UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

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)

(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, 10³/4% due 2006

Series D Senior Notes, 10³/4% 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 þ          No o

      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 þ          No o

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

      The aggregate market value of the shares of Common Stock held by non-affiliates of the Registrant, as of March 1, 2005, (based upon the last sales price of $2.99 as reported by the OTC Bulletin Board) was $33,460,044.

      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 þ          No o

      11,190,650 shares of the Registrant’s common stock, $0.01 par value, were outstanding on March 1, 2005.

      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

PART I

Forward-Looking Statements

      This Annual Report on Form 10-K (“Annual Report”) 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 “anticipate,” “expect,” “estimate,” “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 Annual Report that address activities, events, or developments that we expect or anticipate 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 our 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 our management, directors, or our officers regarding such matters. These statements are based on certain assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate under the circumstances. However, whether actual results and developments will conform with our 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 us, competitive actions by other oil and natural gas companies, changes in laws or regulations, and other factors, many of which are beyond our control. 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 will be realized or, even if substantially realized, that they will have the expected consequences to or effects on our company or our 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. We undertake no obligation to publicly update or revise any forward-looking statements.

      In this Annual Report, unless the context requires otherwise, when we refer to “we,” “us” and “our,” we are describing National Energy Group, Inc.

Introduction

      We are a management company engaged in the business of managing the exploration, development, production and operations of natural gas and oil properties, primarily located in Texas, Oklahoma, Arkansas and Louisiana (both onshore and in the Gulf of Mexico). We manage oil and gas operations of NEG Operating LLC (“Operating LLC”), TransTexas Gas Corporation (“TTG”) and Panaco, Inc. (“Panaco”), all of which are affiliated entities.

      We were incorporated under the laws of the State of Delaware on November 20, 1990 and, prior to February, 1999, operated as an independent natural gas and oil company engaged in the exploration, development, exploitation and acquisition of natural gas and oil reserves in North America. In February 1999, we were placed under involuntary, court ordered bankruptcy protection. We jointly proposed, with the official committee of unsecured creditors, a Plan of Reorganization (the “Plan of Reorganization”) which became effective on August 4, 2000. The final decree closing the case became effective December 13, 2001. Accordingly, we have effectively settled all matters relating to our bankruptcy proceeding.

      As mandated by the Plan of Reorganization and the bankruptcy court on September 12, 2001, but effective May 1, 2001, we contributed all of our operating assets and oil and natural gas properties, excluding cash of $4.3 million, to NEG Holding LLC (“Holding LLC”). In exchange we received an initial 50% membership interest in Holding LLC. Gascon Partners (“Gascon”), an entity owned or controlled by Carl C.

Icahn, contributed certain assets to Holding LLC in exchange for an initial 50% ownership interest. Holding LLC is controlled by the managing member (currently Gascon). Effective May 1, 2001, Holding LLC contributed the majority of its assets and liabilities to Operating LLC, a 100% owned subsidiary of Holding LLC. Concurrently, we entered into a management and operating agreement to manage the operations of Operating LLC.

      In August, 2003 and November, 2004 we entered into agreements to manage the operations of TTG and Panaco, respectively. Both TTG and Panaco are owned by entities owned or controlled by Carl C. Icahn.

      Our headquarters are located in Dallas, Texas.

Ownership and Control of Outstanding Stock

      American Real Estate Holdings L.P. (“AREH”) owns 50.1% of our outstanding common stock at December 31, 2004. The general partner of AREH, American Property Investors, Inc. (“API”) is indirectly wholly owned by Carl C. Icahn. As such, we may be deemed to be controlled by an affiliate of Mr. Icahn and his affiliated entities. Certain members of our 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 was an employee of affiliates of Arnos and High River, until he retired effective November 1, 2004. 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. Our policy is to engage in transactions with related parties on terms that in our opinion, are no less favorable to our company than could be obtained from unrelated parties.

      On January 21, 2005, AREP entered into an agreement to purchase Gascon’s managing membership interest in Holding LLC, including Gascon’s option to redeem our interest in Holding LLC. As of March 1, 2005, AREP had not consummated this transaction.

Our Bankruptcy and Formation of Holding LLC

      On February 11, 1999, the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (“Bankruptcy Court”) entered an involuntary petition placing us 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 that we jointly proposed with the official committee of unsecured creditors. Our Plan of Reorganization became effective on August 4, 2000 and the Bankruptcy Court issued a final decree closing the case effective December 13, 2001. Accordingly, we have effectively settled all matters relating to the Bankruptcy Proceeding.

      As mandated by the Plan of Reorganization and the Bankruptcy Court, on September 12, 2001, but effective May 1, 2001, we contributed all of our operating assets and oil and natural gas properties excluding cash of $4.3 million to Holding LLC, a Delaware limited liability company which was formed in August 2000. In exchange we received an initial 50% membership interest in Holding LLC. Gascon, an entity owned or controlled by Carl C. Icahn, contributed certain assets to Holding LLC in exchange for an initial 50% ownership interest. Holding LLC is controlled by the managing member (currently Gascon). Effective May 1, 2001, Holding LLC contributed the majority of its assets and liabilities to Operating LLC, a 100% owned subsidiary of Holding LLC. Concurrently, we entered into a management and operating agreement to manage the operations of Operating LLC.

      In exchange for our 50% membership interest in Holding LLC we contributed to Holding LLC 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. All amounts reflect book value at the date of contribution.

      In exchange for its initial 50% membership interest in Holding LLC, Gascon contributed:

      All of the oil and natural gas assets that we contributed 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 Holding LLC Operating Agreement

      Holding LLC is governed by an operating agreement effective as of May 12, 2001, which provides for management of Holding LLC by Gascon and distributions to us and Gascon based on a prescribed order of distributions (the “Holding LLC Operating Agreement”).

