cash flow hedges, changes in fair value, to the extent the
hedge is effective, are recognized in other comprehensive income until the hedged item is
recognized in earnings. The Company does not enter into derivative or other financial
instruments for trading purposes. The fair market values of

34

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

the Companys derivative
financial instruments are obtained from thirdparty counterparties.

Change
in Accounting Method

Generally
accepted accounting principles, effective January 1, 2001, establish standards
of accounting for and disclosures of derivative instruments and hedging
activities. See Note 2 to the Companys Consolidated Financial Statements
for a discussion of the impact of SFAS No. 133 on the Companys financial
position and results of operations as of the date of adoption.

Accounting
Pronouncements

In
2001, the Financial Accounting Standards Board issued four new pronouncements:

Statement No.
141, Business Combinations This statement requires that the
purchase method of accounting be used to account for all business combinations
and applies to all business combinations initiated after June 30, 2001. The
statement also establishes specific criteria for the recognition of intangible
assets separately from goodwill. The provisions of this statement would be
applied if the Company were to enter into any future business combination. The
statement has no impact on the Companys historical financial statements.

Statement
No. 142, Goodwill and Other Intangible Assets This statementrequires that goodwill no longer be amortized but tested for impairment at
least annually. Other intangible assets are to be amortized over their useful
lives and reviewed for impairment. An intangible asset with an indefinite useful
life will not be amortized until its useful life becomes determinable. The
effective date of this statement is January 1, 2002. The provisions of this
statement would be applied if the Company were to enter into any future business
combination pursuant to which goodwill or other intangible assets were
recognized. The statement has no impact on the Companys historical
financial statements.

Statement
No. 143, Accounting for Asset Retirement Obligations  This statement
(SFAS No. 143) requires entities to record the fair value of a liability
for an asset retirement obligation in the period in which it is incurred and a
corresponding increase in the carrying amount of the related longlived asset.
The Company will be required to adopt the SFAS No. 143 effective January 1, 2003,
using a cumulative effect approach to recognize transition amounts for asset
retirement obligations, asset retirement costs and accumulated depreciation. The
Company currently records estimated costs of dismantlement, removal, site
reclamation, and similar activities as part of its depreciation, depletion and
amortization for oil and gas properties without recording a separate liability
for such amounts. The Company has not yet completed its assessment of the impact
of SFAS No. 143 on its financial condition and results of operations. It expects
that adoption of the statement will result in increases in the capitalized costs
of its oil and gas properties and in the recognition of additional liabilities
related to asset retirement obligations.

Statement
No. 144, Accounting for the Impairment or Disposal of LongLived Assets
 This statement (SFAS No. 144) retains the fundamental provisions
of SFAS No. 121, Accounting for the Impairment of LongLived Assets and for
LongLived Assets to be Disposed Of (SFAS No. 121), for recognizing
and measuring impairment losses while resolving significant implementation
issues associated with SFAS No. 121. SFAS No. 144 also expands the basic provisions of
APB Opinion No. 30, Reporting the Results of Operations  Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions,regarding presentation of
discontinued operations in the income statement. The scope for reporting a
discontinued operation has been expanded to include a component of
an entity. A component comprises operations and cash flows that can be clearly
distinguished from the rest of the entity. It could be a segment, a reporting
unit, a consolidated subsidiary or an asset group.

The
Company adopted SFAS No.

35

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

144 as of January 1, 2002. Because the Company has elected the
full cost method of accounting for oil and gas exploration and
development activities, the impairment provisions of SFAS No. 144 do not apply to the
Companys oil and gas assets. For the Companys nonoil and gas assets, the
method of impairment assessment is largely unchanged from SFAS No. 121. The adoption of
SFAS No. 144 had no impact on the Companys financial statements.

Environmental

Compliance
with applicable environmental and safety regulations by the Company has not
required any significant capital expenditures or materially affected its
business or earnings. The Company believes it is in substantial compliance with
environmental and safety regulations and foresees no material expenditures in
the future; however, the Company is unable to predict the impact that compliance
with future regulations may have on its capital expenditures, earnings and
competitive position.

ForwardLooking
Statements May Prove Inaccurate

This
document contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, and information that is based on managements belief
and assumptions made by management based on currently available information. All
statements other than statements of historical fact included in this document
are forwardlooking statements. When used in this document, words such as
anticipate, believe, estimate,
expect, forecast, intend,
project and similar expressions serve to identify forwardlooking
statements. Although we believe that the expectations reflected in our
forward-looking statements are reasonable, we can give no assurance that these
expectations will prove correct. Our forwardlooking statements are subject to
risks, uncertainties and assumptions. Should one of these risks or uncertainties
materialize, or should underlying assumptions prove incorrect, our actual
results may vary materially from those expected. Among the key factors that may
have a direct bearing on our results of operations and financial condition are:

- competitive practices in the oil and gas industry;
- geological, mechanical and economic risk inherent in the drilling and operation of exploratory and
              development wells;
- risk of noncash writedown of unproved property costs in countries where proved reserves have not yet
              been established;
- risk of noncash writedown of proved property costs due to declines in prices, downward revisions in
              reserves or significant increases in finding and development costs;
- volatility of energy commodity prices, generally, and fluctuations in the commodity prices for crude oil
              and natural gas that have not been properly hedged;
- general economic and capital markets conditions, including fluctuations in interest rates;
- the impact of current and future laws and governmental regulations, particularly environmental
              regulations, affecting the energy industry in general, and our oil and gas operations in
              particular;
- environmental liabilities that are not covered by insurance or indemnity;
- the political and economic climate in the foreign jurisdictions in which we conduct oil and gas
              operations, including potential adverse results of military or terrorist actions in those
              areas; and
- the effect on our results of operations and financial condition associated with implementing various
              accounting rules and regulations.

Defined
Terms

Natural
gas is stated herein in billion cubic feet (Bcf), million cubic feet
(MMcf) or thousand cubic feet (Mcf). Oil, condensate and
natural gas liquids (NGL) are stated in barrels (Bbl) or
thousand barrels (MBbl). Oil, condensate and NGL are converted to
gas at a ratio of one barrel of liquids per six Mcf of gas. MMBOE, MBOE and BOE
represent one million barrels, one thousand barrels and one barrel of oil
equivalent, respectively, with six Mcf of gas converted to one barrel of liquid.
MMBtu and BBtu are one million British Thermal Units and one billion British Thermal Units, respectively.

36

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

Selected
Quarterly Financial Data

Summarized
quarterly financial data is as follows (amounts in thousands except per share
data):

|                                 | Quarter Ended
|-------------------------------- | -------------
|                                
|
|                                
|2001:                            |              
|Revenues                         |              
|Operating Profit                 |              
|Income Before Extraordinary Item |              
|Earnings Per Share               |              
|Before Extraordinary Item:       |              
|Basic (1)                        |              
|Diluted (1)                      |              
|                                 |              
|Net Income                       |              
|                                 |              
|Earnings per Share:              |              
|Basic (1)                        |              
|Diluted (1)                      |              
|                                 |              
|2000:                            |              
|Revenues                         |              
|Operating Profit (2)             |              
|Net Income (2)                   |              
|Earnings per Share:              |              
|Basic (1)                        |              
|Diluted (1)                      |              

|(1) | Quarterly earnings per common share may not total to the full year per share
     amount, as the weighted average number of shares outstanding for each quarter
     fluctuated as a result of the assumed exercise of stock options.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes pretax impairment of oil and gas assets of $20 million in the fourth
     quarter of 2000 and merger and integration costs of $3 million in the first
     quarter of 2000.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Market
Risk Disclosures

The
Company experiences market risks in two major areas: commodity prices and interest rates.
Because the U.S. dollar is the functional currency for all of the Companys existing
foreign operations, with predominantly all transactions being denominated in U.S.
dollars, the Company currently has limited risk from foreign currency translation.

Commodity
Price RiskThe Company experiences market risk primarily in
the area of commodity prices. The Company has utilized derivative financial
instruments with respect to a portion of its 2002 oil and gas production to
achieve a more predictable cash flow by reducing its exposure to price
fluctuations. The Company does not enter into derivative or other financial
instruments for trading purposes.

At
December 31, 2001, the Company had in place collars covering portions of its 2002 oil and
gas production. The gas collars, which are for the period January through December 2002,
cover contracted volumes of 140 MMcf per day of natural gas with a weighted average floor
price of $2.82 and a weighted average ceiling price of $4.07. Oil collars, which are also
for the period January through December 2002, cover contracted volumes of 15 MBbl per day
of oil with a floor price of $23.00 and a weighted average ceiling price of $28.03. A
related trust has a swap agreement covering gas production through 2005. The quantities
covered are 13,500 MMBtu per day at $4.12 for 2002, 11,100 MMBtu per day at $3.60 for
2003, 9,600 MMBtu per day at $3.41 for 2004 and 8,300 MMBtu per day at $3.28 for 2005.
These instruments have been designated as cash flow hedges. See Notes 2 and 13 to the
Companys Consolidated Financial
Statements for a description of the Companys accounting policies for derivative
financial instruments and for additional information regarding the derivative financial
instruments to which the Company was a party at December 31, 2001.

The
Company also had in place two crude oil basis swap contracts at December 31,
2001, to fix the sales price differential between WTI and

37

---

# Ocean Energy, Inc.Managements Discussion and Analysis of Financial
Conditionand Results of Operations

Brent. The contracts,
which extend through May 2002 and relate to 20 MBbl per day, provide that the
Company receive/pay a net settlement of WTI less Brent less $1.29. These
instruments have not been designated as cash flow hedges.

To
calculate the potential effect of the derivative financial instruments on future
revenues, the Company applied the average NYMEX oil and gas strip prices as of
the end of 2001 to the quantity of the oil and gas production covered by
derivative financial instruments at December 31, 2001. The following table shows
the estimated potential effects of the derivative financial instruments on
revenues (in millions):

|                          |  |  | Estimated | Estimated
|------------------------- |  |  | --------- | ---------
|
|
|
|
|                         
|Oil collars               |  |  | 2002      |          
|Gas collars               |  |  | 2002      |          
|Gas swap of related trust |  |  | 20022005 |          

---

Subsequent
to December 31, 2001, the Company entered into crude oil collars for the period April
through December 2002. The contracts cover 20 MBbl of crude oil per day with a weighted average floor price of
$21.875 and a weighted average ceiling price of $26.275.

All
derivative financial instruments outstanding at December 31, 2000, except for
the gas swap of a related trust noted above, have expired. The effect of
derivative financial instruments outstanding at December 31, 2000 was an $11
million decrease in revenues during 2001.

Interest
Rate RiskThe Company has minimal exposure to risk resulting
from changes in interest rates because substantially all debt obligations at
December 31, 2001, were at fixed interest rates. At December 31, 2001, the
Company had long-term debt outstanding of $1.3 billion. Of this amount, 96% is
fixed rate debt. Approximately $50 million of debt outstanding at December 31,
2001, represents borrowings outstanding under the Companys credit facility
and bears interest at floating rates, which averaged 5.2% for 2001.

The
Company evaluated the potential effect that reasonably possible nearterm
changes in interest rates may have on the Companys credit facility.
Utilizing the actual interest rate in effect and balance outstanding as of
December 31, 2001, and assuming a 10% increase or decrease in interest rates and
no change in the amount of debt outstanding, the potential effect on annual
interest expense is approximately $250,000.

At
December 31, 2001, the Company was party to interest rate swap agreements relating to
its 7 5/8% senior notes due July 2005 and its 7 7/8% senior
notes due August 2003. Under the terms of the agreements, the counterparties pay
the Company a weighted average fixed annual rate of 7.74% on total notional
amounts of $225 million, and the Company pays the counterparties a variable
annual rate equal to the average sixmonth LIBOR rate plus a weighted average
rate of 2.73%. The swap agreements remain in effect through the maturity dates
of the respective notes.

38

---

# Ocean Energy, Inc.
Report of Management to Stockholders

The
management of Ocean Energy, Inc. is responsible for the preparation and
integrity of financial statements and related data in this Annual Report,
whether audited or unaudited. The financial statements were prepared in
conformity with generally accepted accounting principles and include certain
estimates and judgments that management believes are reasonable under the
circumstances.

Management
is also responsible for and maintains a system of internal accounting controls
that is designed to provide reasonable assurance that assets are safeguarded
against loss or unauthorized use and that financial records are reliable for
preparing financial statements, as well as to prevent and detect fraudulent
financial reporting. The internal control system is supported by written
policies and procedures and the employment of trained, qualified personnel. The
Company has an internal audit function that reviews the adequacy of the internal
accounting controls and compliance with them. Management has considered the
recommendations of internal audit and KPMG LLP, independent certified public
accountants, concerning the Companys system of internal controls and has
responded appropriately to those recommendations.

KPMG
LLP, independent certified public accountants, have audited the accompanying
consolidated financial statements of Ocean Energy, Inc. as of December 31, 2001,
and their report is included herein. Their audit was made in accordance with
generally accepted auditing standards and included a review of the system of
internal controls to the extent considered necessary to determine the audit
procedures required to support their opinion on the consolidated financial
statements.

