**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **WASHINGTON,
        DC 20549**
  **FORM
        10-Q**
  x
              QUARTERLY
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934
 
 For
        the
        quarterly period ended March 31, 2006
 
 OR
 
 o
              TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934
 
 For
        the
        transition period from ____________ to _____________
 
 Commission
        file number: **000-24394**
 
 **Penn
        Octane Corporation**
 (Exact
        Name of Registrant as Specified in Its Charter)
 
 **Delaware**
              
              **52-1790357**(State
                  or Other Jurisdiction of Incorporation or Organization)
              
              (I.R.S.
                  Employer Identification No.)
 
 **77-530
                  Enfield Lane, Bldg. D, Palm Desert, California**
              
              **92211**(Address
                  of Principal Executive Offices)
              
              (Zip
                  Code)
 
 Registrant's
        Telephone Number, Including Area Code: **(760)
        772-9080**
 
 Indicate
        by check mark whether the registrant: (1) has filed all reports required
        to be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the preceding 12 months (or for such shorter period that the registrant was
        required to file such reports), and (2) has been subject to such filing
        requirements for the past 90 days.
 Yes x No o
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange
        Act.
  Large
                  Accelerated Filero
              Accelerated
                  Filero
              Non-Accelerated
                  Filerx
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act)
 Yes o No x
 
 The
        number of shares of Common Stock, par value $.01 per share, outstanding on
        May
        8, 2006 was 15,522,745.







1





**PENN
      OCTANE CORPORATION**


**TABLE
      OF CONTENTS**




ITEM
              
              PAGE
                  NO.Part
                  I
              1.
              Financial
                  StatementsReport
                  of Independent Registered Public Accounting
                  Firm
              3Consolidated
                  Balance Sheets as of December 31, 2005 and March
                  31, 2006 (unaudited)
              4-5Unaudited
                  Consolidated Statements of Operations for the three
                  months ended March 31, 2005 and 2006
              6Unaudited
                  Consolidated Statements of Cash Flows for the three
                  months ended March 31, 2005 and 2006
              7Notes
                  to Consolidated Financial Statements (Unaudited)
              8-302.
              Management’s
                  Discussion and Analysis of Financial Condition
                  and Results of Operations
              31-523.
              Quantitative
                  and Qualitative Disclosures About Market
                  Risk
              534.
              Controls
                  and Procedures
              53Part
                  II
              1.
              Legal
                  Proceedings
              541A.
              Risk
                  Factors
              54
                  - 562.
              Unregistered
                  Sales of Equity Securities and Use of
                  Proceeds
              563.
              Defaults
                  Upon Senior Securities
              564.
              Submission
                  of Matters to a Vote of Security
                  Holders
              565.
              Other
                  Information
              566.
              Exhibits
              57-58Signatures
              59




2
 *Table
          of Contents*


Report
      of Independent Registered Public Accounting
      Firm





Board
      of
      Directors and Stockholders


Penn
      Octane Corporation





We
      have
      reviewed the consolidated balance sheet of Penn Octane Corporation and
      subsidiaries (Company) as of March 31, 2006, the consolidated statements of
      operations and the consolidated statement of cash flows for the three months
      ended March 31, 2005 and 2006. These interim financial statements are the
      responsibility of the Company’s management.





We
      conducted our review in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). A review of interim financial
      information consists principally of applying analytical procedures and making
      inquiries of persons responsible for financial and accounting matters. It is
      substantially less in scope than an audit conducted in accordance with the
      standards of the Public Company Accounting Oversight Board, the objective of
      which is the expression of an opinion regarding the financial statements taken
      as a whole. Accordingly, we do not express such an opinion.





Based
      on
      our reviews, we are not aware of any material modifications that should be
      made
      to the accompanying interim financial statements for them to be in conformity
      with United States generally accepted accounting principles.





We
      have
      previously audited, in accordance with the standards of the Public Company
      Accounting Oversight Board (United States), the consolidated balance sheet
      of
      Penn Octane Corporation and Subsidiaries as of December 31, 2005, and the
      related consolidated statements of operations, stockholders’ equity, and cash
      flows for the year then ended (not presented herein); and in our report dated
      February 13, 2006, we expressed an unqualified opinion on those consolidated
      financial statements.





Our
      auditors’ report on the Company’s financial statements as of December 31, 2005
      included an explanatory paragraph referring to the matters discussed in Note
      T
      of those financial statements which raised substantial doubt about the Company’s
      ability to continue as a going concern. As indicated in Note L to the
      accompanying unaudited interim consolidated financial statements, conditions
      continue to exist which raise substantial doubt about the Company’s ability to
      continue as a going concern.






/s/
      BURTON MCCUMBER & CORTEZ, L.L.P.





Brownsville,
      Texas


May
      2,
      2006


3
 *Table
          of Contents*


**Part
      I**


**Item
      1.**





**Penn
      Octane Corporation and Subsidiaries**





**CONSOLIDATED
      BALANCE SHEETS**





**ASSETS**




December
                  31,2005
              
              March
                  31,2006Current
                  Assets
              
              
              
              (Unaudited)Cash
              
              $
              299,597
              
              $
              264,278Restricted
                  cash
              
              
              5,657,623
              
              
              3,527,582Trade
                  accounts receivable (less allowance for doubtful accounts of $0)
              
              
              12,470,891
              
              
              10,682,909Inventories
              
              
              2,878,268
              
              
              2,736,625Prepaid
                  expenses and other current assets
              
              
              100,272
              
              
              185,090Total
                  current assets
              
              
              21,406,651
              
              
              17,396,484Property,
                  plant and equipment - net
              
              
              14,983,247
              
              
              14,738,958Lease
                  rights (net of accumulated amortization of $818,207 and $829,656
                  at
                  December 31, 2005 and March 31, 2006)
              
              
              335,832
              
              
              324,383Other
                  non-current assets
              
              
              31,089
              
              
              32,182Total
                  assets
              
              $
              36,756,819
              
              $
              32,492,007




The
      accompanying notes and accountants’ report are an integral part of these
      statements.


4
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**CONSOLIDATED
      BALANCE SHEETS - CONTINUED**





**LIABILITIES
      AND STOCKHOLDERS' EQUITY**




December
                    31,2005
                
                March
                    31,2006Current
                    Liabilities
                
                
                
                (Unaudited)Current
                    maturities of debt obligations
                
                $
                3,015,054
                
                $
                2,550,054Revolving
                    line of credit
                
                
                560,283
                
                
                4,715,789LPG
                    and Fuel Products trade accounts payable
                
                
                16,888,320
                
                
                8,975,208Other
                    accounts payable
                
                
                1,770,656
                
                
                1,871,160U.S.
                    and foreign taxes payable
                
                
                21,045
                
                
                -Accrued
                    liabilities
                
                
                2,184,168
                
                
                2,438,644Total
                    current liabilities
                
                
                24,439,526
                
                
                20,550,855Long-term
                    debt, less current maturities
                
                
                10,387
                
                
                9,089Minority
                    interest in Rio Vista Energy Partners L.P.
                
                
                11,955,005
                
                
                11,738,569Commitments
                    and contingencies
                
                
                -
                
                
                -Stockholders'
                    EquitySeries
                    A - Preferred stock-$.01 par value, 5,000,000 shares authorized;
                    no shares
                    issued and outstanding at December 31, 2005 and March 31,
                    2006
                
                
                -
                
                
                -Series
                    B - Senior preferred stock-$.01 par value, $10 liquidation value,
                    5,000,000 shares authorized; no shares issued and outstanding
                    at December
                    31, 2005 and March 31, 2006
                
                
                -
                
                
                -Common
                    stock - $.01 par value, 25,000,000 shares authorized; 15,522,745
                    and
                    15,522,745 shares issued and outstanding at December 31, 2005
                    and March
                    31, 2006
                
                
                155,227
                
                
                155,227Additional
                    paid-in capital
                
                
                28,741,122
                
                
                28,865,793Note
                    receivable from a former officer of the Company for exercise
                    of warrants,
                    less reserve of $1,500,000 and $1,500,000 at December 31, 2005
                    and March
                    31, 2006
                
                
                (1,696,693
                )
                
                (1,696,693
                )Accumulated
                    deficit
                
                
                (26,847,755
                )
                
                (27,130,833
                )Total
                    stockholders' equity
                
                
                351,901
                
                
                193,494Total
                    liabilities and stockholders' equity
                
                $
                36,756,819
                
                $
                32,492,007





The
      accompanying notes and accountants’ report are an integral part of these
      statements.


5
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**CONSOLIDATED
      STATEMENTS OF OPERATIONS**





**(Unaudited)**




Three
                  Months EndedMarch
                  31,2005
              
              March
                  31,2006Revenues
              
              $
              59,726,894
              
              $
              69,328,264Cost
                  of goods sold
              
              
              57,337,945
              
              
              68,059,624Gross
                  profit
              
              
              2,388,949
              
              
              1,268,640Selling,
                  general and administrative expensesLegal
                  and professional fees
              
              
              447,426
              
              
              387,343Salaries
                  and payroll related expenses
              
              
              648,450
              
              
              554,206Other
              
              
              520,427
              
              
              498,0231,616,303
              
              
              1,439,572Operating
                  income (loss)
              
              
              772,646
              
              
              (170,932
              )Other
                  income (expense)Interest
                  and LPG and Fuel Products financing expense
              
              
              (391,942
              )
              
              (354,010
              )Interest
                  income
              
              
              4,363
              
              
              9,461Minority
                  interest in (earnings) loss of Rio Vista Energy Partners
                  L.P.
              
              
              (169,045
              )
              
              246,328Income
                  (loss) before taxes
              
              
              216,022
              
              
              (269,153
              )Provision
                  for income tax
              
              
              19,610
              
              
              13,925Net
                  income (loss)
              
              $
              196,412
              
              $
              (283,078
              )Net
                  income (loss) per common share
              
              $
              0.01
              
              $
              (0.02
              )Net
                  income (loss) per common share assuming dilution
              
              $
              0.01
              
              $
              (0.02
              )Weighted
                  average common shares outstanding
              
              
              15,422,120
              
              
              15,522,745





The
      accompanying notes and accountants’ report are an integral part of these
      statements.


6
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**





**(Unaudited)**




Three
                  months endedMarch
                  31,2005
              
              March
                  31,2006Cash
                  flows from operating activities:Net
                  income (loss)
              
              $
              196,412
              
              $
              (283,078
              )Adjustments
                  to reconcile net income to net cash (used in) provided by operating
                  activities:Depreciation
                  and amortization
              
              
              255,986
              
              
              250,666Amortization
                  of lease rights
              
              
              11,449
              
              
              11,449Amortization
                  of loan discount related to detachable warrants
              
              
              81,846
              
              
              22,104Share-based
                  payment expense
              
              
              -
              
              
              132,459Minority
                  interest in loss of Rio Vista Energy Partners L.P.
              
              
              169,045
              
              
              (246,328
              )Changes
                  in current assets and liabilities:Trade
                  accounts receivable
              
              
              (1,836,411
              )
              
              1,787,982Inventories
              
              
              1,474,610
              
              
              141,643Prepaid
                  expenses and other current assets
              
              
              (119,431
              )
              
              (84,818
              )LPG
                  and Fuel Products trade accounts payable
              
              
              (5,946,882
              )
              
              (7,913,112
              )Other
                  accounts payable and accrued liabilities
              
              
              783,431
              
              
              354,980U.S.
                  and Foreign taxes payable
              
              
              (20,146
              )
              
              (21,045
              )Net
                  cash (used in) operating activities
              
              
              (4,950,091
              )
              
              (5,847,098
              )Cash
                  flows from investing activities:Capital
                  expenditures
              
              
              (6,999
              )
              
              (6,377
              )(Increase)
                  decrease in other non-current assets
              
              
              (770
              )
              
              (1,093
              )Net
                  cash used in investing activities
              
              
              (7,769
              )
              
              (7,470
              )Cash
                  flows from financing activities:(Increase)
                  decrease in restricted cash
              
              
              683,811
              
              
              2,130,041Revolving
                  credit facilities
              
              
              4,421,587
              
              
              4,155,506Issuance
                  of common stock
              
              
              97,750
              
              
              -Distributions
                  paid by Rio Vista Energy Partners L.P. to limited partners
              
              
              (477,664
              )
              
              -Reduction
                  in debt
              
              
              (1,298
              )
              
              (466,298
              )Net
                  cash provided by financing activities
              
              
              4,724,186
              
              
              5,819,249Net
                  decrease in cash
              
              
              (233,674
              )
              
              (35,319
              )Cash
                  at beginning of period
              
              
              374,567
              
              
              299,597Cash
                  at end of period
              
              $
              140,893
              
              $
              264,278Supplemental
                  disclosures of cash flow information:Cash
                  paid during the period for:Interest
                  and LPG and Fuel Products financing expense
              
              $
              303,044
              
              $
              457,109Supplemental
                  disclosures of noncash transactions:Equity-common
                  stock and warrants issued and other
              
              $
              108,450
              
              $
              -Note
                  issued for software
              
              $
              55,463
              
              $
              -





The
      accompanying notes and accountants’ report are an integral part of these
      statements.


7
 *Table
          of Contents*


**** **PennOctane
      Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      A - ORGANIZATION**





Penn
      Octane Corporation, formerly known as International Energy Development
      Corporation, was incorporated in Delaware in August 1992. Penn Octane
      Corporation (Penn Octane) and its consolidated subsidiaries, including Rio
      Vista
      Energy Partners, L.P. and its subsidiaries, are collectively hereinafter
      referred to as the Company. The Company has been principally engaged in the
      purchase, transportation and sale of liquefied petroleum gas (LPG) and the
      sale
      of gasoline and diesel fuel (Fuel Products). The Company owns and operates
      terminal facilities in Brownsville, Texas (Brownsville Terminal Facility) and Matamoros,
      Tamaulipas, Mexico (Matamoros Terminal Facility) and approximately 23 miles
      of
      pipelines (US - Mexico Pipelines) which connect the Brownsville Terminal
      Facility to the Matamoros Terminal Facility. The Company has a long-term lease
      agreement for approximately 132 miles of pipeline (Leased Pipeline) which
      connects ExxonMobil Corporation’s (Exxon) King Ranch Gas Plant in Kleberg
      County, Texas and Duke Energy's La Gloria Gas Plant in Jim Wells County, Texas,
      to the Company's Brownsville Terminal Facility .
      In
      connection with the Company’s lease agreement for the Leased Pipeline, the
      Company has access to storage in Markham, Texas (Markham) which has a capacity
      of up to approximately 21,000,000 gallons of storage, as well as other potential
      propane pipeline suppliers, via approximately 155 miles of pipeline located
      between Markham and the Exxon King Ranch Gas Plant.





The
      Company commenced commercial operations for the purchase, transport and sale
      of
      LPG in the fiscal year ended July 31, 1995. The primary market for the Company's
      LPG is the northeastern region of Mexico, which includes the states of Coahuila,
      Nuevo Leon and Tamaulipas. Since operations commenced, the Company’s primary
      customer for LPG has been P.M.I. Trading Limited (PMI). PMI is a subsidiary
      of
      Petroleos Mexicanos, the state-owned Mexican oil company, which is commonly
      known by its trade name “PEMEX.” PMI is the exclusive importer of LPG into
      Mexico. PMI sells the LPG purchased from the Company to PEMEX which distributes
      the LPG into the northeastern region of Mexico. Sales
      of
      LPG to PMI accounted for approximately 56.6% of the Company’s total revenues and
      100% of the Company’s LPG revenues for the three months ended March 31, 2006.
      The Company’s gross profit from LPG sales is dependent on sales volume of LPG to
      PMI, which fluctuates in part based on the seasons. The demand for LPG is
      strongest during the winter season. ****





During
      June 2004, the Company began operations as a reseller of Fuel Products. The
      Company sells Fuel Products (Fuel Sales Business) through transactional, bulk
      and/or rack transactions. Typical transactional and bulk sales are made based
      on
      a predetermined net spread between the purchase and sales price over posted
      monthly variable prices and/or daily spot prices. Rack sales transactions are
      based on variable sale prices charged by the Company which are tied to posted
      daily spot prices and purchase costs which are based on a monthly average or
      3
      day average based on posted prices. The Company pays pipeline and terminal
      fees
      based on regulated rates.





The
      Company has the ability to access certain pipeline and terminal systems located
      in California, Arizona, Nevada and Texas, where it is able to deliver its Fuel
      Products.





For
      bulk
      and transactional sales, the Company enters into individual sales contracts
      for
      each sale. Fuel Products sales are subject to credit limitations imposed on
      each
      individual buyer by the Company. The Company has several supply contracts for
      each of the Fuel Products it sells. The supply contracts are for annual periods
      with flexible volumes but they may be terminated sooner by the supplier if
      the
      Company consistently fails to purchase minimum volumes of Fuel Products. Fuel
      sales approximated 43.4% of total revenues for the three months ended March
      31,
      2006.


8
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(UNAUDITED)





**NOTE
      A - ORGANIZATION - Continued**





On
      September 30, 2004, Penn Octane Corporation (Penn Octane) completed a series
      of
      transactions involving (i) the transfer of substantially all of its owned
      pipeline and terminal assets in Brownsville and Matamoros to its wholly owned
      subsidiary Rio Vista Operating Partnership L.P. and its subsidiaries (RVOP)
      (ii)
      transferred Penn Octane’s 99.9% interest in RVOP to its wholly owned subsidiary
      Rio Vista Energy Partners L.P. and its subsidiaries (Rio Vista) and (iii)
      distributed all of its limited partnership interest (Common Units) in Rio Vista
      to its common stockholders (Spin-Off), resulting in Rio Vista becoming a
      separate public company. The Common Units represented 98% of Rio Vista’s
      outstanding partnership interests. The remaining 2% interest, which is the
      general partner interest, is owned and controlled by Rio Vista GP LLC (General
      Partner), a wholly owned subsidiary of Penn Octane. The General Partner is
      responsible for the management of Rio Vista. Accordingly the Company has control
      of Rio Vista by virtue of its ownership and related voting control of the
      General Partner. Therefore, Rio Vista is consolidated with the Company and
      the
      interests of the limited partners are classified as minority interests in the
      Company’s unaudited consolidated financial statements. Subsequent
      to the Spin-Off, Rio Vista sells LPG directly to PMI and purchases LPG from
      Penn
      Octane under a long-term supply agreement. The purchase price of the LPG from
      Penn Octane is determined based on the cost of LPG under Penn Octane’s LPG
      supply agreements with its suppliers, other direct costs related to PMI sales
      and a formula that takes into consideration operating costs of Penn Octane
      and
      Rio Vista.





**Basis
      of Presentation**





The
      accompanying unaudited consolidated financial statements include Penn Octane
      and
      its U. S. subsidiaries including PennWilson CNG, Inc. (PennWilson) and Penn
      CNG
      Holdings, Inc. and Rio Vista and its U.S. and Mexican subsidiaries, including
      Penn Octane International, L.L.C., Penn Octane de Mexico, S. de R.L. de C.V.
      (PennMex), Termatsal, S. de R.L. de C.V. (Termatsal) and Tergas, S. de R.L.
      de
      C.V. (Tergas), a consolidated affiliate, and Penn Octane’s other inactive
      Mexican subsidiaries, (collectively the Company). All significant intercompany
      accounts and transactions are eliminated.





The
      unaudited consolidated balance sheet as of March 31, 2006, the unaudited
      consolidated statements of operations for the three months ended March 31,
      2005
      and 2006 and the unaudited consolidated statements of cash flows for the three
      months ended March 31, 2005 and 2006, have been prepared by the Company without
      audit. In the opinion of management, the unaudited consolidated financial
      statements include all adjustments (which include only normal recurring
      adjustments) necessary to present fairly the unaudited consolidated financial
      position of the Company as of March 31, 2006, the unaudited consolidated results
      of operations for the three months ended March 31, 2005 and 2006 and the
      unaudited consolidated statements of cash flows for the three months ended
      March
      31, 2005 and 2006.





Certain
      information and footnote disclosures normally included in consolidated financial
      statements prepared in accordance with accounting principles generally accepted
      in the United States of America have been omitted pursuant to the rules and
      regulations of the Securities Exchange Commission, although the Company believes
      that the disclosures made are adequate to make the information not misleading.
      These unaudited consolidated financial statements should be read in conjunction
      with the consolidated financial statements and notes thereto included in the
      Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and
      Rio Vista’s Annual Report on Form 10-K for the year ended December 31,
      2005.





Certain
      reclassifications have been made to prior period balances to conform to the
      current presentation. All reclassifications have been consistently applied
      to
      the periods presented.


9
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**








**NOTE
      B -**  **INCOME
      (LOSS)**  **PER
      COMMON SHARE**





Income
      (loss) per share of common stock is computed on the weighted average number
      of
      shares outstanding. During periods in which the Company incurs losses, giving
      effect to common stock equivalents is not presented as it would be
      antidilutive.





