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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K


[X]               ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

[ ]             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 0-9207

                            HARKEN ENERGY CORPORATION
             (Exact name of registrant as specified in its charter)


              DELAWARE                                     95-2841597
    (State or other jurisdiction of                    (I.R.S. Employer
     incorporation or organization)                    Identification No.)

   5605 N. MACARTHUR BLVD., SUITE 400                         75038
            IRVING, TEXAS                                   (Zip Code)
(Address of principal executive offices)

        Registrant's telephone number, including area code (972) 753-6900

           Securities registered pursuant to Section 12(b) of the Act:



                                                   Name of each exchange 
           Title of each class:                     on which registered:
COMMON STOCK, PAR VALUE $0.01 PER SHARE           American Stock Exchange


        Securities registered pursuant to Section 12(g) of the Act: NONE

     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 IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. [X]

     The aggregate market value of the voting Common Stock, par value $0.01 per
share, held by nonaffiliates of the Registrant as of March 16, 1998 was
approximately $640,000,000. For purposes of the determination of the above
stated amount only, all directors, executive officers and 5% or more
shareholders of the Registrant are presumed to be affiliates.

     The number of shares of Common Stock, par value $0.01 per share,
outstanding as of March 16, 1998 was 122,781,347.

     DOCUMENTS INCORPORATED BY REFERENCE: DEFINITIVE PROXY MATERIALS FOR THE
1998 ANNUAL MEETING OF STOCKHOLDERS -- PART III, ITEMS 10, 11, 12, AND 13.

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                                                 TABLE OF CONTENTS


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<S>              <C>                                                                                         <C>
PART I.

  ITEM  1.       Business..........................................................................             3

  ITEM  2.       Properties........................................................................            18

  ITEM  3.       Legal Proceedings.................................................................            18

  ITEM  4.       Submission of Matters to a Vote of Security Holders...............................            18

PART II.

  ITEM  5.       Market for Registrant's Common Equity and Related Stockholder Matters.............            19

  ITEM  6.       Selected Financial Information and Other Data.....................................            20

  ITEM  7.       Management's Discussion and Analysis of Financial Condition and
                 Results of Operations.............................................................            21

  ITEM  8.       Financial Statements and Supplementary Data.......................................            29

  ITEM  9.       Changes in and Disagreements with Accountants on Accounting and
                 Financial Disclosure..............................................................            61

PART III.

  ITEM 10.       Directors and Executive Officers of the Registrant................................            61

  ITEM 11.       Executive Compensation............................................................            61

  ITEM 12.       Security Ownership of Certain Beneficial Owners...................................            61

  ITEM 13.       Certain Relationships and Related Transactions....................................            61

PART IV.

  ITEM 14.       Exhibits, Financial Statement Schedules and Reports on Form 8-K...................            62
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                                     PART I

ITEM 1. BUSINESS

OVERVIEW

         Harken Energy Corporation (together with its wholly-owned subsidiaries,
"Harken") is engaged in oil and gas exploration, development and production
operations both domestically and internationally through its various
wholly-owned subsidiaries. Harken's domestic operations include oil and gas
exploration, development and production operations in the Four Corners area of
Utah, Arizona and New Mexico, in the onshore region of South Texas, in the Texas
Panhandle region, in the Magnolia region of Arkansas and the Carlsbad region of
New Mexico. Harken's international operations include six exclusive Colombian
Association Contracts with the state-owned Colombian oil company.

         Harken's corporate strategy is to expand its domestic reserve base
through acquisitions and additional exploration and developmental drilling on
its existing oil and gas properties and to reinvest a substantial portion of the
cash flow generated from its domestic assets, along with funds generated from
traditional and other sources of financing, towards developing its higher
potential, and higher risk, international prospects.

         Harken was incorporated in 1973 in the state of California and
reincorporated in 1979 in the state of Delaware. Harken's principal offices are
located at 5605 N. MacArthur Blvd., Suite 400, Irving, Texas 75038 and its
telephone number is (972) 753-6900.

INTERNATIONAL EXPLORATION AND DEVELOPMENT OPERATIONS

         Harken's international operations consist primarily of its exploration
operations in the Republic of Colombia. Harken, through its wholly-owned
subsidiary Harken de Colombia, Ltd. ("Harken Colombia"), currently holds six
exclusive Association Contracts with Empresa Colombiana de Petroleos
("Ecopetrol"), the state-owned Colombian oil company.

         Alcaravan Contract -- During the fourth quarter of 1992, Harken
Colombia and Ecopetrol entered into an Association Contract covering the
Alcaravan area (the "Alcaravan Contract"). The Alcaravan Contract grants Harken
Colombia the exclusive right to explore for, develop and produce oil and gas
throughout approximately 210,000 acres in the Alcaravan area of Colombia. The
Alcaravan area is located in Colombia's Llanos Basin and is located
approximately 140 miles east of Santafe De Bogota. Harken Colombia is required
to conduct a seismic and exploratory drilling program during the initial six
years of the Alcaravan Contract (the "Exploration Period"). At the end of each
of the first six years of the Alcaravan Contract, Harken Colombia has the option
to withdraw from the Alcaravan Contract or to commit to the next year's work
requirements. If during the Exploration Period of the Alcaravan Contract, Harken
Colombia discovers one or more fields capable of producing oil or gas in
quantities that are economically exploitable and Ecopetrol agrees that such
field is economically exploitable (a "commercial discovery"), the term of the
Alcaravan Contract related to the areas of commerciality will be extended for a
period of 22 years from the date of such commercial discovery.

         Upon a discovery of a field capable of commercial production, and upon
commencement of production from that commercial field, Ecopetrol will reimburse
Harken Colombia for 50% of Harken

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Colombia's successful well costs expended up to the point of declaration of a
commercial discovery out of Ecopetrol's share of production. Production from the
field following a commercial discovery will be allocated as follows: Ecopetrol,
on behalf of the Colombian government, will receive a 20% royalty interest in
all production and all production (after royalty payments) will be allocated 50%
to Ecopetrol and 50% to Harken Colombia until cumulative production in such
field reaches 60 million barrels of oil, after which Ecopetrol's share of
production will progressively increase and Harken Colombia's share will
progressively decrease until cumulative production from the field reaches 150
million barrels of oil, and thereafter all production will be allocated 70% to
Ecopetrol and 30% to Harken Colombia. If more than one commercially declared
field is discovered on the Alcaravan area, the production sharing percentages
applicable to the field with the greatest cumulative production will be applied
to all fields within the Alcaravan area. After declaration of a commercial
discovery, Harken Colombia and Ecopetrol will be responsible for all future
development costs and operating expenses in direct proportion to their interest
in production.

         The Alcaravan Contract provides that at the end of the Exploration
Period in February 1999, if a field capable of producing hydrocarbons in
commercial quantities has been discovered, the Alcaravan Contract area will be
reduced by 50%. Two years thereafter, the Alcaravan Contract area will be
further reduced to 25% of the original area. Two years thereafter, the Alcaravan
Contract area will be reduced to the area of the commercial field that is in
production or development, plus a reserve zone of five kilometers in width
around the productive boundary of such field. The commercial field plus the zone
surrounding such field will become the area of exploitation. Harken Colombia
will designate the acreage to be released.

         Harken Colombia has completed all of the work requirements of the first
four years of the Alcaravan Contract. Harken Colombia has committed to drill an
additional exploratory well, the Canacabare #1, thereby extending the Alcaravan
Contract into the fifth year.

         In 1996, Harken Colombia entered into two separate agreements with
industry partners, whereby each industry partner paid 1/3 of the cost of the
Estero #1 well, plus certain additional costs and fees and acquired a 25%
beneficial interest in the Palo Blanco Prospect. In addition, the industry
partners have certain rights to acquire a beneficial interest in any other
prospect on the Alcaravan acreage by paying a portion of the costs associated
with such prospect. Each industry partner has acquired a 25% beneficial interest
in the Anteojos prospect.

         Harken Colombia has to date drilled three wells on the Alcaravan
acreage. The first well, the Alcaravan #1, was drilled in February 1995, and did
not find commercial quantities of oil or gas.

         In February 1997, Harken Colombia drilled the Estero #1 well located on
the Palo Blanco prospect. The Estero #1 well was drilled to a depth of 8,608
feet to test the Carbonera, Mirador, Guadalupe, Gacheta and Ubaque formations.
During initial production testing of the Ubaque formation, the Estero #1 well
produced at the rate of 4,116 barrels of oil per day. Harken Colombia believes
that the production rate was limited by the capacity of the submersible pump and
surface storage facilities at the location. In December 1997, Harken Colombia
spudded the Estero #3, also located on the Palo Blanco Prospect. The Estero #3
has been drilled and completed and is currently being tested. Results are
anticipated in late March or early April.

         Harken Colombia anticipates that it will initiate a 90 day production
test (which period may be extended by the Colombian Mines and Energy Ministry)
of the Estero #1 and, if successful, the Estero #3, in April 1998. Oil produced
during the long-term test is anticipated to be sold and trucked to a pumping

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station approximately 20 miles away. It is anticipated that Harken Colombia will
initially be able to truck and sell up to 1,000 barrels of oil per day.

         In order to produce and sell volumes in excess of the 1,000 barrels of
oil per day which can be trucked from the two Estero wells, it will be necessary
for Harken Colombia to construct a pipeline from the Estero wells to the closest
existing pipeline approximately 6 kilometers from the Estero wells (the "Phase I
Pipeline"). Construction of the Phase I Pipeline is anticipated to begin in
April 1998 and is expected take approximately two months to complete. If,
however, the Phase I Pipeline is not completed by the beginning of the rainy
season, construction of the Phase I Pipeline will be suspended until the
beginning of the next dry season in approximately December 1998. Upon completion
of the Phase I Pipeline, it is anticipated that the Phase I Pipeline will be
able to carry up to 2,200 barrels of oil per day. Harken Colombia is currently
investigating methods to produce and sell volumes in excess of the capacity of
the Phase I Pipeline.

         Harken Colombia anticipates that it will request Ecopetrol to declare
the Palo Blanco field to be commercial in the second half of 1998. Under the
terms of the Alcaravan Contract, Ecopetrol will have 90 days to decide whether
or not to declare the field to be commercial. In the event a discovery is made
and is not deemed to be commercially feasible by Ecopetrol, Ecopetrol may
require Harken Colombia to expend up to $2 million over a one-year period to
further develop the field, 50% of which will be reimbursed if Ecopetrol
subsequently accepts the commercial feasibility thereof. If Ecopetrol does not
declare the field commercial, Harken Colombia may continue to develop the field
at its own expense. In such event, Ecopetrol will have the right to acquire a
50% interest after recovery by Harken Colombia of 200% of the amounts expended
by Harken Colombia.

         On March 10, 1998, Harken Colombia spudded the Canacabare #1, the first
exploratory well to be drilled on the Anteojos prospect. Harken Colombia
anticipates that results on the well will be available in late April 1998.

         Harken Colombia plans to drill an additional exploratory well on the
Alcaravan acreage, the Curi #1 located on the La Ceiba prospect in the first
half of 1999.

         Bocachico Contract -- In January 1994, Harken Colombia signed its
second Association Contract (the "Bocachico Contract") with Ecopetrol, covering
the Bocachico Contract area. Under the Bocachico Contract, Harken Colombia has
acquired the exclusive rights to conduct exploration activities and drilling on
this area, which covers approximately 192,000 acres in the Middle Magdalena
Valley of Central Colombia. During the exploratory period of the Bocachico
Contract, if Harken Colombia makes a commercial discovery on one or more
prospect areas in the contract area, the contract covering such prospect area(s)
will be further extended for a period of 22 years from the date of any
commercial discovery of oil and/or gas. The production sharing and acreage
relinquishment arrangements under the Bocachico Contract are substantially
similar to those under the Alcaravan Contract.

         Harken Colombia has fulfilled all of the work requirements for the
first three years of the Bocachico Contract. The work requirements for the
fourth year require Harken Colombia to drill one exploratory well by September
6, 1998. In addition, Harken Colombia has committed to drill an additional
exploratory well, thereby extending the Bocachico Contract into its fifth year.

         In October 1995, Harken Colombia entered into a Development Finance
Agreement (the "Rio Negro Development Finance Agreement") with four
institutional investors (the "Rio Negro Investors"), pursuant

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to which the Rio Negro Investors provided up to $3,500,000 to Harken Colombia to
finance a portion of the drilling of two wells on the Rio Negro prospect in the
Bocachico Contract area in exchange for the right to receive future payments
from Harken Colombia equal to 40% of the net profits that Harken Colombia may
derive from the sale of oil and gas produced from the Rio Negro prospect (the
"Participation") if the planned drilling on that prospect is successful. In
March 1997, Harken entered into an agreement with the Rio Negro Investors
pursuant to which the Participation was reduced to 10% from 40% in exchange for
900,000 shares of Common Stock.

         Harken Colombia spudded its first well on the Bocachico Contract area,
the Torcaz #2 located on the Rio Negro Prospect, in July 1996. This well was
completed and initially tested at the rate of 635 barrels per day. Harken
Colombia encountered numerous mechanical problems with the down-hole submersible
electric pump compounded by apparent reservoir formation damage which may have
occurred in the completion process. In October 1997, Harken Colombia recompleted
this well, which produced at initial test rates in excess of 650 barrels per
day. Harken Colombia believes that problems initially encountered with this well
have now been corrected. In April 1997, Harken Colombia spudded the second well
on the Rio Negro Prospect, the Torcaz #3. The well initially tested at the rate
of 643 barrels per day. Harken Colombia anticipates initiating a 120 day
production test (which period may be extended by the Colombian Mines and Energy
Ministry) of the Torcaz #2 and Torcaz #3 wells. Production will be sold to a
local purchaser at the well site. Harken Colombia will study the production from
the Torcaz #2 and Torcaz #3 wells in order to determine the optimum equipment
with which to produce the heavy crude encountered in such wells. Harken Colombia
plans to drill a third well on the Rio Negro prospect, the Torcaz #5, in the
second half of 1998.

         Harken Colombia is currently investigating methods to efficiently
develop and produce the Rio Negro field, and plans to request Ecopetrol to
declare the Rio Negro field to be commercial in the second half of 1998. The
commerciality process is similar to the process provided under the Alcaravan
Contract.

         In October and December 1997, Harken entered into two separate
Development Finance Agreements with institutional investors (collectively the
"Institutional Investors"), pursuant to which the Institutional Investors
provided $31.5 million of net proceeds to Harken to finance the drilling of the
initial wells on three unexplored oil and gas prospects in the Middle Magdalena
Basin of Colombia, including one prospect on the Bocachico acreage. In exchange,
the Institutional Investors received the right to receive future payments from
Harken equal to 6.4% of the net profits that Harken Colombia may derive from the
sale of oil and gas produced from each of the three prospects if the planned
drilling on the prospect is successful.

         Cambulos Contract -- In September 1995, Harken Colombia signed an
additional Association Contract (the "Cambulos Contract") with Ecopetrol,
covering the Cambulos Contract area. Under the Cambulos Contract, Harken
Colombia has acquired the exclusive rights to conduct exploration activities in
the Cambulos Contract area, which covers approximately 300,000 acres in the
Middle Magdalena Valley of Central Colombia.

         During the first two years of the Cambulos Contract, Harken Colombia
was required to conduct geologic studies on the lands covered by this contract,
including reprocessing of at least 400 kilometers of existing seismic data and
the acquisition of at least 90 kilometers of new seismic data. Harken Colombia
has completed the work program for the first two years of the Cambulos Contract,
and is required to submit a proposal to Ecopetrol by May 16, 1998 to reduce the
acreage covered by the Cambulos Contract to approximately 173,000 acres. Harken
is currently negotiating an arrangement with Ecopetrol whereby

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Harken Colombia would agree to drill an additional well in exchange for the
obligation to return acreage. During each of the third through the sixth
contract years, Harken Colombia may elect to continue the contract by committing
to the drilling of at least one well during each contract year. Harken has
committed to drill a well on the Cambulos acreage, which must be drilled by
September 1998, thereby extending the Cambulos Contract into its third year.

         If during the exploratory period of the Cambulos Contract, Harken
Colombia discovers a field capable of commercial production of oil or gas, the
term of the Cambulos Contract will be extended for a period of 22 years from the
date of such commercial discovery. Upon a commercial discovery and at the
initiation of production from the commercial field, Harken Colombia will be
reimbursed by Ecopetrol for 50% of all seismic costs and direct exploratory well
costs (including costs related to dry holes) incurred prior to the point at
which a declaration of a commercial discovery is made. Production from a
commercial discovery will be allocated as follows: Ecopetrol, on behalf of the
Colombian government, will receive a 20% royalty interest in all production, and
all production (after royalty payments) will be allocated 50% to Ecopetrol and
50% to Harken Colombia until cumulative production from all fields in the
Cambulos acreage reaches 60 million barrels of oil, after which Ecopetrol's
share of production will increase progressively to 75% and Harken Colombia's
share will decrease progressively to 25%, determined by a formula based on
Harken Colombia's recovery of its total expenditures under the Cambulos
Contract. After a declaration of a commercial discovery, Harken Colombia and
Ecopetrol will be responsible for all future development costs and operating
expenses in direct proportion to their interest in production. The acreage
relinquishment provisions of the Cambulos Contract are substantially similar to
those contained in the Alcaravan Contract.

         Harken Colombia currently plans to drill its first well on the Cambulos
acreage, on the Emerald Mountain prospect, in May 1998. The Emerald Mountain
prospect will be one of the three prospects covered by the Development Finance
Agreement described above.

         Harken Colombia also plans to drill three additional wells to test
three other prospects on the Cambulos acreage in the second half of 1998.

         Bolivar Contract -- In May 1996, Harken Colombia signed an additional
Association Contract (the "Bolivar Contract") with Ecopetrol, covering the
Bolivar Contract area. Under the Bolivar Contract, Harken Colombia has acquired
the exclusive rights to conduct exploration activities in the Bolivar Contract
area, which covers approximately 250,000 acres in the Northern Middle Magdalena
Valley of Central Colombia.

         Harken Colombia has completed all of the work obligations for the first
two years of the Bolivar Contract. During each of the third through the sixth
contract years, Harken Colombia may elect to continue the contract by committing
to the drilling of at least one well during each contract year. The production
sharing and acreage relinquishment arrangements under the Bolivar Contract are
substantially similar to those under the Cambulos Contract.

      In November 1997, Harken spudded its first well on the Bolivar Contract
acreage, the Catalina #1. The Catalina #1 well was drilled as a horizontal well
to test the Rosa Blanca formation. During initial production testing, the
Catalina #1 well produced at rates averaging 7,073 barrels of oil per day and
11.5 million cubic feet of gas per day or 9,680 barrels of oil equivalent per
day. Harken Colombia believes that production rates were limited by surface
facilities, wellbore configurations and recovery of drilling fluids during the
test. The well was designed to be drilled a horizontal distance of up to 6,000
feet. Harken Colombia elected to end the horizontal drilling at approximately
1,265 feet upon achieving significant production rates.

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         On March 2, 1998, Harken Colombia spudded the Olivo #1. The Olivo #1 is
being drilled from the same surface location as the Catalina #1 and will test
the La Luna formation. The Olivo #1 well is planned to be drilled as a
horizontal well, with a 1,500 to 6,000 foot horizontal section. Harken Colombia
anticipates that results from the Olivo #1 will be available in May 1998.

         Following completion of the Olivo #1, Harken Colombia anticipates
initiating a 90-day production test from the Catalina #1 and, if successful, the
Olivo #1 (which period may be extended by the Colombian Mines and Energy
Ministry). Oil produced during the production test will initially be sold and
trucked to a pumping station approximately 32 miles away. It is expected that up
to 3,000 barrels of oil can be trucked and sold per day. In order to produce and
sell volumes in excess of the 3,000 barrels of oil per day which can be trucked
from the two wells, it will be necessary for Harken Colombia to construct a
pipeline from the two wells to the closest existing pipeline approximately five
miles from the two wells. Subject to the timely receipt of environmental
permits, construction of the pipeline is anticipated to begin in the second half
of 1998 and is expected to be completed in 1999.

         Harken Colombia anticipates that it will request Ecopetrol to declare
the Catalina field to be commercial in the second half of 1998. The
commerciality process is similar to the process provided under the Alcaravan
Contract. Harken Colombia also plans to drill two additional exploration wells
on two additional prospects, the Palenque #1 and the Laurel #1, on the Bolivar
acreage in the second half of 1998.

         Miradores Contract -- In December 1997, Harken Colombia signed an
additional Association Contract (the "Miradores Contract") with Ecopetrol,
covering the Miradores Contract area. Under the Miradores Contract, Harken
Colombia has acquired the exclusive rights to conduct exploration activities in
the Miradores Contract area, which covers approximately 32,000 acres in the
Llanos Basin which are contiguous with the Alcaravan acreage.

         During the first year of the Miradores Contract, Harken Colombia is
required to reprocess at least 165 kilometers of existing seismic data and
acquire at least 25 kilometers of new seismic data. During each of the second
through the sixth contract years, Harken Colombia may elect to continue the
contract by committing to the drilling of at least one well during each contract
year. The production sharing and acreage relinquishment provisions of the
Miradores Contract are substantially similar to those contained in the Cambulos
Contract.

         Each of the two industry partners who have acquired beneficial
interests in the Alcaravan Contract have also acquired a similar 25% beneficial
interest in the Miradores Contract.

         Harken Colombia anticipates drilling the first well on the Miradores
acreage in late 1998. The well, the Miradores Norte #1, is located on the Palo
Blanco prospect described above.

         Los Olmos Contract -- In March 1998, Harken Colombia signed the Los
Olmos Association Contract (the "Los Olmos Contract") with Ecopetrol, covering
the Los Olmos Contract area. Under the Los Olmos Contract, Harken Colombia has
acquired the exclusive rights to conduct exploration activities in the Los Olmos
Contract area, which covers approximately 374,000 acres in the Lower Magdalena
Valley.

         During the first two years of the Los Olmos Contract, Harken Colombia
is required to reprocess at least 500 kilometers of existing seismic data and
acquire at least 120 kilometers of new seismic data and 2,000 kilometers of
aeromagnetic data, and prepare an engineering study of the contract areas.
During each

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of the third through the sixth contract years, Harken Colombia may elect to
continue the contract by committing to the drilling of at least one well during
each contract year. The production sharing and acreage relinquishment provisions
of the Los Olmos Contract are substantially similar to those contained in the
Cambulos Contract.

DOMESTIC EXPLORATION AND PRODUCTION OPERATIONS

         Harken operates or owns a non-operating working interest in 338 oil
wells and 87 gas wells in the U.S. Harken's operations are located in the
Paradox Basin in the Four Corners area of Arizona, Utah and New Mexico, the
Texas Panhandle region, the onshore South Texas region, the Carlsbad region of
New Mexico and the Magnolia region of Arkansas.

         Four Corners Operations -- Harken operates a total of 39 oil wells and
6 gas wells in the Four Corners area of Arizona, Utah, and New Mexico. Harken
also owns an interest in the Aneth Gas Plant, a gas processing plant located in
the Paradox Basin (Harken's interest in the Aneth Gas Plant and the Four Corners
area oil and gas wells are hereinafter referred to as the "Four Corners
Properties"). Harken acquired its initial 50% interest in these properties as a
result of the February 1993 acquisition of Chuska Resources Corporation
("Chuska"). Harken's activities in the Four Corners area are carried out
primarily through Harken Southwest Corporation ("HSW"), a wholly-owned
subsidiary.