The
Board of Directors, through its Audit Committee composed exclusively of outside
directors, meets periodically with representatives of management, internal audit
and the independent auditors to ensure the existence of effective internal
accounting controls and that financial information is reported accurately and
timely with all appropriate disclosures included. The independent auditors and
internal audit have full and free access to, and meet with, the Audit Committee,
with and without management present.

|                       |  | 
|---------------------- |  | 
|/s/ James T. Hackett   |  | 
|Chairman of the Board, |  | 
|President and Chief    |  | 
|Executive Officer      |  | 

January 24, 2002

39

---

# Ocean Energy, Inc.Independent Auditors Report

The
Board of Directors and StockholdersOcean Energy, Inc.:

We
have audited the accompanying consolidated balance sheets of Ocean Energy, Inc.
and subsidiaries as of December 31, 2001 and 2000, and the related consolidated
statements of operations, stockholders equity and cash flows for each of
the years in the three-year period ended December 31, 2001. 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 auditing standards generally accepted in
the United States of America. 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 Ocean Energy, Inc. and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2001 in conformity with accounting principles generally
accepted in the United States of America.

As
discussed in Note 2 to the consolidated financial statements, effective January
1, 2001, the Company changed its method of accounting for derivative financial
instruments.

/s/ KPMG
LLP

Houston,
TexasJanuary 24, 2002

40

---

Ocean
Energy, Inc.Consolidated Statements of Operations(Amounts
in Thousands Except Per Share Data)

|                                                         | Year Ended December 31,
|-------------------------------------------------------- | -----------------------
|                                                        
|
|                                                        
|Revenues                                                 |                        
|Costs of Operations:                                     |                        
|Operating expenses                                       |                        
|Depreciation, depletion and amortization                 |                        
|Impairment of oil and gas properties                     |                        
|General and administrative                               |                        
|                                                        
|                                                         |                        
|                                                        
|Operating Profit                                         |                        
|Other (Income) Expense:                                  |                        
|Interest expense                                         |                        
|Merger and integration costs                             |                        
|Interest income and other                                |                        
|                                                        
|Income (Loss) Before Income Taxes                        |                        
|Income Tax Expense (Benefit)                             |                        
|                                                        
|Income (Loss) From Continuing Operations                 |                        
|Income From Discontinued Operations, Net of Income Taxes |                        
|                                                        
|Income (Loss) Before Extraordinary Loss                  |                        
|Extraordinary Loss, Net of Income Taxes                  |                        
|                                                        
|Net Income (Loss)                                        |                        
|Preferred Stock Dividends                                |                        
|                                                        
|Net Income (Loss) Available to Common Stockholders       |                        
|                                                        
|Basic Earnings (Loss) Per Common Share:                  |                        
|Income (Loss) From Continuing Operations                 |                        
|Income From Discontinued Operations, Net of              |                        
|Income Taxes                                             |                        
|Extraordinary Loss, Net of Income Taxes                  |                        
|                                                        
|Net Income (Loss) to Common Stockholders                 |                        
|                                                        
|Diluted Earnings (Loss) Per Common Share:                |                        
|Income (Loss) From Continuing Operations                 |                        
|Income From Discontinued Operations, Net of              |                        
|Income Taxes                                             |                        
|Extraordinary Loss, Net of Income Taxes                  |                        
|                                                        
|Net Income (Loss)                                        |                        
|                                                        
|Cash Dividends Declared Per Common Share                 |                        
|                                                         |                        
|Weighted Average Number of Common Shares Outstanding:    |                        
|Basic                                                    |                        
|                                                        
|Diluted                                                  |                        
|                                                        

See
accompanying Notes to Consolidated Financial Statements.

41

---

Ocean
Energy, Inc.Consolidated Balance Sheets(Amounts in Thousands Except Share Data)

|                                                                       | December 31,
|---------------------------------------------------------------------- | ------------
|                                                                      
|
|                                                                      
|Assets                                                                 |             
|Current Assets:                                                        |             
|Cash and cash equivalents                                              |             
|Accounts receivable, net                                               |             
|Other current assets                                                   |             
|                                                                      
|Total Current Assets                                                   |             
|                                                                      
|                                                                       |             
|Property, Plant and Equipment, at cost, full cost method for oil and   |             
|gas properties:                                                        |             
|Proved oil and gas properties                                          |             
|Oil and gas properties excluded from amortization                      |             
|Other                                                                  |             
|                                                                      
|                                                                       |             
|Accumulated Depreciation, Depletion and Amortization                   |             
|                                                                      
|                                                                       |             
|Deferred Income Taxes                                                  |             
|Other Assets                                                           |             
|                                                                      
|Total Assets                                                           |             
|                                                                      
|Liabilities and Stockholders Equity                                   |             
|Current Liabilities:                                                   |             
|Accounts and note payable                                              |             
|Accrued interest payable                                               |             
|Accrued liabilities                                                    |             
|                                                                      
|Total Current Liabilities                                              |             
|                                                                      
|                                                                       |             
|Long-Term Debt                                                         |             
|Deferred Revenue                                                       |             
|Deferred Income Taxes                                                  |             
|Other Noncurrent Liabilities                                           |             
|Commitments and Contingencies                                          |             
|                                                                       |             
|Stockholders Equity:                                                  |             
|Preferred stock, $1.00 par value; authorized 10,000,000 shares;        |             
|issued 50,000 shares                                                   |             
|Common stock, $0.10 par value; authorized 520,000,000 shares and       |             
|230,000,000 shares, respectively;  issued  174,936,240 and 170,069,114 |             
|shares, respectively                                                   |             
|Additional paid-in capital                                             |             
|Accumulated deficit                                                    |             
|Treasury stock, at cost; 2,641,640 and 2,754,566 shares, respectively  |             
|Deferred compensation and other                                        |             
|Accumulated other comprehensive income                                 |             
|                                                                      
|Total Stockholders Equity                                             |             
|                                                                      
|Total Liabilities and Stockholders Equity                             |             
|                                                                      

See
accompanying Notes to Consolidated Financial Statements.

42

---

Ocean Energy, Inc.
Consolidated Statements of Cash Flows(Amounts in Thousands)

|                                                         | Year Ended December 31,
|-------------------------------------------------------- | -----------------------
|                                                        
|
|                                                        
|Operating Activities:                                    |                        
|Net income (loss)                                        |                        
|Adjustments to reconcile net income (loss) to net cash   |                        
|provided by operating activities:                        |                        
|Depreciation, depletion and amortization                 |                        
|Impairment of oil and gas properties                     |                        
|Deferred income taxes                                    |                        
|Extraordinary loss, net of taxes                         |                        
|Merger and integration costs                             |                        
|Other                                                    |                        
|Changes in operating assets and liabilities, net of      |                        
|acquisitions:                                            |                        
|Decrease (increase) in accounts receivable               |                        
|Decrease (increase) in other current assets              |                        
|Decrease in accounts payable                             |                        
|Amortization of deferred revenue                         |                        
|Increase (decrease) in accrued expenses and other        |                        
|                                                        
|Net Cash Provided by Operating Activities                |                        
|                                                        
|Investing Activities:                                    |                        
|Capital expenditures of continuing operations            |                        
|Acquisition costs, net of cash acquired                  |                        
|Proceeds from sales of property, plant and equipment     |                        
|Other                                                    |                        
|                                                        
|Net Cash Provided by (Used in) Investing Activities      |                        
|                                                        
|Financing Activities:                                    |                        
|Proceeds from debt                                       |                        
|Principal payments on debt                               |                        
|Proceeds from exercise of common stock options           |                        
|Dividends paid                                           |                        
|Purchase of treasury stock                               |                        
|Premiums paid on debt buy back                           |                        
|Increase in deferred revenue                             |                        
|Proceeds from conveyance of Section 29 credit properties |                        
|Other                                                    |                        
|                                                        
|Net Cash Provided by (Used in) Financing Activities      |                        
|                                                        
|Increase (Decrease) in Cash and Cash Equivalents         |                        
|Cash and Cash Equivalents at Beginning of Year           |                        
|                                                        
|Cash and Cash Equivalents at End of Year                 |                        
|                                                        
|                                                         |                        

See
accompanying Notes to Consolidated Financial Statements.

43

---

Ocean
Energy, Inc.Consolidated Statements of Stockholders Equity(Amounts in Thousands)

|                                               |  |  | Additional |   
|---------------------------------------------- |  |  | ---------- | --
|
|
|                                              
|Balance, January 1, 2001                       |  |  | $          | 50
|Exercise of common stock options and employee  |  | 
|stock purchases                                |  |  |            | --
|Treasury stock purchase                        |  |  |            | --
|Deferred compensation                          |  |  |            | --
|Amortization of deferred compensation          |  |  |            | --
|Preferred stock dividends                      |  |  |            | --
|Common stock dividends                         |  |  |            | --
|Tax benefit from exercise of stock options     |  |  |            | --
|Funding of supplemental benefit plans trust    |  |  |            | --
|Transfer of supplemental benefit plans         |  | 
|trust obligation                               |  |  |            | --
|Other                                          |  |  |            | --
|Comprehensive income:                          |  | 
|Net income                                     |  |  |            | --
|Other comprehensive income (net of tax):       |  | 
|Cumulative effect of accounting change for     |  | 
|derivative financial instruments               |  |  |            | --
|Net effect of derivative financial instruments |  |  |            | --
|Other                                          |  |  |            | --
|                                              
|Balance, December 31, 2001                     |  |  | $          | 50
|                                              
|Balance, January 1, 2000                       |  |  | $          | 50
|Exercise of common stock options               |  |  |            | --
|Treasury stock purchase                        |  |  |            | --
|Deferred compensation                          |  |  |            | --
|Amortization of deferred compensation          |  |  |            | --
|Preferred stock dividends                      |  |  |            | --
|Common stock dividends declared                |  |  |            | --
|Other                                          |  |  |            | --
|Comprehensive income:                          |  | 
|Net income                                     |  |  |            | --
|                                              
|Balance, December 31, 2000                     |  |  | $          | 50
|                                              
|Balance, January 1, 1999                       |  |  | $          | 1 
|Effect of Seagull Merger                       |  |  |            | 49
|Exercise of common stock options               |  |  |            | --
|Treasury stock purchase                        |  |  |            | --
|Contribution to ESOP                           |  |  |            | --
|Amortization of deferred compensation          |  |  |            | --
|Preferred stock dividends                      |  |  |            | --
|Other                                          |  |  |            | --
|Comprehensive income (loss):                   |  | 
|Net loss                                       |  |  |            | --
|Other comprehensive income:                    |  | 
|Foreign currency translation adjustment:       |  | 
|Income arising during the year                 |  |  |            | --
|Reclassification adjustment                    |  |  |            | --
|Net foreign currency translation adjustment    |  |  |            | --
|                                              
|Balance, December 31, 1999                     |  |  | $          | 50
|                                              

See
accompanying Notes to Consolidated Financial Statements.

44

---

Ocean
Energy, Inc.Consolidated Statements of Stockholders Equity(Amounts in Thousands)

|                                            |  |  | Accumulated |         |  
|------------------------------------------- |  |  | ----------- | ------- | -
|
|
|
|                                           
|Balance, January 1, 2001                    |  |  | $           | (35,354 | )
|Exercise of common stock options and        |  | 
|employee stock purchases                    |  |  |             | --      |  
|Treasury stock purchase                     |  |  |             | (6,671  | )
|Deferred compensation                       |  |  |             | --      |  
|Amortization of deferred compensation       |  |  |             | --      |  
|Preferred stock dividends                   |  |  |             | --      |  
|Common stock dividends                      |  |  |             | --      |  
|Tax benefit from exercise of stock options  |  |  |             | --      |  
|Funding of supplemental benefit             |  | 
|plans trust                                 |  |  |             | 6,343   |  
|Transfer of supplemental benefit plans      |  | 
|trust obligation                            |  |  |             | --      |  
|Other                                       |  |  |             | 28      |  
|Comprehensive income:                       |  | 
|Net income                                  |  |  |             | --      |  
|Other comprehensive income (net of tax):    |  | 
|Cumulative effect of accounting change      |  | 
|for derivative financial instruments        |  |  |             | --      |  
|Net effect of derivative                    |  | 
|financial instruments                       |  |  |             | --      |  
|Other                                       |  |  |             | --      |  
|                                           
|Balance, December 31, 2001                  |  |  | $           | (35,654 | )
|                                           
|Balance, January 1, 2000                    |  |  | $           | (3,114  | )
|Exercise of common stock options            |  |  |             | --      |  
|Treasury stock purchase                     |  |  |             | (32,217 | )
|Deferred compensation                       |  |  |             | --      |  
|Amortization of deferred compensation       |  |  |             | --      |  
|Preferred stock dividends                   |  |  |             | --      |  
|Common stock dividends declared             |  |  |             | --      |  
|Other                                       |  |  |             | (23     | )
|Comprehensive income:                       |  | 
|Net income                                  |  |  |             | --      |  
|                                           
|Balance, December 31, 2000                  |  |  | $           | (35,354 | )
|                                           
|Balance, January 1, 1999                    |  |  | $           | --      |  
|Effect of Seagull Merger                    |  |  |             | (4,293  | )
|Exercise of common stock options            |  |  |             | --      |  
|Treasury stock purchase                     |  |  |             | (2,840  | )
|Contribution to ESOP                        |  |  |             | 4,019   |  
|Amortization of deferred compensation       |  |  |             | --      |  
|Preferred stock dividends                   |  |  |             | --      |  
|Other                                       |  |  |             | --      |  
|Comprehensive income (loss):                |  | 
|Net loss                                    |  |  |             | --      |  
|Other comprehensive income:                 |  | 
|Foreign currency translation adjustment:    |  | 
|Income arising during the year              |  |  |             |         |  
|Reclassification adjustment                 |  |  |             |         |  
|Net foreign currency translation adjustment |  |  |             | --      |  
|                                           
|Balance, December 31, 1999                  |  |  | $           | (3,114  | )
|                                           

See
accompanying Notes to Consolidated Financial Statements.

