Pinnacle Gas Resources, Inc. (“Pinnacle”). In exchange for this contribution, we received 37.5% of the common stock of Pinnacle and options to purchase additional Pinnacle common stock. We account for our interest in Pinnacle using the equity method. As a result, our contributed operations and reserves are no longer directly reflected in our financial statements.

In March 2004, Credit Suisse First Boston Private Equity Entities (the “CSFB Parties”) contributed additional funds of $11.8 million into Pinnacle to fund its 2004 development program, which increased the CSFB Parties’ ownership to 66.7% on a fully diluted basis assuming we and U.S. Energy Corp. each elect not to exercise our available options.

In 2005, the CSFB Parties contributed $15.0 million to Pinnacle to finance an acquisition of additional undeveloped acreage. CCBM and U.S. Energy Corp. elected not to participate in the equity contribution. In November 2005, the CSFB Parties and a former Pinnacle employee received 30,000 and 2,000 shares of Pinnacle common stock, respectively, after exercising certain warrants and options. Accordingly, CCBM’s ownership in Pinnacle is 32.3% at December 31, 2005 (15.8% on a fully diluted basis). We understand that Pinnacle is in the process of raising additional capital to expand its operations, which may result in a further dilution of our interest. If Pinnacle engages in any such activities that involve the issuance of additional equity, we could be diluted to an extent where we would no longer use the equity method of accounting to account for our investment in Pinnacle.

As of December 31, 2005, on a fully diluted basis, assuming that all parties exercised their Pinnacle warrants and Pinnacle stock options, the CSFB Parties, CCBM and U.S. Energy Corp. would have ownership interests of approximately 68.4%, 15.8% and 15.8%, respectively.

In addition to our interest in Pinnacle, we have maintained interests in approximately 159,000 gross acres at the end of 2005 in the Castle Rock coalbed methane project area in Montana and the Oyster Ridge project area in Wyoming. See “Business and Properties—Pinnacle Transaction” for a description of this transaction. Our discussion of future drilling and capital expenditures does not reflect operations conducted through Pinnacle.

Derivative Transactions

Our financial results are largely dependent on a number of factors, including commodity prices. Commodity prices are outside of our control and historically have been and are expected to remain volatile. Natural gas prices in particular have remained volatile during the last few years and more recently oil prices have become volatile. Commodity prices are affected by changes in market demands, overall economic activity, weather, pipeline capacity constraints, inventory storage levels, basis differentials and other factors. As a result, we cannot accurately predict future natural gas, natural gas liquids and crude oil prices, and therefore, cannot accurately predict revenues.

Because natural gas and oil prices are unstable, we periodically enter into price-risk-management transactions such as swaps, collars, futures and options to reduce our exposure to price fluctuations associated with a portion of our natural gas and oil production and to achieve a more predictable cash flow. The use of these arrangements limits our ability to benefit from increases in the prices of natural gas and oil. Our derivative arrangements may apply to only a portion of our production and provide only partial protection against declines in natural gas and oil prices.

Results of Operations

Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004

Oil and natural gas revenues for 2005 increased 49% to $78.2 million from $52.4 million in 2004. Production volumes for natural gas in 2005 increased 27% to 8,206 MMcf from 6,462 MMcf in 2004. Realized average natural gas prices increased 29% to $7.90 per Mcf in 2005 from $6.14 per Mcf in 2004. Production volumes for oil in 2005 decreased 24% to 234 MBbls from 309 MBbls in 2004. The increase in natural gas production was primarily due to the commencement of production from the Galloway #1 and new wells in the Barnett Shale, Encinitas Project and Peters Ranch areas. The gas production volume increases were partially offset by: (1) production declines from the Delta Farms #1 and the Beach House #1 wells, which were shut-in for workovers during the second and third quarters of 2005; (2) the temporary shut-in of a number of wells as a result of the Katrina and Rita hurricanes; and (3) the sale of the Shadyside #1 in the first quarter of 2005. The decrease in oil production volume was principally due to production declines from the aforementioned workovers, the hurricane related shut-ins, and a natural production decline for the Hankamer #1. Oil and natural gas revenues include the impact of hedging activities as discussed below under “Volatility of Oil and Gas Prices.”

Realized average oil prices increased 37% to $56.36 per Bbl in 2005 from $41.00 per Bbl in 2004.

The following table summarizes production volumes, average sales prices and operating revenues for our oil and natural gas operations for the years ended December 31, 2004 and 2005:

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