         HSW's operations in the Paradox Basin are primarily concentrated on the
16 million acre Navajo Indian Reservation, which comprises portions of Arizona,
New Mexico and Utah. HSW currently has two operating agreements with the Navajo
Tribe of Indians (the "Navajo Nation") allowing oil and gas exploration and
development on an aggregate of 13,724 acres of Navajo tribal lands on the
Reservation (the "Navajo Nation Lands"). HSW has the right to explore for,
produce, and sell oil, natural gas, and other specified gases until July 20,
2012, under the Tribal Agreement effective July 20, 1987 (the "1987 Tribal
Agreement") and until August 26, 2003, under the Tribal Agreement effective
August 26, 1983 (the "1983 Tribal Agreement").

         The Navajo Nation receives 30% of gross revenues from the sale of
production of oil and gas under the 1983 Tribal Agreement and 20% under the 1987
Tribal Agreement (23% with respect to proceeds from oil production in excess of
$22 per barrel). Under both Tribal Agreements, the Navajo Nation is entitled to
receive 50% of all gross proceeds recovered over $35 per barrel of oil. Under
the 1983 Tribal Agreement, the Navajo Nation receives 50% of all gross proceeds
over $4 per MCF of gas. Under the 1987 Tribal Agreement, the Navajo Nation
receives 40% of all gross proceeds over $8 per MCF of gas.

         In order to develop the Navajo Nation Lands, in 1988, HSW entered into
an operating agreement pursuant to which a group of investors acquired an
undivided 50% interest in the gross proceeds receivable by HSW under the 1983
Tribal Agreement and the 1987 Tribal Agreement. Between 1994 and 1997, HSW
reacquired the interests of all of these investors.

         Texas Operations -- Harken operates or owns a non-operated interest in
219 oil wells and 81 gas wells in Texas. Harken operates 185 oil wells and 38
gas wells in Hutchinson and Gray Counties, owns non-operated interests in 34 oil
wells in Hockley County, and owns non-operated interests in 43 gas wells in
various counties of the Texas Gulf Coast region. Harken acquired its Texas
properties as a result of four acquisitions.


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         On May 22, 1995, Harken acquired Search Exploration, Inc., a
publicly-held oil and gas exploration and production company ("Search
Exploration"), through a merger between Search Exploration and Search
Acquisition Corp., a wholly-owned subsidiary of Harken ("Search Acquisition").
At the effective time of the merger, each of the outstanding shares of common
stock, preferred stock and certain outstanding promissory notes of Search
Exploration were converted into approximately 2.2 million shares of Common
Stock. Harken also issued warrants exercisable for 732,771 shares of common
stock of Harken ("Common Stock") in exchange for certain outstanding warrants of
Search Exploration.

         In October 1995, Harken Energy West Texas, Inc., a wholly-owned
subsidiary of Harken, acquired certain non-operated interests in producing
properties located in Hockley County, Texas (the "Yellowhouse Properties"). As
consideration for the purchase of these interests, Harken issued three million
shares of Common Stock, warrants to purchase an additional one million shares of
Common Stock at $2 per share, and assumed $750,000 of short-term notes payable.

         On December 21, 1995, pursuant to a Purchase and Sale Agreement (the
"Panhandle Purchase and Sale Agreement"), Harken Exploration Company, a
wholly-owned subsidiary of Harken ("Harken Exploration"), acquired working
interests in certain producing oil and gas leases located on approximately 6,800
acres in Hutchinson County, Texas, a gas gathering system located thereon,
property and equipment related thereto and the surface rights to a 161 acre
tract of land (the "Panhandle Properties"), in exchange for 2,500,000 shares of
Common Stock (the "Purchase Shares"), $2,500,000 in cash and a promissory note
of Harken Exploration in the principal amount of $13,000,000.

         On August 29, 1997, Harken, along with Harken Exploration, purchased
working interests in oil and gas properties located in the panhandle region of
Texas (the "Cal-T Properties"). The purchase price of approximately $3,416,000
consisted primarily of 565,000 shares of Harken common stock.

         New Mexico Operations -- Harken, through Harken Exploration, owns
non-operated interests in 18 oil wells in the Carlsbad region of New Mexico.
These properties were acquired as a part of the acquisition of the EnerVest
Properties described below.

         Arkansas Operations -- Harken, through Harken Exploration, operates 26
oil wells and owns non-operated interests in 31 oil wells in Arkansas. On July
10, 1996 Harken Exploration purchased working interests in certain producing oil
and gas properties located in the Magnolia area of Arkansas and in the Carlsbad
area of New Mexico (the "EnerVest Properties") from EnerVest Acquisition-II
Limited Partnership ("EnerVest"). The purchase price was approximately
$15,200,000. Harken paid $5,000,000 cash at closing and issued 1,550,000 shares
of Common Stock. Harken also issued to EnerVest warrants to purchase, over a
period of three years from closing, 300,000 shares of Common Stock at an
exercise price of $2.75 per share. Subsequently, Harken issued 1,400,000 shares
of Common Stock in satisfaction of all remaining obligations to EnerVest.



                                       10

<PAGE>   11



EXECUTIVE OFFICERS OF HARKEN

         The officers of Harken are elected annually by the Board of Directors
following each Annual Meeting of Stockholders, or as soon thereafter as
necessary and convenient. Each officer holds office until the earlier of such
time as his or her successor is duly elected and qualified, his or her death or
he or she resigns or is removed from office. Any officer elected or appointed by
the Board of Directors may be removed by the Board of Directors whenever, in its
judgement, the best interests of Harken will be served thereby, but such removal
will be without prejudice to the contract rights, if any, of the person so
removed.

         The executive officers of Harken as of December 31, 1997, their ages
and positions held with Harken and their business experience for the past five
years are listed below.

<TABLE>
<CAPTION>
NAME                                  AGE               POSITION HELD WITH HARKEN
----                                  ---               -------------------------
<S>                                   <C>               <C>
Mikel D. Faulkner                     48                Chairman of the Board of Directors and
                                                        Chief Executive Officer
Richard H. Schroeder                  53                President, Chief Operating Officer and Director
Bruce N. Huff                         47                Senior Vice President, Chief Financial Officer
                                                        and Director
Stephen C. Voss                       47                Senior Vice President and Director
Joseph H. Clark                       66                Senior Vice President - Operations
Larry E. Cummings                     45                Vice President, Secretary and General Counsel
A. Wayne Hennecke                     39                Vice President and Treasurer
Gregory S. Porter                     32                Vice President - Legal
</TABLE>

         Mikel D. Faulkner has served as Chairman of the Board of Harken since
February 1991 and Chief Executive Officer of Harken since 1982. Mr. Faulkner
previously served as President of Harken between 1982 and 1993.

         Richard H. Schroeder has served as President, Chief Operating Officer
and Director of Harken since March 1994. From November 1990 to March 1994, Mr.
Schroeder was President and owner of RHS Management, a management consulting
firm, and from January 1983 to November 1990, Mr. Schroeder was President of
Rosewood Resources, Inc., a privately-owned oil and gas exploration and
production company.

         Bruce N. Huff has served as a Director of Harken since August 1996. Mr.
Huff has served as Senior Vice President and Chief Financial Officer since 1990.

         Stephen C. Voss has served as a Director of Harken since July 1997. Mr.
Voss has served as Senior Vice President of Harken since 1990. Mr. Voss has also
served since 1990 as President of Harken International, Ltd., a wholly-owned
subsidiary of Harken.


                                       11

<PAGE>   12



         Joseph H. Clark has served as Senior Vice President of Operations of
Harken since April 1996. From December 1990 to April 1996, Mr. Clark served as
Vice President of Production for Marsh Operating Company of Dallas, Texas. Mr.
Clark is a registered Professional Engineer.

         Larry E. Cummings has served as Vice President, Secretary and General
Counsel of Harken since 1983. Mr. Cummings previously served as Senior Legal
Counsel and Vice President of Land for Harken from 1978 to 1983.

         A. Wayne Hennecke has been employed with Harken since 1988. Mr.
Hennecke has served as Vice President and Treasurer of Harken since June 1995.
Mr. Hennecke previously served as Vice President - Finance for Harken's
subsidiaries.

         Gregory S. Porter has served as Vice President - Legal of Harken since
September 1995. From April 1994 to September 1995, Mr. Porter was an attorney
with the law firm of Baker & McKenzie and from September 1992 to April 1994, Mr.
Porter was an attorney with the law firm of Johnson & Gibbs.

CAUTIONARY STATEMENTS

         Certain statements contained in this Annual Report, including
statements of Harken management's current expectations, intentions, plans and
beliefs, and statements containing the words "believes," "anticipates,"
"estimates," "expects," or "may," are forward-looking statements, as defined in
Section 21D of the Securities Exchange Act of 1934. Such forward-looking
statements involve known and unknown risk, uncertainties and other factors which
may cause the actual results, performance, timing or achievements of Harken to
be materially different from any results, performance, timing or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others, the following:

         Price Volatility -- The revenues generated by Harken are highly
dependent upon the prices of crude oil and natural gas. Fluctuations in the
energy market make it difficult to estimate future prices of crude oil and
natural gas. Fluctuations in energy prices are caused by a number of factors,
including regional, domestic and international demand, energy legislation,
federal or state taxes (if any) on sales of crude oil and natural gas,
production guidelines established by the Organization of Petroleum Exporting
Countries ("OPEC"), and the relative abundance of supplies of alternative fuel
such as coal. Additionally, changing international economic and political
conditions may have a substantial impact upon crude oil and natural gas prices.
All of these factors are beyond the control of Harken.

         Business Risks -- Harken must continually acquire or explore for and
develop new oil and gas reserves to replace those being depleted by production.
Without successful drilling or acquisition ventures, Harken's oil and gas
assets, properties and the revenues derived therefrom will decline over time. To
the extent Harken engages in drilling activities, such activities carry the risk
that no commercially viable oil or gas production will be obtained. The cost of
drilling, completing and operating wells is often uncertain. Moreover, drilling
may be curtailed, delayed or canceled as a result of many factors, including
shortage of available working capital, title problems, weather conditions,
environmental concerns, shortages of or delays in delivery of equipment, as well
as the financial instability of well operators, major working interest owners
and drilling and well servicing companies. The availability of a ready market
for Harken's oil and gas depends on numerous factors beyond its control,
including the demand for and supply of oil and gas, the proximity of Harken's
crude oil and natural gas reserves to pipelines, the capacity of such pipelines,
fluctuations in seasonal demand, the effects of inclement weather, and
government regulation. New oil and

                                       12

<PAGE>   13



gas wells may be shut-in for lack of a market until a gas pipeline or gathering
system with available capacity is extended into the area.

         International Operations -- Harken presently conducts significant
operations in Colombia and anticipates that it will continue to conduct
operations in Colombia and other foreign countries in the future. Foreign
properties, operations or investments may be adversely affected by local
political and economic developments, exchange controls, currency fluctuations,
royalty and tax increases, retroactive tax claims, renegotiation of contracts
with governmental entities, expropriation, import and export regulations and
other foreign laws or policies governing operations of foreign-based companies,
as well as by laws and policies of the United States affecting foreign trade,
taxation and investment. In addition, as certain of Harken's operations are
governed by foreign laws, in the event of a dispute, Harken may be subject to
the exclusive jurisdiction of foreign courts or may not be successful in
subjecting foreign persons to the jurisdiction of courts in the United States.
Harken may also be hindered or prevented from enforcing its rights with respect
to a governmental instrumentality because of the doctrine of sovereign immunity.
Exploration and production activities in areas outside the United States are
also subject to the risks inherent in foreign operations, including loss of
revenue, and property and equipment as a result of hazards such as
expropriation, nationalization, war, insurrection and other political risks.

         Pursuant to the Foreign Assistance Act of 1961, the President of the
United States is required to determine whether to certify that certain countries
have cooperated with the United States, or taken adequate steps on their own, to
achieve the goals of the United Nations Convention Against Illicit Traffic in
Narcotic Drugs and Psychotropic Substances. In 1995, 1996, 1997 and 1998, the
President did not certify Colombia. The 1995 and 1998 decertifications were
subject to a so-called "national interest" waiver, effectively nullifying its
statutory effects. Based on the 1996 and 1997 Presidential decertification, the
United States imposed substantial economic sanctions on Colombia, including the
withholding of bilateral economic assistance, the blocking of Export-Import Bank
and Overseas Private Investment Corporation loans and political risk insurance,
and the entry of the United States votes against multilateral assistance to
Colombia in the World Bank and the InterAmerican Development Bank.

         The consequences of continued and successive United States
decertifications of Colombian activities are not fully known, but may include
the imposition of additional economic sanctions on Colombia in 1998 and
succeeding years. The President also has authority to impose far-reaching
economic, trade and investment sanctions on Colombia pursuant to the
International Emergency Economic Powers Act of 1978, which powers were exercised
in 1988 and 1989 against Panama in a dispute over narcotics trafficking
activities by the Panamanian government. The Colombian government's reaction to
United States sanctions could potentially include, among other things,
restrictions on the repatriation of profits and the nationalization of Colombian
assets owned by United States entities. Accordingly, imposition of the foregoing
economic and trade sanctions on Colombia could materially affect the performance
of the Common Stock and the Company's long-term financial results.

         Operating Hazards and Uninsured Risks -- The operations of Harken are
subject to the inherent risks normally associated with exploration for and
production of oil and gas, including blowouts, cratering, pollution,
environmental liabilities and fires, each of which could result in damage to or
destruction of oil and gas wells or production facilities or damage to persons
and property. As is common in the oil and gas industry, Harken is not fully
insured against all of these risks, either because insurance is not available or
because Harken has elected to self-insure due to high premium costs. The
occurrence of a significant event that is not fully insured against could have a
material adverse effect on Harken's financial condition.

                                       13

<PAGE>   14



         Environmental Regulation -- Harken's domestic activities are subject to
various Navajo Nation, federal, state, and local laws and regulations covering
the discharge of material into the environment or otherwise relating to
protection of the environment. In particular, Harken's oil and gas exploration,
development, production, its activities in connection with storage and
transportation of liquid hydrocarbons and its use of facilities for treating,
processing, recovering, or otherwise handling hydrocarbons and wastes therefrom
are subject to stringent environmental regulation by governmental authorities.
In addition to these domestic laws and regulations, Harken's international
operations are subject to the laws, regulations and governmental approvals of
each foreign country in which it conducts activities including, but not limited
to, environmental laws and regulations governing oil and gas operations. Such
domestic and foreign laws and regulations have increased the costs of planning,
designing, drilling, installing, operating and abandoning Harken's oil and gas
wells and other facilities.

         Harken has expended significant resources, both financial and
managerial, to comply with environmental regulations and permitting requirements
and anticipates that it will continue to do so in the future. Although Harken
believes that its respective operations and facilities are in general compliance
with applicable environmental laws and regulations, risks of substantial costs
and liabilities are inherent in oil and gas operations, and there can be no
assurance that significant costs and liabilities will not be incurred in the
future. Moreover, it is possible that other developments, such as increasingly
strict environmental laws, regulations and enforcement policies thereunder, and
claims for damages to property, employees, other persons and the environment
resulting from Harken's operations, could result in substantial costs and
liabilities in the future.

         Imprecise Nature of Reserve Estimates -- Reserve estimates are
imprecise and may be expected to change as additional information becomes
available. Furthermore, estimates of crude oil and natural gas reserves, of
necessity, are projections based on engineering data, and there are
uncertainties inherent in the interpretation of such data as well as the
projection of future rates of production and the timing of development
expenditures. Reserve engineering is a subjective process of estimating
underground accumulations of oil and gas that cannot be measured in an exact
way, and the accuracy of any reserve estimate is a function of the quality of
available data and of engineering and geological interpretation and judgment.
Accordingly, there can be no assurance that the information regarding reserves
set forth herein will ultimately be produced.

         Competitive Factors in the Oil and Gas Industry -- The oil and gas
industry is highly competitive in all its phases. Competition is particularly
intense with respect to the acquisition of desirable producing properties and
the sale of crude oil and natural gas production. Harken's competitors in oil
and gas exploration, development and production include major oil companies and
numerous independent oil and gas companies, and individual producers and
operators. Many of Harken's competitors possess and employ financial and
personnel resources substantially greater than those which are available to
Harken and may, therefore, be able to pay greater amounts for desirable leases
and to define, evaluate, bid for and purchase a greater number of producing
prospects than the financial or personnel resources of Harken will permit.

         Extensive Regulation -- The production of oil and gas is subject to
extensive Navajo, federal and state laws, rules, orders and regulations
governing a wide variety of matters, including the drilling and spacing of
wells, allowable rates of production, prevention of waste and pollution and
protection of the environment. In addition to the direct costs borne in
complying with such regulations, operations and revenues may be impacted to the
extent that certain regulations increase the costs of oil and gas production to
below economic levels. Although the particular regulations applicable in each
state in which operations

                                       14

<PAGE>   15



are conducted vary, such regulations are generally designed to ensure that oil
and gas operations are carried out in a safe and efficient manner and to ensure
that similarly-situated operators are provided with reasonable opportunities to
produce their respective fair shares of available crude oil and natural gas
reserves. However, since these regulations generally apply to all oil and gas
producers, management of Harken believes that these regulations should not put
Harken at a material disadvantage to other oil and gas producers.

         Certain sales, transportation, and resales of natural gas by Harken are
subject to Navajo, federal and state laws and regulations, including, but not
limited to, the Natural Gas Act (the "NGA"), the Natural Gas Policy Act (the
"NGPA") and regulations promulgated by the Federal Energy Regulatory Commission
under the NGA, the NGPA and other statutes. The provisions of the NGA and NGPA,
as well as the regulations thereunder, are complex, and can affect all who
produce, resell, transport, purchase or consume natural gas.

PROPERTIES AND LOCATIONS

         Production and Revenues -- The following table shows for the periods
indicated operating information attributable to Harken's oil and gas interests:


<TABLE>
<CAPTION>
                                                           YEAR ENDED DECEMBER 31,
                             -------------------------------------------------------------------------------
                                 1993             1994             1995             1996             1997
                             -----------      -----------      -----------      -----------      -----------
<S>                          <C>              <C>              <C>              <C>              <C>    
Production:
  Oil (Bbls)                     185,000          158,000          217,000          370,000          416,000
  Natural Gas (Mcf)              429,000          426,000          810,000        1,409,000        1,922,000
Revenues:
  Oil                        $ 2,989,000      $ 2,552,000      $ 3,985,000      $ 7,863,000      $ 8,029,000
  Natural Gas                $   792,000      $   806,000      $ 1,188,000      $ 3,611,000      $ 5,331,000
                             -----------      -----------      -----------      -----------      -----------
    Total                    $ 3,781,000      $ 3,358,000      $ 5,173,000      $11,474,000      $13,360,000
                             ===========      ===========      ===========      ===========      ===========

Unit Prices:
  Oil (per Bbl)              $     16.16      $     16.15      $     18.36      $     21.25      $     19.30
  Natural Gas (per Mcf)      $      1.85      $      1.89      $      1.47      $      2.56      $      2.77
  Production costs per
      equivalent barrel      $      7.12      $      6.70      $      6.06      $      7.33      $      7.58
  Amortization per
      equivalent barrel      $      5.58      $      6.31      $      5.68      $      5.58      $      6.60
</TABLE>


                                       15

<PAGE>   16



         Acreage and Wells -- At December 31, 1997, Harken owned interests in
the following oil and gas wells and acreage. In March 1998, Harken Colombia
signed an additional Association Contract in Colombia with Ecopetrol, the Los
Olmos Association Contract, which consists of approximately 374,000 gross acres.

                                    DOMESTIC


<TABLE>
<CAPTION>
a                       Gross Wells                 Net Wells              Developed Acreage          Undeveloped Acreage
                  --------------------        --------------------      ---------------------       ---------------------

STATE               Oil          Gas           Oil           Gas          Gross         Net          Gross          Net
                  ------        ------        ------        ------      ---------     -------       --------       ------
<S>               <C>           <C>           <C>           <C>         <C>           <C>               <C>           <C>
Arizona                1             5          1.00          5.00        4,690         4,417             0             0
Arkansas              57             0         42.80          0.00        4,040         2,256             0             0
New Mexico            25             0         13.08          0.00        1,430           718             0             0
Texas                219            81        204.70         39.23       27,482        19,133         2,520           242
Utah                  36             1         33.90          1.00        9,916         4,007        11,253         3,942
                  ------        ------        ------        ------       ------        ------        ------        ------
  Total              338            87        295.48         45.23       47,558        30,531        13,773         4,184
                  ======        ======        ======        ======       ======        ======        ======        ======
</TABLE>


                            INTERNATIONAL - COLOMBIA


<TABLE>
<CAPTION>
             Contract Area                 Gross Undeveloped Acreage
          --------------------            ---------------------------
          <S>                             <C>    
               Alcaravan                          210,000
               Bocachico                          192,000
               Bolivar                            250,000
               Cambulos                           300,000
               Miradores                           32,000
                                                  -------
                   Total                          984,000
                                                  =======
</TABLE>


                                       16

<PAGE>   17



         Drilling Activity -- A well is considered "drilled" when it is
completed. A productive well is completed when permanent equipment is installed
for the production of oil or gas. A dry hole is completed when it has been
plugged as required and its abandonment is reported to the appropriate
government agency. International activity relates to Harken's Colombian
operations. International net wells drilled information is reflected net of
certain development finance and operating agreements, and does not consider any
potential future participation by Ecopetrol. The following tables summarize
certain information concerning Harken's drilling activity:

                                    DOMESTIC


<TABLE>
<CAPTION>
                                                                    NUMBER OF GROSS WELLS DRILLED
                            ------------------------------------------------------------------------------------------------------

                                    Exploratory                        Developmental                        Total
                            -------------------------------   -------------------------------      -------------------------------

                             Productive          Drilled       Productive          Drilled          Productive          Drilled
                            -------------     -------------   -------------     --------------     -------------     -------------
<S>                         <C>               <C>             <C>               <C>                <C>               <C>
1995                              1                 2                 2                 2                 3                 4
1996                              8                11                 7                 7                15                18
1997                              9                 9                10                10                19                19
                            -------------     -------------     -------------     -------------     -------------     -------------
  Total                          18                22                19                19                37                41
                            =============     =============     =============     =============     =============     =============
</TABLE>



<TABLE>
<CAPTION>
                                                                    NUMBER OF NET WELLS DRILLED
                            --------------------------------------------------------------------------------------------------------

                                    Exploratory                          Developmental                            Total
                            -------------------------------     --------------------------------     -------------------------------

                             Productive          Drilled         Productive          Drilled          Productive          Drilled
                            -------------     -------------     -------------     --------------     -------------     -------------
<S>                         <C>               <C>               <C>               <C>                <C>               <C> 
1995                            0.59              1.59              1.59              1.59              2.18              3.18
1996                            0.19              0.53              1.25              1.25              1.44              1.78
1997                            0.19              0.19              3.41              3.41              3.60              3.60
                            -------------     -------------     -------------     -------------     -------------     -------------
  Total                         0.97              2.31              6.25              6.25              7.22              8.56
                            =============     =============     =============     =============     =============     =============
</TABLE>



                                       17

<PAGE>   18



                           INTERNATIONAL - COLOMBIA
                                      

<TABLE>
<CAPTION>
                                                         NUMBER OF GROSS WELLS DRILLED
                            -------------------------------------------------------------------------------------------------------

                                    Exploratory                         Developmental                            Total
                            ------------------------------      -------------------------------     -------------------------------

                             Productive          Drilled         Productive          Drilled         Productive          Drilled
                            -------------     -------------     -------------     --------------    -------------     -------------
<S>                         <C>               <C>               <C>               <C>               <C>               <C>
1995                              0                 1                --                --                 0                 1
1996                              1                 1                --                --                 1                 1
1997                              2                 2                --                --                 2                 2
                            -------------     -------------     -------------     -------------     -------------     -------------
  Total                           3                 4                --                --                 3                 4
                            =============     =============     =============     =============     =============     =============
</TABLE>


<TABLE>
<CAPTION>
                                                                  NUMBER OF NET WELLS DRILLED
                            -------------------------------------------------------------------------------------------------------

                                     Exploratory                        Developmental                            Total
                            -------------------------------     -------------------------------     -------------------------------

                             Productive           Drilled         Productive         Drilled         Productive          Drilled
                            -------------      ------------     -------------     -------------     -------------     -------------
<S>                         <C>                <C>              <C>               <C>               <C>               <C>
1995                             .00               .50               --                --                .00               .50
1996                             .60               .60               --                --                .60               .60
1997                            1.24              1.24               --                --               1.24              1.24
                            -------------     -------------     -------------     -------------     -------------     -------------
  Total                         1.84              2.34               --                --               1.84              2.34
                            =============     =============     =============     =============     =============     =============
</TABLE>

EMPLOYEES

         As of December 31, 1997, Harken had 106 employees. Harken has
experienced no work stoppages or strikes as a result of labor disputes and
considers relations with its employees to be satisfactory. Harken maintains
group life, medical, dental, surgical and hospital insurance plans for its
employees.