45

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

1.  
Organization

Ocean
Energy, Inc. (the Company, OEI, or Ocean) is
an independent energy company engaged in the exploration, development and
production of crude oil and natural gas. North American operations are focused
primarily in the shelf and deepwater areas of the Gulf of Mexico, the Rocky
Mountains, the Permian Basin, Arklatex, Anadarko, East Texas and the Gulf Coast
areas. Internationally, the Company conducts oil and gas activities in
Equatorial Guinea, Côte dIvoire, Angola, Egypt, Tatarstan, Brazil,
Pakistan and Indonesia. In May 2001, pursuant to a shareholder vote, the Company
was reincorporated from the State of Texas to the State of Delaware.

On
March 30, 1999, Ocean Energy, Inc. (Old Ocean) was merged with and
into Seagull Energy Corporation (Seagull, the Merger).
The resulting company was renamed Ocean Energy, Inc. The Merger was treated for
accounting purposes as an acquisition of Seagull by Ocean with the assets and
liabilities of Old Ocean being recorded based upon their historical costs, and
the assets and liabilities of Seagull being recorded at their estimated fair
market values. The financial results presented here include those of Old Ocean
on a stand-alone basis for the first quarter of 1999 and of the combined company
thereafter.

2.  
Summary of Significant Accounting Policies

General
 The accompanying Consolidated Financial Statements of the Company have
been prepared according to generally accepted accounting principles and pursuant
to the rules and regulations of the Securities and Exchange Commission. These
accounting principles require the use of estimates, judgments and assumptions
that affect the reported amounts of assets and liabilities as of the date of the
financial statements, and revenues and expenses during the reporting period.
Actual results could differ from those estimates. Certain reclassifications of
amounts previously reported have been made to conform to current year
presentations.

Consolidation
 The accompanying Consolidated Financial Statements include the accounts
of Ocean Energy, Inc. and its majority-owned entities. All significant
intercompany transactions have been eliminated.

Cash
Equivalents  The Company considers all highly liquid investments with a
maturity of three months or less when purchased to be cash equivalents.

Inventories
 Materials and supplies and oil inventories are valued at the lower of
average cost or market value (net realizable value).

Oil
and Gas Properties  The Companys exploration and production
activities are accounted for using the full cost method. Under this method, all
acquisition, exploration and development costs, including certain related
employee costs and a portion of interest expense, incurred for the purpose of
finding oil and gas are capitalized. These capitalized costs are accumulated in
pools on a countrybycountry basis. Capitalized costs include the cost of drilling and
equipping productive wells, dry hole costs, lease acquisition costs, delay rentals and
costs related to such activities. Employee costs associated with production operations
and general corporate activities are expensed in the period incurred. Transactions
involving sales of reserves in place, unless significant, are recorded as adjustments to
oil and gas properties.

Where
proved reserves are established, capitalized costs are limited on a
countrybycountry basis to the sum of the present value of future net cash
flows using current unescalated pricing discounted at 10%, related to estimated
production of proved reserves and the lower of cost or estimated fair value of
unproved properties, all net of expected income tax effects (ceiling
limitation). To the extent the full cost pool exceeds the ceiling
limitation, an impairment is made and additional depreciation, depletion and
amortization (DD&A) expense is recorded. Leasehold costs,
seismic costs and other costs incurred during the exploration phase are
capitalized as unproved property costs. Upon evaluation, these costs are moved
to the related full cost pool. Unproved properties whose acquisition costs are
not individually significant are aggregated, and the portion of such costs
estimated to be ultimately nonproductive, based on experience, is amortized
to the full cost pool over an average holding period. Depreciation, depletion
and amortization of oil and gas properties is computed on a countrybycountry
basis using a unitofproduction method based on estimated proved reserves. All
costs associated with proved oil and gas properties, including an estimate of
future development, restoration, dismantlement and abandonment costs associated
therewith, are included in the computation base. The costs of investments in
unproved properties and major development projects are excluded from this
calculation until the project is evaluated and proved reserves are established
or impaired. The Company estimates oil and gas reserves annually. An independent
petroleum engineering firm annually reviews at least 80% of the Companys
estimates of proved reserves.

In
countries where the existence of proved reserves has not yet been determined,
leasehold costs, seismic costs and other costs incurred during

46

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

the exploration
phase remain capitalized as unproved property costs until proved reserves have been
established or until exploration activities cease. If exploration activities result in
the establishment of a proved reserve base, amounts in the unproved property account are
reclassified as proved properties and become subject to depreciation, depletion and
amortization and the application of the ceiling test. If exploration efforts in a country
are unsuccessful in establishing proved reserves and exploration activities cease, the
amounts accumulated as unproved costs are charged against earnings as impairments.

During
the fourth quarter of 2000, the Company recognized an impairment in the amount
of $13 million ($20 million, pretax) related to the discontinuance of
exploration activities in the Republic of Yemen. The Company recognized
impairments in the amount of $43 million ($46 million, pretax) for the year
ended December 31, 1999, related primarily to the sale of the Canadian subsidiary
($23 million, pretax) and to the discontinuance of exploration activities in
Bangladesh ($18 million, pretax) and other international locations ($5 million,
pretax). The Company had no ceiling limitations in 2001, 2000 or 1999.

Interest
cost capitalized as property, plant and equipment amounted to approximately $45
million, $44 million and $41 million in 2001, 2000 and 1999, respectively. The
Company also capitalized certain employee costs related to exploratory and
development activities in the amounts of $58 million, $45 million and $41
million in 2001, 2000 and 1999, respectively.

Other
Property, Plant and Equipment  Other property, plant and equipment
consists of oil and gas pipeline facilities, gas processing plant, and
corporaterelated assets and equipment with a net book value of $102 million and
$100 million at December 31, 2001 and 2000, respectively. Depreciation of other
property is computed principally using the straightline method over their
estimated useful lives, which vary from three to twenty years. The Company
groups and evaluates other property, plant and equipment for impairment based on
the ability to identify separate cash flows generated therefrom in accordance
with Statement of Financial Standards (SFAS) No. 121, Accounting for
the Impairment of LongLived Assets and for LongLived Assets to be Disposed of.
No impairment charges related to other property, plant and equipment were
recorded during 2001, 2000 and 1999.

Maintenance,
repairs and renewals are charged to operating expense except that renewals which
extend the life of the asset are capitalized.

Environmental
Liabilities  Environmental expenditures that relate to an existing
condition caused by past operations, and that do not contribute to current or
future revenue generation, are expensed. Liabilities are accrued when
environmental assessments and/or cleanups are probable, and the costs can be
reasonably estimated.

Treasury
Stock  The Company follows the weighted average cost method of accounting
for treasury stock transactions.

Revenue
Recognition  The Company records revenues from the sales of crude oil and
natural gas when delivery to the customer has occurred and title has
transferred. This occurs when production has been delivered to a pipeline or a tanker
lifting has occurred. The Company may have an interest with other
producers in certain properties. In this case, the Company uses the entitlements
method to account for sales of production. Under the entitlements method, the
Company may receive more or less than its entitled share of production. If the
Company receives more than its entitled share of production, the imbalance is
treated as a liability. If the Company receives less than its entitled share,
the imbalance is recorded as an asset.

Derivative
Instruments and Hedging Activities  From time to time, the Company has
utilized and expects to continue to utilize derivative financial instruments to
hedge cash flow from operations or to hedge the fair value of financial
instruments.

The
Company uses derivative financial instruments with respect to a portion of its
oil and gas production to achieve a more predictable cash flow by reducing its
exposure to price fluctuations. These transactions generally are swaps, collars
or options and are entered into with major financial
institutions or commodities trading institutions.
Derivative financial instruments are intended to reduce the Companys exposure to
declines in the market prices of natural gas and crude oil that the Company produces and
sells, and to manage cash flow in support of the Companys annual capital expenditure
budget. Prior to January 1, 2001, gains and losses from derivative financial instruments
were recognized in oil and gas revenues as the associated production occurred.

The
Company may also utilize derivative financial instruments such as interest rate
swap agreements. Prior to January 1, 2001, gains and losses from interest rate hedges were included in interest
expense.

Effective
January 1, 2001, the Company adopted SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities, as amended. This statement establishes accounting and reporting
standards requiring that derivative instruments (including certain derivative instruments
embedded

47

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

in other
contracts) be recorded at fair market value and included in the balance sheet as assets
or liabilities.

Adoption
of SFAS No. 133 at January 1, 2001, resulted in the recognition of $1 million of
additional derivative assets, included in other current assets; $23 million of
derivative liabilities, $11 million of which were included in current
liabilities and $12 million of which were included in other noncurrent
liabilities in the Companys Consolidated Balance Sheet; and $14 million,
net of taxes, of deferred hedging losses, included in accumulated other
comprehensive income as the effect of the change in accounting principle. The
Company also recorded a deferred tax asset of $9 million upon adoption. Amounts
were determined as of January 1, 2001, based on quoted market values, the
Companys portfolio of derivative instruments, and the Companys
measurement of hedge effectiveness.

The
accounting for changes in the fair value of a derivative instrument depends on
the intended use of the derivative and the resulting designation, which is
established at the inception of a derivative. SFAS No. 133 requires that a company
formally document, at the inception of a hedge, the hedging relationship and the
entitys risk management objective and strategy for undertaking the hedge,
including identification of the hedging instrument, the hedged item or
transaction, the nature of the risk being hedged, the method that will be used
to assess effectiveness and the method that will be used to measure hedge
ineffectiveness of derivative instruments that receive hedge accounting
treatment.

For
derivative instruments designated as cash flow hedges, changes in fair value, to
the extent the hedge is effective, are recognized in other comprehensive income
until the hedged item is recognized in earnings. Hedge effectiveness is assessed
at least quarterly based on total changes in the derivatives fair value.
Any ineffective portion of the derivative instruments change in fair value
is recognized immediately in revenues.

The
Company may utilize derivative financial instruments which have not been
designated as hedges under SFAS No. 133 even though they protect the Company from
changes in commodity prices. These instruments are marked to market with the resulting changes in fair value
recorded in oil and gas revenues.

The
Company may also utilize derivative financial instruments such as interest rate
swap agreements. Interest rate swap contracts are reflected at fair value on the Companys Consolidated
Balance Sheets. If the transaction qualifies as a fair value hedge, the related
portion of fixed-rate debt being hedged is reflected at an amount equal to the
sum of its carrying value plus an adjustment representing the change in its fair
value attributable to the interest rate risk being hedged. The gains or losses
on the derivative financial instrument, as well as the offsetting gains or
losses on the hedged item, are recognized currently in interest expense.
Consequently, if gains or losses on the derivative financial instrument and the
related hedged item do not completely offset, the difference is recognized
currently in interest expense. The net effect of this accounting on the
Companys operating results is that interest expense on the portion of
fixed-rate debt being hedged is generally recorded based on variable interest
rates.

Income
Taxes  The Company uses the liability method of accounting for income
taxes under which deferred tax assets and liabilities are recognized for the
estimated 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 in effect for the year in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized as part of the
provision for income taxes in the period that includes the enactment date.

Discontinued
Operations  During 1999, the Company disposed of its Alaskan operations
(ENSTAR) acquired in the Seagull Merger. See Note 7. ENSTARs
net income, reflected as discontinued operations, was $1 million, net of income
tax expense of $1 million, for the year ended December 31, 1999.

Foreign
Currency Translation - The U.S. dollar is the functional currency for all of the
Companys existing foreign operations, as predominantly all transactions in these
operations are denominated in U.S. dollars.

Stock-Based
Compensation  The Company accounts for stockbased compensation to
employees or directors under the intrinsic value method. Under this method, the
Company records no compensation expense for stock options granted when the
exercise price of options granted is equal to or greater than the fair market
value of the Companys common stock on the date of grant.

Concentrations
of Market Risk  The future results of the Companys oil and gas
operations will be affected by the market prices of oil and gas. The
availability of a ready market for natural gas, oil and liquid products in the
future will depend on numerous factors beyond the control of the Company,
including weather, imports, marketing of competitive fuels, proximity and
capacity of oil and gas pipelines and other transportation facilities, any oversupply or
undersupply of gas, oil and liquid products, the regulatory environment, the economic
environment, and other regional and political events, none of which can be predicted with
certainty.

The
Company operates in various phases of the oil and gas industry. The

48

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Companys
receivables include amounts due from purchasers of oil and gas production and amounts due
from joint venture partners for their respective portions of operating expense and
exploration and development costs. The Company believes that no single customer or joint
venture partner exposes the Company to significant credit risk. While certain of these
customers and joint venture partners are affected by periodic downturns in the economy in
general or in their specific segment of the natural gas or oil industry, the Company
believes that its level of creditrelated losses due to such economic fluctuations
has been and will continue to be immaterial to the Companys results of operations
in the long term. Trade receivables are generally not collateralized. The Company
analyzes customersand joint venture partnershistorical credit positions and
payment history prior to extending credit.

