**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 June 30, 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
        August 4, 2006 was 15,386,187.
  
 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 andJune
                  30, 2006 (unaudited)
              4-5Unaudited
                  Consolidated Statements of Operations for the three
                  months and
                  six months ended June 30, 2005 and 2006
              6Unaudited
                  Consolidated Statements of Cash Flows for the six
                  months ended
                  June 30, 2005 and 2006
              7Notes
                  to Consolidated Financial Statements (Unaudited)
              8-322.
              Management’s
                  Discussion and Analysis of Financial Condition
                  and
                  Results of Operations
              33-563.
              Quantitative
                  and Qualitative Disclosures About Market
                  Risk
              574.
              Controls
                  and Procedures
              57Part
                  II
              
              1.
              Legal
                  Proceedings
              581A.
              Risk
                  Factors
              58
                  - 602.
              Unregistered
                  Sales of Equity Securities and Use of
                  Proceeds
              603.
              Defaults
                  Upon Senior Securities
              604.
              Submission
                  of Matters to a Vote of Security
                  Holders
              605.
              Other
                  Information
              606.
              Exhibits
              61-62Signatures
              63
 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 June 30, 2006, the consolidated statements of
        operations for the three months and six months ended June 30, 2005 and 2006,
        and
        the consolidated statement of cash flows for the six months ended June 30,
        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
 July
        31,
        2006
  3
 *Table
            of Contents*
  **PartI**
 **Item
        1.**
 
 **Penn
        OctaneCorporation and Subsidiaries**
 
 **CONSOLIDATED
        BALANCE SHEETS**
 
 **ASSETS**
  December
                  31,
                2005
              
              June
                  30,
                2006Current
                  Assets
              
              
              
              (Unaudited)Cash
              
              $
              299,597
              
              $
              118,982Restricted
                  cash
              
              
              5,657,623
              
              
              4,093,513Trade
                  accounts receivable (less allowance for doubtful accounts of$0
                  and $63,958
                  at December 31, 2005 and June 30, 2006)
              
              
              12,470,891
              
              
              9,860,408Inventories
              
              
              2,878,268
              
              
              3,594,060Prepaid
                  expenses and other current assets
              
              
              100,272
              
              
              189,528Total
                  current assets
              
              
              21,406,651
              
              
              17,856,491Property,
                  plant and equipment - net
              
              
              14,983,247
              
              
              14,332,711Lease
                  rights (net of accumulated amortization of $818,207 and $841,104
                  at
                  December 31, 2005 and June 30, 2006)
              
              
              335,832
              
              
              312,935Other
                  non-current assets
              
              
              31,089
              
              
              29,575Total
                  assets
              
              $
              36,756,819
              
              $
              32,531,712
  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
              
              June
                  30,
                2006Current
                  Liabilities
              
              
              
              (Unaudited)Current
                  maturities of debt obligations
              
              $
              3,015,054
              
              $
              2,405,425Revolving
                  line of credit
              
              
              560,283
              
              
              4,748,087LPG
                  and Fuel Products trade accounts payable
              
              
              16,888,320
              
              
              10,046,769Other
                  accounts payable
              
              
              1,770,656
              
              
              2,190,506U.S.
                  and foreign taxes payable
              
              
              21,045
              
              
              35,385Accrued
                  liabilities
              
              
              2,184,168
              
              
              1,863,189Total
                  current liabilities
              
              
              24,439,526
              
              
              21,289,361Long-term
                  debt, less current maturities
              
              
              10,387
              
              
              7,791Minority
                  interest in Rio Vista Energy Partners L.P.
              
              
              11,955,005
              
              
              11,313,151Commitments
                  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 June 30,
                  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 June 30, 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
                  June 30,
                  2006
              
              
              155,227
              
              
              155,227Additional
                  paid-in capital
              
              
              28,741,122
              
              
              28,947,526Note
                  receivable from a former officer of the Company for exercise of warrants,
                  less reserve of $1,500,000 and $1,578,889 at December 31, 2005
                  and June
                  30, 2006
              
              
              (1,696,693
              )
              
              (1,696,693
              )Accumulated
                  deficit
              
              
              (26,847,755
              )
              
              (27,484,651
              )Total
                  stockholders' equity (deficit)
              
              
              351,901
              
              
              (78,591
              )Total
                  liabilities and stockholders' equity (deficit)
              
              $
              36,756,819
              
              $
              32,531,712
 
 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 Ended
              
              Six
                  Months EndedJune
                  30,
                2005
              
              June
                  30,
                2006
              
              June
                  30,
                2005
              
              June
                  30,
                2006Revenues
              
              $
              52,262,580
              
              $
              66,943,426
              
              $
              111,989,474
              
              $
              136,271,690Cost
                  of goods sold
              
              
              52,174,553
              
              
              65,994,563
              
              
              109,512,498
              
              
              134,054,187Gross
                  profit
              
              
              88,027
              
              
              948,863
              
              
              2,476,976
              
              
              2,217,503Selling,
                  general and administrative expensesLegal
                  and professional fees
              
              
              565,022
              
              
              465,941
              
              
              1,012,448
              
              
              853,284Salaries
                  and payroll related expenses
              
              
              1,574,149
              
              
              363,048
              
              
              2,222,599
              
              
              917,254Other
              
              
              452,161
              
              
              500,475
              
              
              972,588
              
              
              998,4982,591,332
              
              
              1,329,464
              
              
              4,207,635
              
              
              2,769,036Operating
                  income (loss)
              
              
              (2,503,305
              )
              
              (380,601
              )
              
              (1,730,659
              )
              
              (551,533
              )Other
                  income (expense)Interest
                  and LPG and Fuel Products financing expense
              
              
              (424,075
              )
              
              (397,495
              )
              
              (816,017
              )
              
              (751,505
              )Interest
                  income
              
              
              5,290
              
              
              13,524
              
              
              9,654
              
              
              22,985Minority
                  interest in (earnings) loss of RioVista Energy Partners
                  L.P.
              
              
              713,232
              
              
              425,418
              
              
              544,186
              
              
              671,746Income
                  (loss) before taxes
              
              
              (2,208,858
              )
              
              (339,154
              )
              
              (1,992,836
              )
              
              (608,307
              )Provision
                  for income tax
              
              
              14,237
              
              
              14,663
              
              
              33,847
              
              
              28,588Net
                  income (loss)
              
              $
              (2,223,095
              )
              $
              (353,817
              )
              $
              (2,026,683
              )
              $
              (636,895
              )Net
                  income (loss) per common share
              
              $
              (0.14
              )
              $
              (0.02
              )
              $
              (0.13
              )
              $
              (0.04
              )Net
                  income (loss) per common share assuming dilution
              
              $
              (0.14
              )
              $
              (0.02
              )
              $
              (0.13
              )
              $
              (0.04
              )Weighted
                  average common shares outstanding
              
              
              15,522,745
              
              
              15,522,745
              
              
              15,472,710
              
              
              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)**
 
 Six
                  months endedJune
                  30,
                2005
              
              June
                  30,
                2006Cash
                  flows from operating activities:Net
                  income (loss)
              
              $
              (2,026,683
              )
              $
              (636,895
              )Adjustments
                  to reconcile net income to net cash (used in) provided by operating
                  activities:Depreciation
                  and amortization
              
              
              511,296
              
              
              500,955Amortization
                  of lease rights
              
              
              22,898
              
              
              22,898Amortization
                  of loan discount related to detachable warrants
              
              
              221,218
              
              
              22,104Provision
                  for doubtful accounts
              
              
              -
              
              
              63,958Share-based
                  payment expense
              
              
              -
              
              
              214,192Minority
                  interest in loss of Rio Vista Energy Partners L.P.
              
              
              (544,186
              )
              
              (671,746
              )Discount
                  of note receivable from former officer
              
              
              1,031,307
              
              
              -(Gain)
                  losson sale of assets
              
              
              (24,000
              )
              
              74,520Changes
                  in current assets and liabilities:Trade
                  accounts receivable
              
              
              2,733,067
              
              
              2,546,525Inventories
              
              
              1,499,718
              
              
              (715,792
              )Prepaid
                  expenses and other current assets
              
              
              (61,070
              )
              
              (89,256
              )LPG
                  and Fuel Products trade accounts payable
              
              
              (9,065,342
              )
              
              (6,841,551
              )Other
                  accounts payable and accrued liabilities
              
              
              1,162,841
              
              
              116,940U.S.
                  and Foreign taxes payable
              
              
              (24,293
              )
              
              14,340Net
                  cash used in operating activities
              
              
              (4,563,229
              )
              
              (5,378,808
              )Cash
                  flows from investing activities:Capital
                  expenditures
              
              
              (61,533
              )
              
              (55,715
              )Proceeds
                  from sale of assets
              
              
              175,000
              
              
              130,776Decrease
                  in other non-current assets
              
              
              5,113
              
              
              1,514Net
                  cashprovided by investing activities
              
              
              118,580
              
              
              76,575Cash
                  flows from financing activities:Decrease
                  in restricted cash
              
              
              2,682,451
              
              
              1,564,110Revolving
                  credit facilities
              
              
              2,517,741
              
              
              4,187,804Issuance
                  of common stock
              
              
              97,750
              
              
              -Distributions
                  paid by Rio VistaEnergy Partners L.P. to limited partners
              
              
              (955,330
              )
              
              -Reduction
                  in debt
              
              
              (62,597
              )
              
              (630.296
              )Net
                  cash provided byfinancing activities
              
              
              4,280,015
              
              
              5,121,618Net
                  decrease in cash
              
              
              (164,634
              )
              
              (180,615
              )Cash
                  at beginning of period
              
              
              374,567
              
              
              299,597Cash
                  at end of period
              
              $
              209,933
              
              $
              118,982Supplemental
                  disclosures of cash flow information:Cash
                  paid during the period for:Interest
                  and LPG and Fuel Products financing expense
              
              $
              416,370
              
              $
              911,083Supplemental
                  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*
  **** **Penn
        Octane 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 connectthe Brownsville Terminal Facility
        to the Matamoros Terminal Facility (see note D). 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 (see note J).
 