ITEM 2. PROPERTIES

         See "Item 1. Business" for discussion of oil and gas properties and
locations.


ITEM 3. LEGAL PROCEEDINGS

         Harken and its subsidiaries currently are involved in various lawsuits
and other contingencies, which in management's opinion, will not have a material
adverse effect on Harken's financial position.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         On December 9, 1997, Harken held a special meeting of its stockholders.
At the Special Meeting, the stockholders approved an amendment to Harken's
Certificate of Incorporation increasing the number of authorized shares of
common stock from 150,000,000 to 175,000,000. The total number of votes cast
were

                                       18

<PAGE>   19



as follows: 87,091,670 voting in favor of the proposal, 17,541,325 voting
against the proposal, and 459,662 abstaining.

                                   PART II
                                      
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

PRICE RANGE OF COMMON STOCK

         Since March 18, 1991, the Common Stock has been listed on the American
Stock Exchange and traded under the symbol HEC. At December 31, 1997, there were
approximately 3,600 holders of record of Common Stock.

         The following table sets forth, for the periods indicated, the reported
high and low sales prices of the Common Stock on the American Stock Exchange
Composite Tape.


<TABLE>
<CAPTION>
                                                                      Prices
                                                   --------------------------------------------

                                                         High                         Low
                                                   -----------------            ---------------
<S>           <C>                                  <C>                          <C>  
1996 --       First Quarter                              $2.00                        $1.56
              Second Quarter                              3.13                         1.81
              Third Quarter                               3.13                         1.94
              Fourth Quarter                              3.00                         2.25
1997 --       First Quarter                              $5.44                        $2.88
              Second Quarter                              7.13                         4.00
              Third Quarter                               7.00                         5.25
              Fourth Quarter                              7.50                         4.50
</TABLE>

DIVIDENDS

         Harken has not paid any cash dividends on the Common Stock since its
organization and it is not contemplated that any cash dividends will be paid on
shares of Common Stock in the foreseeable future.



                                       19

<PAGE>   20



ITEM 6. SELECTED FINANCIAL INFORMATION AND OTHER DATA


<TABLE>
<CAPTION>
                                                     1993(1)          1994             1995             1996             1997
                                                -------------    -------------    -------------    -------------    -------------
<S>                                             <C>              <C>              <C>              <C>              <C>          
Revenues                                        $   6,601,000    $   4,895,000    $   7,471,000    $  13,921,000    $  18,768,000
Income (loss) from continuing operations        $  (1,797,000)   $  (8,211,000)   $  (1,625,000)   $    (341,000)   $     189,000
Income (loss) from discontinued operations      $  (3,697,000)   $    (223,000)   $          --    $          --    $          --
Net income (loss)                               $  (5,494,000)   $  (8,434,000)   $  (1,625,000)   $    (341,000)   $     189,000
Basic net income (loss) per common share:
   Income (loss) from continuing operations     $       (0.03)   $       (0.14)   $       (0.02)   $       (0.00)   $        0.00
   Discontinued operations                      $       (0.06)   $       (0.00)   $          --    $          --    $          --
                                                -------------    -------------    -------------    -------------    -------------
   Net income (loss)                            $       (0.09)   $       (0.14)   $       (0.02)   $       (0.00)   $        0.00
                                                =============    =============    =============    =============    =============
Diluted income (loss) per common share:
   Income (loss) from continuing operations     $       (0.03)   $       (0.14)   $       (0.02)   $       (0.00)   $        0.00
   Discontinued operations                      $       (0.06)   $       (0.00)   $          --    $          --    $          --
                                                -------------    -------------    -------------    -------------    -------------
   Net income (loss)                            $       (0.09)   $       (0.14)   $       (0.02)   $       (0.00)   $        0.00
                                                =============    =============    =============    =============    =============
Current assets                                  $   7,677,000    $   6,840,000    $  10,531,000    $  49,838,000    $ 126,392,000
Current liabilities                             $   6,533,000    $   5,133,000    $   4,918,000    $   6,061,000    $  15,752,000
                                                -------------    -------------    -------------    -------------    -------------
Working capital                                 $   1,144,000    $   1,707,000    $   5,613,000    $  43,777,000    $ 110,640,000
                                                =============    =============    =============    =============    =============
Total assets                                    $  37,731,000    $  28,960,000    $  70,794,000    $ 123,000,000    $ 238,513,000
Long-term obligations:
   Long-term obligations and other liabilities  $          --    $          --    $  25,726,000    $  38,600,000    $  39,880,000
   Redeemable preferred stock (2)               $   1,868,000    $   1,868,000    $          --    $          --    $          --
                                                -------------    -------------    -------------    -------------    -------------
     Total                                      $   1,868,000    $   1,868,000    $  25,726,000    $  38,600,000    $  39,880,000
                                                =============    =============    =============    =============    =============
Stockholders' equity                            $  28,963,000    $  21,959,000    $  40,150,000    $  78,339,000    $ 157,881,000
Redeemable preferred stock outstanding (2)            186,760          186,760               --               --               --
Weighted average common stock outstanding(3):
   Basic                                           58,392,901       59,722,853       65,041,063       85,021,894      109,087,697
   Diluted                                         58,392,901       59,722,853       65,041,063       85,021,894      111,933,589
Proved reserves at end of year (4):
   Bbls of oil                                      1,035,000        1,521,000        3,523,000        7,389,000       13,088,000
   Mcf of gas                                       4,970,000        7,148,000       29,203,000       34,160,000       33,293,000
   Future net cash inflows                      $  13,707,000    $  20,178,000    $  99,193,000    $ 234,164,000    $ 144,543,000
   Present value (discounted at 10% per year)   $   8,230,000    $  11,712,000    $  58,776,000    $ 142,243,000    $  90,580,000
</TABLE>

(1)      Financial information for this period has been restated to present the
         operations of Harken's well servicing and contract drilling operations
         as discontinued operations.
(2)      See "Notes to Consolidated Financial Statements, Note 8 -- Redeemable
         Preferred Stock" contained in Part II, Item 8, for a discussion of
         Harken Series C Preferred Stock.
(3)      Harken has adopted Statement of Financial Accounting Standards No. 128,
         "Earnings per Share", effective December 15, 1997 , and as a result
         restated certain prior year weighted average shares outstanding
         calculations.
(4)      These estimated reserve quantities, future net revenues and present
         value figures are related to proved reserves located in the United
         States and Colombia. No consideration has been given to probable or
         possible reserves. Oil and gas year end prices were held constant
         except where future price increases were fixed and determinable under
         existing contracts and government regulations. At December 31, 1997,
         Harken has included proved oil and gas reserve information related to
         its Colombian operations, specifically associated with a portion of its
         Alcaravan, Bocachico and Bolivar Contract areas. (See "Notes to
         Consolidated Financial Statements, Note 5 -- Colombian Operations"
         contained in Part II, Item 8.)

                                       20

<PAGE>   21



ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

OVERVIEW

         During the three year period ended December 31, 1997, Harken has made
significant progress towards implementing its overall business strategy. During
this period, Harken expanded its base domestic operations, providing a growing
and stable cash flow which has contributed to Harken's increasing investment in
its higher-potential international operations in Colombia. Harken's total assets
have increased from approximately $29 million at December 31, 1994 to
approximately $239 million at December 31, 1997, and its total net capital
expenditures related to its Colombia oil and gas properties has totaled
approximately $47 million over the past three years. Harken's proved oil and gas
reserves have increased from a present value of $11.7 million at December 31,
1994 to $90.6 million at December 31, 1997, including approximately $33.6
million of proved reserves in Colombia. During 1995, Harken placed $15 million
of 8% European Notes, all of which converted to Common Stock during 1995 and
1996. In July 1996, Harken placed $40 million of 6 1/2% European Notes, all of
which converted to Common Stock during 1996 and 1997. In June 1997, Harken
placed $70 million of 5 1/2% European Notes, which Harken will have the option
of converting into Common Stock beginning in June 1998. Largely as a result of
the European Note issuances as well as other financing efforts, Harken's working
capital has increased to approximately $111 million at December 31, 1997.

         Domestically, Harken has completed several acquisitions during the past
three years. These acquisitions have greatly increased Harken's cash flow from
operations and have diversified Harken's base of domestic oil and gas operations
to include properties in Texas, New Mexico and Arkansas in addition to Harken's
Four Corners area operations. Total oil and gas operating revenues have
increased from $6.0 million to $12.3 million to $14.1 million during the years
ended December 31, 1995, 1996 and 1997, respectively. In addition, Harken's
profitability has increased, as Harken has reported a net loss of $1.6 million
and $341,000 for the years ended December 31, 1995 and 1996, respectively, and a
net income of $189,000 for the year ended December 31, 1997.

         Internationally, during March 1998, Harken signed an additional
Association Contract in Colombia with Ecopetrol, bringing the total number of
Association Contracts to six and increasing the total number of acres currently
operated in Colombia by Harken to approximately 1,358,000. Following the
drilling of the Alcaravan #1 well during 1995 and the Torcaz #2 well on its
Bocachico Contract area during 1996, Harken has continued its Colombian
exploration efforts during 1997 with the completion of the Estero #1 well on the
Alcaravan Contract area, the sidetrack/recompletion of the Torcaz #2 well and
the completion of the Torcaz #3 well. In addition, in late 1997 Harken spudded
two additional wells which were then completed in early 1998, the Estero #3 well
and the Catalina #1, which is Harken's initial well on the Bolivar Contract
area.

         Harken plans to continue its Colombian exploration program during 1998,
expecting to spud eleven exploratory wells and three development wells as well
as certain pipeline and facility installation efforts.






                                       21

<PAGE>   22



                              RESULTS OF OPERATIONS

         The following table presents certain data for Harken's continuing
operations for the years ended December 31, 1995, 1996 and 1997. A discussion
follows of certain significant factors which have affected Harken's operating
results during such periods. This discussion should be read in conjunction with
Harken's Consolidated Financial Statements and related footnotes contained in
Part II, Item 8.

<TABLE>
<CAPTION>
                                          Year Ended December 31,
                                ----------------------------------------

DOMESTIC EXPLORATION AND
PRODUCTION OPERATIONS              1995           1996           1997
                                ----------     ----------     ----------
<S>                             <C>            <C>            <C>       
  Oil sales revenues            $3,985,000     $7,863,000     $8,029,000
     Oil volumes in barrels        217,000        370,000        416,000
     Oil price per barrel       $    18.36     $    21.25     $    19.30
  Gas sales revenues            $1,188,000     $3,611,000     $5,331,000
     Gas volumes in mcf            810,000      1,409,000      1,922,000
     Gas price per mcf          $     1.47     $     2.56     $     2.77
  Gas plant revenues            $  787,000     $  867,000     $  753,000

OTHER REVENUES
  Interest Income               $  667,000     $1,401,000     $4,626,000
  Other Income                  $  844,000     $  179,000     $   29,000
</TABLE>

FOR THE YEAR ENDED DECEMBER 31, 1997 COMPARED WITH THE PRIOR YEAR

DOMESTIC OPERATIONS

         Gross oil and gas revenues during 1996 and 1997 were generated by
Harken's domestic exploration and production operations, consisting of the Four
Corners area operations primarily on the Navajo Indian Reservation, the onshore
areas of the Texas Gulf Coast, the Western and Panhandle regions of Texas and,
beginning in July 1996, the Magnolia region of Arkansas and the Carlsbad region
of New Mexico.

         Oil revenues increased 2% from $7.9 million in 1996 to $8.0 million in
1997, although oil production volumes reflected a 12% increase in 1997 compared
to 1996. The decrease in the average oil price to $19.30 per barrel during 1997
has had a negative impact on revenues and cash flow from oil production,
particularly in December 1997, where average oil prices were $16.76 per barrel.
During early 1998, oil prices have continued to decline and remained
significantly below average oil prices received during 1997.

         Gas revenues increased 48% from $3.6 million in 1996 to $5.3 million in
1997. The increase was due primarily to increased production (36% increase)
attributable to the acquisition of the Cal-T Properties which were acquired in
August 1997 and additional production from several successful wells drilled in
the Texas Gulf Coast region. The Cal-T Properties contributed gas revenues of
approximately $374,000 and Texas Gulf Coast gas revenues increased $494,000
during 1997 compared to 1996. The increase in gas

                                       22

<PAGE>   23



revenues in 1997 also reflected higher natural gas prices in 1997 as compared to
1996. The average price of gas sold in 1997 increased to $2.77 per mcf from
$2.56 per mcf in 1996.

         Gas plant revenues decreased 13% from $867,000 to $753,000 in 1997 due
to an annual redetermination whereby HSW's interest in the Aneth Gas Plant was
slightly reduced based on each owner's throughput volume. At year end 1997, the
Aneth Gas Plant experienced a temporary plant shutdown due to a series of
explosions and fires that caused damage to a portion of the Plant. This shutdown
has reduced gas plant revenues for the first quarter of 1998.

         Oil and gas operating expenses consist of lease operating expenses and
gas plant expenses, along with a number of production and reserve-based taxes,
including severance, conservation, and property taxes and Navajo severance and
possessory interest taxes. The increase in oil and gas operating expenses during
1997 compared to 1996 reflects the acquisitions of additional oil and gas
properties, particularly the acquisition of the Cal-T Properties, which has
increased oil and gas operating expenses by approximately $242,000, and due to
the inclusion of twelve months of expenses associated with the July 1996
acquisition of the EnerVest Properties, which increased oil and gas operating
expenses by approximately $535,000.

         Harken expects that oil and gas production volumes and operating
expenses from its existing domestic operations will remain flat or decrease
slightly in 1998 as compared to 1997 due to the normal production declines
experienced in its operating areas. Such declines are expected to be minimized
by Harken's continuing workover efforts and exploration and development drilling
during 1998. Harken expects that 1998 domestic oil revenues will decrease
significantly from 1997 levels if crude oil prices remain at early 1998 levels.
Harken's oil and gas revenues are highly dependent upon product prices, which
Harken is unable to predict.

COLOMBIAN OPERATIONS

         Harken reflected no oil and gas revenues or operating expenses from its
Colombian operations during 1996 and 1997. Harken expects, however, that
production from its Estero #1, Estero #3, Torcaz #2, Torcaz #3 and Catalina #1
wells will commence during 1998 as trucking operations from these wellsites are
initiated. In addition, 1998 production operations could further increase if the
current and planned drilling activities in Colombia are successful.

INTEREST AND OTHER INCOME

         Interest and other income increased significantly during 1997 compared
to 1996 due to the interest earned by Harken on its invested funds, including
the net proceeds from the issuance of European Notes, which are initially
maintained and invested in separate interest bearing bank accounts (the
"Segregated Accounts") and from cash received from a development finance
agreement related to Harken's Colombian operations. Harken generated
approximately $4.6 million of interest income during 1997, compared to
approximately $1.4 million of interest income in 1996.

         Harken's cash balances, which include investments in short-term
marketable debt securities, are expected to decrease in 1998 as such funds are
used to support Harken's capital expenditure plans. Harken intends to continue
to pursue other financing arrangements during 1998 and the decrease in existing
cash balances and related interest income could be mitigated or offset if such
efforts are successful.


                                       23

<PAGE>   24



OTHER COSTS AND EXPENSES

         General and administrative expenses have increased 37% during 1997
compared to 1996 and have also increased as a percentage of oil and gas
revenues. General and administrative expenses remained constant, however, as a
percentage of consolidated revenues at 33% in 1996 and 1997, as such general and
administrative expense increases have related to Harken's executive, corporate
and administrative personnel costs associated with Harken's expanding overall
operations. Harken anticipates that general and administrative expenses will
continue to increase as Harken's Colombian operations continue to grow.

         Depreciation and amortization expense increased during 1997 compared to
1996 consistent with the increased production levels during 1997 and due to a
decrease in Harken's domestic oil and gas reserve volumes at December 31, 1997.
The decrease in reserve volumes was primarily caused by the decrease in crude
oil prices in December 1997. As a result, oil and gas depreciation and
amortization increased on a per equivalent barrel basis to $6.60 during 1997
compared to $5.58 during 1996. Depreciation and amortization on oil and gas
properties is calculated on a unit of production basis in accordance with the
full cost method of accounting for oil and gas properties.

         Interest expense and other decreased slightly during 1997 compared to
1996 despite the increase in European Notes due to the increasing amounts of
interest capitalizable to Harken's Colombian oil and gas property costs.
European Notes generated interest expense of approximately $964,000, net of
amounts of interest capitalized, and approximately $455,000 of net amortization
of issuance costs associated with the European Notes.

FOR THE YEAR ENDED DECEMBER 31, 1996 COMPARED WITH THE PRIOR YEAR

DOMESTIC OPERATIONS

         Oil revenues increased 97% to $7.9 million in 1996 from $4.0 million in
1995. The increase was due primarily to increased production attributable to the
acquisition of the Yellowhouse Properties, which were acquired in late 1995 but
which had little impact on 1995 revenues, and the acquisition of the EnerVest
Properties, which was consummated in July 1996. In 1996, Harken recognized
$2,069,000 in oil revenues attributable to the Yellowhouse Properties. Harken
also recorded $1,798,000 in oil revenues attributable to the EnerVest
Properties. Oil revenues were further increased by an increase in average oil
price per barrel of $2.89 in 1996 as compared to 1995.

         Gas revenues increased 204% to $3.6 million in 1996 from $1.2 million
in 1995. The increase was due primarily to increased production attributable to
the acquisition of the Panhandle Properties, which were acquired in late 1995
but which had little impact on 1995 gas revenues, and the acquisition of the
EnerVest Properties. In 1996, Harken recognized $1,394,000 in gas revenues
attributable to the December 1995 acquisition of the Panhandle Properties and
$539,000 attributable to the EnerVest Properties. The increase in gas production
was also the result of additional production from several successful wells
drilled in the Texas Gulf Coast region. The increase in gas revenues in 1996
also reflected significantly higher natural gas prices in 1996 as compared to
1995. The average price of gas sold in 1996 increased to $2.56 per mcf from
$1.47 per mcf in 1995. The increase in gas prices is due in part to the overall
increase in the market price of natural gas. In addition, the gas produced from
the Panhandle Properties is extremely rich in BTU content and sells for a
significant premium on a BTU adjusted basis to spot market prices.


                                       24

<PAGE>   25



         Gas plant revenues increased from $787,000 in 1995 to $867,000 in 1996
despite an annual redetermination whereby HSW's interest in the Aneth Gas Plant
was slightly reduced based on each owner's throughput volume and despite a
temporary plant shutdown experienced during 1996. Higher prices for plant
liquids, particularly during the fourth quarter of 1996, and the acquisition of
additional interests in the Four Corners Properties contributed to the increase.

         The increase in oil and gas operating expenses during 1996 compared to
1995 reflects the acquisitions of additional oil and gas properties,
particularly the acquisition of the Panhandle Properties, which increased oil
and gas operating expenses by approximately $746,000 and the acquisition of the
EnerVest Properties, which increased oil and gas operating expenses by
approximately $639,000.

INTEREST AND OTHER INCOME

         Interest and other income increased during 1996 compared to 1995 due to
the interest earned by Harken on proceeds received from the July 1996 issuance
of $40 million of European 6 1/2% Senior Convertible Notes Payable (the "6 1/2%
European Notes"). Such proceeds, net of issuance costs on the European Notes
earned approximately $803,000 during the last half of 1996.

OTHER COSTS AND EXPENSES

         General and administrative expenses have increased during 1996 compared
to 1995 due to the increase in Harken's corporate and administrative personnel
costs associated with its expanding domestic operations. General and
administrative expenses decreased significantly, however, as a percentage of oil
and gas revenues from 56.6% in 1995 to 36.7% in 1996 reflecting Harken's ability
to minimize increases in administrative staff and office costs despite its
growth in domestic oil and gas operations.

         Depreciation and amortization expense increased during 1996 compared to
1995 consistent with the increased production levels from the acquired oil and
gas property interests during 1995 and 1996. Oil and gas depreciation and
amortization decreased slightly on a per equivalent barrel basis to $5.58 during
1996 compared to $5.68 during 1995.

         Interest expense and other increased significantly during 1996 compared
to 1995 due to the July 1996 issuance of the 6 1/2% European Notes, which
generated interest expense of approximately $851,000, net of amounts of interest
capitalized, and approximately $326,000 of amortization of issuance costs
associated with the 6 1/2% European Notes. In December 1995, Harken issued a
note payable for an initial face amount of $13 million in connection with the
acquisition of the Panhandle Properties, and such note payable generated
interest expense of $234,000 prior to it being exchanged for Common Stock during
1996.

         Provision for asset impairments during 1995 consisted of $457,000
primarily related to Harken's decision to record a valuation adjustment for the
full investment amount in its Bahrain operations, as a result of the January
1996 expiration of the term of the production sharing agreement with the Bahrain
state-owned oil company.




                                       25

<PAGE>   26



                         LIQUIDITY AND CAPITAL RESOURCES

         Harken's working capital at December 31, 1997 was approximately $110.6
million, versus approximately $43.8 million at December 31, 1996. Cash and
temporary investments, including segregated account cash, at December 31, 1997
totaled $123.5 million, an increase of $76 million from December 31, 1996. The
increase in cash and working capital resulted primarily from the issuance in
June 1997 of $70 million of 5 1/2% European Notes (see discussion below), and
approximately $24.5 million of net proceeds received from the sale of beneficial
interest in certain wells to be drilled by Harken Colombia on the Cambulos and
Bocachico acreage. In addition, Harken's operations provided approximately $10.7
million of cash flow.

         Harken's primary need for capital is to fund the planned exploration
and development efforts in Colombia. In 1997, Harken's capital expenditures
totaled approximately $37 million, including $30 million related to exploration
and development in Colombia. Harken anticipates that its 1998 Colombian capital
expenditures will total approximately $113 million, including exploration costs
of approximately $85 million. Harken believes that it will have sufficient cash
resources to fund all of its planned capital expenditures for 1998. In addition,
Harken intends to pursue a number of domestic acquisition opportunities in 1998.
Harken intends to fund such acquisitions, if any are consummated, through a
combination of cash on hand, and issuances of debt or equity securities.