Order of Distributions

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

      We anticipate that the Priority Amount will be used to pay off our 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 our Senior Notes. Because of the continuing substantial uncertainty that there would be any residual value in Holding LLC after the Guaranteed Payments and Priority Amount distributions, no income other than the accretion is currently being given accounting recognition. Our investment in Holding LLC will be reduced to zero upon collection of the Priority Amount in 2006. After that date, we will continue to monitor payments made to Gascon and, at such time as it would appear that there is any residual value to our 50% interest in Holding LLC, it would receive accounting recognition. Throughout, and up to this point, we believe that the 50% interest in Holding LLC represents a residual interest that is currently valued at zero. We account for our residual equity investment in Holding LLC in accordance with

Accounting Principles Board Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” (“APB 18”).

Redemption Provision in the Holding LLC Operating Agreement

      The Holding LLC Operating Agreement contains a provision that allows Gascon, or its successor, at any time, in its sole discretion, to redeem our 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 us. Since all of our operating assets and oil and natural gas properties have been contributed to Holding LLC, following such a redemption, our principal assets would consist solely of cash balances.

      In the event that such redemption right is exercised and there is a subsequent liquidation and distribution of the proceeds, we may be obligated to use the proceeds that we would receive for our redeemed membership interest to pay outstanding indebtedness and operating expenses before the distribution of any portion of such proceeds could be made to our shareholders. Following the payment of our indebtedness, including the outstanding balance of $148.6 million relating to the Senior Notes and our operating expenses, there is a substantial risk that there will be no proceeds remaining for distribution to our 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.

      On January 21, 2005, AREP entered into an agreement to purchase Gascon’s managing membership interest in Holding LLC, including Gascon’s option to redeem our interest in Holding LLC. As of March 1, 2005, AREP had not consummated this transaction.

The Reorganized Company

      As a result of the foregoing transactions and as mandated by the Plan of Reorganization effective May 12, 2001, our principal assets were our remaining cash balances, accounts receivable from affiliates, deferred tax asset and our initial 50% membership interest in Holding LLC. Our principal liabilities were the $10.9 million outstanding under our existing $25 million revolving credit facility with Arnos and our Senior Notes and long-term interest payable on Senior Notes. None of our employees transferred to Holding LLC or Operating LLC. We remain 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 payment 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 our shareholders.

The Operating LLC Management Agreement

      We have undertaken the management and operation of Operating LLC pursuant to a Management Agreement (the “Management Agreement”) which we have entered into with Operating LLC. However, neither our management nor our directors 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 we 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. Our employees 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 are borne by Operating LLC; although the Management Agreement provides that the salary of our 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 our management services, Operating LLC pays us a management fee equal to 115% of the actual direct and indirect administrative and reasonable overhead costs that we incur in operating the oil and natural gas

properties. We or Operating LLC may seek to change the management fee 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 us. In addition, Operating LLC has agreed to indemnify us to the extent we incur any liabilities in connection with our operation of the assets and properties of Operating LLC, except to the extent of our gross negligence or misconduct. We recorded $6.6 million and $6.2 million in management fee income for the years ended December 31, 2003 and 2004, respectively under this agreement.

The TransTexas Management Agreement

      On August 28, 2003, we entered into an agreement (the “TTG Management Agreement”) to manage 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 all of the outstanding stock 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, our President and CEO, and Vice President, Secretary and General Counsel, 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 we will be responsible for and have authority with respect to all of the day-to-day management of TTG’s business but we will not function as a Disbursing Agent as such term is defined in the TTG Plan. As consideration for our services in managing the TTG business, we 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 us, (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. We recorded $1.3 million and $4.7 million in management fee income for the years ended December 31, 2003 and 2004, respectively, under this agreement.

The Panaco Management Agreement

      On November 3, 2004, the United States Bankruptcy Court for the Southern District of Texas issued an order effective November 16, 2004 confirming a plan of reorganization for Panaco (The “Panaco Plan”). In connection with the Panaco Plan, we entered into a Management Agreement with Panaco (the “Panaco Management Agreement”) pursuant to the Bankruptcy Court’s Order confirming the effective date of the Panaco Plan. Affiliates of Mr. Carl C. Icahn own all of the outstanding stock of the reorganized Panaco. Mr. Bob G. Alexander, our President and CEO, has been appointed to the reorganized Panaco Board of Directors and will act as the reorganized Panaco’s President. Mr. Philip D. Devlin, our Vice President, General Counsel and Secretary, has been appointed to serve in the same capacities for Panaco. In exchange for the our management services, Panaco pays us a monthly fee equal to 115% of the actual direct and indirect administrative overhead costs that we incur in operating and administrating the Panaco properties. We recorded $.7 million in management fee income for the year ended December 31, 2004 under this agreement.

Our Credit Facility

      On March 26, 2003, Holding LLC distributed the $10.9 million note outstanding under our revolving credit facility as a distribution of Priority Amount to us , thereby canceling all outstanding balances due under the credit facility.

      Also, on March 26, 2003 we entered into an agreement with Arnos and Operating LLC to assign our 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 us. We 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. As of March 26, 2003, we no longer have a credit facility.

Operating LLC Credit Facility

      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 $120 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 Gascon and us to pledge each of our 50% membership interest in Holding LLC (such interests constituting 100% of the outstanding equity membership interest of Holding LLC). Additionally, Holding LLC has pledged its 100% equity membership interest in Operating LLC.

      The Credit Agreement provides for a loan commitment amount of up to $120 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.

      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 not in compliance with the minimum interest coverage ratio covenant at December 31, 2004. Operating LLC obtained a waiver of compliance with respect to this covenant for the period ended December 31, 2004. Operating LLC was in compliance with all other covenants at December 31, 2004.

      Other than the pledge described above, we are not a party to the Operating LLC credit facility nor do we provide any guarantees (See Note 4 to our Financial Statements included elsewhere herein).