 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 31.8% and 44.4% of the Company’s total revenues and 67.5% and
        85.5% of the Company’s LPG revenues for the three and six months ended June 30,
        2006, respectively. 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 52.8% and 48.0% of total revenues for the three and six
        months ended June 30, 2006, respectively.
 
 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 represented
        the
        general partner interest. The general partner interest is solely owned and
        controlled by Rio Vista GP LLC (General Partner), a wholly owned subsidiary
        of
        Penn Octane at June 30, 2006. On July 1, 2006, options to acquire 50% of
        the
        General Partner were exercised, resulting in Penn Octane having a 50% interest
        in the General Partner. Penn Octane retains control over the General Partner
        pursuant to a voting agreement. Therefore, Rio Vista is consolidated with
        the
        Company and the interests of the General Partner not owned by Penn Octane
        and
        the interests of the limited partners are classified as minority interests
        in
        the Company’s unaudited consolidated financial statements. The General Partner
        is responsible for the management of Rio Vista. 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 June 30, 2006, the unaudited
        consolidated statements of operations for the three months and six months
        ended
        June 30, 2005 and 2006 and the unaudited consolidated statements of cash
        flows
        for the six months ended June 30, 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 June 30, 2006, the unaudited
        consolidated results of operations for the three months and six months ended
        June 30, 2005 and 2006 and the unaudited consolidated statements of cash
        flows
        for the six months ended June 30, 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 June 30, 2005Income
                    (Loss)
                  (Numerator)
              
              Shares
                  (Denominator)
              
              Per-ShareAmountNet
                  income (loss)
              
              $
              (2,223,095
              )**Basic
                  EPS**Net
                  income (loss) available to common stockholders
              
              
              (2,223,095
              )
              
              15,522,745
              
              $
              (0.14
              )**Effect
                  of Dilutive Securities**Warrants
              
              
              -
              
              
              -**Diluted
                  EPS**Net
                  income (loss) available to common stockholders
              
              
              N/A
              
              
              N/A
              
              
              N/A
  For
                    the three months ended June 30, 2006Income
                      (Loss)(Numerator)
                
                Shares(Denominator)
                
                Per-ShareAmountNet
                    income (loss)
                
                $
                (353,817
                )**Basic
                    EPS**Net
                    income (loss) available to common stockholders
                
                
                (353,817
                )
                
                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
        B -**  **INCOME
        (LOSS)**  **PER
        COMMON SHARE** **-
        Continued**
 
 For
                  the six months ended June 30, 2005Income
                  (Loss)
                (Numerator)
              
              Shares
                (Denominator)
              
              Per-Share
                AmountNet
                  income (loss)
              
              $
              (2,026,683
              )**Basic
                  EPS**Net
                  income (loss) available to common stockholders
              
              
              (2,026,683
              )
              
              15,472,710
              
              $
              (0.13
              )**Effect
                  of Dilutive Securities**Warrants
              
              
              -
              
              
              -**Diluted
                  EPS**Net
                  income (loss) available to common stockholders
              
              
              N/A
              
              
              N/A
              
              
              N/A
 
 For
                  the six months ended June 30, 2006Income
                  (Loss)
                (Numerator)
              
              Shares
                (Denominator)
              
              Per-Share
                AmountNet
                  income (loss)
              
              $
              (636,895
              )**Basic
                  EPS**Net
                  income (loss) available to common stockholders
              
              
              (636,895
              )
              
              15,522,745
              
              $
              (0.04
              )**Effect
                  of Dilutive Securities**Warrants
              
              
              -
              
              
              -**Diluted
                  EPS**Net
                  income (loss) available to common stockholders
              
              
              N/A
              
              
              N/A
              
              
              N/A
  11
 *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 three months and six months ended June 30,
        2006, the Company recorded share-based payment expense of $81,733 and $214,192,
        respectively, 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 and six months ended June
        30,
        2005:
 
 Three
                  Months
                Ended
              
              Six
                  Months
                EndedJune
                  30, 2005
              
              June
                  30, 2005Net
                  income (loss), as reported
              
              $
              (2,223,095
              )
              $
              (2,026,683
              )Add: 
                  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
              
              
              (120,023
              )
              
              (160,413
              )Net
                  income (loss), pro forma
              
              $
              (2,343,118
              )
              $
              (2,187,096
              )Net
                  income (loss) per common share, as reported
              
              $
              (0.14
              )
              $
              (0.13
              )Net
                  income (loss) per common share, pro forma
              
              $
              (0.15
              )
              $
              (0.14
              )Net
                  income (loss) per common share assuming dilution, as
                  reported
              
              $
              (0.14
              )
              $
              (0.13
              )Net
                  income (loss) per common share assuming dilution, pro
                  forma
              
              $
              (0.15
              )
              $
              (0.14
              )
  12
 *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 provided for the sale and assignment of all of their respective LPG
        assets
        and refined products assets (LPG Asset Sale) including the Brownsville Terminal
        Facility, the refined products tank farm and associated leases, owned pipelines
        located in the United States, including land, leases, and rights of ways,
        LPG
        inventory, assignment of the lease of the Leased Pipeline, PMI sales agreement
        and Exxon Supply Contract (see note K) and100% of the outstanding stock of
        its
        Mexican subsidiaries. Rio Vista’s Mexican subsidiaries and consolidated
        affiliate own pipelines in Mexico and the Matamoros Terminal Facility, including
        land and rights of way. Penn Octane’s agreement with TransMontaigne did not
        include any assets related to the Fuel Sales Business. The purchase price
        was
        $10,100,000 for assets to be sold by Penn Octane and $17,400,000 for assets
        to
        be sold by Rio Vista.
 
 In
        connection with the PSA’s, TransMontaigne loaned Rio Vista $1,300,000
        (TransMontaigne Note) which was 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 in accordance with its terms, 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
        would be required under the TransMontaigne Note. If the $1,300,000 is repaid
        to
        TransMontaigne, the lease payments will cease and title to the Collateral
        will
        be re-conveyed to Rio Vista.
 
 The
        closing of the LPG Asset Sale was 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 provided that any party could terminate the
        agreements if closing did not occur on or before October 31, 2005. None of
        the
        parties elected to terminate the agreements and the parties continued to
        work
        towards the closing of the LPG Asset Sale.
 
 On
        August
        11, 2006, Penn Octane and TransMontaigne entered into an amended and restated
        purchase and sale agreement (Penn Octane Restated PSA) with an effective
        date of
        August 15, 2006, which provides for the sale and assignment of all of Penn
        Octane’s LPG assets, including assignment of the lease of the Leased Pipeline
        and the Exxon Supply Contract, on terms substantially similar to Penn Octane’s
        PSA. Penn Octane will retain assets related to its Fuel Sales Business, and
        its
        interest in the General Partner. The purchase price for assets to be sold
        under
        the Penn Octane Restated PSA is $10,100,000, subject to certain adjustments.
        The
        Penn Octane Restated PSA provides for a closing date no sooner than August
        22,
        2006 and is subject to several conditions, including the concurrent closing
        of
        the Rio Vista Restated PSA (see below), the assignment of LPG related contracts,
        the consent of RZB and the modification satisfactory to TranMontaigne of
        the
        temporary injunction issued on June 13, 2006 (see note I). The Penn Octane
        Restated PSA provides that any party can terminate the agreement if closing
        does
        not occur on or before October 1, 2006.
  13
 *Table
              of Contents*
 
 **Penn
        Octane Corporation and Subsidiaries**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
  **NOTE
        D - PURCHASE AND SALE AGREEMENT - Continued**
 
 Also
        on
        August 11, 2006, Rio Vista and TransMontaigne entered into an amended and
        restated purchase and sale agreement (Rio Vista Restated PSA) with an effective
        date of August 15, 2006, which provides for the sale and assignment of only
        the
        LPG assets, including the Brownsville Terminal Facility, the refined products
        tank farm and associated leases, and LPG inventory, wherever located,
        (collectively, the Brownsville Terminal Assets) and assignment of the 2006
        PMI
        Agreement (see note K) (Brownsville Terminal Assets and the 2006 PMI Agreement
        collectively, the Acquired Assets). Rio Vista will retain its owned pipelines
        located in the United States, including land, leases and rights of way and
        100%
        of the outstanding stock of its Mexican subsidiaries. Rio Vista’s Mexican
        subsidiaries and consolidated affiliate own pipelines in Mexico and the
        Matamoros Terminal Facility, including land and rights of way (collectively,
        the
        Retained Assets). The purchase price for the Acquired Assets under the Rio
        Vista
        Restated PSA is $8,300,000, subject to certain adjustments. In addition,
        under
        the Rio Vista Restated PSA, TransMontaigne has agreed to exclusively use
        the
        services and Retained Assets of Rio Vista on a fee basis for purposes of
        transportation of LPG to be delivered into northeastern Mexico and/or LPG
        sold
        pursuant to the 2006 PMI Agreement (LPG Transportation Agreement). Rio Vista
        has
        agreed not to transport LPG through Rio Vista’s assets in Mexico except on
        behalf of TransMontaigne, subject to certain conditions. In addition, under
        the
        Rio Vista Restated PSA, TransMontaigne agreed to provide routine and non-routine
        operation and maintenance services for the U.S. portion only of Rio Vista’s
        pipelines between Brownsville, Texas and Matamoros, Mexico (U.S. Pipeline
        Services Agreement). TransMontaigne agreed to provide the routine services
        at
        its sole cost and expense. For the non-routine services, Rio Vista agreed
        to
        reimburse TransMontaigne for all costs actually incurred in performing the
        services and all materials and supplies provided in connection with such
        services, plus 15%. Rio Vista has also granted TransMontaigne certain rights
        of
        first refusal and first offer with respect to a sale of the Retained Assets
        by
        Rio Vista to any third party. The Rio Vista Restated PSA provides for a closing
        date no sooner than August 22, 2006 and is subject to several conditions,
        including the concurrent closing of the Penn Octane Restated PSA, assignment
        of
        LPG related contracts, the consent of RZB and the modification satisfactory
        to
        TranMontaigne of the temporary injunction issued on June 13, 2006 (see note
        I).
        The Rio Vista Restated PSA provides that either party may terminate the
        agreement if closing does not occur on or before October 1, 2006. The
        transactions contemplated by the Penn Octane Restated PSA and the Rio Vista
        Restated PSA are hereafter referred to as the Restated LPG Asset Sale. The
        Penn
        Octane Restated PSA and the Rio Vista Restated PSA are hereafter referred
        to as
        the Restated PSA’s. Under the Restated LPG Asset Sale, the purchase price will
        be reduced for certain adjustments and amounts reserved totaling $983,350
        of
        which $851,173 relates to Rio Vista.
 
