MONTEREY RESOURCES INC, 424B4, 1996-11-14

MONTEREY RESOURCES INC
424B4, 1996-11-14
CRUDE PETROLEUM & NATURAL GAS

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<PAGE> 1
Filed Pursuant to Rule 424(b)(4)
File No. 333-12201

8,150,000 SHARES

MONTEREY RESOURCES, INC.

[MONTEREY RESOURCES, INC. LOGO] COMMON STOCK
(PAR VALUE $.01 PER SHARE)
---------------------
Of the 8,150,000 shares of Common Stock offered, 6,570,000 are being
offered hereby in the United States and 1,580,000 are being offered in a
concurrent international offering outside the United States. The initial public
offering price and the aggregate underwriting discount per share will be
identical for both offerings. See "Underwriting".

All of the 8,150,000 shares of Common Stock offered hereby are being sold
by the Company, which is a wholly owned subsidiary of Santa Fe Energy Resources,
Inc. Upon completion of the offerings, Santa Fe Energy Resources, Inc. will own
approximately 85% (83% if the Underwriters' over-allotment options are exercised
in full) of the outstanding Common Stock of the Company.

Prior to the offerings, there has been no public market for the Common
Stock of the Company. For factors considered in determining the initial public
offering price, see "Underwriting".

SEE "RISK FACTORS" ON PAGE 15 FOR CERTAIN CONSIDERATIONS RELEVANT TO AN
INVESTMENT IN THE COMMON STOCK.

The Common Stock has been approved for listing, subject to notice of
issuance, on the New York Stock Exchange under the symbol "MRC".
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
---------------------

<TABLE>
<CAPTION>
INITIAL PUBLIC UNDERWRITING PROCEEDS TO
OFFERING PRICE DISCOUNT(1) COMPANY(2)
-------------------------------------------------
<S> <C> <C> <C>
Per Share................... $14.50 $0.98 $13.52
Total(3).................... $118,175,000 $7,987,000 $110,188,000
</TABLE>
- ---------------
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933.
(2) Before deducting estimated expenses of $3,000,000 payable by the Company.
(3) The Company has granted the U.S. Underwriters an option for 30 days to
purchase up to an additional 948,000 shares of Common Stock at the initial
public offering price per share, less the underwriting discount, solely to
cover over-allotments. Additionally, the Company has granted the
International Underwriters a similar option with respect to an additional
237,000 shares as part of the concurrent international offering. If such
options are exercised in full, the total initial public offering price,
underwriting discount and proceeds to Company will be $135,357,500,
$9,148,300, and $126,209,200, respectively. See "Underwriting".
---------------------
The shares offered hereby are offered severally by the U.S. Underwriters,
as specified herein, subject to receipt and acceptance by them and subject to
their right to reject any order in whole or in part. It is expected that
certificates for the shares will be ready for delivery in New York, New York, on
or about November 19, 1996, against payment therefor in immediately available
funds.
GOLDMAN, SACHS & CO.
MORGAN STANLEY & CO.
INCORPORATED

PETRIE PARKMAN & CO.
---------------------
The date of this Prospectus is November 13, 1996.
<PAGE> 2

[MAP OF MAJOR PROPERTIES]

The map which shows a portion of the state of California is labeled "Monterey
Resources Major Properties." A smaller locator map indicates the portion of
California which is shown enlarged and in greater detail. The San Joaquin Valley
is identified as are the cities of Bakersfield and Los Angeles. The locations of
the following fields in which the Company has an interest are graphically
depicted and labeled: Coalinga, South Belridge, Kern River and Midway-Sunset,
plus the Company's fields in the general area near Los Angeles are identified as
the LA Basin consistent with the references in the text of the prospectus.

IN CONNECTION WITH THE OFFERINGS, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.

2
<PAGE> 3

ADDITIONAL INFORMATION

The Company has not previously been subject to the informational
requirements of the Securities Exchange Act of 1934 (the "Exchange Act"). The
Company has filed with the Securities and Exchange Commission (the "Commission")
a Registration Statement on Form S-1 (the "Registration Statement") under the
Securities Act of 1933, as amended (the "Securities Act"), with respect to the
shares of common stock, par value $0.01 per share, of the Company offered
hereby. This Prospectus, which constitutes a part of the Registration Statement,
does not contain all of the information set forth in the Registration Statement,
certain items of which are contained in exhibits and schedules to the
Registration Statement as permitted by the rules and regulations of the
Commission. For further information with respect to the Company and the Common
Stock offered hereby, reference is made to the Registration Statement, including
the exhibits and schedules thereto. Statements made in this Prospectus
concerning the contents of any contract, agreement or other document are not
necessarily complete; with respect to each such contract, agreement or other
document filed as an exhibit to the Registration Statement, reference is made to
the exhibit for a more complete description of the matter involved, and each
such statement is qualified in its entirety by such reference. The Registration
Statement and the exhibits and schedules thereto filed with the Commission by
the Company may be inspected and copied at the public reference facilities
maintained by the Commission at Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the regional offices of the Commission located at
7 World Trade Center, Suite 1300, New York, New York 10048 and 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 or on the Internet at
http://www.sec.gov. Copies of such material can also be obtained upon written
request from the Public Reference Section of the Commission at Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. The
Company's periodic reports, proxy statements and other information filed by the
Company with the Commission can also be inspected at the offices of The New York
Stock Exchange, Inc., 20 Broad Street, New York, New York 10005.

The Company intends to furnish its stockholders with annual reports
containing audited financial statements examined by an independent public
accounting firm for each fiscal year.

CERTAIN DEFINITIONS

As used herein, the following terms have the specific meanings set out:
"Common Stock" means the common stock, par value $0.01 per share, of Monterey
Resources, Inc. (the "Company"). "Bbl" means barrel, "MBbl" means thousand
barrels, "MMBbl" means million barrels, "Mcf" means thousand cubic feet, "MMcf"
means million cubic feet, "Bcf" means billion cubic feet, "BOE" means barrel of
oil equivalent, "MBOE" means thousand barrels of oil equivalent, and "MMBOE"
means million barrels of oil equivalent. Natural gas volumes are converted to
barrels of oil equivalent using the ratio of 6.0 Mcf of natural gas to 1.0
barrel of crude oil. Unless otherwise indicated in this Prospectus, natural gas
volumes are stated at the legal pressure base of the state or area in which the
reserves are located and at 60(o) Fahrenheit. "Finding costs" refers to costs
incurred for development, exploration and acquisition activities which add to
the Company's oil and gas reserves. "Finding costs per BOE" refers to the
finding costs divided by net proved reserve additions from acquisitions,
extensions, discoveries, improved recovery and revisions, on a BOE basis.
"Improved recovery", "enhanced oil recovery" and "EOR" include all methods of
supplementing natural reservoir forces and energy, or otherwise increasing
ultimate recovery from a reservoir, and include waterfloods, thermal techniques
(including cyclic steam, steam flood and in situ combustion operations) and
CO(2) (carbon dioxide) injection. "Heavy oil" or "heavy crude" is low gravity,
high viscosity crude oil. "Working interest" means an operating interest which
gives the owner the right to drill, produce and conduct operating activities on
a property and to a share of production and requires the owner to bear a
proportionate share of related expenses. "Net revenue interest" means the
percentage of production to which the owner of a working interest is entitled.
"Net acres" and "net wells" refer to the sum of the fractional working interests
owned in gross acres and gross wells, respectively. Unless otherwise indicated,
references to "reserves" means net proved reserves and references to "wells"
means gross wells. "EBITDA" is defined as the sum of income before provision for
income taxes, interest, depreciation, depletion, amortization, impairments and
certain non-cash charges including gains or losses realized on the disposition
of properties. In this Prospectus, references to "dollars," "U.S.$" and "$" are
to United States dollars.

3
<PAGE> 4

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and historical and pro forma financial statements appearing
elsewhere in this Prospectus. Unless otherwise indicated, references to the
assets, operations and performance of the "Company" prior to the closing of the
Offerings (defined herein) refer to the assets, operations and performance of
the Western Division (the "Western Division") of Santa Fe Energy Resources, Inc.
("SFR"). Unless otherwise indicated, all data in this Prospectus assume the
Underwriters' over-allotment options are not exercised. Certain terms used
herein are defined under "Certain Definitions".

THE COMPANY

Monterey Resources, Inc., a wholly owned subsidiary of SFR (the "Company"),
is an independent oil and gas company engaged in the production, development and
acquisition of oil and natural gas in the State of California. As of September
1, 1996 the Company had net proved reserves of approximately 214 MMBOE with a
pre-tax net present value, discounted at 10%, of approximately $750 million,
according to estimates prepared by Ryder Scott Company, independent petroleum
engineers ("Ryder Scott"). In 1995 the Company's operations generated total
revenues of approximately $211 million, EBITDA of approximately $108 million and
net income of approximately $34 million. During the nine months ended September
30, 1996, the Company's average production was approximately 47 MBOE per day,
resulting in a reserve-to-production ratio of 12.5 years.

The Company was formed in August 1996 to own the properties and conduct the
business of the Western Division of SFR following a determination by SFR's board
of directors to separate SFR's operations into two independent companies. The
SFR board made this determination because SFR's oil and gas operations have
developed, over time, into separate businesses that operate independently and
have diverging capital requirements and risk profiles. In addition, the board
believes that separating SFR's operations into two independent companies will
allow each to more efficiently develop its distinct resource base and pursue
separate business opportunities while providing each with improved access to
capital markets. While the Company will focus its efforts on its California
properties, SFR has advised the Company that SFR intends to focus on developing
and exploiting its properties outside of California and pursuing acquisition and
exploration opportunities in other areas of the United States and abroad. The
Offerings and the other transactions to be effected at or prior to the closing
of the Offerings are the initial phase of the separation of these two
businesses. Immediately after the Offerings are consummated, SFR will own
approximately 85% of the outstanding Common Stock. The second phase of the
separation will involve the distribution of the shares of Common Stock owned by
SFR following the Offerings to the common stockholders of SFR. See
"-- Transactions at Closing" and "-- Relationship Between the Company and
SFR -- Intended Spin Off by SFR".

The Company owns and operates properties in four major oil producing fields
located in the San Joaquin Valley of California: Midway-Sunset, Kern River,
South Belridge and Coalinga. These fields are among the most prolific oil fields
in the United States, particularly Midway-Sunset, Kern River, and South
Belridge, which are the three largest producing oil fields in the lower 48
states. The Midway-Sunset field accounted for approximately 78% of the Company's
total proved reserves at September 1, 1996 and 74% of its average daily
production for the first nine months of 1996. An additional 18% of the Company's
total proved reserves as of September 1, 1996, and 21% of its average daily
production for the first nine months of 1996 were attributable to the Kern
River, South Belridge and Coalinga fields. The Company initiated production from
the San Joaquin Valley fields in 1905 and nearly all of the reserves in these
fields have been characterized by low gravity and high viscosity or "heavy" oil,
the production of which depends primarily on thermally enhanced recovery
techniques. The Company holds an interest in approximately 16,000 gross acres in
these fields with an average working interest in these properties of
approximately 99%.

4
<PAGE> 5

1995, the Company spent a total of $176 million (an average of $35 million per
year) on development activities on its properties. Cumulative production from
the Company's properties during the same five-year period exceeded 78 MMBOE
while additions to proved reserves exceeded 97 MMBOE (yielding 19 MMBOE net
additions after production). The table set forth below demonstrates the growth
in the Company's proved reserve base, as estimated by Ryder Scott:

<TABLE>
<CAPTION>
PROVED RESERVES
------------------------------------------------
DECEMBER 31,
----------------------------------- SEPTEMBER 1,
1991 1992 1993(1) 1994 1995 1996
---- ---- ------- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Crude oil (MMBbls)........ 183 190 184 191 200 212
Natural gas (BCF)......... 22 19 12 13 12 12
Total (MMBOE)........... 187 193 186 193 202 214
</TABLE>

- ---------------

(1) The reduction in proved reserves in 1993 primarily reflects the sale of the
Western Division's interests in certain properties containing estimated
proved reserves of approximately 5.7 MMBOE.

Based on reservoir engineering studies prepared by Ryder Scott, the Company
believes that it can continue to make significant additions to proved reserves
on its properties through additional EOR and development projects, and the
Company has developed a large inventory of such projects. The Company
anticipates spending approximately $46 million during 1996 (of which $35 million
has been expended through September 30, 1996) and $68 million during 1997 on
additional development projects on its properties. Because the actual amounts
expended in the future and the results therefrom will be influenced by numerous
factors, including many beyond the Company's control, and due to the inherent
uncertainty of reservoir engineering studies, no assurances can be given as to
the amounts that will be expended or, if expended, that the results therefrom
will be consistent with the Company's prior experience or expectations. See
"Business -- Development Activities".

ORGANIZATION OF MONTEREY

The Company is currently a wholly owned subsidiary of SFR. Following the
Offerings, SFR and the purchasers in the Offerings will own 84.8% and 15.2%,
respectively, of the Company's outstanding Common Stock. The Company's structure
prior to and after the Offerings is set forth below:

CHART

5
<PAGE> 6

STRATEGY

The Company's strategy is to efficiently and consistently increase its
production rates and proved reserves while maximizing total return to
stockholders. The Company intends to achieve its objectives by developing its
existing fields through the deployment of advanced production techniques, by
pursuing reserve acquisition opportunities which are consistent with its
geographic and operational strengths, and by maintaining a dividend policy that
will provide a significant current return to stockholders. Key elements of the
Company's strategy include:

ACCELERATED EXPLOITATION PROGRAM. The Company plans to increase its
investment in relatively low-risk development and infill drilling opportunities
in its existing fields in order to maximize production and reserves over the
long-term. During the five years ended December 31, 1995, the Company completed
1,064 well operations (which include development and injection wells, workovers
and recompletions), of which 1,062 were successful. These operations contributed
proved reserve additions of approximately 97 MMBOE at an average finding cost of
$2.32 per BOE. Reserve additions in 1995 totaled approximately 24 MMBOE, more
than 150% of production for the year. The Company expects to complete more than
300 well operations in each of 1996 and 1997 with budgeted capital expenditures
during such years of approximately $51 million and $68 million, respectively.
The Company believes that its sizable project inventory will allow it to
continue to increase its production and reserves over the next several years.

INCREASED HORIZONTAL DRILLING. The Company has recently begun to utilize
horizontal drilling techniques, which have increased production and ultimate
reserve recovery on its existing properties. The Company drilled six horizontal
wells in the Midway-Sunset field during the first nine months of 1996 which are
currently producing at rates ranging from 80 to 400 Bbls per day (an average of
150 Bbls per day) per well compared to an average of 20 Bbls per day from the
Company's conventional vertical wells, although there can be no assurance that
such rates can be sustained in the future. The Company expects to complete 45
additional horizontal wells by the end of 1997 at an expected capital cost of
approximately $20 million, although the actual number of horizontal wells
drilled could be increased or decreased based upon the results realized from the
horizontal wells completed. While horizontal drilling has only recently been
employed in the Company's operations, the Company believes that this technology
represents a significant opportunity for more cost-effective development,
increased reserves, increased production and total recovery rates from its
properties.

LOW COST PRODUCER. The Company believes that its finding costs and
producing costs are among the lowest for heavy crude producers in the United
States. Due to the reservoir characteristics of the Company's producing
properties and the extensive development activities conducted to date thereon,
such properties are well suited to low cost development and exploitation
drilling. For example, the Company's average finding cost for the three years
ended December 31, 1995 was $1.97 per BOE. In addition, continuing cost control
efforts have contributed to the reduction of its production and operating costs
from $6.52 per BOE in 1991 to $5.75 per BOE for the first nine months of 1996
(excluding hedging losses of $0.25 per BOE). The Company plans to continue to
pursue operational efficiencies, including facilities upgrades and process
consolidations with adjoining producers, to further reduce both finding and
producing costs.

FINANCIAL AND OPERATIONAL FLEXIBILITY. The Company believes that the
consummation of the Offerings and the related transactions will give the Company
significantly more operational and financial flexibility, including the ability
to (i) maintain an appropriate capital structure, (ii) focus its available
financial resources on the development of its producing properties in California
and (iii) pursue selective acquisition opportunities as they arise. On a pro
forma basis, after giving effect to the consummation of the Offerings and the
Transactions, the Company had total indebtedness of $214 million as of September
30, 1996 and a pro forma ratio of EBITDA to interest expense for the first nine
months of 1996 of 6.6 to 1.0.

6
<PAGE> 7

initial public offering price of $14.50 per share). However, the actual amount
of future dividends declared and paid, if any, will depend upon the declaration
of same by the Company's board of directors and upon the Company's financial
condition, earnings and funds from operations, the level of its capital and
exploration expenditures, dividend restrictions contained in its financing
agreements, its future business prospects and such other matters as the
directors of the Company may deem relevant.

APPLICATION OF ADVANCED TECHNOLOGIES. The Company will continue to utilize
its growing technology base, including increasing use of 3-D seismic surveys,
water floods, thermal EOR techniques, new fracturing techniques and reservoir
modeling. The Company believes that 3-D seismic techniques may identify
significant additional reserves and has recently entered into a joint venture
with Chevron U.S.A., Inc. to conduct a 3-D seismic survey of certain properties
in the Midway-Sunset field. The Company has extensive experience with EOR
techniques and has conducted steamflood operations on its properties since the
1960s. The Company has improved its thermal EOR techniques over time and is
currently focusing on efficient reservoir heat management techniques which are
intended to optimize recoveries and minimize fuel costs. The Company believes
that its expertise in utilizing advanced technologies will allow it to identify
and recover additional reserves in its existing properties.

EXPLOITATION OF FAVORABLE MARKET CONDITIONS. Market conditions for
producers of California heavy crude have improved significantly in recent years.
Based upon statistics developed by the California Energy Commission and the U.S.
Census Bureau, California consumes more energy than any other state in the
United States and its energy consumption is expected to grow through at least
the year 2000 as its population expands. While California's energy consumption
continues to increase, California's aggregate crude supply has decreased
primarily as the result of three factors: (i) declining California crude
production; (ii) reduced oil supplies to California from the Alaskan North Slope
(which provided 60% of the crude oil consumed by refiners in California during
1995) resulting from a decline in production and the initiation of sales to
foreign markets; and (iii) the availability of new transportation systems which
enable San Joaquin producers to sell crude oil outside California. The Company
believes that California's growing energy demand and declining crude oil supply,
together with other market factors, have contributed to the increase in average
posted prices for the Midway-Sunset field (for heavy crude) from $12.08 per Bbl
in 1991 to $15.25 per Bbl for the first nine months of 1996. In addition, the
spread between the West Texas Intermediate ("WTI") posted price (for light
crude) and the Midway-Sunset field posted price (for heavy crude) has declined
from $8.12 per Bbl in 1991 to $4.37 per Bbl for the first nine months of 1996.
There can be no assurances, however, with respect to future Midway-Sunset field
posted prices for crude oil or the future spread between WTI and Midway-Sunset
posted prices.

REGIONAL EXPERTISE. The Company is one of the largest independent oil
producers in California, based upon a 1995 report of the California Department
of Conservation. The Company intends to continue to focus on this region in
order to capitalize on its geologic, engineering and production expertise
developed through continuous operations in the area since 1905. The Company
believes that such expertise gives it the ability to efficiently develop
additions to proved reserves in the Company's existing portfolio of properties
as well as to identify potential acquisitions.

TRANSACTIONS AT CLOSING

Prior to or concurrently with the consummation of the Offerings, the
following transactions will occur:

(a) the Company and SFR will enter into a contribution and conveyance
agreement (the "Contribution Agreement"), pursuant to which, among other
things: (i) SFR will contribute to the Company substantially all of the
assets and properties of the Western Division, subject to the retention by
SFR of the Production Payment (as defined below) and certain other assets
(see "Relationship Between the Company and SFR -- Contractual
Arrangements -- Contribution Agreement"); (ii) SFR will retain a production
payment (the "Production Payment") in an aggregate amount not to exceed $30
million, with respect to certain properties in the Midway-Sunset field,
which Production Payment will be prepayable in whole or in part without
penalty by the Company at any time or from time to time; (iii) the Company
will assume all obligations and liabilities of SFR

7
<PAGE> 8

associated with or allocated to the assets and properties of the Western
Division, including $245 million of indebtedness in respect of SFR's 10.23%
Series E Notes due 1997, 10.27% Series F Notes due 1998 and 10.61% Series G
Notes due 2005 (the "Series E Notes", "Series F Notes" and "Series G
Notes", respectively, and the "SFR Senior Notes", collectively); and (iv)
the Company and SFR will agree that either (A) under certain circumstances
the Company will purchase from SFR the surface rights to approximately 116
surface acres in Orange County, California (the "Olinda Property") to be
retained by SFR, which surface rights are currently held by SFR under a
contract for sale to a third party or (B) if the sale of the Olinda
Property to such third party is consummated, the Company will use
approximately $8.5 million of funds available under the New Credit Facility
to purchase from SFR the $8.5 million promissory note received by SFR from
such third party;

(b) the Company will (i) use a portion of the net proceeds of the
Offerings to repay in full the $70 million aggregate principal amount of
the Series E Notes and Series F Notes and accrued and unpaid interest
thereon, and pay a prepayment penalty of approximately $2.5 million thereon
and (ii) issue $175 million in aggregate principal amount of its 10.61%
Senior Notes due 2005 (the "Company Senior Notes") to holders of the Series
G Notes in exchange for the cancellation of such notes, and pay a $1.3
million consent fee in connection therewith;

(c) (i) SFR and the Company will enter into a new $75 million
revolving credit facility with a group of banks (the "New Credit Facility")
and SFR is expected to borrow approximately $16 million thereunder, and
(ii) upon consummation of the Offerings, the Company will repay all such
indebtedness outstanding under the New Credit Facility with a portion of
the net proceeds of the Offerings; and

(d) SFR and the Company will enter into certain intercompany
agreements regarding corporate services, taxes, indemnification and certain
other matters as more fully described under "-- Relationship Between the
Company and SFR".

Promptly following the consummation of the Offerings, the Company intends
to prepay the Production Payment in full with funds available under the New
Credit Facility. The transactions described above, excluding the Offerings but
including prepayment of the Production Payment, are referred to herein
collectively as the "Transactions".

In addition to the Transactions described above, SFR has (a) commenced an
offer to purchase for cash (the "SFR Tender Offer") outstanding shares of its
Convertible Preferred Stock, 7% Series (the "Convertible Preferred Stock"); and
(b) executed a supplemental indenture relating to its $100 million outstanding
principal amount of 11% Senior Subordinated Debentures due 2004 (the "SFR
Debentures") which permits the Transactions and the Spin Off (defined herein) to
be effected (the "SFR Debenture Amendments"). The closing of the SFR Tender
Offer is not a condition to the consummation of the Offerings.

As of September 30, 1996, and after giving pro forma effect to consummation
of the Offerings and the Transactions, the Company would have had cash of $17
million, total assets of $450 million, total debt outstanding of $214 million
and shareholders' equity of $144 million. See the Pro Forma Financial Statements
of the Company included elsewhere in this Prospectus.

