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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-K





(Mark One)

|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------

For the fiscal year ended December 31, 2008

or



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from              to

Commission file number 000-51888





BASELINE OIL & GAS CORP.

(Exact name of registrant as specified in
its charter







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Nevada                                                         |  | 30-0226902                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|411 North Sam Houston Parkway East, Suite 300 Houston, Texas   |  | 77060                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

(281) 591-6100

Registrants telephone number, including area code





Securities registered
pursuant to Section 12(b) of the Act: Common Stock, $0.001 par value

Securities registered pursuant to section 12(g) of the Act:
None





Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.    Yes   ̈    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes   ̈    No  x

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   ̈

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K   ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈                                                |  | Accelerated filer         |  |  ̈
|                        |  |                                                  | 
|Non-accelerated filer   |  |  ̈  (Do not check if a smaller reporting company) |  | Smaller reporting company |  | x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act).    Yes   ̈    No  x

As of June 30, 2008, the aggregate market value of the common stock of the registrant held by non-affiliates (excluding shares held by directors, officers and other holding more than 5% of the outstanding shares
of the class) was $11,474,013 based upon a closing sale price of $0.49.

As of March 27, 2009, the registrant had outstanding
151,497,530 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

None









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TABLE OF CONTENTS



|                                                                                                                     |  |     
|-------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                     |  | Page
|                                                                                                                     | 
|Cautionary Notice Regarding Forward-Looking Statements                                                               |  | 1   
|                                                                                                                     | 
|PART I                                                                                                               |  | 2   
|Item 1. and Item 2. Description of Business and Properties                                                           |  | 2   
|Item 1A. Risk Factors                                                                                                |  | 14  
|Item 3. Legal Proceedings                                                                                            |  | 23  
|Item 4. Submission of Matters to a Vote of Security Holders of the Registrant                                        |  | 23  
|                                                                                                                     | 
|PART II                                                                                                              |  | 24  
|Item 
5. Market for Registrants Common Stock, Related Shareholder Matters and Issuer Purchases of Equity Securities |  | 24  
|Item 6. Omitted                                                                                                      |  | 26  
|Item 
7. Managements Discussion and Analysis or Plan of Operations of Financial Condition and Results of Operations |  | 26  
|Item 8. Financial Statements                                                                                         |  | 34  
|Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure                         |  | 34  
|Item 9A. Controls and Procedures                                                                                     |  | 34  
|Item 9B. Other Information                                                                                           |  | 35  
|                                                                                                                     | 
|PART III                                                                                                             |  | 36  
|Item 10. Directors, Executive Officers and Corporate Governance; Compliance with Section 
16(a) of the Exchange Act  |  | 36  
|Item 11. Executive Compensation                                                                                      |  | 38  
|Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder
Matters              |  | 42  
|Item 13. Certain Relationships and Related Transactions, and Director Independence                                   |  | 44  
|Item 14. Principal Accountant Fees and Services                                                                      |  | 45  
|                                                                                                                     | 
|PART IV                                                                                                              |  | 47  
|Item 15. Exhibits and Financial Statement Schedules                                                                  |  | 47  
|                                                                                                                     | 
|Consent of Cawley, Gillespie & Associates, Inc. independent petroleum engineers                                      |  |     
|Certification of CEO Pursuant to Section 302                                                                         |  |     
|Certification of CFO Pursuant to Section 302                                                                         |  |     
|Certification of CEO Pursuant to Section 906                                                                         |  |     
|Certification of CFO Pursuant to Section 906                                                                         |  |     
|Summary of Reserve Report                                                                                            |  |     



i



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Cautionary Notice Regarding Forward Looking Statements

Baseline Oil & Gas Corp. desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. This report contains a number of forward-looking statements that reflect managements current views and expectations with respect to business, strategies, future results and events and financial performance. All statements made in this
Annual Report other than statements of historical fact, including statements that address operating performance, events or developments that management expects or anticipates will or may occur in the future, including statements related to revenues,
cash flow, profitability, adequacy of funds from operations, statements expressing general optimism about future operating results and non-historical information, are forward looking statements. In particular, the words believe,
expect, intend, anticipate, estimate, may, will, variations of such words, and similar expressions identify forward-looking statements, but are not the exclusive means of
identifying such statements and their absence does not mean that the statement is not forward-looking.

Readers should not place undue
reliance on these forward-looking statements, which are based on managements current expectations and projections about future events, are not guarantees of future performance, are subject to risks, uncertainties and assumptions and apply only
as of the date of this report. Baselines actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed below in Risk Factors as well as those discussed elsewhere in this report, and the risks discussed in press releases and other communications to stockholders issued by Baseline
from time to time which attempt to advise interested parties of the risks and factors that may affect the business. Except as may be required under the federal securities laws, Baseline undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future events or otherwise.



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PART I



|Items 1 and 2. | Business and Properties.
|-------------- | ------------------------

Company Overview

Baseline Oil & Gas Corp., (Baseline, the Company or we) is a Houston, Texas-based independent oil and natural
gas company engaged in the exploration, production, development, acquisition and exploitation of natural gas and crude oil properties, with interests in the following three core areas: (i) the Eliasville Field located in Stephens County in
North Texas (the Eliasville Field Properties); (ii) the Blessing Field in Matagorda County located onshore along the Texas Gulf Coast (the Blessing Field Properties); and (iii) the New Albany Shale play located in
Southern Indiana (the New Albany Shale play). Our core properties cover approximately 39,945 net acres across the areas identified above.

As of December 31, 2008, based on the reserve report prepared by Cawley, Gillespie & Associates, Inc., independent petroleum engineers (CG&A and the CG&A Reserve Report),
our proved reserves were 60.2 Bcfe, of which 46.5% were natural gas and 68.2% were proved developed. The SEC PV-10 of these proved reserves as of that date was $69.5 million. During 2008, we produced 2.8 Bcfe and had a proved reserve reduction of
6.7 Bcfe as a result of reserve revisions.

Recent Events and Current Capital Requirements

Despite a number of identified opportunities to increase production and develop our reserve base through infill and step-out drilling of new wells,
workovers on existing wells, stimulation of existing wells and the expansion of enhanced oil recovery projects such as waterflood operations, such efforts are heavily dependent on the availability of sufficient capital. Due to a number of events set
forth below which have significantly adversely affected our liquidity, we expect to reduce capital expenditures during 2009. As a result, we expect our production and attendant cash flow to decline in 2009. We also face significant upcoming
repayment obligations with respect to our outstanding senior notes, the majority of which were restructured during the fourth quarter of 2008. Our accompanying financial statements have been prepared assuming that we will continue as a going
concern; however, as reflected in our auditors report and notes accompanying our financial statements, our losses from operations and our year-end working capital deficiency raise substantial doubt about our ability to continue as a going
concern.

During July 2008, funds related to Third Point LLC (Third
Point), a money management firm, purchased and converted all of our $53.5 million in outstanding 14% Senior Subordinated Convertible Notes due 2013 (the Convertible Notes), pursuant to which we ultimately issued to such investors a
total of 117,035,248 shares of our common stock, resulting in such investors holding approximately 77.25% of our outstanding shares of common stock as of July 30, 2008. The purchase of the Convertible Notes resulted in a change of
control and required us to offer to purchase all $115 million aggregate principal amount of our 12 1/2% Senior Secured
Notes due 2012 (the Senior Notes), at price of 101% of par. On August 8, 2008, we commenced a change of control offer in accordance with the provisions of the Indenture governing the Senior Notes, which offer was accepted by all
holders of the Senior Notes. However, because of the turmoil and slowdown in transaction activity which occurred in the U.S. and global credit markets during September and October 2008, we were unable to obtain the loan and equity commitments
required to complete the purchase transaction for the Senior Notes and defaulted on such obligation on October 6, 2008.

After
subsequent negotiations, we arrived at an agreement on October 29, 2008 with the holders of $100 million of the Senior Notes to convert those notes to $106.7 million of 15% Senior Secured PIK Notes (the New Notes). The New Notes
provide for an interest rate of 15%, paid quarterly, commencing January 1, 2009, with 12.5% required to be paid in cash and the remaining 2.5% required to be paid in PIK notes. The New Notes mature on June 15, 2009. Unless and until
converted to New Notes, the remaining non-participating $15 million principal amount of Senior Notes continue to carry a cash interest rate of 12.5%, payable semi-annually on October 1 and April 1.

In addition to the global credit crisis, since we issued the New Notes in October 2008, oil and natural gas prices declined to the lowest levels since
2001 and have remained at low levels for much of the first quarter of 2009. As a result, the operating revenues and stock prices of many publicly traded oil and gas exploration and production companies have fallen sharply and it has become extremely
difficult for below-investment grade companies such as the Company, to raise debt or equity capital in the U.S. markets. As a result of these factors, we do not expect to be able to make the $4.27 million of cash interest payments due April 1,
2009 on any of the Senior Notes or the New Notes. Non-payment of this interest, if not remedied within 30 days, is an event of default under the Indenture governing the Senior Notes and the New Notes, and allows the trustee or the holders of 25% or
more of such notes to declare all unpaid principal and interest immediately due and payable. We also have not currently identified a means for repaying either the Senior Notes which became due in October 2008, or the New Notes when they become due
on June 15, 2009.



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We have engaged a financial advisor to advise the Company on courses of action available to us,
including, without limitation, available financing and capital restructuring alternatives, targeted cost reductions, the sale of assets and the sale or merger of the Company. If we are not able to successfully implement one or more of these
strategies, or in order for us to implement one or more of these strategies, we may voluntarily seek protection under the U.S. Bankruptcy Code.

Employees

As of March 27, 2009, we had 15 full time employees and 2 contract employees. We are not a party to any
collective bargaining agreements and have not experienced any strikes or work stoppages. We believe our relationships with our employees are good. From time to time, we utilize the services of independent contractors to perform various field and
other services.

Offices

Our
headquarters are located at 411 North Sam Houston Parkway East, Suite 300, Houston, Texas 77060. Our telephone number is (281) 591-6100.

Our
Properties and Core Areas of Operation

As of December 31, 2008, 44.7% of our proved reserves were located in the Eliasville Field
Properties and 55.3% in the Blessing Field Properties. We acquired all of our current proved reserves during 2007, including (i) the Blessing Fields Properties on October 1, 2007, consisting of those wells and properties located on 2,374
net acres located onshore along the Texas Gulf Coast and (ii) the Eliasville Fields Properties on April 12, 2007, consisting of those wells and properties located on 5,231 net acres in North Texas. On March 16, 2007, we converted a
prior membership interest in a joint venture into a direct working interest in approximately 171,000 gross acres (32,340 net acres) in the Illinois Basin located in Southern Indiana known to contain the New Albany Shale formation.

Our proved reserves are primarily long-life crude oil located in the Eliasville Field and natural gas and condensate located in the Blessing Field. These
two fields are characterized by over 50 years of development drilling and production history along with active participation by several leading industry companies in and around these fields. We believe the quality and location of our proved reserve
base enables high value realization, with minimal basis differentials applied to our overall crude oil and natural gas prices. The majority of our proved reserve base is classified as proved developed nonproducing and proved undeveloped reserves. We
have identified a large base of workovers and drilling locations targeting proved reserves on our two Texas properties. The timing of pursuing these opportunities is dependent on both our ability to raise additional capital and prevailing oil and
natural gas prices.

Our New Albany Shale play assets, which currently do not have any booked proved reserves, represent upside potential
that we are currently evaluating and developing with our operating partners, Atlas Energy LLC and El Paso Corporation, each of which brings significant regional expertise and financial and operational resources.

We participated in the drilling of 17 (gross) wells during 2008 and performed 19 workovers on existing wells. Of the 17 wells drilled, 15 were
development wells located in our two operated Texas fields and 2 were non-operated exploratory wells drilled in our Southern Indiana acreage. All of the workovers were performed on wells in our two Texas fields.

Blessing Field Properties.

On
October 1, 2007, we acquired, effective as of June 1, 2007, a working interest of over 95% in the Blessing Field Properties located onshore along the Texas Gulf Coast for an adjusted purchase price of $96.6 million. We operate 100% of the
wells on these properties. During December 2008, this field produced at rates of 172 bopd and 2,642 mcfd net to our interest, for an equivalent net rate of approximately 3,674 mcfepd.

Proved net reserves on the Blessing Field Properties have been estimated in the CG&A Report to be 33.3 Bcfe with a pre-tax PV-10 value of $
47.2 million based on year-end SEC pricing. Of the proved reserves, 12.5% are proved developed producing, or PDP, 47.0% are proved developed non-producing, or PDNP, and 40.5% are proved undeveloped, or PUD, reserves.



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The Blessing Field Properties are situated within the Blessing Field area, located in Matagorda County,
Texas, on trend with several prolific Frio fields. Most of these fields were structural traps along down-to-the-coast growth faults containing normally-pressured Frio sand reservoirs. A proprietary 3-D seismic survey was acquired over the area in
1996. As a result, a series of buried faults were identified that set up traps in the deeper, geopressured Frio section basinward of Blessing Field. With the aid of this proprietary 3D seismic survey, 17 wells have been drilled and completed to
date. Production in 5 separate fault blocks has been established, with proved and probable reserves identified in 21 different sands.

We
drilled four new wells in this field in 2008 and also performed seven workovers. All four new wells were drilled to an approximate depth of 12,000 feet and all four were completed and are producing natural gas and condensate. The seven workovers
were done to re-complete existing wells in new zones or add perforations to existing zones. Overall the new wells and workovers are currently not performing as well as expected.

Eliasville Field Properties.

On April 12, 2007, we acquired a 100% working interest in 5,231 net acres in the Eliasville Field located in Stephens County in North Texas, roughly 90 miles west of Fort Worth, Texas. The effective date of the transaction was
February 1, 2007 and we paid an adjusted purchase price of $27.05 million. The Eliasville Field was discovered in the 1920s and produces primarily from the Caddo Lime oil formation at a depth of 3,300 feet. During December 2008, this
field produced at rates of 541 bopd and 71 mcfpd net to our interest, for an equivalent net rate of approximately 553 Boepd of production. There are 92 oil wells producing in the field, and a portion of it is operated as an active waterflood with 57
injection wells. There are 8 leases, 2 central operating facilities and 3 tank batteries.

Proved net reserves have been estimated in the
CG&A Reserve Report to be 4.5 MMBoe with a pre-tax PV-10 value of $22.3 million, based on year-end SEC pricing. Of the proved reserves, 67.6% are PDP, 11.5% PDNP and 20.9% are PUD reserves.

We successfully drilled 11 proved undeveloped wells to the Caddo formation at 3,350 feet during
2008. All of the wells were on production by the end of December. The average initial daily rate for each new well has been approximately 32 bopd (8/8ths). In addition to drilling new wells, we also performed workovers on 12 low-rate or idle wells during 2008. These workovers were on oil wells, which were either returned to production, or on which perforations were
added and/or stimulation was performed. One of the workovers involved the conversion of previously idle oil wells to waterflood injection service.

We have identified 20 proved undeveloped locations to drill in the field and 27 additional workovers to be done. We anticipate performing this work as capital is available and oil prices improve.

New Albany Shale play.

We own
a direct working non-operating interest in leasehold interests covering approximately 171,000 gross (32,340 net) surface acres in the Illinois Basin located in Southern Indiana and known to overlay the New Albany Shale formation. Our total average
working interest is approximately 18.5%, and our acreage is grouped into three separate areas of mutual interest, or AMIs, where we have varying working interests as follows:



| |  |  | 19.7% working interest in approximately 122,000 gross acres (approximately 24,400 net acres) located primarily in Greene County and operated by Atlas Energy LLC
(Wabash AMI);
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 18.2% working interest in approximately 41,000 gross acres (approximately 7,380 net acres) located in Knox and Sullivan Counties and operated by Atlas Energy LLC
(Knox AMI); and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 6.9% working interest in approximately 8,000 gross acres (560 net acres) located in Greene County, operated by El Paso Corporation.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



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The name New Albany Shale refers to a brownish-black shale exposed along the Ohio River at
New Albany in Floyd County, Indiana, and present in the subsurface throughout much of the Illinois Basin. The Illinois Basin covers approximately 60,000 square miles in parts of Illinois, Southwestern Indiana and Western Kentucky. The New Albany
Shale has produced natural gas since 1858, mostly from wells located in Southwestern Indiana and Western Kentucky.

Although the industry
has reported a range of natural gas production rates and reserve potential in the New Albany Shale, there is not extensive production history from horizontal wells completed in the New Albany Shale and we have no active production or proved reserves
booked to our acreage position. We presently consider the acreage contained in our Knox AMI to be highly prospective, as it lies between active producing projects owned by Noble Energy to the north (southern Sullivan County) and El Paso to the
southeast (Knox and Davies Counties).

During 2008, we participated with our partners in the drilling of two vertical wells located in the
Wabash AMI of Greene County, Indiana. Both wells had gas shows in the New Albany Shale but insufficient gas in the Devonian formation. The wells will be use in the development of the New Albany Shale formation. We also participated in the extension
of certain oil and gas leases on our acreage. Currently, our partner Atlas Energy LLC is planning to install gas gathering compression and treating facilities in 2009, as well as to drill up to 25 wells. We are evaluating our participation on a well
by well basis, depending on drilling results, natural gas prices and our available capital.

Natural Gas and Oil Reserves.

Due to the inherent uncertainties and the limited nature of reservoir data, proved reserves are subject to change as additional information becomes
available. The estimates of reserves, future cash flows and present value are based on various assumptions, including those prescribed by the Securities and Exchange Commission (SEC), and are inherently imprecise. Although we believe
these estimates are reasonable, actual future production, cash flows, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves may vary substantially from these estimates. Also, the use of a 10%
discount factor for reporting purposes may not necessarily represent the most appropriate discount factor, given actual interest rates and risks to which our business or the oil and natural gas industry in general are subject.

These calculations were prepared using standard geological and engineering methods generally accepted by the petroleum industry and in accordance with
SEC financial accounting and reporting standards. The estimated present value of proved reserves does not include indirect expenses such as general and administrative expenses, debt service and future income tax expense or to depletion,
depreciation, and amortization.

In accordance with applicable financial accounting and reporting standards of the SEC, the estimates of
our proved reserves and the present value of proved reserves set forth herein are made using oil and natural gas sales prices estimated to be in effect as of the date of such reserve estimates and are held constant throughout the life of the
properties. Estimated quantities of proved reserves and their present value are affected by changes in oil and natural gas prices. The prices utilized for the purpose of estimating our proved reserves and the present value of proved reserves as of
December 31, 2008 were a WTI Cushing spot price of $44.60 per Bbl and a Henry Hub spot natural gas price of $5.620 per MMBtu, adjusted by property for energy content, quality, transportation fees, and regional price differentials.

The following table sets forth our estimated net proved oil and natural gas reserves and the PV-10 value of such reserves as of December 31,
2008. The reserve data and the present value as of December 31, 2008 were prepared by Cawley, Gillespie & Associates, Inc., independent petroleum engineers. For further information concerning our independent engineers estimates
of our proved reserves as of December 31, 2008, see the reserve report filed as Exhibit



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99.1 to this Annual Report on Form 10-K. The PV-10 value is not intended to represent the current market value of the estimated oil and natural gas reserves
owned by us. For further information concerning the present value of future net revenues from these proved reserves, see Note 13 of Notes to Consolidated Financial Statements.



|                       |  |         |  |            |  |                               |  |                                                  
|---------------------- |  | ------- |  | ---------- |  | ----------------------------- |  | -------------------------------------------------
|                       |  | Oil     |  | NaturalGas |  | UndiscountedFuture NetRevenue |  | PresentValue ofProvedReservesDiscounted at10% (1)
|                       |  | (Mbbl)  |  | (MMcf)     |  | ($ thousands)                 |  | ($ thousands)                                    
|Developed Producing    |  | 3,106.8 |  | 3,716.9    |  | 43,954                        |  | 27,270                                           
|Developed Nonproducing |  | 889.9   |  | 13,410.1   |  | 63,871                        |  | 23,495                                           
|Proved Undeveloped     |  | 1,370.5 |  | 10,897.5   |  | 49,721                        |  | 18,719                                           
|                       |  |         |  |            |  |                               |  |                                                  
|Total Proved           |  | 5,367.2 |  | 28,024.5   |  | 157,546                       |  | 69,484                                           
|                       |  |         |  |            |  |                               |  |                                                  



|(1) | Management believes that the presentation of PV-10 may be considered a non-GAAP financial measure as defined in Item 10(e) of Regulation S-K. Therefore we have included a
reconciliation of the measure to the most directly comparable GAAP financial measure (standardized measure of discounted future net cash flows in the table immediately below). Management believes that the presentation of PV-10 value provides useful
information to investors because it is widely used by professional analysts and sophisticated investors in evaluating oil and gas companies. Because many factors that are unique to each individual company may impact the amount of future income taxes
to be paid, the use of the pre-tax measure provides greater comparability when evaluating companies. It is relevant and useful to investors for evaluating the relative monetary significance of our natural gas and oil properties. Further, investors
may utilize the measure as a basis for comparison of the relative size and value of our reserves to other companies. Management also uses this pre-tax measure when assessing the potential return on investment related to its oil and gas properties
and in evaluating acquisition candidates. The PV-10 value is not a measure of financial or operating performance under GAAP, nor is it intended to represent the current market value of the estimated oil and natural gas reserves owned by us. PV-10
should not be considered in isolation or as a substitute for the standardized measure of discounted future net cash flows as defined under GAAP.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The table below provides a reconciliation of PV-10 to the standardized measure of discounted future net cash flows.



|                                                         |  |                        |        |  
|-------------------------------------------------------- |  | ---------------------- | ------ | -
|                                                         |  | As ofDecember 31, 2008 |       
|                                                         |  | (dollars in thousands) |       
|PV-10                                                    |  | $                      | 69,484 |  
|Future income taxes, discounted at 10%                   |  |                        | (4,607 | )
|                                                         |  |                        |        |  
|Standardized measure of discounted future net cash flows |  | $                      | 64,877 |  
|                                                         |  |                        |        |  

Oil and Natural Gas Volumes, Prices and Operating Expense

The table below sets forth certain information regarding the production volumes, revenue, average prices received and average production costs associated
with our sale of oil and natural gas for the years ended December 31, 2007 and 2008. Prior to 2007, we had no operating assets other than an indirect interest in the New Albany Shale play by virtue of our membership interest in a joint venture
acquiring and holding working leasehold interests in leasehold acreage located in Southern Indiana. We redeemed our membership interest for a direct assignment of a working interest in certain oil and gas properties, rights and assets of the joint
venture on March 16, 2007. As indicated elsewhere in this Annual Report, we acquired our additional operating assets located in north Texas and the Texas Gulf Coast in April and October 2007, respectively.



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|                                                  |  |                             |           |                             |   |            
|------------------------------------------------- |  | --------------------------- | --------- | --------------------------- | - | -----------
|                                                  |  | Year EndedDecember 31, 2008 |           | Year EndedDecember 31, 2007
|Net Production:                                   |  |                             |           |                             |   |            
|Oil (Bbl)                                         |  |                             | 252,350   |                             |   | 149,318.9  
|Natural Gas (Mcf)                                 |  |                             | 1,245,911 |                             |   | 335,533.2  
|                                                  |  |                             |           |                             |   |            
|Natural Gas Equivalent (Mcfe)                     |  |                             | 2,760,009 |                             |   | 1,231,446.8
|                                                  |  |                            
|Oil and Natural Gas Sales (dollars in thousands): |  |                             |           |                             |   |            
|Oil                                               |  | $                           | 24,716.1  |                             | $ | 11,511.5   
|Natural Gas                                       |  |                             | 12,645.1  |                             |   | 2,459.1    
|                                                  |  |                             |           |                             |   |            
|Total                                             |  |                             | 37,361.2  |                             |   | 13,970.6   
|                                                  |  |                            
|Average Sales Price:                              |  |                             |           |                             |   |            
|Oil ($ per Bbl)                                   |  | $                           | 97.94     |                             | $ | 77.09      
|Natural Gas ($ per Mcf)                           |  |                             | 10.15     |                             |   | 7.33       
|                                                  |  |                             |           |                             |   |            
|Natural Gas Equivalent ($ per Mcfe)               |  | $                           | 13.54     |                             | $ | 11.35      
|                                                  |  |                            
|Oil and Natural Gas Costs (dollars in thousands): |  |                             |           |                             |   |            
|Lease operating expenses                          |  | $                           | 7,869.3   |                             | $ | 4,190.0    
|Production taxes                                  |  |                             | 2,637.5   |                             |   | 958.4      
|Total                                             |  |                             | 10,506.8  |                             |   | 5,148.4    
|                                                  |  |                            
|Average production cost per Mcfe                  |  | $                           | 3.81      |                             | $ | 4.18       

Exploration, Development and Acquisition Capital Expenditures

The following table sets forth certain information regarding the gross costs incurred in the purchase of proved and unproved properties and in development
and exploration activities:



|                                       |  |                             |            |                             |   |            
|-------------------------------------- |  | --------------------------- | ---------- | --------------------------- | - | -----------
|                                       |  | Year EndedDecember 31, 2008 |            | Year EndedDecember 31, 2007
|Property acquisition costs             |  | $                           |           |                             | $ | 123,153,383
|Unproved prospects                     |  |                             | 34,460     |                             |   | 665,531    
|Exploration costs                      |  |                             |           |                             |   | 0          
|Development costs                      |  |                             | 21,865,577 |                             |   | 5,228,246  
|                                       |  |                             |            |                             |   |            
|Total operations                       |  | $                           | 21,900,037 |                             | $ | 129,047,160
|                                       |  |                             |            |                             |   |            
|Asset retirement obligation (non-cash) |  |                             |           |                             |   | 240,959    



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Drilling Activity

The following table sets forth our drilling activity during the twelve month periods ended December 31, 2008 (excluding wells in progress at the end of the period) and since acquiring our operating assets in
2007. In the table, gross refers to the total number of wells in which we have a working interest and net refers to gross wells multiplied by our working interest therein.



|                  |       |                         |      |     |       |   |     |    
|----------------- | ----- | ----------------------- | ---- | --- | ----- | - | --- | ---
|                  |       | Year Ended December 31,
|                  | 2008  |                         | 2007
|                  | Gross |                         | Net  |     | Gross |   | Net
|Development Wells |       |                         |      |     |       |   |     |    
|Productive        |       | 15                      |      | 15  |       | 6 |     | 6  
|Non-Productive    |       | 0                       |      | 0   |       | 0 |     | 0  
|                  |       |                         |      |    
|Exploratory Wells |       |                         |      |     |       |   |     |    
|Productive        |       | 0                       |      | 0   |       | 8 |     | 1.6
|Non-Productive    |       | 2                       |      | 0.4 |       | 0 |     | 0  

Productive Wells

The following table sets forth the number of productive oil and natural gas wells in which we owned an interest as of December 31, 2008. Productive wells are wells that are capable of producing natural gas or
oil.



|            |       |                  |     |              |       |       |     |     |       |     |     |      
|----------- | ----- | ---------------- | --- | ------------ | ----- | ----- | --- | --- | ----- | --- | --- | -----
|            |       | Company Operated |     | Non-operated |       | Total
|            | Gross |                  | Net |              | Gross |       | Net |     | Gross |     | Net
|Oil         |       | 93               |     | 93           |       | 0     |     | 0   |       | 93  |     | 93   
|Natural Gas |       | 16               |     | 16           |       | 22    |     | 4.4 |       | 38  |     | 20.4 
|            |       |                  |     |              |       |       |     |     |       |     |     |      
|Total       |       | 109              |     | 109          |       | 22    |     | 4.4 |       | 131 |     | 113.4
|            |       |                  |     |              |       |       |     |     |       |     |     |      

Acreage Data

The following table summarizes our gross and net developed and undeveloped oil and natural gas acreage under lease as of December 31, 2008.



|                                |       |                 |     |                   |       |         |     |       
|------------------------------- | ----- | --------------- | --- | ----------------- | ----- | ------- | --- | ------
|                                |       | Developed acres |     | Undeveloped acres
|                                | Gross |                 | Net |                   | Gross |         | Net
|Blessing Field Properties (1)   |       | 1,334           |     | 1,334             |       | 1,040   |     | 1,040 
|Eliasville Field Properties (1) |       | 3,991           |     | 3,991             |       | 1,240   |     | 1,240 
|New Albany Shale play (2)       |       | 0               |     | 0                 |       | 171,000 |     | 32,340
|                                |       |                 |     |                   |       |         |     |       
|Total                           |       | 5,325           |     | 5,325             |       | 173,280 |     | 34,620
|                                |       |                 |     |                   |       |         |     |       



|(1) | Properties held by production, or HBP
|--- | -------------------------------------

|(2) | Primary term expires in 2009.
|--- | -----------------------------

As is customary in the oil
and natural gas industry, we can generally retain our interest in undeveloped acreage by drilling activity that establishes commercial production sufficient to maintain the leases or by paying delay rentals during the remaining primary term of
leases. The oil and natural gas leases in which we have an interest are for varying primary terms, and if production under a lease continues from our developed lease acreage beyond the primary term, we are entitled to hold the lease for as long as
oil or natural gas is produced.

Our oil and natural gas properties consist primarily of oil and natural gas wells and our interests in
leasehold acreage, both developed and undeveloped.



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Major Customers

During fiscal year 2008, the Company sold oil and natural gas production representing 10% or more of its oil and natural gas revenues to the following purchasers:



|                                |  |                    |  
|------------------------------- |  | ------------------ | -
|Customer Name                   |  | Percentageof Sales |  
|Texon, L.P.                     |  | 61                 | %
|HESCO Gathering Company, L.L.C. |  | 24                 | %
|Gulf Mark Energy, Inc.          |  | 15                 | %

Because alternate purchasers of natural gas and oil are readily available, we believe that the loss of any of our
purchasers would not have a material adverse effect on our financial results.

Competition

We encounter competition from other natural gas and oil companies in all areas of our operations, including the acquisition of exploratory prospects and
proven properties. Many of our competitors are large, well-established companies that have been engaged in the natural gas and oil business for much longer than we have and possess substantially larger operating staffs and greater capital resources
than we do. Our ability to explore for oil and natural gas reserves and to acquire additional properties in the future will be dependent upon our ability to conduct our operations, to evaluate and select suitable properties and to consummate
transactions in this highly competitive environment. We believe that our technological expertise, our exploration, land, drilling and production capabilities and the experience of our management generally enable us to compete effectively.

Marketing

Our production is marketed
to third parties consistent with industry practices. Typically, oil is sold at the wellhead at field-posted prices plus a bonus and natural gas is sold under contract at an index price, with certain price adjustments based upon factors normally
considered in the industry, such as distance from the well to the pipeline, well pressure, estimated reserves, quality of natural gas and prevailing supply and demand conditions.

Our marketing objectives are to receive the most favorable prices possible for our oil and natural gas production, to avoid undue credit risk in our
choice of purchasers and to maintain the flexibility to react to changes in the market.

Regulation of the Oil and Natural Gas Industry

Regulation of Transportation and Sale of Oil

Sales
of crude oil, condensate and natural gas liquids are not currently regulated and are made at negotiated prices. Nevertheless, Congress could reenact price controls in the future.

Our sales of crude oil are affected by the availability, terms and cost of transportation. The transportation of oil in common carrier pipelines is also
subject to rate regulation. The Federal Energy Regulatory Commission, or the FERC, regulates interstate oil pipeline transportation rates under the Interstate Commerce Act. In general, interstate oil pipeline rates must be cost-based, although
settlement rates agreed to by all shippers are permitted and market-based rates may be permitted in certain circumstances. Effective January 1, 1995, the FERC implemented regulations establishing an indexing system (based on inflation) for
transportation rates for oil that allowed for an increase or decrease in the cost of transporting oil to the purchaser. A review of these regulations by the FERC in 2000 was successfully challenged on appeal by an association of oil pipelines. On
remand, the FERC in February 2003 increased the index slightly, effective July 2001. Intrastate oil pipeline transportation rates are subject to regulation by state regulatory commissions. The basis for intrastate oil pipeline regulation, and the
degree of regulatory oversight and scrutiny given to intrastate oil pipeline rates, varies from state to state. Insofar as effective interstate and intrastate rates are equally applicable to all comparable shippers, we believe that the regulation of
oil transportation rates will not affect our operations in any way that is of material difference from those of our competitors.

