UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    Form 10-Q

MARK ONE
   |X|        QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
              SECURITIES EXCHANGE ACT OF 1934

                For the Quarterly Period Ended September 30, 1996

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

                          Commission File Number 0-9579


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



            Texas                                                    75-1319083
(State or other jurisdiction of                                 (I.R.S. Employer
incorporation or organization)                            Identification Number)
   4582 South Ulster Street Parkway
             Suite 1700
         Denver, Colorado                                                 80237
(Address of principal executive offices)                              (Zip Code)

       Registrant's telephone number, including area code: (303) 850-7373

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 |_|

Shares of Common Stock outstanding at November 12, 1996          777,126 shares









                                  Page 1 of 16


<PAGE>

<TABLE>
<CAPTION>


PART I.     FINANCIAL INFORMATION
ITEM 1.     FINANCIAL STATEMENTS

                           HALLWOOD ENERGY CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)
                          (In thousands except Shares)



                                                                                   September 30,              December 31,
                                                                                       1996                       1995

CURRENT ASSETS
<S>                                                                                <C>                    <C>
   Cash and cash equivalents                                                       $       879            $         10
   Accounts receivable:
      Affiliates                                                                           598                     372
      Trade                                                                                 77                      26
   Current assets of affiliate                                                           2,388                   2,236
                                                                                      --------               ---------
         Total                                                                           3,942                   2,644
                                                                                     ---------               ---------

PROPERTY,  PLANT  AND  EQUIPMENT,  at cost  Oil and gas  properties  (full  cost
   method):
      Proved mineral interests                                                         113,319                 113,159
      Unproved mineral interests                                                           154                      82
   Other property and equipment                                                          3,780                   3,758
                                                                                     ---------               ---------
         Total                                                                         117,253                 116,999

   Less accumulated depreciation, depletion,
      amortization and property impairment                                           (108,312)               (107,160)
                                                                                      -------                 -------

         Net Property, Plant and Equipment                                               8,941                   9,839
                                                                                     ---------               ---------

OTHER ASSETS
   Investment in common stock of parent
      (carried at market)                                                                3,781                   2,075
   Deferred tax asset                                                                      311                     500
   Noncurrent assets of affiliate                                                        1,604                   1,407
                                                                                     ---------               ---------
         Total                                                                           5,696                   3,982
                                                                                     ---------               ---------

TOTAL ASSETS                                                                          $ 18,579               $  16,465
                                                                                       =======                ========









<FN>

                        (Continued on the following page)
</FN>

</TABLE>
                                                        -2-

<PAGE>

<TABLE>
<CAPTION>


                           HALLWOOD ENERGY CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)
                          (In thousands except Shares)



                                                                                    September 30,            December 31,
                                                                                       1996                     1995

CURRENT LIABILITIES
<S>                                                                                 <C>                     <C>
   Accounts payable and accrued liabilities                                         $      189              $      106
   Current portion of long-term debt                                                       300                     300
   Current liabilities of affiliate                                                      2,394                   2,857
                                                                                      --------                --------

         Total                                                                           2,883                   3,263
                                                                                      --------                --------

NONCURRENT LIABILITIES
   Long-term debt                                                                          600                     825
   Long-term liabilities of affiliate                                                    4,649                   5,366
                                                                                      --------                --------

         Total                                                                           5,249                   6,191
                                                                                      --------                --------

         Total Liabilities                                                               8,132                   9,454
                                                                                      --------                --------

STOCKHOLDERS' EQUITY
   Series D convertible cumulative, redeemable
      preferred stock, $.01 par value; 65,000 shares
      authorized; 18,864 shares issued with a liquidation preference
      of $1,154 (canceled during 1995)
   Series  E  convertible  preferred  stock;  $.01  par  value;  450,000  shares
      authorized;  356,000  shares issued with a liquidation  preference of $.01
      per share (converted to common stock during 1995)
   Common stock, $.50 par value; 80,000,000 shares authorized;
      1,198,121 shares issued                                                              599                     599
   Capital in excess of par value                                                       53,789                  53,789
   Accumulated deficit                                                                (39,696)                (41,584)
   Unrealized gain (loss) on investment in common stock
      of parent                                                                            704                 (1,002)
   Less cost of treasury stock of 420,995 and 405,995 common
      shares at 1996 and 1995, respectively                                            (4,949)                 (4,791)
                                                                                     --------                --------

         Stockholders' Equity - net                                                     10,447                   7,011
                                                                                       -------                --------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                            $ 18,579                $ 16,465
                                                                                       =======                 =======



<FN>

                                    The     accompanying  notes are an  integral
                                            part of the financial statements.
</FN>
</TABLE>