8
<PAGE> 9

THE OFFERINGS

<TABLE>
<S> <C>
Common Stock offered (1)(2):
U.S. Offering........................ 6,570,000 shares
International Offering............... 1,580,000 shares
Total........................ 8,150,000 shares
Common Stock to be outstanding
after the Offerings(2)(3)............ 53,500,000 shares
Use of Proceeds........................ The net proceeds of the Offerings will be used to
repay certain outstanding indebtedness of the
Company (including indebtedness assumed from SFR
pursuant to the Contribution Agreement) and the
balance, if any, will be used for working capital
purposes. See "Use of Proceeds".
Dividend Policy........................ The Company currently intends to pay to its
stockholders a dividend of $0.15 per quarter ($0.60
annually) per share of Common Stock. The first
dividend (which is anticipated to be approximately
$0.22 per share of Common Stock) is anticipated to
be paid in April 1997 in respect of the Company's
first partial quarter ending December 31, 1996 and
its first full quarter of operations ending March
31, 1997. The determination of the amount of cash
dividends (including the initial quarterly dividend
referred to above), if any, to be declared and paid
will depend upon declaration by the Company's board
of directors and upon the Company's financial
condition, earnings and funds from operations, the
level of its capital and exploration expenditures,
dividend restrictions contained in the New Credit
Facility and the Company Senior Notes, its future
business prospects and such other matters as the
Company's directors deem relevant. See "Dividend
Policy".
Listing................................ The Common Stock has been approved for listing on
the New York Stock Exchange (the "NYSE"), subject to
official notice of issuance.
NYSE Stock Symbol...................... "MRC"
</TABLE>

- ---------------

(1) The offering of 6,570,000 shares of Common Stock initially being offered in
the United States (the "U.S. Offering") and the offering of 1,580,000 shares
of Common Stock initially being offered outside of the United States (the
"International Offering") are collectively referred to herein as the
"Offerings".

(2) Assumes the Underwriters' over-allotment options are not exercised. See
"Underwriting".

(3) Does not include 3,500,000 shares reserved for issuance pursuant to the
Company's incentive compensation plans. See "Management".

9
<PAGE> 10

SUMMARY HISTORICAL AND PRO FORMA FINANCIAL INFORMATION

The following table sets forth, for the periods indicated, summary
historical financial data for SFR's Western Division and summary pro forma
financial data for the Company. The summary historical balance sheet data as of
December 31, 1995 and 1994 and the summary historical income statement and cash
flow data for each of the three years in the period ended December 31, 1995 are
derived from the financial statements of the Western Division of SFR, which have
been audited by Price Waterhouse LLP. The summary historical financial data for
the nine month periods ended September 30, 1995 and September 30, 1996 are
derived from the unaudited financial statements of the Western Division of SFR
and include, in the opinion of management, adjustments (consisting only of
normal recurring adjustments) necessary to present fairly the financial data for
such periods. The summary historical balance sheet data as of December 31, 1991,
1992 and 1993 and the summary historical income statement and cash flow data for
each of the two years in the period ended December 31, 1992 have been derived
from the unaudited accounting records of the Western Division of SFR. The
summary pro forma financial data for the Company set forth below are based on
numerous assumptions and include adjustments as explained in the unaudited pro
forma financial statements of the Company and the notes thereto included
elsewhere in this Prospectus. All such summary historical and pro forma
financial data set forth below should be read in conjunction with such financial
statements and notes thereto appearing elsewhere herein. The following
information should not be deemed indicative of future operating results for the
Company. See also "Management's Discussion and Analysis of Financial Condition
and Results of Operations".

<TABLE>
<CAPTION>
WESTERN
DIVISION
WESTERN DIVISION HISTORICAL MONTEREY HISTORICAL MONTEREY
--------------------------------- RESOURCES, INC. -------------- RESOURCES, INC.
PRO FORMA(1) PRO FORMA(1)
YEAR --------------- NINE MONTHS ---------------
ENDED YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED SEPTEMBER 30, ENDED
--------------------------------- DECEMBER 31, -------------- SEPTEMBER 30,
1991 1992 1993 1994 1995 1995 1995 1996 1996
---- ---- ---- ---- ----- --------------- ---- ----- ---------------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues........................... $240 $215 $187 $179 $ 211 $ 211 $159 $ 214 $ 214
---- ---- ---- ---- ----- ----- ---- ----- -----
Costs and expenses:
Production and operating......... 103 105 100 86 85 85 63 76(2) 76(2)
Cost of crude oil purchased...... -- -- -- -- -- -- -- 21 21
Exploration, including dry hole
costs.......................... 3 3 2 1 2 2 2 1 1
Depletion, depreciation and
amortization................... 40 44 41 32 33 33 24 28 28
Impairment of oil and gas
properties(3).................. -- -- 49 -- -- -- -- -- --
General and administrative....... 6 9 9 8 7 9 5 6 7
Taxes (other than income)........ 13 9 9 9 8 8 7 7 7
Restructuring charges(4)......... -- -- 12 1 -- -- -- -- --
---- ---- ---- ---- ----- ----- ---- ----- -----
165 170 222 137 135 137 101 139 140
---- ---- ---- ---- ----- ----- ---- ----- -----
Income (loss) from operations...... 75 45 (35) 42 76 74 58 75 74
Interest, net(5)................. (27) (27) (27) (26) (25) (20) (19) (18) (15)
Other income (expense)........... 5 1 -- -- (1) (1) -- -- --
---- ---- ---- ---- ----- ----- ---- ----- -----
Income (loss) before income
taxes............................ 53 19 (62) 16 50 53 39 57 59
Income taxes..................... (19) (6) 27 (4) (16) (17) (13) (21) (21)
---- ---- ---- ---- ----- ----- ---- ----- -----
Net income (loss).................. $ 34 $ 13 $(35) $ 12 $ 34 $ 36 $ 26 $ 36 $ 38
==== ==== ==== ==== ===== ===== ==== ===== =====
Pro forma earnings (loss) per
common share (in dollars)........ $0.76 $0.68 $0.79 $0.70
===== ===== ===== =====
Average shares outstanding
(millions)....................... 45.3 53.6 45.3 53.6
CASH FLOW DATA:
Net cash provided by operating
activities(6).................... $ 86 $ 59 $ 47 $ 45 $ 76 N/A $ 71 $ 62 N/A
Net cash used in investing
activities....................... 60 17 18 18 54 N/A 47 41 N/A
Net cash used in financing
activities....................... 26 42 29 27 22 N/A 24 21 N/A
Capital expenditures, including
acquisitions of producing
properties....................... 70 20 47 27 54 N/A 47 41 N/A
BALANCE SHEET DATA (at end of period):
Cash and cash equivalents.......... $ -- $ -- $ -- $ -- $ -- N/A $ -- $ -- $ 17
Total assets....................... 503 476 387 376 391 N/A 392 424 450
Total debt......................... 265 263 258 245 245 N/A 245 245 214
Shareholders' equity............... 121 94 35 32 45 N/A 34 60 144
OTHER FINANCIAL DATA:
EBITDA(7).......................... $119 $ 89 $ 55 $ 74 $ 108 $ 106 $ 81 $ 103 $ 102
Ratio of EBITDA to interest
expense.......................... 4.3 3.2 2.0 2.8 4.2 5.1 4.2 5.3 6.6
</TABLE>

10
<PAGE> 11

- ---------------

(1) Pro forma for the consummation of the Offerings and the Transactions as if
the Offerings and the Transactions had occurred on January 1, 1995, except
for the balance sheet data which assumes the Offerings and the Transactions
had occurred on September 30, 1996. See the Pro Forma Condensed Financial
Statements included herein.

(2) Includes $3 million attributable to losses incurred under the Company's
hedging arrangements in respect of natural gas purchased by the Company as
fuel for thermal EOR operations. All such arrangements terminated on or
prior to June 30, 1996.

(3) Reflects a non-cash charge for the impairment of oil and gas properties. For
a further description of the impairments recorded in 1993, see Note 2 of the
Notes to the Financial Statements included elsewhere in this Prospectus.

(4) Includes non-recurring charges in 1993 relating to implementation of SFR's
restructuring program comprised of (i) losses on property dispositions of
$11 million and (ii) accruals for certain personnel benefits and related
costs of $1 million. Includes non-recurring charges in 1994 relating to
SFR's restructuring program of $1 million comprised of severance, benefits
and relocation expenses.

(5) Net of capitalized interest of $0.3 million, $0.1 million, $0.3 million,
$0.6 million and $0.7 million in the years 1991, 1992, 1993, 1994 and 1995,
respectively, and $0.5 million and $0.9 million in the nine months ended
September 30, 1995 and 1996, respectively. Includes interest income of $0.2
million, $0.2 million and $0.2 million in 1991, 1992 and 1993, respectively.

(6) Net cash provided by operating activities equals the sum of net income and
non-cash charges less net changes in current and non-current operating
assets and liabilities.

(7) EBITDA as presented herein is defined as the sum of income before provision
for income taxes, interest, depreciation, depletion, amortization,
impairments and certain non-cash charges including gains or losses realized
on the disposition of properties. EBITDA, as presented herein, is used as a
measure in the New Credit Facility and the Company Senior Notes and provides
information regarding the Company's ability to service and incur debt.
Because the New Credit Facility and the Company Senior Notes contain other
financial measures, covenants and limitations (including mandatory principal
repayments), EBITDA does not represent funds available for discretionary
use. EBITDA should not be considered in isolation or as a substitute for net
income, cash flow provided by operating activities or other income or cash
flow data prepared in accordance with generally accepted accounting
principles or as a measure of a company's profitability or liquidity.
Further, EBITDA, as presented herein, may not be comparable to similarly
titled measures reported by other companies.

11
<PAGE> 12

The following table sets forth certain summary operating data for the
Company for the periods indicated.

SUMMARY OPERATING DATA

WESTERN
MONTEREY DIVISION MONTEREY
WESTERN DIVISION HISTORICAL RESOURCES, INC. HISTORICAL RESOURCES, INC.
--------------------------------------- PRO FORMA(1) -------------- PRO FORMA(1)
YEAR --------------- NINE MONTHS ---------------
ENDED YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED SEPTEMBER 30, ENDED
--------------------------------------- DECEMBER 31, -------------- SEPTEMBER 30,
1991 1992 1993 1994 1995 1995 1995 1996 1996
----- ----- ----- ------ ------ --------------- ------ ----- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Average daily production
Crude oil and liquids (MBbls/d)... 42 42 43(2) 41 42 42 41 46 46
Natural gas (MMcf/d).............. 9 7 6(2) 4 5 5 5 4 4
Total production (MBOE/d)......... 43 43 44(2) 42 43 43 42 47 47
Average realized sales prices,
hedged(3)
Crude oil and liquids ($/Bbl)..... 15.19 13.67 11.63 11.53 13.50 13.50 13.79 15.08 15.08
Natural gas ($/Mcf)............... 1.72 1.57 1.59 1.14 0.98 0.98 1.02 1.00 1.00
Average costs and expenses per BOE
(in dollars)(4)
Production and operating:
Steam generation................ 1.95 2.41 2.26 2.16 1.98 1.98 1.91 2.48(5) 2.48(5)
Lease operating................. 4.57 4.24 4.05 3.47 3.50 3.50 3.59 3.52 3.52
----- ----- ----- ----- ----- ----- ----- ----- -----
Total......................... 6.52 6.65 6.31 5.63 5.48 5.48 5.50 6.00(5) 6.00(5)
----- ----- ----- ----- ----- ----- ----- ----- -----
Exploration, including dry
holes........................... 0.17 0.17 0.11 0.09 0.15 0.15 0.18 0.09 0.09
Depletion, depreciation and
amortization.................... 2.55 2.79 2.59 2.09 2.08 2.08 2.06 2.18 2.18
Impairment of oil and gas
properties...................... -- -- 3.09 -- -- -- -- -- --
General and administrative........ 0.42 0.56 0.58 0.51 0.47 0.60 0.47 0.45 0.55
Restructuring charges............. -- -- 0.75 0.07 -- -- -- -- --
Taxes (other than income)......... 0.83 0.56 0.53 0.56 0.51 0.51 0.58 0.53 0.53
Interest expense, net............. 1.73 1.74 1.69 1.68 1.61 1.28 1.63 1.44 1.14
Average finding cost per BOE
(in dollars) (4).................. 6.05 0.89 3.18 1.04 2.17 2.17 N/A N/A N/A
Gross wells drilled................. 137 31 171 79 225 225 198 191 191
</TABLE>

- ---------------

(1) Pro forma for the consummation of the Offerings and the Transactions as if
the Offerings and the Transactions had occurred on January 1, 1995. See the
Pro Forma Condensed Financial Statements included herein.

(2) Includes production attributable to properties sold in 1993 of 3 MBbls/d of
crude oil and liquids and 2 MMcf/d of natural gas (3 MBOE/d).

(3) From time to time SFR hedges a portion of its oil sales. The Company has
been allocated a portion of SFR's hedging gains and losses based on its
hedged light and heavy oil production. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- General".

(4) Average finding cost per BOE is calculated by dividing (i) costs incurred in
development, exploration and acquisition of oil and gas reserves, by (ii)
net proved reserve additions from acquisitions, extensions, discoveries,
improved recovery and revisions, on a BOE basis.

(5) Historical and pro forma amounts include a $0.25 per BOE loss on hedging in
respect of natural gas purchased for thermal EOR operations. Excluding such
hedging losses, both historical and pro forma steam generation costs for
1995 would have been $2.23 per BOE and both total historical and pro forma
operating costs for the nine months ended September 30, 1996 would have been
$5.75 per BOE. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- General".

12
<PAGE> 13

SUMMARY OIL AND GAS RESERVE INFORMATION

The following table sets forth summary information with respect to the
Company's estimated proved oil and gas reserves as of each of the dates
indicated. The estimates of proved reserves and present value of estimated
future net cash flows have been prepared by Ryder Scott. See "Risk Factors --
Uncertainties in Estimates of Proved Reserves" and "Business -- Reserves".

<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF
--------------------------------------------- SEPTEMBER 1,
1991 1992 1993 1994 1995 1996
----- ----- ----- ----- ----- ------------
<S> <C> <C> <C> <C> <C> <C>
Proved reserves:
Crude oil and liquids (MMBbls)..... 183 190 184 191 200 212
Natural gas (Bcf).................. 22 19 12 13 12 12
Total (MMBOE)...................... 187 193 186 193 202 214
Proved developed reserves (MMBOE).... 149 157 142 142 159 169
Present value of estimated future net
cash flows (millions of dollars):
Before income taxes................ 274 383 167 554 654 750
After income taxes................. 218 275 143 366 426 N/A
Average sales prices at period end:
Oil ($/Bbl)........................ 10.87 12.21 8.44 12.62 13.78 14.82
Natural gas ($/Mcf)................ 2.21 2.32 1.64 1.07 0.98 1.22
Reserve replacement ratio(1)......... 90% 141% 87% 152% 153% 210%
Reserve-to-production ratio
(in years)(2)...................... 11.9 12.2 11.7 12.6 13.0 12.5
</TABLE>

- ---------------

(1) The reserve replacement ratio is a percentage determined on a BOE basis by
dividing the estimated reserves added during a period from exploitation,
development and exploration activities, acquisitions of proved reserves and
revisions of previous estimates, excluding property sales, by the oil and
gas produced during that period.

(2) Reserve-to-production ratio is calculated on a BOE basis by dividing the
total estimated proved reserves at period-end by the total production during
the year, annualizing production for periods of less than a full year.

RELATIONSHIP BETWEEN THE COMPANY AND SFR
GENERAL

The Company was incorporated in Delaware in August 1996 and is currently a
wholly owned subsidiary of SFR. Immediately after the closing of the Offerings,
SFR will own 45,350,000 shares of Common Stock, which will represent
approximately 85% of the Company's outstanding Common Stock after the Offerings.
As the owner of such shares, SFR will be in a position to control all matters
affecting the Company.

INTENDED SPIN OFF BY SFR

13
<PAGE> 14

business or financial condition that causes SFR's board to conclude that the
Spin Off is not in the best interests of SFR's stockholders. The Company has
been advised by SFR that it does not expect the Spin Off to occur prior to June
1997. If SFR consummates the Spin Off, the increased number of shares of Common
Stock available in the market may have an adverse effect on the market price of
the Common Stock. The Company has been advised by SFR that as of September 30,
1996, SFR had 41,326 common stockholders of record. See "Relationship Between
the Company and SFR".

To protect SFR from Federal and state income taxes that would be incurred
by it if the Spin Off were determined to be a taxable event, the Company and SFR
have entered into an agreement (the "Spin Off Tax Indemnity Agreement") pursuant
to which the Company has agreed to indemnify SFR with respect to tax liabilities
resulting primarily from actions taken by the Company at any time during the
one-year period commencing upon the Spin Off (which period is subject to
increase if certain federal tax legislation is approved and is applicable to the
Spin Off). The Company believes that if it is required to make payments pursuant
to such agreement, the amount of such payments would have a material adverse
effect on the Company's financial condition. The actions for which the Company
is required to indemnify SFR pursuant to such agreement are within the Company's
control (which actions include (i) merging or consolidating with or into any
other corporation, (ii) liquidating or partially liquidating, (iii) selling or
transferring all or substantially all of its assets, (iv) redeeming or otherwise
repurchasing any of the Company's stock or (v) issuing additional shares of the
Company's capital stock), and the Company has no intention to take any such
actions during such period. For a further description of the Spin Off Tax
Indemnity Agreement, see "Relationship Between the Company and
SFR -- Contractual Arrangements -- Spin Off Tax Indemnity Agreement".

CERTAIN AGREEMENTS BETWEEN THE COMPANY AND SFR

In anticipation of the Offerings, and in view of SFR's intention to
undertake the Spin Off, the Company and SFR intend to enter into the following
agreements: (a) the Contribution Agreement, pursuant to which SFR will convey to
the Company and the Company will assume and succeed to substantially all of the
assets, liabilities and obligations of SFR associated with its Western Division,
including $245 million of indebtedness in respect of the SFR Senior Notes
(including interest thereon from and after October 1, 1996); (b) the Agreement
for the Allocation of Consolidated Federal Income Tax Liability and State and
Local Taxes Among the Members of the Santa Fe Energy Resources, Inc. Affiliated
Group (the "Tax Allocation Agreement"), which provides for the allocation of
taxes for periods during which the Company and SFR are included in the same
consolidated group for Federal or state tax purposes, the allocation of
responsibility for the filing of tax returns and certain other related matters;
(c) the Services Agreement, which provides for the continued provision of
certain corporate and administrative services by SFR to the Company; (d) the
Spin Off Tax Indemnity Agreement, which, in addition to providing the
indemnification by the Company of SFR described above, provides that SFR shall
prepare and file all consolidated Federal, combined state and local income or
franchise tax returns required to be filed while the Company is a member of
SFR's consolidated group and specifies that the Company will not be compensated
for the carryback to SFR's affiliated group of any Company tax items realized
after the Company ceases to be a member of SFR's affiliated group; and (e) the
Registration Rights and Indemnification Agreement, pursuant to which (i) SFR may
request, subject to certain limitations, that the Company register for sale
under the Securities Act and applicable state securities laws the Common Stock
owned by SFR and (ii) the Company and SFR agree to indemnify each other and
their respective subsidiaries and as well as their respective directors,
officers, employees, agents and representatives for certain costs and
liabilities relating to violations of Federal and state securities laws in
connection with any registration of shares of Common Stock owned by SFR. For a
more detailed summary of the terms of these agreements, see "Relationship
Between the Company and SFR -- Contractual Arrangements".

The Company's principal executive offices are located at 5201 Truxtun
Avenue, Suite No. 100, Bakersfield, California 93309 and its telephone number is
(805) 322-3992.

14
<PAGE> 15

RISK FACTORS

In addition to the other information in this Prospectus, the following
factors should be carefully considered in evaluating the Company and its
business before purchasing the Common Stock offered by this Prospectus.

EFFECTS OF CHANGING OIL AND GAS PRICES

The Company's profitability is determined in large part by the difference
between the prices received for the oil and natural gas that it produces and the
costs of finding, developing and producing such resources. Prices for oil and
natural gas have been subject to wide fluctuations, which continue to reflect
imbalances in supply and demand as well as other market conditions and the world
political situation as it affects OPEC, the Middle East, the former Soviet Union
and other producing countries. Moreover, the price of oil and natural gas may be
affected by the price and availability of alternative sources of energy, weather
conditions and the general state of the economy. Even relatively modest changes
in oil and natural gas prices may significantly change the Company's revenues,
results of operations, cash flows and proved reserves. Based on operating
results for the first nine months of 1996, the Company estimates that on an
annualized basis a $1.00 per barrel increase (or decrease) in its average crude
oil sales prices would result in a corresponding $17 million increase (or
decrease) in income from operations, a $10 million increase (or decrease) in net
income and a $10 million increase (or decrease) in cash flows from operating
activities. Because the Company is a relatively small producer of natural gas,
it consumes more gas in its EOR operations than it produces. As a result, an
increase in natural gas prices adversely affects the Company's results of
operations. Based on operating results for the first nine months of 1996, the
Company estimates that a $0.10 per Mcf increase (or decrease) in the average
domestic natural gas sales price would result in a $2 million decrease (or
increase) in income from operations, a $1 million decrease (or increase) in net
income and a $1 million decrease (or increase) in cash flows from operating
activities. The foregoing estimates do not give effect to changes in any other
factors, such as the effect of the Company's hedging program or depreciation and
depletion, that would result from a change in oil and natural gas prices.

For the nine months ended September 30, 1996, approximately 93% of the
Company's oil production consisted of heavy oil. The market for heavy oil
differs substantially from the market for medium and light crude oil due
principally to the higher transportation and refining costs associated with
heavy crude. As a result, the price received for heavy crude oil is generally
lower than the price received for medium and light crudes. Although the average
price of heavy crude has increased, and the average price of lighter grades has
fallen, from 1991 levels, no assurance can be given that the narrowing of the
price differential between heavy and light crudes will continue in the future.
In addition, there is not currently an effective measure by which to hedge the
spread (or basis differential) between the prices paid for lighter grades of
crude oil and prices paid for California heavy crude oil. See "Business --
Current Markets for Oil and Gas".

NEED TO REPLACE RESERVES

Crude oil and natural gas are depleting assets. Therefore, unless the
Company replaces over the long term the oil and natural gas produced from the
Company's properties, the Company's assets will be depleted over time and its
ability to service and incur debt at constant or declining prices will be
reduced. The Company seeks to replace reserves through exploitation,
development, exploration and acquisition. However, no assurance can be given
that the Company will continue to replace reserves from such activities at
acceptable costs. In addition, exploitation, development and exploration involve
numerous risks, including geological uncertainties or other conditions that may
result in dry holes, the failure to produce oil and gas in commercial quantities
or the inability to fully produce discovered reserves. Therefore, there can be
no assurance that the Company will be able to find and develop or acquire
additional reserves to replace its current and future production.

15
<PAGE> 16

GOVERNMENTAL AND ENVIRONMENTAL REGULATION

The Company's activities are subject to various Federal, state and local
laws and regulations covering the discharge of materials into the environment or
otherwise relating to protection of the environment. In particular, the
Company's oil and gas exploration, development, production and EOR operations,
its activities in connection with storage and transportation of liquid
hydrocarbons and its use of facilities for treating, processing, recovering or
otherwise handling hydrocarbons and waste therefrom are subject to stringent
environmental regulation by governmental authorities. Such regulations have
increased the costs of planning, designing, drilling, installing, operating and
abandoning the Company's oil and gas wells and other facilities.

The Company has expended significant resources, both financial and
managerial, to comply with environmental regulations and permitting requirements
and anticipates that it will continue to do so in the future. Such compliance
costs in 1995 were $1 million and are expected to be approximately $2 million in
1996. Although the Company believes that its operations and facilities are in
general compliance with applicable environmental regulations, risks of
substantial costs and liabilities are inherent in oil and gas operations, and
there can be no assurance that significant costs and liabilities will not be
incurred by the Company in the future. Furthermore, there can be no assurance
that other developments, such as increasingly strict environmental laws,
regulations and enforcement policies thereunder, and claims for damages to
property, employees, other persons and the environment resulting from the
Company's operations, will not result in substantial costs and liabilities in
the future and adversely affect the Company's business, financial condition,
liquidity and results of operations. For a further description of the
environmental regulations to which the Company is subject as well as a
description of certain sites with respect to which the Company will succeed as a
potentially responsible party (as therein defined), see "Business -- Other
Business Matters -- Environmental Regulation".