Further,
interstate and intrastate common carrier oil pipelines must provide service on a non-discriminatory basis. Under this open access standard, common carriers must offer service to all similarly situated shippers requesting service



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on the same terms and under the same rates. When oil pipelines operate at full capacity, access is governed by prorationing provisions set forth in the
pipelines published tariffs. Accordingly, we believe that access to oil pipeline transportation services generally will be available to us to the same extent as to our competitors.

Regulation of Transportation and Sale of Natural Gas

Historically, the transportation and sale for
resale of natural gas in interstate commerce have been regulated pursuant to the Natural Gas Act of 1938, the Natural Gas Policy Act of 1978 and regulations issued under those Acts by the FERC. In the past, the federal government has regulated the
prices at which natural gas could be sold. While sales by producers of natural gas can currently be made at uncontrolled market prices, Congress could reenact price controls in the future. Deregulation of wellhead natural gas sales began with the
enactment of the Natural Gas Policy Act. In 1989, Congress enacted the Natural Gas Wellhead Decontrol Act. The Decontrol Act removed all Natural Gas Act and Natural Gas Policy Act price and non-price controls affecting wellhead sales of natural gas
effective January 1, 1993.

FERC regulates interstate natural gas transportation rates and service conditions, which affects the
marketing of natural gas that we produce, as well as the revenues we receive for sales of our natural gas. Since 1985, the FERC has endeavored to make natural gas transportation more accessible to natural gas buyers and sellers. The FERC has stated
that open access policies are necessary to improve the competitive structure of the interstate natural gas pipeline industry and to create a regulatory framework that will put natural gas sellers into more direct contractual relations with natural
gas buyers by, among other things, unbundling the sale of natural gas from the sale of transportation and storage services. Beginning in 1992, the FERC issued Order No. 636 and a series of related orders to implement its open access policies.
As a result of the Order No. 636 program, the marketing and pricing of natural gas have been significantly altered. The interstate pipelines traditional role as wholesalers of natural gas has been eliminated and replaced by a structure
under which pipelines provide transportation and storage service on an open access basis to others who buy and sell natural gas. Although the FERCs orders do not directly regulate natural gas producers, they are intended to foster increased
competition within all phases of the natural gas industry.

In 2000, the FERC issued Order No. 637 and subsequent orders, which
imposed a number of additional reforms designed to enhance competition in natural gas markets. Among other things, Order No. 637 effected changes in FERC regulations relating to scheduling procedures, capacity segmentation, penalties, rights of
first refusal and information reporting.

We cannot accurately predict whether the FERCs actions will achieve the goal of increasing
competition in markets in which our natural gas is sold. Additional proposals and proceedings that might affect the natural gas industry are pending before the FERC and the courts. The natural gas industry historically has been very heavily
regulated. Therefore, we cannot provide any assurance that the less stringent regulatory approach recently established by the FERC will continue. However, we do not believe that any action taken will affect us in a way that materially differs from
the way it affects other natural gas producers.

Gathering service, which occurs upstream of jurisdictional transmission services, is
regulated by the states on shore and in state waters. Although its policy is still in flux, FERC has reclassified certain jurisdictional transmission facilities as non-jurisdictional gathering facilities, which has the tendency to increase our costs
of getting natural gas to point of sale locations.

Intrastate natural gas transportation is also subject to regulation by state regulatory
agencies. The basis for intrastate regulation of natural gas transportation and the degree of regulatory oversight and scrutiny given to intrastate natural gas pipeline rates and services varies from state to state. Insofar as such regulation within
a particular state will generally affect all intrastate natural gas shippers within the state on a comparable basis, we believe that the regulation of similarly situated intrastate natural gas transportation in any states in which we operate and
ship natural gas on an intrastate basis will not affect our operations in any way that is of material difference from those of our competitors. Like the regulation of interstate transportation rates, the regulation of intrastate transportation rates
affects the marketing of natural gas that we produce, as well as the revenues we receive for sales of our natural gas.



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##### Table of Contents

Regulation of Production

The production of oil and natural gas is subject to regulation under a wide range of local, state and federal statutes, rules, orders and regulations. Federal, state and local statutes and regulations require permits
for drilling operations, drilling bonds and reports concerning operations. All of the states in which we own and operate properties have regulations governing conservation matters, including provisions for the unitization or pooling of oil and
natural gas properties, the establishment of maximum allowable rates of production from oil and natural gas wells, the regulation of well spacing, and plugging and abandonment of wells. The effect of these regulations is to limit the amount of oil
and natural gas that we can produce from our wells and to limit the number of wells or the locations at which we can drill, although we can apply for exceptions to such regulations or to have reductions in well spacing. Moreover, each state
generally imposes a production or severance tax with respect to the production and sale of oil, natural gas and natural gas liquids within its jurisdiction.

The failure to comply with these rules and regulations can result in substantial penalties. Our competitors in the oil and natural gas industry are subject to the same regulatory requirements and restrictions that
affect our operations.

Environmental Matters and Other Regulation

General

Our operations are subject to stringent and complex federal, state and local laws and
regulations governing environmental protection as well as the discharge of materials into the environment. These laws and regulations may, among other things:



| |  |  | require the acquisition of various permits before drilling commences;
| | - |  | ---------------------------------------------------------------------



| |  |  | restrict the types, quantities and concentration of various substances that can be released into the environment in connection with oil and natural gas drilling and
production activities;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | require remedial measures to mitigate pollution from former and ongoing operations, such as requirements to close pits and plug abandoned wells.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------

These laws and regulations may also restrict the rate of oil and natural gas production below the rate that would
otherwise be possible. The regulatory burden on the oil and gas industry increases the cost of doing business in the industry and consequently affects profitability. Additionally, Congress and federal and state agencies frequently revise
environmental laws and regulations, and any changes that result in more stringent and costly waste handling, disposal and cleanup requirements for the oil and gas industry could have a significant impact on our operating costs.

The following is a summary of some of the existing laws, rules and regulations to which our business operations are subject.

Waste Handling

The Resource Conservation and
Recovery Act, or RCRA, and comparable state statutes, regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. Under the auspices of the federal Environmental Protection Agency, or EPA,
the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced waters and most of the other wastes associated with the exploration, development
and production of crude oil or natural gas are currently regulated under RCRA or state non-hazardous waste provisions. Releases or spills of these regulated materials may result in remediation liabilities under these statutes. It is possible that
certain oil and natural gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which
could have a material adverse effect on our results of operations and financial position.



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Comprehensive Environmental Response, Compensation, and Liability Act

The Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, also known as the Superfund Law, imposes joint and several
liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current or former owner or operator of the
site where the release occurred and anyone who disposed or arranged for the disposal of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous
substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal
injury and property damage allegedly caused by the hazardous substances released into the environment.

In the course of our operations, we
generate wastes that may fall within CERCLAs definition of hazardous substances. Further, we currently own, lease or operate properties that have been used for oil and natural gas exploration and production for many years. Hazardous substances
or petroleum may have been released on, at or under the properties owned, leased or operated by us, or on, at or under other locations, including off-site locations, where such hazardous substances or other wastes have been taken for disposal. In
addition, some of our properties have been operated by third parties or by previous owners or operators whose handling, treatment and disposal of hazardous substances, petroleum, or other materials or wastes were not under our control. These
properties and the substances or materials disposed or released on, at or under them may be subject to CERCLA, RCRA or analogous or other state laws. Under such laws, we could be required to remove previously disposed substances and wastes or
released petroleum, remediate contaminated property or perform remedial plugging or pit closure operations to prevent future contamination.

Water
Discharges

The Federal Water Pollution Control Act, or the Clean Water Act, and analogous state laws, impose restrictions and strict
controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances into waters of the United States or state waters. Under these laws, the discharge of pollutants into regulated waters is prohibited except
in accordance with the terms of a permit issued by EPA or an analogous state agency. Federal and state regulatory agencies can impose administrative, civil and criminal penalties for non-compliance with discharge permits or other requirements of the
Clean Water Act and analogous state laws and regulations.

The Oil Pollution Act of 1990, or OPA, which amends and augments the Clean Water
Act, establishes strict liability for owners and operators of facilities that are the site of a release of oil into waters of the United States. In addition, OPA and regulations promulgated pursuant thereto impose a variety of regulations on
responsible parties related to the prevention of oil spills and liability for damages resulting from such spills. OPA also requires certain oil and natural gas operators to develop, implement and maintain facility response plans, conduct annual
spill training for certain employees and provide varying degrees of financial assurance.

We are not aware of any environmental claims
existing as of December 31, 2008, which would have a material impact on our financial position or results of operations. There can be no assurance, however, that current regulatory requirements will not change, or past non-compliance with
environmental laws will not be discovered on our properties.

Air Emissions

The Federal Clean Air Act and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the
imposition of other requirements. In addition, EPA has developed and continues to develop stringent regulations governing emissions of toxic air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil
and criminal penalties for non-compliance with air permits or other requirements of the Federal Clean Air Act and associated state laws and regulations. Oil and gas operations may in certain circumstances and locations be subject to permits and
restrictions under these statutes for emissions of air pollutants, including volatile organic compounds, nitrous oxides, and hydrogen sulfide.



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National Environmental Policy Act

Oil and natural gas exploration and production activities on federal lands are subject to the National Environmental Policy Act, or NEPA. NEPA requires federal agencies, including the Department of Interior, to
evaluate major agency actions that have the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an Environmental Assessment that assesses the potential direct, indirect and cumulative impacts
of a proposed project and, if necessary, will prepare a more detailed Environmental Impact Statement that may be made available for public review and comment. All of our current exploration and production activities, as well as proposed exploration
and development plans, on federal lands require governmental permits that are subject to the requirements of NEPA. This process has the potential to delay the development of oil and natural gas projects.

Endangered Species, Wetlands and Damages to Natural Resources

Various state and federal statutes prohibit certain actions that adversely affect endangered or threatened species and their habitat, migratory birds, wetlands, and natural resources. These statutes include the Endangered Species Act, the
Migratory Bird Treaty Act, the Clean Water Act and CERCLA. Where takings of or harm to species or damages to wetlands, habitat, or natural resources occur or may occur, government entities or at times private parties may act to prevent oil and gas
exploration or production or seek damages to species, habitat, or natural resources resulting from filling or construction or releases of oil, wastes, hazardous substances or other regulated materials.

OSHA and Other Laws and Regulations

We are subject
to the requirements of the federal Occupational Safety and Health Act (OSHA) and comparable state statutes. The OSHA hazard communication standard, the Emergency Planning and Community Right to Know Act and similar state statutes require that we
organize and/or disclose information about hazardous materials stored, used or produced in our operations.

Recent studies have indicated
that emissions of certain gases may be contributing to warming of the Earths atmosphere. In response to these studies, many nations have agreed to limit emissions of greenhouse gases pursuant to the United Nations Framework
Convention on Climate Change, also known as the Kyoto Protocol. Methane, a primary component of natural gas, and carbon dioxide, a byproduct of the burning of oil and natural gas, and refined petroleum products, are greenhouse
gases regulated by the Kyoto Protocol. Although the United States is not participating in the Kyoto Protocol, several states have adopted legislation and regulations to reduce emissions of greenhouse gases. Restrictions on emissions of methane
or carbon dioxide that may be imposed in various states could adversely affect our operations and demand for our products. Additionally, the U.S. Supreme Court has ruled, in Massachusetts, et al. v. EPA, that the U.S. Environmental Protection Agency
abused its discretion under the Clean Air Act by refusing to regulate carbon dioxide emissions from mobile sources. This Supreme Court decision could result in federal regulation of carbon dioxide emissions and other greenhouse gases, and may affect
the outcome of other climate change lawsuits pending in U.S. federal courts in a manner unfavorable to our industry. Currently, our operations are not adversely impacted by existing state and local climate change initiatives and, at this time, it is
not possible to accurately estimate how potential future laws or regulations addressing greenhouse gas emissions would impact our business.

Private
Lawsuits

In addition to claims arising under state and federal statutes, where a release or spill of hazardous substances, oil and gas
or oil and gas wastes have occurred, private parties or landowners may bring lawsuits against oil and gas companies under state law. The plaintiffs may seek property damages, personal injury damages, remediation costs or injunctions to require
remediation or restoration of contaminated property, soil, groundwater or surface water. In some cases, oil and gas operations are located near populated areas and emissions or accidental releases could affect the surrounding properties and
population.



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##### Table of Contents

|Item 1A. | Risk Factors
|-------- | ------------

You should carefully consider each of
the risks described below, together with all of the other information contained in this report, before deciding to invest in our securities. If any of the following risks develop into actual events, our business, financial condition or results of
operations could be materially adversely affected and you may lose all or part of your investment.

We have substantial debt obligations coming due in
2009 that we may be unable to satisfy. Any failure to meet our debt obligations could harm our business, financial condition, results of operations or cash flows.

We have a substantial amount of debt. As of March 27, 2009, we had short term debt of approximately $122.3 million net of discount, relating to our New Notes and Senior Notes. The Senior Notes became due in
October 2008 after we defaulted on our change of control purchase offer, and The New Notes mature June 15, 2009. The default on our Senior Notes is continuing. As of December 31, 2008, our Senior Notes, New Notes, trade payables and other
current liabilities exceeded our current assets by $122.9 million. As such, our short-term and long-term liquidity as of December 31, 2008 was not adequate to fund our operations, including significant capital expenditures, interest and
repayment of the 2009 debt maturities.

Our substantial level of indebtedness has important adverse consequences, including the following:



| |  |  | it may make it difficult for us to satisfy our obligations under our indebtedness and contractual and commercial commitments;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | we must use a substantial portion of our cash flow from operations to pay interest on our indebtedness, which reduces the funds available to us for other purposes;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to obtain additional debt financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes may be limited;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our flexibility in reacting to changes in the industry may be limited and we could be more vulnerable to adverse changes in our business or economic conditions in
general; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we may be at a competitive disadvantage to those of our competitors who operate on a less leveraged basis.
| | - |  | ----------------------------------------------------------------------------------------------------------

We do not have the ability to generate cash flows from operations and to make scheduled payments on our indebtedness (including principal maturities
already due and to become due), and therefore we are forced to adopt an alternative strategy that may include actions such as reducing, delaying or foregoing acquisitions and capital expenditures, selling assets, restructuring or refinancing our
indebtedness or seeking equity capital. We cannot assure you that any of these alternative strategies could be effected on satisfactory terms, if at all, or that they would yield sufficient funds to make required payments of interest and principal
on our debt in the future, including payments on the notes, and any such alternative measures may be unsuccessful or may not permit us to meet scheduled debt service obligations, which could cause us to default on our obligations and impair our
liquidity. Ultimately, it may become necessary for us to seek voluntary protection under the U.S. Bankruptcy Code.

We have had a operating losses and
limited revenues to date and may experience continued losses in the future.

We have operated at a loss each year since inception. Net
losses for the fiscal years ended December 31, 2006, 2007 and 2008 were approximately $3.8 million, $12.7 million and $80.9 million, respectively. Our loss in the fiscal year ended December 31, 2008 was primarily attributed to
(i) conversion of debt, in an amount of $41.5 million, a figure which included $21.3 million for make-whole premiums and approximately $11.5 million for the amortization of various debt issuance discounts, deferred loan costs and premiums
associated with the consent solicitation and change of control purchase offer for the Senior Notes, and (ii) interest expense of $23.5 million. Our revenues for the fiscal years ended December 31, 2006, 2007 and 2008 were $0 million, $11.6
million and $32.6 million, respectively, reflecting the fact that



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##### Table of Contents

we established our first oil and natural gas production operations during 2007. We may not be able to generate significant revenues in the future. In
addition, we expect to incur substantial operating expenses in connection with our natural gas and oil exploration and development activities. As a result, we may continue to experience negative earnings and cash flow for at least the foreseeable
future and cannot predict when, or even if, we might become profitable.

We have substantial capital requirements that, if not met, may hinder
operations and cause us to go out of business.

External financing will be required in the future if we are to successfully fund our
growth. On January 28, 2009, we liquidated our oil and natural gas hedging arrangements and terminated our credit facility with Wells Fargo Foothill, Inc., repaying in full our then existing obligations under such credit facility. Accordingly,
operational revenue represents our only current source of funding for our ongoing operations. We may not be able to obtain additional financing, and financing under new credit facilities may not be available to us in the future. Without additional
capital resources, we may be forced to limit, defer or cease any future natural gas and oil exploration and development, adversely affecting the producing rates and ultimate value of our natural gas and oil properties and, in turn, negatively
affecting our business, financial condition, and results of operations.

Our growth and continued operations could be impaired by
limitations on our access to the capital markets or traditional secured sources of credit. Because of the unprecedented volatility and disruption experienced in the capital and credit markets, adequate capital may not be available to us, or if
available, would be adequate for the long-range growth of the Company or obtainable by us on acceptable terms. In the event we do not raise additional capital from conventional sources, such as our existing investors or commercial banks, our growth
will be restricted and we will need to scale back or curtail implementing our business plan.

Without adequate capital resources or funding
on acceptable terms, we may be forced to limit our planned oil and natural gas acquisition and development activities and thereby adversely affect the producing rates and ultimate value of our oil and natural gas properties. If we are unable to
service our indebtedness, we may also be forced to adopt an alternative strategy that may include actions such as reducing or delaying acquisitions and capital expenditures, selling assets, restructuring or refinancing our indebtedness or seeking
equity capital. Because of todays deteriorating capital market conditions, these alternative strategies may fail to yield sufficient funds to make required payments on our indebtedness.

Natural gas and oil prices are highly volatile, and lower prices will negatively affect our financial results.

Our revenue, profitability, cash flow, oil and natural gas reserves value, future growth, and ability to borrow funds or obtain additional capital, as
well as the carrying value of our properties, are substantially dependent on prevailing prices of natural gas and oil. Historically, the markets for natural gas and oil have been volatile, and those markets are likely to continue to be volatile in
the future. It is impossible to predict future natural gas and oil price movements with certainty. Prices for natural gas and oil are subject to wide fluctuations in response to relatively minor changes in the supply of and demand for natural gas
and oil, market uncertainty, and a variety of additional factors beyond our control. These factors include:



| |  |  | the level of consumer energy product demand;
| | - |  | --------------------------------------------



| |  |  | the domestic and foreign supply of oil and natural gas;
| | - |  | -------------------------------------------------------



| |  |  | overall economic conditions;
| | - |  | ----------------------------



| |  |  | weather conditions;
| | - |  | -------------------



| |  |  | domestic and foreign governmental regulations and taxes;
| | - |  | --------------------------------------------------------



| |  |  | the price and availability of alternative fuels;
| | - |  | ------------------------------------------------



| |  |  | political conditions in or affecting oil and natural gas producing regions;
| | - |  | ---------------------------------------------------------------------------



| |  |  | the level and price of foreign imports of oil and liquefied natural gas; and
| | - |  | ----------------------------------------------------------------------------



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| |  |  | the ability of the members of the Organization of Petroleum Exporting Countries and other state controlled oil companies to agree upon and maintain oil price and
production controls.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Declines in natural gas and oil prices may materially adversely affect our financial condition,
liquidity, and ability to finance planned capital expenditures and results of operations and may reduce the amount of oil and natural gas that we can produce economically.

Drilling for and producing oil and natural gas are high risk activities with many uncertainties that could adversely affect our business, financial condition or results of operations.

Our success largely depends on the success of our exploitation, exploration, development and production activities. Our oil and natural gas exploration
and production activities are subject to numerous risks beyond our control, including the risk that drilling will not result in commercially viable oil or natural gas production. Our decisions to purchase, explore, develop or otherwise exploit
prospects or properties will depend in part on the evaluation of data obtained through geophysical and geological analyses, production data and engineering studies, the results of which are often inconclusive or subject to varying interpretations.
Our costs of drilling, completing and operating wells are often uncertain before drilling commences. Overruns in budgeted expenditures are a common risk that can make a particular project uneconomical. Further, many factors may curtail, delay or
cancel drilling operations, including the following:



| |  |  | delays imposed by or resulting from compliance with regulatory requirements;
| | - |  | ----------------------------------------------------------------------------



| |  |  | pressure or irregularities in geological formations;
| | - |  | ----------------------------------------------------



| |  |  | shortages of or delays in obtaining equipment and qualified personnel;
| | - |  | ----------------------------------------------------------------------



| |  |  | equipment failures or accidents;
| | - |  | --------------------------------



| |  |  | adverse weather conditions;
| | - |  | ---------------------------



| |  |  | reductions in oil and natural gas prices;
| | - |  | -----------------------------------------



| |  |  | oil and natural gas property title problems; and
| | - |  | ------------------------------------------------

A substantial percentage of our proved reserves consists of undeveloped reserves.

As of the end of our 2008 fiscal year,
approximately 21% of the Eliasville Field Properties proved reserves and 40.5% of the Blessing Field Properties proved reserves were classified as proved undeveloped reserves. These reserves may not ultimately be developed or produced,
or quantities developed and produced may be smaller than expected, which in turn may have a material adverse effect on our results of operations.

Reserve estimates depend on many assumptions that may turn out to be inaccurate. Any material inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves.

The process of estimating oil and natural gas reserves is complex. It requires interpretations of available technical data and many
assumptions, including assumptions relating to economic factors. Any significant inaccuracies in these interpretations or assumptions could materially affect the estimated quantities and present value of our reported reserves. In order to prepare
our estimates, we must project production rates and the timing of development expenditures. We must also analyze available geological, geophysical, production and engineering data. The extent, quality and reliability of this data can vary. The
process also requires that economic assumptions be made about matters such as oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. Therefore, estimates of oil and natural gas reserves
are inherently imprecise.

Actual future production, oil and natural gas prices received, revenues, taxes, development expenditures,
operating expenses and quantities of recoverable oil and natural gas reserves most likely will vary from our estimates. Any significant variance could materially affect the estimated quantities and present value of our reported reserves. In
addition, we may adjust estimates of proved reserves to reflect production history, results of exploration and development, prevailing oil and natural gas prices and other factors, many of which are beyond our control.



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Seismic studies do not guarantee that hydrocarbons are present or if present will produce in economic quantities.

We rely on seismic studies to assist us with assessing prospective drilling opportunities on our properties, as well as on properties that
we may acquire. Such seismic studies are merely an interpretive tool and do not necessarily guarantee that hydrocarbons are present or if present will produce in economic quantities.

We depend on successful exploration, development and acquisitions to maintain revenue in the future.

In general, the volume of production from natural gas and oil properties declines as reserves are depleted, with the rate of decline depending on reservoir characteristics. Except to the extent that we conduct successful exploration and
development activities or acquire properties containing proved reserves, or both, our proved reserves will decline as reserves are produced. Our future natural gas and oil production is, therefore, highly dependent on our level of success in finding
or acquiring additional reserves. Additionally, the business of exploring for, developing, or acquiring reserves is capital intensive. Recovery of our reserves, particularly undeveloped reserves, will require significant additional capital
expenditures and successful drilling operations. As a result of the termination of our credit facility in January 2009 and to the extent cash flow from operations continues to be suppressed given the current commodities market, our ability to make
the necessary capital investment to maintain or expand our asset base of natural gas and oil reserves has been impaired unless other external sources of capital become available. In addition, we may be required to find partners for any future
exploratory activity. To the extent that others in the industry do not have the financial resources or choose not to participate in our exploration activities, we will be adversely affected.

Our identified drilling locations are scheduled out over several years, making them susceptible to uncertainties that could materially alter the occurrence or timing
of their drilling.

Scheduled multi-year drilling activities on our existing acreage represent a significant component of any growth
strategy. However, our ability to drill and develop these locations depends on a number of uncertainties, including oil and natural gas prices, the availability of capital, costs, drilling results, regulatory approvals and other factors. Because of
these uncertainties, we do not know if the potential drilling locations we have identified will ever be drilled or if we will be able to produce oil or natural gas from these or any other potential drilling locations. As such, our actual drilling
activities may materially differ from those presently identified, which could adversely affect our business.

We may experience difficulty in achieving
and managing future growth.

We may not be successful in upgrading our technical, operations, and administrative resources or in
increasing our ability to internally provide certain of the services currently provided by outside sources, and we may not be able to maintain or enter into new relationships with project partners and independent contractors. Our inability to
achieve or manage growth may adversely affect our financial condition and results of operations.

We face strong competition from other natural gas and
oil companies.

We encounter competition from other natural gas and oil companies in all areas of our operations, including the
acquisition of exploratory prospects and proved properties. Our competitors include major integrated natural gas and oil companies and numerous independent natural gas and oil companies, individuals, and drilling and income programs. Many of our
competitors are large, well-established companies that have been engaged in the natural gas and oil business much longer than we have and possess substantially larger operating staffs and greater capital resources than we do. These companies may be
able to pay more for exploratory projects and productive natural gas and oil properties and may be able to define, evaluate, bid for, and purchase a greater number of properties and prospects than our financial or human resources permit. In
addition, these companies may be able to expend greater resources on the existing and changing technologies that we believe are and will be increasingly important to attaining success in the industry. We may not be able to conduct our operations,
evaluate, and select suitable properties and consummate transactions successfully in this highly competitive environment.

Our business may suffer if we
lose our Chief Executive Officer.

Our success will be dependent on our ability to continue to employ and retain experienced skilled
personnel. We depend to a large extent on the services of Thomas Kaetzer, our Chief Executive Officer and Chairman. Mr. Kaetzer has experience and expertise in evaluating and analyzing producing oil and natural gas properties and drilling
prospects, maximizing production from oil and natural gas properties and, marketing oil and natural gas production. The loss of Mr. Kaetzer could have a material adverse effect on our operations.



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We cannot control activities on properties that we do not operate and are unable to ensure their proper operation and
profitability.

We do not operate certain of the properties in which we have an interest. As a result, we have limited ability to
exercise influence over, and control the risks associated with, the operations of these properties. The failure of an operator of our wells to adequately perform operations, an operators breach of the applicable agreements or an
operators failure to act in ways that are in our best interests could reduce our production and revenues. The success and timing of our drilling and development activities on properties operated by others therefore depend upon a number of
factors outside of our control, including the operators:



| |  |  | timing and amount of capital expenditures;
| | - |  | ------------------------------------------



| |  |  | expertise and financial resources;
| | - |  | ----------------------------------



| |  |  | inclusion of other participants in drilling wells; and
| | - |  | ------------------------------------------------------



| |  |  | use of technology.
| | - |  | ------------------

The marketability of our
natural gas production depends on facilities that we typically do not own or control, which could result in a curtailment of production and revenues.

The marketability of our natural gas production depends in part upon the availability, proximity and capacity of natural gas gathering systems, pipelines and processing facilities. We generally deliver natural gas
through gas gathering systems and gas pipelines that we do not own under interruptible or short-term transportation agreements. Under the interruptible transportation agreements, the transportation of our gas may be interrupted due to capacity
constraints on the applicable system, due to maintenance or repair of the system, or for other reasons as dictated by the particular agreements. Our ability to produce and market natural gas on a commercial basis could be harmed by any significant
change in the cost or availability of such markets, systems or pipelines.

We may not be able to keep pace with technological developments in our
industry.

The natural gas and oil industry is characterized by rapid and significant technological advancements and introduction of
new products and services which utilize new technologies. As others use or develop new technologies, we may be placed at a competitive disadvantage or competitive pressures may force us to implement those new technologies at substantial costs. In
addition, other natural gas and oil companies may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we are able to. We
may not be able to respond to these competitive pressures and implement new technologies on a timely basis or at an acceptable cost. If one or more of the technologies we use now or in the future were to become obsolete or if we are unable to use
the most advanced commercially available technology, our business, financial condition, and results of operations could be materially adversely affected.

If oil and natural gas prices decrease, we may be required to take write-downs of the carrying values of our oil and natural gas properties, potentially triggering earlier-than-anticipated repayments of any outstanding debt obligations
and negatively impacting the trading value of our securities.

Accounting rules require that we review periodically the carrying value
of our oil and natural gas properties for possible impairment. Based on specific market factors and circumstances at the time of prospective impairment reviews, and the continuing evaluation of development plans, production data, economics and other
factors, we may be required to write down the carrying value of our oil and natural gas properties. Because our properties serve as collateral for advances under our existing credit facility, a writedown in the carrying values of our properties
could require us to repay debt earlier than would otherwise be required. A write-down would also constitute a non-cash charge to earnings. It is likely that the effect of such a write-down could also negatively impact the trading price of our
securities.

We account for our oil and gas properties using the successful efforts method of accounting. Under this method, all
development costs and acquisition costs of proved properties are capitalized and amortized on a units-of-production basis over the remaining life of proved developed reserves and proved reserves, respectively. Costs of drilling exploratory wells



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are initially capitalized, but charged to expenses if and when a well is determined to be unsuccessful. We evaluate impairment of our proved oil and gas
properties whenever events or changes in circumstances indicate an assets carrying amount may not be recoverable. The risk that we will be required to write down the carrying value of our oil and natural gas properties increases when oil and
gas prices are low or volatile. In addition, write-downs would occur if we were to experience sufficient downward adjustments to our estimated proved reserves or the present value of estimated future net revenues.

We are subject to complex laws that can affect the cost, manner or feasibility of doing business.

The exploration, development, production and sale of oil and natural gas is subject to extensive federal, state, local and international regulation. We
may be required to make large expenditures to comply with such governmental regulations. Matters subject to regulation include:



| |  |  | natural disasters.
| | - |  | ------------------



| |  |  | permits for drilling operations;
| | - |  | --------------------------------



| |  |  | drilling and plugging bonds;
| | - |  | ----------------------------



| |  |  | reports concerning operations;
| | - |  | ------------------------------



| |  |  | the spacing and density of wells;
| | - |  | ---------------------------------



| |  |  | unitization and pooling of properties;
| | - |  | --------------------------------------



| |  |  | environmental maintenance and cleanup of drill sites and surface facilities; and
| | - |  | --------------------------------------------------------------------------------



| |  |  | protection of human health.
| | - |  | ---------------------------

From time to time,
regulatory agencies have also imposed price controls and limitations on production by restricting the rate of flow of natural gas and oil wells below actual production capacity in order to conserve supplies of natural gas and oil.

Under these laws, we could be liable for personal injuries, property damage and other damages. Failure to comply with these laws also may result in the
suspension or termination of our operations and subject us to administrative, civil and criminal penalties. Moreover, these laws could change in ways that substantially increase our costs. Any such liabilities, penalties, suspensions, terminations
or regulatory changes could materially adversely affect our financial condition and results of operations.

Our operations may cause us to incur
substantial liabilities for failure to comply with environmental laws and regulations.

Our oil and natural gas operations are subject
to stringent federal, state and local laws and regulations relating to the release or disposal of materials into the environment or otherwise relating to environmental protection. These laws and regulations may require the acquisition of a permit or
other authorizations before drilling commences, restrict the types, quantities and concentration of substances that can be released into the environment in connection with drilling and production activities, require permitting or authorization for
release of pollutants into the environment, limit or prohibit drilling activities on certain lands lying within wilderness, wetlands, areas inhabited by endangered or threatened species, and other protected areas, and impose substantial liabilities
for pollution resulting from historical and current operations. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, incurrence of investigatory or remedial obligations or
the imposition of injunctive relief. Changes in environmental laws and regulations occur frequently, and any changes that result in more stringent or costly waste handling, storage, transport, disposal or cleanup requirements could require us to
make significant expenditures to maintain compliance, and may otherwise have a material adverse effect on our results of operations, competitive position or financial condition as well as on the industry in general. Under these environmental laws
and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination regardless of whether we were responsible for the release or if our operations were standard in the industry
at the time they were performed.



