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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                                    FORM 10-K

(Mark one)

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

             For the fiscal year ended December 31, 2002

                                       OR

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

             For the transition period from __________ to __________

                         Commission File Number 0-15472

                         ENVIRONMENTAL POWER CORPORATION
             (Exact name of registrant as specified in its charter)

            Delaware                                      04-2782065
(State or other jurisdiction of                (IRS Employer Identification No.)
incorporation or organization)

         One Cate Street, Fourth Floor, Portsmouth, New Hampshire 03801
                    (Address of principal executive offices)
                                   (Zip code)

       Registrant's telephone number, including area code: (603) 431-1780

           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $.01 par value

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 or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
Form 10-K. [X]

The aggregate market value of voting stock (common stock, $.01 par value) held
by non-affiliates, computed by reference to the closing price of such stock, was
$4,526,317 on June 28, 2002.

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).

Yes    [ ]         No     [X]

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the last practicable date: On March 19, 2003 there were
21,791,279 outstanding shares of Common Stock, $.01 par value, of the
registrant.

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                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be filed with the Securities and
Exchange Commission and delivered to shareholders in connection with the 2003
Annual Meeting of Shareholders are incorporated by reference into Part III of
this Annual Report filed on Form 10-K. The portions of the Proxy Statement under
the headings "Audit Committee Report", "Report of the Compensation Committee"
and the "Stock Performance Graph" are not incorporated by reference and are not
a part of this Form 10-K Report.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
DESCRIPTION OF CONTENTS                                                          PAGE #
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<S>                                                                                <C>
PART I:

Item 1.  Business                                                                  3
Item 2.  Properties                                                                17
Item 3.  Legal Proceedings                                                         17
Item 4.  Submission of Matters to a Vote of Security Holders                       17
Item 4A. Executive Officers of the Registrant                                      18

PART II:

Item 5.  Market for Registrant's Common Equity and Related Shareholder Matters     19
Item 6.  Selected Financial Data                                                   21
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations                                                             22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk                44
Item 8.  Financial Statements and Supplementary Data                               44
Item 9.  Disagreements on Accounting and Financial Disclosure                      45

PART III:

Item 10. Directors and Executive Officers                                          45
Item 11. Executive Compensation                                                    45
Item 12. Security Ownership of Certain Beneficial Owners and Management            45
Item 13. Certain Relationships and Related Transactions                            46

PART IV:

Item 14. Controls and Procedures                                                   46
Item 15. Index to Financial Statements, Exhibits, and Reports on Form 8-K          46
Signature Page                                                                     54
</TABLE>

                              CAUTIONARY STATEMENT
This Annual Report on Form 10-K contains "forward-looking statements," as
defined by the Private Securities Litigation Reform Act of 1995, in order to
provide investors with prospective information about us. For this purpose, any
statements that are not statements of historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, the words
"believes," "anticipates," "plans," "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of important
factors that could cause our actual results to differ materially from those
indicated by the forward-looking statements. These factors include, without
limitation, those set forth below under the caption "Item 7. - Certain Factors
That May Affect Future Results."

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                                     PART I

ITEM 1.  BUSINESS

Environmental Power Corporation, known as EPC, is an independent developer and
owner of electrical generating facilities powered by non-commodity fuels and
renewable energy sources. Our power generating facilities use alternative fuels,
most of which are wastes, which are generally not subject to the same cost
fluctuations as traditional fuels. Our power generating facilities have also
been able to exceed air quality emission standards and to assist with the
clean-up of wastes that are sources of water pollution. Accordingly, we have
realized financial benefits, such as tax-exempt financing and sales of pollution
allowances from the pollution control benefits of our facilities.

Since our founding in 1982, we have partially or fully developed seven
hydroelectric plants, two municipal waste projects and three waste-coal fired
generating facilities. We sold all but one of these projects as follows:

     .    We sold four hydropower projects during their development phases;

     .    We transferred rights to two municipal waste projects during their
          development phases;

     .    We sold three hydropower facilities after completion;

     .    We sold, during development, a 43 megawatt (net) waste-coal fired
          facility located in Pennsylvania known as the Milesburg Project;

     .    We sold, after completion in 1994, a 51 megawatt (net) waste-coal
          fired facility located in Utah known as the Sunnyside Project; and

     .    We sold, during development, an approximate 83 megawatt (net)
          waste-coal fired facility located in Pennsylvania known as the
          Scrubgrass project. Buzzard Power Corporation, our subsidiary,
          currently owns a 22-year leasehold interest in this project.

In 2001, we acquired all of the common stock of Microgy Cogeneration Systems
Inc., a privately held Colorado company. We operate Microgy as a subsidiary.
Microgy holds an exclusive license in North America for development and
deployment of a proprietary technology for extraction of methane gas from animal
wastes and its use to fuel generation of energy. EPC is currently in the process
of marketing and developing opportunities for sale and development of this
technology.

Our ongoing business activities are discussed further in the following sections.

BUZZARD POWER CORPORATION

Buzzard leases the Scrubgrass project from Scrubgrass Generating Company, L.P.
The Scrubgrass project, located on a 600-acre site in Venango County,
Pennsylvania, is an approximate 83 megawatt waste coal-fired electric generating
station.

Buzzard's lease commenced on June 30, 1994 and provides for a term of 22 years
with a renewal option for up to 3 years. Under the lease, Scrubgrass Generating
Company assigned to Buzzard all principal project agreements and its rights and
obligations under such contracts including:

     .    power purchase agreement;
     .    management services agreement;

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     .    operating and maintenance agreement;
     .    limestone supply agreements;
     .    ground lease agreements;
     .    fuel agreements;
     .    transportation; and
     .    materials handling agreements.

We have pledged Buzzard's common stock to the Scrubgrass Generating Company as
security for Buzzard's performance of its obligations as lessee. PG&E National
Energy Group, a wholly owned indirect subsidiary of NEG, Inc., which in turn is
a wholly owned indirect subsidiary of PG&E Corporation, manages the Scrubgrass
project under a Management Services Agreement.

PG&E Operating Services Company, or PG&E OSC, also a wholly owned indirect
subsidiary of NEG, Inc., operates the plant under a 15-year Operating and
Maintenance Agreement. PG&E OSC prepares a budget for all operating expenses,
including a fixed management fee, and certain targeted output performance
levels. Under the operating agreement, PG&E OSC may be liable for an amount not
to exceed its management fee if it does not achieve certain targeted output
performance levels.

Buzzard sells all of its electric output to Pennsylvania Electric Company, known
as Penelec, a subsidiary of FirstEnergy Group, under a twenty-five year power
sales agreement, which commenced in June 1993. Under this contract, except for
amounts sold above certain hourly and annual limits, all power is sold at fixed
rates which initially averaged 4.68 cents per kilowatt hour and escalated by 5%
annually through 2004. For years 2005 through 2012, the agreement provides for a
rate equal to the greater of a scheduled rate, as adjusted to reflect actual
inflation during the contract term compared to the prior 5% annual adjustment,
or a rate based on the PJM Billing Rate. The PJM Billing Rate is the monthly
average of the hourly rates for purchases by the FirstEnergy Group from, or sale
to, the Pennsylvania-New Jersey-Maryland Interconnection. For years 2013 through
2015 and 2016 through 2018, if Buzzard exercises the renewal term option, terms
of the power purchase agreement applicable during these prospective periods will
apply. The agreement provides for a rate equal to the lower of the average
monthly PJM Billing Rate or the rate paid for calendar year 2012 adjusted
annually by the percentage change in the Gross National Product Deflator less
one percent.

In early 2000, we resolved a protracted legal proceeding with Penelec. The
proceeding, among other issues, involved Penelec's unwillingness to pay contract
rates for power in excess of 80 megawatts produced by the Scrubgrass project. On
March 24, 2000, Penelec paid the outstanding balances due under a settlement
agreement of $3,687,000 for previous deliveries of electric energy plus $608,000
in interest. We reported these revenues in our 2000 consolidated financial
statements. Penelec also agreed to pay for all future net deliveries of electric
energy at the rates set forth in the power sales agreement, subject to, among
other conditions, certain annual and hourly limits, with energy purchased in
excess of such limits paid for at a market based rate. To date, these limits
have not materially affected our revenues.

Buzzard deposits all revenues earned under the power sales agreement into an
account administered by a disbursement agent. Before Buzzard can receive cash
from the operation of the Scrubgrass project, Buzzard must first satisfy all
operating expenses, base lease payments, restricted cash deposits, and other
subordinated obligations. Buzzard's base lease payments consist of Scrubgrass
Generating Company's debt service, equity repayment, base return on equity and
related expenses. Buzzard must also pay to Scrubgrass Generating Company
additional rent of 50 percent of the net cash flows Buzzard receives from the
operation of the Scrubgrass project. We are not required to fund Buzzard's
operating losses, or otherwise invest further from sources outside of the
Scrubgrass project.

The debt obligations for Scrubgrass Generating Company and Buzzard are described
below:

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<TABLE>
<CAPTION>
                                            BALANCE AT         BALANCE AT
     DESCRIPTION OF THE OBLIGATION           12/31/02           12/31/01       INTEREST RATE      MATURES
--------------------------------------- ------------------ ----------------- ------------------  -----------
<S>                                         <C>               <C>            <C>                   <C>
BUZZARD'S LEASE OBLIGATIONS:
Variable rate tax-exempt bonds              $ 135,600,000     $ 135,600,000  Quoted Bond Rates     2012
Swap rate term loan                             8,700,913        10,669,663  7.6725%               2005
Variable rate term loan                         7,089,016         8,344,479  LIBOR + 1.250%        2004
BUZZARD'S DEBT OBLIGATIONS:
 Variable rate term loan                          837,437           985,747  LIBOR + 1.250%        2004
 Working capital loan                             517,112         1,116,905  LIBOR + 1.250%        2008
</TABLE>

Scrubgrass Generating Company or Buzzard pays interest on these obligations at
either quoted rates for tax-exempt debt, rates fixed by swap agreements for
taxable debt, or rates for taxable debt which are based on the London Interbank
Offering Rate, or LIBOR. On December 22, 1995, Scrubgrass Generating Company
entered into an interest rate swap arrangement that fixed the LIBOR component
for the life of its swap rate term loan at 6.4225%. As a result, the interest
rate for the swap rate term loan was fixed at 7.5475% through 2001 and at
7.6725% for its remaining term. Under the terms of the loan agreements, we are
subject to various customary financial and operating covenants. As of December
31, 2002 and 2001, we complied with all such covenants.

The Environmental Protection Agency and the Pennsylvania Department of
Environmental Protection granted Nitrogen Oxide Ozone Transport Region Budget
Allowances, or NOx Credits, to Buzzard based on factors that primarily pertain
to the design and operation of the Scrubgrass project. Buzzard is required
annually to maintain NOx Credits that equal or exceed the quantity of its
nitrogen oxide emissions during a seasonal period known as an ozone season. If
the Scrubgrass plant's nitrogen oxide emissions exceed its available NOx
Credits, Buzzard would be subject to fines by such agencies. During 1999,
Buzzard installed machinery, costing $811,568, which has significantly reduced
its nitrogen oxide emissions. Accordingly, we anticipate that Buzzard may not
require a portion of its future NOx Credits to comply with the applicable
regulations. NOx Credits are transferable and marketable. Buzzard has sold and
may sell, from time to time, its projected excess NOx Credits or purchase
additional NOx credits that are necessary to meet the applicable regulations. To
date, we have entered into several agreements to sell and purchase, when
necessary, NOx credits. We recognized net proceeds from these NOx Credit
transactions of $2,428,200 in 2002, $0 in 2001, $1,156,338 in 2000 and $606,960
in 1999, which were reported as other income in our accompanying consolidated
financial statements. The sale in 2002 was for NOx emission credits for the 2002
through 2007 ozone seasons.

As discussed in Item 7 of this report, we are pursuing the potential sale of
Buzzard. Any such sale could generate cash to support operations, pay certain
liabilities and provide working capital, including to help fund development of
our Microgy business. There can be no assurance that such efforts will result in
a completed sale transaction on terms deemed acceptable by Environmental Power.

MICROGY COGENERATION SYSTEMS

In 2001, we acquired all of the common stock of Microgy Cogeneration Systems
Inc., a privately held development-stage company based in Colorado. Microgy
holds an exclusive license in North America for the development and deployment
of a proprietary technology for the extraction of methane gas from animal wastes
and its use to fuel generation of energy. Microgy's product is expected to
provide certain farms, known as concentrated animal feeding operations, or
CAFO's, with a potentially profitable means of mitigating an existing waste
management problem that affects both water and air quality. Federal and State
agencies either have or may be in the process of passing regulations that
require CAFO's to implement changes to their current waste management practices.

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While Microgy is seeking to help farmers meet their waste management needs, we
are also seeking to produce renewable energy. Many states have either passed or
may be in the process of promulgating legislation requiring utilities to obtain
a certain percentage of their power from renewable sources. This positions
Microgy as a potentially profitable solution to farmers' waste management
problems, while at the same time providing a new renewable energy source for
utilities. We believe that Microgy represents a substantial portion of the
future potential growth of Environmental Power and, as such, we are investing
substantially all our available resources, both financial and human capital, to
take advantage of these opportunities.

ANAEROBIC DIGESTER LICENSE AGREEMENT

The licensor of the anaerobic digester technology is Danish Biogas Technology
A/S, or DBT. DBT is 50% owned by Schouw & Co., a Danish public company. On May
12, 2000, Microgy entered into a revised licensing agreement with DBT which
granted Microgy a perpetual and exclusive license in certain territories,
specifically North America, for use of certain proprietary technologies in its
facilities, including the anaerobic digestion technology. This agreement
superseded previous license agreements.

As part of the agreement, DBT will own a 5% minority equity stake in any legal
entity that owns any project developed by Microgy using the enhanced anaerobic
digester technology and in which Microgy holds an equity position. The agreement
also specifies a fixed payment amount per project to DBT for engineering work
and construction drawings and a licensing fee that is based on a percentage of
the total cost for each project facility where the licensed technology is
installed and operating. A monthly consulting fee will be paid to DBT upon
commercial operation of proposed projects.

Currently, we are in the process of renegotiating with DBT in an effort to
eliminate the monthly consulting fees and DBT's ownership rights in favor of
higher initial design, engineering and royalty payments.

PROPOSED PROJECTS

Microgy plans to develop projects based upon the anaerobic digestion technology
license. Our present business strategy anticipates the outright sale of
facilities; however, we expect that, in some circumstances, we may own some or
even a majority of projects. In addition to any ownership position Microgy may
have, it presently plans to manage and may operate any such proposed facilities.
We anticipate these facilities will deliver renewable energy for supply to the
utility grid and will provide certain pollution control benefits to the
agricultural markets. The ultimate opportunity to develop such projects and/or
to sell these facilities to others, as well as to manage and/or operate them
profitably, depends on factors including the value which can be derived from the
energy and agricultural markets discussed below.

POWER SALES AGREEMENTS

On March 18, 2003, Microgy entered into a power sales agreement with Wisconsin
Public Service Corporation, originally signed on March 21, 2002, which has been
amended and restated. Under the agreement, Microgy may sell up to 15 megawatts
of peak power to Wisconsin Public Service from numerous biogas generation
facilities. The agreement also provides for the sale to Wisconsin Public Service
of the environmental credits derived from a portion of the generation of energy
at the facilities. The term of the agreement is 15 years from the date of the
amended and restated agreement with a five-year option to extend by Wisconsin
Public Service. The yet-to-be developed facilities would be located at various
dairy farms and other agricultural facilities and provide renewable energy
created from agricultural waste.

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Microgy/EPC has also signed memoranda of understanding with Vermont Public Power
Supply Authority, or VPPSA and Dairyland Power Cooperative, or DPC. VPPSA
located in Waterbury Vermont provides wholesale power to municipals and
cooperatives in New England. The VPPSA memorandum of understanding outlines a
relationship where we will develop, construct, interconnect, start up and
operate projects in the New England and New York regions and after successful
testing sell these projects to VPPSA. DPC located in La Crosse Wisconsin
provides wholesale electric power to 25 electric distribution cooperatives and
20 municipal electric systems in Wisconsin, Minnesota, Iowa, Illinois and
Michigan. The DPC memorandum of understanding outlines a relationship where we
will develop, construct, interconnect, start up and operate projects. We will
sell all or part of the digester component of each project to the host farm or
others. DPC will purchase the generating components of each project and contract
with the host farm to purchase biogas produced by the digester components as a
renewable fuel.

COMMODITY ELECTRICITY

The market for traditional commodity electricity, while national in scope has
regional variations in pricing. Variations are due to generating and
transmission capacity, regional production costs, and demand within those
regions. In general, however, prices were generally flat or declining over the
period between 1990 and 2000. Further, between 1990 and 2000, as the market has
moved increasingly toward trading electricity as a commodity, it was marked by
increased volatility. In many markets during 2000, there were very high prices
during certain times for peak period electricity. Peak periods are customarily
defined as the sixteen-hour period encompassing the daytime hours, Monday
through Friday. During 2002 and 2001, the slower economy and lower cost of
conventional fuels used for power generation have brought prices substantially
lower. We expect the near-term market for commodity electricity to remain very
price competitive with upward pressure on prices dependent upon increased costs
of fuels used for electric generation. If and when the economy becomes more
robust and consumption of energy increases, there are likely to be increases in
conventional fuel prices as well as geographical areas within the United States
which will need increased capacity to service demand. Prices will likely
increase accordingly.

For 2003, the U.S. Department of Energy, or DOE, projects increasing prices for
natural gas, which is considered the most influential fuel in determining the
market price of commodity electricity. If such projections prove to be accurate
and commodity electricity prices do increase, the output from any facilities
developed by Microgy will be increasingly price competitive and potentially more
profitable. This should also make it easier for us to attract and execute new
opportunities to develop these projects.

RENEWABLE PEAK PERIOD ELECTRICITY

We plan to develop facilities that serve the market for renewable energy
delivered during peak usage periods. We intend this combination of renewable
energy and peak period delivery to position our output into the highest priced
segments of the electricity markets. During peak periods there is the greatest
use and demand for electricity. Natural gas is the principal fuel source for
generating commodity electricity on a peaking basis. Except for oil, which is
seldom now used, generation from most other fuels is not readily adaptable to
peak period operation. Microgy's anaerobic digestion technology produces biogas
from the processed manure that, like natural gas, can be stored and used to
generate power during peak periods. We believe that Microgy's technology offers
us a valuable generating capability, namely, the ability to produce renewable,
peak energy.

The demand for renewable power in the energy markets is driven largely by
consumer desire for such power and by state legislation. Surveys of electric
customers throughout the United States have shown that a large percentage of
individuals would be willing to pay premiums to purchase renewable energy. These
preferences have resulted in green pricing programs in many local energy
markets. Many states

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and local governments have further encouraged the growth of renewables through
tax incentives and by requiring utilities to offer customers electricity derived
from renewable sources and/or to generate or purchase a small portion of their
electricity from renewable energy providers. Presently, the United States
Congress is considering proposed legislation that would add significant tax
benefits to the generation of electricity produced from biomass involving animal
waste. Further, many states and the Federal government require a portion of the
power consumed in their own facilities to be provided from renewable generating
sources. These Renewable Portfolio Standards, or RPS, have increased over the
last several years. The DOE foresees significant growth in the generation
capacity of renewables.

GREEN TAGS AND POLLUTION OFFSET CREDITS

As a potential producer of renewable energy, we expect to be able to sell
separately electricity and "green" energy credits, also called "green tags".
Green tags can be defined in many ways. We define them as the marketable bundle
of benefits derived from the environmentally friendly generation of power. In
some instances, we may include all or some portion of the green tags in
wholesale electricity purchase agreements. However, we may also separately trade
these green tags or some of their unbundled components in a separate trading
market.

Buzzard has been able to sell pollution-offset credits based upon NOx emissions
which were discussed previously. We may derive future demand, or increased
opportunities, for facility sales if our future facilities are able to sell
greenhouse gases, and other pollution offset credits in addition to electricity
and other green credits. The market for these and similar credits is projected
to grow over the long term as stricter environmental regulations and emission
standards are adopted.

We expect that trends in the energy and green trading markets will play an
important role in our ability to develop future facilities and our potential
profitability. However, there are many competitors in these markets and, in
addition, the local characteristics of each market, such as installed renewable
generating capacity or local legislation, will affect our plans and progress.

AGRICULTURAL MARKETS

We plan to provide anaerobic digester equipment and services to help control
pollution in agricultural markets, specifically concentrated animal feeding
operations or CAFO's. Runoff from animal wastes presents significant water
pollution problems.

The Environmental Protection Agency on December 16, 2002 issued a new rule to
regulate manure run-off on farms, one of the nation's leading causes of water
pollution. The new rules apply to about 15,500 livestock operations across the
country. These CAFO's will need to obtain permits, submit an annual report, and
develop and follow a plan which will ensure that measures are instituted to
protect America's waters from wastewater and manure. The EPA is working with the
United States Department of Agriculture (USDA) to help the agricultural
community find solutions to this environmental problem. Effective manure
management practices required by the rule will maximize the use of manure as a
resource for agriculture while reducing adverse impacts on the environment. The
effective date of the rule is April 14, 2003, but the compliance deadlines vary
depending upon the classification of a company's operations. For operations that
are defined as CAFOs under regulations that are in effect prior to April 14,
2003, the owner or operator must have or seek to obtain coverage under an NPDES
permit as of April 14, 2003, and comply with all applicable NPDES requirements,
including the duty to maintain permit coverage. The compliance deadlines for
other operations are phased in over periods ranging from 90 days to three years.
In addition, permitted CAFOs must have their nutrient management plans developed
and implemented by December 31, 2006.

We believe that the waste management benefits of Microgy's technologies should
help CAFO's meet the stricter guidelines and permitting requirements and, as a
result, many farms would be able to address existing pollution problems over
time and to increase land application of less-pollutant manure and, in some
instances, support a larger herd on the same amount of land. Alternatively, in
critical pollution areas, or where uses for residual products can be identified,
the land application of manure could be substantially curtailed.

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COMPETITION

We face several types of competitors including:

     .    commodity power producers;
     .    renewable power producers;
     .    peak power producers;
     .    pollution control providers; and
     .    "opportunity" competitors.

COMMODITY POWER PRODUCERS

We plan to develop and own or sell power-generating facilities that provide
wholesale electricity to the utility grid. Our competitors include all other
producers of electricity, such as:

     .    traditional utilities;
     .    other independent power producers;
     .    coal-fired plants;
     .    nuclear plants; and
     .    facilities fueled by natural gas, wind-energy, hydro-electric,
          geo-thermal, and various other fuels.

Their markets are very price competitive. Many of our competitors are well
established, more experienced and better capitalized than EPC.

We believe that we have identified a market niche that will enable us to serve
multiple market segments. We believe that providing pollution control benefits
along with green, peaking electric energy, may afford us an opportunity to
avoid, to a certain degree, direct competition with a large segment of the
commodity power market. We will, however, be heavily influenced by that market.

RENEWABLE POWER PRODUCERS

Several other technologies exist to provide "green" renewable energy, including
wind, solar, geo-thermal, other forms of biomass, and landfill gas extraction.
Producers using these sources of renewable power compete with us in the sale of
renewable energy and green tags. They also compete for participation in green
pricing programs, renewable portfolio standard, or RPS programs and state
mandates for renewables. Many of these competitors are experienced, well
financed, and established in our markets.

We believe that our facilities will compete by seeking to provide benefits that
some of these organizations cannot. The Microgy technology will allow us to
store biogas so that we can provide firm power at peak periods. We believe that
most renewable power sources, other than biogas from a highly controlled source,
cannot consistently produce and/or store their energy and cannot easily provide
firm peak power which usually has the greatest market value. We expect that the
pollution control benefits of Microgy's technology, as well as its anticipated
ability to generate green energy during peak periods, will allow us to serve
multiple markets and to compete.

POLLUTION CONTROL PROVIDERS

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Farmers have several options to handle the pollution problems described in the
Agricultural Markets section above. They range from acquiring additional land
for spreading, to reducing herd sizes, to employing other technologies such as
plug-flow digesters.

These pollution control options may limit the number of potential sites for
future Microgy facilities and, to the extent that tradable pollution control
allowances are created, such alternatives are likely to affect Microgy's
opportunities in these markets.

However, we believe that our solution may offer farmers the potential to realize
similar pollution control benefits as some or all of these other solutions and,
at the same time, to receive additional financial incentives.

"OPPORTUNITY" COMPETITORS

We define opportunity competitors in two ways: First, there is the competitor
for farm sites and the competition resulting from other sources of pollution
mitigation as discussed above. Second, there may become competition for the
various resources which affect our operations or potential profitability. For
example, the market to obtain organic byproducts digested in the planned Microgy
projects may become subject to competition. Presently, we believe there is
little competition for these byproducts. However, in the future, the situation
may change.

The following sections describe the competition facing our subsidiaries.

BUZZARD POWER CORPORATION

Buzzard generates electricity using waste coal, an alternative energy source.
Buzzard sells all of its electricity at rates established under a long-term
power purchase agreement. With the exception of the risk that Penelec would seek
and achieve judicial determination that it has a right to renegotiate the terms
of the power purchase agreement the sale of power from our existing facility is
not subject to competition during the term of the power purchase agreement.

However, since our contracted rates in the later years of the agreement are
determined with reference to current consumer price indices and future market
conditions, the rate at which such power is sold after 2004 is influenced by
competitive power rates in the region. Therefore, low wholesale energy rates
during the later years of the power purchase agreement would adversely affect
our profitability and could affect our results of operations and financial
position.

MICROGY COGENERATION SYSTEMS

Microgy plans to generate revenue from the development, sale, and/or ownership
of facilities that market renewable, "green" energy in addition to providing
pollution control features to the agricultural markets. In the energy market,
its competitors include traditional regulated utilities, unregulated
subsidiaries of regulated utilities, energy brokers and traders, energy service
companies in the development and operation of energy-producing projects as well
as the marketers of electric energy, equipment suppliers, providers of pollution
control products or services, and other non-utility generators like EPC.

Microgy's "green" competitors include other energy producers using biomass
combustion, biomass anaerobic digestion, geothermal, solar, wind, new hydro, and
other renewable sources. These companies represent a significant class of
competitors because they will compete with Microgy not only for electricity
sales but also for sale of "green tags" and participation in various renewable
portfolios and other programs.

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In the agricultural markets, Microgy faces many forms of competition from other
providers of pollution control. The most significant among these entities may
include environmental engineers, providers of pollution control systems, and
other developers of anaerobic digesters or plug-flow digesters. Competition
includes private companies, public companies, associations, cooperatives,
government programs, such as AgStar, foreign companies, and educational pilot
programs.

ENVIRONMENTAL REGULATION

Our present and any future projects are and will be subject to various federal,
state and local regulations pertaining to the protection of the environment,
primarily in the areas of water and air pollution. Microgy intends to build
plants in various states. These facilities will be subject to federal, state and
local regulatory requirements in all the locations where they may operate.

In many cases, these regulations require a lengthy and complex process of
obtaining and maintaining licenses, permits and approvals from federal, state
and local agencies. We also have and will have significant administrative
responsibilities to monitor our compliance with the regulations. As regulations
are enacted or adopted in any of these jurisdictions, we cannot predict the
effect of compliance therewith on our business. Our failure to comply with all
the applicable requirements could require modifications to operating facilities.
During periods of non-compliance, our operating facilities may be forced to
shutdown until the compliance issues are resolved. EPC is responsible for
ensuring the compliance of its facilities with all the applicable requirements
and, accordingly, attempts to minimize these risks by dealing with reputable
contractors and using appropriate technology to measure compliance with the
applicable standards. The cost of environmental regulation does and will
continue to affect our profitability.

BUZZARD POWER CORPORATION

We believe the Scrubgrass project, EPC's only operating project, is currently in
compliance with all material applicable environmental regulations. Our
Scrubgrass project is most notably affected by the following environmental
regulations:

Air Quality -- The Scrubgrass project is subject to air quality regulations
under the Federal Clean Air Act of 1970. This Act established National Ambient
Air Quality Standards for certain pollutants including ozone, sulfur dioxide,
nitrogen dioxide, particulate matter, carbon monoxide and lead. In particular,
CAA Title I established the Northeast Ozone Transport Region, which includes 12
northeast states and the District of Columbia, to address the transport of these
pollutants which may lead to the non-attainment of the ozone standards in the
Northeast. Ozone control is facilitated by the control of pollutant precursors,
which are nitrogen oxides, or NOx, and volatile organic compounds. Electric
generating facilities that use fossil fuels, including the Scrubgrass project,
are considered major sources of NOx emissions.