      Draws made under the credit facility are typically made to fund working capital requirements, acquisitions and capital expenditures. During the current fiscal year, Operating LLC’s outstanding balances thereunder have ranged from a low of $44 million to a high of $52 million. As of December 31, 2004 the outstanding balance under the credit facility was $52 million.

Our Properties and Principal Areas of Operations

      At December 31, 2004, we have no direct ownership of oil and natural gas properties or proved reserves, due to the contribution of all oil and natural gas assets to Holding LLC in September 2001. We own 50% of Holding LLC. Because of the continuing substantial uncertainty that there would be any residual value in Holding LLC after the Guaranteed Payments and Priority Amount distributions, we accrete our investment in Holding LLC at the implicit rate of interest up to the Guaranteed Payment and Priority Amount to be collected through 2006. Our investment in Holding LLC will be reduced to zero upon collection of the Priority Amount in 2006. Each quarter, we evaluate the propriety of the carrying amount of our investment in

Holding LLC to determine whether current events or circumstances warrant adjustments to the carrying value for any other than temporary impairment and/or revisions to accretion of income.

Investment in Holding LLC

      We contributed all of our operating assets and oil and natural gas properties, excluding cash of $4.3 million, to Holding LLC in exchange for Holding LLC’s obligation to pay the Company the Guaranteed Payments and Priority Amount and an initial 50% membership interest (“LLC Contribution”). For financial reporting purposes the transaction was as of September 1, 2001. Gascon also contributed oil and natural gas assets and cash in exchange for future payments and a 50% membership interest.

      The Holding LLC operating agreement requires payment of the Guaranteed Payments and Priority Amount to us in order to pay interest on senior debt and the principal amount of the debt of $148.6 million in 2006. After we receive the Guaranteed Payments and Priority Amount that total approximately $300 million (which includes the $148.6 million), the Holding LLC Operating Agreement requires the distribution of an equal amount to Gascon. A discussion of required distributions is included below. Holding LLC is contractually obligated to make the Guaranteed Payments and Priority Amount distributions to us and Gascon before any distributions can be made to the membership interest.

      We originally recorded our investment in Holding LLC at the historical cost of the oil and gas properties contributed to Holding LLC. In evaluating the appropriate accounting to be applied to this investment, we anticipated that we will collect the Guaranteed Payments and Priority Amount through 2006. However, based on cash flow projections prepared by the management of Holding LLC and its reserve engineers, there is substantial uncertainty that there will be any residual value in Holding LLC subsequent to the payment of the amounts required to be paid to Gascon. Due to this uncertainty, we accrete our investment in Holding LLC at the implicit rate of interest up to the Guaranteed Payments and Priority Amount to be collected through 2006, 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 investment in Holding LLC. The investment in Holding LLC is evaluated quarterly for other than temporary impairment. Our rights upon liquidation of Holding LLC are identical to those described above, and we considered those rights in determining the appropriate presentation.

      Because of the continuing substantial uncertainty that there would be any residual value in Holding LLC after the Guaranteed Payments and Priority Amount distributions, we accrete our investment in Holding LLC at the implicit rate of interest up to the Guaranteed Payment and Priority Amount to be collected through 2006. Our investment in Holding LLC will be reduced to zero upon collection of the Priority Amount in 2006. Each quarter, we evaluate the propriety of the carrying amount of our investment in Holding LLC to determine whether current events or circumstances warrant adjustments to the carrying value for any other than temporary impairment and/or revisions to accretion of income. After we receive the Priority Amount in 2006, we will continue to monitor payments made to Gascon and, at such time as it would appear that there is any residual value to our 50% interest in Holding LLC, we will give accounting recognition for our residual interest. Throughout, and up to this point, we believe that the 50% interest in Holding LLC represents a residual interest that is currently valued at zero. We account for our residual equity investment in Holding LLC in accordance with APB 18.

Holding LLC — Principal Areas of Operations

      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 an 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, 2004.

      The following table sets forth Holding LLC’s production by principal area of operation for the year ended December 31, 2004.

Holding LLC — Mid-Continent Area

      At December 31, 2004, approximately 13.8% (32.1 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 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, 2004, Holding LLC drilled 4 Gross (.44 Net) Development Wells and 11 Gross (.93 Net) Exploratory Wells in the Anadarko Basin which were completed as commercially productive. During the same period Holding LLC drilled 1 Gross (.47 Net) Exploratory Well that was not 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, 2004, Holding LLC drilled 1 Gross (.30 Net) Development Well and 1 Gross (1 Net) Exploratory Well in the Arkoma Basin which were completed as commercially productive.

Holding LLC — East and West Texas Area

      At December 31, 2004, approximately 79.9% (185.5 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, 2004, Holding LLC drilled 12 Gross (11.9 Net) Development Wells and 7 Gross (7 Net) Exploratory Wells in the East Texas Basin, which were completed as commercially productive.

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

      During the year ended December 31, 2004, Holding LLC drilled 3 Gross (3 Net) Development Wells at the GAU which were completed as commercially productive.

      During the year ended December 31, 2004, Holding LLC drilled 19 Gross (3.36 Net) Development Wells and 31 Gross (7.55 Net) Exploratory Wells in Longfellow Ranch Field all of which were completed as commercially productive. During the same period Holding LLC drilled 7 Gross (2.15 Net) Exploratory Wells that were not completed as commercially productive.

Holding LLC — Gulf Coast Area

      At December 31, 2004, approximately 6.3% (14.6 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, 2004, Holding LLC drilled 2 Gross (1 Net) Exploratory Wells in the Gulf coast area, which were completed as commercially productive. During the same period Holding LLC drilled 3 Gross (.7 Net) Exploratory Wells that were not completed as commercially productive.

