ENVIRONMENTAL POWER CORP - 10-K Annual Report

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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

December 31, 1995
FOR THE FISCAL YEAR ENDED ________________________________________________

OR

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

FOR THE TRANSITION PERIOD FROM TO

0-15472
COMMISSION FILE NUMBER: __________________________________________________

ENVIRONMENTAL POWER CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

04-2782065
DELAWARE (IRS EMPLOYER
(STATE OR OTHER JURISDICTION IDENTIFICATION NO.)
OF INCORPORATION OR ORGANIZATION)

500 MARKET STREET, PORTSMOUTH, NH 03801
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)

(603) 431-1780
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

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 registrants 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. [_]

State the aggregate market value for the voting stock held by non-affiliates
of the Registrant. The aggregate market value, computed by reference to the
closing price of such stock on March 21, 1996, was $1,877,000.

Indicate the number of shares outstanding of each of Registrant's classes of
common stock, as of the last practicable date: On March 21, 1996, there were
outstanding 11,026,783 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
Annual Meeting of Shareholders to be held on June 3, 1996 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 "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.

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PART I

ITEM 1. BUSINESS

GENERAL

Environmental Power Corporation ("EPC" or the "Company"), a Delaware
Corporation, owns a 22-year leasehold interest in an approximately 85 Mw (net)
waste coal-fired electric generating facility (the "Scrubgrass Project")
located in Pennsylvania, the lease for which commenced on June 30, 1994. Until
December 31, 1994 the Company also held varying ownership interests (80% to
43%) in and oversaw the operation of an approximately 51 Mw (net) waste coal-
fired electric generating facility (the "Sunnyside Project") located in Utah.
Both facilities sell power under long-term contracts to specified Utility
Companies whose contracts have been approved by the respective Public Utility
Commission. In the case of these projects, the Company either acting alone or
in conjunction with others had selected and arranged for the acquisition of
the site, obtained control over their waste coal fuel sources, negotiated
contracts for the design and construction of the facilities and the sale of
their output to the utilities purchasing the power, arranged for financing,
and negotiated contracts for the operation and maintenance of the projects.
The Company has one additional project (the "Milesburg Project") in the
development stage, but believes that it has limited opportunities for
additional similar project development in the United States for the
foreseeable future.

The Company was incorporated in Massachusetts in November 1982 as Cresci
Associates, Inc. and reincorporated in Delaware in September 1986. In recent
years, the Company has concentrated its efforts on the three waste coal
projects referred to above, two of which became operational and a third which
is in the development stage. From 1983 to 1990 the Company acquired,
developed, operated in certain cases, and sold five hydroelectric power
facilities in Maine, Vermont and Connecticut.

THE COMPANY'S PROJECTS

The following summaries outline the Company's projects and their development
status (including the Sunnyside Project in which the Company held an ownership
interest until December 31, 1994). In reading the summaries, the following
points should be kept in mind:

--"Megawatt" (Mw) is a measure of electrical power equal to 1,000,000 watts
and is used to measure a project's capacity for output.

--"Kilowatt-hour" (Kwh) is a measure of electrical energy equal to a
continuous generation of 1,000 watts for one hour and is used to measure a
project's output over a period of time. Projection estimates for waste
coal facilities are based on a plant capacity factor and engineering
estimates of plant heat rates and values for the heat content of specific
fuels to be used. There can be no assurance that the facilities will
perform as represented herein, however the design/build and operating and
maintenance agreements generally include certain performance guarantees.

WASTE COAL

The burning of coal mining residue has become technically, environmentally
and economically feasible. Coal mining operations have historically produced a
substantial amount of residue, herein called waste coal or tailings, which
were considered unusable dulates in conventional furnaces because the high
percentage of rock or other substances negatively affecting combustion of the
coal and the low BTU volume per ton increased material handling costs and
reduced output of equipment. The development of the circulating fluidized bed
combustion system ("CFB") made the use of tailings as fuel technically and
economically feasible. In a CFB system, fuel is burned in a hot, turbulent bed
of ash, sand and, usually, limestone.

Rapid flow of upward moving air suspends fuel and bed particles in a
"fluidized" manner during combustion, creating a turbulence which causes the
tailings to break up, and allows for a more complete combustion of the coal as
well as a greater opportunity for a reaction of sulfur with the limestone.
Further, the

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circulating nature of CFB is designed to separate larger particulate from
stack gases and to reintroduce the material back into the combustor for more
complete burn and greater reaction with the limestone. Lower temperatures and
longer residence time of the fuel in the combustor decreases the formation of
nitrogen oxide.

The Company obtains coal tailings primarily from coal mining companies on a
long-term basis because coal tailings are plentiful and generally create
environmental hazards, such as acid drainage, when not disposed of properly.

SCRUBGRASS PROJECT

The Scrubgrass Project located on a 600 acre site in Venango County,
Pennsylvania is an approximately 85 Mw (net) waste coal-fired electric
generating station (the "Facility") which has been constructed by Bechtel
Power Corporation. The construction contract provided for a guaranteed net
electrical output of 82.85 Mw. Final completion was achieved by the contractor
in June 1994.

On June 30, 1994, Buzzard Power Corporation ("Buzzard"), a wholly owned
subsidiary of the Company, entered into an agreement to lease the Facility
from Scrubgrass Generating Company, L.P. (the "Lessor"), a joint venture of
PG&E Enterprises and Bechtel Enterprises 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 thereunder including, but not limited to the power
purchase agreement, operations and maintenance agreement, limestone
agreements, ground lease agreements, fuel agreements and transportation and
materials handling agreements. The Company has pledged Buzzard's stock to the
Lessor as security for Buzzard's performance of its obligations as lessee.
Buzzard has entered into a management services contract with U.S. Generating
Company, a joint venture of PG&E Enterprises and Bechtel Enterprises Inc., to
manage the project.

Electric output is being sold to Pennsylvania Electric Company ("PENELEC")
pursuant to a 25-year agreement, which commenced in 1993, at a fixed average
rate of approximately 4.68 cents/Kwh and escalates at 5% per year for the
calendar years 1994-1999. Commencing in the year 2000 and through 2012, the
agreement provides for a rate equal to the greater of a scheduled rate or a
rate based on the PJM Billing Rate (the monthly average of the hourly rates
for purchases by the General Public Utilities Group ("GPU") from, or sale by
GPU to, the Pennsylvania-New Jersey-Maryland Interconnection). For the years
2013 through 2015 and 2016 through 2018, if the renewal term option is
exercised, 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
1%. On June 8, 1993, the Facility was declared by PENELEC to have reached
commercial operation.

The Facility is being operated by U.S. Operating Services Company pursuant
to a 15-year Operations and Maintenance Agreement ("O & M"). A budget for all
operational expenses including a fixed management fee is approved annually.
Failure to achieve approved annual budgets can result in operator liability
and/or termination of the O & M. The Scrubgrass Project owns or has under
contract sufficient fuel to operate the facility for approximately 25 years.

A Limestone Purchase and Sale Agreement with Quality Aggregates, Inc. has
been entered into to supply the Scrubgrass Project with limestone for an
initial term of five years which, in December 1995, was extended through the
year 2000 and which may be extended up to 15 additional years. The project
also maintains agreements with initial terms of 15 years for the
transportation and handling of fuel, ash and limestone with Savage Industries,
Inc. Costs established under these agreements will escalate at partially fixed
and partially indexed rates.

All revenues earned by the Scrubgrass Project are deposited into an account
administered by a disbursement agent. Before Buzzard can receive cash
generated by the project, all operating expenses, base lease payments

4

(which include the Lessor's debt as described below), certain maintenance
reserve payments and other subordinated payments must be satisfied. Buzzard,
as lessee, is required to pay the Lessor, in addition to a specified base
rent, consisting of all of the Lessor's debt service and related fees and
expenses, an additional rent of 50 percent of the net cash flows Buzzard
receives from project operations. Buzzard is not required to fund operating
losses, or otherwise invest further, from financing sources outside the
project.

Until December 22, 1995, the Lessor's debt consisted of $135.6 million of
variable rate tax-exempt bonds maturing in 2012, a $20.8 million term loan
maturing in 2005, $4.2 million of demand debt and $2.4 million of junior
subordinated debt maturing in 1999. The Lessor entered into interest rate
swaps which have the effect of fixing the interest rate until May 18, 1996 at
approximately 3.72% on the tax-exempt bonds and over the life of the $20.8
million term loan at 6.42%. After May 18, 1996, the specified base rent will
reflect the affect of floating rates on the Lessor's tax-exempt bonds. On
December 22, 1995, the Lessor restructured certain of its project debt, the
primary effect of which was to extend the term of its demand debt and a
portion of its junior subordinated debt through 2004. As a result of the
Lessor's debt restructuring, Buzzard extended the term of $4 million of
current liabilities through 2004. See Notes A, B, E, F and G to consolidated
financial statements for additional information regarding the Scrubgrass
project.

SUNNYSIDE PROJECT

Sunnyside is an approximately 51 Mw (net) waste coal-fired facility at a
site located adjacent to the Sunnyside Coal Mine in Carbon County, Utah which
was constructed by Parsons Main, Inc., ("PMI"). The facility reached
commercial operation on November 19, 1993. The project is owned by Sunnyside
Cogeneration Associates ("SCA"), a joint venture in which EPC owned an
approximate 70% interest until September 28, 1994 and thereafter an
approximate 40% interest until December 31, 1994, at which time the Company
sold its remaining interest in SCA.

In connection with the sale, the Company received consideration of $2.79
million in cash on January 5, 1995 and promissory notes aggregating $3.25
million, bearing interest at 10% per annum. Interest is payable to the Company
quarterly and principal of $312,500 was received by the Company on September
30, 1995, principal of $1,187,500 is due on December 31, 1996 and the
remaining principal of $1,750,000 is due on December 31, 1997. In addition, in
1994, the Company also recorded a receivable related to a purchase price
adjustment, as provided for in the Purchase and Sale Agreement, of
approximately $1.1 million, of which $708,000 was received in April 1995. The
remaining receivable balance is being disputed through litigation with the
purchasers. The Company also retained certain inchoate rights, including
potential refundable sales taxes arising out of activities prior to the date
of the sale. During 1995, the Company received refunds aggregating $1.1
million in final settlements for all such sales tax refunds. See Notes to
Consolidated Financial Statements for further discussion.

MILESBURG PROJECT

On April 30, 1987, the Company purchased, for an aggregate purchase price of
$5,400,000, all of the outstanding capital stock of Milesburg Energy, Inc.
("MEI"), the company which controlled the development rights to an existing 43
Mw (net) oil-fired facility, which was retired from service in 1984. In
connection with the stock purchase, the Company paid $100,000 in cash and
issued promissory notes totaling $5,120,000 and a subsidiary of the Company
assumed pre-acquisition MEI liabilities totaling $180,000. The notes payable,
pre-acquisition liabilities and other liabilities incurred subsequent to the
purchase become payable only under certain conditions, the most significant of
which relate to the closing of construction financing and commencement of
construction for the project. The Company plans to convert or replace this
facility to use waste coal.