In recent years, the Pennsylvania Department of Environmental Protection
established regulations that required companies with stationary sources of NOx
emissions to establish plans to reduce their NOx emissions. To administer these
regulations, the Department began allocating Nitrogen Oxide Ozone Transport
Region Budget Allowances, or NOx Credits, to facilities based on numerous
factors including the design and operation of each facility. A market-based
trading system was established to allow companies with excess NOx Credits to
trade with companies that required additional NOx Credits to meet the stricter
requirements. More recently, an Ozone Transport Commission established certain
inner and outer zones with seasonal NOx emission reductions that required the
Scrubgrass project to achieve certain targeted NOx emission levels beginning on
May 1, 1999. Under such requirements, the Scrubgrass project will also be
required to achieve reduced emission standards by May 2003. Due to the efficient
design of the Scrubgrass project, the Scrubgrass project met the new 1999
requirements without

11

<PAGE>

any modifications to the facility. However, we made capital improvements of
$811,568 in 1999 to the Scrubgrass project, which are expected to enable the
Scrubgrass project to meet the stricter standards in 2003. To date we have sold
credits through 2007 in anticipation of meeting the air quality standards for
sulfur dioxide, nitrogen dioxide, particulate matter, carbon monoxide and lead
during this period. We do not anticipate needing any additional material
modifications to the Scrubgrass project during this time.

Waste Disposal -- The Scrubgrass project must also comply with various
environmental regulations pertaining to water discharge as well as the handling
and disposal of hazardous and non-hazardous wastes. The Pennsylvania's
Department of Environmental Protection establishes classifications for wastes
and requires companies to follow certain handling and disposal procedures for
each waste classification. Currently, the Scrubgrass project employs special
handling procedures for the transportation of its fuel, which is classified as a
waste, from the waste sites to the Scrubgrass project. The fuel is burned in the
Scrubgrass facility where it is treated with various substances such as
limestone during the electric generation process. Ash, which is a byproduct of
the waste-coal combustion process, is removed from the Scrubgrass facility and
returned to the original waste site, which is reclaimed in part by deposit of
the ash along with the soil. Under existing regulations, ash is not classified
as a hazardous waste. However, various environmental organizations have recently
been lobbying for changes to the applicable regulations for the classification
of ash. If there are changes to the waste classification of ash, our ash
disposal costs may significantly increase which could have material adverse
affect on the results of operations and financial position.

MICROGY COGENERATION SYSTEMS

Microgy has no projects currently in operation. Depending on the location of
each individual plant, state implementation plans of the Clean Air and Clean
Water Acts as described above may apply. The state permitting process could
involve lengthy delays for fact and law source reviews and to purchase of
offsets in order to counter-balance emissions. Microgy's projects may be subject
to the following additional regulations:

CURRENT REGULATIONS

The primary Federal law affecting manure management on animal operations is the
Clean Water Act, under which the National Pollutant Discharge Elimination
System, or NPDES, program covers Concentrated Animal Feeding Operations, or
CAFOs. Federal NPDES permits may be issued by EPA or any state authorized by EPA
to implement the NPDES program. Forty-three states are certified by the EPA to
issue their own NPDES permits. Of note, EPA materials published in 1999
indicated that 32 states have a requirement covering application rates of manure
on the land, and 27 states require at least some animal operations to develop
and use waste management plans.

In addition, each distributed generation site with an installed reciprocating
engine and generator is regulated under a state implementation plan (SIP)
developed in accordance with the Federal Clean Air Act. The engine emissions at
each site will be covered under a general statewide permit or a point source
permit. The engine emissions are considered a minor point source for both the
general and specific permit and no other emission control devices are required.

NEW REGULATIONS

The Environmental Protection Agency on December 16, 2002 issued a new rule to
regulate manure run-off on farms, one of the nation's leading causes of water
pollution. The new rules apply to about 15,500 livestock operations across the
country. These CAFOs will need to obtain permits, submit an annual report, and
develop and follow a plan which will ensure that measures are be instituted to
protect America's waters from wastewater and manure. The EPA is working with the
United States Department

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of Agriculture (USDA) to help the agricultural community find solutions to this
environmental problem. Effective manure management practices required by the
rule will maximize the use of manure as a resource for agriculture while
reducing adverse impacts on the environment.

EXPECTED BENEFITS OF MICROGY SYSTEM

While digesting the raw manure and burning the resulting biogas to make
electricity does not eliminate the nutrients from the manure slurry, the process
does change their chemical makeup. In the anaerobic digestion process, many of
the nutrients that were previously bound in organic molecules are mineralized,
or reduced to the inorganic forms of the nutrients. These are the forms that are
usable by crops. The organic forms in undigested manure must first be broken
down before they can be used. Because this usually takes an extended period of
time, there are residual nutrients in the soil left over from previous years'
manure applications. These residuals must be taken into account when calculating
current manure application rates, resulting in less manure being spread on the
same amount of cropland. By providing the nutrients in readily usable forms,
digested manure has lower potential to produce a residual accumulation of
minerals on the land. Therefore, more of it can be spread on an acre of
cropland, thus reducing manure-spreading costs.

In addition, further environmental benefits can be achieved by subjecting the
digested manure slurry to other nutrient extraction techniques, such as chemical
precipitation. By digesting the manure, these nutrients are in a form that is
more easily extracted in such techniques. Digested manure can also be put to
other beneficial uses, such as bedding for the animals and therefore would not
need to be applied to the land.

ENERGY REGULATION

PURPA

The Public Utility Regulatory Policies Act of 1978, or PURPA, and the
regulations under PURPA by the Federal Energy Regulatory Commission, or FERC,
have provided incentives for the development of cogeneration facilities and
small power production facilities, which are power projects that use renewable
fuels and generally have a capacity of less than 80 megawatts. In general, PURPA
requires utilities to purchase electricity produced by facilities using
alternative fuels or from cogeneration facilities that meet the FERC's
requirements for certification as qualifying facilities, or QFs.

In order to obtain QF status under PURPA, any facilities that we might acquire
or develop will be required to meet certain size, fuel and ownership
requirements and/or co-generate. Specifically, a cogeneration facility must
produce not only electricity, but also useful thermal energy for use in an
industrial or commercial process for heating or cooling applications in certain
proportions to the facility's total energy output and must meet certain energy
efficiency standards. A geothermal facility may qualify as a QF if it produces
less than 80 megawatts of electricity. With respect to small power production
facilities, there is generally no size limit for qualifying solar, wind, or
waste facilities. For small power production facilities, the primary energy
source of the facility must be biomass; waste, renewable resources, geothermal
resources, or any combination thereof, and 75 percent or more of the total
energy input must be from these sources. Any primary energy source which, on the
basis of its energy content, is 50 percent or more biomass is to be considered
biomass. Finally, a QF must not be controlled or more than 50 percent owned by
an electric utility or by an electric utility holding company, or a subsidiary
of such a utility or holding company or any combination thereof.

PURPA provides two primary benefits to QFs. First, QFs generally are relieved of
compliance with extensive federal and state regulations that control the
financial structure of an electric generating plant and the prices and terms on
which electricity may be sold by the plant. Such regulations include the

13

<PAGE>

Public Utility Holding Company Act of 1935, or PUHCA, and the Federal Power Act,
or FPA. Second, electric utilities are required to purchase electricity
generated by QFs at a price based on the purchasing utility's "avoided cost" and
to sell back-up power to the QFs on a non-discriminatory basis. The term
"avoided cost" is defined generally as the price at which the utility could
purchase or produce the same amount of power from sources other than the QF. The
FERC regulations also permit QFs and utilities to negotiate agreements for
utility purchases of power at rates other than the utilities avoided costs.
While public utilities are not explicitly required by PURPA to enter into
long-term power sales agreements, PURPA helped to create a regulatory
environment in which it has been common for long-term agreements to be
negotiated.

Our Scrubgrass project is certified as a QF by the FERC. We believe that the
facilities we would build or develop using Microgy's licensed technology would
also meet the qualifications required to be a QF. The Company endeavors to
develop its projects and monitor compliance of existing projects with applicable
regulations in a manner which minimizes the risks of any project losing its QF
status. Certain factors necessary to maintain QF status are, however, subject to
the risk of events which may be outside our control. Upon the occurrence of such
event, we would seek to correct any non-compliance in order to meet PURPA's
requirements, but no assurance can be given that this would be possible.

If a facility in which we have an interest should lose its status as a QF, the
project would no longer be entitled to the exemptions from PUHCA and the FPA.
This could also trigger certain rights of termination under the facility's power
sales agreement, could subject the facility to rate regulation as a public
utility under the FPA and state law and could result in the Company
inadvertently becoming an electric utility holding company that would not be
exempt under PUHCA. Loss of QF status may also trigger defaults under covenants
to maintain QF status in the project's power sales agreement and potentially
result in termination, penalties or acceleration of indebtedness under such
agreements.

Under the Energy Policy Act of 1992, if a facility can be qualified as an exempt
wholesale generator, or EWG, it will be exempt from PUHCA even if it does not
qualify as a QF. Generally, an EWG is defined as any person, who receives a
determination from the FERC, that it is engaged directly, or indirectly through
one or more affiliates and exclusively in the business of owning or operating,
or both owning and operating, all or part of one or more eligible facilities and
selling electric energy at wholesale. As such, another response to the loss or
potential loss of QF status would be to apply to have the project qualified as
an EWG. However, assuming this changed status would be permissible under the
terms of the applicable power sales agreement, rate approval from FERC would be
required. To the extent applicable, the facility would also be required to cease
selling electricity to any retail customers.

Presently, there are various pending legislative proposals which would amend or
comprehensively restructure PURPA and the electric utility industry. If PURPA is
amended or repealed, the statutory requirement that electric utilities purchase
electricity from QFs at full-avoided cost could be repealed or modified. While
existing contracts are expected to be honored, the repeal or modification of
these statutory purchase requirements under PURPA in the future could, among
other things, increase pressure from electric utilities to renegotiate existing
contracts. Should there be changes in statutory purchase requirements under
PURPA, and should these changes result in amendments to our current power
purchase agreement for Scrubgrass which reduce the contract rates, our results
of operations and financial position could be negatively impacted. There can be
no assurance how any legislation passed would impact our operations.

PUBLIC UTILITY HOLDING COMPANY ACT

14

<PAGE>

Under PUHCA, any legal entity which owns or controls ten percent or more of the
outstanding voting securities of a "public utility company" or a company which
is a "holding company" for a public utility company is subject to registration
with the Securities and Exchange Commission and regulation under PUHCA, unless
eligible for an exemption. Generally, a holding company of a public utility
company that is subject to registration is required by PUHCA to limit its
utility operations to a single integrated utility system and to divest any other
operations not functionally related to the operation of that utility system.
Approval by the SEC is required for nearly all important financial and business
dealings of a registered holding company. Under PURPA, most QFs are not public
utility companies under PUHCA.

The Energy Policy Act of 1992, among other things, amends PUHCA to allow
electric wholesale generators, or EWGs, under certain circumstances, to own and
operate non-QF electric generating facilities without subjecting those producers
to registration or regulation under PUHCA. The effect of such amendments has
been to enhance the development of non-QFs which do not have to meet the fuel,
production and ownership requirements of PURPA. The Company believes that these
amendments benefit us by expanding our ability to own and operate facilities
that do not qualify for QF status. However, they have also resulted in increased
competition by allowing utilities to develop such facilities which are not
subject to the constraints of PUHCA.

FEDERAL POWER ACT REGULATION

Under the FPA, FERC is authorized to regulate the transmission of electric
energy and the sale of electric energy at wholesale in interstate commerce.
Unless otherwise exempt, any person that owns or operates facilities used for
such purposes is considered a "public utility" subject to FERC jurisdiction.
FERC regulation under the FPA includes approval of the disposition of utility
property, authorization of the issuance of securities by public utilities,
regulation of the rates, terms and conditions for the transmission or sale of
electric energy at wholesale in interstate commerce, the regulation of
interlocking corporate directors, officers, and officials, and a uniform system
of accounts and reporting requirements for public utilities.

FERC regulations provide that a QF is exempt from regulation under the foregoing
provisions of the FPA. However, QFs remain subject to limited FPA regulation
concerning interconnection authority, transmission authority, information
requirements, and emergency provisions. An EWG is not exempt from the FPA and
therefore an EWG that makes sales of electric energy at wholesale in interstate
commerce is subject to FERC regulation as a "public utility." However, many of
the regulations that customarily apply to traditional public utilities have been
waived or relaxed for power marketers, EWGs and other non-traditional public
utilities that have demonstrated that they lack market power in the region in
which they are located. EWGs that have demonstrated such a lack of market power
are regularly granted authorization to charge market-based rates, blanket
authority to issue securities, and waivers of FERC's requirements pertaining to
accounts, reports and interlocking corporate directors, officers, and officials.
Such action is intended to implement FERC's policy to foster a more competitive
wholesale power market.

WHOLESALE ELECTRICITY MARKET RESTRUCTURING

On July 31, 2002, FERC issued a notice of proposed rulemaking which is intended
to substantially restructure the nation's wholesale electricity transmission and
sales markets. FERC's objectives in this proposed rule are to remedy various
discriminatory aspects of the industry and establish a standardized transmission
service and wholesale electric market design that will provide a level playing
field for all entities that seek to participate in wholesale electric markets.
FERC is also seeking in this rulemaking to establish regulatory measures to
protect customers against the exercise of market power when structures do not
support a competitive market. We do not know when a final FERC rule in this
matter will be issued or what changes will be made to the proposed rule once it
is issued in final form. We will continue

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<PAGE>

to monitor these regulatory activities to evaluate any impact on the Scrubgrass
project and/or business opportunities for Microgy.

STATE REGULATION

State public utility commissions, or PUCs, have historically had broad authority
to regulate both the rates charged by, and the financial activities of, electric
utilities operating in their states and to promulgate regulations for
implementing PURPA. Since generally a power sales agreement is incorporated into
a utility's cost structure and its retail rates, power sales agreements with
power producers, such as EWGs and QFs, are potentially subject to state
regulatory scrutiny, including the process in which the utility has entered into
the power sales agreement. Where the state regulatory authority has authorized a
utility's process for securing its electric power supply, the regulatory agency
is generally inclined to permit the utility to pass through the costs associated
with power purchase agreement to its retail customers. However, under certain
circumstances, PUCs could disallow full cost recovery for the expenses
associated with a power purchase agreement. Independent power producers which
are not QFs or EWGs are considered to be public utilities in many states. As
such, these entities would be subject to broad regulation by a PUC, ranging from
certificates of public convenience and necessity to regulation of organizational
structure, accounting, and financial and other matters. States may also assert
jurisdiction over the siting and construction of electric generating facilities
including that associated with QFs and EWGs. States may further assert
jurisdiction, with the exception of QFs, over the issuance of securities and the
disposition, sale, or transfer of assets by these electric generation
facilities. PUCs, pursuant to state legislative authority, may also have
jurisdiction over how new federal initiatives associated with power production
are implemented in each state.

The actual scope of jurisdiction over independent power projects by state public
utility regulatory commissions varies from state to state. Presently, through
its power purchase agreement with Penelec, the Scrubgrass plant is affected by
state legislation in Pennsylvania.

On December 3, 1996, in response to changes in the electric industry,
Pennsylvania passed legislation known as the Electricity Generation Customer
Choice & Competition Act, or Customer Choice Act, which became effective on
January 1, 1977. The Customer Choice Act regulates the generation portion of the
electric business by permitting all Pennsylvania retail electric customers to
choose their electric generation supplier over a phase-in period which expired
December 1, 2000. The Customer Choice Act required that all electric utilities
file restructuring plans with the PUC. Penelec filed its proposed restructuring
plan during 1997. The plan was subsequently litigated by numerous parties, and
later settled by an agreement which was approved by the PUC on October 20, 1998.
The settlement agreement set forth a comprehensive plan for restructuring
Penelec's service and for ensuring there would be competition for electric
generation for all of Penelec's customers beginning on January 1, 1999. The
approved restructuring plan provided for Penelec to maintain a separate
non-utility generator cost recovery mechanism for accounting purposes. The
restructuring plan is designed to enable Penelec to recover all of its costs
from non-utility generators, such as the Scrubgrass facility, and should serve
to decrease the pressure on Penelec to renegotiate existing power contracts with
non-utility generators.

Presently, except as discussed above, neither the Customer Choice Act nor
Penelec's restructuring plan directly impacts Environmental Power, since the
legislation and restructuring plan pertain to the retail market or new contracts
in the wholesale market. Nevertheless, we continue to monitor regulatory
developments in order to evaluate any impact on the Scrubgrass project and
possible new business opportunities for Microgy.

EMPLOYEES

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At the time of this filing, we had thirteen employees, including executive
officers and other marketing, finance, engineering and administrative personnel.
Our employees are not represented by a collective bargaining agreement and we
consider relations with our employees to be good.

ITEM 2.  PROPERTIES

Buzzard leases the Scrubgrass facility which is an approximate 83 megawatt waste
coal-fired electric generating facility located on approximately 600 acres in
Venango County, Pennsylvania. The payment terms of the lease are described in
Item 1.

We lease 2,818 square feet of office space for our corporate headquarters in
Portsmouth, New Hampshire under a five-year lease with monthly payments of
$5,520.

Microgy is a tenant-at-will for office space located in Colorado and Wisconsin
with aggregate rents of $1,545 per month.

ITEM 3.  LEGAL PROCEEDINGS

We are currently not involved in any legal proceedings.

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

At our 2002 Annual Meeting of Stockholders, held on July 25, 2002, the following
actions were submitted to a vote of EPC's security holders:

     1.   Our stockholders elected a Board of Directors to serve for the ensuing
          year until their respective successors have been duly elected and
          qualified. The results of the voting were as follows:

                                                           NUMBER OF SHARES
          ELECTED DIRECTOR                        FOR          WITHHELD
          ----------------------              ----------   ---------------
          Joseph E. Cresci                    15,234,325       69,787
          Donald A. Livingston                15,284,325       19,787
          Peter J. Blampied                   15,284,325       19,787
          Robert I. Weisberg                  15,284,325       19,787
          Thomas Matthews                     15,284,325       19,787
          Herman Brubaker                     15,284,325       19,787
          Jessie J. Knight, Jr.               15,284,325       19,787
          August Schumacher, Jr.              15,284,325       19,787

          On August 30, 2002, Herman Brubaker resigned from the Board for
          personal reasons.

     2.   Our stockholders approved the adoption of our 2002 Director Option
          Plan. The results of the voting were as follows:

          RESULT                                           NUMBER OF SHARES
          ---------                                        ----------------
          For      .......................................       12,621,539
          Against  .......................................          278,776
          Abstain  .......................................           55,429

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     3.   Our stockholders ratified the reappointment of the firm of Deloitte &
          Touche LLP as our independent auditors for the fiscal year ending
          December 31, 2002. The results of the voting were as follows:

          RESULT                                           NUMBER OF SHARES
          ---------                                        ----------------
          For      .......................................       15,114,540
          Against  .......................................          136,056
          Abstain  .......................................           53,516

ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT

EPC's executive officers, who are elected annually by the Board of Directors and
serve at the discretion of the Board, are as follows:

         NAME           AGE                  POSITION
---------------------  -----   ------------------------------------

Joseph E. Cresci        60     Chairman and Chief Executive Officer
Donald A. Livingston    60     President and Chief Operating Officer
R. Jeffrey Macartney    48     Chief Financial Officer and Treasurer
Edward Chapman          53     Senior Vice President of Finance
Michael A. McCabe       47     Senior Vice President of Operations
Wallace Long            51     Vice President of Marketing

Joseph E. Cresci, is a founder of Environmental Power, and has served as
Chairman and Chief Executive Officer since EPC's inception in 1982. From 1972 to
1982, Mr. Cresci held various executive positions as either President and or
Chief Executive Officer at G.E. Stimpson Co., Inc., Ogden Recreation Inc. and
Garden State Racing Association. From 1967 to 1969, he was an associate lawyer
with the Philadelphia law firm of Townsend, Elliot and Munson. Mr. Cresci holds
an A.B. degree from Princeton University and a law degree from Cornell Law
School and was a member of the Pennsylvania and Massachusetts Bars. Currently,
Mr. Cresci is a member of the Boards of Directors of the Wang Center for the
Performing Arts and the Commonwealth Shakespeare Company and is an overseer of
the Boston Lyric Opera, all in Boston, Massachusetts.

Donald A. (Andy) Livingston, a director and a founder of Environmental Power,
has served as President and Chief Operating Officer since September 1991 and as
Executive Vice President from EPC's inception. In addition, he serves as
President and Chief Operating Officer of Microgy. Mr. Livingston was previously
President and Chief Executive Officer of Green Mountain Outfitters, Inc., a
manufacturer and distributor of industrial plastic parts. He has also been a
partner in the financial services firm, Capital Resources, Inc., where he was
involved in obtaining debt and equity funds.

R. Jeffrey Macartney has been Chief Financial Officer of Environmental Power
since May 2002. Before joining Environmental Power, Mr. Macartney held a series
of financial positions including Controller of Pitney Bowes Global Financial
Services for four years from 1997 to 2001. Prior to Pitney Bowes, he worked as a
business consultant from 1993 to 1997 and served as Senior Vice President of
Finance and Administration for Bank Austria in San Francisco from 1989 to 1993.
He was also Vice President of Finance for the financial subsidiary of Allied
Signal and has experience working in companies funded by the venture capital
firms, Fostin Capital, Bessemer Partners, and Kliner Perkins.

Edward Chapman, P.E., J.D. has been the Senior Vice President - Finance of
Environmental Power since June 1, 2002. Beginning in November 2001, Mr. Chapman
served as a strategic advisor to the Company. He has spent the vast majority of
his 23-year professional career evaluating and financing power generation
projects, often creating the business or financial structures necessary to

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<PAGE>

complete the financing. In September 2000, Mr. Chapman began the formation of a
small power company, Madison Power Corp., to take advantage of opportunities in
the U.S. electric markets through the acquisition of power generation plants.
Mr. Chapman spent 16 years as an investment banker with Goldman Sachs, from
November 1987 to September 2000, and earlier, with Salomon Brothers, where he
was responsible for all aspects of financing and client development for
independent power producers and traditional electric utilities. He led the
finance group that created the first true debt capital market for the
independent power generation business and completed approximately $3 billion in
project financings. Mr. Chapman's background also includes engineering. He
worked at R.W. Beck and Illinois Power Company. Mr. Chapman holds a B.S. Degree
in Electrical Engineering, an M.B.A. with emphasis on Finance, and a J.D. in
Corporate Law, each from the University of Illinois. He is a Registered
Professional Engineer in Indiana and licensed to practice law in Illinois.

Michael A. McCabe has been Senior Vice President of Operations for Environmental
Power since October 1, 2002. Mr. McCabe served in senior positions as CEO,
President, Chief Operating Officer or Chief Financial Officer for Real Energy
Solutions in 2002, Wallaware Inc. from 2000 to 2002, and Kafus Industries from
1997 to 2000. Mr. McCabe's experience includes over 12 years as a Project
Finance Specialist with Bank of New England, Bank of Tokyo Capital and Key
Global Finance. He holds a BS in Chemistry and Physics from Bridgewater State
College, a MS in Chemical Engineering from Purdue University and a MBA in
Finance from Pace University.

Wallace Long, P.E, has been Vice President of Marketing of Environmental Power
since June 1, 2002. Mr. Long has more than 25 years of development, marketing,
and engineering experience in the energy field. Mr. Long was a consulting
engineer with R.W. Beck from 1978 to 1995 where he served as principal advisor
for numerous clients negotiating and procuring short- and long-term energy
contracts and making transmission arrangements for public utilities, independent
power producers, and industrial companies. Mr. Long has extensive experience
related to the operation of power pools and their associated power markets and
has produced regional market reports for internal and client use. In 1995, after
independently procuring a contract to supply renewable power through an RFP
process, Mr. Long left R. W. Beck to form a development company, the Highland
Power Corporation. From 1995 through 2000, Mr. Long successfully developed,
financed, constructed and operated 2MW of landfill gas projects (which are still
operating today). Related to these projects, Mr. Long created a corporate entity
to allow for the sale of the Section 29 tax credits associated with the
production of the landfill gas and in 1998 in Massachusetts, Mr. Long negotiated
power sales contracts that included a payment for the `green attributes' of the
land fill gas projects. In 2000, he rejoined R.W. Beck to create a new
development company and to participate in unique distributed generation and
power marketing opportunities created by deregulation.

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

STOCK MARKET TRADING:

Our common stock trades on the OTC Bulletin Board under the symbol "POWR". As of
March 3, 2003 there were approximately 274 record holders and approximately 909
beneficial holders of our common stock.

The following table shows the quarterly high and low bid prices during 2001 and
2002 as reported by the OTC Bulletin Board:

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       YEAR            PERIOD                      HIGH         LOW
     ------        -------------                   ----        ----
     2001          First Quarter                   0.56        0.44
                   Second Quarter                  0.86        0.22
                   Third Quarter                   0.70        0.40
                   Fourth Quarter                  0.54        0.40

     2002          First Quarter                   0.60        0.45
                   Second Quarter                  0.90        0.40
                   Third Quarter                   0.62        0.35
                   Fourth Quarter                  0.43        0.15

These over-the-counter quotations reflect inter-dealer prices without retail
mark-up mark-down or commission and may not necessarily represent actual
transactions.

DIVIDENDS:

The Board of Directors declared dividends of $171,107, or $.015 per share,
during the last quarter of 2000. The dividend was paid during the first quarter
of 2001. The Board of Directors has not declared any dividends on our common
stock after the last quarter of 2000. Due to the acquisition of Microgy in 2001
and anticipated expansion of our business, the Board of Directors has concluded
that available cash flows should be used for operating and investing activities
for the foreseeable future.

EQUITY COMPENSATION PLAN INFORMATION:

The following table sets forth the following information, as of December 31,
2002, with respect to compensation plans (including individual compensation
arrangements) under which equity securities of Environmental Power are
authorized for issuance; the number of securities to be issued upon the exercise
of outstanding options, warrants and rights; the weighted-average exercise price
of such options, warrants and rights; and, other than the securities to be
issued upon the exercise of such options, warrants and rights, the number of
securities remaining available for future issuance under the plans.

<TABLE>
<CAPTION>
                                                                                                     NUMBER OF
                                                                                                    SECURITIES
                                                                                                     REMAINING
                                                                                                   AVAILABLE FOR
                                                                                                  FUTURE ISSUANCE
                                                                                                   UNDER EQUITY
                                                                              WEIGHTED AVERAGE  COMPENSATION PLANS
                                                                              EXERCISE PRICE OF     (EXCLUDING
                                      NUMBER OF SECURITIES TO BE ISSUED UPON     OUTSTANDING        SECURITIES
                                         EXERCISE OF OUTSTANDING OPTIONS,     OPTIONS, WARRANTS    REFLECTED IN
                                               WARRANTS AND RIGHTS               AND RIGHTS         COLUMN (a))
PLAN CATEGORY                                          (a)                           (b)                (c)
--------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>                             <C>              <C>
Equity compensation plans approved
 by security holders                                1,141,962                       0.86             4,263,038
--------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
 approved by security holders                         620,000                       0.66                     -
--------------------------------------------------------------------------------------------------------------------
Total                                               1,761,962                       0.79             4,263,038
--------------------------------------------------------------------------------------------------------------------
</TABLE>

The options, warrants and rights to purchase 620,000 shares issued under
compensation arrangements not approved by security holders consist of:

     .    20,000 non-qualified ten-year options exercisable at $0.6875 per share
          issued to two directors in April 1996; and

     .    Options for 450,000 shares and warrants for 50,000 shares issued in
          2001 and options for 100,000 shares issued in 2002 referred to in Note
          L and described in Note O to our Consolidated Financial Statements.

20

<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA

The following selected financial data for the five years ended December 31, 2002
is derived from our audited consolidated financial statements. The data should
be read in conjunction with the consolidated financial statements and other
financial information included elsewhere herein. Dollars are shown in thousands
except per share data.

