NATIONAL ENERGY GROUP INC - 10-K Annual Report

Back to GetFilings.com

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-K

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

OR

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

COMMISSION FILE NO. 0-19136 (COMMON STOCK)
AND 333-9045 (SERIES B SENIOR NOTES)
AND 333-38075 (SERIES D SENIOR NOTES)

NATIONAL ENERGY GROUP, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 58-1922764
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)

4925 GREENVILLE AVENUE
DALLAS, TEXAS 75206
(Address of principal executive offices) (Zip code)

(214) 692-9211
(Registrant's telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE
(Title of Class)

SECURITIES REGISTERED PURSUANT TO SECURITIES ACT OF 1933:
SERIES B SENIOR NOTES, 10 3/4% DUE 2006
SERIES D SENIOR NOTES, 10 3/4% DUE 2006

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 the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]

The aggregate market value of the shares of Common Stock held by
non-affiliates of the Registrant, as of June 30, 2003, (based upon the last
sales price of $.66 as reported by the OTC Bulletin Board) was $7,385,829.

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [X] No [ ]

11,190,650 shares of the Registrant's common stock, $0.01 par value, were
outstanding on March 22, 2004.

Documents Incorporated by Reference: Listed below are documents, parts of
which are incorporated herein by reference and the part of this report into
which the document is incorporated: (1) Proxy Statement for the 2004 Annual
Meeting of Shareholders -- Part III.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

TABLE OF CONTENTS

2

PART I

ITEMS 1. AND 2. BUSINESS AND PROPERTIES

FORWARD-LOOKING STATEMENTS

This document includes "forward-looking statements" within the meaning of
various provisions of the Securities Act of 1933 and the Securities Exchange Act
of 1934, as amended. The words "expect," "estimate," "anticipate," "predict,"
"believe," and similar expressions and variations thereof are intended to
identify forward-looking statements. All statements, other than statements of
historical facts, included in this document that address activities, events, or
developments that National Energy Group, Inc. (the "Company") expects or
anticipates will or may occur in the future, including such things as estimated
future net revenues from oil and natural gas reserves and the present value
thereof, drilling of wells, future production of oil and natural gas, future
capital expenditures (including the amount and nature thereof), business
strategy and measures to implement strategy, competitive strengths, goals,
expansion, and growth of the Company's business and operations, plans,
references to future success, references to intentions as to future matters and
other such matters are forward-looking statements and include statements
regarding the interest, belief or current expectations of the Company, its
directors, or its officers regarding such matters. These statements are based on
certain assumptions and analyses made by the Company in light of its experience
and its perception of historical trends, current conditions and expected future
developments as well as other factors it believes are appropriate under the
circumstances. However, whether actual results and developments will conform
with the Company's expectations and predictions is subject to a number of risks
and uncertainties, including the risk factors discussed in this document, future
oil and natural gas prices, future operating costs, severance and excise taxes,
general economic, market or business conditions, the opportunities (or lack
thereof) that may be presented to and pursued by the Company, competitive
actions by other oil and natural gas companies, changes in laws or regulations,
and other factors, many of which are beyond the control of the Company.
Consequently, all of the forward-looking statements made in this document are
qualified by these cautionary statements and there can be no assurance that the
actual results or developments anticipated by the Company will be realized or,
even if substantially realized, that they will have the expected consequences to
or effects on the Company or its business or operations. Such statements are not
guarantees of future performance and actual results or developments may differ
materially from those projected in the forward-looking statements.

INTRODUCTION

The Company was incorporated under the laws of the State of Delaware on
November 20, 1990. Effective June 11, 1991, Big Piney Oil and Gas Company and VP
Oil, Inc. merged with and into the Company. On August 29, 1996, Alexander Energy
Corporation was merged with and into a wholly-owned subsidiary of the Company,
which subsidiary was merged with and into the Company on December 31, 1996. The
Company is engaged in the business of managing the exploration, development,
production and operations of natural gas and oil properties, primarily located
in Texas, Oklahoma and Louisiana (both onshore and in the Gulf of Mexico). The
Company's headquarters is located in Dallas, Texas.

OWNERSHIP AND CONTROL OF OUTSTANDING STOCK

American Real Estate Holdings L.P. ("AREH") owns 50.1% of the outstanding
common stock of the Company at December 31, 2003. Also, the general partner of
AREH, American Property Investors, Inc. ("API") is an entity indirectly wholly
owned by Carl C. Icahn. As such, the Company may be deemed to be controlled by
an affiliate of Mr. Icahn and his affiliated entities. Certain members of the
Company's Board of Directors have affiliations with various affiliates of AREH,
including Arnos Corp. ("Arnos"), High River Limited Partnership ("High River"),
American Real Estate Partners, LLP ("AREP"), which owns 99% in AREH, API, High
Coast Limited partnership ("High Coast"), Cadus Pharmaceutical Corporation
("Cadus") and Greenville Holding LLC ("Greenville"). Mr. Martin L. Hirsch is the
Executive Vice President of AREH. Mr. Robert J. Mitchell is an employee of
affiliates of Arnos and High River. Mr. Jack G. Wasserman is a member of the
board of directors for both API and Cadus and a member of the API audit
committee. Mr. Icahn is the largest single shareholder of Cadus. Arnos, High
Coast, High River, API,
3

Greenville, AREP and AREH are entities affiliated with Mr. Icahn. It is the
policy of the Company to engage in transactions with related parties on terms,
in the opinion of the Company, that are no less favorable to the Company than
could be obtained from unrelated parties.

BACKGROUND AND RECENT DEVELOPMENTS

On February 11, 1999, the United States Bankruptcy Court for the Northern
District of Texas, Dallas Division ("Bankruptcy Court") entered an involuntary
petition placing the Company under protection of the Bankruptcy Court pursuant
to Title 11, Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy
Proceeding"). On July 24, 2000 the Bankruptcy Court entered a subsequent order
confirming a Plan of Reorganization (the "Plan of Reorganization") jointly
proposed by the Company and the official committee of unsecured creditors, which
Plan of Reorganization became effective on August 4, 2000. The Bankruptcy Court
issued a final decree closing the case effective December 13, 2001. Accordingly,
the Company has effectively settled all matters relating to the Bankruptcy
Proceeding.

NEG HOLDING LLC

As mandated by the Plan of Reorganization and the Bankruptcy Court, NEG
Holding LLC ("Holding LLC"), a Delaware limited liability company, was formed in
August 2000. In exchange for an initial 50% membership interest in Holding LLC,
on September 12, 2001, but effective as of May 1, 2001, the Company contributed
to Holding LLC all of its operating assets and oil and natural gas properties
excluding cash of $4.3 million. In exchange for its initial 50% membership
interest in Holding LLC, Gascon Partners ("Gascon"), an entity owned or
controlled by Carl C. Icahn, contributed (i) its sole membership interest in
Shana National LLC, an oil and natural gas producing company, (ii) cash of $75.2
million, and (iii) a $10.9 million revolving note evidencing borrowings under
the Company's revolving credit facility issued to Arnos. In connection with the
foregoing, Holding LLC initially owns 100% of the membership interest in NEG
Operating LLC ("Operating LLC"), a Delaware limited liability company. Holding
LLC is governed by an operating agreement effective as of May 12, 2001, which
provides for management of Holding LLC by Gascon (the "Holding LLC Operating
Agreement"). All of the oil and natural gas assets contributed by the Company
and all of the oil and natural gas assets associated with Gascon's contribution
to Holding LLC were transferred from Holding LLC to Operating LLC on September
12, 2001, effective as of May 1, 2001.

The assets contributed by the Company to Holding LLC were current assets of
$11.5 million, net oil and natural gas assets of $85.0 million and other assets
of $4.8 million. The liabilities assumed by Holding LLC were current liabilities
of $4.2 million, an intercompany payable to Gascon of $4.8 million and long-term
liabilities of $1.0 million.

THE HOLDING LLC OPERATING AGREEMENT

Pursuant to the Holding LLC Operating Agreement, distributions from Holding
LLC to the Company and Gascon shall be made in the following order.

ORDER OF DISTRIBUTIONS

1. Guaranteed payments ("Guaranteed Payments") are to be paid to the
Company, calculated on an annual interest rate of 10.75% on the outstanding
priority amount (the "Priority Amount"). The Priority Amount includes all
outstanding debt owed to entities owned or controlled by Mr. Carl C. Icahn,
including the amount of the Company's 10.75% Senior Notes (the "Senior Notes").
As of December 31, 2003, the Priority Amount was $148.6 million. The Guaranteed
Payments will be made on a semi-annual basis.

2. The Priority Amount is to be paid to the Company. Such payment is to
occur by November 6, 2006.

3. An amount equal to the Priority Amount and all Guaranteed Payments paid
to the Company, plus any additional capital contributions made by Gascon, less
any distributions previously made by Holding LLC to Gascon, is to be paid to
Gascon.

4

4. An amount equal to the aggregate annual interest (calculated at prime
plus 1/2% on the sum of the Guaranteed Payments), plus any unpaid interest for
prior years (calculated at prime plus 1/2% on the sum of the Guaranteed
Payments), less any distributions previously made by Holding LLC to Gascon, is
to be paid to Gascon.

5. After the above distributions have been made, any additional
distributions will be made in accordance with the ratio of the Company's and
Gascon's respective capital accounts. (Capital accounts as defined in the
Holding LLC Operating Agreement)

It is anticipated that the Priority Amount will be used by the Company to
pay off the Company's indebtedness (currently held by entities owned or
controlled by Carl C. Icahn). The Guaranteed Payments are expected to be
sufficient to make the interest payments on the Company's Senior Notes. Because
of the substantial uncertainty that the Company will receive any distributions
in addition to the Priority Amount and the Guaranteed Payments, the Company
accounts for its investment in Holding LLC as a preferred investment. Guaranteed
Payments received and receipt of the Priority Amount are recorded as reductions
in the investment and income is recognized from accretion of the investment
(based on the interest method) up to the Priority Amount, including the
Guaranteed Payments, and the Company's remaining carrying value of the
investment in Holding LLC will be valued at zero. The Company's membership
interest in Holding LLC is governed by the terms of the Holding LLC Operating
Agreement and is not affected by the accretion of the investment. Cash receipts,
if any, after the Priority Amount and the Guaranteed Payments will be reported
in income as earned.

The Holding LLC Operating Agreement further contains a provision that
allows Gascon, or its successor, at any time, in its sole discretion, to redeem
the Company's membership interest in Holding LLC at a price equal to the fair
market value of such interest determined as if Holding LLC had sold all of its
assets for fair market value and liquidated. A determination of the fair market
value of such assets shall be made by an independent third party jointly engaged
by Gascon and the Company. Since all of the Company's operating assets and oil
and natural gas properties have been contributed to Holding LLC, following such
a redemption, the Company's principal assets would consist solely of its cash
balances. In the event that such redemption right is exercised by Gascon and
there is a subsequent liquidation and distribution of the proceeds, the Company
may be obligated to use the proceeds that it would receive for its redeemed
membership interest to pay outstanding indebtedness and operating expenses
before the distribution of any portion of such proceeds could be made to the
Company's shareholders. Following the payment of the Company's indebtedness,
including the outstanding balance of $148.6 million relating to the Company's
Senior Notes and its operating expenses, there is a substantial risk that there
will be no proceeds remaining for distribution to the Company's shareholders. It
is the present intention of Holding LLC to continue to conduct oil and natural
gas drilling and development activities in the ordinary course of business and
to seek additional reserves.

THE OPERATING LLC MANAGEMENT AGREEMENT

The management and operation of Operating LLC is being undertaken by the
Company pursuant to a Management Agreement (the "Management Agreement") which
the Company has entered into with Operating LLC. However, neither the Company's
officers nor directors will control the strategic direction of Operating LLC's
oil and natural gas business, including oil and natural gas drilling and capital
investments, which shall be controlled by the managing member of Holding LLC
(currently Gascon). The Management Agreement provides that the Company will
manage Operating LLC's oil and natural gas assets and business until the earlier
of November 1, 2006, or such time as Operating LLC no longer owns any of the
managed oil and natural gas properties. The Company's employees will conduct the
day-to-day operations of Operating LLC's oil and natural gas properties, and all
costs and expenses incurred in the operation of the oil and natural gas
properties shall be borne by Operating LLC; although the Management Agreement
provides that the salary of the Company's Chief Executive Officer shall be 70%
attributable to the managed oil and natural gas properties, and the salaries of
each of the General Counsel and Chief Financial Officer shall be 20%
attributable to the managed oil and natural gas properties. In exchange for the
Company's management services, Operating LLC shall pay the Company a management
fee equal to 115% of the actual direct and indirect administrative and
reasonable overhead costs incurred by the Company in operating the oil and
5

natural gas properties which either the Company or Operating LLC may seek to
change within the range of 110%-115% as such change is warranted. However, the
parties have agreed to consult with each other to ensure that such
administrative and reasonable overhead costs attributable to the managed
properties are properly reflected in the management fee paid to the Company. In
addition, Operating LLC has agreed to indemnify the Company to the extent it
incurs any liabilities in connection with its operation of the assets and
properties of Operating LLC, except to the extent of its gross negligence or
misconduct. The Company recorded $6.6 million as a management fee for the year
ended December 31, 2003.

THE REORGANIZED COMPANY

As a result of the foregoing transactions and as mandated by the Plan of
Reorganization effective May 12, 2001, the Company's principal assets were its
remaining cash balances, accounts receivable from affiliates, deferred tax asset
and its initial 50% membership interest in Holding LLC, and its principal
liabilities were the $10.9 million outstanding under its existing $25 million
revolving credit facility with Arnos and its Senior Notes and long-term interest
payable on Senior Notes. None of the Company's employees transferred to Holding
LLC or Operating LLC. The Company remains highly leveraged following
confirmation of the Plan of Reorganization and entry of the final decree closing
the Bankruptcy Proceeding. Further, as a result of the terms and conditions of
the various agreements related to the repayment of the Company's indebtedness to
Arnos and repayment of the Priority Amount and the Guaranteed Payments (plus
accrued interest thereon) to Gascon, there is a substantial risk that there will
be no proceeds remaining for distribution to the Company's shareholders.

SENIOR NOTES/CHARTER AMENDMENT

In August 2001, the Company redeemed both $16.4 million of principal
outstanding under the Senior Note obligations and $4.8 million of long-term
interest payable on Senior Notes for $10.5 million. The Company paid two Arnos
affiliates approximately $0.4 million in current interest on the redeemed Senior
Note obligations at the date of redemption related to interest owed from the
last semi-annual interest payment date of May 1, 2001 to the date of redemption.
As this was a partial redemption of the Senior Notes, it has been accounted for
as a modification of terms that changes the amounts of future cash payments.
Accordingly, the excess of redeemed principal and interest over the redemption
payment, totaling $10.7 million, will be amortized as a reduction to interest
expense over the remaining life of the bonds. In connection with this
transaction, the Company borrowed $10.9 million under its existing credit
facility with Arnos.

On September 9, 2003, following the approval of an amendment to the
Company's Restated Certificate of Incorporation by the shareholders of the
Company and as permitted under the Company's Amended and Restated Certificate of
Incorporation, the Board of Directors approved a request to transfer 49.9% of
the outstanding common stock of the Company held by certain affiliates of Carl
C. Icahn to AREH. On October 2, 2003, the effective date of such transfer, AREH
acquired 5,584,044 shares of common stock of the Company and $148,637,000 in
aggregate principal amount of outstanding Senior Notes due 2006 of the Company,
from entities affiliated with Carl C. Icahn. As a result of the foregoing
transaction and, following the acquisition by AREH of additional shares of
common stock of the Company prior to closing of such transaction, AREH
beneficially owns 50.1% of the issued and outstanding common stock of the
Company.

THE TRANSTEXAS MANAGEMENT AGREEMENT

On August 28, 2003, the Company entered into an agreement (the "TTG
Management Agreement") to manage TransTexas Gas Corporation ("TTG"). The TTG
Management Agreement was entered into in connection with a plan of
reorganization for TTG proposed by Thornwood Associates LP, an entity affiliated
with Carl C. Icahn. The United States Bankruptcy Court, Southern District of
Texas issued an order confirming the TTG Plan of Reorganization, effective
August 29, 2003 (the "TTG Plan"). Affiliates of Mr. Icahn own approximately 89%
of TTG. TTG is engaged in the exploration, production and transmission of
natural gas and oil primarily in South Texas, including the Eagle Bay field in
Galveston Bay, Texas and the Southwest Bonus field located in Wharton County,
Texas. Bob G. Alexander and Philip D. Devlin, President and CEO, and Vice
President, Secretary and General Counsel of the Company, respectively, have been
6

appointed to the TTG Board of Directors and shall act as the two principal
officers of TTG and its subsidiaries, Galveston Bay Pipeline Corporation and
Galveston Bay Processing Corporation.

The TTG Management Agreement provides that the Company shall be responsible
for and have authority with respect to all of the day-to-day management of TTG's
business but shall not function as a Disbursing Agent as such term is defined in
the TTG Plan. As consideration for the Company's services in managing the TTG
business, the Company shall receive a monthly fee of $312,500. The TTG
Management Agreement is terminable (i) upon 30 days prior written notice by TTG,
(ii) upon 90 days prior written notice by the Company, (iii) upon 30 days
following any day where High River designees no longer constitute the TTG Board
of Directors, unless otherwise waived by the newly-constituted Board of
Directors of TTG, or (iv) as otherwise determined by the Bankruptcy Court. The
Company recorded $1.4 million as a management fee for the year ended December
31, 2003.

CREDIT FACILITY

On March 26, 2003, Holding LLC distributed the $10.9 million note
outstanding under the Company's revolving credit facility as a distribution of
Priority Amount to the Company, thereby canceling all outstanding balances due
under the credit facility. Also, on March 26, 2003 the Company, Arnos and
Operating LLC entered into an agreement to assign the existing credit facility
to Operating LLC. Effective with this assignment, Arnos amended the credit
facility to increase the revolving commitment to $150 million, increase the
borrowing base to $75 million and extend the revolving due date until June 30,
2004. Concurrently, Arnos extended a $42.8 million loan to Operating LLC under
the amended credit facility. Operating LLC then distributed $42.8 million to
Holding LLC which, thereafter, made a $40.5 million distribution of Priority
Amount and a $2.3 million Guaranteed Payment to the Company. The Company
utilized these funds to pay the entire amount of the long-term interest on the
Senior Notes and interest accrued thereon outstanding on March 27, 2003.

On December 29, 2003, Operating LLC entered into a Credit Agreement (the
"Credit Agreement") with certain commercial lending institutions, including
Mizuho Corporate Bank, Ltd. as the Administrative Agent and the Bank of Texas,
N.A. and the Bank of Nova Scotia as Co-Agents. The Credit Agreement provides for
a loan commitment amount of up to $100 million and a letter of credit commitment
of up to $15 million (provided, the outstanding aggregate amount of the unpaid
borrowings, plus the aggregate undrawn face amount of all outstanding letters of
credit shall not exceed the borrowing base under the Credit Agreement). As a
condition to the closing of the Credit Agreement, the lenders required that
Operating LLC terminate its secured loan arrangement with Arnos. At the closing
of the Credit Agreement, Operating LLC borrowed $43.8 million to repay $42.9
million owed by Operating LLC to Arnos under the secured loan arrangement which
was then terminated and to pay administrative fees in connection with this
borrowing. As a condition to the lenders obligations under the Credit Agreement,
the lenders required that the Company, Gascon, Holding LLC and Operating LLC
execute and deliver at the closing certain related agreements. (See Note 5 to
the Company's Financial Statements included elsewhere herein).

At December 31, 2003, the Company had no Proved Reserves, due to the
contribution of all oil and natural gas assets to Holding LLC in September 2001.
After the contribution, the Company owns 50% of Holding LLC.

PRINCIPAL AREAS OF OPERATIONS -- PRIOR TO SEPTEMBER 1, 2001

The Company contributed all of its operating assets and oil and natural gas
properties, excluding cash of $4.3 million, to Holding LLC in exchange for an
initial 50% membership interest ("LLC Contribution"). For financial reporting
purposes the transaction is as of September 1, 2001. Due to the LLC
Contribution, the Company had no direct ownership of oil and natural gas
properties at December 31, 2001, December 31, 2002 and at December 31, 2003. The
Company received revenue and incurred expenses from oil and natural gas
properties until September 1, 2001. The following discussion of oil and natural
gas covers periods prior to that date. Effective with the LLC Contribution, all
ownership interests are held by Holding LLC which includes its

7

single member limited liability company, Operating LLC. See "Principal Areas of
Operation -- Holding LLC".

OIL AND NATURAL GAS RESERVES -- PRIOR TO SEPTEMBER 1, 2001

All of the Company's reserves were located in the continental United
States. The Company's reserve report was prepared using constant prices and
costs in accordance with the published guidelines of the Securities and Exchange
Commission ("SEC"). The estimated reserves and related future net revenues as of
August 31, 2001, were prepared internally using the estimated reserves and
related future net revenues prepared by Netherland, Sewell & Associates, Inc. as
of December 31, 2001, for the oil and natural gas properties contributed to
Holding LLC. This was accomplished by adding back the related production for the
four month period August 31, 2001 to December 31, 2001 and using constant prices
in effect at August 31, 2001. The net weighted average prices used in the
Company's reserve report at August 31, 2001, were $26.02 per barrel of oil and
$2.49 per Mcf of natural gas. The estimation of reserves and future net revenues
can be materially affected by the oil and natural gas prices used in preparing
the reserve report. Substantially all of the Company's oil and natural gas
properties were subject to liens, and the remaining oil and natural gas
properties were subject to a negative pledge pursuant to the Company's credit
facility.

All reserves are evaluated at constant temperature and pressure which can
affect the measurement of natural gas reserves. Estimated operating costs,
development costs, abandonment costs, severance taxes and ad valorem taxes were
deducted in arriving at the estimated future net cash flows. No provision was
made for income taxes. The following estimates set forth reserves considered to
be economically recoverable under normal operating methods and existing
conditions at the prices and operating costs prevailing at the dates indicated
above. The estimates of the PV10% from future net cash flows can differ from the
Standardized Measure of discounted future net cash flows set forth in the notes
to the Consolidated Financial Statements of the Company, which is calculated
after provision for future income taxes. There can be no assurance that these
estimates are accurate predictions of future net cash flows from oil and natural
gas reserves or their present value.

Reservoir engineering is a subjective process of estimating the volumes of
underground accumulations of oil and natural gas which cannot be measured
precisely. The accuracy of any reserve estimates is a function of the quality of
available data and of engineering and geological interpretation and judgment.
Reserve estimates prepared by other engineers might differ from the estimates
contained herein. Results of drilling, testing, and production subsequent to the
date of the estimate may justify revision of such estimate. Future prices
received for the sale of oil and natural gas may be different from those used in
preparing these reports. The amounts and timing of future operating and
development costs may also differ from those used. Accordingly, reserve
estimates are often different from the quantities of oil and natural gas that
are ultimately recovered.

No estimates of Proved Reserves of oil and natural gas have been filed by
the Company with, or included in any report to, any United States authority or
agency (other than the SEC) since December 31, 2001.

The following table sets forth certain information for the Company's total
Proved Reserves of oil and natural gas and the PV10% of estimated future net
revenues from such reserves, at August 31, 2001. Also presented is the
Standardized Measure of the Company's total Proved Reserves of oil and natural
gas.

8

OIL AND NATURAL GAS PRODUCTION AND UNIT ECONOMICS -- PRIOR TO SEPTEMBER 1, 2001

The following table shows the approximate net production attributable to
the Company's oil and natural gas interests, the average sales price per barrel
of oil and Mcf of natural gas produced, and the average unit economics per Mcfe
related to the Company's oil and natural gas production for the periods
indicated. Information relating to properties acquired or disposed of is
reflected in this table only since or up to the closing date of their respective
acquisition or sale, and may affect the comparability of the data between the
periods presented.

LEASEHOLD ACREAGE -- PRIOR TO SEPTEMBER 1, 2001

The Company generally acquired a leasehold interest in the properties to be
explored. The leases granted the lessee the right to explore for and extract oil
and natural gas from a specified area. Lease rentals usually consisted of a
fixed annual charge made prior to obtaining production. Once production had been
established, a royalty was paid to the lessor based upon the gross proceeds from
the sale of oil and natural gas. Once wells were drilled, a lease generally
continued as long as production of oil and natural gas continued. In some cases,
leases were acquired in exchange for a commitment to drill or finance the
drilling of a specified number of wells to predetermined depths.

Substantially all of the Company's producing oil and natural gas properties
were located on leases held by the Company for an indeterminate number of years
as long as production was maintained. All of the Company's non-producing acreage
was held under leases from mineral owners or a government entity which expired
at varying dates. The Company was obligated to pay annual delay rentals to the
lessors of certain properties in order to prevent the leases from terminating.
Delay rentals were approximately $.2 million for the eight months ended August
31, 2001.

9

DRILLING ACTIVITY -- PRIOR TO SEPTEMBER 1, 2001

The following table sets forth exploration and development drilling results
for the eight months ended August 31, 2001.

CONTROL OVER PRODUCTION ACTIVITIES -- PRIOR TO SEPTEMBER 1, 2001

The Company operated 303 of the 396 producing wells in which it owned an
interest as of August 31, 2001. The non-operated properties were operated by
unrelated third parties pursuant to operating agreements which are generally
standard in the industry. Significant decisions about operations regarding
non-operated properties have been determined by the outside operator rather than
by the Company. If the Company declined to participate in additional activities
proposed by the outside operator under certain operating agreements, the Company
would not receive revenues from, and/or would lose its interest in the activity
in which it declined to participate.