Holding LLC — Oil and Natural Gas Reserves

      The estimated proved reserves and related future net revenues as of December 31, 2004, 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, 2004, were $42.10 per barrel of oil and $5.92 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. For us, the estimates of the PV10% from future net cash flows are equal to the Standardized Measure of discounted future net cash flows set forth in the notes to the Consolidated Financial Statements of Holding LLC. 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.

      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, 2004. Also presented is the Standardized Measure of Holding LLC’s total Proved Reserves of oil and natural gas.

Holding LLC — Oil and Natural Gas Production and Unit Economics

      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 (including the effects of price risk management activities), and the average unit economics per Mcfe related to Holding LLC’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.

Holding LLC — Productive Well Summary

      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, 2004:

Holding LLC — Leasehold Acreage

      The following table shows the approximate Gross and Net Acres in which Holding LLC had a leasehold interest as of December 31, 2004:

      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 $0.07 million, $0.08 million and $0.2 million for the years ended December 31, 2002, 2003 and 2004 and could increase or decrease in future periods depending on Holding LLC’s lease acquisition activities.

Holding LLC — Drilling Activity

      The following table sets forth Holding LLC’s exploration and development drilling results for the years ended December 31, 2002, 2003 and 2004.

Holding LLC — Title to Oil and Natural Gas Properties

      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.

Holding LLC — Production and Sales Prices

      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 “Holding LLC — Markets and Customers.”

Holding LLC — Control Over Production Activities

      Holding LLC operated 399 of the 678 producing wells in which it owned an interest as of December 31, 2004. The properties not operated by Holding LLC 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.

Holding LLC — Markets and Customers

      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 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, 2004, Plains Marketing and Transportation (“Plains”) accounted for 88.0% of Holding LLC’s oil sales and Riata Energy Company, (“Riata”), Seminole Energy Services (“Seminole”) and Crosstex Energy (“Crosstex”) accounted for 39.5%, 26.1% and 6.7%, respectively of Holding LLC’s gas sales. For the year ended December 31, 2003, Plains accounted for 93.9% of Holding LLC’s oil sales and Riata, Seminole and Crosstex 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, Duke Energy and Oneok Gas Marketing Company accounted for 20%, 11% and 10%, respectively, of Holding LLC’s material 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.

Holding LLC — Regulation

      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 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.

      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.

      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.

Holding LLC — Operational Hazards and Insurance

      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.

Holding LLC — Competition

      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.

Our Office Space

      We lease approximately 25,000 square feet of office space in Dallas, Texas and approximately 5,000 square feet in Houston, Texas. We also have a small amount of office space in Odessa and Halletsville, Texas, Yukon, Oklahoma and Iberville Parish, Louisiana for our business activities.

Our Employees

      On March 1, 2005, we have 92 full-time employees. Of these employees, 35 are field-related personnel. We have no collective bargaining agreements with employees and we believe that relations with our employees are generally satisfactory.

Access to Public Filings

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

      On July 7, 2003, we 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 that

we sold to Osprey in September 2000. Osprey has counterclaimed against us and our 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 us 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.

      On February 24, 2005, the American Arbitration Association issued a ruling in favor of us on all issues. We were awarded the following:

We intend to pursue the judgement awarded by the American Arbitration Association. Whether or not we recover 100% of the award will have no material adverse effect on our financial condition or results of operations.

      During 2000 and 2001 we entered into several hedge contracts with Enron North America Corp (“Enron NAC”). In 2001 Enron Corporation and many Enron Corporation affiliates and subsidiaries, including Enron NAC filed for protection under Chapter 11 of the US bankruptcy code. Operating LLC has filed a claim for damages in that bankruptcy proceeding. The hedge contracts related to production from oil and gas properties that were subsequently contributed to Holding LLC and then to Operating LLC. We have filed a claim for damages in the Enron NAC bankruptcy proceeding and we have appointed a representative to the official committee of unsecured creditors. Our claim represents a hedge against future oil and natural gas prices and does not reflect a cash gain or loss. Any recoveries from Enron NAC will become the property of Operating LLC as a result of the Holding LLC Contribution.

      Other than routine litigation incidental to our business operations which we do not consider to be material, there are no additional legal proceedings in which Operating LLC, Holding, LLC or us are defendants.

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

PART II

      None.

Market Information

      Our common stock currently trades on the OTC Bulletin Board under the symbol “NEGI”. Neither Holding LLC nor Operating LLC are publicly traded. The following table sets forth, for the periods indicated, the high and low closing sales prices as reported on the OTC Bulletin Board for our stock. 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 1, 2005, the latest practicable date for providing price information, the last quoted price for our common stock was $2.99.

Holders

      As of March 1, 2005, we had approximately 7,500 record holders of our shares of common stock, including multiple nominee holders for an undetermined number of beneficial owners.

Dividends on Common Stock

      We have never paid cash dividends on our common stock and we do not expect to declare cash dividends in the foreseeable future.

      The following table sets forth our selected historical financial and operating data as of and for each of the five years in the period ended December 31, 2004. The financial data was derived from our historical financial statements and is not necessarily indicative of our 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 our consolidated financial statements and the related notes thereto included elsewhere herein.

      The following discussion should be read in conjunction with our 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 represents the our best present assessment.

      Statements in our discussion may be forward-looking. These forward-looking statements involve risks and uncertainties. We caution that a number of factors could cause future operations to differ materially from our expectations. See “Forward-Looking Statements” at the beginning of this Annual Report.

Overview of our Business

      We are a management company 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). We manage oil and gas operations of NEG Operating LLC (“Operating LLC”), TransTexas Gas Corporation (“TTG”) and Panaco, Inc. (“Panaco”), all of which are affiliated entities.

      We were incorporated under the laws of the State of Delaware on November 20, 1990 and, prior to February, 1999, operated as an independent natural gas and oil company engaged in the exploration, development, exploitation and acquisition of natural gas and oil reserves in North America. In February, 1999 we were placed under involuntary, court ordered bankruptcy protection. We jointly proposed with the official committee of unsecured creditors a Plan of Reorganization (the “Plan of Reorganization”) which became effective on August 4, 2000. The final decree closing the case became effective December 13, 2001. Accordingly, we have effectively settled all matters relating to our bankruptcy proceeding.