21

<PAGE>

<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31
                                              --------------------------------------------------------
                                                2002      (1) 2001      2000        1999        1998
                                              --------    --------    --------    --------    --------
<S>                                           <C>         <C>         <C>         <C>         <C>
RESULTS OF OPERATIONS DATA:

Power generation revenues                     $ 54,984    $ 53,518    $ 54,303    $ 48,268    $ 45,721
                                              --------    --------    --------    --------    --------

Costs and expenses:
     Operating expenses                         24,140      23,681      22,291      21,931      19,215
     Lease expenses                             25,291      24,706      26,416      23,111      22,971
     General and administrative expenses         5,655       3,973       3,603       2,455       2,197
     Depreciation and amortization                 545         441         415         363         285
                                              --------    --------    --------    --------    --------
                                                55,631      52,801      52,725      47,860      44,668
                                              --------    --------    --------    --------    --------

Operating (loss) income                           (647)        717       1,578         408       1,053

Other income (expense):
     Other income                                   --       2,135          --          --           8
     Interest income                                48          78         737         111         156
     Interest expense                             (142)       (185)       (320)       (375)       (461)
     Sale of NOx emission credits                2,428          --       1,156         607          --
     Amortization of deferred gain                 308         308         308         308         308
     Write-off of receivables in litigation         --          --          --          --      (3,508)
                                              --------    --------    --------    --------    --------
                                                 2,643       2,336       1,881         651      (3,497)
                                              --------    --------    --------    --------    --------

Income (loss) before income taxes                1,996       3,053       3,459       1,059      (2,444)

Income tax (expense) benefit                      (857)     (1,374)     (1,632)       (470)        795
                                              --------    --------    --------    --------    --------

Income (loss) before cumulative effect of a
 change in accounting principle                  1,138       1,679       1,827         589      (1,649)

Cumulative effect of a change in accounting
 principle (3)                                      --          --          --       1,189          --
                                              --------    --------    --------    --------    --------
Net income (loss)                             $  1,138    $  1,679    $  1,827    $  1,778    $ (1,649)
                                              ========    ========    ========    ========    ========

Basic earnings (loss) per common share        $   0.05    $   0.12    $   0.16    $   0.16    $  (0.14)
Diluted earnings (loss) per common share          0.05        0.11        0.16        0.16       (0.14)
Dividends declared                                  --          --        0.06        0.06        0.09
Weighted average number of common shares
 outstanding on a diluted basis                 20,811      14,746      11,409      11,407      11,407

BALANCE SHEET DATA:

Total assets                                  $ 92,958    $ 85,566    $ 69,284    $ 58,782    $ 55,163
Working capital                                   (585)     (1,499)     (1,176)     (2,662)     (1,190)
Deferred gain (2)                                4,164       4,472       4,780       5,089       5,397
Long-term obligations                           75,407      65,216      58,304      51,546      46,511
Shareholders' equity (deficit)                   6,186       4,383      (3,970)     (5,471)     (6,559)
</TABLE>

----------
(1)  The Results of Operations Data for 2001 includes Microgy from July 23, 2001
     to December 31, 2001.
(2)  See Note B of the Consolidated Financial Statements.
(3)  Effective January 1, 2000, we changed the method of accounting for major
      equipment overhauls to a method that is consistent with the viewpoints
      expressed by the Securities and Exchange Commission.

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

22

<PAGE>

OVERVIEW OF THE COMPANY

We are an independent developer, owner and/or operator of waste management
facilities that produce biofuels or electricity by utilizing the fuel sources
derived from our waste management processes and activities. Such fuel sources
are not subject to the pricing and market fluctuations of commodity fuels and,
in some instances, are considered renewable energy fuels. Since 1994, we have
owned a 22-year leasehold interest in an approximately 83 megawatt (net)
waste-coal fired facility located in Pennsylvania known as Scrubgrass. This
leasehold interest is held by our subsidiary, Buzzard Power Corporation or
Buzzard. Scrubgrass sells electricity to Pennsylvania Electric Company, or
Penelec, under a 25-year power sales agreement.

As discussed below, we are pursuing the potential sale of Buzzard. Any such sale
could generate cash to support operations, pay certain liabilities and provide
working capital, including to help fund development of our Microgy business.
There can be no assurance that such efforts will result in a completed sale
transaction on terms deemed acceptable by Environmental Power.

In 2001, we acquired all of the common stock of Microgy Cogeneration Systems
Inc., a privately held development-stage company based in Colorado. Microgy
holds an exclusive license in North America for the development and deployment
of a proprietary technology for the extraction of methane gas from animal wastes
and its use to fuel generation of energy. Microgy's product is expected to
provide certain farms, known as CAFO's, with a potentially profitable means of
mitigating an existing waste management problem that affects both water and air
quality. Federal and State agencies either have or may be in the process of
passing regulations that require CAFO's to implement changes to their current
waste management practices.

In recent years, we have also held ownership positions in a 43 megawatt (net)
waste-coal fired project in development located in Pennsylvania, known as
Milesburg, and a 51 Megawatt (net) waste-coal fired facility located in Utah,
known as Sunnyside. Milesburg was involved in protracted litigation with, among
others, West Penn Power Company. We settled the Milesburg litigation in 1997 and
sold Milesburg to West Penn. We sold Sunnyside in 1994 and, after the sale, the
purchasers sued us claiming breach of certain obligations in connection with the
sale. We counterclaimed for payment of certain obligations of the purchasers.
The Sunnyside matters were settled in fiscal 2001 by a payment to us of
$1,500,000 and the release by the purchasers of certain contingent liabilities
of EPC.

Our business activities are discussed further in Item 1. The following
Management's Discussion and Analysis of Financial Condition and Results of
Operations compares our results of operations for the years ended December 31,
2002, 2001 and 2000 and should be read in conjunction with the consolidated
financial statements and notes thereto, and the comparative summary of selected
financial data appearing elsewhere in this report. Historical results and trends
which might appear should not be taken as indicative of future operations.

CAUTIONARY STATEMENT

This Annual Report on Form 10-K contains "forward-looking statements", as
defined by the Private Securities Litigation Reform Act of 1995, in order to
provide investors with prospective information about us. For this purpose, any
statements which are not statements of historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, the words
"believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of important
factors which could cause our actual results and events to differ materially
from those indicated by the forward-looking statements. These factors include,
without limitation, those set forth below under the caption "Certain Factors
That May Affect Future Results".

23

<PAGE>

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that effect the reported amounts of assets and
liabilities at the date of the financial statements, the reported amounts of
revenues and expenses during the reporting period, and the disclosure of
contingent assets and liabilities at the date of the financial statements.
Actual results could differ from those estimates. Management believes the
following critical accounting policies, among others discussed in Note B to our
consolidated financial statements, involve more significant judgments and
estimates used in the preparation of our consolidated financial statements.

SALE AND LEASE-BACK ACCOUNTING

Our 1990 sale of Scrubgrass Power Corporation, the original developer of the
Scrubgrass facility, was not treated as a sale for financial accounting
purposes. This was originally due to the existence of an option which enabled us
to reacquire Buzzard, then a wholly-owned subsidiary of Scrubgrass Power
Corporation and owner of the right to lease the Scrubgrass facility, for a
substantial portion of its commercial operation. We exercised our option and
reacquired Buzzard in 1991 so that we would have the right to lease the
Scrubgrass facility. The then-proposed lease provided Buzzard with a fair market
value purchase option to acquire the Scrubgrass facility at the end of the
lease. This option meant that we had retained substantial risks or rewards of
ownership of Scrubgrass. Therefore, we were not permitted to recognize the sale
until 1993, when we agreed to a modification to the proposed form of lease and
relinquished the fair market value purchase option. Accordingly, we removed from
our consolidated financial statements the gross assets and liabilities of the
Scrubgrass facility and reported a gain of $6,785,035 arising from the sale of
Scrubgrass. However, due to our anticipated involvement with the lease, we were
required to defer our gain over the 22-year minimum lease term, which commenced
on June 30, 1994. In connection with the operating lease, we incurred aggregate
costs of $3,279,060 to reacquire Buzzard, the lessee of Scrubgrass, and
capitalized these costs as the value of our lease rights. The value of our lease
rights is also being amortized over the 22-year minimum lease term, which
commenced on June 30, 1994.

LEASE EXPENSE RECOGNITION

We have a long-term lease agreement for Scrubgrass, which commenced on June 30,
1994, and continues for a 22-year minimum lease term. Under the terms of the
lease, Buzzard, as lessee, is required to pay the lessor a specified base rent,
which consists of all of the lessor's debt service, scheduled equity repayment,
base return on equity and related expenses. Buzzard is also required to pay the
lessor an additional rent of 50 percent of the net cash flows Buzzard receives
from the operation of Scrubgrass. The lessor's specified base rent increases
over time and is based on a schedule which follows the expected receipt of
revenues. In accordance with accounting principles generally accepted in the
United States of America, we are required to aggregate the estimated lease
payments over the life of the lease and recognize them on a straight-line basis
over the 22-year lease term. As such, during the earlier years of the lease
agreement, a portion of our lease expenses will be paid in cash and a portion
will be recorded to a liability. As December 31, 2002, we have a deferred lease
expense of $70,192,993 recorded on our consolidated balance sheet. This
liability represents accumulated lease expenses recorded on a straight-line
basis in previous years which have not been paid to the lessor. In the later
years of the lease, we expect that our cash payments to the lessor will exceed
the lease expenses recorded on a straight-line basis and the accrued lease
expense will be decreased and reach zero by the end of the lease term. This
straight-line accounting treatment of certain lease expenses under the
Scrubgrass lease resulted in non-cash lease expense of $6,543,998 and $7,460,852
for the years ended December 31, 2002 and 2001, respectively. Environmental
Power, which owns 100% of Buzzard's common stock, is not liable for

24

<PAGE>

future lease rental payments. Buzzard's stock is pledged as security and Buzzard
is only liable for future lease rental payments to the extent Buzzard receives
cash receipts from future power generation revenues.

As of December 31, 2002, without regard to straight-line lease accounting, we
estimate the future minimum lease payments over the remaining base term of the
Scrubgrass lease are as follows:

          2003             16,723,000             2006             26,058,000
          2004             19,703,000             2007             28,910,000
          2005             21,715,000          Thereafter         249,240,000

                                   Total  $ 362,349,000
                                   -----  -------------

Our lease expense components, which are discussed in the following paragraphs,
consist of:

     .    specified base rent payments calculated on a straight-line basis;
     .    additional rent; and
     .    current period adjustments resulting from differences between actual
          lease billings and projected lease billings.

As noted above, Buzzard, as lessee, is required to pay the lessor a specified
base rent, which consists of all of the lessor's debt service, scheduled equity
repayment, base return on equity and related expenses. The lessor's debt service
largely consists of debt obligations with variable interest rates. Therefore, in
order to calculate future minimum lease payments, we estimate an average
interest rate which will be payable in the future for each variable rate debt
obligation. Since actual interest rates will differ from these estimates, our
actual lease expense reported in future periods will differ from these estimates
and the differences may be material.

In order to calculate the straight-line lease expense, we take the total
estimated future minimum lease payments over the lease term and divide it by the
lease term to get an annual lease expense. The annual lease expense is then
compared to the total amount projected to be billed by the lessor in each
period, and the difference is reported as a straight-line lease expense in our
consolidated financial statements. Any differences between actual lease billings
and projected lease billings, which principally result from variances between
actual interest rates and projected interest rates, are reported as a lease
expense in the current period.

We are also required to pay the lessor an additional rent, in addition to the
specified base rent, which additional rent represents 50 percent of the net cash
flows Buzzard receives from the operation of Scrubgrass. We estimate and accrue
additional rent in the accounting period when we believe the cash flows were
generated from operations. However, because additional rent is based on cash
flows and not earnings, it is more subjective to determine when the cash flows
were generated from operations. Lease expenses may also cause large fluctuations
between accounting periods in our reported earnings since the specified base
rent and additional rent are not directly related to our earnings. Additional
rent is not part of the straight-line lease expense calculation.

REVENUE RECOGNITION

We record power generation revenues when electricity is transmitted to the
utility under the terms of the underlying power sales agreement. However, under
the terms of our long-term power sales agreement, or PPA, with Penelec, the same
annual generation of electricity is expected to result in significant increases
in revenues over the life of this agreement. For various reasons, including the
requirement that all the power generated by the Scrubgrass facility be sold to
one customer, we account for power generation

25

<PAGE>

revenues under the lease accounting rules as if the power sales agreement was a
sublease to this customer. In accordance with accounting principles generally
accepted in the United States of America, we are therefore required to aggregate
the expected revenue to be received over the life of the power sales agreement
and recognize it on a straight-line basis over the 22-year lease term. As such,
during the early years of the power sales agreement with Penelec, a portion of
our power generation revenues will be received in cash and a portion will be
recorded to an asset. However, since we cannot predict whether revenues would be
collected over the entire life of the power sales agreement, and absent
revenues, whether Buzzard would be able to perform under the lease, the
recognition of revenue on a straight-line basis was limited to the recognition
of lease expense on a straight-line basis. As a result, net income is not
affected by straight-line lease and revenue accounting. As of December 31, 2002,
we have accrued power generation revenue of $70,192,993 recorded on our
consolidated balance sheet which is equal in amount to the accrued lease
expense. This asset represents accumulated revenue recorded on a straight-line
basis in previous years which has not been collected from Penelec. This
straight-line accounting treatment of power generation revenue under the power
sales agreement with Penelec resulted in non-cash revenues of $6,543,998 and
$7,460,852 for the years ended December 31, 2002 and 2001, respectively. In the
later years of the power sales agreement, we expect that our cash receipts from
Penelec will exceed the revenues recorded on a straight-line basis and the
accrued power generation revenue will be decreased and reach zero by the end of
the lease term. Future cash collections from power generation revenue may vary
from the projections used to aggregate the expected revenue to be received over
the life of the power sales agreement, which we recognize on a straight-line
basis over the 22-year lease term.

ACCOUNTING FOR INCOME TAXES

As part of the process of preparing our consolidated financial statements we are
required to estimate our income taxes in each of the jurisdictions in which we
operate. This process involves us estimating our actual current tax exposure
together with assessing temporary differences resulting from differing treatment
of items, such as our deferred gain and lease rights, for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which
are included within our consolidated balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income and to the extent we believe that recovery is not likely, we must
establish a valuation allowance. To the extent we establish a valuation
allowance or increase this allowance in a period, we must include an expense
within the tax provision in the consolidated statement of operations.

Significant management judgment is required in determining our provision for
income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against our deferred tax assets. As of December 31, 2002, we
have recorded a net deferred income tax liability of $78,071 on our consolidated
balance sheet. We have also recorded a valuation allowance of $227,123 against
our gross deferred income tax assets as of December 31, 2002; due to
uncertainties related to our ability to utilize some of our net operating loss
carry forwards before they expire. The valuation allowance is based on our
estimates of taxable income by jurisdiction in which we operate and the period
over which our deferred tax assets will be recoverable. In the event that actual
results differ from these estimates or we adjust these estimates in future
periods we may need to establish an additional valuation allowance which could
materially impact our financial position and results of operations.

INTANGIBLE ASSETS

In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 142, "Goodwill and Other Intangible
Assets." The most significant changes made by SFAS No. 142 are: 1) goodwill and
indefinite-lived intangible assets will be tested for impairment at least
annually; 2) goodwill and indefinite-lived intangible assets will no longer be
amortized to income; and 3) the amortization period of intangible assets with
finite lives will no longer

26

<PAGE>

be limited to forty years. SFAS No. 142 also requires a two-phase process for
impairment testing of goodwill. The first phase, which screens for impairment,
was to be completed by June 30 2002. Any identified impairments would be treated
as a cumulative effect of a change in accounting principle. The provisions of
SFAS 142 were applied to the goodwill and intangible assets acquired in the
Microgy acquisition. We did not have goodwill or intangible assets recorded on
our balance sheet prior to the Microgy acquisition. We adopted SFAS 142 on
January 1, 2002 and completed the transitional impairment testing in June 2002
and required annual testing at December 31, 2002. The Company assessed the
implied fair value of the reporting unit by using a discounted cash flow
analysis. Given consideration of these factors the Company concluded that the
fair value of the reporting unit exceeded the carrying amount of its net assets
and, thus, goodwill was not impaired as of January 1, 2002 and December 31,
2002.

RESULTS OF OPERATIONS

Year ended December 31, 2002 compared with the year ended December 31, 2001

Our net income decreased to $1,138,383 for 2002 from $1,679,331 in 2001. The
decrease in net income was primarily due to increases in operating, lease,
general administrative and depreciation and amortization expenses.

The effect of these changes was partially offset by an increase in power
generation revenues, other income and a decrease in income tax expense.

Basic earnings per common share decreased to $0.05 per common share in 2002 from
$0.12 per common share in 2001. The decrease was primarily due to a decrease in
net income and an increase in the weighted average common shares outstanding.
Diluted earnings per common share decreased to $0.05 per common share in 2002
from $0.11 per common share in 2001. The decrease was primarily due to a
decrease in net income and an increase in the weighted average common shares
outstanding. The weighted average common shares outstanding increased in 2002
due to the issuance of additional shares for the acquisition of Microgy during
the second half of 2001 and the 2,080,000 shares, including 1,040,000 treasury
shares, sold in our 2002 private placement.

Power generation revenues increased to $54,983,934 for 2002 from $53,518,000 in
2001 and all pertained to Scrubgrass. The increase in power generation revenues
was primarily due to:

     .    greater output from the Scrubgrass facility; and
     .    a 5% increase in certain rates billed to Penelec under the terms of
          the power sales agreement.

Scrubgrass operated at 91.3% of its capacity in 2002 as compared to 91.2% for
2001. The improvement in the capacity rate occurred primarily because of fewer
unplanned shutdowns to respond to equipment malfunctions and utility
curtailments.

This increase in overall power generation revenue was partially offset by a
decrease in the component of power generation revenue recorded as a result of
the straight-line accounting treatment of revenues under the power sales
agreement which amounted to $6,543,998 in 2002 and $7,460,852 in 2001.

Operating expenses increased to $24,139,819 for 2002 from $23,681,081 in 2001
and all pertained to Scrubgrass. The increase in operating expenses was
primarily due to:

     .    higher fuel expense from cost escalations in certain fuel supply
          agreements;
     .    higher fuel expense from changes in fuel mix and the quality of fuel
          sources;
     .    higher fuel expense from the improvement in facility output; and
     .    higher operator fees pursuant to the terms of the operations and
          maintenance agreement;

27

<PAGE>

These increases were partially offset by a decrease in labor, and labor related
costs.

Lease expenses increased to $25,291,293 for 2002 from $24,705,813 in 2001. The
increase was primarily due to:

     .    increases in scheduled base equity rents; and
     .    an increase in additional rent paid to the lessor, which amounts to 50
          percent of the net available cash flows from Scrubgrass, as a result
          of increases in available cash flows from Scrubgrass.

These increases in lease expenses were partially offset by:

     .    an decrease in lease expenses recorded as a result of the
          straight-line accounting treatment of lease expenses under the
          Scrubgrass lease which amounted to $6,543,998 in 2002 and $7,460,852
          in 2001;
     .    a decrease in scheduled principal payments for the Scrubgrass debt
          which were billed to us under the terms of the lease; and
     .    decreases in the lessor's loan costs, which are passed along to us as
          a lease expense, due to lower average interest rates on the tax exempt
          bonds and variable rate term loans and reduced outstanding balances on
          the Scrubgrass debt.

General and administrative expenses increased to $5,655,207 for 2002 from
$3,973,025 in 2001. The increase was primarily due to:

     .    Microgy overhead expenses for a full 12 months, 2001 had approximately
          5 1/2 months following its acquisition on July 23, 2001;
     .    significant expenses related to the Microgy business development, and
          strategic planning; and
     .    increases in our labor force for planned business expansion.

Interest income decreased to $47,753 for 2002 from $78,203 in 2001. The decrease
was primarily due to lower average interest rates for investments.

Interest expense decreased to $141,526 for 2002 from $185,547 in 2001. The
decrease was primarily due to lower variable interest rates.

Results for 2001 included $2,135,048 from the settlement of the Sunnyside
litigation which is discussed further under Liquidity and Capital Resources. No
such settlements were received in 2002.

We earned net proceeds of $2,428,200 from the sale of NOx emissions credits in
2002. Our NOx emission credits are discussed further under Liquidity and Capital
Resources. No such sales occurred in 2001.

Income tax expense decreased to $857,274 for 2002 from $1,373,454 in 2001. The
decrease was primarily due to a decrease in income before taxes in 2002.

Year ended December 31, 2001 compared with the year ended December 31, 2000

Our net income decreased to $1,679,331 for 2001 from $1,826,808 in 2000. The
decrease in net income was primarily due to:

     .    decreases in power generation revenues and interest income;
     .    the absence of revenues from sales of NOx emission credits; and

28

<PAGE>

     .    increases in operating expenses and general and administrative
          expenses.

The effect of these changes was partially offset by an increase in other income
and decreases in lease expenses, interest expense and income tax expense.

Basic earnings per common share decreased to $0.12 per common share in 2001 from
$0.16 per common share in 2000. The decrease was primarily due to a decrease in
net income and an increase in the weighted average common shares outstanding.
The weighted average common shares outstanding increased in 2001 due to the
issuance of additional shares for the acquisition of Microgy. Diluted earnings
per common share decreased to $0.11 per common share in 2001 from $0.16 per
common share in 2000. The decrease was primarily due to a decrease in net income
and an increase in the weighted average common shares outstanding. The weighted
average common shares outstanding increased in 2001 due to the issuance of
additional shares for the acquisition of Microgy.

Power generation revenues decreased to $53,518,000 for 2001 from $54,303,222 in
2000 and all pertained to Scrubgrass. The decrease in power generation revenues
was primarily due to the absence in 2001 of revenues of approximately $3,687,000
from the settlement with Penelec. This decrease was partially offset by:

     .    greater output from the Scrubgrass facility;
     .    a 5% increase in certain rates billed to Penelec under the terms of
          the power sales agreement; and
     .    an increase in revenue recorded as a result of the straight-line
          accounting treatment of revenues under the power sales agreement which
          amounted to $7,460,852 in 2001 and $7,036,012 in 2000.

Scrubgrass operated at 91.2% of its capacity in 2001 as compared to 90.2% for
2000. The improvement in the capacity rate occurred primarily because of fewer
unplanned shutdowns to respond to equipment malfunctions and utility
curtailments.

Operating expenses increased to $23,681,081 for 2001 from $22,291,069 in 2000
and all pertained to Scrubgrass. The increase in operating expenses was
primarily due to:

     .    higher fuel expense from cost escalations in certain fuel supply
          agreements;
     .    higher fuel expense from changes in fuel mix and the quality of fuel
          sources;
     .    higher fuel expense from the improvement in facility output;
     .    increases in labor, labor related costs and operator fees pursuant to
          the terms of the operations and maintenance agreement; and
     .    increases in planned maintenance because of differences in the scope
          of procedures performed during the 2001 and 2000 annual maintenance
          outages.

These increases were partially offset by a decrease in expensed facility
modifications because of differences in the nature of procedures performed in
2001 versus 2000.

Lease expenses decreased to $24,705,813 for 2001 from $26,415,897 in 2000. The
decrease was primarily due to:

     .    decreases in the lessor's loan costs, which are passed along to us as
          a lease expense, due to lower average interest rates on the tax exempt
          bonds and variable rate term loans and reduced outstanding balances on
          the Scrubgrass debt;
     .    decreases in scheduled base equity rents; and
     .    a decrease in additional rent paid to the lessor, which amounts to 50
          percent of the net available cash flows from Scrubgrass, as a result
          of decreases in available cash flows from Scrubgrass.

29

<PAGE>

      During 2000, such cash flows included revenues and interest income from
      the settlement with Penelec and income from sales of NOx emission credits.

These decreases in lease expenses were partially offset by:

     .    an increase in lease expenses recorded as a result of the
          straight-line accounting treatment of lease expenses under the
          Scrubgrass lease which amounted to $7,460,852 in 2001 and $7,036,012
          in 2000; and
     .    increases in scheduled principal payments and fees for the Scrubgrass
          debt which were billed to us under the terms of the lease.

General and administrative expenses increased to $3,973,025 for 2001 from
$3,602,960 in 2000. The increase was primarily due to:

     .    Microgy overhead expenses following its acquisition on July 23, 2001;
     .    significant expenses related to the Microgy acquisition for
          post-acquisition integration, business development, and strategic
          planning;
     .    increases in our staff for planned business expansion; and
     .    an increase in Scrubgrass insurance expense due to changes in the
          insurance market for power generation facilities.

These increases were partially offset by lower Scrubgrass management expenses
during 2001. Scrubgrass had incurred significant professional fees, travel
expenses and labor related costs during 2000 to address certain non-recurring
business matters including the settlement with Penelec and the replacement of
the letter of credit.

Interest income decreased to $78,203 for 2001 from $736,867 in 2000. The
decrease was primarily due to:

     .    the absence of approximately $608,000 of interest income from the
          settlement with Penelec;
     .    lower average interest rates for investments; and
     .    reductions in the average outstanding balances of notes receivable
          from officers.

Interest expense decreased to $185,547 for 2001 from $320,641 in 2000. The
decrease was primarily due to lower variable interest rates and reduced average
outstanding balances for Scrubgrass debt. The decrease was partially offset by
interest incurred on the $750,000 loan made by Alco Financial Services, LLC in
September 2001, which loan is discussed further under Financing Activities.

We had other income of $2,135,048 in 2001 from the settlement of the Sunnyside
litigation which is discussed further under Liquidity and Capital Resources.

We earned net proceeds of $1,156,338 from the sale of NOx emissions credits in
2000. Our NOx emission credits are discussed further under Liquidity and Capital
Resources.

Income tax expense decreased to $1,373,454 for 2001 from $1,632,233 in 2000. The
decrease was primarily due to a decrease in income before taxes and a lower
effective tax rate in 2001. The decrease in the effective tax rate was largely
due to lower state income taxes.

2003 Outlook

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The following forward-looking information concerning our results of operations
for 2003 is being compared to our historical results of operations for 2002 and
does not take into account the effect of a potential sale of Buzzard:

As discussed in Item 7 below in the Cash Flow Outlook, in June of 2003 the
payments terms of our power purchase agreement with Penelec are contractually
extended. This will negatively effect our working capital position, unless other
working capital arrangements are made.

Power generation revenues are expected to increase in 2003 primarily due to a 5%
increase in rates billed to Penelec under the Scrubgrass power sales agreement.
This increase is expected to be partially offset by a decrease in revenue
recorded as a result of the straight-line accounting treatment of revenue under
the power sales agreement.

Operating expenses are expected to increase in 2003 primarily due to:

     .    an escalation in rates for fuel supply cost;
     .    changes in the scope of planned maintenance procedures and facility
          modifications; and
     .    an escalation in operator fees under the terms of the operations and
          maintenance agreement

Lease expenses are expected to increase in 2003 primarily because:

     .    we have scheduled increases in bond principal payments.

However, these increases may be partially offset because:

     .    we expect lower outstanding balances for term loans to lessen the
          lessor's interest costs that would be billed to us under the terms of
          the lease;
     .    we expect the lessor to bill us lower scheduled base equity rents
          pursuant to the terms of the lease; and
     .    we expect to have a decrease in the lease expense recorded as a result
          of the straight-line accounting treatment of lease expenses under the
          lease agreement.

General and administrative expenses are expected to increase during 2003
primarily because:

     .    we expect to make changes in our work force as we further implement
          our Microgy business plan. These changes may include adding marketing,
          sales, engineering, accounting and finance personnel;
     .    we continue to employ consultants for technical, financial, legal,
          marketing, public and investor relations and other strategic advice;
          and
     .    we expect numerous corporate expenses like insurance, office supplies,
          rent, legal, and travel to increase due to business expansion efforts.

Other income is expected to decrease in 2003. During 2002, we reported sales of
NOx emission credits of approximately $2.4 million. We do not anticipate the
sale of NOx emission credits in 2003.

Assuming no additional share issuances and no repurchases, our weighted average
common shares outstanding is expected to remain at 21,892,579 shares in 2003.

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RECENTLY ISSUED ACCOUNTING STANDARDS

There are several recently issued accounting standards which are required to be
adopted in the future which are described in Note B to the Consolidated
Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

Operating Activities

Our cash provided by operating activities was $328,088 in 2002, $2,687,504 in
2001 and $469,770 in 2000. During these periods, our only sources of cash from
operating activities were operating profits from Scrubgrass, proceeds from the
settlement of the Sunnyside litigation, proceeds from sales of NOx emission
credits and investment earnings.

We reported net earnings of $1,138,383 during 2002 which contributed
significantly to the cash provided by operating activities. The following
adjustments, which did not impact our cash flows, need to be considered in order
to reconcile our net income in 2002 to our net cash provided by operating
activities:

Depreciation and amortization - During 2002, we recognized depreciation and
amortization for lease rights of $149,004, licensed technology rights of
$185,500, deferred financing costs of $59,534, property plant and equipment of
$150,756.

Deferred income taxes - We had a net deferred income tax liability of $78,071 as
of December 31, 2002 and $146,396 as of December 31, 2001. On July 23, 2001, we
acquired a significant deferred tax liability from Microgy related to licensed
technology rights which was the primary reason we changed to a net deferred
income tax liability position as of December 31, 2001. This change was partially
offset by the acquired tax benefits from Microgy's net operating loss carry
forwards. The individual components of our deferred income tax expense, which
amounted to $97,268 in 2002, are outlined in the notes to our consolidated
financial statements.

Deferred gain, net - Our deferred gain, net, decreased to $4,163,544 as of
December 31, 2002 from $4,471,955 as of December 31, 2001. The decrease is due
to the amortization of the deferred gain related to Scrubgrass, which is being
amortized on a straight-line basis over 22 years.

Stock-based compensation - We issued stock options with a fair market value of
$49,707 to a consultant for services performed for us.

We also offer the following information to discuss changes in operating assets
and liabilities which most notably impacted our cash position during 2002:

Receivable from utility - Our receivable from utility increased to $7,973,723 as
of December 31, 2002 from $7,905,864 as of December 31, 2001. The increase was
primarily due to a 5% increase in rates billed to Penelec under the terms of the
power sales agreement, offset by lower production in December 2002 versus
December 2001.

Other current assets - Our other current assets increased to $926,577 as of
December 31, 2002 from $607,590 as of December 31, 2001. The increase was
largely due to increases in fuel inventory quantities at Scrubgrass.