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Market conditions or operational impediments may hinder our access to oil and natural gas markets or delay our
production.

Market conditions or the unavailability of satisfactory oil and natural gas transportation arrangements may hinder our
access to oil and natural gas markets or delay our production. The availability of a ready market for our oil and natural gas production depends on a number of factors, including the demand for and supply of oil and natural gas and the proximity of
reserves to pipelines and terminal facilities. Our ability to market our production depends in substantial part on the availability and capacity of gathering systems, pipelines and processing facilities owned and operated by third parties. Our
failure to obtain such services on acceptable terms could materially harm our business.

Our productive properties may be located in areas
with limited or no access to pipelines, thereby necessitating delivery by other means, such as trucking, or requiring compression facilities. Such restrictions on our ability to sell our oil or natural gas have several adverse affects, including
higher transportation costs, fewer potential purchasers (thereby potentially resulting in a lower selling price) or, in the event we were unable to market and sustain production from a particular lease for an extended time, possibly causing us to
lose a lease due to lack of production.

Future hedge transactions may result in our making cash payments or prevent us from benefiting to the fullest
extent possible from increases in prices for natural gas and oil.

Because natural gas and oil prices are unstable, from time to time
we may enter into price-risk-management transactions such as swaps, collars, futures, and options to reduce our exposure to price declines associated with a portion of our natural gas and oil production and thereby to achieve a more predictable cash
flow. Any use of these arrangements may limit our ability to benefit from increases in the prices of natural gas and oil. Hedging arrangements may also apply to only a portion of our production, thereby providing only partial protection against
declines in natural gas and oil prices. These arrangements could expose us to the risk of financial loss in certain circumstances, including instances in which production is less than expected, our customers fail to purchase contracted quantities of
natural gas and oil, or a sudden, unexpected event materially impacts natural gas or oil prices.

The financial condition of our operators could
negatively impact our ability to collect revenues from operations.

We do not operate all of the properties in which we have working
interests. In the event that an operator of our properties experiences financial difficulties, this may negatively impact our ability to receive payments for our share of net production that we are entitled to under our contractual arrangements with
such operator. While we seek to minimize such risk by structuring our contractual arrangements to provide for production payments to be made directly to us by first purchasers of the hydrocarbons, there can be no assurances that we can do so in all
situations covering our non-operated properties.

We may not have enough insurance to cover all of the risks that we face and operations of prospects in
which we participate may not maintain or may fail to obtain adequate insurance.

In accordance with customary industry practices, we
maintain insurance coverage against some, but not all, potential losses in order to protect against the risks we face. We do not carry business interruption insurance. We may elect not to carry insurance if our management believes that the cost of
available insurance is excessive relative to the risks presented. In addition, we cannot insure fully against pollution and environmental risks. The occurrence of an event not fully covered by insurance could have a material adverse effect on our
financial condition and results of operations. The impact of Hurricanes Katrina and Rita have resulted in escalating insurance costs and less favorable coverage terms.

Oil and natural gas operations are subject to particular hazards incident to the drilling and production of oil and natural gas, such as blowouts, cratering, explosions, uncontrollable flows of oil, natural gas or
well fluids, fires and pollution and other environmental risks. These hazards can cause personal injury and loss of life, severe damage to and destruction of property and equipment, pollution or environmental damage and suspension of operation. We
do not operate all of the properties in which we have an interest. In the projects in which we own a non-operating interest directly or own an equity interest in a limited partnership which in turn owns a non- operating interest, the operator for
the prospect maintains insurance of various types to cover our operations with policy limits and retention liability customary in the industry. We believe the coverage and types of insurance are adequate. The occurrence of a significant adverse
event that is not fully covered by insurance could result in the loss of our total investment in a particular prospect which could have a material adverse effect on our financial condition and results of operations.



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Our producing properties are located in regions which make us vulnerable to risks associated with operating in a
limited number of geographic areas, including the risk of damage or business interruptions from hurricanes.

Our Blessing Field
Properties are geographically located in the Texas Gulf Coast region. As a result, we may be affected by any delays or interruptions in production or transportation in these areas caused by governmental regulation, transportation capacity
constraints, natural disasters, regional price fluctuations or other factors.

Such disturbances could in the future have any or all of the
following adverse effects on our business:



| |  |  | interruptions to our operations as we suspend production in advance of an approaching storm;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | damage to our facilities and equipment, including damage that disrupts or delays our production;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | disruption to the transportation systems we rely upon to deliver our products to our customers; and
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | damage to or disruption of our customers facilities that prevents us from taking delivery of our products.
| | - |  | -----------------------------------------------------------------------------------------------------------

Terrorist attacks aimed at our energy operations could adversely affect our business.

The continued threat of terrorism and the impact of military and other government action has led and may lead to further increased volatility in prices
for oil and natural gas and could affect these commodity markets or the financial markets used by us. In addition, the U.S. government has issued warnings that energy assets may be a future target of terrorist organizations. These developments have
subjected our oil and natural gas operations to increased risks. Any future terrorist attack on our facilities, those of our customers, the infrastructure we depend on for transportation of our products, and, in some cases, those of other energy
companies, could have a material adverse effect on our business.

The indenture governing our Senior Notes and New Notes imposes significant operating
and financial restrictions on us that may prevent us from pursuing certain business opportunities and restrict our ability to operate our business.

The indenture governing our outstanding notes contains covenants that restrict our ability to take various actions, such as:



| |  |  | incurring or generating additional indebtedness;
| | - |  | ------------------------------------------------



| |  |  | paying dividends on our capital stock or redeeming, repurchasing or retiring our capital stock or subordinated indebtedness or making other restricted payments;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | entering into certain transactions with affiliates;
| | - |  | ---------------------------------------------------



| |  |  | creating or incurring liens on our assets;
| | - |  | ------------------------------------------



| |  |  | transferring or selling assets;
| | - |  | -------------------------------



| |  |  | incurring dividend or other payment restrictions affecting certain of our future subsidiaries; and
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | consummating a merger, consolidation or sale of all or substantially all of our assets.
| | - |  | ---------------------------------------------------------------------------------------

The restrictions contained in the indenture governing the New Notes and the Senior Notes could:



| |  |  | limit our ability to plan for or react to market conditions or meet capital needs or otherwise restrict our activities or business plans; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | adversely affect our ability to finance our operations, strategic acquisitions, investments or alliances or other capital needs or to engage in other business
activities that would be in our interest.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A breach of any of the restrictive covenants could result in a default under
the indenture governing the notes. If the borrowings under the existing notes were to be accelerated, we cannot assure you that we would be able to repay in full in the notes.

The market price of our common stock may be volatile.

The trading price of our common stock and the
price at which we may sell common stock in the future are subject to large fluctuations in response to any of the following:



| |  |  | limited trading volume in our common stock;
| | - |  | -------------------------------------------



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| |  |  | quarterly variations in operating results;
| | - |  | ------------------------------------------



| |  |  | our involvement in litigation;
| | - |  | ------------------------------



| |  |  | general financial market conditions;
| | - |  | ------------------------------------



| |  |  | the prices of natural gas and oil;
| | - |  | ----------------------------------



| |  |  | announcements by us and our competitors;
| | - |  | ----------------------------------------



| |  |  | our liquidity;
| | - |  | --------------



| |  |  | our ability to raise additional funds;
| | - |  | --------------------------------------



| |  |  | changes in government regulations; and
| | - |  | --------------------------------------



| |  |  | other events.
| | - |  | -------------

Moreover, our common
stock does not have substantial trading volume. As a result, relatively small trades of our common stock may have a significant impact on the price of our common stock and, therefore, may contribute to the price volatility of our common stock.

Because of the limited trading volume of our common stock and the price volatility of our common stock, you may be unable to sell your
shares of our common stock when you desire or at the price you desire. The inability to sell your shares of our common stock in a declining market because of such illiquidity or at a price you desire may substantially increase your risk of loss.

The trading price of our common stock could be adversely affected by sales and issuances of our common stock in the public markets.

As of March 27, 2009, our largest stockholder beneficially owned approximately 58.4%, and our directors and executive officers, as a group,
beneficially owned approximately 22.7%, of the then-outstanding shares of our common stock (inclusive of options and warrants exercisable into shares of our common stock).

Sales of our common stock held by these stockholders, or the perception that such sales might occur, could have a material adverse effect on the trading
price of our common stock or could impair our ability to obtain capital through future offerings of equity securities. In addition, the trading price of our common stock could decline as a result of issuances by us of additional shares of our common
stock. The trading price of our common stock could also decline as the result of the perception that such issuances could occur.

Provisions in our
certificate of incorporation and the indenture governing the notes may inhibit a takeover of our Company.

Under our amended and
restated certificate of incorporation, our board of directors is authorized to issue shares of our capital stock without the approval of our stockholders. Issuance of such shares could make it more difficult to acquire our Company without the
approval of our board of directors as more shares would have to be acquired to gain control.

In addition, upon a change of control of our
Company, each holder of the notes may require us to purchase all or a portion of such holders notes at a purchase price equal to 101% of the aggregate principal amount of such holders notes, together with accrued and unpaid interest, if
any, to the date of purchase.

These provisions may deter hostile takeover attempts that could result in an acquisition of us that would
have been financially beneficial to our stockholders.

We have not previously paid dividends on the shares of our common stock and do not anticipate
doing so in the foreseeable future.

Under the Nevada Revised Statutes, cash dividends on capital stock may not be paid if, after given
effect to any such dividend, we would not be able to pay our debts as they become due in the usual course of business or our total assets would be less than the sum of our total liabilities plus any amount needed to satisfy preferential rights upon
dissolution of our Company.



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In addition, the indenture governing the notes restricts, and any indentures and other financing
agreements that we may enter into in the future may limit, our ability to pay cash dividends on our capital stock, including shares of our common stock issuable upon conversion of the notes. Specifically, under the indenture governing the notes, we
may pay cash dividends and make other distributions on or in respect of our capital stock only if certain covenants are met.

Moreover, we
have not in the past paid any dividends on the shares of our common stock and do not anticipate that we will pay any dividends on our common stock in the foreseeable future. Any future decision to pay a dividend on our common stock and the amount of
any dividend paid, if permitted, will be made at the discretion of our board of directors.



|Item 3. | Legal Proceedings.
|------- | ------------------

From time to time, we are party
to certain legal actions and claims arising in the ordinary course of business. While the outcome of these events cannot be predicted with certainty, management does not expect these matters to have a materially adverse effect on our financial
position or results of operations.



|Item 4. | Submission of Matters to Vote of Security Holders.
|------- | --------------------------------------------------

No matters were submitted to the vote or consent of the holders of the outstanding shares of our common stock during the quarter ended December 31, 2008.



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PART II



|Item 5. | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
|------- | -------------------------------------------------------------------------------------------------------------

Market for Our Common Stock

Our common stock
is quoted on the OTC Bulletin Board under the symbol BOGA. At March 27, 2009, there were 151,497,530 shares of our common stock outstanding. The following table sets forth, for the periods indicated, the high, low and closing sales
prices per common share as reported on the OTC Bulletin Board, and the cash dividends declared per common share.



|                                 |  |      |      |     |   |     
|-------------------------------- |  | ---- | ---- | --- | - | ----
|2008:                            |  | High |      | Low
|Quarter ended December 31, 2008  |  | $    | 0.21 |     | $ | 0.02
|Quarter ended September 30, 2008 |  | $    | 0.72 |     | $ | 0.13
|Quarter ended June 30, 2008      |  | $    | 0.61 |     | $ | 0.23
|Quarter ended March 31, 2008     |  | $    | 0.45 |     | $ | 0.17
|                                 |  |     
|2007:                            |  | High |      | Low
|Quarter ended December 31, 2007  |  | $    | 0.64 |     | $ | 0.37
|Quarter ended September 30, 2007 |  | $    | 0.75 |     | $ | 0.34
|Quarter ended June 30, 2007      |  | $    | 0.71 |     | $ | 0.32
|Quarter ended March 31, 2007     |  | $    | 0.63 |     | $ | 0.37

The last sales price of our common stock on the OTC Bulletin Board on December 31, 2008 was
$0.06 per share. As of March 27, 2009, the closing sale price of a share of our common stock was $0.02. As of March 27, 2009, there were approximately 134 holders of record of our common stock.

We have not paid any cash dividends to date, and have no intention of paying any cash dividends on our common stock in the foreseeable future. The
declaration and payment of dividends is subject to the discretion of our Board of Directors and to certain limitations imposed under provisions of the Nevada Revised Status Governing Corporations. The timing, amount and form of dividends, if any,
will depend on, among other things, our results of operations, financial condition, cash requirements and other factors deemed relevant by our Board of Directors. The indenture governing under which we issued our senior notes contain significant
restrictions on our ability to pay dividends on our common stock.

There were no repurchases of securities during the fourth quarter of
2008.

Recent Sales of Unregistered Securities

We have reported all sales of our unregistered equity securities that occurred during 2008 in our Reports on Form 10-Q or Form 8-K, as applicable.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table
provides information as of December 31, 2008 about our equity compensation plans and arrangements.

Equity Compensation Plan
InformationDecember 31, 2008



|                                                           |  |                                                                                            |     |  |                                                                             |      |                                                                                                                                            |         |    
|---------------------------------------------------------- |  | ------------------------------------------------------------------------------------------ | --- |  | --------------------------------------------------------------------------- | ---- | ------------------------------------------------------------------------------------------------------------------------------------------ | ------- | ---
|Plan category                                              |  | (a)Number of securitiesto be issued uponexercise ofoutstanding options,warrants and rights |     |  | (b)Weighted-averageexercise price
ofoutstanding options,warrants and rights |      | (c)Number of securities remainingavailable for future issuance underequity compensation plans(excluding securities reflected incolumn (a)) |        
|Equity compensation plans approved by security holders     |  | 0                                                                                          |     |  | $                                                                           | 0    |                                                                                                                                            | N/A     |    
|Equity compensation plans not approved by security holders |  | 12,080,833                                                                                 | (1) |  | $                                                                           | 0.40 |                                                                                                                                            | 446,667 | (2)
|                                                           |  |                                                                                            |     |  |                                                                             |      |                                                                                                                                            |         |    
|Total                                                      |  |                                                                                            |     |  | $                                                                           | 0.40 |                                                                                                                                            |         |    



|(1) | Consists of warrants and options granted to our employees, officers, directors and consultants, to the extent vested and exercisable (within the meaning of Rule 13d-3(d)(1)
promulgated by the SEC under the Securities Exchange Act of 1934, as amended) as of December 31, 2008.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(2) | Includes an aggregate of (i) 200,000 shares of our common stock underlying options granted to our employees on April 22, 2008, but not yet vested with respect to such
underlying shares, which options shall vest as to one-half of such remaining underlying shares on each of January 3, 2010 and 2011 and (ii) 246,667 shares of our common stock underlying options granted to our employees on August 3, 2007,
but not yet vested with respect to such underlying shares, which options shall vest as to one-half of the underlying shares on each of the second and third year anniversary of the grant date.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Set forth below is a description of the individual compensation arrangements or equity compensation plans not currently approved by our security holders
pursuant to which 12,080,833 shares of our Common Stock included in the chart above were issuable as of December 31, 2008:



| |  |  | Option granted June 19, 2008 to an officer in recognition of performance and achievement to date, which option expires five years from grant date and is
currently exercisable to purchase up to 3,000,000 shares of our Common Stock at an exercise price of $0.40 per share;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Options granted April 22, 2008 to several of our employees, which options expire five years from grant date and, subject to a vesting schedule, are currently
exercisable with respect to 175,000 shares of our Common Stock at an exercise price of $0.50 per share;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Options granted August 3, 2007 to several of our employees, which options expire five years from grant date and, subject to a vesting schedule, are currently
exercisable with respect to 123,333 shares of our Common Stock at an exercise price of $0.55 per share;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted August 3, 2007 to a director in consideration of services performed on our behalf, which option expires five years from grant date and is
currently exercisable to purchase up to 150,000 shares of our Common Stock at an exercise price of $0.55 per share;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted August 3, 2007 to an officer in consideration of services to be performed on our behalf, which option expires five years from grant date and is
currently exercisable with respect to 500,000 shares of our Common Stock at an exercise price of $0.55 per share;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted August 3, 2007 to an officer in consideration of services to be performed on our behalf, which option expires five years from grant date and is
currently exercisable with respect to 500,000 shares of our Common Stock at an exercise price of $0.825 per share;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted August 3, 2007 to an officer in consideration of services to be performed on our behalf, which option expires five years from grant date and is
currently exercisable with respect to 500,000 shares of our Common Stock at an exercise price of $1.10 per share;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted January 4, 2007 to an officer in consideration of services performed on our behalf, which option expires five years from grant date and is
currently exercisable to purchase up to 100,000 shares of our Common Stock at an exercise price of $0.56 per share;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted December 20, 2006 to an officer in consideration of services to be performed on our behalf, which option expires five years from grant date and
is currently exercisable with respect to 1,000,000 shares of our Common Stock at an exercise price of $0.50 per share;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted December 20, 2006 to an officer in consideration of services to be performed on our behalf, which option expires five years from grant date and
is currently exercisable with respect to 500,000 shares of our Common Stock at an exercise price of $0.60 per share;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted December 20, 2006 to an officer in consideration of services to be performed on our behalf, which option expires five years from grant date and
is currently exercisable with respect to 500,000 shares of our Common Stock at an exercise price of $1.00 per share;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted November 14, 2006 to a consultant in consideration of services performed on our behalf, which option expires five years from grant date and is
currently exercisable to purchase up to 360,000 shares of our Common Stock at an exercise price of $0.50 per share;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Options granted October 20, 2006 to consultants in consideration of services performed on our behalf, which options expire five years from grant date and are
currently exercisable to purchase up to 100,000 shares of our Common Stock, in the aggregate, at an exercise price of $0.50 per share;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted August 15, 2006 to a consultant in consideration of services performed on our behalf, which option expires five years from grant date and is
currently exercisable to purchase up to 100,000 shares of our Common Stock at an exercise price of $1.01 per share;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted December 27, 2005 to an officer in consideration of services performed on our behalf, which option expires five years from grant date and is
currently exercisable to purchase up to 175,000 shares of our Common Stock at an exercise price of $0.94 per share;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Options granted April 29, 2005 to directors, officers and consultants in consideration of services performed on our behalf, which options expire five years
from grant date and are currently exercisable to purchase up to an aggregate of 3,897,500 shares of our Common Stock at an exercise price of $0.05 per share; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Option granted April 1, 2005 to a consultant in consideration of services performed on our behalf, which option expires five years from grant date and is
currently exercisable to purchase up to 400,000 shares of our Common Stock at an exercise price of $0.30 per share.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Item 6. | Selected Financial Data.
|------- | ------------------------

Not Applicable



|Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations.
|------- | --------------------------------------------------------------------------------------

The following discussion will assist you in understanding our financial position, liquidity, and results of operations. The information below should be
read in conjunction with the consolidated financial statements, and the related notes to consolidated financial statements. Our discussion contains both historical and forward-looking information. We assess the risks and uncertainties about our
business, long-term strategy, and financial condition before we make any forward-looking statements, but we cannot guarantee that our assessment is accurate or that our goals and projections can or will be met. Statements concerning results of
future exploration, exploitation, development, and acquisition expenditures as well as expense and reserve levels are forward-looking statements. We make assumptions about commodity prices, drilling results, production costs, administrative
expenses, and interest costs that we believe are reasonable based on currently available information.

Critical Estimates and Accounting Policies

We prepare our consolidated financial statements in this report using accounting principles that are generally accepted in the United
States (GAAP). GAAP represents a comprehensive set of accounting and disclosure rules and requirements. We must make judgments, estimates, and in certain circumstances, choices between acceptable GAAP alternatives as we apply these rules
and requirements, which may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.

The most critical estimate we use is the engineering estimate of proved oil and
gas reserves. This estimate affects the application of the successful efforts method of accounting, the calculation of depreciation and depletion of oil and gas properties and the estimate of the impairment of our oil and gas properties. It also
affects the estimated lives of our assets used to determine asset retirement obligations.

Successful Efforts Method Accounting

We use the successful efforts method of accounting for oil and gas producing activities. Our costs to acquire mineral interests in oil and gas properties,
to drill and equip exploratory wells that find proved reserves, to drill and equip development wells and related asset retirement costs are capitalized. Costs to drill exploratory wells that do not find proved reserves, geological and geophysical
costs, and costs of carrying and retaining unproved properties are expensed. Because we can not predict the timing and the cost of exploratory drilling that is unsuccessful in finding proved reserves, our quarterly and annual net income could vary
dramatically in the future under the successful efforts method of accounting in the event of increased exploratory drilling activity by us.

Impairment
of Oil and Natural Gas Properties

Unproved oil and gas properties that are individually significant are periodically assessed for
impairment of value, and a loss is recognized at the time of the impairment by providing an impairment allowance. An asset would be impaired if the undiscounted cash flows were less than its carrying value. Impairments are measured by the amount by
which the carrying value exceeds its fair value. Because we use the successful efforts method, we assess our properties individually for impairment, instead of on an aggregate pool of costs.



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Depreciation and Depletion of Oil and Natural Gas Properties

Capitalized costs of producing oil and gas properties, after considering estimated residual salvage values, are depreciated and depleted by the
unit-of-production method. This method is applied through the simple multiplication of reserve units produced by the leasehold costs per unit on a field by field basis. Leasehold cost per unit is calculated by dividing the total cost of acquiring
the leasehold by the estimated total proved oil and gas reserves associated with that lease. Well cost per unit is calculated by dividing the total cost by the estimated total proved producing oil and gas reserves associated with that well.

Asset Retirement Obligations

We
record a liability for legal obligations associated with the retirement of tangible long-lived assets in the period in which they are incurred in accordance with Statement of Financial Accounting Standards (SFAS) No. 143
Accounting for Asset Retirement Obligations. Under this method, when liabilities for dismantlement and abandonment costs (ARO) are initially recorded, the carrying amount of the related oil and natural gas properties are increased.
Accretion of the liability is recognized each period using the interest method of allocation, and the capitalized cost is depleted over the useful life of the related asset. Revisions to such estimates are recorded as adjustments to the ARO,
capitalized asset retirement costs and charges to operations during the periods in which they become known. At the time the abandonment cost is incurred, we will be required to recognize a gain or loss if the actual costs do not equal the estimated
costs included in ARO.

Concentrations of Credit Risk

All of our receivables are due from oil and natural gas purchasers. We sold 99.7% of our oil and natural gas production to three customers during 2008.

We maintain our cash in bank deposit accounts which, at times, may exceed federally insured limits. Accounts are guaranteed by the Federal Deposit
Insurance Corporation (FDIC) up to $250,000. At December 31, 2008, we had approximately $6.1 million, in excess of FDIC insured limits. We have not experienced any losses in such accounts.

Revenue and Cost Recognition

We use the sales method
of accounting for natural gas and oil revenues. Under this method, revenues are recognized based on the actual volumes of gas and oil sold to purchasers. The volume sold may differ from the volumes to which we are entitled based on our interest in
the properties. Costs associated with production are expensed in the period incurred.

Fair Value of Financial Instruments

The carrying value of cash and cash equivalents approximates fair value because of the short-term maturity of those instruments. The fair value of the
Companys investments in marketable debt securities is based on the quoted market price on the last business day of the year. Declines in fair value below the Companys carrying value deemed to be other than temporary are charged against
net earnings. The carrying value of short-term and long-term debt approximates fair value.



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Stock-based compensation

On January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment. SFAS 123(R) replaced SFAS No. 123 and supersedes APB Opinion No. 25. SFAS 123(R) requires all stock-based payments
to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values.

Derivatives

Derivative financial instruments, utilized to manage or reduce commodity price risk related to Baselines production, are accounted
for under the provisions of SFAS No. 133, Accounting for Derivative Instruments and for Hedging Activities, and related interpretations and amendments. Under this statement, derivatives are carried on the balance sheet at fair
value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge,
the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income or loss and are recognized in the statement of operations when the hedged item affects earnings. If the derivative is not designated as
a hedge, changes in the fair value are recognized in other expense. Ineffective portions of changes in the fair value of cash flow hedges are also recognized in loss on derivative liabilities.

Income taxes

We recognize deferred tax assets and
liabilities based on differences between the financial reporting and tax bases of assets and liabilities using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. We provide a valuation
allowance for deferred tax assets for which we do not consider realization of such assets to be more likely than not.

Liquidity and Capital Resources

As stated throughout this Annual Report, at December 31, 2008, our current liabilities exceeded our current assets



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by approximately $122.9 million and, absent a financial restructuring, our ability to continue to operate as a going concern is doubtful. Presently, we do
not have the ability to make required interest payments of $4.27 million to the holders of our Senior Notes and New Notes on April 1, 2009. Similarly, we have not identified the means by which we can repay either the Senior Notes or the New
Notes, the latter of which mature on June 15, 2009.

Our main sources of liquidity and capital resources for 2009 are expected to be
cash on hand, internally generated cash flows from operations and any new credit facilities we are able to arrange. As of December 31, 2008, we had $6.4 million of cash on deposit at our principal bank, although this amount was reduced by a
$3.3 million cash interest payment to the holders of our New Notes on January 2, 2009. During January 2009, we elected to terminate our Credit Agreement with Wells Fargo Foothill, Inc., leaving the Company without the use of this source of
liquidity going forward. This Credit Facility was otherwise set to expire on April 15, 2009, 60 days prior to the maturity of our New Notes.

During 2008, net cash flow provided by operations decreased by $0.8 million to $6.2 million, as compared to $7.0 million for our 2007 fiscal year. This decrease occurred despite higher production volumes and oil and gas prices realized
during 2008, primarily because of higher cash interest costs and higher general and administrative expenses during 2008

Excluding the
potentially significant effects of unforeseen expenses, changes in our operating assets and liabilities, interest costs and general and administrative expenses, our cash flow from operations fluctuates primarily because of variations in oil and gas
production rates and in commodity prices. In addition, our oil and gas production from either of our Texas properties may be curtailed due to weather-related factors beyond our control. For example, Hurricane Ike caused us to shut down our
production from the Blessing Field Properties for seven days during September 2008, and to operate at curtailed production rates for several additional days after the storm. In addition, maintenance activities on, or damage to, major pipelines or
processing facilities can also cause us to shut-in production for undetermined lengths of time. Such production delays and damage to facilities were experienced to varying degrees by other exploration and production companies, and by pipeline and
processing facility operators during and after Hurricanes Katrina and Rita in 2005.

Our realized oil and gas prices vary significantly due
to world political events, supply and demand for products, product storage levels, and weather patterns, among other factors. We sell 100% of our production at prevailing spot market prices. Accordingly, product price volatility will affect our cash
flow from operations. To mitigate price volatility and to comply with the terms of our credit facility and bond issues, we entered into hedging arrangements during 2007 covering a substantial portion of our anticipated future production in order to
limit the effect of swings in hydrocarbon prices on our revenues from operations. These hedge positions were liquidated during January 2009, with a portion of the approximate $4.5 million in proceeds used to fully retire and terminate the Credit
Facility extended to the Company by Wells Fargo Foothill.

We incurred capital and drilling expenditures totaling approximately $21.9
million during 2008. These capital expenditures included $5.1 million for drilling and workover activities on the Eliasville Field Properties and $15.5 million for drilling and workovers on the Blessing Field Properties.

We currently do not expect to make significant development capital expenditures during 2009, as a result of the Companys limited liquidity and the
upcoming June 15, 2009 maturity of our New Notes.

Interest on that portion of our Senior Notes that were not restructured ($15
million), is due and payable on April 1, 2009 and semi-annually each October 1 and April 1 thereafter. Such notes carry a cash interest rate of 12.5%. These instruments are carried at a value of $15,450,000, reflecting the fact that
the holders of the Senior Notes accepted our change of control offer to purchase these Senior Notes at a price equal to 103% of their par value. If a holder of the Senior Notes delivers a consent to us prior to the maturity or earlier repayment of
the New Notes, such holder will be entitled to receive New Notes in a principal amount equal to 104.25% of the original face amount, plus any foregone interest since October 1, 2008. Interest on our New Notes of which $106.7 million was
outstanding as of December 31, 2008, is due quarterly on April 1, 2009 and each April 1, July 1, October 1 and January 1 thereafter. The New Notes carry a rate of 15%, of which 12.5% must be paid in cash and
2.5% may be paid in additional PIK notes. The New Notes mature on June 15, 2009. We do not presently have the means to repay such obligations.

Our Convertible Notes were originally due on October 1, 2013 and interest on the Convertible Notes was payable semi-annually beginning April 1, 2008, with us having the option of paying any interest in cash or, subject to certain
conditions being met, as additional principal amounts under the Convertible Notes, or PIK Notes. Our Convertible Notes were converted to common equity in a series of transactions occurring during July 2009 and therefore no longer accrue interest.

Effective October 1, 2007, we entered into a credit agreement with Wells Fargo Foothill, Inc., as arranger and



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administrative agent. This agreement, or Credit Facility, provides for a revolving credit line which is subject to a borrowing base of up to the lesser of
$20.0 million, or an amount determined based on our proved oil and gas reserves. A $10 million sub-limit for the issuance of letters of credit is also established under the terms of the credit agreement. As of December 31, 2008, we had
approximately $4.0 million borrowed under the Credit Facility. The Credit Facility was retired in full and terminated on January 30, 2009, using a portion of the proceeds from our January 28, 2009 liquidation of our hedge positions.

Our oil and gas properties were pledged in October 2007 as collateral for the revolving Credit Facility, as well as the Senior Notes and the
Convertible Notes. These assets currently continue to secure the Senior Notes and the New Notes, as the Credit Facility and the Convertible Notes were retired or converted to equity in January 2009 and July 2008 respectively. We have also agreed not
to pay dividends on our common stock.

The indenture governing the Convertible Notes
is no longer operative as a result of these instruments being converted to equity in July 2008. The indenture governing the Senior Notes was amended and restated as of October 29, 2008 (Amended Senior Indenture). Under the Amended Senior
Indenture, we are required to maintain a minimum ratio of PV-10 to Senior Secured Indebtedness of 1.15 as of June 30thand December 31stof any year starting December 31, 2008. We are also required to maintain a maximum ratio of Senior Secured Indebtedness to LTM EBITDA,
measured quarterly, of 7.75 on December 31, 2008 and 8.75 starting March 31, 2009 and thereafter. Finally, we are required to maintain a maximum ratio of Total Indebtedness to LTM EBITDA, measured quarterly, of 7.75 on December 31,
2008 and 8.75 starting March 31, 2009 and thereafter. We are also limited under the Amended Senior Indenture regarding annual capital expenditures and the acquisition of new assets, and are required to offer to retire a portion of the Senior
Notes and New Notes at 101% of par value using excess cash flow as defined under the Amended Senior Indenture. We have determined that we will breach the PV-10 to Senior Secured Indebtedness ratio test for the period ending December 31, 2008,
but will satisfy all other covenants applicable under the Amended Senior Indenture.