MARKETS AND CUSTOMERS -- PRIOR TO SEPTEMBER 1, 2001

The availability of a ready market for any oil and natural gas produced by
the Company and the prices obtained for such oil and natural gas depended upon
numerous factors beyond its control, including the demand for and supply of oil
and natural gas; fluctuations in production and seasonal demand; the
availability of adequate pipeline and other transportation facilities; weather
conditions; economic conditions; imports of crude oil; production by and
agreements among OPEC members; and the effects of state and federal governmental
regulations on the import, production, transportation, sale and taxation of oil
and natural gas. The occurrence of any factor that affects a ready market for
the Company's oil and natural gas or reduced the price obtained for such oil and
natural gas, would have adversely affected the Company.

A large percentage of the Company's oil and natural gas sales were made to
a small number of purchasers. For the eight months ended August 31, 2001, Plains
Marketing and Transportation ("Plains") accounted for 95% of the Company's oil
sales, and Aquila Energy Marketing, Crosstex Energy Services, Inc. ("Crosstex
Energy") and Duke Energy Services, Inc. ("Duke Energy") accounted for 26%, 20%
and 15%, respectively, of the Company's natural gas sales.

The agreement with Plains, entered into in 1993, provided for Plains
Marketing to purchase the Company's oil pursuant to West Texas Intermediate
posted prices plus a premium. A portion of the Company's natural gas production
was sold pursuant to long-term netback contracts. Under netback contracts, gas
purchasers buy gas from a number of producers, process the gas for natural gas
liquids, and sell the liquids and residue gas. Each producer receives a fixed
portion of the proceeds from the sale of the liquids, and residue gas. The gas
purchasers pay for transportation, processing, and marketing of the gas and
liquids, and assume the risk of contracting pipelines and processing plants in
return for a portion of the proceeds of the sale of the gas and liquids.
Generally, because the purchasers are marketing large volumes of hydrocarbons
gathered from

10

multiple producers, higher prices may be obtained for the gas and liquids. The
remainder of the Company's natural gas was sold on the spot market under
short-term contracts.

INVESTMENT IN HOLDING LLC

As explained below, the Company's investment in Holding LLC is recorded as
a preferred investment. The initial investment was recorded at historical
carrying value of the net assets contributed with no gain or loss recognized on
the transfer.

Under the Holding LLC Operating Agreement, the Company is to receive
Guaranteed Payments in addition to a Priority Amount of $202.2 million before
Gascon receives any monies. The Priority Amount is to be made on or before
November 1, 2006. Guaranteed Payments are to be paid, on a semi annual basis,
based on an annual interest rate of 10.75% of the outstanding Priority Amount.
After the payments to the Company, Gascon is to receive distributions equivalent
to the Priority Amount and Guaranteed Payments plus other amounts as defined.
Following the above distributions to the Company and Gascon, additional
distributions, if any, are to be made in accordance with their respective
capital accounts. The order of distributions is listed below. Because of the
substantial uncertainty that the Company will receive any distributions above
the Priority Amount and Guaranteed Payment amounts, the Company accounts for its
investment in Holding LLC as a preferred investment.

At inception (September 12, 2001), the Company recorded the investment in
Holding LLC at the historical cost of the oil and gas properties contributed
into the partnership (in exchange for Holding LLC's obligation to pay the
Company the Priority Amount and Guaranteed Payments). Subsequently, the Company
accretes its investment in Holding LLC from the initial investment recorded up
to the Priority Amount, including the Guaranteed Payments, at the implicit rate
of interest, recognizing the accretion income in earnings. Accretion income is
periodically adjusted for changes in the timing of cash flows, if necessary due
to unscheduled cash distributions. Receipt of Guaranteed Payments and the
Priority Amount are recorded as reductions in the preferred investment. The
preferred investment is evaluated quarterly for other than temporary impairment.

Because of the substantial uncertainty that the Company will receive any
distributions in excess of the Priority Amount and the Guaranteed Payments
("residual interest"), the residual interest attributable to the investment in
Holding LLC is valued at zero. Upon payment of the Priority Amount in 2006, the
Company's carrying value of the investment in Holding LLC will be zero. The
Company's membership interest in Holding LLC is governed by the terms of the
Holding LLC Operating Agreement and is not affected by the accretion of the
investment. Cash receipts, if any, after the Priority Amount and the Guaranteed
Payments will be reported in income as earned.

The Holding LLC Operating Agreement requires that distributions shall be
made to both the Company and Gascon as follows:

1. Guaranteed Payments are to be paid to the Company, calculated on an
annual interest rate of 10.75% on the outstanding Priority Amount. The
Priority Amount includes all outstanding debt owed to entities owned or
controlled by Carl C. Icahn, including the amount of the Company's 10.75%
Senior Notes. As of December 31, 2003, the Priority Amount was $148.6
million. The Guaranteed Payments will be made on a semi-annual basis.

2. The Priority Amount is to be paid to the Company. Such payment is
to occur by November 6, 2006.

3. An amount equal to the Priority Amount and all Guaranteed Payments
paid to the Company, plus any additional capital contributions made by
Gascon, less any distribution previously made by Holding LLC to Gascon, is
to be paid to Gascon.

4. An amount equal to the aggregate annual interest (calculated at
prime plus 1/2% on the sum of the guaranteed payments), plus any unpaid
interest for prior years (calculated at prime plus 1/2% on the sum

11

of the guaranteed payments), less any distributions previously made by
Holding LLC to Gascon, is to be paid to Gascon.

5. After the above distributions have been made, any additional
distributions will be made in accordance with the ratio of the Company's
and Gascon's respective capital accounts.

PRINCIPAL AREAS OF OPERATIONS -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

In November 2002, Holding LLC completed the acquisition of producing oil
and natural gas properties in Pecos County, Texas known as Longfellow Ranch
Field. The consideration for this acquisition consisted of $45.4 million in
cash, which was funded from Holding LLC's available cash.

In December 2002, Holding LLC completed the acquisition of additional
interest in Longfellow Ranch Field in Pecos County, Texas. The consideration for
this acquisition consisted of $2.9 million in cash, which was funded from
Holding LLC's available cash.

Holding LLC is developing and exploiting existing properties by drilling
Development and Exploratory Wells, and recompleting and reworking existing
wells. It is anticipated that Holding LLC will continue its drilling operations
on existing properties and will selectively participate in drilling
opportunities generated by third parties.

The following table sets forth Holding LLC's principal areas of operations
and Holding LLC's Proved Reserves of oil and natural gas at December 31, 2003.

The following table sets forth Holding LLC's production by principal area
of operation for the year ended December 31, 2003.

MID-CONTINENT AREA -- AFTER SEPTEMBER 1, 2001

At December 31, 2003, approximately 16.7% (33.1 Bcfe) of Holding LLC's
Proved Reserves were located in the Mid-Continent area in Oklahoma and West
Arkansas which includes the Anadarko and Arkoma Basins.

Anadarko Basin. The Anadarko Basin properties are located throughout
central and west Oklahoma. Anadarko Basin is among the most prolific
petroliferous basins of the continental United States. Major tectonic features,
regional facies changes, and significant unconformities provide the trapping
mechanisms for

12

the accumulation of oil and natural gas. The sedimentary sequence is represented
by a wide variety of lithologic units ranging in age from Cambrian through
Permian. The Anadarko Basin is considered a mature oil and natural gas province
characterized by multiple producing horizons and long-lived and predictable
reserves with low cost operations. Most Anadarko Basin reserves are produced
from formations at depths ranging from approximately 5,000 to 15,000 feet.
Drilling a producing well on these locations can convert proved undeveloped
reserves to proved developed producing reserves, and can provide additional
proved undeveloped locations on the Company's leasehold acreage.

During the year ended December 31, 2003, Holding LLC drilled 2 Gross (.24
Net) Development Wells in the Anadarko Basin which were completed as
commercially productive.

Arkoma Basin. The Arkoma Basin properties are located in southeast
Oklahoma and northwest Arkansas. The basin is approximately 250 miles long and
30 to 50 miles wide. The region is essentially a non-associated dry gas
province. Most of the basin is of Atokan (Pennsylvanian) Age and is noted by an
abundance of east-west trending anticlines and synclines, usually faulted along
their axes and expressed at the surface. The Arkoma Basin is considered a mature
natural gas province characterized by multiple producing horizons and long-lived
and predictable reserves with low cost operations. Most Arkoma Basin reserves
are produced from formations at depths ranging from approximately 3,000 to 8,000
feet. The principle productive formations are Atokan and, to a lesser extent,
Morrowan sandstones deposited as deltaic channel sands.

During the year ended December 31, 2003, Holding LLC drilled 2 Gross (1.07
Net) Development Wells in the Arkoma Basin which were completed as commercially
productive.

EAST AND WEST TEXAS AREA -- AFTER SEPTEMBER 1, 2001

At December 31, 2003, approximately 74.2% (146.7 Bcfe) of Holding LLC's
Proved Reserves were located in the East and West Texas area, including East
Texas, South Arkansas and in West Texas, the Goldsmith Adobe Unit and Longfellow
Ranch Field.

East Texas Basin. The reserves in this region are found in the Cotton
Valley formation and the Travis Peak formation. These properties produce from
low permeability reservoirs that generally contain relatively long-lived
reserves. A significant portion of the cost to complete Cotton Valley wells is
incurred due to the low permeability of interbedded sandstones and shales, which
requires large hydraulic fracture stimulation, typically of multiple zones of
the producing formation, to obtain the increased production levels necessary to
make such wells commercially viable. Cotton Valley production occurs in a mature
natural gas province characterized by long-lived reserves producing from
formations at depths ranging from 8,500 to 10,500 feet. Travis Peak is
considered to be a mature oil province characterized by long-lived reserves
producing from formations at a depth of 7,200 feet.

During the year ended December 31, 2003, Holding LLC drilled 8 Gross (8.0
Net) Development Wells in the East Texas Basin, which were completed as
commercially productive.

West Texas. The following fields comprise the West Texas area:

- Goldsmith Adobe Unit ("GAU") is located in the Permian Basin of West
Texas. Holding LLC now owns a 99.9% working interest in this property.
Originally the GAU was drilled on 40-acre spacing units. Previous
operators had drilled several wells on 20-acre spacing units and, based
on the results of this drilling and 20-acre spacing development on
adjoining leases, National Energy Group, Inc. ("NEG") began a drilling
program in July 1994 to develop the GAU on 20-acre spacing units.
Typically, wells drilled at the GAU produce from the Upper Clearfork
formation at an average depth of 6,100 feet.

During the year ended December 31, 2003, Holding LLC drilled 12 Gross (12
Net) Development Wells at the GAU which were completed as commercially
productive.

- Longfellow Ranch Field and associated producing fields are located in the
Val Verde Basin, a prolific gas producing area. Longfellow Ranch Field
(Pinion Field) was discovered in 1983 by Fina Oil and Gas, but was not
extensively developed due to lack of necessary pipeline and associated
facilities. Riata
13

Energy Inc. acquired the field in 1996 and began an extensive development
program. The field is located near the leading edge of the Marathon
thrust belt, where massive sheets of basin-ward Pennsylvanian,
Mississippian and Devonian age rocks were thrust over the shelf onto
deposits of similar age. The thrust belt in this region is further
overlain by early Pennsylvanian and Permian sediments. The primary
producing horizons in the field are the Caballos Novaculites of Devonian
age. These sediments were deposited as laminated cherts ranging in
thicknesses from 75 to over 800 feet thick. Additional producing horizons
include the lower Pennsylvanian Dimple and upper Mississippian Tesnus
formations. The Dimple is a shelf limestone deposit of Atokan or Morrowan
age and the Tesnus is a clastic sandstone sequence. Other objectives
include a normal stratigraphic section of Devonian, Silurian and
Ordovician. These horizons have produced north of the Marathon thrust
belt, where the structures can produce over a TCF of gas. The Longfellow
Ranch Field is not delineated by any dry holes and is considered to be
immature in its oil and gas development. This field presents great
opportunities, both recognized and yet to be recognized.

During the year ended December 31, 2003, Holding LLC drilled 10 Gross (3.8
Net) Development Wells and 29 Gross (7.9 Net) Exploratory Wells in Longfellow
Ranch Field all of which were completed as commercially productive. During the
same period Holding LLC drilled 1 Gross (.1 Net) Exploratory Well that was not
completed as commercially productive.

GULF COAST AREA -- AFTER SEPTEMBER 1, 2001

At December 31, 2003, approximately 9.1% (18 Bcfe) of Holding LLC's Proved
Reserves were located in the Gulf Coast area which includes South Louisiana and
South Texas.

The Gulf Coast area encompasses the large coastal plain from the
southernmost tip of Texas through the southern portion of Louisiana. These rocks
are comprised of sediments ranging from the Cretaceous through the Tertiary in
age. Our production ranges in depth from as shallow as several thousand feet to
in excess of 14,000 feet. New technology, including the use of 3-D seismic with
subsurface mapping, has yielded many new opportunities in the entire coastal
area. The Company is involved in many projects using 3-D seismic technology.

During the year ended December 31, 2003, Holding LLC drilled 2 Gross (1
Net) Development Wells in the Gulf coast area, which were completed as
commercially productive. During the same period Holding LLC drilled 1 Gross (.13
Net) Exploratory Well and 1 Gross (.4 Net) Development Well that were not
completed as commercially productive.

OIL AND NATURAL GAS RESERVES -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

The estimated proved reserves and related future net revenues as of
December 31, 2003, were prepared by Netherland, Sewell & Associates, Inc.,
DeGolyer and MacNaughton and Prator Bett, LLC. All of Holding LLC's reserves are
located in the continental United States. Holding LLC's reserve report was
prepared using constant prices and costs in accordance with the published
guidelines of the Securities and Exchange Commission ("SEC"). The net weighted
average prices used in Holding LLC's reserve report at December 31, 2003, were
$31.14 per barrel of oil and $5.87 per Mcf of natural gas. The estimation of
reserves and future net revenues can be materially affected by the oil and
natural gas prices used in preparing the reserve report.

All reserves are evaluated at constant temperature and pressure which can
affect the measurement of natural gas reserves. Estimated operating costs,
development costs, abandonment costs, severance taxes and ad valorem taxes were
deducted in arriving at the estimated future net cash flows. No provision was
made for income taxes. The following estimates set forth reserves considered to
be economically recoverable under normal operating methods and existing
conditions at the prices and operating costs prevailing at the dates indicated
above. The estimates of the PV10% from future net cash flows can differ from the
Standardized Measure of discounted future net cash flows set forth in the notes
to the Consolidated Financial Statements of Holding LLC, which is calculated
after provision for future income taxes. There can be no assurance that

14

these estimates are accurate predictions of future net cash flows from oil and
natural gas reserves or their present value.

Reservoir engineering is a subjective process of estimating the volumes of
underground accumulations of oil and natural gas which cannot be measured
precisely. The accuracy of any reserve estimates is a function of the quality of
available data and of engineering and geological interpretation and judgment.
Reserve estimates prepared by other engineers might differ from the estimates
contained herein. Results of drilling, testing, and production subsequent to the
date of the estimate may justify revision of such estimate. Future prices
received for the sale of oil and natural gas may be different from those used in
preparing these reports. The amounts and timing of future operating and
development costs may also differ from those used. Accordingly, reserve
estimates are often different from the quantities of oil and natural gas that
are ultimately recovered.

The following table sets forth certain information for Holding LLC's total
Proved Reserves of oil and natural gas and the PV10% of estimated future net
revenues from such reserves, at December 31, 2003. Also presented is the
Standardized Measure of Holding LLC's total Proved Reserves of oil and natural
gas.

OIL AND NATURAL GAS PRODUCTION AND UNIT ECONOMICS -- HOLDING LLC -- AFTER
SEPTEMBER 1, 2001

The following table shows the approximate net production attributable to
the Holding LLC's oil and natural gas interests, the average sales price per
barrel of oil and Mcf of natural gas produced, and the average unit economics
per Mcfe related to Holding LLC's oil and natural gas production for the period
indicated. Information relating to properties acquired or disposed of is
reflected in this table only since or up to the closing date of their respective
acquisition or sale.

15

PRODUCTIVE WELL SUMMARY -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

Holding LLC's production of oil and natural gas is primarily derived from
wells located in Texas, Oklahoma, Louisiana, and Arkansas. The following table
sets forth Holding LLC's interests in Productive Wells, by principal area of
operation, as of December 31, 2003:

LEASEHOLD ACREAGE -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

The following table shows the approximate Gross and Net Acres in which
Holding LLC had a leasehold interest as of December 31, 2003:

Holding LLC generally acquires a leasehold interest in the properties to be
explored. The leases grant the lessee the right to explore for and extract oil
and natural gas from a specified area. Lease rentals usually consist of a fixed
annual charge made prior to obtaining production. Once production has been
established, a royalty is paid to the lessor based upon the gross proceeds from
the sale of oil and natural gas. Once wells are drilled, a lease generally
continues as long as production of oil and natural gas continues. In some cases,
leases may be acquired in exchange for a commitment to drill or finance the
drilling of a specified number of wells to predetermined depths.

Substantially all of Holding LLC's producing oil and natural gas properties
are located on leases held by Holding LLC for an indeterminate number of years
as long as production is maintained. All of Holding LLC's non-producing acreage
is held under leases from mineral owners or a government entity which expire at
varying dates. Holding LLC is obligated to pay annual delay rentals to the
lessors of certain properties in order to prevent the leases from terminating.
Delay rentals were approximately $.01 million for the four months ended December
31, 2001 and $0.07 million and $0.08 million for the years ended December 31,
2002 and 2003 and could increase or decrease in future periods depending on
Holding LLC's lease acquisition activities.

16

DRILLING ACTIVITY -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

The following table sets forth Holding LLC's exploration and development
drilling results for the four months ended December 31, 2001 and the years ended
December 31, 2002 and 2003.

TITLE TO OIL AND NATURAL GAS PROPERTIES -- HOLDING LLC -- AFTER SEPTEMBER 1,
2001

Holding LLC has acquired interests in producing wells and undeveloped
acreage in the form of Working Interests, Royalty Interests, and Overriding
Royalty Interests. To reduce Holding LLC's financial exposure in any one
prospect, Holding LLC often acquires less than 100% of the Working Interest in a
prospect. Working Interests held by Holding LLC may, from time to time, become
subject to minor liens. Prior to an acquisition, due diligence investigations
are made in accordance with standard practices in the industry, which may
include securing an acquisition title opinion.

PRODUCTION AND SALES PRICES -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

Holding LLC produces oil and natural gas solely in the continental United
States. Holding LLC has no obligations to provide a fixed and determinable
quantity of oil and/or natural gas in the future under existing contracts or
agreements. Nor does Holding LLC refine or process the oil and natural gas it
produces, but sells the production to unaffiliated oil and natural gas
purchasing companies in the area in which it is produced. Holding LLC expects to
sell crude oil on a market price basis and to sell natural gas under contracts
to both interstate and intrastate natural gas pipeline companies. Holding LLC
currently sells a significant portion of oil pursuant to a contract with Plains
Marketing and Transportation. See "-- Markets and Customers -- Holding LLC."

CONTROL OVER PRODUCTION ACTIVITIES -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

Holding LLC operated 395 of the 645 producing wells in which it owned an
interest as of December 31, 2003. The non-operated properties are operated by
unrelated third parties pursuant to operating agreements which are generally
standard in the industry. Significant decisions about operations regarding
non-operated properties may be determined by the outside operator rather than by
Holding LLC. If Holding LLC declines to participate in additional activities
proposed by the outside operator under certain operating agreements, Holding LLC
will not receive revenues from, and/or will lose its interest in the activity in
which it declined to participate.

MARKETS AND CUSTOMERS -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

The availability of a ready market for any oil and natural gas produced by
Holding LLC and the prices obtained for such oil and natural gas depend upon
numerous factors beyond its control, including the demand

17

for and supply of oil and natural gas; fluctuations in production and seasonal
demand; the availability of adequate pipeline and other transportation
facilities; weather conditions; economic conditions; imports of crude oil;
production by and agreements among OPEC members; and the effects of state and
federal governmental regulations on the import, production, transportation, sale
and taxation of oil and natural gas. The occurrence of any factor that affects a
ready market for Holding LLC's oil and natural gas or reduces the price obtained
for such oil and natural gas, may adversely affect Holding LLC.

A large percentage of Holding LLC's oil and natural gas sales are made to a
small number of purchasers. For the year ended December 31, 2003, Plains
accounted for 93.9% of Holding LLC's oil sales and Riata Energy Company,
Seminole Energy Services and Crosstex Energy accounted for 49.1%, 11.7% and
14.90%, respectively of Holding LLC's gas sales. For the year ended December 31,
2002, Plains accounted for 83.1% of Holding LLC's oil sales and Crosstex Energy,
Duke Energy and Oneok Gas Marketing Company accounted for 20%, 11% and 10%,
respectively, of Holding LLC's material natural gas sales. For the four months
ended December 31, 2001, Plains accounted for 83% of Holding LLC's oil sales,
and Aquila Energy Marketing, Crosstex Energy and Copano Field Services accounted
for 17% and 15% and 13%, respectively, of Holding LLC's natural gas sales.
Holding LLC does not believe that the loss of any purchaser would have a
material adverse effect on its business because, under prevailing market
conditions, other purchasers are readily available.

The agreement with Plains, entered into in 1993, provides for Plains to
purchase Holding LLC's oil pursuant to West Texas Intermediate posted prices
plus a premium. A portion of Holding LLC's natural gas production is sold
pursuant to long-term netback contracts. Under netback contracts, gas purchasers
buy gas from a number of producers, process the gas for natural gas liquids, and
sell the liquids and residue gas. Each producer receives a fixed portion of the
proceeds from the sale of the liquids, and residue gas. The gas purchasers pay
for transportation, processing, and marketing of the gas and liquids, and assume
the risk of contracting pipelines and processing plants in return for a portion
of the proceeds of the sale of the gas and liquids. Generally, because the
purchasers are marketing large volumes of hydrocarbons gathered from multiple
producers, higher prices may be obtained for the gas and liquids. The remainder
of Holding LLC's natural gas is sold on the spot market under short-term
contracts.

Although Holding LLC acquired certain hedge contracts with Enron North
America Corp. associated with the oil and gas assets contributed by the Company
pursuant to the Plan of Reorganization, the bankruptcy of Enron Corp. and Enron
North America Corp. et al did not have a material effect on Holding LLC's
continuing operations. Holding LLC recorded a $4.6 million non cash valuation
writedown related to the cancellation of existing hedge contracts with Enron
during the four months ended December 31, 2001.

REGULATION -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

General. Holding LLC's oil and natural gas exploration, production, and
related operations are subject to extensive rules and regulations promulgated by
federal and state agencies. Failure to comply with such rules and regulations
can result in substantial penalties. The regulatory burden on the oil and
natural gas industry increases Holding LLC's cost of doing business and affects
its profitability. Because such rules and regulations are frequently amended or
interpreted by federal and state agencies or jurisdictions, the Company is
unable to predict the future cost or impact of complying with such laws. Holding
LLC believes that it operates in compliance with all federal, state and local
regulations.

Exploration and Production. Holding LLC's exploration and development
operations are subject to various types of regulation at the federal, state, and
local levels. Such regulation includes requiring permits for the drilling of
wells; maintaining bonding requirements in order to drill or operate wells; and
regulating the location of wells, the method of drilling and casing wells, the
surface use and restoration of properties upon which wells are drilled, and the
plugging and abandoning of wells. Holding LLC's operations are also subject to
various conservation regulations and rules to protect the correlative rights of
mineral interest owners. These include the regulation of the size of drilling
and spacing units or proration units, the density of wells which may be drilled,
and the unitization or pooling of oil and natural gas properties. In this
regard, some states allow the forced pooling or integration of tracts to
facilitate exploration, while other states rely on voluntary pooling

18

of land and leases. In addition, some state conservation laws establish maximum
rates of production from oil and natural gas wells, generally prohibit the
venting or flaring of natural gas, and impose certain requirements regarding the
ratability of production. The effect of these regulations is to limit the
amounts of oil and natural gas Holding LLC can produce from its wells and to
limit the number of wells or the locations at which Holding LLC can drill.
Legislation in Oklahoma and regulatory action in Texas governs the methodology
by which the regulatory agencies establish permissible monthly production
allowables. Holding LLC cannot predict what effect any change in prorationing
regulations might have on its production and sales of natural gas.

Certain of Holding LLC's Oil, Gas and Mineral Leases are granted by the
federal government and administered by various federal agencies. Such leases
require compliance with detailed federal regulations and orders which regulate,
among other matters, drilling and operations on these leases and calculation and
disbursement of royalty payments to the federal government. The Mineral Lands
Leasing Act of 1920 places limitations on the number of acres under federal
leases that may be owned in any one state.

Environmental Protection and Occupational Safety. Holding LLC is subject
to numerous federal, state and local laws and regulations governing the release
of materials into the environment or otherwise relating to environmental
protection. These laws and regulations may require the acquisition of a permit
before drilling commences, restrict the types, quantities and concentration of
various substances that can be released into the environment in connection with
drilling and production activities, limit or prohibit drilling activities on
certain lands lying within wilderness, wetlands and other protected areas, and
impose substantial liabilities for pollution resulting from operations.
Moreover, the recent trend toward stricter standards in environmental
legislation and regulation is likely to continue. It is not anticipated that
Holding LLC will be required in the near future to expend amounts that are
material in relation to its total capital expenditure program by reason of
environmental laws and regulations. Because such laws and regulations are
frequently changed, Holding LLC is unable to predict the ultimate cost and
effects of such compliance.

The Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without regard
to fault or the legality of the original conduct, on certain classes of persons
who are considered to have contributed to the release or threatened release of a
"hazardous substance" into the environment. These persons include the owner or
operator of the disposal site or sites where the release occurred and companies
that disposed or arranged for the disposal of the hazardous substances. Under
CERCLA, such persons or companies may be subject to joint and several
liabilities for the costs of cleaning up the hazardous substances that have been
released into the environment and for damages to natural resources. Also, it is
not uncommon for neighboring landowners and other third parties to file claims
for personal injury, property damage, and recovery of response costs allegedly
caused by hazardous substance released into the environment.

In addition, the U.S. Oil Pollution Act of 1990 (the "OPA") and regulations
promulgated pursuant thereto impose a variety of regulations on responsible
parties related to the prevention of oil spills and liability for damages
resulting from such spills. The OPA establishes strict liability for owners of
facilities that are the site of a release of oil into "waters of the United
States." While OPA liability more typically applies to facilities near
substantial bodies of water, at least one district court has held that OPA
liability can attach if the contamination could enter waters that may flow into
navigable waters.

The Resource Conservation and Recovery Act ("RCRA") and regulations
promulgated thereunder govern the generation, storage, transfer and disposal of
hazardous wastes. RCRA, however, currently excludes from the definition of
hazardous wastes "drilling fluids, produced waters, and other wastes associated
with the exploration, development, or production of crude oil, natural gas, or
geothermal energy." Because of this exclusion, many of Holding LLC's operations
are exempt from RCRA regulation. Nevertheless, Holding LLC must comply with RCRA
regulations for any of its operations that do not fall within the RCRA exclusion
(such as painting activities or use of solvents). On August 8, 1998, EPA added
four petroleum refining wastes to the list of RCRA hazardous wastes. The impact
is not likely to be any more burdensome to Holding LLC than to any other
similarly situated company involved in oil and natural gas exploration and
production.

19

Because oil and natural gas exploration, production and other activities
have been conducted at some of Holding LLC's properties by previous owners and
operators, materials from these operations may remain on some of the properties
and in some instances require remediation. In addition, Holding LLC has agreed
to indemnify some sellers of producing properties from whom Holding LLC has
acquired reserves against certain liabilities for environmental claims
associated with such properties. While Holding LLC does not believe that costs
to be incurred by Holding LLC for compliance and remediating previously or
currently owned or operated properties will be material, there can be no
guarantee that such costs will not result in future material expenditures.

Additionally, in the course of Holding LLC's routine oil and natural gas
operations, surface spills and leaks, including casing leaks of oil or other
materials occasionally occur, and as a result, Holding LLC incurs costs for
waste handling and environmental compliance. Moreover, Holding LLC is able to
control directly the operations of only those wells for which it acts as the
operator. Notwithstanding Holding LLC's lack of control over wells in which
Holding LLC owns an interest but is operated by others, the failure of the
operator to comply with applicable environmental regulations may, in certain
circumstances, be attributable to Holding LLC.

Holding LLC is also subject to laws and regulations concerning occupational
safety and health. While it is not anticipated that Holding LLC will be required
in the near future to expend amounts that are material in the aggregate to
Holding LLC's overall operations by reason of occupational safety and health
laws and regulations, Holding LLC is unable to predict the ultimate cost of
future compliance.

Marketing and Transportation. Federal legislation and regulatory controls
in the United States have historically affected the price of the natural gas
produced by Holding LLC and the manner in which such production is marketed. The
transportation and sales for resale of natural gas in interstate commerce are
regulated pursuant to the Natural Gas Act of 1938 (the "NGA") and the Federal
Energy Regulatory Commission ("FERC") regulations promulgated thereunder.
Maximum selling prices of certain categories of natural gas, whether sold in
interstate or intrastate commerce, previously were regulated pursuant to The
Natural Gas Policy Act of 1978 ("NGPA"). The NGPA established various categories
of natural gas and provided for graduated deregulation of price controls of
several categories of natural gas and the deregulation of sales of certain
categories of natural gas. All price deregulation contemplated under the NGPA
has already taken place. Subsequently, the Natural Gas Wellhead Decontrol Act of
1989 (the "Decontrol Act") terminated all remaining NGA and NGPA price and
non-price controls on wellhead sales of domestic natural gas on January 1, 1993.
While natural gas producers may currently make sales at uncontrolled market
prices, Congress could re-enact price controls in the future.

In April 1992, the FERC issued its restructuring rule, known as Order No.
636 ("Order No. 636"), that has had a major impact on pipeline operations,
services, and rates. The most significant provisions of Order No. 636: (i)
required interstate pipelines to provide firm and interruptible transportation
solely on an "unbundled" basis, separate from their sales service, and to
convert each pipeline's bundled firm sales service into unbundled firm
transportation service; (ii) provided for the issuance of blanket certificates
to pipelines to provide unbundled sales service giving all utility customers a
chance to purchase their firm supplies from non-pipeline merchants; (iii)
required that pipelines provide firm and interruptible transportation service on
a basis that is equal in quality for all natural gas supplies, whether purchased
from the pipeline or elsewhere; (iv) required that pipelines provide a new,
non-discriminatory "no-notice" transportation service that largely replicates
the "bundled" sales service previously provided by pipelines; (v) established
two new, generic programs for the reallocation of firm pipeline capacity; (vi)
required that all pipelines offer access to their storage facilities on a firm
and interruptible basis; (vii) provided for pregranted abandonment of pipeline
sales agreements, interruptible and firm short-term (defined as one year or
less) transportation agreements and conditional pregranted abandonment of firm
long-term transportation service; (viii) modified transportation rate design by
requiring that all fixed costs related to transportation be recovered through
the reservation charge; and (ix) provided mechanisms for the recovery by
pipelines of certain transition costs occurring from implementation of Order No.
636.

20

The rules contained in Order No. 636, as amended by Order No. 636-A (issued
in August 1992) and Order No. 636-B (issued in November 1992) (collectively,
"Order No. 636"), are far-reaching and complex. While Order No. 636 does not
directly regulate natural gas producers such as Holding LLC, the FERC has stated
that Order No. 636 is intended to foster increased competition within the gas
industry.

OPERATIONAL HAZARDS AND INSURANCE -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

Holding LLC's operations are subject to all of the risks inherent in oil
and natural gas exploration, drilling and production. These hazards can result
in substantial losses to Holding LLC due to personal injury and loss of life,
severe damage to and destruction of property and equipment, pollution or
environmental damage, or suspension of operations. Holding LLC maintains
insurance of various types customary in the industry to cover its operations and
believes it is insured prudently against certain of these risks. In addition,
Holding LLC maintains operator's extra expense coverage that provides coverage
for the care, custody and control of wells drilled by Holding LLC. Holding LLC's
insurance does not cover every potential risk associated with the drilling and
production of oil and natural gas. As a prudent operator, Holding LLC does
maintain levels of insurance customary in the industry to limit its financial
exposure in the event of a substantial environmental claim resulting from sudden
and accidental discharges. However, 100% coverage is not maintained. The
occurrence of a significant adverse event, the risks of which are not fully
covered by insurance, could have a material adverse effect on Holding LLC's
financial condition and results of operations. Moreover, no assurance can be
given that Holding LLC will be able to maintain adequate insurance in the future
at rates it considers reasonable. Holding LLC believes that it operates in
compliance with government regulations and in accordance with safety standards
which meet or exceed industry standards.

COMPETITION -- HOLDING LLC -- AFTER SEPTEMBER 1, 2001

The oil and natural gas industry is intensely competitive in all of its
phases. Holding LLC, which is a small competitive factor in the industry,
encounters strong competition from major oil companies, independent oil and
natural gas concerns, and individual producers and operators, many of which have
financial resources, staffs, facilities and experience substantially greater
than those of Holding LLC. Furthermore, in times of high drilling activity,
exploration for and production of oil and natural gas may be affected by the
availability of equipment, labor, supplies and by competition for drilling rigs.
Holding LLC cannot predict the effect these factors will have on its operations.
Holding LLC owns no drilling rigs, and therefore will be dependent on third
parties for any future drilling. Furthermore, the oil and natural gas industry
also competes with other industries in supplying the energy and fuel
requirements of industrial, commercial, and individual consumers.

OFFICE SPACE

The Company leases approximately 25,000 square feet of office space in
Dallas, Texas. The Company also leases a small amount of office space in Odessa
and Halletsville, Texas, Yukon, Oklahoma and Iberville Parish, Louisiana for its
business activities.

EMPLOYEES

On March 22, 2004, the Company had 77 full-time employees. Of these
employees, 32 are field-related personnel. The Company does not have any
collective bargaining agreements with employees and believes that relations with
its employees are generally satisfactory.

ACCESS TO PUBLIC FILINGS

The Company provides public access to its annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
these reports filed with the SEC under the Securities Exchange Act of 1934.
These documents may be accessed free of charge on the Company's website at the
following address: http://www.negx.com. These documents are provided as soon as
is practicable after filing with the SEC. These documents may also be found at
the SEC's website at http://www.sec.gov. This

21

website address is intended to be an inactive, textual reference only, and none
of the material on this website is part of this report.

ITEM 3. LEGAL PROCEEDINGS

On July 7, 2003, the Company filed a request with the American Arbitration
Association for dispute resolution of a claim in the amount of $21,000 against
Osprey Petroleum Company, Inc. ("Osprey") arising out of Osprey's failure to
post bond for certain plugging and abandonment liabilities associated with oil
and gas properties sold by the Company to Osprey in September 2000. Osprey has
counterclaimed against the Company and its affiliates (Holding LLC and Operating
LLC) in an amount up to $15 million, alleging fraud and breach of contract
related to the sale of such oil and gas properties. The Purchase and Sale
Agreement transferring the properties from the Company to Osprey provides for
dispute resolution through binding arbitration utilizing arbitrator(s)
experienced in oil and gas transactions. The exclusive venue for any such
arbitration is in Dallas, Texas, and the binding, nonappealable judgment by the
arbitrator(s) may be entered in any court having competent jurisdiction.

The Company will vigorously defend against the Osprey counterclaim, which
the Company believes to be without merit. It is the Company's belief that the
ultimate resolution of the arbitration will not have a material adverse effect
on the Company's financial condition or results of operations.

With respect to certain claims of the Company against Enron North America
Corp. relating to the oil and natural gas properties contributed to Holding LLC,
a representative of the Company has been appointed to the official committee of
unsecured creditors in the Enron bankruptcy proceeding, and the Company has
filed a claim for damages in that bankruptcy proceeding. This claim represents a
hedge against future oil and natural gas prices and does not reflect a cash gain
or loss. Any recoveries from Enron North America Corp. will become the property
of Operating LLC as a result of the LLC Contribution.

Other than routine litigation incidental to its business operations which
are not deemed by the Company to be material, there are no additional legal
proceedings in which the Company nor Operating LLC, is a defendant.

The Company's Plan of Reorganization became effective August 4, 2000 and
the Bankruptcy Court issued a final decree effective December 13, 2001 closing
the case.

22

PART II

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

NONE.

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

MARKET INFORMATION

The Company's common stock currently trades on the OTC Bulletin Board. The
Company's common stock trades under the symbol "NEGI". The following table sets
forth, for the periods indicated, the high and low closing sales prices as
reported on the OTC Bulletin Board. The quotations represent prices between
dealers in securities and may not include retail mark-up, mark-down, or
commission and may not represent actual transactions.

On March 22, 2004, the latest practicable date for providing price
information, the last quoted price for the Company's common stock was $3.50.

HOLDERS

As of March 22, 2004, the Company had approximately 7,500 record holders of
its shares of common stock, including multiple nominee holders for an
undetermined number of beneficial owners.

DIVIDENDS ON COMMON STOCK

The Company has never paid cash dividends on its common stock and does not
expect to declare cash dividends in the foreseeable future.

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected historical financial and operating
data with respect to the Company as of and for each of the five years in the
period ended December 31, 2003. The financial data was derived from the
historical financial statements of the Company. This information is not
necessarily indicative of the Company's future performance. The financial data
set forth below should be read in conjunction with "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the consolidated financial statements and the related notes thereto of the
Company included elsewhere herein.

23

- ---------------

(1) Reflects the revenues, results of operations, and production subsequent to
the dates of acquisitions of various oil and natural gas properties that
affect the comparability of the data presented.

(2) Accrual of interest on the Company's Senior Notes was discontinued during
the Bankruptcy Proceeding. Approximately $17.7 million and $10.5 million of
additional interest expense would have been recognized by the Company during
1999 and 2000, respectively, if not for the discontinuation of the interest
accrual.

(3) Due to the Chapter 11 proceedings, these measurements are not meaningful for
the year ended December 31, 1999 and have not been presented. See Notes 1, 5
and 6 in Notes to Consolidated Financial Statements.

(4) Due to the Chapter 11 proceedings, this measurement is not meaningful as of
December 31, 1999 and has not been presented. See Note 6 in Notes to
Consolidated Financial Statements.

(5) Operating data is included only through August 31, 2001 when the oil and
natural gas assets were contributed to Holding LLC.

(6) The Company had no oil and natural gas operations during 2002 and 2003 as
all the oil and natural gas assets were contributed to Holding LLC effective
August 31, 2001.

(7) See Note 10 in Notes to Consolidated Financial Statements.

25

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

The following discussion should be read in conjunction with the Company's
Financial Statements and "Selected Financial Data" and respective notes thereto,
included elsewhere herein. The information below should not be construed to
imply that the results discussed herein will necessarily continue into the
future or that any conclusion reached herein will necessarily be indicative of
actual operating results in the future. Such discussion only represents the best
present assessment by management of the Company.

INTRODUCTION

The Company was incorporated under the laws of the State of Delaware on
November 20, 1990. Effective June 11, 1991, Big Piney Oil and Gas Company and VP
Oil, Inc. merged with and into the Company. On August 29, 1996, Alexander Energy
Corporation was merged with and into a wholly-owned subsidiary of the Company,
which subsidiary was merged with and into the Company on December 31, 1996. The
Company is engaged in the business of managing the exploration, development,
production and operations of natural gas and oil properties, primarily located
in Texas, Oklahoma and Louisiana (both onshore and in the Gulf of Mexico). The
Company's headquarters is located in Dallas, Texas.

OWNERSHIP AND CONTROL OF OUTSTANDING STOCK

American Real Estate Holdings L.P. ("AREH") owns 50.1% of the outstanding
common stock of the Company at December 31, 2003. Also, the general partner of
AREH, American Property Investors, Inc. ("API") is an entity indirectly wholly
owned by Carl C. Icahn. As such, the Company may be deemed to be controlled by
an affiliate of Mr. Icahn and his affiliated entities. Certain members of the
Company's Board of Directors have affiliations with various affiliates of AREH,
including Arnos Corp. ("Arnos"), High River Limited Partnership ("High River"),
American Real Estate Partners, LLP ("AREP"), which owns 99% in AREH, API, High
Coast Limited partnership ("High Coast"), Cadus Pharmaceutical Corporation
("Cadus") and Greenville Holding LLC ("Greenville"). Mr. Martin L. Hirsch is the
Executive Vice President of AREH. Mr. Robert J. Mitchell is an employee of
affiliates of Arnos and High River. Mr. Jack G. Wasserman is a member of the
board of directors for both API and Cadus and a member of the API audit
committee. Mr. Icahn is the largest single shareholder of Cadus. Arnos, High
Coast, High River, API, Greenville, AREP and AREH are entities affiliated with
Mr. Icahn. It is the policy of the Company to engage in transactions with
related parties on terms, in the opinion of the Company, that are no less
favorable to the Company than could be obtained from unrelated parties.

BACKGROUND AND RECENT DEVELOPMENTS

On February 11, 1999, the Bankruptcy Court entered an involuntary petition
placing the Company under protection of the Bankruptcy Court pursuant to Title
11, Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy
Proceeding"). On July 24, 2000 the Bankruptcy Court entered a subsequent order
confirming the Plan of Reorganization jointly proposed by the Company and the
official committee of unsecured creditors, which Plan of Reorganization became
effective on August 4, 2000. The Bankruptcy Court issued a final decree closing
the case effective December 13, 2001. Accordingly, the Company has effectively
settled all matters relating to the Bankruptcy Proceeding.

HOLDING LLC

As mandated by the Plan of Reorganization and the Bankruptcy Court, Holding
LLC was formed in August 2000. In exchange for an initial 50% membership
interest in Holding LLC, on September 12, 2001, but effective as of May 1, 2001,
the Company contributed to Holding LLC all of its operating assets and oil and
natural gas properties excluding cash of $4.3 million. In exchange for its
initial 50% membership interest in Holding LLC, Gascon, an entity owned or
controlled by Carl C. Icahn, contributed (i) its sole membership interest in
Shana National LLC, an oil and natural gas producing company, (ii) cash of $75.2
million, and (iii) a $10.9 million revolving note evidencing borrowings under
the Company's revolving credit facility issued to Arnos. In connection with the
foregoing, Holding LLC initially owns 100% of the membership interest in

26

Operating LLC. Holding LLC is governed by the Holding LLC Operating Agreement,
which provides for management of Holding LLC by Gascon. All of the oil and
natural gas assets contributed by the Company and all of the oil and natural gas
assets associated with Gascon's contribution to Holding LLC were transferred
from Holding LLC to Operating LLC on September 12, 2001, effective as of May 1,
2001.

The assets contributed by the Company to Holding LLC were current assets of
$11.5 million, net oil and natural gas assets of $85.0 million and other assets
of $4.8 million. The liabilities assumed by Holding LLC were current liabilities
of $4.2 million, an intercompany payable to Gascon of $4.8 million and long-term
liabilities of $1.0 million.

THE HOLDING LLC OPERATING AGREEMENT

Pursuant to the Holding LLC Operating Agreement, distributions from Holding
LLC to the Company and Gascon shall be made in the following order.

ORDER OF DISTRIBUTIONS

1. Guaranteed Payments are to be paid to the Company, calculated on an
annual interest rate of 10.75% on the outstanding Priority Amount. The Priority
Amount includes all outstanding debt owed to entities owned or controlled by Mr.
Carl C. Icahn, including the amount of the Company's Senior Notes. As of
December 31, 2003, the Priority Amount was $148.6 million. The Guaranteed
Payments will be made on a semi-annual basis.

2. The Priority Amount is to be paid to the Company. Such payment is to
occur by November 6, 2006.

3. An amount equal to the Priority Amount and all Guaranteed Payments paid
to the Company, plus any additional capital contributions made by Gascon, less
any distributions previously made by Holding LLC to Gascon, is to be paid to
Gascon.

4. An amount equal to the aggregate annual interest (calculated at prime
plus 1/2% on the sum of the Guaranteed Payments), plus any unpaid interest for
prior years (calculated at prime plus 1/2% on the sum of the Guaranteed
Payments), less any distributions previously made by Holding LLC to Gascon, is
to be paid to Gascon.

5. After the above distributions have been made, any additional
distributions will be made in accordance with the ratio of the Company's and
Gascon's respective capital accounts. (Capital accounts as defined in the
Holding LLC Operating Agreement)

It is anticipated that the Priority Amount will be used by the Company to
pay off the Company's indebtedness (currently held by entities owned or
controlled by Carl C. Icahn). The Guaranteed Payments are expected to be
sufficient to make the interest payments on the Company's Senior Notes. Because
of the substantial uncertainty that the Company will receive any distributions
in addition to the Priority Amount and the Guaranteed Payments, the Company
accounts for its investment in Holding LLC as a preferred investment. Guaranteed
Payments received and receipt of the Priority Amount are recorded as reductions
in the investment and income is recognized from accretion of the investment
(based on the interest method) up to the Priority Amount, including the
Guaranteed Payments, and the Company's remaining carrying value of the
investment in Holding LLC will be valued at zero. The Company's membership
interest in Holding LLC is governed by the terms of the Holding LLC Operating
Agreement and is not affected by the accretion of the investment. Cash receipts,
if any, after the Priority Amount and the Guaranteed Payments will be reported
in income as earned.

The Holding LLC Operating Agreement further contains a provision that
allows Gascon, or its successor, at any time, in its sole discretion, to redeem
the Company's membership interest in Holding LLC at a price equal to the fair
market value of such interest determined as if Holding LLC had sold all of its
assets for fair market value and liquidated. A determination of the fair market
value of such assets shall be made by an independent third party jointly engaged
by Gascon and the Company. Since all of the Company's operating assets and oil
and natural gas properties have been contributed to Holding LLC, following such
a redemption,

27

the Company's principal assets would consist solely of its cash balances. In the
event that such redemption right is exercised by Gascon and there is a
subsequent liquidation and distribution of the proceeds, the Company may be
obligated to use the proceeds that it would receive for its redeemed membership
interest to pay outstanding indebtedness and operating expenses before the
distribution of any portion of such proceeds could be made to the Company's
shareholders. Following the payment of the Company's indebtedness, including the
outstanding balance of $148.6 million relating to the Company's Senior Notes and
its operating expenses, there is a substantial risk that there will be no
proceeds remaining for distribution to the Company's shareholders. It is the
present intention of Holding LLC to continue to conduct oil and natural gas
drilling and development activities in the ordinary course of business and to
seek additional reserves.

THE OPERATING LLC MANAGEMENT AGREEMENT

The management and operation of Operating LLC is being undertaken by the
Company pursuant to the Management Agreement which the Company has entered into
with Operating LLC. However, neither the Company's officers nor directors will
control the strategic direction of Operating LLC's oil and natural gas business,
including oil and natural gas drilling and capital investments, which shall be
controlled by the managing member of Holding LLC (currently Gascon). The
Management Agreement provides that the Company will manage Operating LLC's oil
and natural gas assets and business until the earlier of November 1, 2006, or
such time as Operating LLC no longer owns any of the managed oil and natural gas
properties. The Company's employees will conduct the day-to-day operations of
Operating LLC's oil and natural gas properties, and all costs and expenses
incurred in the operation of the oil and natural gas properties shall be borne
by Operating LLC; although the Management Agreement provides that the salary of
the Company's Chief Executive Officer shall be 70% attributable to the managed
oil and natural gas properties, and the salaries of each of the General Counsel
and Chief Financial Officer shall be 20% attributable to the managed oil and
natural gas properties. In exchange for the Company's management services,
Operating LLC shall pay the Company a management fee equal to 115% of the actual
direct and indirect administrative and reasonable overhead costs incurred by the
Company in operating the oil and natural gas properties which either the Company
or Operating LLC may seek to change within the range of 110%-115% as such change
is warranted. However, the parties have agreed to consult with each other to
ensure that such administrative and reasonable overhead costs attributable to
the managed properties are properly reflected in the management fee paid to the
Company. In addition, Operating LLC has agreed to indemnify the Company to the
extent it incurs any liabilities in connection with its operation of the assets
and properties of Operating LLC, except to the extent of its gross negligence or
misconduct. The Company recorded $6.6 million as a management fee for the year
ended December 31, 2003.

THE REORGANIZED COMPANY

As a result of the foregoing transactions and as mandated by the Plan of
Reorganization effective May 12, 2001, the Company's principal assets were its
remaining cash balances, accounts receivable from affiliates, deferred tax asset
and its initial 50% membership interest in Holding LLC, and its principal
liabilities were the $10.9 million outstanding under its existing $25 million
revolving credit facility with Arnos and its Senior Notes and long-term interest
payable on Senior Notes. None of the Company's employees have been transferred
to Holding LLC or Operating LLC. The Company remains highly leveraged following
confirmation of the Plan of Reorganization and entry of the final decree closing
the Bankruptcy Proceeding. Further, as a result of the terms and conditions of
the various agreements related to the repayment of the Company's indebtedness to
Arnos and repayment of the Priority Amount and the Guaranteed Payments (plus
accrued interest thereon) to Gascon, there is a substantial risk that there will
be no proceeds remaining for distribution to the Company's shareholders.

SENIOR NOTES/CHARTER AMENDMENT

In August 2001, the Company redeemed both $16.4 million of principal
outstanding under the Senior Note obligations and $4.8 million of long-term
interest payable on Senior Notes for $10.5 million. The Company paid two Arnos
affiliates approximately $0.4 million in current interest on the redeemed Senior

28

Note obligations at the date of redemption related to interest owed from the
last semi-annual interest payment date of May 1, 2001 to the date of redemption.
As this was a partial redemption of the Senior Notes, it has been accounted for
as a modification of terms that changes the amounts of future cash payments.
Accordingly, the excess of redeemed principal and interest over the redemption
payment, totaling $10.7 million, will be amortized as a reduction to interest
expense over the remaining life of the bonds. In connection with this
transaction, the Company borrowed $10.9 million under its existing credit
facility with Arnos.

On September 9, 2003, following the approval of an amendment to the
Company's Restated Certificate of Incorporation by the shareholders of the
Company and as permitted under the Company's Amended and Restated Certificate of
Incorporation, the Board of Directors approved a request to transfer 49.9% of
the outstanding common stock of the Company held by certain affiliates of Carl
C. Icahn to AREH. On October 2, 2003, the effective date of such transfer, AREH
acquired 5,584,044 shares of common stock of the Company and $148,637,000 in
aggregate principal amount of outstanding Senior Notes due 2006 of the Company,
from entities affiliated with Carl C. Icahn. As a result of the foregoing
transaction and, following the acquisition by AREH of additional shares of
common stock of the Company prior to closing of such transaction, AREH
beneficially owns 50.1% of the issued and outstanding common stock of the
Company.