UNCERTAINTIES IN ESTIMATES OF PROVED RESERVES

There are numerous uncertainties inherent in estimating proved reserves,
including many factors beyond the control of the Company. The reserve data set
forth in the Prospectus represent estimates only. Estimating quantities of
proved reserves is inherently imprecise. Such estimates are based upon certain
assumptions about future production levels, future natural gas and crude oil
prices, the timing and amount of development expenditures and future operating
costs made using currently available geologic, engineering and economic data,
some or all of which may prove to be incorrect over time. As a result of changes
in these assumptions that will occur in the future, and based upon further
production history, results of future exploration and development activities,
future natural gas and crude oil prices and other factors, the quantity of
proved reserves may be subject to upward or downward revisions. The reserve
estimates included in this Prospectus were prepared by Ryder Scott. See
"Business -- Reserves".

Actual future net cash flows from production of the Company's reserves will
be affected by factors such as actual production, supply and demand for oil and
natural gas, curtailments or increases in consumption by oil and gas purchasers,
changes in governmental regulations or taxation and the impact of inflation on
costs. The timing of actual future net revenue from proved reserves, and thus
their actual present value, can be affected by the timing of the incurrence of
expenditures in connection with development of oil and gas properties. The 10%
discount factor, which is required by the Commission to be used to calculate
present value for reporting purposes, is not necessarily the most appropriate
discount factor based on interest rates in effect from time to time and risks
associated with the oil and gas industry. Discounted present value, no matter
what discount rate is used, is materially affected by assumptions as to the
amount and timing of future production, which may and often do prove to be
inaccurate.

LEVERAGE

Upon completion of the Offerings and the application of the net proceeds
therefrom, on a pro forma basis as of September 30, 1996 the Company would have
total outstanding debt of approximately $214 million (after giving effect to $30
million to be drawn under the New Credit Facility in order to

16
<PAGE> 17

prepay the Production Payment promptly following the consummation of the
Offerings and $8.5 million to be used after consummation of the Offerings to
purchase an $8.5 million note from SFR to be secured by the Olinda Property).
The Company will have a total of $75 million of borrowing capacity under the New
Credit Facility (of which approximately $41 million (including approximately $2
million in letters of credit) will be utilized or committed upon consummation of
the Offerings), which the Company can draw upon to finance development and
exploratory drilling and acquisition costs. The Company's level of indebtedness
has several important effects on its operations, including (i) a portion of the
Company's cash flow from operations must be dedicated to the payment of
principal and interest incurred under the Company Senior Notes and, to the
extent drawn upon, the New Credit Facility and will not be available for other
purposes, (ii) the covenants contained in the Company Senior Notes and the New
Credit Facility require the Company to meet certain financial tests, other
restrictions limit its ability to borrow additional funds or to dispose of
assets and may affect the Company's flexibility in planning for, and reacting
to, changes in business conditions and other provisions in the Company Senior
Notes and New Credit Facility will require the Company to prepay indebtedness
outstanding thereunder upon a change in control (as defined therein) and (iii)
the Company's ability to obtain additional financing in the future for working
capital, capital expenditures, acquisitions, general corporate purposes or other
purposes may be impaired. The Company's ability to meet its debt service
obligations and to reduce its total indebtedness will be dependent upon the
Company's future performance, which will be subject to general economic
conditions and to financial, business and other factors affecting the operations
of the Company, many of which are beyond its control. There can be no assurance
that the Company's future performance will not be adversely affected by such
economic conditions and financial, business and other factors. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and Note 1 to the Company's
Financial Statements.

COMPETITION

The oil and gas industry is highly competitive. The Company encounters
competition from other oil and gas companies in all areas of its operations. The
Company's competitors include major integrated oil and natural gas companies and
numerous independent oil and natural gas companies and drilling and income
programs, as well as state-owned energy companies. Many of these competitors
have financial and other resources substantially in excess of those available to
the Company. See "Business -- Other Business Matters -- Competition".

RISKS OF OIL AND GAS OPERATIONS

The oil and gas business involves certain operating hazards such as well
blowouts, cratering, explosions, uncontrollable flows of oil, natural gas or
well fluids, fires, formations with abnormal pressures, pollution, releases of
toxic gas and other environmental hazards and risks, any of which could result
in loss of human life, significant damage to property, environmental pollution,
impairment of the Company's operations and substantial losses to the Company.
The availability of a ready market for the Company's oil and natural gas
production also depends on the proximity of reserves to, and the capacity of,
oil and gas gathering systems, pipelines and trucking or terminal facilities. In
addition, the Company may be liable for environmental damages caused by previous
owners of property purchased and leased by the Company. As a result, substantial
liabilities to third parties or governmental entities may be incurred, the
payment of which could reduce or eliminate the funds available for development,
acquisitions or exploration, or result in the loss of the Company's properties.
In accordance with customary industry practices, the Company maintains insurance
against some, but not all, of such risks. The occurrence of an event not fully
covered by insurance could have a material adverse effect on the financial
condition and results of operations of the Company. See "Business -- Other
Business Matters".

LACK OF INDEPENDENT OPERATING HISTORY

Prior to the consummation of the Offerings, the business of the Company was
operated as the Western Division of SFR. Accordingly, no financial or operating
history of the Company as an independent

17
<PAGE> 18

entity is available for a potential investor to evaluate. Following the
consummation of the Transactions, the Company will operate as a stand-alone
entity and will no longer benefit from the direct operational, financial and
other support previously provided by SFR to the Western Division, although the
Company and SFR will enter into a services agreement (terminable by either party
on 90 days' notice without cause) pursuant to which SFR will provide certain
corporate and administrative services to the Company. Upon termination of such
services agreement or the elimination of any services to be provided thereunder,
the Company will be responsible for obtaining such services on its own. If the
Company is unable to perform such services or obtain them on acceptable terms,
the Company's business, financial condition and results of operations could be
adversely affected. See "Relationship Between the Company and SFR -- Contractual
Arrangements".

CONTROL BY SFR

The Company is currently a wholly owned subsidiary of SFR. Following the
Offerings, SFR will own approximately 85% of the outstanding Common Stock. After
the Offerings, through its ability to elect all directors of the Company, SFR
will control all matters affecting the Company, including any determination with
respect to acquisition or disposition of Company assets, future issuance of
Common Stock or other securities of the Company, the Company's incurrence of
debt and any dividend payable on Common Stock. For a description of SFR's
current intentions with respect to the shares of Common Stock that it owns, see
"-- Intended Spin Off by SFR". The Company has granted SFR certain demand and
piggyback registration rights with respect to the Common Stock owned by SFR. See
"Relationship Between the Company and SFR -- Contractual Arrangements". Although
SFR has announced its intention to distribute its remaining shares to its
stockholders, subject to certain conditions, to the extent SFR maintains a
substantial investment in the Company, SFR will be in a position to control the
policies and affairs of the Company and to determine the outcome of corporate
actions requiring stockholder approval. Conflicts of interest may arise in the
future between the Company and SFR in a number of areas relating to their past
and ongoing relationship, including allocation of capital, dividends, incurrence
of indebtedness, tax matters, financial commitments, registration rights,
administration of benefit plans, service arrangements, potential acquisitions of
businesses or oil and gas properties and other corporate opportunities, the
issuance and sale of capital stock of the Company and the election of directors.

Three of the Company's seven directors are executive officers of SFR and
four of such directors are directors of SFR. Upon consummation of the Offerings,
none of the Company's executive officers will be officers of SFR; however, one
of the Company's seven directors will be a director of SFR and two of the
Company's directors will be executive officers of SFR. It is anticipated that
additional changes to the Company's board of directors will be made following
the Spin Off. See "Risk Factors -- Intended Spin Off by SFR" and
"Management -- Directors and Executive Officers". The Company and SFR have
entered into a number of agreements for the purpose of defining the ongoing
relationship between them. As a result of SFR's ownership interest in the
Company, the terms of such agreements were not, and the terms of any future
amendments to those agreements may not be, the result of arm's length
negotiations. Although SFR has advised the Company that it does not currently
intend to engage in the exploration for natural gas, natural gas liquids and
crude oil or in the hard minerals business in California except through its
ownership of Common Stock of the Company, there are no restrictions, contractual
or otherwise, on SFR's engaging in such activities. Accordingly, if SFR changes
its current strategy, or makes an acquisition, it may compete with the Company.
See "Relationship Between the Company and SFR".

SHARES ELIGIBLE FOR FUTURE SALE

SFR and each director and executive officer of the Company have agreed not
to dispose of any shares of Common Stock for a period of 180 days from the date
of this Prospectus without the consent of the representatives of the
Underwriters. The lockup provisions in these agreements are subject to waiver by
the parties to these agreements. After expiration of the lockup period, the
45,350,000 currently outstanding shares of Common Stock, all of which are held
by SFR, will be eligible for resale, subject to the two-year holding requirement
of Rule 144 under the Securities Act, or pursuant to the exercise of

18
<PAGE> 19

demand registration rights. It is SFR's current intent to distribute the shares
to its stockholders as described in "-- Intended Spin Off by SFR" below. In
addition, upon consummation of the Offerings a total of 3,500,000 shares of
Common Stock will be reserved for issuance pursuant to the Company's incentive
compensation plans, of which a total of 74,166 shares of restricted Common Stock
and options to purchase a total of 268,500 shares of Common Stock, the exercise
price of which will be equal to the initial public offering price per share in
the Offerings, will be issued to certain executive officers, key employees and
non-employee directors of the Company. None of such options or restricted shares
to be so issued upon consummation of the Offerings will be exercisable or
transferable prior to the first anniversary of the Spin Off, except under
certain limited circumstances. See "Management -- Executive Compensation".

Prior to the Offerings, there has been no public market for the Common
Stock, and no prediction can be made as to the effect, if any, that the future
sales of shares or the availability of shares for sale will have on the market
price for Common Stock prevailing from time to time. Sales of substantial
amounts of Common Stock in the public market, or the perception of the
availability of shares for sale, could adversely affect the prevailing market
price of the Common Stock and could impair the Company's ability to raise
capital through the sale of its equity securities. See "Relationship Between the
Company and SFR -- Ownership of Common Stock" and "Shares Eligible for Future
Sale".

BENEFITS OF THE OFFERING TO SFR

SFR, as the sole existing shareholder, will receive substantial benefits as
a result of the Offerings, including the assumption by Monterey of the SFR
Senior Notes and the use of a portion of the net proceeds received by the
Company (i) to repay the $70 million aggregate principal amount of SFR's Series
E Notes and Series F Notes and accrued and unpaid interest thereon, as well as
the $2.5 million prepayment penalty thereon, and (ii) to retire SFR's expected
borrowing of $16 million under the New Credit Facility. The Company will also
issue $175 million of the Company Senior Notes in exchange for the surrender and
cancellation of $175 million of SFR's Series G Notes.

INTENDED SPIN OFF BY SFR

SFR has announced that after the Offerings it intends to distribute pro
rata to its common stockholders all of the shares of Common Stock that it owns
by means of a tax-free distribution. SFR's final determination to proceed with
the Spin Off will require a declaration of the Spin Off by SFR's board of
directors. Such a declaration is not expected to be made until certain
conditions, many of which are beyond the control of SFR, are satisfied,
including: (i) receipt by SFR of a favorable ruling from the Internal Revenue
Service as to the tax-free nature of the Spin Off; (ii) approval of the Spin Off
by SFR's stockholders; (iii) the redemption or conversion of all or a
substantial portion of the shares of each outstanding series of SFR preferred
stock; and (iv) the absence of any future change in market or economic
conditions (including developments in the capital markets) or SFR's or the
Company's business or financial condition that causes SFR's board to conclude
that the Spin Off is not in the best interests of SFR's stockholders. The
Company has been advised by SFR that it does not expect the Spin Off to occur
prior to June 1997. If SFR consummates the Spin Off, the increased number of
shares of Common Stock available in the market may have an adverse effect on the
market price of the Common Stock. The Company has been advised by SFR that as of
September 30, 1996, SFR had 41,326 common stockholders of record. See
"Relationship Between the Company and SFR". No assurance can be given that the
conditions to the Spin Off will be satisfied or that, in any event, SFR's board
of directors will determine to declare the Spin Off or that SFR will not sell
its shares of Common Stock.

To protect SFR from Federal and state income taxes that would be incurred
by it if the Spin Off were determined to be a taxable event, the Company and SFR
have entered into the Spin Off Tax Indemnity Agreement pursuant to which the
Company has agreed to indemnify SFR with respect to tax liabilities resulting
primarily from actions taken by the Company at any time during the one-year
period commencing upon the Spin Off, which period is subject to increase if
certain federal tax legislation is enacted and is applicable to the Spin Off.
The Company believes that if it is required to make payments

19
<PAGE> 20

pursuant to such agreement, the amount of such payments would have a material
adverse effect on the Company's financial condition. The actions for which the
Company is required to indemnify SFR pursuant to such agreement are within the
Company's control, and the Company has no intention to take any actions during
such one-year period that would have such an effect. See "Relationship Between
the Company and SFR -- Contractual Arrangements -- Spin Off Tax Indemnity
Agreement".

It is anticipated that after the Spin Off one director of the Company will
resign and two additional directors who are unaffiliated with the Company and
SFR will be appointed to the Company's board of directors. Such additions, when
completed, will increase the Company's board to eight members, of which only one
will be affiliated with SFR.

CERTAIN ANTI-TAKEOVER PROVISIONS

The Company's Certificate of Incorporation and Bylaws and the Delaware
General Corporation Law contain provisions that may have the effect of
discouraging unsolicited takeover proposals for the Company that a stockholder
might consider to be in that stockholder's best interest. These provisions,
among other things, restrict the ability of stockholders to take action by
written consent, authorize the board of directors to adopt a rights plan and
issue rights thereunder, authorize the board of directors to designate the terms
of and issue new series of preferred stock, limit the personal liability of
directors, require the Company to indemnify directors and officers to the
fullest extent permitted by applicable law and impose restrictions on business
combinations with certain interested parties. See "Description of Capital
Stock -- Certain Provisions of the Company's Charter and Bylaws and Delaware
Law". In addition, certain provisions included in the Company Senior Notes and
New Credit Facility will require the Company to prepay indebtedness outstanding
thereunder upon a change in control (as defined therein) of the Company.

ABSENCE OF A PREVIOUS MARKET FOR COMMON STOCK

There has been no public market for the Common Stock prior to the
Offerings. Although the Common Stock has been approved for listing, subject to
official notice of issuance, on the NYSE, no assurance can be given that an
active trading market will develop or be sustained after the Offerings, or that
purchasers of the Common Stock will be able to resell their Common Stock at
prices equal to or greater than the initial public offering price. The initial
public offering price will be determined by negotiations between the Company and
the Underwriters and may not be indicative of the prices that may prevail in the
public market. See "Underwriting" for a description of the factors to be
considered in determining the initial public offering price for the Common
Stock.

DEPENDENCE ON KEY PERSONNEL

The Company depends to a large extent on the services of R. Graham Whaling,
David Kilpatrick and certain other senior management personnel. The loss of the
services of Messrs. Whaling, Kilpatrick or other senior management personnel
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company does not maintain key man
insurance for the Company's benefit on any of its employees. Although the
Company will enter into a three-year employment agreement with Mr. Whaling and a
two-year employment agreement with Mr. Kilpatrick and certain other senior
management personnel, there can be no assurance that the Company can retain key
management personnel. The Company's success is also dependent upon its ability
to continue to employ and retain skilled technical personnel, and there can be
no assurance that the Company will be able to attract and retain such personnel.
See "Management -- Employment Agreements".

POSSIBLE IMPAIRMENT OF OIL AND GAS PROPERTIES

The Company follows the successful efforts method of accounting for its oil
and gas exploration and production activities. Under this method, costs (both
tangible and intangible) of development wells, as well as the costs of
prospective acreage, are capitalized. The costs of drilling and equipping
exploratory

20
<PAGE> 21

wells which do not result in proved reserves are expensed upon the determination
that the well does not justify commercial development. Other exploratory costs,
including geological and geophysical costs, are expensed as incurred.

The Company periodically reviews individual proved properties to determine
if the carrying value of such properties as reflected in its accounting records
exceeds the estimated undiscounted future net revenues from proved oil and gas
reserves attributable to such properties. Based on this review and the
continuing evaluation of development plans, economics and other factors, if
appropriate, the Company records impairments (additional depletion and
depreciation) pursuant to Statement of Financial Accounting Standards No. 121
("SFAS No. 121") to the extent that the net book values of its properties exceed
the expected discounted future net revenues. Such impairments constitute a
charge to earnings which does not impact the Company's cash flow from operating
activities. However, such writedowns impact the amount of the Company's
stockholders' equity and, therefore, the ratio of debt to equity. The risk that
the Company will be required to write down the carrying value of its oil and
natural gas properties increases when oil and natural gas prices are depressed.
Although the Company recorded an impairment of $49.1 million in 1993, the
Company has not recorded any impairments associated with SFAS No. 121, which
became effective in the fourth quarter of 1995; however, no assurance can be
given that the Company will not experience impairments in the future.

USE OF PROCEEDS

The net proceeds of the Offerings are estimated to be $107 million after
deducting estimated expenses. Such net proceeds will be used for the following
purposes: (i) approximately $72.5 million will be used to repay in full the $70
million principal amount of the Series E Notes and Series F Notes and accrued
and unpaid interest thereon and to pay the prepayment penalty associated
therewith, (ii) approximately $16 million will be used to repay outstanding
indebtedness under the New Credit Facility and (iii) the balance will be used
for general corporate purposes. If the Underwriters' over-allotment options are
exercised, the Company intends to use the net proceeds therefrom to repay any
balance then outstanding under the New Credit Facility and any remaining
proceeds will be used for working capital purposes. For a description of the
interest rate and maturity of the indebtedness to be repaid with the net
proceeds of the Offerings, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources".

Promptly following the consummation of the Offerings, the Company intends
to prepay the $30 million Production Payment in full with funds available under
the New Credit Facility.

DIVIDEND POLICY

The Company currently intends to pay to its stockholders a dividend of
$0.15 per quarter ($0.60 annually) per share of Common Stock. The first dividend
(which is anticipated to be approximately $0.22 per share of Common Stock) is
anticipated to be paid in April of 1997 and will consist of a dividend for the
Company's first partial quarter ended December 31, 1996 and for its first full
quarter of operations ending March 31, 1997.

The determination of the amount of cash dividends (including the initial
quarterly dividend referred to above), if any, to be declared and paid will
depend upon declaration by the Company's board of directors and upon the
Company's financial condition, earnings and funds from operations, the level of
its capital and exploration expenditures, dividend restrictions contained in the
New Credit Facility and the Company Senior Notes, its future business prospects
and such other matters that the Company's directors deem relevant. For a
description of certain restrictions on the Company's ability to pay dividends,
see "Description of Capital Stock -- Restrictions on Dividends".

21
<PAGE> 22

DILUTION

As of September 30, 1996, the pro forma net tangible book value (total
tangible assets less total liabilities) of the Company, after giving effect to
the consummation of the Transactions as if they had occurred on September 30,
1996, was approximately $36.7 million, or $0.81 per share of Common Stock. After
giving effect to the receipt of $107.2 million of net proceeds from the
Offerings (net of underwriting discounts and commissions and estimated offering
expenses) at the initial public offering price of $14.50 per share, the pro
forma net tangible book value of the Common Stock outstanding at September 30,
1996 would have been $2.69 per share of Common Stock, representing an immediate
increase in net tangible book value of $1.88 per share to SFR (the Company's
existing stockholder) and an immediate dilution of $11.81 per share to persons
purchasing Common Stock at the assumed initial public offering price. Dilution
is determined by subtracting net tangible book value per share of Common Stock
after giving effect to the Offerings from the amount of cash paid by a new
investor for a share of Common Stock. The following table illustrates such per
share dilution:

<TABLE>
<S> <C> <C>
Initial public offering price per share................. $14.50
Pro forma net tangible book value per share before the
Offerings.......................................... $ 0.81
Increase in net tangible book value per share
attributable to the sale of Common Stock in the
Offerings.......................................... $ 1.88
Pro forma net tangible book value per share after giving
effect to the Offerings............................ $ 2.69
Dilution in net tangible book value to the purchasers of
Common Stock offered hereby........................ $11.81
</TABLE>

The following table sets forth, as of September 30, 1996, the number of
shares of Common Stock owned by SFR and purchased by new investors in the
Offerings, the total consideration paid therefor and the average price per share
paid by SFR and by new investors:

<TABLE>
<CAPTION>
SHARES OWNED TOTAL CONSIDERATION AVERAGE
---------------------- ------------------------ PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- ------- ------------ ------- ---------
<S> <C> <C> <C> <C> <C>
SFR...................... 45,350,000 84.8% $ 36,700,000 23.7% $ 0.81
New Investors............ 8,150,000 15.2 118,200,000 76.3 14.50
Total.......... 53,500,000 100.0% $154,900,000 100.0% $ 2.90
</TABLE>

The foregoing computations do not include a total of 74,166 restricted
shares of Common Stock and 268,500 shares of Common Stock reserved for issuance
pursuant to options that will be granted to management and other employees upon
completion of the Offerings, at an exercise price per share equal to the initial
public offering price. See "Management -- Benefit Plans". If the foregoing
calculations include such restricted shares and assume exercise of all such
employee options (at the initial public offering price of $14.50 per share), the
pro forma net tangible book value per share before the Offerings would be $0.91,
the pro forma net tangible book value per share after the Offerings would be
$2.77 and the dilution per share to new investors would be $11.73.

22
<PAGE> 23

CAPITALIZATION

The following table sets forth the historical capitalization of the Western
Division as of September 30, 1996, the adjustments thereto to give effect to the
consummation of the Transactions, including the application by the Company of
the net proceeds of the Offerings as described in "Use of Proceeds", and the pro
forma capitalization of the Company. This table should be read in conjunction
with the Financial Statements and the Pro Forma Financial Statements of the
Company and the Notes thereto included elsewhere in this Prospectus.

<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1996
----------------------------------------
WESTERN MONTEREY
DIVISION PRO FORMA RESOURCES, INC.
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------------
<S> <C> <C> <C>
(MILLIONS OF DOLLARS)
CASH AND CASH EQUIVALENTS............... $ -- $ 17 (1) $ 17
==== ===== =====
SHORT-TERM DEBT
Current portion of SFR Senior Notes... $ 35(2) (35)(3) --
Production payment payable............ -- -- (4) --
---- ----- -----
35 (35) --
---- ----- -----
LONG-TERM DEBT
SFR Senior Notes...................... 210(2) (210)(3) --
Company Senior Notes.................. -- 175 (3) 175
30 (4)
-- (5)
New Credit Facility..................... -- 9 (6) 39
---- ----- ----
210 4 214
---- ----- ----
SHAREHOLDERS' EQUITY
Western Division equity............... 60 (60)(7) --
(2)(6)
Shareholders' equity.................. -- 146 (7) 144
---- ----- ------
60 84 144
---- ----- ------
TOTAL CAPITALIZATION.......... $305 $ 53 $ 358
==== ===== =====
</TABLE>

- ---------------

(1) Includes the net proceeds from the Offerings reduced by application of a
portion of such proceeds as described in notes (3), (5) and (6) below.

(2) Represents a portion of the $245 million of indebtedness of SFR attributable
to the SFR Senior Notes that is allocated to the Western Division, which is
to be assumed by the Company at or prior to consummation of the Offerings.

(3) Gives effect to the retirement of $70 million of aggregate principal amount
of the Series E and Series F Notes to be assumed by the Company at or prior
to consummation of the Offerings, the exchange (the "Exchange") by the
Company of the Company Senior Notes for cancellation of the $175 million
Series G Notes and the payment of accrued and unpaid interest on the Company
Senior Notes.

(4) Gives effect to (a) the retention by SFR of a $30 million Production Payment
pursuant to the Contribution Agreement and (b) the prepayment of the
Production Payment by the Company promptly following the consummation of the
Offerings with funds borrowed under the New Credit Facility.