Accounts payable and accrued expenses - Our accounts payable and accrued
expenses decreased to $9,650,092 as of December 31, 2002 from $10,070,205 as of
December 31, 2001. The decrease was primarily because:

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     .    our corporate taxes payable decreased, due to lower pre-tax income;
     .    our lease payable for the lessor's bond payments decreased due to
          timing of bond maturities.

Investing Activities

Our cash used in investing activities was $180,654 in 2002, $1,071,915 in 2001
and $291,009 in 2000. Our investing activities were concentrated primarily in
the following areas:

Restricted cash - We are contractually required to make scheduled deposits to a
restricted maintenance fund for Scrubgrass to ensure that funds are available in
the future for scheduled major equipment overhauls. We are allowed to use
restricted cash for major equipment overhauls subject to certain restrictions.
We made scheduled deposits to the restricted major maintenance fund of
$1,083,573 in 2002, $808,936 in 2001 and $678,524 in 2000. Our payments for
major equipment overhauls amounted to $971,339 in 2002, $415,460 in 2001 and
$418,670 in 2000. The remaining changes to restricted cash primarily pertain to
investment earnings on available cash balances. Major equipment overhauls are
subject to certification by an independent engineer and are performed on a
pre-established schedule which can differ widely from year to year. The
selection of equipment for service and/or replacement each year depends on
factors such as the condition of the equipment, expected wear and tear, and
recommendations made by equipment manufacturers. Beginning in February 2002, we
are required to make deposits to the restricted major maintenance fund of
$91,520 per month through April 2005. The required monthly payment is subject to
possible recalculation after each annual maintenance outage to ensure that funds
are sufficient to cover the long-term schedule of major equipment overhauls.

Property, plant and equipment - Property, plant and equipment expenditures were
$50,533 in 2002, $232,691 in 2001 and $3,023 in 2000. All capitalized
expenditures during 2002 were incurred by Microgy and Environmental Power
Corporation. During 2001, we made machinery and equipment modifications of
$227,295 to improve the raw water pre-treatment systems at the Scrubgrass
facility. The remaining capital expenditures in 2001 were primarily purchases of
office equipment for our corporate headquarters.

Sale of NOx Credits - Under applicable environmental laws and regulations,
Scrubgrass needed to achieve certain seasonal nitrogen oxide emission levels
beginning on May 1, 1999, and was also required to achieve reduced emission
standards by May 2002. Due to the efficient design of the Scrubgrass facility,
Scrubgrass met the 1999 requirements without any modifications to the facility.
During 1999, we made capital improvements of $811,568 to the Scrubgrass
facility, which enabled Scrubgrass to meet the stricter standards in 2002. By
making improvements to the facility before 2002, we anticipated that we would
not require a portion of our future NOx Credits to maintain our compliance with
the applicable regulations. Consequently, we sold our anticipated excess NOx
Credits in recent years and used the proceeds to finance the capital
improvements and generate additional cash flows for operations. We expect to
comply with all material environmental regulations for the foreseeable future
without any additional material modifications to the Scrubgrass facility.
Recently, we received our next award of NOx Credits for the ozone seasons in
2002 through 2007. Similar to prior years, we expected that we may not require a
portion of these future NOx Credits to maintain our compliance with the
applicable regulations and sold the anticipated excess NOx Credits in 2002 for
$2,428,200. We do not anticipate the sale of NOx Credits in 2003.

Project development activities - We expect to begin development and construction
of facilities using Microgy's licensed technology during 2003. To the extent we
are the owner of these facilities, we will require financing to complete the
development and construction of the facilities which is discussed under
financing activities.

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<PAGE>

Financing Activities

Our cash provided by (used in) financing activities was $119,038 in 2002,
($1,454,984) in 2001 and ($177,283) in 2000. We offer the following information
concerning the financing activities for our business:

Related Party Loan - On September 14, 2001, we borrowed $750,000 from Alco
Financial Services LLC, or Alco, to fund certain expenses related to the
acquisition of Microgy and provide additional working capital for our expansion
efforts. Robert Weisberg, one of our directors, is the President, Director and a
member of Alco. The loan is evidenced by a promissory note which bears interest
at the prime rate plus 3.5%. We also pay an administrative fee of 0.6% per
month. The loan is secured by all of EPC's assets, except for the common stock
of Buzzard, which is already pledged to the lessor of Scrubgrass. In connection
with the loan, we granted Alco five year warrants to purchase 50,000 shares of
common stock at $0.60 per share. The loan has been extended with a maturity date
of September 13, 2003.

Working Capital Loan for Scrubgrass - Buzzard may borrow up to $4 million under
a Lessee Working Capital Loan Agreement with the lessor of Scrubgrass for
ongoing working capital requirements of this project. The outstanding borrowings
under this loan were $517,112 as of December 31, 2002 and $1,116,905 as of
December 31, 2001. As discussed below, the Lessee Working Capital Loan Agreement
was due to expire in December 2002. The Lessee Working Capital Loan Agreement
has been extended four years until December 2006. Under the existing terms of
this loan, we were required to pay the outstanding balance to zero for a minimum
of twenty days during 2001 and 2002. We have met the pay down requirement for
this loan for 2002 and 2003.

Refinancing at Scrubgrass -. NEG is addressing the following financing matter:

     .    Buzzard is expected to require additional working capital beginning in
          June 2003, when Penelec's contracted payment terms will be extended by
          24 business days.

During most of 2002, PG&E National Energy Company, or NEG, the manager of
Scrubgrass has been in refinancing discussions with the lending agent for the
project. Under the terms of the project documents, NEG is not only a project
participant but is also the manager of the project with sole responsibility and
authority for discussions with project lenders. As of the quarter ending
September 2002, NEG's credit rating was downgraded by the rating agencies. This
has made loan refinancing more difficult, even though the debt has recourse only
to the Scrubgrass project. NEG continues to address the financing matter
regarding Buzzard's expected requirement for additional working capital
beginning in June 2003, when Penelec's contracted payment terms will be extended
by 24 business days. NEG is in discussions with Penelec regarding paying a fee
to them rather than extending the payment terms. The project lender recently
approved an extension of the existing $4 million working capital loan facility
until 2006. See the cash flow section of this report for further discussion of
expected cash flows.

Scrubgrass Debt Obligations

Buzzard and the lessor have various debt obligations related to Scrubgrass.
Under the terms of the Scrubgrass lease, Buzzard is required to pay the
principal, interest and fees for the lessor's debt obligations as a base lease
payment. As such, Buzzard is committed to pay all of the Scrubgrass debt
obligations as either a debt or lease obligation. Scrubgrass had the following
debt obligations as of December 31, 2002 and 2001:

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<TABLE>
<CAPTION>
                                            BALANCE AT         BALANCE AT
     DESCRIPTION OF THE OBLIGATION           12/31/02           12/31/01            INTEREST RATE          MATURES
--------------------------------------- ------------------ ----------------- ------------------------- -------------
<S>                                      <C>                <C>                    <C>                      <C>
BUZZARD'S LEASE OBLIGATIONS:

Variable rate tax-exempt bonds           $ 135,600,000      $ 135,600,000          Quoted Bond Rates        2012
Swap rate term loan                          8,700,913         10,669,663          7.6725%                  2005
 Variable rate term loan                     7,089,016          8,344,479          LIBOR + 1.250%           2004

BUZZARD'S DEBT OBLIGATIONS:

 Variable rate term loan                       837,437            985,747          LIBOR + 1.250%           2004
 Working capital loan                          517,112          1,116,905          LIBOR + 1.250%           2008

</TABLE>

Buzzard's lease obligations for the lessor's debt are not reported in our
consolidated financial statements. As these debt obligations mature, they will
be billed by the lessor to Buzzard and reported as a lease expense in our
consolidated financial statements.

Notes Receivable from Officers - We have outstanding notes receivable from
officers and directors for shares purchased in connection with stock option
plans which amounted to $645,948 as of December 31, 2002 and $645,948 as of
December 31, 2001. These notes, which are secured by the underlying shares of
stock, are payable upon demand and bear interest at a floating rate which is
payable monthly. During 2000, we received aggregate note repayments of $363,783
from executive officers. During 2001, executive officers borrowed an aggregate
of $200,000 from us.

Dividends - We declared dividends on common stock of $684,408, or 6 cents per
share, in 2000. Since December of 2000, the Board of Directors has not declared
any dividends on our common stock. Due to the recent acquisition of Microgy and
anticipated expansion of our business, the Board of Directors has concluded that
available cash flows should be used for operating and investing activities for
the foreseeable future. Buzzard also paid dividends of $5,000 per year to its
preferred stockholder during 2002, 2001 and 2000. The dividends, we declared of
$171,102 in 2000 were paid in 2001.

Sunnyside Contingent Obligations - We had contingent obligations of $1,218,078
on our consolidated balance sheet as of December 31, 2000. The contingent
obligations were principally expenses for the sale of Sunnyside which were
payable upon collection of certain obligations from the purchasers of Sunnyside.
On April 10, 2001, we received aggregate proceeds of $1,500,000 from the
purchasers of Sunnyside and resolved litigation by executing a Binding
Settlement Agreement. In this agreement, we were formally released from
contingent obligations of $177,962. We have also been released by the statute of
limitations or the terms of the underlying agreements from additional contingent
obligations of $457,086. We reported the settlement proceeds of $1,500,000 and
the released liabilities of $635,048 as other income in our consolidated
financial statements for 2001.

Because of the terms of this settlement agreement, which terms represented a
substantial compromise of our previous claims against the purchasers of
Sunnyside, we are presently considering our rights and obligations with respect
to the remaining contingent obligations of $583,030. Until we resolve these
remaining issues, the unsettled contingent obligations will remain recorded in
our consolidated financial statements.

Cash Flow Outlook

During 2003, we expect to principally fund our business activities from
available cash balances, investment earnings, cash which may become available
from Scrubgrass, the sale of assets or a subsidiary and or raising

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<PAGE>

additional debt or equity funding. As discussed in Item 1, we are not able to
receive distributions from Scrubgrass until all operating expenses, base lease
payments, restricted cash deposits and other subordinated payments of Scrubgrass
are satisfied. Nevertheless, Scrubgrass cash flows in 2003 are expected to be
sufficient to satisfy all of these restrictions and provide us with continuing
distributions.

On December 31, 2002, our unrestricted cash balance was $734,743 as compared to
$468,271 as of December 31, 2001. On December 31, 2002, our restricted cash
balance was $1,144,701 as compared to $1,014,580 as of December 31, 2001. As
discussed further under investing activities, we are allowed to spend restricted
cash to fund the cost of major equipment overhauls at Scrubgrass subject to
certain restrictions.

During the three months ended March 31, 2003, we received distributions of
$1,211,250 from Scrubgrass which is less than our distributions of $1,555,506
during the same period in 2002. The decrease in distributions in the first
quarter of 2002 is the result of proceeds of $2,428,200 from the sale of Nox
emissions credits in the first quarter 2002, no such sales occurred in 2003.
Scrubgrass has been operating favorably with annual capacity rates in excess of
90% for the last three years. Since Scrubgrass is leveraged with variable rate
debt, the recent trend of low interest rates, the sale of NOx emission credits
and favorable operations has allowed Scrubgrass to generate unprecedented cash
flows from its operations. Assuming the continuing trends of favorable
operations and low interest rates during 2003, we anticipate record power
revenues from Scrubgrass in 2003.

However our cash flow from revenues provided by Scrubgrass in 2003 may be
significantly reduced as a result of terms of the power sales agreement
originally executed with Penelec in 1987. Unless modified as discussed below,
Penelec's payment terms will automatically be extended in June 2003 from the
current 23 business days after month end to 47 business days after month end. As
a result, Buzzard will incur a need for increased working capital. Under the
terms of the project documents, NEG is not only a project participant but is
also the manager of the project with sole responsibility and authority for
discussions with project lenders. As of the quarter ending September 2002, NEG's
credit rating was downgraded by the rating agencies. We believe this has made
working capital loan refinancing more difficult, even though the debt is
recourse only to the Scrubgrass project. The lender which recently approved an
extension of the existing $4 million working capital loan facility until 2006
was also approached to increase the facility to $10 million to accommodate the
change in the Penelec payment terms. The lender has decided not to increase the
loan amount to accommodate this change. NEG is in discussions with Penelec
regarding paying a fee to Penelec, or making modifications to current operating
practices rather than extending the payment terms.

The extended Penelec payment terms, unless adjusted, are likely to result in a
significantly longer period during 2003 than in prior years when Buzzard will
not receive any distributions from the Scrubgrass Project. Accordingly, in the
event no additional credit accommodation is arranged for the increased working
capital requirements at the Scrubgrass plant, our cash flow from Scrubgrass
operations for 2003 will not be sufficient to fund:

     .    EPC's historic corporate overhead requirements;
     .    Current taxes due;
     .    continued implementation of the Microgy business plan; and
     .    repayment of the Alco loan to the extent the loan is not extended,
          refinanced or replaced.

Even if additional working capital is arranged, without additional funding or
the sale of Scrubgrass EPC would need to extend the payment terms of certain
liabilities. Furthermore, we will be restricted in our ability to develop
Microgy without additional funding.

We are working with a financial advisor to assist us in securing additional debt
or equity financing for our business. Additionally, we are pursuing and have
received offers concerning the potential sale of our subsidiary Buzzard. Such a
sale, if consummated, based on the terms and conditions of these offers, would
generate sufficient cash to fund the cost of selling Buzzard and all currently
estimated EPC expenses for the remainder of 2003 and a portion of 2004 including
EPC corporate overhead, EPC corporate obligations including the repayment of the
Alco loan and taxes and provide working capital to continue to fund the
development of our Microgy business. While we would then no longer be

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<PAGE>

entitled to future cash flows from the Scrubgrass Project, we would, however,
avoid uncertainties relating to scheduled changes in Penelec's payment terms,
working capital financing involving the Scrubgrass Project, the potential
bankruptcy by NEG and changes in power rates paid by Penelec beginning in 2005,
all of which could adversely affect Buzzard's cash flows. There can, however, be
no assurance that Environmental Power will successfully negotiate and conclude a
financing or sale transaction on terms deemed acceptable.

During 2003, subject to financing constraints described above, Microgy plans to
commence the sale, development and construction of projects based upon the
anaerobic digestion technology license. Our present business strategy generally
anticipates the outright sale of facilities; however, in some circumstances, we
expect that Microgy may own some or even a majority of the projects. We
anticipate that, to the extent Microgy is the owner of projects, project
financing may be obtained in the form of a credit facility with one or more
lenders, the sale of tax exempt or taxable bonds to investors or equity or other
financing. Microgy can offer no assurance that it or any other prospective
project owner will be able to secure project financing in the amount required to
fulfill any development or construction requirements, that project financing
will be obtained in time to meet such requirements, or that any such proposed
project financing, if obtained, will be on terms acceptable to Microgy or any
other prospective project owner. However, to the extent Microgy is the owner of
projects, Microgy will need to obtain financing to allow it to develop and
construct such projects.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Annual Report on Form 10-K.

Microgy, a company that we recently acquired, has very little operating history
from which to evaluate its business and products.

Microgy was formed in 1999 and is still in the development stage. Microgy
intends to develop facilities which use environmentally friendly anaerobic
digestion and other technologies to produce bio-energy from animal and organic
wastes. Because a large part of our future business is anticipated to involve
Microgy's bio-energy projects and Microgy is an enterprise with very little
operating history upon which to judge, we are unable to determine whether our
investment in Microgy will prove to be profitable.

Microgy has experienced losses to date and we anticipate it will continue to
experience losses in the foreseeable future.

Microgy had accumulated losses due primarily to expenses of business development
of approximately $4,127,000 through December 31, 2002. We expect our Microgy
subsidiary to continue to incur losses, reduce our earnings or, as the case may
be, add to our earnings deficit as we seek to further develop its business.
These ongoing losses will likely adversely affect our financial condition into
the foreseeable future.

We have not completed our plans for deployment of our anaerobic digester
technology and therefore, cannot predict its related costs or outlook for
profitability.

The strategic implementation planning necessary to determine our course of
action for deployment of our anaerobic digester technology has not been
completed. The decision as to whether we will sell, install and operate, or
develop and own the related facilities, is expected to be made on a case by case
basis. In addition, we do not have experience in, or a basis for, predicting the
general and administrative and other costs associated with developing anaerobic
digester facilities. Because of this we are unable to determine when or if these
facilities will generate a profit. If the organizational, structural, staffing
and other

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<PAGE>

overhead costs associated with the anaerobic digester facilities outstrip any
profits, the value of your investment will be adversely affected.

If we are unable to obtain needed financing for Microgy's anaerobic digestion
bioenergy projects, the valuation of our Microgy investment may be reduced
significantly.

We are considering corporate, project and group financing to fund the cost of
any development we may decide to pursue for our anaerobic digestion bioenergy
projects. In such event, we are likely to require financing and such financing
may be difficult to obtain. If we are unable to obtain such financing, the
valuation of our Microgy investment may be reduced significantly, and we may be
required to substantially curtail our business or close any anaerobic digester
projects. This financing will depend on the lender's or investor's review of the
financial capabilities of us as well as specific project or projects and other
factors, including their assessment of our ability to successfully construct and
manage the project.

Microgy's technologies could become obsolete before commercial deployment,
reducing the value of your investment.

We do not expect to commercially deploy Microgy's licensed anaerobic digestion
bioenergy technologies until we further develop Microgy's business plan, decide
on project structures and arrange necessary financing. Current technologies or
solutions that may be developed in the future by competitors could make our
anaerobic digestion bioenergy technologies obsolete before they are commercially
deployed. Accordingly, we cannot guarantee that our technologies will ensure a
competitive position within the marketplace in the future. If we are unable to
obtain a competitive position in the agricultural and alternative power
generation markets, the value of your investment will be reduced.

If we experience delays in obtaining the technical information and specifics
needed to build our licensed anaerobic digester technologies, our business could
be harmed and the value of your investment could be reduced.

The company from which we license intellectual property regarding our anaerobic
digestion bioenergy products still holds trade secret and other proprietary
information that is important to us. Prior to our ownership of Microgy, it
experienced delays in obtaining and completing information necessary to
successfully develop anaerobic digester projects. The inability to readily
obtain this information from our licensor could delay our product offerings,
make them more expensive to bring to market and reduce the value of your
investment.

The market for anaerobic digester bioenergy technology is crowded and our market
share may not be sufficient to be profitable.

There are many companies that offer anaerobic digester systems. We believe that
at least 60 companies offer complete systems or components to these systems in
the U.S. market. The presence of these companies may dilute our market share to
a degree that we are not profitable.

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<PAGE>

We currently rely on the Scrubgrass Project for all of our operating revenues.

We own a 22 year leasehold interest that commenced in 1994 in our Scrubgrass
Project; a waste coal fired electric generating facility in Pennsylvania.
Because all of our operating revenue currently results from the Scrubgrass
Project, we are dependent on its successful and continued operating experiences.
Increased working capital requirements of the Scrubgrass Project, significant
unscheduled shutdowns or large increases in interest rates at Scrubgrass would
reduce our cash flow. This may necessitate a substantial curtailment of our
operations and require the termination of any anaerobic digester projects and
would have an adverse effect on our results of operations.

We do not control the management of the Scrubgrass Project, our primary revenue
generating asset.

We have a management services agreement with PG&E National Energy Group to
manage the Scrubgrass Project and a 15-year operations and maintenance agreement
with PG&E Operating Services to operate the facility. Under the terms of these
agreements, there are provisions that limit our participation in the management
and operation of the Scrubgrass Project. Because we do not exercise control over
the operation or management of the Scrubgrass Project, decisions may be made,
notwithstanding our opposition that may have an adverse effect on our business.
The bankruptcy filing by PG&E and the credit down grade of NEG creates
additional uncertainty regarding the management of the project.

Our current power generation revenue is derived from only one customer, the loss
of which would severely harm our financial condition and the value of your
investment.

Our current Scrubgrass Project power generation revenue is earned under a
long-term power purchase agreement with one customer, Pennsylvania Electric
Company, or Penelec, a subsidiary of FirstEnergy Corporation. We expect that the
concentration of our revenue with this customer will continue for the
foreseeable future. If this customer goes out of business or defaults on its
payments to us, our financial condition will be adversely affected.

A large increase in interest rates may adversely affect our operating results.

Our Buzzard subsidiary is leveraged with mostly variable rate and some fixed
rate debt obligations. Should market interest rates rise significantly, our
operating results will be adversely impacted.

Our Scrubgrass Project's long-term power purchase agreement is subject to a
change in rates in 2005 and market conditions in its later years which may
affect our profitability.

The Scrubgrass Project generates electricity that is sold at rates established
under a long-term power purchase agreement with Penelec, approved by the
Pennsylvania Public Utility Commission. For years 2005 through 2012, the
agreement provides for a rate determined based on a scheduled rate adjusted for
actual inflation during prior contract years compared to the automatic 5%
adjustment in such prior years. Contracted rates in the later years of the
agreement are determined with reference to then existing market conditions.
Therefore, the existence of inflation less than 5% in years prior to 2005 will
negatively impact revenue. Low wholesale energy rates during the later years of
the power purchase agreement would negatively impact our profitability and could
affect our financial position.

Payment terms on our Scrubgrass Project will change in 2003 and, if our working
capital is not increased to satisfy the change, our cash available for other
uses will be significantly limited.

In 2003, the payment schedule on our power purchase agreement will be modified
to allow Penelec more time to pay us for the power that we produce. If these
payment terms are not modified or other working

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<PAGE>

capital arranged and the financing or sale of Scrubgrass is not achieved, this
payment schedule change will cause a reduction in our working capital and will
limit our ability to pay for corporate overhead, service our debt and allocate
resources to other projects.

We are a small company and the entrance of large companies into the alternative
fuels and renewable energy business will likely harm our business.

Competition in the traditional energy business from electric utilities and other
energy companies is well established with many substantial entities having
multi-billion dollar multi-national operations. Competition in the alternative
fuels and renewable energy business is expanding with growth of the industry and
advent of many new technologies. Larger companies, due to their better
capitalization, will be better positioned to develop new technologies and to
install existing or more advanced renewable energy generators, which could harm
our market share and business.

If we are unable to obtain sufficient waste resources our renewable energy
technologies will not likely operate profitably.

The performance of our renewable energy technologies is dependent on the
availability of certain waste resources to produce the raw energy and meet
performance standards in the generation of power or bio-fuel. Lack of these
waste resources or adverse changes in the nature or quality of such waste
resources would seriously affect our ability to develop and finance projects and
to efficiently operate and generate income. As a result, our revenue and
financial condition will be materially and negatively affected. We cannot be
sure that waste resources will be available in the future for free or at a price
that make them affordable for our waste-to-energy technologies.

Our reliance on licenses, agreements and business alliances links our fate to
the fate of these businesses, of which we cannot predict or control.

We intend to rely on a network of various licenses, agreements and alliances
with other businesses to provide important technologies and services for our
businesses. Specifically, we rely on third party companies for the operation and
maintenance of our Scrubgrass facility and for the technology upon which we base
our proposed anaerobic digester projects. The failure of any of these third
party companies or the termination of any of these or other material licenses,
agreements or business alliances will have a detrimental impact on the success
of one or all projects or categories of projects and negatively impact our
revenue. We cannot predict or control the fate of these other businesses on
which we rely.

Because we have not filed patents to protect Microgy's intellectual property, we
might not be able to prevent others from employing competing products.
Conversely, others who have filed for patent or other protection might be able
to prevent us from employing our products.

Neither we nor, it is believed, our primary licensor have filed any patent
applications on the intellectual property Microgy plans to use. Should we or our
primary licensor decide to file patent applications, there can be no assurance
that any patent applications relating to our existing or future products or
technologies will result in patents being issued, that any issued patents will
afford adequate protection to us, or that such patents will not be challenged,
invalidated, infringed or circumvented. Furthermore, there can be no assurance
that others have not developed, or will not develop, similar products or
technologies that will compete with our products without infringing upon, or
which do not infringe upon, our intellectual property rights.

Third parties, including potential competitors, may already have filed patent
applications relating to the subject matter of our current or future products.
In the event that any such patents are issued to such parties, such patents may
preclude our licensors from obtaining patent protection for their technologies,
products or processes. In addition, such patents may hinder or prevent us from
commercializing our

40

<PAGE>

products and could require us to enter into licenses with such parties. There
can be no assurance that any required licenses would be available to us on
acceptable terms, or at all.

We rely heavily on confidentiality agreements and licensing agreements to
maintain the proprietary nature of our base of technologies relating to
currently licensed technologies. To compete effectively, we may have to defend
the rights to our intellectual property from time to time. The defense costs can
be significant. As such, we may lack the financial resources to adequately
defend our intellectual property.

The large amount of obstacles necessary to overcome for the development of power
projects increases the possibility that such projects will incur costly delays.

In our development of power projects for ourselves or on behalf of our
customers, we will be required to enter into or obtain some or all of the
following:

     .    site agreements;
     .    supply contracts;
     .    design/build or other construction related agreements;
     .    power sales contracts;
     .    various co-product sales agreements;
     .    waste disposal agreements;
     .    licenses;
     .    environmental and other permits;
     .    local government approvals; and
     .    financing commitments required for the successful completion of
          development projects.

Our failure to accomplish any of these objectives could materially increase the
cost or prevent the successful completion of development projects and incur the
loss of any investment made. These events could adversely affect our business
and results of operations.

System failure of our power generation projects will reduce our revenue.

Whether we have sold our facilities to customers or continue to own them, our
revenue and performance under various agreements and in our markets will depend
on the efficient and uninterrupted operation of our bioenergy plants and
systems, including automated control systems. Any system failure that causes
interruptions in our operations in facilities that we have sold but continue to
manage could have an adverse effect on our business and results of operations.
Also, any system failure that causes interruptions in facilities that we own
could have a material adverse effect on our business, results of operations and
financial condition. As we expand our operations, there will be increased stress
placed upon hardware and information management systems. There can be no
assurance that we will not experience system failures. In addition, our systems
and operations are vulnerable to damage or interruption from fire, flood, power
loss, telecommunications failure, break-ins and similar events. Our systems and
operations will also face contamination due to the actions of farmers and others
who may have access to our sites. We do not presently have redundant systems or
a formal disaster recovery plan to mitigate the risk of losses that may occur.
There can also be no assurance that any business interruption or property and
casualty insurance that we would carry in the future would be sufficient to
compensate for any losses that may occur.

Scheduled and unscheduled shutdowns of our power generation projects will reduce
our revenue.

Our Scrubgrass Project and any future power generation projects we develop will
experience both scheduled and unscheduled shutdowns. Periodically, power
generation projects incur scheduled shutdowns in order to perform maintenance
procedures to equipment that cannot be performed while the

41

<PAGE>

equipment is operating. Occasionally, our power generation projects may also
incur unscheduled shutdowns and be required to temporarily cease operation or to
operate at reduced capacity levels following the detection of equipment
malfunctions, or following minimum generation orders received by the utility.
During periods when these projects shut down or are operating at reduced
capacity levels, we may incur losses due to reduced operating revenue and due to
additional costs that may be required to complete any maintenance procedures.

Our power generation entities expose us to significant liability that our
insurance cannot cover.

Our power generation activities involve significant risks to us for
environmental damage, equipment damage and failures, personal injury and fines
and costs imposed by regulatory agencies. In the event a liability claim is made
against us, or if there is an extended outage or equipment failure or damage at
our power plant for which it is inadequately insured or subject to a coverage
exclusion, and we are unable to defend such claim successfully or obtain
indemnification or warranty recoveries, there may be a material adverse effect
on our financial condition.

Poor fuel and other materials quality will expose us to environmental liability
and reduce our operating results.

For our Scrubgrass facility, we obtain waste coal primarily from coal mining
companies on a long-term basis because waste coal is plentiful and generally
creates environmental hazards, such as acid drainage, when not disposed of
properly. The waste coal is burned in the Scrubgrass facility using a
circulating fluidized bed combustion system. During the circulating fluidized
bed combustion process, the waste coal is treated with other substances such as
limestone. Depending on the quality of the waste coal and the limestone, the
facility operator may need to add additional waste coal or other substances to
create the appropriate balance of substances which would result in the best fuel
or sorbent consistency for power generation and compliance with air quality
standards. Therefore, the cost of generating power is directly impacted by the
quality of the waste coal which supplies the Scrubgrass power generation
facility. Certain conditions, such as poor weather, can create situations where
the facility operator has less control over the quality of the waste coal. Poor
fuel quality may impact our future operating results.

The composition of effluents from our anaerobic digester facilities is not
certain and may expose us to liability.

We do not have experience in blending the wastes that will occur in our
anaerobic digester facilities. Such blends could result in unpredictable
regulatory compliance costs, related liabilities and unwanted materials in waste
effluents and co-products, all of which could harm our financial condition.

Unless our sale of power is under a long-term contract, future power sales into
unregulated and retail markets will likely subject our revenue to large swings
or prolonged depression of prices.