 Under
        the
        terms of the Rio Vista Restated PSA, $300,000 of the TransMontaigne Note
        will be
        repaid on the closing of the Rio Vista Restated PSA and the remaining balance
        of
        $1,000,000 of the TransMontaigne Note will be restructured to provide for
        the
        repayment of principal one year from the closing date of the Rio Vista Restated
        PSA. Rio Vista will be required to prepay a portion of the TransMontaigne
        Note
        in an amount equal to the excess of amounts held in reserve for the payment
        of
        certain obligations of Rio Vista over actual amounts required as specified
        in
        the Rio Vista Restated PSA. Upon the closing of the Restated LPG Asset Sale,
        the
        collateral of the TransMontaigne Note will be changed to consist of the US
        portion of the eight-inch pipeline owned by Rio Vista. The TransMontaigne
        Note
        bears interest at the rate of prime (8.25% as of June 30, 2006) plus 2% annually
        and interest is payable monthly.
 
 In
        connection with the Restated LPG Asset Sale, Penn Octane intends to use
        approximately $1,000,000 of its proceeds to pay off the remaining amounts
        owed
        under the Restructured Notes and $280,000 Notes including accrued interest.
        Penn
        Octane intends to use the balance of the proceeds from the Restated LPG Asset
        Sale to fund working capital requirements and to pursue activities intended
        to
        enhance stockholder value. Penn Octane estimates that it may have a federal
        tax
        liability of approximately $1,500,000 in connection with the Restated LPG
        Asset
        Sale after utilization of available net operating loss carryforward as of
        December 31, 2005.
 
 14
 *Table
              of Contents*
 
 **Penn
        Octane Corporation and Subsidiaries**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
  **NOTE
        D - PURCHASE AND SALE AGREEMENT - Continued**
 
 Rio
        Vista
        intends to use any remaining proceeds to fund working capital requirements
        and
        to pursue activities intended to enhance unitholder value.
 
 Th e
        following unaudited pro forma consolidated financial information (Pro Forma
        Statements) for the Company gives effect to the Restated PSA’s. The unaudited
        pro forma consolidated balance sheet assumes that the Restated PSA’s was
        consummated on June 30, 2006. The unaudited pro forma consolidated statement
        of
        operations for the six months ended June 30, 2006 assumes that the Restated
        PSA’s 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 unaudited consolidated financial statements and notes thereto included
        herein.
 
 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**
 **PRO
        FORMA CONSOLIDATED BALANCE SHEET**  **AT
        JUNE 30, 2006**
 **(Unaudited)**
  **As
                    Reported**
                  **June
                    30, 2006**
                
                **Pro
                    Forma**
                  **Adjustments**
                
                
                
                **Pro
                    Form**
                  **June
                    30, 2006****ASSETS**Current
                    AssetsCash
                
                $
                118,982
                
                $
                18,400,000
                
                
                (1
                )
                $
                16,225,944(983,350
                )
                
                (1
                )(1,009,688
                )
                
                (3
                )(300,000
                )
                
                (3
                )Restricted
                    cash
                
                
                4,093,513
                
                
                
                
                
                
                
                
                4,093,513Trade
                    accounts receivable, net
                
                
                9,860,408
                
                
                
                
                
                
                
                
                9,860,408Inventories
                
                
                3,594,060
                
                
                (1,278,678
                )
                
                (1
                )
                
                2,315,382Prepaid
                    expenses and other current assets
                
                
                189,528
                
                
                
                
                
                
                
                
                189,528Total
                    current assets
                
                
                17,856,491
                
                
                14,828,284
                
                
                
                
                
                32,684,775Property,
                    plant and equipment — net
                
                
                14,332,711
                
                
                (3,306,577
                )
                
                (1
                )
                
                11,026,134Lease
                    rights — net
                
                
                312,935
                
                
                (312,935
                )
                
                (1
                )
                
                -Other
                    non-current assets
                
                
                29,575
                
                
                
                
                
                
                
                
                29,575Total
                    assets
                
                $
                32,531,712
                
                $
                11,208,772
                
                
                
                
                $
                43,740,484**LIABILITIES
                    AND STOCKHOLDERS’ EQUITY**Current
                    LiabilitiesCurrent
                    maturities of long-term debt
                
                $
                2,405,425
                
                $
                (940,000
                )
                
                (3
                )
                $
                165,425(1,000,000
                )
                
                (8
                )(300,000
                )
                
                (3
                )Revolving
                    line of credit
                
                
                4,748,087
                
                
                
                
                
                
                
                
                4,748,087LPG
                    and Fuel Products trade accounts payable
                
                
                10,046,769
                
                
                
                
                
                
                
                
                10,046,769U.S.
                    and foreign taxes payable
                
                
                35,385
                
                
                1,500,000
                
                
                (5
                )
                
                1,535,385Other
                    accounts payable
                
                
                2,190,506
                
                
                
                
                
                
                
                
                2,190,506Accrued
                    liabilities
                
                
                1,863,189
                
                
                (69,688
                )
                
                (3
                )
                
                1,843,50150,000
                
                
                (4
                )Total
                    current liabilities
                
                
                21,289,361
                
                
                (759,688
                )
                
                
                
                
                20,529,673Long-term
                    debt, less current maturities
                
                
                7,791
                
                
                1,000,000
                
                
                (8
                )
                
                1,007,791Minority
                    interest in Rio Vista Energy Partners L.P.
                
                
                11,313,151
                
                
                5,040,430
                
                
                (6
                )
                
                16,353,581Stockholders’
                    EquityCommon
                    stock
                
                
                155,227
                
                
                
                
                
                
                
                
                155,227Additional
                    paid in capital
                
                
                28,947,526
                
                
                
                
                
                
                
                
                28,947,526Notes
                    receivable from a former officer of the Company
                
                
                (1,696,693
                )
                
                252,453
                
                
                (7
                )
                
                (1,444,240
                )Accumulated
                    deficit
                
                
                (27,484,651
                )
                
                12,518,460
                
                
                (1
                )
                
                (21,809,074
                )(1,500,000
                )
                
                (5
                )(5,040,430
                )
                
                (6
                )(252,453
                )
                
                (7
                )(50,000
                )
                
                (4
                )Total
                    stockholders’ equity (deficit)
                
                
                (78,591
                )
                
                5,928,030
                
                
                
                
                
                5,849,439Total
                    liabilities and stockholders’ equity (deficit)
                
                $
                32,531,712
                
                $
                11,208,772
                
                
                
                
                $
                43,740,484
  16
 *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**
 **FOR
        THE SIX MONTHS ENDED JUNE 30, 2006**
 **(Unaudited)**
 
 **As
                  Reported**
                **June
                  30, 2006**
              
              **Pro
                  Forma**
                **Adjustments**
              
              
              
              **Pro
                  Forma**
                **June
                  30, 2006**Revenues
              
              $
              136,271,690
              
              $
              (69,410,275
              )
              
              (2
              )
              $
              66,861,415Cost
                  of Goods Sold
              
              
              134,054,187
              
              
              (68,778,758
              )
              
              (2
              )
              
              65,275,429Gross
                  Profit
              
              
              2,217,503
              
              
              (631,517
              )
              
              
              
              
              1,585,986Selling,
                  general and administrative expensesLegal
                  and professional fees
              
              
              853,284
              
              
              (50,976
              )
              
              (2
              )
              
              802,308Salaries
                  and payroll related expenses
              
              
              917,254
              
              
              
              
              
              
              
              
              917,254Other
              
              
              998,498
              
              
              
              
              
              
              
              
              998,4982,769,036
              
              
              (50,976
              )
              
              
              
              
              2,718,060Operating
                  income (loss)
              
              
              (551,533
              )
              
              (580,541
              )
              
              
              
              
              (1,132,074
              )Other
                  income (expense)Interest
                  and LPG and Fuel Productsfinancing
                  expense
              
              
              (751,505
              )
              
              510,950
              
              
              (2
              )
              
              (240,555
              )Interest
                  income
              
              
              22,985
              
              
              (1,369
              )
              
              (2
              )
              
              21,616Gain
                  on LPG Asset Sale
              
              
              
              
              
              12,879,605
              
              
              (1
              )
              
              11,562,331(333,924
              )
              
              (7
              )(983,350
              )
              
              (1
              )Minority
                  interest in earnings or loss ofRio
                  Vista Energy Partners L.P.
              
              
              671,746
              
              
              (4,921,225
              )
              
              (6
              )
              
              (4,249,479
              )Income
                  (loss) before taxes
              
              
              (608,307
              )
              
              6,570,146
              
              
              
              
              
              5,961,839Provision
                  for income taxes
              
              
              28,588
              
              
              1,500,000
              
              
              (5
              )
              
              1,528,588Net
                  income (loss)
              
              $
              (636,895
              )
              $
              5,070,146
              
              
              
              
              $
              4,433,251Net
                  income (loss) per common share
              
              $
              (0.04
              )
              
              
              
              
              
              
              $
              0.29Net
                  income (loss) per common share assuming dilution
              
              $
              (0.04
              )
              
              
              
              
              
              
              $
              0.29Weighted
                  average common shares outstanding
              
              
              15,522,745
              
              
              
              
              
              
              
              
              15,522,745
  17
 *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**
 **June
        30, 2006**
 **(Unaudited)**
  (1)
              To
                  reflect the Restated PSA’s, including net proceeds received and the
                  resulting gain. This amount assumes reductions to the purchase
                  price for
                  certain adjustments and reserves of $983,350.(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 and payment of a portion of principal and all accrued
                  interest
                  on the TransMontaigne Note.(4)
              To
                  accrue for estimated expenses associated with the Restated
                  PSA’s.(5)
              To
                  accrue for federal and state taxes estimated to result from the
                  Restated
                  PSA’s.(6)
              To
                  record minority interest in the equity in the earnings of Rio Vista
                  in
                  connection with the Restated PSA’s.(7)
              To
                  accrue fee due to Jerome B. Richter in connection with the Restated
                  PSA’s
                  and offset gainst receivables from Mr. Richter (see note
                  J).(8)
              To
                  reclass the TransMontaigne Note to long-term debt in connection
                  with the
                  Restated PSA’s.
 