MEI has executed a 30 year power purchase agreement with West Penn Power
Company ("WPPC") for the sale of all of the facility's electrical output with
a fixed capacity rate component and an additional fluctuating rate component
which is derived from WPPC's avoided energy cost. The power purchase agreement
was approved by the Public Utilities Commission of the State of Pennsylvania
("PUC"), and was subsequently appealed to the Commonwealth Court of
Pennsylvania by certain industrial customers, the Office of the

5

Consumer Advocate and WPPC. The PUC subsequently ordered the rates contained
in the power purchase agreement to be recalculated due to the later start-up
date for this project necessitated by the delays caused by the appeal. This
order has been appealed by the same litigants through various courts,
including the United States Supreme Court, and upheld in every case in favor
of MEI. In August 1995, the PUC issued a tentative order for final contract
rates. The order has been temporarily stayed by mutual agreement of MEI and
WPPC pending settlement discussions.

In 1990, as a result of the uncertainties related to approval of the power
contract and the rates provided therein and the Company's working capital
position which, at that time, could have prevented it from continuing to fund
development efforts, management provided a reserve of $940,144 against its
investment in the project. However, the Company has continued to invest monies
in an effort to protect its legal and contractual interests and to support its
ability to commence construction in the event of a favorable resolution to the
power purchase agreement. MEI is currently seeking the sale of the project or
partnership of the project with an entity that would provide equity financing
for development and construction. There can be no assurance that MEI will be
successful in selling the project, finding a partner or in further
developmental efforts or that the project will reach commercial operation. See
Notes to Consolidated Financial Statements for additional information
regarding this project.

SEGMENT FINANCIAL INFORMATION

Reportable operating results relating to the Company's electric generating
facilities for the years ended December 31, 1995 and 1994 and their related
percentage to total operations are as follows:

1995 1994
---------------- ---------------------------------
SCRUBGRASS SCRUBGRASS SUNNYSIDE
---------------- ---------------- ---------------
AMOUNT % AMOUNT % AMOUNT %
----------- --- ----------- --- ----------- ---

Power Generation Revenues.. $40,693,465 100% $18,182,301 59% $12,522,288 41%
Income (Loss) from Opera-
tions..................... $(1,139,101) (1) $(2,982,816) (1) $ 2,196,327 (1)

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(1) Percentage omitted as (loss) income from segment operations vary
significantly from consolidated operating loss shown in accompanying
consolidated financial statements.

COMPETITION

Utilities, contractors, and equipment suppliers, as well as other
organizations similar to the Company, have entered or are attempting to enter
the alternative energy market. Many of these companies have substantially
greater resources than the Company.

The primary bases of competition are quality of development plans, ability
(including financial ability) of the developer to complete the project and the
price to be paid for the development opportunity. In certain cases,
competitive bidding for a development opportunity or bidding for supplying
electric energy to utilities is required. Competition for attractive
development opportunities is expected to be intense as there are a number of
competitors in the industry interested in the limited number of such
opportunities.

REGULATION

The Company's projects are subject to regulation under federal and state
energy laws and regulations and federal, state and local environmental and
mining laws and regulations. The Company's facilities are either self-
certified as a qualifying facility under the Public Utility Regulatory
Policies Act of 1978 ("PURPA"), or formally certified as a qualifying facility
by the Federal Energy Regulatory Commission ("FERC"). Pursuant to PURPA, FERC
has promulgated regulations which exempt certain qualifying facilities from
the Federal Power Act of 1920, the Public Utility Holding Company Act of 1935,
and, except under certain limited circumstances, state laws regulating the
rates charged by electric utilities. In order to qualify under PURPA, the
Company's

6

facilities must meet certain size, fuel and ownership requirements and/or co-
generate. In addition to regulation of qualifying facilities, PURPA requires
that electric utilities purchase electric energy produced by qualifying
facilities at negotiated rates or at a price equal to the incremental or
avoided cost that would have been incurred by the utility if it were to
generate the power itself or purchase it from another source.

The Company's projects must also comply with applicable federal, state and
local laws relating to the protection of the environment, primarily in the
areas of water and air pollution. As regulations are enacted or adopted the
Company cannot predict the effect of compliance therewith on its business.
Failure to comply with all applicable requirements could result in required
modifications to facilities including the inability to operate during periods
of non-compliances. The Company is responsible to ensure compliance of its
facilities with all applicable requirements and, accordingly, attempts to
minimize these risks by dealing with reputable contractors.

The Company is not presently subject to regulation under the Public Utility
Holding Company Act of 1935. The Company does not presently intend to engage
in any activities that would cause it to be so regulated.

EMPLOYEES

As of December 31, 1995, the Company had four full-time and two part-time
employees. The loss of any of its executive officers could have a material
adverse effect on the Company. None of the Company's employees are represented
by a collective bargaining agreement. The Company considers relations with its
employees to be good.

ITEM 2. PROPERTIES

The Company, through a subsidiary, leases the Scrubgrass waste coal-fired
electric generating facility located on approximately 600 acres in Venango
County, Pennsylvania. The Company, through a subsidiary, owns the
decommissioned Milesburg oil-fired electric generating facility located on
approximately 10 acres in Centre County, Pennsylvania. The Company, through a
subsidiary, owns approximately 80 acres in Fayette County, Pennsylvania for
which it has abandoned efforts to develop electric generating facilities
utilizing coal mine-fire technology. (See "The Company's Projects" above under
Item 1 for a description of various property rights the Company has or is
seeking with respect to its present and proposed projects).

The Company is a tenant pursuant to a three-year lease, which commenced in
February 1996, at its headquarters in Portsmouth, New Hampshire for which
current monthly payments are $1,300.

ITEM 3. LEGAL PROCEEDINGS

In the normal course of business, the Company is involved in various
lawsuits. The Company is not engaged in any litigation which management
believes would, if resolved adversely to the Company, have a material impact
on the financial position or results of operations of the Company.

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

Not applicable.

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

The Common Stock of the Company (the "Common Stock") is traded over-the-
counter on the National Association of Securities Dealers, Inc. Automated
Quotation ("NASDAQ") Small-Cap Market under the symbol POWR. As of March 21,
1996 there were approximately 300 holders of record of the Common Stock.
Insofar as many of the shares are held in street name, the Company believes
that the number of beneficial holders is substantially higher.

7

The following table shows the quarterly high and low bid prices on the over-
the-counter market for 1994 and 1995 as reported in the NASDAQ Small-Cap
Market. Such bid prices reflect inter-dealer prices, without retail mark-up,
bid down or commission and may not necessarily represent actual transactions.

YEAR PERIOD HIGH LOW
---- ------ ------ ----

1994 First Quarter........................................... 9/16 1/2
Second Quarter.......................................... 3/4 1/2
Third Quarter........................................... 5/8 1/2
Fourth Quarter.......................................... 5/8 1/2
1995 First Quarter........................................... 5/8 7/16
Second Quarter.......................................... 9/16 1/4
Third Quarter........................................... 1/2 7/16
Fourth Quarter.......................................... 7/16 5/32

In December 1995, the Company declared and paid a dividend of 8 cents per
share. Prior to that date, the policy of the Company had been to retain
earnings, if any, for use in its business. In March 1996, the Company declared
a first quarter dividend of 3 cents per share. The Company has initiated a
quarterly dividend policy which is subject to review and reconsideration by
the Board of Directors each quarter. During 1995, the Company acquired 498,100
shares of treasury stock through open market purchases at an average price of
$.19 per share. No such shares were acquired during 1994. For additional
information with respect to treasury shares acquired in private transactions
see Note K of Notes to Consolidated Financial Statements.

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ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data for the five years ended December 31,
1995 are derived from the audited consolidated financial statements of the
Company. The data should be read in conjunction with the consolidated
financial statements and notes thereto and the other financial information
included elsewhere herein.

YEAR ENDED DECEMBER 31
----------------------------------------------
1995 1994 1993 1992 1991
------- ------- -------- -------- --------
(000'S OMITTED EXCEPT PER SHARE DATA)

RESULTS OF OPERATIONS DATA :
Power generation revenues....... $40,693 $30,705 $ 1,571 $ -- $ --
------- ------- -------- -------- --------
Costs and expenses:
Operating expenses............. 16,975 16,123 1,088 -- --
Lease expense.................. 23,020 10,538 -- -- --
General and administrative
expenses...................... 3,668 2,998 1,613 831 534
Depreciation and amortization.. 167 3,018 428 44 43
Increase (reduction) of
expenses from litigation
settlement.................... -- -- -- 84 (257)
------- ------- -------- -------- --------
43,830 32,677 3,129 959 320
------- ------- -------- -------- --------
Operating loss.................. (3,137) (1,972) (1,558) (959) (320)
------- ------- -------- -------- --------
Other income (expense):
Gain on sale of
affiliate/project............. -- 3,946 -- 44 --
Other income................... 1,593 5,465 1 1 115
Interest income................ 468 695 161 72 169
Realized gain on sale of
marketable debt securities.... -- -- 1,678 -- --
Minority interest.............. -- 1,866 -- -- --
Equity in net loss of
affiliate..................... -- (84) -- -- --
Interest expense............... (107) (8,830) (1,376) (13) (4)
------- ------- -------- -------- --------
1,954 3,058 464 104 280
------- ------- -------- -------- --------
(Loss) Income before income
taxes and cumulative effect of
accounting change.............. (1,183) 1,086 (1,094) (855) (40)
Income tax (benefit) expense.... (448) 416 (414) (177) (7)
Cumulative effect of accounting
change......................... -- -- -- -- 4,765
------- ------- -------- -------- --------
Net (loss) income............. $ (735) $ 670 $ (680) $ (678) $ 4,732
======= ======= ======== ======== ========
Net (loss) income per share
before cumulative effect of
accounting change.............. $ (0.07) $ 0.06 $ (0.11) $ (0.12) $ (0.03)
Net (loss) income per share..... (0.07) 0.06 (0.11) (0.12) 0.49
Weighted average number of
shares outstanding............. 10,649 11,321 8,592 7,586 9,200

1995 1994 1993 1992 1991
------- ------- -------- -------- --------
(000'S OMITTED)

BALANCE SHEET DATA :
Total assets.................... $45,226 $35,962 $149,788 $301,285 $147,819
Working capital (deficit)....... 3,224 1,212 7,201 (484) 1,251
Long-term obligations........... 24,405 11,533 130,360 104,425 46,138
Deferred gain(1)................ 6,322 6,631 6,785 -- --
Deferred revenue(1)............. 3,065 2,826 -- -- --
Liabilities and net proceeds of
project transferred under
contractual arrangement........ -- -- -- 189,962 92,888
Shareholders' equity............ 2,797 4,443 3,303 5,443 6,232

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(1) See Notes A and B of Notes to Financial Statements.

The Company declared and paid a dividend of $.08 per share in 1995. Prior to
1995 the Company had not declared or paid any dividends.

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

FINANCIAL CONDITION

On December 31, 1995, the Company had cash and cash equivalents of
$1,011,822 as compared to $356,527 at December 31, 1994. The increase is
primarily due to the 1995 receipt of a portion of the proceeds from the 1994
sale of the Company's remaining interest in the Sunnyside project together
with the receipt of sales tax refunds related to the Sunnyside project
construction period.

On December 31, 1995, the Company had working capital of $3,223,507 compared
to $1,211,927 at December 31, 1994. The increase is primarily due to the
receipt of proceeds from the sale of the Company's remaining interest in
Sunnyside, the receipt of sales tax refunds related to the Sunnyside project
and the restructuring of debt related to the Scrubgrass project which allowed
the Company to record such obligations as non-current.