Electricity is a commodity available from a large amount of sources with no
pricing control. When we sell power under long term supply contracts or into the
unregulated wholesale and retail markets, we will be subject to very competitive
pricing pressures and some market risks. Low energy rates would negatively
impact our profitability and could adversely affect our financial condition.
Currently, we sell or have agreed to sell all of our power under existing long
term contracts. We are not certain of what form our future contracts will take.
The form of future contracts could subject us to unforeseen risks.

Our products and services involve long sales cycles that result in high costs
and uncertainty.

The negotiation of the large number of agreements necessary to sell, develop,
install, operate and manage any of our facilities, as well as to market the
energy and other co-products and to provide necessary related resources and
services, involves a long sales cycle and decision-making process. Delays in the

42

<PAGE>

parties' decision-making process are outside of our control and may have a
negative impact on our cost of sales, receipt of revenue and sales projections.
We estimate that it can take from nine months to a year or more to obtain
decisions and to negotiate and close these complex agreements.

Because the market for renewable energy and waste management is unproven, it is
possible that we may expend large sums of money to bring our offering to market
and the revenue that we derive may be insufficient to fund our operations.

Our business approach to the renewable energy and waste management industry may
not produce results as anticipated, be profitable or be readily accepted by the
marketplace. We cannot estimate whether demand for our bio-energy products will
materialize at anticipated prices, or whether satisfactory profit margins will
be achieved. If such pricing levels are not achieved or sustained, or if our
technologies and business approach to our markets does not achieve or sustain
broad acceptance, our business, operating results and financial condition will
be materially and negatively impacted.

If we violate performance guarantees granted to Penelec we will be required to
provide them with an incentive payment.

Our agreement for the sale of power to Penelec contains a provision that
requires our Scrubgrass facility to provide Pennsylvania Electric Company a
certain percentage of its average output over a given period of time. If we do
not comply with this performance guarantee, we will be required to compensate
Penelec with an incentive payment. The payment of an incentive payment would
have an adverse effect on our financial condition.

Our products and services will be subject to numerous governmental regulations.

We expect to provide services involving government regulation, which will
subject us to certain regulatory policies and procedures. Compliance with these
regulations could be costly and harm our financial condition. Many of these
regulations cover air and water quality and related pollution issues. These
regulations are mandated by the United States Environmental Protection Agency
and various state and local governments. More specifically, our activities in
anaerobic digestion and/or nutrient management related to animal manure, and
other wastes, as well as the air emissions and waste effluent control from our
facilities will involve a permitting process and other forms of scrutiny from
these agencies. In addition, our activities will fall under a number of health
and safety regulations and laws and regulations relating to farms and zoning.

Our power producing activities could be subject to costly regulations and
tariffs.

Our Scrubgrass facility and many of our planned bio-energy projects may or do
produce power for sale to the electric grid. As such, the sale of this power may
come under the regulations of various state public utility commissions. These
commissions set the price tariffs under which energy can be sold or purchased
and they set the design standards for the interconnection of power producing
equipment with the electric power grid. Most of our power projects where
electricity is sold to the grid will come under regulation by these commissions.
These regulations may impede or delay the process of approving and implementing
our projects. Substantial delays may materially affect our financial condition.

Government regulations can be burdensome and may result in delays and expense.
In addition, modifications to regulations could adversely affect our ability to
sell power or to implement our chosen strategy for the sale of power. Subsequent
changes in the applicable regulations could also affect our ability to sell or
install new facilities or develop and install facilities in an efficient manner
or at all. Failure to comply with applicable regulatory requirements can result
in, among other things, operating restrictions and fines which could harm our
financial condition.

43

<PAGE>

We depend on a small number of key executives and our business could suffer if
they were to leave.

We employ a small group of skilled individuals to accomplish our goals. We
believe our performance is substantially dependent on the continued employment
and performance of our senior management. Many of these individuals are not
currently subject to employment agreements or employee non-compete agreements.
If we fail to retain the services of one or more of these persons, our business
could suffer significantly. We do not maintain key-man insurance on the life of
any of our officers at this time.

Our plans to enter into the anaerobic digester market will require the retention
of skilled employees and contractors, the success of which cannot be assured.

In order for us to enter into the anaerobic digester market we will be required
to hire and retain highly skilled employees and independent contractors. It is
anticipated that such persons may be difficult to locate and engage. If we are
not successful in hiring and retaining qualified persons, our ability to enter
into the anaerobic digester market and the value of your investment will be
impaired.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our most significant market risk exposure is changing interest rates which may
affect our short-term investments, debt and certain of our lease expenses. We
offer the following information about these market risks:

Short-term investments - We invest cash balances which are in excess of our
normal operating requirements in short term investments generally with
maturities of 3 months of less. Because of the short duration of these
investments, we do not believe our short-term investments are subject to
material market risk.

Debt - We have borrowings which bear interest at variable rates which are based
on the London Interbank Offering Rate. We monitor market conditions for interest
rates and, from time to time, enter into interest rate swaps to manage our
interest payments. The interest rate swaps have the effect of converting the
variable rate borrowings to fixed rate borrowings for specified time periods.

Lease Expense - As a lease cost of the Scrubgrass project, we are required to
fund the lessor's debt service which consists primarily of borrowings which bear
interest at variable rates based on either quoted bond rates or the London
Interbank Offering Rate. The manager of Scrubgrass monitors market conditions
for interest rates and, from time to time, enters into interest rate swaps to
manage the interest payments for Scrubgrass. The interest rate swaps have the
effect of converting the variable rate borrowings to fixed rate borrowings for
specified time periods.

As of December 31, 2002, the aggregate outstanding balance of our variable rate
debt obligations was $2,104,549. As of December 31, 2002, the aggregate
outstanding balance of the lessor's variable rate debt obligations, which are
passed along to us as a lease expense, was $143,526,453. Based on these
balances, an immediate change of one percent for the variable interest rates
would cause a change in interest expense of $21,046 and lease expense of
$1,435,264. Our objective in maintaining these variable rate borrowings is to
achieve a lower overall cost when compared to fixed-rate borrowings. We believe
the lessor has the same objective for maintaining their variable rate
borrowings.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

44

<PAGE>

The financial statements listed in the following Index to Financial Statements
are filed as a part of this annual report under Item 14 - Exhibits, Index to
Financial Statements, and Reports on Form 8-K.

                          INDEX TO FINANCIAL STATEMENTS

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

<TABLE>
<CAPTION>
                                                                                                          PAGE
                                                                                                          ----
<S>                                                                                                       <C>
Independent Auditors' Report                                                                              F-1
Consolidated Balance Sheets as of December 31, 2002 and 2001                                              F-2
Consolidated Statements of Operations and Other Comprehensive Income for the Years Ended December 31,     F-3
2002, 2001 and 2000
Consolidated Statements of Shareholders' Equity (Deficit) for the Years Ended December 31, 2002, 2001     F-4
and 2000
Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000                F-5
Notes to Consolidated Financial Statements                                                                F-6
</TABLE>

ITEM 9.  DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

         None

                                    PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS

Information with respect to our directors may be found in the section captioned
"Occupations of Directors" appearing in the definitive Proxy Statement to be
delivered to shareholders in connection with the 2003 Annual Meeting of
Shareholders. Such information is incorporated herein by reference. Information
concerning executive officers is contained in Item 4A above.

ITEM 11. EXECUTIVE COMPENSATION

Information with respect to this item may be found in the section captioned
"Compensation and Other Information Concerning Directors and Officers" appearing
in the definitive Proxy Statement to be delivered to shareholders in connection
with the 2003 Annual Meeting of Shareholders. Such information is incorporated
herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information with respect to this item may be found in the sections captioned
"Principal Holders of Voting Securities" and "Proposal One - Election of
Directors" appearing in the definitive Proxy Statement to be delivered to
shareholders in connection with the 2003 Annual Meeting of Shareholders. Such
information is incorporated herein by reference.

45

<PAGE>

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information with respect to this item may be found in the section captioned
"Compensation and Other Information Concerning Directors and Officers" appearing
in the definitive Proxy Statement to be delivered to shareholders in connection
with the 2003 Annual Meeting of Shareholders. Such information is incorporated
herein by reference.

                                     PART IV

ITEM 14. CONTROLS AND PROCEDURES

     a)  Under the supervision and with the participation of the Environmental
         Power's management, including our chief executive officer and the
         principal accounting officer, we have evaluated the effectiveness of
         our disclosure controls and procedures as of a date within 90 days
         prior to the filing of this report. They have concluded that these
         disclosure controls provide reasonable assurance that Environmental
         Power can collect process and disclose, within the time periods
         specified in the Commission's rules and forms, the information
         required to be disclosed in its periodic Exchange Act reports.

     b)  There have been no significant changes in Environmental Power's
         internal controls or in other factors that could significantly affect
         its internal controls subsequent to the date of their most recent
         evaluation.

ITEM 15. INDEX TO FINANCIAL STATEMENTS, EXHIBITS, AND REPORTS ON FORM 8-K

The following documents are filed as part of this annual report:

         (a)  1.   Consolidated Financial Statements

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

<TABLE>
<CAPTION>
                                                                                                          PAGE
                                                                                                          ----
<S>                                                                                                       <C>
Independent Auditors' Report                                                                              F-1
Consolidated Balance Sheets as of December 31, 2002 and 2001                                              F-2
Consolidated Statements of Operations and Other Comprehensive Income for the Years Ended December 31,     F-3
2002, 2001 and 2000
Consolidated Statements of Shareholders' Equity (Deficit) for the Years Ended                             F-4
December 31, 2002, 2001  and 2000
Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000                F-5
Notes to Consolidated Financial Statements                                                                F-6
</TABLE>

         (a)  2.   Financial Statement Schedules

The following consolidated financial statement schedule is required to be filed
with this annual report:

Schedule II - Valuation and Qualifying Accounts

46

<PAGE>

<TABLE>
<CAPTION>
              Column A                   Column B                   Column C              Column D        Column E
----------------------------------------------------------------------------------------------------------------------
                                                          Additions      Additions
                                        Balance at     (resulting from   (charged to
                                       beginning of    acquisition of    income tax                      Balance at
            Description                   period         subsidiary)     expense)        Deductions    end of period
----------------------------------------------------------------------------------------------------------------------
<S>                                        <C>                <C>             <C>          <C>              <C>
Year Ended December 31, 2001:

  Valuation reserve for net operating
   loss carry forwards
                                           $      --          $ 139,521       $  8,856                      $ 148,377

Year Ended December 31, 2002:

  Valuation reserve for net operating
   loss carry forwards
                                           $ 148,377          $      --       $ 78,746                      $ 227,123
</TABLE>

(a) 3.   Exhibits

The following Exhibits are included in this report:

<TABLE>
<CAPTION>
          EXHIBIT                                                                                         INCORPORATION
          NUMBER                                       DESCRIPTION                                           REFERENCE
          -------   ------------------------------------------------------------------------------------- ------------
           <S>      <C>                                                                                           <C>
           3.01     Certificate of Incorporation, as amended.                                                     A

           3.02     Certificate of Designations related to the Company's newly designated, $.01 par               J
                    value, Series B Convertible Preferred Stock.

           3.03     Amendment to Certificate of Incorporation effective November 9, 2001.                         M

           3.04     Bylaws of the Registrant, as amended.                                                         F

           4.01     2001 Stock Incentive Plan                                                                     L

           4.02     2002 Director Option Plan                                                                     L

           4.03     Option Agreement dated as of May 2, 2001 between the Company and Robert I. Weisberg           L

           4.04     Option Agreement dated as of September 14, 2001 between the Company and Robert I.             L
                    Weisberg

          10.01     Share Exchange Agreement dated June 20, 2001 among the Company, Microgy and the               H
                    Principal Microgy Shareholders.

          10.02     Stockholders' Agreement dated July 23, 2001 among the Company, the Principal Microgy          H
                    Shareholders, Joseph E. Cresci and Donald A. Livingston.
</TABLE>

47

<PAGE>

<TABLE>
<CAPTION>
          EXHIBIT                                                                                         INCORPORATION
          NUMBER                                       DESCRIPTION                                           REFERENCE
          -------   ------------------------------------------------------------------------------------- ------------
          <S>       <C>                                                                                           <C>
          10.03     Registration Rights Agreement dated July 23, 2001 among the Company, the Principal            H
                    Microgy Shareholders, Joseph E. Cresci, Donald A. Livingston and future exchanging
                    Microgy security holders who become a party thereto.

          10.04     Form of Joiner Agreement related to Share Exchange Agreement.                                 H

          10.05     Form of Waiver Agreement dated July 23, 2001 executed by certain Microgy                      H
                    Shareholders.

          10.06     Warrant Agreement dated July 23, 2001 between the Company and Daniel J. Eastman.              I

          10.07     Technology Licensing Agreement dated May 12, 2000 between Microgy and Danish Biogas           K
                    Technology, A.S. (portions of this exhibit have been omitted and filed separately
                    with the Securities and Exchange Commission pursuant to a request for confidential
                    treatment).

          10.08     Promissory Note dated September 14, 2001 between the Company and Alco Financial               K
                    Services, LLC.

          10.09     Security Agreement dated September 14, 2001 between the Company and Alco Financial            K
                    Services, LLC.

          10.10     Warrant to purchase 50,000 shares of common stock issued to Alco Financial Services,          K
                    LLC.

          10.11     Services Agreement dated September 13, 2001 between the Company and PG&E Energy               M
                    Trading Power, L.P. pertaining to the sale and purchase of Nitrogen Oxide Ozone
                    Transport Region (NOx) Budget Allowances completed in 2002.

          10.12     Wisconsin Public Service Corporation Amended and Restated Agreement for Power
                    Purchase with Microgy Cogeneration System, Inc. dated March 18, 2003.

          10.13     Environmental Power Corporation Retirement Plan, as restated, effective as of                 M
                    January 1, 1998 and dated as of December 23, 1998.

          10.14     Trust Agreement for Environmental Power Corporation Retirement Plan, as amended and           M
                    restated, effective as of January 1, 1998 and dated as of December 23, 1998.

          10.15     Indemnification Agreement dated February 12, 2002 between the Company and Joseph              M
                    Cresci, Donald Livingston, William Linehan, and their successors.

          10.16     Office Building Lease Agreement dated December 21, 2001 between the Company and               M
                    Merkle, Soupcoff, & Fiorentino, Inc.

          10.17     Form of Warrant Agreement executed by certain Microgy warrant holders.                        M
</TABLE>

48

<PAGE>

<TABLE>
<CAPTION>
          EXHIBIT                                      DESCRIPTION                                        INCORPORATION
          NUMBER                                                                                             REFERENCE
          -------   ------------------------------------------------------------------------------------- ------------

          <S>       <C>                                                                                           <C>
          10.18     Agreement for the Sale of Electric Energy from the Scrubgrass Generating Plant by             B
                    and between Pennsylvania Electric Company and Scrubgrass Power Corporation dated
                    August 7, 1987 which was assigned by Scrubgrass Power Corporation to Scrubgrass
                    Generating Company, L.P. on December 15, 1990 and assigned by Scrubgrass Generating
                    Company, L.P. to Buzzard Power Corporation on June 17, 1994.

          10.19     Supplemental Agreement for the Sale of Electric Energy from the Scrubgrass                    B
                    Generating Plant by and between Pennsylvania Electric Company and Scrubgrass Power
                    Corporation dated February 22, 1989, as amended by letter agreement dated March 28,
                    1989, which was assigned by Scrubgrass Power Corporation to Scrubgrass Generating
                    Company, L.P. on December 15, 1990 and assigned by Scrubgrass Generating Company,
                    L.P. to Buzzard Power Corporation on June 17, 1994.

          10.20     Second Supplemental Agreement for the Sale of Electric Energy from the Scrubgrass             B
                    Generating Plant by and between Pennsylvania Electric Company and Scrubgrass Power
                    Corporation dated September 27, 1989 which was assigned by Scrubgrass Power
                    Corporation to Scrubgrass Generating Company, L.P. on December 15, 1990 and
                    assigned by Scrubgrass Generating Company, L.P. to Buzzard Power Corporation
                    on June 17, 1994.

          10.21     Third Supplemental Agreement for the Sale of Electric Energy from the Scrubgrass              B
                    Generating Plant by and between Pennsylvania Electric Company and Scrubgrass Power
                    Corporation dated August 13, 1990 which was assigned by Scrubgrass Power Corporation
                    to Scrubgrass Generating Company, L.P. on December 15, 1990 and assigned by
                    Scrubgrass Generating Company, L.P. to Buzzard Power Corporation on June 17, 1994.

          10.22     Amendment to the Third Supplemental Agreement for the Sale of Electric Energy from            B
                    the Scrubgrass Generating Plant by and between Pennsylvania Electric Company and
                    Scrubgrass Power Corporation dated November 27, 1990 which was assigned by
                    Scrubgrass Power Corporation to Scrubgrass Generating Company, L.P. on December 15,
                    1990 and assigned by Scrubgrass Generating Company, L.P. to Buzzard Power
                    Corporation on June 17, 1994.

          10.23     Letter Agreement dated December 20, 1990 amending the Agreement for the Sale of               B
                    Electric Energy from the Scrubgrass Generating Plant by and between Pennsylvania
                    Electric Company and Scrubgrass Power Corporation dated August 7, 1987, as amended
                    and supplemented from time to time through November 27, 1990, which was assigned by
                    Scrubgrass Power Corporation to Scrubgrass Generating Company, L.P. on December 15,
                    1990 and assigned by Scrubgrass Generating Company, L.P. to Buzzard Power
                    Corporation on June 17, 1994.

          10.60     Management Services Agreement by and between Scrubgrass Generating Company, L.P. and          B
                    PG&E-Bechtel Generating Company dated December 15, 1990 which was assigned by
                    Scrubgrass Generating Company, L.P. to Buzzard Power Corporation on June 17, 1994.
                    PG&E-Bechtel Generating Company has assigned its rights to this agreement ultimately
                    to U.S. Gen. (now PG&E National Energy Group). Exhibit A to this agreement was
                    omitted because it was previously filed as Exhibit 10.67.
</TABLE>

49

<PAGE>

<TABLE>
<CAPTION>
          EXHIBIT                                                                                         INCORPORATION
          NUMBER                                       DESCRIPTION                                           REFERENCE
          -------   ------------------------------------------------------------------------------------- ------------
          <S>       <C>                                                                                           <C>
          10.61     Agreement for Operation and Maintenance of the Scrubgrass Cogeneration Plant between          B
                    Scrubgrass Generating Company, L.P. and Bechtel Power Corporation dated December 21,
                    1990 which was assigned by Scrubgrass Generating Company, L.P. to Buzzard Power
                    Corporation on June 17, 1994. Bechtel Power Corporation has assigned its rights to
                    this agreement ultimately to U.S. Operating Services Company (now PG&E Operating
                    Services Company).

          10.62     First Amendment to the Agreement for Operation and Maintenance of the Scrubgrass              B
                    Cogeneration Plant between Buzzard Power Corporation and, ultimately, U.S. Operating
                    Services Company (now PG&E Operating Services Company) dated December 22, 1995.

          10.67     Appendix I to the Amended and Restated Participation Agreement, dated as of December          G
                    22, 1995, among Buzzard Power Corporation, Scrubgrass Generating Company, L.P.,
                    Environmental Power Corporation, Bankers Trust Company and Credit Lyonnais, which
                    Appendix defines terms used and not otherwise defined in other contracts.

          10.70     Stock Pledge Agreement, dated December 19, 1991, between Environmental Power                  D
                    Corporation and Scrubgrass Generating Company, L.P.

          10.71     Amended and Restated Participation Agreement, dated as of December 22, 1995, among            G
                    Buzzard Power Corporation, Scrubgrass Generating Company, L.P., Environmental Power
                    Corporation, Bankers Trust Company and Credit Lyonnais.

          10.72     Amendment No. 1, dated as of May 22, 1997, to the Amended and Restated Participation          C
                    Agreement, dated as of December 22, 1995, among Buzzard Power Corporation,
                    Scrubgrass Generating Company, L.P., Environmental Power Corporation, Bankers Trust
                    Company and Credit Lyonnais.

          10.73     Director Option Plan.                                                                         F

          10.80     Amended and Restated Lease Agreement between Scrubgrass Generating Company, L.P., a           B
                    Delaware limited partnership, as Lessor, and Buzzard Power Corporation, a Delaware
                    corporation, as Lessee, dated as of December 22, 1995. Schedules and similar
                    attachments listed in the Lease have been omitted and we agree to furnish
                    supplementally a copy of any omitted schedule or attachment to the Securities and
                    Exchange Commission upon request.

          10.83     Amended and Restated Disbursement and Security Agreement between Scrubgrass                   B
                    Generating Company, L.P., as Lessor, Buzzard Power Corporation, as Lessee, Bankers
                    Trust Company as Disbursement Agent and Credit Lyonnais acting through its New York
                    Branch as Agent, dated as of December 22, 1995. Schedules and similar attachments
                    listed in this agreement have been omitted and we agree to furnish supplementally a
                    copy of any omitted schedule or attachment to the Securities and Exchange Commission
                    upon request.
</TABLE>

50

<PAGE>

<TABLE>
<CAPTION>
          EXHIBIT                                                                                         INCORPORATION
          NUMBER                                       DESCRIPTION                                           REFERENCE
          -------   ------------------------------------------------------------------------------------- ------------
          <S>       <C>                                                                                           <C>
          10.84     Amended and Restated Lessee Working Capital Loan Agreement between Scrubgrass                 B
                    Generating Company, L.P., as Lender, and Buzzard Power Corporation, as Lessee, dated
                    as of December 22, 1995.

          10.85     Amendment No. 1, dated as of May 22, 1997, to the Amended and Restated Disbursement           C
                    and Security Agreement between Scrubgrass Generating Company, L.P., as Lessor,
                    Buzzard Power Corporation, as Lessee, Bankers Trust Company as Disbursement Agent
                    and Credit Lyonnais acting through its New York Branch as Agent, dated as of
                    December 22, 1995.

          10.91     Amendment No. 2, dated as of September 2, 1998, to the Amended and Restated                   E
                    Participation Agreement, dated as of December 22, 1995, among Buzzard Power
                    Corporation, Scrubgrass Generating Company, L.P., Environmental Power Corporation,
                    Bankers Trust Company and Credit Lyonnais.

          10.92     Amendment No. 1, updated as of October 9, 1998, to the Amended and Restated                   E
                    Disbursement and Security Agreement between Scrubgrass Generating Company, L.P., as
                    Lessor, Buzzard Power Corporation, as Lessee, Bankers Trust Company as Disbursement
                    Agent and Credit Lyonnais acting through its New York Branch as Agent, dated as of
                    December 22, 1995.

          10.93     Amendment No. 1, dated as of June 1, 1996, but not executed until July 24, 1998, to           E
                    the Amended and Restated Lease Agreement between Scrubgrass Generating Company,
                    L.P., a Delaware limited partnership, as Lessor, and Buzzard Power Corporation, a
                    Delaware corporation, as Lessee, dated as of December 22, 1995.

          10.94     Lease between Adams Realty Trust and Environmental Power Corporation, dated January           E
                    26, 2000.

          10.95     Settlement Agreement and Release between GEC Alsthom International, Inc. and Buzzard          E
                    Power Corporation dated May 28, 1998.

          10.96     Purchase and Sale Agreements, dated as of December 16, 1998, January 4, 2000 and              E
                    January 8, 2000, between PG&E Energy Trading - Power, L.P. and Buzzard Power
                    Corporation pertaining to Nitrogen Oxide Ozone Transport Region (NOx) Budget
                    Allowances.

          10.97     Environmental Power Corporation Medical Expense Reimbursement Plan effective as of            E
                    September 1, 1998 and dated as of December 18, 1998.

          10.99     Settlement Agreement, dated August 3, 2000 and effective February 27, 2001, among
                    Buzzard Power Corporation, Scrubgrass Generating Company L.P. and Pennsylvania
                    Electric Company.                                                                             F

          10.101    Promissory Noted dated July 30, 1993 by Joseph E. Cresci in favor of Environmental
                    Power Corporation in the original amount of $161,000 (remaining principal balance
                    $86,875).

          10.102    Promissory Noted dated July 30, 1993 by Donald A. Livingston in favor of
                    Environmental Power Corporation in the original amount of $161,000
</TABLE>

51

<PAGE>

<TABLE>
<CAPTION>
          EXHIBIT                                                                                         INCORPORATION
          NUMBER                                       DESCRIPTION                                           REFERENCE
          -------   ------------------------------------------------------------------------------------- ------------
          <S>                                                                                                     <C>
          10.103    Promissory Noted dated December 15, 1995 by Donald A. Livingston in favor
                    of Environmental Power Corporation in the original amount of $267,280.50
                    (remaining principal balance $149,498.31).

          10.104    Promissory Noted dated September 9, 1997 by Robert I. Weisberg in favor of
                    Environmental Power Corporation in the original amount of $48,575.00.

          10.105    Promissory Noted dated April 12, 2001 by Joseph E. Cresci in favor of Environmental
                    Power Corporation in the original amount of $100,000.00.

          10.106    Promissory Noted dated April 12, 2001 by Donald A. Livingston in favor of
                    Environmental Power Corporation in the original amount of $100,000.00.

          10.107    First Amendment, dated July 11, 2002, to the Environmental Power Corporation
                    Retirement Plan (the "Plan").

          10.108    EGTRAA Amendment, dated December 19, 2002 and effective January 1, 2002,
                    to the Environmental Power Corporation Retirement Plan (the "Plan").

          11.01     Computation of earnings per share

          21.01     Subsidiaries of the Registrant

          23.01     Consent of Deloitte & Touche LLP

          99.01     Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350

          99.02     Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
</TABLE>

          INCORPORATION REFERENCES:
<TABLE>
<S>                <C>
          A         Intentionally omitted

          B         Previously filed as part of our Report on Form 10-K for
                    the year ended December 31, 1996 (Commission File No. 0-15472).

          C         Previously filed as part of our Report on Form 10-Q for
                    the quarter ended June 30, 1997 (Commission File No. 0-15472).

          D         Previously filed as part of our Report on Form 10-K for
                    the year ended December 31, 1997 (Commission File No. 0-15472).

          E         Previously filed as part of our Report on Form 10-K for
                    the year ended December 31, 1998 (Commission File No. 0-15472).

          F         Previously filed as part of our Report on Form 10-K for
                    the year ended December 31, 1999 (Commission File No. 0-15472).

          G         Previously filed as part of our Report on Form 10-K for
                    the year ended December 31, 2000 (Commission File No. 0-15472).
</TABLE>

52

<PAGE>

<TABLE>
<S>                <C>
         H         Previously  filed as part of Amendment No. 7 to Schedule 13D
                   filed by Joseph E. Cresci on August 2, 2001

         I         Previously filed as part of Schedule 13D filed by
                   Daniel J. Eastman on August 2, 2001

         J         Previously  filed as part of our Report on Form 8-K dated as
                   of August 7, 2001 (Commission File No. 0-15472).

         K         Previously  filed as part of our Report on Form 10-Q for the
                   quarter ended September 30, 2001 (Commission File No. 0-15472).

         L         Previously filed as part of our Registration Statement on
                   Form S-8 filed August 22, 2002 (Commission File No.333-98559)

         M         Previously filed as part of our Report on Form 10-K for the
                   year ended December 31, 2001 (Commission File No. 0-15472).
</TABLE>

 (B) REPORTS ON FORM 8-K

             i).   On October 15, 2002, the Registrant disclosed pursuant to
                   Regulation FD a press release announcing that Environmental
                   Power Corporation ("POWR") had signed a memorandum of
                   understanding with Vermont Public Power Supply Authority
                   (VPPSA) for the construction, sale and operation of anaerobic
                   digester/electric generation facilities in New England and
                   New York.

             ii).  On November 1, 2002, the Registrant disclosed pursuant to
                   Regulation FD a Case Study, which was published by The
                   Harvard Business School in connection with its educational
                   activities.

             iii). On November 14, 2002, the Registrant disclosed pursuant to
                   Regulation FD an earnings release of Environmental Power
                   Corporation ("POWR"), dated November 14, 2002.

             iv).  On November 26, 2002, the Registrant disclosed pursuant to
                   Regulation FD the Letter to Shareholders dated November 15,
                   2002, which was included in its Third Quarter 2002 Quarterly
                   Brochure to Shareholders.

53

<PAGE>

                                   SIGNATURES

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

Dated:                             ENVIRONMENTAL POWER CORPORATION

March 31, 2003             By                    /s/ Joseph E. Cresci
                                   --------------------------------------------
                                                     Joseph E. Cresci, Chairman
                                                     and Chief Executive Officer

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

         SIGNATURE             TITLE                         DATE

 /s/ Joseph E. Cresci          Chairman, Chief               March 31, 2003
----------------------------   Executive Officer,
Joseph E. Cresci               & Director (Principal
                               Executive Officer)

 /s/ Donald A. Livingston      President & Chief             March 31, 2003
---------------------------    Operating Officer
Donald A. Livingston

 /s/ R. Jeffrey Macartney      Treasurer and Chief           March 31, 2003
---------------------------    Financial Officer
R. Jeffrey Macartney           (Principal Financial and
                               Accounting Officer)

 /s/ Peter J. Blampied         Director                      March 31, 2003
----------------------------
Peter J. Blampied

/s/ Jessie Knight Jr.          Director                      March 31, 2003
----------------------------
Jessie Knight Jr.