THE TTG MANAGEMENT AGREEMENT

On August 28, 2003, the Company entered into the TTG Management Agreement
whereby the Company manages TTG. The TTG Management Agreement was entered into
in connection with a plan of reorganization for TTG proposed by Thornwood
Associates LP, an entity affiliated with Carl C. Icahn. The United States
Bankruptcy Court, Southern District of Texas issued an order confirming the TTG
Plan. Affiliates of Mr. Icahn own approximately 89% of TTG. TTG is engaged in
the exploration, production and transmission of natural gas and oil primarily in
South Texas, including the Eagle Bay field in Galveston Bay, Texas and the
Southwest Bonus field located in Wharton County, Texas. Bob G. Alexander and
Philip D. Devlin, President and CEO, and Vice President, Secretary and General
Counsel of the Company, respectively, have been appointed to the TTG Board of
Directors and shall act as the two principal officers of TTG and its
subsidiaries, Galveston Bay Pipeline Corporation and Galveston Bay Processing
Corporation.

The TTG Management Agreement provides that the Company shall be responsible
for and have authority with respect to all of the day-to-day management of TTG's
business but shall not function as a Disbursing Agent as such term is defined in
the TTG Plan. As consideration for the Company's services in managing the TTG
business, the Company shall receive a monthly fee of $312,500. The TTG
Management Agreement is terminable (i) upon 30 days prior written notice by TTG,
(ii) upon 90 days prior written notice by the Company, (iii) upon 30 days
following any day where High River designees no longer constitute the TTG Board
of Directors, unless otherwise waived by the newly-constituted Board of
Directors of TTG, or (iv) as otherwise determined by the Bankruptcy Court. The
Company recorded $1.4 million as a management fee for the year ended December
31, 2003.

CREDIT FACILITY

On March 26, 2003, Holding LLC distributed the $10.9 million note
outstanding under the Company's revolving credit facility as a distribution of
Priority Amount to the Company, thereby canceling all outstanding balances due
under the credit facility. Also, on March 26, 2003 the Company, Arnos and
Operating LLC entered into an agreement to assign the existing credit facility
to Operating LLC. Effective with this assignment, Arnos amended the credit
facility to increase the revolving commitment to $150 million, increase the
borrowing base to $75 million and extend the revolving due date until June 30,
2004. Concurrently, Arnos extended a $42.8 million loan to Operating LLC under
the amended credit facility. Operating LLC then distributed $42.8 million to
Holding LLC which, thereafter, made a $40.5 million distribution of Priority
Amount and a $2.3 million Guaranteed Payment to the Company. The Company
utilized these funds to pay the entire amount of the long-term interest on the
Senior Notes and interest accrued thereon outstanding on March 27, 2003.

29

On December 29, 2003, Operating LLC entered into the Credit Agreement with
certain commercial lending institutions, including Mizuho Corporate Bank, Ltd.
as the Administrative Agent and the Bank of Texas, N.A. and the Bank of Nova
Scotia as Co-Agents. The Credit Agreement provides for a loan commitment amount
of up to $100 million and a letter of credit commitment of up to $15 million
(provided, the outstanding aggregate amount of the unpaid borrowings, plus the
aggregate undrawn face amount of all outstanding letters of credit shall not
exceed the borrowing base under the Credit Agreement). As a condition to the
closing of the Credit Agreement, the lenders required that Operating LLC
terminate its secured loan arrangement with Arnos. At the closing of the Credit
Agreement, Operating LLC borrowed $43.8 million to repay $42.9 million owed by
Operating LLC to Arnos under the secured loan arrangement which was then
terminated and to pay administrative fees in connection with this borrowing. As
a condition to the lenders obligations under the Credit Agreement, the lenders
required that the Company, Gascon, Holding LLC and Operating LLC execute and
deliver at the closing certain related agreements. (See Note 5 to the Company's
Financial Statements included elsewhere herein).

RESULTS OF OPERATIONS

On September 12, 2001 the Company contributed all its operating assets and
oil and natural gas properties, excluding cash of $4.3 million to Holding LLC,
in exchange for an initial 50% membership interest ("LLC Contribution"). For tax
and valuation purposes the effective date is May 1, 2001, however, for financial
reporting purposes the transaction is as of September 1, 2001. Operations from
September 1 to September 12 were not significant. In 2001, the Company recorded
eight months of oil and natural gas operations and four months of accretion of
the preferred investment and management fees. Beginning with 2002 and in the
future, it is anticipated the Company will only recognize income from accretion
of the preferred investment and management fees.

OVERVIEW OF PRODUCTION, SALES AND UNIT ECONOMICS

The following table sets forth certain information regarding the production
volumes, oil and natural gas sales, average sales prices, and unit economics per
Mcfe for revenues and costs and expenses related to the Company's oil and
natural gas production for the periods indicated.

30

YEAR ENDED DECEMBER 31, 2003, COMPARED WITH YEAR ENDED DECEMBER 31, 2002

Revenues. Total revenues decreased by $2.4 million (5.9%) to $38.1 million
for 2003 from $40.5 million in 2002. The decrease in revenues is due to the
decrease in accretion of the investment in Holding LLC. The Company recorded
$32.9 million and $30.1 million in accretion of investment in Holding LLC and
management fees of $7.6 and $8.0 million in 2002 and 2003.

Costs and Expenses. General and administrative costs increased $0.1
million (1.8%) to $7.2 million for 2003 compared to $7.1 million for 2002.

Other Income and Expenses. The $3.9 million decrease in interest expense
to $15.1 million for 2003 from $19.0 million for 2002 was due primarily to
reduced amounts outstanding of senior note obligations and the long-term
interest. The weighted average interest rate for 2003 was 10.7% compared to
10.4% for the same period in 2002.

No other expense was recognized for the year ended December 31, 2003.

Income Taxes. As of December 31, 2003, the Company had consolidated net
operating loss carryforwards of approximately $58.0 million for income tax
reporting purposes which begin expiring in 2009. Prior to the formation of
Holding LLC, the income tax benefit associated with the loss carryforwards had
not been recognized since, in the opinion of management, there was not
sufficient positive evidence of future taxable income to justify recognition of
a benefit. Upon the formation of Holding LLC, management again evaluated all
evidence, both positive and negative, in determining whether a valuation
allowance to reduce the carrying value of deferred tax assets was still needed
and concluded, based on the projected allocations of taxable income by Holding
LLC, the Company more likely than not will realize a partial benefit from the
loss carryforwards. Accordingly, the Company recorded a deferred tax asset of
$31.9 million in September 2001, $25.5 million as of December 31, 2002 and $25.9
million as of December 31, 2003. The Company reduced the valuation allowance by
$5.1 million in 2003. Ultimate realization of the deferred tax asset is
dependent upon, among other factors, the Company's ability to generate
sufficient taxable income within the carryforward periods and is subject to
change depending on the tax laws in effect in the years in which the
carryforwards are used. As a result of the recognition of expected future income
tax benefits, subject to additional changes in the valuation allowance,
subsequent periods will reflect a full effective tax rate provision.

YEAR ENDED DECEMBER 31, 2002, COMPARED WITH YEAR ENDED DECEMBER 31, 2001

Revenues. Total revenues decreased by $5.2 million (11.4%) to $40.5
million for 2002 from $45.7 million in 2001. The decrease in revenues is due to
the LLC Contribution. Average natural gas prices were $4.92 per Mcf for 2001 and
average oil prices were $27.70 per barrel for 2001. The Company recorded $9.8
million and $32.9 million in accretion of investment in Holding LLC and
management fees of $2.7 and $7.6 million in 2001 and 2002.

In 2001, the Company produced 428 Mbbls of oil and 4,333 Mmcf of natural
gas. The Company had no oil and natural gas production during 2002 due to the
LLC Contribution.

Costs and Expenses. Due to the LLC Contribution, the Company did not
record any lease operating expenses for 2002 compared to $3.9 million for 2001.
Lease operating expenses per Mcfe were $0.56 for 2001.

Due to the LLC Contribution, the Company did not record any oil and natural
gas production taxes for 2002 compared to $1.7 million for 2001.

Due to the LLC Contribution, the Company did not record any depreciation,
depletion and amortization for 2002 compared to $6.2 million for 2001.

General and administrative costs increased $1.2 million (20.3%) to $7.1
million for 2002 compared to $5.9 million for 2001. This increase is the result
of the LLC Contribution and the resulting change in the Company's recording of
general and administrative costs. Effective September 1, 2001, the Company no
longer offsets general and administrative costs by field employee costs or lease
management income, but is reimbursed a management fee for these and other costs
of 115% of general and administrative costs as defined

31

in the Management Agreement. As discussed in Note 2 to the consolidated
financial statements, prior to September 2001, the Company capitalized internal
general and administrative costs that can be directly identified with
acquisition, development and exploration activities. The Company's capitalized
general and administrative expenses totaled $0.5 million for the year ended
December 31, 2001.

Other Income and Expenses. The $2.2 million decrease in interest expense
to $19.0 million for 2002 from $21.2 million for 2001 was due primarily to
reduced amounts outstanding of senior note obligations and the Reinstated
Interest. The Company accrued interest on the revised senior note obligation
amount at December 31, 2000 of $210.8 million through July 31, 2001. In August
2001, the Company redeemed both $16.4 million of principal outstanding under the
senior note obligations and $4.8 million of the Reinstated Interest for $10.5
million. The weighted average interest rate for 2002 was 10.4% compared to 10.6%
for the same period in 2001.

Of the $0.3 million other expense recognized for the year ended December
31, 2001, $0.7 million represents the non-cash decrease in the fair value of the
Company's derivative contracts. No other expense was recognized for the year
ended December 31, 2002.

Income Taxes. As of December 31, 2002, the Company had consolidated net
operating loss carryforwards of approximately $101.3 million for income tax
reporting purposes that begin expiring in 2003. Prior to the formation of
Holding LLC, the income tax benefit associated with the loss carryforwards had
not been recognized since, in the opinion of management, there was not
sufficient positive evidence of future taxable income to justify recognition of
a benefit. Upon the formation of Holding LLC, management again evaluated all
evidence, both positive and negative, in determining whether a valuation
allowance to reduce the carrying value of deferred tax assets was still needed
and concluded, based on the projected allocations of taxable income by Holding
LLC, the Company more likely than not will realize a partial benefit from the
loss carryforwards. Accordingly, the Company recorded a deferred tax asset of
$31.9 million in September 2001, $25.5 million as of December 31, 2002. Ultimate
realization of the deferred tax asset is dependent upon, among other factors,
the Company's ability to generate sufficient taxable income within the
carryforward periods and is subject to change depending on the tax laws in
effect in the years in which the carryforwards are used. As a result of the
recognition of expected future income tax benefits, subject to additional
changes in the valuation allowance, subsequent periods will reflect a full
effective tax rate provision.

Net Income. Net income of $37.3 million was recognized for 2001, compared
with a net income of $9.4 million for the comparable 2002 period. Results for
2001 include income of $0.2 million related to the Bankruptcy Proceeding and a
$31.9 million benefit from income taxes as a result of the LLC Contribution and
$1.3 million in deferred income tax expense.

LIQUIDITY AND CAPITAL RESOURCES

YEAR ENDED DECEMBER 31, 2003, COMPARED WITH YEAR ENDED DECEMBER 31, 2002

Net cash used in operating activities was $59.1 million for the year ended
December 31, 2003, compared to net cash used in operating activities of $21.3
million for the same period in 2002. This increase is due to the repayment of
accrued interest on Senior Notes -- affiliates.

Net cash provided by financing activities was $58.7 million for 2003
compared with net cash provided by financing activities of $21.6 million for
2002. Net cash provided by financing activities in 2003 consisted of Guaranteed
Payments and distributions of the Priority Amount from Holding LLC.

There was no cash used in or provided by investing activities in 2002 or
2003.

The Guaranteed Payments are expected to be sufficient to make the interest
payments on the Senior Notes until their due date of 2006. The fees received
under the Management Agreement and the TTG Management Agreement are expected to
be sufficient to fund the Company's operations. While there is no assurance, the
Company currently anticipates the distributions of the Priority Amount will be
sufficient to repay the Senior Notes due 2006. The Company cannot be assured
that Holding LLC will have sufficient cash to make the distribution of Priority
Amount in 2006.

32

The Company's working capital surplus at December 31, 2003 was $1.7 million
compared to a working capital deficit at December 31, 2002 of $40 million.

The following table is a summary of contractual obligations as of December
31, 2003.

YEAR ENDED DECEMBER 31, 2002, COMPARED WITH YEAR ENDED DECEMBER 31, 2001

Net cash used in operating activities was $21.3 million for the year ended
December 31, 2002, compared to net cash provided by operating activities of
$11.5 million for the same period in 2001. The decrease in cash flow from
operating activities is primarily due to LLC Contribution.

There was no net cash used in or provided by investing activities for 2002
compared with net cash used in investing activities of $30.8 million for 2001.
The cash used by investing activities for 2001 consisted primarily of drilling
activities on the oil and natural gas assets prior to the LLC Contribution.

Net cash used in financing activities in 2001 was $20.9 million. The net
cash used in financing activities in 2001 consisted of repayment of the
outstanding borrowing of $25 million under the credit facility. In August 2001,
the Company borrowed $10.9 under its existing credit facility with Arnos in
order to redeem $16.4 million of principal outstanding under the senior note
obligations and $4.8 million of the long-term interest payable on Senior Notes
for $10.5 million. The net cash provided by financing activities in 2002 of
$21.7 million consisted of Guaranteed Payments.

The Guaranteed Payments are expected to be sufficient to make the interest
payments on the Senior Notes until their due date of 2006. The fees received
under the Operating LLC Management Agreement are expected to be sufficient to
fund the Company's operations. While there is no assurance, the Company
currently anticipates distributions of the Priority Amount will be sufficient to
repay the Senior Notes due 2006. The Company cannot be assured that Holding LLC
will have sufficient cash to make the distribution of Priority Amount in 2006.

The Company's working capital deficit at December 31, 2002 was $40 million
compared to a working capital surplus at December 31, 2001 of $1.7 million.
Effective with the March 2003 distribution of Priority Amount, working capital
increased by $43 million.

FUTURE CAPITAL AND FINANCING REQUIREMENTS

At December 31, 2002, the Company had $10.9 million outstanding under its
existing $100 million credit facility with Arnos. Arnos continued to be the
holder of the credit facility; however, the $10.9 million note outstanding under
the credit facility was contributed to Holding LLC as part of Gascon's
contribution to Holding LLC on September 12, 2001. In December 2001, the
maturity date of the credit facility was extended to December 31, 2003 and the
Company was given a waiver of compliance with respect to any and all covenant
violations. The Company anticipates repayment of this amount through the
distribution of Priority Amount from Holding LLC. The Company was not in
compliance with the minimum interest coverage ratio at September 30, 2002 and
December 31, 2002 and the current ratio at December 31, 2002, however, in
December 2001 the Company was given a waiver of compliance with respect to any
and all covenant violations through December 31, 2003.

On March 26, 2003, Holding LLC distributed the $10.9 million note
outstanding under the existing credit facility to the Company as a distribution
of Priority Amount. Also, on March 26, 2003 the Company, Arnos and Operating LLC
entered into an agreement to assign the existing credit facility to Operating
LLC. Effective with this assignment, Arnos amended the credit facility to
increase the revolving commitment to $150 million, increase the borrowing base
to $75 million and extend the revolving due date until June 30, 2004.

33

Concurrently, Arnos extended a $42.8 million loan to Operating LLC under the
amended credit facility; Operating LLC then distributed $42.8 million to Holding
LLC who, thereafter, made a $40.5 million distribution of Priority Amount and a
$2.3 million Guaranteed Payment to the Company. The Company utilized these funds
to pay the entire amount of the long-term interest payable on the Senior Notes
and interest accrued thereon outstanding on March 27, 2003. The Arnos facility
was canceled on December 29, 2003 in conjunction with the Mizuho Corporate Bank,
Ltd. financing.

On December 29, 2003, Operating LLC entered into the Credit Agreement with
certain commercial lending institutions, including Mizuho Corporate Bank, Ltd.
as the Administrative Agent and the Bank of Texas, N.A. and the Bank of Nova
Scotia as Co-Agents.

The Credit Agreement provides for a loan commitment amount of up to $100
million and a letter of credit commitment of up to $15 million (provided, the
outstanding aggregate amount of the unpaid borrowings, plus the aggregate
undrawn face amount of all outstanding letters of credit shall not exceed the
borrowing base under the Credit Agreement). The Credit Agreement provides
further that the amount available to Operating LLC at any time is subject to
certain restrictions, covenants, conditions and changes in the borrowing base
calculation. In partial consideration of the loan commitment amount, Operating
LLC has pledged a continuing security interest in all of its oil and natural gas
properties and its equipment, inventory, contracts, fixtures and proceeds
related to its oil and natural gas business.

At Operating LLC's option, interest on borrowings under the Credit
Agreement bear interest at a rate based upon either the prime rate or the LIBOR
rate plus, in each case, an applicable margin that, in the case of prime rate
loans, can fluctuate from 0.75%to 1.50% per annum, and, in the case of LIBOR
rate loans, can fluctuate from 1.75% to 2.50% per annum. Fluctuations in the
applicable interest rate margins are based upon Operating LLC's total usage of
the amount of credit available under the Credit Agreement, with the applicable
margins increasing as Operating LLC's total usage of the amount of the credit
available under the Credit Agreement increases.

As a condition to the closing of the Credit Agreement, the lenders required
that the Operating LLC terminate its secured loan arrangement with Arnos, an
affiliate of Carl C. Icahn. Mr. Icahn is an affiliate of AREH which is the
beneficial owner of 50.1% of the outstanding common stock of the Company. At the
closing of the Credit Agreement, Operating LLC borrowed $43.8 million to repay
$42.9 million owed by Operating LLC to Arnos under the secured loan arrangement
which was then terminated and to pay administrative fees in connection with this
borrowing. Operating LLC intends to use any future borrowings under the Credit
Agreement to finance potential acquisitions.

As a condition to the lenders obligations under the Credit Agreement, the
lenders required that the Company, Gascon, Holding LLC and Operating LLC execute
and deliver at the closing that certain Pledge Agreement and Irrevocable Proxy
in favor of Bank of Texas, N.A., its successors and assigns, the ("Pledge
Agreement"). Pursuant to the terms of the Pledge Agreement, in order to secure
the performance of the obligations of Operating LLC (i) each of the Company and
Gascon have pledged their 50% membership interest in Holding LLC (such interests
constituting 100% of the outstanding equity membership interest of Holding LLC);
(ii) Holding LLC has pledged its 100% equity membership interest in Operating
LLC; and (iii) Operating LLC has pledged its 100% equity membership interest in
its subsidiary, Shana National LLC (the membership interests referred to in
clauses (i), (ii) and (iii) above are collectively referred to as the
"Collateral"). The Pledge Agreement also provides for a continuing security
interest in the Collateral and that Bank of Texas, N.A. as the Collateral Agent
is the duly appointed attorney-in-fact of Operating LLC. The Collateral Agent
may take all action deemed reasonably necessary for the maintenance,
preservation and protection of the Collateral and the security interest therein
until such time that all of Operating LLC's obligations under the Credit
Agreement are fulfilled, terminated or otherwise expired. If under the Credit
Agreement an event of default shall have occurred and is continuing, the
Collateral Agent may enforce certain rights and remedies, including, but not
limited to the sale of the Collateral, the transfer of all or part of the
Collateral to the Collateral Agent or its nominee and/or the execution of all
endorsements, assignments, stock powers and other instruments of conveyance or
transfer with respect to all or part of the Collateral.

34

The Credit Agreement requires, among other things, semiannual engineering
reports covering oil and natural gas properties, and maintenance of certain
financial ratios, including the maintenance of a minimum interest coverage, a
current ratio, and a minimum tangible net worth. Operating LLC was in compliance
with all covenants at December 31, 2003.

Other than the Company's encumbrance of its 50% membership interest in
Holding LLC and its indemnification of the Collateral Agent as set forth in the
Pledge Agreement, the Company has incurred no obligations under the Credit
Agreement, nor does it act as guarantor of the obligations of Operating LLC or
any other guarantor or other entity thereunder.

Although the Company is highly leveraged following confirmation of the Plan
of Reorganization, the Company expects that availability under its existing
credit facility, expected cash flows from guaranteed payments, priority
distributions and management fees will be sufficient to fund its operations and
debt service. However, no assurances can be given that Holding LLC will generate
sufficient cash flows to make these payments and in that event, the Company
would not be able to meet its obligations.

OFF BALANCE SHEET ARRANGEMENTS

The Company has no off balance sheet financing arrangements.

FINANCIAL REPORTING IMPACT OF FULL COST METHOD OF ACCOUNTING

Prior to the contribution of all its operating assets and oil and natural
gas properties to Holding LLC, "LLC Contribution", the Company followed the full
cost method of accounting for oil and natural gas properties. Under such method,
the net book value of such properties, less related deferred income taxes, may
not exceed a calculated "ceiling." The ceiling is the estimated after-tax future
net revenues from proved oil and natural gas properties, discounted at 10% per
year. In calculating future net revenues, prices and costs in effect at the time
of the calculation are held constant indefinitely, except for changes which are
fixed and determinable by existing contracts. The net book value is compared to
the ceiling on a quarterly and yearly basis. The excess, if any, of the net book
value above the ceiling is required to be written off as a non-cash expense. The
Company had no ceiling limitation writedowns during 1999 or 2000. There will be
no writedowns in future periods under the full cost method of accounting due to
the LLC Contribution in 2001.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company follows certain significant accounting policies when preparing
its consolidated financial statements. A complete summary of these policies is
included in Note 1 of Notes to Consolidated Financial Statements.

Certain of the policies require management to make significant and
subjective estimates, which are sensitive to deviations of actual results from
management's assumptions. In particular, management makes estimates regarding
(i) the total amount and timing of guaranteed payments and priority
distributions that will actually be received from Holding LLC in determining the
amount of accretion income to be recorded; and, (ii) estimates of future taxable
income in determining the amount of deferred tax assets which are more likely
than not be realized.

Under the Holding LLC Operating Agreement, the Company is to receive
Guaranteed Payments in addition to a Priority Amount of $202.2 million before
Gascon receives any monies. The Priority Amount is to be made on or before
November 1, 2006. Guaranteed Payments are to be paid, on a semi annual basis,
based on an annual interest rate of 10.75% of the outstanding Priority Amount.
After the payments to the Company, Gascon is to receive distributions equivalent
to the Priority Amount and Guaranteed Payments plus other amounts as defined.
Following the above distributions to the Company and Gascon, additional
distributions, if any, are to be made in accordance with their respective
capital accounts. Because of the substantial uncertainty that the Company will
receive any distributions above the Priority Amount and Guaranteed Payments, the
Company accounts for its investment in Holding LLC as a preferred investment.

35

At inception (September 12, 2001), the Company recorded the investment in
Holding LLC at the historical cost of the oil and gas properties contributed
into the partnership (in exchange for Holding LLC's obligation to pay the
Company the Priority Amount and Guaranteed Payments). Subsequently, the Company
accretes its investment in Holding LLC from the initial investment recorded up
to the Priority Amount, including the Guaranteed Payments, at the implicit rate
of interest, recognizing the accretion income in earnings. Accretion income is
periodically adjusted for changes in the timing of cash flows, if necessary due
to unscheduled cash distributions. Receipt of Guaranteed Payments and the
Priority Amount are recorded as reductions in the preferred investment. The
preferred investment is evaluated quarterly for other than temporary impairment
based on the Company's underlying proportionate share of Holding LLC's oil and
natural gas reserves. Estimates of oil and natural gas reserves are very
subjective and a significant revision could alter our conclusions as to
impairment.

Because of the substantial uncertainty that the Company will receive any
distributions in excess of the Priority Amount and the Guaranteed Payments
("residual interest"), the residual interest attributable to the investment in
Holding LLC is valued at zero. Upon payment of the Priority Amount in 2006, the
Company's carrying value of the investment in Holding LLC will be zero. The
Company's membership interest in Holding LLC is governed by the Holding LLC
Operating Agreement and is not affected by the accretion of the investment. Cash
receipts, if any, after the Priority Amount and the Guaranteed Payments will be
reported in income as earned.

The ability of Holding LLC to make the Guaranteed Payments and
distributions of Priority Amounts may be significantly impacted by the market
prices of natural gas and crude oil and the ability of Holding LLC to
effectively replace existing natural gas and crude oil reserves. Current
estimates could change if future events are different than assumed by
management.

Upon the formation of Holding LLC, management again evaluated all evidence,
both positive and negative, in determining whether a valuation allowance to
reduce the carrying value of deferred tax assets was still needed and concluded,
based on the projected allocations of taxable income by Holding LLC, the Company
more likely than not will realize a partial benefit from the loss carryforwards.
Ultimate realization of the deferred tax asset is dependent upon, among other
factors, the Company's ability to generate sufficient taxable income within the
carryforward periods and is subject to change depending on the tax laws in
effect in the years in which the carryforwards are used.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for
Asset Retirement Obligations" ("SFAS 143"). SFAS No. 143 requires the Company to
record the fair value of an asset retirement obligation as a liability in the
period in which it incurs a legal obligation associated with the retirement of
tangible long-lived assets that result from the acquisition, construction,
development, and/or normal use of the assets. It also requires the Company to
record a corresponding asset that is depreciated over the life of the asset.
Subsequent to the initial measurement of the asset retirement obligation, the
obligation will be adjusted at the end of each period to reflect the passage of
time and changes in the estimated future cash flows underlying the obligation.
The Company adopted SFAS No. 143 on January 1, 2003. The adoption of SFAS No.
143 had no material impact on the Company's financial statements.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. ("SFAS 146") SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002, with early application
encouraged. The adoption of SFAS No. 146 had no material effect on the Company's
financial statements.