(5) Prior to consummation of the Offerings, SFR and the Company will enter into
the New Credit Facility, and SFR is expected to borrow $16 million under the
New Credit Facility. Concurrently with the closing of the Offerings, SFR
will be released as an obligor under the New Credit Facility and the Company
is expected to use $16 million of the net proceeds from the Offerings to
repay such borrowing in full.

(6) Gives effect to (i) Monterey's purchase of SFR's $8.5 million in notes
receivable representing a portion of the purchase price to be received under
a contract for sale with a third party of the Olinda Property which purchase
is expected to be funded by Monterrey with borrowings available under the
New Credit Facility, and (ii) $3.5 million ($2.1 million, net of related
taxes) of site improvement costs incurred by Monterey pursuant to the
contract for sale relating to the Olinda Property. See "Relationship Between
the Company and SFR -- Contractual Arrangements -- Contribution Agreement."

(7) Gives effect to (a) the contribution by SFR of the net assets of the Western
Division pursuant to the Contribution Agreement (approximately $88 million
after giving effect to liabilities assumed by SFR and deferred income tax
effects), (b) the retention by SFR of the $30 million Production Payment
pursuant to the Contribution Agreement, (c) the assumption by the Company of
the $16 million liability for amounts outstanding under the New Credit
Facility as described in note (5) above, (d) the receipt by the Company of
$107.2 million in net proceeds from the Offerings (consisting of the sale of
8.2 million shares at $14.50 per share, net of underwriting discounts and $3
million of estimated expenses of the Offerings), (e) the payment by the
Company of a $2.5 million prepayment penalty ($1.5 million, net of related
taxes) related to the prepayment of the Series E and F Notes referred to in
note (3) above and (f) the payment by the Company of a $1 million consent
fee ($1 million, net of related taxes) in connection with the Exchange. See
the Pro Forma Condensed Financial Statements included elsewhere in this
Prospectus.

23
<PAGE> 24

SELECTED HISTORICAL AND PRO FORMA FINANCIAL INFORMATION

The following table sets forth, for the periods indicated, selected
historical financial data for SFR's Western Division and selected pro forma
financial data for the Company. The selected historical balance sheet data as of
December 31, 1995 and 1994 and the selected historical income statement and cash
flow data for each of the three years in the period ended December 31, 1995 are
derived from the financial statements of the Western Division of SFR, which have
been audited by Price Waterhouse LLP. The selected historical financial data for
the nine month periods ended September 30, 1995 and September 30, 1996 are
derived from the unaudited financial statements of the Western Division of SFR
and include, in the opinion of management, adjustments (consisting only of
normal recurring adjustments) necessary to present fairly the financial data for
such periods. The selected historical balance sheet data as of December 31,
1991, 1992 and 1993 and the selected historical income statement and cash flow
data for each of the two years in the period ended December 31, 1992 have been
derived from the unaudited accounting records of the Western Division of SFR.
The selected pro forma financial data for the Company set forth below are based
on numerous assumptions and include adjustments as explained in the unaudited
pro forma financial statements of the Company and the notes thereto included
elsewhere in this Prospectus. All such selected historical and pro forma
financial data set forth below should be read in conjunction with such financial
statements and notes thereto appearing elsewhere herein. The following
information should not be deemed indicative of future operating results for the
Company. See also "Management's Discussion and Analysis of Financial Condition
and Results of Operations".

<TABLE>
<CAPTION>
WESTERN
MONTEREY DIVISION
WESTERN DIVISION HISTORICAL RESOURCES, HISTORICAL MONTEREY
--------------------------------- INC. -------------- RESOURCES, INC.
PRO FORMA(1) PRO FORMA(1)
YEAR -------------- NINE MONTHS ---------------
ENDED YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED SEPTEMBER 30, ENDED
--------------------------------- DECEMBER 31, -------------- SEPTEMBER 30,
1991 1992 1993 1994 1995 1995 1995 1996 1996
---- ---- ---- ---- ----- -------------- ---- ----- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Revenues................................ $240 $215 $187 $179 $ 211 $ 211 $159 $ 214 $ 214
---- ---- ---- ---- ----- ------ ---- ----- ------
Costs and expenses:
Production and operating.............. 103 105 100 86 85 85 63 76(2) 76(2)
Cost of crude oil purchased........... -- -- -- -- -- -- -- 21 21
Exploration, including dry hole
costs............................... 3 3 2 1 2 2 2 1 1
Depletion, depreciation and
amortization........................ 40 44 41 32 33 33 24 28 28
Impairment of oil and gas
properties(3)....................... -- -- 49 -- -- -- -- -- --
General and administrative............ 6 9 9 8 7 9 5 6 7
Taxes (other than income)............. 13 9 9 9 8 8 7 7 7
Restructuring charges(4).............. -- -- 12 1 -- -- -- -- --
---- ---- ---- ---- ----- ------ ---- ----- ------
165 170 222 137 135 137 101 139 140
---- ---- ---- ---- ----- ------ ---- ----- ------
Income (loss) from operations........... 75 45 (35) 42 76 74 58 75 74
Interest, net(5)...................... (27) (27) (27) (26) (25) (20) (19) (18) (15)
Other income (expense)................ 5 1 -- -- (1) (1) -- -- --
---- ---- ---- ---- ----- ------ ---- ----- ------
Income (loss) before income taxes....... 53 19 (62) 16 50 53 39 57 59
Income taxes.......................... (19) (6) 27 (4) (16) (17) (13) (21) (21)
---- ---- ---- ---- ----- ------ ---- ----- ------
Net income (loss)....................... $ 34 $ 13 $(35) $ 12 $ 34 $ 36 $ 26 $ 36 $ 38
===== ===== ===== ===== ===== ====== ===== ===== =====
Pro forma earnings (loss) per common
share (in dollars).................... $0.76 $ 0.68 $0.79 $0.70
===== ====== ===== =====
Average shares outstanding (millions)... 45.3 53.6 45.3 53.6
CASH FLOW DATA:
Net cash provided by operating
activities............................ $ 86 $ 59 $ 47 $ 45 $ 76 N/A $ 71 $ 62 N/A
Net cash used in investing activities... 60 17 18 18 54 N/A 47 41 N/A
Net cash used in financing activities... 26 42 29 27 22 N/A 24 21 N/A
Capital expenditures, including
acquisitions of producing
properties............................ 70 20 47 27 54 N/A 47 41 N/A
BALANCE SHEET DATA (at end of period):
Cash and cash equivalents............... $ -- $ -- $ -- $ -- $ -- N/A $ -- $ -- $ 17
Total assets............................ 503 476 387 376 391 N/A 392 424 450
Total debt.............................. 265 263 258 245 245 N/A 245 245 214
Shareholders' equity.................... 121 94 35 32 45 N/A 34 60 144
OTHER FINANCIAL DATA:
EBITDA(6)............................... $119 $ 89 $ 55 $ 74 $ 108 $ 106 $ 81 $ 103 $ 102
Ratio of EBITDA to interest expense..... 4.3 3.2 2.0 2.8 4.2 5.1 4.2 5.3 6.6
</TABLE>

24
<PAGE> 25

- ---------------

(1) Pro forma for the consummation of the Offerings and the Transactions as if
the Offerings and the Transactions had occurred on January 1, 1995, except
for the balance sheet data which assumes that the Offerings and the
Transactions had occurred on September 30, 1996. See the Pro Forma Condensed
Financial Statements included herein.

(6) EBITDA as presented herein is defined as the sum of income before provision
for income taxes, interest, depreciation, depletion, amortization,
impairments and certain non-cash charges including gains or losses realized
on the disposition of properties. EBITDA, as presented herein, is used as a
measure in the Company's New Credit Facility and the Company Senior Notes
and provides information regarding the Company's ability to service and
incur debt. Because the New Credit Facility and the Company Senior Notes
contain other financial measures, covenants and limitations (including
mandatory principal repayments), EBITDA does not represent funds available
for discretionary use. EBITDA should not be considered in isolation or as a
substitute for net income, cash flow provided by operating activities or
other income or cash flow data prepared in accordance with generally
accepted accounting principles or as a measure of a company's profitability
or liquidity. Further, EBITDA, as presented herein, may not be comparable to
similarly titled measures reported by other companies.

25
<PAGE> 26

The following table sets forth certain selected operating data for the
Company for the periods indicated.

SELECTED OPERATING DATA

WESTERN
MONTEREY DIVISION MONTEREY
WESTERN DIVISION HISTORICAL RESOURCES, INC. HISTORICAL RESOURCES, INC.
-------------------------------------- PRO FORMA(1) --------------- PRO FORMA(1)
YEAR --------------- NINE MONTHS ---------------
ENDED YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED SEPTEMBER 30, ENDED
-------------------------------------- DECEMBER 31, --------------- SEPTEMBER 30,
1991 1992 1993 1994 1995 1995 1995 1996 1996
------ ------ ----- ------ ------ --------------- ------ ----- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Average daily production
Crude oil and liquids
(MBbls/d).................. 42 42 43(2) 41 42 42 41 46 46
Natural gas (MMcf/d)......... 9 7 6(2) 4 5 5 5 4 4
Total production (MBOE/d).... 43 43 44(2) 42 43 43 42 47 47
Average realized sales prices,
hedged(3)
Crude oil and liquids
($/Bbl).................... 15.19 13.67 11.63 11.53 13.50 13.50 13.79 15.08 15.08
Natural gas ($/Mcf).......... 1.72 1.57 1.59 1.14 0.98 0.98 1.02 1.00 1.00
Average costs and expenses per
BOE(in dollars)(4)
Production and operating:
Steam generation........... 1.95 2.41 2.26 2.16 1.98 1.98 1.91 2.48(5) 2.48(5)
Lease operating............ 4.57 4.24 4.05 3.47 3.50 3.50 3.59 3.52 3.52
----- ----- ----- ----- ----- ----- ----- ----- -----
Total.................. 6.52 6.65 6.31 5.63 5.48 5.48 5.50 6.00(5) 6.00(5)
----- ----- ----- ----- ----- ----- ----- ----- -----
Exploration, including dry
holes...................... 0.17 0.17 0.11 0.09 0.15 0.15 0.18 0.09 0.09
Depletion, depreciation and
amortization............... 2.55 2.79 2.59 2.09 2.08 2.08 2.06 2.18 2.18
Impairment of oil and gas
properties................. -- -- 3.09 -- -- -- -- -- --
General and administrative... 0.42 0.56 0.58 0.51 0.47 0.60 0.47 0.45 0.55
Restructuring charges........ -- -- 0.75 0.07 -- -- -- --
Taxes (other than income).... 0.83 0.56 0.53 0.56 0.51 0.51 0.58 0.53 0.53
Interest expense, net........ 1.73 1.74 1.69 1.68 1.61 1.28 1.63 1.44 1.14
Average production costs
(including related
production, severance and
ad valorem taxes) per BOE
(in dollars)............... 7.28 7.13 6.76 6.12 5.92 5.92 6.00 6.46(5) 6.46(5)
Average finding cost per BOE
(in dollars)(4).............. 6.05 0.89 3.18 1.04 2.17 2.17 N/A N/A N/A
Gross wells drilled............ 137 31 171 79 225 225 198 191 191
</TABLE>

- ---------------

(1) Pro forma for the consummation of the Offerings and the Transactions as if
the Offerings and Transactions had occurred on January 1, 1995. See the Pro
Forma Condensed Financial Statements included herein.

(2) Includes production attributable to properties sold in 1993 of 3 MBbls/d of
crude oil and liquids and 2 MMcf/d of natural gas (3 MBOE/d).

(5) Historical and pro forma amounts include a $0.25 per BOE loss on hedging in
respect of natural gas purchased for thermal EOR operations. Excluding such
hedging losses, both historical and pro forma steam generation costs would
have been $2.23 per BOE and both total historical and pro forma operating
costs would have been $5.75 per BOE. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- General".

26
<PAGE> 27

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

The discussion presented herein relates to the Western Division of SFR. Due
to the fact that the Company will be an independent entity after the Offerings,
certain items may differ from those presented below and the results of the
Western Division may not necessarily be indicative of future results of the
Company. See also the discussion below under "-- Intercompany Agreements".

As an independent oil and gas producer, the Company's results of operations
are dependent upon the difference between the prices received for oil and gas
and the costs of finding and producing such resources. The Company produces most
of its oil and gas from long-lived fields in the San Joaquin Valley of
California utilizing various EOR methods. The market price of heavy (i.e., low
gravity, high viscosity) and sour (i.e., high sulfur content) crude oils
produced in these fields is lower than sweeter, light (i.e., low sulfur and low
viscosity) crude oils, reflecting higher transportation and refining costs. In
addition, the lifting costs of heavy crude oils are generally higher than the
lifting costs of light crude oils. As a result, even relatively modest changes
in crude oil prices may significantly affect the Company's revenues, results of
operations, cash flows and proved reserves. In addition, prolonged periods of
high or low oil prices may have a material effect on the Company's financial
condition and results of operations.

The average sales price of the Company's crude oil and liquids (unhedged)
for 1995 was $13.50 per barrel, or approximately 81% of the average posted price
of $16.76 per barrel for WTI crude oil (an industry posted price generally
indicative of prices for sweeter light crude oil). During the nine months ended
September 30, 1996, the Company's average sales price for the Company's crude
oil was $15.33 per barrel, approximately 78% of the average posted price for WTI
during such period. For the period from January 1, 1991 to September 30, 1996,
the average sales price for the Company's crude oil was approximately 71% of the
average posted price for WTI during such period.

Crude oil prices are subject to significant changes in response to
fluctuations in the domestic and world supply and demand and other market
conditions, as well as the world political situation as it relates to OPEC, the
Middle East and various producing countries. Since the beginning of 1994, the
average sales price (unhedged) received by the Company ranged from a low of
$8.80 per barrel for the first quarter of 1994 to a high of $15.79 per barrel in
the second quarter of 1996. Based on operating results for the first nine months
of 1996, the Company estimates that on an annualized basis a $1.00 per barrel
increase or decrease in its average crude oil sales price would result in a
corresponding $17 million change in income from operations and a $10 million
change in cash flow from operating activities. The foregoing estimates do not
give effect to changes in any other factors, such as the effect of hedging or
depreciation and depletion, that would result from a change in oil prices.

The price of natural gas fluctuates due to supply and demand, which may be
affected by weather conditions, the level of natural gas in storage and other
economic factors. Increases in the price of natural gas adversely impact the
Company's results of operations because the natural gas consumed in the
Company's EOR operations exceeds the amount of natural gas produced by the
Company. Based on operating results for the first nine months of 1996, the
Company estimates that on an annualized basis a $0.10 per Mcf increase (or
decrease) in the average domestic natural gas sales price would result in a $2
million decrease (or increase) in income from operations and a $1 million
decrease (or increase) in cash flow from operating activities. The foregoing
estimates do not give effect to changes in any other factors, such as depletion
and depreciation, that would result from a change in natural gas prices.

In February 1996 the Bureau of Land Management ("BLM") of the United States
Department of the Interior (which oversees the Company's leases of Federal
lands) agreed, effective as of June 1, 1996, to reduce the royalties payable on
any Federal lease that produces crude oil with a weighted average gravity of
less than 20 degrees API. The reduced royalty rates are based upon the weighted
average API gravity of the heavy oil produced from the subject Federal leases
and are as low as 3.9%, compared to 12.5% before the reduction. The reduced
royalty rates continue in effect for 12-month periods, after which the

27
<PAGE> 28

operator can establish a new reduced rate for continued heavy oil production by
submitting an application. As a result of this program, the Company's royalty
rate on its Federal leases has been reduced from 12.5% to an average of 4.8%,
resulting in a net increase in the production attributable to the Company's net
revenue interests in such leases of approximately 1.6 MBbls per day. During the
period that such royalty reduction is in effect, the Company (and other working
interests owners, if any) will bear all of the thermal EOR costs to produce the
heavy oil from such properties. The royalty reduction will be terminated upon
the first to occur of (i) the determination by the BLM that the WTI average oil
price (as adjusted for inflation) has remained above $24 per barrel for six
consecutive months and (ii) such time after September 10, 1999, as the Secretary
of the Interior determines that the heavy oil royalty rate reduction has not
produced the intended results (i.e., to reduce the loss of otherwise recoverable
reserves).

From time to time SFR hedges a portion of its oil sales to provide a
certain minimum level of cash flow from its sales of oil. While the hedges are
generally intended to reduce SFR's exposure to declines in market price, SFR's
gain from increases in market price may be limited. SFR uses various financial
instruments whereby monthly settlements are based on differences between the
prices specified in the instruments and the settlement prices of certain futures
contracts quoted on the New York Mercantile Exchange ("NYMEX") or certain other
indices. Generally, in instances where the applicable settlement price is less
than the price specified in the contract, SFR receives a settlement based on the
difference; in instances where the applicable settlement price is higher than
the specified price, SFR pays an amount based on the difference. The instruments
utilized by SFR differ from futures contracts in that there is no contractual
obligation which requires or allows for the future delivery of the product.
Gains or losses on hedging activities are recognized in oil and gas revenues in
the period in which the hedged production is sold. SFR's hedging program in 1995
and 1996 has been to hedge the price of its light oil production. In certain
months when a favorable price could be obtained, heavy oil quantities (i.e.,
quantities in excess of light oil production) were hedged. The allocation of
hedging gains and losses to the Western Division during this period has been
calculated on the basis of its light oil production and its heavy oil hedges as
determined above. During the first nine months of 1996, the Company's share of
SFR's net loss on crude oil hedges was $3 million. The Company does not expect
to hedge a substantial portion of its oil production.

In addition to crude oil sales hedges, during the first six months of 1996
SFR hedged 20 MMcf per day of the natural gas purchased for use in the Company's
steam generation operations. Such hedges, which terminated at the end of the
second quarter, resulted in a $3 million increase in the Company's production
and operating costs in the first nine months of 1996. While the Company has no
natural gas hedges currently in place, the Company's management may determine
that such arrangements are appropriate in the future in order to reduce the
Company's exposure to increases in gas prices.

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<PAGE> 29

RESULTS OF OPERATIONS

The following table reflects certain components of the Company's revenues
(expressed in millions of dollars) and expenses (expressed in dollars per BOE)
for the periods indicated:

<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- --------------
1993 1994 1995 1995 1996
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
REVENUE DATA:
Crude oil and liquids:
Average realized sales prices ($/Bbl)
Unhedged................................... 11.63 11.53 13.50 13.75 15.33
Hedged..................................... 11.63 11.53 13.50 13.79 15.08
Sales volumes (MBbls/d)....................... 43 41 42 41 46
Revenues ($ Millions)
Sales...................................... 180 173 206 155 194
Hedging.................................... -- -- -- -- (3)
Net profits payments....................... -- -- (1) -- (1)
----- ----- ----- ----- -----
Total................................. 180 173 205 155 190
===== ===== ===== ===== =====
Natural Gas:
Average realized sales prices ($/Mcf)......... 1.59 1.14 0.98 1.02 1.00
Sales volumes (MMcf/d)........................ 6 4 5 5 4
Revenues ($ Millions)......................... 4 2 2 1 1
EXPENSE DATA ($/BOE):
Production and operating expenses:
Steam generation.............................. 2.26 2.16 1.98 1.91 2.48(1)
Lease operating............................... 4.05 3.47 3.50 3.59 3.52
Total................................. 6.31 5.63 5.48 5.50 6.00(1)
Exploration, including dry holes................ 0.11 0.09 0.15 0.18 0.09
Depletion, depreciation and amortization........ 2.59 2.09 2.08 2.06 2.18
Impairment of oil and gas properties............ 3.09 -- -- -- --
General and administrative...................... 0.58 0.51 0.47 0.47 0.45
Taxes (other than income)....................... 0.53 0.56 0.51 0.58 0.53
Restructuring changes........................... 0.75 0.07 -- -- --
Interest, net................................... 1.69 1.68 1.61 1.63 1.44
</TABLE>

- ---------------

(1) Includes $0.25 per BOE loss on hedging, see "-- General". The hedging
transactions which generated these losses expired on June 30, 1996.
Excluding such hedging losses, historical steam generation costs would have
been $2.23 per BOE and historical total production costs would have been
$5.75 per BOE.

NINE MONTHS ENDED SEPTEMBER 30, 1996, COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1995

OPERATING REVENUES. Revenues for the first nine months of 1996 of $214
million were 35% higher than the $159 million reported in the first nine months
of 1995. The increase primarily reflects the effects of increased crude oil
sales prices ($18 million) and sales volumes ($21 million). The increase in
crude and liquids volumes in 1996 primarily reflects the success of the
Company's well operations in the Midway-Sunset field and the drilling of new
wells in the Kern River field. Crude oil and liquids revenues for the first nine
months of 1996 include a $3 million loss on hedging. Effective June 1, 1996, the
Department of the Interior instituted a royalty reduction program for heavy
crude producers, which reduces from 12.5% to an average 4.8% the royalties the
Company is required to pay on production from its Federal leases. See
"-- General". Such royalty reduction program resulted in a $2.8 million increase
in revenues

29
<PAGE> 30

and a $0.7 million increase in production and operating costs for the period
June 1 to September 30, 1996. Revenues for the first nine months of 1996 also
include $21 million related to the sales of purchased crude oil which was
blended with a portion of the Company's heavy oil to facilitate pipeline
transportation.

OPERATING COSTS AND EXPENSES. Costs and expenses totaled $139 million in
the first nine months of 1996, an increase of 38% compared to $101 million in
the first nine months of 1995. Production and operating costs for the first nine
months of 1996 were $13 million higher than in the same period in 1995 primarily
because of higher steam generation costs principally due to higher volumes and
higher prices paid for natural gas used in the steam generation process. In
addition, steam generation costs for 1996 include $3 million in expenses related
to hedges of natural gas purchased. See "-- General". The increase in DD&A in
the first nine months of 1996 primarily reflects higher capital expenditures in
recent periods which have resulted in a higher rate per BOE produced. Costs and
expenses for 1996 also include $21 million related to the cost of crude oil
purchased for blending as discussed above.

INCOME TAX. Income taxes in the first nine months of 1996 were $21 million,
an increase of 62% compared to $13 million in the same period of 1995 and
primarily reflect higher pre-tax income. The Company's effective tax rate in the
first nine months of 1996 of 36% is up from 32% in the same period in 1995,
primarily reflecting a reduction in the amount of EOR credits generated (due to
a reduction in expenditures qualifying for EOR credits) relative to the level of
pre-tax income.

YEAR ENDED DECEMBER 31, 1995, COMPARED TO YEAR ENDED DECEMBER 31, 1994

OPERATING REVENUES. Revenues for 1995 of $211 million were 18% higher than
the $179 million reported in 1994. The increase primarily reflects the effects
of increased sales prices ($30 million) and increased sales volumes ($2
million).

OPERATING COSTS AND EXPENSES. Costs and expenses totaled $135 million in
1995, a decrease of 1% compared to $137 million in 1994. Exploration costs for
1995 include $1 million related to the drilling of two dry exploratory wells.
Costs and expenses for 1994 included $1 million in restructuring costs related
to SFR's 1993 corporate restructuring program. Although other 1995 costs showed
no significant change from the 1994 levels, steam generation costs and general
and administrative costs declined $0.18 per BOE and $0.03 per BOE, respectively.

INCOME TAX. Income taxes in 1995 were $16 million, an increase of 240%
compared to $5 million in 1994 and primarily reflect higher pre-tax income. The
Company's effective tax rate in 1995 of 32% was up from 29% in 1994, primarily
reflecting the amount of EOR credits generated relative to the level of pre-tax
income.