                                                        -3-

<PAGE>

<TABLE>
<CAPTION>


                           HALLWOOD ENERGY CORPORATION
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)
                      (In thousands except per Share data)


                                                                                          For the Three Months Ended
                                                                                                September 30,
                                                                                         1996                    1995

REVENUES:
<S>                                                                                  <C>                     <C>
   Oil revenue                                                                       $     637               $     623
   Gas revenue                                                                           1,021                     842
   Acquisition fee                                                                         287                       2
                                                                                      --------              ----------
                                                                                         1,945                   1,467
                                                                                       -------                 -------

EXPENSES:
   Production operating expense                                                            356                     417
   General and administrative                                                              456                     384
   Depreciation, depletion and amortization                                                336                     456
   Interest                                                                                104                     140
                                                                                      --------                --------
                                                                                         1,252                   1,397
                                                                                       -------                 -------

OTHER INCOME:                                                                               54                     131
                                                                                     ---------                --------

INCOME  BEFORE INCOME TAXES                                                                747                     201

PROVISION FOR INCOME TAXES:
   Current                                                                                  28
   Deferred                                                                                 31
                                                                                            59

NET INCOME                                                                                 688                     201

PREFERRED STOCK DIVIDENDS                                                                                          534

NET INCOME (LOSS) FOR COMMON STOCKHOLDERS                                                  688                   (333)
                                                                                       =======               ========

NET INCOME (LOSS) PER COMMON SHARE                                                  $      .89              $    (.74)
                                                                                     =========               ========

WEIGHTED AVERAGE COMMON SHARES                                                             777                     447
                                                                                      ========                ========







<FN>

                                    The    accompanying  notes  are an  integral
                                           part of the financial statements.
</FN>

</TABLE>

                                                        -4-

<PAGE>

<TABLE>
<CAPTION>


                           HALLWOOD ENERGY CORPORATION
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)
                      (In thousands except per Share data)



                                                                                          For the Nine Months Ended
                                                                                                September 30,
                                                                                         1996                    1995

REVENUES:
<S>                                                                                    <C>                     <C>
   Oil revenue                                                                         $ 1,982                 $ 1,660
   Gas revenue                                                                           3,260                   2,332
   Acquisition fee                                                                         296                       7
                                                                                       -------               ---------
                                                                                         5,538                   3,999
                                                                                        ------                  ------

EXPENSES:
   Production operating expense                                                          1,088                   1,059
   General and administrative                                                              890                     884
   Depreciation, depletion and amortization                                              1,152                   1,297
   Impairment of oil and gas properties                                                                            464
   Interest                                                                                358                     344
                                                                                       -------                 -------
                                                                                         3,488                   4,048
                                                                                        ------                  ------

OTHER INCOME                                                                               109                     136
                                                                                       -------                 -------

INCOME BEFORE INCOME TAXES                                                               2,159                      87

PROVISION FOR INCOME TAXES:
   Current                                                                                  82                      92
   Deferred                                                                                189
                                                                                       -------
                                                                                           271                      92
                                                                                       -------                --------

NET INCOME (LOSS)                                                                        1,888                     (5)

PREFERRED STOCK DIVIDENDS                                                                                          890

NET INCOME (LOSS) FOR COMMON STOCKHOLDERS                                              $ 1,888                $  (895)
                                                                                        ======                 ======

NET INCOME (LOSS) PER COMMON SHARE                                                    $   2.40                $ (2.04)
                                                                                       =======                 ======

WEIGHTED AVERAGE COMMON SHARES                                                             785                     440
                                                                                       =======                 =======





<FN>

                                    The    accompanying  notes  are an  integral
                                           part of the financial statements.
</FN>
</TABLE>

                                                        -5-

<PAGE>

<TABLE>
<CAPTION>


                           HALLWOOD ENERGY CORPORATION
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                                 (In thousands)


                                                                                          For the Nine Months Ended
                                                                                               September 30,
                                                                                         1996                    1995

OPERATING ACTIVITIES:
<S>                                                                                    <C>                 <C>
   Net income (loss)                                                                   $ 1,888             $       (5)
   Adjustments  to  reconcile  net income  (loss) to net cash used in  operating
      activities:
         Depreciation, depletion, amortization and
            property impairment                                                          1,152                   1,761
         Equity in earnings of affiliate                                               (3,438)                 (2,208)
         Amortization of bond discount                                                                            (24)
         Deferred income tax expense                                                       189
                                                                                       -------
               Cash used in operations before working
                 capital changes                                                         (209)                   (476)

