<PAGE>   1

                                                                    EXHIBIT 10.7

                              EMPLOYMENT AGREEMENT


         THIS EMPLOYMENT AGREEMENT (the "Agreement") is entered into by and
between INLAND RESOURCES INC. (hereinafter referred to as "Employer") and BILL
I. PENNINGTON (hereinafter referred to as "Employee").

         WHEREAS, Employer desires to continue the employment of Employee as its
Chief Executive Officer and Chief Financial Officer and Employee desires to
continue such employment; and

         WHEREAS, Employer and Employee have previously entered into an
Employment Agreement dated June 1, 1996, as amended (the "Original Employment
Agreement"), and Employer and Employee desire to mutually terminate the Original
Employment Agreement in connection with the execution of this Agreement; and

         WHEREAS, Employer has granted options and warrants (collectively the
"Existing Options/Warrants") to Employee exercisable for 235,000 shares of
common stock, par value $.001 per share (the "Common Stock"), of Employer, and
Employer and Employee desire to mutually terminate the Existing Options/Warrants
in connection with this Agreement, and grant new options to Employee as provided
herein.

         NOW, THEREFORE, in consideration of the mutual promises herein
contained, and other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, Employer and Employee agree as
follows:

         1.       TERMINATION OF ORIGINAL EMPLOYMENT AGREEMENT. Employer and
Employee hereby agree that the Original Employment Agreement is terminated
effective the date hereof.

         2.       TERMINATION OF EXISTING OPTIONS/WARRANTS. Employer and
Employee hereby agree that the Existing Options/Warrants are terminated
effective the date hereof.

         3.       AGREEMENT TO GRANT OPTIONS. Employer hereby grants to
Employee, effective the date of execution of this Agreement, an option to
purchase 875,000 shares of Common Stock exercisable at the closing sale price of
the Common Stock on the date of execution of this Agreement. The number of
option shares granted herein shall be increased or decreased to the same extent
that the outstanding shares of Common Stock of Employer are increased or
decreased by any stock split occurring after the effective date of this
Agreement. Such options shall vest over a period of five years, as provided for
herein. On each of the first four anniversary dates of the effective date of
this Agreement, ten percent (10%) of such options shall be vested and, on the
fifth anniversary of the date of execution of this Agreement, the remaining
sixty percent (60%) shall vest. All options granted hereunder will be
exercisable for a period of five years after the





                                      -1-
<PAGE>   2

last options are vested, regardless whether Employer subsequently voluntarily
leaves the employment of Employer or is terminated with or without "Cause" (as
hereinafter defined). Options will vest on each such anniversary date if
Employee continues to be employed by Employer on such anniversary date. All
non-vested options will vest immediately upon a "Change of Control" (as
hereinafter defined). Employer will concurrently with execution of this
Agreement prepare an Option Agreement incorporating these terms and such other
standard terms as have been contained in prior options or warrants granted to
Employee.

         4.       EMPLOYMENT. Employer hereby employs Employee to serve as Chief
Executive Officer and Chief Financial Officer of Employer and otherwise at the
direction of the Board of Directors.

         5.       DUTIES. During his employment, Employee shall devote all of
his working time, energies and skills to the management of Employer's business.
Employee agrees to serve Employer diligently and to the best of his ability.
Employee shall render services consistent with those of a person in his position
and shall perform all duties incident to such office and all such further
similar duties that may, from time to time, be assigned to him by Employer.
Employee's duties include finding further business opportunities for Employer
and Employee agrees to bring to Employer for acceptance or rejection all
business opportunities located by or made available to Employee.

         6.       COMPENSATION. Employee's compensation for services performed
under this Agreement shall be as follows:

                  (a) Base Salary. Employer shall pay Employee a base salary
         ("Base Salary") of Two Hundred Fifty Thousand and No/100 Dollars
         ($250,000.00) per year, commencing effective October 1, 1999. In
         addition, the Board of Directors of Employer shall, in good faith,
         consider granting increases in such salary based upon such factors as
         Employee's performance and the growth and/or profitability of Employer,
         but it shall have no obligation to grant any such increases in
         compensation. Such Base Salary shall be payable in equal monthly
         installments, or at such other times and in such installments as may be
         agreed upon between Employer and Employee. All payments shall be
         subject to the deduction of payroll taxes and similar assessments as
         required by law.

                  (b) Bonus. In addition to the Base Salary, Employee shall be
         eligible to receive bonus compensation in such amounts and at such
         times as the Board of Directors shall, from time to time, determine.

                  Termination Payment. If Employee's employment is terminated by
         the Company for any reason prior to September 30, 2001 (i.e., with
         "Cause" or without "Cause"), Employee shall be paid a termination
         payment, computed below, payable immediately upon the date of
         termination. However, if Employee voluntarily leaves the employment of
         Employer prior to September 30, 2001, payment of the termination
         payment shall be forfeited by Employee. The termination payment shall
         be $168,000, which amount shall




                                      -2-
<PAGE>   3
          be decreased by the sum of $21,000 for each calendar quarter during
          which Employee's employment is retained by Employer. For example, the
          termination payment shall be decreased by $21,000 on each of January
          1, 2000, April 1, 2000, July 1, 2000, October 1, 2000, January 1,
          2001, April 1, 2001, July 1, 2001 and September 30, 2001.