YEAR ENDED DECEMBER 31, 1994, COMPARED TO YEAR ENDED DECEMBER 31, 1993

OPERATING REVENUES. Revenues for 1994 of $179 million were 4% lower than
the $187 million reported in 1993. Revenues for 1993 included crude oil and
liquids revenues of $13 million (2.5 MBbls per day) and natural gas revenues of
$2 million (2.3 MMcf per day) attributable to certain producing properties which
were sold to Vintage Petroleum, Inc. ("Vintage") in the fourth quarter of 1993.
Crude oil and liquids revenues from other properties increased $6 million
primarily reflecting the effects of increased sales volumes.

OPERATING COSTS AND EXPENSES. Costs and expenses totaled $137 million in
1994, a decrease of 38% compared to $222 million in 1993. Costs and expenses in
1993 included impairments of oil and gas properties of $49 million with regard
to two properties in the LA Basin and restructuring charges of $11.9 million.
The restructuring charges were incurred in the fourth quarter of 1993 as a
result of the adoption by SFR of a corporate restructuring program which
included, among other things, (i) the concentration of capital spending in SFR's
core operating areas (one of which is the San Joaquin Valley of California);
(ii) the disposition of non-core assets; and (iii) an evaluation of SFR's cost
structures. As a result of the program, certain of the Company's producing
properties were sold to Vintage and the

30
<PAGE> 31

Company's salaried work force was reduced. In implementing the corporate
restructuring program, the Company recorded restructuring charges of $11.9
million in 1993, comprised of losses on property dispositions of $11.3 million
and accruals for certain personnel benefits and related costs of $0.6 million.
Also, costs and expenses in 1993 included $9 million of production and operating
costs, $4 million in DD&A and $0.4 million of taxes (other than income) related
to certain producing properties sold to Vintage in the fourth quarter of 1993.
The remainder of the decrease in DD&A was primarily attributable to the effect
of the impairments taken in 1993. General and administrative expense was lower
in 1994, primarily reflecting the effect of the 1993 corporate restructuring
program.

INCOME TAX. Income taxes in 1994 were $5 million, compared to a $27 million
benefit in 1993 attributable to the net loss of $62 million incurred in that
year. The Company's effective tax rate in 1994 was 29%.

LIQUIDITY AND CAPITAL RESOURCES

The Company's cash flow from operating activities is a function of the
volumes of oil and gas produced from the Company's properties and the sales
prices received therefor. Since crude oil and natural gas are depleting assets,
unless the Company replaces the oil and gas produced from its properties, the
Company's assets will be depleted over time and its ability to incur debt at
constant or declining prices will be reduced. The Company increased its proved
reserves (net of production and sales) by approximately 12% from December 31,
1991 to September 1, 1996; however, no assurances can be given that similar
increases will occur in the future. Historically, the Company has generally
funded development and exploration expenditures and working capital requirements
from cash provided by operating activities; however, the future levels of
operating cash flows, which are significantly affected by oil and gas prices,
may limit the cash available for future exploration, development and acquisition
activities. Net cash provided by operating activities and net proceeds from
sales of properties totaled $62 million in the first nine months of 1996; net
cash used for capital expenditures and producing property acquisitions in such
period totaled $41 million. The Company intends to continue to meet its
short-term (through 1997) and long-term (the foreseeable future after 1997)
liquidity needs with cash provided by operating activities, supplemented from
time to time with borrowings under the New Credit Facility and, if appropriate,
debt and equity financing.

The Company expects to increase its capital expenditures from an average of
$35 million per year over the five year period ended December 31, 1995 to
approximately $51 million and $68 million in 1996 and 1997, respectively.
However, the actual amount expended by the Company in 1996 and 1997 will be
based upon numerous factors, the majority of which are outside its control,
including, without limitation, prevailing oil and natural gas prices and the
outlook therefor and the availability of funds. Through September 30, 1996, the
Company had expended approximately $38 million of its 1996 budgeted amount. The
Company intends to fund such future capital expenditures with cash provided by
operating activities and borrowings under the New Credit Facility.

As described in this Prospectus under the caption "Prospectus
Summary -- Transactions at Closing", concurrently with the consummation of the
Offerings the Company will issue the Company Senior Notes in exchange for
cancellation of certain SFR Senior Notes. The Company Senior Notes will be in
the original principal amount of $175 million, bear interest at 10.61% per
annum, will be due and payable in full in 2005 and will require that the Company
prepay, without premium, $25 million of the principal amount each year from 1999
through 2004. The Note Agreement pursuant to which the Company Senior Notes will
be issued contains covenants which, among other things, restrict the Company's
ability to incur or maintain additional indebtedness and to pay cash dividends
unless certain conditions are satisfied, as well as requiring prepayment of the
Company Senior Notes (accompanied by a prepayment premium) in the event of a
change in control of the Company (as defined therein). The restriction on
indebtedness will permit the Company to maintain indebtedness only to the extent
that the Company's total debt outstanding at such time does not exceed 300% of
the Company's EBITDA less Restricted Payments (as defined in the Note Agreement)
for the most recent four consecutive quarters then ended. On a pro forma basis,
after giving effect to the Offerings and the Transactions, as of

31
<PAGE> 32

September 30, 1996, the Company would have had additional debt capacity of
approximately $170 million under such restriction. In addition, the Note
Agreement requires that the Company maintain net worth through December 31, 1998
of not less than $115 million, increasing each year thereafter by 20% of net
income generated thereafter. At September 30, 1996 on a pro forma basis after
giving effect to the Offerings and the Transactions, the Company's net worth
would have been approximately $144 million.

At or prior to the closing of the Offerings the Company will also enter
into the New Credit Facility with The Chase Manhattan Bank ("Chase"), as both
agent (the "Agent") and lender. Chase has the right to syndicate the New Credit
Facility to a group of lenders (together with Chase, the "Lenders"), but has
not, to date, identified any such group to the Company. The credit agreement for
the New Credit Facility (the "Credit Agreement") will permit the Company to
obtain revolving credit loans (the "Loans") and the issuance of letters of
credit ("Letters of Credit") in an aggregate amount not to exceed $75 million
(with a sublimit of $15 million for Letters of Credit) at any time outstanding
(the "Commitment"). The obligations of the Company under the Credit Agreement
will be unsecured. All outstanding Loans are due and payable on the date that is
four years from the date the Credit Agreement becomes effective. At the
Company's option, each Loan will bear interest at (i) the higher of the federal
funds effective rate plus one-half of 1% or Chase's prime rate or (ii) the rate
at which eurodollar deposits for one, two, three or six months (as selected by
the Company) are offered by the Agent in the interbank eurodollar market in the
amount of such Loan (the "Eurodollar Rate"). An additional margin ranging from
one-half of 1% to 1% shall be added to the Eurodollar Rate depending upon the
ratio of (i) total indebtedness of the Company to (ii) EBITDA of the Company for
the four consecutive fiscal quarters most recently ended minus dividends paid
during such four fiscal quarters (the "Debt to Adjusted EBITDA Ratio"). The
Company will also pay to the Lenders a fee on the unused portion of the
Commitment ranging from 0.20% to 0.35% and a fee for the issuance of Letters of
Credit ranging from 0.50% to 1.00%, in each case based on the Debt to Adjusted
EBITDA Ratio. In addition, Chase, as the issuer of each Letter of Credit, will
receive an additional issuance fee equal to 1/8 of 1% of the face amount of each
Letter of Credit. The Credit Agreement will contain covenants similar to those
contained in the Note Agreement, which, among other things, restrict the
Company's ability to incur additional indebtedness and to pay cash dividends
unless certain conditions are satisfied. The restriction on indebtedness will
permit the Company to incur additional debt only if the Company's total debt
outstanding at such time would not exceed 300% of the Company's EBITDA (as
defined in the Credit Agreement) for the most recent four consecutive quarters
most recently ended. In addition, the Credit Agreement will require that the
Company maintain a ratio of EBITDA (as defined in the Credit Agreement) to
interest expense of at least 3.0 times. At September 30, 1996, on a pro forma
basis after giving effect to the Offerings and the Transactions, the Company's
ratio of EBITDA (as defined in the Credit Agreement) to interest expense was
approximately 6.6.

To the extent that the Company is restricted from incurring additional
indebtedness under the Note Agreement or the New Credit Facility, the cash
available for use in its operations may be reduced.

Pursuant to the Contribution Agreement, SFR will retain the Production
Payment upon consummation of the Offerings. The Company's $30 million obligation
under the Production Payment represents in the aggregate approximately 20% of
1995 net sales proceeds from the Midway-Sunset field. Annual amortization of the
Production Payment represents 7% of 1995 net sales proceeds from the Midway-
Sunset field. It is anticipated, however, that the Production Payment will be
repaid promptly after the closing of the Offerings with borrowings under the New
Credit Facility.

The $19 million increase in accounts receivable and $12 million increase in
accounts payable from December 31, 1995 to September 30, 1996 were primarily due
to higher crude oil prices and certain transactions in the third quarter of 1996
which involved back-to-back purchases and sales of crude oil.

DIVIDENDS

The Company currently intends to pay to its stockholders a quarterly
dividend of $0.15 per share of Common Stock ($0.60 annually). The first dividend
is anticipated to be paid in April 1997 and will consist of a prorated dividend
(estimated to be $0.22) in respect of the Company's first partial quarter ending

32
<PAGE> 33

December 31, 1996 and for its first full quarter of operations ending March 31,
1997. Although the Company currently intends to pay quarterly dividends, the
determination of the amount of future cash dividends, if any, to be declared and
paid will depend upon declaration by the Company's board of directors and upon
the Company's financial condition, earnings and funds from operations, the level
of its capital and exploration expenditures, dividend restrictions contained in
the New Credit Facility and the Company Senior Notes, future business prospects
and such other matters as the Company's directors deem relevant. For a
description of certain restrictions on the Company's ability to pay dividends,
see "Description of Capital Stock -- Common Stock -- Dividends".

ENVIRONMENTAL MATTERS

Almost all phases of the Company's oil and gas operations are subject to
stringent environmental regulation by governmental authorities. Such regulation
has increased the costs of planning, designing, drilling, installing, operating
and abandoning oil and gas wells and other facilities. The Company has expended
significant financial and managerial resources to comply with such regulations.
These efforts include both an employee responsible for environmental compliance
and paid consultants who have evaluated known sites for which the Company may
face environmental liability and who monitor the Company's properties and waste
handling and disposal practices. All oilfield wastes are disposed of at
facilities authorized to accept such wastes. The Company's cost of compliance
with environmental regulations was $1.1 million in 1993, $0.6 million in 1994,
$1.0 million in 1995 and $1.5 million for the first nine months of 1996.
Although the Company believes its operations and facilities are in general
compliance with applicable environmental regulations, risks of substantial costs
and liabilities are inherent in oil and gas operations. It is possible that
other developments, such as increasingly strict environmental laws, regulations
and enforcement policies or claims for damages to property, employees, other
persons and the environment resulting from the Company's operations, could
result in significant costs and liabilities in the future. As it has done in the
past, the Company intends to fund its cost of environmental compliance from
operating cash flows.

INTERCOMPANY AGREEMENTS

As an operating division of SFR, the Western Division has been able to
utilize the administrative services and personnel of SFR's corporate offices,
including the services and personnel of SFR's data processing, accounting, tax
and legal departments. Prior to the closing of the Offerings, the Company and
SFR intend to enter into the Services Agreement pursuant to which SFR will, upon
the Company's request, continue to perform such administrative services in
return for reimbursement by the Company of SFR's costs incurred therefor.
Payments to SFR under the Services Agreement are expected to diminish as the
Company assumes full responsibility during 1997 for each of the services covered
by the Services Agreement. The Company anticipates that its general and
administrative costs will increase over 1995 levels to approximately $9 million
in 1997 as it assumes full responsibility for each of these services and
functions. Such increase is expected to include costs related to additional
salaries and benefits, investor reporting and communications, annual costs of
computer hardware and telecommunications systems, annual computer software
licenses and maintenance, separate insurance and other costs.

The net income generated by the Western Division has historically been
included in SFR's consolidated Federal and state returns. Although SFR's Federal
and state income tax liability has typically been substantially lower than the
Western Division's liability would have been had it not been included in SFR's
consolidated returns, the amounts reflected in the Company's Financial
Statements have been prepared as if the Western Division had been an independent
taxpayer. Pursuant to the Tax Allocation Agreement, the Company will agree with
SFR that from and after the closing of the Offerings and continuing for so long
as the Company is included in SFR's consolidated group, the Company will pay to
SFR an amount approximating the Federal, state and local tax liability it would
have paid if the Company were not included in SFR's consolidated group. If the
Spin Off is effected or the Company otherwise ceases to be a member of SFR's
affiliated group, the Company will file separate Federal and state tax returns.

33
<PAGE> 34

During 1995, SFR elected for Federal income tax purposes to capitalize,
rather than expense, the intangible drilling costs attributable to the Western
Division's operations (which aggregated $22 million during 1995), which costs
are deductible ratably over the next 60 months. As a result of that election,
the net taxable income attributable to the operations of the Western Division is
higher than it would have been had such costs been expensed. SFR has advised the
Company that, so long as the Company remains a member of SFR's affiliated group,
SFR intends to continue to elect to capitalize intangible drilling costs
attributable to the Company's operations. That election will result in higher
net taxable income generated by the Company's operations and, therefore, a
larger payment to SFR under the Tax Allocation Agreement than would have been
generated and paid had such costs been expensed, although the Company's net
taxable income and payments for future periods will be reduced by a similar
amount to the extent that capitalized costs are deducted during such periods.
After the Company ceases to be a member of SFR's affiliated group, the Company
intends to elect to expense similar costs thereafter incurred.

In addition to the Services Agreement and Tax Allocation Agreement, at or
prior to the closing of the Offerings, the Company will enter into the
Registration Rights Agreement (pursuant to which SFR will have the right to
require that its shares of Common Stock be registered for sale), the
Contribution Agreement (pursuant to which the assets of the Western Division
will be contributed to the Company) and the Spin Off Tax Indemnity Agreement
(pursuant to which the Company will agree to indemnify SFR for costs incurred in
the event that actions taken by the Company result in the Spin Off being
taxable). Although the Company has no intention to take any actions that would
result in an indemnity payment becoming due under the Spin Off Tax Indemnity
Agreement, as described under "Risk Factors -- Intended Spin Off by SFR", the
Company believes that if it is required to make a payment pursuant to such
Agreement, the amount of such payment would have a material adverse effect on
the Company's financial condition. For a description of such contractual
arrangements see "Relationship Between the Company and SFR".

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<PAGE> 35

BUSINESS

GENERAL

The Company is an independent oil and gas company engaged in the
production, development and acquisition of oil and natural gas in the State of
California. As of September 1, 1996 the Company had net proved reserves of
approximately 214 MMBOE with a pre-tax net present value, discounted at 10%, of
approximately $750 million, according to estimates prepared by Ryder Scott. In
1995, the Company's operations generated total revenues of approximately $211
million, EBITDA of approximately $108 million and net income of approximately
$34 million. During the nine months ended September 30, 1996, the Company's
average production was approximately 47 MBOE per day, resulting in a
reserve-to-production ratio of 12.5 years.

The Company was formed in August 1996 to own the properties and conduct the
business of the Western Division of SFR following a determination by SFR's board
of directors to separate SFR's operations into two independent companies. The
SFR board made this determination because SFR's oil and gas operations have
developed, over time, into separate businesses that operate independently and
have diverging capital requirements and risk profiles. In addition, the board
believes that separating SFR's operations into two independent companies will
allow each to more efficiently develop its distinct resource base and pursue
separate business opportunities while providing each with improved access to
capital markets. While the Company will focus its efforts on exploitation
opportunities on its California properties, SFR has advised the Company that SFR
intends to focus on developing and exploiting its properties outside of
California and pursuing acquisition and exploration opportunities in other areas
of the United States and abroad. The Offerings and the other transactions to be
effected at or prior to the closing of the Offerings are the initial phase of
the separation of these two businesses. Immediately after the Offerings are
consummated, SFR will own approximately 85% of the outstanding Common Stock. The
second phase of the separation will involve the distribution to the common
stockholders of SFR of the shares of Common Stock owned by SFR following the
Offerings. See "-- Transactions at Closing" and "-- Relationship Between the
Company and SFR -- Intended Spin Off by SFR".

The Company owns and operates properties in four major oil producing fields
located in the San Joaquin Valley of California: Midway-Sunset, Kern River,
South Belridge and Coalinga. These fields are among the most prolific oil fields
in the United States, particularly the Midway-Sunset, Kern River, and South
Belridge fields which are the three largest producing oil fields in the lower 48
states. The Midway-Sunset field accounted for approximately 78% of the Company's
total proved reserves at September 1, 1996 and 74% of its average daily
production for the first nine months of 1996. An additional 18% of the Company's
total proved reserves as of September 1, 1996, and 21% of its average daily
production for the first nine months of 1996 were attributable to the Kern
River, South Belridge and Coalinga fields. The Company initiated production from
the San Joaquin Valley fields in 1905 and nearly all of the reserves in these
fields have been characterized by low gravity and high viscosity or "heavy" oil,
the production of which depends primarily on thermally enhanced recovery
techniques. The Company holds an interest in approximately 16,000 gross acres in
these fields with an average working interest in these properties of
approximately 99%.

35
<PAGE> 36

The Company seeks to accelerate its growth in both production and reserves
through an active development program which concentrates on the use of heat
(typically in the form of steam) to reduce the viscosity and increase the
producibility of its reserve base. During the five years ended December 31,
1995, the Company spent a total of $176 million (an average of $35 million per
year) on development activities on its properties. Cumulative production from
the Company's properties during the same five year period exceeded 78 MMBOE
while additions to proved reserves exceeded 97 MMBOE (yielding 19 MMBOE net
additions after production). The table set forth below demonstrates the growth
in the Company's proved reserve base, as estimated by Ryder Scott:

<TABLE>
<CAPTION>
PROVED RESERVES
---------------------------------------------------------
DECEMBER 31,
---------------------------------------- SEPTEMBER 1,
1991 1992 1993(1) 1994 1995 1996
---- ---- ---- ---- ---- ------------
<S> <C> <C> <C> <C> <C> <C>
Crude oil (MMBbls)................ 183 190 184 191 200 212
Natural gas (BCF)................. 22 19 12 13 12 12
Total (MMBOE)........... 187 193 186 193 202 214
</TABLE>

- ---------------

(1) The reduction in proved reserves in 1993 primarily reflects the sale of the
Western Division's interests in certain properties containing estimated
proved reserves of approximately 5.7 MMBOE.

Based on reservoir engineering studies prepared by Ryder Scott, the Company
believes that it can continue to make significant additions to proved reserves
on its properties through additional EOR and development projects, and the
Company has developed a large inventory of such projects from which it expects
to make such additions. The Company anticipates spending approximately $46
million during 1996 (of which $35 million has been expended through September
30, 1996) and $68 million during 1997 on additional development projects on its
properties. Because the actual amounts expended in the future and the results
therefrom will be influenced by numerous factors, including many beyond the
Company's control, and due to the inherent uncertainty of reservoir engineering
studies, no assurances can be given as to the amounts that will be expended or,
if expended, that the results therefrom will be consistent with the Company's
prior experience or expectations. See "Business -- Development Activities".

STRATEGY

The Company's strategy is to efficiently and consistently increase its
production rates and proved reserves while maximizing total return to
stockholders. The Company intends to achieve its objectives by developing its
existing fields through the deployment of advanced production techniques, by
pursuing reserve acquisition opportunities which are consistent with its
geographic and operational strengths, by maintaining a dividend policy that will
provide a significant current return to stockholders. Key elements of the
Company's strategy include:

ACCELERATED EXPLOITATION PROGRAM. The Company plans to increase its
investment in relatively low-risk development and infill drilling opportunities
in its existing fields in order to maximize production and reserves over the
long-term. During the five years ended December 31, 1995, the Company completed
1,064 well operations (which include development and injection wells, workovers
and recompletions), of which 1,062 were successful. These operations contributed
to proved reserve additions of approximately 97 MMBOE at an average finding cost
of $2.32 per BOE. Reserve additions in 1995 totaled approximately 24 MMBOE, more
than 150% of production for the year. The Company expects to complete more than
300 well operations in each of 1996 and 1997 with budgeted capital expenditures
during such years of approximately $51 million and $68 million, respectively.
The Company believes that its sizable project inventory will allow it to
continue to increase its production and reserves over the next several years.

36
<PAGE> 37

day) per well compared to an average of 20 Bbls per day from the Company's
conventional vertical wells, although there can be no assurance that such rates
can be sustained in the future. The Company expects to complete 45 additional
horizontal wells by the end of 1997 at an expected capital cost of approximately
$20 million, although the actual number of horizontal wells drilled could be
increased or decreased based upon the results realized from the horizontal wells
completed. While horizontal drilling has only recently been employed in the
Company's operations, the Company believes that this technology represents a
significant opportunity for more cost effective development, increased reserves
and increased production and total recovery rates from its properties.

SIGNIFICANT DIVIDEND PAYOUT. Following the Offerings, the Company intends
to maintain a dividend policy that will provide a significant return to
stockholders. The Company intends to pay dividends at a rate of $0.60 per share
per annum to the holders of Common Stock (representing a yield of 4.1% at the
initial public offering price of $14.50 per share). However, the actual amount
of future dividends declared and paid, if any, will depend upon the declaration
of same by the Company's board of directors and upon the Company's financial
condition, earnings and funds from operations, the level of its capital and
exploration expenditures, dividend restrictions contained in its financing
agreements, its future business prospects and such other matters as the
directors of the Company may deem relevant.

APPLICATION OF ADVANCED TECHNOLOGIES. The Company will continue to utilize
its growing technology base, including increasing use of 3-D seismic surveys,
water floods, thermal EOR techniques, new fracturing techniques and reservoir
modeling. The Company believes that 3-D seismic techniques may identify
significant additional reserves and is currently negotiating a joint venture
with Chevron U.S.A., Inc. to conduct a 3-D seismic survey of certain properties
in the Midway-Sunset field. The Company has extensive experience with EOR
techniques and has conducted steamflood operations on its properties since the
1960s. The Company has improved its thermal EOR techniques over time and is
currently focusing on efficient reservoir heat management techniques which are
intended to optimize recoveries and minimize fuel costs. The Company believes
that its expertise in utilizing advanced technologies will allow it to identify
and recover additional reserves in its existing properties.

37
<PAGE> 38

production; (ii) reduced oil supplies to California from the Alaskan North Slope
(which provided 60% of the crude oil consumed by refiners in California during
1995) resulting from a decline in production and the initiation of sales to
foreign markets; and (iii) the availability of new transportation systems which
enable San Joaquin producers to sell crude oil outside California. The Company
believes that California's growing energy demand and declining crude oil supply,
together with other market factors, have contributed to the increase in average
posted prices for the Midway-Sunset field (for heavy crude) from $12.08 per Bbl
in 1991 to $15.25 per Bbl for the first nine months of 1996. In addition, the
spread between the West Texas Intermediate ("WTI") posted price (for light
crude) and the Midway-Sunset field posted price (for heavy crude) has declined
from $8.12 per Bbl in 1991 to $4.37 per Bbl for the first nine months of 1996.
There can be no assurances, however, with respect to future Midway-Sunset field
posted prices for crude oil or the future spread between WTI and Midway-Sunset
posted prices.

DEVELOPMENT ACTIVITIES

The Company is engaged in development activities primarily through the
application of thermal EOR techniques on its heavy oil properties in the San
Joaquin Valley. Thermal EOR operations involve the injection of steam into a
reservoir to raise the temperature and reduce the viscosity of heavy oil,
facilitating the flow of the oil into producing wellbores. The Company has
conducted thermal EOR projects in the San Joaquin Valley since the mid-1960s and
employs two principal techniques: cyclic steam stimulation, which involves the
injection of steam through a wellbore for a period of days or weeks after which
the same wellbore is used to produce oil, typically for a period of weeks or
months; and steam flooding, a process by which steam is injected into the center
of a well pattern and oil is produced from surrounding producing wells. The
Company has also employed a third technique, referred to as insitu combustion,
in which air is injected into a dedicated wellbore, a combustion zone is
established within a reservoir to heat the oil and reduce its viscosity and oil
is produced from surrounding wellbores. In addition to these thermal techniques,
the Company has extensive experience in the use of waterfloods, which involves
the injection of water into a reservoir to drive hydrocarbons into producing
wellbores.