The most significant restrictive financial covenant
under our Credit Facility was a minimum EBITDA test that became operative at the end of any quarter during which our cash plus unused credit availability under our line of credit fell below $10 million at any time. This covenant was never operative
while the original Credit Agreement was in effect, because our combined cash and unused credit availability at any measuring point never fell below the $10 million threshold. We entered into a Forebearance, First Amendment to Credit Agreement and
First Amendment to Fee Letter dated October 29, 2008 with Wells Fargo Foothill, which among other things required that we achieve minimum monthly EBITDA targets starting with the month ending October 31, 2008. We met this requirement until
the January 30, 2009 repayment in full, and termination of, this Credit Agreement

The following table summarizes our contractual
obligations and commercial commitments as of December 31, 2008:



|                         |                |                        |                 |  |            |         |            |   |               |  |   |     |  |   |  
|------------------------ | -------------- | ---------------------- | --------------- |  | ---------- | ------- | ---------- | - | ------------- |  | - | --- |  | - | -
|                         |                | Payments due by period
|                         | Total          |                        | Less than1 year |  | 2 - 3years |         | 4 - 5years |   | After 5 years
|                         | (in thousands)
|Contractual obligations: |                |                        |                 |  |            |         |            |   |               |  |   |     |  |   |  
|Debt and interest(*)     |                | $                      | 141,212         |  | $          | 141,212 |            | $ | 0             |  | $ | 0   |  | $ | 0
|Office Lease             |                |                        | 550             |  |            | 141     |            |   | 287           |  |   | 121 |  |   | 0
|                         |                |                        |                 |  |            |         |            |   |               |  |   |     |  |   |  
|Total                    |                | $                      | 141,761         |  | $          | 141,353 |            | $ | 287           |  | $ | 121 |  | $ | 0
|                         |                |                        |                 |  |            |         |            |   |               |  |   |     |  |   |  



|(*) | Assumes Senior Notes convert to New Notes and are repaid June 15, 2009
|--- | ----------------------------------------------------------------------

Changes in our working capital accounts from 2007 to 2008 include a decrease in our cash and marketable securities accounts of $12.6 million, primarily reflecting the use of a portion of net remaining proceeds from
our two bond offerings which closed on October 1, 2007 to pay interest and capital costs during 2008. Our accounts receivable decreased by $1.6 million during 2008 from $3.8 million at year-end 2007 to $2.1 million. These accounts receivable
are comprised entirely of oil and natural gas sales receivables. Due to an increase in our operating activities, our accounts payable balance increased from $2.1 million to $2.7 million as of year-end 2008. Royalties payable as of December 31,
2008 were $4.2 million, up from a balance of $3.8 million at year-end 2007, a reflection of an increase in suspense royalties as of year-end 2008. Accrued expenses as of December 31, 2008 were $1.3 million, an increase of $1.0 million over the
year-end 2007 level. Accrued interest fell by $1.0 million to $4.5 million at year-end 2008 from the prior years level, primarily due to the retirement of our Convertible Notes in July 2008.



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On December 31, 2008, our current liabilities exceeded our current assets by $122.9 million,
primarily a function of our Senior Notes and New Notes being classified as short term liabilities.

We believe our short-term and long-term
liquidity as of December 31, 2008 is not adequate to fund operations, including significant capital expenditures, interest and repayment of 2009 debt maturities.

Results of Operations

Revenue

The following table discloses the net oil and natural gas production volumes, sales, and sales prices for the years ended December 31, 2008 and 2007:



|                              |      |              |          |  |   |         
|----------------------------- | ---- | ------------ | -------- |  | - | --------
|                              |      | December 31,
|                              | 2008 |              | 2007    
|Oil production volume (Mbbls) |      |              | 252.3    |  |   | 149.3   
|Oil sales revenue ($000)      |      | $            | 24,716.1 |  | $ | 11,511.5
|Price per Bbl                 |      | $            | 97.94    |  | $ | 77.09   
|                              |      |             
|Gas production volume (Mmcf)  |      |              | 1,245.9  |  |   | 335.5   
|Gas sales revenue ($000)      |      | $            | 12,645.1 |  | $ | 2,459.1 
|Price per Mcf                 |      | $            | 10.15    |  | $ | 7.33    

Lease operating expense and production taxes

Our production expenses totaled $10.5 million during 2008, an increase of $5.4 million compared to $5.1 million during 2007. The following table presents
the major components of our operating costs on a per Mcfe basis for fiscal years 2008 and 2007:



|                          |       |              |            |  |       |      |         |   |         |  |   |  
|------------------------- | ----- | ------------ | ---------- |  | ----- | ---- | ------- | - | ------- |  | - | -
|                          |       | December 31,
|                          | 2008  |              | 2007      
|                          | Total |              | PerMcfe    |  | Total |      | PerMcfe
|Direct Operating Expenses |       | $            | 7,180,261  |  | $     | 2.60 |         | $ | 3,862.3 |  | $ | 3
|Ad Valorem Taxes          |       |              | 549,739    |  |       | 0.20 |         |   | 243.0   |  |   | 0
|Production Taxes          |       |              | 2,087,788  |  |       | 0.76 |         |   | 715.4   |  |   | 0
|Field Office Expense      |       |              | 689,047    |  |       | 0.25 |         |   | 327.7   |  |   | 0
|                          |       |              |            |  |       |      |         |   |         |  |   |  
|                          |       | $            | 10,506,835 |  | $     | 3.81 |         | $ | 5,148.4 |  | $ | 4
|                          |       |              |            |  |       |      |         |   |         |  |   |  

Accretion of asset retirement obligation

Accretion expense for fiscal year 2008 was $32 thousand, as compared to $42 thousand of accretion expense for fiscal year 2007.

Depletion, depreciation and amortization (DD&A)

For our fiscal year 2008, we recorded DD&A expense of $32.4 million, compared to 2007 DD&A expense of $1.8 million. The major components of this 2008 expense were impairment of oil and gas properties of $26.0 million and depletion
of our oil and gas properties of $6.3 million.



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General and administrative expense (G&A expense)

General and administrative expense for fiscal year 2008 increased $3.2 million from the comparable 2007 period to $6.6 million. The largest portion of the
2008 total was comprised of salary and labor costs of $3.4 million. Other major components of 2008 general and administrative costs included consulting and professional fees of $1.3 million, office expense of $1.0 million and loan fees of $0.9
million. General and administrative expense for 2008 equaled $2.39 per Mcfe, compared to $2.77 per Mcfe during 2007.

Other income (expense)

Other income (expense) for fiscal year 2008 totaled an expense of $64.0 million, compared to a 2007 fiscal year expense of $13.9
million. The largest component of this total during 2008 was loss on conversion of debt of $41.5 million, mainly comprised of conversion make whole premium on the Convertible Notes, net of interest accrued through the date of conversion, of $21.3
million, unamortized deferred loan costs related to the Senior Notes of $8.7 million, unamortized deferred loan costs related to the Convertible Note of $4.5 million, unamortized debt discount on the Senior Notes of $3.5 million, consent
solicitation premiums of $2.3 million and change of control purchase offer premiums of $1.2 million. Also included in other income (expense) during 2008 was interest expense of $23.5 million, as detailed below.

Interest income

Interest income increased to $514
thousand during fiscal year 2008, up from $99 thousand during 2007, an increase of $415 thousand. Interest earned during 2008 was attributable to interest earned on our sweep operating accounts as well as interest earned on the remaining
net proceeds from our Senior Note offering which closed on October 1, 2007.

Interest expense

Interest expense during 2008 totaled $23.5 million, compared to 2007 interest expense of $14.1 million, an increase of $9.4 million. Total interest
expense during 2008 included interest either paid or accrued on credit facilities and bonds of $19.3 million and amortization of debt issuance costs and discounts of $4.3 million.

The 2007 interest expense total included cash interest paid on credit facilities and notes payable of $1.8 million, accrued interest (primarily
attributable to our two bond issues) of $5.6 million, amortization of fees, warrants and other consideration granted under various credit facilities of $6.2 million and amortization of debt discount of $0.6 million.

Loss on derivative instruments

We recorded an
unrealized gain of $12.3 million on our derivative instruments in Other Comprehensive Income (Loss) as of December 31, 2008, compared to an unrealized loss of $7.4 million as of December 31, 2007. This figure represents the cumulative
change in fair value of our hedge positions which qualify for cash-flow hedge accounting since the establishment of these positions during fiscal year 2007.

Net loss available to common shareholders

For the fiscal year 2008, our total comprehensive loss increased to $68.6
million, compared to our 2007 total comprehensive loss of $20.1 million. The major components of the 2008 comprehensive loss included loss on conversion of debt of $41.5 million, DD&A expense of $32.4 million and interest expense of $23.5
million. Our 2008 loss from operations totaled $16.9 million, compared to income from operations of $1.2 million during 2007. The 2008 loss from operations is primarily a reflection of an oil and gas property impairment charge of $26.0 million.

New Accounting Pronouncements

On December 31, 2008, the SEC published the final rules and interpretations updating its oil and gas reporting requirements. Many of the revisions are updates to definitions in the existing oil and gas rules to make them consistent
with the petroleum resource management system, which is a widely accepted standard for the management of petroleum resources that was developed by several industry organizations. Key revisions include changes to the pricing used to estimate reserves
utilizing a 12-month average price rather than a single day spot price which eliminates the ability to utilize subsequent prices to the end of a reporting period when the full cost ceiling was exceeded and subsequent pricing exceeds pricing at the
end of a reporting period, the ability to include nontraditional resources in reserves, the use of new technology for determining reserves, and permitting disclosure of probable and possible reserves. The SEC will require



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companies to comply with the amended disclosure requirements for registration statements filed after January 1, 2010, and for annual reports on Form
10-K for fiscal years ending on or after December 15, 2009. Early adoption is not permitted. The Company is currently assessing the impact that the adoption will have on the Companys disclosures, operating results, financial position and
cash flows.

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, (SFAS
162), which identifies a consistent framework for selecting accounting principles to be used in preparing financial statements for nongovernmental entities that are presented in conformity with United States generally accepted accounting principles
(GAAP). The current GAAP hierarchy was criticized due to its complexity, ranking position of FASB Statements of Financial Accounting Concepts and the fact that it is directed at auditors rather than entities. SFAS 162 will be effective 60 days
following the SECs approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The FASB does not expect that
SFAS 162 will have a change in current practice, and the Company does not believe that SFAS 162 will have an impact on operating results, financial position or cash flows.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161), an
amendment of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). SFAS 161 is effective beginning January 1, 2009 and required entities to provide expanded disclosures
about derivative instruments and hedging activities including (1) the ways in which an entity uses derivatives, (2) the accounting for derivatives and hedging activities, and (3) the impact that derivatives have (or could have) on an
entitys financial position, financial performance, and cash flows. SFAS 161 requires expanded disclosures and does not change the accounting for derivatives. The Company is currently evaluating the impact of SFAS 161, but we do not expect the
adoption of this standard to have a material impact on our financial results.

In December 2007, the FASB issued SFAS No. 141(R),
Business Combinations (SFAS 141(R)). SFAS 141(R) replaces SFAS 141, Business Combinations, however it retains the fundamental requirements that the acquisition method of accounting be used for all business
combinations and for an acquirer to be identified for each business combination. SFAS 141(R) requires an acquirer to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, be
measured at their fair values as of that date, with specified limited exceptions. Changes subsequent to that date are to be recognized in earnings, not goodwill. Additionally, SFAS 141 (R) requires costs incurred in connection with an
acquisition be expensed as incurred. Restructuring costs, if any, are to be recognized separately from the acquisition. The acquirer in a business combination achieved in stages must also recognize the identifiable assets and liabilities, as well as
the noncontrolling interests in the acquiree, at the full amounts of their fair values. SFAS 141(R) is effective for business combinations occurring in fiscal years beginning on or after December 15, 2008. The Company will apply the
requirements of SFAS 141(R) upon its adoption on January 1, 2009 and is currently evaluating whether SFAS 141(R) will have an impact on its financial position and results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS
159). SFAS 159 permits companies to elect to measure many financial instruments and certain other items at fair value. Upon adoption of SFAS 159, a company may elect the fair value option for eligible items that exist at the adoption date.
Subsequent to the initial adoption, the election of the fair value option should only be made at initial recognition of the asset or liability or upon a remeasurement event that gives rise to new-basis accounting. The decision about whether to elect
the fair value option is applied on an instrument-by-instrument basis, is irrevocable and is applied only to an entire instrument and not only to specified risks, cash flows or portions of that instrument. SFAS No. 159 does not affect any
existing accounting standards that require certain assets and liabilities to be carried at fair value nor does it eliminate disclosure requirements included in other accounting standards. Baseline adopted SFAS No. 159 effective January 1,
2008 and did not elect the fair value option for any existing eligible items.

In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements (SFAS 157). SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 does not impose fair value
measurements on items not already accounted for at fair value; rather it applies, with certain exceptions, to other accounting pronouncements that either require or permit fair value measurements. Under SFAS No. 157, fair value refers to the
price that would be received to sell an asset or paid to



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transfer a liability in an orderly transaction between market participants in the principal or most advantageous market. The standard clarifies that fair
value should be based on the assumptions market participants would use when pricing the asset or liability. In February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157 (FSP FAS
157-2), which delays the effective date of SFAS 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until fiscal years beginning after
November 15, 2008. These non-financial items include assets and liabilities such as non-financial assets and liabilities assumed in a business combination, reporting units measured at fair value in a goodwill impairment test and asset
retirement obligations initially measured at fair value. Effective January 1, 2008, Baseline adopted SFAS 157 for fair value measurements not delayed by FSP FAS No. 157-2. The adoption resulted in additional disclosures as required by the
pronouncement (See Note 7  Fair Value Measurements) related to our fair value measurements for oil and gas derivatives and marketable securities but no change in our fair value calculation methodologies. Accordingly, the adoption had no impact
on our financial condition or results of operations.



|Item 8. | Financial Statements.
|------- | ---------------------

The response to this item is
included in Item 15Financial Statements.



|Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
|------- | -------------------------------------------------------------------------------------

None.



|Item 9A. | Controls and Procedures.
|-------- | ------------------------

(a) Disclosure
Controls and Procedures.

We maintain disclosure controls and procedures that are designed to provide reasonable assurance that
information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (the Exchange Act) is recorded, processed, summarized and reported within the time periods specified
in the SEC rules and forms. Disclosure controls and procedures include processes to accumulate and evaluate relevant information and communicate such information to our management, including our Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), as appropriate, to allow for timely decisions regarding required disclosures.

In designing such
disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also
is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Noting these assumptions, under the
supervision and with the participation of management, including our CEO and CFO, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2008, as required by Rule 13a-15(e) of the
Exchange Act.

Based on this evaluation, our CEO and CFO have concluded that, as of December 31, 2008, our disclosure controls and
procedures were effective to ensure that information required to be disclosed by us in reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.

(b) Managements Annual Report on Internal Control over Financial Reporting.

Management is responsible for establishing and maintaining adequate internal control over financial reporting of our Company, as such term is defined in
Rule 13(a)-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external
reporting purposes in accordance with generally accepted accounting principles (GAAP). Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in
reasonable detail, accurately reflect transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use
or disposition of our Companys assets that could have a material effect on our financial statements.



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Internal control over financial reporting cannot provide absolute assurance of achieving financial
reporting objectives because of its inherent limitations. Because of such inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

Management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2008, based on the framework
in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework) to identify any material weaknesses with respect to our internal control over
financial reporting as of December 31, 2008. A material weakness in internal controls over financial reporting is a significant deficiency, or a combination of significant deficiencies, such that there is a reasonable possibility that a material
misstatement of the Companys annual or interim financial statements will not be prevented or detected on a timely basis.

From our
evaluation, as of December 31, 2008 we identified as a material weakness deficiencies in the documentation and consistent performance of certain detective controls surrounding account balances. Specifically, we did not maintain effective controls
over certain reconciliations and, as a result, our controls over the preparation, review and monitoring of certain account reconciliations were ineffective to provide reasonable assurance that account balances were accurate and agreed with
appropriate supporting detail, calculations or other documentation. Based on the foregoing material weakness and the criteria set forth by the COSO Framework, we have concluded that our internal control over financial reporting at December 31, 2008,
was not effective.

We believe that the above deficiencies stem principally from our rapid growth over a relatively short span and may be
adequately addressed through process changes. Accordingly, during 2009 we intend to modify our analytical procedures to ensure the accurate, timely and complete reconciliation of all major accounts to remediate such ineffectiveness and strengthen
our internal controls environment. Proposed actions is an iterative process and will evolve as we continue to evaluate and improve our internal controls over financial reporting. Management will review progress on these activities on a consistent
and ongoing basis at the CEO and senior management level in conjunction with our board of directors.

Despite the need to augment our
internal controls over financial reporting, as outlined above, our management currently believes that the financial reports underlying our financial statements contained in this annual report are reliable given the organizational and process changes
implemented through the date of this report.

This annual report does not include an attestation report of our registered public accounting
firm regarding internal control over our financial reporting. Our managements report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only
managements report in this annual report.

(c) Changes in Internal Control Over Financial Reporting.

There have not been any changes in the Companys internal control over financial reporting during the fiscal quarter ended December 31, 2008
that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



|Item 9B. | Other Information.
|-------- | ------------------

None.



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PART III



|Item 10. | Directors, Executive Officers and Corporate Governance; Compliance with Section 16(a) of the Exchange Act.
|-------- | ----------------------------------------------------------------------------------------------------------

The following table sets forth certain information regarding our current directors and executive officers:



|                        |  |     |  |                                                 |  | 
|----------------------- |  | --- |  | ----------------------------------------------- |  | 
|Name                    |  | Age |  | Position                                        |  | 
|Thomas R. Kaetzer       |  | 50  |  | Chairman, Chief Executive Officer and President |  | 
|Patrick H. McGarey      |  | 51  |  | Chief Financial Officer                         |  | 
|Randal B. McDonald, Jr. |  | 51  |  | Controller                                      |  | 
|John V. Lovoi           |  | 47  |  | Director                                        |  | 
|Joshua L. Targoff       |  | 39  |  | Director                                        |  | 

Their business experience is set forth below:

Thomas R. Kaetzer. Mr. Kaetzer was promoted to our Chairman and Chief Executive Officer on March 21, 2007. He previously was our
President and Chief Operating Officer, titles he held since December 2006. Mr. Kaetzer began his career with Texaco Inc., where, from 1981 to 1995, he held various positions. In 1995, Mr. Kaetzer left Texaco and worked for Vastar Resources
Inc., a major independent oil and gas company. In 1996 Mr. Kaetzer formed Southwest Texas Oil & Gas Co., which subsequently merged into GulfWest Energy Inc. in 1998. Mr. Kaetzer served as President/Chief Operating Officer of
GulfWest from 1999 to 2004, and as Vice President of Operations for its successor, Crimson Exploration Inc., from 2005 to July 2006. From August 2006 to immediately prior to joining Baseline, Mr. Kaetzer worked as a consultant to several
companies in the oil and gas industry. Mr. Kaetzer earned a B.S. degree in Civil Engineering from the University of Illinois in 1981 and a M.S. degree in Petroleum Engineering from Tulane University in 1988.

Patrick H. McGarey. Mr. McGarey has served as Chief Financial Officer since August 16, 2007. From 2004 until May 2007, he served as
Executive Vice President  Finance, Planning and Corporate Development at Goldking Energy Corporation, a private exploration and production company sold to Dune Energy, Inc. in May 2007. During 2003, Mr. McGarey was principal of his own
firm, Energy Growth & Value, LLC, which specialized in sourcing debt and equity capital for energy projects. From 1998 through 2002, he served in a variety of managerial roles within the Energy Capital and Structured Finance business units
of The Williams Companies, in Houston, Texas. Prior to 1998, Mr. McGarey worked in commercial and investment banking, focusing on the energy industry. He began his career as a petroleum engineer with Texaco. Mr. McGarey has a B.S. degree
in Civil Engineering from Virginia Polytechnic Institute and State University and an MBA degree from Loyola Marymount University in Los Angeles.

Randal B. McDonald, Jr. Mr. McDonald has served as Controller since October 1, 2007. Prior to October 1, 2007, he performed contract accounting work for us from April 1, 2007 until September 30, 2007. From
May 1, 1998 until September 30, 2007, Mr. McDonald served as Chief Financial Officer of VTEX Energy, Inc., (OTCBB: VXEN), an independent publicly traded oil and gas exploration and production company. He also served on the board of
directors of VTEX Energy, Inc. during this period. Mr. McDonald has a B.B.A. degree in Accounting from the University of Texas at Austin.

John V. Lovoi. Mr. Lovoi is the managing partner of JVL Partners LLC, a private oil and gas investment partnership. Mr. Lovoi is a Director of Helix Energy Solutions (NYSE: HLX), an oilfield services company engaged in
exploration and production and offshore oil and gas field development and Dril-Quip, Inc. (NYSE: DRQ), a provider of subsea equipment. From 1988 to 2003, Mr. Lovoi held a number of positions in the global oil and gas business, primarily in the
areas of investment banking and equity research. From December 2000 until August 2002, Mr. Lovoi served as Head of Morgan Stanleys Global Oil and Gas investment banking practice. Mr. Lovoi graduated from Texas A&M University in
1984 with a B.S degree in Chemical Engineering and received his Masters in Business Administration with an emphasis on Finance and Accounting from the University of Texas at Austin in 1988.

Joshua L. Targoff.Mr. Targoff is the General Counsel of Third Point LLC. Prior to joining Third Point in May of 2008, he served in the legal
department of Jefferies & Company, Inc. from 2003, where he was most recently a Senior Vice President and the General Counsel for Investment Banking. From 1996 to 2003, he was an associate at the Debevoise & Plimpton LLP law firm.
He received a B.A. from Brown University in 1991 and a J.D. from Yale Law School in 1996.



36



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No Familial Relationships or Legal Proceedings

There are no family relationships among any of our current executive officers or directors.

At no time in the last five years has any bankruptcy petition been filed by or against any business of which any of our current executive officers or
directors was a general partner or executive officer at the time of such bankruptcy or within two years prior to that time.

None of our
current executive officers or directors has, during the last five years, been convicted in a criminal proceeding (excluding traffic violations or similar misdemeanors). None of our current executive officers or directors has, during the last five
years, been a party to a civil proceeding of a judicial or administrative body of competent jurisdiction and, as a result of such proceeding, was or is subject to a judgment, decree or final order enjoining future violations of, or prohibiting or
mandating activities subject to, federal or state securities laws, or finding any violation with respect to such laws.

Section 16(a) Beneficial
Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 (the Exchange Act) requires our
directors, executive officers and beneficial owners of more than 10% of our common stock, or reporting persons to file with the SEC reports of their holdings of, and transactions in, our common stock. Reporting persons are required by
SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based solely on our review of copies of these reports furnished to the Company, we believe that all reports required to be filed by reporting persons pursuant to
Section 16(a) of the Exchange Act were filed for the year ended December 31, 2008 on a timely basis, except for the Form 3 of John V. Lovoi, a director, and a Form 4 for each of Randal B. McDonald, Jr., our Controller, and Patrick H.
McGarey, our CFO, which were filed late.

Code of Business Conduct and Ethics

We have adopted a written code of business conduct and ethics (Code of Conduct and Ethics) that applies to all our directors, officers and
employees, including our Chairman, Chief Executive Officer and Chief Financial Officer. A copy of our current Code of Conduct and Ethics is attached as Exhibit 14.1 to the amendment of our 2007 fiscal year annual report on Form 10-K/A filed with the
SEC on April 25, 2008. All documents which we have filed on the SECs EDGAR system are available for retrieval at the SECs website at www.sec.gov, as well as available to the public from commercial document retrieval services. You
may also obtain a copy of our Code of Conduct and Ethics at no cost, by writing or telephoning us at: Baseline Oil & Gas Corp., 411 North Sam Houston Parkway East, Suite 300, Houston, Texas 77060 (Tel: 281-591-6100). We undertake to make
all disclosures that are required by law and the rules of the OTC Bulletin Board, where our common stock is currently traded, governing amendments to, or waivers from, any provision of the Code of Conduct and Ethics.

Corporate Governance

The OTC Bulletin Board does not
require that we establish or maintain an audit committee. Currently management has the primary responsibility for the preparation of financial statements and the reporting process, including the system of internal controls, with the Board of
Directors exercising oversight of the Companys financial reporting process.

The rules of the OTC Bulletin Board, on which automated
system our common stock is currently traded, does not require that we establish or maintain a nominations committee. Currently the Board identifies and selects director nominees for election at our annual meetings or for fulfilling vacancy(ies) on
the Board, based upon qualifying criteria established by the Board. Under such criteria, directors are expected to bring a range of experience, knowledge and judgment and to act with integrity and commitment to our Company, our business plans and
long-term stockholder value. Directors are also expected to have relevant business and industry experience in order to provide a useful perspective on



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significant risks and competitive issues facing us, and in particular, to demonstrate competence in one or more of the following areas: accounting or
finance, markets, business or management experience, oil and gas industry knowledge, end user experience or perspective, crisis management, or leadership and strategic planning. Directors will also be expected to become familiar with the qualitative
requirements necessary to serve as a director of a corporation engaged in the oil and gas industry.



|Item 11. | Executive Compensation.
|-------- | -----------------------

Although the OTC Bulletin
Board does not require that we establish or maintain a compensation committee, historically our non-employee Directors have provided oversight of managements decisions regarding the compensation of all other executive officers and other
employees, including recommendations relating to the compensation of our Chief Executive Officer.

Set forth in the chart below is the
compensation received by our Chief Executive Officer, our two most highly compensated officers other than the Chief Executive Officer, as well as the two most highly compensated former officers (collectively, the Named Executive
Officers), at our fiscal years ended December 31, 2008 and December 31, 2007:

Summary Compensation Table



|                                                                     |      |      |  |         |         |      |       |        |             |   |              |           |           |                                      |   |                       |  |   |        |     
|-------------------------------------------------------------------- | ---- | ---- |  | ------- | ------- | ---- | ----- | ------ | ----------- | - | ------------ | --------- | --------- | ------------------------------------ | - | --------------------- |  | - | ------ | ----
|Name and Principal Position                                          |      | Year |  | Salary  |         |      | Bonus |        | StockAwards |   | OptionAwards |           |           | Non-EquityIncentive PlanCompensation |   | All OtherCompensation | 
|Thomas R. Kaetzer,Chairman, Chief Executive Officer and President(1) |      | 2008 |  | $       | 235,000 |      |       | $      |            |   |             |           | 3,000,000 | (2)                                  |   |                      |  | $ | 97,916 | (3) 
|                                                                     | 2007 |      |  | 190,000 |         |      |       | 50,000 |             |  |              |          |           |                                      |  |                       |  |  |       
|                                                                     |      |      |  |         |         |      |      
|Patrick H. McGarey,Chief Financial Officer(4)                        |      | 2008 |  | $       | 200,000 |      |       | $      | 33,000      |   |             |           |          |                                      |   |                      |  | $ | 83,333 | (5) 
|                                                                     | 2007 |      |  | 61,875  | (6)     |      |       | 500    |             |  |              | 1,500,000 | (7)       |                                      |  |                       |  |  |       
|                                                                     |      |      |  |         |         |      |      
|Randal B. McDonald, Jr.Controller(8)                                 |      | 2008 |  | $       | 150,000 |      |       | $      | 7,500       |   |             |           | 100,000   | (9)                                  |   |                      |  | $ | 37,500 | (10)
|                                                                     | 2007 |      |  | 37,500  | (11)    |      |       | 750    |             |  |              | 50,000    | (12)      |                                      |  |                       |  |  |       
|                                                                     |      |      |  |         |         |      |      
|Richard M. Cohen,Chief Financial Officer(13)                         |      | 2007 |  | $       | 56,219  | (14) |       |        |            |   |             |           | 100,000   | (15)                                 |   |                      |  |   |       |     
|                                                                     |      |      |  |         |         |      |      
|Barrie Damson,Chairman and Chief Executive Officer(16)               |      | 2007 |  | $       | 0       |      |       |        |            |   |             |           |          |                                      |   |                      |  |   |       |     



|(1) | Mr. Kaetzer became our President and Chief Operating Officer as of December 5, 2006. He was also appointed Chairman and Chief Executive Officer on March 21, 2007,
upon the resignation of Mr. Damson.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Represents options granted June 19, 2008 currently exercisable to purchase up to 3,000,000 shares of our common stock at an exercise price of $0.40 per share.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Represents portion of severance payment, equal to Mr. Kaetzers 12-month base salary, for which he became entitled to upon the change of control that occurred
in July 2008. Severance was payable $58,750 on October 29, 2008 and $19,583.33 per month thereafter, subject to the terms of that letter agreement dated as of October 29, 2008 between him and the Company.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Mr. McGarey was hired as our Chief Financial Officer effective as of August 16, 2007.
|--- | -------------------------------------------------------------------------------------

|(5) | Represents portion of severance payment, equal to Mr. McGareys 12-month base salary, for which he became entitled to upon the change of control that occurred
in July 2008. Severance was payable $50,000 on October 29, 2008 and $16,666.67 per month thereafter, subject to the terms of that letter agreement dated as of October 29, 2008 between him and the Company.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | In 2007 Mr. McGarey was paid an amount equal to 137 days salary at his then annual salary of $165,000 as provided for in his employment agreement, or 37.5%.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Represents options granted August 3, 2007 to purchase (i) up to 500,000 shares of our common stock at an exercise price of $0.55 per share, (ii) up to 500,000 shares
of our common stock at an exercise price of $0.825 per share and (iii) up to 500,000 shares of our common stock at an exercise price of $1.10 per share. Notwithstanding an initial three year vesting schedule, all of the options vested in full
upon the occurrence of a Change of Control Event (as defined under the option agreement) in July 2008.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(8) | Mr. McDonald became our Controller as of October 1, 2007.
|--- | ---------------------------------------------------------

|(9) | Represents option granted April 22, 2008 to purchase up to 100,000 shares of our common stock, at an exercise price
of $0.50 per share, which option is currently exercisable with respect to 33,333 of the underlying shares. The option vests as to 1/3rdof such
underlying shares on each of April 22, 2008, 2009 and 2010.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) | Represents a retention payment equal to 3 months base salary.
|---- | --------------------------------------------------------------

|(11) | Represents 3 months base salary, commencing October 1, 2007, at his then annual salary of $150,000. Form April 1, 2007 to September 30, 2007, Mr. McDonald
was engaged by our Company to do contract accounting work, for which services he received $46,000.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(12) | Represents options granted August 3, 2007 to purchase up to 50,000 shares of our common stock, at an exercise price
of $0.55 per share, which option is currently exercisable with respect to 16,666 of the underlying shares. The option vests as to 1/3rdof such
underlying shares on each of August 3, 2008, 2009 and 2010.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(13) | Mr. Cohen became our Chief Financial Officer in December 2005, at which time he received a salary of $7,500 per month. Mr. Cohen stepped down as Chief Financial Officer in
August 2007 upon the hiring of Mr. McGarey.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(14) | In 2007 Mr. Cohen was paid an amount equal to 228 days salary at his then annualized salary of $90,000.
|---- | --------------------------------------------------------------------------------------------------------

|(15) | Option granted January 4, 2007 currently exercisable to purchase up to 100,000 shares of our common stock at an exercise price of $0.56 per share.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------

|(16) | Mr. Damson joined our board of directors and became our Chairman and Chief Executive Officer as of February 1, 2006. Mr. Damson resigned as Chairman and Chief
Executive Officer, effective March 21, 2007.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Set forth in the chart below are the outstanding equity awards held by our
Named Executive Officers at our fiscal year ended December 31, 2008:

Outstanding Equity Awards at 2008 Fiscal Year-End



|                                                                     |                                                            |               |     |                                                              |        |     |                     |   |                       |  |                  
|-------------------------------------------------------------------- | ---------------------------------------------------------- | ------------- | --- | ------------------------------------------------------------ | ------ | --- | ------------------- | - | --------------------- |  | -----------------
|Name                                                                 |                                                            | Option Awards
|                                                                     | Number ofSecuritiesUnderlyingUnexercisedOptionsExercisable |               |     | Number ofSecuritiesUnderlyingUnexercisedOptionsUnexercisable |        |     | OptionExercisePrice |   | Option ExpirationDate
|Thomas R. Kaetzer,Chairman, President and Chief Operating Officer(1) |                                                            | 3,000,000     |     |                                                              | 0      |     |                     | $ | 0.40                  |  | June 19, 2013    
|                                                                     |                                                            | 1,000,000     |     |                                                              | 0      |     |                     |   | 0.50                  |  | December 20, 2011
|                                                                     |                                                            | 500,000       |     |                                                              | 0      |     |                     |   | 0.60                  |  | December 20, 2011
|                                                                     |                                                            | 500,000       |     |                                                              | 0      |     |                     |   | 1.00                  |  | December 20, 2011
|                                                                     |                                                            |               |     |                                                             
|Patrick H. McGarey,Chief Financial Officer(2)                        |                                                            | 500,000       |     |                                                              | 0      |     |                     |   | 0.55                  |  | August 3, 2012   
|                                                                     |                                                            | 500,000       |     |                                                              | 0      |     |                     |   | 0.825                 |  | August 3, 2012   
|                                                                     |                                                            | 500,000       |     |                                                              | 0      |     |                     |   | 1.10                  |  | August 3, 2012   
|                                                                     |                                                            |               |     |                                                             
|Randal B. McDonald, Jr.Controller(3)                                 |                                                            | 33,333        | (4) |                                                              | 66,667 | (4) |                     |   | 0.50                  |  | April 22, 2013   
|                                                                     |                                                            | 16,666        | (4) |                                                              | 33,334 | (5) |                     |   | 0.55                  |  | August 3, 2012   
|                                                                     |                                                            |               |     |                                                             
|Richard M. Cohen,Chief Financial Officer(6)                          |                                                            | 175,000       |     |                                                              | 0      |     |                     |   | 0.94                  |  | December 26, 2011
|                                                                     |                                                            | 100,000       |     |                                                              | 0      |     |                     |   | 0.56                  |  | January 4, 2012  
|                                                                     |                                                            |               |     |                                                             
|Barrie Damson,Chief Executive Officer(7)                             |                                                            | 1,730,000     | (7) |                                                              | 0      |     |                     |   | 0.05                  |  | April 28, 2010   



|(1) | Mr. Kaetzer was hired as President and Chief Operating Officer on December 5, 2006. He was appointed as Chairman and Chief Executive Officer on March 21, 2007.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Mr. McGarey was hired as our Chief Financial Officer, effective as of August 16, 2007.
|--- | --------------------------------------------------------------------------------------

|(3) | Mr. McDonald became our Controller as of October 1, 2007.
|--- | ---------------------------------------------------------



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|(4) | Option granted April 22, 2008 to purchase up to 100,000 shares of our common stock, at an exercise price of $0.50
per share, which option vests as to 1/3rdof such underlying shares on each of April 22, 2008, 2009 and 2010; provided, that
Mr. McDonalds employment has not been terminated for any reason.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Option granted August 3, 2007 to purchase up to 50,000 shares of our common stock, at an exercise price of $0.55
per share, which option vests as to 1/3rdof such underlying shares on each of August 3, 2008, 2009 and 2010; provided, that
Mr. McDonalds employment has not been terminated for any reason.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Mr. Cohen stepped down as Chief Financial Officer in August 2007.
|--- | -----------------------------------------------------------------

|(7) | Mr. Damson resigned as Chairman and Chief Executive Officer, effective March 21, 2007.
|--- | --------------------------------------------------------------------------------------

|(8) | Option grants awarded on April 29, 2005 to purchase initially up to 6,000,000 shares of our common stock, at an exercise price of $0.05 per share, which amount of shares was
adjusted to reflect the subsequent cancellations of options with respect to the purchase of 4,270,000 shares of our common stock in the aggregate since December 20, 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Employment Agreements

Thomas R. Kaetzer
Employment Agreement.