Receivable from utility relates to the Scrubgrass project and was $6,536,506
at December 31, 1995 as compared to $5,370,098 at December 31, 1994.

The current portion of notes receivable was $1,673,091 at December 31, 1995
as compared to $375,608 at December 31, 1994. The increase is primarily due to
the maturity of the current portion of notes receivable related to the sale of
the Sunnyside project and notes receivable related to the Scrubgrass project.

Receivable from sale of affiliate relates to the Sunnyside project and was
$276,444 at December 31, 1995 compared to $3,853,400 at December 31, 1994. The
decrease is primarily related to the receipt in 1995 of a portion of such
proceeds.

Other current assets were $1,112,152 and $1,785,531 at December 31, 1995 and
1994, respectively. The decrease is due primarily to receipt in 1995 of
construction management and overhead receivables related to the Scrubgrass
project.

Deferred income tax assets at December 31, 1995 were $5,543,229 as compared
to $4,995,245 as of December 31, 1994. The increase is due to the income tax
benefit recorded in 1995.

Non-current notes receivable declined to $1,868,409 at December 31, 1995 as
compared with $3,263,164 at December 31, 1994. This is primarily due to the
maturity of the current portion of notes receivable related to the sale of the
Sunnyside project and notes receivable related to the Scrubgrass project.

Accrued power generation revenue increased to $15,161,689 at December 31,
1995 as compared to $5,311,324 at December 31, 1994. This relates to the
Scrubgrass project and represents a receivable recorded as a result of the
straight-line accounting treatment of certain revenues under the power
purchase agreement.

Other assets were $661,311 at December 31, 1995 as compared to $419,412 at
December 31, 1994. The increase is primarily due to deferred financing costs
incurred for the partial debt restructuring related to Scrubgrass project.

Accounts payable and accrued expenses decreased from $6,969,386 at December
31, 1994 to $6,338,160 at December 31, 1995. The decline is primarily due to
the payment of Scrubgrass project related liabilities.

Other current liabilities at December 31, 1995 were $2,298,686 as compared
to $3,559,851 at December 31, 1994. The decrease is primarily related to the
non-current reclassification of certain Scrubgrass related liabilities as a
result of the completion of a refinancing, in December 1995, by the Lessor of
the Scrubgrass project.

Deferred gain, net decreased to $6,322,419 at December 31, 1995 from
$6,630,830 at December 31, 1994. The decline is due to the 1995 amortization
of a deferred gain related to the Scrubgrass project, which is being amortized
on a straight-line basis over 22 years.

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Secured promissory notes payable and other borrowings increased from
$5,971,270 at December 31, 1994 to $8,543,767 at December 31, 1995. The
increase is primarily due to the reclassification of current liabilities
related to the Scrubgrass project as a result of a partial project refinancing
completed in December 1995 by the Lessor.

Accrued lease expense was $15,161,689 at December 31, 1995 as compared to
$5,311,324 at December 31, 1994. This relates to the Scrubgrass project and
represents an accrued expense recorded as a result of the straight-line
accounting treatment of the lease expense over the initial 22 year lease term.

Deferred revenue was $3,064,964 at December 31, 1995 compared to $2,825,972
at December 31, 1994. The increase relates to the Scrubgrass project and
represents the deferral of power generation revenues pursuant to conditions
set forth in the power purchase agreement. The Company defers such revenues
until earned, which is expected to occur primarily during fiscal 1996.

RESULTS OF OPERATIONS

General

In 1995, the Company derived revenues primarily from power generation at the
Scrubgrass project and from other income primarily as a result of sales tax
refunds related to the Sunnyside project. In 1994, the Company derived
revenues primarily from power generation at the Scrubgrass and Sunnyside
projects and other income related to the sale of its remaining interest in the
Sunnyside project. In 1993, the Company derived revenues primarily from power
generation at the Sunnyside project and other income primarily from short-term
investment interest.

The Company has been developing alternative energy projects which during
1993 did not produce operating revenues until November 19, 1993 at which time
the Sunnyside project commenced commercial operations. The net loss in 1995 is
primarily due to operating losses from the Scrubgrass project. Net income in
1994 is primarily due to the gain and other income realized as a result of the
sale of the Sunnyside project. The net loss in 1993 was primarily due to
annual operating expenses in excess of power generation revenues generated
since November 19, 1993 at the Sunnyside project.

Revenues & Expenses

Power generation revenues in 1995 were $40,693,465, all of which were from
the Scrubgrass project which the Company commenced leasing on June 30, 1994.
Revenues in 1994 were $30,704,589, which represent power generation revenues
from the Sunnyside project until September 28, 1994 after which time the
Company commenced reporting its investment in Sunnyside on the equity method,
together with revenues from the Scrubgrass project which the Company commenced
leasing on June 30, 1994. Revenues in 1993 were $1,570,649 and represent less
than two months of power generation at the Sunnyside project.

Operating expenses for 1995 relate to the Scrubgrass project and were
$16,975,186 as compared to operating expenses for 1994 which were $16,122,617
which relate to the Scrubgrass and Sunnyside projects for six and nine months,
respectively. The operating expenses for 1993 were $1,088,334, representing
less than two months of Sunnyside project operations.

Lease expense relates to the Scrubgrass project and was $23,020,132 in 1995
as compared to $10,537,623 in 1994. There is no such expense in 1993 since the
lease was entered into on June 30, 1994.

General and administrative expenses in 1995 were $3,668,066 and include
twelve months of Scrubgrass operations. Comparatively, general and
administrative expenses in 1994 were $2,998,325 and include six months of
Scrubgrass operations and nine months of Sunnyside operations. General and
administrative expenses were $1,613,041 in 1993 and include less than two
months of Sunnyside operations.

11

Depreciation and amortization decreased from $3,017,766 in 1994 to $167,333
in 1995 primarily due to the absence of such expenses related to the Sunnyside
project, which was sold in 1994. Depreciation and amortization was $427,615 in
1993 and related principally to two months of Sunnyside project operations.

Gain on sale of affiliate for 1994 was $3,945,494 and represents the gain on
the sale of the Company's remaining interest in the Sunnyside project.

Other income for 1995 was $1,592,814 and consisted primarily of Sunnyside
project sales tax refunds of $1.1 million related to activities prior to the
date of sale of the project. In addition, other income in 1995 included fee
income related to the Scrubgrass project and approximately $308,000 from a
deferred gain related to the Scrubgrass project, which is being recognized on
a straight-line basis over the initial 22-year lease term. Other income for
1994 was $5,465,418 and consisted primarily of the recognition in 1994 of
construction management and interest income related to the Sunnyside project.
On September 28, 1994 the remaining equity bridge loans to the Sunnyside
project were converted to equity, thereby reducing the Company's equity
ownership in the project below 50%. Until that date the Company had eliminated
such intercompany income from its consolidated financial statements for
accounting purposes. After that date the Company reported its investment in
the Sunnyside project on the equity method and such intercompany income was
recorded as deferred revenue. On December 31, 1994 the Company recognized such
deferred revenue as a result of the sale of the Sunnyside project.

Interest income decreased from $695,142 in 1994 to $468,626 in 1995
primarily due to the absence of the earnings on investment balances related to
the Sunnyside project. Interest income of $161,227 in 1993 was primarily
related to earnings on investment balances related to the Sunnyside project.

Interest expense decreased from $8,829,893 in 1994 to $106,783 in 1995. The
decrease was primarily due to the absence in 1995 of such expenses related to
the Sunnyside project which was sold in 1994. Interest expense was $1,375,625
in 1993 and was primarily related to the Sunnyside project which commenced
commercial operations on November 19, 1993.

In 1994, income from gain on sale of affiliate, minority interest and equity
in net loss of affiliate aggregated $5,726,799 and was related to the
Sunnyside project.

Realized gain on sale of marketable debt securities of $1,677,916 in 1993
relates to the Sunnyside project and represents the reportable gain arising
from the sale of such securities.

RECENTLY ISSUED ACCOUNTING STANDARDS

See Note B of Notes to Financial Statements for recently issued accounting
standards which are required to be adopted in 1996.

LIQUIDITY AND CAPITAL RESOURCES

1995

The Company's principal source of cash to continue its general corporate
activities in 1995 was from proceeds received pursuant to the sale of the
Sunnyside project and the receipt of sales tax refunds related to the
Sunnyside project arising out of activities prior to the date of the sale and
interest income.

1996

The Company's principal source of cash to continue its general corporate
activities in 1996 will be from the receipt of note proceeds pursuant to the
sale of the Sunnyside project, current cash balances, interest income earned
on short-term investments and from cash flows, if any, from the Scrubgrass
project. Various Scrubgrass contractual obligations may require that any cash
flows from the Scrubgrass project be used to increase certain reserve accounts
and/or be used to fund contractual obligations of the project and, therefore,
may not be available to the Company. As of December 31, 1995 there were no
such deficiencies. Management continues to implement a cost reduction program
in an effort to significantly reduce general corporate overhead.

12

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

PAGE
----
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

Independent Auditors' Report............................................. F-1
Consolidated Balance Sheets at December 31, 1995 and 1994................ F-2
Consolidated Statements of Operations for the Years Ended December 31,
1995, 1994 and 1993..................................................... F-3
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1995,
1994 and 1993........................................................... F-4
Consolidated Statements of Cash Flows for the Years Ended December 31,
1995, 1994 and 1993..................................................... F-5
Notes to Consolidated Financial Statements............................... F-6

ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

N/A

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

Information with respect to the directors of the Company 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 Annual
Meeting of Shareholders to be held on June 3, 1996. Such information is
incorporated herein by reference.

The executive officers of the Company are as follows:

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

Joseph E. Cresci........... 53 Chairman and Chief Financial Officer
Donald A. Livingston....... 52 President and Chief Operating Officer
Bayard R. Kraft, III....... 44 Treasurer, Secretary and Chief Executive Officer

Officers are elected annually by the Board of Directors and serve at the
discretion of the Board.

Joseph E. Cresci, a founder of the Company, has served as Chairman and Chief
Executive Officer since the Company's inception in 1982, as Treasurer of the
Company from its inception until September 1987 and as President from
inception until September 1991. From 1976 to 1982, Mr. Cresci was President
and Chief Executive Officer of G.E. Stimpson Co., Inc. and Stimpson Systems,
Inc., a distributor of office and printing products. From 1972 to 1975, Mr.
Cresci was President of Ogden Recreation, Inc., a subsidiary of Ogden Corp.
(NYSE) where he was responsible for the operation of racing facilities, a
hotel/resort, a parking company and a promotions company providing services to
large crowd facilities. Mr. Cresci was Executive Vice President and Chief
Operating Officer of Garden State Racing Association from 1969 to 1972. From
1967 to 1969, he was an associate lawyer with the Philadelphia law firm of
Townsend, Elliott and Munson. Mr. Cresci holds a B.A. degree from Princeton
University and a law degree from Cornell Law School and is a member of the
Pennsylvania and Massachusetts Bar Associations.