In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of
36

FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No.
34. This Interpretation elaborates on the disclosures to be made by a guarantor
in its interim and annual financial statements about its obligations under
guarantees issued. The Interpretation also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability for the fair
value of the obligation undertaken. The initial recognition and measurement
provisions of the Interpretation are applicable to guarantees issued or modified
after December 31, 2002 and did not have a material effect on the Company's
financial statements. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 31, 2002.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure, an amendment of FASB Statement No.
123" ("SFAS 123"). SFAS No. 148 amends FASB Statement No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
Statement No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain of the disclosure modifications are required for
fiscal years ending after December 15, 2002. The adoption of SFAS No. 148 had no
material impact on the Company's financial statements.

In December 2003, the FASB issued Interpretation No. 46 (revised December
2003), "Consolidation of Variable Interest Entities, an Interpretation of ARB
No. 51" ("FIN 46R"). FIN 46R requires a company to consolidate a variable
interest entity, as defined, when the company will absorb a majority of the
variable interest entity's expected losses, receive a majority of the variable
interest entity's expected residual returns, or both. FIN 46R also requires
certain disclosures relating to consolidated variable interest entities and
unconsolidated variable interest entities in which a company has a significant
variable interest. The provisions of FIN 46R are required for companies that
have interests in variable interest entities, or potential variable interest
entities commonly referred to as special-purpose entities for periods ending
after December 15, 2003. The provisions of FIN 46R are required to be applied
for periods ending after March 15, 2004 for all other types of entities. The
Company's interests in, and related management arrangements associated with,
Holding LLC constitute variable interests in variable interest entities under
FIN 46R. However, the Company is not considered the primary beneficiary of
Holding LLC as defined by FIN 46R, and accordingly is not required to
consolidate Holding LLC.

The EITF is considering two issues related to the reporting of oil and gas
mineral rights. Issue No. 03-O, "Whether Mineral Rights Are Tangible or
Intangible Assets," is whether or not mineral rights are intangible assets
pursuant to SFAS No. 141, "Business Combinations." Issue No. 03-S, "Application
of SFAS No. 142, Goodwill and Other Intangible Assets, to Oil and Gas
Companies," is, if oil and gas drilling rights are intangible assets, whether
those assets are subject to the classification and disclosure provisions of SFAS
No. 142.

Holding LLC classifies the cost of oil and gas mineral rights as properties
and equipment and believes that this is consistent with oil and gas accounting
and industry practice. If the EITF determines that oil and gas mineral rights
are intangible assets and are subject to the applicable classification and
disclosure provisions of SFAS No. 142, Holding LLC would be required to
reclassify these costs from properties and equipment to intangible assets on its
consolidated balance sheets as of December 31, 2003 and 2002. These amounts
would represent oil and gas mineral rights acquired after June 2001 through the
end of the respective periods and be net of accumulated DD&A. In addition, the
disclosures required by SFAS Nos. 141 and 142 would be made in the notes to the
consolidated financial statements. There would be no effect on the consolidated
statements of income or cash flows as the intangible assets related to oil and
gas mineral rights would continue to be amortized under the full cost method of
accounting. Holding LLC is currently unable to estimate the net carrying value
of its intangible assets relating to leasehold costs.

CHANGES IN PRICES

Oil and natural gas prices are subject to seasonal and other fluctuations
that are beyond the Company's ability to control or predict.

37

INFLATION

Although certain of the Company's costs and expenses are affected by the
level of inflation, inflation has not had a significant effect on the Company's
results of operations during the three years ended December 31, 2003.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the past, the Company utilized various hedging instruments, principally
to control risk related to future oil and natural gas prices. While the use of
hedge contracts can limit the downside risk of adverse price movements, it may
also limit future gains from favorable movements. The Company addressed market
risk by selecting instruments whose value fluctuations correlated strongly with
the underlying commodity. Credit risk related to derivative activities was
managed by requiring minimum credit standards for counterparties, periodic
settlements, and market to market valuations.

No hedge assets, or liabilities have been recorded by the Company as all of
the hedges entered into by the Company were contributed to Holding LLC in
September 2001. (See Note 1 to the Financial Statements)

The Company's exposure to interest rates relates primarily to its
borrowings under its credit facility. The Company does not currently use
derivatives to manage interest rate risk. Interest is payable on borrowings
under the credit facility based on a floating rate. If short-term interest rates
average 10% higher in 2004 than they were in 2003, the Company's interest
expense would increase by approximately $1.6 million. This amount was determined
by applying the hypothetical interest rate change to the Company's outstanding
borrowings under the credit facility at December 31, 2003.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Financial Statements of the Company required by this Item 8 are
included as part of Item 15(a)(1) hereof. These Financial Statements also serve
as financial statements required pursuant to Rule 15d-21 and Form 11-K of the
Exchange Act for the National Energy Group, Inc. Employee Stock Purchase Plan,
as such Plan invests solely in the Company's common stock.

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

None.

ITEM 9A. CONTROLS AND PROCEDURES

In accordance with Exchange Act Rules 13a-15 and 15d-15, the Company, under
the supervision and with the participation of its Chief Executive Officer and
Chief Financial Officer, carried out an evaluation of the effectiveness of its
disclosure controls and procedures as of the end of the period covered by this
report. Based on that evaluation, the Company's Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures were effective as of the end of the period covered by this report, to
provide reasonable assurance that information required to be disclosed in its
reports filed or submitted under the Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms.

No change occurred in the Company's internal controls concerning financial
reporting (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934)
during the year ended December 31, 2003 that has materially affected, or is
reasonably likely to materially affect, the Company's internal controls over
financial reporting.

38

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item 10 will be provided in the sections
entitled "Director Election", "Management" and "Certain Relationships and
Related Transactions" in the Company's definitive Proxy Statement for its 2004
Annual Meeting of Shareholders (the "Proxy Statement"), and is incorporated
herein by reference.

The Company has adopted a Code of Business Conduct and Ethics that applies
to directors, officers and employees, including its principal executive officer,
principal financial officer and principal accounting officer. The Company's Code
of Business Conduct and Ethics is posted on the Company's website at
http://www.negx.com. Changes to and waivers granted with respect to this Code of
Business Conduct and Ethics related to officers identified above, and other
executive officers and directors of the Company that it is required to disclose
pursuant to applicable rules and regulations of the Commission will also be
posted on the Company's website.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item 11 will be provided in the section
entitled, "Executive Compensation" in the Company's Proxy Statement, and is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item 12 will be provided in the section
entitled "Security Ownership of Certain Beneficial Owners and Management" in the
Company's Proxy Statement, and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item 13 will be provided in the section
entitled "Certain Relationships and Related Transactions" in the Company's Proxy
Statement, and is incorporated herein by reference.

ITEM 14. PRINCIPLE ACCOUNTING FEES AND SERVICES

The information requested by this Item 14 will be provided in the section
entitled "Principle Accounting Fees and Services" in the Company's Proxy
Statement, and is incorporated herein by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

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

1. Financial Statements: See Index to Financial Statements and
Financial Statement Schedules on page F-1 of this report.

2. Financial Statement Schedules: See Index to Financial Statements
and Financial Statement Schedules on page F-1 of this report.

(b) Reports on Form 8-K:

On September 10, 2003, National Energy Group, Inc. filed a Current
Report on Form 8-K (dated August 28, 2003), which reported the execution of
the Management Agreement with TransTexas Gas Corporation.

39

(c) Exhibits:

Reference is made to the Index to Exhibits immediately following the
Notes to Consolidated Financial Statements for a list of all exhibits filed
as part of this report.

GLOSSARY

Wherever used herein, the following terms shall have the meaning specified.

Bbl -- One stock tank barrel, or 42 U.S. gallons liquid volume, used herein
in reference to crude oil or other liquid hydrocarbons.

Bcf -- One billion cubic feet.

Bcfe -- One billion cubic feet of Natural Gas Equivalent.

Behind the Pipe -- Hydrocarbons in a potentially producing horizon
penetrated by a well bore the production of which has been postponed pending the
production of hydrocarbons from another formation penetrated by the well bore.
The hydrocarbons are classified as proved but non-producing reserves.

Developed Acreage -- Acres which are allocated or assignable to producing
wells or wells capable of production.

Development Well -- A well drilled within the proved area of an oil and
natural gas reservoir to the depth of stratigraphic horizon known to be
productive.

Dry Well -- A well found to be incapable of producing either oil or natural
gas in sufficient quantities to justify completion as an oil or natural gas
well.

Exploratory Well -- A well drilled to find and produce oil or natural gas
in an unproved area, to find a new reservoir in a field previously found to be
productive of oil or natural gas in another reservoir, or to extend a known
reservoir.

Gross Acres or Gross Wells -- The total acres or wells, as the case may be,
in which a Working Interest is owned.

Infill Well -- A well drilled between known producing wells.

Mbbl -- One thousand Bbl.

Mcf -- One thousand cubic feet.

Mcfe -- One thousand cubic feet of Natural Gas Equivalent.

Mmcf -- One million cubic feet.

Mmcfe -- One million cubic feet of Natural Gas Equivalent.

Natural Gas Equivalent -- The ratio of one Bbl of crude oil to six Mcf of
natural gas.

Net Acres or Net Wells -- The sum of the fractional Working Interests owned
in Gross Acres or Gross Wells.

NYMEX -- New York Mercantile Exchange.

Oil, Gas and Mineral Lease -- An instrument by which a mineral fee owner
grants to a lessee the right for a specific period of time to explore for oil
and natural gas underlying the lands covered by the lease and the right to
produce any oil and natural gas so discovered generally for so long as there is
production in economic quantities from such lands.

OPEC -- Organization of Petroleum Exporting Countries.

40

Overriding Royalty Interest -- A fractional undivided interest in an oil
and natural gas property entitling the owner of a share of oil and natural gas
production, in addition to the usual royalty paid to the owner, free of costs of
production.

PDNP -- Proved developed, nonproducing, or Behind the Pipe reserves.

Productive Well -- A well that is producing oil or natural gas or that is
capable of production.

Proved Developed Producing Reserves -- Proved reserves that can be expected
to be recovered from currently producing zones under the continuation of present
operating methods.

Proved Developed Reserves -- Reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods.

Proved Reserves -- The estimated quantities of crude oil, natural gas, and
natural gas liquids which geological and engineering data demonstrate with
reasonable certainty to be recoverable in future years from known reservoirs
under existing economic and operating conditions.

Proved Undeveloped Reserves -- Reserves that are expected to be recovered
from new wells on undrilled acreage, or from existing wells where a relatively
major expenditure is required for completion.

PUD -- See Proved Undeveloped Reserves.

PV 10% -- The discounted future net cash flows for Proved Reserves of oil
and natural gas computed on the same basis as the Standardized Measure, but
without deducting income taxes, which is not in accordance with generally
accepted accounting principles. PV 10% is an important financial measure for
evaluating the relative significance of oil and natural gas properties and
acquisitions, but should not be construed as an alternative to the Standardized
Measure (as determined in accordance with generally accepted accounting
principles).

Revenue Interest -- The interest in a lease or well that receives a
proportionate share of all revenues from that lease or well as identified in the
division order.

Royalty Interest -- An interest in an oil and natural gas property
entitling the owner to a share of oil and natural gas production free of costs
of production.

Secondary Recovery -- A method of oil and natural gas extraction in which
energy sources extrinsic to the reservoir are utilized.

Standardized Measure -- The estimated future net cash flows from Proved
Reserves of oil and natural gas computed using prices and costs, at the date
indicated, after income taxes and discounted at 10%.

Undeveloped Acreage -- Lease acreage on which wells have not been drilled
or completed to a point that would permit the production of commercial
quantities of oil and natural gas regardless of whether such acreage contains
Proved Reserves.

Working Interest -- The operating interest which gives the owner the right
to participate in the drilling, producing, and conducting operating activities
on the property and a share of all costs of exploration, development, and
operations and all risks in connection therewith.

41

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.

NATIONAL ENERGY GROUP, INC.

By: /s/ BOB G. ALEXANDER
------------------------------------
Bob G. Alexander
President and Chief Executive
Officer

March 30, 2004

By: /s/ RANDALL D. COOLEY
------------------------------------
Randall D. Cooley
Vice President and Chief Financial
Officer

March 30, 2004

POWER OF ATTORNEY AND SIGNATURES

The undersigned directors and officers of National Energy Group, Inc.
hereby constitute and appoint Bob G. Alexander with full power to act and with
full power of substitution and resubstitution, our true and lawful
attorney-in-fact with full power to execute in our name and on our behalf in the
capacities indicated below any and all amendments to this Form 10-K and to file
the same, with all exhibits thereto and other documents in connection therewith
with the Commission, and hereby ratify and confirm all that such
attorney-in-fact, which he or his substitute shall lawfully do or cause to be
done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities on March 30, 2004.

/s/ BOB G. ALEXANDER President, Chief Executive Officer and Director
- --------------------------------------
Bob G. Alexander

/s/ MARTIN L. HIRSCH Director
- --------------------------------------
Martin L. Hirsch

/s/ ROBERT H. KITE Director
- --------------------------------------
Robert H. Kite

/s/ ROBERT J. MITCHELL Director
- --------------------------------------
Robert J. Mitchell

/s/ JACK G. WASSERMAN Director
- --------------------------------------
Jack G. Wasserman

42

INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

FINANCIAL STATEMENTS

FINANCIAL STATEMENT SCHEDULES

All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.

F-1

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders
National Energy Group, Inc:

We have audited the accompanying balance sheets of National Energy Group,
Inc ("the Company") and as of December 31, 2003 and 2002 and the related
statements of operation, stockholders' equity, and cash flows for each of the
years in the three-year period ended December 31, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of National Energy Group, Inc
and subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.

KPMG, LLP

Dallas, Texas
March 12, 2004

F-2

NATIONAL ENERGY GROUP, INC.

BALANCE SHEETS

See accompanying notes.

F-3

NATIONAL ENERGY GROUP, INC.

STATEMENTS OF OPERATIONS

See accompanying notes.

F-4

NATIONAL ENERGY GROUP, INC.

STATEMENTS OF CASH FLOWS

See accompanying notes.

F-5

NATIONAL ENERGY GROUP, INC.

STATEMENTS OF STOCKHOLDERS' DEFICIT

See accompanying notes.
F-6

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003

1. BACKGROUND AND BANKRUPTCY FILING

National Energy Group, Inc. (the "Company") was incorporated under the laws
of the State of Delaware on November 20, 1990. Effective June 11, 1991, Big
Piney Oil and Gas Company and VP Oil, Inc. merged with and into the Company. On
August 29, 1996, Alexander Energy Corporation was merged with and into a
wholly-owned subsidiary of the Company, which subsidiary was merged with and
into the Company on December 31, 1996.

On February 11, 1999, the United States Bankruptcy Court for the Northern
District of Texas, Dallas Division ("Bankruptcy Court") entered an involuntary
petition placing the Company under protection of the Bankruptcy Court pursuant
to Title 11, Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy
Proceeding"). On July 24, 2000, the Bankruptcy Court entered a subsequent order
confirming a Plan of Reorganization (the "Plan of Reorganization") jointly
proposed by the Company and the official committee of unsecured creditors, which
Plan of Reorganization became effective on August 4, 2000. The Bankruptcy Court
issued a final decree closing the case effective December 13, 2001. Accordingly,
the Company has effectively settled all matters relating to the Bankruptcy
Proceeding.

As mandated by the Plan of Reorganization and the Bankruptcy Court, NEG
Holding LLC ("Holding LLC"), a Delaware limited liability company, was formed in
August 2000. In exchange for an initial 50% membership interest in Holding LLC,
on September 12, 2001, but effective as of May 1, 2001, the Company contributed
to Holding LLC all of its operating assets and oil and natural gas properties
excluding cash of $4.3 million ("LLC Contribution"). In exchange for its initial
50% membership interest in Holding LLC, Gascon Partners, ("Gascon") an entity
owned or controlled by Carl C. Icahn, contributed (i) its sole membership
interest in Shana National LLC, an oil and natural gas producing company, (ii)
cash of 75.2 million, and (iii) a $10.9 million revolving note issued to Arnos
Corp. ("Arnos"), an entity owned or controlled by Carl C. Icahn, evidencing the
borrowings under the Company's revolving credit facility. In connection with the
foregoing, Holding LLC initially owns 100% of the membership interest in NEG
Operating LLC ("Operating LLC"), a Delaware limited liability company. All of
the oil and natural gas assets contributed by the Company and all of the oil and
natural gas assets associated with Gascon's contribution to Holding LLC were
transferred from Holding LLC to Operating LLC on September 12, 2001, but
effective as of May 1, 2001.

The assets contributed by the Company to Holding LLC were current assets of
$11.5 million, net oil and natural gas assets of $85.0 million and other assets
of $4.8 million. The liabilities assumed by Holding LLC were current liabilities
of $4.2 million, intercompany payable to Gascon of $4.8 million and long-term
liabilities of $1.0 million.

The Holding LLC Operating Agreement entered into on September 12, 2001,
contains a provision that allows Gascon at any time, in its sole discretion, to
redeem the Company's membership interest in Holding LLC at a price equal to the
fair market value of such interest determined as if Holding LLC had sold all of
its assets for fair market value and liquidated. Since all of the Company's
operating assets and oil and natural gas properties have been contributed to
Holding LLC, as noted above, following such a redemption, the Company's
principal assets would consist solely of its cash balances. In the event that
such redemption right is exercised by Gascon, the Company may be obligated to
use the proceeds that it would receive for its redeemed membership interest to
pay outstanding indebtedness and operating expenses before the distribution of
any portion of such proceeds to the Company's shareholders. Following the
payment of the Company's indebtedness (currently held by entities owned or
controlled by Carl C. Icahn) and its operating expenses, there is a substantial
risk that there will be no proceeds remaining for distribution to the Company's
shareholders.

F-7

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

As a result of the foregoing transactions and as mandated by the Plan of
Reorganization effective September 12, 2001, the Company's principal assets were
its remaining cash balances, accounts receivable from affiliates, deferred tax
asset and its initial 50% membership interest in Holding LLC and its principal
liabilities were the $10.9 million outstanding under its existing $100 million
revolving credit facility with Arnos, the 10 3/4% Senior Notes (the "Senior
Notes") and the long-term interest payable on the Senior Notes. None of the
Company's employees were transferred to Holding LLC or Operating LLC.

As a result of the terms and conditions of the various agreements related
to the repayment of the Company's indebtedness and repayment of the priority
distribution amounts and the guaranteed payments (plus accrued interest thereon)
to Gascon, there is a substantial risk that there will be no amounts remaining
for distribution to the Company's stockholders.

The Company remains highly leveraged after confirmation of the Plan of
Reorganization.

2. SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The Company's contribution of all its operating assets and oil and natural
gas properties occurred on September 12, 2001. For tax and valuation purposes,
the effective date is as of May 1, 2001, however, solely for financial reporting
purposes the transaction is as of September 1, 2001. Operations from September 1
to September 12 were not significant. Management fees and guaranteed payments
accruing from May 1 through September 1, 2001 aggregating $7,465,694 were
recorded as an increase to additional paid-in capital.

RECLASSIFICATIONS

Certain reclassifications have been made to prior period's financial
statements to conform to the current presentation.

ACCOUNTING ESTIMATES

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

CASH AND CASH EQUIVALENTS

Cash and cash equivalents may include demand deposits, short-term
commercial paper, and/or money-market investments with maturities of three
months or less when purchased.

INVESTMENT IN HOLDING LLC

Due to the substantial uncertainty that the Company will receive any
distribution above the Priority Amount and Guaranteed Payment amounts, the
Company accounts for its investment in Holding LLC as a preferred investment
whereby Guaranteed Payment amounts received and receipts of distributions of
Priority Amount are recorded as reductions in the investment and income is
recognized from accretion of the investment up to the Priority Amount, including
the Guaranteed Payments (based on the interest method) (see Note 8). Following
receipt of the Guaranteed Payments and distributions of Priority Amount, the
residual interest in the investment will be valued at zero.

The Company periodically evaluates the propriety of the carrying amount of
its investment in Holding LLC to determine whether current events or
circumstances warrant adjustments to the carrying value for any
F-8

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

other than temporary impairment and/or revisions to accretion of income. The
Company currently believes that no such impairment has occurred and that no
revision to the accretion of income is warranted.

OIL AND NATURAL GAS PROPERTIES

Prior to the LLC Contribution, the Company utilized the full cost method of
accounting for its crude oil and natural gas properties. Under the full cost
method, all productive and nonproductive costs incurred in connection with the
acquisition, exploration, and development of crude oil and natural gas reserves
were capitalized and amortized on the units-of-production method based upon
total proved reserves. The costs of unproven properties were excluded from the
amortization calculation until the individual properties were evaluated and a
determination was made as to whether reserves exist. Conveyances of properties,
including gains or losses on abandonments of properties, were treated as
adjustments to the cost of crude oil and natural gas properties, with no gain or
loss recognized.

Under the full cost method, the net book value of oil and natural gas
properties, less related deferred income taxes, may not exceed the estimated
after-tax future net revenues from proved oil and natural gas properties,
discounted at 10% per year (the ceiling limitation). In arriving at estimated
future net revenues, estimated lease operating expenses, development costs,
abandonment costs, and certain production related and ad-valorem taxes are
deducted. In calculating future net revenues, prices and costs in effect at the
time of the calculation are held constant indefinitely, except for changes which
are fixed and determinable by existing contracts. The net book value is compared
to the ceiling limitation on a quarterly and yearly basis. The excess, if any,
of the net book value above the ceiling limitation is required to be written off
as a non-cash expense. The Company did not incur ceiling limitation writedowns
during 2001.

The Company contributed all of its oil and natural gas assets to Holding
LLC in September 2001.

The Company capitalized internal costs of $454,000 for the year ended
December 31, 2001 as costs of oil and natural gas properties. Such capitalized
costs include salaries and related benefits of individuals directly involved in
the Company's acquisition, exploration, and development activities based on a
percentage of their salaries. The Company did not capitalize interest during
2001. Effective with the transfer of the Company's oil and natural gas assets to
Holding LLC, the Company no longer capitalizes internal costs.

As an operator of oil and natural gas properties, the Company was subject
to extensive federal, state, and local environmental laws and regulations. These
laws, which are constantly changing, regulate the discharge of materials into
the environment and may require the Company to remove or mitigate the
environment effects of the disposal or release of petroleum or chemical
substances at various sites. Environmental expenditures were expensed or
capitalized depending on their future economic benefit. Expenditures that relate
to an existing condition caused by past operations and that have no future
economic benefits were expensed. Liabilities for expenditures of a noncapital
nature were recorded when environmental assessment and/or remediation is
probable, and the costs can be reasonably estimated. Effective with the LLC
Contribution, the Company no longer owns any oil and natural gas properties and
is not subject to the above expenditures.

OTHER PROPERTY AND EQUIPMENT

Other property and equipment includes furniture, fixtures, and other
equipment. Such assets are recorded at cost and are depreciated over their
estimated useful lives using the straight-line method. Effective with the LLC
Contribution, the Company no longer owns any property and equipment.

INCOME TAXES

Deferred tax assets and liabilities are determined based on differences
between financial reporting and tax basis of assets and liabilities and are
measured using enacted tax rates. The effect on deferred tax assets and
liabilities of a change in tax rate is recognized in the period that includes
the enactment date. The
F-9

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

measurement of deferred tax assets is adjusted by a valuation allowance, if
necessary, to recognize the extent to which, based on available evidence, the
future tax benefits more likely than not will be realized.

FINANCIAL INSTRUMENTS

See Notes 5 and 6 for disclosure of the fair value of borrowings under the
Company's credit facility and the 10 3/4% Senior Notes, respectively.

The Company's marketable securities were classified as available-for-sale.
Available-for-sale securities were carried at fair value, with the unrealized
gains and losses, net of tax, reported as a separate component of stockholders'
equity. Realized gains and losses and declines in value judged to be
other-than-temporary were included in income. The cost of securities sold is
based on the specific identification method.

The Company had no purchases or sales of marketable securities during 2002
or 2003.

The Company sold crude oil and natural gas to various customers. In
addition, the Company participated with other parties in the operation of crude
oil and natural gas wells. Substantially all of the Company's accounts
receivable were due from either purchasers of crude oil and natural gas or
participants in crude oil and natural gas wells for which the Company served as
the operator. Generally, operators of crude oil and natural gas properties have
the right to offset future revenues against unpaid charges related to operated
wells. Crude oil and natural gas sales were generally unsecured.

At December 31, 2002 and 2003, the carrying value of the Company's accounts
receivable approximates fair value.

NATURAL GAS PRODUCTION IMBALANCES

Prior to the LLC Contribution, the Company accounted for natural gas
production imbalances using the sales method, whereby the Company recognized
revenue on all natural gas sold to its customers notwithstanding the fact that
its ownership may be less than 100% of the natural gas sold. Liabilities were
recorded by the Company for imbalances greater than the Company's proportionate
share of remaining estimated natural gas reserves. After the LLC Contribution,
the Company had no oil and natural gas production imbalances.