         Harken anticipates that full development of its Colombian reserves will
take several years and will also require extensive production facilities,
transportation pipelines and development activity which would require
significant additional capital expenditures. The ultimate amount of such
expenditures cannot be presently predicted. Harken anticipates that amounts
required to fund its Colombian activities will be funded from existing cash
balances, asset sales, future issuances of debt and/or equity securities,
production payments, operating cash flows and from industry partners; however,
there can be no assurances that Harken will have adequate funds available to it
to fund all of its Colombian activities. Terms of each of the Association
Contracts entered into between Harken Colombia and Ecopetrol commit Harken to
perform certain activities in accordance with a prescribed timetable. Failure by
Harken to perform these activities as required could result in Harken losing its
rights under the particular Association Contract, which could potentially have a
material adverse effect on Harken's business. For a detailed discussion of each
of the Association Contracts entered into between Harken Colombia and Ecopetrol,
see "Item 1. Business -- International Exploration and Development Operations."

         Harken's domestic operating strategy includes efforts to acquire
additional oil and gas reserves through drilling activities in North America and
through acquisitions. Harken plans to continue development of proved undeveloped
reserves on its North American properties in addition to a continual workover
program on producing properties. Harken expects such drilling and workover costs
to total approximately $4 million in 1998. The targeted results of these efforts
are to maintain North American production and cash flow levels during 1998.

         On June 11, 1997, Harken issued a total of $70 million in 5 1/2% Senior
Convertible Notes (the "5 1/2% European Notes") which mature on June 10, 2002.
In connection with the sale and issuance of the 5 1/2% European Notes, Harken
paid approximately $5,174,000 from the 5 1/2% European Notes proceeds for
commission and issuance costs. Interest incurred on these notes is payable
semi-annually in June and December of each year to maturity or until the 5 1/2%
European Notes are converted. Such 5 1/2% European Notes are convertible into
shares of Common Stock at a conversion price of $5.00 per share, subject to

                                       26

<PAGE>   27



adjustment in certain circumstances. Harken also has the right to require
conversion of the 5 1/2% European Notes into shares of Common Stock at any time
on or after June 11, 1998. Harken intends to mandatorily convert all of the 5
1/2% European Notes which remain outstanding on June 11, 1998. Between June 11,
1997 and December 31, 1997, $30,120,000 in principal amount of the 5 1/2%
European Notes converted into Common Stock.

         All proceeds from the sale of the 5 1/2% European Notes were initially
paid to a Trustee pursuant to a Trust Indenture and held in Segregated Accounts
to be maintained for Harken's benefit. Until all of the 5 1/2% European Notes
are converted, Harken must maintain an Asset Value Coverage Ratio equal to or
greater than 1:1, which is calculated as the ratio of (i) the sum of (x) 100% of
the aggregate amount of Harken's cash on deposit in the Segregated Accounts plus
(y) 50% of the net present value of Harken's domestic unencumbered total proved
reserves plus (z) 25% of the net present value of Harken's total proved
Colombian reserves to (ii) the aggregate outstanding principal amount of the 5
1/2% European Notes. As of December 31, 1997, Harken was in compliance with the
Asset Value Coverage Ratio test. In order for any of the proceeds to be released
from the Segregated Accounts, Harken must demonstrate that the Asset Value
Coverage Ratio (as defined in the Trust Indenture) test would continue to be met
after such release of funds and that no Event of Default with respect to the 5
1/2% European Notes has occurred and is continuing at the date of such release.
Such request must be accompanied by an independent reserve engineering report or
other independent third party valuation of Harken's unencumbered proved
reserves. At December 31, 1997, all proceeds held in the Segregated Accounts
were available to be released. For a detailed discussion of the 5 1/2% European
Notes see "Notes to Consolidated Financial Statements, Note 7 -- European
Convertible Notes Payable."

         To the extent that proceeds invested in the Segregated Accounts at the
balance sheet date are available under the above Asset Value Coverage Ratio
limitations, such cash is included as a current asset as it is available to
Harken to fund international and domestic activities including acquisitions,
drilling costs and other capital expenditures or other working capital needs.
Interest payments will be funded from cash flow from operations, existing cash
balances or from available proceeds in the Segregated Accounts.

         In October and December 1997, Harken entered into two separate
Development Finance Agreements with institutional investors (collectively the
"Institutional Investors"), pursuant to which the Institutional Investors
provided $31.5 million (the "Payment Amount") of net proceeds to Harken to
finance the drilling of the initial wells on three unexplored oil and gas
prospects in the Middle Magdalena Basin of Colombia, $24.5 million of net
proceeds was received in October 1997 and the remaining $7 million of net
proceeds was received in January 1998. In exchange, the Institutional Investors
received the right to receive future payments from Harken equal to 6.4% of the
net profits that Harken Colombia may derive from the sale of oil and gas
produced from each of the three prospects if the planned drilling on the
prospect is successful (the "Institutional Participation"). Pursuant to the
Development Finance Agreements, Harken is obligated to drill each of the three
wells prior to October 2000.

         Pursuant to the Development Finance Agreements, the Institutional
Investors have the right, for a period of two years beginning in October 1998,
to convert all or part of the Institutional Participation into shares of Common
Stock. The number of shares of Common Stock to be issued upon conversion of the
Institutional Participation will be equal to the quotient of (i) the Payment
Amount (less any distributions made in respect of the Institutional
Participation) plus an amount equal to 15% interest per annum on the net Payment
Amount compounded monthly (the "Invested Amount"), divided by (ii) the market
price of the Common Stock at the time of conversion. During the same two year
period, Harken also has the right to

                                       27

<PAGE>   28



convert the Institutional Participation into shares of Common Stock with the
number of shares of Common Stock to be issued to be equal to the quotient of (i)
the Payment Amount (less any distribution made in respect of the Institutional
Participation) plus an amount equal to 25% interest per annum on the net Payment
Amount compounded monthly, divided by (ii) the market price of Common Stock at
the time of conversion. Harken can also elect to pay cash upon any conversion of
the Institutional Participation in lieu of issuing Common Stock. The Development
Finance Agreements also provide for additional shares of Common Stock to be
issued by Harken in the event of a conversion to the extent that the
Institutional Investors do not, under certain circumstances, realize the
Invested Amount from the sale of shares of Common Stock issued at the
conversion.

         At the present time, it is not known whether the Institutional
Investors or Harken will exercise their rights to convert the Institutional
Interest into Common Stock, nor can Harken determine the number of shares of
Common Stock which would be required to be issued in the event that Harken or
the Institutional Investors elect to convert the Institutional Participation
into shares of Common Stock.

         The exploration, development and production of oil and gas are subject
to various Colombian, Navajo, federal, state and local laws and regulations
designed to protect the environment. Compliance with these regulations is part
of Harken's day-to-day operating procedures. Accidental discharge of such
materials as oil, natural gas or drilling fluids can occur and such accidents
can require material expenditures to correct. Harken maintains levels of
insurance customary in the industry to limit its financial exposure. Management
is unaware of any material capital expenditures required for environmental
control during the next fiscal year.

         Harken has accrued approximately $1.8 million at December 31, 1997
relating to operational or regulatory contingent liabilities related to Harken's
domestic operations. Harken and its subsidiaries currently are involved in
various lawsuits and other contingencies, which in management's opinion, will
not result in significant loss exposure to Harken.

         Harken has completed an assessment of its core financial and
operational software systems, all of which are purchased from outside software
vendors, and has found them to have anticipated the issues associated with the
year 2000 date change. Year 2000 issues result from the inability of computer
programs or computerized equipment to accurately calculate, store or use a date
subsequent to December 31, 1999. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business. Assessment of other less critical software systems
and various types of equipment is continuing and should be completed during
1998. Harken believes that the potential impact, if any, of these systems not
being Year 2000 compliant will at most require employees to manually complete
otherwise automated tasks or calculations.

         Following the completion of the aforementioned assessment, Harken will
initiate formal communication with its significant suppliers, business partners
and customers to determine the extent to which Harken is vulnerable to those
third parties' failure to correct their own Year 2000 issues. However, there can
be no guarantee that the systems of other companies on which Harken's systems
rely will be timely converted, or that a failure to convert by another company,
or a conversion that is incompatible with Harken's systems would not have a
material adverse effect on Harken.



                                       28

<PAGE>   29



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The following financial statements appear on pages 30 through 61 in
this report.

<TABLE>
<CAPTION>
                                                                                                  PAGE
                                                                                                  ----
<S>                                                                                               <C>
Report of Independent Public Accountants...........................................................30

Consolidated Balance Sheets --  December 31, 1996 and 1997.........................................31

Consolidated Statements of Operations --
  Years ended December 31, 1995, 1996 and 1997.....................................................32

Consolidated Statements of Stockholders' Equity --
  Years ended December 31, 1995, 1996 and 1997.....................................................33

Consolidated Statements of Cash  Flows --
  Years ended December 31, 1995, 1996 and 1997.....................................................34

Notes to Consolidated Financial  Statements........................................................35
</TABLE>


                                       29

<PAGE>   30



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS




To the Stockholders and Board of Directors of Harken Energy Corporation:



         We have audited the accompanying consolidated balance sheets of Harken
Energy Corporation (a Delaware corporation) and subsidiaries as of December 31,
1996 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Harken Energy
Corporation and subsidiaries as of December 31, 1996 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.




                                                       ARTHUR ANDERSEN LLP



Dallas, Texas,
March 17, 1998

                                       30

<PAGE>   31



                   HARKEN ENERGY CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                  ASSETS

                                                                                           DECEMBER 31,
                                                                                --------------------------------

                                                                                     1996               1997
                                                                                -------------      -------------
<S>                                                                             <C>                <C>          
Current Assets:
     Cash and temporary investments                                             $   9,855,000      $  85,740,000
     Cash in segregated accounts                                                   37,662,000         37,771,000
     Accounts receivable, net                                                       2,058,000          2,175,000
     Related party notes receivable                                                        --            295,000
     Prepaid expenses and other current assets                                        263,000            411,000
                                                                                -------------      -------------
          Total Current Assets                                                     49,838,000        126,392,000

Property and Equipment:
     Oil and gas properties, using the full cost method of accounting:
          Evaluated                                                                65,990,000         90,185,000
          Unevaluated                                                              10,266,000         27,193,000
     Gas plants and other property                                                  7,500,000          8,325,000
     Less accumulated depreciation and amortization                               (13,721,000)       (18,905,000)
                                                                                -------------      -------------
          Total Property and Equipment, net                                        70,035,000        106,798,000

Other Assets, net                                                                   3,127,000          5,323,000
                                                                                -------------      -------------
                                                                                $ 123,000,000      $ 238,513,000
                                                                                =============      =============


                                       LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
     Trade payables                                                             $   1,272,000      $   6,268,000
     Accrued liabilities and other                                                  3,889,000          8,668,000
     Revenues and royalties payable                                                   900,000            816,000
                                                                                -------------      -------------
          Total Current Liabilities                                                 6,061,000         15,752,000

European Convertible Notes Payable                                                 38,600,000         39,880,000

Deferred Revenue                                                                           --         25,000,000

Commitments and Contingencies (Note 15)

Stockholders' Equity:
     Common stock, $0.01 par value; 150,000,000 and 175,000,000 shares
       authorized, respectively; 93,862,266 and 121,811,534 shares issued,
       respectively                                                                   939,000          1,218,000
     Additional paid-in capital                                                   171,191,000        248,770,000
     Retained deficit                                                             (92,401,000)       (92,107,000)
     Treasury stock, 440,896 shares held at December 31, 1996                      (1,390,000)                --
                                                                                -------------      -------------
          Total Stockholders' Equity                                               78,339,000        157,881,000
                                                                                -------------      -------------
                                                                                $ 123,000,000      $ 238,513,000
                                                                                =============      =============
</TABLE>

          The accompanying Notes to Consolidated Financial Statements
                   are an integral part of these Statements.

                                       31

<PAGE>   32



                   HARKEN ENERGY CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS



<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31,
                                                  ------------------------------------------------
                                                      1995              1996              1997
                                                  ------------      ------------      ------------
<S>                                               <C>               <C>               <C>         
Revenues:
     Oil and gas operations                       $  5,960,000      $ 12,341,000      $ 14,113,000
     Interest and other income                       1,511,000         1,580,000         4,655,000
                                                  ------------      ------------      ------------
                                                     7,471,000        13,921,000        18,768,000
                                                  ------------      ------------      ------------

Costs and Expenses:
     Oil and gas operating expenses                  2,135,000         4,438,000         5,581,000
     General and administrative expenses, net        3,376,000         4,537,000         6,222,000
     Depreciation and amortization                   2,251,000         3,595,000         5,183,000
     Provision for asset impairments                   457,000                --                --
     Interest expense and other, net                   877,000         1,692,000         1,530,000
                                                  ------------      ------------      ------------
                                                     9,096,000        14,262,000        18,516,000
                                                  ------------      ------------      ------------

Income (loss) before income taxes                   (1,625,000)         (341,000)          252,000

Income tax expense                                          --                --            63,000
                                                  ------------      ------------      ------------

Net income (loss)                                 $ (1,625,000)     $   (341,000)     $    189,000
                                                  ============      ============      ============

Income (loss) per common share:
     Basic income (loss) per common share         $      (0.02)     $      (0.00)     $       0.00
                                                  ============      ============      ============
     Weighted average shares outstanding            65,041,063        85,021,894       109,087,697
                                                  ============      ============      ============

     Diluted income (loss) per common share       $      (0.02)     $      (0.00)     $       0.00
                                                  ============      ============      ============
     Weighted average shares outstanding            65,041,063        85,021,894       111,933,589
                                                  ============      ============      ============
</TABLE>


          The accompanying Notes to Consolidated Financial Statements
                   are an integral part of these Statements.

                                       32

<PAGE>   33



                   HARKEN ENERGY CORPORATION AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


<TABLE>
<CAPTION>
                                                          ADDITIONAL
                                             COMMON         PAID-IN           RETAINED          TREASURY
                                             STOCK          CAPITAL           DEFICIT             STOCK           TOTAL
                                         -------------   -------------   -----------------   --------------   -------------
<S>                                      <C>             <C>             <C>                 <C>              <C>          
Balance, December 31, 1994               $     664,000   $ 132,572,000   $ (90,520,000)(A)   $ (20,757,000)   $  21,959,000

  Issuance of common stock, net                 79,000       1,740,000              --          15,760,000       17,579,000
  Conversions of European notes
      payable                                   16,000       2,123,000              --                  --        2,139,000
  Adjustment for unrealized losses
      on available-for-sale securities              --              --         100,000                  --          100,000
  Equity adjustment from foreign
      currency translation                          --              --          (2,000)                 --           (2,000)
  Net loss                                          --              --      (1,625,000)                 --       (1,625,000)
                                         -------------   -------------   -------------       -------------    -------------
Balance, December 31, 1995                     759,000     136,435,000     (92,047,000)         (4,997,000)      40,150,000

  Issuance of common stock, net                 90,000      22,090,000              --           3,607,000       25,787,000
  Conversions of European notes
      payable                                   90,000      12,666,000              --                  --       12,756,000
  Equity adjustment from foreign
      currency translation                          --              --         (13,000)                 --          (13,000)
  Net loss                                          --              --        (341,000)                 --         (341,000)
                                         -------------   -------------   -------------       -------------    -------------
Balance, December 31, 1996                     939,000     171,191,000     (92,401,000)         (1,390,000)      78,339,000

  Issuance of common stock, net                 77,000      20,208,000              --                  --       20,285,000
  Conversions of European notes                
      payable                                  202,000      57,371,000              --           1,390,000       58,963,000
  Equity adjustment from foreign
      currency translation                          --              --         105,000                  --          105,000
  Net income                                        --              --         189,000                  --          189,000
                                         -------------   -------------   -------------       -------------    -------------
Balance, December 31, 1997               $   1,218,000   $ 248,770,000   $ (92,107,000)      $          --    $ 157,881,000
                                         =============   =============   =============       =============    =============
</TABLE>

(A)      Includes, as a component of Retained Deficit, net unrealized losses on
         available-for-sale securities of $100,000 as of December 31, 1994. See
         Note 3 -- Investments for further discussion.


          The accompanying Notes to Consolidated Financial Statements
                   are an integral part of these Statements.

                                       33

<PAGE>   34



                  HARKEN ENERGY CORPORATION AND SUBSIDIARIES
                    CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
                                                                                          Year Ended December 31,
                                                                             ------------------------------------------------
                                                                                  1995              1996              1997
                                                                             ------------      ------------      ------------
<S>                                                                          <C>               <C>               <C>         
Cash flows from operating activities:
  Net income (loss)                                                          $ (1,625,000)     $   (341,000)     $    189,000
    Adjustment to reconcile net income (loss) to net cash provided by
       operating activities:
       Depreciation and amortization                                            2,251,000         3,595,000         5,183,000
       Forgiveness of related party note receivable                               232,000           232,000                --
       Provision for asset impairments                                            457,000                --                --
       Provision for doubtful accounts                                           (180,000)           25,000                --
       Accretion of note payable                                                   27,000           234,000                --
       (Gain) loss on sales of assets and other                                  (832,000)           72,000                --
       Amortization of European note issuance costs                               337,000           504,000           555,000

  Change in assets and liabilities, net of effect of companies acquired:
       (Increase) decrease in accounts receivable                                  43,000          (592,000)         (217,000)

       Increase (decrease) in trade payables and other                           (339,000)        1,169,000         4,956,000
                                                                             ------------      ------------      ------------
            Net cash provided by operating activities                             371,000         4,898,000        10,666,000
                                                                             ------------      ------------      ------------

Cash flows from investing activities:
       Proceeds from sales of assets                                            3,423,000           192,000             7,000
       Cash from acquired subsidiary                                              190,000                --                --
       Capital expenditures                                                    (7,908,000)      (17,213,000)      (37,082,000)
       Investor advances                                                               --         5,800,000        32,953,000
                                                                             ------------      ------------      ------------
            Net cash used in investing activities                              (4,295,000)      (11,221,000)       (4,122,000)
                                                                             ------------      ------------      ------------

Cash flows from financing activities:
       Transfer from segregated account cash                                    2,500,000        10,877,000        64,564,000
       Proceeds from issuances of common stock, net of issuance costs           4,409,000         3,276,000         5,680,000
       Repayments of notes payable and long-term obligations                   (1,025,000)       (1,258,000)               --
       Investment in segregated account cash, net                                (332,000)       (1,173,000)         (903,000)
                                                                             ------------      ------------      ------------
            Net cash provided by financing activities                           5,552,000        11,722,000        69,341,000
                                                                             ------------      ------------      ------------

Net increase in cash and temporary investments                                  1,628,000         5,399,000        75,885,000

Cash and temporary investments at beginning of year                             2,828,000         4,456,000         9,855,000
                                                                             ------------      ------------      ------------
Cash and temporary investments at end of year                                $  4,456,000      $  9,855,000      $ 85,740,000
                                                                             ============      ============      ============
</TABLE>


          The accompanying Notes to Consolidated Financial Statements
                   are an integral part of these Statements.

                                       34

<PAGE>   35



                   HARKEN ENERGY CORPORATION AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 1995, 1996 AND 1997

(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Principles of Consolidation and Presentation -- The Consolidated
Financial Statements include the accounts of Harken Energy Corporation (a
Delaware corporation) and all of its wholly-owned subsidiaries ("Harken") after
elimination of significant intercompany balances and transactions. Interests in
oil and gas properties jointly owned and operated pursuant to a Joint Operations
Agreement are proportionately consolidated. Data is as of December 31 of each
year or for the year then ended and dollar amounts in tables are in thousands
unless otherwise indicated.

         The preparation of financial statements in conformity with generally
accepted accounting principles 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 amounts of revenues and expenses during the reported
period. Actual results could differ from those estimates. Certain prior year
amounts have been reclassified to conform with the 1997 presentation.

         Cash and Temporary Investments -- For purposes of the Consolidated
Statements of Cash Flows, Harken considers all highly liquid investments
purchased with an original maturity of three months or less to be cash
equivalents. Gross cash outflows for purchases of held-to-maturity investments
during 1997 totaled $446,328,000. Gross cash inflows for maturities of such
investments during 1997 totaled $365,124,000. Harken paid cash for interest in
the amounts of $246,000, $464,000 and $0 during 1995, 1996 and 1997,
respectively. All significant noncash investing and financing activities are
discussed in Notes 2, 6, 7, 8 and 9 -- Acquisitions, Development Finance and
Operating Agreements, European Convertible Notes Payable, Redeemable Preferred
Stock and Stockholders' Equity.

         Harken includes in cash and temporary investments certain balances
which are restricted to use for specific project expenditures, collateral or for
distribution to outside interest owners and are not available for general
working capital purposes. Such restricted cash amounts totaled approximately
$3,355,000 and $6,861,000 at December 31, 1996 and 1997, respectively. In
addition, Harken excludes from cash and temporary investments certain proceeds
received from the issuance of European Convertible Notes Payable that remain in
the Segregated Accounts. See Note 7 -- European Convertible Notes Payable for
further discussion.

         Accounts Receivable -- Harken maintains a reserve for potential losses
in collection of its accounts receivable. The allowance for doubtful accounts
was $405,000 and $327,000 as of December 31, 1996 and 1997, respectively.

         Concentrations of Credit Risk -- Although Harken's cash and temporary
investments and accounts receivables are exposed to credit loss, Harken does not
believe such risk to be significant. Cash and temporary investments, including
cash in Segregated Accounts, includes investments in high-grade, short-term
securities, placed with highly rated financial institutions. Most of Harken's
accounts receivable are from a broad and diverse group of oil and gas companies
and, accordingly, do not represent a significant credit risk.

                                       35

<PAGE>   36



         Property and Equipment -- Harken follows the full cost accounting
method to account for the costs incurred in the acquisition, exploration,
development and production of oil and gas reserves. Gas plants and other
property are depreciated on the straight-line method over their estimated useful
lives ranging from four to twenty years.

         Other Assets -- Harken includes in other assets certain deferred
commissions and issuance costs associated with the issuance of European
Convertible Notes Payable and certain development finance agreements. See Notes
6 and 7 -- Development Finance and Operating Agreements and European Convertible
Notes Payable for further discussion. At December 31, 1996, such deferred costs
totaled $2,725,000 net of $323,000 of accumulated amortization. At December 31,
1997, such deferred costs totaled $4,088,000 net of $439,000 of accumulated
amortization.

         Accrued Liabilities and Other -- Accrued liabilities and other at
December 31, 1996, includes an amount of $1,605,000 related to certain
operational or regulatory contingent liabilities related to Harken's domestic
operations and other accrued expense liabilities of $2,284,000. The December 31,
1997 balance includes an amount of $4,255,000 related to prepaid investor
advances, $1,785,000 related to certain operational or regulatory contingent
liabilities associated with Harken's domestic operations and other accrued
expense liabilities of $2,628,000.