13

Donald A. Livingston, a founder of the Company, has served as President and
Chief Operating Officer since September 1991, and as Executive Vice President
from the Company's inception until September 1991. From 1974 to 1982, Mr.
Livingston was President and Chief Executive Officer of Green Mountain
Outfitters, Inc., a manufacturer and distributor of large plastic parts.
During the three previous years, he was a partner in the financial services
firm of Capital Resources, Inc., where he was involved in obtaining debt and
equity funds, and negotiating mergers and acquisitions. Mr. Livingston was a
registered representative in the retail stock brokerage business with Baxter,
Blyden and Selheimer from 1967 to 1971 and Bellamah, Neuhauser & Barrett from
1965 to 1967.

Bayard R. Kraft, III, who will be leaving the Company effective March 29,
1996, has served as Chief Financial Officer of the Company since May, 1989, as
the Treasurer of the Company since September, 1987, as the Controller of the
Company since April, 1985 and as Secretary since June, 1989. From 1976 to 1985
he was a senior accountant with the certified public accounting firm of Van
Blarcom and Harrison, specializing in auditing, income tax preparation and
planning, and management advisory services. He attended Stetson University and
the University of Vermont.

William D. Linehan, who will replace Bayard R. Kraft III as Treasurer, Chief
Financial Officer and Secretary of the Company effective March 29, 1996, was
most recently employed since 1993 as a manager in the audit and consulting
practice of Moody, Cavanaugh and Company, where he specialized in providing
audit, tax advisory and business consulting services to closely-held
corporations. From 1991 to 1993, Mr. Linehan was the Controller of Technology
Procurement, Inc., and later the Secretary and Treasurer of Computer Finance
and Rental, Inc., a corporation formed in 1993 after a corporate
reorganization of Technology Procurement, Inc., where he was responsible for
managing the accounting and financial activities of these corporations, which
both were distributors and lessors of computer equipment and related
peripheral products. From 1987 to 1991, Mr. Linehan was employed in the middle
market audit and consulting practice of KPMG Peat Marwick, where he advanced
to the position of supervisor and specialized in providing audit and
management advisory services to publicly-traded and privately-held growth
companies. Mr. Linehan, who received a Bachelor of Science Degree in
Accountancy from Bentley College in 1987, is a Certified Public Accountant in
the Commonwealth of Massachusetts and a member of the American Institute of
Certified Public Accountants and the Massachusetts Society of Certified Public
Accountants.

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 Annual Meeting of Shareholders to be held on June 3, 1996.
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 "Election of Directors" appearing
in the definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held June 3, 1996.
Such information is incorporated herein by reference.

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 Annual Meeting of Shareholders to be held June 3, 1996.
Such information is incorporated herein by reference.

14

PART IV

ITEM 14. EXHIBITS, INDEX TO FINANCIAL STATEMENTS 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
PAGE
----

Independent Auditors' Report............................................. F-1
Consolidated Balance Sheets at December 31, 1995 and 1994................ F-2
Consolidated Statements of Operations for the Years Ended December 31,
1995, 1994 and 1993..................................................... F-3
Consolidated Statements of Shareholders' Equity for Years Ended December
31, 1995, 1994 and 1993................................................. F-4
Consolidated Statements of Cash Flows for the Years Ended December 31,
1995, 1994 and 1993..................................................... F-5
Notes to Consolidated Financial Statements............................... F-6

(a) 2. FINANCIAL STATEMENT SCHEDULES

The following consolidated financial statement schedules for the Company and
its subsidiaries are filed as part of this annual report:

No schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are required under the
related instructions or are applicable, and therefore have been omitted.

(a) 3. EXHIBITS

The following Exhibits are included in this report:

EXHIBIT INCORPORATION
NUMBER DESCRIPTION REFERENCE PAGE
------- ----------- ------------- ----

3.01 Certificate of Incorporation, as amended. A
4.01 Certificate of Designation as filed with the
Secretary of State of Delaware. Q
4.02 Bylaws of the Registrant, as amended. AB
5.01 Opinion of Townley & Updike as to the legality
of Shares of Common Stock being registered. AA
10.03 Cash Bonus Plan A
10.12 Stock Purchase Agreement for 20,000 shares of
common stock of Milesburg Energy, Inc., between
Environmental Power Corporation and Neil W.
Hedrick, Richard Mase and Sylvia B. Mase, dated
April 30, 1987. G
10.13 Non-recourse Secured Note of Environmental
Power Corporation to Neil W. Hedrick, Richard
Mase and Sylvia B. Mase for $220,000, dated
April 30, 1987. G
10.14 Non-recourse Secured Note of Environmental
Power Corporation to Neil W. Hedrick, Richard
Mase and Sylvia B. Mase for $4,900,000, dated
April 30, 1987. G

15

EXHIBIT INCORPORATION
NUMBER DESCRIPTION REFERENCE PAGE
------- ----------- ------------- ----

10.15 Note of Milesburg Energy, Inc., to Antrim
Mining, Inc., for $41,000, dated April 30,
1987. G
10.16 Note of Milesburg Energy, Inc., to Richard Mase
and Sylvia B. Mase for $139,000, dated April
30, 1987. G
10.17 Electric Energy Purchase Agreement between West
Penn Power Company and Milesburg Energy, dated
February 25, 1987. F
10.57 1990 Stock Plan with forms of Incentive Stock
Option Agreement and Non-Qualified Stock Option
Agreement. Q
10.63a Allonge to Promissory Note between Commonwealth
Bank and Milesburg Energy, Inc., dated December
6, 1993. AB
10.63b Amendment to Promissory Note between
Commonwealth Bank and Milesburg Energy, Inc.,
dated October 26, 1994. AC
10.66 Stock Purchase Agreement, dated as of December
15, 1990, by and among Environmental Power
Corporation, Scrubgrass Power Corporation and
Falcon Power Corporation. Schedules and similar
attachments of the Purchase and Sale Agreement
have been omitted; the Company agrees to
furnish supplementally a copy of any omitted
schedule to the Securities and Exchange
Commission upon request. T
10.67 Appendix I to the Amended and Restated
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, which Appendix
defines terms used and not otherwise defined in
the Stock Purchase Agreement filed as Exhibit
2.1.
10.69 Transfer Agreement, dated as of December 19,
1991, between Environmental Power Corporation
and Scrubgrass Generating Company, L.P. V
10.70 Stock Pledge Agreement, dated December 19,
1991, between Environmental Power Corporation
and Scrubgrass Generating Company, L.P. V
10.71 Amended and Restated 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.
10.72 Lease between Equinox Resort Associates, L.P.,
and Environmental Power Corporation, dated May
14, 1993. AB
10.73 Director Option Plan. AB
10.74 Order and Stipulation of Settlement, dated as
of January 24, 1994, between Environmental
Power Corporation and Drexel Burnham Lambert,
Inc. AB
10.80 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
June 17, 1994. Schedules and similar
attachments, listed in the Lease have been
omitted; the Company agrees to furnish
supplementally a copy of any omitted schedule
to the Securities and Exchange Commission upon
request. AC

16

EXHIBIT INCORPORATION
NUMBER DESCRIPTION REFERENCE PAGE
------- ----------- ------------- ----

10.81 Purchase and Sale Agreement by and among NRG
Sunnyside Inc. and B&W Sunnyside L.P. and
Kaiser Systems, Inc., Kaiser Power of
Sunnyside, Inc., Sunnyside Power Corporation
and Environmental Power Corporation, dated
December 31, 1994. Schedules and similar
attachments of the Purchase and Sale Agreement
have been omitted; the Company agrees to
furnish supplementally a copy of any omitted
schedule to the Securities and Exchange
Commission upon request. AC
11 Computation of Earnings per Share
21 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP
28.02 Order of Pennsylvania Public Utility Commission
in connection with Milesburg Energy, Inc.,
adopted September 21, 1989. R

17

Incorporation References:

A Previously filed as part of Registration Statement No. 33-9808 (the
"Registration Statement"), filed with the Securities and Exchange
Commission on October 28, 1986.

B Previously filed as part of Amendment No. 1 to Registration Statement
No. 33- 9808, filed with the Securities and Exchange Commission on
November 17, 1986.

F Previously filed as part of the Company's Annual Report on Form 10-K
for the year ended December 31, 1986, filed with the Securities and
Exchange Commission on March 30, 1987.

G Previously filed as part of the Company's Report on Form 8-K, filed
with the Securities and Exchange Commission on May 15, 1987.

Q Previously filed as part of the Company's Report on Form 8-K, filed
with the Securities and Exchange Commission on February 7, 1990.

R Previously filed as part of the Company's Annual Report on Form 10-K
for the year ended December 31, 1989, filed with the Securities and
Exchange Commission on November 14, 1990.

T Previously filed as part of the Company's Report on Form 8-K, dated
December 28, 1990.

V Previously filed as part of the Company's Report on Form 10-K for the
year ended December 31, 1991, filed with the Securities Exchange
Commission on April 12, 1992.

AB Previously filed as part of the Company's Report on form 10-K for the
year ended December 31, 1993.

AC Previously filed as part of the Company's Report on Form 10-K for the
year ended December 31, 1994.

(b) REPORTS ON FORM 8-K

Not Applicable.

18

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 21, 1996
/s/ Joseph E. Cresci
By: _________________________________
Joseph E. Cresci,
Chairman and Chief Executive
Officer

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.

SIGNATURE TITLE DATE

/s/ Joseph E. Cresci Chairman, Chief March 21, 1996
- ------------------------------------- Executive Officer,
JOSEPH E. CRESCI & Director
(Principal
Executive Officer)

/s/ Donald A. Livingston President & Chief March 21, 1996
- ------------------------------------- Operating Officer
DONALD A. LIVINGSTON

/s/ Bayard R. Kraft Treasurer, Chief March 21, 1996
- ------------------------------------- Financial Officer &
BARARD R. KRAFT III Secretary
(Principal
Financial Officer)

/s/ Edward Koehler Director March 21, 1996
- -------------------------------------
EDWARD KOEHLER

/s/ Peter J. Blampied Director March 21, 1996
- -------------------------------------
PETER J. BLAMPIED

/s/ Robert I. Weisberg Director March 21, 1996
- -------------------------------------
ROBERT I. WEISBERG

19

INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders of
Environmental Power Corporation

We have audited the accompanying consolidated balance sheets of
Environmental Power Corporation and subsidiaries as of December 31, 1995 and
1994 and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the three years in the period ended
December 31, 1995. These 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Environmental Power
Corporation and subsidiaries at December 31, 1995 and 1994 and the results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1995, in conformity with generally accepted
accounting principles.