STOCK COMPENSATION

The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, in accounting for its employee
stock options. Under APB 25, if the exercise price of an employee's stock
options equals or exceeds the market price of the underlying stock on the date
of grant, no compensation expense is recognized.

In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" ("FIN 44"), an interpretation of APB 25. FIN 44, which was adopted
prospectively by the Company as of July 1, 2000, requires certain changes to the
previous practice regarding the accounting for certain stock compensation
arrangements. FIN 44 does not change APB 25's intrinsic value method, under
which compensation expense is generally not recognized for grants of stock
options to employees with an exercise price equal to the market price of the
stock at the date of grant, but it has narrowed its application. The adoption of
FIN 44 did not have a significant effect on the Company's existing accounting
for its employee stock options.

EARNINGS (LOSS) PER SHARE

Earnings (loss) per share is computed in accordance with Financial
Accounting Standards Board Statement No. 128, Earnings per Share. Basic earnings
per share data is computed by dividing net income (loss) applicable to common
shareholders by the weighted average number of common shares outstanding
F-10

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

and excludes any dilutive effects of options, warrants, and convertible
securities. Shares issuable upon exercise of options and warrants are included
in the computation of diluted earnings per common and common equivalent share to
the extent that they are dilutive. Diluted earnings per share computations also
assume the conversion of the Company's preferred stock (Note 10) if such
conversion has a dilutive effect. For the year ended December 31, 2000, prior to
the confirmation of the Joint Plan, neither the options and warrants nor the
assumed conversion of the preferred stock had a dilutive effect on the loss per
share calculations. Subsequent to the confirmation of the Plan of Reorganization
and in 2001, all common stock equivalents had been canceled. Accordingly, both
basic and diluted loss per share calculations for such periods are based on the
weighted average number of common shares outstanding during 2002 and 2003.

COMPREHENSIVE INCOME

Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources. There were no differences between net earnings and total
comprehensive income in 2001, 2002 and 2003.

DERIVATIVES

In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Certain Hedging Activities." In June 2000, the FASB
issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activity, an Amendment of SFAS 133." SFAS No. 133 and SFAS No. 138
require that all derivative instruments be recorded on the balance sheet at
their respective fair values. SFAS No. 133 and SFAS No. 138 are effective for
all fiscal quarters of all fiscal years beginning after June 30, 2000. The
adoption of SFAS 133 and 138 did not have an impact on the Company's financial
statements.

All derivatives are recognized on the balance sheet at their fair value.
Prior to the LLC Contribution, the Company periodically managed its exposure to
fluctuations in oil and natural gas prices by entering into various derivative
instruments consisting principally of collar options and swaps. The Company
elected not to designate these instruments as hedges for accounting purposes,
accordingly the change in unrealized gains and losses is included in other
income and expense. Cash settlements of these instruments are included in oil
and natural gas sales. The following summarizes the cash settlements and
unrealized gains and losses for the years ended December 31, 2001, 2002, and
2003:

In connection with the LLC Contribution in September 2001, the Company
contributed all of its derivative financial instruments with a fair value of
$(135,954) to Holding LLC. Subsequent to the LLC Contribution, the Company has
not entered into any derivative financial instruments.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for
Asset Retirement Obligations" ("SFAS 143"). SFAS No. 143 requires the Company to
record the fair value of an asset retirement obligation as a liability in the
period in which it incurs a legal obligation associated with the retirement of
tangible long-lived assets that result from the acquisition, construction,
development, and/or normal use of the assets. It also requires the Company to
record a corresponding asset that is depreciated over the life of the asset.
Subsequent to the initial measurement of the asset retirement obligation, the
obligation will be adjusted at the end of each period to

F-11

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

reflect the passage of time and changes in the estimated future cash flows
underlying the obligation. The Company adopted SFAS No. 143 on January 1, 2003.
The adoption of SFAS No. 143 had no material impact on the Company's financial
statements.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure, an amendment of FASB Statement No.
123" ("SFAS 123"). SFAS No. 148 amends FASB Statement No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
Statement No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain of the disclosure modifications are required for
fiscal years ending after December 15, 2002. The adoption of SFAS No. 148 had no
material impact on the Company's financial statements.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. ("SFAS 146") SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002, with early application
encouraged. The adoption of SFAS No. 146 had no material effect on the Company's
financial statements.

In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions of the
Interpretation are applicable to guarantees issued or modified after December
31, 2002 and did not have a material effect on the Company's financial
statements. The disclosure requirements are effective for financial statements
of interim and annual periods ending after December 31, 2002.

In December 2003, the FASB issued Interpretation No. 46 (revised December
2003), "Consolidation of Variable Interest Entities, an Interpretation of ARB
No. 51" ("FIN 46R"). FIN 46R requires a company to consolidate a variable
interest entity, as defined, when the company will absorb a majority of the
variable interest entity's expected losses, receive a majority of the variable
interest entity's expected residual returns, or both. FIN 46R also requires
certain disclosures relating to consolidated variable interest entities and
unconsolidated variable interest entities in which a company has a significant
variable interest. The provisions of FIN 46R are required for companies that
have interests in variable interest entities, or potential variable interest
entities commonly referred to as special-purpose entities for periods ending
after December 15, 2003. The provisions of FIN 46R are required to be applied
for periods ending after March 15, 2004 for all other types of entities. The
Company's interests in, and related management arrangements associated with, NEG
Holding LLC constitute variable interests in variable interest entities under
FIN 46R. However, the Company is not considered the primary beneficiary of NEG
Holding LLC as defined by FIN 46R, and accordingly is not required to
consolidate NEG Holding LLC.

The EITF is considering two issues related to the reporting of oil and gas
mineral rights. Issue No. 03-O, "Whether Mineral Rights Are Tangible or
Intangible Assets," is whether or not mineral rights are intangible assets
pursuant to SFAS No. 141, "Business Combinations." Issue No. 03-S, "Application
of SFAS No. 142, Goodwill and Other Intangible Assets, to Oil and Gas
Companies," is, if oil and gas drilling rights are intangible assets, whether
those assets are subject to the classification and disclosure provisions of SFAS
No. 142.
F-12

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Holding LLC classifies the cost of oil and gas mineral rights as properties
and equipment and believes that this is consistent with oil and gas accounting
and industry practice. If the EITF determines that oil and gas mineral rights
are intangible assets and are subject to the applicable classification and
disclosure provisions of SFAS No. 142, Holding LLC would be required to
reclassify these costs from properties and equipment to intangible assets on its
consolidated balance sheets as of December 31, 2003 and 2002. These amounts
would represent oil and gas mineral rights acquired after June 2001 through the
end of the respective periods and be net of accumulated DD&A. In addition, the
disclosures required by SFAS Nos. 141 and 142 would be made in the notes to the
consolidated financial statements. There would be no effect on the consolidated
statements of income or cash flows as the intangible assets related to oil and
gas mineral rights would continue to be amortized under the full cost method of
accounting. Holding LLC is currently unable to estimate the net carrying value
of its intangible assets relating to leasehold costs.

3. MANAGEMENT AGREEMENTS

The management and operation of Operating LLC is being undertaken by the
Company pursuant to the Management Agreement which the Company has entered into
with Operating LLC. However, neither the Company's officers nor directors will
control the strategic direction of Operating LLC's oil and natural gas business
including oil and natural gas drilling and capital investments, which shall be
controlled by the managing member of Holding LLC (currently Gascon). The
Management Agreement provides that the Company will manage Operating LLC's oil
and natural gas assets and business until the earlier of November 1, 2006, or
such time as Operating LLC no longer owns any of the managed oil and natural gas
properties. The Company's employees will conduct the day-to-day operations of
Operating LLC's oil and natural gas properties, and all costs and expenses
incurred in the operation of the oil and natural gas properties shall be borne
by Operating LLC; although the Management Agreement provides that the salary of
the Company's Chief Executive Officer shall be 70% attributable to the managed
oil and natural gas properties, and the salaries of each of the General Counsel
and Chief Financial Officer shall be 20% attributable to the managed oil and
natural gas properties. In exchange for the Company's management services,
Operating LLC shall pay the Company a management fee equal to 115% of the actual
direct and indirect administrative and reasonable overhead costs incurred by the
Company in operating the oil and natural gas properties, which either the
Company or Operating LLC may seek to change within the range of 110%-115% as
such change is warranted; however, the parties have agreed to consult with each
other to ensure that such administrative and reasonable overhead costs
attributable to the managed properties are properly reflected in the management
fee paid to the Company. In addition, Operating LLC has agreed to indemnify the
Company to the extent it incurs any liabilities in connection with its operation
of the assets and properties of Operating LLC, except to the extent of its gross
negligence, or misconduct. The Company recorded $6.6 million as a management fee
for the year ended December 31, 2003.

On August 28, 2003, the Company entered into the TTG Management Agreement
whereby the Company manages TTG. The TTG Management Agreement was entered into
in connection with a plan of reorganization for TTG proposed by Thornwood
Associates LP, an entity affiliated with Carl C. Icahn. The United States
Bankruptcy Court, Southern District of Texas issued an order confirming the TTG
Plan. Affiliates of Mr. Icahn own approximately 89% of TTG. TTG is engaged in
the exploration, production and transmission of natural gas and oil primarily in
South Texas, including the Eagle Bay field in Galveston Bay, Texas and the
Southwest Bonus field located in Wharton County, Texas. Bob G. Alexander and
Philip D. Devlin, President and CEO, and Vice President, Secretary and General
Counsel of the Company, respectively, have been appointed to the TTG Board of
Directors and shall act as the two principal officers of TTG and its
subsidiaries, Galveston Bay Pipeline Corporation and Galveston Bay Processing
Corporation.

The TTG Management Agreement provides that the Company shall be responsible
for and have authority with respect to all of the day-to-day management of TTG's
business but shall not function as a Disbursing Agent as such term is defined in
the TTG Plan. As consideration for the Company's services in
F-13

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

managing the TTG business, the Company shall receive a monthly fee of $312,500.
The TTG Management Agreement is terminable (i) upon 30 days prior written notice
by TTG, (ii) upon 90 days prior written notice by the Company, (iii) upon 30
days following any day where High River designees no longer constitute the TTG
Board of Directors, unless otherwise waived by the newly-constituted Board of
Directors of TTG, or (iv) as otherwise determined by the Bankruptcy Court. The
Company recorded $1.4 million as a management fee for the year ended December
31, 2003.

4. ACQUISITIONS AND DISPOSALS

In January 2001, the Company sold its interest in the Shell Bayou Sorrel
field located in Iberville Parish Louisiana for $.75 million.

In the first quarter of 2001, the Company purchased additional working
interests in the Goldsmith Adobe Unit, for approximately $2.3 million. The
Company owned an approximate 99.9% working interest in this property prior to
the LLC Contribution.

5. CREDIT FACILITIES

At December 31, 2002, the Company had $10.9 million outstanding under its
existing $100 million credit facility with Arnos. Arnos continued to be the
holder of the credit facility; however, the $10.9 million note outstanding under
the credit facility was contributed to Holding LLC as part of Gascon's
contribution to Holding LLC on September 12, 2001. In December 2001, the
maturity date of the credit facility was extended to December 31, 2003 and the
Company was given a waiver of compliance with respect to any and all covenant
violations. The Company was not in compliance with the minimum interest coverage
ratio at September 30, 2002 and December 31, 2002 and the current ratio at
December 31, 2002, however, in December 2001 the Company was given a waiver of
compliance with respect to any and all covenant violations through December 31,
2003.

On March 26, 2003, Holding LLC distributed the $10.9 million note
outstanding under the Company's revolving credit facility as a distribution of
Priority Amount to the Company, thereby canceling the note. Also, on March 26,
2003 the Company, Arnos and Operating LLC entered into an agreement to assign
the credit facility to Operating LLC. Effective with this assignment, Arnos
amended the credit facility to increase the revolving commitment to $150
million, increase the borrowing base to $75 million and extend the revolving due
date until June 30, 2004. Concurrently, Arnos extended a $42.8 million loan to
Operating LLC under the amended credit facility. Operating LLC then distributed
$42.8 million to Holding LLC who, thereafter, made a $40.5 million distribution
of Priority Amount and a $2.3 million Guaranteed Payment to the Company. The
Company utilized these funds to pay the entire amount of the long-term interest
payable on the Senior Notes and interest accrued thereon outstanding on March
27, 2003. The Arnos facility was canceled on December 29, 2003 in conjunction
with the Mizuho Corporate Bank Ltd. (Mizuho) financing.

On December 29, 2003, Operating LLC entered into a Credit Agreement (the
"Credit Agreement") with certain commercial lending institutions, including
Mizuho as the Administrative Agent and the Bank of Texas, N.A. and the Bank of
Nova Scotia as Co-Agents.

The Credit Agreement provides for a loan commitment amount of up to $100
million and a letter of credit commitment of up to $15 million (provided, the
outstanding aggregate amount of the unpaid borrowings, plus the aggregate
undrawn face amount of all outstanding letters of credit shall not exceed the
borrowing base under the Credit Agreement). The Credit Agreement provides
further that the amount available to Operating LLC at any time is subject to
certain restrictions, covenants, conditions and changes in the borrowing base
calculation. In partial consideration of the loan commitment amount, Operating
LLC has pledged a continuing security interest in all of its oil and natural gas
properties and its equipment, inventory, contracts, fixtures and proceeds
related to its oil and natural gas business.

F-14

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

At Operating LLC's option, interest on borrowings under the Credit
Agreement bear interest at a rate based upon either the prime rate or the LIBOR
rate plus, in each case, an applicable margin that, in the case of prime rate
loans, can fluctuate from 0.75% to 1.50% per annum, and, in the case of LIBOR
rate loans, can fluctuate from 1.75% to 2.50% per annum. Fluctuations in the
applicable interest rate margins are based upon Operating LLC's total usage of
the amount of credit available under the Credit Agreement, with the applicable
margins increasing as the Operating LLC's total usage of the amount of the
credit available under the Credit Agreement increases.

At the closing of the Credit Agreement, Operating LLC borrowed $43.8
million to repay $42.9 million owed by Operating LLC to Arnos under the secured
loan arrangement which was then terminated and to pay administrative fees in
connection with this borrowing. Operating LLC intends to use any future
borrowings under the Credit Agreement to finance potential acquisitions.

As a condition to the lenders obligations under the Credit Agreement, the
lenders required that the Company, Gascon, Holding LLC and Operating LLC execute
and deliver at the closing that certain Pledge Agreement and Irrevocable Proxy
in favor of Bank of Texas, N.A., its successors and assigns, the ("Pledge
Agreement"). Pursuant to the terms of the Pledge Agreement, in order to secure
the performance of the obligations of Operating LLC (i) each of the Company and
Gascon have pledged their 50% membership interest in Holding LLC (such interests
constituting 100% of the outstanding equity membership interest of Holding LLC);
(ii) Holding LLC has pledged its 100% equity membership interest in Operating
LLC; and (iii) Operating LLC has pledged its 100% equity membership interest in
its subsidiary, Shana National LLC (the membership interests referred to in
clauses (i), (ii) and (iii) above are collectively referred to as the
"Collateral"). The Pledge Agreement also provides for a continuing security
interest in the Collateral and that Bank of Texas, N.A. as the Collateral Agent
is the duly appointed attorney-in-fact of Operating LLC. The Collateral Agent
may take all action deemed reasonably necessary for the maintenance,
preservation and protection of the Collateral and the security interest therein
until such time that all of Operating LLC's obligations under the Credit
Agreement are fulfilled, terminated or otherwise expired. If under the Credit
Agreement an event of default shall have occurred and is continuing, the
Collateral Agent may enforce certain rights and remedies, including, but not
limited to the sale of the Collateral, the transfer of all or part of the
Collateral to the Collateral Agent or its nominee and/or the execution of all
endorsements, assignments, stock powers and other instruments of conveyance or
transfer with respect to all or part of the Collateral.

The Credit Agreement requires, among other things, semiannual engineering
reports covering oil and natural gas properties, and maintenance of certain
financial ratios, including the maintenance of a minimum interest coverage, a
current ratio, and a minimum tangible net worth. Operating LLC was in compliance
with all covenants at December 31, 2003.

Other than the Company's encumbrance of its 50% membership interest in
Holding LLC and its indemnification of the Collateral Agent as set forth in the
Pledge Agreement, the Company has incurred no obligations under the Credit
Agreement, nor does it act as guarantor of the obligations of Operating LLC or
any other guarantor or other entity thereunder.

6. SENIOR NOTES DUE 2006

Upon confirmation of the Joint Plan, the Senior Notes were held in their
entirety by Arnos and its affiliates. Effective October 2, 2003, the Senior
Notes are held by AREH. The Senior Notes bear interest at an annual rate of
10 3/4%, payable semiannually in arrears on May 1 and November 1 of each year.
The Senior Notes are senior, unsecured obligations of the Company, ranking pari
passu with all existing and future senior indebtedness of the Company, and
senior in right of payment to all future subordinated indebtedness of the
Company. Subject to certain limitations set forth in the indenture covering the
Senior Notes (the "Indenture"), the Company and its subsidiaries may incur
additional senior indebtedness and other indebtedness.
F-15

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The Indenture contains certain covenants limiting the Company with respect
to the following: (i) asset sales; (ii) restricted payments; (iii) the
incurrence of additional indebtedness and the issuance of certain redeemable
preferred stock; (iv) liens; (v) sale and leaseback transactions; (vi) lines of
business; (vii) dividend and other payment restrictions affecting subsidiaries;
(viii) mergers and consolidations; and (ix) transactions with affiliates.

On December 4, 1998, certain holders of the Senior Notes filed an
Involuntary Petition for an Order for Relief under Chapter 11 of Title 11 of the
United States Bankruptcy Code (see Note 1). Accrual of interest on the Senior
Notes was discontinued during the Bankruptcy Proceeding. Approximately $10.5
million additional interest expense would have been recognized by the Company
during 2000 if not for the discontinuation of the interest accrual. In
connection with the Plan of Reorganization, Unaccrued Interest (including
compounding interest) totalling approximately $35.3 million was reinstated.

The Company is unable to reasonably determine the fair value of the Senior
Notes at December 31, 2003, due to a lack of available market quotations, credit
ratings and inability to determine an appropriate discount rate.

In August 2001, the Company redeemed both $16.4 million of principal
outstanding under the senior note obligations and $4.8 million of long-term
interest payable on the Senior Notes for cash consideration of $10.5 million.
The Company paid two Arnos affiliates approximately $0.4 million in current
interest on the redeemed senior note obligations at the date of redemption
related to interest owed from the last semi-annual interest payment date of May
1, 2001, to the date of redemption. As this was a partial redemption of the
Senior Notes, it has been accounted for as a modification of terms that changes
the amounts of future cash payments. Accordingly, the excess of redeemed
principal and interest over the redemption payment of $10.5 million will be
amortized as a reduction to interest expense over the remaining life of the
bonds. In connection with this transaction, the Company borrowed $10.9 million
under its existing credit facility with Arnos.

7. COMMITMENTS AND CONTINGENCIES

The Company leases office space under an operating lease. Rental expense
charged to operations was approximately $553,000, 564,000 and $606,000 during
the years ended December 31, 2001, 2002 and 2003, respectively. Minimum lease
payments under future operating lease commitments at December 31, 2003, are as
follows:

2004........................................................ $596,128
2005........................................................ $596,128
2006........................................................ $596,128
2007........................................................ $596,128

The Company is not a party to any material pending legal proceedings. The
Company's Joint Plan became effective August 4, 2000, at which time the Company
emerged from bankruptcy with the authority to conduct its business operations
without Bankruptcy Court approval.

8. INVESTMENT IN HOLDING LLC

As explained below, the Company's investment in Holding LLC is recorded as
a preferred investment. The initial investment was recorded at historical
carrying value of the net assets contributed with no gain or loss recognized on
the transfer.

F-16

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The following is a summary income statement for Holding LLC for the years
ended December 31, 2002 and 2003.

Under the Holding LLC Operating Agreement, the Company is to receive
Guaranteed Payments in addition to a Priority Amount of $202.2 million before
Gascon receives any monies. The Priority Amount is to be made on or before
November 1, 2006. Guaranteed Payments are to be paid, on a semi annual basis,
based on an annual interest rate of 10.75% of the outstanding Priority Amount.
After the payments to the Company, Gascon is to receive distributions equivalent
to the Priority Amount and Guaranteed Payments plus other amounts as defined.
Following the above distributions to the Company and Gascon, additional
distributions, if any, are to be made in accordance with their respective
capital accounts. Because of the substantial uncertainty that the Company will
receive any distributions above the Priority Amount and Guaranteed Payment
amounts, the Company accounts for its investment in Holding LLC as a preferred
investment.

At inception (September 12, 2001), the Company recorded the investment in
Holding LLC at the historical cost of the oil and gas properties contributed
into the partnership (in exchange for Holding LLC's obligation to pay the
Company the Priority Amount and Guaranteed Payments). Subsequently, the Company
accretes its investment in Holding LLC from the initial investment recorded up
to the Priority Amount, including the Guaranteed Payments, at the implicit rate
of interest, recognizing the accretion income in earnings. Accretion income is
periodically adjusted for changes in the timing of cash flows, if necessary due
to unscheduled cash distributions. Receipt of Guaranteed Payments and the
Priority Amount are recorded as reductions in the preferred investment. The
preferred investment is evaluated quarterly for other than temporary impairment.

Because of the substantial uncertainty that the Company will receive any
distributions in excess of the Priority Amount and the Guaranteed Payments
("residual interest"), the residual interest attributable to the investment in
Holding LLC is valued at zero. Upon payment of the Priority Amount in 2006, the
Company's carrying value of the investment in Holding LLC will be zero. The
Company's membership interest in Holding LLC is governed by the Holding LLC
Operating Agreement and is not affected by the accretion of the investment. Cash
receipts, if any, after the Priority Amount and the Guaranteed Payments will be
reported in income as earned.

The following is a rollforward of the Investment in Holding LLC as of
December 31, 2002 and 2003:

F-17

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The Company received a Guaranteed Payment of $10.9 million from Holding LLC
in November 2001. The portion of the Guaranteed Payment related to the period
prior to the transfer has been reflected as a contribution to the Company's
equity.

The Holding LLC Operating Agreement requires that distributions shall be
made to both the Company and Gascon as follows:

1. Guaranteed Payments are to be paid to the Company, calculated on an
annual interest rate of 10.75% on the outstanding Priority Amount. The
Priority Amount includes all outstanding debt owed to entities owned or
controlled by Carl C. Icahn, including the amount of the Company's 10.75%
Senior Notes. As of December 31, 2003, the Priority Amount was $148.6
million. The Guaranteed Payments will be made on a semi-annual basis.

2. The Priority Amount is to be paid to the Company. Such payment is
to occur by November 6, 2006.

3. An amount equal to the Priority Amount and all Guaranteed Payments
paid to the Company, plus any additional capital contributions made by
Gascon, less any distribution previously made by Holding LLC to Gascon, is
to be paid to Gascon.

4. An amount equal to the aggregate annual interest (calculated at
prime plus 1/2% on the sum of the Guaranteed Payments), plus any unpaid
interest for prior years (calculated at prime plus 1/2% on the sum of the
Guaranteed Payments), less any distributions previously made by Holding LLC
to Gascon, is to be paid to Gascon.

5. After the above distributions have been made, any additional
distributions will be made in accordance with the ratio of the Company's
and Gascon's respective capital accounts. (Capital accounts as defined in
the Holding LLC Operating Agreement)

9. STOCKHOLDERS' EQUITY

In connection with the Plan of Reorganization, all 330,000 shares of the
Company's preferred stock issuances were converted into 714,286 shares of newly
issued common stock of the reorganized Company. Accordingly, no shares of
preferred stock are outstanding as of December 31, 2002 and 2003.

COMMON STOCK

Holders of common stock are entitled to one vote for each share held of
record on all matters voted on by stockholders. The shares of the common stock
do not have cumulative voting rights, which means that the holders of more than
50% of the shares of the common stock voting for the election of the directors
can elect all of the directors to be elected by holders of the common stock, in
which event the holders of the remaining shares of common stock will not be able
to elect any director. Upon any liquidation, dissolution, or winding-up of the
affairs of the Company, holders of the common stock would be entitled to
receive, pro rata, all of the assets of the Company available for distribution
to stockholders, after payment of any liquidation preference of any Preferred
Stock that may be issued and outstanding at the time. Holders of the common
stock have no subscription, redemption, sinking fund, or preemptive rights. The
Company has never paid cash dividends on its common stock and does not expect to
declare cash dividends in the foreseeable future.

Under terms of the Plan of Reorganization, each holder of common stock
received one share of stock in the reorganized Company for every seven shares
cancelled as a result of the reorganization. The new certificates were issued
pursuant to a registration exemption under Section 1145 of the United States
Bankruptcy Code and include a restrictive legend mandated by the Plan of
Reorganization which prohibits transactions in the Company's common stock by
anyone who is or will become, as a result of any such transaction, a "5 percent
shareholder" within the meaning of Section 382 of the Internal Revenue Code. All
F-18

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

information relating to shares of common stock for periods prior to confirmation
of the Plan of Reorganization have been restated to reflect the effects of this
reverse stock split.