From December 20, 2006 until October 10, 2008, Mr. Kaetzers employment was governed by an
employment agreement dated as of December 20, 2006. Under the employment agreement, Mr. Kaetzer served as our President and Chief Operating Officer, effective as of December 5, 2006. Mr. Kaetzer was appointed to serve also as our
Chairman and Chief Executive Officer on March 21, 2007. Pursuant to that agreement, Mr. Kaetzer received a base salary of $190,000 during the first year of the agreement and a $50,000 performance bonus at the end of his first year of
employment. Effective as of January 1, 2008, Mr. Kaetzers base salary was increased to $235,000 per annum. In addition, his employment agreement provided for us to issue to him three non-qualified stock options to purchase
(i) up to 1,000,000 shares of our common stock, at an exercise price of $0.50 per share, (ii) up to 500,000 shares, at an exercise price of $0.60 per share and (iii) up to 500,000 shares, at an exercise price of $1.00 per share.

On October 10, 2008, Mr. Kaetzer submitted his resignation for good reason based upon the July 2008 conversion by
Third Point and its affiliates of all of the outstanding Convertible Notes into shares of our common stock representing, in the aggregate, approximately 77.25% of the issued and outstanding common stock as of July 30, 2008. By letter agreement
effective as of October 29, 2008, Mr. Kaetzer agreed to continue to serve as our Chief Executive Officer until the earlier of a merger of the Company into another entity, a sale of substantially all of the assets of the Company, or
June 15, 2009 (each, an Event). In consideration for such commitment, we agreed to continue to pay Mr. Kaetzers at his then current salary, plus current benefits. By reason of the change of control, we also agreed to pay
Mr. Kaetzer a severance payment equal to 12-months of his then current base salary, or $235,000, payable (i) $58,750 upon entry into the letter agreement, (ii) $19,583.33 per month during each month of employment preceding an Event,
and (iii) the balance upon an Event. The Companys obligation to make payment in full of the $235,000 is unconditional. Except for non-competition, confidentiality and intellectual property covenants contained therein,
Mr. Kaetzers December 2006 employment agreement was mutually terminated as of the October 29, 2008 effective date of the letter agreement.

Patrick H. McGarey Employment Agreement.

From August 3, 2007 until October 10, 2008,
Mr. McGareys employment was governed by an employment agreement dated as of August 3, 2007. Under the employment agreement, Mr. McGarey served as our Chief Financial Officer, effective August 16, 2007. Pursuant to the
agreement, Mr. McGarey received an initial base salary of $165,000 per annum and a $33,000 performance bonus at the end of his first full year of employment. Effective as of January 1, 2008, Mr. McGareys base salary was
increased to $200,000 per annum. In addition, his employment agreement provided for us to grant him three separate stock options to purchase (i) up to 500,000 shares of our common stock, at an exercise price of $0.55 per share, (ii) up to
500,000 shares, at an exercise price of $0.825 per share and (iii) up to 500,000 shares, at an exercise price of $1.10 per share.

On
October 10, 2008, Mr. McGarey submitted his resignation for good reason based upon that change of control event in July 2008 occasioned by Third Point and affiliates acquiring outstanding Convertible Notes
convertible into shares of our common stock representing, in the aggregate, approximately 77.25% of the issued and outstanding Common Stock as of July 30, 2008. By letter agreement effective as of October 29, 2008, Mr. McGarey agreed
to continue to serve as our Chief Financial Officer until the earlier of a merger of the Company into another entity, a sale of



40



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##### Table of Contents

substantially all of the assets of the Company, or June 15, 2009 (each, an Event). In consideration for such commitment, we agreed to
continue to pay Mr. McGarey at his then current salary, plus current benefits. By reason of the change of control, we also agreed to pay Mr. McGarey a severance payment equal to 12-months of his then current base salary, or $200,000,
payable (i) $50,000 upon entry into the letter agreement, (ii) $16,666.67 per month during each month of employment preceding an Event, and (iii) the balance upon an Event. The Companys obligation to make payment in full of the
$200,000 is unconditional. Except for non-competition, confidentiality and intellectual property covenants contained therein, Mr. McGareys August 2007 employment agreement was mutually terminated as of the October 29, 2008 effective
date of the letter agreement.

Director Compensation

During fiscal year 2008, our non-employee directors were entitled to receive $6,500 for each fiscal quarter. We also reimburse our directors for reasonable expenses in connection with attendance at board and committee
meetings. Directors may also eligible to receive stock options offered by our Company from time to time.

Set forth in the chart below is
compensation received by our directors for the fiscal year ended December 31, 2008:



|                            |  |                                |        |                       |   |                     |   |                                             |   |                                                                        |   |                              |   |              |   |       
|--------------------------- |  | ------------------------------ | ------ | --------------------- | - | ------------------- | - | ------------------------------------------- | - | ---------------------------------------------------------------------- | - | ---------------------------- | - | ------------ | - | ------
|Name (a)                    |  | FeesEarnedor PaidinCash ($)(b) |        | StockAwards(4) ($)(c) |   | OptionAwards ($)(d) |   | Non-EquityIncentive PlanCompensation ($)(e) |   | Change inPension Valueand NonqualifiedDeferredCompensationEarnings (f) |   | All OtherCompensation ($)(g) |   | Total ($)(h)
|Thomas R. Kaetzer, Chairman |  |                                |       |                       |  |                     |  |                                             |  |                                                                        |  |                              |  |              |   | 0     
|Richard DAbo               |  | $                              | 24,277 |                       |  |                     |  |                                             |  |                                                                        |  |                              |  |              | $ | 24,277
|Alan D. Gaines              |  | $                              | 24,277 |                       |  |                     |  |                                             |  |                                                                        |  |                              |  |              | $ | 24,777
|John V. Lovoi(1)            |  | $                              | 0      |                       |  |                     |  |                                             |  |                                                                        |  |                              |  |              | $ | 0     
|Todd Swanson(2)             |  | $                              | 0      |                       |  |                     |  |                                             |  |                                                                        |  |                              |  |              | $ | 0     



|(1) | Mr. Lovoi became a Director as of August 27, 2008.
|--- | --------------------------------------------------

|(2) | Mr. Swanson became a Director as of August 27, 2008. On February 10, 2009, Mr. Swanson resigned as a Director and was replaced by Joshua L. Targoff.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.
|-------- | -----------------------------------------------------------------------------------------------

The following table sets forth certain information regarding the beneficial ownership of our common stock as of the March 27, 2009 by (i) each
of our current directors and our Named Executive Officers, (ii) each person who, to our knowledge, beneficially owns more than 5% of outstanding shares of our common stock; and (iii) all of our current directors and executive officers as a
group. The information contained in the following table is determined in accordance with Rule 13d-3 promulgated under the Exchange Act based upon information furnished by the persons listed or contained in filings made by them with the SEC.



|                                                                              |  |                              |                        |  |               |  
|----------------------------------------------------------------------------- |  | ---------------------------- | ---------------------- |  | ------------- | -
|Name and Address Of Beneficial Owner(1)                                       |  | Shares Beneficially Owned(2) |                        |  | Percentage(3) |  
|Thomas R. Kaetzer, President, Chief Executive Officer and Director (Chairman) |  | 5,009,000                    | (4)(5)                 |  | 3.2           | %
|Patrick H. McGarey, Chief Financial Officer                                   |  | 1,515,000                    | (6)                    |  | 1.0           | %
|Randal B. McDonald, Jr., Controller                                           |  | 63,332                       | (7)(8)                 |  | *             |  
|John V. Lovoi, Director                                                       |  | 29,200,000                   | (9)(15)                |  | 19.3          | %
|Joshua L. Targoff, Director                                                   |  | 0                            |                        |  | *             |  
|Third Point LLC(10)                                                           |  | 88,321,348                   | (11)(12)               |  | 58.3          | %
|Third Point Partners L.P.(10)                                                 |  | 35,502,047                   | (12)                   |  | 23.4          | %
|Third Point Qualified Partners L.P.(9)                                        |  | 52,423,301                   | (12)                   |  | 34.6          | %
|JVL Advisors, LLC(13)                                                         |  | 23,350,000                   | (14)(15)               |  | 15.4          | %
|JVL Global Energy (QP), LP(13)                                                |  | 8,842,593                    | (15)                   |  | 5.8           | %
|Alan Gaines(16)                                                               |  | 7,664,250                    | (17)                   |  | 5.0           | %
|Current Executive Officers and Directors as a Group (consisting of 5 persons) |  | 35,807,332                   | (4)(5)(6)(7)(8)(9)(15) |  | 22.7          | %



|(*) | less than 1%
|--- | ------------

|(1) | Unless otherwise indicated, the address of each beneficial owner reported above is c/o Baseline Oil & Gas Corp., 411 North Sam Houston Parkway East, Suite 300, Houston,
Texas 77060.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from March 27, 2009 upon the exercise of warrants or options.
Each beneficial owners percentage ownership is determined by assuming that options or warrants that are held by such person (but not those held by any other person) and which are exercisable within 60 days from March 27, 2009 have been
exercised.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | At March 27, 2009, a total of 151,497,530 shares of our common stock were issued and outstanding.
|--- | -------------------------------------------------------------------------------------------------

|(4) | Includes options currently exercisable to purchase: (i) up to 3,000,000 shares of our common stock at an exercise price of $0.40 per share; (ii) up to 1,000,000 shares of
our common stock at an exercise price of $0.50 per share; (iii) up to 500,000 shares of our common stock at an exercise price of $0.60 per share; and (iv) up to 500,000 shares of our common stock at an exercise price of $1.00 per share.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes 5,000 shares of our common stock held for the benefit of children of Mr. Kaetzer, which Mr. Kaetzer has discretionary authority to vote and accordingly may be
deemed to be the beneficial owner thereof. Mr. Kaetzer expressly disclaims any such beneficial ownership of these shares.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Refers to options currently exercisable to purchase (i) up to 500,000 shares of our common stock at an exercise price of $0.55 per share, (ii) up to 500,000 shares of our
common stock at an exercise price of $0.825 per share, and (iii) up to 500,000 shares of our common stock at an exercise price of $1.10 per share.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Includes option granted April 22, 2008 to purchase up to 100,000 shares of our common stock at an exercise price of $0.50 per share, which option is currently exercisable with
respect to 46,666 underlying shares. The option vests with respect to 20% of such underlying shares at the grant date and then, as to 1/3rd of such remaining underlying shares on each of January 3, 2009, 2010 and 2011.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Includes option granted August 3, 2007 to purchase up to 50,000 shares of our common stock at an exercise price of $0.55 per share, which option is currently exercisable with
respect to 16,666 underlying shares. The option vests as to 1/3rd of such underlying shares on each of August 3, 2008, 2009 and 2010.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(9) | John V. Lovoi is the managing partner of each of JVL Advisors, LLC (Advisors) and Peninsula  JVL Capital Advisors, LLC (Capital Advisors), and may be
deemed to beneficially own the 23,350,000 aggregate shares of our common stock directly or indirectly owned or held by Advisors and the 5,850,000 shares of our common stock directly or indirectly owned or held by Capital Advisors. Capital Advisors
is the general partner of Belridge Energy Advisors, LP (Belridge), which directly or indirectly owns 5,850,000 shares of our common stock, and accordingly may be deemed to beneficially own all of the shares of our common stock directly
or indirectly owned or held by Belridge. See notes (14) and (15) below.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) | Beneficial owners address is 390 Park Avenue, 18th floor, New York, New York 10022.
|---- | ------------------------------------------------------------------------------------

|(11) | Third Point LLC acts as the investment manager of (i) Third Point Partners L.P. (Partners), which directly or indirectly owns 35,502,047 shares of our common stock
and (ii) Third Point Partners Qualified L.P. (Qualified Partners), which directly or indirectly owns 52,423,301 shares of our common stock. Third Point LLC, as investment manager of Partners and Qualified Partners, and Daniel S.
Loeb, as Chief Executive Officer of Third Point LLC, may each be deemed to beneficially own the shares of our common stock directly or indirectly owned or held by Partners and by Qualified Partners.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(12) | Based on the relationships described in note (11) above, the entities named therein may also be deemed to constitute a group within the meaning of Rule 13d-5(b)(1)
under the Exchange Act; however, this statement shall not be construed as an admission that Third Point LLC, Partners, Qualified Partners and Mr. Loeb are a group, or have agreed to act as a group. Each joint filer disclaims beneficial
ownership of these securities except to the extent of any direct pecuniary interest therein, and this report shall not be deemed to be an admission that any such joint filer is the beneficial owner of these securities for purposes of Section 16
or for any other purpose. The foregoing information is based upon (i) the Schedule 13D, as amended through December 30, 2008, initially filed with the SEC on July 18, 2008 by Third Point LLC, Partners, Qualified Partners and
Mr. Loeb and (ii) Form 4 filed December 31, 2008 by Third Point LLC.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(13) | Beneficial owners address is 10,000 Memorial Drive, Suite 550, Houston, TX 77024.
|---- | ----------------------------------------------------------------------------------

|(14) | Advisors is the general partner of: (i) JVL Global Energy (QP), LP (Energy Qualified LP), which directly or indirectly owns 8,842,593 shares of our common stock;
(ii) JVL Global Energy, LP (Energy LP), which directly or indirectly owns 6,718,110 shares of our common stock; (iii) Navitas Fund LP (Navitas LP), which directly or indirectly owns 6,143,094 shares of our common
stock; and (iv) Navitas Fund (QP), LP (Navitas Qualified LP), which directly or indirectly owns 1,646,203 shares of our common stock. As the general partner, Advisors may be deemed to beneficially own all of the shares of our common
stock directly or indirectly owned or held by Energy Qualified LP, Energy LP, Navitas LP and Navitas Qualified LP.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(15) | Based on the relationships described in notes (9) and (14) above, the entities and persons named therein may also be deemed to constitute a group within the
meaning of Rule 13d-5(b)(1) under the Exchange Act; however, this statement shall not be construed as an admission that Advisors, Energy Qualified LP, Energy LP, Navitas LP, Navitas Qualified LP, Capital Advisors, Belridge and Mr. Lovoi are a
group, or have agreed to act as a group. Each joint filer disclaims beneficial ownership of these securities except to the extent of any direct pecuniary interest therein, and this report shall not be deemed to be an admission that any such joint
filer is the beneficial owner of these securities for purposes of Section 16 or for any other purpose. The foregoing information is based upon the Schedule 13D, as amended through December 30, 2008, initially filed with the SEC on
August 22, 2008. See Notes (14) and (15).
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(16) | Beneficial owners address is c/o Thompson & Knight, 919 Third Avenue, 39thFloor, New York, NY 10022.
|---- | ----------------------------------------------------------------------------------------------------

|(17) | Includes options currently exercisable to purchase up to 1,730,000 shares of our common stock at an exercise price of $0.05 per share.
|---- | --------------------------------------------------------------------------------------------------------------------------------------

Except as otherwise indicated, we believe that the beneficial owners of the common stock listed above, based on information furnished by the owners, have
sole investment and voting power over the shares listed opposite their names.

Change in Control

As previously reported by us and disclosed by Third Point in its Schedule 13D, on July 17, 2008 Third Point converted into 62,018,850 shares of our
common stock $44,650,000 aggregate principal amount of the Subordinated Notes acquired by them in a series of transactions commencing July 7, 2008, which acquisition and conversion resulted in a change in the controlling interest of our Company
(the Change of Control Event). In subsequent transactions, Third Point acquired an additional $8,850,000 aggregate principal amount of the Subordinated Notes and, on July 30, 2008, converted into 12,292,650 more shares of our common
stock. After we elected to issue additional shares pursuant to the make-whole provisions of the Indenture under which the Subordinated Notes were issued, Third Point received an additional 42,723,747 shares of our common stock with
respect to the total principal amount of the Subordinated Notes converted. As disclosed in Nos. 4 and 5 to its Schedule 13D, on August 12, 2008 and December 30, 2008, Third Point and its affiliates sold, in privately negotiated
transactions, an aggregate of 11,700,000 and 17,500,000 shares of our common stock, respectively, then held.



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Accordingly, after giving effect to the above conversions and accounting for the shares of common stock
otherwise held and subsequently sold by it, at March 27, 2009 Third Party held a total of 88,321,348 shares, representing approximately 58.3% of our then outstanding shares of common stock.

Third Point, acting through affiliated funds, collectively expended an aggregate of approximately $49,669,243 of its own or affiliated investment capital
to acquire the shares of our common stock held by it. Other than shares of common stock acquired upon the conversion of Subordinated Notes previously held, Third Party effected the purchases of common stock primarily through margin accounts, which
are maintained for them with Goldman, Sachs & Co., Citigroup Global Markets, Inc., UBS Securities LLC and Bear, Stearns Securities Corp. and which may extend margin credit to the funds managed by Third Point as and when required to open or
carry positions in the margin accounts, subject to applicable Federal margin regulations, stock exchange rules and the firms credit policies. In such instances, the positions held in the margin accounts are pledged as collateral security for
the repayment of debit balances in the accounts.



|Item 13. | Certain Relationships and Related Transactions, and Director Independence. Certain Relationships and Related Party Transactions
|-------- | -------------------------------------------------------------------------------------------------------------------------------

Relationships and Related Transactions.

Except as set forth below, since January 1, 2007 there have been no transactions, or currently proposed transactions, of an amount exceeding or to exceed $120,000, to which we were or are to be a party, in which any of our directors,
executive officers or other Related Party (as defined below) had or is to have a direct or indirect material interest.

Mr. Lovoi, a
current director, is a managing partner of JVL Advisors LLC and Peninsula  JVL Capital Advisors LLC, money management firms and, at March 27, 2009, indirect holders of an aggregate of 29,200,000 shares of our common stock, or 19.3% of our
Company, as disclosed in the amended Schedule 13D filed on December 30, 2008 by such firms and elsewhere in this Annual Report under Securities Ownership of Certain Beneficial Owners and Management  Change of Control. As
managing partner, Mr. Lovoi shares voting and dispositive power over the 29,200,000 shares of common stock beneficially owned by such money management firms.

Mr. Targoff, another current director, is General Counsel of Third Point and, as disclosed elsewhere in this Annual Report under Securities Ownership of Certain Beneficial Owners and Management 
Change of Control, Third Point presently has voting and dispositive power over 88,321,348 shares, or 58.3% of our common stock, following the Change of Control Event. Mr. Targoff replaced Todd Q. Swanson, a former director, who serves as
an analyst at Third Point. Mr. Swanson resigned as a member of our Board of Directors on February 10, 2009.

In addition, as
previously disclosed on our Current Report on Form 8-K filed with the SEC on January 29, 2007, on January 26, 2007 then Chairman and Chief Executive Officer Barrie Damson and then director Alan Gaines each made a loan of $50,000 to us to
be used for our short-term working capital needs and evidenced by promissory notes. The notes accrued interest at an annual rate of six percent (6%) and matured, as extended by amendment dated April 10, 2007, on the earlier to occur of
(i) the date on which we close an equity offering in which we obtain gross proceeds in excess of three million dollars ($3,000,000) or (ii) October 13, 2010. On October 1, 2007, we repaid the outstanding principal amount of
$50,000 plus aggregate accrued interest in the amount of $2,252. Such amounts were repaid from the net proceeds realized by our October 1, 2007 placement to institutional investors of the Convertible Notes and our 12.5% Senior Secured Notes due
2012.

As previously disclosed on our Current Report on Form 8-K filed with the SEC on January 29, 2007, on January 26, 2007 then
Chairman and Chief Executive Officer Barrie Damson and Alan Gaines, a director, each made a loan of $50,000 to us to be used for our short-term working capital needs and evidenced by promissory notes. The notes accrued interest at an annual rate of
six percent (6%) and matured, as extended by amendment dated April 10, 2007, on the earlier to occur of (i) the date on which we close an equity offering in which we obtain gross proceeds in excess of three million dollars
($3,000,000) or (ii) October 13, 2010. On October 1, 2007, we repaid the outstanding principal amount of $50,000 plus aggregate accrued interest in the amount of $2,252. Such amounts were repaid from the net proceeds realized by our
October 1, 2007 placement to institutional investors of the Notes and our 12.5% Senior Secured Notes due 2012.



44



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##### Table of Contents

Policies and Procedures Regarding Related Party Transactions

A Related Party Transaction is any transaction, arrangement or relationship where the Company is a participant, the Related Party (defined
below) had, has or will have a direct or indirect material interest and the aggregate amount involved is expected to exceed $120,000 in any calendar year. Related Party includes (a) any person who is or was (at any time during the
last two fiscal years) an executive officer, director or nominee for election as a director; (b) any person or group who is a beneficial owner of more than 5% of the Companys voting securities; (c) any immediate family member of a
person described in provisions (a) or (b) of this sentence; or (d) any entity in which any of the foregoing persons is employed, is a partner or has a greater than 5% beneficial ownership interest.

When reviewing and approving the terms and conditions of all related party transactions, members of our Board of Directors other than the Related Party
will consider all relevant facts and circumstances available to it to determine whether such related party transaction is in, or is not inconsistent with, our best interests, including, without limitation, (a) the extent of the Related
Partys interest in the transaction; (b) the availability of other sources of comparable products or services; (c) whether the terms are competitive with terms generally available in similar transactions with persons that are not
Related Parties; (d) the benefit to our Company; and (e) the aggregate value of the transaction.

There were no transactions in
2007 which required review, approval or ratification by our Board of Directors as a Related Party Transaction other than the above-described loan to the Company on January 26, 2007.

Certain Matters Involving Promoters

Immediately prior to our merger with Coastal Energy Services, Inc. (Coastal) in April 2005, 47.3% of our then outstanding shares of common stock were held by Mr. David Loev. Mr. Loev was an attorney residing in the
State of Texas at such time who performed legal services for our Company prior to the merger with Coastal. In November 2005, the SEC filed a civil lawsuit in the Houston federal district court against certain parties unrelated to us and sued
Mr. Loev for allegedly violating certain registration provisions of the federal securities laws (SEC Litigation Release No. 19476 dated; November 29, 2005). Mr. Loev settled the lawsuit with the SEC by consenting to the
entry of an order permanently enjoining him from violating the securities registration provisions, ordering him to disgorge $25,785.50, plus interest, and imposing a $25,000 civil penalty. At no time was Mr. Loev an officer or a director of our
Company.

Director Independence

The
OTC Bulletin Board, on which our common stock is currently traded, does not maintain director independence standards.



|Item 14. | Principal Accountant Fees and Services.
|-------- | ---------------------------------------

Audit and Tax Fees

During fiscal year 2008 and fiscal year 2007, the aggregate fees for which we were billed by Malone & Bailey, PC, our independent
registered public accounting firm, for professional services were as follows:



|                      |                   |                   |                   |  |   |         |    
|--------------------- | ----------------- | ----------------- | ----------------- |  | - | ------- | ---
|                      |                   | Fiscal Year Ended |                  
|                      | December 31, 2008 |                   | December 31, 2007 | 
|Audit Fees(1)         |                   | $                 | 168,750           |  | $ | 133,966 |    
|Audit-Related Fees(2) |                   | $                 | N/A               |  | $ | 187,047 | (3)
|Tax Fees(4)           |                   | $                 | 13,045            |  | $ | 5,496   |    
|All Other Fees        |                   |                   | N/A               |  |   | N/A     |    



|(1) | Fees for audit services include fees associated with the audit of our annual financial statements for the years ended December 31, 2008 and 2007, review of our annual reports
on Form 10-K and the review of our quarterly reports on Form 10-Q, during the year reported. Also includes fees associated with SEC registration statements, comfort letters and consents.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|(2) | Consist primarily of fees associated with accounting consultations and diligence services with respect to acquisitions, related debt offerings and Sarbanes-Oxley compliance.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | In connection with our Sarbanes-Oxley review, we also paid the consulting firm Axia Resources fees totaling $69,861.25 during the fiscal year ended 2007.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Consist primarily of professional services rendered for tax compliance, tax advice and tax planning.
|--- | ----------------------------------------------------------------------------------------------------

The Board considers whether the provision of the foregoing services is compatible with maintaining the auditors independence and has concluded that
the foregoing non-audit-related services did not adversely affect the independence of Malone & Bailey, PC.

The Board
periodically monitors the services rendered and actual fees paid to its independent registered public accounting firm to ensure that such services are satisfactory and that related fees are reasonable.



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##### Table of Contents

PART IV



|Item 15. | Exhibits, Financial Statement Schedules.
|-------- | ----------------------------------------

(a)(1) Financial
Statements

The response to this item is submitted in a separate section of this report.