         Colombian Operations -- Harken's operations include oil and gas
exploration and development efforts in Colombia pursuant to certain Colombian
Association Contracts. See further discussion at Note 5 -- Colombian Operations.
Harken accounts for its activities in Colombia using the Colombian peso as the
functional currency. Any foreign currency translation adjustment relating to the
translation to U.S. dollars of Harken's investment in Colombian operations is
accounted for as an equity adjustment from foreign currency translation and is
included as a component of stockholders' equity in the accompanying consolidated
financial statements. At December 31, 1996 and 1997, Harken reflects its
exploration activities in Colombia primarily as a capitalized cost of oil and
gas properties. See further discussion at Notes 4 and 14 -- Oil and Gas
Properties and Oil and Gas Disclosures.

         Capitalization of Interest -- Harken capitalizes interest on certain
oil and gas exploration and development costs which are classified as
unevaluated costs, or which have not yet begun production. During 1995, Harken
recorded interest expense of $540,000, net of $204,000 of interest which was
capitalized to Harken's oil and gas properties. During 1996, Harken recorded
interest expense of $1,673,000, net of $370,000 of interest which was
capitalized to Harken's oil and gas properties. During 1997, Harken recorded
interest expense of $1,530,000, net of $1,416,000 of interest which was
capitalized to Harken's oil and gas properties.

         General and Administrative Expenses -- Harken reflects general and
administrative expenses net of operator overhead charges and other amounts
billed to joint interest owners. General and administrative expenses are net of
$94,000, $61,000 and $30,000 for such amounts during 1995, 1996 and 1997,
respectively.

         Provision for Asset Impairments -- Assets which are used in Harken's
operations, or are not held for resale, are carried at cost, less any
accumulated depreciation. Harken reviews its long-lived assets, other than its
investment in oil and gas properties, whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. When evidence indicates that operations will not produce sufficient
cash flows to cover the carrying amount of the related asset, and when the
carrying

                                       36

<PAGE>   37



amount of the related asset cannot be realized through sale, a permanent
impairment is recorded and the asset value is written down to recoverable fair
value. Harken reflected a provision for asset impairments from continuing
operations in the amount of $457,000 during 1995.

(2)  ACQUISITIONS

         Acquisitions of Additional Four Corners Property Interests -- In May
1995, Harken acquired additional interests in its oil and gas operations in the
Four Corners area of Arizona, Utah and New Mexico (the "Four Corners
Properties"). The acquisition of the seller's interest raised Harken's total
interest in the Four Corners Properties from approximately 70% to approximately
82% of Harken's total operated interest. As consideration for this acquisition,
Harken paid $300,000 in cash, issued a total of 534,000 shares of restricted
Harken common stock and assumed certain liabilities of the seller relating to
the properties, and the seller in turn retained responsibility for certain
contingent operational and environmental liabilities related to the interests
purchased. During the second quarter of 1996, Harken acquired additional
interests in the Four Corners Properties, raising Harken's total interest to
approximately 94% of the total interest operated by Harken. The purchase
consideration paid by Harken to the sellers consisted of $338,000 cash plus the
issuance of approximately 509,000 shares of restricted Harken common stock.
Harken also assumed certain liabilities of the sellers relating to the property
interests. On June 30, 1997, Harken acquired the remaining operating interest in
the Four Corners Properties for approximately $450,000 cash. Harken also assumed
certain liabilities of the seller relating to the property interests. All of the
above acquisitions of the additional interests in the Four Corners Properties
have been accounted for under the purchase method of accounting.

         Merger with Search Exploration, Inc. -- In May 1995, Search
Exploration, Inc. ("Search"), a company engaged primarily in the domestic
exploration for, and development and production of oil and gas, was acquired by
Harken pursuant to an Amended and Restated Agreement and Plan of Merger. Search
was merged with and into Search Acquisition Corp., a wholly-owned subsidiary of
Harken. Upon consummation of the merger, Harken issued approximately 2.2 million
shares of Harken common stock to holders of Search common stock, preferred stock
and promissory notes. In addition, the holders of Search common stock, certain
notes and overriding royalty interests in certain properties of Search received
the contingent right to receive additional shares of Harken common stock based
upon the increase in value of certain properties of Search as of June 30, 1996.
No contingent shares were ultimately required to be issued. The merger was
accounted for under the purchase method of accounting due to the above mentioned
contingently issuable shares of Harken common stock.

         Acquisition of Texas Properties -- In October 1995, Harken Energy West
Texas, Inc., a wholly-owned subsidiary of Harken, acquired certain non-operated
interests in producing properties located in Hockley County, Texas ("Yellowhouse
Properties"). As consideration for the purchase of these interests, Harken
issued three million shares of restricted Harken common stock, warrants to
purchase one million additional shares of restricted Harken common stock at $2
per share, and assumed $750,000 of short-term notes payable. Harken and the
seller made payments totaling approximately $417,000 on these notes payable at
closing and the remaining balance was repaid in full by Harken during the first
quarter of 1996. The acquisition of the Yellowhouse Properties has been
accounted for under the purchase method of accounting.

         On December 21, 1995, pursuant to a Purchase and Sale Agreement (the
"Panhandle Purchase and Sale Agreement"), Harken Exploration Company ("Harken
Exploration"), a wholly-owned subsidiary of Harken, acquired working interests
in certain producing properties located in the panhandle region of Texas

                                       37

<PAGE>   38



("Panhandle Properties"). As consideration for the purchase of these interests,
Harken issued, along with other consideration, 2.5 million shares of restricted
Harken common stock (the "Purchase Shares"), $2.5 million in cash and a note
payable by Harken Exploration to the seller for an initial face amount of $13
million. Harken had the option over the following two years to repay all or part
of this $13 million note with restricted Harken common stock at conversion rates
tied to future trading prices of Harken common stock. The $13 million note was
to mature and become payable in two stages, with each maturity amount subject to
certain adjustments. On July 11, 1996, Harken Exploration entered into an
exchange agreement with the holder of the $13 million note, whereby it was
exchanged for, among other consideration, the issuance of 5,150,000 restricted
shares of Harken common stock. The acquisition of the Panhandle Properties has
been accounted for under the purchase method of accounting. With the July 11,
1996 exchange agreement resulting in the issuance of 5,150,000 restricted shares
of Harken common stock with a market value of approximately $10,429,000 in full
payment of the outstanding balance on the note, Harken adjusted the recording of
the initial purchase price of the Panhandle Properties to give effect to the
finalization of the consideration issued in the purchase.

         On August 29, 1997, Harken, along with Harken Exploration, purchased
working interests in oil and gas properties located in the panhandle region of
Texas (the "Cal-T Properties"). The purchase price of approximately $3,416,000
consisted primarily of 565,000 shares of Harken common stock. The acquisition of
the Cal-T Properties has been accounted for under the purchase method of
accounting.

         Acquisition of EnerVest Properties -- On July 10, 1996 Harken, along
with Harken Exploration, purchased working interests in certain producing oil
and gas properties located in the Magnolia region of Arkansas and in the
Carlsbad region of New Mexico (the "EnerVest Properties") from EnerVest
Acquisition- II Limited Partnership ("EnerVest"). The purchase price of
approximately $15,200,000, plus the assumption of certain operational
liabilities relating to these properties, was paid in the form of $5,000,000
cash paid at closing, 1,550,000 shares of Harken common stock which were issued
following closing, and 1,400,000 shares of Harken common stock which were issued
in March 1997 pursuant to a Resolution and Settlement Agreement, whereby the
contingent issuance of additional shares of Harken common stock provided for in
the Asset Purchase and Sale Agreement was eliminated. Harken also issued to
EnerVest warrants to purchase, over a period of three years from closing,
300,000 restricted shares of Harken common stock at an exercise price of $2.75
per share.

         Pro Forma Information -- The following unaudited pro forma combined
condensed statement of operations for the year ended December 31, 1996 gives
effect to the acquisitions of the EnerVest Properties and the Cal-T Properties
and the issuance of the European 6 1/2% Senior Convertible Notes Payable (See
Note 7 -- European Convertible Notes Payable for further discussion) as if each
had been consummated at January 1, 1996. The following unaudited pro forma
combined condensed statement of operations for the year ended December 31, 1997
gives effect to the acquisition of the Cal-T Properties and the issuance of the
European 5 1/2% Senior Convertible Notes Payable as if each had been consummated
at January 1, 1997.

         The unaudited pro forma data is presented for illustrative purposes
only and is not necessarily indicative of the operating results that would have
occurred had the transactions been consummated at the dates indicated, nor are
they indicative of future operating results. The unaudited pro forma data does
not reflect the effect of the various conversions of European Notes, the
capitalization of certain amounts of interest on the European Notes or the
interest income earned from investment of the European Note proceeds.


                                       38

<PAGE>   39



              PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
                      FOR THE YEAR ENDED DECEMBER 31, 1996
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                            Period from
                                                          January 1, 1996
                                                          to Closing Date
                                                          of Acquisition
                                                         ----------------

                                                             EnerVest          Cal-T
                                             Harken         Properties      Properties        Pro Forma
                                              Actual          Actual          Actual         Adjustments       Pro Forma
                                          -------------    ------------    -----------    ----------------   ------------
<S>                                       <C>              <C>             <C>            <C>                <C>   
Oil and gas revenue                        $     12,341    $      2,173    $      1,417                      $     15,931
Other revenues                                    1,580              --              --           (125)(1)          1,455
                                           ------------    ------------    ------------   ------------       ------------
     Total Revenues                              13,921           2,173           1,417           (125)            17,386
                                           ------------    ------------    ------------   ------------       ------------

Oil and gas operating expenses                    4,438             710             818                             5,966
General and administrative expenses, net          4,537              --              --             60(3)           4,597
Depreciation and amortization                     3,595              --              --          1,010(2)           4,605
Interest expense and other, net                   1,692              --              --          1,967(4)           3,425
                                                                                                  (234)(5)
                                           ------------    ------------    ------------   ------------       ------------
     Total Expenses                              14,262             710             818          2,803             18,593
                                           ------------    ------------    ------------   ------------       ------------

Income tax expense                                   --              --              --                                --
                                           ------------    ------------    ------------   ------------       ------------
Net income (loss)                          $       (341)   $      1,463    $        599         (2,928)      $     (1,207)
                                           ============    ============    ============   ============       ============

Basic net loss per share attributable to
common stock                               $      (0.00)                                                     $      (0.01)
                                           ============                                                      ============

Basic Weighted Average Shares
Outstanding                                  85,021,894                                                        92,984,625
                                           ============                                                      ============
</TABLE>

PRO FORMA ADJUSTMENTS-PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS -
YEAR ENDED DECEMBER 31, 1996

(1)      Pro forma entry to reflect the reduction in interest income earned due
         to the $5,000,000 cash consideration paid in connection with the
         acquisition of the EnerVest Properties.
(2)      Pro forma entry to adjust actual depreciation and amortization expense
         on oil and gas properties for the acquired interests to the
         depreciation and amortization expense calculated on a consolidated
         basis.
(3)      Pro forma entry to record additional general and administrative
         expenses expected to be incurred by Harken related to the EnerVest
         Properties. The additional general and administrative expenses consist
         of $10,000 per month, net of overhead reimbursements, for additional
         necessary operating and administrative employees to serve the EnerVest
         Properties.
(4)      Pro forma entry to reflect interest and amortization expense incurred
         on the 6 1/2% European Notes Payable.
(5)      Pro forma entry to reflect the reduction in the accretion of interest
         expense related to the July 1996 exchange of the note payable issued by
         Harken as part of the acquisition of the Panhandle Properties.



                                       39

<PAGE>   40



              PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
                      FOR THE YEAR ENDED DECEMBER 31, 1997
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                  Period from
                                                                January 1, 1997
                                                                to Closing Date
                                                                of Acquisition
                                                                ----------------
                                                                      Cal-T
                                                    Harken          Properties       Pro Forma
                                                    Actual            Actual        Adjustments         Pro Forma
                                                 -------------   --------------   --------------      -------------
<S>                                              <C>             <C>              <C>                 <C>
Oil and gas revenue                              $      14,113   $         911                        $      15,024
Other revenues                                           4,655              --                                4,655
                                                 -------------   -------------    -------------       -------------
     Total Revenues                                     18,768             911                               19,679
                                                 -------------   -------------    -------------       -------------

Oil and gas operating expenses                           5,581             665                                6,246
General and administrative expenses, net                 6,222              --                                6,222
Depreciation and amortization                            5,183              --              333(1)            5,516
Interest expense and other, net                          1,530              --            2,049(2)            3,579
                                                 -------------   -------------    -------------       -------------
     Total Expenses                                     18,516             665            2,382              21,563
                                                 -------------   -------------    -------------       -------------

Income tax expense                                          63              --              (63)(3)              --
                                                 -------------   -------------    -------------       -------------
Net income (loss)                                $         189   $         246           (2,319)      $      (1,884)
                                                 =============   =============    =============       =============

Basic net income (loss) per share attributable
to common stock                                  $        0.00                                        $       (0.02)
                                                 =============                                        =============

Basic Weighted Average Shares Outstanding          109,087,697                                          109,460,752
                                                 =============                                        =============
</TABLE>

PRO FORMA ADJUSTMENTS-PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS -
YEAR ENDED DECEMBER 31, 1997

(1)      Pro forma entry to adjust actual depreciation and amortization expense
         on oil and gas properties for the acquired interests to the
         depreciation and amortization expense calculated on a consolidated 
         basis.
(2)      Pro forma entry to reflect interest and amortization expense incurred
         on the 5 1/2% European Notes Payable.
(3)      Pro forma entry to eliminate federal and state income tax expense.

                                       40

<PAGE>   41



(3)  INVESTMENTS

         Investments are classified by Harken management at the time of purchase
as either held-to-maturity, available-for-sale or trading. Such classification
is reevaluated as of each balance sheet date. Included within cash and temporary
investments and cash in segregated accounts as of December 31, 1997 are certain
investments in marketable debt securities having maturities of sixty days or
less. Such debt securities are classified as held-to-maturity as Harken has the
positive intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost, adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization is included in
interest and other income. During 1996 and 1997, Harken held no securities which
were classified as available-for-sale or trading.

         During a portion of 1995, Harken carried an investment in the common
stock of E-Z Serve Corporation, a former subsidiary ("E-Z Serve"), including
shares of E-Z Serve common stock resulting from the June 1994 and January 1995
conversions of certain shares of E-Z Serve $6.00 Convertible Preferred Stock,
Series C. Harken classified its investment in E-Z Serve common stock as
available-for-sale. Harken sold its investment in the common stock of E-Z Serve
during the third quarter of 1995.

         Held-to-maturity securities -- The amortized cost and estimated fair
value of the marketable debt securities are as follows:

<TABLE>
<CAPTION>
                                                  December 31,
                                             --------------------
                                                1996      1997
                                             ----------   -------
<S>                                               <C>    <C>    
Included in cash and temporary investments
         Cost                                     $ --   $50,906
         Estimated Fair Value                     $ --   $50,973

Included in Segregated Accounts
         Cost                                     $ --   $37,184
         Estimated Fair Value                     $ --   $37,242
</TABLE>

         Harken includes in cash and temporary investments and cash in
segregated accounts other cash and cash equivalent amounts in addition to the
above marketable debt securities.

         Available-for-sale securities -- The gross realized gains and gross
realized losses on the investment in the common stock of E-Z Serve are as
follows:


<TABLE>
<CAPTION>
                           Year Ended December 31,
                          ------------------------
                           1995      1996     1997
                          -----     -----    -----
<S>                       <C>         <C>      <C>
Gross Realized Gains      $ 309       $--      $--
Gross Realized Losses        --        --       --
</TABLE>




                                       41

<PAGE>   42



(4)  OIL AND GAS PROPERTIES

         Harken follows the full cost accounting method to account for the costs
incurred in the acquisition, exploration, development and production of oil and
gas reserves. Under this method, all costs, including internal costs, directly
related to acquisition, exploration and development activities are capitalizable
as oil and gas property costs. Harken capitalized $1,182,000, $2,167,000 and
$3,126,000 of internal costs, net of reimbursements from joint interest owners,
directly related to these activities in 1995, 1996 and 1997, respectively. Such
costs include office and personnel costs of Harken's international and domestic
exploration field offices and does not include any corporate overhead. Harken
also accrues costs of dismantlement, restoration and abandonment to the extent
that such costs, in the aggregate, are anticipated to exceed the aggregate
salvage value of equipment and facilities removed from producing wells and other
facilities. See Note 14 -- Oil and Gas Disclosures for further discussion.

         The capitalized costs of oil and gas properties, excluding unevaluated
properties, are amortized on a country-by-country basis using a unit of
production method (equivalent physical units of 6 mcf of gas to each barrel of
oil) based on estimated proved recoverable oil and gas reserves. Such
amortization of domestic oil and gas properties was $5.68, $5.58 and $6.60 per
equivalent barrel of oil produced during 1995, 1996 and 1997, respectively. The
evaluated costs at December 31, 1996 and 1997 also include $5,802,000 and
$22,754,000, respectively, related to Colombia which have not yet begun to be
amortized (see Note 5 -- Colombian Operations for a discussion of Colombian
operations).

         The unevaluated property costs at December 31, 1996 and 1997 includes
$3,656,000 and $21,413,000, respectively, related to Colombia and $6,610,000 and
$5,780,000, respectively, related to domestic prospects. Amortization of
unevaluated property costs will begin when the properties become proved or their
values become impaired. Harken assesses realizability of unevaluated properties
on at least an annual basis or when there has been an indication that an
impairment in value may have occurred. Fair value of unevaluated prospects is
determined based on management's intention with regard to future exploration and
development of individually significant properties and the ability of Harken to
obtain funds to finance such exploration and development.

         Under full cost accounting rules, for each cost center, capitalized
costs, less accumulated amortization and related deferred income taxes, shall
not exceed an amount ("the cost ceiling") equal to the sum of (a) the present
value of future net revenues from estimated production of proved oil and gas
reserves discounted at 10%, plus (b) the cost of properties not being amortized,
plus (c) the lower of cost or estimated fair value of any unproved properties
included in the costs being amortized, less (d) any income tax effects related
to differences between the book and tax basis of the properties involved.

(5)  COLOMBIAN OPERATIONS

         Harken's Colombian operations are conducted through Harken de Colombia,
Ltd., a wholly-owned subsidiary of Harken, which held five exclusive Colombian
Association Contracts with Empresa Colombiana de Petroleos ("Ecopetrol") as of
December 31, 1997. These Association Contracts include the Alcaravan Contract,
awarded in 1992, the Bocachico Contract, awarded in 1994, the Cambulos Contract,
awarded in 1995, the Bolivar Contract, awarded in 1996 and the Miradores
Contract, awarded in December 1997. The Alcaravan and Miradores Contracts
currently cover a combined area of approximately 242,000 acres in the Llanos
Basin of Eastern Colombia. The Bocachico and Cambulos Contracts cover a combined
area of approximately 492,000 acres in the Middle Magdalena Valley of Central
Colombia and the Bolivar Contract

                                       42

<PAGE>   43



covers an area of approximately 250,000 acres in the Northern Middle Magdalena
Valley of Central Colombia. In March 1998, Harken de Colombia, Ltd. signed its
sixth Association Contract with Ecopetrol, the Los Olmos Contract, which covers
approximately 374,000 acres in the Lower Magdalena Valley of Northern Colombia.
Terms of each of the Association Contracts commit Harken to perform certain
activities in accordance with a prescribed timetable. As of December 31, 1997,
Harken was in compliance with the requirements of each of the Association
Contracts, as amended.

         Under the terms of the Association Contracts, if, during the first six
years of each contract, Harken discovers one or more fields of producing oil or
gas in quantities that are economically exploitable and Ecopetrol agrees that
such field is economically exploitable (a "commercial discovery"), the term of
that contract will be extended for a period of 22 years from the date of such
commercial discovery. Upon discovery of a field capable of commercial
production, and upon commencement of production from that commercial field,
Ecopetrol will reimburse Harken for 50% of Harken's successful well costs
expended up to the point of declaration of a commercial discovery plus, in the
case of the Cambulos, Bolivar, Miradores and Los Olmos Contracts, 50% of all
seismic and dry well costs incurred prior to the point of declaration of a
commercial discovery. Production from a commercial discovery will be allocated
as follows: Ecopetrol, on behalf of the Colombian government, will receive a 20%
royalty interest in all production, and all production (after royalty payments)
will be allocated 50% to Ecopetrol and 50% to Harken until cumulative production
from all fields in the Association Contract acreage reaches 60 million barrels
of oil. As cumulative production increases in excess of 60 million barrels of
oil, Ecopetrol's share of production will increase progressively (to a maximum
of 75% under certain of the Association Contracts) with a corresponding decrease
in Harken's share of production. After a declaration of a commercial discovery,
Harken and Ecopetrol will be responsible for all future development costs and
operating expenses in direct proportion to their interest in production. For any
fields that are not declared by Ecopetrol to be a commercial discovery, Harken
would retain the rights to all production after royalty.

         Harken has entered into certain development finance and operating
agreements with outside parties whereby such parties have received a beneficial
interest in certain of Harken's Colombian operations. For further discussion see
Note 6 -- Development Finance and Operating Agreements.

(6)  DEVELOPMENT FINANCE AND OPERATING AGREEMENTS

         Rio Negro Development Finance Agreement -- In October 1995, Harken
entered into a Development Finance Agreement (the "Rio Negro Development Finance
Agreement") with Arbco Associates L.P., Offense Group Associates L.P., Kayne
Anderson Nontraditional Investments L.P. and Opportunity Associates L.P.
(collectively, the "Rio Negro Investors"), pursuant to which the Rio Negro
Investors provided $3,500,000 to Harken to finance drilling on the Rio Negro
prospect in the Bocachico Contract area in exchange for the right to receive
future payments from Harken equal to 40% of the net profits that Harken de
Colombia, Ltd. may derive from the sale of oil and gas produced from the Rio
Negro prospect (the "Rio Negro Participation").

         In March 1997, Harken and the Rio Negro Investors entered into a
Conversion Agreement whereby Harken purchased 75% of the Rio Negro Participation
relating to the Rio Negro Development Finance Agreement in exchange for 900,000
restricted shares of Harken common stock which were issued within 30 days
following closing. From the remaining 25% of the Rio Negro Participation
retained, the Rio Negro Investors have the right to receive 10% of the net
profits that Harken de Colombia, Ltd. may derive from the sale of oil and gas
produced from the Rio Negro prospect.

                                       43

<PAGE>   44



         Palo Blanco Development Finance Agreements -- In June 1996, Harken,
along with Harken de Colombia, Ltd., entered into separate Development Finance
Agreements with two investors. Under the terms of the agreements, the two
investors provided an aggregate of $2,500,000 to finance the drilling of a well
on the Palo Blanco prospect in the Alcaravan Association Contract area. In
return for the $2,500,000, the investors were initially granted a beneficial
interest in 40% of the net profits from the Palo Blanco prospect which might
have been received by Harken de Colombia, Ltd. In 1996, the investors exercised
their rights under the agreement to convert one-half of their beneficial
interest into 599,988 shares of restricted Harken common stock. During the first
quarter of 1997, the investors exercised their right to convert the remaining
portion of their beneficial interest into an additional 599,988 shares of
restricted Harken common stock.

         Rochester Agreement -- Harken de Colombia, Ltd. has entered into an
operating agreement (the "Rochester Agreement") with Rochester Energy
Corporation ("Rochester", a Canadian corporation) pursuant to which Rochester
has paid 331/3% of the aggregate costs of the Estero #1 well and related
production facilities on the Palo Blanco prospect, 25% of the aggregate costs
related to the Estero #3 well, and 25% of the aggregate costs of the initial
well to be drilled on the Anteojos prospect, the Canacabare #1, all of which are
located within the Alcaravan Contract area, along with 25% of the aggregate
costs related to the Miradores Association Contract. In exchange, Rochester
acquired a beneficial interest equal to 25% of the interest held by Harken de
Colombia, Ltd. in the Palo Blanco and Anteojos prospect operations. The Estero
#1 well was drilled in the first half of 1997 and Estero #3 was spudded in
December 1997. The Canacabare #1 well is scheduled to begin drilling in early
1998.

