TITLE TO PROPERTIES; ACQUISITION RISKS

We believe we have satisfactory title to all of our producing properties in accordance with standards generally accepted in the natural gas and oil industry. Our properties are subject to customary royalty interests, liens incident to operating agreements, liens for current taxes and other burdens which we believe do not materially interfere with the use of or affect the value of these properties. As is customary in the industry in the case of undeveloped properties, we make little investigation of record title at the time of acquisition (other than a preliminary review of local records). Investigations, including a title opinion of local counsel, are generally made before commencement of drilling operations. Our revolving credit facility is secured by substantially all of our natural gas and oil properties.

In acquiring producing properties, we assess the recoverable reserves, future natural gas and oil prices, operating costs, potential liabilities and other factors relating to the properties. Our assessments are necessarily inexact and their accuracy is inherently uncertain. Our review of a subject property in connection with our acquisition assessment will not reveal all existing or potential problems or permit us to become sufficiently familiar with the property to assess fully its deficiencies and capabilities. We may not inspect every well, and we may not be able to observe structural and environmental problems even when we do inspect a well. If problems are identified, the seller may be unwilling or unable to provide effective contractual protection against all or part of those problems. Any acquisition of property interests may not be economically successful, and unsuccessful acquisitions may have a material adverse effect on our financial condition and future results of operations. See "Risk Factors -- Our future acquisitions may yield revenues or production that varies significantly from our projections."

CUSTOMERS

We sold oil and natural gas production representing more than 10% of our oil and natural gas revenues for the year ended December 31, 2004 to Cokinos Natural Gas Company (17%), Texon L.P. (13%) and WMJ Investments Corp. (12%); for the year ended December 31, 2003 to WMJ Investments Corp. (16%), Cokinos Natural Gas Company (15%) and Gulfmark Energy, Inc. (14%); and for the year ended December 31, 2002 to Cokinos Natural Gas Company (12%) and Discovery Producer Services, LLC (10%). Because alternate purchasers of oil and natural gas are readily available, we believe that the loss of any of our purchasers would not have a material adverse effect on our financial results.

EMPLOYEES

At December 31, 2004, we had 38 full-time employees, including six geoscientists and six engineers. We believe that our relationships with our employees are good.

In order to optimize prospect generation and development, we utilize the services of independent consultants and contractors to perform various professional services, particularly in the areas of 3-D seismic data mapping, acquisition of leases and lease options, construction, design, well site surveillance, permitting and environmental assessment. Independent contractors generally provide field and on-site production operation services, such as pumping, maintenance, dispatching, inspection and testings. We believe that this use of third-party service providers has enhanced our ability to contain general and administrative expenses.

We depend to a large extent on the services of certain key management personnel, the loss of, any of which could have a material adverse effect on our operations. We do not maintain key-man life insurance with respect to any of our employees.

PINNACLE TRANSACTION

Formation and Operations

During the second quarter of 2003, we and Rocky Mountain Gas, Inc. ("RMG") each contributed our interests in certain natural gas and oil leases in Wyoming and Montana in areas prospective for coalbed methane to a newly formed joint venture, Pinnacle Gas Resources, Inc. In exchange for the contribution of these assets, we each received 37.5% of the common stock of Pinnacle and options to purchase additional Pinnacle common stock, or on a fully diluted basis, we each received an ownership interest in file:///C|/Program%20Files/crzo04/crzo-10K.txt (28 of 124) [5/1/2005 3:37:33 AM] file:///C|/Program%20Files/crzo04/crzo-10K.txt Pinnacle of 26.9%. At the end of 2004, we retained our interests in approximately 139,000 gross acres in the Castle Rock project area in Montana and the Oyster Ridge project area in Wyoming. We no longer have a drilling obligation in connection with the oil and natural gas leases contributed to Pinnacle. During 2004, we opted to exercise our right to cancel one-half of a remaining note payable to RMG, or approximately $300,000 in exchange for assigning one-half of our interest in the Oyster Ridge project area to RMG.

Simultaneously with the contribution of these assets, affiliates and related parties of CSFB Private Equity ("CSFB") contributed approximately $17.6 million of cash to Pinnacle in return for redeemable preferred stock of Pinnacle, 25% of Pinnacle's common

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