The
      following tables present reconciliations from income (loss) per common share
      to
      income (loss) per common share assuming dilution (see note H for the
      warrants):




For
                    the three months ended March 31, 2005Income
                    (Loss)(Numerator)
                
                Shares(Denominator)
                
                Per-ShareAmountNet
                    income (loss)
                
                $
                196,412**Basic
                    EPS**Net
                    income (loss) available to common stockholders
                
                
                196,412
                
                
                15,422,120
                
                $
                0.01**Effect
                    of Dilutive Securities**Warrants
                
                
                -
                
                
                78,291**Diluted
                    EPS**Net
                    income (loss) available to common stockholders
                
                $
                196,412
                
                
                15,500,411
                
                $
                0.01
  For
                    the three months ended March 31, 2006Income
                    (Loss)(Numerator)
                
                Shares(Denominator)
                
                Per-ShareAmountNet
                    income (loss)
                
                $
                (283,078
                )**Basic
                    EPS**Net
                    income (loss) available to common stockholders
                
                
                (283,078
                )
                
                15,522,745
                
                $
                (0.02
                )**Effect
                    of Dilutive Securities**Warrants
                
                
                -
                
                
                -**Diluted
                    EPS**Net
                    income (loss) available to common stockholders
                
                
                N/A
                
                
                N/A
                
                
                N/A




10
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      C - SHARE-BASED PAYMENT**





During
      the quarter ended March 31, 2006, the Company adopted the provisions of
      Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”
(SFAS 123R) using the modified prospective application transition method. Under
      this method, previously reported amounts should not be restated to reflect
      the
      provisions of SFAS 123R. SFAS 123R requires measurement of all employee
      share-based payment awards using a fair-value method and recording of such
      expense in the consolidated financial statements over the requisite service
      period. Previously, the Company had applied the provisions of Accounting
      Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB
      25) and related interpretations and elected to utilize the disclosure option
      of
      Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based
      Compensation” (SFAS 123). In the quarter ended March 31, 2006, the Company
      recorded share-based payment expense of $132,459 under the fair-value provisions
      of SFAS 123R. The Company utilizes share-based awards as a form of compensation
      for employees, officers and directors.





Had
      compensation cost related to the warrants granted to employees been determined
      based on the fair value at the grant dates, consistent with the provisions
      of
      SFAS 123, the Company’s pro forma net income, and net income per common share
      would have been as follows for the three months ended March 31,
      2005:





Net
                income (loss), as reported
            
            $
            196,412Add:
                Stock-based employee compensation cost expense included in reported
                net
                income (loss), net of related tax effects
            
            
            -Less:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards, net of related tax
                effects
            
            
            (34,443
            )Net
                income (loss), pro forma
            
            $
            161,969Net
                income (loss) per common share, as reported
            
            $
            0.01Net
                income (loss) per common share, pro forma
            
            $
            0.01Net
                income (loss) per common share assuming dilution, as
                reported
            
            $
            0.01Net
                income (loss) per common share assuming dilution, pro
                forma
            
            $
            0.01




11
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      D - PURCHASE AND SALE AGREEMENT**





On
      August
      15, 2005, Penn Octane and Rio Vista each entered into separate purchase and
      sale
      agreements (PSA’s) with TransMontaigne Product Services Inc. (TransMontaigne)
      which provide for the sale and assignment of all of their respective LPG assets
      and refined products assets (LPG Asset Sale) including the Brownsville Terminal
      Facility and refined products tank farm and associated leases, owned pipelines
      located in the United States, including land, leases, and rights of ways, LPG
      inventory, 100% of the outstanding stock of Mexican subsidiaries and affiliate,
      which in turn own pipelines and the Matamoros Terminal Facility, including
      land
      and rights of way, and assignment of the lease of the Leased Pipeline, PMI
      sales
      agreement and Exxon Supply Contract (see note K). Penn Octane’s agreement with
      TransMontaigne does not include any assets related to the Fuel Sales Business.
      The purchase price is $10,100,000 for assets to be sold by Penn Octane and
      $17,400,000 for assets to be sold by Rio Vista. The purchase price may be
      reduced as provided for in the PSA’s.





In
      connection with the PSA’s, TransMontaigne loaned Rio Vista $1,300,000
      (TransMontaigne Note) which is to be repaid, including interest, as a reduction
      of the total purchase price at the time of closing or 120 days following demand
      by TransMontaigne. The TransMontaigne Note is secured by the tank farm and
      certain LPG storage tanks located at the Brownsville Terminal Facility
      (Collateral). The TransMontaigne Note began to accrue interest on November
      15,
      2005 at the prime rate plus 2%. In connection with the TransMontaigne Note,
      RZB
      Finance, LLC (RZB) provided a consent and the Brownsville Navigation District
      issued an estoppel letter. Rio Vista used the proceeds from the TransMontaigne
      Note to fund certain expenses associated with the PSA’s and for working capital
      purposes. If the LPG Asset Sale does not occur and Rio Vista does not pay the
      TransMontaigne Note as provided for above, Rio Vista is required to convey
      title
      to the Collateral to TransMontaigne and to lease the Collateral from
      TransMontaigne for $10,000 per month until such time as Rio Vista pays the
      $1,300,000, in addition to the lease payments, to TransMontaigne. In the event
      of a conveyance of the title to the Collateral, no further interest payments
      will be required under the TransMontaigne Note. When the $1,300,000 is repaid
      to
      TransMontaigne, if ever, the lease payments will ceases and title to the
      Collateral will be re-conveyed to Rio Vista.





The
      closing of the LPG Asset Sale is subject to several conditions, including
      TransMontaigne’s satisfactory completion of its due diligence review, including
      financial, business, environmental and legal, assignment of LPG related
      contracts, and the modification of LPG related permits and the related Mexican
      governmental approvals. Certain of the conditions to closing were not met by
      October 31, 2005. The PSA’s provide that any party may terminate the agreements
      if closing did not occur on or before October 31, 2005. None of the parties
      have
      elected to terminate the agreements and the parties continue to work towards
      the
      closing of the LPG Asset Sale.





In
      connection with the LPG Asset Sale, Penn Octane filed a definitive proxy
      statement with the Securities Exchange Commission (SEC) on September 27, 2005
      pursuant to the requirement to obtain approval for the LPG Asset Sale from
      Penn
      Octane’s stockholders. On October 26, 2005, Penn Octane held a special meeting
      of stockholders at which the stockholders approved the LPG Asset Sale.





In
      connection with the LPG Asset Sale, Rio Vista filed a definitive proxy statement
      with the SEC on September 27, 2005 pursuant to the requirement to obtain
      approval for the LPG Asset Sale from Rio Vista’s unitholders. In addition, in
      order to permit Rio Vista’s continued existence following the LPG Asset Sale,
      Rio Vista’s proxy statement contained a proposal to amend a provision in its
      partnership agreement to remove the requirement to dissolve upon a sale of
      all
      or substantially all of its assets. On October 26, 2005, Rio Vista held a
      special meeting of unitholders at which the unitholders approved the LPG Asset
      Sale and the amendment to its partnership agreement.


12
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(UNAUDITED)





**NOTE
      D - PURCHASE AND SALE AGREEMENT - Continued**





Th e
      following unaudited pro forma consolidated financial information (Pro Forma
      Statements) for the Company gives effect to the LPG Asset Sale. The unaudited
      pro forma consolidated balance sheet assumes that the LPG Asset Sale was
      consummated on March 31, 2006. The unaudited pro forma consolidated statement
      of
      operations for the three months ended March 31, 2006 assumes that the LPG Asset
      Sale was consummated as of January 1, 2006.





The
      Pro
      Forma Statements are based on the available information and contain certain
      assumptions that the Company deems appropriate. The Pro Forma Statements do
      not
      purport to be indicative of the financial position of the Company had the
      transaction referred to above occurred on the dates indicated, nor are the
      Pro Forma Statements necessarily indicative of the future financial
      position of the Company. The Pro Forma Statements should be read in conjunction
      with the consolidated financial statements and notes thereto included herein.


13
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(UNAUDITED)




**NOTE
      D - PURCHASE AND SALE AGREEMENT - Continued**





**Penn
      Octane Corporation and Subsidiaries**


**PRO
      FORMA CONSOLIDATED BALANCE SHEET**


**(Unaudited)**




**As
                Reported March 31, 2006**
            
            **Pro
                Forma Adjustments**
            
            **Pro
                Forma March 31, 2006****ASSETS**Current
                AssetsCash
            
            $
            264,278
            
            $
            27,500,000
            (1)
            $
            24,897,659(1,325,612
            )(1)(333,453
            )(1)(1,207,554
            )(3)Restricted
                cash
            
            
            3,527,582
            
            
            
            
            
            3,527,582Trade
                accounts receivable
            
            
            10,682,909
            
            
            
            
            
            10,682,909Inventories
            
            
            2,736,625
            
            
            (1,733,979
            )(1)
            
            1,002,646Prepaid
                expenses and other current assets
            
            
            185,090
            
            
            
            
            
            185,090Total
                current assets
            
            
            17,396,484
            
            
            22,899,402
            
            
            40,295,886Property,
                plant and equipment— net
            
            
            14,738,958
            
            
            (14,674,870
            )(1)
            
            64,088Lease
                rights— net
            
            
            324,383
            
            
            (324,383
            )(1)
            
            -Other
                non-current assets
            
            
            32,182
            
            
            —
            
            
            32,182Total
                assets
            
            $
            32,492,007
            
            $
            7,900,149
            
            $
            40,392,156**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**Current
                LiabilitiesCurrent
                maturities of long-term debt
            
            $
            2,550,054
            
            $
            (1,085,000
            )(3)
            $
            165,054(1,300,000
            )(3)Revolving
                line of credit
            
            
            4,715,789
            
            
            
            
            
            4,715,789LPG
                and Fuel Products trade accounts payable
            
            
            8,975,208
            
            
            (546,813
            )(1)
            
            8,428,395U.S.
                and foreign taxes payable
            
            
            -
            
            
            1,500,000
            (5)
            
            1,500,000Other
                accounts payable
            
            
            1,871,160
            
            
            —
            
            
            1,871,160Accrued
                liabilities
            
            
            2,438,645
            
            
            (122,555
            )(3)
            
            2,107,025(333,453
            )(1)(25,612
            )(1)150,000
            (4)Total
                current liabilities
            
            
            20,550,856
            
            
            (1,763,433
            )
            
            18,787,423Long
                term debt, less current maturities
            
            
            9,089
            
            
            —
            
            
            9,089Minority
                interest in Rio Vista Energy Partners L.P.
            
            
            11,738,569
            
            
            3,464,219
            (6)
            
            15,202,788Stockholders’
                EquityCommon
                stock
            
            
            155,227
            
            
            —
            
            
            155,227Additional
                paid in capital
            
            
            28,865,793
            
            
            —
            
            
            28,865,793Notes
                receivable from a former officer of the Company
            
            
            (1,696,693
            )
            
            477,120
            (7)
            
            (1,219,573
            )Accumulated
                deficit
            
            
            (27,130,834
            )
            
            11,313,582
            (1)
            
            (21,408,591
            )(150,000
            )(4)(1,500,000
            )(5)(3,464,219
            )(6)(477,120
            )(7)Total
                stockholders’ equity
            
            
            193,493
            
            
            6,199,363
            
            
            6,392,856Total
                liabilities and stockholders’ equity
            
            $
            32,492,007
            
            $
            7,900,149
            
            $
            40,392,156




14
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(UNAUDITED)





**NOTE
      D - PURCHASE AND SALE AGREEMENT - Continued**





**Penn
      Octane Corporation and Subsidiaries**


**PRO
      FORMA CONSOLIDATED STATEMENT OF OPERATIONS**


**(Unaudited)**




**As
                Reported March 31, 2006**
            
            **Pro
                Forma Adjustments**
            
            **Pro
                Forma March 31, 2006**Revenues
            
            $
            69,328,264
            
            $
            (39,237,102
            )(2)
            $
            30,091,162Cost
                of Goods Sold
            
            
            68,059,624
            
            
            (38,494,747
            )(2)
            
            29,564,877Gross
                Profit
            
            
            1,268,640
            
            
            (742,355
            )
            
            526,285Selling,
                general and administrative expensesLegal
                and professional fees
            
            
            387,343
            
            
            (70,787
            )(2)
            
            316,556Salaries
                and payroll related expenses
            
            
            554,206
            
            
            (30,000
            )(2)
            
            524,206Other
            
            
            498,023
            
            
            (45,703
            )(2)
            
            452,3201,439,572
            
            
            (146,490
            )
            
            1,293,082Operating
                income (loss)
            
            
            (170,932
            )
            
            (595,865
            )
            
            (766,797
            )Other
                income (expense)Interest
                and LPG and Fuel Products financing expense
            
            
            (354,010
            )
            
            269,036
            
            
            (84,974
            )Interest
                income
            
            
            9,461
            
            
            (740
            )(2)
            
            8,721Gain
                on LPG Asset Sale
            
            
            -
            
            
            10,567,223
            (1)
            
            10,031,363(535,860
            )(7)Minority
                interest in earnings or loss of Rio Vista Energy Partners
                L.P.
            
            
            246,328
            
            
            (2,949,800
            )(6)
            
            (2,703,472
            )Income
                (loss) before taxes
            
            
            (269,153
            )
            
            6,753,994
            
            
            6,484,841Provision
                for income taxes
            
            
            13,925
            
            
            1,500,000
            (5)
            
            1,513,925Net
                income (loss)
            
            $
            (283,078
            )
            $
            5,253,994
            
            $
            4,970,916Net
                income (loss) per common share
            
            $
            (0.02
            )
            
            
            
            $
            0.32Net
                income (loss) per common share assuming dilution
            
            $
            (0.02
            )
            
            
            
            $
            0.32Weighted
                average common shares outstanding
            
            
            15,522,745
            
            
            
            
            
            15,522,745




15
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(UNAUDITED)





**NOTE
      D - PURCHASE AND SALE AGREEMENT - Continued**





**Penn
      Octane Corporation and Subsidiaries**


**Notes
      to Pro Forma Unaudited Consolidated Financial Information**


**March
      31, 2006**


**(Unaudited)**





(1)
            To
                reflect the LPG Asset Sale, including net proceeds received, the
                payment
                by Rio Vista of the Mexican subsidiaries net working capital deficit
                estimated at $333,000, the payment of the TransMontaigne Note including
                accrued interest and the resulting gain. This amount does not assume
                any
                reductions to the purchase price other than in connection with the
                Mexican
                subsidiaries net working capital deficit as provided for in the PSA’s.
                (See adjustments 4, 5 and 7 below which are related to the
                sale).


(2)
              To
                  eliminate revenues and expenses related to the LPG
                  operations.





(3)
            To
                reflect the payment of outstanding promissory notes including accrued
                interest which are collateralized by the LPG assets and refined products
                assets sold.





(4)
            To
                accrue for estimated expenses associated with the LPG Asset
                Sale.





(5)
            To
                accrue for federal and state taxes estimated to result from the LPG
                Asset
                Sale.


(6)
              To
                  record minority interest in the equity in the earnings of Rio Vista
                  in
                  connection with the LPG Asset
                  Sale.





(7)
            To
                accrue fee to Jerome B. Richter on the LPG Asset Sale and offset
                against
                receivables from Mr. Richter (see note
                J).


16
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(UNAUDITED)





**NOTE
      E - PROPERTY, PLANT AND EQUIPMENT**





Property,
      plant and equipment consist of the following:




December
                31,
            
            March
                31,2005
            
            2006LPG:Midline
                pump station (b)
            
            $
            2,326,985
            
            $
            2,326,985Brownsville
                Terminal Facility: (a)Building
            
            
            173,500
            
            
            173,500Terminal
                facilities
            
            
            3,631,207
            
            
            3,631,207Tank
                Farm
            
            
            373,945
            
            
            373,945Leasehold
                improvements
            
            
            318,807
            
            
            318,807Equipment
            
            
            226,285
            
            
            226,285Truck
            
            
            25,968
            
            
            25,9687,076,697
            
            
            7,076,697US
                - Mexico Pipelines and Matamoros Terminal Facility: (a)(c)U.S.
                Pipelines and Rights of Way
            
            
            6,914,770
            
            
            6,919,045Mexico
                Pipelines and Rights of Way
            
            
            993,300
            
            
            993,300Matamoros
                Terminal Facility
            
            
            5,874,781
            
            
            5,874,781Land
            
            
            705,358
            
            
            705,35814,488,209
            
            
            14,492,484Total
                LPG
            
            
            21,564,906
            
            
            21,569,181Other:Office
                equipment (b)
            
            
            108,487
            
            
            110,589Software
                (b)
            
            
            57,163
            
            
            57,163165,650
            
            
            167,75221,730,556
            
            
            21,736,933Less:
                accumulated depreciation and amortization
            
            
            (6,747,309
            )
            
            (6,997,975
            )$
            14,983,247
            
            $
            14,738,958




(a)
            Rio
                Vista assets


(b)
            Penn
                Octane and Subsidiaries other than Rio
                Vista


(c)
            Rio
                Vista owns, leases, or is in the process of obtaining the land or
                rights
                of way used related to the US-Mexico
                Pipelines





Property,
      plant and equipment, net of accumulated depreciation, includes $5,327,098 and
      $5,224,353 of costs located in Mexico at December 31, 2005 and March 31, 2006,
      respectively.


17
 *Table
          of Contents*




**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**





**NOTE
      F - INVENTORIES**





Inventories
      are valued at the lower of FIFO cost or market (LCM) and consist of the
      following:





December
                31, 2005
            
            March
                31, 2006Gallons
            
            LCM
            
            Gallons
            
            LCMLPG:Leased
                Pipeline
            
            
            1,175,958
            
            $
            1,266,040
            
            
            1,175,958
            
            $
            1,089,690Brownsville
                Terminal Facility and Matamoros Terminal Facility
            
            
            349,564
            
            
            376,342
            
            
            306,215
            
            
            283,749Markham
                Storage and other
            
            
            33,535
            
            
            36,104
            
            
            389,086
            
            
            360,5401,559,057
            
            
            1,678,486
            
            
            1,871,259
            
            
            1,733,979687,115
            
            
            1,199,782
            
            
            502,398
            
            
            1,002,646Fuel
                Products
            
            
            
            
            $
            2,878,268
            
            
            
            
            $
            2,736,625





**NOTE
      G - DEBT OBLIGATIONS**




Debt
                  obligations are as follows:
              
              December
                  31,2005
              
              March
                  31,2006Noninterest-bearing
                  note payable, discounted at 7%, for legal services; due in February
                  2001
              
              $
              137,500
              
              $
              137,500Restructured
                  Notes and $280,000 Notes
              
              
              1,550,000
              
              
              1,085,000TransMontaigne
                  Note (see note D)
              
              
              1,300,000
              
              
              1,300,000Other
                  debt
              
              
              37,941
              
              
              36,643Total
                  debt
              
              
              3,025,441
              
              
              2,559,143Less:
                  Current maturities
              
              
              3,015,054
              
              
              2,550,054Long-term
                  debt
              
              $
              10,387
              
              $
              9,089





The
      Restructured Notes and the $280,000 Notes (collectively the Notes) have a face
      value of $1,085,000, bear interest at an annual rate of 16.5%, and were due
      December 15, 2005. The Notes are collateralized by substantially all of the
      Company’s tangible assets, excluding inventories, accounts receivable and sales
      contracts with respect to which the Company has granted a subordinated security
      interest. Mr. Jerome B. Richter, former chairman of the board and chief
      executive officer of the Company, has also pledged 2,000,000 shares of common
      stock of Penn Octane owned by Mr. Richter including 1,000,000 shares of common
      stock collateralizing Mr. Richter’s promissory note to the Company. As a result
      of the Spin-Off, Mr. Richter was also required to provide 250,000 Common Units
      of Rio Vista owned by him.





On
      September 30, 2005, the Company and holders of the Notes agreed to an amendment
      whereby the interest payments required to be paid on June 15, 2005 and September
      15, 2005 were extended to December 15, 2005 (Deferred Interest). Under the
      terms
      of the amendment, the Company agreed to pay additional interest at an annual
      rate of 16.5% on the Deferred Interest from the original due date through the
      date the Deferred Interest is paid. In addition, the Company agreed to pay
      to
      the holders of the Notes, an additional amount equal to 5% of the principal
      amount outstanding of the Notes upon maturity. Mr. Richter agreed that he would
      deliver 250,000 Common Units of Rio Vista (referred to above) to the collateral
      agent. The Company also agreed that it would not enter into any additional
      severance payment obligation in connection with the resignation of Mr. Richter
      until the Notes are fully paid. In addition, the holders of the Notes agreed
      to
      allow Rio Vista to pledge and deliver certain assets in connection with the
      TransMontaigne Note (see note D). The 250,000 Common Units of Rio Vista
      referenced above have not yet been delivered.


18
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(UNAUDITED)





**NOTE
      G - DEBT OBLIGATIONS - Continued**





The
      Company did not pay the entire balance of principal and interest due under
      the
      Notes on December 15, 2005. On December 15, 2005 and January 1, 2006, the
      Company paid $426,143 and $159,171 to the holders of the Notes of which $267,750
      represented payment of principal and related penalties to certain holders of
      the
      Notes and $317,564 represented total accrued and unpaid interest on the Notes
      through December 15, 2005.





