Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003

Oil and natural gas revenues for 2004 increased 36% to $52.4 million from $38.5 million in 2003. Production volumes for natural gas in 2004 increased 36% to 6,462 MMcf from 4,763 MMcf in 2003. Realized average natural gas prices increased 15% to $6.14 per Mcf in 2004 from $5.35 per Mcf in 2003. Production volumes for oil in 2004 decreased 31% to 309 MBbls from 450 MBbls in 2003. The increase in natural gas production was primarily due to the commencement of production from the Beach House #1 and #2, the Peal Ranch wells, the Barnett Shale wells, the Shadyside #1 (which we later sold in February 2005), the new Encinitas wells and the LL&E #1, partially offset by the natural decline in production from the Hankamer #1, Espree #1, Staubach #1, Burkhart #1R, Pauline Huebner A-382 #1, Matthes Huebner #1, Pitchfork Ranch #1 and other wells. The decrease in oil production was due primarily to the natural decline of production at the Staubach #1, Burkhart #1R, Pauline Huebner A-382 #1, Beach House #1, Matthes Huebner #1, Hankamer #1 and Espree #1, partially offset by the commencement of production from the Delta Farms #1 workover, LL&E #1 and other wells. Oil and natural gas revenues in 2003 include the impact of hedging activities as discussed below under “Volatility of Oil and Gas Prices.”

Average oil prices increased 42% to $41.00 per Bbl in 2004 from $28.90 per Bbl in 2003.

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, 2003 and 2004:

Oil and natural gas operating expenses for 2004 increased 25% to $8.4 million from $6.7 million in 2003. Oil and natural gas operating expenses increased primarily due to higher severance taxes of $0.7 million on higher commodity prices, while higher lifting costs of $0.9 million were attributable to the increased number of producing wells and in part due to higher ad valorem taxes. Operating expenses per equivalent unit in 2004 increased to $1.01 per Mcfe from $0.90 per Mcfe in 2003. The per unit cost increased primarily as a result of the higher costs noted above.

Depreciation, depletion and amortization (“DD&A”) expense for 2004 increased 30% to $15.4 million from $11.9 million in 2003. This increase was primarily due to the increased land, seismic and drilling costs added to the proved property cost base.

General and administrative (“G&A”) expense for 2004 increased 28% to $7.2 million from $5.6 million for 2003. The increase in G&A was due primarily to higher incentive compensation of $0.4 million, higher compensation costs of $0.2 million, higher professional fees of $0.7 million in connection with (1) the 2003 annual audit and Section 404 of the Sarbanes-Oxley Act compliance project ($0.5 million), and (2) discontinued refinancing projects ($0.2 million), and due to an increase in the allowance for doubtful accounts of $0.3 million.

We recorded a $1.4 million after tax charge, or $0.06 per fully diluted share, on our minority interest in Pinnacle. Of this charge, $0.3 million relates to a valuation allowance for federal income taxes. It is likely that Pinnacle will continue to record a valuation allowance on the deferred federal tax benefit generated from the operating losses incurred during the early development stages of Pinnacle’s coalbed methane project. Concurrently, we will record valuation allowances relative to our share of Pinnacle’s financial results. There were no such gains reported in 2003.

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