During
2001, purchases by Duke Energy Trading & Marketing and affiliates
(DETM), a whollyowned subsidiary of Duke Energy Corp., and ExxonMobil Sales and Supply (EMSS),
a whollyowned subsidiary of ExxonMobil Corporation,
accounted for 42% and 19%, respectively, of the Companys total oil and gas production revenues.
During 2000, purchases by DETM and EMSS accounted for 44%
and 20%, respectively, of the Companys total oil and gas production revenues.
During 1999, purchases by DETM, EMSS, and Enron Corporation accounted for
11%, 18%, and 16%, respectively, of the Companys total oil and gas production revenues.
DETM has an implied senior debt rating of A from Standard & Poors (S&P)
and Duke Energy Corporations senior debt is rated A+ by S&P and A1 by Moodys. EMSS is not rated but ExxonMobil
Corporations senior debt is rated AAA by S&P and Aaa by Moodys.

The
Company has a significant portion of its operations in various international
areas. The Companys activities in these areas are subject to risks
associated with international operations, including political and economic
uncertainties, risks of cancellation or unilateral modification of agreements,
operating restrictions, currency repatriation restrictions, expropriation,
export restrictions, the imposition of new taxes and the increase of existing
taxes, inflation, foreign exchange fluctuations and other risks arising out of
international government sovereignty over areas in which the operations are
conducted. The Company has endeavored to protect itself against political and
commercial risks inherent in these operations. There is no certainty that the
steps taken by the Company will provide adequate protection.

Concentrations
of Credit Risk  Derivative financial instruments that hedge the price of
oil and gas and interest rates are generally executed with major financial or
commodities trading institutions which expose the Company to market and credit risks, and may at times be concentrated with certain
counterparties or groups of counterparties. Although notional amounts are used
to express the volume of these contracts, the amounts potentially subject to
credit risk, in the event of nonperformance by the counterparties, are
substantially smaller. The credit worthiness of counterparties is subject to
continuing review and full performance is anticipated. The Companys policy
is to execute financial derivatives only with counterparties having a senior debt
rating of A or higher.

Impact
of Recently Issued Accounting Pronouncements  During 2001, the Financial
Accounting Standards Board issued four new pronouncements:

Statement
No. 141, Business Combinations, requires that the purchase method of accounting be
used to account for all business combinations and applies to all business
combinations initiated after June 30, 2001. The statement also establishes
specific criteria for the recognition of intangible assets separately from
goodwill. The provisions of this statement would be applied if the Company were
to enter into any future business combination. The statement has no impact on
the Companys historical financial statements.

Statement
No. 142, Goodwill and Other Intangible Assets, requires that goodwill no longer be
amortized but tested for impairment at least annually. Other intangible assets
are to be amortized over their useful lives and reviewed for impairment. An
intangible asset with an indefinite useful life will not be amortized until its
useful life becomes determinable. The effective date of this statement is
January 1, 2002. The provisions of this statement would be applied if the
Company were to enter into any future business combination pursuant to which
goodwill or other intangible assets were recognized. The statement has no impact
on the Companys historical financial statements.

Statement
No. 143, Accounting for Asset Retirement Obligations (SFAS No. 143), requires
entities to record the fair value of a liability for an asset retirement
obligation in the period in which it is incurred and a corresponding increase in
the carrying amount of the related longlived asset. The Company will be
required to adopt SFAS No. 143 effective January 1, 2003, using a cumulative effect
approach to recognize transition amounts for asset retirement obligations, asset
retirement costs and accumulated depreciation. The Company currently records
estimated costs of dismantlement, removal, site reclamation and similar
activities as part of its depreciation, depletion, and amortization for oil and
gas properties without recording a separate liability for such amounts. The
Company has not yet completed its assessment of the impact of SFAS No. 143 on its
financial condition and results of operations. It expects that adoption of the
statement will result in increases in the capitalized costs of its oil and gas
properties and in the recognition of additional liabilities related to asset
retirement obligations.

Statement
No. 144, Accounting for the Impairment or Disposal of LongLived Assets(SFAS
No. 144), retains

49

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

the fundamental
provisions of SFAS No. 121, Accounting for the Impairment of LongLived Assets and
for LongLived Assets to be Disposed Of(SFAS No. 121), for recognizing
and measuring impairment losses while resolving significant implementation issues
associated with SFAS No. 121. SFAS No. 144 also expands the basic provisions of APB
Opinion No. 30, Reporting the Results of Operations Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions, regarding presentation of discontinued operations in
the income statement. The scope for reporting a discontinued operation has been expanded
to include a componentof an entity. A component comprises operations and cash
flows that can be clearly distinguished from the rest of the entity. It could be a
segment, a reporting unit, a consolidated subsidiary or an asset group.

The
Company adopted SFAS No. 144 as of January 1, 2002. Because the Company has elected
the full cost method of accounting for oil and gas exploration and development
activities, the impairment provisions of SFAS No. 144 do not apply to the
Companys oil and gas assets, which are subject to the ceiling limitations.
For the Companys nonoil and gas assets, the method of impairment
assessment is largely unchanged from SFAS No. 121. The adoption of SFAS No. 144 had no
impact on the Companys financial statements.

3.  
Income from Continuing Operations Per Share

The
following table provides a reconciliation between basic and diluted income from
continuing operations per share (stated in thousands except per share data):

|                                        | 2001 | 2000
|--------------------------------------- | ---- | ----
|                                       
|
|                                       
|Income before extraordinary loss        |      |     
|Extraordinary loss, net of income taxes |      |     
|                                       
|Net income                              |      |     
|Preferred stock dividends               |      |     
|                                       
|Net income available to common          |      |     
|stockholders                            |      |     
|                                       
|Weighted average common shares          |      |     
|outstanding                             |      |     
|Effect of dilutive securities:          |      |     
|Stock options                           |      |     
|Convertible preferred stock             |      |     
|                                       
|Average common shares outstanding       |      |     
|                                       
|Earnings per common share:              |      |     
|Income before extraordinary loss        |      |     
|Extraordinary loss, net of income taxes |      |     
|                                       
|Net income                              |      |     
|                                       

Income
from continuing operations per share is computed by dividing income from
continuing operations available to common stockholders by the weighted average
number of common shares outstanding during the period. Diluted income from
continuing operations per share is determined on the assumption that outstanding
stock options have been converted using the average common stock price for the
period and that convertible preferred stock has been converted at its stated
conversion price.

Information for 1999 is
not included in the table above because 1999 was a loss year. For
purposes of computing income from continuing operations per share in a
loss year, common stock equivalents are excluded from the computation of
weighted average common shares
outstanding because their effect is antidilutive. The preferred stock conversion is also
excluded from the computation for the same year because of its antidilutive effect.

Weighted
average options to purchase 4.3 million shares of common stock at $18.35 to
$36.54 per share and 6.6 million shares of common stock at $13.46 to $36.54 per
share were outstanding during 2001 and 2000, respectively, but were not included
in the computation of diluted income from continuing operations per share
because the options exercise prices were greater than the average market
price of the common shares. These options expire at various dates through 2011.
Options to purchase 22.5 million shares of common stock were outstanding at
December 31, 1999, but were not included in the computation of diluted loss from
continuing operations per share because the effect of the assumed exercise of
these stock options as of the beginning of the year would have an antidilutive
effect. These options had exercise prices ranging from $2.11 to $36.54 and
expire at various dates through 2009.

50

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

4.  
Operating Expenses

Components
of operating expenses are as follows (in thousands):

|                        | Year Ended December 31,
|----------------------- | -----------------------
|                       
|
|                       
|Lease operating expense |                        
|Production taxes        |                        
|Transportation expenses |                        
|Ad valorem taxes        |                        
|                       
|Operating expenses      |                        
|                       

5.  
Supplemental Disclosures of Cash Flow Information

Supplemental
disclosures of cash flow information are as follows (in thousands):

|                               | Year Ended December 31,
|------------------------------ | -----------------------
|                              
|
|                              
|Cash paid during the year for: |                        
|Interest                       |                        
|Income taxes                   |                        

6.  
Other Current Assets

Other
current assets include the following at December 31, 2001 and 2000 (in
thousands):

|                                             | December 31,
|-------------------------------------------- | ------------
|
|
|
|Prepaid drilling costs                       |             
|Inventories                                  |             
|Oil and gas derivative financial instruments |             
|Other                                        |             
|                                            
|Other current assets                         |             
|                                            

7.  
Acquisition and Disposition of Assets

2001
Acquisitions  During 2001, the Company acquired Texoil, Inc.
(Texoil) for a cash purchase price of approximately $115 million
before assumed bank debt of $15 million. Texoil was an independent oil and gas
company engaged in exploration, development, and acquisition of oil and gas
reserves in Texas and Louisiana. No goodwill was recorded in connection with the
purchase of Texoil. The Company also acquired certain oil and gas assets from
Ensight Resources, L.L.C. for a purchase price of approximately $118 million.
The properties are located primarily in East Texas and North Louisiana. Pro
forma results of operations assuming acquisitions occurred at the beginning of
the period would not have been significantly different from actual results for
2001.

2001
Dispositions  The Company received approximately $64 million in proceeds
from the sales of certain noncore properties during 2001.

2000
Dispositions  On March 31, 2000, the Company completed the sale of its
East Bay Complex receiving net proceeds of approximately $78 million. The
properties were located in the Mississippi Delta Region of the Gulf of Mexico.
The Company had no other significant dispositions in 2000.

1999
Dispositions  During 1999, the Company disposed of ENSTAR for net proceeds of
$287 million; domestic properties located in the Arkoma Basin and Gulf of Mexico
for net proceeds of $231 million and $66 million, respectively; and its Canadian
subsidiary for net proceeds of $68 million.

Proceeds
from the dispositions were used primarily to repay amounts outstanding under the
Companys existing credit facility.

8.  
Other Noncurrent Assets

Other
noncurrent assets include the following at December 31, 2001 and 2000 (in
thousands):

|                                                                      | December 31,
|--------------------------------------------------------------------- | ------------
|                                                                     
|
|                                                                     
|Oil and gas imbalances (net of current portion of $3.5 million and $5 |             
|million in 2001 and 2000, respectively)                               |             
|Deferred financing costs                                              |             
|Interest rate swap agreements                                         |             
|Assets held in supplemental benefit plans trust at fair market value  |             
|Other                                                                 |             
|                                                                     
|Other noncurrent assets                                               |             
|                                                                     

51

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

9.  
Accrued Liabilities

Accrued
liabilities include the following at December 31, 2001 and 2000 (in thousands):

|                                              | December 31,
|--------------------------------------------- | ------------
|
|
|
|Income taxes payable                          |             
|Contribution to Ocean Retirement Savings Plan |             
|Production and ad valorem taxes               |             
|Payroll and related employee benefits         |             
|Other                                         |             
|                                             
|Accrued liabilities                           |             
|                                             

10.  
Debt

Longterm
debt consisted of the following at December 31, 2001 and 2000 (in thousands):

|                                                               | December 31,
|-------------------------------------------------------------- | ------------
|
|
|                                                              
|Credit Facility (average interest rate of 5.2%) due March 2004 |             
|Public Notes:                                                  |             
|7 7/8% Senior Notes, due August 2003                           |             
|7 5/8% Senior Notes, due July 2005                             |             
|7 1/4% Senior Notes, due October 2011                          |             
|8 1/4% Senior Notes, due July 2018                             |             
|7 1/2% Senior Notes, due September 2027                        |             
|8 5/8% Senior Subordinated Notes, due August 2005              |             
|9 3/4% Senior Subordinated Notes, due October 2006             |             
|8 7/8% Senior Subordinated Notes, due July 2007                |             
|8 3/8% Senior Subordinated Notes, due July 2008                |             
|Other                                                          |             
|                                                              
|                                                               |             
|Less:  Current maturities                                      |             
|Unamortized debt discount                                      |             
|                                                              
|Total long-term debt                                           |             
|                                                              

Credit
Facility  As of December 31, 2001, the Companys credit facility
consisted of a $500 million revolving credit facility with a maturity date of
March 30, 2004. The credit facility bears interest, at the Companys
option, at LIBOR or prime rates plus applicable margins ranging from zero to
1.7% or at a competitive bid. As of December 31, 2001, borrowings outstanding
against the credit facility totaled $50 million and letters of credit totaled
$31 million, leaving $419 million of available credit.

Other
Financing Activities  During 2001, the Company issued $350 million of
71⁄4% senior notes due 2011 pursuant to a shelf registration statement. The
notes are redeemable at the Companys option, and upon certain changes in
control, the notes would be subject to a mandatory repurchase offer. A portion
of the proceeds was used to repay amounts outstanding under the Companys
credit facility, and the remainder of the proceeds was used to retire existing
higher interest rate debt by exercising call provisions for the Companys
8 5/8% senior subordinated notes due 2005 and 93⁄4% senior subordinated notes
due 2006.

Also
during 2001, the Company repurchased on the open market approximately $22
million of its 8 3/8% senior subordinated notes due July 2008 and $25 million of
its 8 7/8% senior subordinated notes due July 2007. The repurchase of these notes
was funded with available cash balances and borrowings under the Companys
existing credit facility.

In
connection with these early extinguishments of debt, the Company recorded a
total aftertax extraordinary loss of approximately $4 million, or ($0.02) per
diluted share. The extraordinary loss was net of a tax benefit of approximately
$2 million.

During
1999, the Company repurchased the outstanding balance of its 10 3/8% senior
subordinated notes, which totaled $150 million, and $158 million of its
93⁄4% senior subordinated notes. The repurchase of these notes was funded
with available cash balances and borrowings under the credit facility. In
connection with this repurchase, the Company recorded an aftertax extraordinary
loss of $23 million, or ($0.16) per basic and diluted share. The extraordinary
loss included a current tax benefit of approximately $13 million.