      As mandated by the Plan of Reorganization and the bankruptcy court, on September 12, 2001, but effective May 1, 2001, we contributed all of our operating assets and oil and natural gas properties excluding cash of $4.3 million to NEG Holding, LLC (“Holding LLC”). In exchange we received an initial 50% membership interest in Holding LLC. Gascon Partners, (“Gascon”), an entity owned or controlled by Carl C. Icahn, contributed certain assets to Holding LLC in exchange for an initial 50% ownership interest. Holding LLC is controlled by the managing member (currently Gascon). Effective May 1, 2001, Holding LLC contributed the majority of its assets and liabilities to Operating LLC, a 100% owned subsidiary of Holding LLC. Concurrently, we entered into a management and operating agreement to manage the operations of Operating LLC.

      In August, 2003 and November, 2004 we entered into agreements to manage the operations of TTG and Panaco, respectively. Both TTG and Panaco are majority owned by affiliates of Carl C. Icahn.

      Due to the substantial uncertainty relating to distributions from Holding LLC, we account for our investment in Holding LLC as a preferred investment. We recognize income from the accretion of our investment in Holding LLC using the interest method. Our revenues are comprised solely of the accretion of our investment in Holding LLC and fees received for the management of Operating LLC, TTG and Panaco.

      Our headquarters are located in Dallas, Texas.

Ownership and Control of Outstanding Stock

      American Real Estate Holdings L.P. (“AREH”) owns 50.1% of our outstanding common stock at December 31, 2004. The general partner of AREH, American Property Investors, Inc. (“API”) is an entity indirectly wholly owned by Carl C. Icahn. As such, we may be deemed to be controlled by an affiliate of Mr. Icahn and his affiliated entities. Certain members of our 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 was an employee of affiliates of Arnos and High River, until he retired effective November 1, 2004. 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 our policy to engage in transactions with related parties on terms that, in our opinion, are no less favorable to us than could be obtained from unrelated parties.

      On January 21, 2005, AREP entered into a purchase agreement to purchase Gascon’s managing membership interest in Holding LLC, including Gascon’s option to redeem our interest in Holding LLC. As of March 1, 2005, AREP had not consummated this transaction.

Our Bankruptcy and Formation of Holding LLC

      On February 11, 1999, the United States Bankruptcy Court for the Northern District of Texas, Dallas Division (“Bankruptcy Court”) entered an involuntary petition placing us 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 that we jointly proposed with the official committee of unsecured creditors. Our Plan of Reorganization became effective on August 4, 2000 and the Bankruptcy Court issued a final decree closing the case effective December 13, 2001. Accordingly, we have effectively settled all matters relating to the Bankruptcy Proceeding.

      As mandated by the Plan of Reorganization and the Bankruptcy Court, on September 12, 2001, but effective May 1, 2001, we contributed all of our operating assets and oil and natural gas properties excluding cash of $4.3 million to Holding LLC, a Delaware limited liability company which was formed in August 2000. In exchange we received an initial 50% membership interest in Holding LLC. Gascon, an entity owned or controlled by Carl C. Icahn, contributed certain assets to Holding LLC in exchange for an initial 50% ownership interest. Holding LLC is controlled by the managing member (currently Gascon). Effective May 1, 2001, Holding LLC contributed the majority of its assets and liabilities to Operating LLC, a 100% owned subsidiary of Holding LLC. Concurrently, we entered into a management and operating agreement to manage the operations of Operating LLC.

      In exchange for our 50% membership interest in Holding LLC, we contributed to Holding LLC 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. All amounts reflect our book value at the date of contribution. For accounting purposes, the contribution was made as of September, 2001.

The Holding LLC Operating Agreement

      Holding LLC is governed by an operating agreement effective as of May 12, 2001, which provides for management of Holding LLC by Gascon and distributions to us and Gascon based on a prescribed order of distributions (the “Holding LLC Operating Agreement”).

Order of Distributions

      Guaranteed payments (“Guaranteed Payments”) are to be paid to us, 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 our 10.75% Senior Notes (the “Senior Notes”). As of December 31, 2004, the Priority Amount was $148.6 million. The Guaranteed Payments will be made on a semi-annual basis.

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

      We anticipate that the Priority Amount will be used to pay off our 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 our Senior Notes. Because of the continuing substantial uncertainty that there would be any residual value in Holding LLC after the Guaranteed Payments and Priority Amount distributions, no income other than the accretion is currently being given accounting recognition. Our investment in Holding LLC will be reduced to zero upon collection of the Priority Amount in 2006. After that date, we will continue to monitor payments made to Gascon and, at such time as it would appear that there is any residual value to our 50% interest in Holding LLC, it would receive accounting recognition. Throughout, and up to this point, we believe that the 50% interest in Holding LLC represents a residual interest that is currently valued at zero. We account for our residual equity investment in Holding LLC in accordance with Accounting Principles Board Opinion No. 18 “the Equity Method of Accounting for Investments in Common Stock” (“APB 18”).

Redemption Provision in the Holding LLC Operating Agreement

      The Holding LLC Operating Agreement contains a provision that allows Gascon, or its successor, at any time, in its sole discretion, to redeem our 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 us. Since all of our operating assets and oil and natural gas properties have been contributed to Holding LLC, following such a redemption, our principal assets would consist solely of cash balances.

      In the event that such redemption right is exercised and there is a subsequent liquidation and distribution of the proceeds, we may be obligated to use the proceeds that we would receive for our redeemed membership interest to pay outstanding indebtedness and operating expenses before the distribution of any portion of such proceeds could be made to our shareholders. Following the payment of our indebtedness, including the outstanding balance of $148.6 million relating to the our Senior Notes and our operating expenses, there is a substantial risk that there will be no proceeds remaining for distribution to our 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.