(a)(3) Exhibits



|             |  |                                                                                                                                                                                                                                                                                                                                                                 
|------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Nos. |  | Description                                                                                                                                                                                                                                                                                                                                                     
|2.1          |  | Purchase and Sale Agreement, dated December 20, 2006, by and among the Company, Statex Petroleum I, L.P. and Charles W. Gleeson LP. (incorporated herein by reference to Exhibit 10.1 of the
Companys Form 8-K report, filed December 21, 2006).                                                                                                               
|             | 
|2.1.1        |  | Second Amendment to Purchase and Sale Agreement, dated March 9, 2007, by and among the Company, Statex Petroleum I, L.P. and Charles W. Gleeson LP (incorporated herein by reference to Exhibit
99.1 of the Companys Form 8-K report, filed March 15, 2007).                                                                                                   
|             | 
|2.2          |  | Form of Membership Interest Redemption Agreement, dated as of March 16, 2007, by and between the Company and New Albany-Indiana, LLC (incorporated herein by reference to Exhibit 99.5 of the
Companys Form 8-K report, filed March 19, 2007).                                                                                                                 
|             | 
|2.3          |  | Form of Assignment, Bill of Sale, and Conveyance, dated March 16, 2007, from New Albany-Indiana, LLC to the Company (incorporated herein by reference to Exhibit 99.6 of the Companys
Form 8-K report, filed March 19, 2007).                                                                                                                                  
|             | 
|2.4          |  | Asset Purchase and Sale Agreement , dated August 9, 2007, among the Company and each of DSX Energy Limited, LLP, Kebo Oil & Gas, Inc., Sanchez Oil & Gas Corp., Sue Ann Operating,
L.L.C., and twenty-three other individuals, trusts, and companies (incorporated herein by reference to Exhibit 99.1 of the Companys Form 8-K report, filed August 15, 2007).
|             | 
|3.1          |  | Amended and Restated Articles of Incorporation (incorporated herein by reference to Exhibit 3.1 to the Companys Form 8-K report, filed January 19, 2006).                                                                                                                                                                                                      
|             | 
|3.1.1        |  | Certificate of Amendment of Articles of Incorporation (incorporated herein by reference to Exhibit 3.1.1 to the Companys Form 8-K report, filed July 15, 2008).                                                                                                                                                                                                
|             | 
|3.2          |  | By-Laws (incorporated herein by reference to Exhibit 3.2 of the Companys registration statement on Form SB-2, filed June 25, 2004).                                                                                                                                                                                                                            
|             | 
|4.1          |  | Form of Warrant (incorporated by reference to Exhibit 99.2 to the Companys Form 8-K report, filed November 16, 2006).                                                                                                                                                                                                                                          
|             | 
|4.2          |  | Form of Common Stock Warrant, dated February 1, 2006 (incorporated by reference to Exhibit 4.3 to the Companys Form 10-KSB annual report, filed March 31, 2006).                                                                                                                                                                                               
|             | 
|4.3          |  | Form of Registration Rights Agreement for February Private Placement (incorporated by reference to Exhibit 10.5 of the Companys Amendment No. 1 to this Registration Statement on Form
SB-2 filed on August 1, 2006).                                                                                                                                          
|             | 
|4.4          |  | Form of Common Stock Warrant, dated February 1, 2006, issued to Lakewood Group, LLC (incorporated by reference to Exhibit 4.3 to the Companys Form 10-KSB annual report, filed March 31,
2006).                                                                                                                                                                
|             | 
|4.5          |  | Form of Warrant A-2, dated April 12, 2007, issued to Drawbridge Special Opportunities Fund LP (incorporated by reference to Exhibit 99.3 to the Companys Form 8-K report, filed April 18,
2007).                                                                                                                                                               
|             | 
|4.6          |  | Form of Warrant A-1, dated April 12, 2007, issued to D.B. Zwirn Special Opportunities Fund LP (incorporated by reference to Exhibit 99.4 to the Companys Form 8-K report, filed April 18,
2007).                                                                                                                                                               
|             | 
|4.7          |  | Registration Rights Agreement, dated as of April 12, 2007, among the Company and each of Drawbridge Special Opportunities Fund LP and D.B. Zwirn Special Opportunities Fund, L.P. (incorporated
herein by reference to Exhibit 99.5 of the Companys Form 8-K report, filed April 18, 2007).                                                                    
|             | 
|4.8          |  | Senior Secured Notes Indenture, dated as of October 1, 2007, by and among the Company and The Bank of New York, as trustee and collateral agent (incorporated herein by reference to
Exhibit 4.1 of the Companys Form 8-K report, filed October 5, 2007)                                                                                                       



47



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##### Table of Contents

|       |  |                                                                                                                                                                                                                                                                                                                                                             
|------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|4.8.1  |  | Amended and Restated Indenture, dated as of October 30, 2008 among the Company and The Bank of New York Mellon. (incorporated herein by reference to Exhibit 4.1 of the Companys Form
8-K report, filed November 3, 2008)                                                                                                                                  
|       | 
|4.9    |  | Form of Global 121/2% Senior Secured Exchange Note due 2012 (incorporated herein by
reference to Exhibit 4.9 of the Companys Annual Report on Form 10-K report, filed March 31, 2008).                                                                                                                                                                     
|       | 
|4.10   |  | Form of Global 15% Senior Secured PIK Note due 2009 (incorporated herein by reference to Exhibit 4.2 of the Companys Report on Form 8-K report, filed November 3, 2008).                                                                                                                                                                                   
|       | 
|4.11   |  | Senior Notes Registration Rights Agreement, dated October 1, 2007, between the Company and Jefferies & the Company, Inc. (incorporated herein by reference to Exhibit 4.11 of the
Companys Form 8-K report, filed October 5, 2007)                                                                                                                         
|       | 
|4.12   |  | Convertible Notes Indenture, dated as of October 1, 2007, by and among the Company and The Bank of New York, as trustee and collateral agent (incorporated herein by reference to Exhibit 4.6
of the Companys Form 8-K report, filed October 5, 2007).                                                                                                     
|       | 
|4.13   |  | Form of Rule 144A Global 14% Senior Subordinated Convertible Secured Note due 2013 (incorporated herein by reference to Exhibit 4.7 of the Companys Form 8-K report, filed October 5,
2007).                                                                                                                                                               
|       | 
|4.14   |  | Form of Regulation S Global 14% Senior Subordinated Convertible Secured Note due 2013 (incorporated herein by reference to Exhibit 4.8 of the Companys Form 8-K report, filed
October 5, 2007).                                                                                                                                                            
|       | 
|4.15   |  | Form of IAI Global 14% Senior Subordinated Convertible Secured Note due 2013 (incorporated herein by reference to Exhibit 4.9 of the Companys Form 8-K report, filed October 5, 2007).                                                                                                                                                                     
|       | 
|4.16   |  | Convertible Notes Registration Rights Agreement, dated October 1, 2007, between the Company and Jefferies & the Company, Inc. (incorporated herein by reference to Exhibit 4.12 of the
Companys Form 8-K report, filed October 5, 2007)                                                                                                                    
|       | 
|4.17   |  | Consent, dated October 29, 2008, from Cede & Co., with acknowledgement by the Company (incorporated herein by reference to Exhibit 10.4 of the Companys Form 8-K report, filed November
3, 2008)                                                                                                                                                           
|       | 
|10.1   |  | Credit Agreement, dated October 1, 2007, among the Company, Wells Fargo Foothills, Inc., as arranger and administrative agent, and lenders named therein (incorporated herein by reference to
Exhibit 10.1 of the Companys Form 8-K report, filed October 5, 2007)                                                                                         
|       | 
|10.1.1 |  | Forbearance, First Amendment to Credit Agreement and First Amendment to Fee Letter, dated October 30, 2008, among the Company, Wells Fargo Foothill, Inc., as arranger, administrative agent and
lender, and other lenders identified therein. (incorporated herein by reference to Exhibit 10.1.1 of the Companys Form 8-K report, filed November 3, 2008)
|       | 
|10.2   |  | Security Agreement, dated October 1, 2007, among Wells Fargo Foothills, Inc. and the Company (incorporated herein by reference to Exhibit 10.2 of the Companys Form 8-K report, filed
October 5, 2007)                                                                                                                                                     
|       | 
|10.3   |  | Intercreditor Agreement, dated October 1, 2007, among Wells Fargo Foothills, Inc., The Bank of New York and the Company (incorporated herein by reference to Exhibit 10.3 of the Companys
Form 8-K report, filed October 5, 2007)                                                                                                                          
|       | 
|10.3.1 |  | First Amendment to Intercreditor Agreement, dated October 30, 2008, among the Company, The Bank of New York Mellon and Wells Fargo Foothills, Inc. (incorporated herein by reference to
Exhibit 10.2.1 of the Companys Form 8-K report, filed November 3, 2008)                                                                                            
|       | 
|10.4   |  | Senior Notes Security Agreement, dated October 1, 2007, among The Bank of New York Trust the Company, NA, as collateral agent, and the Company (incorporated herein by reference to Exhibit 4.5 of
the Companys Form 8-K report, filed October 5, 2007)                                                                                                    
|       | 
|10.5   |  | Convertible Notes Security Agreement, dated October 1, 2007, among The Bank of New York Trust the Company, NA, as collateral agent, and the Company (incorporated herein by reference to Exhibit
4.10 of the Companys Form 8-K report, filed October 5, 2007)                                                                                              
|       | 
|10.6   |  | Form of Stock Option Agreement issued in April 2005 by the Company to Barrie Damson and Alan Gaines (incorporated herein by reference to Exhibit 99.1 of the Companys Form 8-K report, filed
May 3, 2005).                                                                                                                                                 



48



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|        |  |                                                                                                                                                                                                                     
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|        | 
|10.7    |  | Employment Agreement, dated December 5, 2006, by and between the Company and Thomas Kaetzer (incorporated herein by reference to Exhibit 10.2 of the Companys Form 8-K report, filed
December 21, 2006.            
|        | 
|10.8    |  | Stock Option Agreement, dated December 20, 2006, by and between the Company and Thomas Kaetzer (incorporated herein by reference to Exhibit 10.3 of the Companys Form 8-K report, filed
December 21, 2006).        
|        | 
|10.9    |  | Stock Option Agreement, dated December 20, 2006, by and between the Company and Thomas Kaetzer (incorporated herein by reference to Exhibit 10.4 of the Companys Form 8-K report, filed
December 21, 2006).        
|        | 
|10.10   |  | Stock Option Agreement, dated December 20, 2006, by and between the Company and Thomas Kaetzer (incorporated herein by reference to Exhibit 10.5 of the Companys Form 8-K report, filed
December 21, 2006).        
|        | 
|10.11   |  | Employment Agreement, dated August 3, 2007, by and between the Company and Patrick McGarey (incorporated herein by reference to Exhibit 99.1 of the Companys Form 8-K report, filed August
6, 2007).               
|        | 
|10.12   |  | Stock Option Agreement, dated August 3, 2007, by and between the Company and Patrick McGarey (incorporated herein by reference to Exhibit 99.2 of the Companys Form 8-K report, filed August
6, 2007).             
|        | 
|10.13   |  | Purchase Agreement, dated September 17, 2007, between the Company and Jefferies & Company, Inc. (incorporated herein by reference to Exhibit 10.1 of the Companys Form 8-K report,
filed September 20, 2007).      
|        | 
|10.14   |  | Form of Lease Agreement, dated October 26, 2007, between the Company and 411 NSHP Partner, LP (incorporated herein by reference to Exhibit 10.14 of the Companys Annual Report on Form 10-K,
filed March 31, 2007).
|        | 
|10.14.1 |  | Lease Addendum, dated October 26, 2007, between the Company and 411 NSHP Partner, LP (incorporated herein by reference to Exhibit 10.14.1 of the Companys Annual Report on Form 10-K, filed
March 31, 2007).       
|        | 
|10.15   |  | Form of Indemnification Agreement (incorporated herein by reference to Exhibit 99.1 the Companys Report on Form 8-K, filed February 3, 2009).                                                                      
|        | 
|14.1    |  | Code of Business Conduct and Ethics. (incorporated herein by reference to Exhibit 14.1 the Companys amended Annual Report on Form 10-K/A, filed April 24, 2007).                                                   
|        | 
|23.1 *  |  | Consent of Cawley, Gillespie & Associates, Inc.                                                                                                                                                                     
|        | 
|31.1 *  |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                  
|        | 
|31.2 *  |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                  
|        | 
|32.1 *  |  | Certification pursuant to 18 U.S.C. 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Executive Officer                                                                             
|        | 
|32.2 *  |  | Certification pursuant to 18 U.S.C. 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Financial Officer                                                                             
|        | 
|99.1 *  |  | Evaluation SummaryReserve Report of Independent Petroleum Engineering Firm*                                                                                                                                        



|(*) | Indicates filed herewith
|--- | ------------------------



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BASELINE OIL & GAS CORP.

INDEX TO FINANCIAL STATEMENTS



|                                                                                                       |  |     
|------------------------------------------------------------------------------------------------------ |  | ----
|                                                                                                       |  | PAGE
|Baseline Oil & Gas Corp. -                                                                             |  |     
|Report of Independent Registered Public Accounting Firm                                                |  | F-2 
|Balance Sheets at December 31, 2008 and 2007                                                           |  | F-3 
|Statements of Operations for the Years Ended December 31, 2008 and 2007                                |  | F-4 
|Statements of Cash Flows for the Years Ended December 31, 2008 and 2007                                |  | F-5 
|Statements of Changes in Stockholders Equity (Deficit) for the Years Ended December 31, 2008 and 2007 |  | F-6 
|Notes to Financial Statements                                                                          |  | F-7 



F - 1



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors

Baseline Oil & Gas Corp.

Houston, Texas

We have audited the accompanying balance sheets of Baseline
Oil and Gas Corp. (a Nevada Corporation) as of December 31, 2008 and 2007, and the related statements of operations, stockholders equity (deficit), and cash flows for the years then ended. These financial statements are the responsibility
of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits
in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing
audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of Baseline Oil and Gas Corp. as of December 31, 2008 and 2007 and the results of operations and cash flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that Baseline Oil & Gas
Corp. will continue as a going concern. As discussed in Note 2 to the financial statements, Baseline Oil & Gas Corp. suffered losses from operations and has a working capital deficiency, which raises substantial doubt about its ability to
continue as a going concern. Managements plans regarding those matters also are described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.



|                       
|-----------------------
|/s/ Malone & Bailey, PC
|www.malone-bailey.com  
|Houston, Texas         
|                       

March 31, 2009



F - 2



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##### Table of Contents

BASELINE OIL & GAS CORP.

BALANCE SHEETS



|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------------ | - | ----------------- | - | ----------- | -
|                                                                                                                                                |  | December 31, 2008 |              |   | December 31, 2007 |  
|ASSETS                                                                                                                                          |  |                   |              |   |                   |   |             |  
|CURRENT ASSETS                                                                                                                                  |  |                   |              |   |                   |   |             |  
|Cash and cash equivalents                                                                                                                       |  | $                 | 6,350,520    |   |                   | $ | 5,014,455   |  
|Short term investments  trading securities                                                                                                     |  |                   |             |   |                   |   | 13,901,275  |  
|Accounts receivable                                                                                                                             |  |                   | 2,137,204    |   |                   |   | 3,774,033   |  
|Derivative asset                                                                                                                                |  |                   | 4,432,079    |   |                   |   |            |  
|Deferred loan costs                                                                                                                             |  |                   | 341,152      |   |                   |   | 2,310,975   |  
|Prepaid and other current assets                                                                                                                |  |                   | 157,210      |   |                   |   | 111,884     |  
|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|Total current assets                                                                                                                            |  |                   | 13,418,165   |   |                   |   | 25,112,622  |  
|OIL AND NATURAL GAS PROPERTIES  using successful efforts method of accounting                                                                  |  |                   |              |   |                   |   |             |  
|Proved properties                                                                                                                               |  |                   | 149,699,206  |   |                   |   | 128,381,629 |  
|Unproved properties                                                                                                                             |  |                   | 8,510,126    |   |                   |   | 8,475,666   |  
|Less accumulated depletion, depreciation and amortization                                                                                       |  |                   | (34,119,869  | ) |                   |   | (1,823,233  | )
|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|Oil and natural gas properties, net                                                                                                             |  |                   | 124,089,463  |   |                   |   | 135,034,062 |  
|Other assets                                                                                                                                    |  |                   | 37,939       |   |                   |   | 15,989      |  
|Deferred loan costs, net of accumulated amortization of $22,197,084 and $6,390,283, respectively                                                |  |                   |             |   |                   |   | 13,038,093  |  
|Other property and equipment, net of accumulated depreciation of $98,129 and $17,519, respectively                                              |  |                   | 371,151      |   |                   |   | 184,551     |  
|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|                                                                                                                                                |  |                  
|TOTAL ASSETS                                                                                                                                    |  | $                 | 137,916,718  |   |                   | $ | 173,385,317 |  
|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|                                                                                                                                                |  |                  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)                                                                                                  |  |                   |              |   |                   |   |             |  
|CURRENT LIABILITIES                                                                                                                             |  |                   |              |   |                   |   |             |  
|Accounts payable                                                                                                                                |  | $                 | 2,718,303    |   |                   | $ | 2,151,549   |  
|Accrued interest                                                                                                                                |  |                   | 4,483,359    |   |                   |   | 5,387,671   |  
|Accrued expenses                                                                                                                                |  |                   | 1,303,056    |   |                   |   | 405,465     |  
|Royalties payable                                                                                                                               |  |                   | 4,164,955    |   |                   |   | 3,827,901   |  
|Short term debt and current portion of long-term debt, net of discount of $2,444,967 and $0, respectively                                       |  |                   | 123,693,783  |   |                   |   | 65,006      |  
|Derivative liabilities  short term                                                                                                             |  |                   |             |   |                   |   | 3,076,709   |  
|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|Total current liabilities                                                                                                                       |  |                   | 136,363,456  |   |                   |   | 14,914,301  |  
|Long term debt, net of discount of $0 and $4,436,137, respectively                                                                              |  |                   |             |   |                   |   | 160,816,395 |  
|Asset retirement obligations                                                                                                                    |  |                   | 314,532      |   |                   |   | 282,947     |  
|Derivative liability  long term                                                                                                                |  |                   |             |   |                   |   | 5,759,471   |  
|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|Total liabilities                                                                                                                               |  |                   | 136,677,988  |   |                   |   | 181,773,114 |  
|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|                                                                                                                                                |  |                  
|COMMITMENTS AND CONTINGENCIES                                                                                                                   |  |                   |             |   |                   |   |            |  
|                                                                                                                                                |  |                  
|STOCKHOLDERS EQUITY (DEFICIT)                                                                                                                  |  |                   |              |   |                   |   |             |  
|Common stock, $0.001 par value per share; 300,000,000 shares authorized; 151,497,530 and 34,408,006 shares issued and outstanding,
respectively |  |                   | 151,498      |   |                   |   | 34,408      |  
|Additional paid-in capital                                                                                                                      |  |                   | 111,703,204  |   |                   |   | 33,617,266  |  
|Accumulated other comprehensive gain (loss)                                                                                                     |  |                   | 4,955,580    |   |                   |   | (7,362,151  | )
|Accumulated deficit                                                                                                                             |  |                   | (115,571,552 | ) |                   |   | (34,677,320 | )
|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|Total stockholders equity (deficit)                                                                                                            |  |                   | 1,238,730    |   |                   |   | (8,387,797  | )
|                                                                                                                                                |  |                   |              |   |                   |   |             |  
|                                                                                                                                                |  |                  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT) (DEFICIT)                                                                                  |  | $                 | 137,916,718  |   |                   | $ | 173,385,317 |  
|                                                                                                                                                |  |                   |              |   |                   |   |             |  

The accompanying notes are an integral part of the financial statements



F - 3



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##### Table of Contents

BASELINE OIL & GAS CORP.

STATEMENTS OF OPERATIONS



|                                                     |  |                         |             |   |      |   |             |  
|---------------------------------------------------- |  | ----------------------- | ----------- | - | ---- | - | ----------- | -
|                                                     |  | Year Ended December 31, |            
|                                                     |  | 2008                    |             |   | 2007 |  
|REVENUES                                             |  |                         |             |   |      |   |             |  
|Oil and gas sales                                    |  | $                       | 37,361,186  |   |      | $ | 13,970,654  |  
|Oil and gas hedging                                  |  |                         | (4,706,964  | ) |      |   | (2,361,614  | )
|                                                     |  |                         |             |   |      |   |             |  
|Total revenue                                        |  |                         | 32,654,222  |   |      |   | 11,609,040  |  
|                                                     |  |                         |             |   |      |   |             |  
|                                                     |  |                        
|COSTS AND EXPENSES                                   |  |                         |             |   |      |   |             |  
|Production                                           |  |                         | 10,506,835  |   |      |   | 5,148,418   |  
|General and administrative                           |  |                         | 6,597,315   |   |      |   | 3,406,450   |  
|Depreciation, depletion, amortization and impairment |  |                         | 32,377,246  |   |      |   | 1,840,752   |  
|Accretion expense                                    |  |                         | 31,585      |   |      |   | 41,988      |  
|                                                     |  |                         |             |   |      |   |             |  
|Total costs and expenses                             |  |                         | 49,512,981  |   |      |   | 10,437,608  |  
|                                                     |  |                         |             |   |      |   |             |  
|                                                     |  |                        
|Net Income (loss) from operations                    |  | $                       | (16,858,759 | ) |      | $ | 1,171,432   |  
|                                                     |  |                        
|OTHER INCOME (EXPENSE)                               |  |                         |             |   |      |   |             |  
|Other income                                         |  |                         | 497,417     |   |      |   | 66,407      |  
|Interest income                                      |  |                         | 514,422     |   |      |   | 98,885      |  
|Interest expense                                     |  |                         | (23,517,437 | ) |      |   | (14,094,504 | )
|Loss on conversion of debt                           |  |                         | (41,482,678 | ) |      |   |            |  
|Realized loss on marketable securities               |  |                         | (47,197     | ) |      |   |            |  
|Unrealized gain on marketable securities             |  |                         |            |   |      |   | 45,875      |  
|                                                     |  |                         |             |   |      |   |             |  
|Total other expense, net                             |  |                         | (64,035,473 | ) |      |   | (13,883,337 | )
|                                                     |  |                         |             |   |      |   |             |  
|                                                     |  |                        
|NET LOSS                                             |  | $                       | (80,894,232 | ) |      | $ | (12,711,905 | )
|                                                     |  |                         |             |   |      |   |             |  
|                                                     |  |                        
|OTHER COMPREHENSIVE INCOME (LOSS)                    |  |                         |             |   |      |   |             |  
|Unrealized gain (loss) on derivative instruments     |  |                         | 12,317,731  |   |      |   | (7,362,151  | )
|                                                     |  |                         |             |   |      |   |             |  
|                                                     |  |                        
|Total comprehensive loss                             |  | $                       | (68,576,501 | ) |      | $ | (20,074,056 | )
|                                                     |  |                         |             |   |      |   |             |  
|                                                     |  |                        
|NET LOSS PER SHARE  Basic and Diluted               |  | $                       | (0.93       | ) |      | $ | (0.39       | )
|                                                     |  |                         |             |   |      |   |             |  
|                                                     |  |                        
|WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING        |  |                         | 87,354,985  |   |      |   | 32,554,343  |  
|                                                     |  |                         |             |   |      |   |             |  

The accompanying notes are an integral part of the financial statements



F - 4



---

##### Table of Contents

BASELINE OIL & GAS CORP.

STATEMENTS OF CASH FLOWS



|                                                             |  |                         |             |   |      |   |              |  
|------------------------------------------------------------ |  | ----------------------- | ----------- | - | ---- | - | ------------ | -
|                                                             |  | Year Ended December 31, |            
|                                                             |  | 2008                    |             |   | 2007 |  
|CASH FLOWS FROM OPERATING ACTIVITIES                         |  |                         |             |   |      |   |              |  
|Net loss                                                     |  | $                       | (80,894,232 | ) |      | $ | (12,711,905  | )
|Adjustments to reconcile net loss to net cash                |  |                         |             |   |      |   |              |  
|Used in operating activities                                 |  |                         |             |   |      |   |              |  
|Share based compensation                                     |  |                         | 1,612,711   |   |      |   | 816,365      |  
|Common stock issued for services                             |  |                         |            |   |      |   | 360,000      |  
|Depreciation, depletion, amortization and impairment         |  |                         | 32,377,246  |   |      |   | 1,840,752    |  
|Amortization of debt discount                                |  |                         | 1,712,617   |   |      |   | 576,812      |  
|Amortization of deferred loan costs                          |  |                         | 2,558,765   |   |      |   | 6,153,091    |  
|Loss(gain) on derivative instruments                         |  |                         | (950,528    | ) |      |   | 1,893,069    |  
|Loss on conversion of debt                                   |  |                         | 41,482,678  |   |      |   |             |  
|Unrealized gain on marketable securities                     |  |                         |            |   |      |   | (45,875      | )
|Loss on sale of short term investments                       |  |                         | 47,197      |   |      |   |             |  
|Accretion expense                                            |  |                         | 31,585      |   |      |   | 41,988       |  
|Changes in operating assets and liabilities                  |  |                         |             |   |      |   |              |  
|Accounts receivable                                          |  |                         | 1,636,829   |   |      |   | (3,774,033   | )
|Prepaid and other current assets                             |  |                         | (67,276     | ) |      |   | 96,838       |  
|Accounts payable                                             |  |                         | 566,754     |   |      |   | 2,068,676    |  
|Accrued interest                                             |  |                         | 4,782,587   |   |      |   | 5,526,618    |  
|Accrued expenses                                             |  |                         | 976,170     |   |      |   | 319,971      |  
|Royalties payable                                            |  |                         | 337,054     |   |      |   | 3,827,901    |  
|                                                             |  |                         |             |   |      |   |              |  
|Net cash provided by operating activities                    |  |                         | 6,210,157   |   |      |   | 6,990,268    |  
|CASH FLOWS FROM INVESTING ACTIVITIES                         |  |                         |             |   |      |   |              |  
|Acquisition of proved oil and gas properties                 |  |                         |            |   |      |   | (124,490,793 | )
|Investment in proved properties                              |  |                         | (21,865,577 | ) |      |   | (5,228,246   | )
|Investment in unproved properties                            |  |                         | (34,460     | ) |      |   | (665,531     | )
|Premiums paid for hedge contracts                            |  |                         |            |   |      |   | (419,040     | )
|Purchase of marketable securities                            |  |                         | (10,563,674 | ) |      |   | (15,851,790  | )
|Proceeds from sale of marketable securities                  |  |                         | 24,417,752  |   |      |   | 1,996,390    |  
|Purchase of property and equipment, other                    |  |                         | (267,210    | ) |      |   | (202,070     | )
|                                                             |  |                         |             |   |      |   |              |  
|Net cash used in investing activities                        |  |                         | (8,313,169  | ) |      |   | (144,861,080 | )
|CASH FLOWS FROM FINANCING ACTIVITIES                         |  |                         |             |   |      |   |              |  
|Proceeds from debt                                           |  |                         | 11,405,859  |   |      |   | 195,847,305  |  
|Repayments of debt                                           |  |                         | (7,715,897  | ) |      |   | (36,914,178  | )
|Deferred loan costs incurred                                 |  |                         | (250,885    | ) |      |   | (16,171,538  | )
|                                                             |  |                         |             |   |      |   |              |  
|Net cash provided By financing activities                    |  |                         | 3,439,077   |   |      |   | 142,761,589  |  
|                                                             |  |                        
|INCREASE IN CASH AND CASH EQUIVALENTS                        |  |                         | 1,336,065   |   |      |   | 4,890,777    |  
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD               |  |                         | 5,014,455   |   |      |   | 123,678      |  
|                                                             |  |                         |             |   |      |   |              |  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                     |  | $                       | 6,350,520   |   |      | $ | 5,014,455    |  
|                                                             |  |                         |             |   |      |   |              |  
|SUPPLEMENTAL DISCLOSURES:                                    |  |                         |             |   |      |   |              |  
|Cash paid for interest                                       |  |                         | 14,384,039  |   |      |   | 1,571,815    |  
|Cash paid for income taxes                                   |  |                         |            |   |      |   |             |  
|NON-CASH ACTIVITIES                                          |  |                         |             |   |      |   |              |  
|Unrealized gain (loss) on derivative liability               |  |                         | 12,317,731  |   |      |   | (7,362,151   | )
|Debt issued in lieu of cash interest                         |  |                         | 3,500,000   |   |      |   |             |  
|Stock issued in lieu of cash interest                        |  |                         |            |   |      |   | 226,203      |  
|Stock issued on conversion of debt                           |  |                         | 53,041,544  |   |      |   | 725,000      |  
|Stock issued for make whole premium on conversion of debt    |  |                         | 17,906,744  |   |      |   |             |  
|Warrants issued in conjunction with debt                     |  |                         |            |   |      |   | 2,373,674    |  
|Overriding royalty interest granted in conjunction with debt |  |                         |            |   |      |   | 2,678,000    |  
|Stock issued for note extension                              |  |                         |            |   |      |   | 190,000      |  
|Asset retirement obligation incurred                         |  |                         |            |   |      |   | 240,959      |  

The accompanying notes are an integral part of the financial statements



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BASELINE OIL & GAS CORP.

STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (DEFICIT)



|                                                       |  |              |  |                |         |  |                        |             |   |                    |   |            |             |  |   |              |   |  |   |             |  
|------------------------------------------------------ |  | ------------ |  | -------------- | ------- |  | ---------------------- | ----------- | - | ------------------ | - | ---------- | ----------- |  | - | ------------ | - |  | - | ----------- | -
|                                                       |  | Common Stock |  | Paid-inCapital |         |  | OtherComprehensiveLoss |             |   | AccumulatedDeficit |   |            | TotalEquity | 
|                                                       |  | Shares       |  | Amount         |         |  |                        |            
|Balance at December 31, 2006                           |  | 31,342,738   |  | $              | 31,343  |  | $                      | 28,423,418  |   |                    | $ |           |             |  | $ | (21,564,640  | ) |  | $ | 6,890,121   |  
|Fair value of warrants issued in conjunction with debt |  |             |  |                |        |  |                        | 2,373,674   |   |                    |   |           |             |  |   |             |   |  |   | 2,373,674   |  
|Stock-based compensation                               |  |             |  |                |        |  |                        | 816,365     |   |                    |   |           |             |  |   |             |   |  |   | 816,365     |  
|Stock issued for consulting fees                       |  | 600,000      |  |                | 600     |  |                        | 359,400     |   |                    |   |           |             |  |   |             |   |  |   | 360,000     |  
|Stock issued for note extension                        |  | 380,000      |  |                | 380     |  |                        | 189,620     |   |                    |   |           |             |  |   |             |   |  |   | 190,000     |  
|Stock issued on conversion of debt                     |  | 1,450,000    |  |                | 1,450   |  |                        | 723,550     |   |                    |   |           |             |  |   |             |   |  |   | 725,000     |  
|Stock issued in lieu of cash interest                  |  | 393,032      |  |                | 393     |  |                        | 225,810     |   |                    |   |           |             |  |   |             |   |  |   | 226,203     |  
|Stock issued for cashless exercise of stock options    |  | 242,236      |  |                | 242     |  |                        | (242        | ) |                    |   |           |             |  |   |             |   |  |   |             |  
|Cumulative change in derivative liability              |  |             |  |                |        |  |                        | 505,671     |   |                    |   |           |             |  |   | (400,775     | ) |  |   | 104,896     |  
|Unrealized loss on hedge contracts                     |  |             |  |                |        |  |                        |            |   |                    |   | (7,362,151 | )           |  |   |              |   |  |   | (7,362,151  | )
|Net loss                                               |  |             |  |                |        |  |                        |            |   |                    |   |            |             |  |   | (12,711,905  | ) |  |   | (12,711,905 | )
|                                                       |  |              |  |                |         |  |                        |             |   |                    |   |            |             |  |   |              |   |  |   |             |  
|Balance at December 31, 2007                           |  | 34,408,006   |  | $              | 34,408  |  | $                      | 33,617,266  |   |                    | $ | (7,362,151 | )           |  | $ | (34,677,320  | ) |  | $ | (8,387,797  | )
|Stock-based compensation                               |  |             |  |                |        |  |                        | 1,612,711   |   |                    |   |           |             |  |   |             |   |  |   | 1,612,711   |  
|Stock issued on conversion of debt                     |  | 117,035,248  |  |                | 117,036 |  |                        | 76,473,281  |   |                    |   |           |             |  |   |             |   |  |   | 76,590,317  |  
|Stock issued for cashless exercise of stock options    |  | 54,276       |  |                | 54      |  |                        | (54         | ) |                    |   |           |             |  |   |             |   |  |   |             |  
|Unrealized gain on hedge contracts                     |  |             |  |                |        |  |                        |            |   |                    |   | 12,317,731 |             |  |   |              |   |  |   | 12,317,731  |  
|Net loss                                               |  |             |  |                |        |  |                        |            |   |                    |   |            |             |  |   | (80,894,232  | ) |  |   | (80,894,232 | )
|                                                       |  |              |  |                |         |  |                        |             |   |                    |   |            |             |  |   |              |   |  |   |             |  
|Balance at December 31, 2008                           |  | 151,497,530  |  | $              | 151,498 |  | $                      | 111,703,204 |   |                    | $ | 4,955,580  |             |  | $ | (115,571,552 | ) |  | $ | 1,238,730   |  
|                                                       |  |              |  |                |         |  |                        |             |   |                    |   |            |             |  |   |              |   |  |   |             |  

The accompanying notes are an integral part of the financial statements



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BASELINE OIL & GAS CORP.

NOTES TO FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations and Organization

Baseline Oil & Gas Corp. (Baseline or the Company) is an independent exploration and production company primarily engaged
in the acquisition, development, production and exploration of oil and natural gas properties onshore in the United States.

Use of Estimates

The preparation of these financial statements is in conformity with accounting principles generally accepted in the United States of
America and requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of
revenues and expenses during the reporting period. Actual results could differ from those estimates.

The most critical estimate the
Company uses is the engineering estimate of proved oil and gas reserves. This estimate affects the application of the successful efforts method of accounting, the calculation of depreciation and depletion of oil and gas properties and the estimate
of the impairment of the Companys oil and gas properties. It also affects the estimated lives of the Companys assets used to determine asset retirement obligations.

Successful Efforts Method Accounting

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

Impairment of Oil and Natural Gas Properties

Unproved oil and gas properties that are individually
significant are periodically assessed for impairment of value, and a loss is recognized at the time of the impairment by providing an impairment allowance. An asset would be impaired if the undiscounted cash flows were less than its carrying value.
Impairments are measured by the amount by which the carrying value exceeds its fair value. Because the Company uses the successful efforts method, the Company assesses its properties individually for impairment, instead of on an aggregate pool of
costs.

Depreciation and Depletion of Oil and Natural Gas Properties

Capitalized costs of producing oil and gas properties, after considering estimated residual salvage values, are depreciated and depleted by the unit-of-production method. This method is applied through the simple
multiplication of reserve units produced by the leasehold costs per unit on a field by field basis. Leasehold cost per unit is calculated by dividing the total cost of acquiring the leasehold by the estimated total proved oil and gas reserves
associated with that lease. Field cost is calculated by dividing the total cost by the estimated total proved producing oil and gas reserves associated with that field.

Asset Retirement Obligations

The Company records a liability for legal obligations associated with
the retirement of tangible long-lived assets in the period in which they are incurred in accordance with SFAS No. 143 Accounting for Asset Retirement Obligations. Under this method, when liabilities for dismantlement and abandonment
costs (ARO) are initially recorded, the carrying amount of the related oil and natural gas properties are increased. Accretion of the liability is recognized each period using the interest method of allocation, and the capitalized cost is depleted
over the useful life of the related asset. Revisions to such estimates are recorded as adjustments to the ARO, capitalized asset retirement costs and charges to operations during the periods in which they become known. At the time the abandonment
cost is incurred, the Company is required to recognize a gain or loss if the actual costs do not equal the estimated costs included in ARO.