During
      February 2006, the Company repaid $500,021 to certain holders of the Notes
      representing $488,250 of principal and related penalties and $11,771 of accrued
      interest.





During
      March 2006, the Company agreed to extend from December 31, 2006 to December
      31,
      2008 the expiration date on the Rio Vista warrants corresponding to the Notes
      then outstanding. The warrants were initially issued in connection with the
      December 15, 2003 amendment of the Notes. In connection with the extension,
      the
      Company recorded additional interest expense of approximately
      $22,000.





During
      May 2006, the Company paid $61,418 to the holders of the Notes representing
      accrued interest and fees through March 15, 2006.




**NOTE
      H - STOCKHOLDERS’ EQUITY**





**Penn
      Octane 2001 Warrant Plan**





On
      March
      9, 2005, the board of directors of Penn Octane approved the grant of warrants
      to
      purchase a total of 1,005,000 shares of Penn Octane common stock under Penn
      Octane’s 2001 Warrant Plan previously approved by the Penn Octane stockholders.
      Of the total number of warrants granted, 625,000 were granted to executive
      officers of Penn Octane, 255,000 were issued to outside directors of Penn Octane
      and 125,000 were issued to a consultant. The exercise price for the warrants
      is
      $1.50 per share, which was the closing price for Penn Octane’s common stock as
      reported by the Nasdaq Stock Market on March 9, 2005. Warrants granted to
      executive officers vest in equal monthly installments over a period of 36 months
      from the date of grant. Warrants granted to outside directors vest in equal
      monthly installments over a period of 12 months from the date of grant. All
      warrants become fully exercisable upon a change in control event and expire
      five
      years from the date of grant.





**Note
      Receivable from a Former Officer of the Company**





The
      note
      receivable from Mr. Richter, in the amount of $3,196,693, was due July 29,
      2005.
      On August 3, 2005 in connection with Mr. Richter’s retirement in May 2005 and in
      consideration of his past services, the Company approved an extension of the
      note to July 29, 2007 and a discount of the note to $1,696,693 plus accrued
      interest not waived (see below) on its maturity date, subject to satisfaction
      of
      certain conditions. The Company considers it to be probable that the note will
      be discounted at maturity and accordingly, has recorded a charge to compensation
      expense as of June 30, 2005 in the amount of $1,031,307 with a corresponding
      credit to the reserve. The interest rate on the extended note is 6.75%. The
      Company will waive interest provided that Mr. Richter guarantees debt of the
      Company to any person in an amount equal to at least $1,800,000 (see Note G).
      Beginning December 15, 2005, the Company reduced the amount of guaranteed debt
      below $1,800,000. Accordingly, the Company began accruing interest and reserving
      the interest on Mr. Richter’s note.


19
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      I - OPTIONS AND WARRANTS OF RIO VISTA**





**General
      Partner Options**




Penn
      Octane’s 100% interest in the General Partner may be decreased to 50% as a
      result of the exercise by Shore Capital LLC (Shore Capital), an affiliate of
      Mr.
      Richard Shore, Jr., former president of the Company, and by Mr. Richter of
      options to each acquire 25% of the General Partner (General Partner Options).
      The exercise price for each option is approximately $82,000. The options expire
      on July 10, 2006. Following the exercise of any of the General Partner Options,
      Penn Octane will retain voting control of the General Partner pursuant to a
      voting agreement.




**Common
      Unit Warrants**




On
      March
      9, 2005, the board of managers of the General Partner of Rio Vista approved
      the Rio Vista 2005 Equity Incentive Plan (2005 Plan). The 2005 Plan permits
      the
      grant of common unit options, common unit appreciation rights, restricted common
      units and phantom common units to any person who is an employee (including
      to
      any executive officer) or consultant of Rio Vista or the General Partner or
      any
      affiliate of Rio Vista or the General Partner. The 2005 Plan provides that
      each
      outside manager of the General Partner shall be granted a common unit option
      once each fiscal year for not more than 5,000 common units, in an equal amount
      as determined by the board of managers. The aggregate number of common units
      authorized for issuance as awards under the 2005 Plan is 750,000. The 2005
      Plan
      shall remain available for the grant of awards until March 9, 2015, or such
      earlier date as the board of managers may determine. The 2005 Plan is
      administered by the compensation committee of the board of managers. Under
      the
      terms of the Agreement and applicable rules of the Nasdaq Stock Market, no
      approval of the 2005 Plan by the common unitholders of Rio Vista was
      required.




On
      March
      9, 2005, the board of managers of the General Partner of Rio Vista approved
      the grant of options to purchase a total of 108,750 common units under the
      2005
      Plan. Of the total number of options granted, 93,750 were granted to certain
      executive officers of the General Partner and Mr. Richter and 15,000 were issued
      to outside managers of the General Partner. The exercise price for the options
      is $12.51 per common unit, which was the average of the high and low sales
      prices for Rio Vista common units as reported by the Nasdaq Stock Market on
      March 9, 2005. The options granted to executive officers (including Mr. Richter)
      were fully vested on the date of grant. The options granted to outside managers
      vest in equal monthly installments over a period of 12 months from the date
      of
      grant. All options become fully exercisable upon a change in control event
      and
      expire three years from the date of grant. The board of managers has not yet
      determined if Rio Vista will grant any common unit options for the fiscal year
      2006.




20
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      J - COMMITMENTS AND CONTINGENCIES**





**Credit
      Facility, Letters of Credit and Other**





As
      of
      March 31, 2006, Penn Octane had a $20,000,000 credit facility with RZB Finance,
      LLC (RZB) for demand loans and standby letters of credit (RZB Credit Facility)
      to finance Penn Octane’s purchases of LPG and Fuel Products. The RZB Credit
      Facility includes a $3,000,000 limit for purchase of Fuel Products inventory
      for
      a maximum of 30 days. The RZB Credit facility is an uncommitted facility under
      which the letters of credit have an expiration date of no more than 90 days
      and
      the facility is reviewed annually at March 31. In connection with the RZB Credit
      Facility, the Company granted RZB a security interest and assignment in any
      and
      all of the Company’s accounts, inventory, real property, buildings, pipelines,
      fixtures and interests therein or relating thereto, including, without
      limitation, the lease with the Brownsville Navigation District of Cameron County
      for the land on which the Company’s Brownsville Terminal Facility is located,
      the Pipeline Lease, and in connection therewith entered into leasehold deeds
      of
      trust, security agreements, financing statements and assignments of rent. Under
      the RZB Credit Facility, the Company may not permit to exist any subsequent
      lien, security interest, mortgage, charge or other encumbrance of any nature
      on
      any of its properties or assets, except in favor of RZB, without the consent
      of
      RZB. After the Spin-Off and transfer of assets to Rio Vista, RZB continued
      to
      retain a security interest in the transferred assets.





Under
      the
      RZB Credit Facility, the Company is required to pay a fee with respect to each
      letter of credit thereunder in an amount equal to the greater of (i) $500,
      (ii)
      2.5% of the maximum face amount of such letter of credit for LPG and 2% for
      Fuel
      Products, or (iii) such higher amount as may be agreed to between the Company
      and RZB. Any loan amounts outstanding under the RZB Credit Facility accrue
      interest at a rate equal to the rate announced by the JPMorgan Chase Bank as
      its
      prime rate (7.75% at March 31, 2006) plus 2.5%. Pursuant to the RZB Credit
      Facility, RZB has sole and absolute discretion to limit or terminate its
      participation in the RZB Credit Facility and to refrain from making any loans
      or
      issuing any letters of credit thereunder. RZB also has the right to demand
      payment of any and all amounts outstanding under the RZB Credit Facility at
      any
      time. In addition to the fees described above, the Company is required to pay
      RZB annual fees of $50,000.





Based
      on
      current minimum purchase commitments under the Company’s LPG supply agreement
      and current LPG prices, the amount available to finance Fuel Products and LPG
      purchases in excess of current minimum purchase commitments is limited and
      therefore the ability of the Company to grow the Fuel Sales Business is
      dependent on future increases in its RZB Credit Facility or other sources of
      financing, the reduction of LPG supply commitments and/or the reduction in
      LPG
      or Fuel Products purchase prices.





Under
      the
      terms of the RZB Credit Facility, either Penn Octane or Rio Vista is required
      to
      maintain net worth of a minimum of $10,000,000.





In
      connection with the Company’s purchases of LPG and Fuel Products, letters of
      credit are issued based on anticipated purchases. Outstanding letters of credit
      for purchases of LPG and Fuel Products at March 31, 2006 totaled approximately
      $11,200,000 of which approximately $9,400,000 represents March 2006 purchases
      and approximately $1,800,000 represents April 2006 purchases.





In
      connection with the Company’s purchase of LPG and Fuel Products, under the RZB
      Credit Facility, assets related to product sales (Assets) are required to be
      in
      excess of borrowings and commitments (including restricted cash of approximately
      $3,000,000 at March 31, 2006). At March 31, 2006, the Company’s borrowings and
      commitments were less than the amount of the Assets.


21
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      J - COMMITMENTS AND CONTINGENCIES - Continued**





**Credit
      Facility, Letters of Credit and Other - Continued**





In
      connection with the Company’s Fuel Sales Business, the Company has issued bonds
      totaling $662,000 to the states of California, Nevada, Arizona and Texas (Bonds)
      to secure payments of excise and other taxes collected from customers in
      connection with sales of Fuel Products. The Bonds are partially secured by
      letters of credit totaling $452,600. At March 31, 2006, such taxes in the amount
      of approximately $960,000 were due. The letters of credit issued have all been
      secured by cash in the amount of approximately $467,000 which is included in
      restricted cash in the Company’s balance sheet at March 31, 2006.





LPG
      and
      Fuel Products financing expense associated with the RZB Credit Facility totaled
      $203,301 and $239,768 for the three months ended March 31, 2005 and 2006,
      respectively.





**Distributions
      of Available Cash**





All
      Rio
      Vista unitholders have the right to receive distributions from Rio Vista of
      “available cash” as defined in the Rio Vista partnership agreement in an amount
      equal to at least the minimum distribution of $0.25 per quarter per unit, plus
      any arrearages in the payment of the minimum quarterly distribution on the
      units
      from prior quarters. The General Partner has a right to receive a distribution
      corresponding to its 2% general partnership interest and the incentive
      distribution rights described below. The distributions are to be paid 45 days
      after the end of each calendar quarter. However, Rio Vista is prohibited from
      making any distributions to unitholders if it would cause an event of default,
      or an event of default exists, under **** any
      obligation of Penn Octane which Rio Vista has guaranteed.





In
      addition to its 2% general partner interest, the General Partner is currently
      the holder of incentive distribution rights which entitle the holder to an
      increasing portion of cash distributions as described in the partnership
      agreement. As a result, cash distributions from Rio Vista are shared by the
      holders of Rio Vista common units and the General Partner interest based on
      a
      formula whereby the General Partner receives disproportionately more
      distributions per percentage interest than the holders of the common units
      as
      annual cash distributions exceed certain milestones.





On
      both
      February 14, 2005 and May 13, 2005, Rio Vista made cash distributions of
      $487,000 for the quarters ended December 31, 2004 and March 31, 2005. Because
      of
      insufficient available cash, Rio Vista has not declared any other distributions
      since May, 2005.





**Partnership
      Tax Treatment**





Rio
      Vista
      is not a taxable entity for U.S. tax purposes (see below) and incurs no U.S.
      federal income tax liability. Rio Vista’s Mexican subsidiaries are taxed on
      their income directly by the Mexican government. The income/loss of Rio Vista’s
      Mexican subsidiaries is included in the U.S. partnership income tax return
      of
      Rio Vista. The holders of the common units and General Partner interest will
      be
      entitled to their proportionate share of any tax credits resulting from any
      income taxes paid to the Mexican government. Each unitholder of Rio Vista is
      required to take into account that unitholder’s share of items of income, gain,
      loss and deduction of Rio Vista in computing that unitholder’s federal income
      tax liability, even if no cash distributions are made to the unitholder by
      Rio
      Vista. Distributions by Rio Vista to a unitholder are generally not taxable
      unless the amount of cash distributed is in excess of the unitholder’s adjusted
      tax basis in Rio Vista.


22
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      J - COMMITMENTS AND CONTINGENCIES - Continued**





**Partnership
      Tax Treatment - Continued**





Section
      7704 of the Internal Revenue Code (Code) provides that publicly traded
      partnerships, as a general rule, are taxed as corporations despite the fact
      that
      they are not classified as corporations under Section 7701 of the Code. Section
      7704 of the Code provides an exception to this general rule for a publicly
      traded partnership if 90% or more of its gross income for every taxable year
      consists of “qualifying income” (Qualifying Income Exception). For purposes of
      this exception, “qualifying income” includes income and gains derived from the
      exploration, development, mining or production, processing, refining,
      transportation (including pipelines) or marketing of any mineral or natural
      resource. Other types of “qualifying income” include interest (other than from a
      financial business or interest based on profits of the borrower), dividends,
      real property rents, gains from the sale of real property, including real
      property held by one considered to be a “dealer” in such property, and gains
      from the sale or other disposition of capital assets held for the production
      of
      income that otherwise constitutes “qualifying income”.





No
      ruling
      has been or will be sought from the IRS and the IRS has made no determination
      as
      to Rio Vista’s classification as a partnership for federal income tax purposes
      or whether Rio Vista’s operations generate a minimum of 90% of “qualifying
      income” under Section 7704 of the Code.





If
      Rio
      Vista were classified as a corporation in any taxable year, either as a result
      of a failure to meet the Qualifying Income Exception or otherwise, Rio Vista’s
      items of income, gain, loss and deduction would be reflected only on Rio Vista’s
      tax return rather than being passed through to Rio Vista’s unitholders, and Rio
      Vista’s net income would be taxed at corporate rates.





If
      Rio
      Vista were treated as a corporation for federal income tax purposes, Rio Vista
      would pay tax on income at corporate rates, which is currently a maximum of
      35%.
      Distributions to unitholders would generally be taxed again as corporate
      distributions, and no income, gains, losses, or deductions would flow through
      to
      the unitholders. Because a tax would be imposed upon Rio Vista as a corporation,
      the cash available for distribution to unitholders would be substantially
      reduced and Rio Vista’s ability to make minimum quarterly distributions would be
      impaired. Consequently, treatment of Rio Vista as a corporation would result
      in
      a material reduction in the anticipated cash flow and after-tax return to
      unitholders and therefore would likely result in a substantial reduction in
      the
      value of Rio Vista’s common units.





Current
      law may change so as to cause Rio Vista to be taxable as a corporation for
      federal income tax purposes or otherwise subject Rio Vista to entity-level
      taxation. The Agreement provides that, if a law is enacted or existing law
      is
      modified or interpreted in a manner that subject Rio Vista to taxation as a
      corporation or otherwise subjects Rio Vista to entity-level taxation for
      federal, state or local income tax purposes, then the minimum quarterly
      distribution amount and the target distribution amount will be adjusted downward
      to reflect the impact of that law on Rio Vista.





The
      Partnership’s significant basis differences between the tax bases and the
      financial statement bases of the Company’s asset and liabilities are the cost
      basis and depreciation differences of the Company’s depreciable assets and
      deferred interest costs on unexercised warrants. The net reversal of cost basis
      and depreciation differences varies considerably from limited partner to limited
      partner due to allocations under Section 734 and 743 of the Internal Revenue
      Code. The deferred interest cost for tax purposes is $1,408,000. Interest
      expense may or may not be recognized for tax purposes depending on the exercise
      of related warrants prior to their expiration.


23
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      J - COMMITMENTS AND CONTINGENCIES - Continued**





**Litigation**





Penn
      Octane, Rio Vista and/or Rio Vista’s subsidiaries have been named as defendants
      in two lawsuits filed in connection with an accident in the town of Lucio
      Blanco, Mexico on August 11, 2005, involving a tanker truck carrying LPG which
      was struck by a train resulting in an explosion. None of Penn Octane, Rio Vista
      nor any of Rio Vista’s subsidiaries owned or operated the tanker truck or
      employed or controlled the driver of the tanker truck. Further, none of the
      Penn
      Octane, Rio Vista nor any of Rio Vista’s subsidiaries owned or had custody of
      the LPG on the tanker truck at the time and location of the accident.





The
      tanker truck reportedly took delivery of LPG at the Matamoros Terminal Facility
      operated under agreement with Rio Vista’s Mexican subsidiaries. According to the
      lawsuits, after leaving the Matamoros Terminal Facility, the tanker truck was
      involved in a collision with a train in Lucio Blanco, Mexico, resulting in
      a
      tragic explosion that killed and injured several persons and caused significant
      property damage. Published reports indicate that the truck used a road not
      approved for large trucks and failed to stop at an unprotected rail crossing,
      resulting in the collision and explosion. The operator of the tanker truck,
      or
      its insurance company, is reportedly taking claims in Mexico from victims of
      the
      accident.





Even
      though the accident took place in Mexico, both lawsuits were filed in Texas.
      The
      first case is captioned *Lesly
      Camacho by Her Mother Dora Adame as Next Friend, et al. vs. Penn Octane
      International LLC* and
      was
      filed in the 404 th District
      Court for Cameron County, Texas on September 26, 2005. The plaintiffs seek
      unspecified monetary damages and a temporary injunction in order to preserve
      evidence relevant to the case and assets to secure a potential judgment. An ex
      parte temporary restraining order was sought and obtained by the plaintiffs on
      September 27, 2005, in order to preserve evidence and prevent any sale of
      assets, including Penn Octane’s and Rio Vista’s LPG Asset Sales. This order was
      issued without prior notice to, or opportunity to contest by, Penn Octane or
      Rio
      Vista. The temporary restraining order expired in accordance with its terms
      on
      October 19, 2005 and no further injunctive relief has been granted. On November
      29, 2005, the parties entered into an agreement on the record wherein a
      subsidiary of Rio Vista assumed the obligation of preserving and delivering
      relevant evidence, and the plaintiffs dropped their request for a temporary
      injunction against a sale of assets. Limited discovery has been conducted to
      date.





The
      second case is captioned *Faustino
      Izaguirre Gonzalez, et al. vs. Penn Octane Corporation, et al.* and was
      filed in the 107 th District
      Court for Cameron County, Texas, on November 14, 2005. The plaintiffs seek
      unspecified monetary damages. On December 28, 2005, Penn Octane, Rio Vista
      and
      Rio Vista’s subsidiaries filed a motion for removal of the case in the U.S.
      District Court for the Southern District of Texas, Brownsville Division. On
      February 15, 2006, the U.S. District Court denied a motion by the plaintiffs
      to
      remand the case to state court and dismissed the case as to defendants other
      than Penn Octane Corporation. The court found that the plaintiffs failed to
      provide factual allegations sufficient to establish a possibility of recovery
      against Rio Vista or its subsidiaries. The plaintiffs filed a motion for
      reconsideration in which they added a new allegation that Rio Vista and its
      subsidiaries failed to properly odorize the LPG before the accident. Because
      of
      the new allegation by the plaintiffs, the U.S. District Court on May 2, 2006
      reinstated Rio Vista and its subsidiaries as defendants and remanded the case
      to
      the Cameron County, Texas state court. In its remand order, the U.S. District
      Court noted that it had not found that the conduct of Rio Vista and its
      subsidiaries caused the injuries of the plaintiffs, but only that plaintiffs
      had
      made sufficient allegations to reinstate the Rio Vista defendants and return
      the
      case to state court. Penn Octane and Rio Vista believe that there is no factual
      basis to support the new allegation by the plaintiffs.


24
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      J - COMMITMENTS AND CONTINGENCIES - Continued**





**Litigation
      - Continued**





Management
      believes the above lawsuits against Penn Octane, Rio Vista and/or Rio Vista’s
      subsidiaries are without merit and, based on the advice of counsel, does not
      anticipate either liability for damages or the issuance of a temporary
      injunction against a sale of Penn Octane’s or Rio Vista’s assets. The Company’s
      insurance carrier is expected to bear the legal fees and expenses in connection
      with defending these cases. If, however, a court found liability on the part
      of
      Penn Octane, Rio Vista or their subsidiaries, a judgment or settlement in excess
      of insurance coverage could have a material adverse effect on Penn Octane’s and
      Rio Vista’s business, financial condition and results of operations. If a court
      enjoined the sale of all or any portion of Penn Octane’s or Rio Vista’s assets
      to a third party, such an injunction could delay or prevent Penn Octane’s or Rio
      Vista’s LPG Asset Sale before resolution of the claims underlying the lawsuit. A
      lengthy delay of, or inability to close, the LPG Asset Sale could have a
      material adverse effect on Penn Octane’s and Rio Vista’s business, financial
      condition and results of operations.





In
      October 2005 in a case captioned *Rio
      Vista Operating Partnership L.P. vs. J. Guajardo, Jr. Farms,
      Inc.* ,
      the
      Special Commissioners appointed by the District Court of Cameron County, Texas
      awarded $100,000 to a land owner in connection with the acquisition of a right
      of way by the Company. The $100,000 was deposited into the Registry of the
      Court
      on November 17, 2006. The Company is currently appealing the $100,000 award.
      Subsequently the land owner has filed an inverse condemnation action against
      both Rio Vista and Penn Octane seeking damages of $1,800,000. In response to
      the
      Company’s motion, the Court granted partial summary judgment in favor of the
      Company, holding that there are no compensable damages arising from an inverse
      condemnation.