/s/ August Schumacher Jr.      Director                      March 31, 2003
----------------------------
August Schumacher Jr.

/s/ Tom M. Matthews            Director                      March 31, 2003
----------------------------
Tom M. Matthews

/s/ Robert I. Weisberg         Director                      March 31, 2003
----------------------------
Robert I. Weisberg

54

<PAGE>

                           SECTION 302 CERTIFICATIONS

I, Joseph E. Cresci, certify that:

     1.   I have reviewed this annual report of Environmental Power Corporation;

     2.   Based on my knowledge, this annual report does not contain any untrue
          statement of a material fact or omit to state a material fact
          necessary in order to make the statements made in light of the
          circumstances under which such statements were made, not misleading
          with respect to the period covered by this annual report;

     3.   Based on my knowledge, the financial statements, and other financial
          information included in this annual report, fairly present in all
          material respects the financial condition, results of operations and
          cash flows of the registrant as of, and for, the periods presented in
          this annual report;

     4.   The registrant's other certifying officer and I are responsible for
          establishing and maintaining disclosure controls and procedures (as
          defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
          and we have:n Exchange Act Rules 13a-14 and 15d-14) for the registrant
          and we have:

          .    designed such disclosure controls and procedures to ensure that
               material information relating to the registrant, including its
               consolidated subsidiaries, is made known to us by others within
               those entities, particularly during the period in which the
               annual report is being prepared;

          .    evaluated the effectiveness of the issuer's disclosure controls
               and procedures as of a date within 90 days prior to the filing
               date of this annual report (the "Evaluation Date"); and

          .    presented in this annual report our conclusions about the
               effectiveness of the disclosure controls and procedures based on
               our evaluation as of the Evaluation Date;

     5.   The registrant's other certifying officer and I have disclosed, based
          on our most recent evaluation, to the registrant's auditors and the
          audit committee of registrant's board of directors (or persons
          performing the equivalent function):

          .    all significant deficiencies in the design or operation of
               internal controls which could adversely affect the registrant's
               ability to record, process, summarize and report financial data
               and have identified for the registrant's auditors any material
               weaknesses in internal controls; and

          .    any fraud, whether or not material, that involves management or
               other employees who have a significant role in the registrant's
               internal controls; and

     6.   The registrant's other certifying officer and I have indicated in this
          annual report whether or not there were significant changes in
          internal controls or in other factors that could significantly affect
          internal controls subsequent to the date of our most recent
          evaluation, including any corrective actions with regard to
          significant deficiencies and material weaknesses.

          /s/ Joseph E. Cresci
          -----------------------
          Joseph E. Cresci
          Chief Executive Officer
          March 31, 2003

55

<PAGE>

I, R. Jeffrey Macartney, certify that:

     1.   I have reviewed this annual report of Environmental Power Corporation;

     2.   Based on my knowledge, this annual report does not contain any untrue
          statement of a material fact or omit to state a material fact
          necessary in order to make the statements made in light of the
          circumstances under which such statements were made, not misleading
          with respect to the period covered by this annual report;

     3.   Based on my knowledge, the financial statements, and other financial
          information included in this annual report, fairly present in all
          material respects the financial condition, results of operations and
          cash flows of the registrant as of, and for, the periods presented in
          this annual report;

     4.   The registrant's other certifying officer and I are responsible for
          establishing and maintaining disclosure controls and procedures (as
          defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
          and we have:

          .    designed such disclosure controls and procedures to ensure that
               material information relating to the registrant, including its
               consolidated subsidiaries, is made known to us by others within
               those entities, particularly during the period in which the
               annual report is being prepared;

          .    evaluated the effectiveness of the issuer's disclosure controls
               and procedures as of a date within 90 days prior to the filing
               date of this annual report (the "Evaluation Date"); and

          .    presented in this annual report our conclusions about the
               effectiveness of the disclosure controls and procedures based on
               our evaluation as of the Evaluation Date;

     5.   The registrant's other certifying officer and I have disclosed, based
          on our most recent evaluation, to the registrant's auditors and the
          audit committee of registrant's board of directors (or persons
          performing the equivalent function):

          .    all significant deficiencies in the design or operation of
               internal controls which could adversely affect the registrant's
               ability to record, process, summarize and report financial data
               and have identified for the registrant's auditors any material
               weaknesses in internal controls; and

          .    any fraud, whether or not material, that involves management or
               other employees who have a significant role in the registrant's
               internal controls; and

     6.   The registrant's other certifying officer and I have indicated in this
          annual report whether or not there were significant changes in
          internal controls or in other factors that could significantly affect
          internal controls subsequent to the date of our most recent
          evaluation, including any corrective actions with regard to
          significant deficiencies and material weaknesses.

          /s/ R. Jeffrey Macartney
          -------------------------
          R. Jeffrey Macartney
          Chief Financial Officer
          March 31, 2003

<PAGE>

                          INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders of
   Environmental Power Corporation:

We have audited the accompanying consolidated balance sheets of Environmental
Power Corporation (the "Corporation") and subsidiaries as of December 31, 2002
and 2001 and the related consolidated statements of operations and comprehensive
income, shareholders' equity (deficit), and cash flows for each of the three
years in the period ended December 31, 2002. Our audits also included the
financial statement schedule listed in the index at Item 15, (a) 2. These
consolidated financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on the consolidated
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Environmental Power Corporation and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

/s/ Deloitte & Touche LLP

February 28, 2003

F-1

<PAGE>

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                          DECEMBER 31              DECEMBER 31
                                                                                              2002                    2001
                                                                                     --------------------    --------------------
<S>                                                                                  <C>                     <C>
ASSETS

CURRENT ASSETS:
    Cash  and  cash equivalents                                                      $            734,743    $            468,271
    Restricted cash                                                                             1,144,701               1,014,580
    Receivable from utility                                                                     7,973,723               7,905,864
    Other current assets                                                                          926,577                 607,590
                                                                                     --------------------    --------------------
            TOTAL CURRENT ASSETS                                                               10,779,744               9,996,305

PROPERTY, PLANT AND EQUIPMENT, NET                                                                552,607                 652,830

LEASE RIGHTS, NET                                                                               2,012,499               2,161,503

ACCRUED POWER GENERATION REVENUES                                                              70,192,993              63,648,995

GOODWILL                                                                                        4,912,866               4,912,866

UNRECOGNIZED PRIOR PENSION SERVICE COST                                                           641,885                 687,734

LICENSED TECHNOLOGY RIGHTS, NET                                                                 3,442,677               3,628,177

OTHER ASSETS                                                                                      422,628                 565,570
                                                                                     --------------------    --------------------
            TOTAL ASSETS                                                             $         92,957,899    $         86,253,980
                                                                                     ====================    ====================

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
    Accounts payable and accrued expenses                                            $          9,650,092    $         10,070,205
    Secured promissory note payable to related party                                              750,000                 750,000
    Other current liabilities                                                                     965,014               1,363,108
                                                                                     --------------------    --------------------
            TOTAL CURRENT LIABILITIES                                                          11,365,106              12,183,313

DEFERRED GAIN, NET                                                                              4,163,544               4,471,955

SECURED PROMISSORY NOTES PAYABLE
 AND OTHER BORROWINGS                                                                             972,565               1,420,467
DEFERRED INCOME TAX LIABILITY                                                                      78,071                 146,396
ACCRUED LEASE EXPENSES                                                                         70,192,993              63,648,995
                                                                                     --------------------    --------------------
            TOTAL LIABILITIES                                                                  86,772,279              81,871,126
                                                                                     --------------------    --------------------

SHAREHOLDERS' EQUITY:
    Preferred Stock ($.01 par value; 2,000,000 shares authorized
     no shares issued)                                                                                  0                       0
    Preferred Stock (no par value, 10 shares authorized; 10 shares
     issued as of December 31, 2002 and December 31, 2001, respectively)                              100                     100

  Common Stock ($.01 par value; 50,000,000 shares authorized; 22,410,293 and
   21,370,293 issued; and 21,852,059 and 20,251,653 outstanding as of
   December 31, 2002 and December 31, 2001, respectively)                                         224,103                 213,702
    Additional paid-in capital                                                                  7,669,351               6,850,046
    Accumulated deficit                                                                          (385,007)             (1,518,390)
    Accumulated other comprehensive loss                                                         (312,850)                (60,385)
                                                                                     --------------------    --------------------
                                                                                                7,195,697               5,485,073

    Treasury stock (558,234 and 1,118,640 common shares, at cost, as of
      December 31, 2002 and December 31, 2001, respectively)                                     (364,129)               (456,271)
    Notes receivable from officers and board members                                             (645,948)               (645,948)
                                                                                     --------------------    --------------------
            TOTAL SHAREHOLDERS' EQUITY                                                          6,185,620               4,382,854
                                                                                     --------------------    --------------------
            TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                               $         92,957,899    $         86,253,980
                                                                                     ====================    ====================
</TABLE>

See Notes to Consolidated Financial Statements.

F-2

<PAGE>

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

<TABLE>
<CAPTION>
                                                                                                YEAR ENDED DECEMBER 31
                                                                         2002                 2001                 2000
                                                                   ---------------    ------------------    -----------------
<S>                                                                <C>                <C>                   <C>
POWER GENERATION REVENUES                                          $    54,983,934    $       53,518,000    $      54,303,222

COSTS AND EXPENSES:
     Operating expenses                                                 24,139,819            23,681,081           22,291,069
     Lease expenses                                                     25,291,293            24,705,813           26,415,897
     General and administrative expenses                                 5,655,207             3,973,025            3,602,960
     Depreciation and amortization                                         544,796               441,410              415,230
                                                                   ---------------    ------------------    -----------------
                                                                        55,631,115            52,801,329           52,725,156
                                                                   ---------------    ------------------    -----------------
OPERATING (LOSS) INCOME                                                   (647,181)              716,671            1,578,066
                                                                   ---------------    ------------------    -----------------
OTHER INCOME (EXPENSE):
     Interest income                                                        47,753                78,203              736,867
     Interest expense                                                     (141,526)             (185,547)            (320,641)
     Amortization of deferred gain                                         308,411               308,410              308,411
     Sales of NOx emission credits                                       2,428,200                    --            1,156,338
     Settlement of the Sunnyside Project litigation                                            2,135,048                   --
                                                                   ---------------    ------------------    -----------------
                                                                         2,642,838             2,336,114            1,880,975
                                                                   ---------------    ------------------    -----------------
INCOME BEFORE INCOME TAXES                                               1,995,657             3,052,785            3,459,041

INCOME TAX EXPENSE                                                        (857,274)           (1,373,454)          (1,632,233)
                                                                   ---------------    ------------------    -----------------
NET INCOME                                                               1,138,383             1,679,331            1,826,808
OTHER COMPREHENSIVE LOSS:
    Minimum pension liability adjustment, net of
     income tax benefit of $165,592 in 2002 and $39,606 in 2001           (252,465)              (60,385)                  --
                                                                   ---------------    ------------------    -----------------
COMPREHENSIVE INCOME                                                       885,918             1,618,946            1,826,808
                                                                   ---------------    ------------------    -----------------
DIVIDENDS DECLARED:
     Common shares                                                 $             0    $                0    $         684,408
     Preferred shares                                              $         5,000    $            5,000    $           5,000
     Dividends declared per common share                           $          0.00    $             0.00    $            0.06

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
     Basic                                                              20,720,614            14,144,222           11,406,783
     Diluted                                                            20,810,823            14,745,695           11,408,809

BASIC EARNINGS PER COMMON SHARE                                    $          0.05    $             0.12    $            0.16

DILUTED EARNINGS PER COMMON SHARE                                  $          0.05    $             0.11    $            0.16
</TABLE>

See Notes to Consolidated Financial Statements.

F-3

<PAGE>

ENVIRONMENTAL POWER CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

<TABLE>
<CAPTION>
                                                                            PREFERRED
                                                   PREFERRED STOCK            STOCK             COMMON STOCK          ADDITIONAL
                                                  ($.01 PAR VALUE)         (NO PAR; 10        ($.01 PAR VALUE)         PAID-IN
                                                  SHARES     AMOUNT      SHARES ISSUED)       SHARES     AMOUNT        CAPITAL
                                               ------------------------  ----------------  ------------------------  -------------
<S>                                              <C>         <C>         <C>                 <C>        <C>          <C>
BALANCE AT JANUARY 1, 2000                              0.0           0               100    12,525,423     125,254              0

     Dividends paid
     Notes receivable repayments
     Net income
                                               ------------------------  ----------------  ------------------------  -------------
BALANCE AT DECEMBER 31, 2000                            0.0           0               100    12,525,423     125,254              0

     Issuance of stock options for services                                                                                113,600
     Issuance of warrant to lender                                                                                          14,398
     Dividends paid
     Borrowings under notes receivable
     Exchange of convertible preferred stock
      and common stock for 87.7% of
      outstanding equity of Microgy               197,760.7   1,528,690                       5,521,549      55,215      4,212,942
     Issuance of additional common stock
      to holders of 87.7% of outstanding
      equity in Microgy                                                                         258,884       2,589        197,528
     Conversion of preferred stock to
      common stock                               (197,760.7) (1,528,690)                      1,977,607      19,776      1,508,914

     Exchange of common stock for 12.3%
      of outstanding equity of Microgy                                                        1,086,830      10,868        829,252
     Exchange of options and warrants for
      options and warrants of Microgy                                                                                       55,697
     Stock issuance and registration costs                                                                                 (82,285)
     Net income
     Minimum pension liability adjustment, net
                                               ------------------------  ----------------  ------------------------  -------------
BALANCE AT DECEMBER 31, 2001                              0           0               100    21,370,293     213,702      6,850,046

     Issuance of stock options for services                                                                                 49,707
     Dividends paid
     Reclassify prior year Dividends paid
     Purchase of common stock
     Private placement common stock                                                           1,040,000      10,401        769,598
     Stock issuance and registration costs
     Net income
     Minimum pension liability adjustment, net
                                               ------------------------  ----------------  ------------------------  -------------

BALANCE AT DECEMBER 31, 2002                            0.0  $        0               100    22,410,293 $   224,103  $   7,669,351
                                               ========================  ================  ========================  =============

<CAPTION>
                                                                  Accumulated                      Receivable
                                                                     Other                       from Officers
                                                Accumulated      Comprehensive      Treasury       and Board
                                                  Deficit            Loss             Stock         Members           Total
                                               ---------------  ---------------   -----------   --------------    --------------
<S>                                            <C>              <C>               <C>           <C>               <C>
BALANCE AT JANUARY 1, 2000                          (4,330,121)               0      (456,271)        (809,731)       (5,470,769)

     Dividends paid                                   (689,408)                                                         (689,408)
     Notes receivable repayments                                                                       363,783          363,783
     Net income                                      1,826,808                                                         1,826,808
                                               ---------------  ---------------   -----------   --------------    --------------
BALANCE AT DECEMBER 31, 2000                        (3,192,721)               0      (456,271)        (445,948)       (3,969,586)

     Issuance of stock options for services                                                                              113,600
     Issuance of warrant to lender                                                                                        14,398
     Dividends paid                                     (5,000)                                                           (5,000)
     Borrowings under notes receivable                                                                (200,000)         (200,000)
     Exchange of convertible preferred stock
      and common stock for 87.7% of
      outstanding equity of Microgy
                                                                                                                       5,796,847
     Issuance of additional common stock
      to holders of 87.7% of outstanding
      equity in Microgy                                                                                                  200,117
     Conversion of preferred stock to
      common stock                                                                                                             0
     Exchange of common stock for 12.3%
      of outstanding equity of Microgy                                                                                   840,120
     Exchange of options and warrants for
      options and warrants of Microgy                                                                                     55,697
     Stock issuance and registration costs                                                                               (82,285)
     Net income                                      1,679,331                                                         1,679,331
     Minimum pension liability adjustment, net                          (60,385)                                         (60,385)
                                               ---------------  ---------------   -----------   --------------    --------------
BALANCE AT DECEMBER 31, 2001                        (1,518,390)         (60,385)     (456,271)        (645,948)        4,382,854

     Issuance of stock options for services                                                                               49,707
     Dividends paid                                     (5,000)                                                           (5,000)
     Reclassify prior year Dividends paid
     Purchase of common stock                                                        (167,858)                          (167,858)
     Private placement common stock                                                   260,000                          1,039,999
     Stock issuance and registration costs                                                                                     0
     Net income                                      1,138,383                                                         1,138,383
     Minimum pension liability adjustment, net                         (252,465)                                        (252,465)
                                               ---------------  ---------------   -----------   --------------    --------------
BALANCE AT DECEMBER 31, 2002                   $      (385,007) $      (312,850)  $  (364,129)  $     (645,948)   $    6,185,620
                                               ===============  ===============   ===========   ==============    ==============
</TABLE>

F-4

<PAGE>

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                     YEAR ENDED DECEMBER 31
                                                                           2002               2001                 2000
                                                                    -----------------  -------------------   ----------------
<S>                                                                 <C>                <C>                   <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net income                                                      $       1,138,383  $         1,679,331   $      1,826,808
    Adjustments to reconcile net income to net cash
     provided by operating activities:
          Depreciation and amortization                                       544,794              441,410            415,230
          Deferred income taxes (decrease) increase                           (68,325)             104,425            121,112
          Amortization of deferred gain                                      (308,411)            (308,410)          (308,411)
          Release of Sunnyside Project liabilities                                 --             (635,048)                --
          Non-cash compensation expense                                            --                                      --
          Non-cash and stock based compensation                                49,707              113,600                 --
          Accrued power generation revenues                                (6,543,998)          (7,460,852)        (7,036,012)
          Accrued lease expenses                                            6,543,998            7,460,852          7,036,012
          Changes in operating assets and liabilities:
               (Increase) decrease in receivable from utility                 (67,859)            (569,456)        (3,632,486)
               Decrease (increase) in unrecognized prior pension
                service cost                                                   45,849             (106,637)          (581,097)
               (Increase) decrease in other current assets                   (318,987)             164,510           (115,128)
               Decrease (Increase) in other assets                             83,408              (20,730)            37,599
               (Decrease) increase in accounts payable and
                 accrued expenses                                            (672,578)           1,917,062          2,781,245
               Increase in long-term liabilities                                   --                   --             11,400
               Decrease in long-term debt to supplier                         (97,893)             (92,553)           (86,502)
                                                                    -----------------  -------------------   ----------------
                 Net cash provided by operating activities                    328,088            2,687,504            469,770
                                                                    -----------------  -------------------   ----------------

CASH FLOWS FROM INVESTING ACTIVITIES:
    Decrease (increase) in restricted cash                                   (130,121)            (427,104)          (287,986)
    Cash paid for the acquisition of Microgy, net of cash acquired                 --             (412,120)                --
    Property, plant and equipment expenditures                                (50,533)            (232,691)            (3,023)
                                                                    -----------------  -------------------   ----------------
                 Net cash used in investing activities                       (180,654)          (1,071,915)          (291,009)
                                                                    -----------------  -------------------   ----------------

CASH FLOWS FROM FINANCING ACTIVITIES:
    Dividend payments                                                          (5,000)            (176,102)          (689,408)
    Private placement of common stock                                         779,999
    (Repayments) net borrowings  under working capital loan                  (599,793)          (1,626,056)           748,342
    Borrowings under secured promissory note payable to
     related party                                                                                 750,000                 --
    Sale of treasury stock                                                     92,142
    (Borrowings under) proceeds from officer notes receivable                                     (200,000)           363,783
    Repayment of secured promissory notes payable and
     other borrowings                                                        (148,310)            (202,826)          (600,000)
                                                                    -----------------  -------------------   ----------------
                 Net cash provided by (used in) financing
                  activities                                                  119,038           (1,454,984)          (177,283)
                                                                    -----------------  -------------------   ----------------

INCREASE IN CASH AND CASH EQUIVALENTS                                         266,472              160,605              1,478

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                468,271              307,666            306,188
                                                                    -----------------  -------------------   ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD                            $         734,743  $           468,271            307,666
                                                                    =================  ===================   ================
</TABLE>

See Notes to Consolidated Financial Statements.

F-5

<PAGE>

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A--BUSINESS AND ORGANIZATION

Environmental Power Corporation (individually "EPC" or consolidated "We") is an
independent developer and owner of generating facilities powered by
non-commodity fuels and renewable energy sources. Our operations are discussed
further in the following sections.

SCRUBGRASS PROJECT

The Scrubgrass project, located on a 600 acre site in Venango County,
Pennsylvania, is an approximately 83 Megawatt waste coal-fired electric
generating station (the "Facility") which was constructed by Bechtel Power
Corporation. On June 30, 1994, Buzzard Power Corporation ("Buzzard"), a
subsidiary of EPC, entered into an agreement to lease the Facility from
Scrubgrass Generating Company, L.P. (the "Lessor"), a joint venture of certain
wholly owned indirect subsidiaries of PG&E Corporation and Bechtel Generating
Company, Inc. On October 20, 1998, Bechtel Generating Company, Inc. transferred
its interest in the Lessor to a wholly owned subsidiary of Cogentrix Energy,
Inc. The lease provides for an initial term of 22 years with a renewal option
for up to 3 years. Pursuant to the lease, the Lessor assigned to Buzzard all
principal project agreements and its rights and obligations there under
including, but not limited to, the power purchase agreement, management services
agreement, operations and maintenance agreement, limestone supply agreements,
ground lease agreements, fuel agreements and transportation and materials
handling agreements. EPC has pledged Buzzard's common stock to the Lessor as
security for Buzzard's performance of its obligations as lessee. PG&E National
Energy Group ("NEG"), a wholly owned indirect subsidiary of NEG, Inc., which in
turn is a wholly owned indirect subsidiary of PG&E Corporation, manages the
Scrubgrass project.

PG&E Operating Services Company (the "Operator"), a wholly owned indirect
subsidiary of NEG, Inc., operates the Facility pursuant to a 15-year Operating
and Maintenance Agreement (the "O&M"). The Operator prepares a budget for all
operating expenses, including a fixed management fee, and certain targeted
output performance levels, which is approved annually. Under the terms of the
O&M, the Operator can incur a liability not to exceed its management fee if the
Operator does not achieve certain targeted output performance levels.

Buzzard maintains a long-term supply agreement with Quality Aggregates, Inc. to
supply the Scrubgrass project with limestone which, in September 2000, was
extended through the year 2008 and which may be extended up to 10 additional
years. Buzzard also maintains a 15-year agreement with Savage Industries, Inc.
for the transportation of fuel, ash and limestone which expires in 2005. The
costs established under these agreements will escalate at partially fixed and
partially indexed rates.

Buzzard sells electric output to Pennsylvania Electric Company, known as
Penelec, a subsidiary of FirstEnergy Group, pursuant to a twenty-five year Power
Sales Agreement ("PSA") which commenced in June 1993, at fixed rates initially
averaging 4.68 cents per kwh and which escalated at five percent per year
through calendar year 2004. For the years 2005 through 2012, the PSA provides
for a rate equal to the greater of an inflation adjusted rate or a rate based on
the PJM Billing Rate (the monthly average of the hourly rates for purchases by
FirstEnergy Group (originally General Public Utilities Group or GPU which merged
with FirstEnergy in 2002) from, or sale by FirstEnergy Group to, the
Pennsylvania-New Jersey-Maryland Interconnection). For years 2005 through 2012,
we estimate that the prevailing rate will be lower than the 5% increase which is
currently assumed. This will result in a decrease in average bill rate between
2004 and 2005. For the years 2013 through 2015 and 2016 through 2018, if the
renewal

F-6

<PAGE>

term option is exercised, the PSA provides for a rate equal to the lower of the
average monthly PJM Billing Rate or the rate paid for the calendar year 2012
adjusted annually by the percentage change in the Gross National Product
Deflator less one percent. The Facility achieved commercial operation on June 8,
1993.

We were involved in a legal proceeding with Penelec whereby, among other
complaints, we alleged that Penelec failed to pay the Lessor and Buzzard
contract rates for power in excess of 80 Megawatts produced by the Facility. On
August 3, 2000, the Lessor and Buzzard jointly entered into a settlement
agreement with Penelec to terminate the ongoing litigation. Under the terms of
the settlement agreement, in full settlement of all alleged claims, Penelec
agreed to pay the Plaintiffs for all previous net deliveries of electric energy
from the Scrubgrass project in excess of 80 Megawatt at rates set forth in the
PSA, minus the total payments Penelec previously made at 90% of a market based
rate, plus interest at the legal rate of 6%. Penelec also agreed in the
settlement agreement to pay for future net deliveries of electric energy at the
rates set forth in the PSA subject to, among other conditions, certain annual
and hourly limits, with energy purchased in excess of such limits paid for at a
market based rate. On March 24, 2000, Penelec remitted the outstanding balances
due under the settlement agreement for previous net deliveries of electric
energy and interest which amounted to approximately $3,687,000 and $608,000,
respectively. We reported these revenues in its consolidated statement of
operations for 2000.

Buzzard deposits all revenues earned under the PSA into an account administered
by a disbursement agent. Before Buzzard can receive cash generated by the
Scrubgrass project, all operating expenses, base lease payments (which are
described below), restricted cash deposits and other subordinated payments must
be satisfied. Buzzard, as lessee, is required to pay the Lessor, in addition to
a specified base rent, which consists of all of the Lessor's debt service,
equity repayment, base return on equity and related expenses, and an additional
rent of 50 percent of the net cash flows Buzzard receives from the Scrubgrass
project's operations. Buzzard is not required to fund operating losses, or
otherwise invest further, from sources outside of the Scrubgrass project.

Buzzard and the Lessor have various debt obligations related to the Scrubgrass
project. As discussed above, Buzzard is required to pay the principal, interest
and fees for the Lessor's debt obligations as a base lease payment. As such,
Buzzard is committed to pay all of the Scrubgrass debt obligations as either a
debt or lease obligation. The Scrubgrass project had the following debt
obligations as of December 31, 2002 and 2001:

<TABLE>
<CAPTION>
                                           BALANCE AT         BALANCE AT
    DESCRIPTION OF THE OBLIGATION           12/31/02           12/31/01           INTEREST RATE          MATURES
--------------------------------------- -----------------  ----------------- ------------------------- -------------
<S>                                         <C>               <C>             <C>                           <C>
BUZZARD'S LEASE OBLIGATIONS:

Variable rate tax-exempt bonds              $ 135,600,000     $ 135,600,000   Quoted Bond Rates             2012
Swap rate term loan                             8,700,913        10,669,663   7.6725%                       2005
 Variable rate term loan                        7,089,016         8,344,479   LIBOR + 1.250%                2004

BUZZARD'S DEBT OBLIGATIONS:

 Variable rate term loan                          837,437           985,747   LIBOR + 1.250%                2004
 Working capital loan                             517,112         1,116,905   LIBOR + 1.250%                2008
</TABLE>

The Lessor's debt obligations and Buzzard's debt obligation incur interest at
either quoted rates, rates fixed by swap agreements, or variable rates which are
based on the London Interbank Offering Rate ("LIBOR"). On December 22, 1995, the
Lessor entered into an interest rate swap arrangement which

F-7

<PAGE>

fixed the LIBOR component for the life of its swap rate term loan at 6.4225%. As
a result, the interest rate for the swap rate term loan was fixed at 7.5475%
(LIBOR + 1.125%) through December 31, 2001 and 7.6725% (LIBOR + 1.25%) for the
remaining term of the obligation. The Lessor's tax-exempt bonds incurred
interest at floating rates ranging from 1.10% to 2.70% and 2.00% to 4.50% during
2002 and 2001, respectively. Under the terms of the Lessor's loan agreements, we
are subject to various customary financial and operating covenants. As of
December 31, 2002 and 2001, we were in compliance with these covenants.

The Environmental Protection Agency and the Pennsylvania Department of
Environmental Protection (the "Regional Authorities") granted Nitrogen Oxide
Ozone Transport Region Budget Allowances ("NOx Credits") to Environmental Power
Corp. based on numerous factors that primarily pertain to the design and
operation of the Facility. We are required annually to maintain sufficient NOx
Credits which equal or exceed the quantity of its nitrogen oxide emissions
during a specified seasonal period (the "ozone season"). If our nitrogen oxide
emissions exceed its available NOx Credits, we would be subject to fines by the
Regional Authorities. During 2000, we installed machinery, costing $811,568,
which has significantly reduced our nitrogen oxide emissions. Accordingly, we
anticipate that it may not require a portion of its future NOx Credits to
maintain its compliance with the applicable regulations. Because NOx Credits are
transferable and marketable, we have sold for delivery through 2007 and may
sell, from time to time, our available NOx Credits or purchase additional NOx
credits that are necessary to meet the applicable regulations. We received net
proceeds from NOx Credit transactions of $2,428,200, $0 and $1,156,338 in 2002,
2001, and 2000 respectively, which have been reported as other income in the
accompanying consolidated statements of operations.