Deloitte & Touche LLP

New York, New York
March 5, 1996

F-1

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31
------------------------
1995 1994
----------- -----------

ASSETS
CURRENT ASSETS:
Cash and cash equivalents--Note B.................. $ 1,011,822 $ 356,527
Restricted cash--Note B............................ 1,250,338 --
Receivable from utility............................ 6,536,506 5,370,098
Notes receivable................................... 1,673,091 375,608
Receivable from sale of affiliate--Note A ......... 276,444 3,853,400
Other current assets--Note C....................... 1,112,152 1,785,531
----------- -----------
TOTAL CURRENT ASSETS............................. 11,860,353 11,741,164
PROPERTY, PLANT AND EQUIPMENT, NET--Notes A, B, D and
I................................................... 7,075,907 7,026,804
DEFERRED INCOME TAX ASSET--Notes B and J............. 5,543,229 4,995,245
LEASE RIGHTS, NET--Notes A and B..................... 3,055,526 3,204,531
NOTES RECEIVABLE--Note A............................. 1,868,409 3,263,164
ACCRUED POWER GENERATION REVENUE--Note B............. 15,161,689 5,311,324
OTHER ASSETS--Notes A and E.......................... 661,311 419,412
----------- -----------
$45,226,424 $35,961,644
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses--Note F...... $ 6,338,160 $ 6,969,386
Other current liabilities--Note G.................. 2,298,686 3,559,851
----------- -----------
TOTAL CURRENT LIABILITIES........................ 8,636,846 10,529,237
DEFERRED GAIN, NET--Note B........................... 6,322,419 6,630,830
SECURED PROMISSORY NOTES PAYABLE AND OTHER
BORROWINGS--Notes A and H........................... 8,543,767 5,971,270
ACCRUED LEASE EXPENSE--Note B........................ 15,161,689 5,311,324
DEFERRED REVENUE--Notes A and B...................... 3,064,965 2,825,972
MAINTENANCE RESERVE--Note B.......................... 699,429 250,000
SHAREHOLDERS' EQUITY--Note K:
Preferred Stock ($.01 par value; 1,000,000 shares
authorized; 18,740 shares issued at December 31,
1994)............................................. -- 187
Common Stock ($.01 par value; 20,000,000 shares
authorized; 12,145,423 shares and 10,602,179
shares issued at December 31, 1995 and 1994,
respectively; 11,547,323 shares and 10,582,179
shares outstanding at December 31, 1995 and 1994,
respectively)..................................... 121,454 106,822
Additional paid-in capital......................... 12,592,808 13,963,993
Unearned compensation.............................. (66,941) (147,281)
Accumulated deficit................................ (8,847,585) (8,112,974)
----------- -----------
3,799,736 5,810,747
Less: 598,100 and 100,000 common shares held in
treasury, at cost, at December 31, 1995 and
1994, respectively............................ (168,395) (75,000)
18,740 preferred shares held in treasury, at cost,
at December 31, 1994............................. -- (890,860)
Notes receivable from officers.................... (834,032) (401,876)
----------- -----------
2,797,309 4,443,011
----------- -----------
$45,226,424 $35,961,644
=========== ===========

See notes to consolidated financial statements.

F-2

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

YEAR ENDED DECEMBER 31
-------------------------------------
1995 1994 1993
----------- ----------- -----------

POWER GENERATION REVENUES............... $40,693,465 $30,704,589 $ 1,570,649
----------- ----------- -----------
Costs and expenses:
Operating expenses.................... 16,975,186 16,122,617 1,088,334
Lease expense--Notes A, B and L ...... 23,020,132 10,537,623 --
General and administrative expenses... 3,668,066 2,998,325 1,613,041
Depreciation and amortization--Note
B.................................... 167,333 3,017,766 427,615
----------- ----------- -----------
43,830,717 32,676,331 3,128,990
----------- ----------- -----------
OPERATING LOSS.......................... (3,137,252) (1,971,742) (1,558,341)
----------- ----------- -----------
Other income (expense):
Other income--Note A.................. 1,592,814 5,465,418 600
Interest income....................... 468,626 695,142 161,227
Interest expense--Note I.............. (106,783) (8,829,893) (1,375,625)
Gain on sale of affiliate/project--
Note A............................... -- 3,945,494 --
Minority interest--Note A............. -- 1,866,017 --
Equity in net loss of affiliate....... -- (84,712) --
Realized gain on sale of marketable
debt securities...................... -- -- 1,677,916
----------- ----------- -----------
1,954,657 3,057,466 464,118
----------- ----------- -----------
(LOSS) INCOME BEFORE INCOME TAXES....... (1,182,595) 1,085,724 (1,094,223)
INCOME TAX (BENEFIT) EXPENSE--Notes B
and J.................................. (447,984) 415,894 (413,849)
----------- ----------- -----------
NET (LOSS) INCOME....................... $ (734,611) $ 669,830 $ (680,374)
=========== =========== ===========
NET (LOSS) INCOME PER SHARE--Note B..... $ (0.07) $ 0.06 $ (0.11)
=========== =========== ===========

See notes to consolidated financial statements.

F-3

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

PREFERRED COMMON UNREALIZED NOTES
STOCK STOCK ADDITIONAL LOSS ON RECEIVABLE
($.01 PAR ($.01 PAR PAID-IN MARKETABLE UNEARNED ACCUMULATED TREASURY FROM
VALUE) VALUE) CAPITAL SECURITIES COMPENSATION DEFICIT STOCK OFFICERS
--------- --------- ----------- ---------- ------------ ----------- --------- ----------

BALANCE AT JANUARY 1,
1993................... $ 187 $ 76,108 $13,580,847 -- -- $(8,102,430) $(111,742) --
Net Loss............... (680,374)
Exercise of options.... 29,573 383,146 $(401,876)
Purchase of preferred
shares................ (890,860)
Purchase of common
shares................ (214,268)
Issuance of restricted
stock................. 1,141 $(227,621) 251,010
Unrealized losses on
non-current marketable
securities............ $(390,325)
----- -------- ----------- --------- --------- ----------- --------- ---------
BALANCE AT DECEMBER 31,
1993................... 187 106,822 13,963,993 (390,325) (227,621) (8,782,804) (965,860) (401,876)
----- -------- ----------- --------- --------- ----------- --------- ---------
Net Income............. 669,830
Unrealized loss related
to affiliate sold..... 390,325
Amortization of
unearned
compensation--Note K.. 80,340
----- -------- ----------- --------- --------- ----------- --------- ---------
BALANCE AT DECEMBER 31,
1994................... 187 106,822 13,963,993 -- (147,281) (8,112,974) (965,860) (401,876)
----- -------- ----------- --------- --------- ----------- --------- ---------
Net Loss............... (734,611)
Preferred stock
retired............... (187) (890,673) 890,860
Exercise of options.... 14,632 443,274 (432,156)
Purchase of common
shares................ (93,395)
Amortization of
unearned
compensation--Note K.. 80,340
Dividends paid--Note
K..................... (923,786)
----- -------- ----------- --------- --------- ----------- --------- ---------
BALANCE AT DECEMBER 31,
1995................... $ -- $121,454 $12,592,808 $ -- $ (66,941) $(8,847,585) $(168,395) $(834,032)
===== ======== =========== ========= ========= =========== ========= =========

See notes to consolidated financial statements.

F-4

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEAR ENDED DECEMBER 31
---------------------------------------
1995 1994 1993
----------- ------------ ------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income.................... $ (734,611) $ 669,830 $ (680,374)
Adjustments to reconcile net (loss)
income to net cash provided by (used
in) operating activities:
Gain on sale of marketable debt
securities.......................... -- -- (1,677,916)
Depreciation and amortization........ 167,333 3,017,766 427,615
Deferred income taxes................ (547,984) 415,894 (413,849)
Amortization of deferred gain........ (308,411) (154,205) --
Minority interest.................... -- (1,866,017) --
Gain on sale of interest in
affiliate........................... -- (3,945,494) --
Amortization of unearned
compensation........................ 80,340 80,340 --
Equity in net loss of affiliate...... -- 84,712 --
Payment of debt issuance costs....... -- -- (570,705)
Other income......................... (77,982) (5,460,367) 35,358
Accrued power generation revenue..... (9,850,365) (5,311,324) --
Accrued lease expense................ 9,850,365 5,311,324 --
Changes in operating assets and
liabilities:
Increase in receivable from
utility............................ (1,166,408) (4,393,710) --
Decrease (increase) in receivable
from sale of affiliate............. 3,576,956 (3,853,400) --
Increase in notes receivable........ -- (701,272) --
Decrease (increase) in other
current assets..................... 610,151 (2,173,384) (1,333,947)
Increase in accounts payable and
accrued expenses................... 803,436 1,821,548 739,273
Increase in deferred revenue........ 238,993 2,825,972 --
(Decrease) increase in other
current liabilities................ (1,187,668) 1,798,035 1,240,094
Decrease in income taxes payable.... -- -- (168,000)
Increase in maintenance reserve..... 449,429 250,000 --
----------- ------------ ------------
Cash provided by (used in)
operating activities.............. 1,903,574 (11,583,752) (2,402,451)
----------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Reduction of cash as a result of
conversion to equity method of
accounting for investment in
affiliate........................... -- (5,872,438) --
Conversion to equity method of
accounting for investment in
affiliate........................... -- 3,496,675 --
Proceeds from notes receivable....... 312,500 -- --
Purchase of marketable debt
securities.......................... -- -- (10,665,575)
Sale of marketable debt securities... -- -- 9,611,625
Lease rights expenditures............ -- 415,974 (417,689)
Restricted deposits and other
assets.............................. (316,899) 1,098,560 (1,913,417)
Property, plant & equipment
expenditures........................ (66,449) (165,741) (14,640,780)
----------- ------------ ------------
Cash used in investing activities.. (70,848) (1,026,970) (18,025,836)
----------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from tax exempt borrowings
and equity bridge loans............. -- 4,229,336 28,994,286
Payment of secured promissory notes
payable and other borrowings........ (186,000) (327,500) (54,115)
Dividends paid....................... (923,786) -- --
Purchase of treasury stock........... (93,395) -- (203,423)
Proceeds from sale of common stock... 25,750 -- 570
----------- ------------ ------------
Cash (used in) provided by
financing activities.............. (1,177,431) 3,901,836 28,737,318
----------- ------------ ------------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS.......................... 655,295 (8,708,886) 8,309,031
CASH AND CASH EQUIVALENTS, BEGINNING
OF YEAR.............................. 356,527 9,065,413 756,382
----------- ------------ ------------
CASH AND CASH EQUIVALENTS, END OF
YEAR................................. $ 1,011,822 $ 356,527 $ 9,065,413
=========== ============ ============

See notes to consolidated financial statements.

F-5

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A--BUSINESS AND ORGANIZATION

Business: Environmental Power Corporation ("EPC" or the "Company") owns a
22-year leasehold interest in an approximately 85 Mw (net) waste coal-fired
electric generating facility (the "Scrubgrass Project") located in
Pennsylvania, the lease for which commenced on June 30, 1994. Until December
31, 1994, the Company had varying ownership interests (80% to 43%) in, and
oversaw the operation of, an approximately 51 Mw (net) waste coal-fired
electric generating facility located in Utah. Both facilities sell power under
long-term contracts to specified utility companies whose contracts have been
approved by the respective Public Utility Commission. In the case of these two
projects, the Company, either acting alone or in conjunction with others, has
selected and arranged for the acquisition of the site, obtained control over
their waste coal fuel sources, negotiated contracts for the design and
construction of the facilities and the sale of their output to the utilities
purchasing the power, arranged for financing, and negotiated contracts for the
operation and maintenance of the projects. The Company has one additional
project (the "Milesburg Project") in the development stage.

Scrubgrass

The Scrubgrass Project located on a 600 acre site in Venango County,
Pennsylvania, is an approximately 85 Mw (net) waste coal-fired electric
generating station (the "Facility") which has been constructed by Bechtel
Power Corporation. The construction contract provided for a guaranteed net
electrical output of 82.85 Mw. Final completion was achieved by the contractor
in June 1994.