Public
Notes  The Companys senior and senior subordinated notes are general
unsecured obligations of the Company. Ocean Energy, Inc. (incorporated in
Louisiana), a whollyowned subsidiary of the Company, has guaranteed the payment
of principal, premium (if any), and interest. Other than intercompany
arrangements and transactions, the consolidated financial statements of the
subsidiary are equivalent in all material respects to those of the Company and
therefore are not presented separately.

The
Companys debt contains conditions and restrictive provisions including, among other
things, restrictions on additional indebtedness by the Company and its subsidiaries, and
entering into sale and leaseback transactions, the maintenance of certain financial
ratios and restrictions on dividend payments or stock repurchases.

52

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Under the most
restrictive of these provisions, approximately $371 million was available for payment of
cash dividends on common stock or to repurchase common stock as of December 31, 2001.

Annual
Maturities  At December 31, 2001, the Companys aggregate annual
maturities of longterm debt are $1 million, $101 million, $51 million, $126
million and $1 million for the years 2002, 2003, 2004, 2005 and 2006,
respectively.

Deferred
Financing Costs  Deferred financing costs represent financing costs
incurred in connection with the execution of various debt facilities entered
into or securities issued by the Company. These costs are capitalized as other
noncurrent assets in the Companys Consolidated Balance Sheet and amortized
to interest expense over the life of the related debt.

11.  
Deferred Revenue

During
2000, the Company entered into a marketsensitive prepaid natural gas sales
contract to deliver approximately 53,500 MMBtu per day of natural gas for the
period January 2002 through December 2003. In exchange for the natural gas to be
provided, the Company received an advance payment of approximately $75 million.
The contract was subsequently amended to provide for delivery of 53,500 MMBtu per
day of natural gas for the period January 2003 through December 2003 and 55,600 MMBtu per day
of natural gas for the period January 2004 through December 2004. To the extent that the
index price, as defined, exceeds a stated amount per MMBtu for any delivery
month ($2.50 for 2003 and $3.00 for 2004), the purchaser will make payments to
the Company equal to the difference between the index price and the stated
amount times the delivery quantity for that month.

In
1999, the Company entered into a prepaid crude oil sales contract to deliver
approximately 5.6 MBbl per day of crude oil for the period February 2000 through
May 2003. In exchange for the crude oil to be provided, the Company received an
advance payment of approximately $100 million.

The
obligations associated with the future delivery of the natural gas and crude oil
have been recorded as deferred revenue. The amounts received are amortized into
revenue as scheduled deliveries of natural gas and crude oil are made as
follows:

|                           | Year Ended December 31,
|-------------------------- | -----------------------
|
|
|
|Revenues (in thousands)    |                        
|Annual oil delivery (MBbl) |                        
|Annual gas delivery (BBtu) |                        

12.  
Other Noncurrent Liabilities

Other
noncurrent liabilities include the following at December 31, 2001 and 2000 (in
thousands):

|                                                                     | December 31, | 
|-------------------------------------------------------------------- | ------------ | 
|                                                                    
|
|                                                                    
|Conveyance of Section 29 credit properties                           |              | 
|Oil and gas imbalances (net of current portion of $2 million in 2001 |              | 
|and $2 million in 2000)                                              |              | 
|Supplemental benefit and directors deferred fee plans                |              | 
|Other                                                                |              | 
|                                                                    
|Other noncurrent liabilities                                         |              | 
|                                                                    

Conveyance
of Section 29 Credit Properties  In September 2000, the Company conveyed
certain Internal Revenue Code Section 29 Tax Creditbearing properties to a
trust for approximately $70 million, which was recorded in other noncurrent
liabilities. The trust receives the operating cash flow from the properties
until the investor recoups its investment plus a required aftertax rate of
return. As part of the transaction, the trust was required to hedge 85% of its
total estimated gas production through December 31, 2005. Although the Company
is not a party to the financial instrument, under SFAS No. 133 this transaction is
determined to have an embedded derivative financial instrument. The fair market
value of that financial derivative at December 31, 2001, is $7.6 million and is
offset against the amount included in other noncurrent liabilities.

Supplemental
Benefit and Directors Deferred Fee Plans  Supplemental benefit and
directors deferred fee plans represent the Companys obligation under its
executive supplemental retirement plan ($4.8 million), the outside directors
deferred fee plan ($1.6 million) and other supplemental benefit plans ($2.1
million).

53

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

13.  
Fair Value of Financial Instruments

The
estimated fair value of financial instruments has been determined by the Company
using available market information and valuation methodologies described below.
Considerable judgment is required in interpreting market data to develop the
estimates of fair value. The use of different market assumptions or valuation
methodologies may have a material effect on the estimated fair value amounts.
The estimated fair values of the Companys financial instruments are
summarized as follows (in thousands):

|                                             | December 31,
|-------------------------------------------- | ------------
|
|
|
|
|
|                                            
|Long-term debt                               |             
|Derivative financial instruments:            |             
|Interest rate swaps                          |             
|Oil and gas derivative financial instruments |             
|Embedded derivative financial instrument     |             

Debt
 The fair value of public notes is estimated based on quoted market prices
for the same or similar issues. The carrying amount of all other debt
approximates fair value because these instruments bear interest at rates tied to
current market rates or mature in one year.

Derivative
Financial Instruments  As discussed in Note 2, the Company adopted SFAS
No. 133 as of January 1, 2001. As a result, the Companys derivative financial
instruments are recorded at fair market value on the Companys Consolidated
Balance Sheet at December 31, 2001. The fair market values are the amounts the
Company would expect to receive or pay to settle the instruments at the
reporting date, taking into account the difference between market prices or
index prices at yearend and the contract prices of the instruments. The fair
market values were obtained from the thirdparty counterparties to the
instruments.

Interest
Rate Swaps  At December 31, 2001, the Company was party to interest rate
swap agreements relating to its 7 5/8% senior notes due July 2005
and its 7 7/8% senior notes due August 2003. Under the terms of the agreements, the
counterparties pay the Company a weighted average fixed annual rate of 7.74% on
total notional amounts of $225 million, and the Company pays the counterparties
a variable annual rate equal to the average sixmonth LIBOR rate plus a weighted
average rate of 2.73%. The swap agreements remain in effect through the maturity
dates of the respective notes. The swap agreements have been designated as fair
value hedges pursuant to SFAS No. 133 and are included in other noncurrent assets in
the Companys Consolidated Balance Sheet. Interest expense for 2001 was
reduced by approximately $3 million as a result of the interest rate swaps.

Oil
and Gas Derivative Financial Instruments  At December 31, 2001, the
Company had in place collars covering portions of its 2002 oil and gas
production. The gas collars, which are for the period January through December
2002, cover contracted volumes of 140 MMcf per day of natural gas with a
weighted average floor price of $2.82 per Mcf and a weighted average ceiling
price of $4.07 per Mcf. The oil collars, which are also for the period January
through December 2002, cover contracted volumes of 15 MBbl per day of oil
with a floor price of $23.00 per Bbl and a weighted average ceiling price of
$28.03 per Bbl. The Companys oil and gas derivative financial instruments
have been designated as cash flow hedges in accordance with SFAS No. 133 and are
included in other current assets in the Companys Consolidated Balance
Sheet.  The carrying amount for oil and gas derivative financial instruments at December 31,
2000, represents premiums paid by the Company upon entering the contracts.

Subsequent
to December 31, 2001, the Company entered into crude oil collars for the period April
through December 2002. The contracts cover 20 MBbl of crude oil per day with a weighted average floor price of
$21.875 and a weighted average ceiling price of $26.275.

The
Company occasionally utilizes derivative financial instruments which have not
been designated as cash flow hedges even though they protect the Company from
changes in commodity prices. These instruments are marked to market quarterly
with the resulting changes in fair value recorded in oil and gas revenues. As of
December 31, 2001, the Company has in place two crude oil basis swap contracts
to fix the sales price differential between WTI and Brent. The contracts, which
extend through May 2002 and relate to 20 MBbl per day, provide that the Company
receives/pays a net settlement of WTI less Brent less $1.29 per Bbl.

Embedded
Derivative Financial InstrumentA related trust, to which the Company conveyed
Section 29 tax creditbearing properties, is required to hedge 85% of total
estimated gas production from these properties through 2005. Through a swap agreement,
the trust has hedged 13,500 MMBtu per day at $4.12 for 2002, 11,100 MMBtu per day at
$3.60 for 2003, 9,600 MMBtu per day at $3.41 for 2004 and 8,300 MMBtu per day at $3.28
for 2005. The fair market value

54

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

of the embedded
derivative financial instrument is the amount the trust would expect to receive or pay to
settle the instrument at the reporting date. The financial instrument has been designated
as a cash flow hedge in accordance with SFAS No. 133. See Note 12.

The
portion of the change in fair values of the Companys oil and gas
derivative financial instruments and the embedded derivative financial
instrument included in revenues comprises the following (in thousands):

|                                                                             | Year Ended
|---------------------------------------------------------------------------- | ----------
|
|                                                                            
|Financial derivative settlements transferred from other comprehensive income |           
|Net change in fair market value of put options                               |           
|Ineffective portion of derivative financial instruments                      |           
|                                                                            
|Decrease in revenues from derivative financial instruments qualifying        |           
|as cash flow hedges                                                          |           
|Decrease in revenues from other oil and gas derivative financial instruments |           
|                                                                            
|Decrease in revenues from oil and gas derivative financial instruments       |           
|                                                                            

Approximately
$23 million of net deferred gains included in accumulated other comprehensive
income at December 31, 2001, will be reversed during the next twelve months as
the forecasted transactions actually occur. All forecasted transactions
currently being hedged are expected to occur by December 2005.

Prior
to the adoption of SFAS No. 133, the impact of oil and gas derivative financial
instruments and the embedded derivative financial instrument were recorded in
revenues as the associated production occurred. During 2001, there were no gains
or losses reclassified into earnings as a result of the discontinuance of hedge
accounting treatment for any of the Companys derivative financial
instruments.

The
net effect of the Companys oil and gas derivative financial instruments
and the embedded derivative financial instrument included as a component of
other comprehensive income (loss), net of tax, is as follows (in thousands):

|                                                                        | Year Ended
|----------------------------------------------------------------------- | ----------
|
|                                                                       
|Cumulative effect of accounting change for oil and gas                  |           
|derivative financial instruments                                        |           
|Net change in fair market value of oil and gas derivative               |           
|financial instruments                                                   |           
|Financial derivative settlements taken to income                        |           
|                                                                       
|Net effect of oil and gas derivative financial instruments (increase in |           
|stockholders' equity)                                                   |           
|                                                                       

14.  
Stockholders Equity

The
following table reflects the activity in shares of the Companys common
stock, preferred stock and treasury stock during the three years ended December
31, 2001:

|                                                | Year Ended December 31,
|----------------------------------------------- | -----------------------
|
|
|
|Common Stock Outstanding:                       |                        
|Shares at beginning of year                     |                        
|Shares issued in connection with Seagull Merger |                        
|Exercise of common stock options                |                        
|Deferred compensation                           |                        
|Employee stock purchase plan                    |                        
|                                               
|Shares at end of year                           |                        
|                                               
|Preferred Stock Outstanding                     |                        
|                                               

|                                                 | Year Ended December 31,
|------------------------------------------------ | -----------------------
|
|
|
|Treasury Stock Outstanding:                      |                        
|Shares at beginning of year                      |                        
|Shares assumed in connection with Seagull Merger |                        
|Purchase of shares                               |                        
|Transfer to supplemental benefit plans trust     |                        
|Contribution of shares to employee plans         |                        
|                                                
|Shares at end of year                            |                        
|                                                

55

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Preferred
Stock  The Company is authorized to issue 10,000,000 shares of preferred
stock, in one or more series. In 1998, the Company completed a private placement
of 50,000 shares of Class C Convertible Preferred Stock for $38 million of oil
and gas properties and $12 million cash from one of its institutional investors
and an affiliate of such investor. The preferred stock has a 6.5% cumulative
dividend payable semiannually and ranks senior to the Companys common
stock with respect to dividend distribution and distribution upon liquidation.
Upon liquidation, the holders of the preferred shares are entitled to receive
$1,000 per share, plus any accrued and unpaid dividends. The conversion price of
the shares decreases based on the amount of dividends paid on common stock and
was $14.84 at December 31, 2001.

Common
Stock Dividends  At December 31, 2001, the Company had accrued dividends
payable of $6.9 million ($0.04 per share) on the Companys outstanding
common stock. Dividends of $27.4 million were charged to retained earnings
during 2001. See Note 10 for discussion of restrictions on payment of cash
dividends on common stock.

Treasury
Stock  During 2001, the Company purchased 361,278 shares of its stock for
approximately $6.7 million and contributed 472,000 shares to the supplemental
benefit plans trust (see Note 15) and 2,204 shares to employee benefit plans.
During 2000, the Company purchased approximately 2.4 million shares of its stock
for $32 million. In December 1999, the Company purchased 394,000 shares of stock
in the open market for $2.8 million and subsequently contributed 488,107 shares
of treasury stock to its Employee Stock Ownership Plan. In connection with the
Seagull Merger, the Company acquired 472,278 shares of treasury stock.