The
      Company and its subsidiaries are involved with other proceedings, lawsuits
      and
      claims. The Company believes that the liabilities, if any, ultimately resulting
      from such proceedings, lawsuits and claims should not materially affect its
      consolidated financial results.





**Consulting
      Agreement**





During
      November 2005, Penn Octane, Rio Vista and Mr. Richter entered into a consulting
      agreement whereby Mr. Richter shall serve as a special advisor to the board
      of
      directors of Penn Octane and the board of managers of Rio Vista and will provide
      the following services (Services) to both Penn Octane and Rio Vista: assistance
      with the sale of all or part of their LPG assets, assistance with other
      transactions (including restructurings) involving the companies as mutually
      agreed by the parties and such other services that the companies may reasonably
      request.





In
      consideration of the Services rendered by Mr. Richter to the companies, Penn
      Octane and Rio Vista agreed to pay the following fees (Fees) to Mr. Richter:
      an
      amount equal to two percent (2%) of (i) the net proceeds, as defined, to
      the companies resulting from a sale of assets to a third party, and (ii) the
      net
      proceeds, as defined, to the companies from sales of LPG to PMI for any calendar
      month in which such sales exceed the volumes pursuant to the PMI Agreement
      (see
      Note K). Amounts expensed pursuant to (ii) above through March 31, 2006 totaled
      approximately $5,000.





The
      companies may, in their discretion, offset the amount of any Fees due and
      payable to Mr. Richter against any amounts owed (whether or not then due or
      payable) by Mr. Richter to the Company, including without limitation, any
      amounts owed by Mr. Richter to Penn Octane pursuant to his promissory note
      payable to Penn Octane.





The
      term
      of Mr. Richter’s consulting agreement shall continue until the earlier of
      November 26, 2006 or termination of the agreement upon 30 days written notice
      to
      the other party.


25
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      J - COMMITMENTS AND CONTINGENCIES - Continued**





**Concentrations
      of Credit Risk**





Financial
      instruments that potentially subject the Company to credit risk include cash
      balances at banks which at times exceed the federal deposit insurance
      limit.








**NOTE
      K - CONTRACTS**





**LPG
      Sales to PMI**




PMI
      and
      the Company operated under a three month contract for the period from January
      1,
      2005 to March 31, 2005 and monthly contracts for April 2005 and May 2005.
      Effective June 4, 2005, the Company entered into an agreement with PMI for
      the
      period June 4, 2005 through March 31, 2006 for the sale of LPG to PMI (PMI
      Agreement). The following table sets forth the minimum monthly volume of LPG
      that PMI committed to purchase from the Company pursuant to the PMI Agreement
      and the actual volumes purchased for the months January 2006 through March
      2006.




Month
              
              Minimum
                  Contract Volumes
              
              Actual
                  Volumes Sold(gallons)
              
              (gallons)January
                  2006
              
              
              11,700,000
              
              
              14,757,646February
                  2006
              
              
              11,700,000
              
              
              11,940,257March
                  2006
              
              
              8,100,000
              
              
              11,606,435




On
      March
      31, 2006, the PMI Agreement expired. During the month of April 2006, the Company
      sold LPG to PMI under a monthly contract which provided for volumes of
      approximately 6,000,000 gallons at prices similar to the PMI Agreement. During
      April 2006, PMI purchased approximately 6,000,000 gallons.




On
      April
      28, 2006, the Company received electronic confirmation (PMI Confirmation) from
      PMI of the terms of a new purchase and sale agreement for LPG for the period
      May 1, 2006 through March 31, 2007 (Term). The PMI Confirmation
      remains subject to execution of a definitive written agreement between Rio
      Vista
      and PMI. The PMI Confirmation provides that PMI does not have a financial
      obligation with respect to any short falls if volumes actually purchased are
      less than minimum volumes contained in the PMI Confirmation.




26
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      K - CONTRACTS - Continued**





**LPG
      Sales to PMI - Continued**




The
      minimum volumes and applicable margins contained in the PMI Confirmation are
      expected to provide the Company with gross profit similar to the gross profit
      the Company would have received if PMI had purchased only the minimum volumes
      provided under its agreements with Rio Vista during the period from May 1,
      2005 to March 31, 2006 as a result of increased margins on lower volume
      levels contained in the PMI Confirmation. The
      following table sets forth the minimum monthly volume of LPG contained in the
      PMI Confirmation.




Month
              
              Minimum
                  Volume(gallons)May
                  2006
              
              4,500,000June
                  2006
              
              4,500,000July
                  2006
              
              4,500,000August
                  2006
              
              4,500,000September
                  2006
              
              4,500,000October
                  2006
              
              8,100,000November
                  2006
              
              8,100,000December
                  2006
              
              9,000,000January
                  2007
              
              9,000,000February
                  2007
              
              8,100,000March
                  2007
              
              8,100,000





PMI
      has
      primarily used the Matamoros Terminal Facility to load LPG purchased from the
      Company for distribution by truck in Mexico. The Company continues to use the
      Brownsville Terminal Facility in connection with LPG delivered by railcar to
      other customers, storage and as an alternative terminal in the event the
      Matamoros Terminal Facility cannot be used.





Revenues
      from PMI totaled approximately $39,237,000 for the three months ended March
      31,
      2006, representing approximately 56.6% of total revenues for the period.




27
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      K - CONTRACTS - Continued**





**LPG
      Supply Agreements**





Effective
      October 1, 1999, the Company and Exxon entered into a ten year LPG supply
      contract, as amended (Exxon Supply Contract), whereby Exxon has agreed to supply
      and the Company has agreed to take, 100% of Exxon’s owned or controlled volume
      of propane and butane available at Exxon’s King Ranch Gas Plant (Plant) up to
      13,900,000 gallons per month blended in accordance with required specifications
      (Plant Commitment). For the three months ended March 31, 2006, under the Exxon
      Supply Contract, Exxon has supplied an average of approximately 9,356,000
      gallons of LPG per month. The purchase price is indexed to variable posted
      prices.





Effective
      March 1, 2006, the Exxon Supply Contract was amended to extend through September
      30, 2010.





In
      addition to the LPG costs charged by its suppliers, the Company also incurs
      additional costs to deliver LPG to the Company’s facilities. Furthermore, the
      Company may incur significant additional costs associated with the storage,
      disposal and/or changes in LPG prices resulting from the excess of LPG purchased
      under the Exxon Supply Contract over actual sales volumes to PMI. Under the
      terms of the Exxon Supply Contract, the Company must provide letters of credit
      in amounts equal to the cost of the product to be purchased. In addition, the
      cost of the product purchased is tied directly to overall market conditions.
      As
      a result, the Company’s existing letter of credit facility may not be adequate
      to meet the letter of credit requirements if there are increases in quantities
      of LPG purchased and/or to finance future price increases of LPG.





In
      order
      to meet sales volumes in excess of LPG provided under the Exxon Supply Contract,
      the Company has entered into monthly arrangements with other LPG suppliers.
      The
      costs of such LPG supplies vary but are less than amounts received under the
      PMI
      Agreement.


28
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**




**NOTE
      L** **- REALIZATION OF ASSETS**





The
      accompanying unaudited consolidated financial statements have been prepared
      in
      conformity with accounting principles generally accepted in the United States
      of
      America, which contemplate continuation of the Company as a going concern.
      The
      Company has a loss from operations for the three months ended March 31, 2006,
      has had an accumulated deficit since inception and has a deficit in working
      capital. In addition, substantially all of the Company’s assets are pledged or
      committed to be pledged as collateral on existing debt in connection with the
      Notes, the RZB Credit Facility and/or the TransMontaigne Note, and therefore,
      the Company may be unable to obtain additional financing collateralized by
      those
      assets. The Notes were due December 15, 2005 and notes totaling $720,000 were
      paid in December 2005 and February 2006. Notes totaling $ 1,085,000 are still
      outstanding and have not been extended. The LPG Asset Sale has not closed and
      the TransMontaigne Note may be due on the earlier of the time of closing or
      120
      days following demand by TransMontaigne (see note D). The RZB Credit Facility
      may be insufficient to finance the Company’s LPG purchases and/or Fuel Products
      purchases, assuming increases in product costs per gallon, or volumetric growth
      in product sales, and may be terminated by RZB with 90 days notice.





The
      minimum volumes and applicable margins contained in the PMI Confirmation are
      expected to provide the Company with gross profit similar to the gross profit
      the Company would have received if PMI had purchased only the minimum volumes
      provided under its agreements with Rio Vista during the period from May 1,
      2005 to March 31, 2006 as a result of increased margins on lower volume
      levels contained in the PMI Confirmation. Actual volumes purchased by PMI under
      those prior agreements, however, exceeded minimum contractual amounts by
      approximately 35%. There is no assurance that PMI will purchase volumes as
      indicated in the PMI Confirmation or that PMI will continue to purchase LPG
      from
      Rio Vista or in quantities or prices that are profitable upon the expiration
      of
      the PMI Confirmation. Assuming that the LPG Asset Sale does not close, the
      Company projects that its gross profit from operations based on the minimum
      volumes and applicable margins contained in the PMI Confirmation will not
      provide sufficient cash flow to pay its normal operating expenses through
      March 31, 2007, assuming breakeven results from its Fuel Sales Business,
      unless it can sufficiently reduce its operating expenses. In addition, the
      Company’s cash flow at the minimum volumes contained in the PMI Confirmation is
      projected not to be sufficient to pay its other obligations, including its
      secured debt. The Fuel Sales Business is a relatively new business and, as
      a
      result, the Company does not believe it can rely on that portion of its business
      to provide sufficient additional cash flow.




Also,
      Penn Octane and Rio Vista project that monthly cash flows from LPG sales during
      the months of May 2006 through September 2006 will be less than during the
      months of October 2006 through March 2007 as a result of reduced monthly volumes
      committed to be purchased during May 2006 through September 2006. In
      addition, the Company may be unable to make any necessary capital expenditures
      or to pay arrearages in distributions or to pay future distributions to Rio
      Vista’s unitholders during the Term of the PMI Confirmation.




In
      the
      event Penn Octane does not pay its obligations when due, Rio Vista’s guarantees
      to Penn Octane and Penn Octane’s creditors may be triggered. Accordingly, Rio
      Vista may be required to pay such obligations of Penn Octane to avoid
      foreclosure against Rio Vista’s assets by Penn Octane’s creditors. Assuming that
      the LPG Asset Sale does not close, Rio Vista projects that its gross profit
      from
      operations under the PMI Confirmation, based on the minimum volumes and
      applicable margins, will not provide sufficient cash flow for Rio Vista to
      pay
      its normal operating expenses through March 31, 2007 unless it can
      sufficiently reduce its operating expenses. If the Company’s revenues and other
      sources of liquidity are not adequate to pay its obligations, Penn Octane or
      Rio
      Vista may be required to raise additional funds to avoid such foreclosure.
      There
      can be no assurance that such additional funding will be available on terms
      attractive to either Penn Octane or Rio Vista or available at all. If additional
      amounts cannot be raised and the Company is unable to restructure its
      obligations, the Company would suffer material adverse consequences to its
      business, financial condition and results of operations, and Penn Octane and/or
      Rio Vista would likely be required to seek other alternatives, which could
      include the sale of assets, closure of operations and/or protection under the
      U.S. bankruptcy laws.


29
 *Table
          of Contents*


**Penn
      Octane Corporation and Subsidiaries**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(UNAUDITED)




**NOTE
      L - REALIZATION OF ASSETS - Continued**





In
      view
      of the matters described in the preceding paragraphs, recoverability of the
      recorded asset amounts shown in the accompanying unaudited consolidated balance
      sheet is dependent upon either (1) closing of the LPG Asset Sale or (2) the
      ability of the Company to generate sufficient cash flow through operations
      or
      additional debt or equity financing to pay its liabilities and obligations
      when
      due. If the LPG Asset Sale does not close, the ability for the Company to
      generate sufficient cash flows from operations is significantly dependent on
      the
      sale of LPG to PMI at adequate average monthly sales volumes and margins, the
      success of the Fuel Sales Business and the adequacy of the RZB Credit Facility
      to finance such sales. The unaudited consolidated financial statements do not
      include any adjustments related to the recoverability and classification of
      recorded asset amounts or amounts and classification of liabilities that might
      be necessary should the Company be unable to continue in existence.





To
      provide the Company with the ability it believes necessary to continue in
      existence, management is taking steps to close the LPG Asset Sale. Because
      the
      LPG Asset Sale has not closed, management (i) is seeking to expand its Fuel
      Sales Business and to further diversify its operations to reduce dependency
      on
      sales of LPG, (ii) is seeking to maintain the amount of financing for its
      products and operations, and (iii) is seeking to reduce supply costs and
      operating expenses. In the event that the LPG Asset Sale is not closed,
      management may also continue to attempt to sell its LPG and refined products
      assets.


30
 *Table
          of Contents*


**Item
                    2**.
                **Management's
                    Discussion and Analysis of Financial Condition and Results of
                    Operations**





***Penn
      Octane Corporation (“Penn Octane”) and its consolidated subsidiaries which
      includes Rio Vista Energy Partners L.P. (“Rio Vista”) and its subsidiaries are
      collectively hereinafter referred to as the
“Company”.***





*The
      following discussion of the Company's results of operations and liquidity and
      capital resources should be read in conjunction with the unaudited consolidated
      financial statements of the Company and related notes thereto appearing
      elsewhere herein. References to specific years preceded by “fiscal” (e.g. fiscal
      2006) refer to the Company's fiscal year ended December 31.*





**Forward-Looking
      Statements**





*The
      statements contained in this Quarterly Report that are not historical facts
      are
      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. These
      forward-looking statements may be identified by the use of forward-looking
      terms
      such as “believes,” “expects,” “may,” “will”, “should”, “estimates”, “projects”
or “anticipates” or by discussions of strategy that inherently involve risks and
      uncertainties. From time to time, the Company has made or may make
      forward-looking statements, orally or in writing. These forward-looking
      statements include statements regarding anticipated future revenues, sales,
      LPG
      supply, LPG pricing, operations, demand, competition, capital expenditures,
      future acquisitions, additional financing, the deregulation of the LPG market
      in
      Mexico, the operations of the US - Mexico Pipelines, the Matamoros Terminal
      Facility, other upgrades to facilities, foreign ownership of LPG operations,
      short-term obligations and credit arrangements, Fuel Sales Business, LPG Asset
      Sale, the PMI Confirmation, cash distributions, “Qualifying Income”, partnership
      tax treatment, risk factors and other statements regarding matters that are
      not
      historical facts, and involve predictions which are based upon a number of
      future conditions that ultimately may prove to be inaccurate. Actual results,
      performance or achievements could differ materially from the results expressed
      in, or implied by, these forward-looking statements. Factors that may cause
      or
      contribute to such differences include those discussed under “Risk Factors” and
“Management’s Discussion and Analysis of Financial Condition and Results of
      Operations,” as well as those discussed elsewhere in this Report on Form 10-Q.
      We caution you, however, that the risks contained in this report may not include
      all material risks facing the Company.*





**Purchase
      and Sale Agreements**





On
      August
      15, 2005, Penn Octane and Rio Vista each entered into separate purchase and
      sale
      agreements (“PSA’s”) with TransMontaigne Product Services Inc.
      (“TransMontaigne”) which provide for the sale and assignment of all of their
      respective LPG assets and refined products assets (the “LPG Asset Sale”)
      including the Brownsville Terminal Facility and refined products tank farm
      and
      associated leases, owned pipelines located in the United States, including
      land,
      leases, and rights of ways, LPG inventory, 100% of the outstanding stock of
      Mexican subsidiaries and affiliate, which in turn own pipelines and the
      Matamoros Terminal Facility, including land and rights of way, and assignment
      of
      the lease of the Leased Pipeline, PMI sales agreement and Exxon Supply Contract
      (see note K to the unaudited consolidated financial statements). Penn Octane’s
      agreement with TransMontaigne does not include any assets related to the Fuel
      Sales Business. The purchase price is $10.1 million for assets to be sold by
      Penn Octane and $17.4 million for assets to be sold by Rio Vista. The purchase
      price may be reduced as provided for in the PSA’s.





In
      connection with the PSA’s, TransMontaigne loaned Rio Vista $1.3 million (the
“TransMontaigne Note”) which is to be repaid, including interest, as a reduction
      of the total purchase price at the time of closing or 120 days following demand
      by TransMontaigne. The TransMontaigne Note is secured by the tank farm and
      certain LPG storage tanks located at the Brownsville Terminal Facility (the
      “Collateral”). The TransMontaigne Note began to accrue interest on November 15,
      2005 at the prime rate plus 2%. In connection with the TransMontaigne Note,
      RZB
      Finance, LLC (“RZB”) provided a consent and the Brownsville Navigation District
      issued an estoppel letter. Rio Vista used the proceeds from the TransMontaigne
      Note to fund certain expenses associated with the PSA’s and for working capital
      purposes. If the LPG Asset Sale does not occur and Rio Vista does not pay the
      TransMontaigne Note as provided for above, Rio Vista is required to convey
      title
      to the Collateral to TransMontaigne and to lease the Collateral from
      TransMontaigne for $10,000 per month until such time as Rio Vista pays the
      $1.3
      million, in addition to the lease payments, to TransMontaigne. In the event
      of a
      conveyance of the title to the Collateral, no further interest payments will
      be
      required under the TransMontaigne Note. When the $1.3 million is repaid to
      TransMontaigne, if ever, the lease payments will ceases and title to the
      Collateral will be re-conveyed to Rio Vista.


31
 *Table
          of Contents*


The
      closing of the LPG Asset Sale is subject to several conditions, including
      TransMontaigne’s satisfactory completion of its due diligence review, including
      financial, business, environmental and legal, assignment of LPG related
      contracts, and the modification of LPG related permits and the related Mexican
      governmental approvals. Certain of the conditions to closing were not met by
      October 31, 2005. The PSA’s provide that any party may terminate the agreements
      if closing did not occur on or before October 31, 2005. None of the parties
      have
      elected to terminate the agreements and the parties continue to work towards
      the
      closing of the LPG Asset Sale.





There
      can
      be no assurance that the LPG Asset Sale will be completed according to the
      terms
      contained in the PSA’s or according to different terms or at all. Even if the
      LPG Asset Sale is completed, Rio Vista may be unable to resume payment of
      minimum quarterly distributions or to pay the arrearages of such distributions,
      in order to maintain cash reserves necessary for the conduct of business. A
      continued delay of or inability to close the LPG Asset Sale could have a
      material adverse effect on Penn Octane’s and Rio Vista’s business, financial
      condition and results of operations.





In
      connection with the LPG Asset Sale, Penn Octane filed a definitive proxy
      statement with the Securities Exchange Commission (the “SEC”) on September 27,
      2005 pursuant to the requirement to obtain approval for the LPG Asset Sale
      from
      Penn Octane’s stockholders. On October 26, 2005, Penn Octane held a special
      meeting of stockholders at which the stockholders approved the LPG Asset Sale.





In
      connection with the LPG Asset Sale, Rio Vista filed a definitive proxy statement
      with the SEC on September 27, 2005 pursuant to the requirement to obtain
      approval for the LPG Asset Sale from Rio Vista’s unitholders. In addition, in
      order to permit Rio Vista’s continued existence following the LPG Asset Sale,
      Rio Vista’s proxy statement contained a proposal to amend a provision in its
      partnership agreement to remove the requirement to dissolve upon a sale of
      all
      or substantially all of its assets. On October 26, 2005, Rio Vista held a
      special meeting of unitholders at which the unitholders approved the LPG Asset
      Sale and the amendment to its partnership agreement.





If
      the
      LPG Asset Sale is completed, Penn Octane intends to use a portion of its
      proceeds to pay off the Restructured Notes and $280,000 Notes (collectively
      the
“Notes”) plus accrued interest. In addition, Penn Octane estimates that it may
      have a federal tax liability in connection with the sale of its assets. The
      remaining proceeds will be available to Penn Octane to fund working capital
      requirements and to pursue transactions intended to enhance stockholder value.
      Penn Octane intends to continue to operate its Fuel Sales Business.





If
      the
      LPG Asset Sale is completed, Rio Vista intends to use the proceeds to fund
      working capital requirements and to pursue transactions intended to enhance
      unitholder value.


32
 *Table
          of Contents*


*The
      following discussion of the Company's results of operations and liquidity and
      capital resources should be read in conjunction with the unaudited consolidated
      financial statements of the Company and related notes thereto appearing
      elsewhere herein.*





**Overview**





The
      Company has been principally engaged in the purchase, transportation and sale
      of
      LPG for distribution into northeast Mexico and the sale of Fuel Products. To
      the
      extent that Penn Octane purchases quantities of LPG under its supply contracts
      in excess of LPG sold to PMI, the Company sells the excess LPG to U.S. and
      other
      customers.





During
      the three months ended March 31, 2006, the Company derived 56.6% of its total
      revenues and 100% of LPG revenues from sales of LPG to PMI, its primary
      customer.