In addition to the thermal and waterflood development techniques described
above, the Company has recently begun to utilize horizontal drilling and 3-D
seismic surveys. The Company has drilled six horizontal wells in the
Midway-Sunset field during the first nine months of 1996, which are producing at
rates ranging from 80 to 400 Bbls per day (an average of 150 Bbls per day) per
well, compared to an average of 20 Bbls per day from the Company's vertical
wells, although there can be no assurance that such rates can be sustained in
the future. The Company plans to drill 45 additional horizontal wells by the end
of 1997 at an expected cost of approximately $20 million, although the actual
number of horizontal wells drilled could be increased or decreased based on the
results realized from the horizontal wells completed. While horizontal wells are
more expensive to drill than vertical wells, the Company believes that its
experience to date demonstrates both that horizontal wells are capable of
producing in excess of the 20 Bbl per day levels typical of vertical wells in
the area and that horizontal wells will enable the Company to find and produce
reserves which would not have been recovered using conventional vertical well
techniques. Accordingly, the Company believes that horizontal drilling
represents an opportunity to significantly reduce the cost and improve the
efficiency of its development efforts. In addition to undertaking its horizontal
drilling program, the Company is currently negotiating a joint venture with
Chevron USA, Inc. to develop a 3-D seismic survey of certain properties in the
Midway-Sunset field. The Company believes that 3-D seismic techniques may
identify significant additional reserves.

38
<PAGE> 39

SIGNIFICANT PRODUCING PROPERTIES

The following table sets forth information with respect to the most
significant producing properties of the Company, which are described in more
detail following such table. Each of the Midway-Sunset, Kern River, South
Belridge and Coalinga fields is commonly referred to as a "giant" field because
of the presence of ultimate producible reserves in excess of 100 MMBOE.

<TABLE>
<CAPTION>
NET PROVED
PRODUCTION(1) RESERVES(2)
-------------------------------------------- ---------------------------------------
OIL GAS TOTAL PERCENTAGE OIL GAS TOTAL PERCENTAGE
FIELD OR OPERATIONS AREA (MBBLS/D) (MMCF/D) (MBOE/D) OF TOTAL (MMBBLS) (BCF) (MMBOE) OF TOTAL
- ------------------------------------------ -------- -------- ---------- -------- ----- ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Midway-Sunset.................... 34 2 35 74 166 8 167 78
Kern River....................... 5 1 5 10 19 -- 19 9
South Belridge................... 3 1 3 6 14 4 15 7
Coalinga......................... 2 -- 2 5 4 -- 4 2
Other (primarily LA Basin)....... 2 -- 2 5 9 -- 9 4
-- -- -- --
--- --- --- ---
Total producing properties... 46 4 47 100 212 12 214 100
== == == === === == === ===
</TABLE>

- ---------------

(1) Average daily production rates during the first nine months of 1996.

(2) As of September 1, 1996.

MIDWAY-SUNSET. The Company owns and operates a 100% working interest (96%
average net revenue interest) in over 13,000 gross acres and 2,300 producing
wells in the Midway-Sunset field. The Company is currently the largest producer
in the field and has operated there continuously since 1905. With field-wide
production rates of approximately 166 MBbls per day, the Midway-Sunset field is
the largest producing oil field in the lower 48 states and has produced in
excess of 2 billion barrels of oil. Substantially all of the oil produced from
the Midway-Sunset field is heavy crude oil located in the Pleistocene and
Miocene reservoirs at depths of less than 2,000 feet. Producing formations
include (in order of increasing depth) the Tulare and Etchegoin formations as
well as the Potter, Spellacy and Diatomite horizons of the Monterey formation.
During the first nine months of 1996, the Midway-Sunset field accounted for
approximately 74% of the Company's crude production. As of September 1, 1996,
the Company's total proved reserves in the Midway-Sunset field were
approximately 167 MMBOE, or approximately 78% of its total proved reserves.

Despite being in continuous production since 1905, the Company's
Midway-Sunset properties have produced at record levels in the first nine months
of 1996. These production rates are the result of development activities using
cyclic steam injection, steamflood, in situ combustion and horizontal drilling
operations, which have increased net daily production from approximately 24
MBbls per day in early 1990 to in excess of 35 MBbls per day by September 1996.
The Company has focused most of its development efforts and technology on the
Potter horizon which has demonstrated approximately 5.1% compounded annual
growth in production rates from 1990 through September 30, 1996. Capital
expenditures for development in the Midway-Sunset field have averaged $20
million over the six-year period from 1990 through 1995. Since May 1995, the
Company has drilled seven horizontal wells in the Midway-Sunset field, which are
currently producing at rates ranging from 80 to 400 Bbls per day (an average of
150 Bbls per day) per well. The Company plans to drill 40 additional horizontal
wells in this field by the end of 1997.

Despite record levels of production, the Company believes, based on
reservoir engineering studies prepared by Ryder Scott, that it can continue to
make significant additions to its proved reserves in this field through
additional EOR and development projects. While most of the Company's EOR efforts
in this field have concentrated on the Potter horizon, the Company believes that
these techniques may generate similar production and reserve additions in each
of the Spellacy, Tulare and Diatomite horizons. The Company has identified in
excess of 1,300 well operations that could be undertaken in the field and
anticipates completing 250 of these operations in 1996 and 300 in 1997 at an
estimated capital cost of $35 million and $51 million, respectively.

39
<PAGE> 40

KERN RIVER. The Company owns and operates a 100% working interest (91%
average net revenue interest) in four properties in the Kern River field,
located near Bakersfield, California. The Company acquired its interest in the
Kern River field in 1905. With field-wide production rates of approximately 138
MBbls per day, the Kern River field is the second largest producing oil field in
the lower 48 states and has produced in excess of 1.5 billion barrels of oil.
Most of the oil produced from the Kern River field is heavy crude oil produced
from Plio-Pleistocene reservoirs at depths of less than 1,000 feet. During the
first nine months of 1996, the Kern River field accounted for approximately 10%
of the Company's total crude production. As of September 1, 1996, the Company's
total proved reserves in the Kern River field were approximately 19 MMBOE, or
approximately 9% of its total proved reserves.

The Company's production from the Kern River field has increased from
approximately 2 MBbls per day in 1990 to approximately 5 MBbls per day in the
first nine months of 1996. Capital expenditures over the same period of time
have increased from $2 million in 1991 to a projected $5 million in 1996.

As with the Midway-Sunset field, management believes, based on engineering
studies prepared by Ryder Scott, that the Company can continue to make
significant additions to its proved reserves in the Kern River field through
additional thermal development projects. The Company has identified 128 well
operations (including two horizontal wells) that could be undertaken in the
field and anticipates completing 49 of these operations in 1996, and 20 in 1997,
at an estimated capital cost of $5 million and $2 million, respectively.

SOUTH BELRIDGE. The Company has a 46% average working interest (40% average
net revenue interest) in its properties in the South Belridge field, which is
located 15 miles north of the Midway-Sunset field. The Company acquired
interests in the South Belridge field in 1987 and expanded its holdings in 1991.
With production of approximately 110 MBbls per day, the South Belridge field is
the third highest producing oil field in the lower 48 states and has produced in
excess of one billion barrels of oil. The oil in the South Belridge field is
heavy and intermediate crude that is produced from Tulare, Etchegoin and
Diatomite formations equivalent to those found in the Midway-Sunset field,
generally at depths of less than 2,000 feet. During the first nine months of
1996, the South Belridge field accounted for approximately 5% of the Company's
total crude production. As of September 1, 1996, the Company's total proved
reserves in the South Belridge field were approximately 15 MMBOE, or
approximately 7% of its total proved reserves.

The Company has identified 83 additional drilling and remediation projects
(including one horizontal well) in the South Belridge field and anticipates
completing 40 of the projects by the end of 1997 at an estimated cost of
approximately $3 million.

COALINGA. The Company has a 100% average working interest (84% average net
revenue interest) in its properties in the Coalinga field which is located 55
miles southwest of Fresno, California. Total field-wide production from Coalinga
has exceeded 800 million barrels with total current production of approximately
26 MBbls per day. During the first nine months of 1996, the Coalinga field
accounted for approximately 5% of the Company's crude production. As of
September 1, 1996, the Company's total proved reserves in the Coalinga field
were approximately 4 MMBOE, or approximately 2% of its total proved reserves.

The Company acquired its interest in the Coalinga field in 1977. The
Company has identified 104 additional drilling and remediation projects
(including two horizontal wells) in the Coalinga field and anticipates
completing 48 of the projects by the end of 1997 at an estimated cost of
approximately $4 million.

LA BASIN. The Company has an average 30% working interest (24% average net
revenue interest) in four producing properties in Los Angeles and Orange
Counties in California (the "LA Basin"). During the first nine months of 1996,
the Company's LA Basin properties accounted for approximately 5% of the
Company's total crude production. As of September 1, 1996, the Company's total
proved reserves in the LA Basin were approximately 8 MMBOE, or approximately 4%
of its total proved reserves. The Company's LA Basin properties include a 69%
working interest (51% net revenue interest) in the Santa

40
<PAGE> 41

Fe Springs field which was acquired in May 1996. As of September 1, 1996,
production from this interest was 2,040 Bbls per day (1,100 Bbls per day net).

RESERVES

The following table sets forth information regarding changes in Ryder
Scott's estimates of proved net reserves from January 1, 1992 to September 1,
1996.

<TABLE>
<CAPTION>
NET
PURCHASES CHANGES IN
BALANCE AT REVISIONS (SALES) OF OWNERSHIP BALANCE
BEGINNING OF PREVIOUS IMPROVED MINERALS IN AT END
OF PERIOD ESTIMATES RECOVERY IN PLACE PARTNERSHIP PRODUCTION OF PERIOD
---------- ----------- -------- ---------- ----------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Proved reserves, for year
ended:
December 31, 1992
Oil and condensate
(MMBbls)................ 183 9 13 -- -- (15) 190
Natural gas (Bcf)......... 22 -- -- -- -- (3) 19
Oil equivalent (MMBOE).... 187 9 13 -- -- (16) 193
December 31, 1993
Oil and condensate
(MMBbls)................ 190 (14) 27 (4) 1 (16) 184
Natural gas (Bcf)......... 19 -- -- (5) -- (2) 12
Oil equivalent (MMBOE).... 193 (14) 27 (5) 1 (16) 186
December 31, 1994
Oil and condensate
(MMBbls)................ 184 10 12 -- -- (15) 191
Natural gas (Bcf)......... 12 2 -- -- -- (1) 13
Oil equivalent (MMBOE).... 186 10 12 -- -- (15) 193
December 31, 1995
Oil and condensate
(MMBbls)................ 191 10 14 -- -- (15) 200
Natural gas (Bcf)......... 13 1 -- -- -- (2) 12
Oil equivalent (MMBOE).... 193 10 14 -- -- (15) 202
September 1, 1996(1)
Oil and condensate
(MMBbls)................ 200 8 13 2 -- (11) 212
Natural gas (Bcf)......... 12 1 -- -- -- (1) 12
Oil equivalent (MMBOE).... 202 8 13 2 -- (11) 214
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER
------------------------------------ 1,
1991 1992 1993 1994 1995 1996
---- ---- ---- ---- ---- -----------
<S> <C> <C> <C> <C> <C> <C>
Proved developed reserves (MMBOE)................. 149 157 142 142 159 169
</TABLE>

- ---------------

(1) For the eight-month period beginning January 1, 1996.

Historically, the Company has utilized active development and exploration
programs as well as selected acquisitions to replace its reserves depleted by
production. The Company has increased its proved reserves (net of production and
sales) by approximately 6% over the five years ended December 31, 1995.
Substantially all of such increases are attributable to proved reserve additions
from the Company's producing oil properties in the San Joaquin Valley of
California and acquisitions of oil and gas reserves.

Ryder Scott, a firm of independent petroleum engineers, prepared the above
estimates of the Company's total proved reserves as of December 31, 1992 through
1995 and as of September 1, 1996.

41
<PAGE> 42

As of September 1, 1996, approximately 21% of the Company's total proved
reserves was classified as proved undeveloped reserves.

The standardized measure of discounted future net cash flows (after income
taxes) relating to proved reserves for the Company as of December 31, 1995 was
$426 million ($654 million before income taxes). The discounted future net cash
flows (before income taxes) relating to proved reserves for the Company as of
September 1, 1996 was $750 million.

In accordance with the Commission's guidelines, Ryder Scott's estimate of
standardized measure of discounted future net cash flows from the Company's
properties has been made using oil and natural gas sales prices in effect as of
the date of such estimate and have been held constant throughout the life of the
properties except where such guidelines permit alternate treatment, including
the use of fixed and determinable contractual price escalations. Prices for
natural gas, natural gas liquids and crude oil are subject to substantial
fluctuations as a result of numerous other factors. The standardized measure of
discounted future net cash flows relating to proved reserves should not be
construed as the current market value of estimated natural gas, natural gas
liquids and crude oil reserves. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".

There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and timing of
development expenditures, including many factors beyond the control of the
Company. The reserve data set forth herein represent estimates only. Reserve
engineering is a subjective process of estimating underground accumulations of
crude oil and natural gas that cannot be measured in an exact manner, and the
accuracy of any reserve estimate is a function of the quality of available data
and of engineering and geological interpretation and judgment. See "Risk
Factors -- Uncertainties in Estimates of Proved Reserves".

During 1995 SFR filed Energy Information Administration Form 23 which
reported natural gas and oil reserves for the year 1994. The reserve estimates
reported on Form 23 are not comparable with the reserve estimates reported
herein because Form 23 required that reserves be reported on a gross operated
basis rather than on a net interest basis. On an equivalent barrel basis, the
reserve estimates for the year 1994 contained in such report and those reported
herein for the year 1994 do not differ by more than five percent.

DEVELOPMENT, EXPLORATION AND ACQUISITION EXPENDITURES

The following table shows the Company's total oil and gas development,
exploration and acquisition expenditures since the beginning of 1991 through
December 31, 1995 and budgeted development and exploration expenditures for
1996. Actual exploration and development expenditures in 1996 may vary
materially from the budgeted amounts set out below because such expenditures are
based upon factors beyond the Company's control, such as the success or failure
of drilling activities and industry and market conditions.

<TABLE>
<CAPTION>
BUDGETED
HISTORICAL YEAR ENDED DECEMBER 31, YEAR ENDING
-------------------------------------------- DECEMBER 31,
1991 1992 1993 1994 1995 1996
---- ---- ---- ---- ---- ------------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Development costs(1)........... $54 $17 $38 $23 $48 $ 46
Exploration costs.............. 3 3 2 1 3 2
Acquisition costs:
Unproved leasehold........... -- -- -- -- -- --
Proved properties............ 29 -- 4 -- 1 3
--- --- --- --- --- ---
Total costs.......... $86 $20 $44 $24 $52 $ 51
=== === === === === ===
</TABLE>

- ---------------

(1) Development expenditures include costs of EOR projects, infill drilling and
primary development drilling of offset wells.

42
<PAGE> 43

The foregoing table reflects all acquisition, exploration and development
expenditures (including capitalized interest and allocated exploratory support
costs), whether capitalized or charged to expense. Capitalized interest for the
years ended December 31, 1991, 1992, 1993, 1994 and 1995 was $0.3 million, $0.1
million, $0.3 million, $0.6 million and $0.7 million, respectively. Through
September 30, 1996, the Company has spent $40 million on all such expenditures.
Capitalized interest for the same period is estimated to be $0.9 million.

ACQUISITION ACTIVITIES

The Company continually evaluates acquisitions of producing and
non-producing oil and gas properties that would add to its reserve base and
present additional development opportunities at attractive prices. From 1994
through the third quarter of 1996, the Company spent approximately $4 million in
3 transactions to purchase an estimated 4.4 MMBOE of proved oil and gas reserves
in California. Although the Company may pursue opportunities in other areas, the
Company plans to focus primarily on areas contiguous with, or in close proximity
to, its existing operations. Future acquisitions will depend upon, among other
things, the availability of opportunities to purchase reserves that would
complement the Company's existing properties and that would meet or exceed the
Company's economic criteria with respect to, among other things, cost of reserve
additions, the availability of funding on acceptable terms and other projects to
which the Company may be committed that would compete with the personal or
capital resources required to be dedicated to a particular acquisition
opportunity.

DRILLING ACTIVITIES

The table below sets forth, for the periods indicated, the number of wells
drilled in which the Company had an economic interest. As of September 30, 1996,
no wells were in progress.

<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED
------------------------------------------------- SEPTEMBER 30,
1993 1994 1995 1996
------------- ------------- ------------- --------------
GROSS NET GROSS NET GROSS NET GROSS NET
----- --- ----- --- ----- --- ----- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Development wells:
Completed............ 170 152 78 70 222 208 188 183
Dry holes............ 1 1 1 1 -- -- 2 2
--- --- -- -- --- --- --- ---
Total........ 171 153 79 71 222 208 190 185
--- --- -- -- --- --- --- ---
Exploration wells:
Completed............ -- -- -- -- -- -- -- --
Dry holes............ -- -- -- -- 3 3 1 --
--- --- -- -- --- --- --- ---
Total........ -- -- -- -- 3 3 1 --
--- --- -- -- --- --- --- ---
Total.................. 171 153 79 71 225 211 191 185
=== === == == === === === ===
</TABLE>

The number of wells drilled may not be a valid measure or indicator of the
relative success or value of a drilling program because the significance of the
reserves and their economic potential may vary widely for each property and
well.

PRODUCING WELLS

The following table sets forth the Company's ownership in producing wells
at September 30, 1996:

<TABLE>
<CAPTION>
TOTAL PRODUCING
WELLS
-----------------
GROSS NET
----- -----
<S> <C> <C>
Oil............................................................... 5,560 4,995
Natural gas....................................................... 2 --
----- -----
Total................................................... 5,562 4,995
===== =====
</TABLE>

43
<PAGE> 44

PRODUCTION AND PRICES

The following table sets forth certain information regarding the Company's
volumes of production and sales prices during the years 1993, 1994 and 1995 and
the nine months ended September 30, 1995 and September 30, 1996:

<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- --------------
1993 1994 1995 1995 1996
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Average daily production:
Crude oil and liquids production (MBbls/d)........ 43 41 42 41 46
Natural gas production (MMcf/d)................... 6 4 5 5 4
Total production (MBOE)........................... 44 42 43 42 47
Crude oil and liquids average sales price ($/Bbl)
Unhedged....................................... 11.63 11.53 13.50 13.75 15.33
Hedged......................................... 11.63 11.53 13.50 13.79 15.08
Natural gas average sales price ($/Mcf)............. 1.59 1.14 0.98 1.02 1.00
</TABLE>

ACREAGE

The following table summarizes the Company's developed and undeveloped fee
and leasehold acreage at September 30, 1996. Excluded from such information is
acreage in which the Company's interest is limited to royalty, overriding
royalty and other similar interests.

<TABLE>
<CAPTION>
DEVELOPED UNDEVELOPED TOTAL
---------------- -------------- ----------------
FIELD GROSS NET GROSS NET GROSS NET
-------------------------------- ------ ------ ----- ----- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Midway-Sunset................... 12,795 12,787 320 320 13,115 13,107
Kern River...................... 595 595 -- -- 595 595
South Belridge.................. 919 710 -- -- 919 710
Coalinga........................ 1,474 1,474 -- -- 1,474 1,474
LA Basin........................ 1,342 1,342 234 234 1,576 1,576
Other........................... 19,816 4,610 6,053 6,053 25,869 10,663
------ ------ ----- ----- ------ ------
Total................. 36,941 21,518 6,607 6,607 43,548 28,125
====== ====== ===== ===== ====== ======
</TABLE>

CURRENT MARKETS FOR OIL AND GAS

The Company's profitability is determined in large part by the difference
between the prices received for the oil and natural gas that it produces and the
costs of finding, developing and producing such reserves. Prices for oil and
natural gas have been subject to wide fluctuations, which continue to reflect
imbalances in supply and demand as well as other market conditions and the world
political situation as it affects OPEC, the Middle East, the former Soviet Union
and other producing countries. Moreover, the price of oil and natural gas may be
affected by the price and availability of alternative sources of energy, weather
conditions and the general state of the economy. Even relatively modest changes
in oil and natural gas prices may significantly change the Company's revenues,
results of operations, cash flows and proved reserves. Based on operating
results for the first nine months of 1996, the Company estimates that on an
annualized basis a $1.00 per barrel increase (or decrease) in its average crude
oil sales price would result in a $17 million increase (or decrease) in income
from operations, a $10 million increase (or decrease) in net income and a $10
million increase (or decrease) in cash flow from operating activities. Because
the Company is a relatively small producer of natural gas, it consumes more gas
in its EOR operations than it produces. As a result, an increase in natural gas
prices adversely affects the Company's results of operations. Based on operating
results for the first nine months of 1996, the Company estimates that on an
annualized basis a $0.10 per Mcf increase (or decrease) in the average domestic
natural gas sales price would result in a $2 million decrease (or increase) in
income from operations, a $1 million decrease (or increase) in net income and a
$1 million decrease (or increase) in

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<PAGE> 45

cash flow from operating activities. The foregoing estimates do not give effect
to changes in any other factors, such as the effect of the Company's hedging
program or depreciation and depletion, that would result from a change in oil
and natural gas prices. See "Risk Factors -- Effects of Changing Oil and Gas
Prices".

The market for heavy crude oil produced in California differs substantially
from the remainder of the domestic crude oil market, due principally to the
transportation and refining requirements associated with heavy crude. Although
the prices realized for heavy crude oil are generally lower than those realized
from the sale of light crude oil, several economic trends have favorably
affected the market for the Company's production in recent years. See
"-- Strategy". In addition to the current favorable economic trends in
California heavy crude prices, the Company has facilities in place that it
believes will allow it to adapt to changes in pricing trends to a greater extent
than many of its competitors. For example, the Company owns and operates a large
gathering, blending and transportation system on its properties in the San
Joaquin Valley. At this terminal up to 30 MBbls of heavy oil per day can be
mixed or blended with lighter grades, a capability which enables the Company to
upgrade the majority of its heavy oil into a lighter crude which can be sold at
a higher price. The terminal also directly connects the Company's production
with five major pipelines serving refineries throughout California and gives the
Company the ability to meet the product specifications of multiple pipelines and
inter- and intra-state markets.

From time to time the Company has hedged a portion of its oil and natural
gas production to manage its exposure to volatility in prices of oil and natural
gas. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- General" for a discussion of the Company's hedging
activities.

CUSTOMERS

For the first nine months of 1996, affiliates of Shell Oil Company
("Shell") and Celeron Corporation ("Celeron") accounted for approximately 39%
and 28%, respectively, of the Company's crude oil and liquids sales (which with
respect to certain properties includes royalty and working interest owners'
share of production). The Company has sales contracts with several customers,
including Shell and Celeron, which generally provide for sales of the Company's
crude oil and liquids at market responsive prices and are cancellable by either
party thereto upon short notice (generally 60 days or less). Because the
Company's markets are characterized by a number of potential customers who are
willing to purchase the Company's crude oil and liquids at market responsive
prices, the Company does not believe that the loss or cancellation of its
contracts with Shell or Celeron would have a material adverse effect on its
financial condition or results of operations. No other individual customer
accounted for more than 10% of the Company's crude oil and liquids revenues
during 1995. Substantially all of the Company's oil production is currently sold
at market prices that approximate posted field prices. Availability of a ready
market for the Company's oil production depends on numerous factors, including
the level of consumer demand, the level of worldwide oil production, the cost
and availability of alternative fuels, the availability of refining capacity,
the cost of and proximity of pipelines and other transportation facilities,
regulation by state and federal authorities and the cost of complying with
applicable environmental regulations.