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Concentrations of Credit Risk

All of the Companys receivables are due from oil and natural gas purchasers. The Company sold 99% and 89% of its oil and natural gas production to three customers in 2008 and 2007, respectively.

Baseline maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. Accounts are guaranteed by the Federal Deposit
Insurance Corporation (FDIC) up to $250,000. At December 31, 2008 and 2007, Baseline had approximately $6,100,520 and $4,774,678, in excess of FDIC insured limits, respectively. Baseline has not experienced any losses in such
accounts.

Revenue and Cost Recognition

The Company uses the sales method of accounting for natural gas and oil revenues. Under this method, revenues are recognized based on the actual volumes of gas and oil sold to purchasers. The volume sold may differ from the volumes to which
the Company is entitled based on its interest in the properties. Costs associated with production are expensed in the period incurred.

Cash and Cash
Equivalents

Cash and cash equivalents include cash in banks and liquid deposit with maturities of three months or less.

Short-term Investments

The Companys short-term
investments consist primarily of U. S. government and agency securities and investment grade corporate notes and bonds, all of which are classified as trading securities. Trading securities are recorded at fair value, and unrealized holding gains
and losses are included in net earnings. The maximum maturity of securities is two years at the time of purchase with an average maturity not to exceed one year for the entire portfolio. Available-for-sale securities are classified as short-term
based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. Realized gains and losses are accounted for on the specific identification method. Purchases and
sales are recorded on a trade date basis.

Fair Value of Financial Instruments

The carrying value of cash and cash equivalents approximates fair value because of the short-term maturity of those instruments. The fair value of the
Companys investments in marketable debt securities is based on the quoted market price on the last business day of the year. Declines in fair value below the Companys carrying value deemed to be other than temporary are charged against
net earnings. The carrying value of short-term and long-term debt approximates fair value.

Property and Equipment

Support equipment and other property and equipment are valued at cost and depreciated over their estimated useful lives, using the straight-line method
over estimated useful lives of 3 to 5 years. Additions are capitalized and maintenance and repairs are charged to expense as incurred. Gains and losses on dispositions of equipment are reflected in income or loss from operations.

Stock-based compensation

On January 1, 2006,
the Company adopted SFAS No. 123(R), Share-Based Payment. SFAS 123(R) replaced SFAS No. 123 and supersedes APB Opinion No. 25. SFAS 123(R) requires all stock-based payments to employees, including grants of employee stock
options, to be measured at their grant-date fair value and recognized over the requisite service period, which is normally the vesting period.

Loss per
share

Basic earnings per share amounts are calculated based on the weighted average number of shares of common stock outstanding during
each period. Diluted earnings per share is based on the weighted average numbers of shares of common stock outstanding for the periods, including the dilutive effects of stock options, warrants granted and convertible preferred stock. Dilutive
options and warrants that are issued during a period or that expire or are canceled during a period are reflected in the computations for the time they were outstanding during the periods being reported. Since the Company has incurred losses for all
periods, the impact of the common stock equivalents would be antidilutive and therefore are not included in the calculation.



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Derivatives

Derivative financial instruments, utilized to manage or reduce commodity price risk related to Baselines production, are accounted for under the provisions of SFAS No. 133, Accounting for Derivative Instruments and for
Hedging Activities, and related interpretations and amendments. Under this statement, derivatives are carried on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the
derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other
comprehensive income or loss and are recognized in the statement of operations when the hedged item affects earnings. If the derivative is not designated as a hedge, changes in the fair value are recognized in other expense. Ineffective portions of
changes in the fair value of cash flow hedges are also recognized in loss on derivative liabilities.

Income taxes

The Company recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities
using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. The Company provides a valuation allowance for deferred tax assets for which it does not consider realization of such assets to
be more likely than not.

In July 2006, the FASB issued Financial Interpretation (FIN) 48, Accounting for Uncertainty in Income
Taxesan Interpretation of FASB 109 (FIN 48). FIN 48 created a single model to address accounting for the uncertainty in income tax positions and prescribes a minimum recognition threshold a tax position must meet before recognition in the
financial statements.

The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step is a recognition
process to determine whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether
a tax position has met the more likely than not recognition threshold, it is presumed that the position will be examined by the appropriate taxing authority with full knowledge of all relevant information. The second step is a measurement process
whereby a tax position that meets the more likely than not recognition threshold is calculated to determine the amount of benefit/expense to recognize in the financial statements. The tax position is measured at the largest amount of benefit/expense
that is more likely than not of being realized upon ultimate settlement.

The Company adopted the provisions of FIN 48 effective
January 1, 2007 which did not have a material impact on the Companys operating results, financial position or cash flows. The Company did not record a cumulative effect adjustment related to the adoption of FIN 48.

New Accounting Pronouncements

On December 31,
2008, the SEC published the final rules and interpretations updating its oil and gas reporting requirements. Many of the revisions are updates to definitions in the existing oil and gas rules to make them consistent with the petroleum resource
management system, which is a widely accepted standard for the management of petroleum resources that was developed by several industry organizations. Key revisions include changes to the pricing used to estimate reserves utilizing a 12-month
average price rather than a single day spot price which eliminates the ability to utilize subsequent prices to the end of a reporting period when the full cost ceiling was exceeded and subsequent pricing exceeds pricing at the end of a reporting
period, the ability to include nontraditional resources in reserves, the use of new technology for determining reserves, and permitting disclosure of probable and possible reserves. The SEC will require companies to comply with the amended
disclosure requirements for registration statements filed after January 1, 2010, and for annual reports on Form 10-K for fiscal years ending on or after December 15, 2009. Early adoption is not permitted. The Company is currently assessing
the impact that the adoption will have on the Companys disclosures, operating results, financial position and cash flows.

In May
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, (SFAS 162), which identifies a consistent framework for selecting accounting principles to be used in preparing financial statements for
nongovernmental entities that are presented in conformity with United States



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generally accepted accounting principles (GAAP). The current GAAP hierarchy was criticized due to its complexity, ranking position of FASB Statements of
Financial Accounting Concepts and the fact that it is directed at auditors rather than entities. SFAS 162 will be effective 60 days following the United States Securities and Exchange Commissions (SECs) approval of the Public
Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The FASB does not expect that SFAS 162 will have a change in current practice, and
the Company does not believe that SFAS 162 will have an impact on operating results, financial position or cash flows.

In March 2008, the
FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161), an amendment of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133). SFAS 161 is effective beginning January 1, 2009 and required entities to provide expanded disclosures about derivative instruments and hedging activities including (1) the ways in which an entity uses derivatives,
(2) the accounting for derivatives and hedging activities, and (3) the impact that derivatives have (or could have) on an entitys financial position, financial performance, and cash flows. SFAS 161 requires expanded disclosures and
does not change the accounting for derivatives. The Company is currently evaluating the impact of SFAS 161, but we do not expect the adoption of this standard to have a material impact on our financial results.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (SFAS 141(R)). SFAS 141(R) replaces SFAS 141,
Business Combinations, however it retains the fundamental requirements that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination. SFAS 141(R)
requires an acquirer to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, be measured at their fair values as of that date, with specified limited exceptions. Changes
subsequent to that date are to be recognized in earnings, not goodwill. Additionally, SFAS 141 (R) requires costs incurred in connection with an acquisition be expensed as incurred. Restructuring costs, if any, are to be recognized separately
from the acquisition. The acquirer in a business combination achieved in stages must also recognize the identifiable assets and liabilities, as well as the noncontrolling interests in the acquiree, at the full amounts of their fair values. SFAS
141(R) is effective for business combinations occurring in fiscal years beginning on or after December 15, 2008. The Company will apply the requirements of SFAS 141(R) upon its adoption on January 1, 2009 and is currently evaluating
whether SFAS 141(R) will have an impact on its financial position and results of operations.

In February 2007, the FASB issued SFAS
No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits companies to elect to measure many financial instruments and certain other items at fair value. Upon adoption of
SFAS 159, a company may elect the fair value option for eligible items that exist at the adoption date. Subsequent to the initial adoption, the election of the fair value option should only be made at initial recognition of the asset or liability or
upon a remeasurement event that gives rise to new-basis accounting. The decision about whether to elect the fair value option is applied on an instrument-by-instrument basis, is irrevocable and is applied only to an entire instrument and not only to
specified risks, cash flows or portions of that instrument. SFAS No. 159 does not affect any existing accounting standards that require certain assets and liabilities to be carried at fair value nor does it eliminate disclosure requirements
included in other accounting standards. Baseline adopted SFAS No. 159 effective January 1, 2008 and did not elect the fair value option for any existing eligible items.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS No. 157 defines fair value,
establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 does not impose fair value measurements on items not already accounted for at fair value; rather it applies, with certain
exceptions, to other accounting pronouncements that either require or permit fair value measurements. Under SFAS No. 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the principal or most advantageous market. The standard clarifies that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In February 2008, the
FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157 (FSP FAS 157-2), which delays the effective date of SFAS 157 for all non-financial assets and liabilities, except those that are recognized or
disclosed at fair value in the financial statements on a recurring basis, until fiscal years beginning after November 15, 2008. These non-financial items include assets and liabilities such as non-financial assets and liabilities assumed in a
business combination, reporting units measured at fair value in a goodwill impairment test and asset retirement obligations initially measured at fair value. Effective January 1, 2008, Baseline adopted SFAS 157 for fair value measurements not
delayed by FSP FAS No. 157-2. The adoption resulted in additional disclosures as required by the pronouncement (See Note 7  Fair Value Measurements) related to our fair value measurements for oil and gas derivatives and marketable
securities but no change in our fair value calculation methodologies. Accordingly, the adoption had no impact on our financial condition or results of operations.



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NOTE 2  GOING CONCERN

The accompanying financial statements have been prepared assuming the Company will continue as a going concern. On October 31, 2008, the Company completed a restructuring of its debt. As result of such
restructuring, the majority of its debt will mature on June 15, 2009. The future of the Company is dependent on its ability to obtain addition capital through debt or equity offerings or the sale of oil and natural gas properties. Given the
current instability in the financial and equity markets and current oil and natural gas pricing levels there is no assurance that the Company will be able to raise the capital needed.

These conditions raise substantial doubt about the Companys ability to continue as a going concern. The financial statements do not include any
adjustments that might be necessary if the Company was unable to continue as a going concern.

NOTE 3  DEBT

Total debt at December 31, 2008 and 2007 consists of the following:



|                                                           |  |                  |              |   |                  |   |             |  
|---------------------------------------------------------- |  | ---------------- | ------------ | - | ---------------- | - | ----------- | -
|                                                           |  | December 31,2008 |              |   | December 31,2007 |  
|Short term notes                                           |  | $                |             |   |                  | $ | 65,006      |  
|Senior secured notes, net of discount                      |  |                  | 15,450,000   |   |                  |   | 111,051,530 |  
|New notes, net of discount                                 |  |                  | 104,236,283  |   |                  |   |            |  
|Convertible notes, net of discount                         |  |                  |             |   |                  |   | 49,512,333  |  
|Revolving line of credit                                   |  |                  | 4,007,500    |   |                  |   | 252,532     |  
|                                                           |  |                  |              |   |                  |   |             |  
|                                                           |  |                  | 123,693,783  |   |                  |   | 160,881,401 |  
|                                                           |  |                 
|Less short term debt and current portion of long-term debt |  |                  | (123,693,783 | ) |                  |   | (65,006     | )
|                                                           |  |                  |              |   |                  |   |             |  
|Long-term debt                                             |  | $                |             |   |                  | $ | 160,816,395 |  
|                                                           |  |                  |              |   |                  |   |             |  

On October 1, 2007 Baseline completed
a debt offering consisting of $115 million aggregate principal amount of 121/2% Senior Secured Notes due 2012 (the Senior Secured Notes) and $50 million in aggregate principal amount of 14% Senior Subordinated Convertible Notes due 2013 (the
Convertible Notes). The bulk of the proceeds from these bond offerings were used to fund the purchase of the Blessing Field Properties, retire prior outstanding indebtedness and to pay fees and expenses related to the offerings.

Interest on the $115 million of Senior Secured Notes was due semi-annually on
April 1stand October 1st. The principal on the Senior Secured Notes was due on October 1, 2012. The Senior Secured Notes were
subject to an optional redemption beginning October 1, 2009 in the amount of 25% per quarter, at Baselines option and upon certain conditions being met. Upon a Change of Control (as defined in the indenture governing the
Senior Secured Notes), the Senior Secured Notes could be put back to us at 101% of par, plus accrued unpaid interest.

Interest on the $50 million of Convertible Notes was payable semi-annually on
April 1stand October 1st, with Baseline having the option of paying any interest in cash or, subject to certain conditions being met, as
additional principal amounts under the Convertible Notes, or Paid-in Kind (PIK) Notes. On April 1, 2008, Baseline elected to issue PIK notes to the holders of the Convertible Notes for interest payable for the period from October 1, 2007
through March 31, 2008 in the amount of $3,500,000. The Convertible Notes were convertible into shares of our common stock at an initial conversion price of $0.72 per share, or 1,389 shares of common stock for each $1,000 principal amount of
the Convertible Notes converted.

On October 1, 2007, Baseline also entered into a Credit Agreement with Wells Fargo Foothill, Inc.
(the Credit Agreement). Subject to the satisfaction of a Borrowing Base formula (based on Proved Developed Producing and Proved Developed Nonproducing reserves of Baseline minus certain reserves established by the administrative agent
related to credit exposure created by other bank products, including 125% of the mark-to-market value of the hedge positions), and numerous conditions precedent and covenants, the Credit Agreement provided for a revolving commitment of up to $20
million, with a sublimit of $10 million for the issuance of letters of credit. Unless earlier repayment was required under the Credit Agreement, advances under the loan facility were due on or before October 1, 2010. Baselines oil and gas
properties were pledged as collateral under the Credit Agreement, as well as the Senior Notes and the Convertible Notes. Baseline also agreed not to pay dividends on its common stock.

During July 2008, a group of related investors acquired all of Baselines outstanding Convertible Notes and converted all of such debt into common
stock. Accordingly, Baseline issued to the investors a total of 74,311,500



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shares of its common stock, valued at the $53,500,000 face value of the debt net of the unamortized discount of $458,456. In addition, Baseline issued an
additional 42,723,748 shares of its common stock under the related conversion make-whole premium, valued at $23,548,773. As a result of these transactions, the investors beneficially held, as of July 30, 2008, approximately 77.25% of
Baselines issued and outstanding common stock which constituted a Change of Control. Issuance of the above conversion shares of common stock, together with the make-whole payment, satisfied in full Baselines obligations under the
Convertible Notes.

As a result of the conversion of the Convertible Notes, the $115 million of Senior Secured Notes became due resulting
in the accelerated recognition of the remaining unamortized balance of deferred loan costs, totaling $4,531,634, this amount was expensed during the year and included in our loss on conversion of debt. In addition, Baseline expensed the $23,548,773
related to the conversion make-whole premium, net of $2,265,478 in interest accrued through the date of conversion as loss on conversion of debt.

On August 8, 2008, by reason of the Change of Control, Baseline commenced an offer to purchase for cash all of its Senior Secured Notes at a price equal to 101% of the principal amount of the Senior Secured Notes tendered prior to the
close of business on October 2, 2008, plus all accrued and unpaid interest. In addition, Baseline solicited consents from the holders of the Senior Secured Notes to amend the indenture governing the Senior Secured Notes and other collateral
agreements. The proposed amendments among other things eliminated or modified substantially all of the restrictive covenants, certain events of default and related provisions contained in the indenture and limited the rights of the holders of the
Senior Secured Notes and, consequently the practical benefit of the liens securing the Senior Secured Notes allowing Baseline to utilize the collateral to obtain financing to be used to purchase the Senior Secured Notes. As an incentive to holders
of the Senior Secured Notes, Baseline agreed to pay a consent payment equal to 2% of the principal amount of the Senior Secured Notes for which consents were validly delivered under the consent solicitation. Consents were delivered by holders of
Senior Secured Notes having an aggregate outstanding principal amount of $115 million, representing 100% of the outstanding Senior Secured Notes. As a result, Baseline was obligated to repurchase all of the outstanding Senior Secured Notes for
$118,450,000, plus accrued and unpaid interest. On October 6, 2008, Baseline failed to repurchase the notes and by virtue of such non-payment, was in default of the Indenture governing the Notes, as well as its Credit Agreement (see further
discussion below).

As a result of the purchase offer for the Senior Secured Notes, recognition of the remaining unamortized balances of
deferred loan costs and note discount, totaling $8,716,402 and $3,501,347, respectively, were accelerated and expensed during the year as loss on conversion of debt. In addition, the face amount of the Senior Secured Notes was increased by
$3,450,000 related to the premium under the Change of Control purchase offer and the consent solicitation. Such amount was expensed during the year as loss on conversion of debt.

Total loss on conversion of debt expensed during the year ended December 31, 2008 consists of the following:



|                                                                                      |  |   |           
|------------------------------------------------------------------------------------- |  | - | ----------
|Conversion make-whole premium, net of interest accrued through the date of conversion |  | $ | 21,283,295
|Unamortized deferred loan costs related to the Senior Secured Notes                   |  |   | 8,716,402 
|Unamortized debt discount on the Senior Secured Notes                                 |  |   | 3,501,347 
|Unamortized deferred loan costs related to the Convertible Notes                      |  |   | 4,531,634 
|1% premium under the Change of Control purchase offer                                 |  |   | 1,150,000 
|2% premium under the consent solicitation                                             |  |   | 2,300,000 
|                                                                                      |  |   |           
|                                                                                      |  | $ | 41,482,678
|                                                                                      |  |   |           

Baseline successfully reached an agreement with the majority of its note holders with respect to
its failure to repurchase the Companys outstanding Senior Secured Notes (the Old Notes) on October 6, 2008. As a result of such agreement, On October 31, 2008, holders of $100 million (the Majority Holders) of
the $115 million outstanding aggregate principal amount of the Old Notes exchanged all of their Old Notes for new Senior Secured Notes (the New Notes) in the aggregate principal amount of $106,681,250. Such amount represents 103% of the
principal amount of Old Notes held by the Majority Holders, plus an additional $3,681,250 (payable as satisfaction of certain consent, solicitation and other fees owing from the Company, including fees associated with the waiver of certain existing
defaults under the Indenture for the Old Notes), which was recorded as a discount to the debt and is being amortized into interest expense over the life of the New Notes. In addition, there remains outstanding $15,450,000 in principal amount of Old
Notes.

The New Notes mature on June 15, 2009 and accrue annualized interest of 15%, 12.5% of which is payable in cash, and 2.5% of
which may be payable by the Company in additional New Notes (the PIK Interest). Interest under the New Notes will be payable quarterly. The New Notes and the Old Notes will share in the existing security interest on substantially all of
the Companys properties that had been held by the holders of the Old Notes, on a pro rata basis.



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If a holder of Old Notes delivers a consent to the Company prior to the maturity or earlier repayment of
the New Notes, such holder will be entitled to receive, in exchange for its Old Notes, New Notes in a principal amount equal to (i) 104.25% of the principal amount of its Old Notes being exchanged and (ii) the amount of PIK Interest that
would have accrued with respect to such New Notes had they been issued to such holder on October 30, 2008 through and including the date of such consent, offset by any interest received under such holders Old Notes since October 1,
2008.

The New Notes have not been and will not be registered under the Securities Act of 1933, as amended, may not be offered or sold in
the United States absent registration or an applicable exemption from registration requirements, and will therefore be subject to substantial restrictions on transfer.

The exchange of notes transaction was evaluated to determine whether the Old Notes were extinguished under SFAS No. 140 and EITF Issue No. 96-19. Based on this evaluation, the transaction was accounted for as a
modification. Therefore, no gain or loss on extinguishment was recognized.

The Companys senior lender, Wells Fargo Foothill, Inc.,
subject to certain conditions, agreed to forbear from exercising remedies available to it under its senior credit facility and hedge agreement with the Company until April 15, 2009.

The senior credit facility has also been amended to provide, among other things, for (i) a new maturity date, with respect to any advances under the
revolving credit commitment, of the earlier of October 1, 2010 or sixty days prior to the maturity date of the New Notes and (ii) an increase of 2% on the interest rate margin for both Prime and LIBOR based loans thereunder. The
Intercreditor Agreement was also modified to permit the restructuring of the Companys obligations under the Old Notes and to extend the standstill period, during which time the Trustee for the Old Notes and New Notes cannot enforce any rights
with respect to collateral from 90 to 180 days.

As part of the restructuring, on October 17, 2008, the Company paid to the holders of
record on September 15, 2008 all accrued and unpaid interest initially due on October 1, 2008 under the Old Notes.

NOTE 4  SHORT-TERM
INVESTMENTS

The Companys short-term investments consisted of the following at December 31, 2007:



|                                 |  |      |            |                      |   |        |            |  |   |           
|-------------------------------- |  | ---- | ---------- | -------------------- | - | ------ | ---------- |  | - | ----------
|                                 |  | Cost |            | UnrealizedGain(Loss) |   |        | Fair Value
|U.S. government and agency notes |  | $    | 3,713,696  |                      | $ | 21,422 |            |  | $ | 3,735,118 
|Commercial paper                 |  |      | 7,895,439  |                      |   | 32,036 |            |  |   | 7,927,475 
|Corporate debt securities        |  |      | 2,246,265  |                      |   | (7,583 | )          |  |   | 2,238,682 
|                                 |  |      |            |                      |   |        |            |  |   |           
|Long-term debt                   |  | $    | 13,855,400 |                      | $ | 45,875 |            |  | $ | 13,901,275
|                                 |  |      |            |                      |   |        |            |  |   |           

At December 31, 2008, all of the Companys short-term investments have been liquidated
and converted into cash resulting in realized losses of $47,197

NOTE 5  ACQUISITIONS

On April 12, 2007, Baseline acquired producing oil and natural gas properties located in Stephens County, Texas, from Statex Petroleum I, L.P. and
Charles W. Gleeson LP. The properties consist of a 100% working interest in approximately 5,200 acres in the Eliasville Field. The preliminary adjusted purchase price was $26.6 million. Upon execution of the Purchase and Sale Agreement Baseline paid
a $1,000,000 non-refundable deposit credited against the purchase price. Baseline entered into an amendment to the agreement, whereby for an additional deposit of $300,000, the deadline to close on the purchase was extended. The effective date for
the transfer of the assets was February 1, 2007. Baseline funded the adjusted purchase price, less the deposits previously paid, and a portion of the costs associated with the transaction through borrowings under a newly created credit
agreement.

On October 1, 2007 Baseline acquired producing natural gas and oil properties located in Matagorda County, Texas, from DSX
Energy Limited LLP, Kebo Oil & Gas, Inc., and 25 other related parties for a preliminary adjusted purchase price of $96.6 million. The properties acquired by Baseline consist of a greater than 95% working interest in 2,374 net acres in the
Blessing Field which contained twelve (12) producing wells. The effective date of the acquisition was June 1, 2007.



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The Blessing Field acquisition was funded with proceeds from Baselines issuance of $115 million of
12.5% Senior Secured Notes due 2012 at a purchase price of $110.9 million, plus $50 million of 14.0% Senior Subordinated Convertible Secured Notes due 2013 at a purchase price of $49.5 million. In addition, Baseline retired $33.1 million of
indebtedness with proceeds of the offering, with the remainder being utilized for general corporate purposes, fees and expenses. Baseline also entered into a $20 million credit facility with a senior lender. The line of credit will be used for
implementing Baselines oil and natural gas hedging strategy, and for working capital if needed. The line of credit was not drawn at closing.

The following unaudited pro forma information assumes the acquisitions occurred as of the beginning of each period. The pro forma results are not necessarily indicative of what actually would have occurred had the acquisition been in effect
for the period presented.



|                             |  |             |             |   |           |   |             |  
|---------------------------- |  | ----------- | ----------- | - | --------- | - | ----------- | -
|                             |  | As Reported |             |   | Pro Forma |  
|Year ended December 31, 2007 |  |             |             |   |           |   |             |  
|Revenues                     |  | $           | 11,609,040  |   |           | $ | 33,295,512  |  
|Net Loss                     |  |             | (12,711,905 | ) |           |   | (19,264,526 | )
|Loss Per Share               |  |             | (0.39       | ) |           |   | (0.59       | )

NOTE 6  COMMITMENTS AND CONTINGENCIES

From time to time Baseline may become involved in litigation in the ordinary course of business. At the present time the Companys management is not
aware of any such litigation.

The Company, as an owner or lessee and operator of oil and gas properties, is subject to various federal,
state and local laws and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on the lessee under an oil and gas lease for the cost of pollution
clean-up resulting from operations and subject the lessee to liability for pollution damages. In some instances, the Company may be directed to suspend or cease operations in the affected area. We maintain insurance coverage, which we believe is
customary in the industry, although we are not fully insured against all environmental risks. The Company is not aware of any environmental claims existing as of December 31, 2008, which have not been provided for, covered by insurance or
otherwise have a material impact on its financial position or results of operations. There can be no assurance, however, that current regulatory requirements will not change, or past non-compliance with environmental laws will not be discovered on
the Companys properties.

The Company has a long-term operating lease agreement for its corporate offices that expires in October
2012. Rent expense for the years ended December 31, 2008 and 2007 was $130,149 and $63,909, respectively.

Minimum rentals for each of
the five years subsequent to December 31, 2008 are as follows:



|           |  |   |        
|---------- |  | - | -------
|2009       |  | $ | 141,468
|2010       |  |   | 142,095
|2011       |  |   | 145,231
|2012       |  |   | 121,026
|2013       |  |   |       
|Thereafter |  |   |       
|           |  |   |        
|           |  | $ | 549,820
|           |  |   |        

NOTE 7  FAIR VALUE MEASUREMENTS

Baseline has various financial instruments that are measured at fair value in the financial statements, including marketable debt securities and commodity
derivatives. Baselines financial assets and liabilities are measured using input from three levels of the fair value hierarchy. A financial asset or liability classification within the hierarchy is determined based on the lowest level input
that is significant to the fair value measurement. The three levels are as follows:

Level 1  Inputs are unadjusted quoted prices in
active markets for identical assets or liabilities that Baseline has the ability to access at the measurement date.

Level 2  Inputs
include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability
and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).



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Level 3  Unobservable inputs reflect Baselines judgments about the assumptions market
participants would use in pricing the asset of liability since limited market data exists. Baseline develops these inputs based on the best information available, using internal and external data.

The following table presents Baselines assets and liabilities recognized in the balance sheet and measured at fair value on a recurring basis as of
December 31, 2008:



|                      |  |                                          |  |         |           |         |   |       |   |          
|--------------------- |  | ---------------------------------------- |  | ------- | --------- | ------- | - | ----- | - | ---------
|                      |  | Input Levels for Fair Value Measurements
|Description           |  | Level 1                                  |  | Level 2 |           | Level 3 |   | Total
|Assets:               |  |                                          |  |         |           |         |   |       |   |          
|Commodity derivatives |  |                                         |  | $       | 4,432,079 |         |  |       | $ | 4,432,079
|                      |  |                                          |  |         |           |         |   |       |   |          
|                      |  |                                         |  | $       | 4,432,079 |         |  |       | $ | 4,432,079
|                      |  |                                          |  |         |           |         |   |       |   |          

Baselines investments in debt securities are classified as trading securities and stated at
fair value. The quoted market price or net asset value of an identical security in the principal market is used to record the fair value by multiplying the quoted market price or net asset value by the number of shares owned or par value. As of
December 31, 2008, all such investments had been sold.

Baseline uses various commodity derivative instruments, including collars,
swaps, floors and swaptions. The fair value of commodity derivatives is determined using forward price curves derived from market price quotations, externally developed and commercial models, with internal and external fundamental data inputs.
Market price quotations are obtained from independent energy brokers, direct communication with market participants and actual transactions executed by Baseline. Market price quotations for the natural gas trading hubs utilized in our commodity
derivatives are generally readily obtainable for the first six years, and therefore Baselines forward price curves reflect observable market quotes.

NOTE 8  STOCKHOLDERS EQUITY

Common Stock

On July 14, 2008, Baseline filed a Certificate of Amendment with the Secretary of State of Nevada which amended our Articles of Incorporation to increase the number of authorized shares of common stock, from
140,000,000 shares to 300,000,000 shares. The Certificate of Amendment became effective upon filing.

On March 31, 2007, Baseline
issued an aggregate of 93,750 shares of common stock, with a value of $46,875, in payment of accrued interest through February 15, 2007, to holders of 10% convertible promissory notes.

On May 15, 2007, Baseline issued an aggregate of 93,750 shares of common stock, with a value of $46,875, in payment of accrued interest through
May 15, 2007, to holders of 10% convertible promissory notes.

On May 30, 2007, Baseline issued 380,000 shares to holders of 10%
convertible promissory notes in consideration of the holders agreement to extend the maturity of the notes by six months. Such shares were valued at $190,000 which was charged to interest expense.

During June and July 2007, Baseline issued a total of 600,000 shares to outside consultants as compensation for services valued at $360,000.

On July, 5, 2007 non-employee option holders exercised options to purchase 200,000 shares of Common Stock at $ .05 per share on a
cashless basis. As a result Baseline issued 185,714 shares.

On July 13, 2007, a consultant exercised an option to
purchase 100,000 shares of Common Stock at $0.30 per share on a cashless basis. As a result, Baseline issued 56,522 shares.

During July and August 2007 holders of $250,000 of Baselines 10% Convertible Promissory Notes converted such notes into 501,676 shares.



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##### Table of Contents

On August 15, 2007, Baseline issued an aggregate of 109,023 shares of common stock, with a value of
$54,402, in payment of accrued interest through August 15, 2007, to holders of 10% convertible promissory notes.

During October and
November 2007 holders of $475,000 of Baselines 10% Convertible Promissory Notes converted such notes into 950,000 shares.

On
November 15, 2007, Baseline issued an aggregate of 91,500 shares of common stock, with a value of $45,750, in payment of accrued interest through November 15, 2007, to holders of 10% convertible promissory notes.

On April, 15, 2008 a non-employee option holder exercised options to purchase 62,500 shares of Common Stock at $ .05 per share on a
cashless basis. As a result Baseline issued 54,276 shares.

During July 2008, Baseline issued 74,311,500 shares of its common
stock upon the conversion of its Convertible Notes. Such shares were valued at the $53,500,000 face value of the debt net of the unamortized discount of $458,456.

During July 2008, Baseline issued 42,723,748 shares of its common stock related to the conversion make-whole premium on the Convertible Notes. Such shares were valued at $23,548,773 base on the trading price of the
Companys common stock on the date of issuance.

Stock Options and Warrants

Baseline utilizes restricted stock, stock options and warrants to compensate employees, officers, directors and consultants. Total stock based
compensation expense (including options, warrants and restricted stock) was $1,612,711 and $816,365 for the years ended December 31, 2008 and 2007, respectively. The total unrecognized stock based compensation expense relating to non-vested
options is $308,540 at December 31, 2008 and will be recognized over a weighted average period of one year.

On October 10, 2008,
options with respect to 2,000,000 shares of Common Stock granted to Thomas Kaetzer, the Companys Chief Executive Officer, on December 20, 2006 vested in full as result of his resignation for good reason following conversion of
the Companys Convertible Notes into shares of Common Stock representing greater than 50% of the then outstanding capital stock.

In
July 2008, options with respect to 1,500,000 shares of Common Stock granted to Patrick McGarey, the Companys Chief Financial Officer, on August 3, 2007 vested in full as a result of that Change of Control following the
acquisition by affiliated persons of the Companys Convertible Notes convertible into shares of Common Stock representing greater than 30% of the combined voting power of the Companys then issued and outstanding voting stock.