MICROGY COGENERATION SYSTEMS

In the second half of 2001, we acquired Microgy Cogeneration Systems, Inc., a
development-stage company based in Golden, Colorado. The acquisition is
described in Note C to our consolidated financial statements. Microgy intends to
market and operate in the renewable energy and distributed generation sectors of
the electric energy industry and the pollution mitigation area of the
agricultural industry. Microgy has an exclusive license to an anaerobic
digestion technology that is designed to provide efficient conversion of certain
agricultural wastes into combustible biogas and an environmentally improved
waste effluent.

The licensor of the anaerobic digester technology is Danish Biogas Technology
A/S ("DBT"). DBT is 50% owned by Schouw & Co., a Danish public company. On May
12, 2000, Microgy entered into a revised licensing agreement with DBT which
granted Microgy a perpetual and exclusive license in certain territories,
specifically North America, for use of certain proprietary technologies in its
cogeneration facilities, including the anaerobic digestion technology. This
agreement superseded previous license agreements.

As part of the agreement, DBT will own a 5% minority equity stake in any legal
entity that owns any project developed by Microgy using the enhanced anaerobic
digester technology and in which Microgy holds an equity position. The agreement
also specifies a fixed payment amount per project to DBT for engineering work
and construction drawings and a licensing fee that is based on a percentage of
the total cost for each project facility where the licensed technology is
installed and operating. A monthly consulting fee will be paid to DBT upon
commercial operation of proposed projects.

F-8

<PAGE>

Currently, we are in the process of renegotiating with DBT in an effort to
eliminate the monthly consulting fees and DBT's ownership rights in favor of
higher initial design, engineering and royalty payments.

Microgy plans to develop projects based upon the anaerobic digestion technology
license and may hold various interests in these facilities. Microgy's present
business strategy anticipates the outright sale of facilities, however, in some
instances, Microgy may own some or a portion of the projects. In addition,
Microgy may or may not operate and/or manage the facilities. These facilities
are expected to deliver renewable energy for supply to the utility grid and
provide pollution control benefits to the agricultural markets.

SUNNYSIDE PROJECT

The Sunnyside Project is an approximately 51 Megawatt (net) waste coal-fired
facility located at a site adjacent to the Sunnyside Coal Mine in Carbon County,
Utah. We sold its remaining interest in the Sunnyside Project on December 31,
1994 to B&W Sunnyside, L.P. and NRG Sunnyside, Inc. (the "Purchasers"). From May
1996 to April 2001, we had been involved in a legal proceeding to collect the
Purchasers' remaining obligations from the sale.

On April 10, 2001, we received aggregate proceeds of $1,500,000 from the
Purchasers and resolved the litigation by executing a Binding Settlement
Agreement dated April 9, 2001 ("the Settlement"). At the time of making the
Settlement, we had contingent obligations of $1,218,078 recorded on our
consolidated balance sheet. The contingent obligations were principally expenses
for the sale of the Sunnyside Project which were payable upon collection of the
Purchasers' obligations. In the Settlement, we were formally released from
contingent obligations of $177,962. We have also been released as a result of
the statute of limitations or by the terms of the underlying agreements from
additional contingent obligations of $457,086. We reported the settlement
proceeds of $1,500,000 and the released liabilities of $635,048 as other income
in our consolidated statement of operations for 2001.

Because of the terms of the Settlement, which terms represented a substantial
compromise of our previous claims against the Purchasers; we are presently
considering its rights and obligations with respect to the remaining contingent
obligations. Until we resolve these remaining issues, the unsettled contingent
obligations will remain recorded on our consolidated balance sheet.

NOTE B -- SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The consolidated financial statements include the
accounts of Environmental Power Corporation and its wholly owned or majority
owned subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation. The consolidated financial statements include
the accounts of Microgy from the date of acquisition (July 23, 2001) (See Note
C).

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

F-9

<PAGE>

Cash Equivalents: We consider all highly liquid investments with maturities of
three months or less when purchased to be cash equivalents.

Concentrations of Credit Risk: Our financial instruments that are exposed to
concentrations of credit risk consist primarily of cash equivalents and
receivable from utility. Our cash equivalents represent short-term financial
instruments which are issued from reputable financial institutions. Receivable
from utility represents amounts due from our sole customer Penelec, a subsidiary
of FirstEnergy Group, a public utility with a credit rating of BBB- by Standard
& Poors, pursuant to the terms of the 25 year power sales agreement.

Restricted Cash: Restricted cash includes all cash held by the disbursement
agent for the Scrubgrass project pursuant to project agreements which require
requisition and/or certification by the Lessor or bank to withdraw (See Note A).
We make scheduled deposits to restricted cash accounts which are restricted
primarily for scheduled maintenance procedures.

Non-Cash Activities: We had the following non-cash investing and financing
activities during 2002:

     Fair value of a warrant for 100,000 shares issued
      for consulting services:                              $  49,707
                                                            =========

Fuel Inventory: Fuel inventory consists primarily of handling and hauling costs
and is recorded on a lower of cost or market basis with cost determined on a
monthly weighted average basis.

Property, Plant and Equipment: Property, plant and equipment are stated at cost
less accumulated depreciation. We capitalize significant renewals and
betterments that increase the useful lives of assets while repairs and
maintenance charges are expensed when incurred. The cost and accumulated
depreciation for property, plant and equipment disposals are removed from the
balance sheet and any resulting gains or losses are reported in the statement of
operations at the time of the asset disposition. We depreciate property plant
and equipment using straight-line and accelerated methods over the estimated
useful lives of the assets. We record depreciation for office equipment and
furniture using the straight-line method over periods ranging from three to five
years, for machinery and equipment modifications using the double declining
balance method over seven years, and for leasehold improvements using the
straight-line method over the life of the lease. We evaluate the impairment of
long-lived assets based on the projection of undiscounted cash flows whenever
events or changes in circumstances indicated that the carrying amounts of such
assets may not be recoverable. In the event such cash flows are not expected to
be sufficient to recover the recorded value of the assets, the assets are
written down to their estimated fair values.

Goodwill and Intangible Assets: Intangible assets are recorded at cost and
consist of licensed technology rights and goodwill. Licensed technology rights
are being amortized using the straight-line method over a useful life of 20
years. Goodwill represents the excess of cost over the fair value of tangible
and identifiable intangible assets and is not being amortized pursuant to
Statement of Financial Accounting Standards ("SFAS") No. 142 "Goodwill and Other
Intangible Assets". We periodically review the carrying value of other
intangible assets against the operating performance and future undiscounted net
cash flows of the related businesses and recognizes impairment losses whenever
circumstances indicate that the carrying values may not be recoverable. Goodwill
is reviewed for impairment on an annual basis in accordance with SFAS No. 142.
We did not have acquired goodwill or intangible assets recorded on our balance
sheet prior to the Microgy acquisition. Accumulated amortization of licensed
technology rights was $267,323 and $81,823 at December 31, 2002 and 2001,
respectively. We adopted SFAS 142 on January 1, 2002 and completed the
transitional impairment testing in June 2002 and required annual

F-10

<PAGE>

testing at December 31, 2002. We assessed the implied fair value of the
reporting unit by using a discounted cash flow analysis. Given consideration of
these factors, we concluded that the fair value of the reporting unit exceeded
the carrying amount of our net assets and, thus, goodwill was not impaired as of
January 1, 2002 and December 31, 2002. The future estimated amortization expense
for licensed technology rights is as follows:

                For the year ended December 31,

                          2003                 $   185,500
                          2004                     185,500
                          2005                     185,500
                          2006                     185,500
                          2007                     185,500
                    Thereafter                   2,515,177
                                               ------------
                         Total                 $ 3,442,677
                                               ============

Deferred Financing Costs: In 1997 and 1995, we incurred deferred financing costs
of $139,925 and $300,000, respectively, in connection with restructuring debt
related to the Scrubgrass project. Deferred financing costs are being amortized
over the lives of the related debt which range from three to nine years.
Accumulated amortization of deferred financing costs was $389,435 and $353,795
at December 31, 2002 and 2001, respectively.

Lease Rights: Lease rights are recorded at cost and are being amortized over the
22-year lease term for the Scrubgrass project. Accumulated amortization of lease
rights was $1,266,561 and $1,117,557 at December 31, 2002 and 2001,
respectively.

Accrued Power Generation Revenue and Accrued Lease Expense: As discussed in Note
A, we have entered into a long-term agreement, to provide electricity to
Penelec, which provides for scheduled rate increases. In accordance with
accounting principles generally accepted in the United States of America,
revenue has been recorded on the straight-line basis over the 22-year lease
term. The accrual for power generation revenue is limited to the amount of
accrued lease expense, as described below. Therefore, no amount for the straight
lining of future revenues, which would result in profits, has been provided for
in the consolidated financial statements. Accrued power generation revenue was
$70,192,993 and $63,648,995 at December 31, 2002 and 2001, respectively, and
represents the portion of revenue earned that has not yet been received.

As discussed in Note A, we have entered into a long-term lease agreement for the
Scrubgrass project which provides for scheduled lease expense increases. In
accordance with accounting principles generally accepted in the United States of
America, the scheduled lease expense has been recorded on the straight-line
basis over the 22-year lease term. Accrued lease expense was $70,192,993 and
$63,648,995 at December 31, 2002 and 2001, respectively, and represents the
portion of lease expense that has not yet been paid.

Deferred Gain: Our sale of the Scrubgrass project on December 28, 1990 was not
treated as a sale for financial accounting purposes. This was originally due to
the existence of an option which enabled us to reacquire Buzzard and to lease
the Scrubgrass project for a substantial portion of its commercial operation.
This option constituted a significant continuing involvement by our company
which provided evidence that we had retained substantial risks or rewards of
ownership of the Scrubgrass project. In

F-11

<PAGE>

December 1993, we agreed to a modification to the proposed form of lease thereby
relinquishing the fair market value purchase option. Accordingly, we removed
from the Consolidated Balance Sheet the gross assets and liabilities of the
Scrubgrass project and recorded a deferred gain of $6,785,035 arising from the
original sale of the Scrubgrass project in 1990. The deferred gain is being
amortized over the 22-year minimum lease term, which commenced on June 30, 1994.
Accumulated amortization of the deferred gain was $2,621,491 and $2,313,080 at
December 31, 2002 and 2001, respectively.

Major Maintenance: We record the expense of major equipment overhauls as
incurred.

Interest Payments: We classify interest payments according to the nature of our
contractual obligations. Our base lease payments for interest on the Lessor's
debt obligations are reported as lease expense. Our interest payments on our own
debt obligations are reported as interest expense. We paid interest on our debt
obligations of $141,526, $196,811 and $289,116 during the years ended December
31, 2002, 2001 and 2000, respectively.

Income Taxes: We account for income taxes in accordance SFAS No. 109,
"Accounting for Income Taxes". Under SFAS No. 109, deferred tax assets and
liabilities are determined based on differences between the financial reporting
and tax reporting bases of assets and liabilities and are measured by applying
the enacted tax rates and laws to taxable years in which the differences are
expected to reverse. We recognize a deferred tax asset for the tax benefit of
net operating loss carry forwards when it is more likely than not that the tax
benefits will be realized and reduce the deferred tax asset with a valuation
reserve when it is more likely than not that some portion of the tax benefits
will not be realized.

Earnings Per Common Share: We compute earnings per common share using the
treasury stock method in accordance with SFAS No. 128, "Earnings per Share". We
compute basic earnings per share by dividing net income for the period, less
Buzzard's preferred stock dividends, by the weighted average number of shares of
common stock outstanding during the period. For purposes of calculating diluted
earnings per share, we consider shares issuable in connection with stock options
to be dilutive common stock equivalents when the exercise price is less than the
average market price of our common stock for the period. We exclude antidilutive
common stock equivalents from the calculation of diluted earnings per share. The
following table outlines the calculation of basic earnings per share and diluted
earnings per share for the years ended December 31, 2002, 2001 and 2000.

F-12

<PAGE>

<TABLE>
<CAPTION>
                                                                     INCOME             SHARES           PER SHARE
                                                                   (NUMERATOR)      (DENOMINATOR)         AMOUNTS
                                                                 ----------------------------------------------------
<S>                                                              <C>                      <C>         <C>
YEAR ENDED DECEMBER 31, 2002:

Income available to shareholders                                 $     1,138,383          20,720,614  $          0.05
Effect of dividends to preferred stockholders                             -5,000
                                                                 ----------------------------------------------------
Basic EPS - income available to common shareholders                    1,133,383          20,720,614             0.05
Effect of dilutive securities:
Assumed exercise of dilutive stock options                                                    90,209
                                                                 ----------------------------------------------------
Diluted EPS - income available to common shareholders            $     1,133,383          20,810,823  $          0.05
                                                                 ====================================================

YEAR ENDED DECEMBER 31, 2001:

Income available to shareholders                                 $     1,679,331          14,144,222  $          0.12
Effect of dividends to preferred stockholders                             -5,000
                                                                 ----------------------------------------------------
Basic EPS - income available to common shareholders                    1,674,331          14,144,222             0.12
Effect of dilutive securities:
Assumed conversion of preferred stock                                                        585,155
Assumed exercise of dilutive stock options                                                    16,318
                                                                 ----------------------------------------------------
Diluted EPS - income available to common shareholders            $     1,674,331          14,745,695  $          0.11
                                                                 ====================================================

YEAR ENDED DECEMBER 31, 2000:

Income available to shareholders                                 $     1,826,808          11,406,783  $          0.16
Effect of dividends to preferred stockholders                             -5,000
                                                                 ----------------------------------------------------
Basic EPS - income available to common shareholders                    1,821,808          11,406,783             0.16
Effect of dilutive securities:
Assumed exercise of dilutive stock options                                                     2,026
                                                                 ----------------------------------------------------
Diluted EPS - income available to common shareholders            $     1,821,808          11,408,809  $          0.16
                                                                 ====================================================
</TABLE>

As of December 31, 2002 and 2001 respectively, there were outstanding options
and warrants to purchase 1,116,962 and 1,442,499 shares of our common stock
which were antidilutive and not included in the computation of diluted EPS. The
options and warrants expire at various dates through 2012.

Stock Options: As permitted by SFAS 123, "Accounting for Stock-Based
Compensation," we account for employee and director stock compensation plans
under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees." Generally, compensation expense has not been recorded as
our options have been issued at an option price equal to the quoted market price
on the date of the grant. Compensation expense is recorded for those options
issued outside of option plans. During 2002, we recognized $49,707 in
stock-based compensation expense for options issued outside of its option plans
for employees and directors.

Under the provisions of Accounting Principles Board Opinion ("APB") No. 25, we
do not recognize compensation expense for stock option awards under the 2001
Plan, 1993 Director Plan and 2002 Director Option Plan since the underlying
options have exercise prices equal to 100 percent of the fair market value of
the common stock on the date of grant (110 percent of the fair market value in
the case officers or other employees holding 10% or more of our common stock for
the 2001 Plan). However, pursuant to the provisions of SFAS No. 123, we are
required to calculate the fair market value of its stock options using different
criteria from the provisions of APB No. 25. Using the fair market value criteria
required by SFAS No. 123 to calculate compensation expense, pro forma net income
and earnings per share would be as follows:

F-13

<PAGE>

<TABLE>
<CAPTION>
                                                                2002             2001          2000
----------------------------------------------------------------------------------------------------
<S>                                                          <C>            <C>           <C>
Fair Market Per Share                                        $      0.38    $       0.28  $     0.18
ASSUMPTIONS

  Risk-free rate of return                                          3.82%           3.73%       5.99%
  Volatility                                                       74.31%          88.04%      42.03%
  Expected Annual Dividend Yield                                       0%              0%          6%

  Option Life                                                      10.00            2.00        5.00

  Compensation expense under the intrinsic value method      $    49,707    $    113,600  $        -
  Net Income available to common shareholders, as reported     1,133,383       1,674,331   1,821,808

  Compensation Expense under SFAS 123, net of taxes               51,896           3,118       1,864
----------------------------------------------------------------------------------------------------
    Net Income available to common shareholders under
     SFAS 123                                                  1,081,487       1,671,213   1,819,944
====================================================================================================
  Basic EPS, as reported                                     $      0.05    $       0.12  $     0.16
  Basic EPS, under SFAS 123                                  $      0.05    $       0.12  $     0.16
  Diluted EPS, as reported                                   $      0.05    $       0.11  $     0.16
  Diluted EPS, under SFAS 123                                $      0.05    $       0.11  $     0.16
</TABLE>

================================================================================

Derivative Instruments and Hedging Activities: On January 1, 2001, we adopted
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities",
which established accounting and reporting standards for derivative instruments,
derivative instruments embedded in other contracts, and hedging activities. SFAS
No. 133 requires that entities recognize all derivative instruments as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. We do not have any derivative instruments which
should be recognized in its financial statements. However, the Lessor has
certain interest rate swap arrangements with financial institutions that meet
the definition of derivative instruments under SFAS No. 133. Since Buzzard funds
the Lessor's debt obligations as a base lease payment, we have disclosed in Note
M certain information about the Lessor's derivative instruments.

Recent Accounting Pronouncements:

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which is effective January 1, 2003. SFAS 143 addresses the
financial accounting and reporting for obligations and retirement costs related
to the retirement of tangible long-lived assets. We do not expect that the
adoption of SFAS 143 will have a significant impact on our consolidated
financial statements.

In June 2002, the Financial Accounting Standards Board issued SFAS No 146
"Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146
addresses financial accounting and reporting for costs associated with or
disposal activities and replaces Emerging Issues Task Force (EITF) Issue No.
94-3. "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." It requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred, rather than
at the date of a commitment to an exit or disposal plan. The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation, Transition and Disclosure". SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. SFAS No. 148 also requires
that disclosures of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed more prominently
in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro
forma effect in interim financial statements. The transition

F-14

<PAGE>

and annual disclosure requirements of SFAS No. 148 are effective for the fiscal
year ended December 31, 2002. We do not expect to change to the fair value based
method, therefore, SFAS No. 148 will not have a material effect on our results
of operations or financial position. The disclosure provisions of SFAS No. 148
have been adopted currently.

In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45), which requires that, for
guarantees within the scope of FIN 45 issued or amended after December 31, 2002,
a liability for the fair value of the obligation undertaken in issuing the
guarantee be recognized. FIN 45 also requires additional disclosures in
financial statements for periods ending after December 15, 2002. It is not
expected that the recognition and measurement provisions of FIN 45 will have a
material effect on our financial position or operating results.

NOTE C -- ACQUISITION

During 2001, we acquired 100% of the common stock of Microgy in two related
transactions. On July 23, 2001, we exchanged our securities for approximately
87.7% of the outstanding common stock of Microgy under a June 20, 2001 agreement
with Microgy and certain principal Microgy shareholders. Under the agreement, we
agreed to offer the remaining Microgy shareholders the opportunity to exchange
their Microgy securities for our securities. On December 28, 2001, we completed
the exchange of our securities for the remaining outstanding securities of
Microgy. The details of the two exchange transactions are discussed in the
following section.

TRANSACTION DETAILS

On July 23, 2001, we issued an aggregate of 5,521,549 shares of common stock and
197,760.7 shares of newly designated Series B Convertible Preferred Stock to
certain principal stockholders of Microgy in exchange for 15,919,147 shares of
Microgy common stock. Each share of preferred stock, which voted with the common
stock on an as-converted basis, was automatically converted into ten shares of
common stock as of November 9, 2001 upon an increase in the authorized common
stock to an amount sufficient to allow conversion of the preferred stock. The
exchange ratio of 0.4711 shares of our common stock for each share of Microgy
common stock was determined by negotiations among EPC, Microgy and the primary
principal Microgy shareholders. The exchange ratio is based on all of the fully
diluted equity of Microgy being exchanged for 45% of fully diluted equity and
assumes exercise or conversion of all derivative securities. The exchange ratio
may be increased to reflect certain issuances of equity by us to generate funds
to be available for financing Microgy. However, holders of approximately 94% of
the Microgy common stock agreed to waive their right to adjustments in the
exchange ratio, other than any adjustment resulting from 400,000 options and
warrants issued in September 2001. One of the principal Microgy shareholders
exchanged a warrant to purchase 800,000 shares of Microgy common stock for a
warrant to purchase our securities based on the exchange ratio such warrant
expired unexercised on September 30, 2002. In connection with our issuance of
400,000 options and warrants in September 2001, we adjusted the exchange ratio
to 0.4873 shares of our common stock for each share of Microgy common stock. We
then issued 258,884 additional shares of common stock to the principal Microgy
shareholders on December 28, 2001 and amended the warrant issued to the
principal Microgy shareholder to reflect the adjusted exchange ratio.

On October 17, 2001, we offered the remaining security holders of Microgy, who
owned an aggregate of 2,230,126 shares of Microgy common stock, warrants to
purchase 885,000 shares of Microgy common stock and options to purchase 290,000
shares of Microgy common stock, an opportunity to exchange their securities of
Microgy for our securities based on the adjusted exchange ratio. On December 28,
2001, we issued 1,086,830 shares of our common stock and exchanged warrants to
purchase 821,170 shares of our common stock and options to purchase 141,329
shares of our

F-15

<PAGE>

common stock for the remaining Microgy securities. Such warrants expired
unexercised on September 30, 2002.

Under the terms of a Registration Rights Agreement dated July 23, 2001, we were
required to file a resale registration statement for the former Microgy security
holders by November 30, 2001. In November 2001, the deadline for filing the
registration statement was extended to March 31, 2002. The registration
statement was filed April 4, 2002.

PURCHASE ACCOUNTING AND VALUATION

We acquired Microgy to pursue a prospective growth opportunity in the area of
environmentally sound power generation. We believe that trends in the power and
agricultural markets create an opportunity to develop power generation projects
using Microgy's exclusive licensed technology. We paid $7,343,528 for Microgy
and accounted for the transaction using the purchase method of accounting as
required by SFAS No. 141. The purchase price represents the fair value of the
securities issued and the direct costs of the acquisition. The fair value of the
common stock was determined using available market information and appropriate
valuation methodologies. The fair value of the common stock options and warrants
were determined using an option pricing model (See Note L). The following table
outlines the components of the purchase price:

                                            NUMBER            FAIR
                                           OF SHARES          VALUE
                                        --------------    -------------

          Common stock                      8,844,870      $ 6,837,084
          Common stock options                141,329           11,967
          Common stock warrants               821,170           43,730
          Acquisition costs                                    450,747
                                        --------------    -------------
          Total purchase price              9,807,369      $ 7,343,528
                                        ==============    =============

The purchase price was allocated to the assets acquired and liabilities assumed
based on their fair values as of July 23, 2001. The fair values of the assets
acquired and liabilities assumed are summarized as follows:

          Cash                            $        18,306
          Other current assets                      4,662
          Property plant, and equipment            29,127
          Investment in projects                  100,694
          Licensed technology rights            3,710,000
          Goodwill                              4,912,866
                                          ---------------
                                                8,775,655
          Less: Liabilities assumed            (1,432,127)
                                          ---------------
          Total Purchase Price            $     7,343,528
                                          ---------------

At the time of the acquisition, We believed that Microgy held numerous elements
of value which could not be separated from the value of the overall business.
These elements of value were assigned to goodwill and included: 1) technology
rights for products and processes which currently do not have a commercial
application; 2) preliminary business relationships; 3) an established workforce;
4) a proprietary market analysis; and 5) strategic business plans to capitalize
on future market opportunities.

F-16

<PAGE>

On July 23, 2001, we commenced accounting for 100% of Microgy's operations since
the minority interest shareholders were no longer at risk for Microgy's losses.

PRO FORMA INFORMATION

The following summarized unaudited pro forma information assumes the acquisition
of Microgy occurred on January 1, 2000. The unaudited pro forma results are not
necessarily indicative of the results which might actually have been obtained
had the acquisition occurred as of January 1, 2000, nor are they intended to be
indicative of future results of operations. The amounts below do not include any
amortization of goodwill or indefinite-lived intangible assets.

                                           YEAR ENDED             YEAR ENDED
                                        DECEMBER 31, 2001     DECEMBER 31, 2000
                                     ----------------------  -------------------

Power generation revenues                     $ 54,303,222         $ 53,518,000
Net income                                       1,038,323            1,131,696
Basic earnings per common share                       0.05                 0.06
Diluted earnings per common share                     0.05                 0.06

NOTE D -- OTHER CURRENT ASSETS

Other current assets consist of the following as of December 31, 2002 and 2001:

                                                2002             2001
                                             ----------       ---------
Fuel inventory                                $ 776,187       $ 455,907
Prepaid expenses                                149,487         123,670
Deferred financing costs                              0          18,894
Deposits and other current assets                   903           9,119
                                             ----------       ---------
                                              $ 926,577       $ 607,590
                                             ==========       =========

NOTE E - PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment is recorded at cost less accumulated depreciation
and consists of the following as of December 31, 2002 and 2001:

                                                2002            2001
                                             -----------    -----------
Power generating facilities:
  Machinery and equipment modifications
   - Scrubgrass                              $ 1,163,863    $ 1,163,863
  Less: Accumulated depreciation                (683,184)      (555,081)
                                             -----------    -----------
                                                 480,679        608,782
                                             -----------    -----------
Office:
  Equipment and furniture                        117,987         83,067
  Less: Accumulated depreciation                 (46,059)       (39,019)
                                             -----------    -----------
                                                  71,928         44,048
                                             -----------    -----------
                                             $   552,607    $   652,830
                                             ===========    ===========

F-17

<PAGE>

During 2002 and 2001, we retired from service and removed from its balance sheet
fully depreciated property, plant and equipment with an original cost of $15,832
and $94,628, respectively. Depreciation expense for the years ended 2002, 2001
and 2000 was $150,756, $167,003 and $223,872, respectively.

NOTE F -- OTHER ASSETS

Other assets consists of the following as of December 31, 2002 and 2001:

                                         2002            2001
                                      ---------      ---------
Scrubgrass project deposits           $ 361,098      $ 367,706
Deferred financing costs (See Note B)    50,490         86,130
Investment in projects                        0        100,694
Security deposits                        11,040         11,040
                                      ---------      ---------
                                      $ 422,628      $ 565,570
                                      =========      =========

Scrubgrass project deposits represent performance bonds required by state and
local governing authorities for excess highway maintenance and reclamation of
fuel sites.

NOTE G -- ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consists of the following as of December
31, 2002 and 2001:

                                 2002                  2001
                              -----------          -----------
Accounts payable              $ 4,547,993          $ 4,124,390
Accrued expenses                4,214,152            4,101,015
Corporate taxes payable           887,947            1,157,066
                              -----------          -----------
                              $ 9,650,092          $ 9,382,471
                              ===========          ===========

Accounts payable at December 31, 2002 and 2001 includes $4,516,845 and
$3,936,058, respectively, which are related to Scrubgrass project operations.

Accrued expenses at December 31, 2002 and 2001 include $2,953,665 and
$3,796,008, respectively, which are related to Scrubgrass project operations.

NOTE H -- RETIREMENT PLAN

Effective January 1, 1998 we established a non-contributory defined benefit
pension plan (the "Plan") covering all of its employees who are at least 21
years of age and who have completed at least one year of service. Under the
Plan, the benefits payable to each employee at normal retirement age 62 are
based on years of service and compensation during the three consecutive years of
the latest 10 years immediately preceding retirement which would yield the
highest monthly benefit payment. Employees who have at least 20 years of service
at the time of their retirement would receive the maximum retirement benefit.
Our general funding policy is to contribute annually to the Plan the maximum
amount that can be deducted for Federal income tax purposes.

As of January 1, 1998, the commencement date for the Plan, we had a projected
benefit obligation of $871,130. The projected benefit obligation as of January
1, 1998 is being amortized as a prior service

F-18

<PAGE>

cost over 18 years which represents the average future years of service for the
participants in the Plan at that date.

Effective January 1, 2003 we amended the Plan. Certain employees after 2002 will
have an accrued benefit plus the benefit earned under the new formula applied to
years of credited service earned after 2002. The normal retirement age is now
age 65. The amended plan has a two year waiting period before employees enter
the plan, it was previously one year. Employees who join the plan after two
years will be fully vested at that time. After 2002 the benefit is accrued at
1.5% of the average monthly compensation for each year of credited service,
without a cap.