On June 30, 1994, Buzzard Power Corporation ("Buzzard"), a wholly owned
subsidiary of the Company, entered into an agreement to lease the Facility
from Scrubgrass Generating Company, L.P. (the "Lessor"), a joint venture of
PG&E Enterprises, Inc. and Bechtel Enterprises. 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 principle project agreements and
its rights and obligations thereunder including, but not limited to, the power
purchase agreement, operations and maintenance agreement, limestone
agreements, ground lease agreements, fuel agreements and transportation and
materials handling agreements. The Company has pledged Buzzard's stock to the
Lessor as security for Buzzard's performance of its obligations as lessee. The
project is managed by U.S. Generating Company, a joint venture of PG&E
Enterprises and Bechtel Enterprises, Inc.

Electric output is being sold to Pennsylvania Electric Company ("PENELEC")
pursuant to a 25-year agreement, which commenced in 1993, at a fixed average
rate of approximately 4.68 cents/Kwh and escalates at 5% per year for the
calendar years' 1994-1999. Commencing in the year 2000 and through 2012, the
agreement provides for a rate equal to the greater of a scheduled rate or a
rate based on the PJM Billing Rate (the monthly average of the hourly rates
for purchases by the General Public Utilities Group ["GPU"] from, or sale by
GPU to, the Pennsylvania-New Jersey-Maryland Interconnection). For the years
2013 through 2015 and 2016 through 2018, if the renewal term option is
exercised, 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
1%. On June 8, 1993, the Facility was declared by PENELEC to have reached
commercial operation.

The Facility is being operated by U.S. Operating Services Company pursuant
to a 15-year Operations and Maintenance Agreement ("O & M"). A budget for all
operational expenses, including a fixed management fee, is approved annually.
Failure to achieve approved annual budgets can result in operator liability
and/or termination of the O & M. The Scrubgrass Project owns or has under
contract sufficient fuel to operate the facility for approximately 25 years.

A Limestone Purchase and Sale Agreement with Quality Aggregates, Inc. has
been entered into to supply the Scrubgrass Project with limestone for an
initial term of five years which, in December 1995, was extended through the
year 2000, and which may be extended up to 15 additional years. The project
also maintains agreements with initial terms of 15 years for the
transportation and handling of fuel, ash and limestone with Savage Industries,
Inc. Costs established under these agreements will escalate at partially fixed
and partially indexed rates.

F-6

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE A--BUSINESS AND ORGANIZATION--(CONTINUED)

All revenues earned by the Scrubgrass Project are deposited into an account
administered by a disbursement agent. Before Buzzard can receive cash
generated by the project, all operating expenses, base lease payments (which
include the Lessor's debt as described below), certain maintenance reserve
payments and other subordinated payments must be satisfied. Buzzard, as
lessee, is required to pay the Lessor, in addition to a specified base rent
consisting of all of the Lessor's debt service and related fees and expenses,
an additional rent of 50 percent of the net cash flows Buzzard receives from
project operations. Buzzard is not required to fund operating losses or
otherwise invest further from financing sources outside the project.

Until December 22, 1995, the Lessor's debt consisted of $135.6 million of
variable rate tax-exempt bonds maturing in 2012, a $20.8 million term loan
maturing in 2005, $4.2 million of demand debt and $2.4 million of junior
subordinated debt maturing in 1999. The Lessor entered into interest rate
swaps which have the effect of fixing the interest rate until May 18, 1996, at
approximately 3.72% on the tax-exempt bonds and over the life of the $20.8
million term loan at 6.42%. After May 18, 1996, the specified base rent will
reflect the effect of floating rates on the Lessor's tax-exempt bonds. On
December 22, 1995, the Lessor restructured certain of its project debt, the
primary effect of which was to extend the term of its demand debt and a
portion of its junior subordinated debt through 2004. As a result of the
Lessor's debt restructuring, Buzzard extended the term of $4 million of
current liabilities through 2004 (See Notes B, E, F and G).

Sunnyside

Sunnyside is an approximately 51 Mw (net) waste coal-fired facility at a
site located adjacent to the Sunnyside Coal Mine in Carbon County, Utah, that
was constructed by Parsons Main, Inc. ("PMI"). The facility reached commercial
operation on November 19, 1993. The project is owned by Sunnyside Cogeneration
Associates ("SCA"), a joint venture in which EPC owned an approximate 70%
interest until September 28, 1994, and thereafter an approximate 40% interest
until December 31, 1994, at which time the Company sold its remaining interest
in SCA.

In connection with the sale, the Company received consideration of $2.79
million in cash on January 5, 1995, and promissory notes aggregating $3.25
million, bearing interest at 10% per annum. Interest is payable to the Company
quarterly and principal of $312,500 was received by the Company on September
30, 1995, principal of $1,187,500 is due December 31, 1996, and the remaining
principal of $1,750,000 is due December 31, 1997. In addition, in 1994, the
Company also recorded a receivable related to a purchase price adjustment, as
provided for in the Purchase and Sale Agreement, of approximately $1.1
million, of which $708,000 was received in April 1995. The remaining
receivable balance is being disputed through litigation with the purchasers.
The Company also retained certain inchoate rights, including potential
refundable sales taxes arising out of activities prior to the date of the
sale. During 1995, the Company received refunds aggregating $1.1 million in
final settlements for all such sales tax refunds, which have been included in
other income in the accompanying statements of operations.

In 1994 as a result of the sale of its interest in SCA, the Company recorded
a gain on the sale of approximately $3.9 million and recognized other income
for management services and interest income aggregating approximately $5.5
million which is included in other income on the accompanying consolidated
statements of operations. The Company had previously earned these management
fees and interest income from services and loans provided to SCA but such
amounts had been eliminated in consolidation prior to the sale.

Milesburg

On April 30, 1987, the Company purchased, for an aggregate purchase price of
$5,400,000, all the outstanding capital stock of Milesburg Energy, Inc.
("MEI"), the Company which controlled the development rights to an existing 43
Mw (net) oil-fired facility, which was retired from service in 1984. In
connection with

F-7

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE A--BUSINESS AND ORGANIZATION--(CONTINUED)

the stock purchase, the Company paid $100,000 in cash and issued promissory
notes totaling $5,120,000 and asubsidiary assumed pre-acquisition MEI
liabilities totaling $180,000. The notes payable, pre-acquisition liabilities
and other liabilities incurred subsequent to the purchase become payable only
under certain conditions, the most significant of which relate to the closing
of construction financing and commencement of construction for the project.
The Company plans to convert or replace this facility to use waste coal. (See
Notes D and H). MEI has executed a 30-year power purchase agreement with West
Penn Power Company ("WPPC") for the sale of all of the facility's electrical
output with a fixed capacity rate component and an additional fluctuating rate
component which is derived from WPPC's avoided energy cost. The power purchase
agreement was approved by the Public Utilities Commission of the State of
Pennsylvania ("PUC") and was subsequently appealed to the Commonwealth Court
of Pennsylvania by certain industrial customers, the Office of the Consumer
Advocate and WPPC. The PUC subsequently ordered the rates contained in the
power purchase agreement to be recalculated due to the later start-up date for
this project necessitated by the delays caused by the appeal. This order has
been appealed by the same litigants through various courts, including the
United States Supreme Court, and upheld in every case in favor of MEI. In
August 1995, the PUC issued a tentative order for final contract rates. The
order has been temporarily stayed by mutual agreement of MEI and WPPC pending
settlement discussions.

In 1990, as a result of the uncertainties related to approval of the power
contract and the rates provided therein and the Company's working capital
position which, at that time, could have prevented it from continuing to fund
development efforts, management provided a reserve of $940,144 against its
investment in the project. However, the Company has continued to invest monies
in an effort to protect its legal and contractual interests and to support its
ability to commence construction in the event of a favorable resolution to the
power purchase agreement. MEI is currently seeking the sale of the project or
partnership of the project with an entity that would provide equity financing
for development and construction. There can be no assurance that MEI will be
successful in selling the project, finding a partner or in further
developmental efforts or that the project will reach commercial operation (See
Notes D, H and I).

NOTE B--SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The consolidated financial statements include
the accounts of Environmental Power Corporation and its wholly owned and
majority owned subsidiaries. The equity method of accounting had been used for
any subsidiary in which the Company held less than a majority interest. All
significant intercompany accounts and transactions have been eliminated in
consolidation.

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

Cash Flows: The Company considers all highly liquid investments with a
maturity of three months or less when purchased to be cash equivalents. In
1995, non-cash investing and financing activities include the retirement of
preferred treasury shares ($890,860), the issuance of a non-current obligation
to refinance a trade obligation ($250,000), the issuance of a secured note
payable ($2,435,000) to refinance certain trade obligations ($1,184,662) and
provide restricted cash for plant maintenance ($1,250,338), the exchange of
notes receivable for the purchase of the Company's common stock ($439,156) and
the issuance of notes receivable to refinance accrued interest receivable
($63,228). In 1993, non-cash investing and financing activities include the
issuance of a note payable to the DBL trust for $1,850,000 (discounted value
of $1,608,217) and the Company's purchase of preferred treasury shares
($890,860) and the exchange of a note receivable to purchase common stock of
$10,845.

F-8

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

Concentrations of Credit Risk: The Company's financial instruments that are
exposed to concentrations of credit risk consist primarily of cash
equivalents, notes receivable and receivables from utility. The Company's cash
equivalents represent certificates of deposit issued from high quality
financial institutions. Notes receivable represent amounts due from the
acquirers of the Company's interest in the Sunnyside project. The Company
believes these acquirers are credit worthy entities which, to date, have paid
all obligations as they've matured under such notes receivable. Receivable
from Utility represent amounts due from its sole customer PENELEC, a public
utility with a credit rating of A- by Standard & Poors, pursuant to the terms
of the 22 year power purchase 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).

Property, Plant and Equipment: Property, plant and equipment are stated at
cost less accumulated depreciation. Depreciation of the Sunnyside power
generating facility, which was sold on December 31, 1994, was computed using
the straight-line method over a composite life of 35 years. Significant
renewals and betterments that increase the useful lives of the assets are
capitalized; maintenance and dispositions are recorded in current operations
as incurred. Facility Under Development represents project acquisition costs
and costs incurred during the development stage of the Milesburg project.
Other costs include professional services, salaries and other costs that are
directly related to the Milesburg project. In addition, certain indirect costs
are also allocated to the Milesburg project. If and when the facility becomes
operational, such costs will be amortized over the useful life of the project.
Accumulated costs of development projects may be expensed in the year that it
becomes probable, in management's opinion, that the costs will not be
recovered. Depreciation on office equipment and furniture is computed using
the straight-line method over five years.

Deferred Financing Costs: In 1995, the Company incurred $300,000 in
connection with the restructuring of certain debt related to the Scrubgrass
project. Such costs are being amortized over nine years, the life of the debt
(See Note E). The Company amortized deferred financing costs related to the
Sunnyside project over the terms of the Sunnyside project debt. From November
19, 1993, to September 28, 1994, the date through which SCA was consolidated
into the Company's operations, the Company charged the amortization of such
costs to operations. Until November 19, 1993, the Company capitalized the
amortization of such deferred Sunnyside financing costs in property, plant and
equipment.