Preferred
Share Purchase Rights  The Company has a Share Purchase Rights Plan to
protect the Companys stockholders from coercive or unfair takeover
tactics. Under this Plan, each outstanding share and each share of common stock
subsequently issued has attached to it one Right, exercisable at $30.75, subject
to certain adjustments. In the event a person or group acquires 10% or more of
the outstanding common stock, or in the event the Company is acquired in a
merger or other business combination, or 50% or more of the Companys
consolidated assets or earning power is sold, each Right unless redeemed
entitles the holder to purchase $30.75 worth of shares of common stock of the
Company or of the acquiring company, as the case may be, for half of the
thencurrent, pershare market prices.

The
Rights, under certain circumstances, are redeemable at the option of OEIs
Board of Directors at a price of $0.005 per Right, within 10 days (subject to
extension) following the day on which the acquiring person or group exceeds the
10% threshold. If any person or group acquires 10% or
more (but less than 50%) of the Companys outstanding common stock, the Board may,
at its option, issue common stock in exchange for all or part of the outstanding and
exercisable Rights (other than Rights owned by such person or group which would become
null and void) at an exchange ratio of one share of common stock for each two shares of
common stock for which each Right is then exercisable, subject to adjustment. The Rights
expire on May 21, 2003, but may be extended by an action of the Board of Directors.

Accumulated
Other Comprehensive Income  Components of accumulated other comprehensive
income (loss) consisted of the following at December 31, 2001 (in thousands):

|                                                           | December 31, 2001
|---------------------------------------------------------- | -----------------
|                                                          
|Net effect of oil and gas derivative financial instruments |                  
|Minimum supplemental retirement plans liability            |                  
|adjustment and other                                       |                  
|                                                          
|Accumulated other comprehensive income                     |                  
|                                                          

At
December 31, 2001, the effect of derivative financial instruments is net of
deferred income tax expense of $15 million. The minimum supplemental retirement
plans liability adjustment and other is net of deferred income tax benefit of $260,000.

15.  
Benefit Plans

Stock
Option Plans  The Company currently has various stock option plans. The
stock options generally become exercisable over a threeyear period and expire
10 years after the date of grant. At December 31, 2001, approximately 4.6
million shares of common stock were available for grant. Information relating to
stock options is summarized as follows:

|                        | 2001 | 2000 | 1999
|----------------------- | ---- | ---- | ----
|                       
|
|
|
|
|
|                       
|Balance outstanding    |      |      |     
|Beginning of year       |      |      |     
|Seagull options assumed |      |     
|at merger date          |      |      |     
|Granted                 |      |      |     
|Exercised               |      |      |     
|Forfeited               |      |      |     
|                       
|Balance outstanding    |      |     
|End of year             |      |      |     
|                       
|Options exercisable    |      |     
|End of year             |      |      |     
|                       

56

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

The
weighted average fair value of stock options granted during 2001, 2000 and 1999
was $7.99, $4.86 and $4.28 per share, respectively. The fair value of each
option grant is estimated on the date of grant using the BlackScholes
optionspricing model with the following weighted average assumptions used for
grants in 2001, 2000, and 1999:

|                        | Year Ended December 31,
|----------------------- | -----------------------
|                       
|
|                       
|Risk-free interest rate |                        
|Expected life           |                        
|Expected volatility     |                        
|Expected dividend yield |                        

Actual
value realized, if any, is dependent on the future performance of Ocean common
stock and overall stock market conditions. There is no assurance the value
realized by an optionee will be at or near the value estimated by the
BlackScholes model.

Information
relating to stock options outstanding at December 31, 2001 is summarized as
follows:

|             | Options Outstanding | Options Exercisable
|------------ | ------------------- | -------------------
|            
|
|
|
|
|            
|$3.657.30   |                     |                    
|$7.3110.96  |                     |                    
|$10.9714.61 |                     |                    
|$14.6218.26 |                     |                    
|$18.2721.92 |                     |                    
|$21.9325.57 |                     |                    
|$25.5836.54 |                     |                    
|            
|             |                     |                    
|            

The
Company accounts for its stockbased compensation plans under Accounting
Principles Board Opinion 25, Accounting for Stock Issued to Employees, and
related interpretations. All outstanding options were issued at an exercise
price equal to fair market value or greater of the Companys common stock
as of the date of grant. Accordingly, for the years ended December 31, 2001,
2000 and 1999, no compensation expense relating to these options was recognized
in the Companys results of operations.

Had
compensation costs for the Companys stock option plans been determined
based on the fair value at the grant dates in accordance with SFAS No. 123,
Accounting for StockBased Compensation, the Companys net income (loss)
and earnings (loss) per share would have been restated to the pro forma amounts
(stated in thousands except pershare data) indicated below:

|                             | Year Ended December 31,
|---------------------------- | -----------------------
|                            
|
|                            
|Net income (loss):           |                        
|As reported                  |                        
|Pro forma                    |                        
|Net income (loss) per share: |                        
|Basic:                       |                        
|As reported                  |                        
|Pro forma                    |                        
|Diluted:                     |                        
|As reported                  |                        
|Pro forma                    |                        

57

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Under
SFAS No. 123, the acceleration of vesting of options due to the Seagull Merger
resulted in the recognition of all remaining pro forma unamortized compensation
expense relating to those options in the calculation of the 1999 pro forma
amounts above.

Executive
Supplemental Retirement Plan  The Executive Supplemental Retirement Plan
(the Plan) was established to provide supplemental retirement
benefits to certain key employees. The Plan is a noncontributory defined
benefit retirement plan, which provides for supplemental benefits based on the
employees years of service and compensation. The Companys
policy generally is to fund the benefits as they become payable.

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

The
following tables set forth the Plans benefit obligation, Plan assets,
reconciliation of funded status, amounts recognized in the Consolidated Balance
Sheets, and the actuarial assumptions used (in thousands):

|                                               | Year Ended December 31,
|---------------------------------------------- | -----------------------
|                                              
|
|                                              
|Change in benefit obligation:                  |                        
|Benefit obligation at beginning of year        |                        
|Service cost                                   |                        
|Interest cost                                  |                        
|Actuarial (gain) loss                          |                        
|Benefits paid                                  |                        
|                                              
|Benefit obligation at end of year              |                        
|                                              
|Change in Plan assets:                         |                        
|Fair value of Plan assets at beginning of year |                        
|Employer contribution                          |                        
|Benefits paid                                  |                        
|                                              
|Fair value of Plan assets at end of year       |                        
|                                              
|Funded status                                  |                        
|Unrecognized actuarial gain                    |                        
|                                              
|Net amount recognized                          |                        
|                                              

|Amounts recognized in the balance sheets consist of: |  |  |   |        |   |   |        |  
|---------------------------------------------------- |  |  | - | ------ | - | - | ------ | -
|Accrued benefit cost                                 |  |  | $ | (4,219 | ) | $ | (4,108 | )
|Additional minimum liability                         |  |  |   | (629   | ) |   | --     |  
|Deferred taxes                                       |  |  |   | 240    |   |   | --     |  
|Accumulated other comprehensive loss                 |  |  |   | 389    |   |   | --     |  
|                                                    
|Net amount recognized                                |  |  | $ | (4,219 | ) | $ | (4,108 | )
|                                                    

Net
periodic benefit cost for the Plan includes the following components (in
thousands):

|                          | Year Ended December 31,
|------------------------- | -----------------------
|                         
|
|                         
|Service Cost              |                        
|Interest cost             |                        
|Recognized actuarial gain |                        
|                         
|Net periodic benefit cost |                        
|                         

Weighted
average assumptions include the following:

|              | Year Ended December 31,
|------------- | -----------------------
|             
|
|             
|Discount rate |                        

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Employee
Stock Purchase Plan  During 2001, the Company established an Employee Stock
Purchase Plan (ESPP) that allows eligible employees to purchase
common stock of the Company at a 15% discount from the lower of the stock price
at the beginning of the offering period or at the end of the offering period.
There are two offering periods annually, and employees may elect to make
contributions to the ESPP in amounts from 1% to 15% of eligible compensation,
subject to certain limits.

Deferred
Compensation  During 2001, the Company awarded a total of 779,500 shares of
common stock as deferred compensation with an average fair market value of
$17.81 per share and a threeyear vesting period to various Company employees.
During 2000, the Company awarded a total of 269,125 shares of restricted common
stock with an average fair market value of $9.31 per share and a threeyear
vesting period. The fair market value of the stock at the date of grant is
included as a charge to equity and amortized to earnings as compensation expense
over the vesting period.

Supplemental
Benefit Plans Trust  During 2001, the Company established a trust
(the Trust) to assist the Company in funding its obligations under
deferred compensation plans for certain employees and nonemployee directors.
Trust assets consist of investments in marketable securities and shares of
Company common stock, and participants are invested either in the marketable
securities and/or the shares of Company common stock in the deferred plans.

58

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

The
Trust assets are included in the Companys Consolidated Balance Sheet.
Investments in marketable securities of $3.7 million are classified as trading
securities and reported at fair value, with unrealized gains and losses included
in earnings in accordance with Statement of Financial Accounting Standards No.
115, Accounting for Certain Investments in Debt and Equity Securities.
Obligations which are to be settled by Trust assets other than shares of Company
common stock total $3.7 million at December 31, 2001, and are included in other
noncurrent liabilities in the Companys Consolidated Balance Sheet.

For
investments in Company stock, the Trust is funded with treasury stock as
compensation is earned. The related compensation obligation will be settled by
the delivery of a fixed number of shares of Company stock, and diversification is
not permitted. As a result, when funding of shares of stock to the Trust occurs,
the balance in the Companys treasury stock account is reduced by the
average cost of the shares to the Company. The Trust records the shares at fair
market value, and the difference is recorded to additional paidin capital. The
stock held by the Trust is included in stockholders equity at December 31,
2001, and changes in the fair value are not recognized subsequent to funding.
The related obligation totaled $7.9 million at December 31, 2001, and is also
classified in stockholders equity. The Trust held 472,000 shares of stock
at December 31, 2001. These shares are included in the calculations of basic and
diluted earnings per share as though they were outstanding.

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

The
Trust assets and the related obligation were as follows at December 31, 2001 (in
millions):

|                                                   | December 31, 2001
|-------------------------------------------------- | -----------------
|                                                  
|Assets Funded to Supplemental Benefit Plans Trust: |                  
|Marketable securities and other                    |                  
|Common stock                                       |                  
|                                                  
|Total assets held in Trust                         |                  
|                                                  
|Amount included in other noncurrent liabilities    |                  
|Amount included in stockholders' equity            |                  
|                                                  
|Total supplemental benefit plans obligation        |                  
|                                                  

Other
Benefit Plans  The Company maintains the Ocean Retirement Savings Plan
(the ORS Plan), a defined contribution plan created from the January
2001 merger of several previous 401(k) plans and an employee stock ownership
plan. All regular employees are eligible to participate, and the Company matches
a portion of employees contributions. Company contributions, including
additional optional annual contributions, to the ORS Plan and the previous plans
were approximately $8 million, $8 million and $6 million in 2001, 2000 and 1999,
respectively, and were included in operating and general and administrative
expenses.

16.  
Income Taxes

The
income (loss) before income taxes and the components of income tax expense
(benefit) for each of the years ended December 31, 2001, 2000 and 1999 were
as follows (in thousands):

|                                                          | Year Ended December 31,
|--------------------------------------------------------- | -----------------------
|                                                         
|
|                                                         
|Income (loss) before income taxes and extraordinary item: |                        
|Domestic                                                  |                        
|Foreign                                                   |                        
|                                                         
|                                                          |                        
|                                                         
|Current income tax expense (benefit):                     |                        
|Federal                                                   |                        
|Foreign                                                   |                        
|State                                                     |                        
|                                                         
|Total current                                             |                        
|                                                         
|Deferred income tax expense (benefit):                    |                        
|Federal                                                   |                        
|Foreign                                                   |                        
|State                                                     |                        
|                                                         
|Total deferred                                            |                        
|                                                         
|Income tax expense (benefit)                              |                        
|                                                         

59

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

The
Company recognized tax benefits on the exercise of nonqualified stock options
of $15 million in 2001, $5.6 million in 2000 and $1.2 million in 1999;
recognized tax benefits on extraordinary items of $2 million in 2001 and $13
million in 1999; and incurred tax expense of $1 million on discontinued
operations in 1999. In addition, the Company recognized a deferred tax liability
of approximately $50 million due to the excess of book over tax basis of the oil
and gas properties acquired in the purchase of Texoil.

As
of December 31, 2001 and 2000, the Company and its subsidiaries had U.S. federal
net operating loss (NOL) carryforwards of approximately $488 million and $354
million, respectively. These loss carryforward amounts will expire during the
years 2006 through 2021. The Company has a statutory depletion carryforward of
$7.7 million and an alternative minimum tax credit carryforward of $5.9 million
at December 31, 2001.

For
federal income tax purposes, certain limitations are imposed on an entitys
ability to utilize its NOLs in future periods if a change of control, as defined
for federal income tax purposes, has taken place. In general terms, the
limitation on utilization of NOLs and other tax attributes during any one year
is determined by the value of an acquired entity at the date of the change of
control multiplied by the thenexisting longterm, taxexempt interest rate. The
manner of determining an acquired entitys value has not yet been addressed
by the Internal Revenue Service. The Company has determined that, for federal
income tax purposes, a change of control occurred during 1999. However, the
Company does not believe such limitations will significantly impact the
Companys ability to utilize the NOLs.