On January 4, 2007, Baseline granted a stock option to its former CFO, exercisable for up to 100,000 shares of Common Stock at an exercise price
of $0.56 per share. Such option had a fair value of $55,371.

On March 15, 2007, concurrently with the closing of bridge loan
financing , Alan Gaines, a former director and Barrie Damson, a former officer and director of Baseline, each cancelled stock options to purchase 1,670,000 shares of Baselines common stock at an exercise price of $0.05 per share.

In connection with its entry into the Drawbridge Agreement, on April 12, 2007 the Company issued warrants to Drawbridge and D.B. Zwirn Special
Opportunities Fund, L.P., another lender participating therein, which warrants are each exercisable for up to an aggregate of 3,200,000 shares of its Common Stock, at an exercise price of $0.50 per share. Pursuant to certain warrant agreements
executed with these two lenders, any unexercised warrants expire on April 11, 2014. The warrants also afford the holders certain anti-dilution protection. In connection with the issuance of the warrants the Company also entered into a
registration rights agreement dated April 12, 2007 with each of the holders of the warrants, under which the Company granted piggy-back registration rights, demand registration rights and shelf registration rights to these holders. Such
warrants had a fair value of $1,150,603 which was capitalized as a deferred loan cost and amortized over the term of the Credit Agreement.

On April 12, 2007, concurrently with the execution of the Drawbridge Agreement, Alan Gaines, a former director, and Barrie Damson, a former officer and director of its Company, each surrendered additional options to purchase 1,600,000
shares of Common Stock at an exercise price of $0.05 per share.

On August 3, 2007, Baseline granted five-year stock options
exercisable for up to an aggregate of 370,000 shares of common stock to several employees at an exercise price of $0.55. Such options vest in equal one-third installments on each of the first, second and third anniversary dates from the date of
grant and had a fair value of $191,440.

On August 3, 2007, Baseline granted a five-year stock option to Richard dAbo, former
director, exercisable for up to 150,000 shares of common stock at an exercise price of $0.55. Such option had a fair value of $73,844.

On
August 3, 2007 the Company entered into a two year employment agreement with Mr. Patrick McGarey to become Chief Financial Officer effective August 16, 2007. Mr. McGarey succeeded Richard Cohen. Concurrently with the entry into
the employment agreement with Mr. McGarey, Baseline granted to Mr. McGarey five-year options, exercisable for (i) up to 500,000 shares of common stock, at an exercise price equal to $0.55, (ii) up to 500,000 shares, at an
exercise price of $0.825 per share, and (iii) up to 500,000 shares, at an exercise price of



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$1.10 per share. Each option grant provides for the following vesting schedule: (i) 166,666 shares on August 3, 2007, (ii) 166,667 shares on
August 3, 2008 and (iii) 166,667 shares on August 3, 2009, provided that Mr. McGarey remains in the employ of the Company through such dates. Such options had a fair value of $757,826.

On April 22, 2008, Baseline granted to its employees options to purchase up to 375,000 shares of its common stock at $0.50 per share. Such options
vest in various amounts through April 22, 2010. The stock options have a five year term expiring on April 22, 2013. The grant-date fair value of these options was $94,608.

On June 19, 2008, Baseline granted to its Chief Executive Officer, Thomas R. Kaetzer, an option to purchase up to 3,000,000 shares of its common
stock, immediately exercisable at $0.40 per share, in recognition of Mr. Kaetzers performance and achievement to date. Such options vested on the grant date. The stock options have a five year term expiring on June 19, 2013. The
grant-date fair value of these options was $896,527

The weighted average fair value of the stock options granted during year ended
December 31, 2008 was $0.30. Variables used in the Black-Scholes option-pricing model include (1) risk free interest rates between 2.43% and 3.28%, (2) expected option life ranged from two and 1/2 to three years, (3) expected
volatility is 141% to 142% and (4) zero expected dividends. A summary of stock option transactions follow:



|                          |  |                                |      |                  |            |  
|------------------------- |  | ------------------------------ | ---- | ---------------- | ---------- | -
|                          |  | Weighted AverageExercise Price |      | Number ofOptions |           
|Balance December 31, 2006 |  | $                              | 0.18 |                  | 13,985,000 |  
|Granted                   |  |                                | 0.75 |                  | 2,120,000  |  
|Exercised                 |  |                                | 0.13 |                  | (300,000   | )
|Forfeited or expired      |  |                                | 0.05 |                  | (6,540,000 | )
|                          |  |                                |      |                  |            |  
|Balance December 31, 2007 |  |                                | 0.40 |                  | 9,265,000  |  
|Granted                   |  |                                | 0.41 |                  | 3,375,000  |  
|Exercised                 |  |                                | 0.05 |                  | (62,500    | )
|Forfeited or expired      |  |                                | 1.00 |                  | (50,000    | )
|                          |  |                                |      |                  |            |  
|Balance December 31, 2008 |  |                                | 0.41 |                  | 12,527,500 |  
|                          |  |                                |      |                  |            |  

The following table summarizes information about the Companys outstanding stock options:



|                    |  |                                |  |                                |      |                          |   |          
|------------------- |  | ------------------------------ |  | ------------------------------ | ---- | ------------------------ | - | ---------
|Number Outstanding  |  | Weighted AverageRemaining Life |  | Weighted AverageExercise Price |      | AggregateIntrinsic Value
|December 31, 2007   |  |                                |  |                                |      |                          |   |          
|Options Outstanding |  |                                |  |                                |      |                          |   |          
|9,265,000           |  | 3.29                           |  | $                              | 0.40 |                          | $ | 1,644,000
|Options Exercisable |  |                                |  |                                |      |                          |   |          
|7,228,330           |  | 2.97                           |  | $                              | 0.32 |                          | $ | 1,644,000
|December 31, 2008   |  |                                |  |                                |      |                          |   |          
|Options Outstanding |  |                                |  |                                |      |                          |   |          
|12,527,500          |  | 2.88                           |  | $                              | 0.41 |                          | $ | 38,975   
|Options Exercisable |  |                                |  |                                |      |                          |   |          
|12,080,833          |  | 2.84                           |  | $                              | 0.40 |                          | $ | 38,975   

On August 13, 2007, Baseline issued seven-year warrants to its then senior lenders,
exercisable in the aggregate for up to 260,000 shares of common stock at an exercise price of $0.52 per share. These warrants were issued as partial consideration for its lenders advancing us $2.5 million on August 13, 2007, thereby enabling us
to make a $2.5 million performance deposit in connection with its then pending acquisition of assets from DSX Energy Limited. Such warrants were valued at $140,008 capitalized as a deferred loan cost and fully amortized upon payment of the related
debt.

On August 20, 2007, Baseline issued five-year warrants to a former placement agent, exercisable in the aggregate for up to
340,000 shares of common stock at an exercise price of $0.65 per share. These warrants were issued as partial consideration for the termination of an agreement with such placement agent. Such warrants were valued at $216,087 and fully amortized as a
component of interest expense upon issuance.



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A summary of stock warrant transactions follow:



|                          |  |                                |      |                   |          
|------------------------- |  | ------------------------------ | ---- | ----------------- | ---------
|                          |  | Weighted AverageExercise Price |      | Number ofWarrants
|Balance December 31, 2006 |  | $                              | 0.79 |                   | 734,090  
|Granted                   |  |                                | 0.51 |                   | 7,140,000
|                          |  |                                |      |                   |          
|Balance December 31, 2007 |  |                                | 0.53 |                   | 7,874,090
|                          |  |                                |      |                   |          
|Balance December 31, 2008 |  |                                | 0.53 |                   | 7,874,090
|                          |  |                                |      |                   |          

The following table summarizes information about the Companys outstanding stock warrants:



|                     |  |                              |  |                              |      |                         |  
|-------------------- |  | ---------------------------- |  | ---------------------------- | ---- | ----------------------- | -
|Number Outstanding   |  | WeightedAverageRemainingLife |  | WeightedAverageExercisePrice |      | AggregateIntrinsicValue
|December 31, 2007    |  |                              |  |                              |      |                         |  
|Warrants Outstanding |  |                              |  |                              |      |                         |  
|7,874,090            |  | 4.97                         |  | $                            | 0.53 |                         | 
|Warrants Exercisable |  |                              |  |                              |      |                         |  
|7,874,090            |  | 4.97                         |  | $                            | 0.53 |                         | 
|December 31, 2008    |  |                              |  |                              |      |                         |  
|Warrants Outstanding |  |                              |  |                              |      |                         |  
|7,874,090            |  | 3.97                         |  | $                            | 0.53 |                         | 
|Warrants Exercisable |  |                              |  |                              |      |                         |  
|7,874,090            |  | 3.97                         |  | $                            | 0.53 |                         | 

NOTE 9  INVESTMENT IN JOINT VENTURE AND REDEMPTION OF MEMBERSHIP INTEREST

On March 16, 2007, Baseline delivered $300,000 to New Albany-Indiana LLC (New Albany) in partial satisfaction of the outstanding capital
calls that it, as a member of New Albany, was required to make. Pursuant to a Membership Interest Redemption Agreement between the Company and New Albany, Baseline then redeemed its membership interest in New Albany for the direct assignment to the
Company of an undivided 40.423% working interest in and to all oil and gas properties, rights, and assets of New Albany. Such assets were then pledged to under a mortgage to secure our Senior Secured Debenture. The reduction in our membership
interest of 50% to a 40.423% direct working interest reflected an adjustment of our membership interest in New Albany at the time of our redemption, as a result of outstanding capital calls owed by us but assumed by the affiliates and/or assigns of
Rex Energy, the other joint venture partner.

After redeeming its membership interest in New Albany on March 16, 2007, Baseline now
owns the following assets:



| |  |  | 19.7% working interest in an area of mutual interest, covering approximately 122,000 gross acres (approximately 24,400 acres net to Baseline), primarily located in
Greene County and operated by Atlas Energy, L.L.C. (the Wabash AMI);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 18.2% working interest in an area of mutual interest, covering approximately 41,000 total acres (approximately 7,380 acres net to Baseline) primarily located in
Knox County and operated by Atlas Energy, L.L.C. (the Knox AMI); and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 6.9% working interest in an area of mutual interest, covering approximately 8,000 gross acres (560 acres net to Baseline), primarily located in Greene County and
operated by El Paso (the Greene AMI)
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

NOTE 10  DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

On April 12, 2007, in accordance with a requirement of the Drawbridge Agreement, Baseline entered into a Swap Agreement with Macquarie Bank Limited,
which provided that Baseline put in place, for each month through the third anniversary of April 12, 2007, separate swap hedges with respect to approximately 75% of the projected production from Proved Developed Producing Reserves from the
Eliasville Field Properties. The swap hedges provided for a fixed price of $68.20 per barrel for a three year period, commencing June 1, 2007 and ending May 31, 2010. The hedging arrangement was based upon a monthly volume of 11,000
barrels during the first year and provided for monthly settlements.



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##### Table of Contents

During July 2007, Baseline modified its hedge from a fixed price swap to a collar with a floor of $68.20
and a ceiling of $74.20 for the period from August 2007 through December 2008. The original fixed price $68.20 swap remained in place for the period January 2009 to May 2010. In exchange for the July 2007December 2008 modification from a fixed
price swap to a collar, Baseline provided a right to the hedge provider to purchase 7,000 barrels per month at $73.20 per barrel from June 2010 through December 2011.

At the closing of the Blessing Field Properties acquisition on October 1, 2007, Baselines hedge positions under the Macquarie Swap Agreement, as described above, were novated to Wells Fargo Foothill, Inc.
Also since the closing of this acquisition, Baseline has added to its hedge positions, in accordance with the requirement of the Wells Fargo Agreement, the Senior Notes Indenture and the Convertible Note Indenture. These additional hedges include
both collars and floors, with Wells Fargo Foothill serving as our counterparty on each hedge position. All of our hedge positions as of December 31, 2008 are detailed in the table at the end of this section.

SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities requires that all derivative instruments be recorded on the
balance sheet at their fair value. Changes in the fair value of each derivative is recorded each period in current earnings or other comprehensive income, depending on whether the derivative is designated as part of a hedge transaction and, if it
is, the type of hedge transaction. To make this determination, management formally documents the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the item, the nature of the risk
being hedged, how the hedging instruments effectiveness in offsetting the hedged risk will be assessed, and a description of the method of measuring effectiveness. This process includes linking all derivatives that are designated as cash-flow
hedges to specific cash flows associated with assets and liabilities on the balance sheet or to specific forecasted transactions. Baseline also formally assesses, both at the hedges inception and on an ongoing basis, whether the derivatives
that are used in hedging transactions are highly effective in offsetting cash flows of hedged items. A derivative that is highly effective and that is designated and qualifies as a cash-flow hedge has its changes in fair value recorded in other
comprehensive income to the extent that the derivative is effective as a hedge. Any other changes determined to be ineffective do not qualify for cash-flow hedge accounting and are reported currently in earnings.

Baseline discontinues cash-flow hedge accounting when it is determined that the derivative is no longer effective in offsetting cash flows of the hedged
item, the derivative expires or is sold, terminated, or exercised, the derivative is redesignated as a non-hedging instrument because it is unlikely that a forecasted transaction will occur, or management determines that designation of the
derivative as a cash-flow hedge instrument is no longer appropriate. In situations in which cash-flow hedge accounting is discontinued, Baseline continues to carry the derivative at its fair value on the balance sheet and recognizes any subsequent
changes in its fair value in earnings.

When the criteria for cash-flow hedge accounting are not met, realized gains and losses (i.e., cash
settlements) are recorded in income (loss) from operations (oil and gas hedging) in the Statements of Operations. Similarly, changes in the fair value of the derivative instruments are recorded as income (loss) from operations in the Statements of
Operations. In contrast cash settlements for derivative instruments that qualify for hedge accounting are recorded as additions to or reductions in income (loss) from operations (oil and gas hedging) while changes in fair value of cash flow hedges
are recognized, to the extent the hedge is effective, in other comprehensive income until the hedged item is recognized in earnings.

Based
on the above, management has determined the swaps and collars noted above qualify for cash-flow hedge accounting treatment. Due to the sharp decline in oil and gas prices during the fourth quarter of 2008, we recorded a $12,317,731 unrealized gain
related to the mark-to-market of our open hedge contracts. At December 31, 2008, we had a derivative asset of $4,432,079. The unrealized gain is reported as a component of other comprehensive income.



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As of December 31, 2008 Baseline had the following hedge contracts outstanding:

Crude Oil Hedges (1)



|           |  |               |  |            |  |       |       |         |   |       |  |               |       |               |         |               |        |  |       
|---------- |  | ------------- |  | ---------- |  | ----- | ----- | ------- | - | ----- |  | ------------- | ----- | ------------- | ------- | ------------- | ------ |  | ------
|Instrument |  | BeginningDate |  | EndingDate |  | Floor |       | Ceiling |   | Fixed |  | TotalBbls2009 |       | TotalBbls2010 |         | TotalBbls2011
|Collar     |  | Jan-09        |  | Dec-09     |  | $     | 68.00 |         | $ | 74.05 |  |               |       |               | 42,000  |               |        |  |       
|Swap       |  | Jan-09        |  | Dec-09     |  |       |       |         |   |       |  | $             | 68.20 |               | 117,000 |               |        |  |       
|Swap       |  | Jan-10        |  | May-10     |  |       |       |         |   |       |  | $             | 68.20 |               |         |               | 47,500 |  |       
|Floor      |  | Jan-09        |  | Dec-09     |  | $     | 75.00 |         |   |       |  |               |       |               | 48,000  |               |        |  |       
|Swaption   |  | June-10       |  | Dec-10     |  |       |       |         | $ | 73.20 |  |               |       |               |         |               | 49,000 |  |       
|Swaption   |  | Jan-11        |  | Dec-11     |  |       |       |         | $ | 73.20 |  |               |       |               |         |               |        |  | 84,000
|           |  |               |  |            |  |       |       |         |   |       |  |               |       |               |         |               |        |  |       
|           |  |               |  |            |  |       |       |         |   |       |  |               |       |               | 207,000 |               | 96,500 |  | 84,000
|           |  |               |  |            |  |       |       |         |   |       |  |               |       |               |         |               |        |  |       



|(1) | All indexed to NYMEX WTI Cushing Light Sweet Crude
|--- | --------------------------------------------------

Natural Gas Hedges
(1)



|           |  |               |  |            |  |       |      |         |   |       |  |                |  |                |  |                |  |  
|---------- |  | ------------- |  | ---------- |  | ----- | ---- | ------- | - | ----- |  | -------------- |  | -------------- |  | -------------- |  | -
|Instrument |  | BeginningDate |  | EndingDate |  | Floor |      | Ceiling |   | Fixed |  | TotalMMBtu2009 |  | TotalMMBtu2010 |  | TotalMMBtu2011
|Collar     |  | Jan-09        |  | Dec-09     |  | $     | 7.50 |         | $ | 8.44  |  |                |  | 660,000        |  |                |  |  
|           |  |               |  |            |  |       |      |         |   |       |  |                |  |                |  |                |  |  
|           |  |               |  |            |  |       |      |         |   |       |  |                |  | 660,000        |  |               |  | 
|           |  |               |  |            |  |       |      |         |   |       |  |                |  |                |  |                |  |  



|(1) | All indexed to inside FERC Houston Ship Channel
|--- | -----------------------------------------------

NOTE 11  INCOME
TAXES

Net deferred tax assets at December 31, 2008 and 2007 consisted primarily of deferred tax assets related to tax attributes
including the Companys NOL and timing differences associated with the recognition of depletion, debt discount, deferred financing costs and intangible drilling costs. Deferred tax assets have a valuation allowance provided for the total
amount.



|                           |  |                  |             |   |                  |   |            |  
|-------------------------- |  | ---------------- | ----------- | - | ---------------- | - | ---------- | -
|                           |  | December 31,2008 |             |   | December 31,2007 |  
|Deferred tax assets - NOLs |  | $                | 14,386,918  |   |                  | $ | 3,321,000  |  
|Less: valuation allowance  |  |                  | (14,386,918 | ) |                  |   | (3,321,000 | )
|                           |  |                  |             |   |                  |   |            |  
|Net deferred tax asset     |  | $                |            |   |                  | $ |           |  
|                           |  |                  |             |   |                  |   |            |  

Baseline has net operating loss carry-forwards of approximately $42,314,464 at December 31,
2008, which begin expiring in 2024.

Our effective tax rate applicable to operations in 2008 and 2007 is as follows:



|                                                     |  |      |    |  |      |   
|---------------------------------------------------- |  | ---- | -- |  | ---- | --
|                                                     |  | 2008 |    |  | 2007 |   
|Statutory tax rate                                   |  | (34  | )% |  | (34  | )%
|Change in valuation allowance recognized in earnings |  | 34   | %  |  | 34   | % 
|                                                     |  |      |    |  |      |   
|                                                     |  |     |    |  |     |   
|                                                     |  |      |    |  |      |   

NOTE 12  ASSET RETIREMENT OBLIGATION



|                                                  |  |                         |         |      |   |        
|------------------------------------------------- |  | ----------------------- | ------- | ---- | - | -------
|                                                  |  | Year Ended December 31,
|                                                  |  | 2008                    |         | 2007
|Asset retirement obligations, beginning of year   |  | $                       | 282,947 |      | $ |       
|Fair value of liabilities assumed in acquisitions |  |                         |        |      |   | 240,959
|Accretion expense                                 |  |                         | 31,585  |      |   | 41,988 
|                                                  |  |                         |         |      |   |        
|Asset retirement obligations, end of year         |  | $                       | 314,532 |      | $ | 282,947
|                                                  |  |                         |         |      |   |        



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NOTE 13  SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED)

There are numerous uncertainties inherent in estimating quantities of proved crude oil and natural gas reserves. Crude oil and natural gas reserve
engineering is a subjective process of estimating underground accumulations of crude oil and natural gas that cannot be precisely measured. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and
geological interpretation and judgment.

The Company retained Cawley, Gillespie & Associates, Inc., independent third-party
reserve engineers, to perform an independent evaluation of proved reserves as of December 31, 2008. Results of drilling, testing and production subsequent to the date of the estimates may justify revision of such estimates. Accordingly, reserve
estimates are often different from the quantities of crude oil and natural gas that are ultimately recovered. All of the Companys reserves are located in the United States.

Proved Reserves

The following reserve schedule was developed by the Companys reserve engineers
and sets forth the changes in estimated quantities for proved reserves of the Company during each of the periods presented:



|                                            |  |                |   |  |          |  
|------------------------------------------- |  | -------------- | - |  | -------- | -
|                                            |  | Oil(Bbls)      |   |  | Gas(Mcf) |  
|                                            |  | (in thousands) |  
|Proved Reserves                             |  |                |   |  |          |  
|Estimated Quantities  December 31, 2006    |  |               |   |  |         |  
|Purchase of minerals in place               |  | 6,389          |   |  | 32,633   |  
|Production                                  |  | (149           | ) |  | (336     | )
|Extensions, discoveries and other additions |  |               |   |  |         |  
|Revisions of Previous estimates             |  |               |   |  |         |  
|                                            |  |                |   |  |          |  
|Estimated Quantities  December 31, 2007    |  | 6,240          |   |  | 32,297   |  
|Purchase of minerals in place               |  |               |   |  |         |  
|Production                                  |  | (252           | ) |  | (1,246   | )
|Extensions, discoveries and other additions |  | 505            |   |  | 1,461    |  
|Revisions of Previous estimates             |  | (1,126         | ) |  | (4,487   | )
|                                            |  |                |   |  |          |  
|Estimated Quantities  December 31, 2008    |  | 5,367          |   |  | 28,025   |  
|                                            |  |                |   |  |          |  
|                                            |  |               
|Proved Developed Reserves                   |  |                |   |  |          |  
|December 31, 2007                           |  | 4,202          |   |  | 16,791   |  
|                                            |  |                |   |  |          |  
|December 31, 2008                           |  | 3,996          |   |  | 17,127   |  
|                                            |  |                |   |  |          |  

Oil and Gas Operations

Aggregate results of operations, in connection with the Companys crude oil and natural gas producing activities are shown below:



|                                                                    |  |                         |             |   |      |   |            |  
|------------------------------------------------------------------- |  | ----------------------- | ----------- | - | ---- | - | ---------- | -
|                                                                    |  | Year Ended December 31, |            
|                                                                    |  | 2008                    |             |   | 2007 |  
|Revenues                                                            |  | $                       | 32,654,222  |   |      | $ | 11,609,040 |  
|Production costs                                                    |  |                         | (10,506,835 | ) |      |   | (5,148,418 | )
|Exploration expenses                                                |  |                         |            |   |      |   |           |  
|Depreciation, depletion and amortization                            |  |                         | (32,296,636 | ) |      |   | (1,823,233 | )
|Accretion expense                                                   |  |                         | (31,585     | ) |      |   | (41,988    | )
|                                                                    |  |                         |             |   |      |   |            |  
|Income (loss) before income tax                                     |  |                         | (10,180,834 | ) |      |   | 4,595,401  |  
|Income tax                                                          |  |                         |            |   |      |   |           |  
|                                                                    |  |                         |             |   |      |   |            |  
|Results of operations from oil and natural gas producing activities |  | $                       | (10,180,834 | ) |      | $ | 4,595,401  |  
|                                                                    |  |                         |             |   |      |   |            |  



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Costs Incurred in Oil and Gas Activities

Costs incurred in connection with the Companys crude oil and natural gas acquisition, exploration and development activities are shown below:



|                                       |  |                         |            |      |   |            
|-------------------------------------- |  | ----------------------- | ---------- | ---- | - | -----------
|                                       |  | Year Ended December 31,
|                                       |  | 2008                    |            | 2007
|Property acquisition costs             |  | $                       |           |      | $ | 123,153,383
|Unproved prospects                     |  |                         | 34,460     |      |   | 665,531    
|Exploration costs                      |  |                         |           |      |   |           
|Development costs                      |  |                         | 21,865,577 |      |   | 5,228,246  
|                                       |  |                         |            |      |   |            
|Total Operations                       |  | $                       | 21,900,037 |      | $ | 129,047,160
|                                       |  |                         |            |      |   |            
|Asset retirement obligation (non-cash) |  | $                       |           |      | $ | 240,959    
|                                       |  |                         |            |      |   |            

Aggregate Capitalized Costs

Aggregate capitalized costs relating to the Companys crude oil and natural gas producing activities, including asset retirement costs and related accumulated depreciation, depletion and amortization are as
follows:



|                                                     |  |              |             |   |      |   |             |  
|---------------------------------------------------- |  | ------------ | ----------- | - | ---- | - | ----------- | -
|                                                     |  | December 31, |            
|                                                     |  | 2008         |             |   | 2007 |  
|Proved oil and gas properties                        |  | $            | 149,699,206 |   |      | $ | 128,381,629 |  
|Unproved oil and gas properties                      |  |              | 8,510,126   |   |      |   | 8,475,666   |  
|Accumulated depreciation, depletion and amortization |  |              | (34,119,869 | ) |      |   | (1,823,233  | )
|                                                     |  |              |             |   |      |   |             |  
|Net capitalized costs                                |  | $            | 124,089,463 |   |      | $ | 135,034,062 |  
|                                                     |  |              |             |   |      |   |             |  

Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves

The following information is based on the Companys best estimate of the required data for the Standardized Measure of Discounted
Future Net Cash Flows as of December 31, 2008 and 2007 in accordance with SFAS No. 69, Disclosures About Oil and Gas Producing Activities which requires the use of a 10% discount rate. This information is not the fair market
value, nor does it represent the expected present value of future cash flows of the Companys proved oil and gas reserves.



|                                                         |  |                  |          |   |      |   |          |  
|-------------------------------------------------------- |  | ---------------- | -------- | - | ---- | - | -------- | -
|                                                         |  | December 31,     |         
|                                                         |  | 2008             |          |   | 2007 |  
|                                                         |  | ($ in thousands) |         
|Future cash inflows                                      |  | $                | 402,043  |   |      | $ | 849,361  |  
|Future production costs                                  |  |                  | (197,276 | ) |      |   | (262,906 | )
|Future development costs                                 |  |                  | (47,221  | ) |      |   | (43,468  | )
|Future income tax expense                                |  |                  | (10,421  | ) |      |   | (141,470 | )
|                                                         |  |                  |          |   |      |   |          |  
|Future net cash flows                                    |  |                  | 147,125  |   |      |   | 401,517  |  
|10% annual discount for estimating timing of cash flows  |  |                  | (82,248  | ) |      |   | (190,905 | )
|                                                         |  |                  |          |   |      |   |          |  
|Standardized measure of discounted future net cash flows |  | $                | 64,877   |   |      | $ | 210,612  |  
|                                                         |  |                  |          |   |      |   |          |  

Future cash inflows are computed by applying year-end commodity prices, adjusted for location and
quality differentials on a property-by-property basis, to year-end quantities of proved reserves, except in those instances where fixed and determinable price changes are provided by contractual arrangements at year-end. The discounted future cash
flow estimates do not include the effects of the Companys derivative instruments. In its 2008 year-end reserve report, the Company used the December 31, 2008 WTI Cushing spot price of $44.60 per Bbl and Henry Hub spot natural gas price of
$5.62 per MMbtu, adjusted by property for energy content, quality, transportation fees, and regional price differentials. The weighted average price over the lives of the properties was $44.06 per Bbl for oil and $5.91 per Mcf for gas.

Future production and development costs, which include dismantlement and restoration expense, are computed by estimating the expenditures to be
incurred in developing and producing the Companys proved crude oil and natural gas reserves at the end of the year, based on the year-end costs, and assuming continuation of existing economic conditions. While the Company believes that future
operating costs can be reasonably estimated, future



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prices are difficult to estimate since market prices are influenced by events beyond its control. Future global economic and political events will most
likely result in significant fluctuations in future oil prices, while future U.S. natural gas prices will continue to be influenced by primarily domestic market factors, including supply and demand, weather patterns and public policy.

Future income tax expenses are computed by applying the appropriate year-end statutory tax rates to the estimated future pretax net cash flows relating
to the Companys proved crude oil and natural gas reserves, less the tax basis of the properties involved. The future income tax expenses give effect to tax credits and allowances, but do not reflect the impact of general and administrative
costs and exploration expenses of ongoing operations relating to the Companys proved crude oil and natural gas reserves.

Sources of Changes in
Discounted Future Net Cash Flows

Principal changes in the aggregate standardized measure of discounted future net cash flows
attributable to the Companys proved crude oil and natural gas reserves, as required by SFAS No. 69, during 2008 and 2007 are set forth in the table below:



|                                                                                      |  |                         |          |   |      |   |         |  
|------------------------------------------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | ------- | -
|                                                                                      |  | Year Ended December 31, |         
|                                                                                      |  | 2008                    |          |   | 2007 |  
|                                                                                      |  | ($ in thousands)        |         
|Standardized measure of discounted future net cash flows at The beginning of the year |  | $                       | 210,610  |   |      | $ |        |  
|Purchases of mineral in place                                                         |  |                         |         |   |      |   | 153,696 |  
|Extensions discoveries and improved recovery                                          |  |                         | 13,612   |   |      |   | 18,531  |  
|Revisions of previous quantity estimates                                              |  |                         | (75,403  | ) |      |   | 1,417   |  
|Net changes in timing                                                                 |  |                         | (3,747   | ) |      |   | (11,537 | )
|Changes in estimated future development costs                                         |  |                         | (2,012   | ) |      |   | (1,036  | )
|Net changes in prices and production costs                                            |  |                         | (162,716 | ) |      |   | 76,212  |  
|Accretion of discount                                                                 |  |                         | 21,061   |   |      |   | 5,850   |  
|Sales of oil and gas produced, net of production costs                                |  |                         | (28,854  | ) |      |   | (8,822  | )
|Development costs incurred during the period                                          |  |                         | 21,865   |   |      |   | 5,228   |  
|Net change in income taxes                                                            |  |                         | 68,461   |   |      |   | (28,927 | )
|                                                                                      |  |                         |          |   |      |   |         |  
|Standardized measure of discounted future net cash flows                              |  | $                       | 64,877   |   |      | $ | 210,610 |  
|                                                                                      |  |                         |          |   |      |   |         |  

NOTE 14  SUBSEQUENT EVENTS

On January 28, 2009, the Company liquidated all of its oil and natural gas hedge positions resulting in net proceeds to the Company of approximately
$4.5 million. The cumulative unrealized gain, reported as a component of accumulated other comprehensive income in stockholders equity, will be recognized into income in the periods for which the related oil and gas volumes are produced.

On January 30, 2009, the Company fully repaid all of its obligations (approximately $3.6 million) under its Credit Agreement with
Wells Fargo Foothill, Inc. As a result, the Credit Agreement was terminated and the Agent released its liens on all of the Companys properties and assets. The Company utilized a portion of the funds obtained from the liquidation of its hedges
to fund the repayment of the debt.



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SIGNATURES

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



|                     |  |                          |  |                        
|-------------------- |  | ------------------------ |  | -----------------------
|                     |  | BASELINE OIL & GAS CORP.
|                     |  |                         
|Date: March 31, 2009 |  | By:                      |  | /S/ THOMAS KAETZER     
|                     |  |                          |  | Thomas Kaetzer         
|                     |  |                          |  | Chief Executive Officer

In accordance with the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant in the capacities indicated below on March 31, 2009.



|                                    
|------------------------------------
|Signature and Title                 
|                                    
|/s/ THOMAS KAETZER                  
|Thomas Kaetzer                      
|Chief Executive Officer and Director
|                                    
|/s/ PATRICK MCGAREY                 
|Patrick McGarey                     
|Chief Financial Officer             
|                                    
|/s/ JOHN V. LOVOI                   
|John V. Lovoi                       
|Director                            
|                                    
|/s/ JOSUAH L. TARGOFF               
|Josuah L. Targoff                   
|Director