         Changes in operating assets and liabilities provided (used) cash net of
            noncash activity:
               Receivables from affiliates                                               (226)                   (158)
               Receivables - trade                                                        (51)                     (9)
               Accounts payable and accrued liabilities                                     83                     (5)
                                                                                      --------              ---------
                 Net cash used in operating activities                                   (403)                   (648)
                                                                                      -------                 -------

INVESTING ACTIVITIES:
   Additions to property                                                                  (21)                    (51)
   Property development costs                                                            (112)
   Distributions received from affiliate                                                 1,943                   2,301
   Refinance of Spraberry investment                                                     (155)
   Sale of bonds                                                                                                 1,376
   Purchase of common stock of parent                                                                            (458)
                                                                                    ----------                -------
                 Net cash provided by investing activities                               1,655                   3,168
                                                                                        ------                 -------

FINANCING ACTIVITIES:
   Payments on long-term debt                                                            (225)
   Proceeds from long-term debt                                                                                  1,200
   Dividends paid                                                                                              (2,038)
   Repurchase of common stock                                                            (158)                 (1,189)
   Repurchase of Series D preferred shares                                                                     (1,042)
                                                                                     ---------                -------
                 Net cash used in financing activities                                   (383)                 (3,069)
                                                                                       ------                 -------

INCREASE (DECREASE) IN CASH AND CASH
   EQUIVALENTS                                                                             869                   (549)

CASH AND CASH EQUIVALENTS:

BEGINNING OF PERIOD                                                                         10                     668
                                                                                       -------                 -------

END OF PERIOD                                                                          $   879                $    119
                                                                                        ======                 =======

<FN>

                                   The     accompanying  notes  are an  integral
                                           part of the financial statements.
</FN>
</TABLE>

                                                        -6-

<PAGE>



                           HALLWOOD ENERGY CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


NOTE 1 - GENERAL

Hallwood Energy Corporation ("HEC" or the "Company") is a Texas corporation
engaged  in the  development,  production  and sale of oil and  gas.  HEC is the
general partner of Hallwood Energy  Partners,  L. P. ("HEP"),  a publicly traded
Delaware  limited  partnership.  HEC  now  conducts  substantially  all  of  its
operations  through HEP.  HEP's  properties  are primarily  located in the Rocky
Mountain, Mid-Continent,  Texas and Gulf Coast regions of the United States. The
activities of HEP are conducted by HEP  Operating  Partners,  L. P. ("HEPO") and
EDP Operating, Ltd. ("EDPO").

HEC's wholly-owned  subsidiary,  Hallwood G. P., Inc., is the general partner of
EDPO. Unless otherwise  indicated,  all references to HEC in connection with the
ownership,  exploration,  development  or production  of oil and gas  properties
refer to HEC and its  proportionate  ownership of HEP. As of September 30, 1996,
HEC's parent company, The Hallwood Group Incorporated  ("Hallwood Group"),  owns
approximately 82% of the outstanding common shares of HEC.

The interim financial data are unaudited; however, in the opinion of management,
the interim data include all  adjustments,  consisting only of normal  recurring
adjustments,  necessary for a fair  presentation  of the results for the interim
periods.  These  financial  statements  should be read in  conjunction  with the
financial  statements and accompanying  footnotes included in HEC's December 31,
1995 Annual Report on Form 10-K.

Accounting Policies

Investment in HEP

HEC's  general  partner  interest in HEP  entitles it to a share of net revenues
derived  from  HEP's   properties   ranging  from  2%  to  25%,  and  HEC  holds
approximately  6.5%  of  HEP's  limited  partner  Units.  HEC  accounts  for its
ownership  of HEP using the  proportionate  consolidation  method of  accounting
whereby  HEC  records  its  proportionate  share of each of HEP's  revenues  and
expenses,  current assets,  current  liabilities,  noncurrent assets,  long-term
obligations  and fixed  assets.  HEP owns  approximately  46% of its  affiliate,
Hallwood Consolidated  Resources  Corporation  ("HCRC"),  which HEP accounts for
under the equity method.

Investment in Parent

Hallwood  Group, a public company  traded on the New York Stock  Exchange,  owns
approximately  82% of the outstanding  common shares of HEC. Hallwood Group is a
diversified   holding   company  with  interests  in  oil  and  gas,   specialty
restaurants, real estate, textile products and hotels.

From 1990 through  1995,  HEC acquired  267,709  shares  (adjusted  for Hallwood
Group's 1-for-4 reverse split) or approximately 17% of the outstanding shares of
Hallwood Group,  on the open market.  Because HEC has the ability and the intent
to hold the stock of  Hallwood  Group  indefinitely,  HEC has  recorded  it as a
long-term investment and has classified it as an available-for-sale security.