The
      Company provides LPG products and services through a combination of fixed-margin
      and fixed-price LPG contracts. Costs included in cost of goods sold, other
      than
      the purchase price of LPG, may affect actual profits from sales, including
      costs
      relating to transportation, storage, leases and maintenance. Mismatches in
      volumes of LPG purchased from suppliers and volumes sold to PMI or others could
      result in gains during periods of rising LPG prices or losses during periods
      of
      declining LPG prices as a result of holding inventories or disposing of excess
      inventories.





During
      June 2004, the Company began the Fuel Sales Business with the ability to access
      certain pipeline and terminal systems located in California, Arizona, Nevada
      and
      Texas. Fuel Sales approximated $30.1 million for the three months ended March
      31, 2006 which represents approximately 43.4% of total revenues.





On
      September 30, 2004, Penn Octane completed a series of transactions involving
      (i)
      the transfer of substantially all of its owned pipeline and terminal assets
      in
      Brownsville and Matamoros to RVOP (ii) transferred Penn Octane’s 99.9% interest
      in RVOP to Rio Vista and (iii) the Spin-Off, resulting in Rio Vista becoming
      a
      separate public company. The Common Units represented 98% of Rio Vista’s
      outstanding partnership interests. The remaining 2% interest, which is the
      general partner interest, is owned and controlled by the General Partner. The
      General Partner is responsible for the management of Rio Vista. Accordingly
      the
      Company has control of Rio Vista by virtue of its ownership and related voting
      control of the General Partner. Therefore, Rio Vista is consolidated with the
      Company and the interests of the limited partners are classified as minority
      interests in the Company’s unaudited consolidated financial statements. Subsequent
      to the Spin-Off, Rio Vista sells LPG directly to PMI and purchases LPG from
      Penn
      Octane under a long-term supply agreement. The purchase price of the LPG from
      Penn Octane is determined based on the cost of LPG under Penn Octane’s LPG
      supply agreements with its suppliers, other direct costs related to PMI sales
      and a formula that takes into consideration operating costs of Penn Octane
      and
      Rio Vista.





Penn Octane
      continues to sell LPG to PMI through its supply contract with Rio Vista, and
      it
      shifted certain costs of operations related to the Brownsville and Matamoros
      terminals and pipelines, and certain administrative costs to Rio Vista. In
      addition, it continues to manage Rio Vista through the General Partner and
      to
      explore opportunities to acquire and grow other lines of business such as the
      Fuel Sales Business described below.


33
 *Table
          of Contents*


**LPG
      Sales**





The
      following table shows the Company's volume sold in gallons and average sales
      price for LPG for the three months ended March 31, 2005 and 2006;





Three
                months ended March 31,2005
            
            Three
                months ended March 31,2006Volume
                SoldLPG
                (millions of gallons) - PMI
            
            
            32.3
            
            
            38.3LPG
                (millions of gallons) - Other
            
            
            3.6
            
            
            -35.9
            
            
            38.3Average
                sales priceLPG
                (per gallon) - PMI
            
            $
            0.88
            
            $
            1.02LPG
                (per gallon) - Other
            
            
            0.72
            
            
            -




***Recent
      Trends.*** Since
      April 2004, PMI has contracted with the Company for volumes which were
      significantly lower than amounts purchased by PMI in similar periods during
      previous years, and beginning in April 2005 margins have been significantly
      lower than historical levels. See Liquidity and Capital Resources - Sales to
      PMI
      below. The Company believes that the reduction of volume commitments and margins
      for April 2004 through March 2006 is based on additional LPG production by
      PEMEX
      being generated from the Burgos Basin field in Reynosa, Mexico, an area within
      the proximity of the Company’s Matamoros Terminal Facility and increased
      competition from U.S. suppliers (see below). Although the Company is not aware
      of the total amount of LPG actually being produced by PEMEX from the Burgos
      Basin, it is aware that PEMEX has constructed and is operating two new cryogenic
      facilities at the Burgos Basin which it believes may have a capacity of
      producing up to 12 million gallons of LPG per month. The Company also believes
      that PEMEX intends to install two additional cryogenic facilities, with similar
      capacity, to be operational in 2006. The Company is also not aware of the
      capacity at which the current cryogenic facilities are being operated.
      Furthermore, the Company is not aware of the actual gas reserves of the Burgos
      Basin or the gas quality, each of which could significantly impact LPG
      production amounts.





During
      June 2004, Valero L.P. (“Valero”) began operation of a newly constructed LPG
      terminal facility in Nuevo Laredo, Mexico and a newly constructed pipeline
      connecting the terminal facility in Nuevo Laredo, Mexico to existing pipelines
      in Juarez, Texas which connect directly to Valero Energy Corporation’s Corpus
      Christi, Texas and Three Rivers, Texas refineries. Valero originally contracted
      with PMI under a five year agreement to deliver approximately 6.3 million
      gallons (of which 3.2 million gallons were previously delivered by truck from
      Three Rivers, Texas) of LPG per month. During July 2005, Valero announced that
      it had entered into a new agreement with PMI which provides for double the
      amount of LPG previously contracted for with PMI.





During
      2004, a pipeline operated by El Paso Energy between Corpus Christi, Texas and
      Hidalgo County, Texas was closed. Historically these facilities had supplied
      approximately 5.0 million gallons of LPG per month to the Company’s strategic
      zone. The Company is not aware of any future plans for these facilities.





During
      2003, PMI constructed and began operations of a refined products cross border
      pipeline connecting a pipeline running from PEMEX’s Cadereyta Refinery in
      Monterrey, Mexico to terminal facilities operated by TransMontaigne, Inc. in
      Brownsville, Texas. The pipeline crosses the US-Mexico border near the proximity
      of the Company’s pipelines. In connection with the construction of the pipeline,
      PMI utilizes an easement from the Company for an approximate 21.67 acre portion
      of the pipeline. Under the terms of the easement, PMI has agreed that it will
      not transport LPG through October 15, 2017.


34
 *Table
          of Contents*


**Fuel
      Sales Business**





The
      following table shows the Company's volume sold and delivered in gallons and
      average sales price for Fuel Products for the three months ended March 31,
      2005
      and 2006;




Three
                    months ended March 31,2005
                
                Three
                    months ended March 31,2006Volume
                    SoldFuel
                    Products (millions of gallons)
                
                
                18.8
                
                
                15.2Average
                    sales priceFuel
                    Products (per gallon)
                
                $
                1.53
                
                $
                1.98





**Results
      of Operations**





The
      following summarizes the gross profit among the Company’s LPG and Fuel Sales
      Business for the three months ended March 31, 2005 and 2006. All amounts are
      in
      thousands.


For
                    the three months ended March 31, 2005LPG
                
                Fuel
                    Sales
                
                TotalRevenues
                
                $
                30,970
                
                $
                28,757
                
                $
                59,727Cost
                    of goods sold
                
                
                29,381
                
                
                27,957
                
                
                57,338Gross
                    profit (loss)
                
                $
                1,589
                
                $
                800
                
                $
                2,389
 
 For
                    the three months ended March 31, 2006LPG
                
                Fuel
                    Sales
                
                TotalRevenues
                
                $
                39,237
                
                $
                30,091
                
                $
                69,328Cost
                    of goods sold
                
                
                38,495
                
                
                29,565
                
                
                68,060Gross
                    profit
                
                $
                742
                
                $
                526
                
                $
                1,268


***Three
      Months Ended March 31, 2006 Compared With Three Months Ended March 31,
      2005***





*Revenues.* Revenues
      for the three months ended March 31, 2006, were $69.3 million compared with
      $59.7 million for the three months ended March 31, 2005, an increase of $9.6
      million or 16.1%. Of this increase, $4.7 million was attributable to increases
      in average sales prices of LPG sold to PMI during the three months ended March
      31, 2006, $6.1 million was attributable to increased volumes of LPG sold to
      PMI
      during the three months ended March 31, 2006, and $8.4 million was attributable
      to increases in average sales prices of Fuel Products sold during the three
      months ended March 31, 2006, partially offset by $2.6 million attributable
      to
      decreased volumes of LPG sold to customers other than PMI during the three
      months ended March 31, 2006 and $7.1 million attributable to decreased volumes
      of Fuel Products sold during the three months ended March 31,
      2006.


35
 *Table
          of Contents*


*Cost
      of goods sold.* Cost of
      goods sold for the three months ended March 31, 2006 was $68.1 million compared
      with $57.3 million for the three months ended March 31, 2005, an increase of
      $10.7 million or 18.7%. Of this increase, $5.7 million was attributable to
      increases in the average costs of LPG sold to PMI during the three months ended
      March 31, 2006, $5.8 million was attributable to increased volumes of LPG sold
      to PMI during the three months ended March 31, 2006, $8.5 million was
      attributable to increases in average costs of Fuel Products sold during the
      three months ended March 31, 2006, and $0.3 million was attributable to
      increases in other direct costs associated with the LPG and Fuel Sales Business
      during the three months ended March 31, 2006, partially offset by $6.9 million

      attributable to decreased volumes of Fuel Products sold during the three months
      ended March 31, 2006 and $2.6 million attributable to decrease volumes of LPG
      sold to customers other than PMI during the three months ended March 31,
      2006.





*Selling,
      general and administrative expenses.* Selling,
      general and administrative expenses were $1.4 million for the three months
      ended
      March 31, 2006, compared with $1.6 million for the three months ended March
      31,
      2005. The decrease was principally attributable to reduced professional fees
      and
      payroll related costs during the three months ended March 31, 2006.





*Other
      income (expense).* Other
      expense was $(0.1) million for the three months ended March 31, 2006, compared
      with other expense of $(0.6) million for the three months ended March 31, 2005.
      The decrease in other expense was due primarily to an increase in the minority
      interest in the losses of Rio Vista of $0.4 million during the three months
      ended March 31, 2006.





**Liquidity
      and Capital Resources**





*General.* The
      Company has a loss from operations for the three months ended March 31, 2006,
      has had an accumulated deficit since its inception and has a deficit in working
      capital. In addition, substantially all of the Company’s assets are pledged or
      committed to be pledged as collateral on existing debt in connection with the
      Notes, the RZB Credit Facility and/or the TransMontaigne Note, and therefore,
      the Company may be unable to obtain additional financing collateralized by
      those
      assets. The Notes were due December 15, 2005 and notes totaling $720,000 were
      paid in December 2005 and February 2006. Notes totaling $1.1 million are still
      outstanding and have not been extended. The LPG Asset Sale has not closed and
      the TransMontaigne Note may be due on the earlier of the time of closing or
      120
      days following demand by TransMontaigne (see note D to the unaudited
      consolidated financial statements). The RZB Credit Facility is an uncommitted
      facility which is authorized every ninety days and is reviewed annually at
      March
      31. The Company may need to increase its credit facility for increases in
      quantities of LPG and Fuel Products purchased and/or to finance future price
      increases of LPG and Fuel Products. The Company depends heavily on sales to
      one
      major customer, PMI. The Company's sources of liquidity and capital resources
      historically have been provided by sales of LPG and Fuel Products, proceeds
      from
      the issuance of short-term and long-term debt, revolving credit facilities
      and
      credit arrangements, sale or issuance of preferred and common stock of the
      Company and proceeds from the exercise of warrants to purchase shares of the
      Company's common stock.


36
 *Table
          of Contents*


The
      minimum volumes and applicable margins contained in the PMI Confirmation are
      expected to provide the Company with gross profit similar to the gross profit
      the Company would have received if PMI had purchased only the minimum volumes
      provided under its agreements with Rio Vista during the period from May 1,
      2005 to March 31, 2006 as a result of increased margins on lower volume
      levels contained in the PMI Confirmation. Actual volumes purchased by PMI under
      those prior agreements, however, exceeded minimum contractual amounts by
      approximately 35%. There is no assurance that PMI will purchase volumes as
      indicated in the PMI Confirmation or that PMI will continue to purchase LPG
      from
      Rio Vista or in quantities or prices that are profitable upon the expiration
      of
      the PMI Confirmation. Assuming that the LPG Asset Sale does not close, the
      Company projects that its gross profit from operations based on the minimum
      volumes and applicable margins contained in the PMI Confirmation will not
      provide sufficient cash flow to pay its normal operating expenses through
      March 31, 2007, assuming breakeven results from its Fuel Sales Business,
      unless it can sufficiently reduce its operating expenses. In addition, the
      Company’s cash flow at the minimum volumes contained in the PMI Confirmation is
      projected not to be sufficient to pay its other obligations, including its
      secured debt. The Fuel Sales Business is a relatively new business and, as
      a
      result, the Company does not believe it can rely on that portion of its business
      to provide sufficient additional cash flow.




Also,
      Penn Octane and Rio Vista project that monthly cash flows from LPG sales during
      the months of May 2006 through September 2006 will be less than during the
      months of October 2006 through March 2007 as a result of reduced monthly volumes
      committed to be purchased during May 2006 through September 2006. In
      addition, the Company may be unable to make any necessary capital expenditures
      or to pay arrearages in distributions or to pay future distributions to its
      unitholders during the Term of the PMI Confirmation.




In
      the
      event Penn Octane does not pay its obligations when due, Rio Vista’s guarantees
      to Penn Octane and Penn Octane’s creditors may be triggered. Accordingly, Rio
      Vista may be required to pay such obligations of Penn Octane to avoid
      foreclosure against Rio Vista’s assets by Penn Octane’s creditors. Assuming that
      the LPG Asset Sale does not close, Rio Vista projects that its gross profit
      from
      operations under the PMI Confirmation, based on the minimum volumes and
      applicable margins, will not provide sufficient cash flow for Rio Vista to
      pay
      its normal operating expenses through March 31, 2007 unless it can
      sufficiently reduce its operating expenses. If the Company’s revenues and other
      sources of liquidity are not adequate to pay its obligations, Penn Octane or
      Rio
      Vista may be required to raise additional funds to avoid such foreclosure.
      There
      can be no assurance that such additional funding will be available on terms
      attractive to either Penn Octane or Rio Vista or available at all.




Although
      Rio Vista is not required to do so, if Penn Octane is unable to pay its
      obligations when they become due, Rio Vista may lend the necessary funds to
      Penn
      Octane. Conversely, if Rio Vista does not have the funds necessary to pay its
      obligations and to make its distributions, to the extent that Penn Octane has
      sufficient cash to do so, it may (but is not required to) lend such amounts
      to
      Rio Vista.





If
      Penn
      Octane and/or Rio Vista are required to raise additional funds, management
      does
      not believe that either company would be able to obtain such financing from
      traditional commercial lenders. Rather, they may have to conduct sales of assets
      or sales of equity and/or debt securities through public or private financings,
      collaborative relationships or other arrangements. There
      can be no assurance that such additional funding will be available on terms
      attractive to either Penn Octane or Rio Vista or that such funding will be
      available in the required timeframe, if available at all. If additional
      financing is obtained through the sale of securities of Penn Octane, substantial
      and immediate dilution to existing Penn Octane common stockholders may occur. If
      additional amounts cannot be raised and the Company is unable to restructure
      its
      obligations, the Company would suffer material adverse consequences to its
      business, financial condition and results of operations. In such event, Penn
      Octane and/or Rio Vista would likely be required to seek other alternatives
      which could include the sale of assets, closure of operations and/or protection
      under U.S. bankruptcy laws .





Further,
      if Penn Octane is determined to have a federal income tax liability in excess
      of
      the amounts which were included in the federal income tax return related to
      the
      Spin-Off and if Penn Octane is unable to pay such liabilities or Rio Vista
      is
      unable to pay, then the Internal Revenue Service may assert that the Penn Octane
      stockholders who received Rio Vista’s common units in the Spin-Off are liable
      for unpaid federal income taxes of Penn Octane, including interest and any
      penalties, up to the value of the Rio Vista common units received by each
      stockholder.


37
 *Table
          of Contents*





The
      following summary table reflects comparative cash flows for the three months
      ended March 31, 2005 and 2006. All information is in thousands.




Three
                  months ended March 31,2005
              
              Three
                  months ended March 31,2006Net
                  cash (used in) operating activities
              
              $
              (4,950
              )
              $
              (5,847
              )Net
                  cash (used in) investing activities
              
              
              (8
              )
              
              (7
              )Net
                  cash provided by financing activities
              
              
              4,724
              
              
              5,819Net
                  (decrease) in cash
              
              $
              (234
              )
              $
              (35
              )




*Sales
      to PMI* .
      PMI and
      the Company operated under a three month contract for the period from January
      1,
      2005 to March 31, 2005 and monthly contracts for April 2005 and May of 2005.
      Effective June 4, 2005, the Company entered into an agreement with PMI for
      the
      period June 4, 2005 through March 31, 2006 for the sale of LPG to PMI (the
“PMI
      Agreement”). The following table sets forth the minimum monthly volume of LPG
      that PMI committed to purchase from the Company pursuant to the PMI Agreement
      and the actual volumes purchased for the months January 2006 through March
      2006.




Month
              
              Minimum
                  Contract Volumes
              
              Actual
                  Volumes Sold(gallons)
              
              (gallons)January
                  2006
              
              
              11,700,000
              
              
              14,757,646February
                  2006
              
              
              11,700,000
              
              
              11,940,257March
                  2006
              
              
              8,100,000
              
              
              11,606,435




On
      March
      31, 2006, the PMI Agreement expired. During the month of April 2006, the Company
      sold LPG to PMI under a monthly contract which provided for volumes of
      approximately 6.0 million gallons at prices similar to the PMI Agreement. During
      April 2006, PMI purchased approximately 6.0 million gallons.




38
 *Table
          of Contents*




On
      April
      28, 2006, the Company received electronic confirmation (the “PMI Confirmation”)
      from PMI of the terms of a new purchase and sale agreement for LPG for the
      period May 1, 2006 through March 31, 2007 (the “Term”). The PMI
      Confirmation remains subject to execution of a definitive written agreement
      between Rio Vista and PMI. The PMI Confirmation provides that PMI does not
      have
      a financial obligation with respect to any shortfalls if volumes actually
      purchased are less than minimum volumes contained in the PMI Confirmation.




The
      minimum volumes and applicable margins contained in the PMI Confirmation are
      expected to provide the Company with gross profit similar to the gross profit
      the Company would have received if PMI had purchased only the minimum volumes
      provided under its agreements with Rio Vista during the period from May 1,
      2005 to March 31, 2006 as a result of increased margins on lower volume
      levels contained in the PMI Confirmation. The following table sets forth the
      minimum monthly volume of LPG contained in the PMI Confirmation.




Month
              
              Minimum
                  Volume(gallons)May
                  2006
              
              4,500,000June
                  2006
              
              4,500,000July
                  2006
              
              4,500,000August
                  2006
              
              4,500,000September
                  2006
              
              4,500,000October
                  2006
              
              8,100,000November
                  2006
              
              8,100,000December
                  2006
              
              9,000,000January
                  2007
              
              9,000,000February
                  2007
              
              8,100,000March
                  2007
              
              8,100,000




All
      of Penn
      Octane’s and Rio Vista's assets are pledged as collateral for existing debt of
      Penn Octane. If the cash flow of Penn Octane or Rio Vista is not adequate to
      pay
      their obligations, Penn Octane or Rio Vista may be required to raise additional
      funds to avoid foreclosure by Penn Octane’s creditors. There can be no assurance
      that such additional funding will be available on terms attractive to either
      Penn Octane or Rio Vista or available at all. Because Penn Octane’s and Rio
      Vista’s assets are pledged to Penn Octane’s creditors, Penn Octane and Rio Vista
      may be unable to obtain additional financing collateralized by its assets.
      If
      additional amounts cannot be raised and cash flow is inadequate, Penn Octane
      and/or Rio Vista would likely be required to seek alternatives as more fully
      described in reports on Form 10-K, Form 10-Q and Form 8-K of Penn
      Octane and Rio Vista as filed with the U.S. Securities and Exchange
      Commission.





PMI
      has
      primarily used the Matamoros Terminal Facility to load LPG purchased from the
      Company for distribution by truck in Mexico. The Company continues to use the
      Brownsville Terminal Facility in connection with LPG delivered by railcar to
      other customers, storage and as an alternative terminal in the event the
      Matamoros Terminal Facility cannot be used.





Revenues
      from PMI totaled approximately $39.2 million for the three months ended March
      31, 2006, representing approximately 56.6% of total revenues for the period.


39
 *Table
          of Contents*


*LPG
      Supply Agreements* .
      Effective October 1, 1999, the Company and Exxon entered into a ten year LPG
      supply contract, as amended (the “Exxon Supply Contract”), whereby Exxon has
      agreed to supply and the Company has agreed to take, 100% of Exxon’s owned or
      controlled volume of propane and butane available at Exxon’s King Ranch Gas
      Plant (the “Plant”) up to 13,900,000 gallons per month blended in accordance
      with required specifications (the “Plant Commitment”). For the three months
      ended March 31, 2006, under the Exxon Supply Contract, Exxon has supplied an
      average of approximately 9.4 million gallons of LPG per month. The purchase
      price is indexed to variable posted prices.





Effective
      March 1, 2006, the Exxon Supply Contract was amended to extend through September
      30, 2010.