         Parkcrest Financing Agreement -- Harken de Colombia, Ltd. has entered
into a financing agreement ("the Parkcrest Financing Agreement") with Parkcrest
Explorations, Ltd. ("Parkcrest", a Canadian corporation) pursuant to which
Parkcrest has paid 331/3% of the aggregate costs of the Estero #1 well and
related production facilities on the Palo Blanco prospect, 331/3% of the
aggregate costs of the initial well to be drilled on the Anteojos prospect, the
Canacabare #1, and 25% of the aggregate costs related to the Estero #3 well, all
of which are located within the Alcaravan Contract area. In addition, Parkcrest
will pay 331/3% of the aggregate costs of the initial well to be drilled under
the Miradores Association Contract. Parkcrest is also responsible for their
contracted percentage share of costs related to seismic on the Alcaravan and
Miradores Contract areas. In exchange, Parkcrest, upon its full performance,
will acquire a beneficial interest equal to 25% of the interest held by Harken
de Colombia, Ltd. in these prospects.

         EnCap Development Finance Agreement -- In October 1997, Harken entered
into a Development Finance Agreement (the "EnCap Development Finance Agreement")
with EnCap Energy Capital Fund III, L.P., EnCap Energy Capital Fund III-B, L.P.,
BOCP Energy Partners, L.P. and Energy Capital Investment Company PLC
(collectively the "EnCap Investors"), pursuant to which the EnCap Investors
provided $25 million (the "Payment Amount"), less a 2% investment banking fee,
to Harken to finance the planned drilling of the initial wells on three
unexplored oil and gas prospects in the Middle Magdalena Basin of Colombia. As
part of the transaction, Harken issued 150,000 shares of Harken common stock to
the EnCap Investors. The three well exploratory program contemplates the
drilling of one prospect on Harken's Bocachico Contract area and the drilling of
two prospects on Harken's Cambulos Contract area. In exchange, the EnCap
Investors received the right to receive future payments from Harken equal to 5%
of the net profits that Harken de Colombia, Ltd. may derive from the sale of oil
and gas produced from each of the three prospects if the planned drilling on the
prospect is successful (the "EnCap Participation"). Pursuant to the EnCap
Development Finance Agreement, Harken is obligated to drill each of the three
wells prior to October 2000.


                                       44

<PAGE>   45



         Pursuant to the EnCap Development Finance Agreement, the EnCap
Investors have the right, for a period of two years beginning in October 1998,
to convert all or part of the EnCap Participation into shares of Harken common
stock. The number of shares of Harken common stock to be issued upon conversion
of the EnCap Participation will be equal to the quotient of (i) the Payment
Amount (less any distributions made in respect of the EnCap Participation) plus
an amount equal to 15% interest per annum on the net Payment Amount compounded
monthly (the "Invested Amount"), divided by (ii) the market price of Harken
common stock at the time of conversion. During the same two year period, Harken
also has the right to convert the EnCap Participation into shares of Harken
common stock with the number of shares of Harken common stock to be issued to be
equal to the quotient of (i) the Payment Amount (less any distribution made in
respect of the EnCap Participation) plus an amount equal to 25% interest per
annum on the net Payment Amount compounded monthly, divided by (ii) the market
price of Harken common stock at the time of conversion. Harken can also elect to
pay cash upon any conversion of the EnCap Participation in lieu of issuing
Harken common stock. The EnCap Development Finance Agreement also provides for
additional shares of Harken common stock to be issued by Harken in the event of
a conversion to the extent that the EnCap Investors do not, under certain
circumstances, realize the Invested Amount from the sale of shares of Harken
common stock issued at the conversion. See Note 12 -- Related Party Transactions
for a discussion of the relationship between Harken and the EnCap Investors.

         European Development Finance Agreement -- In December 1997, Harken
entered into a Development Finance Agreement and other related agreements (the
"European Development Finance Agreement") whereby Sidro S.A., Lambertine
Holdings, Ltd. and Rauscher Pierce and Clark (collectively the "European
Investors") purchased all of the outstanding common stock of Harken Capital
Corporation, ("HCC", a newly-formed U.S. corporation) for $7 million. Pursuant
to the European Development Finance Agreement, HCC then provided the $7 million
to Harken in January 1998 to finance a portion of the cost of the three-well
exploratory program discussed above pursuant to the EnCap Development Finance
Agreement. In exchange, HCC received the right to receive future payments from
Harken equal to 1.4% of the net profits that Harken de Colombia, Ltd. may derive
from the sale of oil and gas produced from each of the three prospects if the
planned drilling on the prospect is successful. As part of the transaction,
Harken issued 42,000 shares of Harken common stock to the European Investors and
paid a cash fee of $175,000 to one of the European Investors.

         Pursuant to the European Development Finance Agreement, the European
Investors and Harken each have the right to convert the European Investors
interest into shares of common stock of Harken pursuant to conversion rights
terms identical to those terms related to the EnCap Development Finance
Agreement, for a period of two years beginning in December 1998.

(7)  EUROPEAN CONVERTIBLE NOTES PAYABLE

         8% European Notes -- During the second quarter of 1995, Harken issued
to qualified purchasers a total of $15 million in 8% Senior Convertible Notes
(the "8% European Notes") which were to mature in May 1998. Interest on these
notes was payable semi-annually in May and November of each year to maturity or
until the 8% European Notes were converted. Such 8% European Notes were
convertible at any time by the holders into shares of Harken common stock at a
conversion price of $1.50 per share ("the 8% European Note Conversion Price").
In connection with the sale and issuance of the 8% European Notes, Harken paid
approximately $1,750,000 from the 8% European Note proceeds for commissions and
issuance costs. Between September 30, 1995 and July 31, 1996, all holders of
these 8% European Notes exercised

                                       45

<PAGE>   46



their conversion options and Harken issued an aggregate total of 9,999,975
shares of Harken common stock pursuant to these conversions.

         6 1/2% European Notes -- On July 30, 1996, Harken issued to qualified
purchasers a total of $40 million in 6 1/2% Senior Convertible Notes (the "6
1/2% European Notes") which were to mature on July 30, 2000. In connection with
the sale and issuance of the 6 1/2% European Notes, Harken paid approximately
$3,142,000 from the 6 1/2% European Note proceeds for commissions and issuance
costs. Interest incurred on these notes was payable semi-annually in January and
July of each year to maturity or until the 6 1/2% European Notes were converted.
Such 6 1/2% European Notes were convertible at any time by the holders into
shares of Harken common stock at a conversion price of $2.50 per share ("the 6
1/2% European Note Conversion Price"). The 6 1/2% European Notes were also
convertible by Harken into shares of Harken common stock after one year
following issuance, if for any period of thirty consecutive days commencing on
or after November 28, 1996, the closing price of Harken common stock for each
trading day during such period shall have equaled or exceeded 135% of the 6 1/2%
European Note Conversion Price (or $3.375 per share of Harken common stock).

         During the last half of 1996, holders of 6 1/2% European Notes totaling
$1,400,000 exercised their conversion option and such holders were issued
560,000 shares of Harken common stock. In February 1997, Harken gave notice as
required under the Trust Indenture that it had met the market price criteria
necessary to call for mandatory conversion of the 6 1/2% European Notes and on
June 2, 1997 formally called the 6 1/2% European Notes for conversion on July
31, 1997. During the first six months of 1997, holders of 6 1/2% European Notes
totaling $19,300,000 exercised their conversion option and such holders were
issued 7,720,000 shares of Harken common stock. On July 31, 1997, Harken
converted the remaining 6 1/2% European Notes into 7,720,000 shares of Harken
common stock.

         5 1/2% European Notes -- On June 11, 1997, Harken issued to qualified
purchasers a total of $70 million in 5 1/2% Senior Convertible Notes ( the "5
1/2% European Notes") which mature on June 10, 2002. In connection with the sale
and issuance of the 5 1/2% European Notes, Harken paid approximately $5,174,000
from the 5 1/2% European Notes proceeds for commissions and issuance costs.
Interest incurred on these notes is payable semi-annually in June and December
of each year to maturity or until the 5 1/2% European Notes are converted. Such
5 1/2% European Notes are convertible into shares of Harken common stock at an
initial conversion price of $5.00 per share, subject to adjustment in certain
circumstances ("the 5 1/2% European Note Conversion Price"). The Trust Indenture
provided for a five percent premium on the number of shares of Harken common
stock issuable on conversion that was paid to holders converting the 5 1/2%
European Notes prior to December 11, 1997. The 5 1/2% European Notes are also
convertible by Harken into shares of Harken common stock after one year
following issuance, if for any period of thirty consecutive days commencing on
or after June 11, 1997, the average of the closing prices of Harken common stock
for each trading day during such thirty day period shall have equaled or
exceeded 130% of the 5 1/2% European Note Conversion Price (or $6.50 per share
of Harken common stock). In October 1997, Harken met the market price criteria
necessary to call for mandatory conversion of the 5 1/2% European Notes any time
on or after June 11, 1998, and provided notice to the holders as required under
the Trust Indenture. Harken intends to mandatorily convert all of the 5 1/2%
European Notes which remain outstanding on June 11, 1998. As of December 31,
1997, holders of 5 1/2% European Notes totaling $30,120,000 have exercised their
conversion option and such holders were issued 6,325,200 shares of Harken common
stock. Subsequent to December 31, 1997, and as of March 17, 1998, additional
holders of 5 1/2% European Notes totaling $610,000 have exercised their
conversion option and such holders were issued an additional 122,000 shares of
Harken common stock. The 5 1/2% European Notes are listed on the Luxembourg
Stock Exchange.

                                       46

<PAGE>   47



         Upon closing, all proceeds from the sale of each of the European Notes
issuances were each initially paid to a Trustee under the terms of a Trust
Indenture covering each issue and held in separate interest bearing Trust
accounts (the "Segregated Accounts") to be maintained for Harken's benefit,
until the Trustee is presented with evidence of sufficient asset value, as
defined in the Trust Indenture, held by Harken to permit an advance of a portion
of the proceeds. Until all of the 5 1/2% European Notes are converted, Harken
must maintain an Asset Value Coverage Ratio equal to or greater than 1:1 which
is calculated as the ratio of (i) the sum of (x) 100% of the aggregate amount of
Harken's cash on deposit in the Segregated Accounts plus (y) 50% of the net
present value of Harken's domestic unencumbered total proved reserves plus (z)
25% of the net present value of Harken's total proved Colombian reserves to (ii)
the aggregate outstanding principal amount of the 5 1/2% European Notes. Upon a
conversion, any proceeds attributable to the 5 1/2% European Notes converted
which remain in the Segregated Accounts may be withdrawn by Harken without
regard to the asset value then existing. Harken was in compliance with the Asset
Value Coverage Ratio at December 31, 1997.

         The 5 1/2% European Notes were sold strictly to non-U.S. purchasers in
the form of bearer instruments in $10,000 and $50,000 increments. The 5 1/2%
European Notes and the Harken common stock issuable upon conversion of the 5
1/2% European Notes have been or will be issued without registration under the
United States Securities Act of 1933 (the "Securities Act") pursuant to an
exemption contained in Regulation S promulgated under the Securities Act.

         Commissions and issuance costs associated with the European Notes are
deferred and are included in Other Assets and are amortized to interest expense
over the period until conversion or maturity of the European Notes. As European
Notes are converted to Harken common stock, a pro-rata portion of these deferred
costs are charged to Additional Paid-In Capital.

         All Segregated Account cash related to the 6 1/2% European Notes is
reflected as a current asset at December 31, 1996 as Harken had the intent and
ability to convert all outstanding 6 1/2% European Notes to Harken common stock
prior to December 31, 1997. During March 1997, Harken transferred approximately
$15.3 million of 6 1/2% European Note proceeds from the Segregated Accounts to
Harken's operating cash account due to the conversions of the 6 1/2% European
Notes. On July 31, 1997, Harken transferred the remaining approximately $21.3
million of 6 1/2% European Notes proceeds from the Segregated Accounts to
Harken's operating cash account. All Segregated Account cash related to the 5
1/2% European Notes is reflected as a current asset at December 31, 1997 as all
such cash is available according to the Trust Indenture. During December 1997,
Harken transferred approximately $28 million of the 5 1/2% European Note
proceeds from the Segregated Accounts to Harken's operating cash account due to
the conversions of the 5 1/2% European Notes. The initial cash proceeds from the
issuance of the European Notes are not included in the Statement of Cash Flows
because the proceeds are not considered to be cash equivalents. Transfers of
proceeds from the Segregated Accounts are included in cash flows from financing
activities in the accompanying consolidated statements of cash flows.

(8)  REDEEMABLE PREFERRED STOCK

         During 1988, Harken completed the private placement of 3,000,000 shares
of newly-issued Series C 12% $1 par value cumulative convertible redeemable
preferred stock ("Series C Preferred") for $30,000,000. Each share of preferred
stock was convertible into 1.667 shares of common stock at the option of the
holder and was mandatorily redeemable at $10 per share over a five year period
beginning in 1993.


                                       47

<PAGE>   48



         At December 31, 1994, 186,760 shares of Series C Preferred outstanding
were held by Tejas Power Corporation, a former subsidiary ("Tejas") and
represented the only remaining Series C Preferred shares outstanding. In
connection with the issuance of 1,000 shares of Tejas Series B Preferred Stock
("Tejas Preferred Stock") to Harken, Tejas agreed to waive certain of the
provisions under the terms of the Harken Series C Preferred, including the
payment of the 12% annual dividend. In December 1995, Harken entered into a
purchase, sale and exchange agreement in which it exchanged the 1,000 shares of
Tejas Preferred Stock it held along with a note payable for $394,000 to Tejas
for the 186,760 shares of Series C Preferred. At December 31, 1995 there were no
remaining outstanding shares of Series C Preferred.

(9)  STOCKHOLDERS' EQUITY

         Common Stock -- Harken currently has authorized 175,000,000 shares of
$.01 par common stock. At December 31, 1996 and 1997, Harken had issued
93,862,266 shares and 121,811,534 shares, respectively. Harken held 400,896
shares as treasury stock at a cost of $1,390,000 at December 31, 1996.

         Acquisition of Additional Four Corners Property Interests -- In May
1995, Harken acquired an additional interest in the Four Corners Properties
primarily in exchange for, among other consideration, 534,000 restricted shares
of Harken common stock. In April 1996, Harken again acquired an additional
interest in the Four Corners Properties primarily in exchange for, among other
consideration, 509,000 restricted shares of Harken common stock. See Note 2 --
Acquisitions for further discussion.

         Acquisition of Search Exploration, Inc. -- In May 1995, Harken
consummated the Merger with Search. See Note 2 -- Acquisitions for further
discussion. Pursuant to the terms of the Merger Agreement, a total of
approximately 2.2 million shares of Harken common stock were issued to the
common stockholders of Search, preferred stockholders of Search and certain
noteholders of Search. In connection with the Merger, Harken issued warrants
entitling the holders to purchase up to 732,771 shares of Harken common stock at
the exercise price of $1.82 per share. As of the October 30, 1996 expiration
date for these warrants, 713,021 shares of Harken common stock had been issued
upon exercise of such warrants.

         Issuance of European Convertible Notes Payable -- At December 31, 1995,
$2,450,000 of the 8% European Notes had been converted into 1,633,327 shares of
Harken common stock. In 1996, all of the remaining outstanding 8% European Notes
were converted into 8,366,648 additional shares of Harken common stock. In
connection with the issuance of the 8% European Notes, Harken issued to the
placement agents for the 8% European Notes certain non-registered
non-transferrable stock purchase warrants to purchase one million shares of
Harken common stock which were exercisable by the holders thereof at any time on
or before May 11, 1999 at an exercise price of $1.50 per share. As of December
31, 1997, only approximately 37,000 of such warrants remained outstanding and
were subsequently exercised for shares of Harken common stock in February 1998.
Also, Harken paid a fee of 92,308 shares of Harken common stock to a financial
advisor in connection with the 8% European Notes and the market value of such
shares as of the date issued was included as deferred issuance costs in Other
Assets in the accompanying consolidated balance sheets.

         In July 1996, Harken issued to qualified purchasers a total of $40
million in 6 1/2% European Notes which were to mature on July 30, 2000. The 6
1/2% European Notes were convertible under certain terms into approximately
16,000,000 shares of Harken common stock. During 1996, holders of 6 1/2%
European Notes totaling $1,400,000 exercised their conversion option and such
holders were issued 560,000 shares of Harken common stock. In February 1997,
Harken gave notice as required under the Trust Indenture that it had met

                                       48

<PAGE>   49



the market price criteria necessary to call for mandatory conversion of the 6
1/2% European Notes and on June 2, 1997, formally called the 6 1/2% European
Notes for conversion on July 31, 1997 (see Note 7 -- European Convertible Notes
Payable for further discussion). During the first six months of 1997, holders of
6 1/2% European Notes totaling an additional $19,300,000 exercised their
conversion option and such holders were issued 7,720,000 shares of Harken common
stock. On July 31, 1997, Harken converted the remaining 6 1/2% European Notes
into 7,720,000 shares of Harken common stock.

         In connection with the issuance of the 6 1/2% European Notes, Harken
issued to the placement agents for the 6 1/2% European Notes certain
non-registered non-transferrable stock purchase warrants to purchase 1,280,000
shares of Harken common stock which are currently exercisable by the holders
thereof at any time on or before July 31, 1999 at an exercise price of $2.50 per
share. As of December 31, 1997, all but approximately 787,000 of such warrants
had been exercised for shares of Harken common stock and as of March 17, 1998,
all but approximately 60,000 of such warrants had been exercised for shares of
Harken common stock.

         In June 1997, Harken issued to qualified purchasers a total of $70
million in 5 1/2% European Notes which mature on June 11, 2002. The 5 1/2%
European Notes are convertible under certain terms into a maximum of
approximately 14,700,000 shares of Harken common stock. In connection with the
issuance of the 5 1/2% European Notes, Harken issued to the placement agents for
the 5 1/2% European Notes warrants to purchase 1,120,000 shares of Harken common
stock at any time after December 11, 1997 and on or before December 11, 1999 at
an exercise price of $5.00 per share. As of December 31, 1997, holders of 5 1/2%
European Notes totaling $30,120,000 have exercised their conversion option and
such holders were issued 6,325,200 shares of Harken common stock. Subsequent to
December 31, 1997 and as of March 17, 1998, holders of 5 1/2% European Notes
totaling an additional $610,000 have exercised their conversion option and such
holders were issued 122,000 shares of Harken common stock.

         Private Placements of Common Stock -- On March 1, 1995, Harken sold
600,000 shares of newly-issued Harken common stock to an institutional purchaser
in exchange for net proceeds of $657,000. Harken subsequently entered into an
agreement on April 7, 1995 to sell to this same institutional purchaser an
additional 600,000 newly-issued shares of Harken common stock in exchange for
net proceeds of $747,000. In July and August of 1995, Harken received additional
net proceeds of $654,000 and $757,000, respectively, related to the sale of a
combined total of 1,300,000 newly-issued shares of Harken common stock to
certain institutional or accredited purchasers. In November 1995, Harken
received an additional $1,633,000 related to the sale of 1,460,000 shares of
Harken common stock previously held as treasury stock to a certain institutional
or accredited purchaser. In March 1996, Harken received $1,289,000 related to
the sale of 1,040,000 shares of Harken common stock previously held as treasury
stock. In connection with certain of these placements, Harken issued to certain
financial advisors warrants to purchase an aggregate total of 410,000 shares of
Harken common stock at an average exercise price of $1.71 per share. During
1997, these warrants were exercised for shares of Harken common stock.

         Acquisition of Texas Properties -- In October 1995, a wholly-owned
subsidiary of Harken paid as consideration three million shares of restricted
Harken common stock previously held as treasury stock in exchange for the
Yellowhouse Properties. As part of the purchase of these interests, Harken also
issued warrants to purchase one million additional shares of restricted Harken
common stock at $2 per share. During 1997, these warrants were exercised for
shares of Harken common stock.


                                       49

<PAGE>   50



         In December 1995, Harken Exploration acquired certain interests in
producing properties located in the panhandle region of Texas ("Panhandle
Properties") in exchange for, among other consideration, 2.5 million shares of
Harken common stock and a $13 million note payable which was payable, at
Harken's option, in shares of Harken common stock. In July 1996, Harken
Exploration entered into an exchange agreement with the seller of the Panhandle
Properties, pursuant to which Harken issued 5,150,000 restricted shares of
Harken common stock in satisfaction of all obligations owed by the subsidiary to
the seller under the terms of the Panhandle Note. See Note 2 -- Acquisitions for
further discussion.

         Acquisition of EnerVest Properties -- On July 10, 1996, Harken
Exploration acquired the EnerVest Properties for a purchase price valued at
approximately $15,200,000 and the assumption of certain operational liabilities
relating to these properties. See Note 2 -- Acquisitions for further discussion.
As partial consideration for the properties, Harken issued 1,550,000 in shares
of Harken common stock issued after closing. Pursuant to a Resolution and
Settlement Agreement in March 1997, Harken issued an additional 1,400,000 shares
of common stock as final consideration for the properties. Harken also issued to
EnerVest warrants to purchase, for a period of three years from closing, 300,000
restricted shares of Harken common stock at an exercise price of $2.75 per
share. During the third quarter of 1997, the holder exercised warrants to
purchase 100,000 shares of Harken common stock.

         Acquisition of Cal-T Properties -- In August, 1997, Harken acquired
working interests in the Cal-T Properties in exchange for 565,000 shares of
Harken common stock. See Note 2 -- Acquisitions for further discussion.

         Rio Negro Development Finance Agreement -- In October 1995, Harken and
the Rio Negro Investors entered into the Rio Negro Development Finance
Agreement. Related to the Agreement, Harken issued to a financial advisor 82,759
shares of restricted Harken common stock as well as warrants to purchase 100,000
additional shares of restricted Harken common stock. In March 1997, Harken and
the Rio Negro Investors entered into a Conversion Agreement whereby Harken
purchased 75% of the Participation relating to the Rio Negro Development Finance
Agreement for 900,000 restricted shares of Harken common stock. These shares
were issued in April 1997. See Note 6 -- Development Finance and Operating
Agreements for further discussion of the Rio Negro Development Finance
Agreement.

         Palo Blanco Development Finance Agreements -- In June 1996, Harken,
along with Harken de Colombia, Ltd., entered into two separate Development
Finance Agreements with two investors. In 1996, the investors exercised their
rights under the agreements to convert one-half of their beneficial interest
into 599,988 shares of restricted Harken common stock, and during the first
quarter of 1997, exercised their rights to convert the remaining portion of
their beneficial interest into 599,988 shares of restricted Harken common stock.
See Note 6 -- Development Finance and Operating Agreements for further
discussion.

         EnCap Development Finance Agreement -- In October 1997, Harken and the
EnCap Investors entered into a Development Finance Agreement under which the
EnCap Investors funded approximately $25 million to finance the drilling of
three wells in the Middle Magdalena Basin of Colombia. Pursuant to the EnCap
Development Finance Agreement, both Harken and the EnCap Investors have the
right under certain circumstances to convert all or part of the EnCap
Participation into shares of Harken common stock. Harken also issued 150,000
shares of Harken common stock to the EnCap Investors. See Note 6 -- Development
Finance and Operating Agreements for further discussion of the EnCap Development
Finance Agreement and Note 12 -- Related Party Transactions for further
discussion of the EnCap Investors.