      On January 25, 2005, Gascon entered into an agreement to sell its managing membership interest in Holding LLC, including Gascon’s option to redeem our interest in Holding LLC.

The Reorganized Company

      As a result of the foregoing transactions and as mandated by the Plan of Reorganization effective May 12, 2001, our principal assets were our remaining cash balances, accounts receivable from affiliates, deferred tax asset and our initial 50% membership interest in Holding LLC, and our principal liabilities were the $10.9 million outstanding under our existing $25 million revolving credit facility with Arnos and our Senior Notes and long-term interest payable on Senior Notes. None of our employees have been transferred to Holding LLC or Operating LLC. We remain 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 our 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 our shareholders.

Management Agreements

      The management and operation of Operating LLC is being undertaken by us pursuant to the Management Agreement which we entered into with Operating LLC. However, neither our management nor directors 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 we 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. Our employees 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 are 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 our management services, Operating LLC pays us a management fee equal to 115% of the actual direct and indirect administrative and reasonable overhead costs that we incur in operating the oil and natural gas properties. We or Operating LLC may seek to change the management fee to within the range of 110%-115% as such change is warranted. However, we both 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 that we are paid. In addition, Operating LLC has agreed to indemnify us to the extent we incur any liabilities in connection with our operation of the assets and properties of Operating LLC, except to the extent of our gross negligence or misconduct.

      On August 28, 2003, we entered into the TTG Management Agreement whereby we manage 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 all of the outstanding stock 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, our President and CEO, and our Vice President, Secretary and General Counsel, 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 we 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 our services in managing the TTG business, we 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 us, (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.

      On November 3, 2004, the United States Bankruptcy Court for the Southern District of Texas issued an order effective November 16, 2004 confirming a plan of reorganization for Panaco. In connection with the Panaco Plan, the Company entered into the Panaco Management Agreement pursuant to the Bankruptcy Court’s Order confirming the effective date of the Panaco Plan. Affiliates of Mr. Carl C. Icahn own all of the outstanding stock of the reorganized Panaco. Mr. Bob G. Alexander, our President and CEO, has been appointed to the reorganized Panaco Board of Directors and shall act as the reorganized Panaco’s President. Mr. Philip D. Devlin, our Vice President, General Counsel and Secretary, has been appointed to serve in the same capacities for Panaco. In exchange for our management services, Panaco pays us a monthly fee equal to 115% of the actual direct and indirect administrative overhead costs that we incur in operating and administrating the Panaco properties.

Credit Facility

      On March 26, 2003, Holding LLC distributed to us the $10.9 million note outstanding under our revolving credit facility as a distribution of Priority Amount, thereby canceling all outstanding balances due under the credit facility. Also, on March 26, 2003 we entered into an agreement with Arnos and Operating LLC 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 us. We 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. The Arnos facility was canceled on December 27, 2003 in conjunction with the Operating LLC credit facility described below. As a result, we no longer have a credit facility.

Operating LLC Credit Facility

      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 $120 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.

      The Credit Agreement provides for a loan commitment amount of up to $120 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.

      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 not in compliance with the minimum interest coverage ratio covenant at December 31, 2004. Operating LLC obtained a waiver of compliance with respect to this covenant for the period ended December 31, 2004. Operating LLC was in compliance with all other covenants at December 31, 2004.

      As a condition to the lenders obligations under the Credit Agreement, the lenders required that Gascon, Holding LLC, Operating LLC and us 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) we and Gascon have pledged our 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 not in compliance with the minimum interest coverage ratio covenant at December 31, 2004. Operating LLC obtained a waiver of compliance with respect to this covenant for the period ended December 31, 2004. Operating LLC was in compliance with all other covenants at December 31, 2004.

      Other than our encumbrance of our 50% membership interest in Holding LLC and our indemnification of the Collateral Agent as set forth in the Pledge Agreement, we have incurred no obligations under the Credit Agreement, nor do we act as guarantor of the obligations of Operating LLC or any other guarantor or other entity thereunder.

Results of Operations

      On September 12, 2001 we contributed all of our 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. Subsequent to the contribution, our primary sources of income have been the accretion of our investment in Holding LLC and management fees from affiliates.

Accretion of Our Investment in Holding LLC

      We originally recorded our investment in Holding LLC at the historical cost of the oil and gas properties contributed to Holding LLC. Based on internal and external estimates of reserves and cash flows, we anticipate that we will collect the Guaranteed Payments and Priority Amount through 2006. However, there is substantial uncertainty that there will be any residual value in Holding LLC subsequent to the payment of the amounts required to be paid to Gascon. Due to this uncertainty, we account for our investment in Holding LLC as a preferred investment. Accordingly, we accrete our investment in Holding LLC at the implicit rate of

interest up to the Guaranteed Payments and Priority Amount to be collected through 2006, 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 investment in Holding LLC. The investment in Holding LLC is evaluated quarterly for other than temporary impairment.

      Because of the continuing substantial uncertainty that there would be any residual value in Holding LLC after the Guaranteed Payments and Priority Amount distributions, no income other than the accretion is currently being given accounting recognition. Our investment in Holding LLC will be reduced to zero upon collection of the Priority Amount in 2006. After that date, we will continue to monitor payments made to Gascon and, at such time as it would appear that there is any residual value to our 50% interest in Holding LLC, it would receive accounting recognition. Throughout, and up to this point, we believe that the 50% interest in Holding LLC represents a residual interest that is currently valued at zero. We account for our residual equity investment in Holding LLC in accordance with APB 18.

      Accretion income is based on our best estimates of timing of cash flows of distributions and could vary significantly from the expected amounts.