In
      addition to the LPG costs charged by its suppliers, the Company also incurs
      additional costs to deliver LPG to the Company’s facilities. Furthermore, the
      Company may incur significant additional costs associated with the storage,
      disposal and/or changes in LPG prices resulting from the excess of LPG purchased
      under the Exxon Supply Contract over actual sales volumes to PMI. Under the
      terms of the Exxon Supply Contract, the Company must provide letters of credit
      in amounts equal to the cost of the product to be purchased. In addition, the
      cost of the product purchased is tied directly to overall market conditions.
      As
      a result, the Company’s existing letter of credit facility may not be adequate
      to meet the letter of credit requirements if there are increases in quantities
      of LPG purchased and/or to finance future price increases of LPG.





In
      order
      to meet future sales volumes in excess of LPG provided under the Exxon Supply
      Contract, the Company will enter into monthly arrangements with other LPG
      suppliers. The costs of such LPG supplies may vary but are expected to be less
      than amounts received under the PMI Agreement.







*Fuel
      Sales Business.* The
      Company sells Fuel Products through transactional, bulk and/or rack
      transactions. Typical transactional and bulk sales are made based on a
      predetermined net spread between the purchase and sales price over posted
      monthly variable prices and/or daily spot prices. Rack sales transactions are
      based on variable sale prices charged by the Company which are tied to posted
      daily spot prices and purchase costs which are based on a monthly average or
      3
      day average based on posted prices. The Company pays pipeline and terminal
      fees
      based on regulated rates.





The
      Fuel
      Products market on the west coast of the United States is characterized by
      limited pipeline and terminal space to move sufficient Fuel Products to
      locations where demand for Fuel Products exists. The Company has the ability
      to
      access to certain pipeline and terminal systems located in California, Arizona,
      Nevada and Texas, where it is able to deliver its Fuel Products. The markets
      where the Company has targeted its products are generally in areas where the
      Fuel Products are difficult to deliver due to the infrastructure limitations
      and
      accordingly, the Company’s access may provide an advantage over other potential
      competitors who may not have access to these pipelines or terminals. In
      addition, the Company’s supply contracts provide it with greater flexibility to
      manage changes in the prices of the Fuel Products. The Company believes it
      has
      an advantage over other competitors based on its favorable supply contracts
      and
      existing access to certain pipelines and terminals.





For
      bulk
      and transactional sales, the Company enters into individual sales contracts
      for
      each sale. Fuel Products sales are subject to credit limitations imposed on
      each
      individual buyer by the Company. The Company has several supply contracts for
      each of the Fuel Products it sells. The supply contracts are for annual periods
      with flexible volumes but they may be terminated sooner by the supplier if
      the
      Company consistently fails to purchase minimum volumes of Fuel Products. Fuel
      sales approximated 43.4% of total revenues for the three months ended March
      31,
      2006.





Fuel
      Sales revenues totaled $30.1 million and cost of fuel and other direct operating
      expenses totaled $29.6 million during the three months ended March 31, 2006.
      Future success of the Fuel Sales Business is dependent on the demand for Fuel
      Products in the Company’s markets and the Company’s ability to manage
      fluctuations in the price of such products.





The
      ability of the Company to participate in the Fuel Sales Business is largely
      dependent on the Company’s ability to finance its supplies. Currently, the
      Company utilizes the RZB Credit Facility to finance the purchases of Fuel
      Products. Based on the Company’s commitments under the Exxon Supply Contract,
      increases in the costs of LPG and/or the increases in the costs of Fuel Products
      may reduce the amount of financing available for the Fuel Sales
      Business.


40
 *Table
          of Contents*


Federal
      and State agencies require the Company to obtain the necessary regulatory and
      other approvals for its Fuel Sales Business.





*Credit
      Arrangements* .
      As of
      March 31, 2006, Penn Octane had a $20.0 million credit facility with RZB
      Finance, LLC (“RZB”) for demand loans and standby letters of credit (the “RZB
      Credit Facility”) to finance Penn Octane’s purchases of LPG and Fuel Products.
      The RZB Credit Facility includes a $3.0 million limit for purchase of Fuel
      Products inventory for a maximum of 30 days. The RZB Credit facility is an
      uncommitted facility under which the letters of credit have an expiration date
      of no more than 90 days and the facility is reviewed annually at March 31.
      In
      connection with the RZB Credit Facility, the Company granted RZB a security
      interest and assignment in any and all of the Company's accounts, inventory,
      real property, buildings, pipelines, fixtures and interests therein or relating
      thereto, including, without limitation, the lease with the Brownsville
      Navigation District of Cameron County for the land on which the Company’s
      Brownsville Terminal Facility is located, the Pipeline Lease, and in connection
      therewith entered into leasehold deeds of trust, security agreements, financing
      statements and assignments of rent. Under the RZB Credit Facility, the Company
      may not permit to exist any subsequent lien, security interest, mortgage, charge
      or other encumbrance of any nature on any of its properties or assets, except
      in
      favor of RZB, without the consent of RZB. After the Spin-Off and transfer of
      assets to Rio Vista, RZB continued to retain a security interest in the
      transferred assets.





Under
      the
      RZB Credit Facility, the Company pays a fee with respect to each letter of
      credit thereunder in an amount equal to the greater of (i) $500, (ii) 2.5%
      of
      the maximum face amount of such letter of credit for LPG and 2% for Fuel
      Products, or (iii) such higher amount as may be agreed to between the Company
      and RZB. Any loan amounts outstanding under the RZB Credit Facility accrue
      interest at a rate equal to the rate announced by the JPMorgan Chase Bank as
      its
      prime rate (7.75% at March 31, 2006) plus 2.5%. Pursuant to the RZB Credit
      Facility, RZB has sole and absolute discretion to limit or terminate its
      participation in the RZB Credit Facility and to refrain from making any loans
      or
      issuing any letters of credit thereunder. RZB also has the right to demand
      payment of any and all amounts outstanding under the RZB Credit Facility at
      any
      time. In addition to the fees described above, the Company is required to pay
      RZB annual fees of $50,000.





Based
      on
      current minimum purchase commitments under the Company’s LPG supply agreement
      and current LPG prices, the amount available to finance Fuel Products and LPG
      purchases in excess of current minimum purchase commitments is limited and
      therefore the ability of the Company to grow the Fuel Sales Business is
      dependent on future increases in its RZB Credit Facility or other sources of
      financing, the reduction of LPG supply commitments and/or the reduction in
      LPG
      or Fuel Products prices.





Under
      the
      terms of the RZB Credit Facility, either Penn Octane or Rio Vista is required
      to
      maintain net worth of a minimum of $10.0 million.





In
      connection with the Company’s purchases of LPG and Fuel Products, letters of
      credit are issued based on anticipated purchases. Outstanding letters of credit
      for purchases of LPG and Fuel Products at March 31, 2006 totaled approximately
      $11.2 million of which approximately $9.4 million represents March 2006
      purchases and approximately $1.8 million represents April 2006
      purchases.





In
      connection with the Company’s purchase of LPG and Fuel Products, under the RZB
      Credit Facility, assets related to product sales (the “Assets”) are required to
      be in excess of borrowings and commitments (including restricted cash of
      approximately $3.0 million at March 31, 2006). At March 31, 2006, the Company’s
      borrowings and commitments were less than the amount of the Assets.





In
      connection with the Company’s Fuel Sales Business, the Company has issued bonds
      totaling $662,000 to the states of California, Nevada, Arizona and Texas (the
      “Bonds”) to secure payments of excise and other taxes collected from customers
      in connection with sales of Fuel Products. The Bonds are partially secured
      by
      letters of credit totaling $452,600. At March 31, 2006, such taxes in the amount
      of approximately $960,000 were due. The letters of credit issued have all been
      secured by cash in the amount of approximately $467,000 which is included in
      restricted cash in the Company’s balance sheet at March 31, 2006.


41
 *Table
          of Contents*


LPG
      and
      Fuel Products financing expense associated with the RZB Credit Facility totaled
      $203,301 and $239,768 for the three months ended March 31, 2005 and 2006,
      respectively.





If
      the
      LPG Asset Sale is completed, the Company expects that the RZB Credit Facility
      will be restructured and/or reduced.





The
      following is a summary of the Company’s estimated minimum contractual
      obligations and commercial obligations as of March 31, 2006. Where applicable,
      LPG prices are based on the March 31, 2006 monthly average as published by
      Oil
      Price Information Service.


**Payments
                  due by Period****(Amounts
                  in Millions)**Contractual
                  Obligations
              
              Total
              
              Less
                  than1
                  Year
              
              1
                  -
                  3Years
              
              4
                  -
                  5Years
              
              After5
                  YearsLong-Term
                  Debt Obligations and Note Payable
              
              $
              2.6
              
              $
              2.6
              
              $
              -
              
              $
              -
              
              $
              -Operating
                  Leases
              
              
              7.7
              
              
              1.1
              
              
              2.0
              
              
              1.9
              
              
              2.7LPG
                  Purchase Obligations
              
              
              541.0
              
              
              144.2
              
              
              288.5
              
              
              108.3
              
              
              -Other
                  Long-Term Obligations
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Total
                  Contractual Cash Obligations
              
              $
              551.3
              
              $
              147.9
              
              $
              290.5
              
              $
              110.2
              
              $
              2.7
 
 **Amount
                  of Commitment Expiration Per Period****(Amounts
                  in Millions)**Commercial
                  Commitments
              
              Total
                  Amounts
                Committed
              
              Less
                  than1
                  Year
              
              1
                  -
                  3Years
              
              4
                  -
                  5Years
              
              Over5
                  YearsLines
                  of Credit
              
              $
              4.7
              
              $
              4.7
              
              $
              -
              
              $
              -
              
              $
              -Standby
                  Letters of Credit
              
              
              11.2
              
              
              11.2
              
              
              -
              
              
              -
              
              
              -Guarantees
              
              
              N/A
              
              
              N/A
              
              
              N/A
              
              
              N/A
              
              
              N/AStandby
                  Repurchase Obligations
              
              
              N/A
              
              
              N/A
              
              
              N/A
              
              
              N/A
              
              
              N/AOther
                  Commercial Commitments
              
              
              N/A
              
              
              N/A
              
              
              N/A
              
              
              N/A
              
              
              N/ATotal
                  Commercial Commitments
              
              $
              15.9
              
              $
              15.9
              
              $
              -
              
              $
              -
              
              $
              -




*Distributions
      of Available Cash.* All
      Rio
      Vista unitholders have the right to receive distributions from Rio Vista of
      “available cash” as defined in the Rio Vista partnership agreement in an amount
      equal at least to the minimum distribution of $0.25 per quarter per unit, plus
      any arrearages in the payment of the minimum quarterly distribution on the
      units
      from prior quarters. The General Partner has a right to receive a distribution
      corresponding to its 2% general partner interest and the incentive distribution
      rights described below. The distributions are to be paid 45 days after the
      end
      of each calendar quarter. However, Rio Vista is prohibited from making any
      distributions to unitholders if it would cause an event of default, or an event
      of default exists, under **** any
      obligation of Penn Octane which Rio Vista has guaranteed.


42
 *Table
          of Contents*


In
      addition to its 2% general partner interest, the General Partner is currently
      the holder of incentive distribution rights which entitle the holder to an
      increasing portion of cash distributions as described in the partnership
      agreement. As a result, cash distributions from Rio Vista are shared by the
      holders of Rio Vista common units and the General Partner interest based on
      a
      formula whereby the General Partner receives disproportionately more
      distributions per percentage interest than the holders of the common units
      as
      annual cash distributions exceed certain milestones.





On
      both
      February 14, 2005 and May 13, 2005, Rio Vista made cash distributions of
      $487,000 for the quarters ended December 31, 2004 and March 31, 2005. Because
      of
      insufficient available cash, Rio Vista has not declared any other distributions
      since May 2005.





Rio
      Vista’s ability to make distributions will continue to be adversely impacted if
      sales to PMI are not at sufficient volumes and margins, payments are required
      on
      its guarantees, expenses increase, Rio Vista is unable to obtain additional
      financing on its pledged assets or the LPG Asset Sale does not close. Although
      Penn Octane is not required to do so, to the extent that Penn Octane has
      sufficient cash to do so, it may lend amounts to Rio Vista to meet the minimum
      distributions. If Rio Vista’s revenues and other sources of liquidity after its
      quarterly distributions are not adequate to satisfy such payment obligations
      of
      Penn Octane and/or Penn Octane does not have the necessary cash to loan to
      Rio
      Vista, Rio Vista may be unable to resume the quarterly distributions to
      unitholders or pay any arrearages, and Penn Octane and/or Rio Vista may be
      required to raise additional funds to avoid foreclosure against their assets.
      However, there can be no assurance that such additional funding will be
      available on terms attractive to either Penn Octane or Rio Vista or available
      at
      all.





There
      can
      be no assurance that the LPG Asset Sale will be completed according to the
      terms
      contained in the PSA’s or according to different terms or at all. Even if the
      LPG Asset Sale is completed, Rio Vista may be unable to resume payment of
      minimum quarterly distributions or to pay the arrearages of such distributions,
      in order to maintain cash reserves necessary for the conduct of business. A
      continued delay of or inability to close the LPG Asset Sale could have a
      material adverse effect on Penn Octane’s and Rio Vista’s business, financial
      condition and results of operations.





The
      following is a reconciliation of Rio Vista’s consolidated net income to
      distributable cash flow for the three months ended March 31, 2005 and March
      31,
      2006.





Three
                Months EndedMarch
                31,2005
            
            March
                31,2006Net
                income (loss)
            
            $
            172,000
            
            $
            (251,000
            )Plus
                interest and LPG financing expense and taxes, net
            
            
            119,000
            
            
            145,000Plus
                depreciation and amortization
            
            
            205,000
            
            
            200,000Earnings
                before interest, taxes, depreciation and amortization
                (“EBITDA”)
            
            
            496,000
            
            
            94,000Plus
                other non-cash expenses
            
            
            -
            
            
            8,000Less
                cash interest, LPG financing expense and taxes, net
            
            
            (61,000
            )
            
            (122,000
            )Distributable
                cash flow (deficit)
            
            
            435,000
            
            
            (20,000
            )Distributable
                cash flow (deficit) applicable to general partner
            
            
            (9,000
            )
            
            -Distributable
                cash flow (deficit) applicable to limited partners
            
            $
            426,000
            
            $
            (20,000
            )




43
 *Table
          of Contents*


Rio
      Vista
      utilizes two financial measures, EBITDA and distributable cash flow, which
      are
      not defined in GAAP. Management uses these financial measures because they
      are
      widely accepted financial indicators used by investors to compare partnership
      performance. In addition, management believes that these measures provide
      investors an enhanced perspective of the operating performance of Rio Vista’s
      assets and the cash flow the business is generating. Neither EBITDA nor
      distributable cash flow are intended to represent cash flows for the period,
      nor
      are they presented as an alternative to net income. They should not be
      considered in isolation or as substitutes for a measure of performance prepared
      in accordance with GAAP.





*Partnership
      Tax Treatment.* See note
      J to the unaudited consolidated financial statements for discussion of
      partnership tax treatment.





*Litigation.* See
      note
      J to the unaudited consolidated financial statements for litigation discussion.





*Consulting
      Agreement.* See
      note
      J to the unaudited consolidated financial statements for discussion of Mr.
      Richter’s consulting agreement.





*Pipeline
      Lease* .
      The
      Pipeline Lease currently expires on December 31, 2013, pursuant to an amendment
      (the “Pipeline Lease Amendment”) entered into between the Company and Seadrift
      on May 21, 1997, which became effective on January 1, 1999 (the “Effective
      Date”). Pursuant to the Pipeline Lease Amendment, the Company’s fixed annual
      rent for the use of the Leased Pipeline is $1.0 million. The Company is also
      required to pay for a minimum volume of storage. However due to limitations
      of
      Seadrift’s storage facility, the Company has not incurred such charges since
      January 2004. In addition, the Pipeline Lease Amendment provides for variable
      rental increases based on monthly volumes purchased and flowing into the Leased
      Pipeline and storage utilized.





The
      Company at its own expense installed a mid-line pump station which included
      the
      installation of additional piping, meters, valves, analyzers and pumps along
      the
      Leased Pipeline to increase the capacity of the Leased Pipeline. The Leased
      Pipeline’s capacity
      is estimated to be between 300 million and 360 million gallons per
      year.





*Other.* The
      Company intends to upgrade its computer and information systems at a total
      estimated cost of approximately $350,000 expected to be completed during 2006.





*Mexican
      Operations.* ****** Under
      current Mexican law, foreign ownership of Mexican entities involved in the
      distribution of LPG or the operation of LPG terminal facilities is prohibited.
      Foreign ownership is permitted in the transportation and storage of LPG. Mexican
      law also provides that a single entity is not permitted to participate in more
      than one of the defined LPG activities (transportation, storage or
      distribution). PennMex has a transportation permit and Termatsal owns, leases,
      or is in the process of obtaining the land or rights of way used in the
      construction of the Mexican portion of the US-Mexico Pipelines, and owns the
      Mexican portion of the assets comprising the US-Mexico Pipelines. The Company’s
      consolidated Mexican affiliate, Tergas, owns the Matamoros Terminal Facility
      and
      has been granted the permit to operate the Matamoros Terminal Facility. The
      Company relies on Tergas’ permit to continue its delivery of LPG at the
      Matamoros Terminal Facility. Tergas is owned 95% by Mr. Vicente Soriano, and
      the
      remaining balance is owned by an unrelated party. The
      Company has an option to purchase Tergas for a nominal price of approximately
      $5,000.





Through
      its operations in Mexico and the operations of the Mexican Subsidiaries and
      Tergas, the Company is subject to the tax laws of Mexico which, among other
      things, require that the Company comply with transfer pricing rules, the payment
      of income, asset and ad valorem taxes, and possibly taxes on distributions
      in
      excess of earnings. In addition, distributions to foreign corporations,
      including dividends and interest payments may be subject to Mexican withholding
      taxes.





*Deregulation
      of the LPG Industry in Mexico.* ****** The
      Mexican petroleum industry is governed by the *Ley
      Reglarmentaria del Artículo 27 Constitutional en el Ramo del
      Petróleo* (the
      Regulatory Law to Article 27 of the Constitution of Mexico concerning Petroleum
      Affairs (the “Regulatory Law”)), Reglamento de Gas Licuado de Petroleo
      (Regulation of LPG) and *Ley
      Orgánica del Petróleos Mexicanos y Organismos Subsidiarios* (the
      Organic Law of Petróleos Mexicanos and Subsidiary Entities (the “Organic Law”)).
      Under Mexican law and related regulations, PEMEX is entrusted with the central
      planning and the strategic management of Mexico's petroleum industry, including
      importation, sales and transportation of LPG. In carrying out this role, PEMEX
      controls pricing and distribution of various petrochemical products, including
      LPG.


44
 *Table
          of Contents*


Beginning
      in 1995, as part of a national privatization program, the Regulatory Law was
      amended to permit private entities to transport, store and distribute natural
      gas with the approval of the Ministry of Energy. As part of this national
      privatization program, the Mexican Government is expected to deregulate the
      LPG
      market (“Deregulation”). In June 1999, Regulation of LPG was enacted to permit
      foreign entities to participate without limitation in the defined LPG activities
      related to transportation and storage. However, foreign entities are prohibited
      from participating in the distribution of LPG in Mexico. Upon Deregulation,
      Mexican entities will be able to import LPG into Mexico. Under Mexican law,
      an
      entity with a permit to transport LPG is not permitted to obtain permits for
      the
      other defined LPG activities (storage and distribution). The Company or its
      consolidated affiliate expect to sell LPG directly to independent Mexican
      distributors as well as PMI upon Deregulation. The Company anticipates that
      the
      independent Mexican distributors will be required to obtain authorization from
      the Mexican government for the importation of LPG upon Deregulation prior to
      entering into contracts with the Company.





During
      July 2001, the Mexican government announced that it would begin to accept
      applications from Mexican companies for permits to allow for the importation
      of
      LPG pursuant to provisions already provided for under existing Mexican law.





In
      connection with the above, in August 2001, Tergas received a one year permit
      from the Mexican government to import LPG. During September 2001, the Mexican
      government decided to delay the implementation of Deregulation and asked Tergas
      to defer use of the permit and as a result, the Company did not sell LPG to
      distributors other than PMI. In March 2002, the Mexican government again
      announced its intention to issue permits for free importation of LPG into Mexico
      by distributors and others beginning August 2002, which was again delayed.
      To
      date the Mexican government has continued to delay implementation of
      Deregulation. Tergas’ permit to import LPG expired during August 2002. Tergas
      intends to obtain a new permit when the Mexican government again begins to
      accept applications. As a result of the foregoing, it is uncertain as to when,
      if ever, Deregulation will actually occur and the effect, if any, it will have
      on the Company. However, should Deregulation occur and should the LPG Asset
      Sale
      not close, it is the Company’s intention to sell LPG directly to distributors in
      Mexico as well as to PMI.





The
      point
      of sale for LPG which flows through the US-Mexico Pipelines for delivery to
      the
      Matamoros Terminal Facility is the United States-Mexico border. For LPG
      delivered into Mexico, PMI is the importer of record.