The following table sets forth the changes during 2002 and 2001 in the projected
benefit obligation for the Plan:

                                                         2002          2001
                                                     -----------   -----------
Projected benefit obligation, beginning of the year  $ 1,694,111   $ 1,438,313
Service cost                                             220,785        96,914
Interest cost                                            114,352       100,682
Actuarial loss                                            54,030        58,202
                                                     -----------   -----------
Projected benefit obligation, end of the year        $ 2,083,278   $ 1,694,111
                                                     ===========   ===========

The following table sets forth a reconciliation of the funded status of the Plan
to the amounts recognized in the consolidated balance sheets as of December 31,
2002 and 2001:

                                                       2002            2001
                                                    -----------    -----------
Projected benefit obligation                        $ 2,083,278    $ 1,694,111
Fair market value of Plan assets                       (851,046)      (599,577)
                                                    -----------    -----------
Unfunded projected benefit
obligation                                            1,232,232      1,094,534
Unrecognized actuarial loss                            (638,665)      (424,901)
Unrecognized prior service cost                        (641,885)      (687,734)
                                                    -----------    -----------
(Prepaid) accrued pension cost                      $   (48,318)   $   (18,101)
                                                    ===========    ===========

The amounts recognized in the consolidated balance sheets as of December 31,
2002 and 2001 consist of

                                                        2002          2001
                                                    -----------    -----------
Accrued benefit liability                           $ 1,100,604    $   769,624
Intangible asset                                       (641,885)      (687,734)
Other comprehensive income                             (507,037)       (99,991)
                                                    -----------    -----------
Net amount recognized                               $   (48,318)   $   (18,101)
                                                    ===========    ===========

The accrued benefit liability and intangible asset are reported in accounts
payable and accrued expenses and unrecognized prior pension service cost,
respectively on the consolidated balance sheets. Other comprehensive income is
reported, net of tax, in stockholders' equity on the consolidated balance sheet.

The following table sets forth the changes during 2002 and 2001 in the fair
market value of Plan assets:

<TABLE>
<CAPTION>
                                                                 2002         2001
                                                             -----------   -----------
<S>                                                          <C>           <C>
Fair market value of Plan assets, beginning of the period    $   599,577   $   347,400
Contributions by us to the Plan                                  382,890       346,879
Benefits paid                                                         --        (8,401)
Return on Plan assets                                           (131,421)      (86,301)
                                                             -----------   -----------
Fair market value of Plan assets, end of the period          $   851,046   $   599,577
                                                             ===========   ===========
</TABLE>

F-19

<PAGE>

We have invested the Plan assets in a portfolio of mutual funds which consist
primarily of growth stocks.

Our net periodic pension cost for 2002 and 2001 are comprised of the following
components:

                                           2002                     2001
                                       ------------           -------------
Service cost                           $    220,785           $      96,914
Interest cost                               114,352                 100,682
Expected return on assets                   (47,966)                (27,456)
Amortization of actuarial loss               19,653                  10,071
Amortization of prior service cost           45,849                  45,849
                                       ------------           -------------
Net periodic pension cost              $    352,673           $     226,060
                                       ============           =============

The actuarial assumptions used in 2002 and 2001 to determine the pension
benefits for the Plan were:

                                                              2002    2001
                                                            -------  -------
Weighted average discount rate                                6.1%    6.75%
Expected long-term return on Plan assets                      8.0%     8.0%
Weighted average rate of increase in compensation levels      5.0%     5.0%

NOTE I -- OTHER CURRENT LIABILITIES

Other current liabilities consist of the following as of December 31, 2002 and
2001:

                                                     2002            2001
                                                   ---------     -----------
Scrubgrass project working capital loan           $ 517,112     $ 1,116,905
Scrubgrass project note payable-current
 portion (See Note J)                               447,902         148,310
Scrubgrass project long-term debt to supplier-
 current portion (See Note J)                             0          97,893
                                                  ---------     -----------
                                                  $ 965,014     $ 1,363,108
                                                  =========     ===========

The Scrubgrass project working capital loan represents outstanding borrowings
due to the Lessor under a Lessee Working Capital Loan Agreement. Under the terms
of this agreement, which expires in December 2008, Buzzard may borrow up to $4
million for the ongoing working capital requirements of the Scrubgrass project.
Buzzard paid interest on the outstanding borrowings under this agreement at
LIBOR plus 1.25% during 2001 and 2002. The interest rate was 1.38% as of
December 31, 2002 and ranged from 1.38% to 2.08% during 2002, and 3.33% to 8.23%
during 2001).

The Scrubgrass project long-term debt to supplier represents the present value
of the long-term installments due to GEC Alsthom, the manufacturer of the
Facility's generator, under a non-interest bearing financing agreement. Under
the terms of the agreement, we financed the cost of repairs to the generator
with five installments payable as follows: $50,000 in May 1998; $100,000 in May
1999, $100,000 in May 2000; $100,000 in May 2001 and $100,000 in May 2002. As of
December 31, 2002 and 2001, we has recorded on our balance sheet the present
value of the remaining installments, discounted at the Facility's incremental
borrowing rate (6.75%), which amounted to $0 and $97,893, respectively.

NOTE J -- SECURED PROMISSORY NOTES PAYABLE AND OTHER BORROWINGS

Secured promissory notes payable and other borrowings as of December 31, 2002
and 2001 consist of:

F-20

<PAGE>

                                                  2002           2001
                                                ---------    -----------
Scrubgrass project note payable (See Note I)    $ 389,535    $   837,437
Sunnyside Project obligations (See Note A)        583,030        583,030
                                                ---------    -----------
                                                $ 972,565    $ 1,420,467
                                                =========    ===========

The Scrubgrass project note payable represents an installment obligation that
was incurred as part of the Lessor's debt restructuring in December 1995, when
Buzzard extended the term of certain current liabilities through 2004. Buzzard
paid interest on the outstanding borrowings under the Scrubgrass project note
payable at LIBOR plus 1.25% (1.38% as of December 31, 2002 and ranging from
1.38% to 2.08% during 2002, 3.33% to 8.23% during 2001). The scheduled aggregate
annual repayments for the Scrubgrass project note payable are $447,902 in 2003
and $389,535 in 2004.

NOTE K -- INCOME TAXES

Income tax expense consists of the following for the years ended December 31,
2002, 2001 and 2000:

                                       2002         2001          2000
                                    -------------------------------------
Current:
  Federal                           $  511,380  $    788,843  $   853,791
  State                                248,627       480,186      657,330
                                    -------------------------------------
         Total current tax expense     760,007     1,269,029    1,511,121
                                    -------------------------------------

Deferred:
  Federal                              135,910        90,530       99,245
  State                                (38,642)       13,895       21,867
                                    -------------------------------------
        Total deferred tax expense      97,268       104,425      121,112
                                    -------------------------------------
                                    $  857,274  $  1,373,454  $ 1,632,233
                                    =====================================

Income taxes paid during the years ended December 31, 2002, 2001 and 2000
amounted to $1,172,127 $855,363 and $1,273,280, respectively.

A reconciliation between the actual income tax expense and the income tax
expense computed by applying the statutory federal income tax rate to the income
before income taxes for the years ended December 31, 2002, 2001 and 2000 is as
follows:

                                         2002         2001            2000
                                    -----------------------------------------
Federal tax expense at 34%            $ 678,523   $ 1,037,947     $ 1,176,074
State tax expense, net of federal
 tax benefit                             89,364       320,249         448,270
State tax valuation allowance, net
 of federal tax benefit                  85,827         8,856              --
Permanent differences                     3,560         5,141           5,970
Other                                        --         1,261           1,919
                                     ----------------------------------------
                                      $ 857,274   $ 1,373,454     $ 1,632,233
                                     ========================================

F-21

<PAGE>

The components of the net deferred income tax liability as of December 31, 2002
and 2001 are as follows:

<TABLE>
<CAPTION>
                                                                                 2002            2001
                                                                             ------------     ------------
<S>                                                                          <C>              <C>
Deferred tax assets:
  Accrued lease expense                                                      $ 28,493,722     $ 25,837,291
  Deferred tax effect of the sale of the Scrubgrass project for which
   the net gain was deferred for financial reporting purposes                     832,238          893,914
  Capital loss carry forwards                                                      99,025           99,025
  Expenses deferred for tax reporting purposes                                         --           46,684
  Stocks and warrants                                                              75,838               --
  Other comprehensive income                                                      205,199           39,606
  Pre-acquisition net operating loss carry forward of Microgy                     497,285          622,374
  State net operating loss carry forwards                                          94,681            8,856
                                                                             ------------     ------------
                                                                               30,297,990       27,547,750
                                                                             ------------     ------------
Deferred tax liabilities:
  Accrued power generation revenue                                             28,493,722       25,837,291
  Defined benefit pension plan contribution                                       175,163          158,833
  Licensed technology rights                                                    1,275,712        1,344,450
  Other                                                                           204,339          205,195
                                                                             ------------     ------------
                                                                               30,148,936       27,545,769
                                                                             ------------     ------------
                                                                                  149,052            1,981
Less: valuation allowances                                                       (227,123)        (148,377)
                                                                             ------------     ------------
Deferred income tax liability, net                                           $    (78,071)    $   (146,396)
                                                                             ============     ============
</TABLE>

As of December 31, 2002, we have Federal and state net operating loss carry
forwards of $1,298,183 and $1,666,094, respectively, which are available to
reduce future taxable income. These net operating loss carry forwards relate to
the acquisition of Microgy and expire at various dates through 2020. Due to the
change of ownership provisions in Section 382 of the Internal Revenue Code, our
utilization of Microgy's pre-acquisition net operating loss carry forwards is
limited to $367,911 per year.

As of December 31, 2002, we had a $227,123 valuation reserve for the tax benefit
of net operating loss carry forwards which may not be realized in the future. We
expect that future taxable income would be sufficient to realize the tax
benefits of the remaining net operating loss carry forwards.

NOTE L -- SHAREHOLDERS' EQUITY

STOCK OPTIONS

In November 2001, our Board of Directors and stockholders approved the 2001
Stock Incentive Plan ("the 2001 Plan"), which provides for the award of up to
3,000,000 shares of common stock to eligible employees, consultants and
directors of EPC. Our awards under the 2001 Plan may consist of incentive stock
options, nonqualified stock options, restricted stock, stock appreciation rights
and other stock awards. The 2001 Plan provides that stock options and similar
awards may be issued with exercise periods of up to 10 years and minimum option
prices equal to 100 percent of the fair market value of the common stock on the
date of grant (110 percent of the fair market value in the case of individuals
holding 10% or more of our common stock). During 2002, we granted options for
665,633 shares under the 2001 Plan. As of December 31, 2002, there were
2,243,038 shares available for grant under the 2001 Plan.

F-22

<PAGE>

We have reserved 405,000 shares of common stock for issuance upon exercise of
stock options which are outstanding or may be granted under our 1993 Director
Plan. The options granted under the 1993 Director Plan were principally intended
to constitute non-qualified options with an option price of 100 percent of the
fair market value of the common stock on the date of the grant. The options vest
at the date of grant and expire 10 years from the date of grant. We granted
155,000 shares in 2002 and 20,000 shares in 2001 and 2002. As of December 31,
2002, the 1993 Director Plan has been terminated and replaced by the 2002
Director Plan.

In July 2002, our Board of Directors and stockholders approved the 2002 Director
Option Plan ("the 2002 Plan"), which provides for the award of up to 2,000,000
shares of common stock to eligible directors of the company. The options granted
under the 2002 Plan were principally intended to constitute non-qualified
options with an option price of 100 percent of the fair market value of the
common stock on the date of the grant. The options vest at the date of grant and
expire 10 years from the date of grant. We granted options for 150,000 shares
under the 2002 Director Plan during 2002. As of December 31, 2002, there were
1,850,000 shares available for grant under the 2002 Director Plan.

During 2002, we granted options for 120,000 shares of common stock to related
parties outside of stock plans. During 2001, we granted options for 450,000
shares of common stock and warrants for 50,000 shares of common stock to related
parties outside of stock plans. These stock options and warrants are discussed
in Note O.

Stock option transactions during 2002, 2001 and 2000 are summarized as follows:

         DESCRIPTION                     SHARES   EXERCISE PRICE RANGE
---------------------------------------------------------------------

Balance at January 1, 2000               40,000       0.63      1.69

2000
  Options Granted                        20,000       0.50      0.69
  Options Expired or Exercised                -
Balance at December 31, 2000             60,000       0.50      1.69

2001
  Options Granted                     1,456,866       0.43      3.08
  Options Expired or Exercised         (845,537)
Balance at December 31, 2001            671,329       0.43      3.08

2002
  Options Granted                     1,090,633       0.20      0.65
  Options Expired or Exercised                -
---------------------------------------------------------------------
Balance at December 31, 2002          1,761,962       0.20      3.08
=====================================================================

The following table summarizes information about our options outstanding as of
December 31, 2002:

<TABLE>
<CAPTION>
SUMMARY OF OPTIONS                             OUTSTANDING                                  EXCERCISABLE
                         SHARES            REMAINING LIFE    PRICE            SHARES             PRICE
--------------------------------------------------------------------------------------------------------------------
<S>                               <C>                    <C>              <C>           <C>                    <C>
$ 0.00 - $ 0.42                     340,000              9.69             0.37            200,000              0.35
$ 0.43 - $ 0.63                     875,000              6.81             0.53            325,000              0.54
$ 0.64 - $ 0.83                     410,000              4.16             0.72            410,000              0.72
$ 0.84 +                            136,962              3.97             2.86             97,975              2.78
--------------------------------------------------------------------------------------------------------------------
TOTAL OPTIONS                     1,761,962              6.53             0.73          1,032,975              0.79
====================================================================================================================
</TABLE>

F-23

<PAGE>

DIVIDENDS

We declared aggregate dividends of $684,408 (6 cents per share) during 2000.
Since December 2000, our Board of Directors has not declared dividends on its
common stock. Due to the recent acquisition of Microgy and anticipated expansion
of its business, our Board of Directors has concluded that available cash flows
should be redirected to operating and investing activities for the foreseeable
future.

Buzzard paid dividends of $5,000 per year to a preferred stockholder during
2002, 2001 and 2000. The preferred stockholder is entitled to cumulative
dividends of $5,000 per year and has a liquidation preference to receive $500
per share, plus any cumulative unpaid dividends, prior to the distribution of
any remaining assets to common shareholders. There were no dividends in arrears
to the preferred stockholder as of December 31, 2002.

OTHER EQUITY TRANSACTIONS

We have outstanding notes receivable from officers and directors for shares
purchased in connection with the 1990 Stock Plan and 1993 Director Plan which
amounted to $645,948 as of December 31, 2002 and 2001. The notes, which are
classified as a reduction of shareholders' equity, are payable upon demand and
bear interest at a floating rate which is payable monthly. The notes are also
secured by the shares purchased by the officers and directors. As of December
31, 2002, we have interest receivable from officers of $131.

NOTE M -- COMMITMENTS

CORPORATE

We are obligated under various non-cancelable operating leases for office space
and automotive vehicles. As of December 31, 2002, the future minimum payments
due under these leases are as follows:

                         2003         $  93,980
                         2004            84,648
                         2005            68,441
                         2006            66,240
                         2007            11,040
                                      ---------
                         Total        $ 324,349
                                      =========

Rent expense for these operating leases was $94,758, $46,800 and, $46,689 in
2002, 2001 and 2000, respectively.

SCRUBGRASS PROJECT

We are obligated under a facility lease related to the Scrubgrass project. As of
December 31, 2002, the estimated minimum lease payments over the remaining 14.5
year base term of the Scrubgrass lease are as follows:

F-24

<PAGE>

                       2003      16,723,000
                       2004      19,703,000
                       2005      21,715,000
                       2006      26,058,000
                       2007      28,910,000
                 Thereafter     249,240,000
                              -------------
                      Total   $ 362,349,000
                              =============

Our Scrubgrass project lease expense was $25,291,293, $24,705,813 and
$26,415,897 in 2002, 2001 and 2000, respectively. As discussed in Note A, in
addition to scheduled base rent and additional rent payments, the Scrubgrass
project lease expense includes principal, interest and related fees on the
Lessor's debt obligations. Since a portion of the Lessor's debt obligations have
variable interest rates, we has estimated its future minimum lease payments
using average interest rates of 3.12% for the tax-exempt bonds and 7.795% for
the variable rate term loan.

As discussed in Notes A and B, the Lessor has an interest rate swap arrangement
for one of its term debt obligations which is considered a derivative
instrument. Beginning July 1, 2001, the Lessor was required to recognize the
interest rate swap as either an asset or liability in its statement of financial
position in accordance with SFAS No. 133. As of December 31, 2002, the Lessor
had a liability of $600,776 in its statement of financial position for the
estimated fair market value of the interest rate swap.

We have also been assigned various long-term non-cancelable obligations under
contractual agreements for fuel handling and excavation, limestone supply, and
waste disposal. The contractual terms are generally for 5 to 15 years and
provide for renewal options. The estimated future minimum payments due under
these non-cancelable obligations at December 31, 2002 are as follows (See Note
A):

                       2003       2,413,000
                       2004       2,496,000
                       2005       2,581,000
                       2006       2,668,000
                       2007       2,759,000
                 Thereafter      11,109,000
                               ------------
                      Total    $ 24,026,000
                               ============

NOTE N -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

Our financial instruments primarily consist of cash and cash equivalents,
restricted cash, receivable from utility, accounts payable, Lessee working
capital loan, short-term debt obligations and long-term debt obligations. As of
December 31, 2002 and 2001, the carrying amounts for cash and cash equivalents,
restricted cash, receivable from utility, accounts payable, Lessee working
capital loan and short-term debt obligations approximate fair value because of
the short maturity of these instruments. As of December 31, 2002 and 2001, the
carrying amounts for the long-term debt obligations also approximate fair value
because such obligations incur interest at variable rates.

NOTE O -- RELATED PARTY TRANSACTIONS

In September 2001, we paid $150,000 to George Kast, previously a Principal
Microgy Shareholder, a principal shareholder of EPC and Director, in full
satisfaction of a pre-acquisition Microgy obligation.

F-25

<PAGE>

On September 14, 2001, we borrowed $750,000 from Alco Financial Services, LLC
("Alco"). Robert Weisberg, a Director of Environmental Power, Corp. is the
President, Director and a member of Alco. The loan is evidenced by a one-year
promissory note that bears interest at the prime rate plus 3.5%. We also pay an
administrative fee of 0.6% per month and paid a commitment fee of $7,500 to
secure the loan. The loan is secured by all of our assets (other than the stock
of its subsidiary, Buzzard Power Corporation). In connection with the loan, we
granted Alco five year warrants to purchase 50,000 shares of common stock at
$0.60 per share. During 2002, we recognized interest expense and administrative
fees of $62,563 and $61,500, respectively for this loan.

In May 2001, we granted Mr. Weisberg five-year options to purchase 100,000
shares of common stock at $.43 per share. In September 2001, we granted Mr.
Weisberg five-year options to purchase 350,000 shares of common stock at $0.72
per share. The options were issued in exchange for Mr. Weisberg's services
performed for EPC.

We reported the fair value of the securities granted to Mr. Weisberg as
stock-based compensation in its general and administrative expenses for 2001.
The fair value of the securities granted to Alco, along with the commitment fee
and related legal expenses were reported as deferred financing costs were
amortized over the initial term of the loan.

On May 2, 2002, Benjamin Brant, a director of EPC and a former officer of our
Microgy subsidiary, granted to EPC a transferable one-year option to purchase
1,802,486 shares of his Common Stock at $0.35 per share. EPC is required to
exercise the option to purchase at least 342,857 of such shares by specified
times. To the extent any portion of the option expires unexercised, Mr. Brant
would grant EPC a transferable right of first refusal for the underlying shares
for a 12 month period beginning upon expiration of the option. Mr. Brant also
agreed to deliver an additional 197,514 shares of his Common Stock to EPC in
satisfaction of an obligation in the amount of $69,129 to Microgy by a company
of which Mr. Brant is a principal. Mr. Brant had previously guaranteed this
obligation to Microgy under a June 2001 agreement. Mr. Brant also agreed to a 24
month standstill whereby an additional 753,066 shares of his Common Stock would
not be sold into the public markets.

On May 3, 2002, EPC exercised the option to purchase 120,000 shares of Mr.
Brant's Common Stock by a cash payment of $42,000. On May 3, 2002, Mr. Brant
also delivered 197,514 shares of his Common Stock to EPC in full satisfaction of
the obligation to Microgy described in the previous paragraph. On May 17, 2002,
EPC exercised the option to purchase 20,260 shares of Mr. Brant's Common Stock
by a cash payment of $7,091. As of March 5, 2003 EPC had exercised the option to
purchase 100% of the required 342,857 shares. The shares acquired by the Company
from Mr. Brant are being held as treasury shares, reducing the outstanding
Common Stock.

On May 22, 2002, EPC granted Madison Power a ten-year option to purchase 100,000
shares of common stock at $.58 per share. Edward Chapman, a Senior Vice
President of EPC, is an owner of Madison Power. The options were issued in
exchange for Mr. Chapman's services prior to joining EPC as an officer.

F-26

<PAGE>

NOTE P - SEGMENT INFORMATION

We manage and evaluate our operations in two reportable business segments:
Scrubgrass project and Microgy. These segments have been classified separately
by the chief operating decision maker because of the different technologies used
in the generation of energy and the future growth prospects of those
technologies. Our reportable business segments, which are described in Note A,
follow the same significant accounting policies discussed in Note B. Financial
data for reportable business segments is as follows:

<TABLE>
<CAPTION>
                                              SCRUBGRASS
                                               PROJECT            MICROGY            OTHER          CONSOLIDATED
                                           ----------------- ----------------- ----------------- -----------------
<S>                                              <C>             <C>             <C>              <C>
YEAR ENDED DECEMBER 31, 2002:
Power generation revenues                        54,983,934              --              --       $ 54,983,934
Depreciation and amortization                       312,747         194,055          37,994            544,796
Operating (Loss) Income                            (325,671)     (2,586,432)      2,264,922           (647,181)
Interest income                                      22,607           2,859          22,287             47,753
Interest expense                                    (78,964)         (2,573)        (59,989)          (141,526)
Income tax expense (benefit)                       (885,000)        766,611        (738,885)          (857,274)
Net income (loss)                                 1,161,172      (1,819,535)      1,796,746          1,138,383
Goodwill                                                 --       4,192,886              --          4,192,886
Identifiable assets                              83,106,156       8,415,600       1,436,143         92,957,899

YEAR ENDED DECEMBER 31, 2001:
Power generation revenues                        53,518,000              --              --         53,518,000
Depreciation and amortization                       339,049          85,446          16,915            441,410
Operating Income                                  3,150,908        (487,619)     (1,946,618)           716,671
Interest income                                      40,969              --          37,234             78,203
Interest expense                                    164,252           4,604          16,691            185,547
Income tax expense (benefit)                      1,273,000        (112,600)        213,054          1,373,454
Net income (loss)                                 1,754,625        (379,408)        304,114          1,679,331
Goodwill                                                 --       4,192,886              --          4,192,886
Identifiable assets                              76,358,553       8,668,675         539,018         85,566,246

Year Ended December 31, 2000:
Power generation revenues                        54,303,222              --              --         54,303,222
Depreciation and amortization                       405,723              --           9,507            415,230
Operating Income                                  3,354,658              --      (1,776,592)         1,578,066
Interest income                                     656,024              --          80,843            736,867
Interest expense                                    309,241              --          11,400            320,641
Income tax expense (benefit)                      2,045,062              --        (412,829)         1,632,233
Net income (loss)                                 2,812,717              --        (985,909)         1,826,808
Identifiable assets                              68,181,102              --       1,103,072         69,284,174
</TABLE>

There were no transactions between reportable business segments. Excluding
reportable business segments, we had income from the settlement of the Sunnyside
Project litigation, general corporate assets and operating activities for our
corporate office. General corporate assets primarily consist of cash and
equivalents, office equipment, prepaid expenses and a deferred income tax asset.
Since the Sunnyside Project is no longer an operating business, this income was
not included in a reportable business segment and therefore is included in
"Other" in the table above.

F-27

<PAGE>

SELECTED UNAUDITED QUARTERLY FINANCIAL RESULTS

The following table sets forth certain unaudited quarterly data of the Company
for each of the quarters since January 2001. This information has been prepared
on the same basis as the annual financial statements and all necessary
adjustments, consisting only of normal recurring adjustments, have been included
in the amounts stated below to present fairly the selected quarterly information
when read in conjunction with the annual financial statements and the notes
thereto included elsewhere in this document. The quarterly operating results are
not necessarily indicative of future results of operations. See "Factors That
May Affect Future Results and Financial Condition - Historical Net Losses;
Variability of Quarterly Results."

F-28

<PAGE>

<TABLE>
<CAPTION>
                                                                            QUARTERS ENDED
                                            -------------------------------------------------------------------------------
                                              MARCH 31, 2002       JUNE 30, 2002        SEPT. 30, 2002       DEC. 31, 2002
                                            -----------------    -----------------    -----------------    ----------------
<S>                                         <C>                  <C>                  <C>                  <C>
POWER GENERATION REVENUES                   $      14,113,256    $      11,977,205    $      14,683,232    $     14,210,241
                                            -----------------    -----------------    -----------------    ----------------
COSTS AND EXPENSES:
     Operating expenses                             5,144,733            7,469,811            5,564,303           5,960,972
     Lease expenses                                 6,783,380            6,291,677            5,332,121           6,884,115
     General and administrative expenses            1,357,879              976,662            1,774,198           1,546,468
     Depreciation and amortization                    135,971              136,689              136,719             135,417
                                            -----------------    -----------------    -----------------    ----------------
                                                   13,421,963           14,874,839           12,807,341          14,526,972
                                            -----------------    -----------------    -----------------    ----------------
OPERATING INCOME (LOSS)                               691,293           (2,897,634)           1,875,891            (316,731)
                                            -----------------    -----------------    -----------------    ----------------
OTHER INCOME (EXPENSE):
     Interest income                                    9,553               12,479               12,350              10,512
     Interest expense                                 (30,499)             (40,062)             (41,355)            (29,610)
     Amortization of deferred gain                     77,103               77,102               77,103              77,103
     Sales of NOx emission credits                  2,428,200                    0                    0                   0
     Other income                                       2,000                  859                    0                   0
                                            -----------------    -----------------    -----------------    ----------------
                                                    2,486,357               50,378               48,098              58,005
                                            -----------------    -----------------    -----------------    ----------------
INCOME (LOSS) BEFORE INCOME TAXES                   3,177,650           (2,847,256)           1,923,989            (258,726)
INCOME TAX EXPENSE (BENEFIT)                        1,411,000           (1,104,749)           1,048,150            (497,127)
                                            -----------------    -----------------    -----------------    ----------------
NET INCOME (LOSS)                           $       1,766,650    $      (1,742,507)   $         875,839    $        238,401
                                            =================    =================    =================    ================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
     Basic                                         20,251,653           20,038,591           20,600,872          21,881,128
     Diluted                                       20,273,141           20,159,583           20,707,675          21,990,683
EARNINGS (LOSS) PER COMMON SHARE:
     Basic                                  $            0.09    $           (0.09)   $            0.04    $           0.01
     Diluted                                $            0.09    $           (0.09)   $            0.04    $           0.01
</TABLE>

<TABLE>
<CAPTION>
                                                                              QUARTERS ENDED
                                            --------------------------------------------------------------------------------
                                              March 31, 2001        June 30, 2001       Sept. 30, 2001        Dec. 31, 2001
                                            -----------------    -----------------    -----------------    -----------------
<S>                                         <C>                  <C>                  <C>                  <C>
POWER GENERATION REVENUES                   $      13,482,891    $      12,096,878    $      13,914,475    $     14,023,756
                                            -----------------    -----------------    -----------------    ----------------
COSTS AND EXPENSES:
     Operating expenses                             4,957,240            7,529,833            5,292,285           5,901,723
     Lease expenses                                 6,015,022            5,859,101            5,988,593           6,843,097
     General and administrative expenses              685,729              802,751            1,101,420           1,383,125
     Depreciation and amortization                     86,547               86,564              111,870             156,429
                                            -----------------    -----------------    -----------------    ----------------
                                                   11,744,538           14,278,249           12,494,168          14,284,374
                                            -----------------    -----------------    -----------------    ----------------
OPERATING INCOME (LOSS)                             1,738,353           (2,181,371)           1,420,307            (260,618)
                                            -----------------    -----------------    -----------------    ----------------
OTHER INCOME (EXPENSE):
     Interest income                                   18,784               22,960               17,944              18,515
     Interest expense                                 (69,303)             (33,124)             (43,047)            (40,073)
     Amortization of deferred gain                     77,103               77,102               77,103              77,102
     Sales of NOx emission credits                         --                   --                   --                  --
     Other income                                          --            1,677,962               32,723             424,363
                                            -----------------    -----------------    -----------------    ----------------
                                                       26,584            1,744,900               84,723             479,907
                                            -----------------    -----------------    -----------------    ----------------
INCOME (LOSS) BEFORE INCOME TAXES                   1,764,937             (436,471)           1,505,030             219,289
INCOME TAX EXPENSE (BENEFIT)                          777,000             (219,000)             583,000             232,454
                                            -----------------    -----------------    -----------------    ----------------
NET  INCOME (LOSS)                          $         987,937    $        (217,471)    $        922,030    $        (13,165)
                                            =================    =================    =================    ================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
     Basic                                         11,406,783           11,406,783           15,547,945          18,126,115
     Diluted                                       11,407,990           11,406,783           17,063,405          18,969,966
EARNINGS (LOSS) PER COMMON SHARE:
     Basic                                  $            0.09    $           (0.02)    $           0.06    $          (0.00)
     Diluted                                $            0.09    $           (0.02)    $           0.05    $          (0.00)
</TABLE>

F-29