During  1991 and 1992,  HEC  acquired  $2,439,000  principal  amount of Hallwood
Group's 13.5%  Subordinated  Debentures due July 31, 2009, which it subsequently
exchanged for 7%  Collateralized  Subordinated  Debentures due July 31, 2000. On
March 29, 1995,  Hallwood Group repurchased the 7%  Collateralized  Subordinated
Debentures for $1,376,000 plus accrued  interest  through the purchase date. The
debentures were repurchased for an amount  approximately equal to their carrying
value.



                                                        -7-

<PAGE>




NOTE 2 - DEBT

During the second quarter of 1995, the Company  entered into a credit  agreement
with a bank that has  committed  to loan the  Company  up to  $1,500,000.  As of
September  30,  1996,  the Company has $900,000  outstanding  against the credit
line.  Borrowings against the credit line bear interest at the bank's prime rate
plus 2% (10.25% at  September  30,  1996).  Interest  is  payable  monthly,  and
principal  payments of $75,000 are due quarterly.  The credit line is secured by
the  Class A HEP  Units  owned  by the  Company.  The  credit  agreement  limits
aggregate dividends paid by the Company to $3.50 per share each fiscal year.


NOTE 3 - REPURCHASE OF COMMON STOCK

In May 1996, HEC purchased  15,000 shares of its common stock from an individual
in a privately negotiated transaction for $10.50 per share.


NOTE 4 - STATEMENT OF CASH FLOWS

Cash paid for interest  during the nine months ended September 30, 1996 and 1995
was $73,000 and  $34,000,  respectively.  Cash paid for income  taxes during the
nine  months  ended  September  30,  1996  and  1995 was  $54,000  and  $49,000,
respectively.


NOTE 5 - PROPERTY INTEREST ACQUISITION

On July 1, 1996, HEP and HCRC completed a transaction  involving the acquisition
from Fuel Resources Development Co., a wholly owned subsidiary of Public Service
Company of Colorado, and other interest owners of their interests in 38 coal bed
methane wells located in La Plata County,  Colorado and Rio Arriba  County,  New
Mexico.  Thirty-four  of the wells,  estimated to have  reserves of 53 BCF, were
assigned to 44 Canyon LLC ("44  Canyon"),  a special  purpose  entity owned by a
large east coast financial institution.  The wells qualify for tax credits under
Section 29 of the Internal Revenue Code. Hallwood  Petroleum,  Inc. ("HPI") will
manage and  operate the  properties  on behalf of 44 Canyon.  The $27.8  million
purchase  price  was  funded  by 44  Canyon  through  the  sale of a  volumetric
production  payment to an affiliate of Enron Capital & Trade Resources  Corp., a
subsidiary of Enron Corp.,  the sale of a  subordinated  production  payment and
certain  other  property  interests for $3.45 million to an affiliate of HEP and
HCRC, La Plata  Associates,  LLC ("LPA") and additional cash  contributed by the
owners of 44 Canyon.  LPA is owned  equally by HEP and HCRC.  As a result of the
transaction,  HEP  expects  to add 9.8  BCF of gas to its  reserve  base,  which
represents approximately 52% of its estimated 1996 production.

HEC will receive a 4% economic interest in HEP's interest in LPA in satisfaction
of the  acquisition  fee payable to HEC. The  assignment  of this  interest will
result in the  addition  of  approximately  400,000  mcf of gas to HEC's  direct
reserve  base.  HEC also  received a cash  acquisition  fee of $284,000 for this
acquisition.


NOTE 6 - LEGAL PROCEEDINGS

In June 1996,  HEP and the other  parties  to the  lawsuits  styled  Lamson
Petroleum  Corporation v. Hallwood Petroleum,  Inc. et al. settled the lawsuits.
The plaintiffs in the lawsuits  claimed they had valid leases  covering  streets
and roads in the units of the A. L.  Boudreaux #1 well, G. S. Boudreaux #1 well,
Paul Castille #1 well,  Evangeline  Shrine Club #1 well and Duhon #1 well, which
represented approximately .4% to 2.3% of HEP's interest in these properties, and
they were  entitled to a portion of the  production  from the wells  dating from
February 1990. In the settlement,  HEP and the plaintiffs agreed to cross-convey
interests in certain leases to one another, and HEP agreed to pay the plaintiffs

                                                        -8-

<PAGE>



$728,000.  HEP has not recognized  revenue  attributable to the contested leases
since January 1993. These revenues plus accrued interest, totaling $506,000, had
been placed in escrow  pending the  resolution of the  lawsuits.  HEC's pro rata
share of the excess of the cash paid over the escrowed  amounts,  is included in
other  income  (expense)  in  the   accompanying   financial   statements.   The
cross-conveyance  of the  interests  in the leases  will result in a decrease in
HEP's reserves of $374,000 in future net revenues, discounted at 10%.