 18
 *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,
              
              June
                  30,2005
              
              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
              
              
              6,919,046Mexico
                  Pipelines and Rights of Way
              
              
              993,300
              
              
              1,038,300Matamoros
                  Terminal Facility
              
              
              5,874,781
              
              
              5,646,822Land
              
              
              705,358
              
              
              705,35814,488,209
              
              
              14,309,526Total
                  LPG
              
              
              21,564,906
              
              
              21,386,223Other:Office
                  equipment (b)
              
              
              108,487
              
              
              114,926Software
                  (b)
              
              
              57,163
              
              
              57,163165,650
              
              
              172,08921,730,556
              
              
              21,558,312Less:
                  accumulated depreciation and amortization
              
              
              (6,747,309
              )
              
              (7,225,601
              )$
              14,983,247
              
              $
              14,332,711
 
 (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
        $4,962,874 of costs located in Mexico at December 31, 2005 and June 30, 2006,
        respectively.
 
 19
 *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
              
              June
                  30, 2006Gallons
              
              LCM
              
              Gallons
              
              LCMLPG:Leased
                  Pipeline
              
              
              1,175,958
              
              $
              1,266,040
              
              
              1,175,958
              
              $
              1,277,622Brownsville
                  Terminal Facility and Matamoros Terminal Facility
              
              
              349,564
              
              
              376,342
              
              
              240,007
              
              
              260,756Markham
                  Storage and other
              
              
              33,535
              
              
              36,104
              
              
              -
              
              
              -1,559,057
              
              
              1,678,486
              
              
              1,415,965
              
              
              1,538,378Fuel
                  Products
              
              
              687,115
              
              
              1,199,782
              
              
              917,513
              
              
              2,055,682$
              2,878,268
              
              
              
              
              $
              3,594,060
 
 **NOTE
        G - DEBT OBLIGATIONS**
  Debt
          obligations are as follows:
 December
                  31,
                2005
              
              June
                  30,
                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
              
              
              940,000TransMontaigne
                  Note (see note D)
              
              
              1,300,000
              
              
              1,300,000Other
                  debt
              
              
              37,941
              
              
              35,716Total
                  debt
              
              
              3,025,441
              
              
              2,413,216Less:Current
                  maturities
              
              
              3,015,054
              
              
              2,405,425Long-term
                  debt
              
              $
              10,387
              
              $
              7,791
 
 At
        June
        30, 2006, the Restructured Notes and the $280,000 Notes (collectively the
        Notes)
        have a face value of $940,000, 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.
 
 20
 *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
        of
        the warrants, the Company recorded additional interest expense of approximately
        $22,000. The Notes have not been renewed or extended since December 15,
        2005.
 
 During
        May 2006, the Company paid $61,418 to the holders of the Notes representing
        accrued interest and fees through March 15, 2006.
 
 During
        June 2006, the Company paid $212,474 to the holders of the Notes representing
        $145,000 of principal and $67,474 of accrued interest and fees through June
        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.
 
 21
 *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**
  On
        July
        1, 2006, Penn Octane’s 100% interest in the General Partner was 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 was approximately $82,000. Mr. Richter’s
        option was amended to permit payment of the exercise price by surrender of
        Penn
        Octane common stock having a fair market value equal to the exercise price.
        Mr.
        Richter paid the exercise price for his options by surrender of 136,558 shares
        of Penn Octane common stock. In connection with the exercise of the General
        Partner Options, Penn Octane retained voting control of the General Partner
        pursuant to a voting agreement with each of Shore Capital and Mr. Richter.
 
 **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 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 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 vested 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.
 
 22
 *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
        June 30, 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. The March 31, 2006 review
        was
        deferred on a month to month basis while the Company continued to pursue
        the LPG
        Asset Sale. 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 (8.25% at June 30, 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 June 30, 2006 totaled approximately
        $13,817,000 of which approximately $9,999,000 represents June 2006 purchases
        and
        approximately $3,818,000 represents July 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
        $3,593,000 at June 30, 2006). At June 30, 2006, the Company’s borrowings and
        commitments were less than the amount of the Assets.
 
 23
 *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 June 30, 2006, such taxes in the
        amount
        of approximately $785,000 were due. The letters of credit issued have all
        been
        secured by cash in the amount of approximately $474,000 which is included
        in
        restricted cash in the Company’s balance sheet at June 30, 2006.
 
 LPG
        and
        Fuel Products financing expense associated with the RZB Credit Facility totaled
        $166,615 and $285,808 for the three months ended June 30, 2005 and 2006,
        respectively, and $369,925 and $525,576 for the six months ended June 30,
        2005
        and 2006, respectively.
 
 **Amended
        Leased Pipeline Lease Agreement**
 
 On
        July
        21, 2006, the Company and Seadrift entered into an amended and restated lease
        agreement (Amended Lease) for the Leased Pipeline. The Amended Lease is
        effective August 1, 2006 and expires on December 31, 2013. Pursuant to the
        terms
        of the Amended Lease, the Company will have the exclusive right to transport
        materials through the Leased Pipeline, and Seadrift will no longer have certain
        rights to utilize the pipeline for its own purposes as provided in the original
        lease agreement. In addition, the Company will no longer be required to make
        minimum payments for propane storage in Markham, Texas and will no longer
        have
        access to such storage. The Company will also no longer have access to the
        Ella-Seadrift pipeline (running approximately 155 miles between Markham and
        the
        King Ranch Gas Plant) or to access other propane suppliers via such pipeline.
        The Company has agreed to indemnify Seadrift for environmental liabilities,
        including claims relating to the condition of the leased property and any
        environmental remediation costs, arising after the inception date of the
        lease,
        September 1, 1993. Seadrift has agreed to indemnify the Company for similar
        environmental liabilities arising before that date. The Company’s lease
        payments, which previously consisted of fixed amounts plus certain variable
        charges and periodic increases, will now consist of a fixed annual amount
        of
        $1,600,000 (total lease expenses for the year ended December 31, 2005 were
        approximately $1,400,000). The Company may assign the Amended Lease to a
        third
        party with Seadrift’s written consent, which consent may not be unreasonably
        withheld.
 
 **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 subject to any reserves determined by the General Partner.
        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.
 
 24
 *Table
              of Contents*
 
 **Penn
        Octane Corporation and Subsidiaries**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
  **NOTE
        J - COMMITMENTS AND CONTINGENCIES - Continued**
 
 **Distributions
        of Available Cash - Continued**
 
 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. As a result of the exercise of the General Partner Options,
        Penn
        Octane will only be entitled to receive up to 50% of any distributions paid
        in
        the future by Rio Vista distributed by the General Partner, including any
        distributions associated with arrearages prior to the exercise of the General
        Partner Options.
 
 **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.
 
 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.
 
 25
 *Table
              of Contents*
 
 **Penn
        Octane Corporation and Subsidiaries**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
  **NOTE
        J - COMMITMENTS AND CONTINGENCIES - Continued**
 
 **Partnership
        Tax Treatment - Continued**
 
 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.
  **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. Neither 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, neither 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. 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. 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. On June 13,
        2006,
        the plaintiffs requested, and the court granted, an order for a temporary
        injunction requiring a subsidiary of Rio Vista to make available for inspection
        by plaintiffs Rio Vista’s terminal facilities in Brownsville, Texas and
        Matamoros, Mexico and associated equipment and records. The order also requires
        Rio Vista to give 30 days advance notice to plaintiffs before conducting
        any
        alteration, repair, service, work or changes to the facilities or equipment.
        In
        addition, the order requires Rio Vista to make available its employees for
        deposition by the plaintiffs and to secure and preserve certain physical
        evidence believed to be located in Mexico. The temporary injunction was issued
        without prior notice to, or opportunity to contest by, Penn Octane or Rio
        Vista.
        The terms of the temporary injunction are broader than the order as agreed
        by
        the parties on November 29, 2005. Accordingly, Rio Vista has filed a motion
        to
        set aside the temporary injunction and to enter a more limited order consistent
        with the November 29, 2005 agreement between the parties. A hearing on Rio
        Vista’s motion has been scheduled for August 24, 2006. Limited discovery has
        been conducted to date.
 
 26
 *Table
              of Contents*
 
 **Penn
        Octane Corporation and Subsidiaries**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
  **NOTE
        J - COMMITMENTS AND CONTINGENCIES - Continued**
 
 **Litigation
        - Continued**
 
 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.
 
 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.
 
 On
        December 14, 2004, a subsidiary of Rio Vista brought a condemnation action
        against a landowner in order to obtain a right-of-way in connection with
        Rio
        Vista’s existing pipelines that run between Brownsville, Texas and Matamoros,
        Mexico. The case is captioned *Rio
        Vista Operating Partnership L.P. vs. Guajardo, Jr. Farms, Inc.* ,
        and was
        filed in the County Court No. 3 of Cameron County, Texas. In October, 2005,
        special commissioners appointed by the court awarded $100,000 to the landowner
        in connection with the condemnation action. Pursuant to the award, Rio Vista
        deposited $100,000 into the Registry of the Court on November 17, 2006. The
        Company is currently challenging this award in the trial court. Subsequently,
        the landowner filed an inverse condemnation counterclaim against Rio Vista
        and
        Penn Octane seeking damages of $1,800,000. The Company moved for summary
        judgment against the landowner on its counterclaim. 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 landowner has subsequently amended his counterclaim seeking
        damages of $273,000 as rent. The parties are currently conducting discovery
        and
        a trial date is set for January 8, 2007.
 
 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.
 
 27
 *Table
              of Contents*
 
 **Penn
        Octane Corporation and Subsidiaries**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
  **NOTE
        J - COMMITMENTS AND CONTINGENCIES - Continued**
 
 **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 2005 PMI Agreement
        (see Note K). Amounts expensed pursuant to (ii) above for the six months
        ended
        June 30, 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.
 