                                       50

<PAGE>   51



         European Development Finance Agreement -- In December 1997, Harken, HCC
and the European Investors entered into a Development Finance Agreement under
which HCC funded $7 million in January 1998 to finance the drilling of three
wells in the Middle Magdalena Basin of Colombia. Pursuant to the European
Development Finance Agreement, both Harken and HCC have the right under certain
circumstances to convert some or all of the shares of HCC common stock into
shares of Harken common stock. In addition, Harken issued 42,000 shares of
Harken common stock to the European Investors. See Note 6 -- Development Finance
and Operating Agreements for further discussion.

         Per Share Data -- Basic earnings per common share was computed by
dividing net income or loss by the weighted average number of shares of Harken
common stock outstanding during the year. Diluted earnings per common share for
1997 was determined by including the effect of outstanding options and warrants
using the treasury stock method to the extent that the average share price
exceeds the exercise price. The impact of unconverted European Convertible Notes
was not included in any of the years presented as their effect would have been
antidilutive. Harken has adopted Statement of Financial Accounting Standards No.
128, "Earnings per Share", effective December 15, 1997, and as a result has
restated certain prior year weighted average shares outstanding calculations,
although there was no impact on prior year loss per share amounts. A
reconciliation of the 1997 calculation of diluted earnings per common share is
as follows (not in thousands):


<TABLE>
<CAPTION>
                                                               Year Ended December 31, 1997
                                                  ------------------------------------------------------
                                                                      Weighted Average
                                                      Income               Shares                Per Share
                                                  --------------    ---------------------      --------------
<S>                                               <C>               <C>                        <C>           
Basic earnings per common share                   $      189,000              109,087,697      $         0.00
Treasury stock method effect of:
   Outstanding employee stock options                         --                1,654,970                  --
   Outstanding warrants                                       --                1,190,922                  --
                                                  --------------    ---------------------      --------------
Diluted earnings per common share                 $      189,000              111,933,589      $         0.00
                                                  ==============    =====================      ==============
</TABLE>


         Summary of Outstanding Warrants -- At December 31, 1997, Harken has the
following outstanding warrants available to be exercised (not in thousands):


<TABLE>
<CAPTION>
   Year of Issuance         Number of Shares            Exercisable                 Price                Expiration Date
----------------------   ----------------------    ---------------------    ----------------------    ---------------------
<S>                            <C>                       <C>                    <C>      <C>               <C>    <C> 
1995                           2,083,000                 2,083,000              $1.50 to $2.00             1997 - 1999
1996                           1,784,000                 1,784,000              $1.50 to $2.75             1998 - 1999
1997                           2,143,937                 2,143,937              $1.50 to $5.00                1999
</TABLE>

(10)  STOCK OPTION PLAN

         Harken has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", ("FAS 123") requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB 25,

                                       51

<PAGE>   52



because the exercise price of Harken's employee stock options equals or exceeds
the market price of the underlying stock on the date of grant, no compensation
expense is recognized.

         Harken's 1993 Stock Option and Restricted Plan has authorized the grant
of options to Harken employees and directors for up to 4,000,000 shares of
Harken common stock. Harken's 1996 Stock Option and Restricted Stock Plan has
authorized the grant of 4,270,000 shares of Harken common stock. All options
granted have 10-year terms and vest and become fully exercisable at the end of 4
years of continued employment.

         Pro forma information regarding net loss and loss per share is required
by FAS 123, and has been determined as if Harken had accounted for its employee
stock options under the fair value method of that Statement. The fair value for
these options was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted-average assumptions for 1995, 1996 and
1997, respectively: risk- free interest rates of 7%, 6% and 5 1/2%; dividend
yields of 0%; volatility factors of the expected market price of Harken common
stock of .779, .614 and .588; and a weighted-average expected life to the option
of 4 years.

         The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because Harken's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

         For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Harken's pro
forma information follows (in thousands except for earnings per share
information):


<TABLE>
<CAPTION>
                                                     Year Ended December 31,
                                        ----------------------------------------------
                                           1995               1996              1997
                                        ---------          ---------         ---------
<S>                                     <C>                <C>               <C>       
Pro forma net loss                      $  (1,958)         $    (929)        $  (2,013)
Pro forma basic loss per share          $   (0.03)         $   (0.01)        $   (0.02)
</TABLE>

         The weighted average fair value of the options issued in 1996 and 1997
was $1.30 and $2.63 per share, respectively, underlying such option.



                                       52

<PAGE>   53



         A summary of the Company's stock option activity, and related
information for the year ended December 31, 1996 and 1997 follows (not in
thousands):


<TABLE>
<CAPTION>
                                                                  Year Ended December 31,
                                     -------------------------------------------------------------------------
                                                    1996                                      1997
                                     ----------------------------------     ----------------------------------
                                                      Weighted-Average                       Weighted-Average
                                      Options          Exercise Price         Options         Exercise Price
                                     ----------      ------------------     ----------      ------------------
<S>                                   <C>              <C>                  <C>               <C>        
Outstanding-beginning of year         3,484,300        $      1.76          5,224,300         $      2.15
   Granted                            1,740,000        $      2.92          3,320,000         $      5.14
   Exercised                                 --                              (114,051)        $      1.90
   Forfeited                                 --                               (53,250)        $      2.28
                                     ----------        -----------         ----------         -----------

Outstanding-end of year               5,224,300        $      2.15          8,376,999         $      3.34

Exercisable-end of year               1,739,300        $      1.77          2,773,999         $      1.93
</TABLE>

         Exercise prices for options outstanding as of December 31, 1996 ranged
from $1.00 to $5.625. Exercise prices for options outstanding as of December 31,
1997 ranged from $1.00 to $6.00.

(11)  INCOME TAXES

         At December 31, 1997, Harken had available for federal income tax
reporting purposes, net operating loss (NOL) carryforward for regular tax
purposes of approximately $60,000,000 which expires in 1998 through 2012,
alternative minimum tax NOL carryforward of approximately $51,000,000 which
expires in 1998 through 2011, investment tax credit carryforward of
approximately $842,000 which expires in 1998 through 2002, statutory depletion
carryforward of approximately $2,400,000 which does not have an expiration date,
and a net capital loss carryforward of approximately $12,400,000 which expires
in 2007 through 2011. Approximately $16,000,000 of the net operating loss
carryforward has been acquired with the purchase of subsidiaries and must be
used to offset future income from profitable operations within those
subsidiaries.

         The following is a reconciliation of the reported amount of income tax
expense for the year ended December 31, 1997 to the amount of income tax expense
that would result from applying domestic federal statutory tax rates to pretax
income:


<TABLE>
<CAPTION>
                                                                              1997
                                                                              ----
<S>                                                                           <C> 
Tax expense using statutory rate                                              $ 86
Application of net operating loss carryforward                                 (86)
Alternative minimum tax provision                                               27
State income taxes                                                              36
                                                                              ----
     Current tax expense                                                      $ 63
                                                                              ====
</TABLE>



                                       53

<PAGE>   54



         At December 31, 1995, total deferred tax liabilities, relating
primarily to property and equipment, increased to approximately $7,528,000 while
total deferred tax assets increased to approximately $22,364,000. The resulting
decrease in net deferred tax assets was offset by a corresponding decrease in
the valuation allowance to approximately $14,836,000 at December 31, 1995,
resulting in no impact to Harken's results of operations.

         At December 31, 1996, total deferred tax liabilities, relating
primarily to property and equipment, decreased to approximately $3,216,000 while
total deferred tax assets, primarily related to the net operating loss
carryforward, increased to approximately $23,136,000. The resulting increase in
net deferred tax assets was offset by a corresponding increase in the valuation
allowance to approximately $19,920,000 at December 31, 1996, resulting in no
impact to Harken's results of operations.

         Total deferred tax liabilities, relating primarily to property and
equipment as of December 31, 1997, were approximately $680,000. Total deferred
tax assets, primarily related to the net operating loss carryforward, were
approximately $20,538,000 at December 31, 1997. The total net deferred tax asset
is offset by a valuation allowance of approximately $19,858,000 at December 31,
1997, resulting in no impact to Harken's results of operations.

         The Tax Reform Act of 1986 made substantial changes with regard to NOL
carryforwards. After an "ownership change," the taxable income of a loss
corporation is limited annually to a prescribed rate times the value of the loss
corporation's stock immediately before the ownership change. In general, an
ownership change occurs if ownership of more than 50% in value of the stock of
the loss corporation changes during the three-year period preceding the test
date.

(12)  RELATED PARTY TRANSACTIONS

         In June 1997, Harken added to its Board of Directors a new director who
is also a managing director of EnCap Investments L.C. ("EnCap"). EnCap has
historically provided financial consulting and investment banking services to
Harken. In connection with the June 1997 placement of the 5 1/2% European Notes,
EnCap received as a financial consulting fee, $466,667 in cash, and a warrant to
purchase 50,000 shares of Harken common stock at any time after December 11,
1997 and on or before December 11, 1999 at an exercise price of $5.00 per share.
As described in Note 6 -- Development Finance and Operating Agreements, in
October 1997, Harken entered into a Development Finance Agreement with the EnCap
Investors. EnCap serves as the general partner of three of the EnCap Investors
and the new Harken director serves as a director of the fourth EnCap Investor.
In connection with the EnCap Development Finance Agreement, EnCap received an
investment banking fee of $500,000.

         During 1997, Harken made short-term loans totaling $295,000 to certain
members of Harken's Board of Directors and Management. Such notes receivable are
reflected in Harken's consolidated balance sheet at December 31, 1997 as Related
Party Notes Receivable.

         During 1994, an agreement was reached with an officer whereby a certain
note receivable from the officer for $520,000, together with accrued interest,
was forgiven equally over three installments dated April 1994, July 1995 and
December 1996 with each installment of such forgiveness contingent upon the
officer's continued employment through the date of each such installment. Harken
included an installment of this forgiveness totaling $232,000 per year in
general and administrative expense during the years ended December 31, 1995 and
1996.

                                       54

<PAGE>   55



(13)  OTHER INFORMATION

         Quarterly Data -- (Unaudited) -- The following tables summarize
selected quarterly financial data for 1996 and 1997 expressed in thousands,
except per share amounts.


<TABLE>
<CAPTION>
                                                               Quarter Ended
                                      ----------------------------------------------------------      Total
                                       March 31        June 30      September 30    December 31       Year
                                      ----------     -----------   --------------  -------------   -----------
<S>                                   <C>             <C>            <C>            <C>             <C>     
1996
Revenues                              $  2,341        $  2,590       $  4,115       $  4,875        $ 13,921
Gross profit                             1,237           1,548          2,337          2,781           7,903
Net income (loss)                         (296)             68             45           (158)           (341)
Basic and diluted income (loss)
  per common share                    $  (0.00)       $   0.00       $   0.00       $  (0.00)       $  (0.00)

1997
Revenues                              $  4,251        $  4,027       $  5,000       $  5,490        $ 18,768
Gross profit                             2,441           1,917          1,986          2,188           8,532
Net income                                  68              46             38             37             189
Basic and diluted income
  per common share                    $   0.00        $   0.00       $   0.00       $   0.00        $   0.00
</TABLE>

         Significant Customers -- In 1995, a single oil purchaser represented
47% of consolidated revenues. In 1996, two oil purchasers and a gas purchaser
represented 27%, 16% and 10%, respectively, of consolidated revenues. In 1997,
one oil purchaser represented 15% of consolidated revenues. Harken has secured
and maintains letters of credit with significant purchasers. In addition,
management does not feel that the loss of a significant purchaser would
significantly impact the operations of Harken due to the availability of other
potential purchasers for its oil and gas production.



                                       55

<PAGE>   56



         Geographic Segment Information -- For the three years ended December
31, 1997, Harken has reflected no revenues or operating profit from its
Colombian operations. Identifiable net asset and capital expenditure information
for each of the three years ended December 31, 1997 is as follows:


<TABLE>
<CAPTION>
                                            December 31,
                               --------------------------------------
IDENTIFIABLE NET ASSETS:         1995           1996           1997
                               --------       --------       --------
<S>                            <C>            <C>            <C>     
     United States             $ 65,858       $113,437       $193,448
     Colombia                     4,936          9,563         45,065
                               --------       --------       --------
          Total                $ 70,794       $123,000       $238,513
                               ========       ========       ========
</TABLE>


<TABLE>
<CAPTION>
                                      Year Ended December 31,
                               -----------------------------------
CAPITAL EXPENDITURES:            1995          1996          1997
                               -------       -------       -------
<S>                            <C>           <C>           <C>    
     United States             $30,879       $18,896       $ 6,413
     Colombia                    3,354         9,161        34,709
     Other International           303            --            --
                               -------       -------       -------
          Total                $34,536       $28,057       $41,122
                               =======       =======       =======
</TABLE>

(14)  OIL AND GAS DISCLOSURES

         Costs Incurred in Property Acquisition, Exploration and Development
Activities:


<TABLE>
<CAPTION>
                                                   Year Ended December 31,
                                             -----------------------------------
                                               1995          1996          1997
                                             -------       -------       -------
<S>                                          <C>           <C>           <C>    
DOMESTIC COSTS INCURRED:
  Acquisition of properties
    Evaluated                                $22,054       $16,316       $ 3,896
    Unevaluated                                6,313            --            --
  Exploration                                    696           162           170
  Development                                  1,816         2,418         2,347
                                             -------       -------       -------
      Total domestic costs incurred          $30,879       $18,896       $ 6,413
                                             =======       =======       =======

INTERNATIONAL COSTS INCURRED:
  Acquisition of properties
  Evaluated                                  $    --       $    --       $ 4,115
  Unevaluated                                     --            --            --
Exploration                                    3,657         9,161        30,594
Development                                       --            --            --
                                             -------       -------       -------
    Total international costs incurred       $ 3,657       $ 9,161       $34,709
                                             =======       =======       =======
</TABLE>

         International costs incurred during 1995, 1996 and 1997 relates to
Harken's Colombian operations, with the exception of approximately $303,000
during 1995 related to Harken's Bahrain operations.

                                       56

<PAGE>   57



         Capitalized Costs Relating to Oil and Gas Producing Activities:


<TABLE>
<CAPTION>
                                                                        December 31,
                                                         -------------------------------------------
                                                            1995             1996             1997
                                                         ---------        ---------        ---------
<S>                                                      <C>              <C>              <C>      
CAPITALIZED COSTS:
  Unevaluated international properties                   $   4,866        $   3,656        $  21,413
  Unevaluated domestic properties                           11,117            6,610            5,780
  Evaluated international properties                            --            5,802           22,754
  Evaluated domestic properties                             39,526           60,188           67,431
                                                         ---------        ---------        ---------
  Total capitalized costs                                   55,509           76,256          117,378
    Less accumulated depreciation and amortization          (4,691)          (8,069)         (12,928)
                                                         ---------        ---------        ---------
  Net capitalized costs                                  $  50,818        $  68,187        $ 104,450
                                                         =========        =========        =========
</TABLE>


         Oil and Gas Reserve Data -- (Unaudited) -- The following information is
presented with regard to Harken's proved oil and gas reserves. Such reserve
information excludes Harken's share of the future cash flows from the Aneth Gas
Plant, which is part of Harken's Four Corners Properties. The reserve values
reflected in the following reserve disclosures are based on prices received as
of year end. During 1995 and 1996, Harken consummated certain acquisition
transactions resulting in significant additions to its domestic proved oil and
gas reserves. (See Note 2 -- Acquisitions for further discussion). The majority
of all Colombian reserves represent proved undeveloped reserves to be developed
by Harken in the future. As of December 31, 1997, Harken has included no proved
reserves related to its Cambulos or Miradores Association Contracts. As Harken
identifies proved reserves associated with its Cambulos or Miradores Association
Contracts, or identifies proved reserves from additional prospects within its
Alcaravan, Bocachico or Bolivar Association Contracts, such reserves will be
added in the year of their discovery. Colombian reserves reflect Harken's net
interest after consideration for certain development finance and operating
agreements and additionally reflect the net Harken interest assuming full
participation by Ecopetrol. If any of Harken's producing fields are considered
by Ecopetrol not to be a commercial discovery, Harken's share of such reserves
could be increased accordingly. As of December 31, 1997, Harken has not applied
to Ecopetrol for a declaration of a commercial discovery relating to any of its
proved Colombian reserves. For further discussion of Harken's Colombian
operations, see Note 5 -- Colombian Operations.


                                       57

<PAGE>   58




<TABLE>
<CAPTION>
                                                                    (UNAUDITED)
                                     ----------------------------------------------------------------------
                                          United States             Colombia             Total Worldwide
                                     ---------------------   ---------------------    ---------------------
                                         Oil         Gas         Oil         Gas          Oil         Gas
                                      (Barrels)     (Mcf)     (Barrels)     (Mcf)      (Barrels)     (Mcf)
                                     ----------   --------   -----------   -------    -----------   -------
                                                                      (IN THOUSANDS)
<S>                                  <C>          <C>        <C>           <C>        <C>           <C>  
PROVED RESERVES:
AS OF DECEMBER 31, 1994                1,521        7,148           --          --       1,521        7,148
  Extensions and discoveries              70           20           --          --          70           20
  Revisions                              (43)      (3,241)          --          --         (43)      (3,241)
  Production                            (217)        (615)          --          --        (217)        (615)
  Purchases of reserves in place       2,192       25,891           --          --       2,192       25,891
                                     -------      -------      -------     -------     -------      -------

AS OF DECEMBER 31, 1995                3,523       29,203           --          --       3,523       29,203
  Extensions and discoveries               5        2,401        1,426         257       1,431        2,658
  Revisions                              (22)      (3,117)          --          --         (22)      (3,117)
  Production                            (370)      (1,409)          --          --        (370)      (1,409)
  Purchases of reserves in place       2,216        4,770          611       2,055       2,827        6,825
                                     -------      -------      -------     -------     -------      -------

AS OF DECEMBER 31, 1996                5,352       31,848        2,037       2,312       7,389       34,160
  Extensions and discoveries              95        3,977        3,922         134       4,017        4,111
  Revisions                             (546)      (8,437)       1,586       1,067       1,040       (7,370)
  Production                            (416)      (1,922)          --          --        (416)      (1,922)
  Purchases of reserves in place         345        4,185          713         129       1,058        4,314
                                     -------      -------      -------     -------     -------      -------

AS OF DECEMBER 31, 1997                4,830       29,651        8,258       3,642      13,088       33,293
                                     =======      =======      =======     =======     =======      =======

PROVED DEVELOPED RESERVES AT:
  December 31, 1995                    2,147        8,466           --          --       2,147        8,466
  December 31, 1996                    3,757       11,822          252          45       4,009       11,867
  December 31, 1997                    3,002       15,080        1,599         167       4,601       15,247
</TABLE>


                                       58

<PAGE>   59



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


<TABLE>
<CAPTION>
                                                                          (UNAUDITED)
                                                         --------------------------------------------
                                                                                              Total
                                                         United States      Colombia        Worldwide
                                                         -------------      --------        ---------
                                                                         (IN THOUSANDS)
<S>                                                       <C>              <C>              <C>      
DECEMBER 31, 1996:
     Future cash inflows                                  $ 309,820        $  41,859        $ 351,679
        Production costs                                    (80,869)          (6,770)         (87,639)
        Development costs                                   (13,398)          (8,737)         (22,135)
                                                          ---------        ---------        ---------
     Future net inflows before income tax                   215,553           26,352          241,905
     Future income taxes                                         --           (7,741)          (7,741)
                                                          ---------        ---------        ---------
     Future net cash flows                                  215,553           18,611          234,164
     10% discount factor                                    (85,750)          (6,171)         (91,921)
                                                          ---------        ---------        ---------
Standardized measure of discounted future
net cash flows                                            $ 129,803        $  12,440        $ 142,243
                                                          =========        =========        =========

DECEMBER 31, 1997:
     Future cash inflows                                  $ 176,308        $ 118,825        $ 295,133
        Production costs                                    (60,213)         (24,996)         (85,209)
        Development costs                                   (14,874)         (29,083)         (43,957)
                                                          ---------        ---------        ---------
     Future net inflows before income tax                   101,221           64,746          165,967
     Future income taxes                                         --          (21,424)         (21,424)
                                                          ---------        ---------        ---------
     Future net cash flows                                  101,221           43,322          144,543
     10% discount factor                                    (44,244)          (9,719)         (53,963)
                                                          ---------        ---------        ---------
Standardized measure of discounted future
net cash flows                                            $  56,977        $  33,603        $  90,580
                                                          =========        =========        =========
</TABLE>


                                       59

<PAGE>   60



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


<TABLE>
<CAPTION>
                                                                      (UNAUDITED)
                                                      ---------------------------------------
                                                         1995           1996           1997
                                                      ---------      ---------      ---------
                                                                    (IN THOUSANDS)
<S>                                                   <C>            <C>            <C>      
Worldwide
Standardized measure -- beginning of year             $  11,712      $  58,776      $ 142,243
Increase (decrease)
  Sales, net of production costs                         (3,224)        (7,577)        (8,195)
  Net change in prices, net of production costs           1,045         51,070        (67,852)
  Development costs incurred                                391            949          5,345
  Change in future development costs                      1,858            209          2,901
  Change in future income taxes                              --         (5,465)        (4,898)
  Revisions of quantity estimates                        (3,420)        (7,791)        (3,931)
  Accretion of discount                                   1,171          5,878         14,224
  Changes in production rates, timing and other          (1,361)         1,227        (14,051)
  Extensions and discoveries, net of future costs           792         12,475         16,007
  Purchases of reserves-in-place                         49,812         32,492          8,787
                                                      ---------      ---------      ---------
Standardized measure -- end of year                   $  58,776      $ 142,243      $  90,580
                                                      =========      =========      =========
</TABLE>

(15) COMMITMENTS AND CONTINGENCIES

         Operating Leases -- Harken leases its corporate and certain other
office space and certain field operating offices. Total office and operating
lease expense during 1995, 1996 and 1997 was $442,000, $359,000 and $551,000,
respectively. Future minimum rental payments required under all leases that have
initial or remaining noncancellable lease terms in excess of one year as of
December 31, 1997, net of sublease arrangements, are as follows:


<TABLE>
<CAPTION>
     Year                                                       Amount
---------------                                             ---------------
<S>                                                         <C>            
1998                                                        $           399
1999                                                                    399
2000                                                                    115
2001                                                                     --
2002                                                                     --
Thereafter                                                               --
                                                            ---------------

   Total minimum payments required                          $           913
                                                            ===============
</TABLE>


                                       60

<PAGE>   61



         Operational Contingencies -- The exploration, development and
production of oil and gas are subject to various Navajo, federal and state laws
and regulations designed to protect the environment. Compliance with these
regulations is part of Harken's day-to-day operating procedures. Infrequently,
accidental discharge of such materials as oil, natural gas or drilling fluids
can occur and such accidents can require material expenditures to correct.
Harken maintains levels of insurance customary in the industry to limit its
financial exposure. Management is unaware of any material capital expenditures
required for environmental control during the next fiscal year.