Lease Rights: Lease Rights are recorded at cost and are being amortized over
the 22-year lease term related to the Scrubgrass Project. Accumulated
amortization related to the lease rights was $223,534 and $74,529 at December
31, 1995 and 1994, respectively.

Accrued Power Generation Revenue and Accrued Lease Expense: As discussed in
Note A, the Company has entered into a long term agreement, to provide
electricity to PENELEC, which provides for scheduled rate increases. In
accordance with generally accepted accounting principles, 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
$15,161,689 and $5,311,324 at December 31, 1995 and 1994, respectively, and
represents that portion of revenue earned that has not yet been received.

As discussed in Note A, the Company has entered into a long-term lease
agreement for the Scrubgrass Project which provides for scheduled lease
expense increases. In accordance with generally accepted accounting
principles, lease expense has been recorded on the straight-line basis over
the 22-year lease term. Accrued lease expense was $15,161,689 and $5,311,324
at December 31, 1995 and 1994, respectively, and represents that portion of
lease expense that has not yet been paid.

F-9

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

Deferred Gain: The sale of the Scrubgrass Project by the Company 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 the Company to
reacquire Buzzard and to lease the project for a substantial portion of its
commercial operation. This option constituted a significant continuing
involvement by the Company which provided evidence that it had retained
substantial risks or rewards of ownership of the project. In December 1993,
the Company agreed to a modification to the proposed form of lease thereby
relinquishing the fair market value purchase option. Accordingly, the Company
removed from the 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 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 at December 31, 1995 and 1994,
was $462,616 and $154,205, respectively.

Deferred Revenue: Deferred revenue of $3,064,965 and $2,825,972 at December
31, 1995 and 1994, respectively, represents amounts received for power
generation from the Scrubgrass project at rates in excess of forecasted rates
as set forth in the power purchase agreement. The Company defers such revenues
until earned which is expected to occur during 1996.

Maintenance Reserve: The Company records the expense of major equipment
overhauls related to the Scrubgrass Project on a straight-line basis using
management's best estimate of future outlays. Amounts are charged to expense
and are credited to the reserve in anticipation of future outlays for major
overhauls.

Income Taxes: The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes." This standard requires, among other things, recognition of future tax
benefits, measured by enacted tax rates, attributable to deductible temporary
differences between financial bases of assets and liabilities, and net
operating loss carryforwards to the extent that realization of such benefits
is more likely than not. Deferred income taxes are recognized for temporary
differences between financial statement and income tax bases of assets and
liabilities and net operating loss carryforwards for which the Company expects
income tax benefits will be realized in future years.

Income (loss) Per Share: The Company computes its earnings per common share
using the modified treasury stock method ("modified method") in accordance
with Accounting Principles Board Opinion No. 15. The modified method is used
when the number of shares obtainable upon exercise of outstanding options,
warrants and their equivalents exceed 20% of the Company's outstanding common
stock. Under this method, all options, warrants and their equivalents are
assumed exercised (whether dilutive or antidilutive) with aggregate proceeds
used to purchase up to 20% of the Company's outstanding common stock and the
remainder invested in US government securities. If the combined effect of the
assumed exercise is dilutive, all options, warrants and their equivalents are
included in the computation.

Primary income (loss) per share is computed by dividing net income (loss),
increased by the assumed earnings on US government security purchases, divided
by the weighted average number of shares of Common Stock and dilutive common
stock equivalents outstanding (10,649,161, 11,321,178 and 8,591,564 shares for
the years ended December 31, 1995, 1994 and 1993, respectively).

Shares issuable in connection with stock options and stock purchase warrants
are considered common stock equivalents. Common stock equivalents are
considered dilutive of earnings but not losses for this purpose when the
exercise price is below the average market price of the Company's Common Stock
for the period. The weighted average number of shares outstanding during the
period is increased by the excess of the shares to be issued over the shares
that could have been purchased from the proceeds of the exercise of the stock
options and

F-10

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

warrants using the average market price of the Company's Common Stock during
the period the stock options and warrants are outstanding. For the year ended
December 31, 1995, there were no such common stock equivalents since they were
antidilutive.

Fully diluted income (loss) per share is computed based on the weighted
average number of shares of Common Stock outstanding, dilutive common stock
equivalents outstanding and convertible preferred stock outstanding after
adjustment for the related dividends on preferred stock and the assumed
earnings on US government security purchases (10,649,161, 11,321,178 and
8,591,564 for the years ended December 31, 1995, 1994 and 1993, respectively).
Common stock equivalents are considered dilutive of earnings but not losses
for this purpose when the exercise price is below the higher of the market
price of the Company's Common Stock at the end of the period or the average
price of the Company's Common Stock for the period. The closing market price
of the Company's Common Stock on December 31, 1995 was $.31.

Recently Issued Accounting Standards: In March 1995, the FASB issued SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to Be Disposed Of." This standard is effective for the Company's
financial statements beginning in 1996. SFAS No. 121 establishes the
accounting for the impairment of long-lived assets, certain identifiable
intangibles and goodwill related to those assets to be held and used and for
long-lived assets and certain identifiable intangibles to be disposed of. In
the opinion of the Company's management, it is not anticipated that the
adoption of SFAS No. 121 will have a material effect on the financial position
or results of operations of the Company.

In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation", which requires adoption of the disclosure provisions no later
than fiscal years beginning after December 15, 1995, and adoption of the
measurement and recognition provisions for nonemployee transactions no later
than after December 15, 1995. The new standard defines a fair value method of
accounting for the issuance of stock options and other equity instruments.
Under the fair value method, compensation is measured at the grant date based
on the fair value of the award and is recognized over the service period,
which is usually the vesting period. Pursuant to SFAS No. 123, companies are
encouraged, but not required, to adopt the fair value method of accounting for
employee stock-based transactions. Companies are also permitted to continue to
account for such transactions under Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," but would be required to
disclose in a note to the financial statements pro forma net income and per
share amounts as if the company had applied the new method of accounting. SFAS
No. 123 also requires increased disclosures for stock-based compensation
arrangements regardless of the method chosen to measure and recognize
compensation for employee stock-based arrangements. The Company has not yet
determined if it will elect to change to the fair value method, nor has it
determined the effect the new standard will have on its financial position or
operating results and per share results should it elect to make such a change.

Reclassification: Certain amounts in 1994 and 1993 have been reclassified to
conform with the current period presentation.

F-11

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE C--OTHER CURRENT ASSETS

At December 31, 1995 and 1994, other current assets consist of the
following:

1995 1994
---------- ----------

Interest receivable.................................. $ 139,319 --
Construction management and overhead receivable...... -- $ 688,601
Prepaid expenses..................................... 380,138 397,363
Note receivable and accrued interest due from
officer............................................. 103,612 98,482
Fuel inventory....................................... 484,991 588,066
Deposits............................................. 4,092 13,019
---------- ----------
$1,112,152 $1,785,531
========== ==========

NOTE D--PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are recorded at cost less accumulated
depreciation and consists of the following at December 31, 1995 and 1994:

1995 1994
---------- ----------

Power generating facilities:
Facility Under Development--Milesburg............ $7,981,987 $7,910,584
Less Reserve for Non-recovery of Costs--
Milesburg....................................... (940,144) (940,144)
---------- ----------
7,041,843 6,970,440
---------- ----------
Office:
Equipment and furniture.......................... 92,009 216,382
Less accumulated depreciation.................... 57,945 160,018
---------- ----------
34,064 56,364
---------- ----------
$7,075,907 $7,026,804
========== ==========

Salary costs of certain employees capitalized as part of project costs in
1994 above amounted to approximately $32,740. Certain other indirect costs
also capitalized as part of project costs above amounted to approximately
$124,437 in 1994. These costs were allocated to the projects based on the
relationship of direct salary costs to total salary costs. There were no such
costs capitalized in 1995.

NOTE E--OTHER ASSETS

Other assets consist of the following at December 31, 1995 and 1994:

1995 1994
-------- --------

Scrubgrass project receivables............................. $261,311 $244,412
Deferred financing costs--Note B........................... 300,000 --
Hamilton investment........................................ 100,000 175,000
-------- --------
$661,311 $419,412
======== ========

Scrubgrass project receivables represent deposits in connection with fuel
reserves under long-term leases.

F-12

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE E--OTHER ASSETS--(CONTINUED)

Hamilton investment represents an investment in the stock of Hamilton
Technologies, Inc. ("Hamilton"), a privately held Massachusetts developer of
computer aided software engineering (CASE) software. In 1994 the Company
provided a reserve against its investment of $75,000. In 1995 the Company
increased the reserve to $150,000.

NOTE F--ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consist of the following at December
31, 1995 and 1994:

1995 1994
---------- ----------

Accounts payable....................................... $3,437,670 $4,807,106
Accrued expenses....................................... 2,900,490 2,162,280
---------- ----------
$6,338,160 $6,969,386
========== ==========

Accounts payable at December 31, 1995 and 1994 includes $2,505,085 and
$2,805,844, respectively, which are related to Scrubgrass project operations.

Accrued expenses at December 31, 1995 and 1994 includes $2,672,912 and
$2,021,066, respectively, which are related to Scrubgrass project operations.

NOTE G--OTHER CURRENT LIABILITIES

Other current liabilities consist of the following at December 31, 1995 and
1994:

1995 1994
---------- ----------

Scrubgrass note payable................................ $ 300,000 --
DBL note payable....................................... -- $1,475,000
Scrubgrass working capital loan........................ 1,628,143 1,607,811
Other.................................................. 370,543 477,040
---------- ----------
$2,298,686 $3,559,851
========== ==========

The Scrubgrass note payable represents the current portion of an obligation
related to the Scrubgrass project (See Note H).

The DBL note payable represents the current portion of a non-interest
bearing note payable to the DBL Liquidating Trust (See Note K).

The Scrubgrass project working capital loan represents borrowings under a
working capital loan agreement. In 1994, Buzzard entered into a Lessee Working
Capital Loan Agreement with the Lessor whereby the Lessor has provided Buzzard
with a $4 million line of credit for seasonal working capital requirements for
the Scrubgrass project.

F-13

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE H--SECURED PROMISSORY NOTES PAYABLE AND OTHER BORROWINGS

Secured promissory notes payable and other borrowings at December 31, 1995
and 1994, consist of the following:

1995 1994
---------- ----------

Milesburg borrowings................................... $5,858,767 $5,858,768
Scrubgrass notes payable............................... 2,435,000 --
Other.................................................. 250,000 112,502
---------- ----------
$8,543,767 $5,971,270
========== ==========

The Milesburg borrowings are noninterest-bearing and payable only under
certain conditions, the most significant of which relates to the closing of
construction financing and commencement of construction for the Milesburg
project. Borrowings of $5,120,000 are collateralized by all of the common
stock of MEI (See Note A).

The Scrubgrass notes payable represent the non-current portion of an
obligation related to the Scrubgrass project (See Note G).

Other borrowings represent selling expenses incurred in connection with the
sale of the Sunnyside project which are payable upon receipt of the principal
proceeds from the notes receivable which become due December 31, 1997 (See
Note A).