NOTE 7 - SUBSEQUENT EVENT

During  October  1996,  HEC entered into a Merger  Agreement  providing  for the
merger of HEC into Hallwood Group. On October 15, 1996, Hallwood Group commenced
a tender offer for all the outstanding  shares of common stock of HEC at a price
of $19.50 per share.  Hallwood  Group  currently owns  approximately  82% of the
outstanding  common  shares  of  HEC.  The  completion  of the  merger  will  be
conditioned on the valid tender of a majority of the shares of HEC not currently
held by Hallwood Group.


ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
            AND RESULTS OF OPERATIONS

Liquidity and Capital Resources

Financing

During the second quarter of 1995, the Company  entered into a credit  agreement
with a bank that has  committed  to loan the  Company  up to  $1,500,000.  As of
September  30,  1996,  the Company has $900,000  outstanding  against the credit
line.  Borrowings against the credit line bear interest at the bank's prime rate
plus 2% (10.25% at  September  30,  1996).  Interest  is  payable  monthly,  and
principal  payments of $75,000 are due quarterly.  The credit line is secured by
the HEP  Class  A Units  owned  by the  Company.  The  credit  agreement  limits
aggregate dividends paid by the Company to $3.50 per share each fiscal year.

Included in the  accompanying  balance sheet at September 30, 1996 are long-term
obligations of affiliate of $4,649,000  which represents HEC's pro rata share of
the  long-term  obligations  of HEP. The  long-term  obligations  of HEP consist
primarily of $26,700,000 borrowed under a line of credit and $8,571,000 borrowed
under a note purchase agreement. HEP's borrowings are secured by a first lien on
approximately 80% in value of HEP's oil and gas properties.

Development Projects and Acquisitions

In the first nine months of 1996, HEC through its interest in the Saxon Drilling
Venture,  participated  in drilling or  recompleting  fourteen  wells in Winkler
County, Texas. Total net cost to HEC is approximately $100,000.  Effective April
1,  1996,  HEC  repaid  its share of the loan  provided  to  Hallwood  Spraberry
Drilling Company,  L.L.C. ("HSD") by an outside third party. The net cost to HEC
was approximately  $176,000,  and HEC now has direct ownership of an interest of
approximately 2% in the Rocker "b" Ranch properties.

In the second quarter of 1996, HEC repurchased 15,000 shares of its common stock
from an individual in a privately negotiated transaction for $10.50 per share.

HEC  had  no  other  material  property  acquisitions,   sales,  exploration  or
development  activity  during the first nine months of 1996.  A summary of HEP's
significant property transactions follows.


                                                        -9-

<PAGE>




Through September 30, 1996, HEP incurred approximately $441,000 for the purchase
of shares of Hallwood Consolidated Resources Corporation ("HCRC") and $9,505,000
for  exploration,  development  and  acquisition  costs  toward the revised 1996
capital budget of $12,700,000.  The expenditures were comprised of approximately
$6,838,000  for  exploration  and  development  expenditures  and  approximately
$2,667,000 for property acquisitions.  A description of significant  exploration
and development projects to date in 1996 follows.

During the second quarter of 1996,  HEP purchased  12,965 shares of HCRC for $34
per share.  The shares were  originally  purchased by HCRC in connection with an
odd lot  repurchase  offer and then were resold to HEP at the price paid by HCRC
for such shares.

HEP continues to devote capital resources to the West Texas Kermit area in 1996.
HEP drilled or participated in the drilling of fourteen wells, thirteen of which
were  successful,  and participated in four  recompletions,  three of which were
successful,  in the first nine months of 1996, for a total cost of approximately
$1,100,000.  The wells in this area are currently  producing  approximately  700
gross equivalent  barrels of oil per day. HEP's interest in these wells averages
27%. HEP plans to drill or recomplete up to nine additional wells by year end.

HEP  acquired 106 square miles of three  dimensional  (3-D)  seismic data on the
Cowden Ranch in Crane  County,  Texas.  The prospect will be operated by a major
oil company, and HEP has a 12.5% working interest.  HEP's share of costs to date
is $455,000.  Seismic interpretation was recently completed, and two exploratory
wells are planned for the fourth quarter of 1996,  with  additional  exploratory
activity to follow in 1997.