OTHER BUSINESS MATTERS

COMPETITION

The Company faces competition in all aspects of its business, including,
but not limited to, acquiring reserves, leases, licenses and concessions;
obtaining goods, services and labor needed to conduct its operations and manage
the Company; and marketing its oil and gas. The Company's competitors include
multinational energy companies, other independent producers, oil and gas
syndication programs and individual producers and operators. Many competitors
have greater financial and other resources than the Company, more favorable
exploration prospects and ready access to more favorable markets for their
production. The Company believes that the well-defined nature of the reservoirs
in its long-lived oil fields, its expertise in EOR methods, its extensive fee
and leasehold acreage position, its regional focus, its

45
<PAGE> 46

active development position and its experienced management may give it a
competitive advantage over some other producers, and management believes that
the Company effectively competes in its markets. Availability of a ready market
for the Company's oil and gas production depends on numerous factors, including
the level of consumer demand, the extent of worldwide oil production, the cost
and availability of alternative fuels, the cost of and proximity of pipelines
and other transportation facilities, regulation by state and federal authorities
and the cost of complying with applicable environmental regulations.

REGULATION OF CRUDE OIL AND NATURAL GAS PRODUCTION

The petroleum industry is subject to various types of regulation, including
regulation by state and Federal agencies. State and federal legislation
affecting the oil and gas industry is under constant review for amendment or
expansion, frequently increasing the regulatory burden. Also, numerous
departments and agencies, both Federal and state, are authorized by statute to
issue and have issued rules and regulations binding on the oil and gas industry
and its individual members, compliance with which is often difficult and costly
and which may carry substantial penalties for non-compliance. State statutes and
regulations require permits for drilling operations, drilling bonds and reports
concerning operations. The states in which the Company operates also have
statutes and regulations governing conservation matters, including the
unitization or pooling of oil and gas properties and rates of production from
oil and gas wells. The Company does not appear to be affected by these burdens
to any greater or lesser extent than other companies in the industry with
similar types and amounts of production. Set forth below is a general
description of certain Federal and state regulations which have an effect on the
Company's operations.

A portion of the Company's oil and gas leases are granted by the federal
government and administered by the Bureau of Land Management ("BLM") and the
Minerals Management Service ("MMS"), both of which are Federal agencies. Such
leases are issued through competitive bidding, contain relatively standardized
terms and require compliance with detailed BLM and MMS regulations and orders
(which are subject to change by the BLM and the MMS).

Federal legislation and regulatory controls in the United States have
historically affected the price of the natural gas produced and consumed by the
Company. The transportation and sale for resale of natural gas in interstate
commerce are regulated pursuant to the Natural Gas Act of 1938 (the "NGA") the
Natural Gas Policy Act of 1978 (the "NGPA") and the Federal Energy Regulatory
Commission (the "FERC"). Although maximum selling prices of natural gas were
formerly regulated, on July 26, 1989, the Natural Gas Wellhead Decontrol Act of
1989 ("Decontrol Act") was enacted, which terminated wellhead price controls on
all domestic natural gas on January 1, 1993, amended the NGPA to remove
completely by January 1, 1993 price and nonprice controls for all "first sales"
of natural gas, which will include all sales by the Company of its own
production; consequently, sales of the Company's natural gas currently may be
made at market prices, subject to applicable contract provisions. The FERC's
jurisdiction over natural gas transportation was unaffected by the Decontrol
Act.

The FERC also regulates interstate natural gas transportation rates and
service conditions, which affect the price of natural gas consumed by the
Company, as well as the revenues received by the Company for sales of natural
gas it produces. Since the latter part of 1985, the FERC has endeavored to make
interstate natural gas transportation more accessible to gas buyers and sellers
on an open and nondiscriminatory basis. The FERC's efforts have significantly
altered the marketing and pricing of natural gas. Commencing in April 1992, the
FERC issued Order Nos. 636, 636-A and 636-B (collectively, "Order No. 636"),
which, among other things, require interstate pipelines to "restructure" to
provide transportation separate or "unbundled" from the pipelines' sales of gas.

Although Order No. 636 does not regulate natural gas producers such as the
Company, the FERC has stated that Order No. 636 is intended to foster increased
competition within all phases of the natural gas industry. It is unclear what
impact, if any, increased competition within the natural gas industry under
Order No. 636 will have on the Company.

46
<PAGE> 47

Additional proposals and proceedings that might affect the natural gas
industry are considered from time to time by Congress, the FERC, state
regulatory bodies and the courts. The Company cannot predict when or if any such
proposals might become effective, or their effect, if any, on the Company's
financial condition or results of operations. The natural gas industry
historically has been very heavily regulated; therefore, there is no assurance
that the less stringent regulatory approach recently pursued by the FERC and
Congress will continue indefinitely into the future.

The Mineral Leasing Act of 1920 (the "Mineral Act") prohibits direct or
indirect ownership of any interest in Federal onshore oil and gas leases by a
foreign citizen of a country that denies "similar or like privileges" to
citizens of the United States. Such restrictions on citizens of a
"non-reciprocal" country applies ownership of controlling stock in a corporation
that holds a Federal onshore oil and gas lease. If this restriction is violated,
the corporation's lease can be canceled in a proceeding instituted by the United
States Attorney General. Although the regulations of the BLM (which administers
the Mineral Act) provide for agency designations of non-reciprocal countries,
there are presently no such designations in effect. The Company owns interests
in numerous Federal onshore oil and gas leases, and a portion of the Common
Stock will be offered to citizens of foreign countries, which at some time in
the future might be determined to be nonreciprocal under the Mineral Act.

Sales of crude oil, condensate and gas liquids by the Company are not
regulated and are made at market prices. The price the Company receives from the
sale of these products is affected by the cost of transporting the products to
market. Effective as of January 1, 1995, the FERC implemented regulations
establishing an indexing system for transportation rates for oil pipelines,
which would generally index such rates to inflation, subject to certain
conditions and limitations. These regulations could increase the cost of
transporting crude oil, liquids and condensate by pipeline. These regulations
are subject to pending petitions for judicial review. The Company is not able to
predict what effect, if any, these regulations will have on its business, but
other factors being equal, the Company believes that such regulations are likely
to increase transportation costs, effectively reducing wellhead prices for such
commodities.

The Company's gathering operations are subject to safety and operational
regulations relating to the design, installation, testing, construction,
operation, replacement and management of such facilities. The Company believes
that its operations, to the extent they may be subject to current pipeline
safety requirements, comply in all material respects with such requirements. The
Company cannot predict what effect, if any, the adoption of additional pipeline
safety legislation might have on its operations, but the Company could be
required to incur additional capital expenditures and increased costs as a
result of such future legislative and regulatory changes.

ENVIRONMENTAL REGULATION

GENERAL. The Company's operations are subject to Federal, state and local
laws and regulations governing the discharge of materials into the environment
or otherwise relating to environmental protection. Environmental laws and
regulations carry substantial penalties for failure to comply. 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 the Company's operations. State laws
often require some form of remedial action to prevent pollution from former
operations, such as pit closure and plugging abandoned wells. In addition, these
laws and regulations may restrict the rate of oil and natural gas production
below the rate that would otherwise exist.

These laws and regulations increase the Company's cost of doing business
and consequently affect its profitability. The Company anticipates that it will
expend significant resources, both financial and managerial, to comply with
environmental regulations and permitting requirements in order to comply with
stricter industry and regulatory environmental and health and safety standards
such as those described

47
<PAGE> 48

below. The Company estimates that capital expenditures necessary for foreseeable
environmental control facilities are within normal provisions for maintenance
capital expenditures. Although the Company believes that its operations and
facilities are in compliance in all material respects with applicable
environmental regulations, risks of substantial costs and liabilities are
inherent in oil and gas operations and there can be no assurance that
significant cost and liabilities will not be incurred in the future.

Other developments, such as increasingly strict environmental laws and
regulations and enforcement policies thereunder, and claims for damages to
property, employees, other persons and the environment resulting from the
Company's operations, could result in substantial costs and liabilities in the
future. Currently, the Company does not believe that such costs will have a
material adverse effect on its financial condition or results of operations.

SOLID AND HAZARDOUS WASTE. The Company currently owns or leases numerous
properties that have been used for production of oil and gas for many years.
Although the Company has utilized operating and disposal practices that were
standard in the industry at the time, hydrocarbons or other wastes may have been
disposed or released on or under these properties. The Company could be required
to remove or remediate previously disposed wastes and any related contamination
or to perform remedial plugging operations to prevent future contamination.

SUPERFUND. The Comprehensive Environmental Response, Compensation and
Liability Act ("CERCLA"), also known as the "Superfund" law, imposes joint and
several liability, without regard to fault or the legality of the original
conduct, on certain classes of persons that contributed to the release of a
"hazardous substance" into the environment. These persons include the owner or
operator of a site and companies that disposed or arranged for the disposal of
the hazardous substance found at a site. CERCLA also authorizes the
Environmental Protection Agency (the "EPA") and, in some cases, third parties to
take actions in response to threats to the public health or the environment and
to seek to recover from the responsible classes of persons the costs they incur.
In the course of its operations, the Company has generated and will generate
wastes that may fall within CERCLA's definition of "hazardous substances". The
Company may be responsible under CERCLA for all or part of the costs to clean up
sites at which such wastes have been disposed. Certain properties owned or used
by the Company or its predecessors have been investigated under state and
Federal Superfund statutes, and the Company has been and could be named a
potentially responsible party ("PRP") for the cleanup of some of these sites.

The Company's facilities in California are also subject to California
Proposition 65, which was adopted in 1986 to address discharges and releases of,
or exposures to, toxic chemicals in the environment. Proposition 65 makes it
illegal to knowingly discharge a listed chemical if the chemical will pass (or
probably will pass) into any source of drinking water. It also prohibits
companies from knowingly and intentionally exposing any individual to such
chemicals through ingestion, inhalation or other exposure pathways without first
giving a clear and reasonable warning.

The Company has been identified as one of over 250 PRPs at a Superfund site
in Los Angeles County, California (the "OII Site"). The OII Site was operated by
a third party as a waste disposal facility from 1948 until 1983. The EPA is
requiring the PRPs to undertake remediation of the OII Site in several phases,
which include site monitoring and leachate control, gas control and final
remediation. In 1989 the EPA and a group of PRPs that includes the Company
entered into a consent decree covering the site monitoring and leachate control
phases of remediation. The Company was a member of the group Coalition
Undertaking Remediation Efforts ("CURE") which was responsible for constructing
and operating the leachate treatment plant. This phase is now complete and the
Company's share of costs with respect to this phase was $0.9 million. Another
consent decree provides for the predesign, design and construction of a gas
plant to harness and market methane gas emissions. The Company is a member of
the New CURE group which is responsible for the gas plant construction and
operation and landfill cover. Currently, New CURE is in the design stage of the
gas plant. The Company's share of costs of this phase is expected to be $1.9
million and such costs have been provided for in the Company's financial
statements. Pursuant to consent decrees settling lawsuits against the
municipalities and transporters involved with the OII site but not named by the
EPA as PRPs, such parties are required to

48
<PAGE> 49

pay approximately $84 million, of which approximately $76 million will be
credited against future remediation expenses. The EPA and the PRPs are currently
negotiating the final closure requirements. After taking into consideration the
credits from the municipalities and transporters, the Company estimates that its
share of the final costs of the closure will be approximately $0.8 million,
which amount has been provided for by the Company. The Company has entered into
a Joint Defense Agreement with the other PRPs to defend against a lawsuit filed
September 7, 1994 by 95 homeowners alleging, among other things, nuisance,
trespass, strict liability and infliction of emotional distress. A second
lawsuit has been filed by 33 additional homeowners against the Company and the
other PRPs alleging similar damages and wrongful death. The Company intends to
enter into a Joint Defense Agreement with the other PRPs and is not able to
estimate costs or potential liability.

In 1994 the Company received a request from the EPA for information
pursuant to Section 104(e) of CERCLA and a letter ordering the Company and seven
other PRPs to negotiate with the EPA regarding implementation of a remedial plan
for a site located in Santa Fe Springs, California (the "Santa Fe Springs
Site"). The Company owned the property on which the Santa Fe Springs Site is
located from 1921 to 1932. During that time the property was leased to another
company and in 1932 the property was sold to that company. During the time the
other company leased or owned the property, hazardous wastes were allegedly
disposed at the Santa Fe Springs Site. The EPA estimates that the total past and
future costs for remediation will approximate $8 million. The Company filed its
response to the Section 104(e) order setting forth its position and defenses
based on the fact that the other company was the lessee and operator of the site
during the time the Company was the owner of the property. However, the Company
has also given its Notice of Intent to comply with the EPA's order to prepare a
remediation design plan. The PRPs estimate the total cost to complete the final
remediation to be $3 million and the Company has provided $250,000 for such
costs in its financial statements.

In March 1995 the Company and 12 other companies received notice that they
have been identified as PRPs by the California Department of Toxic Substances
Control (the "DTSC") as having generated and/or transported hazardous waste to
the Environmental Protection Corporation ("EPC") Eastside Landfill during its
fourteen-year operation from 1971 to 1985 (the "Eastside Site"). EPC has since
liquidated all assets and placed the proceeds in trust (the "EPC Trust") for
closure and post-closure activities. However, these monies may not be sufficient
to close the site. The PRPs have entered into an agreement with the DTSC to
characterize the contamination at the site and prepare a focused remedial
investigation and feasibility study. The DTSC has agreed to implement reasonable
measures to bring new PRPs into the agreement. The DTSC will address subsequent
phases of the cleanup, including remedial design and implementation in a
separate order agreement. The cost of the remedial investigation and feasibility
study for the Eastside Site is estimated to be $0.8 million, the cost of which
will be shared by the PRPs and the EPC Trust. The ultimate costs of subsequent
phases will not be known until the remedial investigation and feasibility study
is completed and a remediation plan is accepted by the DTSC. The Company
currently estimates final remediation could cost $2 million to $6 million and
believes the monies in the EPC Trust will be sufficient to fund the lower end of
this range of costs. The Company has provided $80,000 in its financial
statements for its share of costs related to this site.

Pursuant to the Contribution Agreement, the Company will agree to indemnify
and hold harmless SFR from and against any costs incurred in the future relating
to environmental liabilities of the Western Division assets (other than the
assets retained by SFR), including any costs or expenses incurred at any of the
OII Site, the Santa Fe Springs Site and the Eastside Site, and any costs or
liabilities that may arise in the future that are attributable to laws, rules or
regulations in respect of any property or interest therein located in California
and formerly owned or operated by the Western Division or its predecessors. SFR
will agree to indemnify the Company from and against any costs relating to
environmental liabilities of any assets or operations of SFR (whether or not
currently owned or operated by SFR) to the extent not attributable to the
Western Division (other than the assets retained by SFR).

AIR EMISSIONS. The operations of the Company are subject to Federal, state
and local regulations for the control of emissions from sources of air
pollution. The Company's properties have been and may in the future be the
subject of administrative enforcement actions for failure to comply with air
regulations or

49
<PAGE> 50

permits. These administrative actions are generally resolved by payment of a
monetary penalty and correction of any identified deficiencies. Alternatively,
regulatory agencies may require the Company to forego construction or operation
of certain air emission sources, although the Company believes that in the
latter cases it would have enough permitted or permitable capacity to continue
its operations without a material adverse effect on any particular producing
field.

After acquisition of the South Belridge Field in 1987, the Company's
predecessor entered into discussions with the Kern County Air Pollution Control
District to resolve certain permit compliance issues that had been identified
prior to the acquisition. These county permit issues have been satisfactorily
resolved. During this process, the Company discovered that the steam generators
at the field were being operated in violation of Federal air emission permits.
The Company has negotiated a consent decree with the EPA regarding the Federal
permit violations requiring the payment of a $201,000 civil penalty and use of
continuous emission monitoring systems on each operating steam generator at
South Belridge.

OIL POLLUTION ACT. Under the Oil Pollution Act of 1990 ("OPA"), owners and
operators of onshore facilities and pipelines and lessees or permittees of an
area in which an offshore facility is located ("Responsible Parties") are
strictly liable on a joint and several basis for removal costs and damages that
result from a discharge of oil into United States waters. These damages include,
for example, natural resource damages, real and personal property damages and
economic losses. OPA limits the strict liability of Responsible Parties for
removal costs and damages that result from a discharge of oil to $350 million in
the case of onshore facilities, except that these limits do not apply if the
discharge was caused by gross negligence or wilful misconduct, or by the
violation of an applicable Federal safety, construction or operating regulation
by the Responsible Party, its agent or subcontractor.

OSHA. The Company is subject to the requirements of the Federal
Occupational Safety and Health Act ("OSHA") and comparable state statutes. The
OSHA hazard communication standard, the EPA community right-to-know regulations
under Title III of the Federal Superfund Amendment and Reauthorization Act and
similar state statutes require the Company to organize information about
hazardous materials used or produced in its operations. Certain of this
information must be provided to employees, Federal, state and local governmental
authorities and local citizens.

OTHER. Kern County, California is proposing to adopt a comprehensive Kern
Valley Floor Habitat Conservation Plan (the "HCP") for the San Joaquin Valley.
The HCP, if adopted, will obviate the need for consultations with the U.S. Fish
and Wildlife Service under certain provisions of the Endangered Species Act.
Although intended to allow projects on both Federal and private lands to be
completed with a minimum of uncertainty, no assurance can be given that this
plan will not delay or prevent the issuance of permits necessary for expanded
operations or exploration, and such plan could impact the costs of operations in
the area covered by the HCP. The Kern County Planning Department anticipates
adoption of the HCP before December 31, 1996. The Company does not believe that
adoption of the HCP in its current form would have a material adverse effect on
the Company's current or proposed operations in Kern County, California.

TITLE TO PROPERTIES

As is customary in the oil and gas industry, only a cursory title
examination is conducted when leases are acquired, except leases covering proved
reserves. Prior to drilling a well, a more thorough title examination of the
drill site tract is conducted and curative work is performed with respect to
significant title defects, if any, before proceeding with operations. Such
examinations have been performed with respect to substantially all of the
Company's leasehold properties in the process of drilling. The Company believes
that the title to its oil and gas properties is good and defensible in
accordance with standards generally accepted in the oil and gas industry,
subject to such exceptions as, in the opinion of the Company, are not so
material as to detract substantially from the use or value of such properties.
The Company's properties are typically subject, in one degree or another, to one
or more of the following: (i) royalties and other burdens and obligations,
express and implied, under oil and gas leases; (ii) overriding royalties and
other burdens created by the Company or its predecessors in title; (iii) a

50
<PAGE> 51

variety of contractual obligations (including, in some cases, development
obligations) arising under operating agreements, farmout agreements, production
sales contracts and other agreements that may affect the properties or their
titles; (iv) liens that arise in the normal course of operations, such as those
for unpaid taxes, statutory liens securing unpaid suppliers and contractors and
contractual liens under operating agreements; (v) pooling, unitization and
communitization agreements, declarations and orders; and (vi) easements,
restrictions, right-of-way and other matters that commonly affect property. To
the extent that such burdens and obligations affect the Company's rights to
production and production revenues, they have been taken into account in
calculating the Company's net revenue interests and in estimating the Company's
net reserves. The Company believes that the burdens and obligations affecting
its properties are customary in the industry for properties of the kind owned by
the Company and do not, in the aggregate, materially interfere with the use of
the properties or materially reduce the value of the properties.

Pursuant to the Contribution Agreement, SFR is retaining the Production
Payment (which will be cancelled upon the satisfaction thereof), the surface
rights to the Olinda Property and SFR's royalty interests that are held by a
royalty trust formed by SFR in 1992. Pursuant to the Contribution Agreement, the
Company has agreed to indemnify SFR from any cost or liability including costs
of compliance with environmental and related laws, that may arise in the future,
attributable to its (i) assets or future operations and (ii) assets in
California formerly owned or operated by the Western Division or its predecessor
(whether or not so owned or operated) on the date of the closing of the
Offerings. For a description of certain other agreements between the Company and
SFR relating to the Olinda Property, see "Relationship Between the Company and
SFR -- Contractual Arrangements -- Contribution Agreement".

EMPLOYEES

It is anticipated that the Company will have approximately 342 employees at
or soon after the closing of the Offerings, 192 of whom are covered by a
collective bargaining agreement that expires on January 31, 1999. The Company
believes that its relations with its employees are satisfactory. The Company's
hourly employees are represented by the Oil, Chemical and Atomic Workers Union.

LITIGATION

The Company and other related companies are defendants in several lawsuits
and named parties in certain governmental proceedings arising in the ordinary
course of business. In addition, in 1996 the MMS announced that it would seek to
recover additional royalties for past production from producers on certain
Federal leases. Because the Company's operations include Federal lease sites in
California, the Company may be required to pay such "back royalties" but does
not believe that any amounts so paid would have a material impact on its
financial condition or results of operations. For a description of certain
proceedings in which the Company is involved, see "-- Regulation of Crude Oil
and Natural Gas Production" and "-- Environmental Regulation". While the outcome
of lawsuits or other proceedings against the Company cannot be predicted with
certainty, management does not expect these matters to have a material adverse
effect on the business, financial condition, liquidity or results of operations
of the Company.

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<PAGE> 52

MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The current directors, executive officers and key employees of the Company
and their ages and positions are listed below. Directors are elected at the
Company's annual meeting of shareholders and serve a term of three years.
Officers are elected annually by the board of directors and serve at its
discretion. Of the Company's seven directors, three are currently executive
officers of SFR (Whaling, Boyt and Payne), four are directors of SFR (Huff,
Morphy, Payne and Vagt), and one is neither an employee nor a director of SFR
(Wasielewski). Upon consummation of the Offerings, none of the Company's
executive officers will be officers of SFR, one of the Company's seven directors
(Payne) will serve as a director and the principal executive officer of SFR, and
one of the Company's directors (Boyt) will serve as an executive officer of SFR.

It is anticipated that prior to consummation of the Spin Off one of the
Company's directors (Boyt) will resign and two additional directors who are
unaffiliated with the Company or SFR will be appointed to the Company's board of
directors, which additions, when completed, will increase the Company's board to
eight members, of which only one will be affiliated with SFR (Payne). In
addition, the Company intends to hire an additional executive to serve as Chief
Financial Officer following consummation of the Offerings.

<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------- ----- -----------------------------------------------------
<S> <C> <C>
R. Graham Whaling(1) 42 Chairman of the Board, Chief Executive Officer,
Chief Financial Officer and Director (Class III)
David B. Kilpatrick 46 President and Chief Operating Officer
C. Ed Hall 54 Vice President -- Public Affairs
Jeffrey B. Williams 51 Vice President -- Development
Lou E. Shuflin 42 Director -- Administration
Terry L. Anderson 49 General Counsel and Secretary
Hugh L. Boyt(2) 51 Director (Class I)
Craig A. Huff(3) 32 Director (Class II)
Michael A. Morphy(3) 64 Director (Class I)
James L. Payne(4) 58 Director (Class III)
Robert F. Vagt(3) 49 Director (Class I)
Robert J. Wasielewski 33 Director (Class II)
</TABLE>

- ---------------

(1) Mr. Whaling is currently Chief Financial Officer of SFR and is expected to
resign that position prior to consummation of the Offerings.

(2) Mr. Boyt is currently an executive officer of SFR. Mr. Boyt has advised the
Company that he intends to resign as a director of the Company prior to
consummation of the Spin Off.

(3) Messrs. Huff, Morphy and Vagt are currently directors of SFR and have
advised the Company that they intend to resign as directors of SFR prior to
consummation of the Offerings.

(4) Mr. Payne is Chairman of the Board, President and Chief Executive Officer of
SFR.