*Private
      Placements and Other Transactions* .
      During
      March 2005, warrants to purchase a total of 106,250 shares of common stock
      of
      Penn Octane were exercised resulting in cash proceeds to the Company of $97,750.





**Board
      Compensation Plan**





During
      the meeting of the Penn Octane board of directors (the “Board”) held on
      September 3, 1999, the Board approved the implementation of a plan to compensate
      each outside director serving on the Board (the “Plan”). Under the Plan, all
      outside directors upon election to the Board are entitled to receive warrants
      to
      purchase 20,000 shares of common stock of Penn Octane and are to be granted
      warrants to purchase 10,000 shares of common stock of Penn Octane for each
      year
      of service as a director. Such warrants will expire five years after the
      warrants are granted. The exercise price of the warrants issued under the Plan
      are based on the average trading price of Penn Octane’s common stock on the
      effective date the warrants are granted, and the warrants vest monthly over
      a
      one year period.


45
 *Table
          of Contents*


In
      connection with the Plan, during the year ended July 31, 2004 and the transition
      period August 1, 2004 through December 31, 2004, the Board granted warrants
      to
      purchase 30,000 shares and 20,000 shares, respectively of common stock of Penn
      Octane at exercise prices equal to or greater than the reported trading price
      at
      the date of issuance per share to outside directors. Based on the provisions
      of
      APB 25, no compensation expense was recorded for these warrants.





The
      Plan
      was terminated in March 2005 in connection with warrants granted to Directors
      and others under the 2001 Warrant Plan.





**Penn
      Octane 2001 Warrant Plan**





On
      March
      9, 2005, the board of directors of Penn Octane approved the grant of warrants
      to
      purchase a total of 1.0 million shares of Penn Octane common stock under Penn
      Octane’s 2001 Warrant Plan previously approved by the Penn Octane stockholders.
      Of the total number of warrants granted, 625,000 were granted to executive
      officers of Penn Octane, 255,000 were issued to outside directors of Penn Octane
      and 125,000 were issued to a consultant. The exercise price for the warrants
      is
      $1.50 per share, which was the closing price for Penn Octane’s common stock as
      reported by the Nasdaq Capital Market on March 9, 2005. Warrants granted to
      executive officers vest in equal monthly installments over a period of 36 months
      from the date of grant. Warrants granted to outside directors vest in equal
      monthly installments over a period of 12 months from the date of grant. All
      warrants become fully exercisable upon a change in control event and expire
      five
      years from the date of grant.





**Note
      Receivable from a Former Officer of the Company**





The
      note
      receivable from Mr. Richter, in the amount of $3.2 million, was due July 29,
      2005. On August 3, 2005 in connection with Mr. Richter’s retirement in May 2005
      and in consideration of his past services, the Company approved an extension
      of
      the note to July 29, 2007 and a discount of the note to $1.7 million plus
      accrued interest not waived (see below) on its maturity date, subject to
      satisfaction of certain conditions. The Company considers it to be probable
      that
      the note will be discounted at maturity and accordingly, has recorded a charge
      to compensation expense as of June 30, 2005 in the amount of $1.0 million with
      a
      corresponding credit to the reserve. The interest rate on the extended note
      is
      6.75%. The Company will waive interest provided that Mr. Richter guarantees
      debt
      of the Company to any person in an amount equal to at least $1.8 million (see
      Note G to the unaudited consolidated financial statements). Beginning December
      15, 2005, the Company reduced the amount of guaranteed debt below $1.8 million.
      Accordingly, the Company began accruing interest and reserving the interest
      on
      Mr. Richter’s note.





**Restructured
      Notes and $280,000 Notes** *.* ****





The
      Restructured Notes and the $280,000 Notes (collectively the “Notes”) have a face
      value of $1.1 million, bear interest at an annual rate of 16.5%, and were due
      December 15, 2005. The Notes are collateralized by substantially all of the
      Company’s tangible assets, excluding inventories, accounts receivable and sales
      contracts with respect to which the Company has granted a subordinated security
      interest. Mr. Richter has also pledged 2.0 million shares of common stock of
      Penn Octane owned by Mr. Richter including 1.0 million shares of common stock
      collateralizing Mr. Richter’s promissory note to the Company. As a result of the
      Spin-Off, Mr. Richter was also required to provide 250,000 Common Units of
      Rio
      Vista owned by him.





On
      September 30, 2005, the Company and holders of the Notes agreed to an amendment
      whereby the interest payments required to be paid on June 15, 2005 and September
      15, 2005 were extended to December 15, 2005 (the “Deferred Interest”). Under the
      terms of the amendment, the Company agreed to pay additional interest at an
      annual rate of 16.5% on the Deferred Interest from the original due date through
      the date the Deferred Interest is paid. In addition, the Company agreed to
      pay
      to the holders of the Notes, an additional amount equal to 5% of the principal
      amount outstanding of the Notes upon maturity. Mr. Richter agreed that he would
      deliver 250,000 Common Units of Rio Vista (referred to above) to the collateral
      agent. The Company also agreed that it would not enter into any additional
      severance payment obligation in connection with the resignation of Mr. Richter
      until the Notes are fully paid. In addition, the holders of the Notes agreed
      to
      allow Rio Vista to pledge and deliver certain assets in connection with the
      TransMontaigne Note (see note D to the unaudited consolidated financial
      statements). The 250,000 Common Units of Rio Vista referenced above have not
      yet
      been delivered.


46
 *Table
          of Contents*


The
      Company did not pay the entire balance of principal and interest due under
      the
      Notes on December 15, 2005. On December 15, 2005 and January 1, 2006, the
      Company paid $426,143 and $159,171 to the holders of the Notes of which $267,750
      represented payment of principal and related penalties to certain holders of
      the
      Notes and $317,564 represented total accrued and unpaid interest on the Notes
      through December 15, 2005.





During
      February 2006, the Company repaid $500,021 to certain holders of the Notes
      representing $488,250 of principal and related penalties and $11,771 of accrued
      interest.





During
      March 2006, the Company agreed to extend from December 31, 2006 to December
      31,
      2008 the expiration date on the Rio Vista warrants corresponding to the Notes
      then outstanding. The warrants were initially issued in connection with the
      December 15, 2003 amendment of the Notes. In connection with the extension,
      the
      Company recorded additional interest expense of approximately $22,000.





During
      May 2006, the Company paid $61,418 to the holders of the Notes representing
      accrued interest and fees through March 15, 2006.





**Options
      and Warrants of Rio Vista**




***General
      Partner Options.*** Penn
      Octane’s 100% interest in the General Partner may be decreased to 50% as a
      result of the exercise by Shore Capital LLC (“Shore Capital”), an affiliate of
      Mr. Shore, and by Mr. Richter of options to each acquire 25% of the General
      Partner (the “General Partner Options”). The exercise price for each option is
      approximately $82,000. The options expire on July 10, 2006. Following the
      exercise of any of the General Partner Options, Penn Octane will retain voting
      control of the General Partner pursuant to a voting agreement.




***Common
      Unit Warrants.*** On
      March
      9, 2005, the board of managers of the General Partner of Rio Vista,
      approved the Rio Vista 2005 Equity Incentive Plan (the “2005 Plan”). The 2005
      Plan permits the grant of common unit options, common unit appreciation rights,
      restricted common units and phantom common units to any person who is an
      employee (including to any executive officer) or consultant of Rio Vista or
      the
      General Partner or any affiliate of Rio Vista or the General Partner. The 2005
      Plan provides that each outside manager of the General Partner shall be granted
      a common unit option once each fiscal year for not more than 5,000 common units,
      in an equal amount as determined by the board of managers. The aggregate number
      of common units authorized for issuance as awards under the 2005 Plan is
      750,000. The 2005 Plan shall remain available for the grant of awards until
      March 9, 2015, or such earlier date as the board of managers may determine.
      The
      2005 Plan is administered by the compensation committee of the board of
      managers. Under the terms of the Agreement and applicable rules of the Nasdaq
      Capital Market, no approval of the 2005 Plan by the common unitholders of Rio
      Vista was required.




On
      March
      9, 2005, the board of managers of the General Partner of Rio Vista approved
      the grant of options to purchase a total of 108,750 common units under the
      2005
      Plan. Of the total number of options granted, 93,750 were granted to certain
      executive officers of the General Partner and to Mr. Richter and 15,000 were
      issued to outside managers of the General Partner. The exercise price for the
      options is $12.51 per common unit, which was the average of the high and low
      sales prices for Rio Vista common units as reported by the Nasdaq Capital Market
      on March 9, 2005. The options granted to executive officers (including Mr.
      Richter) were fully vested on the date of grant. The options granted to outside
      managers vest in equal monthly installments over a period of 12 months from
      the
      date of grant. All options become fully exercisable upon a change in control
      event and expire three years from the date of grant. The board of managers
      has
      not yet determined if Rio Vista will grant any common unit options for the
      fiscal year 2006.




*The
      Spin-Off.*




**Intercompany
      Agreements**





As
      a
      result of the Spin-Off, Rio Vista owns and operates the LPG distribution,
      transportation and marketing business previously conducted by Penn Octane.
      Rio
      Vista sells LPG directly to PMI and purchases LPG from Penn Octane under a
      long-term supply agreement. Intercompany agreements between Penn Octane and
      Rio
      Vista are as follows:


47
 *Table
          of Contents*


***LPG
      Supply Agreement with Rio Vista.*** **** Penn
      Octane entered into a long-term supply agreement (the “LPG Supply Agreement”)
      with Rio Vista pursuant to which Rio Vista agrees to purchase all of its LPG
      requirements for sales which utilize the assets transferred to Rio Vista by
      Penn
      Octane to the extent Penn Octane is able to supply such LPG requirements. The
      LPG Supply Agreement further provides that Rio Vista has no obligation to
      purchase LPG from Penn Octane to the extent the distribution of such LPG to
      Rio
      Vista’s customers would not require the use of any of the assets Penn Octane
      transferred to Rio Vista or Penn Octane ceases to have the right to access
      the
      Leased Pipeline. The LPG Supply Agreement terminates on the earlier to occur
      of:


·
            Penn
                Octane ceases to have the right to access the Leased Pipeline that
                connects to Rio Vista’s Brownsville Terminal Facility;
                or




·
            Rio
                Vista ceases to sell LPG using any of the assets transferred by Penn
                Octane to Rio Vista pursuant to the
                Spin-Off.




***Omnibus
      Agreement.*** In
      connection with the Spin-Off, Penn Octane entered into an Omnibus Agreement
      with
      Rio Vista that governs, among other things, indemnification obligations among
      the parties to the agreement, related party transactions and the provision
      of
      general administration and support services by Penn Octane.





The
      Omnibus Agreement prohibits Rio Vista from entering into any material agreement
      with Penn Octane without the prior approval of the conflicts committee of the
      board of managers of the General Partner. For purposes of the Omnibus Agreement,
      a material agreement is any agreement between Rio Vista and Penn Octane that
      requires aggregate annual payments in excess of $100,000.





The
      Omnibus Agreement may be amended by written agreement of the parties; provided,
      however that it may not be amended without the approval of the conflicts
      committee of the General Partner if the amendment would adversely affect the
      unitholders of Rio Vista. The Omnibus Agreement has an initial term of five
      years that automatically renews for successive five-year terms and, other than
      the indemnification provisions, will terminate if Rio Vista is no longer an
      affiliate of Penn Octane.





**General
      Partner Options**





Penn
      Octane’s 2% general partnership interest in Rio Vista is expected to be
      decreased to 1% as a result of the exercise by Shore Capital and Mr. Richter
      of
      the options to each acquire 25% of the General Partner causing Penn Octane’s
      ownership in the General Partner to be decreased from 100% to 50%. Mr. Shore
      and
      Mr. Richter each were formerly executives and members of the board of directors
      of Penn Octane and the board of managers of Rio Vista. The exercise price of
      the
      two options total approximately $164,000.





**Rio
      Vista’s Guarantees**





***Debt
      Guarantee*** *.*  Rio
      Vista
      is liable as guarantor on the RZB Credit Facility and will continue to pledge
      all of its assets as collateral in connection with the RZB Credit Facility
      and
      other debt of the Company. Rio Vista may also be prohibited from making any
      distributions to unit holders if it would cause an event of default, or if
      an
      event of default exists, under the RZB Credit Facility.





***Tax
      Guarantee*** *.* Further,
      if Penn Octane is determined to have a federal income tax liability in excess
      of
      the amounts which were included in the federal income tax return related to
      the
      Spin-Off and if Penn Octane is unable to pay such liabilities or Rio Vista
      is
      unable to pay, then the Internal Revenue Service may assert that the Penn Octane
      stockholders who received common units in the Spin-Off are liable for unpaid
      federal income taxes of Penn Octane, including interest and any penalties,
      up to
      the value of the Rio Vista Common Units received by each
      stockholder.


48
 *Table
          of Contents*


*Realization
      of Assets.* The
      accompanying unaudited consolidated financial statements have been prepared
      in
      conformity with accounting principles generally accepted in the United States
      of
      America, which contemplate continuation of the Company as a going concern.
      The
      Company has a loss from operations for the three months ended March 31, 2006,
      has had an accumulated deficit since inception and has a deficit in working
      capital. In addition, substantially all of the Company’s assets are pledged or
      committed to be pledged as collateral on existing debt in connection with Notes,
      the RZB Credit Facility and/or the TransMontaigne Note, and therefore, the
      Company may be unable to obtain additional financing collateralized by those
      assets. The Notes were due December 15, 2005 and notes totaling $720,000 were
      paid in December 2005 and February 2006. Notes totaling $ 1,085,000 and still
      outstanding and have not been extended. The LPG Asset Sale has not closed and
      the TransMontaigne Note may be due on the earlier of the time of closing or
      120
      days following demand by TransMontaigne (see note D to the unaudited
      consolidated financial statements). The RZB Credit Facility may be insufficient
      to finance the Company’s LPG purchases and/or Fuel Products purchases, assuming
      increases in product costs per gallon, or volumetric growth in product sales,
      and may be terminated by RZB with 90 days notice.





The
      minimum volumes and applicable margins contained in the PMI Confirmation are
      expected to provide the Company with gross profit similar to the gross profit
      the Company would have received if PMI had purchased only the minimum volumes
      provided under its agreements with Rio Vista during the period from May 1,
      2005 to March 31, 2006 as a result of increased margins on lower volume
      levels contained in the PMI Confirmation. Actual volumes purchased by PMI under
      those prior agreements, however, exceeded minimum contractual amounts by
      approximately 35%. There is no assurance that PMI will purchase volumes as
      indicated in the PMI Confirmation or that PMI will continue to purchase LPG
      from
      Rio Vista or in quantities or prices that are profitable upon the expiration
      of
      the PMI Confirmation. Assuming that the LPG Asset Sale does not close, the
      Company projects that its gross profit from operations based on the minimum
      volumes and applicable margins contained in the PMI Confirmation will not
      provide sufficient cash flow to pay its normal operating expenses through
      March 31, 2007, assuming breakeven results from its Fuel Sales Business,
      unless it can sufficiently reduce its operating expenses. In addition, the
      Company’s cash flow at the minimum volumes contained in the PMI Confirmation is
      projected not to be sufficient to pay its other obligations, including its
      secured debt. The Fuel Sales Business is a relatively new business and, as
      a
      result, the Company does not believe it can rely on that portion of its business
      to provide sufficient additional cash flow.





Also,
      Penn Octane and Rio Vista project that monthly cash flows from LPG sales during
      the months of May 2006 through September 2006 will be less than during the
      months of October 2006 through March 2007 as a result of reduced monthly volumes
      committed to be purchased during May 2006 through September 2006. In
      addition, the Company may be unable to make any necessary capital expenditures
      or to pay arrearages in distributions or to pay future distributions to its
      unitholders during the Term of the PMI Confirmation.





In
      the
      event Penn Octane does not pay its obligations when due, Rio Vista’s guarantees
      to Penn Octane and Penn Octane’s creditors may be triggered. Accordingly, Rio
      Vista may be required to pay such obligations of Penn Octane to avoid
      foreclosure against Rio Vista’s assets by Penn Octane’s creditors. Assuming that
      the LPG Asset Sale does not close, Rio Vista projects that its gross profit
      from
      operations under the PMI Confirmation, based on the minimum volumes and
      applicable margins, will not provide sufficient cash flow for Rio Vista to
      pay
      its normal operating expenses through March 31, 2007 unless it can
      sufficiently reduce its operating expenses. If the Company’s revenues and other
      sources of liquidity are not adequate to pay its obligations, Penn Octane or
      Rio
      Vista may be required to raise additional funds to avoid such foreclosure.
      There
      can be no assurance that such additional funding will be available on terms
      attractive to either Penn Octane or Rio Vista or available at all. If additional
      amounts cannot be raised and the Company is unable to restructure its
      obligations, the Company would suffer material adverse consequences to its
      business, financial condition and results of operations, and Penn Octane and/or
      Rio Vista would likely be required to seek other alternatives, which could
      include the sale of assets, closure of operations and/or protection under the
      U.S. bankruptcy laws.


49
 *Table
          of Contents*


In
      view
      of the matters described in the preceding paragraphs, recoverability of the
      recorded asset amounts shown in the accompanying unaudited consolidated balance
      sheet is dependent upon either (1) closing of the LPG Asset Sale or (2) the
      ability of the Company to generate sufficient cash flow through operations
      or
      additional debt or equity financing to pay its liabilities and obligations
      when
      due. If the LPG Asset Sale does not close, the ability for the Company to
      generate sufficient cash flows from operations is significantly dependent on
      the
      sale of LPG to PMI at adequate average monthly sales volumes and margins, the
      success of the Fuel Sales Business and the adequacy of the RZB Credit Facility
      to finance such sales. The unaudited consolidated financial statements do not
      include any adjustments related to the recoverability and classification of
      recorded asset amounts or amounts and classification of liabilities that might
      be necessary should the Company be unable to continue in existence.





To
      provide the Company with the ability it believes necessary to continue in
      existence, management is taking steps to close the LPG Asset Sale. Because
      the
      LPG Asset Sale has not closed, management (i) is seeking to expand its Fuel
      Sales Business and to further diversify its operations to reduce dependency
      on
      sales of LPG, (ii) is seeking to maintain the amount of financing for its
      products and operations, and (iii) is seeking to reduce supply costs and
      operating expenses. In the event that the LPG Asset Sale is not closed,
      management may also continue to attempt to sell its LPG and refined products
      assets.





**Impact
      of Inflation**




Inflation
      in the United States and Mexico has been relatively low in recent years and
      did
      not have a material impact on the consolidated financial statements of the
      Company. However, inflation remains a factor in the United States and the
      Mexican economies and could increase the Company’s cost to acquire or replace
      property, plant and equipment as well as our labor and supply
      costs.




The
      Company may be adversely impacted as a result of increases in LPG prices and
      Fuel Products prices, which are related to oil and natural gas prices, because
      of limits on the RZB Credit Facility.




**Environmental
      Matters**




The
      Company’s operations are subject to environmental laws and regulations adopted
      by various governmental authorities in the jurisdictions in which these
      operations are conducted. Under the Omnibus Agreement, Penn Octane will
      indemnify Rio Vista for five years after the completion of the Spin-Off against
      certain potential environmental liabilities associated with the assets it
      contributed to Rio Vista relating to events or conditions that existed before
      the completion of the Spin-Off.




50
 *Table
          of Contents*


**Recently
      Issued Financial Accounting Standards**




In
      December 2004, the FASB issued Statement of Financial Accounting Standard No.
      153, “Exchanges of Nonmonetary Assets-An Amendment of APB Opinion No. 29” (“SFAS
      153”). The amendments made by SFAS 153 are based on the principle that exchanges
      on nonmonetary assets should be measured based on the fair value of the assets
      exchanged. The provisions in SFAS 153 are effective for nonmonetary asset
      exchanges occurring in fiscal periods beginning after June 15, 2005. Early
      application is permitted and companies must apply the standard prospectively.
      The Company has determined that SFAS 153 will not have a material impact on
      their consolidated results of operations, financial position or cash
      flows.





In
      May
      2005, the FASB issued Statement of Financial Accounting Standard No. 154,
“Accounting Changes and Error Corrections” (“SFAS 154”). This new standard
      replaces APB Opinion No. 20, “Accounting Changes” and FASB Statement No. 3,
“Reporting Accounting Changes in Interim Financial Statements”. Among other
      changes, SFAS 154 requires that a voluntary change in accounting principle
      be
      applied retrospectively with all prior period financial statements presented
      on
      the new accounting principle, unless it is impracticable to do so. SFAS 154
      also
      provides that (1) a change in method of depreciating or amortizing a long-lived
      nonfinancial asset be accounted for as a change in estimate (prospectively)
      that
      was effected by a change in accounting principle, and (2) correction of errors
      in previously issued financial statements should be termed a “restatement.” The
      new standard is effective for accounting changes and correction of errors made
      in fiscal years beginning after December 15, 2005. Early adoption of this
      standard is permitted for accounting changes and correction of errors made
      in
      fiscal years beginning after June 1, 2005. The Company has determined that
      SFAS
      154 will not have a material impact on their consolidated results of operations,
      financial position or cash flows.