         Harken has accrued approximately $1,785,000 at December 31, 1997
relating to certain operational or regulatory contingent liabilities related to
Harken's domestic operations. Harken and its subsidiaries currently are involved
in various lawsuits and other contingencies, which in management's opinion, will
not result in significant loss exposure to Harken.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

         None.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         See "Item 1. Business" above for a discussion of the Executive Officers
of Harken. Reference is made to the material under the caption "Election of
Directors" in the Registrant's definitive Proxy Statement to be filed on or
before April 30, 1998 pursuant to Regulation 14A in connection with its Annual
Meeting of Stockholders to be held in June 1998, which is incorporated herein by
reference.

ITEM 11. EXECUTIVE COMPENSATION

         Reference is made to the material under the caption "Compensation of
Executive Officers" in the Registrant's definitive Proxy Statement to be filed
on or before April 30, 1998 pursuant to Regulation 14A in connection with its
Annual Meeting of Stockholders to be held in June 1998, which is incorporated
herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

         Reference is made to the material under the caption "Ownership of
Common Stock" in the Registrant's definitive Proxy Statement to be filed on or
before April 30, 1998 pursuant to Regulation 14A in connection with its Annual
Meeting of Stockholders to be held in June 1998, which is incorporated herein by
reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Reference is made to the material under the caption "Certain
Transactions" in the Registrant's definitive Proxy Statement to be filed on or
before April 30, 1998 pursuant to Regulation 14A in connection with its Annual
Meeting of Stockholders to be held in June 1998, which is incorporated herein by
reference.


                                       61

<PAGE>   62



                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K


(a)      The following documents are filed as a part of this report:

         (1) Financial Statements included in PART II of this report:

<TABLE>
<CAPTION>
                                                                                                        PAGE
                                                                                                        ----
           Harken Energy Corporation and Subsidiaries
<S>                                                                                                       <C>
           -- Report of Independent Public Accountants...............................................     30
           -- Selected Financial Information and Other Data for the five years ended
              December 31, 1997 .....................................................................     20
           -- Consolidated Balance Sheets -- December 31, 1996 and 1997..............................     31
           -- Consolidated Statements of Operations for the three years ended
              December 31, 1997 .....................................................................     32
           -- Consolidated Statements of Stockholders' Equity for the three years ended
              December 31, 1997 .....................................................................     33
           -- Consolidated Statements of Cash Flows for the three years ended
              December 31, 1997 .....................................................................     34
           -- Notes to Consolidated Financial Statements.............................................     35
</TABLE>

       (2) The information required by Schedule I is either provided in the
           related financial statements or in a note thereto, or is not
           applicable to the Company. The information required by all other
           Schedules is not applicable to the Company.

       (3) Exhibits

       3.1      Certificate of Incorporation of Harken Energy Corporation as
                amended (filed as Exhibit 3.1 to Harken's Annual Report on Form
                10-K for fiscal year ended December 31, 1989, File No.
                0-9207, and incorporated by reference herein).

       3.2      Amendment to Certificate of Incorporation of Harken Energy
                Corporation (filed as Exhibit 28.8 to the Registration Statement
                on Form S-1 of Tejas Power Corporation, file No. 33- 37141, and
                incorporated by reference herein).

       3.3      Amendment to the Certificate of Incorporation of Harken Energy
                Corporation (filed as Exhibit 3 to Harken's Quarterly Report on
                Form 10-Q for fiscal quarter ended March 31, 1991, File No.
                0-9207, and incorporated by reference herein).

       3.4      Amendments to the Certificate of Incorporation of Harken Energy
                Corporation (filed as Exhibit 3 to Harken's Quarterly Report on
                Form 10-Q for fiscal quarter ended June 30, 1991, File No.
                0-9207, and incorporated by reference herein).


                                       62

<PAGE>   63



       3.5      Amendments to the Certificate of Incorporation of Harken Energy
                Corporation (filed as Exhibit 3.5 to Harken's Annual Report on
                Form 10-K for the fiscal year ended December 31, 1996, File No.
                0-9207, and incorporated herein by reference).

       3.6      Amendment to the Certificate of Incorporation of Harken Energy
                Corporation.

       3.7      Bylaws of Harken Energy Corporation, as amended (filed as
                Exhibit 3.2 to Harken's Annual Report on Form 10-K for fiscal
                year ended December 31, 1989, File No. 0-9207, and incorporated
                by reference herein).

       4.1      Form of certificate representing shares of Harken common stock,
                par value $.01 per share (filed as Exhibit 1 to Harken's
                Registration Statement on Form 8-A, File No. 0-9207, and
                incorporated by reference herein).

       4.2      Certificate of Designations, Powers, Preferences and Rights of
                Series A Cumulative Convertible Preferred Stock, $1.00 par
                value, of Harken Energy Corporation (filed as Exhibit 4.1 to
                Harken's Annual Report on Form 10-K for the fiscal year ended
                December 31, 1989, File No. 0-9207, and incorporated herein by
                reference).

       4.3      Certificate of Designations, Powers, Preferences and Rights of
                Series B Cumulative Convertible Preferred Stock, $1.00 par
                value, of Harken Energy Corporation (filed as Exhibit 4.2 to
                Harken's Annual Report on Form 10-K for the fiscal year ended
                December 31, 1989, File No. 0-9207, and incorporated herein by
                reference).

       4.4      Certificate of the Designations, Powers, Preferences and Rights
                of Series C Cumulative Convertible Preferred Stock, $1.00 par
                value of Harken Energy Corporation (filed as Exhibit 4.3 to
                Harken's Annual Report on Form 10-K for fiscal year ended
                December 31, 1989, File No. 0-9207, and incorporated by
                reference herein).

       4.5      Certificate of the Designations of Series D Preferred Stock,
                $1.00 par value of Harken Energy Corporation (filed as Exhibit
                4.3 to Harken's Quarterly Report on Form 10-Q for the fiscal
                quarter ended September 30, 1995, File No. 0-9207, and
                incorporated by reference herein).

       10.1     Seventh Amendment and Restatement of Harken's Amended Stock
                Option Plan (filed as Exhibit 10.1 to Harken's Annual Report on
                Form 10-K for the fiscal year ended December 31, 1991, File No.
                0-9207, and incorporated by reference herein).

       10.2     Amended and Restated Non-Qualified Incentive Stock Option Plan
                of Harken adopted by Harken's stockholders on February 18, 1991
                (filed as Exhibit 10.2 to Harken's Annual Report on Form 10-K
                for the fiscal year ended December 31, 1991, File No. 0-9207,
                and incorporated by reference herein).

       10.3     Form of Advancement Agreement dated September 13, 1990, between
                Harken and each director of Harken (filed as Exhibit 10.38 to
                Harken's Annual Report on Form 10-K for the fiscal year ended
                December 31, 1989, File No. 0-9207, and incorporated by
                reference herein).


                                       63

<PAGE>   64



       10.4     Operating Agreement between Chuska Energy Corporation and the
                Navajo Tribe of Indians dated February 18, 1987, and effective
                July 20, 1987 (filed as Exhibit 10(b) to Chuska Energy
                Corporation's Form 10 - General Form for Registration of
                Securities (the "Chuska Form 10"), and incorporated by reference
                herein).

       10.5     Operating Agreement between Chuska Energy Corporation and the
                Navajo Tribe of Indians dated July 28, 1983, and effective
                August 26, 1983 and First Addendum thereto (filed as Exhibit
                10(a) to Chuska's Form 10, and incorporated by reference
                herein).

       10.6     Association Contract (Cambulos), dated September 17, 1995, and
                effective as of November 17, 1995, by and between Harken de
                Colombia, Ltd., and Empresa Colombiana de Petroleos (filed as
                Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the
                quarterly period ended September 30, 1995, File No. 0-9207, and
                incorporated by reference herein).

       10.7     Development Finance Agreement, dated October 12, 1995, by and
                among Harken Energy Corporation, Arbco Associates L.P., Offense
                Group Associates L.P., Kayne Anderson Nontraditional Investments
                L.P. and Opportunity Associates L.P. (filed as Exhibit 10.2 to
                Harken's Quarterly Report on Form 10-Q for the quarterly period
                ended September 30, 1995, File No. 0-9207, and incorporated by
                reference herein).

       10.8     Harken Energy Corporation's 1993 Stock Option and Restricted
                Stock Plan (filed as Exhibit 4.3 to Harken's Registration
                Statement on Form S-8, and incorporated by reference herein).

       10.9     Harken Energy Corporation's Directors Stock Option Plan (filed
                as Exhibit 4.3 to Harken's Registration Statement on Form S-8,
                and incorporated herein by reference).

       10.10    Association Contract (Bolivar) by and between Harken de
                Colombia, Ltd. and Empresa Colombia de Petroleos (filed as
                Exhibit 10.4 to Harken's Quarterly Report on Form 10-Q for the
                quarterly period ended June 30, 1996, and incorporated herein by
                reference).

       10.11    Harken Energy Corporation 1996 Incentive and Nonstatutory Stock
                Option Plan (filed as Exhibit 10.1 to Harken's Quarterly Report
                on Form 10-Q for the quarterly period ended September 30, 1996,
                and incorporated herein by reference).

       10.12    Association Contract (Alcaravan) dated as of December 13, 1992,
                but effective as of February 13, 1993, by and between Empresa
                Colombia de Petroleos (filed as Exhibit 10.1 to Harken's Annual
                Report on Form 10-K for the fiscal year ended December 31, 1992,
                File No. 0-9207, and incorporated herein by reference).

       10.13    Association Contract (Bocachico) dated as of January 1994, but
                effective as of April 1994, by and between Empresa Colombia de
                Petroleos (filed as Exhibit 10.1 to Harken's Quarterly Report on
                Form 10-Q for the quarterly period ended March 31, 1994, File
                No. 0-9207, and incorporated herein by reference).

       10.14    Association Contract (Miradores) dated as of December 1997, but
                effective as of February 1998, by and between Empresa Colombia
                de Petroleos.


                                       64

<PAGE>   65



       10.15    Development Finance Agreement dated as of October 17, 1997, by
                and among Harken, Harken Capital Corporation and the other
                signatories thereto (filed as Exhibit 10.1 to Harken's Quarterly
                Report on Form 10-Q for the quarterly period ended September 30,
                1997, File No.
                0-9207, and incorporated herein by reference).

       10.16    Development Finance Agreement dated as of December 24, 1997, by
                and among Harken and the other signatories thereto.

       10.17    Exchange Agreement dated as of December 24, 1997, by and among
                Harken, Harken Capital Corporation and the other signatories
                thereto.

       10.18    Trust Indenture dated June 11, 1997, by and between Harken and
                Marine Midland Bank plc (filed as Exhibit 10.1 to Harken's
                Quarterly Report on Form 10-Q for the quarterly period ended
                June 30, 1997, File No. 0-9207, and incorporated herein by
                reference).

       10.19    Placing Agreement Dated June 3, 1997, by and among Harken and
                the other signatories thereto (filed as Exhibit 10.2 to Harken's
                Quarterly Report on Form 10-Q for the quarterly period ended
                June 30, 1997, File No. 0-9207, and incorporated herein by
                reference).

       10.20    Drilling Contract dated as of July 22, 1997, between Harken de
                Colombia, Ltd., and Parker Drilling Company International Ltd.
                (filed as Exhibit 10.4 to Harken's Quarterly Report on Form 10-Q
                for the quarterly period ended June 30, 1997, File No. 0-9207,
                and incorporated herein by reference).

       10.21    Drilling Contract dated as of May 15, 1997, between Harken de
                Colombia, Ltd., and Marlin Colombia Drilling Company, Inc.
                (filed as Exhibit 10.5 to Harken's Quarterly Report on Form 10-Q
                for the quarterly period ended June 30, 1997, File No. 0-9207,
                and incorporated herein by reference).

       22       Subsidiaries of Harken.

       24       Power of Attorney.

       27       Financial Data Schedule.

(b)    Reports on Form 8-K

       None.


                                       65

<PAGE>   66


                                                    SIGNATURES

       Pursuant to the requirements of the 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, in the City of Irving,
State of Texas, on March 23, 1998.

       HARKEN ENERGY CORPORATION


                          *
       ----------------------------------------
       Mikel D. Faulkner, Chairman of the Board and Chief Executive Officer


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


<TABLE>
<CAPTION>
           Signature                                      Title                                         Date
-------------------------------         -----------------------------------------           ----------------------------
<S>                                     <C>                                                        <C> 
             *                          Chairman of the Board and Chief                            March 23, 1998
-------------------------------         Executive Officer (Principal
Mikel D. Faulkner                       Executive Officer)          
                                        



             *                          President and Chief Operating                              March 23, 1998
-------------------------------         Officer and Director
Richard H. Schroeder                    




/s/ Bruce N. Huff                       Senior Vice President, Chief                               March 23, 1998
-------------------------------         Financial Officer and Director   
Bruce N. Huff                           (Principal Accounting Officer and
                                        Principal Financial Officer)     
                                        



             *                          Senior Vice President and Director                         March 23, 1998
-------------------------------
Stephen C. Voss
</TABLE>



                                       66
<PAGE>   67

<TABLE>
<S>                                     <C>                                                        <C> 
             *                          Director                                                   March 23, 1998
-------------------------------
Michael M. Ameen, Jr.



             *                          Director                                                   March 23, 1998
-------------------------------
Michael R. Eisenson



            *                           Director                                                   March 23, 1998
--------------------------------
Gary R. Peterson



            *                           Director                                                   March 23, 1998
--------------------------------
Donald W. Raymond



                                        Director                                                   March 23, 1998
--------------------------------
Hobart A. Smith



            *                           Director                                                   March 23, 1998
-------------------------------
Gary B. Wood
</TABLE>



*Bruce N. Huff, by signing his name hereto, does hereby sign this Annual Report
on Form 10-K for the year ended December 31, 1997 on behalf of Harken Energy
Corporation and each of the above-named officers and directors of such Company
pursuant to powers of attorney, executed on behalf of the Company and each
officer and director.



/s/ Bruce N. Huff
-----------------------------------------
Bruce N. Huff,
Attorney-in-Fact

                                       67
<PAGE>   68
                               INDEX TO EXHIBITS


<TABLE>
<CAPTION>
     EXHIBIT
     NUMBER                             DESCRIPTION                                       PAGE
     --------                           -----------                                       ----
     <S>        <C>                                                                       <C>
       3.1      Certificate of Incorporation of Harken Energy Corporation as
                amended (filed as Exhibit 3.1 to Harken's Annual Report on Form
                10-K for fiscal year ended December 31, 1989, File No.
                0-9207, and incorporated by reference herein).

       3.2      Amendment to Certificate of Incorporation of Harken Energy
                Corporation (filed as Exhibit 28.8 to the Registration Statement
                on Form S-1 of Tejas Power Corporation, file No. 33- 37141, and
                incorporated by reference herein).

       3.3      Amendment to the Certificate of Incorporation of Harken Energy
                Corporation (filed as Exhibit 3 to Harken's Quarterly Report on
                Form 10-Q for fiscal quarter ended March 31, 1991, File No.
                0-9207, and incorporated by reference herein).

       3.4      Amendments to the Certificate of Incorporation of Harken Energy
                Corporation (filed as Exhibit 3 to Harken's Quarterly Report on
                Form 10-Q for fiscal quarter ended June 30, 1991, File No.
                0-9207, and incorporated by reference herein).

       3.5      Amendments to the Certificate of Incorporation of Harken Energy
                Corporation (filed as Exhibit 3.5 to Harken's Annual Report on
                Form 10-K for the fiscal year ended December 31, 1996, File No.
                0-9207, and incorporated herein by reference).

       3.6      Amendment to the Certificate of Incorporation of Harken Energy
                Corporation.

       3.7      Bylaws of Harken Energy Corporation, as amended (filed as
                Exhibit 3.2 to Harken's Annual Report on Form 10-K for fiscal
                year ended December 31, 1989, File No. 0-9207, and incorporated
                by reference herein).

       4.1      Form of certificate representing shares of Harken common stock,
                par value $.01 per share (filed as Exhibit 1 to Harken's
                Registration Statement on Form 8-A, File No. 0-9207, and
                incorporated by reference herein).

       4.2      Certificate of Designations, Powers, Preferences and Rights of
                Series A Cumulative Convertible Preferred Stock, $1.00 par
                value, of Harken Energy Corporation (filed as Exhibit 4.1 to
                Harken's Annual Report on Form 10-K for the fiscal year ended
                December 31, 1989, File No. 0-9207, and incorporated herein by
                reference).

       4.3      Certificate of Designations, Powers, Preferences and Rights of
                Series B Cumulative Convertible Preferred Stock, $1.00 par
                value, of Harken Energy Corporation (filed as Exhibit 4.2 to
                Harken's Annual Report on Form 10-K for the fiscal year ended
                December 31, 1989, File No. 0-9207, and incorporated herein by
                reference).

       4.4      Certificate of the Designations, Powers, Preferences and Rights
                of Series C Cumulative Convertible Preferred Stock, $1.00 par
                value of Harken Energy Corporation (filed as Exhibit 4.3 to
                Harken's Annual Report on Form 10-K for fiscal year ended
                December 31, 1989, File No. 0-9207, and incorporated by
                reference herein).

       4.5      Certificate of the Designations of Series D Preferred Stock,
                $1.00 par value of Harken Energy Corporation (filed as Exhibit
                4.3 to Harken's Quarterly Report on Form 10-Q for the fiscal
                quarter ended September 30, 1995, File No. 0-9207, and
                incorporated by reference herein).

       10.1     Seventh Amendment and Restatement of Harken's Amended Stock
                Option Plan (filed as Exhibit 10.1 to Harken's Annual Report on
                Form 10-K for the fiscal year ended December 31, 1991, File No.
                0-9207, and incorporated by reference herein).

       10.2     Amended and Restated Non-Qualified Incentive Stock Option Plan
                of Harken adopted by Harken's stockholders on February 18, 1991
                (filed as Exhibit 10.2 to Harken's Annual Report on Form 10-K
                for the fiscal year ended December 31, 1991, File No. 0-9207,
                and incorporated by reference herein).

       10.3     Form of Advancement Agreement dated September 13, 1990, between
                Harken and each director of Harken (filed as Exhibit 10.38 to
                Harken's Annual Report on Form 10-K for the fiscal year ended
                December 31, 1989, File No. 0-9207, and incorporated by
                reference herein).
</TABLE>

<PAGE>   69

<TABLE>
     <S>        <C>                                                                       <C>
       10.4     Operating Agreement between Chuska Energy Corporation and the
                Navajo Tribe of Indians dated February 18, 1987, and effective
                July 20, 1987 (filed as Exhibit 10(b) to Chuska Energy
                Corporation's Form 10 - General Form for Registration of
                Securities (the "Chuska Form 10"), and incorporated by reference
                herein).

       10.5     Operating Agreement between Chuska Energy Corporation and the
                Navajo Tribe of Indians dated July 28, 1983, and effective
                August 26, 1983 and First Addendum thereto (filed as Exhibit
                10(a) to Chuska's Form 10, and incorporated by reference
                herein).

       10.6     Association Contract (Cambulos), dated September 17, 1995, and
                effective as of November 17, 1995, by and between Harken de
                Colombia, Ltd., and Empresa Colombiana de Petroleos (filed as
                Exhibit 10.1 to Harken's Quarterly Report on Form 10-Q for the
                quarterly period ended September 30, 1995, File No. 0-9207, and
                incorporated by reference herein).

       10.7     Development Finance Agreement, dated October 12, 1995, by and
                among Harken Energy Corporation, Arbco Associates L.P., Offense
                Group Associates L.P., Kayne Anderson Nontraditional Investments
                L.P. and Opportunity Associates L.P. (filed as Exhibit 10.2 to
                Harken's Quarterly Report on Form 10-Q for the quarterly period
                ended September 30, 1995, File No. 0-9207, and incorporated by
                reference herein).

       10.8     Harken Energy Corporation's 1993 Stock Option and Restricted
                Stock Plan (filed as Exhibit 4.3 to Harken's Registration
                Statement on Form S-8, and incorporated by reference herein).

       10.9     Harken Energy Corporation's Directors Stock Option Plan (filed
                as Exhibit 4.3 to Harken's Registration Statement on Form S-8,
                and incorporated herein by reference).

       10.10    Association Contract (Bolivar) by and between Harken de
                Colombia, Ltd. and Empresa Colombia de Petroleos (filed as
                Exhibit 10.4 to Harken's Quarterly Report on Form 10-Q for the
                quarterly period ended June 30, 1996, and incorporated herein by
                reference).

       10.11    Harken Energy Corporation 1996 Incentive and Nonstatutory Stock
                Option Plan (filed as Exhibit 10.1 to Harken's Quarterly Report
                on Form 10-Q for the quarterly period ended September 30, 1996,
                and incorporated herein by reference).

       10.12    Association Contract (Alcaravan) dated as of December 13, 1992,
                but effective as of February 13, 1993, by and between Empresa
                Colombia de Petroleos (filed as Exhibit 10.1 to Harken's Annual
                Report on Form 10-K for the fiscal year ended December 31, 1992,
                File No. 0-9207, and incorporated herein by reference).

       10.13    Association Contract (Bocachico) dated as of January 1994, but
                effective as of April 1994, by and between Empresa Colombia de
                Petroleos (filed as Exhibit 10.1 to Harken's Quarterly Report on
                Form 10-Q for the quarterly period ended March 31, 1994, File
                No. 0-9207, and incorporated herein by reference).

       10.14    Association Contract (Miradores) dated as of December 1997, but
                effective as of February 1998, by and between Empresa Colombia
                de Petroleos.
</TABLE>

<PAGE>   70

<TABLE>
     <S>        <C>                                                                       <C>
       10.15    Development Finance Agreement dated as of October 17, 1997, by
                and among Harken, Harken Capital Corporation and the other
                signatories thereto (filed as Exhibit 10.1 to Harken's Quarterly
                Report on Form 10-Q for the quarterly period ended September 30,
                1997, File No.
                0-9207, and incorporated herein by reference).

       10.16    Development Finance Agreement dated as of December 24, 1997, by
                and among Harken and the other signatories thereto.

       10.17    Exchange Agreement dated as of December 24, 1997, by and among
                Harken, Harken Capital Corporation and the other signatories
                thereto.

       10.18    Trust Indenture dated June 11, 1997, by and between Harken and
                Marine Midland Bank plc (filed as Exhibit 10.1 to Harken's
                Quarterly Report on Form 10-Q for the quarterly period ended
                June 30, 1997, File No. 0-9207, and incorporated herein by
                reference).

       10.19    Placing Agreement Dated June 3, 1997, by and among Harken and
                the other signatories thereto (filed as Exhibit 10.2 to Harken's
                Quarterly Report on Form 10-Q for the quarterly period ended
                June 30, 1997, File No. 0-9207, and incorporated herein by
                reference).

       10.20    Drilling Contract dated as of July 22, 1997, between Harken de
                Colombia, Ltd., and Parker Drilling Company International Ltd.
                (filed as Exhibit 10.4 to Harken's Quarterly Report on Form 10-Q
                for the quarterly period ended June 30, 1997, File No. 0-9207,
                and incorporated herein by reference).

       10.21    Drilling Contract dated as of May 15, 1997, between Harken de
                Colombia, Ltd., and Marlin Colombia Drilling Company, Inc.
                (filed as Exhibit 10.5 to Harken's Quarterly Report on Form 10-Q
                for the quarterly period ended June 30, 1997, File No. 0-9207,
                and incorporated herein by reference).

       22       Subsidiaries of Harken.

       24       Power of Attorney.

       27       Financial Data Schedule.
</TABLE>