STOCK OPTIONS

The Company had no stock option activity during the years ended December
31, 2001, 2002 and 2003.

STOCK PURCHASE PLAN

During 1998, the Company's shareholders approved the Company's Employee
Stock Purchase Plan ("ESPP"). Pursuant to the ESPP, employees can purchase the
common stock of the Company at a specified price through payroll deductions
during an offering period, currently established on a semi-annual basis. This
plan was terminated during 2001.

10. INCOME TAXES

The (provision) benefit for U.S. federal income taxes attributable to
continuing operations is as follows:

The reconciliation of income taxes computed at the U.S. federal statutory
tax rates to the benefit for income taxes on income from continuing operations
is as follows:

The computation of the net deferred tax asset follows:

At December 31, 2003, the Company had net operating loss carryforwards
available for federal income tax purposes of approximately $58 million which
begin expiring in 2009. Utilization of approximately

F-19

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

$0.2 million of the net operating loss carryforwards is subject to various
limitations because of previous changes in control of ownership (as defined in
the Internal Revenue Code) of the Company and Alexander Energy. Additional net
operating loss limitations may be imposed as a result of subsequent changes in
stock ownership of the Company. Prior to the formation of Holding LLC, the
income tax benefit associated with the loss carryforwards had not been
recognized since, in the opinion of management, there was not sufficient
positive evidence of future taxable income to justify recognition of a benefit.
Upon the formation of Holding LLC, management again evaluated all evidence, both
positive and negative, in determining whether a valuation allowance to reduce
the carrying value of deferred tax assets was still needed and concluded, based
on the projected allocations of taxable income by Holding LLC, the Company more
likely than not will realize a partial benefit from the loss carryforwards.
Accordingly, the Company recorded a deferred tax asset of $31.9 million in
September 2001, $25.5 million as of December 31, 2002 and $25.9 million as of
December 31, 2003. The Company reduced the valuation allowance by $5.1 million
in 2003. Ultimate realization of the deferred tax asset is dependent upon, among
other factors, the Company's ability to generate sufficient taxable income
within the carryforward periods and is subject to change depending on the tax
laws in effect in the years in which the carryforwards are used. As a result of
the recognition of expected future income tax benefits, subsequent periods will
reflect a full effective tax rate provision.

11. NATURAL GAS HEDGING ACTIVITIES AND FORWARD SALES CONTRACTS

While the use of derivative contracts can limit the downside risk of
adverse price movements, it may also limit future gains from favorable
movements. The Company addressed market risk by selecting instruments whose
value fluctuations correlated strongly with the underlying commodity. Credit
risk related to derivative activities was managed by requiring minimum credit
standards for counterparties, periodic settlements, and mark to market
valuations.

During 2001, the Company entered into several derivative contracts. These
contracts were contributed to Holding LLC in September 2001.

12. CRUDE OIL AND NATURAL GAS PRODUCING ACTIVITIES

The Company contributed all of its oil and natural gas assets to Holding
LLC in September 2001.

Costs incurred in connection with the exploration acquisition, development,
and exploration of the Company's crude oil and natural gas properties for the
years ended December 31, 2001 2002, and 2003, are as follows:

The Company did not incur ceiling limitation writedowns during 2001.

F-20

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Revenues from individual purchasers that exceed 10% of total crude oil and
natural gas sales are as follows:

The Company no longer owns any oil and natural gas assets and,
consequently, no longer transacted business with the above purchasers from
September 2001 due to the transfer of it's oil and natural gas assets to Holding
LLC.

13. SUPPLEMENTARY CRUDE OIL AND NATURAL GAS RESERVE INFORMATION (UNAUDITED)

The revenues generated by the Company's operations were highly dependent
upon the prices of, and demand for, oil and natural gas. The price received by
the Company for its oil and natural gas production depended on numerous factors
beyond the Company's control, including seasonality, the condition of the U.S.
economy, foreign imports, political conditions in other oil and natural gas
producing countries, the actions of the Organization of Petroleum Exporting
Countries and domestic governmental regulations, legislation and policies.

The Company has made ordinary course capital expenditures for the
development, and exploitation of oil and natural gas reserves, subject to
economic conditions. The Company had interests in crude oil and natural gas
properties that are principally located onshore in Texas, Louisiana, Oklahoma,
and Arkansas. The Company does not own or lease any crude oil and natural gas
properties outside the United States.

The estimated reserves and related future net revenues as of August 31,
2001, were prepared internally using the estimated reserves and related future
net revenues prepared by Netherland, Sewell & Associates, Inc. as of December
31, 2001 for the oil and natural gas properties contributed to Holding LLC. This
was accomplished by adding back production for the four month period August 31,
2001 to December 31, 2001 and using constant prices in effect at August 31,
2001. Estimated proved net recoverable reserves as shown below, include only
those quantities that can be expected to be recoverable at prices and costs in
effect at the balance sheet dates under existing regulatory practices and with
conventional equipment and operating methods.

Proved developed reserves represent only those reserves expected to be
recovered through existing wells. Proved undeveloped reserves include those
reserves expected to be recovered from new wells on undrilled acreage or from
existing wells on which a relatively major expenditure is required for
recompletion.

F-21

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Net quantities of proved developed and undeveloped reserves of natural gas
and crude oil, including condensate and natural gas liquids, are summarized as
follows:

The Company contributed all of its oil and natural gas assets to Holding
LLC in September 2001, in exchange for a 50% interest in Holding LLC.

Reservoir engineering is a subjective process of estimating the volumes of
underground accumulations of oil and natural which cannot be measured precisely.
The accuracy of any reserve estimates is a function of the quality of available
data and of engineering and geological interpretation and judgment. Reserve
estimates prepared by other engineers might differ from the estimates contained
herein. Results of drilling, testing, and production subsequent to the date of
the estimate may justify revision of such estimate. Future prices received for
the sale of oil and natural gas may be different from those used in preparing
these reports. The amounts and timing of future operating and development costs
may also differ from those used. Accordingly, reserve estimates are often
different from the quantities of oil and natural gas that are ultimately
recovered.

The following is a summary of a standardized measure of discounted net cash
flows related to the Company's proved crude oil and natural gas reserves. For
these calculations, estimated future cash flows from estimated future production
of proved reserves were computed using crude oil and natural gas prices as of
the end of each period presented. Future development, production and abandonment
costs attributable to the proved reserves were estimated assuming that existing
conditions would continue over the economic lives of the individual leases and
costs were not escalated for the future. Estimated future income tax expenses
were calculated by applying future statutory tax rates (based on the current tax
law adjusted for permanent differences and tax credits) to the estimated future
pretax net cash flows related to proved crude oil and natural gas reserves, less
the tax basis of the properties involved and net operating loss carryforwards.

The Company cautions against using this data to determine the fair value of
its crude oil and natural gas properties. To obtain the best estimate of fair
value of the crude oil and natural gas properties, forecasts of future economic
conditions, varying discount rates, and consideration of other than proved
reserves would have to be incorporated into the calculation. In addition, there
are significant uncertainties inherent in estimating quantities of proved
reserves and in projecting rates of production that impair the usefulness of the
data.

F-22

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The standardized measure of discounted future net cash flows relating to
proved crude oil and natural gas reserves are summarized as follows:

The following are the principal sources of change in the standardized
measure of discounted future net cash flows:

During recent years, there have been significant fluctuations in the prices
paid for crude oil in the world markets. This situation has had a destabilizing
effect on crude oil posted prices in the United States, including the posted
prices paid by purchasers of the Company's crude oil. The net weighted average
prices of crude oil and natural gas at August 31, 2001, used in the above table
was $26.02 per barrel of crude oil, $2.49 per thousand cubic feet of natural
gas, respectively.

F-23

NATIONAL ENERGY GROUP, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

14. QUARTERLY FINANCIAL RESULTS (UNAUDITED)

The Company's operating results for each quarter of 2002 and 2003 are
summarized below (in thousands, except per share data).

F-24

INDEPENDENT AUDITORS' REPORT

The Members
NEG Holding LLC:

We have audited the accompanying consolidated balance sheets of NEG Holding
LLC ("the Company") and subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of operation, members' equity and cash flows for
each of the years in the three-year period ended December 31, 2003. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of NEG Holding
LLC and subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.

As discussed in Note 1 to the consolidated financial statements, effective
January 1, 2003, the Company changed its method of accounting for asset
retirement obligations.

KPMG, LLP

Dallas, Texas
March 12, 2004

F-25

NEG HOLDING LLC

CONSOLIDATED BALANCE SHEETS

See accompanying notes.

F-26

NEG HOLDING LLC

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes.

F-27

NEG HOLDING LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.
F-28

NEG HOLDING LLC

CONSOLIDATED STATEMENTS OF MEMBERS' EQUITY

See accompanying notes.
F-29

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003

1. BACKGROUND

NEG Holding LLC (the "Company"), a Delaware limited liability company, was
formed in August 2000. Start up costs of the Company were incurred by Gascon
Partners ("Gascon") and were not significant. No other activity occurred from
August 2000 until the Members' contributions in September 2001. In exchange for
an initial 50% membership interest in the Company, on September 12, 2001, but
effective as of May 1, 2001, National Energy Group, Inc. ("NEG") contributed to
the Company all of its operating assets and oil and natural gas properties. In
exchange for its initial 50% membership interest in the Company, Gascon
contributed its sole membership interest in Shana National LLC, an oil and
natural gas producing company, and cash, including a $10.9 million Revolving
Note issued to Arnos Corp. ("Arnos"), evidencing the borrowings under the NEG
revolving credit facility. In connection with the foregoing, the Company
initially owns 100% of the membership interest in NEG Operating LLC ("Operating
LLC"), a Delaware limited liability company. Gascon is currently the managing
member of the Company. All of the oil and natural gas assets contributed by NEG
and all of the oil and natural gas assets associated with Gascon's contribution
to the Company were transferred from the Company to Operating LLC on September
12, 2001, but effective as of May 1, 2001. Allocation of membership interest in
the Company was based principally on the estimated fair value of the assets
contributed as of May 1, 2001, with each member contributing assets of equal
fair value. The following summarizes the historical book carrying value of the
net assets contributed as of September 1, 2001.

The Holding LLC Operating Agreement entered into on September 12, 2001,
contains a provision that allows Gascon at any time, in its sole discretion, to
redeem NEG's membership interest in the Company at a price equal to the fair
market value of such interest determined as if Holding LLC had sold all of its
assets for fair market value and liquidated.

The Company shall be dissolved and its affairs wound up in accordance with
the Delaware Limited Liability Company Act and the Holding LLC Operating
Agreement on December 31, 2024, unless the Company shall be dissolved sooner and
its affairs wound up in accordance with the Delaware Limited Liability Company
Act or the Holding LLC Operating Agreement.

F-30

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. SIGNIFICANT ACCOUNTING POLICIES

CONSOLIDATION

The consolidated financial statements include the accounts of the Company,
and its sole subsidiary Operating LLC. All significant intercompany transactions
and balances have been eliminated.

ACCOUNTING ESTIMATES

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

CASH AND CASH EQUIVALENTS

Cash and cash equivalents may include demand deposits, short-term
commercial paper, and/or money-market investments with maturities of three
months or less when purchased.

OIL AND NATURAL GAS PROPERTIES

The Company utilizes the full cost method of accounting for its crude oil
and natural gas properties. Under the full cost method, all productive and
nonproductive costs incurred in connection with the acquisition, exploration,
and development of crude oil and natural gas reserves are capitalized and
amortized on the units-of-production method based upon total proved reserves.
The costs of unproven properties are excluded from the amortization calculation
until the individual properties are evaluated and a determination is made as to
whether reserves exist. Conveyances of properties, including gains or losses on
abandonments of properties, are treated as adjustments to the cost of crude oil
and natural gas properties, with no gain or loss recognized.

Under the full cost method, the net book value of oil and natural gas
properties, less related deferred income taxes, may not exceed the estimated
after-tax future net revenues from proved oil and natural gas properties,
discounted at 10% per year (the ceiling limitation). In arriving at estimated
future net revenues, estimated lease operating expenses, development costs,
abandonment costs, and certain production related and ad-valorem taxes are
deducted. In calculating future net revenues, prices and costs in effect at the
time of the calculation are held constant indefinitely, except for changes which
are fixed and determinable by existing contracts. The net book value is compared
to the ceiling limitation on a quarterly basis. The excess, if any, of the net
book value above the ceiling limitation is required to be written off as a
non-cash expense. The Company did not incur a ceiling writedown in 2001, 2002
and 2003. Using December 31, 2001, constant prices and costs in accordance with
the published guidelines of the SEC, there was a potential ceiling writedown of
$6.3 million in the fourth quarter of 2001. On March 18, 2002, the ceiling
limitation test was performed using pricing in effect at that date. The net
weighted average prices used were $23.79 per barrel of oil and $3.49 per Mcf of
natural gas. Using this pricing, there is no ceiling limitation as of March 18,
2002. There can be no assurance that there will not be additional writedowns in
future periods under the full cost method of accounting as a result of sustained
decreases in oil and natural gas prices or other factors.

The Company has capitalized internal costs of $202,000, $601,000 and
$646,000 for the years ended December 31, 2001, 2002 and 2003, respectively, as
costs of oil and natural gas properties. Such capitalized costs include salaries
and related benefits of individuals directly involved in the Company's
acquisition, exploration, and development activities based on a percentage of
their salaries.

The Company is subject to extensive federal, state, and local environmental
laws and regulations. These laws, which are constantly changing, regulate the
discharge of materials into the environment and may require

F-31

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the Company to remove or mitigate the environment effects of the disposal or
release of petroleum or chemical substances at various sites. Environmental
expenditures are expensed or capitalized depending on their future economic
benefit. Expenditures that relate to an existing condition caused by past
operations and that have no future economic benefits are expensed. Liabilities
for expenditures of a noncapital nature are recorded when environmental
assessment and/or remediation is probable, and the costs can be reasonably
estimated.

The Company's operations are subject to all of the risks inherent in oil
and natural gas exploration, drilling and production. These hazards can result
in substantial losses to the Company due to personal injury and loss of life,
severe damage to and destruction of property and equipment, pollution or
environmental damage, or suspension of operations. The Company maintains
insurance of various types customary in the industry to cover its operations and
believes it is insured prudently against certain of these risks. In addition,
the Company maintains operator's extra expense coverage that provides coverage
for the care, custody and control of wells drilled by the Company. The Company's
insurance does not cover every potential risk associated with the drilling and
production of oil and natural gas. As a prudent operator, the Company does
maintain levels of insurance customary in the industry to limit its financial
exposure in the event of a substantial environmental claim resulting from sudden
and accidental discharges. However, 100% coverage is not maintained. The
occurrence of a significant adverse event, the risks of which are not fully
covered by insurance, could have a material adverse effect on the Company's
financial condition and results of operations. Moreover, no assurance can be
given that the Company will be able to maintain adequate insurance in the future
at rates it considers reasonable. The Company believes that it operates in
compliance with government regulations and in accordance with safety standards
which meet or exceed industry standards.

In November 2002, the Company completed the acquisition of producing oil
and natural gas properties in Pecos County, Texas known as Longfellow Ranch
Field. The consideration for this acquisition consisted of $45.4 million in
cash, which was funded from available cash.

In December 2002, the Company completed the acquisition of additional
interest in Longfellow Ranch Field in Pecos County, Texas. The consideration for
this acquisition consisted of $2.9 million in cash, which was funded from
available cash.

OTHER PROPERTY AND EQUIPMENT

Other property and equipment includes furniture, fixtures, and other
equipment. Such assets are recorded at cost and are depreciated over their
estimated useful lives using the straight-line method.

The Company's investment in Longfellow Ranch Field includes a minority
interest in a gas separation facility. This investment is included in the oil
and natural gas properties and depleted over the life of the reserves.

Maintenance and repairs are charged against income when incurred; renewals
and betterments, which extend the useful lives of property and equipment, are
capitalized.

INCOME TAXES

The Company will be taxed as a partnership under federal and applicable
state laws; therefore, the Company has not provided for federal or state income
taxes since these taxes are the responsibility of the Members.

FINANCIAL INSTRUMENTS

The Company sells crude oil and natural gas to various customers. In
addition, the Company participates with other parties in the operation of crude
oil and natural gas wells. Substantially all of the Company's

F-32

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

accounts receivable are due from either purchasers of crude oil and natural gas
or participants in crude oil and natural gas wells for which the Company serves
as the operator. Generally, operators of crude oil and natural gas properties
have the right to offset future revenues against unpaid charges related to
operated wells. Crude oil and natural gas sales are generally unsecured.

Allowances for bad debt totaled approximately $104,000 at December 31, 2002
and $104,000 at December 31, 2003. At December 31, 2003, the carrying value of
the Company's accounts receivable approximates fair value.

NATURAL GAS PRODUCTION IMBALANCES

The Company accounts for natural gas production imbalances using the sales
method, whereby the Company recognizes revenue on all natural gas sold to its
customers notwithstanding the fact that its ownership may be less than 100% of
the natural gas sold. Liabilities are recorded by the Company for imbalances
greater than the Company's proportionate share of remaining estimated natural
gas reserves.

COMPREHENSIVE INCOME

Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources. There were no differences between net earnings and total
comprehensive income in 2001, 2002 and 2003.

DERIVATIVES

The Company follows SFAS No. 133, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" and SFAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activity, an Amendment of
SFAS 133" that requires, that all derivative instruments be recorded on the
balance sheet at their respective fair value.

Prior to contributing all oil and natural gas assets to the Company, NEG
periodically managed its exposure to fluctuations in oil and natural gas prices
by entering into various derivative instruments consisting principally of collar
options and swaps. NEG elected not to designate these instruments as hedges for
accounting purposes, accordingly the change in unrealized gains and losses is
included in oil and natural gas sales. Cash settlements of these instruments are
included in oil and natural gas sales. The Company has accounted for these
instruments in the same manner. The following summarizes the cash settlements
and unrealized gains and losses for the years ended December 31, 2001, 2002 and
2003:

While the use of derivative contracts can limit the downside risk of
adverse price movements, it may also limit future gains from favorable
movements. The Company addresses market risk by selecting instruments whose
value fluctuations correlate strongly with the underlying commodity. Credit risk
related to derivative activities is managed by requiring minimum credit
standards for counterparties, periodic settlements, and mark to market
valuations.

The Company received various commodity swap agreements ("contracts") from
Gascon and NEG as part of their initial contribution of assets and liabilities
in September 2001. The counterparty to these instruments was through Enron North
America Corp. As of December 2001, Enron Corp. and Enron North America Corp. et
al ("Enron") filed for protection under Chapter 11, Title 18 of the United
States Code. Enron ceased making payments under the various contracts in
November 2001, prior to the bankruptcy filings.

F-33

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Accordingly, each of the contracts shall be administered as a claim filed by the
Company in the Enron bankruptcy proceedings. The Company estimates its claim
against Enron related to these contracts is approximately $7.25 million. The
$7.25 million claim represents a hedge against future oil and natural gas prices
and does not reflect a cash gain or loss on the contracts. For this reason, no
asset or liability was recorded at December 31, 2001 and the Company recorded a
net non cash valuation loss of $4.6 million through December 31, 2001 in
connection with these contracts. The Company cannot predict what amount, if any
may be ultimately received in the Enron bankruptcy proceeding.

The following is a summary of the oil and natural gas no-cost commodity
price collars with Shell Trading Company outstanding at December 31, 2002 and
2003:

A liability of $3.6 million and $6.6 million was recorded by the Company as
of December 31, 2002 and 2003 respectively, in connection with these contracts.
In addition, the Company had $1.8 and $1.7 million on deposit with Shell Trading
as of December 31, 2002 and 2003, respectively, to collateralize these
contracts.

On January 28, 2003, the Company entered into an eleven month fixed price
swap agreement with Plains Marketing, L.P., consisting of a contract for 28,000
barrels of oil per month at a fixed price of $28.35 effective February 2003
through December 2003.

The following is a summary of natural gas contracts entered into with Bank
of Oklahoma on January 6, 2004.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards (SFAS) No. 143, "Accounting for
Asset Retirement Obligations" ("SFAS 143"). SFAS No. 143 requires the Company to
record the fair value of an asset retirement obligation as a liability in the
period in which it incurs a legal obligation associated with the retirement of
tangible long-lived assets that result from the acquisition, construction,
development, and/or normal use of the assets. It also requires the Company to
record a corresponding asset that is depreciated over the life of the asset.
Subsequent to the initial measurement of the asset retirement obligation, the
obligation will be adjusted at the end of each period to reflect the passage of
time and changes in the estimated future cash flows underlying the obligation.
The Company adopted SFAS No. 143 on January 1, 2003. Upon adoption of SFAS No.
143, the Company

F-34

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

increased oil and natural gas properties $4.9 million, and recorded an
abandonment obligation of $3.0 million and a cumulative transition adjustment
gain of $1.9 million.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." ("SFAS 146") SFAS No. 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity. The provisions of this Statement are effective for exit or
disposal activities that are initiated after December 31, 2002, with early
application encouraged. The adoption of SFAS No. 146 is not expected to have a
material effect on the Company's financial statements.

In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions of the
Interpretation are applicable to guarantees issued or modified after December
31, 2002 and did not have a material effect on the Company's financial
statements. The disclosure requirements are effective for financial statements
of interim and annual periods ending after December 31, 2002.

In December 2003, the FASB issued Interpretation No. 46 (revised December
2003), "Consolidation of Variable Interest Entities, an Interpretation of ARB
No. 51" ("FIN 46R"). FIN 46R requires a company to consolidate a variable
interest entity, as defined, when the company will absorb a majority of the
variable interest entity's expected losses, receive a majority of the variable
interest entity's expected residual returns, or both. FIN 46R also requires
certain disclosures relating to consolidated variable interest entities and
unconsolidated variable interest entities in which a company has a significant
variable interest. The provisions of FIN 46R are required for companies that
have interests in variable interest entities, or potential variable interest
entities commonly referred to as special-purpose entities for periods ending
after December 15, 2003. The provisions of FIN 46R are required to be applied
for periods ending after March 15, 2004 for all other types of entities. NEG's
interests in, and related management arrangements associated with the Company
constitute variable interests in variable interest entities under FIN 46R.
However, NEG is not considered the primary beneficiary of the Company as defined
by FIN 46R, and accordingly NEG is not required to consolidate the Company.

The EITF is considering two issues related to the reporting of oil and gas
mineral rights. Issue No. 03-O, "Whether Mineral Rights Are Tangible or
Intangible Assets," is whether or not mineral rights are intangible assets
pursuant to SFAS No. 141, "Business Combinations." Issue No. 03-S, "Application
of SFAS No. 142, Goodwill and Other Intangible Assets, to Oil and Gas
Companies," is, if oil and gas drilling rights are intangible assets, whether
those assets are subject to the classification and disclosure provisions of SFAS
No. 142.

The Company classifies the cost of oil and gas mineral rights as properties
and equipment and believes that this is consistent with oil and gas accounting
and industry practice. If the EITF determines that oil and gas mineral rights
are intangible assets and are subject to the applicable classification and
disclosure provisions of SFAS No. 142, the Company would be required to
reclassify these costs from properties and equipment to intangible assets on its
consolidated balance sheets as of December 31, 2003 and 2002. These amounts
would represent oil and gas mineral rights acquired after June 2001 through the
end of the respective periods and be net of accumulated DD&A. In addition, the
disclosures required by SFAS Nos. 141 and 142 would be made in the notes to the
consolidated financial statements. There would be no effect on the consolidated
statements of income or cash flows as the intangible assets related to oil and
gas mineral rights would continue to be
F-35

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

amortized under the full cost method of accounting. The Company is currently
unable to estimate the net carrying value of its intangible assets relating to
leasehold costs.

3. MANAGEMENT AGREEMENT

The management and operation of Operating LLC is being undertaken by NEG
pursuant to the Management Agreement which NEG has entered into with Operating
LLC. The strategic direction of Operating LLC's oil and natural gas business,
including oil and natural gas drilling and capital investments, which shall be
controlled by the managing member of the Company (currently Gascon). The
Management Agreement provides that NEG will manage Operating LLC's oil and
natural gas assets and business until the earlier of November 1, 2006, or such
time as Operating LLC no longer owns any of the managed oil and natural gas
properties. NEG's employees will conduct the day-to-day operations of Operating
LLC's oil and natural gas properties, and all costs and expenses incurred in the
operation of the oil and natural gas properties shall be borne by Operating LLC,
although the Management Agreement provides that the salary of NEG's Chief
Executive Officer shall be 70% attributable to the managed oil and natural gas
properties, and the salaries of each of the General Counsel and Chief Financial
Officer shall be 20% attributable to the managed oil and natural gas properties.
In exchange for NEG's management services, Operating LLC shall pay NEG a
management fee of 115% of the actual direct and indirect administrative and
reasonable overhead costs incurred by NEG in operating the oil and natural gas
properties which either NEG, or Operating LLC may seek to change within the
range of 110%-115% as such change is warranted; however, the parties have agreed
to consult with each other to ensure that such administrative and reasonable
overhead costs attributable to the managed properties are properly reflected in
the management fee paid to NEG. In addition, Operating LLC has agreed to
indemnify NEG to the extent it incurs any liabilities in connection with its
operation of the assets and properties of Operating LLC, except to the extent of
its gross negligence, or misconduct. The Company recorded $7.6 million and $6.6
million as a management fee to NEG for the years ended December 31, 2002 and
2003. These amounts are included in the general and administrative expenses.