 **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 (2005
        PMI
        Agreement).
  On
        March
        31, 2006, the 2005 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 2005 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 was
        subject to execution of a definitive written agreement between Rio Vista
        and
        PMI. The agreement (2006 PMI Agreement) was executed during July 2006 with
        the
        terms specified in the PMI Confirmation. The 2006 PMI Agreement 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
        2006
        PMI Agreement.
 
 28
 *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 2006 PMI Agreement
        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 2006 PMI Agreement.
  The
        following table sets forth the minimum monthly volume of LPG that PMI committed
        to purchase from the Company pursuant to the 2005 PMI Agreement, the April
        2006
        monthly contract and the 2006 PMI Agreement and the actual volumes purchased
        for
        the months January 2006 through July 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
              11,606,435April
                  2006
              6,000,000
              6,035,733May
                  2006
              4,500,000
              5,733,193June
                  2006
              4,500,000
              7,130,666July
                  2006
              4,500,000
              4,937,441August
                  2006
              4,500,000
              *September
                  2006
              4,500,000
              *October
                  2006
              8,100,000
              *November
                  2006
              8,100,000
              *December
                  2006
              9,000,000
              *January
                  2007
              9,000,000
              *February
                  2007
              8,100,000
              *March
                  2007
              8,100,000
              **
                  Not yet available
  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.
 
 29
 *Table
              of Contents*
 
 **Penn
        Octane Corporation and Subsidiaries**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **(UNAUDITED)**
 
 **NOTE
        K - CONTRACTS - Continued**
 
 **LPG
        Sales to PMI - Continued**
 
 Revenues
        from PMI totaled approximately $21,299,000 and $60,537,000 for the three
        and six
        months ended June 30, 2006, respectively, representing approximately 31.8%
        and
        44.4% of total revenues for the three and six months ended June 30, 2006,
        respectively.
 
 **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 June 30, 2006, under the Exxon
        Supply Contract, Exxon has supplied an average of approximately 9,400,000
        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
        Confirmation.
  30
 *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 and six months ended
        June 30, 2006, has had an accumulated deficit since inception, has a deficit
        in
        working capital and a deficit in stockholders’ equity. 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 $865,000 were paid in December
        2005, February 2006 and June 2006. Notes totaling $940,000 are still outstanding
        and have not been extended. The TransMontaigne Note may be due on demand
        by
        TransMontaigne unless the Restated LPG Asset Sale closes (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 2006 PMI Agreement
        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 2006 PMI Agreement. 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
        2006 PMI Agreement or that PMI will continue to purchase LPG from Rio Vista
        or
        in quantities or prices that are profitable upon the expiration of the 2006
        PMI
        Agreement. Assuming that the Restated 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 2006 PMI Agreement 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 2006 PMI Agreement 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.
 
 Penn
        Octane and Rio Vista project that monthly cash flows from LPG sales during
        the
        months of July 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 July 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 2006 PMI Agreement.
 
 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 Restated LPG Asset Sale does not close, Rio Vista projects that its gross
        profit from operations under the 2006 PMI Agreement, 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.
 
 31
 *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 Restated 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 Restated 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 Restated LPG Asset Sale.
        Management is also (i) seeking to expand its Fuel Sales Business and to further
        diversify its operations to reduce dependency on sales of LPG, (ii) seeking
        to
        maintain the amount of financing for its products and operations, and (iii)
        seeking to reduce supply costs and operating expenses. In the event that
        the
        Restated LPG Asset Sale is not closed, management may also continue to attempt
        to sell its LPG and refined products assets.
 
 32
 *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 proceeded 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, Restated LPG Asset Sale, the PMI Confirmation, 2006 PMI Agreement,
        TransMontaigne Note, 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 provided 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, the refined products tank farm
        and
        associated leases, owned pipelines located in the United States, including
        land,
        leases, and rights of ways, LPG inventory, assignment of the lease of the
        Leased
        Pipeline, PMI sales agreement and Exxon Supply Contract (see note K to the
        unaudited consolidated financial statements) and 100% of the outstanding
        stock
        of its Mexican subsidiaries. Rio Vista’s Mexican subsidiaries and consolidated
        affiliate own pipelines in Mexico and the Matamoros Terminal Facility, including
        land and rights of way. Penn Octane’s agreement with TransMontaigne did not
        include any assets related to the Fuel Sales Business. The purchase price
        was
        $10.1 million for assets to be sold by Penn Octane and $17.4 million for
        assets
        to be sold by Rio Vista.
 
 33
 *Table
              of Contents*
 
 In
        connection with the PSA’s, TransMontaigne loaned Rio Vista $1.3 million
        (TransMontaigne Note) which was 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 in accordance with its terms, 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
        would be required under the TransMontaigne Note. If the $1.3 million is repaid
        to TransMontaigne, the lease payments will cease and title to the Collateral
        will be re-conveyed to Rio Vista.
 
 The
        closing of the LPG Asset Sale was 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 provided that any party could terminate the
        agreements if closing did not occur on or before October 31, 2005. None of
        the
        parties elected to terminate the agreements and the parties continued to
        work
        towards the closing of the LPG Asset Sale.
 
 On
        August
        11, 2006, Penn Octane and TransMontaigne entered into an amended and restated
        purchase and sale agreement (the “Penn Octane Restated PSA”) with an effective
        date of August 15, 2006, which provides for the sale and assignment of all
        of
        Penn Octane’s LPG assets, including assignment of the lease of the Leased
        Pipeline and the Exxon Supply Contract, on terms substantially similar to
        Penn
        Octane’s PSA. Penn Octane will retain assets related to its Fuel Sales Business,
        and its interest in the General Partner. The purchase price for assets to
        be
        sold under the Penn Octane Restated PSA is $10.1 million, subject to certain
        adjustments. The Penn Octane Restated PSA provides for a closing date no
        sooner
        than August 22, 2006 and is subject to several conditions, including the
        concurrent closing of the Rio Vista Restated PSA (see below), the assignment
        of
        LPG related contracts, the consent of RZB and the modification satisfactory
        to
        TransMontaigne of the temporary injunction issued on June 13, 2006 (see note
        I).
        The Penn Octane Restated PSA provides that any party can terminate the agreement
        if closing does not occur on or before October 1, 2006.
 
 Also
        on
        August 11, 2006, Rio Vista and TransMontaigne entered into an amended and
        restated purchase and sale agreement (the “Rio Vista Restated PSA”) with an
        effective date of August 15, 2006, which provides for the sale and assignment
        of
        only the LPG assets, including the Brownsville Terminal Facility, the refined
        products tank farm and associated leases, and LPG inventory, wherever located,
        (collectively, the “Brownsville Terminal Assets”) and assignment of the 2006 PMI
        Agreement (see note K to the unaudited consolidated financial statements)
        (Brownsville Terminal Assets and the 2006 PMI Agreement collectively, the
        “Acquired Assets”). Rio Vista will retain its owned pipelines located in the
        United States, including land, leases and rights of way and 100% of the
        outstanding stock of its Mexican subsidiaries. Rio Vista’s Mexican subsidiaries
        and consolidated affiliate own pipelines in Mexico and the Matamoros Terminal
        Facility, including land and rights of way (collectively, the “Retained
        Assets”). The purchase price for the Acquired Assets under the Rio Vista
        Restated PSA is $8.3 million, subject to certain adjustments. In addition,
        under
        the Rio Vista Restated PSA, TransMontaigne has agreed to exclusively use
        the
        services and Retained Assets of Rio Vista on a fee basis for purposes of
        transportation of LPG to be delivered into northeastern Mexico and/or LPG
        sold
        pursuant to the 2006 PMI Agreement (the “LPG Transportation Agreement”). Rio
        Vista has agreed not to transport LPG through Rio Vista’s assets in Mexico
        except on behalf of TransMontaigne, subject to certain conditions. In addition,
        under the Rio Vista Restated PSA, TransMontaigne
        agreed to provide routine and non-routine operation and maintenance services
        for the
        U.S.
        portion only of Rio Vista’s pipelines between Brownsville, Texas and Matamoros,
        Mexico (the
“U.S. Pipeline Services Agreement”). TransMontaigne agreed to provide the
        routine services at its sole cost and expense. For the non-routine services,
        Rio
        Vista agreed to reimburse TransMontaigne for all costs actually incurred
        in
        performing the services and all materials and supplies provided in connection
        with such services, plus 15%. Rio
        Vista
        has also granted TransMontaigne certain rights of first refusal and first
        offer
        with respect to a sale of the Retained Assets by Rio Vista to any third party.
        The Rio Vista Restated PSA provides for a closing date no sooner than August
        22,
        2006 and is subject to several conditions, including the concurrent closing
        of
        the Penn Octane Restated PSA, assignment of LPG related contracts, the consent
        of RZB and the modification satisfactory to TransMontaigne of the temporary
        injunction issued on June 13, 2006 (see note I). The Rio Vista Restated PSA
        provides that either party may terminate the agreement if closing does not
        occur
        on or before October 1, 2006. The transactions contemplated by the Penn Octane
        Restated PSA and the Rio Vista Restated PSA are hereafter referred to as
        the
        Restated LPG Asset Sale. The Penn Octane Restated PSA and the Rio Vista Restated
        PSA are hereafter referred to as the Restated PSA’s. Under the Restated LPG
        Asset Sale, the purchase price will be reduced for certain adjustments and
        amounts reserved totaling $983,350 of which $851,173 relates to Rio
        Vista.
 
 34
 *Table
              of Contents*
 
 Under
        the
        terms of the Rio Vista Restated PSA, $300,000 of the TransMontaigne Note
        will be
        repaid on the closing date of the Rio Vista Restated PSA and the remaining
        balance of $1.0 million of the TransMontaigne Note will be restructured to
        provide for the repayment of principal one year from the closing date of
        the Rio
        Vista Restated PSA. Rio Vista will be required to prepay a portion of the
        TransMontainge Note in an amount equal to the excess of amounts held in reserve
        for the payment of certain obligations of Rio Vista over actual amounts required
        as specified in the Rio Vista Restated PSA. Upon the closing of the Restated
        LPG
        Asset Sale, the collateral of the TransMontaigne Note will be changed to
        consist
        of the US portion of the eight-inch pipeline owned by Rio Vista. The
        TransMontaigne Note bears interest at the rate of prime (8.25% as of June
        30,
        2006) plus 2% annually and interest is payable monthly.
 