HEP  acquired 3-D seismic  data and related  acreage in the Merkel  Project Area
which  covers  18 square  miles in Jones,  Taylor  and  Nolan  Counties,  Texas.
Expenditures  in the first nine months of 1996 totaled  $567,000.  Thus far, HEP
has  participated  in drilling  five wells on four  exploration  prospects for a
total cost of $135,000,  including  one well  drilled in late 1995.  Four of the
wells are each  producing at average  rates of 70 gross  barrels of oil per day,
two of the wells  encountered  multiple pay zones but only one zone is currently
producing and one well was  unsuccessful.  HEP's interest in the wells is 12.5%.
Two wells are  planned  for the fourth  quarter of 1996,  and an  additional  10
prospects  will be tested in 1997 and beyond.  An  additional 74 square miles of
3-D seismic data, which is presently being interpreted, was acquired in the same
area.  HEP's  working  interest  in  this  area  averages  27.5%,  and  prospect
exploratory  drilling will begin in the first quarter of 1997.  Preliminary work
indicates as many as 25 wells may be drilled.

HEP  participated in the drilling of two nonoperated  wells in Williams  County,
North  Dakota in the latter part of 1995 and the first  quarter of 1996,  one of
which was dry and the other  only  marginally  successful,  for a total  cost of
approximately  $300,000.  HEP also drilled an  exploratory  dry hole in Richland
County,  Montana,  at a cost of $150,000.  HEP completed an Interlake  Formation
development  well,  drilled in the second  quarter,  at a cost of  approximately
$535,000. This well is currently producing at a rate of 130 gross barrels of oil
per day, and HEP's interest is 45%.

HEP incurred approximately $230,000 in the first quarter, net to HEP's interest,
for four  recompletions  and one drilled  well in the Rocker "b" Ranch in Reagan
County,  Texas.  This  activity has  increased  HEP's share of  production by 44
equivalent  barrels of oil per day. During the first quarter,  HEP also acquired
interests  in five  additional  producing  leases on the  Rocker "b" Ranch for a
total of $93,000. In the second and third quarters of 1996, HEP recompleted five
wells,  four of which were  successful,  and drilled one  additional  well for a
total cost of $230,000.  This activity increased HEP's share of production by 57
equivalent  barrels of oil per day.  HEP has plans to  recomplete  at least five
more wells  before  year end and will  consider  other  work,  if the capital is
available.  Exploitation in this area is expected to slow toward the end of 1997
as HEP's undeveloped acreage position declines.

In the San Juan Basin area of  Colorado,  HEP,  through  an  affiliate  La Plata
Associates  L L C  ("LPA"),  acquired  interests  in 34 coal bed  methane  wells
located in La Plata County, Colorado for $1,734,000. HEP's interest in the wells
is  expected  to add  9.8  bcf of gas to  its  reserve  base,  which  represents
approximately  52%  of  its  estimated  1996  production.  The  acquisition  was
completed on July 1, 1996. Seven refracs/recompletions have been completed since
July  1 at  a  net  cost  to  HEP  of  approximately  $300,000.  Numerous  other
recompletions and facility projects are planned for the

                                                       -10-

<PAGE>



remainder of 1996 at an estimated net cost to HEP of $490,000.  Gross production
has increased by 2,500 mcf of gas per day as a result of the work done thus far.
Similar  activity  levels  in 1997  are  anticipated  on  these  newly  acquired
properties.  In other parts of the New Mexico portion of the San Juan Basin, HEP
has recompleted three wells, two of which were successful, drilled two wells and
is converting  another well to be a disposal  well. The total cost for this work
was $497,000,  and  production  has increased by 2,000 mcf of gas per day. HEP's
share of this production is approximately 50%.

HEP participated in a 13 square mile 3-D seismic shoot at the Packsaddle Project
in the Big Horn Basin of Wyoming. The data is now being processed and additional
development  and  exploration is expected in the area  following  HEP's previous
discovery. HEP's ownership in the Big Horn Basin continues to increase through a
joint venture  created to evaluate a 4,000 mile 2-D Seismic Data Base from which
HEP hopes to create additional drillable prospects.

In September,  HEP spent $225,000 for a recompletion of the A. L. Boudreaux well
into a  shallower  interval  of the  Bol  Mex 3  Formation  after  the  previous
completion  in the  Bol  Mex 3  Formation  began  to  produce  water  and  sand.
Production  after the  recompletion is currently 22 mmcf per day and 450 barrels
of condensate per day.

Numerous other  projects,  which are  individually  less  significant  have been
completed or are underway in Kansas, Louisiana,  Texas and New Mexico, including
participation in five other 3-D seismic data  acquisition  programs not included
in the above activity.