In
      March
      2005, the Financial Accounting Standards Board issued FASB Interpretation No.
      47, *Accounting
      for Conditional Asset Retirement Obligations.* Under
      the provisions of FIN No. 47, the term conditional asset retirement obligation
      as used in SFAS No. 143, *Accounting
      for Asset Retirement Obligations* ,
      refers
      to a legal obligation to perform an asset retirement activity in which the
      timing and/or method of settlement are conditional on a future event that may
      or
      may not be within the control of the entity while the obligation to perform
      the
      asset retirement activity is unconditional. Accordingly, an entity is required
      to recognize a liability for the fair value of a conditional asset retirement
      obligation if the fair value of the liability can be reasonably estimated.
      The
      fair value of a liability for the conditional asset retirement obligation is
      required to be recognized when incurred - generally upon acquisition,
      construction, or development and/or through the normal operation of the asset.
      The Company has adopted FIN No. 47 as of December 31, 2005. Adoption of this
      pronouncement did not have a significant effect on its 2005 consolidated
      financial statements, and the Company does not expect this pronouncement to
      have
      a significant effect on our future reported financial position or
      earnings.





In
      February 2006, the FASB issued FASB Statement No. 155, *Accounting
      for Certain Hybrid Instruments.* This
      standard amends the guidance in FASB Statements No. 133, *Accounting
      for Derivative Instruments and Hedging Activities,* and No.
      140, *Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities.* Statement
      155 allows financial instruments that have embedded derivatives to be accounted
      for as a whole (eliminating the need to bifurcate the derivative from its host)
      if the holder elects to account for the whole instrument on a fair value basis.
      Statement 155 is effective for all financial instruments acquired or issued
      after the beginning of an entity’s first fiscal year that begins after September
      15, 2006.


51
 *Table
          of Contents*


**Critical
      Accounting Policies**





The
      unaudited consolidated financial statements of the Company reflect the selection
      and application of accounting policies which require management to make
      significant estimates and judgments. See note B to the Company’s consolidated
      financial statements included in its Annual Report on Form 10-K for the fiscal
      year ended December 31, 2005, “Summary of Significant Accounting Policies”. The
      Company believes that the following reflect the more critical accounting
      policies that affect the financial position and results of
      operations.





Revenue
      recognition - the Company expects in the future to enter into sales agreements
      to sell LPG and Fuel Products for future delivery. The Company will not record
      sales until the LPG and Fuel Products are delivered to the
      customer.





Impairment
      of long-lived assets - The determination of whether impairment has occurred
      is
      based on an estimate of undiscounted cash flows attributable to assets in future
      periods. If impairment has occurred, the amount of the impairment loss
      recognized will be determined by estimating the fair value of the assets and
      recording a loss if the fair value is less than the carrying value. Assessments
      of impairment are subject to management’s judgments and based on estimates that
      management is required to make.





Depreciation
      and amortization expenses - Property, plant and equipment are carried at cost
      less accumulated depreciation and amortization. Depreciation and amortization
      rates are based on management’s estimate of the future utilization and useful
      lives of the assets.





Share-based
      payment - The Company accounts for share-based payment using the provisions
      of
      SFAS 123R (fair value method).





Allowance
      for doubtful accounts - The carrying value of trade accounts receivable is
      based
      on estimated fair value. The determination of fair value is subject to
      management’s judgments and is based on estimates that management is required to
      make.




**Statement
      by Management Concerning Review of Interim Information by An Independent
      Registered Public Accounting Firm.**





The
      unaudited consolidated financial statements included in this filing on Form
      10-Q
      have been reviewed by Burton McCumber & Cortez, L.L.P., an independent
      registered public accounting firm, in accordance with established professional
      standards and procedures for such review. The report of Burton McCumber &
Cortez, L.L.P. commenting on their review, accompanies the unaudited
      consolidated financial statements included in Item 1 of Part I.


52
 *Table
          of Contents*


**Item
                  3.**
              **Quantitative
                  and Qualitative Disclosures About Market
                  Risk.**





To
      the
      extent that the Company maintains quantities of LPG inventory in excess of
      commitments for quantities of undelivered LPG and/or has commitments for
      undelivered LPG in excess of inventory balances, the Company is exposed to
      market risk related to the volatility of LPG prices. In the event that inventory
      balances exceed commitments for undelivered LPG, during periods of falling
      LPG
      prices, the Company may sell excess inventory to customers to reduce the risk
      of
      these price fluctuations.





The
      Company generally does not maintain quantities of LPG inventory in excess of
      quantities actually ordered by PMI. Therefore, the Company has not currently
      entered into and does not currently expect to enter into any arrangements in
      the
      future to mitigate the impact of commodity price risk.





To
      the
      extent the Company maintains quantities of Fuel Products inventory in excess
      of
      commitments for quantities of undelivered Fuel Products, the Company is exposed
      to market risk related to the volatility of Fuel Product prices. In the event
      that inventory balances exceed commitments for undelivered Fuel Products, during
      periods of falling Fuel Products prices, the Company may sell excess inventory
      to customers to reduce the risk of these price fluctuations.





The
      Company has existing debt at both fixed and variable interest rates (see note
      I
      to the consolidated financial statements). Trade accounts receivable from the
      Company’s limited number of customers and the Company’s trade and other accounts
      payable generally do not bear interest. The Company’s credit facility with RZB
      provides for cash advances at a current variable interest rate. Fees paid to
      RZB
      for letters of credit are based on a fixed schedule as provided in the Company’s
      agreement with RZB. The Company currently has limited, if any, interest rate
      risk.





The
      Company routinely converts U.S. dollars into Mexican pesos to pay terminal
      operating costs and income taxes. Such costs have historically been less than
      $1
      million per year and the Company expects such costs will remain at less than
      $1
      million in any year. The Company does not maintain Mexican peso bank accounts
      with other than nominal balances. Therefore, the Company has limited, if any,
      risk related to foreign currency exchange rates.





**Item
                  4.**
              **Controls
                  and Procedures.**





The
      Company’s management, including the principal executive officer and principal
      financial officer, are responsible for establishing and maintaining disclosure
      controls and procedures and internal controls and therefore have conducted
      an
      evaluation of the Company’s disclosure controls and procedures and internal
      controls, as such term is defined under Rule 13a-15 promulgated under the
      Securities Exchange Act of 1934, as of March 31, 2006. Based on their
      evaluation, the Company’s principal executive officer and principal accounting
      officer concluded that the Company’s disclosure controls and procedures and
      internal controls are effective.





There
      have been no significant changes (including corrective actions with regard
      to
      significant deficiencies or material weaknesses) in the Company’s internal
      controls or in other factors that could significantly affect these controls
      subsequent to the date of the evaluation referenced in paragraph
      above.





The
      Company is not required to complete an annual evaluation pursuant to Section
      404
      of the Sarbanes Oxley Act of 2002 of its internal controls systems until the
      year ended December 31, 2007.


53
 *Table
          of Contents*




**PART
      II**


**Item
                  1.**
              **Legal
                  Proceedings**
 
 See
        note
        J to the Company’s unaudited consolidated financial statements included in this
        Report.
 
 **Item
                  1A.**
              **Risk
                  Factors**




*Business
      Factors.* Beginning
      with the expiration of the LPG sales contract with PMI effective March 31,
      2004
      and continuing through the PMI Confirmation entered into with PMI effective
      May
      1, 2006, the Company has experienced materially lower LPG sales volumes and/or
      margins that have adversely affected the Company’s results of operations. Penn
      Octane has one major customer for LPG, Rio Vista, and Rio Vista has only one
      customer for LPG in Mexico, PMI. The Company commenced its Fuel Sales Business
      in June 2004. There is no assurance that PMI will purchase volumes as indicated
      in the PMI Confirmation or that PMI will continue to purchase LPG from Rio
      Vista
      or in quantities or prices that are profitable upon the expiration of the PMI
      Confirmation. There are a limited number of suppliers of LPG that connect to
      the
      Company’s pipelines and a limited supply of LPG. The Company may lose its
      competitive advantage when the Company’s Seadrift pipeline lease expires in
      2013. The Company may be unable to successfully develop additional sources
      of
      revenue in order to reduce its dependence on PMI. The Company may not have
      sufficient cash to meet its obligations. All of the Company’s assets are pledged
      as collateral for existing debt, and the Company therefore may be unable to
      obtain additional financing collateralized by such assets. The Company is at
      risk of economic loss due to fixed margin contracts. If the Company cannot
      develop sufficient capital resources for acquisitions or opportunities for
      expansion, the Company’s growth will be limited. The Company’s ability to grow
      the Fuel Sales Business is largely dependent on available financing which may
      be
      limited. Future acquisitions and expansions may not be successful, may
      substantially increase the Company’s indebtedness and contingent liabilities,
      and may create integration difficulties. The Company’s business would be
      adversely affected if operations at the Company’s transportation, terminal and
      distribution facilities were interrupted. The Company’s business would also be
      adversely affected if the operations of the Company’s customers or suppliers
      were interrupted.





*LPG
      Asset Sale* . There
      can
      be no assurance that the LPG Asset Sale will be completed according to the
      terms
      contained in the PSA’s or according to different terms or at all. Even if the
      LPG Asset Sale is completed, Rio Vista may be unable to resume payment of
      minimum quarterly distributions or to pay the arrearages of such distributions,
      in order to maintain cash reserves necessary for the conduct of business. If
      the
      LPG Asset Sale is completed, the RZB Credit Facility may be restructured and/or
      reduced. A continued delay of or inability to close the LPG Asset Sale could
      have a material adverse effect on Penn Octane’s and Rio Vista’s business,
      financial condition and results of operations.  See the
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations - Purchases and Sale Agreements.





*NASDAQ
      Listing* . On
      May
      25, 2005, Penn Octane received written notification from The NASDAQ Stock
      Market’s Listing Qualification Department stating that, for the last 30
      consecutive business days, the bid price of Penn Octane’s common stock had
      closed below the minimum $1.00 per share requirement for continued inclusion
      under Marketplace Rule 4310(c)(4) (the “Bid Price Rule”). In
      accordance with Marketplace Rule 4310(c)(8)(D), Penn Octane was granted 180
      calendar days, until November 21, 2005, to regain compliance. Had at any time
      before November 21, 2005, the bid price of Penn Octane’s common stock closed at
      $1.00 per share or more for a minimum of 10 consecutive trading days, Penn
      Octane would have regained compliance with the Bid Price Rule. The bid price
      of
      Penn Octane’s common stock did not close at or above $1.00 from May 25, 2005
      through November 21, 2005.





Because
      Penn Octane met the NASDAQ Capital Market initial listing criteria set forth
      in
      Marketplace Rule 4310(c), except for the bid price requirement in November
      2005, Penn Octane was granted an additional 180 calendar day extension until
      May
      20, 2006 to regain compliance with the Bid Price Rule. The bid price of Penn
      Octane’s common stock has not closed at or above $1.00 for a minimum 10
      consecutive trading days during the period November 22, 2005 through May 20,
      2006. Therefore, Penn Octane did not comply with the minimum bid price
      requirement by May 20, 2006. Because Penn Octane did not meet the Bid Price
      Rule
      by May 20, 2006, the Company expects NASDAQ will notify Penn Octane that its
      common stock will be delisted. Penn Octane may request a hearing by NASDAQ
      to
      appeal the delisting. There is no assurance that Penn Octane’s request to remain
      listed on the NASDAQ Capital Market will be successful.


54
 *Table
          of Contents*


If
      Penn
      Octane is delisted from the NASDAQ Capital Market, Penn Octane will continue
      to
      file all required reports with the Securities and Exchange Commission and
      intends to seek quotation in the OTC Bulletin Board through a market maker.
      The
      OTC Bulletin Board is a regulated quotation service that displays real-time
      quotes, last sale prices and volume information in over-the-counter securities.
      Delisting by NASDAQ may result in decreased market interest in Penn Octane
      common stock, investors and stockholders may experience more difficulty in
      buying and selling Penn Octane common stock, and Penn Octane’s common stock
      price may decline. In addition, Penn Octane may experience greater difficulty
      in
      obtaining necessary debt and equity capital for potential acquisitions or the
      operation of its business.





*Competitive
      Factors.* The
      energy industry is highly competitive. There is competition within the
      industries and also with other industries in supplying the energy and fuel
      needs
      of the industrial and individual consumers. The Company competes with other
      companies in the sale or purchase of LPG and Fuel Products as well as the
      transportation of these products in the US and Mexican markets and employs
      all
      methods of competition which are lawful and appropriate for such purposes.
      A key
      component of the Company’s competitive position, particularly given the
      commodity nature of its products, is its ability to manage its expenses
      successfully, which requires continuous management focus on reducing unit costs
      and improving efficiency and its ability to secure unique opportunities for
      the
      purchase, sale and/or delivery methods of its products.





*International
      Factors.* Mexican
      economic, political and social conditions may change and adversely affect the
      Company’s operations. The Company may not be able to continue operations in
      Mexico if Mexico restricts the existing ownership structure of its Mexican
      operations, requiring the Company to increase its reliance on Mexican nationals
      to conduct its business. The LPG market in Mexico has yet to be deregulated.
      If
      deregulation occurs, the results may hinder the Company’s ability to negotiate
      acceptable contracts with distributors. The Company’s contracts and Mexican
      business operations are subject to volatility in currency exchange rates which
      could negatively impact its earnings.





*Political
      Factors.* The
      operations and earnings of the Company in the US and Mexico have been, and
      may
      in the future be, affected from time to time in varying degree by political
      instability and by other political developments and laws and regulations, such
      as forced divestiture of assets; restrictions on production, imports and
      exports; war or other international conflicts; civil unrest and local security
      concerns that threaten the safe operation of the Company’s facilities; price
      controls; tax increases and retroactive tax claims; expropriation of property;
      cancellation of contract rights; and environmental regulations. Both the
      likelihood of such occurrences and their overall effect upon the Company vary
      greatly and are not predictable.





*Industry
      and Economic Factors.* The
      operations and earnings of the Company throughout the US and Mexico are affected
      by local, regional and global events or conditions that affect supply and demand
      for the Company’s products. These events or conditions are generally not
      predictable and include, among other things, general economic growth rates
      and
      the occurrence of economic recessions; the development of new supply sources
      for
      its products; supply disruptions; weather, including seasonal patterns that
      affect energy demand and severe weather events that can disrupt operations;
      technological advances, including advances in exploration, production, refining
      and advances in technology relating to energy usage; changes in demographics,
      including population growth rates and consumer preferences; and the
      competitiveness of alternative hydrocarbon or other energy sources or product
      substitutes.





*Acquisition
      Factors.* In
      addition to the factors cited above, the advancement, cost and results of
      particular projects sought by the Company, including projects which do not
      specifically fall within the areas of the Company’s current lines of businesses
      will depend on: the outcome of negotiations for such projects; the ability
      of
      the Company’s management to manage such businesses; the ability of the Company
      to obtain financing for such acquisitions; business integration issues; changes
      in operating conditions or costs; and the occurrence of unforeseen technical
      difficulties.





*Market
      Risk Factors.* See
“Notes to Consolidated Financial Statements,” “Management’s Discussion and
      Analysis of Financial Condition and Results of Operations” and “Quantitative and
      Qualitative Disclosures About Market Risk” in this report for discussion of the
      impact of market risks, inflation and other uncertainties.


55
 *Table
          of Contents*


*Internal
      Control Factors.* Pursuant
      to Section 404 of the Sarbanes Oxley Act of 2002, beginning with the fiscal
      year
      ended December 31, 2007, the Company is required to complete an annual
      evaluation of its internal control systems. In addition, the Company’s
      independent auditors are required to provide an opinion regarding such
      evaluation and the adequacy of the Company’s internal accounting controls. The
      Company’s internal controls may be found to be inadequate, deficiencies or
      weaknesses may be discovered, and remediation may not be successful. If the
      Company acquires an existing business, the internal control systems of the
      acquired business may be inadequate and may require additional
      strengthening.




*Projections* .
      Projections, estimates and descriptions of the Company’s plans and objectives
      included or incorporated in Part I. Items 1. and 2. and Part II. Items 1. and
      1A. of this report are forward-looking statements. Actual future results could
      differ materially due to, among other things, the factors discussed above and
      elsewhere in this report.




**Item
                2.**
            **Unregistered
                Sales of Equity Securities and Use of
                Proceeds**





None.





**Item
                3.**
            **Defaults
                Upon Senior Securities**





None.





**Item
                4.**
            **Submission
                of Matters to a Vote of Security
                Holders**





None.





**Item
                5.**
            **Other
                Information**





None.


56
 *Table
          of Contents*


**Item
                6**.
            **Exhibits**





**The
      following exhibits are incorporated by reference to previously filed reports,
      as
      noted.**





Exhibit
                No.10.1
            
            Matamoros
                LPG Mix Purchase and Sales Agreement made and entered into as of
                June 4,
                2005, by and between Rio Vista Energy Partners L.P. and P.M.I. Trading
                Limited (Incorporated by reference to the Company’s Quarterly Report on
                Form 10-Q for the quarter ended June 30, 2005 filed on August 19,
                2005,
                SEC File No. 000-24394).10.2
            
            Purchase
                and Sale Agreement dated as of August 15, 2005 between Penn Octane
                Corporation and TransMontaigne Product Services Inc. (Incorporated
                by
                reference to the Company’s Quarterly Report on Form 10-Q for the quarter
                ended June 30, 2005 filed on August 19, 2005, SEC File No.
                000-24394).10.3
            
            Form
                of Amendment of Promissory Note(s) of Penn Octane Corporation due
                December
                15, 2005 and Related Agreements dated September 30, 2005. (Incorporated
                by
                reference to the Company’s Quarterly Report on Form 10-Q for the quarter
                ended September 30, 2005 filed on May 22, 2006, SEC File No. 000-24394).10.4
            
            Form
                of Escrow Agreement dated as of September 30, 2005 by and between
                Jerome
                B. Richter, Penn Octane Corporation and the Noteholders of Promissory
                Notes of Penn Octane due on December 15, 2005. (Incorporated by reference
                to the Company’s Quarterly Report on Form 10-Q for the quarter ended
                September 30, 2005 filed on May 22, 2006, SEC File No. 000-24394).10.5
            
            Fourth
                Amendment to Purchase, Sale and Service Agreement for Propane/Butane
                Mix
                made and extended into effective March 1, 2006 by and between Exxon
                Mobil
                Gas and Power Marketing Company and Penn Octane Corporation. (Incorporated
                by reference to the Company’s Annual Report on Form 10-K for the year
                ended December 31, 2005 filed on April 6, 2006, SEC File No.
                000-24394).10.6
            
            Amendment
                No. 1 to Purchase and Sale Agreement between Penn Octane Corporation
                and
                TransMontaigne Product Services Inc., dated January 26, 2006.
                (Incorporated by reference to the Company’s Annual Report on Form 10-K for
                the year ended December 31, 2005 filed on April 6, 2006, SEC File
                No.
                000-24394).10.7
            
            Amended
                and Restated Consulting Agreement dated November 15, 2005 between
                Penn
                Octane Corporation, Rio Vista Energy Partners L.P. and Jerome B.
                Richter.
                (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q
                for the quarter ended September 30, 2005 filed on November 21, 2005,
                SEC
                File No. 000-24394).10.8
            
            Amended
                and Restated Promissory Note by Jerome B. Richter to the Company
                dated
                November 15, 2005. (Incorporated by reference to the Company’s Quarterly
                Report on Form 10-Q for the quarter ended September 30, 2005 filed
                on
                November 21, 2005, SEC File No. 000-24394).10.9
            
            Agreement
                dated as of November 15, 2005 by and between Penn Octane Corporation
                and
                Jerome B. Richter. (Incorporated by reference to the Company’s Quarterly
                Report on Form 10-Q for the quarter ended September 30, 2005 filed
                on
                November 21, 2005, SEC File No.
                000-24394).


57
 *Table
          of Contents*


**The
      following Exhibits are filed as part of this report:**





15
            
            Accountant’s
                Acknowledgment.31.1
            
            Certification
                Pursuant to Rule 13a - 14(a) / 15d - 14(a) of the Exchange
                Act.31.2
            
            Certification
                Pursuant to Rule 13a - 14(a) / 15d - 14(a) of the Exchange
                Act.32
            
            Certification
                Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section
                906 of
                the Sarbanes -Oxley Act of 2002.





All
      of
      the Exhibits are available from the SEC’s website at www.sec.gov .
      In
      addition, Penn Octane will furnish a copy of any Exhibit upon payment of a
      fee
      (based on the estimated actual cost which shall be determined at the time of
      a
      request) together with a request addressed to Ian T. Bothwell, Penn Octane
      Corporation, 77-530 Enfield Lane, Bldg. D, Palm Desert, California
      92211.


58
 *Table
          of Contents*


**SIGNATURES**





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





**PENN
                OCTANE CORPORATION**May
                22, 2006
            By:
            /s/ 
                Ian T. BothwellIan
                T. BothwellVice
                President, Chief Financial Officer, Treasurer, and Assistant Secretary






59