Management Fees from Affiliates

      During the three year period ended December 31, 2004, we received management fees from the management agreements described above as follows:

Costs and Expenses

      Our cost and expenses are as follows:

      Interest expense decreased in 2003 from 2002 due to the reduction in outstanding debt. We paid off the reinstated interest and credit facility in 2003. Interest expense decreased in 2004 for the same reason.

      Salaries and wages along with insurance increased from 2003 to 2004 due to the increase in the number employees needed to manage TTG and Panaco.

      Other G&A expenses increased from 2003 to 2004 due to a variety of items including costs associated with Sarbanes-Oxley compliance and implementation of additional corporate governance controls.

Deferred Income Tax Asset

      As of December 31, 2004, we had consolidated net operating loss carryforwards of approximately $75.9 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 our opinion, there was not sufficient positive evidence of future taxable income to justify recognition of a benefit. Upon the formation of Holding LLC, we 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, that, more likely than not we will realize a partial benefit from the loss carryforwards. Accordingly, we recorded a deferred tax asset of $25.5 million, $25.9 million and $19.2 million as of December 31, 2002, 2003 and 2004, respectively. We reduced the valuation allowance by $5.1 million in 2003 and $1.3 million in 2004. Ultimate realization of the deferred tax asset is dependent upon, among other factors, our 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.

Liquidity and Capital Resources

      Net cash used in operating activities was $16.6 million for the year ended December 31, 2004, compared to net cash used in operating activities of $59.1 million for the same period in 2003. This decrease is due to the repayment of accrued interest on Senior Notes — affiliates in 2003 compared to 2004.

      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 investing activities was $16.0 million for 2004 compared with net cash provided by investing activities of $58.7 million for 2003. Net cash provided by investing activities in 2003 consisted of Guaranteed Payments and distributions of the Priority Amount from Holding LLC. In 2004 we did not receive a distribution of the Priority Amount, only Guaranteed Payments.

      Net cash provided by investing activities was $58.7 million for 2003 compared with net cash provided by investing activities of $21.6 million for 2002. Net cash provided by investing 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 financing activities in 2002, 2003 or 2004.

      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, the TTG Management Agreement and the Panaco Management Agreement are expected to be sufficient to fund our operations. While there is no assurance, we currently anticipate that the distributions of the Priority Amount will be sufficient to repay the Senior Notes due 2006.

      Our working capital surplus at December 31, 2004 was $2.2 million compared to a working capital surplus at December 31, 2003 of $1.7 million and a working capital deficit of $40.0 million at December 31, 2002. Effective with the Priority Amount distribution in March 2003, working capital increased by $43 million.

Table of Contractual Obligations

      The following table is a summary of contractual obligations as of December 31, 2004.

Future Capital and Financing Requirements

      Although we are highly leveraged following confirmation of the Plan of Reorganization, we expect that cash flows from Guaranteed Payments, Priority Distributions and management fees from affiliates will be sufficient to fund our 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, we would not be able to meet our obligations.

Off Balance Sheet Arrangements

      We have no off balance sheet financing arrangements.

Critical Accounting Policies and Estimates

      We follow certain significant accounting policies when preparing our 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 us 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 Amount 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.

      The Holding LLC operating agreement requires payment of the Guaranteed Payments and Priority Amount to us in order to pay interest on senior debt and the principal amount of the debt of $148.6 million in 2006. After we receive the Guaranteed Payments and Priority Amount that total approximately $300 million (which includes the $148.6 million), the Holding LLC Operating Agreement requires the distribution of an equal amount to Gascon. Holding LLC is contractually obligated to make the Guaranteed Payments and Priority Amount distributions to us and Gascon before any distributions can be made to the LLC interest.

      We originally recorded our investment in Holding LLC at the historical cost of the oil and gas properties contributed to Holding LLC. In evaluating the appropriate accounting to be applied to this investment, we anticipated we will collect the Guaranteed Payments and Priority Amount through 2006. However, based on cash flow projections prepared by the management of Holding LLC and its reserve engineers, there is substantial uncertainty that there will be any residual value in Holding LLC subsequent to the payment of the amounts required to be paid to Gascon. Due to this uncertainty, we have been accreting our investment in Holding LLC at the implicit rate of interest up to the Guaranteed Payments and Priority Amount to be collected through 2006, 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 investment in Holding LLC. The investment in Holding LLC is evaluated quarterly for other than temporary impairment. Our rights upon liquidation of Holding LLC are identical to those described above, and the Company considered those rights in determining the appropriate presentation.

      Because of the continuing substantial uncertainty that there would be any residual value in Holding LLC after the Guaranteed Payments and Priority Amount distributions, no income other than the accretion is currently being given accounting recognition. Our investment in Holding LLC will be reduced to zero upon collection of the Priority Amount in 2006. After that date, we will continue to monitor payments made to Gascon and, at such time as it would appear that there is any residual value to our 50% interest in Holding LLC, it would receive accounting recognition. Throughout, and up to this point, we believe that the 50% interest in Holding LLC represents a residual interest that is currently valued at zero. We account for our residual equity investment in Holding LLC in accordance with APB 18.

      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, more likely than not we will realize a partial benefit from the loss carryforwards. Ultimate realization of the deferred tax asset is dependent upon, among other factors, our 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

      On December 16, 2004, the FASB issued Statement 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”) that will require compensation costs related to share-based payment transactions (issuance of stock options and restricted stock) to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. Statement 123(R) replaces SFAS 123, “Accounting for Stock-Based Compensation”, and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”. For us, SFAS 123(R) is effective for the first reporting period after June 15, 2005. Entities that use the fair-value-based method for either recognition or disclosure under SFAS 123 are required to apply SFAS 123(R) using a modified version of prospective application. Under this method, an entity records compensation expense for all awards it grants after the date of adoption. In addition, the entity is required to record compensation expense for the unvested portion of previously granted awards that remain outstanding at the date of adoption. In addition, entities may elect to adopt SFAS 123(R) using a modified retrospective method where by previously issued financial statements are restated based on the expense previously calculated and reported in their pro forma footnote disclosures. We did not have any share based or liability based instruments for any years presented, therefore the adoption of SFAS 123(R) will have no effect on us.