                  (d) Performance Bonus. In addition to the Base Salary and the
         bonuses payable pursuant to Sections 6(b) and (c) hereof, Employer
         shall pay to Employee a performance bonus of $250,000, as follows: (A)
         one-third shall vest on each of the years ending December 31, 2000,
         December 31, 2001 and December 31, 2002 provided (i) Employee continues
         to be employed by Employer on such dates and (ii) Employer has met the
         financial performance targets for each of such years; such financial
         performance targets to be determined by the Board of Directors (and
         approved by Trust Company of the West) at a later date and attached to
         this Agreement as Schedule "A" and (B) shall be payable equally, if
         vested, on December 31, 2003, December 31, 2004 and December 31, 2005.
         Upon a "Change of Control", any unvested portion of the performance
         bonus shall be deemed to be immediately vested and shall be paid to
         Employee immediately if Employee is terminated within ninety days of
         such Change of Control. If Employee voluntarily leaves the employment
         of Employer, Employee shall forfeit any unpaid vested installments.

         7.       EXPENSES AND BENEFITS. Employee is authorized to incur
reasonable expenses in connection with the business of Employer, including
expenses for entertainment, travel and similar matters. Employer will reimburse
Employee for such expenses upon presentation by Employee of such accounts and
records as Employer shall, from time to time, require. Employer also agrees to
provide Employee with the following benefits:

                  (a) Employee Benefit Plans. Employee shall be entitled to
         participate in employee benefit plans or programs of Employer, if any,
         to the extent that his position, tenure, salary, age, health and other
         qualifications make him eligible to participate, subject to the rules
         and regulations applicable thereto. Such additional benefits shall
         include, subject to the approval of the Board of Directors, full
         medical, dental and disability income insurance.

                  (b) Other. Such items and benefits as Employer shall, from
         time to time, consider necessary or appropriate to assist Employee in
         the performance of his duties.

                  (c) Vacations. Employee shall be entitled (in addition to the
         usual public holidays) to a paid vacation for a period in each calendar
         year not exceeding three (3) weeks, to be taken at such times as may be
         approved by Employer.

         8.       TERM. The term of this Agreement shall be for a term of one
(1) year, beginning from the effective date hereof and for month to month
thereafter unless terminated by either party on thirty (30) days' notice.




                                      -3-
<PAGE>   4



         9.       DISABILITY. In the event that Employee becomes Permanently
Disabled (as hereafter defined) during the term of this Agreement and while
engaged in the scope of his employment by Employer, Employee shall continue in
the employ of Employer but his compensation hereunder shall be reduced to
one-half (1/2) of the Base Salary then in effect, as set forth in Section 6(a)
hereof, commencing upon the determination of Employee's Permanent Disability and
continuing thereafter until the first to occur of (a) twelve (12) months or (b)
the death of Employee or (c) the expiration of the term of this Agreement; and
during such period of time, Employee shall not be entitled to payment of
expenses or benefits specified in Section 7 hereof (except for reimbursement of
expenses incurred by Employee prior to becoming Permanently Disabled), except
that Employer shall continue to provide Employee with the insurance benefits
specified in Section 7(a) hereof. In addition, any compensation payable to
Employee by Employer shall be reduced by any amount which Employee is eligible
to receive from workers compensation, social security or disability insurance
provided by Employer. If Employee becomes Permanently Disabled while not engaged
in the scope of his employment by Employer, such disability may be cause for
termination for "Cause" under Section 10 hereof.

                  (a) Definition of Disability. For purposes of this Agreement,
         the terms "Permanent Disability" or "Permanently Disabled" shall mean
         three (3) months of substantially continuous disability. Disability
         shall be deemed "substantially continuous" if, as a practical matter,
         Employee, by reason of his mental or physical health, is unable to
         sustain reasonably long periods of substantial performance of his
         duties. Frequent long illnesses, though different from the preceding
         illness and though separated by relatively short periods of
         performance, shall be deemed to be "substantially continuous".
         Disability shall be determined in good faith by the Board of Directors
         whose decision shall be final and binding upon Employee. Employee
         hereby consents to medical examinations by such physicians and medical
         consultants as Employer shall, from time to time, require.

         10.      TERMINATION BY EMPLOYER. Employer shall have the right to
terminate Employee's employment as hereinafter provided.

                  (a) Termination by Employer for Cause. The Board of Directors
         shall have the right to terminate Employee's employment under this
         Agreement for Cause, in which event no compensation under Sections
         6(a), (b) or (d) shall be paid or other benefits furnished to Employee
         after termination for Cause. Termination for Cause shall be effective
         immediately upon notice sent or given to Employee.