4. ACQUISITIONS

In November 2002, the Company completed the acquisition of producing oil
and natural gas properties in Pecos County, Texas known as Longfellow Ranch
Field. The consideration for this acquisition consisted of $45.4 million in
cash, which was funded from available cash.

In December 2002, the Company completed the acquisition of additional
interest in Longfellow Ranch Field in Pecos County, Texas. The consideration for
this acquisition consisted of $2.9 million in cash, which was funded from
available cash.

The following pro forma data presents the results of the Company for the
year ended 2002, as if the acquisition of properties had occurred on January 1,
2002. The pro forma results of operations are presented for comparative purposes
only and are not necessarily indicative of the results which would have been
obtained had the acquisition been consummated as presented. The following data
reflect pro forma adjustments for the

F-36

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

oil and natural gas revenues, production costs, and depreciation and depletion
related to the properties (in thousands).

The impact of this acquisition was insignificant to the 2001 pro forma
results of operations.

5. NOTE RECEIVABLE FROM AFFILIATE

A $10.9 million note receivable from NEG was contributed to the Company as
part of Gascon's contribution on September 12, 2001. The maturity date on the
note was extended to December 31, 2003. The interest rate on the note accrues at
variable rates based on prime rates. The carrying value of the note approximates
the fair value at December 31, 2002. This note was distributed to NEG as a
Priority Amount on March 26, 2003, thereby canceling the note.

6. INVESTMENTS

In January 2002, the Company acquired stock valued at $49.95 million, which
was sold at a gain of $8.7 million in February 2002. In an unrelated
transaction, the Company completed a short sale of stock in November 2002 for
$10.4 million. At December 31, 2002, this short sale position remained open and
the mark-to-market value of such stock resulted in an unrealized loss of $0.3
million. The proceeds received and additional amounts required to settle the
short sale obligation of $10.7 million are classified as restricted cash. In
January 2003, the Company settled this position and recorded a loss of $1.0
million on the transaction.

In October 2003, the Company committed to an investment of $6.0 million in
Petrosource Energy Company, LLC ("Petrosource"). The Company acquired 24.79% of
the outstanding stock for a price of $3.6 million and advanced $2.4 million as a
subordinated loan bearing 6% interest due in 6 years. $3.6 million of this
commitment was paid in October 2003 and $2.4 million in February 2004.
Petrosource is in the business of selling CO(2) and also owns pipelines and
compressor stations for delivery purposes. The Company

F-37

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

recorded a $0.1 million net loss in 2003 as a result of accounting for the
Petrosource investment under the equity method.

7. CREDIT FACILITIES

On March 26, 2003, the Company distributed the $10.9 million note
outstanding under the existing credit facility to NEG as a distribution of
Priority Amount. Also, on March 26, 2003 NEG, Arnos and Operating LLC entered
into an agreement to assign the existing credit facility to Operating LLC.
Effective with this assignment, Arnos amended the credit facility to increase
the revolving commitment to $150 million, increase the borrowing base to $75
million and extend the revolving due date until June 30, 2004. Concurrently,
Arnos extended a $42.8 million loan to Operating LLC under the amended credit
facility; Operating LLC then distributed $42.8 million to the Company who,
thereafter, made a $40.5 million distribution of Priority Amount and a $2.3
million Guaranteed Payment to NEG. NEG utilized these funds to pay the entire
amount of the long-term interest payable on the Senior Notes and interest
accrued thereon outstanding on March 27, 2003. The Arnos facility was canceled
on December 29, 2003 in conjunction with the Mizuho Corporate Bank, Ltd.
financing.

On December 29, 2003, The Company entered into a Credit Agreement (the
"Credit Agreement") with certain commercial lending institutions, including
Mizuho Corporate Bank, Ltd. as the Administrative Agent and the Bank of Texas,
N.A. and the Bank of Nova Scotia as Co-Agents.

The Credit Agreement provides for a loan commitment amount of up to $100
million and a letter of credit commitment of up to $15 million (provided, the
outstanding aggregate amount of the unpaid borrowings, plus the aggregate
undrawn face amount of all outstanding letters of credit shall not exceed the
borrowing base under the Credit Agreement). The Credit Agreement provides
further that the amount available to the Company at any time is subject to
certain restrictions, covenants, conditions and changes in the borrowing base
calculation. In partial consideration of the loan commitment amount, the Company
has pledged a continuing security interest in all of its oil and natural gas
properties and its equipment, inventory, contracts, fixtures and proceeds
related to its oil and natural gas business.

At the Company's option, interest on borrowings under the Credit Agreement
bear interest at a rate based upon either the prime rate or the LIBOR rate plus,
in each case, an applicable margin that, in the case of prime rate loans, can
fluctuate from 0.75%to 1.50% per annum, and, in the case of LIBOR rate loans,
can fluctuate from 1.75% to 2.50% per annum. Fluctuations in the applicable
interest rate margins are based upon Operating LLC's total usage of the amount
of credit available under the Credit Agreement, with the applicable margins
increasing as the Company's total usage of the amount of the credit available
under the Credit Agreement increases.

At the closing of the Credit Agreement, the Company borrowed $43.8 million
to repay $42.9 million owed by the Company to Arnos under the secured loan
arrangement which was then terminated and to pay administrative fees in
connection with this borrowing. The Company intends to use any future borrowings
under the Credit Agreement to finance potential acquisitions. The Company
capitalized $1.0 million of loan issuance costs in connection with the closing
of this transaction. These costs will be amortized over the life of the loan
using the interest method.

As a condition to the lenders obligations under the Credit Agreement, the
lenders required that the NEG, Gascon, Holding LLC and the Company execute and
deliver at the closing that certain Pledge Agreement and Irrevocable Proxy in
favor of Bank of Texas, N.A., its successors and assigns, the ("Pledge
Agreement"). Pursuant to the terms of the Pledge Agreement, in order to secure
the performance of the obligations of the Company (I) each of NEG and Gascon
have pledged their 50% membership interest in Holding LLC (such interests
constituting 100% of the outstanding equity membership interest of Holding LLC);
(ii) Holding LLC has pledged its 100% equity membership interest in the Company;
and (iii) the Company has pledged its

F-38

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

100% equity membership interest in its subsidiary, Shana National LLC (the
membership interests referred to in clauses (I), (ii) and (iii) above are
collectively referred to as the "Collateral"). The Pledge Agreement also
provides for a continuing security interest in the Collateral and that Bank of
Texas, N.A. as the Collateral Agent is the duly appointed attorney-in-fact of
the Company. The Collateral Agent may take all action deemed reasonably
necessary for the maintenance, preservation and protection of the Collateral and
the security interest therein until such time that all of the Company's
obligations under the Credit Agreement are fulfilled, terminated or otherwise
expired. If under the Credit Agreement an event of default shall have occurred
and is continuing, the Collateral Agent may enforce certain rights and remedies,
including, but not limited to the sale of the Collateral, the transfer of all or
part of the Collateral to the Collateral Agent or its nominee and/or the
execution of all endorsements,

The Credit Agreement requires, among other things, semiannual engineering
reports covering oil and natural gas properties, and maintenance of certain
financial ratios, including the maintenance of a minimum interest coverage, a
current ratio, and a minimum tangible net worth. The Company was in compliance
with all covenants at December 31, 2003.

8. COMMITMENTS AND CONTINGENCIES

The Company has entered into a management agreement with NEG to manage
Operating LLC's oil and natural gas assets until the earlier of November 1,
2006, or such time as Operating LLC no longer owns any oil and natural gas
assets.

The Company is obligated to make semi-annual payments to NEG "Guaranteed
Payments" as defined in the Holding LLC Operating Agreement referred herein. One
payment for $10.9 million was made in 2001, two payments totaling $21.7 million
were made in 2002 and three payments totaling $18.2 million were made in 2003
under this obligation. In March 2003, the Company made a distribution of
Priority Amount of $51.4 million to NEG.

On July 7, 2003, the Company filed a request with the American Arbitration
Association for dispute resolution of a claim in the amount of $21,000 against
Osprey Petroleum Company, Inc. ("Osprey") arising out of Osprey's failure to
post bond for certain plugging and abandonment liabilities associated with oil
and gas properties sold by the Company to Osprey in September 2000. Osprey has
counterclaimed against the Company and its affiliates (Holding LLC and Operating
LLC) in an amount up to $15 million, alleging fraud and breach of contract
related to the sale of such oil and gas properties. The Purchase and Sale
Agreement transferring the properties from the Company to Osprey provides for
dispute resolution through binding arbitration utilizing arbitrator(s)
experienced in oil and gas transactions. The exclusive venue for any such
arbitration is in Dallas, Texas, and the binding, nonappealable judgment by the
arbitrator(s) may be entered in any court having competent jurisdiction.

The Company will vigorously defend against the Osprey counterclaim, which
the Company believes to be without merit. It is the Company's belief that the
ultimate resolution of the arbitration will not have a material adverse effect
on the Company's financial condition or results of operations.

With respect to certain claims of the Company against Enron North America
Corp. relating to the oil and natural gas properties contributed to Holding LLC,
a representative of the Company has been appointed to the official committee of
unsecured creditors in the Enron bankruptcy proceeding, and the Company has
filed a claim for damages in that bankruptcy proceeding. The Company estimates
its claim against Enron related to these contracts is approximately $7.25
million. The $7.25 million claim represents a hedge against future oil and
natural gas prices and does not reflect a cash gain or loss. Any recoveries from
Enron North America Corp. will become the property of Operating LLC as a result
of the LLC Contribution. No receivable has been recorded as a result of this
claim.

F-39

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Other than routine litigation incidental to its business operations which
are not deemed by the Company to be material, there are no additional legal
proceedings in which the Company nor Operating LLC, is a defendant.

9. ASSET RETIREMENT OBLIGATION

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards (SFAS) No. 143, "Accounting for
Asset Retirement Obligations" ("SFAS 143"). The Company adopted SFAS 143 on
January 1, 2003 and recorded an abandonment obligation of $3.0 million. SFAS No.
143 required the Company to record the fair value of an asset retirement
obligation as a liability in the period in which it incurs a legal obligation
associated with the retirement of tangible long-lived assets that result from
the acquisition, construction, development, and/or normal use of the assets. It
also requires the Company to record a corresponding asset that is depreciated
over the life of the asset. Subsequent to the initial measurement of the asset
retirement obligation, the obligation will be adjusted at the end of each period
to reflect the passage of time and changes in the estimated future cash flows
underlying the obligation. The Company would have recorded accretion of the
asset abandonment obligation of $0.2 million for both 2001 and 2002 had SFAS 143
been adopted in these years.

The following is a rollforward of the abandonment obligation as of December
31, 2003.

Balance as of January 1, 2003............................... $3,034,395
Add: Accretion.............................................. 242,752
Additions............................................. 89,548
Revisions............................................. 9,396
Less: Settlements........................................... (57,008)
Dispositions.......................................... (50,702)
----------
Balance as of December 31, 2003............................. $3,268,381
==========

10. INVESTMENT IN HOLDING LLC OPERATING AGREEMENT

Under the Holding LLC Operating Agreement, NEG is to receive Guaranteed
Payments in addition to a Priority Amount of $202.2 million before Gascon
receives any monies. The distribution of Priority Amount is to be made on or
before November 1, 2006. Guaranteed Payments are to be paid, on a semi annual
basis, based on an annual interest rate of 10.75% of the outstanding Priority
Amount. After the payments to NEG, Gascon is to receive distributions equivalent
to the Priority Amount and Guaranteed Payments plus other amounts as defined.
Following the above distributions to NEG and Gascon, additional distributions,
if any, are to be made in accordance with their respective capital accounts. The
order of distributions is listed below.

The Holding LLC Operating Agreement requires that distributions shall be
made to both NEG and Gascon as follows:

1. Guaranteed Payments are to be paid to NEG, calculated on an annual
interest rate of 10.75% on the outstanding Priority Amount. The Priority
Amount includes all outstanding debt owed to entities owned or controlled
by Carl C. Icahn, including the amount of the Company's 10.75% Senior
Notes. As of December 31, 2003, the Priority Amount was $148.6 million. The
Guaranteed Payments will be made on a semi-annual basis.

2. The Priority Amount is to be paid to NEG. Such payment is to occur
by November 6, 2006.

F-40

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. An amount equal to the Priority Amount and all Guaranteed Payments
paid to NEG, plus any additional capital contributions made by Gascon, less
any distribution previously made by the Company to Gascon, is to be paid to
Gascon.

4. An amount equal to the aggregate annual interest (calculated at
prime plus 1/2% on the sum of the Guaranteed Payments), plus any unpaid
interest for prior years (calculated at prime plus 1/2% on the sum of the
Guaranteed Payments), less any distributions previously made by the Company
to Gascon, is to be paid to Gascon.

5. After the above distributions have been made, any additional
distributions will be made in accordance with the ratio of the NEG's and
Gascon's respective capital accounts. (Capital accounts as defined in the
Holding LLC Operating Agreement)

11. CRUDE OIL AND NATURAL GAS PRODUCING ACTIVITIES

Costs incurred in connection with the exploration acquisition, development,
and exploitation of the Company's crude oil and natural gas properties for the
years ended December 31, 2001, 2002 and 2003, (all of which occurred after the
contribution of assets by NEG and Gascon) are as follows:

Revenues from individual purchasers that exceed 10% of total crude oil and
natural gas sales are as follows:

12. SUPPLEMENTARY CRUDE OIL AND NATURAL GAS RESERVE INFORMATION (UNAUDITED)

The revenues generated by the Company's operations are highly dependent
upon the prices of, and demand for, oil and natural gas. The price received by
the Company for its oil and natural gas production depends on numerous factors
beyond the Company's control, including seasonality, the condition of the U.S.
economy, foreign imports, political conditions in other oil and natural gas
producing countries, the actions of the Organization of Petroleum Exporting
Countries and domestic governmental regulations, legislation and policies.

The Company has made ordinary course capital expenditures for the
development and exploitation of oil and natural gas reserves, subject to
economic conditions. The Company has interests in crude oil and natural gas
properties that are principally located onshore in Texas, Louisiana, Oklahoma,
and Arkansas. The Company does not own or lease any crude oil and natural gas
properties outside the United States.

In 2001 and 2002, estimates of the Company's net recoverable crude oil,
natural gas, and natural gas liquid reserves were prepared by Netherland, Sewell
& Associates, Inc. and Prator Bett, LLC. In 2003, estimates of the Company's
reserves and future net revenues were prepared by Netherland, Sewell &
F-41

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Associates, Prator Bett, LLC and DeGolyer and MacNaughton. Estimated proved net
recoverable reserves as shown below include only those quantities that can be
expected to be recoverable at prices and costs in effect at the balance sheet
dates under existing regulatory practices and with conventional equipment and
operating methods.

Proved developed reserves represent only those reserves expected to be
recovered through existing wells. Proved undeveloped reserves include those
reserves expected to be recovered from new wells on undrilled acreage or from
existing wells on which a relatively major expenditure is required for
recompletion.

Net quantities of proved developed and undeveloped reserves of natural gas
and crude oil, including condensate and natural gas liquids, are summarized as
follows:

Reservoir engineering is a subjective process of estimating the volumes of
underground accumulations of oil and natural gas which cannot be measured
precisely. The accuracy of any reserve estimates is a function of the quality of
available data and of engineering and geological interpretation and judgment.
Reserve estimates prepared by other engineers might differ from the estimates
contained herein. Results of drilling, testing, and production subsequent to the
date of the estimate may justify revision of such estimate. Future prices
received for the sale of oil and natural gas may be different from those used in
preparing these reports. The amounts

F-42

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

and timing of future operating and development costs may also differ from those
used. Accordingly, reserve estimates are often different from the quantities of
oil and natural gas that are ultimately recovered.

The following is a summary of a standardized measure of discounted net cash
flows related to the Company's proved crude oil and natural gas reserves. For
these calculations, estimated future cash flows from estimated future production
of proved reserves were computed using crude oil and natural gas prices as of
the end of each period presented. Future development, production and net asset
retirement obligations attributable to the proved reserves were estimated
assuming that existing conditions would continue over the economic lives of the
individual leases and costs were not escalated for the future.

The Company cautions against using this data to determine the fair value of
its crude oil and natural gas properties. To obtain the best estimate of fair
value of the crude oil and natural gas properties, forecasts of future economic
conditions, varying discount rates, and consideration of other than proved
reserves would have to be incorporated into the calculation. In addition, there
are significant uncertainties inherent in estimating quantities of proved
reserves and in projecting rates of production that impair the usefulness of the
data.

The standardized measure of discounted future net cash flows relating to
proved crude oil and natural gas reserves are summarized as follows:

The following are the principal sources of change in the standardized
measure of discounted future net cash flows:

F-43

NEG HOLDING LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

During recent years, there have been significant fluctuations in the prices
paid for crude oil in the world markets. This situation has had a destabilizing
effect on crude oil posted prices in the United States, including the posted
prices paid by purchasers of the Company's crude oil. The net weighted average
prices of crude oil and natural gas at December 31, 2001, 2002 and 2003, used in
the above table were $18.48, $29.86 and $31.14 per barrel of crude oil,
respectively, and $2.68, $4.92 and $5.87 per thousand cubic feet of natural gas,
respectively.

F-44

INDEX TO EXHIBITS

2.1 Debtors Joint Plan of Reorganization under Chapter 11 of the
Bankruptcy Code dated May 12, 2000(9)
2.2 Debtor's and Official Committee of Unsecured Creditors Joint
Disclosure Statement under Section 1125 of the Bankruptcy
Code Regarding the Debtor's and Official Committee of
Unsecured Creditors' Joint Plan of Reorganization under
Chapter 11 of the Bankruptcy Code, dated May 12, 2000(9)
3.1 Restated Certificate of Incorporation filed with the
Secretary of State of Delaware on October 16, 2000(10)
3.2 By-laws of the Company(2)
3.3 Amendment to Restated Certificate of Incorporation filed
with the Secretary of State of Delaware on November 10,
2003(15)
4.1 Indenture dated as of November 1, 1996, among the Company,
National Energy Group of Oklahoma, Inc. (the "Guarantor"),
formerly NEG-OK, and Bank One, Columbus, N.A.(3)
4.2 Indenture dated August 21, 1997, among the Company and Bank
One, N.A.(6)
4.3 Instrument of Resignation, Appointment and Acceptance, dated
October 23, 1998, between the Company, Bank One, N.A. and
Norwest Bank Minnesota, N.A.(8)
10.5 Restated Loan Agreement dated August 29, 1996 among Bank One
and Credit Lyonnais New York Branch ("Credit Lyonnais") and
the Company, NEG-OK and Boomer Marketing Corporation
("Boomer")(1)
10.6 $50,000,000 Revolving Note dated August 29, 1996 payable to
Bank One(1)
10.7 $50,000,000 Revolving Note dated August 29, 1996 payable to
Credit Lyonnais(1)
10.8 Assignment of $50,000,000 Revolving Note to Arnos Corp. from
Bank One, Texas, N.A.(8)
10.9 Assignment of $50,000,000 Revolving Note to Arnos Corp. from
Credit Lyonnais New York Branch(8)
10.10 Unlimited Guaranty of NEG-OK dated August 29, 1996 for the
benefit of Bank One(1)
10.11 Unlimited Guaranty of NEG-OK, dated August 29, 1996 for the
benefit of Credit Lyonnais(1)
10.12 Unlimited Guaranty of Boomer dated August 29, 1996 for the
benefit of Bank One(1)
10.13 Unlimited Guaranty of Boomer dated August 29, 1996 for the
benefit of Credit Lyonnais(1)
10.14 First Amendment to Restated Loan Agreement dated October 31,
1996 among Bank One and Credit Lyonnais and the Company,
Guarantor and Boomer(4)
10.15 Second Amendment to Restated Loan Agreement dated October
31, 1996, among Bank One and Credit Lyonnais and the
Company, Guarantor and Boomer(5)
10.16 Third Amendment to Restated Loan Agreement dated October 31,
1996, among Bank One and Credit Lyonnais and the Company,
Guarantor and Boomer(5)
10.17 Fourth Amendment to Restated Loan Agreement dated October
31, 1996, among Bank One and Credit Lyonnais and the
Company, Guarantor and Boomer(7)
10.18 Multi-State Assignment Agreement dated December 22, 1998
between Bank One, Texas, N.A., Credit Lyonnais New York
Branch and Arnos Corp.(8)
10.19 Multi-State Assignment Agreement, LaFourche Parish,
Louisiana, dated December 22, 1998, between Bank One, Texas,
N.A., Credit Lyonnais New York Branch and Arnos Corp.(8)
10.20 Multi-State Assignment Agreement, Iberville Parish,
Louisiana, dated December 22, 1998, between Bank One, Texas,
N.A., Credit Lyonnais New York Branch and Arnos Corp.(8)
10.21 Oklahoma Assignment Agreement, dated December 22, 1998,
between Bank One, Texas, N.A., Credit Lyonnais New York
Branch and Arnos Corp.(8)
10.27 Fifth Amendment to Restated Loan Agreement dated August 1,
2001, among the Company and Arnos Corp.(12)
10.28 Debt Purchase Agreement dated August 1, 2001 between the
Company and High River Limited Partnership.(12)
10.29 Debt Purchase Agreement dated August 1, 2001 between the
Company and High Coast Limited Partnership.(12)

10.30 Debt Purchase Agreement dated August 1, 2001 between the
Company and High River Limited Partnership.(10)
10.31 Debt Purchase Agreement dated August 1, 2001 between the
Company and High Coast Limited Partnership.(10)
10.32 NEG Holding LLC Operating Agreement dated May 1, 2001
between the Company and Gascon Partners.(11)
10.33 NEG Operating LLC Operating Agreement dated May 1, 2001
executed by NEG Holding LLC.(11)
10.34 Shana National LLC Amended and Restated Operating Agreement
dated September 12, 2001 executed by NEG Operating LLC.(11)
10.35 Management Agreement dated September 12, 2001 between the
Company and NEG Operating LLC.(11)
10.36 Master Conveyance dated September 12, 2001 executed by the
Company in favor of NEG Holding LLC.(11)
10.37 Master Conveyance dated September 12, 2001 executed by
Gascon Partners in favor of NEG Holding LLC.(11)
10.38 Master Conveyance dated September 12, 2001 executed by NEG
Holding LLC in favor of NEG Operating LLC.(11)
10.39 Master Conveyance dated September 12, 2001 executed by Shana
Petroleum Company in favor of Gascon Partners.(11)
10.40 Master Conveyance dated September 12, 2001 executed by Shana
Petroleum Company in favor of Shana National LLC.(11)
10.41 Final Decree of Bankruptcy Court(13)
10.42 Sixth Amendment to Restated Loan Agreement dated December
15, 2001, among the Company and Arnos Corp.(14)
10.43 Assignment of Restated Loan Agreement dated March 26, 2003,
among Arnos Corp., the Company and NEG Operating LLC.(14)
10.44 Seventh Amendment to Restated Loan Agreement dated March 26,
2003, among Arnos Corp. and NEG Operating LLC.(14)
10.45 Management Agreement with TransTexas Gas Corporation dated
August 28, 2003(15)
10.46 Credit Agreement dated as of December 29, 2003 among NEG
Operating LLC, Certain Commercial Lending Institutions,
Mizuho Corporate Bank, Ltd., Bank of Texas N.A., and the
Bank of Nova Scotia(16)
10.47 Security Agreement dated as of December 29, 2003 made by NEG
Operating LLC in favor of Bank of Texas, N.A.(16)
10.48 Pledge Agreement and Irrevocable Proxy dated as of December
29, 2003 made by NEG Operating LLC in favor of Bank of
Texas, N.A.(16)
10.49 Pledge Agreement and Irrevocable Proxy dated as of December
29, 2003 made by National Energy Group, Inc. in favor of
Bank of Texas, N.A.(16)
10.50 Code of Business Conduct and Ethics Adopted March 24,
2004(17)
12.1 Computation of Ratio of Earnings to Fixed Charges(17)
23.2 Consent of Netherland Sewell & Associates, Inc., Independent
Engineers(17)
23.3 Consent of Prator Bett, LLC, Independent Engineers(17)
23.4 Consent of DeGolyer and MacNaughton, Independent
Engineers(17)
24.1 Power of Attorney (included in signature pages to this Form
10-K)(17)
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002(17)
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002(17)

32.1 Certification of Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section
1350(17). Pursuant to SEC Release 34-47551 this Exhibit is
furnished to the SEC and shall not be deemed to be "filed".
32.2 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section
1350(17). Pursuant to SEC Release 34-47551 this Exhibit is
furnished to the SEC and shall not be deemed to be "filed".

- ---------------

(1) Incorporated by reference to the Company's Current Report on Form 8-K,
dated August 29, 1996.

(2) Incorporated by reference to the Company's Registration Statement on Form
S-4 (No. 33-38331), dated April 3, 1991.

(3) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996.

(4) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
the year ended December 31, 1995.

(5) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997.

(6) Incorporated by reference to the Company's Form S-4 (No. 333-38075), filed
October 16, 1997.

(7) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997.

(8) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 1998.

(9) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2000.

(10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 2000.

(11) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 2000.

(12) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2001.

(13) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 2001.

(14) Incorporated by reference to the Company's Annual Report on Form 10-K for
the year ended December 31, 2002.

(15) Incorporated by reference to the Company's Quarterly Report Form 10-Q for
the quarter ended September 30, 2003.

(16) Incorporated by reference to the Company's Form 8-K filed December 29,
2003.

(17) Filed herewith.