      On December 16, 2004, the FASB issued Statement 153, “Exchanges of Nonmonetary Assets”, an amendment of APB Opinion No. 29, to clarify the accounting for nonmonetary exchanges of similar productive assets. SFAS 153 provides a general exception from fair value measurement for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The Statement will be applied prospectively and is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not have any nonmonetary transactions for any period presented that this Statement would apply. We do not expect the adoption of SFAS 153 to have a material impact on our financials statements.

Changes in Prices

      Oil and natural gas prices are subject to seasonal and other fluctuations that are beyond our ability to control or predict.

Inflation

      Although certain of our costs and expenses are affected by the level of inflation, inflation has not had a significant effect on our results of operations during the three years ended December 31, 2004.

      As of December 31, 2003 and 2004, we had no exposure to interest, currency or commodity risk.

      Our Financial Statements 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.

      None.

Conclusion Regarding The Effectiveness Of Disclosure Controls And Procedures

      In accordance with Exchange Act Rules 13a-15 and 15d-15, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our 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.

Changes In Internal Control Over Financial Reporting

      In November, 2004 the audit committee authorized and we engaged a third party consultant, Pt Platinum Consulting, LLC, to supplement our staff in complying with financial reporting matters. Pt Platinum Consulting, LLC provides assistance in determining proper accounting for unusual transactions and an additional level of accounting review for our SEC filings.

      In October and November 2004, we implemented a number of improvements in our policies and procedures surrounding our information technology processes and infrastructure. In performing our assessment of internal control over financial reporting, we noted several instances where these policies and procedures were not being followed. The major items were:

      In the aggregate, these constitute a significant deficiency in our internal control over financial reporting. A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects a company’s ability to initiate, authorize, record, process, or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the company’s annual or interim financial statements that is more than inconsequential will not be prevented or detected.

      We have discussed these control deficiencies with our audit committee and Grant Thornton LLP and have implemented remediation actions which are expected to be completed in the first quarter of 2005.

      Other than the items mentioned above, no other changes occurred in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934) during the quarter ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

      Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control — Integrated Framework issued by COSO, our management concluded that our internal control over financial reporting was effective as of December 31,2004. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedure may deteriorate.

      Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report which is included below:

Auditors’ Report on Internal Control Over Financial Reporting

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors

National Energy Group, Inc.

      We have audited management’s assessment, included in the accompanying Management’s Assessment of Internal Control over Financial Reporting, that National Energy Group, Inc. (the “Company”) (a Delaware Corporation) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

      We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

      A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

      Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

      In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

      We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheet of National Energy Group, Inc. as of December 31, 2004, and the related statements of operations, stockholders’ deficit and cash flows for the year then ended, and our report dated March 4, 2005 expressed an unqualified opinion on those financial statements.

Houston, Texas

March 4, 2005

PART III

      The information required by this Item 10 will be provided in the sections entitled “Director Election”, “Management” and “Certain Relationships and Related Transactions” in our definitive Proxy Statement for its 2005 Annual Meeting of Shareholders (the “Proxy Statement”), and is incorporated herein by reference.

      We have adopted a Code of Business Conduct and Ethics that applies to directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer. Our Code of Business Conduct and Ethics is posted on our 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 our website and a Current Report on Form 8-K will be filed within 4 days of the change or waiver.

      The information required by this Item 11 will be provided in the section entitled, “Executive Compensation” in our definitive proxy statement that is to be filed with the SEC pursuant to the Exchange Act within 120 days of the end of our fiscal year on December 31, 2004, and is incorporated herein by reference.

      The information required by this item 12 will be provided in the section entitled “Security Ownership of Certain Beneficial Owners and Management” in our definitive proxy statement that is to be filed with the SEC pursuant to the Exchange Act within 120 days of the end of our fiscal year on December 31, 2004, and is incorporated herein by reference.

      The information required by this Item 13 will be provided in the section entitled “Certain Relationships and Related Transactions” in our definitive proxy statement that is to be filed with the SEC pursuant to the Exchange Act within 120 days of the end of our fiscal year on December 31, 2004 and is incorporated herein by reference.

      The information requested by this Item 14 will be provided in the section entitled “Principle Accounting Fees and Services” in our definitive proxy statement that is to be filed with the SEC pursuant to the Exchange Act within 120 days of the end of our fiscal year on December 31, 2004 and is incorporated herein by reference.

PART IV

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

      (b) Exhibits:

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.

      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 and asset retirement obligations, 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.

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.

March 15, 2005

March 15, 2005

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 15, 2005.

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.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

National Energy Group, Inc:

      We have audited the accompanying balance sheet of National Energy Group, Inc. (“the Company”) and as of December 31, 2003 and the related statements of operations, stockholders’ deficit, and cash flows for each of the years in the two-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 the standards of the Public Company Accounting Oversight Board (United States). 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 the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2003, in conformity with U.S. generally accepted accounting principles.

Dallas, Texas

March 12, 2004

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors

National Energy Group, Inc.

      We have audited the accompanying balance sheet of National Energy Group, Inc. (the “Company”) as of December 31, 2004, and the related statements of operations, stockholders’ deficit and cash flows for the year then ended. 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 audit.

      We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 audit provides 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 the Company as of December 31, 2004, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

      We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of National Energy Group, Inc.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 4, 2005 expressed an unqualified opinion.

Houston, Texas

March 4, 2005

NATIONAL ENERGY GROUP, INC.

BALANCE SHEETS

The accompanying notes are an integral part of these financial statements.

NATIONAL ENERGY GROUP, INC.

STATEMENTS OF OPERATIONS