 In
        connection with the Restated LPG Asset Sale, Penn Octane intends to use
        approximately $1.0 million of its proceeds to pay off the remaining amounts
        owed
        under the Restructured Notes and $280,000 Notes including accrued interest.
        Penn
        Octane intends to use the balance of the proceeds from the Restated LPG Asset
        Sale to fund working capital requirements and to pursue activities intended
        to
        enhance stockholder value. Penn Octane estimates that it may have a federal
        tax
        liability of approximately $1.5 million in connection with the Restated LPG
        Asset Sale after utilization of available net operating loss carryforward
        as of
        December 31, 2005.
 
 Rio
        Vista
        intends to use any remaining proceeds to fund working capital requirements
        and
        to pursue activities intended to enhance unitholder value.
 
 There
        can
        be no assurance that the Restated LPG Asset Sale will be completed according
        to
        the terms contained in the Restated PSA’s or according to different terms or at
        all. Even if the Restated 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 Restated LPG
        Asset
        Sale could have a material adverse effect on Penn Octane’s and Rio Vista’s
        business, financial condition and results of operations.
 
 Immediately
        following the closing of the Restated LPG Asset Sale, Penn Octane’s sources of
        cash flows are expected to be derived from net profits from the Fuel Sales
        Business, income from cash investments and any distributions from its General
        Partner interest in Rio Vista. Rio Vista’s sources of cash flows are expected to
        be derived from net profits from the LPG Transportation Agreement and income
        from cash investments.
 
 Upon
        the
        closing of the Restated LPG Asset Sale, the LPG Supply Agreement between
        Penn
        Octane and Rio Vista will be terminated. In connection with the Omnibus
        Agreement, Penn Octane will continue to be entitled to reimbursement of costs
        incurred by it on behalf of Rio Vista. Neither Penn Octane nor Rio Vista
        can be
        certain that future cash flows will be adequate to cover all of their working
        capital requirements, including minimum distributions of Rio Vista.
 
 
 *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 and six months ended June 30, 2006, the Company derived 31.8% and
        44.4% of its total revenues and 67.5% and 85.5% of LPG revenues from sales
        of
        LPG to PMI, its primary customer.
 
 35
 *Table
              of Contents*
 
 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 $35.4 million and $65.5 million in revenues
        for
        the three months and six months ended June 30, 2006, respectively, which
        represents approximately 52.8% and 48.0% of total revenues,
        respectively.
 
 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 represented
        the
        general partner interest. The general partner interest is solely owned and
        controlled by Rio Vista GP LLC (General Partner), a wholly owned subsidiary
        of
        Penn Octane at June 30, 2006. On July 1, 2006, options to acquire 50% of
        the
        General Partner were exercised, resulting in Penn Octane having a 50% interest
        in the General Partner. Penn Octane retains control over the General Partner
        pursuant to a voting agreement. Therefore, Rio Vista is consolidated with
        the
        Company and the interests of the General Partner not owned by Penn Octane
        and
        the interests of the limited partners are classified as minority interests
        in
        the Company’s unaudited consolidated financial statements. The General Partner
        is responsible for the management of Rio Vista. 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.
 
 **LPG
        Sales**
 
 The
        following table shows the Company's volume sold in gallons and average sales
        price for LPG for the  three
        months and six months ended June 30, 2005 and 2006;
 
 Three
                  months ended
                June
                  30, 2005
              
              Three
                  months ended
                June
                  30, 2006
              
              Six
                  months ended
                June
                  30, 2005
              
              Six
                  months ended
                June
                  30, 2006Volume
                  SoldLPG
                  (millions of gallons) - PMI
              
              
              20.4
              
              
              18.9
              
              
              52.7
              
              
              57.2LPG
                  (millions of gallons) - Other
              
              
              8.4
              
              
              10.0
              
              
              12.0
              
              
              10.028.8
              
              
              28.9
              
              
              64.7
              
              
              67.2Average
                  sales priceLPG
                  (per gallon) - PMI
              
              $
              0.90
              
              $
              1.13
              
              $
              0.89
              
              $
              1.06LPG
                  (per gallon) - Other
              
              
              0.82
              
              
              1.03
              
              
              0.78
              
              
              1.03
  36
 *Table
              of Contents*
 
 ***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.
  **Fuel
        Sales Business**
 
 The
        following table shows the Company's volume sold and delivered in gallons
        and
        average sales price for the Fuel Products for the three months and six months
        ended June 30, 2005 and 2006, respectively:
 
 Three
                  months ended
                June
                  30, 2005
              
              Three
                  months ended
                June
                  30, 2006
              
              Six
                  months ended
                June
                  30, 2005
              
              Six
                  months ended
                June
                  30, 2006Volume
                  SoldFuel
                  Products (millions of gallons)
              
              
              15.8
              
              
              15.0
              
              
              34.6
              
              
              30.2Average
                  sales priceFuel
                  Products (per gallon)
              
              $
              1.71
              
              $
              2.36
              
              $
              1.61
              
              $
              2.17
  37
 *Table
              of Contents*
 
 **Results
        of Operations**
 
 The
        following summarizes the gross profit among the Company’s LPG and Fuel Sales
        Business for the three months and six months ended June 30, 2005 and 2006.
        All
        amounts are in thousands.
 
 For
                  the three months ended June 30, 2005LPG
              
              Fuel
                  Sales
              
              TotalRevenues
              
              $
              25,227
              
              $
              27,036
              
              $
              52,263Cost
                  of goods sold
              
              
              25,217
              
              
              26,958
              
              
              52,175Gross
                  profit
              
              $
              10
              
              $
              78
              
              $
              88
 
 For
                  the three months ended June 30, 2006LPG
              
              Fuel
                  Sales
              
              TotalRevenues
              
              $
              31,577
              
              $
              35,366
              
              $
              66,943Cost
                  of goods sold
              
              
              30,944
              
              
              35,050
              
              
              65,994Gross
                  profit
              
              $
              633
              
              $
              316
              
              $
              949
 
 For
                  the six months ended June 30, 2005LPG
              
              Fuel
                  Sales
              
              TotalRevenues
              
              $
              56,208
              
              $
              55,782
              
              $
              111,990Cost
                  of goods sold
              
              
              54,598
              
              
              54,915
              
              
              109,513Gross
                  profit
              
              $
              1,610
              
              $
              867
              
              $
              2,477
 
 For
                  the six months ended June 30, 2006LPG
              
              Fuel
                  Sales
              
              TotalRevenues
              
              $
              70,812
              
              $
              65,460
              
              $
              136,272Cost
                  of goods sold
              
              
              69,439
              
              
              64,615
              
              
              134,054Gross
                  profit
              
              $
              1,373
              
              $
              845
              
              $
              2,218
  38
 *Table
              of Contents*
 
 ***Three
        Months Ended June 30, 2006 Compared With Three Months Ended June 30,
        2005***
 
 *Revenues.* Revenues
        for the three months ended June 30, 2006, were $66.9 million compared with
        $52.3
        million for the three months ended June 30, 2005, an increase of $14.7 million
        or 28.1%. Of this increase, $4.7 million was attributable to increases in
        average sales prices of LPG sold to PMI during the three months ended June
        30,
        2006, $1.7 million was attributable to increases in average sales prices
        of LPG
        sold to customers other than PMI during the three months ended June 30, 2006,
        $1.6 million was attributable to increased volumes of LPG sold to customers
        other than PMI during the three months ended June 30, 2006, and $10.3 million
        was attributable to increases in average sales prices of Fuel Products sold
        during the three months ended June 30, 2006, partially offset by $1.7 million
        attributable to decreased volumes of LPG sold to PMI during the three months
        ended June 30, 2006 and $1.9 million attributable to decreased volumes of
        Fuel
        Products sold during the three months ended June 30, 2006.
 
 *Cost
        of goods sold.* Cost of
        goods sold for the three months ended June 30, 2006 was $66.0 million compared
        with $52.2 million for the three months ended June 30, 2005, an increase
        of
        $13.8 million or 26.5%. Of this increase, $4.6 million was attributable to
        increases in the average costs of LPG sold to PMI during the three months
        ended
        June 30, 2006, $1.0 million was attributable to increases in average costs
        of
        LPG sold to customers other than PMI during the three months ended June 30,
        2006, $1.6 million was attributable to increased volumes of LPG sold to
        customers other than PMI during the three months ended June 30, 2006, $9.9
        million was attributable to increases in average costs of Fuel Products sold
        during the three months ended June 30, 2006, and $0.1 million was attributable
        to increases in other direct costs associated with the LPG and Fuel Sales
        Business during the three months ended June 30, 2006, partially offset by
        $1.9
        million attributable to decreased volumes of Fuel Products sold during the
        three
        months ended June 30, 2006 and $1.5 million attributable to decrease volumes
        of
        LPG sold to PMI during the three months ended June 30, 2006.
 
 *Selling,
        general and administrative expenses.* Selling,
        general and administrative expenses were $1.3 million for the three months
        ended
        June 30, 2006, compared with $2.6 million for the three months ended June
        30,
        2005, a decrease of $1.3 million or 48.7%. The decrease was principally
        attributable to reduced professional fees of $0.1 million and reduced payroll
        related costs of $1.2 million (including $1.0 million associated with the
        discount of a note receivable from a former officer) during the three months
        ended June 30, 2006.
 
 *Other
        income (expense).* Other
        income was $0.1 million for the three months ended June 30, 2006, compared
        with
        other income of $0.3 million for the three months ended June 30, 2005. The
        decrease in other income was due primarily to an increase in the minority
        interest in the losses of Rio Vista of $0.2 million during the three months
        ended June 30, 2006.
 