NOTE I--INTEREST CAPITALIZED

Interest costs for the years ended December 31, 1995, 1994, and 1993 consist
of the following:

1995 1994 1993
-------- ---------- ----------

Total interest costs incurred............... $119,696 $8,850,266 $8,380,791
Amount included in operations............... 106,783 8,829,893 1,375,625
-------- ---------- ----------
Amounts capitalized in development and
construction of projects................... $ 12,913 $ 20,373 $7,005,166
======== ========== ==========

Interest costs incurred for 1993 are net of interest earnings of $3,032,767
on unexpended Sunnyside construction funds held by the trustee.

Total interest paid during the years ended December 31, 1995, 1994 and 1993
amounted to $111,913, $11,109,122 and $11,047,106, respectively.

Interest costs incurred for 1994 and 1995 do not include debt service
included in lease expense related to the Scrubgrass project.

NOTE J--INCOME TAXES

The income tax (benefit) expense for the years ended December 31, 1995, 1994
and 1993 consist of the following:

1995 1994 1993
--------- -------- ---------

Current:
Federal..................................... $100,000 -- --
Deferred:
Federal..................................... (477,175) $350,227 $(348,435)
State....................................... (70,809) 65,667 (65,414)
--------- -------- ---------
$(447,984) $415,894 $(413,849)
========= ======== =========

F-14

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE J--INCOME TAXES--(CONTINUED)

A reconciliation between the actual income tax (benefit) expense and the
income tax (benefit) expense computed by applying the statutory federal income
tax rate to the (loss) income before income taxes for the years ended December
31, 1995, 1994 and 1993 is as follows:

1995 1994 1993
--------- -------- ---------

Federal tax (benefit) expense at 34%........ $(402,082) $368,880 $(372,035)
State tax (benefit) expense, net of federal
tax........................................ (46,734) 43,340 (43,331)
Nondeductible portion of meals and
entertainment.............................. 832 3,674 1,517
--------- -------- ---------
$(447,984) $415,894 $(413,849)
========= ======== =========

At December 31, 1995 and 1994, the components of the net deferred income tax
asset are as follows:

1995 1994
---------- ----------

Deferred tax assets:
Accrued lease expense............................... $5,757,502 $2,018,303
Accrued expenses.................................... 322,572 123,501
Deferred tax effect of the sale of the Scrubgrass
project for which the gain was deferred for
financial reporting purposes....................... 918,578 1,303,793
Federal and state net operating loss carryforwards.. 3,748,800 4,720,079
Federal alternative minimum tax credit
carryforwards...................................... 137,390 37,390
Deferred compensation............................... 70,548 --
Reserve for non-recovery of certain project costs
not currently deductible for income tax purposes... 435,908 435,908
Deferred revenue.................................... 1,164,591 1,073,870
---------- ----------
12,555,889 9,712,844
---------- ----------
Deferred tax liabilities:
Accrued power generation revenue.................... 5,757,502 2,108,303
Installment sale--Sunnyside......................... 1,255,158 2,699,296
---------- ----------
7,012,660 4,717,599
---------- ----------
Deferred income tax asset--net...................... $5,543,229 $4,995,245
========== ==========

The Company's net operating loss carryforwards of $9,737,591 expire between
2003 and 2010. The Company's alternative minimum tax credit carryforwards do
not expire and can be credited against future regular taxes to the extent they
exceed alternative minimum taxes. Of the Company's two major development
projects, Sunnyside was sold on December 31, 1994, and Scrubgrass became fully
operational on June 30, 1994, at which time the Company commenced leasing the
project (See Note A). Management believes that it is more likely than not that
future income resulting from operations of the Scrubgrass project will be
sufficient to realize the recorded tax benefits resulting from the Company's
net operating loss carryforwards and reversing temporary differences.
Alternatively, management believes that the Company could implement tax
planning strategies, including the sale or disposition of its lease rights to
the Scrubgrass project to generate sufficient income to realize the recorded
tax benefits. For these reasons, the Company has not recorded a valuation
allowance against its deferred tax asset balance as of December 31, 1995 and
1994.

NOTE K--SHAREHOLDERS' EQUITY

Under the Company's 1986 and 1990 Stock Plans and 1993 Director Plan, the
Company reserved 5,020,540 shares of common stock for issuance upon exercise
of outstanding options in connection with awards or direct

F-15

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE K--SHAREHOLDERS' EQUITY--(CONTINUED)

purchases of stock. The Company also reserved 375,000 shares for issuance upon
exercise of outstanding options granted outside of such plans. Options granted
under these plans were intended to constitute incentive stock options under
the Internal Revenue Code of 1986 or non-qualified options principally at an
option price of 100 percent of the fair market value of the common stock on
the date of the grant (110 percent of the fair market value in the case
officers or other employees holding 10% or more of the Company's common stock
for the 1990 plan). All options are fully vested. Options expire on the 10th
anniversary from the date of the grant. At December 31, 1995, options for all
of the stock reserved under the 1986 and 1990 plans have been granted. Of the
500,000 options under the 1993 Director Plan, 435,000 remain available for
grant.

Stock option transactions during 1995, and 1994 are summarized as follows:

OPTIONS OUTSTANDING
-----------------------
SHARES PRICE
---------- -----------

Balance at January 1, 1994.......................... 1,963,244 $.125- .625
Options granted..................................... 60,000 .5625
---------- -----------
Balance at December 31, 1994........................ 2,023,444 .125- .625
Options granted..................................... 30,000 .25-.4375
Options canceled.................................... (250,000) .5625
Options exercised................................... (1,463,244) .125- .625
---------- -----------
Balance at December 31, 1995........................ 340,000 $ .14-.5625
========== ===========

During 1992, the Company authorized a program to purchase shares or certain
warrants for its outstanding Common Stock through market or other
transactions. As of December 31, 1995, the Company has purchased 988,356
shares, including 498,100 shares purchased during 1995, and warrants to
purchase 600,000 shares for an aggregate of $569,404 at an average price of
$.36 per share.

During 1993 the Company issued 594,356 shares of restricted common stock to
executive officers. The shares are subject to a three-year vesting period
based upon continued employment through November 1996. Unearned compensation
has been charged for the market value of the restricted common stock when
shares were issued. The unearned compensation is amortized ratably over the
restricted period. The unamortized compensation value is $66,941 at December
31, 1995 and 1994. During 1995 and 1994, $80,340 of unearned compensation was
amortized and recorded in the respective statements of operations.

Notes receivable from officers for shares purchased in connection with the
1990 Stock Plan amounted to $834,032 and $401,876 at December 31, 1995 and
1994, respectively, and are classified as a deduction from shareholders'
equity. The notes bear interest at a floating rate, payable monthly, and
principal is payable upon demand by the Company.

In March 1996, the Company purchased 520,540 shares of common stock from a
resigning executive officer for $287,876 representing all of the officer's
holdings in the Company. The Company's note receivable from the officer in the
amount of $72,876 was deducted from the purchase price.

Pursuant to an agreement with Drexel Burnham Lambert Incorporated ("Drexel")
dated January 26, 1990, the Company issued to Drexel 18,740 shares of non-
voting Series A Convertible Preferred Stock, $.01 par value per share (the
Preferred Stock). The Preferred Stock was convertible into common stock at a
ratio of 1:181 and had a liquidation value of $1,874,000. Dividends on the
Preferred Stock accrued at a rate of 14% per annum (total of $1,030,812 at
December 31, 1993) and were payable either in cash out of funds legally
available therefore or, at the option of the Company, in additional shares of
Preferred Stock. On January 24, 1994, the Company entered into an agreement
with Drexel's successor, The DBL Liquidating Trust ("The Trust") under which
the Company acquired the Preferred Stock.

F-16

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Under the agreement the Company acquired the Trust's rights to all of its
Preferred Stock. In addition, the Company was not required to pay dividends
accrued on such Preferred Stock. The agreement also provided that the Company
pay the Trust an aggregate of $1,850,000 over 30 monthly installments
beginning January 1994. During 1994, the Company made monthly installments
aggregating $300,000. On December 31, 1994, the parties agreed to settle the
remaining outstanding obligation for $1,475,000 which was paid on January 5,
1995 and at which time the Preferred Stock was retired (See Note G).

In December 1995, the Company declared and paid a dividend to the
shareholders of its common stock at the rate of $.08 per share totalling
$923,786. On March 4, 1996, the Company declared a first quarter dividend of
$.03 per share.

NOTE L--COMMITMENTS

Corporate

The Company is obligated to make payments under various operating leases for
office space and automotive vehicles. The Company is also obligated under
leases or other agreements relating to the Scrubgrass project (see Note A).

Future minimum payments due under non-cancelable leases in effect at
December 31, 1995, are as follows:

1996................................. $41,385
1997................................. 26,063
1998................................. 21,510
1999................................. 1,500
-------
Total.............................. $90,458
=======

Rent expense totaled $70,722, $56,397 and $74,771 in 1995, 1994 and 1993,
respectively.

Scrubgrass Project

Pursuant to the lease agreement for the Scrubgrass Project the Company is
obligated to make estimated minimum lease payments at December 31, 1995, over
the remaining 20.5 year base term of the lease as follows:

1996............................ $ 12,237,000
1997............................ 12,618,000
1998............................ 13,544,000
1999............................ 13,799,000
2000............................ 14,523,000
Thereafter...................... 385,916,000
------------
Total........................... $452,637,000
============

Lease expense in 1995 and 1994 was $23,020,132 and $10,537,623,
respectively.

F-17

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE L--COMMITMENTS--(CONTINUED)

In addition, the Company has been assigned various long-term noncancelable
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.

Future minimum payments due under these noncancelable obligations at
December 31, 1995, are as follows: (See Notes A and F).

1996.............................. $ 703,000
1997.............................. 731,000
1998.............................. 760,000
1999.............................. 790,000
2000.............................. 821,000
Thereafter........................ 2,438,000
----------
Total............................. $6,243,000
==========

NOTE M--DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
Disclosures about Fair Value of Financial Instruments. The estimated fair
value amounts have been determined by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required in interpreting market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts that the Company could realize in a
current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair
value amounts.

The carrying amount and the estimated fair value of financial instruments is
as follows:

DECEMBER 31, 1995
-----------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
----------- -----------

Assets:
Cash and cash equivalents........................ $ 1,011,822 $ 1,011,822
Other current assets............................. 10,848,531 10,848,531
Notes receivable................................. 1,868,409 1,868,409
Other assets..................................... 15,823,000 15,723,000
Liabilities:
Accounts payable and accrued expenses............ 6,338,160 6,338,160
Other current liabilities........................ 2,298,686 2,298,686
Long-term debt:
Secured promissory notes payable and other
borrowing....................................... 8,543,767 8,543,767
Other liabilities................................ 15,161,689 15,161,689

F-18

ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE M--DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS--(CONTINUED)

The carrying amount and the estimated fair value of financial instruments is
as follows:

DECEMBER 31, 1994
-----------------------
CARRYING ESTIMATED
AMOUNT FAIR VALUE
----------- -----------

Assets:
Cash and cash equivalents........................ $ 356,527 $ 356,527
Other current assets............................. 11,384,637 11,384,637
Notes receivable................................. 3,263,164 3,263,164
Other assets..................................... 5,730,736 5,555,736
Liabilities:
Accounts payable and accrued expenses............ 6,969,386 6,969,386
Other current liabilities........................ 3,559,851 3,559,851
Long-term debt:
Secured promissory notes payable and other
borrowing....................................... 5,971,270 5,971,270
Other liabilities................................ 5,311,324 5,311,324

F-19