Property Sales

During the first quarter of 1996, HEP received approximately  $1,300,000 for the
sale of its  interests in the Hoople  Field in Crosby  County,  Texas.  HEP also
received  another  $88,000 in early  April for the sale of various  nonstrategic
properties at auction.  In June 1996, HEP completed the sale of its interests in
the Bethany  Longstreet  area of  Louisiana  (approximately  575,000  equivalent
barrels of oil,  measured  using  December 31, 1995  pricing) for  approximately
$3,800,000.

HEP Distributions

HEP declared a limited  partner  distribution  of $.13 per Class A Unit and $.25
per Class C Unit and a general  partner  distribution  of $510,000 for the third
quarter of 1996,  payable on November 15, 1996.  The total of the  distributions
receivable  by HEC is  $588,000,  which has been  accrued  in  receivables  from
affiliates at September 30, 1996.

Cautionary Statement Regarding Forward-Looking Statements

In the interest of providing the Company's  stockholders and potential investors
with certain  information  regarding the Company's  future plans and operations,
certain  statements  set forth in this Form 10-Q relate to  management's  future
plans and objectives.  Such statements are  "forward-looking  statements" within
the meaning of Section 27A of the  Securities  Act of 1933,  as amended,  and in
Section 21E of the  Securities  Exchange Act of 1934,  as amended.  Although any
forward-looking statements contained in this Form 10-Q or otherwise expressed by
or on behalf of the Company  are, to the  knowledge  and in the  judgment of the
officers and  directors  of the  Company,  expected to prove true and to come to
pass,  management  is not able to predict  the future with  absolute  certainty.
Forward-looking  statements  involve known and unknown  risks and  uncertainties
which may cause the Company's actual performance and financial results in future
periods to differ materially from any projection, estimate or forecasted result.
These risks and uncertainties include, among other things, volatility of oil and
gas prices, competition, risks inherent in the Company's oil and gas operations,
the  inexact  nature of  interpretation  of  seismic  and other  geological  and
geophysical  data,  imprecision of reserve  estimates,  the Company's ability to
replace and expand oil and gas reserves,  and such other risks and uncertainties
described from time to time in the Company's  periodic  reports and filings with
the Securities and Exchange Commission. Accordingly,  stockholders and potential
investors are cautioned that certain events or circumstances  could cause actual
results to differ materially from those projected, estimated or predicted.


                                                       -11-

<PAGE>



Results of Operations

The  following  table is presented to contrast  HEC's average oil and gas prices
and  production.  Significant  fluctuations  are  discussed in the  accompanying
narrative.

<TABLE>
<CAPTION>

                                                      Oil and Gas Prices and Production
                                                       (In thousands except for price)
                                    For the Three Months                              For the Nine Months
                                    Ended September 30,                              Ended September 30,
                                    --------------------                             -------------------
                               1996                     1995                    1996                     1995
                               -----                    -----                   -----                    ----
                            Oil          Gas         Oil          Gas         Oil         Gas          Oil         Gas
                           (bbl)        (mcf)       (bbl)        (mcf)       (bbl)       (mcf)        (bbl)       (mcf)
<S>                       <C>          <C>         <C>          <C>         <C>         <C>          <C>         <C>
Average price             $21.97       $ 2.34      $17.80       $ 1.88      $19.62      $ 2.39       $17.11      $ 1.75
Production                    29          436          35          449         101       1,364           97       1,329
</TABLE>

Quarter Ended September 30, 1996 Compared to Quarter Ended September 30, 1995

Oil Revenue

Oil revenue  increased $14,000 during the third quarter of 1996 as compared with
the third  quarter of 1995.  This  increase is  comprised  of an increase in oil
prices  from  $17.80 per  barrel in 1995 to $21.97 per barrel in 1996  partially
offset by a decrease in production from 35,000 barrels in 1995 to 29,000 barrels
in 1996.  The decrease in oil  production is primarily due to normal  production
declines.

Gas Revenue

Gas revenue increased $179,000 during the third quarter of 1996 as compared with
the third  quarter of 1995  primarily  as a result of an increase in average gas
prices  from  $1.88  per mcf in 1995 to  $2.34  in 1996  partially  offset  by a
decrease in  production  from  449,000  mcf in 1995 to 436,000 mcf in 1996.  The
decrease in gas production is primarily due to normal production declines.

Acquisition Fee

The  acquisition  fee earned in 1996 and 1995  relates to property  acquisitions
made by HEP. The fee  increased  during the third quarter of 1996 as compared to
the third quarter of 1995 due to the property interest acquisition  described in
Item 1 - Note 5.

Production Operating Expense

Production  operating expense decreased $61,000 during the third quarter of 1996
as  compared  with the third  quarter of 1995.  The  decrease is  primarily  the
production decrease described above.