 ***Six
        Months Ended June 30, 2006 Compared With Six Months Ended June 30,
        2005***
 
 *Revenues.* Revenues
        for the six months ended June 30, 2006, were $136.3 million compared with
        $112.0
        million for the six months ended June 30, 2005, an increase of $24.3 million
        or
        21.7%. Of this increase, $9.1 million was attributable to increases in average
        sales prices of LPG sold to PMI during the six months ended June 30, 2006,
        $2.8
        million was attributable to increases in average sales prices of LPG sold
        to
        customers other than PMI during the six months ended June 30, 2006, $4.8
        million
        was attributable to increased volumes of LPG sold to PMI during the six months
        ended June 30, 2006, and $19.2 million was attributable to increases in average
        sales prices of Fuel Products sold during the six months ended June 30, 2006,
        partially offset by $2.1 million attributable to decreased volumes of LPG
        sold
        to customers other than PMI during the six months ended June 30, 2006 and
        $9.6
        million attributable to decreased volumes of Fuel Products sold during the
        six
        months ended June 30, 2006.
 
 39
 *Table
              of Contents*
 
 *Cost
        of goods sold.* Cost of
        goods sold for the three months ended June 30, 2006 was $134.1 million compared
        with $109.5 million for the six months ended June 30, 2005, an increase of
        $24.5
        million or 22.4%. Of this increase, $10.0 million was attributable to increases
        in the average costs of LPG sold to PMI during the six months ended June
        30,
        2006, $2.2 million was attributable to increases in average costs of LPG
        sold to
        customers other than PMI during the six months ended June 30, 2006, $4.5
        million
        was attributable to increased volumes of LPG sold to PMI during the six months
        ended June 30, 2006, $18.9 million was attributable to increases in average
        costs of Fuel Products sold during the six months ended June 30, 2006, and
        $0.4
        million was attributable to increases in other direct costs associated with
        the
        LPG and Fuel Sales Business during the six months ended June 30, 2006, partially
        offset by $9.4 million attributable to decreased volumes of Fuel Products
        sold
        during the six months ended June 30, 2006 and $2.1 million attributable to
        decrease volumes of LPG sold to customers other than PMI during the six months
        ended June 30, 2006.
 
 *Selling,
        general and administrative expenses.* Selling,
        general and administrative expenses were $2.8 million for the six months
        ended
        June 30, 2006, compared with $4.2 million for the six months ended June 30,
        2005, a decrease of $1.4 million or 34.2%. The decrease was principally
        attributable to reduced professional fees of $0.2 million and reduced payroll
        related costs of $1.3 million (including $1.0 million associated with the
        discount of a note receivable from a former officer) during the six months
        ended
        June 30, 2006.
 
 *Other
        income (expense).* Other
        expense was $(0.3) million for the six months ended June 30, 2005. The decrease
        in other expense was due primarily to an increase in the minority interest
        in
        the losses of Rio Vista of $0.3 million during the six months ended June
        30,
        2006 and decreased amortization of discounts on outstanding debt
        incurred.
 
 **Liquidity
        and Capital Resources**
 
 *General.* The
        Company has a loss from operations for the three months and six months ended
        June 30, 2006, has had an accumulated deficit since its inception, has a
        deficit
        in working capital and a deficit in stockholder’s equity. 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 $865,000 were paid in December
        2005, February 2006 and June 2006. Notes totaling $940,000 are still outstanding
        and have not been extended. The TransMontaigne Note may be due on demand
        by
        TransMontaigne unless the Restated LPG Asset Sale closes (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.
 
 The
        minimum volumes and applicable margins contained in the 2006 PMI Agreement
        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 2006 PMI Agreement. 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
        2006 PMI Agreement or that PMI will continue to purchase LPG from Rio Vista
        or
        in quantities or prices that are profitable upon the expiration of the 2006
        PMI
        Agreement. Assuming that the Restated 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 2006 PMI Agreement 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 2006 PMI Agreement 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.
  
 40
 *Table
              of Contents*
  Penn
        Octane and Rio Vista project that monthly cash flows from LPG sales during
        the
        months of July 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 July 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 2006 PMI Agreement.
  All
        of
        Penn Octane’s and Rio Vista's assets are pledged as collateral for existing debt
        of Penn Octane. 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 Restated LPG Asset Sale does not close, Rio
        Vista
        projects that its gross profit from operations under the 2006 PMI Agreement,
        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.
 
 On
        July
        19, 2006 pursuant to a written determination received from The NASDAQ Stock
        Market’s Listing Qualification Department on July 17, 2006, Penn Octane’s common
        stock was delisted from the NASDAQ Capital Market. As a result of the delisting,
        Penn Octane’s common stock began trading on the Pink Sheets, a centralized
        quotation service that collects and publishes market maker quotes for
        over-the-counter securities in real time. Penn Octane is currently seeking
        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. There is no
        assurance that Penn Octane will be quoted on the OTC Bulletin Board. Penn
        Octane
        will continue to file all required reports with the Securities and Exchange
        Commission. The delisting by NASDAQ could 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.
  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.
 
 41
 *Table
              of Contents*
  The
        following summary table reflects comparative cash flows for the six months
        ended
        June 30, 2005 and 2006. All information is in thousands.
 
 Six
                  months
                endedJune
                  30,
                2005
              
              Six
                  months
                endedJune
                  30,
                2006Net
                  cash (used in) operating activities
              
              $
              (4,563
              )
              $
              (5,379
              )Net
                  cash provided by investing activities
              
              
              118
              
              
              76Net
                  cash provided by financing activities
              
              
              4,280
              
              
              5,122Net
                  (decrease) in cash
              
              $
              (165
              )
              $
              (181
              )
  *Sales
        to PMI* .
        PMI and
        the Company operated under a three month contract for the period from January
        1,
        2005 to June 30, 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
“2005
        PMI Agreement”).
  On
        March
        31, 2006, the 2005 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 2005 PMI Agreement.
        During April 2006, PMI purchased approximately 6.0 million gallons.
  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 was subject to execution of a definitive written agreement between
        Rio Vista and PMI. The agreement (the “2006 PMI Agreement”) was executed during
        July 2006 with the terms specified in the PMI Confirmation. The 2006 PMI
        Agreement 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 2006 PMI Agreement
  The
        minimum volumes and applicable margins contained in the 2006 PMI Agreement
        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 2006 PMI Agreement.
  42
 *Table
              of Contents*
 
 The
        following table sets forth the minimum monthly volume of LPG PMI committed
        to
        purchase from the Company pursuant to the 2005 PMI agreement, the April 2006
        monthly contract and the 2006 PMI Agreement and the actual volumes purchased
        for
        the months January 2006 through July 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
              11,606,435April
                  2006
              6,000,000
              6,035,733May
                  2006
              4,500,000
              5,733,193June
                  2006
              4,500,000
              7,130,666July
                  2006
              4,500,000
              4,937,441August
                  2006
              4,500,000
              *September
                  2006
              4,500,000
              *October
                  2006
              8,100,000
              *November
                  2006
              8,100,000
              *December
                  2006
              9,000,000
              *January
                  2007
              8,100,000
              *February
                  2007
              8,100,000
              *March
                  2007
              8,100,000
              **
                  Not yet available
 
 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 $21.3 and $60.5 million for the three and
        six
        months ended June 30, 2006, respectively, representing approximately 31.8%
        and
        44.4% of total revenues for the three and six months ended June 30, 2006,
        respectively.
 
 *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 June 30, 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.
  43
 *Table
              of Contents*
  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
        2006 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 52.8% and 48.0% of total revenues for the three months
        and
        six months ended June 30, 2006, respectively.
 
 Fuel
        Sales revenues totaled $35.4 million and $65.5 million and cost of fuel and
        other direct operating expenses totaled $35.1 million and $64.6 million during
        the three months and six months ended June 30, 2006, respectively. 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.
 
 Federal
        and State agencies require the Company to obtain the necessary regulatory
        and
        other approvals for its Fuel Sales Business.
 
 44
 *Table
              of Contents*
 
 *Credit
        Arrangements* .
        As of
        June 30, 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. The March
        31,
        2006 review was deferred on a month to month basis while the Company continued
        to pursue the LPG Asset Sale. 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 (8.25% at June 30, 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 June 30, 2006 totaled approximately
        $13.8 million of which approximately $10.0 million represents June 2006
        purchases and approximately $3.8 million represents July 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 $3.6 million at June 30, 2006). At June 30, 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 June 30, 2006, such taxes in the
        amount
        of approximately $785,000 were due. The letters of credit issued have all
        been
        secured by cash in the amount of approximately $474,000 which is included
        in
        restricted cash in the Company’s balance sheet at June 30, 2006.
 
 LPG
        and
        Fuel Products financing expense associated with the RZB Credit Facility totaled
        $166,615 and $285,808 for the three months ended June 30, 2005 and 2006,
        respectively, and $369,925 and $525,576 for the six months ended June 30,
        2005
        and 2006, respectively.
 
 If
        the
        Restated LPG Asset Sale is completed, the Company expects that the RZB Credit
        Facility will be restructured and/or reduced.
 
 45
 *Table
              of Contents*
 
 The
        following is a summary of the Company’s estimated minimum contractual
        obligations and commercial obligations as of June 30, 2006. Where applicable,
        LPG prices are based on the June 30, 2006 monthly average as published by
        Oil
        Price Information Service.
 
 **Payments
                  due by Period**
                **(Amounts
                  in Millions)**Contractual
                  Obligations
              
              Total
              
              Less
                  than
                1
                  Year
              
              1
                  -
                  3
                Years
              
              4
                  -
                  5
                Years
              
              After
                5
                  YearsLong-Term
                  Debt Obligations and Note Payable
              
              $
              2.4
              
              $
              2.4
              
              $
              -
              
              $
              -
              
              $
              -Operating
                  Leases
              
              
              7.4
              
              
              1.0
              
              
              2.0
              
              
              2.0
              
              
              2.4LPG
                  Purchase Obligations
              
              
              540.6
              
              
              166.2
              
              
              332.5
              
              
              41.9
              
              
              -Other
                  Long-Term Obligations
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Total
                  Contractual Cash Obligations
              
              $
              550.4
              
              $
              169.6
              
              $
              334.5
              
              $
              43.9
              
              $
              2.4
 
 **Amount
                  of Commitment Expiration**
                **Per
                  Period**
                **(Amounts
                  in Millions)**Commercial
                  Commitments
              
              Total
                  Amounts
                Committed
              
              Less
                  than
                1
                  Year
              
              1
                  -
                  3
                Years
              
              4
                  -
                  5
                Years
              
              Over
                5
                  YearsLines
                  of Credit
              
              $
              4.7
              
              $
              4.7
              
              $
              -
              
              $
              -
              
              $
              -Standby
                  Letters of Credit
              
              
              13.8
              
              
              13.8
              
              
              -
              
              
              -
              
              
              -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
              
              $
              18.5
              
              $
              18.5
              
              $
              -
              
              $
              -
              
              $
              -
 
 *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 subject to any reserves determined by the General Partner.
        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.
 