Income
tax expense (benefit) for each of the years ended December 31, 2001,
2000 and 1999 was different than the amount computed using the federal statutory
rate (35%) for the following reasons (in thousands):

|                                                             | Year Ended December 31,
|------------------------------------------------------------ | -----------------------
|                                                            
|
|                                                            
|Amount computed using the statutory rate                     |                        
|Increase (reduction) in taxes resulting from:                |                        
|Net book deductions not available for tax due to differences |                        
|in book/tax basis                                            |                        
|Tax gain in excess of book gain                              |                        
|State and local income taxes, net of federal effect          |                        
|Taxation of foreign operations, net of federal effect        |                        
|Accrual to actual adjustments                                |                        
|Decrease in deferred tax asset valuation allowance           |                        
|Other                                                        |                        
|                                                            
|Income tax expense (benefit)                                 |                        
|                                                            

60

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

The
significant components of deferred income tax expense (benefit) attributable to
income from continuing operations for the years ended December 31, 2001, 2000
and 1999 were as follows (in thousands):

|                                                                 | Year Ended December 31,
|---------------------------------------------------------------- | -----------------------
|                                                                
|
|                                                                
|Deferred tax expense (benefit) exclusive of the effects of other |                        
|components listed below                                          |                        
|Decrease in deferred tax asset valuation allowance               |                        
|                                                                
|                                                                 |                        
|                                                                

The
tax effects of temporary differences that gave rise to significant portions of
the deferred tax liabilities and deferred tax assets as of December 31, 2001 and
2000 were as follows (in thousands):

|                                                                   | December 31,
|------------------------------------------------------------------ | ------------
|                                                                  
|
|                                                                  
|Deferred tax assets:                                               |             
|Net operating loss carryforwards                                   |             
|Deferred revenue                                                   |             
|Percentage depletion carryforwards                                 |             
|Alternative minimum tax credit carryforwards                       |             
|Other                                                              |             
|                                                                  
|Deferred tax assets                                                |             
|                                                                  
|Deferred tax liabilities:                                          |             
|Property, plant and equipment, due to differences in depreciation, |             
|depletion and amortization                                         |             
|Components of other comprehensive income                           |             
|                                                                  
|Deferred tax liabilities                                           |             
|                                                                  
|Net deferred tax assets (liabilities)                              |             
|Less - reclassification to current deferred tax assets             |             
|                                                                  
|Net noncurrent deferred tax assets (liabilities)                   |             
|                                                                  

61

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

17.  
Related Party Transactions

During
2001 and 2000, the Company purchased 300,000 shares and 750,000 shares,
respectively, of its common stock from members of its Board of Directors, or
related entities, for approximately $5.7 million and $11.5 million,
respectively. These transactions were part of the Companys stock
repurchase plan and were purchased at market prices on the day of the
transaction. Such director purchase programs are no longer in place at the Company.

The
Company pays an annual consulting fee of $425,000 from June 1, 1999 through May
31, 2002 to a member of the Companys Board of Directors as part of a
contractual severance agreement in relinquishing his role as an officer of the
predecessor company.

Effective
January 1, 2000, the Company paid an annual salary of $100,000 to the Vice
Chairman of the Board of Directors of the Company. Upon the Vice Chairmans
resignation on January 23, 2001, the contract was terminated. In addition,
severance benefits of $5.4 million  paid to the
former Vice Chairman have been included in merger and acquisition costs for the year
ended December 31, 1999.

During
1999, the Company paid fees of $4.9 million to Merrill Lynch & Co., Inc. for financial
advisory services related to the Seagull Merger. A member of the Companys Board of
Directors also serves on the Board of Merrill Lynch & Co., Inc.

During
2001, the Company retained the law firm of Vinson & Elkins L.L.P. (V&E) to perform various legal services for the Company.
One of the members of the Board of Directors of the Company is retired managing partner of V&E.  Fees paid to V&E totaled
$0.9 million and $1.1 million for the years ended December 31, 2001 and 2000, respectively.  V&E has been retained to
perform similar services in 2002.

18.  
Commitments and Contingencies

Marketing
Contract  Approximately 62% of the Companys monthly domestic gas
production is being sold pursuant to a purchase and sale agreement with Duke
Energy Trading and Marketing, L.L.C. The agreement is in effect through
September 30, 2002.

Transportation
Commitments  The Company has entered into various agreements for
transportation of specified quantities of natural gas with estimated future
minimum transportation expense payments required for years ending December 31,
2002 through 2006 of $5.5 million, $1 million, $1 million, $1 million and
$1 million, respectively.

Lease
Commitments  The Company leases certain office space and equipment under
operating lease arrangements which require future minimum rental payments of $9
million in each of the years 2002 through 2004, $3 million in 2005 and 2006, and
total less than $1 million for all subsequent years. Total rental expense under
operating leases net of sublease income was approximately $7 million in 2001,
$5 million in 2000, and $5 million in 1999.

At
December 31, 2001, the Company was a party to lease agreements (Nansen and Boomvang ConstructionPeriod Leases) in which the
lessors agreed to construct and lease to the Company two spars that would be
used in the development of the Nansen and Boomvang fields in the Gulf of Mexico.
The lessors share of the estimated construction and related costs for the
two spars is approximately $170 million. The agreements provided that lease
payments were to begin upon completion of construction and continue for a period
of three years, subject to certain renewal options. Upon expiration of each
lease term, including any renewals, the Company had the option to purchase the
leased property for a specified price or to arrange for the sale of the lessors interest in the spars to
a third party. No rental expense was recorded pursuant to these leases for the
year ended December 31, 2001, as the spars were still under construction at
December 31, 2001.

The
Nansen spar was completed and installed in January 2002. In accordance with the
terms of the Nansen Construction Period Lease, the Company arranged for the sale of the
lessors interest in the spar to a thirdparty purchaser. The Company has entered into a 20year
operating lease (Nansen Operating Lease) with the purchaser. The Nansen Operating Lease contains various options whereby
the Company may purchase the lessors interest in the spar. Future cash payments under the Nansen Operating Lease will total $2
million, $7 million, $8 million, $11 million and $11 million for the years 2002,
2003, 2004, 2005, and 2006, respectively, and $194 million total for all years
thereafter.

The
Boomvang spar is scheduled for completion during the third
quarter of 2002. The Company has arranged to replace the Boomvang ConstructionPeriod
Lease with a 20year operating lease (Boomvang Operating Lease) that is expected to have terms similar to the Nansen Operating
Lease and rental payments of less than $1 million in 2002, approximately $3 million in
2003 and averaging approximately $4 million annually thereafter. The Boomvang Operating Lease is also expected to contain
an option whereby the Company may purchase the lessors interest in the
spar. The estimated total construction cost for the lessors share of
the Boomvang spar is approximately $45 million.

OtherThe
Company is a party to ongoing litigation in the normal course of business. Management
regularly ana

62

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

lyzes current
information and, as necessary, provides accruals for probable liabilities on the eventual
disposition of these matters. While the outcome of lawsuits or other proceedings against
the Company cannot be predicted with certainty, management believes that the effect on
its financial condition, results of operations and cash flows, if any, will not be
material.

19.  
Supplemental Oil and Gas Information (Unaudited)

During
2001, the Company acquired oil and gas assets located primarily in Texas and
Louisiana, and sold certain noncore properties. The Company sold its interest in
East Bay during 2000, and sold its Canadian subsidiary and portions of its
domestic assets in the Arkoma and Gulf of Mexico regions during 1999. See Note
7.

Capitalized
Costs Relating to Oil and Gas Producing Activities(Amounts in Thousands)

|                           |  | Equatorial | Côte |            | Other |  
|-------------------------- |  | ---------- | ---- | ---------- | ----- | -
|
|                          
|December 31, 2001:         |  |            |      |            |       |  
|Proved oil and             |  |           
|gas properties             |  |            | $    | 4,036,538  |       | $
|Oil and gas properties     |  |           
|excluded from              |  |           
|amortization               |  |            |      | 510,489    |       |  
|                          
|Total capitalized costs    |  |            |      | 4,547,027  |       |  
|Accumulated depreciation,  |  |           
|depletion and              |  |           
|amortization               |  |            |      | (2,274,508 | )     |  
|                          
|Net capitalized costs      |  |            | $    | 2,272,519  |       | $
|                          
|December 31, 2000:         |  |           
|Proved oil and             |  |           
|gas properties             |  |            | $    | 3,235,958  |       | $
|Oil and gas properties     |  |           
|excluded from              |  |           
|amortization               |  |            |      | 370,509    |       |  
|                          
|Total capitalized costs    |  |            |      | 3,606,467  |       |  
|Accumulated depreciation,  |  |           
|depletion and amortization |  |            |      | (1,991,236 | )     |  
|                          
|Net capitalized costs      |  |            | $    | 1,615,231  |       | $
|                          

|(1) |  | Other International unproved properties are located in Angola ($84 million),
          Pakistan ($45 million), Brazil ($26 million), and other international locations
          ($18 million).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

63

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Costs
Incurred in Oil and Gas Property Acquisition, Exploration and Development Activities(Amounts in Thousands)

|                              |  | Equatorial | Côte |           | Other |  
|----------------------------- |  | ---------- | ---- | --------- | ----- | -
|
|                             
|Year Ended December 31,       |  |            |      |           |       |  
|2001:                         |  |           
|Acquisition costs:            |  |           
|Proved                        |  |            | $    | 234,510   |       | $
|Unproved                      |  |            |      | 126,120   |       |  
|Exploration costs             |  |            |      | 270,584   |       |  
|Development costs             |  |            |      | 307,060   |       |  
|                             
|Total costs incurred          |  |            | $    | 938,274   |       | $
|                             
|Year Ended December 31, 2000: |  |           
|Acquisition costs:            |  |           
|Proved                        |  |            | $    | 6,276     |       | $
|Unproved                      |  |            |      | 46,915    |       |  
|Exploration costs             |  |            |      | 148,703   |       |  
|Development costs             |  |            |      | 191,318   |       |  
|                             
|Total costs incurred          |  |            | $    | 393,212   |       | $
|                             
|Year Ended December 31, 1999: |  |           
|Acquisition costs:            |  |           
|Proved                        |  |            | $    | 751,266   |       | $
|Unproved                      |  |            |      | 116,319   |       |  
|Exploration costs             |  |            |      | 91,207    |       |  
|Development costs             |  |            |      | 52,321    |       |  
|                             
|Total costs incurred          |  |            | $    | 1,011,113 |       | $
|                             

Costs
being excluded from amortization consist of the following at December 31, 2001,
and are presented by the year incurred (in thousands):

|                        |  | Year Ended December 31,
|----------------------- |  | -----------------------
|
|
|
|
|Unproved property costs |  |                        
|Exploration costs       |  |                        
|Development costs       |  |                        
|                       
|                        |  |                        
|                       

64

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Results
of Operations for Oil and Gas Producing Activities(Amounts in Thousands)

|                              |  | Equatorial | Côte |         | Other |  
|----------------------------- |  | ---------- | ---- | ------- | ----- | -
|
|                             
|Year Ended December 31, 2001: |  |            |      |         |       |  
|Revenues                      |  |            | $    | 881,460 |       | $
|Operating expenses(1)         |  |            |      | 233,509 |       |  
|DD&A (2)                      |  |            |      | 235,008 |       |  
|Income tax expense (3)        |  |            |      | 154,854 |       |  
|                             
|Results of activities         |  |            | $    | 258,089 |       | $
|                             
|Year Ended December 31, 2000: |  |           
|Revenues                      |  |            | $    | 711,012 |       | $
|Operating expenses(1)         |  |            |      | 185,909 |       |  
|DD&A(2)                       |  |            |      | 198,669 |       |  
|Impairment of oil and         |  |           
|gas properties                |  |            |      | --      |       |  
|Income tax expense (3)        |  |            |      | 122,413 |       |  
|                             
|Results of activities         |  |            | $    | 204,021 |       | $
|                             
|Year Ended December 31, 1999: |  |           
|Revenues                      |  |            | $    | 489,612 |       | $
|Operating expenses(1)         |  |            |      | 183,300 |       |  
|DD&A(2)                       |  |            |      | 212,089 |       |  
|Impairment of oil and         |  |           
|gas properties                |  |            |      | --      |       |  
|Income tax expense            |  |           
|(benefit)(3)                  |  |            |      | 34,391  |       |  
|                             
|Results of activities         |  |            | $    | 59,832  |       | $
|                             

|(1) |  | Operating expenses represent costs incurred to operate and maintain wells and
          related equipment and facilities. These costs include, among other things,
          repairs and maintenance, labor, materials, supplies, property taxes, insurance,
          severance taxes, transportation expense, and all overhead expenses directly
          related to oil and gas producing activities.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | DD&A represents
depreciation, depletion and amortization.
|--- |  | ---------------------------------------------------------

|(3) |  | Income tax expense (benefit) is calculated by applying the statutory tax rate to
          operating profit, then adjusting for any applicable permanent tax differences or
          tax credits and allowances.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

