CARRIZO OIL & GAS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   NATURE OF OPERATIONS

Carrizo Oil & Gas, Inc., a Texas corporation (“Carrizo” or the “Company”) is an independent energy company engaged in the exploration, development and production of natural gas and oil. Its current operations are focused proven, producing natural gas and oil geologic trends in the Barnett Shale area in North Texas and along the onshore Gulf Coast area in Texas and Louisiana, primarily in the Miocene, Wilcox, Frio and Vicksburg trends. The Company’s other interests include properties in the U.K. NorthSea, East Texas and acreage in shale plays in the Barnett/Woodford in West Texas/New Mexico, the Floyd/Neal in Mississippi, the western New Albany in Kentucky/Illinois, the Fayetteville in Arkansas and the Marcellus in Pennsylvania/New York. The Company also has a coalbed methane investment in the Rocky Mountains, largely through its minority interest in Pinnacle Gas Resources, Inc.

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements are presented in accordance with U.S. generally accepted accounting principles. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after elimination of allsignificant intercompany transactions and balances. The financial statements reflect necessary adjustments, all of which were of a recurring nature and are in the opinion of management necessary for a fair presentation.

Investment in Unconsolidated Subsidiary

Prior to April 2006, the Company’s investment in Pinnacle Gas Resources, Inc. (“Pinnacle”) was recorded using the equity method of accounting and was adjusted for the Company’s equity in the subsidiary’s profit or loss. In April 2006, the Company changed its accounting for Pinnacle to the cost method of accounting and adjusts the carrying amount of its investment for contributions to and distributions from the subsidiary.

In 2007, Pinnacle became a publicly traded entity on the Nasdaq Global Market. For accounting purposes, the Pinnacle common stock now has a readily determinable fair market value. The Company classifies the investment as available-for-sale andadjusts the book value to fair market value through other comprehensive income, net of taxes.

Reclassifications

Certain reclassifications have been made to prior periods’ financial statements to conform to the current presentation. These reclassifications had no effect on total assets, shareholders’ equity or net income.

Use of Estimates

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

Significant estimates include volumes of oil and natural gas reserves used in calculating depletion of proved oil and natural gas properties, future net revenues and abandonment obligations, impairment of undeveloped properties, future income taxes and related assets/liabilities, the collectability of outstanding accounts receivable, fair values of derivatives, stock-based compensation expense, contingencies and the results of current and future litigation. Oil and natural gas reserve estimates, which are the basis for unit-of-production depletion and the ceiling test, have numerous inherent uncertainties. The accuracy of any reserve estimateis a function of the quality of available data and of engineering and geological interpretation and judgment. Subsequent drilling results, testing and production may justify revision of such estimates. Accordingly, reserve estimates are often different from the quantities of oil and natural gas that are ultimately recovered. In addition, reserve estimates are vulnerable to changes in wellhead prices of crude oil and natural gas. Such prices have been volatile in the past and can be expected to be volatile in the future.

The significant estimates are based on current assumptions that may be materially effected by changes to future economic conditions such as the market prices received for sales of volumes of oil and natural gas, interest rates, the market value of the Company’s common stock and corresponding volatility and the Company’s ability to generate future taxable income. Future changes in these assumptions may affect these significant estimates materially in the near term.