 46
 *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. As a result of the exercise of the General Partner Options,
        Penn
        Octane will only be entitled to receive up to 50% of any distributions paid
        in
        the future by Rio Vista and distributed by the General Partner including
        any
        distributions associated with arrearages prior to the exercise of the General
        Partner Options.
 
 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 Restated 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 Restated LPG Asset Sale will be completed according
        to
        the terms contained in the Restated PSA’s or according to different terms or at
        all. Even if the Restated 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 Restated 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 loss to
        distributable cash flow for the three months ended March 31, 2006 and June
        30,
        2006.
 
 Three
                  Months EndedMarch
                  31, 2006
              
              June
                  30, 2006Net
                  loss
              
              $
              (251,000
              )
              $
              (434,000
              )Plus
                  interest and LPG financing expense and taxes, net
              
              
              145,000
              
              
              137,000Plus
                  depreciation and amortization
              
              
              200,000
              
              
              202,000Earnings
                  before interest, taxes,depreciation and
                  amortization(“EBITDA”)
              
              
              94,000
              
              
              (95,000
              )Plus
                  other non-cash expenses
              
              
              8,000
              
              
              -Less
                  cash interest, LPG financing expense and taxes, net
              
              
              (122,000
              )
              
              (137,000
              )Distributable
                  cash flow (deficit)
              
              
              (20,000
              )
              
              (232,000
              )Distributable
                  cash flow (deficit) applicable to general partner
              
              
              -
              
              
              5,000Distributable
                  cash flow (deficit) applicable to limited partners
              
              $
              (20,000
              )
              $
              (227,000
              )
  47
 *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 Generally Accepted Accounting Principles.
 
 *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.
 
 *Amended
        Leased Pipeline Lease Agreement* .
        On July
        21, 2006, the Company and Seadrift entered into an amended and restated lease
        agreement (the “Amended Lease”) for the Leased Pipeline. The Amended Lease is
        effective August 1, 2006 and expires on December 31, 2013. Pursuant to the
        terms
        of the Amended Lease, the Company will have the exclusive right to transport
        materials through the Leased Pipeline, and Seadrift will no longer have certain
        rights to utilize the pipeline for its own purposes as provided in the original
        lease agreement. In addition, the Company will no longer be required to make
        minimum payments for propane storage in Markham, Texas and will no longer
        have
        access to such storage. The Company will also no longer have access to the
        Ella-Seadrift pipeline (running approximately 155 miles between Markham and
        the
        King Ranch Gas Plant) or to access other propane suppliers via such pipeline.
        The Company has agreed to indemnify Seadrift for environmental liabilities,
        including claims relating to the condition of the leased property and any
        environmental remediation costs, arising after the inception date of the
        lease,
        September 1, 1993. Seadrift has agreed to indemnify the Company for similar
        environmental liabilities arising before that date. The Company’s lease
        payments, which previously consisted of fixed amounts plus certain variable
        charges and periodic increases, will now consist of a fixed annual amount
        of
        $1.6 million (total lease expenses for the year ended December 31, 2005 were
        approximately $1.4 million). The Company may assign the Amended Lease to
        a third
        party with Seadrift’s written consent, which consent may not be unreasonably
        withheld.
 
 *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.
  48
 *Table
              of Contents*
  *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.
 
 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* .
 
 **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 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.
 
 49
 *Table
              of Contents*
 
 **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** *.* ****
 
 At
        June
        30, 2006, the Restructured Notes and the $280,000 Notes (collectively the
        “Notes”) have a face value of $940,000, 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. 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.
 
 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. The Notes have not been renewed
        or
        extended since December 15, 2006. In connection with the extension of the
        warrants, the Company recorded additional interest expense of approximately
        $22,000. The Notes have not been renewed or extended since December 31, 2005.
 
 During
        May 2006, the Company paid $61,418 to the holders of the Notes representing
        accrued interest and fees through March 15, 2006.
 
 During
        June 2006, the Company paid $212,474 to the holders of the Notes representing
        $145,000 of principal and $67,474 of accrued interest and fees through June
        15,
        2006.
 
 50
 *Table
              of Contents*
 
 **Options
        and Warrants of Rio Vista**
  ***General
        Partner Options.*** On
        July
        1, 2006, Penn Octane’s 100% interest in the General Partner was 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 was
        approximately $82,000. Mr. Richter’s option was amended to permit payment of the
        exercise price by surrender of Penn Octane common stock having a fair market
        value equal to the exercise price. Mr. Richter paid the exercise price for
        his
        options by surrender of 136,558 shares of Penn Octane common stock. In
        connection with the exercise of the General Partner Options, Penn Octane
        retained control of the General Partner pursuant to a voting agreement with
        each
        of Shore Capital and Mr. Richter.
  ***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
        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 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 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 vested 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:
 
 51
 *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 has agreed 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.
 
 **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.
 
 52
 *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 and six months ended
        June 30, 2006, has had an accumulated deficit since inception, has a deficit
        in
        working capital and a deficit in stockholders’ equity. 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 $865,000 were paid in December
        2005, February 2006 and June 2006. Notes totaling $940,000 and still outstanding
        and have not been extended. The TransMontaigne Note may be due on demand
        by
        TransMontaigne unless the Restated LPG Asset Sale closes (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 2006 PMI Agreement
        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 2006 PMI Agreement. 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
        2006 PMI Agreement or that PMI will continue to purchase LPG from Rio Vista
        or
        in quantities or prices that are profitable upon the expiration of the 2006
        PMI
        Agreement. Assuming that the Restated 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 2006 PMI Agreement 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 2006 PMI Agreement 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.
 
 Penn
        Octane and Rio Vista project that monthly cash flows from LPG sales during
        the
        months of July 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 July 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 2006 PMI Agreement.
 
 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 Restated LPG Asset Sale does not close, Rio Vista projects that its gross
        profit from operations under the 2006 PMI Agreement, 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.
 
 53
 *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 Restated 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 Restated 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 Restated LPG Asset Sale.
        Management is also (i) seeking to expand its Fuel Sales Business and to further
        diversify its operations to reduce dependency on sales of LPG, (ii) seeking
        to
        maintain the amount of financing for its products and operations, and (iii)
        seeking to reduce supply costs and operating expenses. In the event that
        the
        Restated 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.
  Pursuant
        to the Amended Lease, the Company has agreed to indemnify Seadrift for
        environmental liabilities, including claims relating to the condition of
        the
        Leased Pipeline and any environmental remediation costs, arising after the
        inception date of the lease, September 1, 1993.
  54
 *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 its
        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 its 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 its 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.
 
 55
 *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.
 
 56
 *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.
 
 **Item4.**
              **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 June 30, 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.
  57
 *Table
              of Contents*
 
 **PART
        II**
  **Item
                  1.**
              **Legal
                  Proceedings**
 
 See
        note
        J to the Company’s unaudited consolidated financial statements included in this
        Report.
 
 **Item1A.**
              **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.
 
 *Restated
        LPG Asset Sale* . There
        can
        be no assurance that the Restated LPG Asset Sale will be completed according
        to
        the terms contained in the Restated LPG Asset Sale or according to different
        terms or at all. Even if the Restated 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 Restated LPG Asset Sale is completed,
        the
        RZB Credit Facility may be restructured and/or reduced. A continued delay
        of or
        inability to close the Restated 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 - Purchase and Sale Agreements.
 
 *Market
        Listing* .
        On July
        19, 2006 pursuant to a written determination received from The NASDAQ Stock
        Market’s Listing Qualification Department on July 17, 2006, Penn Octane’s common
        stock was delisted from the NASDAQ Capital Market. As a result of the delisting,
        Penn Octane’s common stock began trading on the Pink Sheets, a centralized
        quotation service that collects and publishes market maker quotes for
        over-the-counter securities in real time. Penn Octane is currently seeking
        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. There is no
        assurance that Penn Octane will be quoted on the OTC Bulletin Board. Penn
        Octane
        will continue to file all required reports with the Securities and Exchange
        Commission. The delisting by NASDAQ could 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.
  58
 *Table
              of Contents*
  *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.
 
 59
 *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.
 
 **Item3.**
              **Defaults
                  Upon Senior Securities**
 
 None.
 
 **Item4.**
              **Submission
                  of Matters to a Vote of Security
                  Holders**
 
 None.
  **Item5.**
              **Other
                  Information**
 
 None.
 
 60
 *Table
              of Contents*
 
 **Item6**.
              **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 August 14, 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 August 14, 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).
 
 61
 *Table
              of Contents*
 
 **The
        following Exhibits are filed as part of this report:**
 
 2.1
              Purchase
                    and Sale Agreement dated August 15, 2006 as amended and restated
                  on August
                  15, 2006 entered into by and between Penn Octane Corporation and
                  TransMontaigne Product Services
                  Inc.
 
 2.2
              Purchase
                  and Sale Agreement dated August 15, 2006 as amended and restated
                  on August
                  15, 2006 entered into by and between Rio Vista Operating Partnership
                  L.P.
                  and TransMontaigne Product Services
                  Inc.
 
 10.10
              Ella-Brownsville
                  Pipeline Lease Agreement effective as of August 1, 2006 between
                  Seadrift
                  Pipeline Corporation and Penn Octane
                  Corporation.
 
 10.11
              Matamoros
                  LPG Mix Purchase and Sales Agreement made and entered into as of
                  April 28,
                  2006, by and between Rio Vista Operating Partnership L.P. and P.M.I.
                  Trading Limited.
  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.
 
 62
 *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**August
                  14, 2006
              
              By:
              
              /s/Ian
                  T. BothwellIan
                  T. BothwellVice
                  President, Chief Financial Officer, Treasurer, and Assistant Secretary
   63