65

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Reserve
Quantity Information

|                                |  | Equatorial | Côte |         | Other | 
|------------------------------- |  | ---------- | ---- | ------- | ----- | 
|
|                               
|Proved Reserves (MBOE):         |  |            |      |         |       | 
|January 1, 2001                 |  |            |      | 284,448 |       | 
|Revisions of previous estimates |  |            |      | 582     |       | 
|Extensions and discoveries      |  |            |      | 101,738 |       | 
|Purchases of reserves in place  |  |            |      | 43,052  |       | 
|Sales of reserves in place      |  |            |      | (15,774 | )     | 
|Production                      |  |            |      | (35,493 | )     | 
|                               
|December 31, 2001               |  |            |      | 378,553 |       | 
|                               
|January 1, 2000                 |  |            |      | 282,483 |       | 
|Revisions of previous estimates |  |            |      | (2,153  | )     | 
|Extensions and discoveries      |  |            |      | 74,353  |       | 
|Purchases of reserves in place  |  |            |      | 1,193   |       | 
|Sales of reserves in place      |  |            |      | (38,666 | )     | 
|Production                      |  |            |      | (32,762 | )     | 
|                               
|December 31, 2000               |  |            |      | 284,448 |       | 
|                               
|January 1, 1999                 |  |            |      | 194,106 |       | 
|Revisions of previous estimates |  |            |      | 7,696   |       | 
|Extensions and discoveries      |  |            |      | 39,131  |       | 
|Purchases of reserves in place  |  |            |      | 141,850 |       | 
|Sales of reserves in place      |  |            |      | (63,901 | )     | 
|Production                      |  |            |      | (36,399 | )     | 
|                               
|December 31, 1999               |  |            |      | 282,483 |       | 
|                               

|Proved Developed Reserves (MBOE):     |  |  |  |           |  |  |        |  |  |        |  |  |        |  |  |         |  |  |           | 
|------------------------------------- |  |  |  | --------- |  |  | ------ |  |  | ------ |  |  | ------ |  |  | ------- |  |  | --------- | 
|December 31, 2001                     |  |  |  | 258,067   |  |  | 32,394 |  |  | 12,358 |  |  | 12,247 |  |  | 28,769  |  |  | 343,835   | 
|December 31, 2000                     |  |  |  | 185,673   |  |  | 22,302 |  |  | 11,104 |  |  | 7,672  |  |  | 21,210  |  |  | 247,961   | 
|December 31, 1999                     |  |  |  | 225,773   |  |  | 18,381 |  |  | 13,382 |  |  | 11,003 |  |  | 18,285  |  |  | 286,824   | 
|December 31, 1998                     |  |  |  | 143,603   |  |  | 10,620 |  |  | 10,566 |  |  | --     |  |  | 21,467  |  |  | 186,256   | 
|Proved Developed Oil Reserves (Mbbl): |  | 
|December 31, 2001                     |  |  |  | 73,679    |  |  | 32,394 |  |  | 3,497  |  |  | 12,129 |  |  | 20,950  |  |  | 142,649   | 
|December 31, 2000                     |  |  |  | 43,477    |  |  | 22,302 |  |  | 2,750  |  |  | 7,572  |  |  | 14,962  |  |  | 91,063    | 
|December 31, 1999                     |  |  |  | 74,445    |  |  | 18,381 |  |  | 2,836  |  |  | 10,809 |  |  | 11,929  |  |  | 118,400   | 
|December 31, 1998                     |  |  |  | 64,183    |  |  | 10,620 |  |  | 2,251  |  |  | --     |  |  | 3,900   |  |  | 80,954    | 
|Proved Developed Gas Reserves (MMcf): |  | 
|December 31, 2001                     |  |  |  | 1,106,330 |  |  | --     |  |  | 53,165 |  |  | 709    |  |  | 46,911  |  |  | 1,207,115 | 
|December 31, 2000                     |  |  |  | 853,176   |  |  | --     |  |  | 50,121 |  |  | 608    |  |  | 37,487  |  |  | 941,392   | 
|December 31, 1999                     |  |  |  | 907,968   |  |  | --     |  |  | 63,273 |  |  | 1,167  |  |  | 38,134  |  |  | 1,010,542 | 
|December 31, 1998                     |  |  |  | 476,522   |  |  | --     |  |  | 49,891 |  |  | --     |  |  | 105,401 |  |  | 631,814   | 

The
reserve volumes presented are estimates only and should not be construed as
being exact quantities. These reserves may or may not be recovered and may
increase or decrease as a result of future operations of the Company and changes
in economic conditions.

66

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Reserve
Quantity Information

|                                |  | Equatorial | Côte |         | Other | 
|------------------------------- |  | ---------- | ---- | ------- | ----- | 
|
|                               
|Proved Oil Reserves (Mbbl):     |  |            |      |         |       | 
|January 1, 2001                 |  |            |      | 80,682  |       | 
|Revisions of previous estimates |  |            |      | 3,896   |       | 
|Extensions and discoveries      |  |            |      | 41,071  |       | 
|Purchases of reserves in place  |  |            |      | 12,463  |       | 
|Sales of reserves in place      |  |            |      | (12,405 | )     | 
|Production                      |  |            |      | (10,170 | )     | 
|                               
|December 31, 2001               |  |            |      | 115,537 |       | 
|                               
|January 1, 2000                 |  |            |      | 89,808  |       | 
|Revisions of previous estimates |  |            |      | (330    | )     | 
|Extensions and discoveries      |  |            |      | 27,546  |       | 
|Purchases of reserves in place  |  |            |      | 406     |       | 
|Sales of reserves in place      |  |            |      | (26,774 | )     | 
|Production                      |  |            |      | (9,974  | )     | 
|                               
|December 31, 2000               |  |            |      | 80,682  |       | 
|                               
|January 1, 1999                 |  |            |      | 82,936  |       | 
|Revisions of previous estimates |  |            |      | 10,234  |       | 
|Extensions and discoveries      |  |            |      | 7,682   |       | 
|Purchases of reserves in place  |  |            |      | 14,717  |       | 
|Sales of reserves in place      |  |            |      | (12,229 | )     | 
|Production                      |  |            |      | (13,532 | )     | 
|                               
|December 31, 1999               |  |            |      | 89,808  |       | 
|                               

|Proved Gas Reserves (MMcf):     |  |  |  |           |   |  |    |  |  |         |   |  |       |   |  |          |   |  |           |  
|------------------------------- |  |  |  | --------- | - |  | -- |  |  | ------- | - |  | ----- | - |  | -------- | - |  | --------- | -
|January 1, 2001                 |  |  |  | 1,222,602 |   |  | -- |  |  | 154,825 |   |  | 609   |   |  | 52,820   |   |  | 1,430,856 |  
|Revisions of previous estimates |  |  |  | (19,892   | ) |  | -- |  |  | 2,602   |   |  | 331   |   |  | (3,357   | ) |  | (20,316   | )
|Extensions and discoveries      |  |  |  | 364,000   |   |  | -- |  |  | --      |   |  | --    |   |  | --       |   |  | 364,000   |  
|Purchases of reserves in place  |  |  |  | 183,538   |   |  | -- |  |  | --      |   |  | --    |   |  | --       |   |  | 183,538   |  
|Sales of reserves in place      |  |  |  | (20,216   | ) |  | -- |  |  | --      |   |  | --    |   |  | --       |   |  | (20,216   | )
|Production                      |  |  |  | (151,937  | ) |  | -- |  |  | (6,914  | ) |  | (218  | ) |  | (2,552   | ) |  | (161,621  | )
|                               
|December 31, 2001               |  |  |  | 1,578,095 |   |  | -- |  |  | 150,513 |   |  | 722   |   |  | 46,911   |   |  | 1,776,241 |  
|                               
|January 1, 2000                 |  |  |  | 1,156,049 |   |  | -- |  |  | 176,943 |   |  | 1,375 |   |  | 52,820   |   |  | 1,387,187 |  
|Revisions of previous estimates |  |  |  | (10,935   | ) |  | -- |  |  | (13,566 | ) |  | (549  | ) |  | 3,312    |   |  | (21,738   | )
|Extensions and discoveries      |  |  |  | 280,840   |   |  | -- |  |  | --      |   |  | --    |   |  | --       |   |  | 280,840   |  
|Purchases of reserves in place  |  |  |  | 4,723     |   |  | -- |  |  | --      |   |  | --    |   |  | --       |   |  | 4,723     |  
|Sales of reserves in place      |  |  |  | (71,353   | ) |  | -- |  |  | --      |   |  | --    |   |  | --       |   |  | (71,353   | )
|Production                      |  |  |  | (136,722  | ) |  | -- |  |  | (8,552  | ) |  | (217  | ) |  | (3,312   | ) |  | (148,803  | )
|                               
|December 31, 2000               |  |  |  | 1,222,602 |   |  | -- |  |  | 154,825 |   |  | 609   |   |  | 52,820   |   |  | 1,430,856 |  
|                               
|January 1, 1999                 |  |  |  | 667,019   |   |  | -- |  |  | 167,743 |   |  | --    |   |  | 111,004  |   |  | 945,766   |  
|Revisions of previous estimates |  |  |  | (15,236   | ) |  | -- |  |  | (1,927  | ) |  | (400  | ) |  | 1,171    |   |  | (16,392   | )
|Extensions and discoveries      |  |  |  | 188,693   |   |  | -- |  |  | --      |   |  | --    |   |  | --       |   |  | 188,693   |  
|Purchases of reserves in place  |  |  |  | 762,799   |   |  | -- |  |  | 22,177  |   |  | 2,039 |   |  | 61,311   |   |  | 848,326   |  
|Sales of reserves in place      |  |  |  | (310,031  | ) |  | -- |  |  | --      |   |  | --    |   |  | (115,000 | ) |  | (425,031  | )
|Production                      |  |  |  | (137,195  | ) |  | -- |  |  | (11,050 | ) |  | (264  | ) |  | (5,666   | ) |  | (154,175  | )
|                               
|December 31, 1999               |  |  |  | 1,156,049 |   |  | -- |  |  | 176,943 |   |  | 1,375 |   |  | 52,820   |   |  | 1,387,187 |  
|                               

67

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

The
Companys standardized measure of discounted future net cash flows as of
December 31, 2001 and 2000, and changes therein for each of the years 2001, 2000
and 1999, are provided based on the present value of future net revenues from
proved oil and gas reserves. The Companys estimates of proved oil and gas
reserves are prepared by internal petroleum engineers in accordance with
guidelines established by the Securities and Exchange Commission and are reviewed by an
independent petroleum engineering firm. These estimates were computed by applying
yearend prices for oil and gas to estimated future production of proved oil and gas
reserves over the economic lives of the reserves and assuming continuation of existing
operating conditions. Yearend 2001 and 2000 calculations were made using prices of
$17.23 per Bbl and $22.97 per Bbl, respectively, for oil and $2.64 per Mcf and $8.81 per
Mcf, respectively, for gas.

Because
the disclosure requirements are standardized, significant changes can occur in
these estimates based upon oil and gas prices in effect at yearend. The
following estimates should not be viewed as an estimate of fair market value.
Income taxes are computed by applying the statutory income tax rate in the
jurisdiction to the net cash inflows relating to proved oil and gas reserves
less the tax bases of the properties involved and giving effect to appropriate
net operating loss carryforwards, tax credits and allowances relating to such
properties.

Standardized
Measure of Discounted Future Net Cash Flows(Amounts in Thousands)

|                         |  | Equatorial | Côte |            | Other |  
|------------------------ |  | ---------- | ---- | ---------- | ----- | -
|
|                        
|December 31, 2001:       |  |            |      |            |       |  
|Future cash inflows      |  |            | $    | 6,299,765  |       | $
|Future development costs |  |            |      | (839,346   | )     |  
|Future production costs  |  |            |      | (2,030,995 | )     |  
|                        
|Future net cash flows    |  |           
|before income taxes      |  |            |      | 3,429,424  |       |  
|10% annual discount      |  |            |      | (1,417,802 | )     |  
|                        
|Discounted future net    |  |           
|cash flows before        |  |           
|income taxes             |  |            |      | 2,011,622  |       |  
|Discounted income taxes  |  |            |      | (257,220   | )     |  
|                        
|Standardized measure of  |  |           
|discounted future        |  |           
|net cash flows           |  |            | $    | 1,754,402  |       | $
|                        
|December 31, 2000:       |  |           
|Future cash inflows      |  |            | $    | 13,982,861 |       | $
|Future development costs |  |            |      | (485,669   | )     |  
|Future production costs  |  |            |      | (1,884,571 | )     |  
|                        
|Future net cash flows    |  |           
|before income taxes      |  |            |      | 11,612,621 |       |  
|10% annual discount      |  |            |      | (4,736,565 | )     |  
|                        
|Discounted future net    |  |           
|cash flows before        |  |           
|income taxes             |  |            |      | 6,876,056  |       |  
|Discounted income taxes  |  |            |      | (2,045,909 | )     |  
|                        
|Standardized measure of  |  |           
|discounted future        |  |           
|net cash flows           |  |            | $    | 4,830,147  |       | $
|                        

68

---

# Ocean Energy, Inc.Notes to Consolidated Financial Statements

Principal
Sources of Change in the Standardized Measure ofDiscounted Future Net Cash Flows(Amounts in Thousands)

|                                                            | Year Ended December 31,
|----------------------------------------------------------- | -----------------------
|                                                           
|
|                                                           
|Beginning of Year                                           |                        
|                                                            |                        
|Revisions of previous quantity estimates less related costs |                        
|Extensions and discoveries less related costs               |                        
|Purchases of reserves in place                              |                        
|Sales of reserves in place                                  |                        
|Net changes in future prices and production costs           |                        
|Future development costs incurred during the period         |                        
|Sales of oil and gas produced, net of production costs      |                        
|Accretion of discount                                       |                        
|Net changes in income taxes                                 |                        
|Changes in estimated future development costs, production,  |                        
|timing and other                                            |                        
|                                                           
|                                                            |                        
|                                                           
|End of Year                                                 |                        
|                                                           

69

---