                                                       -12-

<PAGE>



General and Administrative Expense

General  and   administrative   expense   includes  costs  incurred  for  direct
administrative  services  such as legal and  audit  fees,  as well as  allocated
internal overhead incurred by Hallwood Petroleum,  Inc. ("HPI"), an affiliate of
HEC, which manages and operates certain oil and gas properties on behalf of HEC,
HEP and their affiliates. These costs increased $72,000 during the third quarter
of 1996 as compared to the third  quarter of 1995,  primarily due to an increase
in Directors' and Officers'  insurance costs as well as an increase in allocated
internal overhead.

Depreciation, Depletion and Amortization

Depreciation,  depletion and amortization  expense decreased $120,000 during the
third quarter of 1996 as compared  with the third quarter of 1995.  The decrease
is primarily due to lower capitalized costs in 1996.

Interest Expense

Interest expense  decreased $36,000 during the third quarter of 1996 as compared
with the third  quarter  of 1995 as a result of lower  outstanding  debt  during
1996.

Other Income

Other income  consists  primarily of HEC's direct  interest  income,  as well as
HEC's share of HEP's  interest  income,  facilities  income  from two  gathering
systems in New Mexico,  pipeline  revenue,  equity in income (loss) of affiliate
and  miscellaneous  income or expense.  The decrease of $77,000 during the third
quarter of 1996 as compared with the third quarter of 1995 is primarily due to a
decrease  in  HEP's  equity  in  earnings  of  affiliate  due to an  income  tax
adjustment  during 1995.  The remaining  decrease is comprised of numerous other
items, none of which are individually significant.

First Nine Months of 1996 Compared to First Nine Months of 1995

The  comparisons  for the first nine months of 1996 and the first nine months of
1995 are consistent  with those  discussed in the third quarter of 1996 compared
to the third quarter of 1995 except for the following:

Oil Revenue

Oil revenue increased  $322,000 during the first nine months of 1996 as compared
with the first nine  months of 1995 due to an increase in oil prices from $17.11
per barrel in 1995 to $19.62 per barrel in 1996 combined with an increase in oil
production  from  97,000  barrels  in 1995  to  101,000  barrels  in  1996.  The
production  increase  is due to  increased  production  from  developmental  and
exploratory  drilling  projects  in Montana,  Wyoming  and West Texas  partially
offset by normal production declines.

Gas Revenue

Gas revenue increased  $928,000 during the first nine months of 1996 as compared
with the same period in 1995 due to an increase in gas prices from $1.75 per mcf
in 1995 to $2.39 in 1996 combined with an increase in production  from 1,329,000
mcf in 1995 to  1,364,000  mcf in 1996.  The  increase in  production  is due to
increased  production from  developmental  and exploratory  drilling projects in
Montana, Wyoming and West Texas partially offset by normal production declines.

Production Operating Expense

Production  operating  expense increased $29,000 during the first nine months of
1996 as compared  with the first nine months of 1995  primarily due to increased
production  taxes  and  operating  expenses  associated  with  the  increase  in
production discussed above.

                                                       -13-

<PAGE>



Impairment of Oil and Gas Properties

Impairment  of oil and gas  properties  for the nine months ended  September 30,
1995,  represents  HEC's pro rata  share of the  write-off  of HEP's  Indonesian
operations.

Interest Expense

Interest  expense  increased  $14,000  during the first  nine  months of 1996 as
compared  with the first nine months of 1995 as HEC had  outstanding  borrowings
for nine months in 1996 and for five months in 1995.

                                                       -14-

<PAGE>



PART II -      OTHER INFORMATION


ITEM 1  -      LEGAL PROCEEDINGS

               Reference  is made to Item 8 - Note 12 of Form  10-K for the year
               ended December 31, 1995, and Item 1 - Note 4 of this Form 10-Q.


ITEM 2  -      CHANGES IN SECURITIES

               None.


ITEM 3  -      DEFAULTS UPON SENIOR SECURITIES

               None.


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

               None.


ITEM 5  -      OTHER INFORMATION

               None.


ITEM 6  -      EXHIBITS AND REPORTS ON FORM 8-K

               None.

                                                       -15-

<PAGE>


SIGNATURE

Pursuant  to the  requirements  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.


                           HALLWOOD ENERGY CORPORATION


Date: November 12 , 1996                    By: /s/Robert S. Pfeiffer
     ------------------------                   ----------------------
                       Robert S. Pfeiffer, Vice President
                                                     (Chief Financial Officer)



Document: P:\DOC\HECQ1.DOC
                                                       -16-

<PAGE>