                           (i) Definition of Cause. For purposes of this
                  Agreement, the term "Cause" shall mean and be strictly limited
                  to: (1) conviction of a crime constituting a felony under
                  state or federal law; (2) determination by the Board of
                  Directors that Employee has committed any act of dishonesty
                  against Employer; (3) gross negligence by Employee in carrying
                  out his duties; (4) breach of this Agreement by Employee; (5)
                  gross misconduct by Employee, such as intoxication on the job,
                  use of drugs on the job for non-medical purposes or other
                  misconduct which has a substantial adverse effect on the
                  business of Employer; or (6) Employee





                                      -4-
<PAGE>   5

                  becoming Permanently Disabled while not engaged in the scope
                  of his employment by Employer.

                  (b) Termination by Employer without Cause. The Board of
         Directors shall have the right to terminate Employee's employment under
         this Agreement without Cause at any time, by giving written notice of
         termination to Employee. In such event, Employer will immediately pay
         the sum of the remaining amount, if any, set forth in Sec. 6(c) and the
         amount vested under Sec. 6(d) above.

         11.      CHANGE OF CONTROL. For purposes of this Agreement, a "Change
of Control" shall mean: (i) the issuance of shares of capital stock of Employer
or the granting of options or other derivative securities representing on a
combined basis more than 50% of the outstanding capital stock following such
issuance and grant, or the issuance of shares of capital stock by Employer or
the granting of options or other derivative securities to a person who, when
added to shares acquired by such person in the market or from other stockholders
of Employer, would result in such person owning more than 50% of the outstanding
capital stock (assuming for this purpose, exercise of such options or other
derivative securities) of Employer; or (ii) the sale or other disposition by
Employer of substantially all of the assets of Employer.

         12.      GENERAL PROVISIONS.

                  (a) Notices. Any notices to be given hereunder by either party
         to the other may be effected by personal delivery, in writing or by
         mail, registered or certified, postage prepaid with return receipt
         requested. Mailed notices shall be addressed to the parties at the
         addresses set forth below, but each party may change his or its address
         by written notice in accordance with this Section 12(a). Notices
         delivered personally shall be deemed communicated as of the actual
         receipt; mailed notices shall be deemed communicated as of three (3)
         days after mailing.

                                    If to Employee:
                                    Inland Resources Inc.
                                    410 17th Street, Suite 700
                                    Denver, Colorado  80202

                                    If to  Employer:
                                    Inland Resources Inc.
                                    410 17th Street, Suite 700
                                    Denver, Colorado  80202

                  (b) Partial Invalidity. If any provision in this Agreement is
         held by a court of competent jurisdiction to be invalid, void, or
         unenforceable, the remaining provisions shall, nevertheless, continue
         in full force without being impaired or invalidated in any way.




                                      -5-
<PAGE>   6



                  (c) Law Governing Agreement. This Agreement shall be governed
         by and construed in accordance with the laws of the State of Colorado.

                  (d) Attorneys' Fees and Costs. If any action at law or in
         equity is necessary to enforce or interpret the terms of this
         Agreement, the prevailing party shall be entitled to reasonable
         attorneys' fees, costs and necessary disbursements in addition to any
         other relief to which he or it may be entitled.

                  (e) Assignment. This Agreement shall inure to the benefit of
         and bind the parties hereto and their respective legal representatives,
         successors and assigns.

                  (f) Entire Agreement. This Agreement supersedes any and all
         other agreements, either oral or in writing, between the parties hereto
         with respect to the employment of Employee by Employer and contain all
         of the covenants and agreements between the parties with respect to
         such employment. Each party to this Agreement acknowledges that no
         representations, inducements, or agreements, oral or otherwise, have
         been made by any party, or anyone acting on behalf of any party, which
         are not embodied herein, and no other agreement, statement or promise
         not contained in this Agreement shall be valid or binding. Any
         modification of this Agreement will be effected only if it is in
         writing signed by the party to be charged.

         IN WITNESS WHEREOF, the parties have executed this Agreement on October
21, 1999, but to be effective the 1st day of October, 1999.


                                   EMPLOYER:
                                   INLAND RESOURCES INC.

                                   By:       /s/ Michael J. Stevens
                                            ------------------------------
                                            Michael J. Stevens
                                            Vice President
                                            Secretary and Treasurer


                                   EMPLOYEE:

                                   /s/ Bill I. Pennington
                                   ---------------------------------------
                                   Bill I. Pennington




                                      -6-
<PAGE>   7




                                  SCHEDULE "A"
                          FINANCIAL PERFORMANCE TARGETS




THE FINANCIAL PERFORMANCE TARGET, TO BE SATISFIED FOR THE INITIAL ONE YEAR
VESTING PERIOD ENDING DECEMBER 31, 2000 IS TOTAL EARNINGS BEFORE INTEREST,
TAXES, DEPRECIATION AND AMORTIZATION, DETERMINED UTILIZING GENERALLY ACCEPTED
ACCOUNTING PRINCIPALS, CONSISTENTLY APPLIED, OF AT LEAST $17.3 MILLION. THE
FINANCIAL PERFORMANCE TARGETS FOR THE ONE YEAR VESTING PERIODS ENDING DECEMBER
31, 2001 AND DECEMBER 31, 2002 WILL BE ESTABLISHED BY AMENDMENT TO THIS SCHEDULE
A.













                                      -7-