R. Graham Whaling has been Senior Vice President and Chief Financial
Officer of SFR since January 1995. Prior to that time he was with CS First
Boston Corporation, an investment banking firm. While with First Boston, Mr.
Whaling served as Vice President, Corporate Finance from 1991 to 1994 and
Director, Corporate Finance from 1994 to 1995. Prior to joining First Boston,
Mr. Whaling served as a petroleum engineer for Sun Oil Company and petroleum
reservoir consulting engineer for Ryder Scott. Mr. Whaling has been an officer
and director of the Company since September 1996.

David B. Kilpatrick has been Division Manager -- Production for SFR's
Western Division since January 1990. Mr. Kilpatrick also served as Regional and
District Manager -- Production for various SFR

52
<PAGE> 53

Districts from 1986 through 1990. Mr. Kilpatrick served as President of the
California Independent Petroleum Association from 1992 through 1994.

C. Ed Hall has been Vice President -- Public Affairs of SFR since March
1991. Mr. Hall had previously held the position of Director -- Public Affairs of
SFR since 1984.

Jeffrey B. Williams has been Corporate Production Manager of SFR since July
1996. Prior to that time, Mr. Williams was employed by SFR as Regional,
Corporate or Division Production Manager, a position he assumed in 1983.

Lou E. Shuflin has been Manager -- Strategic Analysis of SFR since
September 1994. Mr. Shuflin has also served as SFR's Corporate
Manager -- Production from May 1993 to August 1993 and District
Manager -- Production beginning in 1987.

Terry L. Anderson has been Manager -- Business Development of SFR since
December 1994. Prior to that time and beginning in 1988, Mr. Anderson was Senior
Counsel of SFR.

Hugh L. Boyt has been Senior Vice President -- Production of SFR since
March 1, 1990. From 1989 until March 1990, Mr. Boyt served as Corporate
Production Manager of SFR. Mr. Boyt has been a director of the Company since its
formation in August 1996.

Craig A. Huff has been a principal in Ziff Brothers Investments since July
of 1993 and is currently a director of SFR. Prior to joining Ziff Brothers, Mr.
Huff received a degree from the Harvard Business School in 1993. Ziff Brothers
currently holds approximately 3.7% of SFR's outstanding common stock.

Michael A. Morphy for the past five years has been the retired Chairman and
Chief Executive Officer of California Portland Cement Company. Mr. Morphy is
also a director of Cyprus Amax Minerals Co., Santa Fe Pacific Pipelines, Inc.
and SFR.

James L. Payne has been Chairman of the Board, President and Chief
Executive Officer of SFR since June 1990. Mr. Payne was President of Santa Fe
Energy Company, a predecessor of SFR from January 1986 to January 1990, when he
became President of SFR. From 1982 to 1986, Mr. Payne was Senior Vice
President -- Exploration and Land of Santa Fe Energy Company. Mr. Payne is also
a director of Pool Energy Services Co., an oil field services company.

Robert F. Vagt has been President and Chief Operating Officer of Seagull
Energy Corporation since October 1996. Mr. Vagt was Chairman of the Board,
President and Chief Executive Officer and director of Global Natural Resources,
Inc. from May 1992 until October 1996. Prior to that time, Mr. Vagt was
President and Chief Operating Officer of Adobe Resources Corporation ("Adobe")
from November 1990 to May 1992, Executive Vice President of Adobe from August
1987 to October 1990 and Senior Vice President of Adobe from October 1985 to
August 1987. Mr. Vagt is also a director of SFR.

Robert Wasielewski has been employed by GKH Partners, L.P. ("GKH") since
October 1991. GKH is an investment partnership whose general partners include
entities controlled by Jay and Tom Pritzker, Dan W. Lufkin and Melvyn N. Klein.
From July 1996 to the present Mr. Wasielewski has held the position of Managing
Director of GKH. He was employed by Citicorp in the Leveraged Capital Division
from September 1987 to October 1991, serving as an Assistant Vice-President from
December 1990 until joining GKH. Mr. Wasielewski serves as a director and
officer of various privately-held affiliates of GKH. GKH currently holds
approximately 5.6% of SFR's outstanding common stock.

The Company's Amended and Restated Certificate of Incorporation (the
"Charter") and Amended and Restated Bylaws (the "Bylaws") provide for
indemnification of directors to the full extent permitted by the Delaware
General Corporation Law and, to the extent permitted by such law, eliminate or
limit the personal liability of directors to the Company and its stockholders
for monetary damages for certain breaches of fiduciary duty. In addition,
concurrently with or prior to the Offerings the Company intends to enter into an
indemnification agreement with each of its directors and executive officers,
pursuant to which such persons will be entitled to indemnification by the
Company for matters not covered by the

53
<PAGE> 54

indemnification provisions in the Company's Charter and Bylaws or the Company's
officers and directors insurance policy.

The Company's board of directors is divided into three classes, of which
two classes (Class II and Class III) consist of two members and one class (Class
I) consists of three members. The initial terms for Class I, Class II and Class
III will expire at the annual meetings of stockholders to be held in 1997, 1998
and 1999, respectively.

COMMITTEES

The Company's board of directors has established Audit and Compensation
Committees. The Audit Committee consists of three directors, at least two of
whom will be non-employee directors of the Company. The Audit Committee will
meet separately with representatives of the Company's independent auditors and
with representatives of senior management in performing its functions. The Audit
Committee will review the general scope of audit coverages, the fees charged by
the independent auditors, matters relating to the Company's internal control
system and other matters related to audit functions.

The Compensation Committee consists of three directors, at least two of
whom will be non-employee directors of the Company. The Compensation Committee
will administer the Company's benefit plans, and in this capacity will make all
option grants or awards to Company employees, including executive officers,
under such plans. In addition, the Compensation Committee will be responsible
for making recommendations to the board of directors with respect to the
compensation of the Company's Chief Executive Officer and its other executive
officers, and will be responsible for the establishment of policies dealing with
various compensation and employee benefit matters for the Company.

DIRECTOR COMPENSATION

Each director who is not also an officer of the Company or SFR (a
"Nonemployee Director") will receive an initial grant of 10,000 non-qualified
stock options pursuant to the Company's Incentive Stock Compensation Plan, an
annual retainer composed of a cash payment of $10,000, 1,000 shares of
restricted Common Stock and 5,000 non-qualified stock options as well as a fee
of $1,000 for each meeting of the board or committee of the board attended. Each
committee chairman will receive an additional annual fee of $2,000. Following
the Spin Off, each Nonemployee Director will receive an initial grant of 10,000
non-qualified stock options, if such director did not receive such a grant upon
consummation of the Offerings, and thereafter will receive the above described
annual retainer. All directors receive reimbursement for their out-of-pocket
expenses in attending meetings of the board or committees of the board.

EMPLOYMENT AGREEMENTS

The Company will enter into employment agreements ("Employment Agreements")
covering each of the individuals named in the Summary Compensation Table. The
initial term of each Employment Agreement, with the exception of Mr. Whaling's,
expires on December 31, 1998; however, beginning January 1, 1998 and on each
January 1 thereafter the term of the Employment Agreements will automatically be
extended for additional one-year periods, unless by September 30 of the
preceding year the Company gives notice that the Employment Agreement will not
be so extended. The term of each Employment Agreement, with the exception of Mr.
Whaling's, is automatically extended for a period of two years following a
Change in Control (as defined herein). Mr. Whaling's Employment Agreement has an
initial term which expires on December 31, 1999, is automatically extended for
one-year periods beginning January 1, 1999 and is automatically extended for a
three-year period following a Change in Control.

In the event that following a Change in Control employment is terminated by
the employee for "Good Reason" or the employee is involuntarily terminated by
the Company other than for "Cause" (as those terms are defined in the Employment
Agreements), or if during the six months preceding a Change in Control, the
employee's employment is terminated by the employee for Good Reason or by the
Company

54
<PAGE> 55

other than for Cause, and such termination is demonstrated to be connected with
the Change in Control, the Employment Agreements provide for payment of certain
amounts to the employee based on the employee's salary and bonus under the
Company's Incentive Compensation Plan; payout of nonvested restricted stock,
phantom units, stock options, if any, and continuation of certain insurance
benefits for a period of up to 24 months (36 months in the case of Mr. Whaling).
The payments and benefits are payable pursuant to the Employment Agreements only
to the extent they are not paid out under the terms of any other plan of the
Company. The payments and benefits provided by the Employment Agreements for all
individuals except Mr. Whaling may be further limited by the Parachute Payment
Limit described in the discussion of the Company Stock Plans below. In the event
Mr. Whaling's payments would exceed the Parachute Payment Limit, he will be made
"whole" on a net after-tax basis for any excise tax incurred. Without giving
effect to such limitation, the estimated value of the payments and benefits that
Messrs. Whaling, Kilpatrick, Williams, Hall, Shuflin and Anderson and all
executive officers as a group would be entitled to receive if a qualifying
termination occurred on January 1, 1997 (assuming salaries and ICP levels in
effect on January 1, 1997, a SFR common stock price of $14 per share and no
value received from Monterey stock or option grants) are $1,383,125, $635,500,
$443,875, $326,750, $384,125, $334,500 and $3,507,875, respectively.

EXECUTIVE COMPENSATION

The following table reflects cash compensation paid by SFR for the year
ended December 31, 1995 to each of the six most highly compensated executive
officers and key employees of the Company, and to all executive officers and key
employees as a group.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION AWARDS
-------------------------------------- -------------
OTHER ANNUAL SECURITIES ALL OTHER
NAME AND COMPEN- UNDERLYING COMPEN-
PRINCIPAL POSITION YEAR SALARY($) BONUS($)(1) SATION(2) OPTIONS(#)(3) SATION($)(4)
- ---------------------------------- ---- --------- ----------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
R. Graham Whaling................. 1995(5) 222,548 109,766 -- 250,000 6,000
Chairman of the Board, 1994 -- -- -- -- --
Chief Executive Officer and 1993 -- -- -- -- --
Chief Financial Officer
David B. Kilpatrick............... 1995 143,680 62,000 -- -- 8,069
President and 1994 138,240 60,000 -- 19,000 7,066
Chief Operating Officer 1993 124,548 38,430 -- -- 7,559
Jeffrey B. Williams............... 1995 139,300 57,255 -- -- 7,880
Vice President -- Development 1994 137,400 57,708 -- 15,000 7,033
1993 125,517 38,430 -- -- 7,559
C. Ed Hall........................ 1995 107,500 44,185 -- -- 6,064
Vice President -- Public Affairs 1994 105,000 43,100 -- 10,000 5,420
1993 100,001 30,500 -- -- 6,000
Lou E. Shuflin.................... 1995 128,250 40,000 -- -- 7,246
Director -- Administration 1994 126,000 40,000 -- 13,000 6,503
1993 120,002 29,280 -- -- 7,049
Terry L. Anderson................. 1995 109,750 34,300 -- -- 6,204
General Counsel 1994 108,000 36,288 -- 13,000 5,579
and Secretary 1993 103,201 25,181 -- -- 6,191
Executive Officers and key 1995 851,038 347,506 -- 250,000 41,463
employees as a group 1994 614,640 237,096 -- 70,000 31,601
(6 individuals)................. 1993 573,369 161,821 -- -- 34,358
</TABLE>

- ---------------

(1) The bonus amounts shown, while determined on a cash basis, were actually
paid partially in shares of SFR common stock pursuant to the SFR Stock
Plans. For 1993, Messrs. Kilpatrick, Williams, Hall, Shuflin and Anderson
received 2,092, 2,092, 1,660, 1,594, 1,371 shares, respectively, and 8,809
as a group. For 1994, Messrs. Kilpatrick, Williams, Hall, Shuflin and
Anderson received 3,583, 3,446, 2,574, 2,389 and 2,167 shares, respectively,
and 14,159 shares as a group. For 1995, Messrs, Whaling, Kilpatrick,
Williams, Hall, Shuflin and Anderson received 1,818, 3,242, 2,994, 2,310,
2,092 and 1,793 shares of SFR common stock, respectively, and 14,249 as a
group.

(2) Does not include perquisites and other personal benefits because the value
of these items did not exceed the lesser of $50,000 or 10% of reported
salary and bonus of any of the named executive officers and key employees.

55
<PAGE> 56

(3) Effective upon his date of employment by SFR (January 4, 1995), Mr. Whaling
was granted 250,000 Non-Qualified Stock Options ("NQSOs") to purchase shares
of SFR common stock pursuant to the SFR Stock Plans. The NQSOs were granted
at Fair Market Value as defined in the SFR Stock Plans ($8.00 per share) and
vested immediately as to one-half of the grant, an additional one-quarter
after one year and the final one-quarter after two years.

(4) Amounts shown reflect matches made by SFR for employee contributions to the
Santa Fe Energy Resources, Inc. Savings Investment Plan, as well as the
performance match. (See "Benefit Plans -- Compensation Pursuant to SFR
Plans -- Savings Plan" for a description of the Savings Investment Plan and
the performance match). The performance match is contributed in the year
following the performance and therefore total amounts shown for 1993, 1994
and 1995 include the match made for 1992, 1993 and 1994 results,
respectively. SFR made a performance match in March 1996 for 1995 results
for each of Messrs. Whaling, Kilpatrick, Williams, Hall, Shuflin and
Anderson in the amount of $2,460, $2,356, $2,284, $1,763, $2,103 and $1,799,
respectively.

(5) Mr. Whaling was first employed by SFR on January 4, 1995.

Effective upon the consummation of the Offerings, Mr. Whaling's annual
salary will be $325,000 with a potential bonus of 100% of such amount, Mr.
Kilpatrick's annual salary will be $210,000 with a potential bonus of 80% of
such amount, Mr. Williams' annual salary will be $160,000 with a potential bonus
of 70% of such amount, Mr. Hall's annual salary will be $125,000 with a
potential bonus of 50% of such amount, Mr. Shuflin's annual salary will be
$147,000 with a potential bonus of 50% of such amount and Mr. Anderson's annual
salary will be $130,000 with a potential bonus of 50% of such amount.

STOCK OPTION GRANTS DURING 1995

The following table provides details regarding SFR stock options granted by
SFR in 1995 to the executive officers of the Company.

OPTION GRANTS IN 1995

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
% OF VALUE AT ASSUMED
TOTAL ANNUAL RATES OF
NUMBER OF OPTIONS STOCK PRICE
SECURITIES GRANTED APPRECIATION FOR
UNDERLYING TO EXERCISE OR OPTION TERM
OPTIONS EMPLOYEES BASE PRICE ---------------------
NAME GRANTED(#) IN 1995 ($/SH) EXPIRATION DATE 5%($) 10%($)
- ---------------------------- ---------- --------- ----------- ---------------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
R. Graham Whaling(1)........ 250,000 100% 8.00 January 3, 2005 1,257,500 3,187,500
</TABLE>

- ---------------

(1) Mr. Whaling was the only executive officer of the Company to be granted
options in 1995.

1995 OPTION EXERCISES AND OUTSTANDING STOCK OPTION VALUES AS OF DECEMBER 31,
1995

The following table shows the number of SFR shares acquired by the
executive officers upon their exercise of stock options during 1995, the value
realized by such executive officers and key employees upon such exercises, the
number of shares of SFR common stock covered by both exercisable and non-
exercisable stock options as of December 31, 1995 and their values at such date.

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
SHARES OPTIONS AT IN-THE-MONEY OPTIONS AT
ACQUIRED ON DECEMBER 31, 1995 (#) DECEMBER 31, 1995 ($)
EXERCISE VALUE --------------------------- ---------------------------
NAME (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------------- ----------- ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
R. Graham Whaling........... --0-- --0-- 125,000 125,000 195,312 195,312
David B. Kilpatrick......... --0-- --0-- 61,578 12,667 10,687 21,376
Jeffrey B. Williams......... --0-- --0-- 60,245 10,000 8,438 16,875
C. Ed Hall.................. --0-- --0-- 47,529 6,667 5,624 11,251
Lou E. Shuflin.............. --0-- --0-- 51,578 8,667 7,312 14,626
Terry L. Anderson........... --0-- --0-- 35,004 8,667 7,312 14,626
</TABLE>

The average sales price of SFR common stock at December 29, 1995 was
$9.5625.

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<PAGE> 57

On July 2, 1996, SFR granted NQSOs to Messrs. Whaling, Kilpatrick,
Williams, Hall, Shuflin and Anderson in the amount of 35,000, 20,000, 5,000,
6,000, 7,000, and 4,000, respectively. These options have an exercise price of
$11.625, vest one-third per year over a three-year period and expire ten years
from the date of grant.

LONG-TERM INCENTIVE PLAN AWARDS DURING 1995

The following table provides details regarding awards granted by SFR under
its Long-Term Incentive Plans in 1995 to the executive officers of the Company:

<TABLE>
<CAPTION>
NUMBER OF PERFORMANCE OR ESTIMATED FUTURE PAYOUTS UNDER
SHARES, UNITS OTHER PERIOD NON-STOCK PRICE-BASED PLANS
OR OTHER UNTIL MATURATION -------------------------------------
NAME RIGHTS(#) OR PAYOUT THRESHOLD(#) TARGET(#) MAXIMUM(#)
- ----------------------------------------- ---------------- ------------ --------- ----------
<S> <C> <C> <C> <C> <C>
R. Graham Whaling........... 9,375 1/1/96-12/31/98 2,812 9,375 14,062
David B. Kilpatrick......... 5,833 1/1/96-12/31/98 1,750 5,833 8,750
</TABLE>

In December 1995, the individuals described above received grants of
Phantom Units pursuant to the SFR Stock Plans in the amounts indicated. The
grant was effective January 1, 1996 with the Phantom Units being earned over a
three-year period. Ultimate payout if any, is to be made in an equivalent number
of shares of SFR common stock. Four equally weighted goals have been established
which must be attained over the three-year performance periods. Full payout at
target level will result if discretionary cash flow and production volumes equal
the three-year projected levels established by the 1996 profit plan, SFR's
common stock price performance equals the S&P 500 Index over the three-year
period and SFR's common stock price at the end of the three years equals an
established target. If the above goals are substantially exceeded, possible
payouts may increase to the maximum shown. Failure to meet a threshold level
shown above as the combined threshold level of all four goals will result in a
reduction or total elimination of a payout. It is anticipated that the SFR
Compensation and Benefits Committee will take steps to accelerate the payout of
these awards at the target level upon the closing of the Offerings.

COMPANY BENEFIT PLANS

The Company has adopted a cash incentive compensation plan and two stock
incentive compensation plans for its employees in order to tie compensation to
the Company's performance. The Company has also entered into employment
agreements with certain officers and key employees, adopted a severance program
for all full-time salaried employees and adopted a 401(k) savings plan and an
ESOP, both of which will become effective at the Spin Off. These plans and
agreements are described above under "-- Employment Agreements" and below under
"-- Compensation Pursuant to Company Plans".

Following the consummation of the Offerings, the officers and salaried
employees of the Company will continue to be eligible to participate in certain
employee benefit plans of SFR. Those SFR plans pursuant to which officers of the
Company received compensation during 1995 or will receive compensation with
respect to 1996 and subsequent to the Offerings are briefly described below
under "-- Compensation Pursuant to SFR Plans".

COMPENSATION PURSUANT TO COMPANY PLANS

INCENTIVE COMPENSATION PLAN. The Company has adopted an Incentive
Compensation Plan (the "ICP"), which provides for the establishment of a variety
of annual performance goals, which, if achieved, result in the payment of
additional cash compensation to participants for that year that can be paid in
cash or, in the discretion of the Compensation Committee of the board (the
"Committee"), stock awards under the Company Stock Plans (as defined below).
Goals under the ICP include general Company and business unit performance
objectives, and may include individual productivity objectives based on a
participant's responsibilities. The amount of a participant's compensation
depends on the goals achieved, with the maximum possible award being an amount
between 20% and 100% of the participant's regular salary, depending upon his
position. The establishment of performance goals with

57
<PAGE> 58

respect to a particular year (both Company and, if applicable, individual
goals), the weighting of such goals and the determination of the extent to which
such goals are achieved are matters determined by the Committee each year at its
discretion. The Committee has retained the right, at its discretion, to increase
or decrease ultimate payments by up to 25%. All executive officers of the
Company participate in the ICP. All executive officers of the Company received
awards in 1995 under the SFR 1990 Incentive Compensation Plan as amended (the
"SFR ICP"). Such awards are included in the table set forth above under
"Executive Compensation". The SFR ICP is substantially the same as the ICP.
Effective January 1, 1997, all of the officers will become participants in the
Company's ICP in lieu of the SFR ICP.

The ICP provides, as long as SFR owns 35% or more of the outstanding voting
securities of the Company, that in the event of a Change in Control of SFR, the
performance objectives of the ICP will be deemed to have been met in full at the
maximum performance level established, and each participant shall be entitled to
receive a bonus for the year in which the Change in Control occurs; if a
participant's employment is terminated prior to December 31 of such year, the
participant shall receive a prorated bonus as set forth in the ICP. A "Change in
Control" is generally defined to occur if: (a) any "person" becomes the
beneficial owner of securities representing 25% or more of the voting power of
SFR's outstanding securities, or (b) during any period of two consecutive years,
individuals who at the beginning of such period constitute the board of
directors of SFR cease to constitute at least a majority of such board; or (c)
SFR's stockholders approve a merger or consolidation of SFR with another
corporation and the voting securities of SFR do not represent 80% of the voting
power of the combined entity; or (d) SFR's stockholders approve a plan of
complete liquidation or an agreement for the sale or disposition by SFR of all
or substantially all of its assets. If SFR no longer owns 80% or more of the
outstanding voting securities of the Company, the term "Company" shall be
inserted in lieu of "SFR" for purposes of this provision, and the provision will
continue in effect with such alternate definitions for as long as SFR owns 35%
or more of the Company's outstanding Common Stock. The proposed Spin Off by SFR
shall not constitute a Change in Control under any circumstances.

1996 INCENTIVE STOCK COMPENSATION PLANS. The Company has adopted the 1996
Incentive Stock Compensation Plan for Key Employees (the "Key Employee Plan")
and the 1996 Incentive Stock Compensation Plan for Nonexecutive Employees (the
"Nonexecutive Plan" and, together with the Key Employee Plan, the "Company Stock
Plans"). The Company Stock Plans will also permit the Committee to grant (i)
options to purchase shares of Common Stock, which may be, under the Key Employee
Plan, either Incentive Stock Options, as defined in Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"), or NQSOs, and, which may be,
under the Nonexecutive Plan, NQSOs only, (ii) shares of Restricted Stock, (iii)
Stock Appreciation Rights ("SARs"), (iv) Phantom Units and (v) Bonus Stock. In
addition, replacement or substitution options may be granted to employees in
conjunction with a spinoff, acquisition or other similar corporate transaction
involving the Company or a subsidiary. Options and awards with respect to no
more than 3,000,000 shares of Common Stock may be issued under the Key Employee
Plan. The Nonexecutive Plan allows for the grant of up to 500,000 shares
annually. The Committee, in its discretion, will select those employees to whom
awards will be granted, the form and amount of awards, and the terms and
conditions of awards. All nonexecutive employees of the Company who are
responsible for the Company's growth and profitability will be eligible to
receive awards under the Nonexecutive Plan.

Incentive Stock Options must have an exercise price of not less than the
fair market value of the underlying stock at the time the option was granted.
Non-Qualified Stock Options will not be subject to that requirement but may not
be issued at less than 100% of the fair market value at the date of grant.
Substitution options shall be granted on such terms as the Committee deems
equitable. All options must be exercised within 10 years of the date granted.

The Committee will determine the period during which SARs may be exercised,
which period may not begin until six months after the date of the grant. Upon
the exercise of an SAR, the Company may pay the amount by which the fair market
value of a share of Common Stock on the exercise date exceeds the exercise price
of a share of such stock on the date the SAR was granted in cash, Common Stock
or a combination of both.

58
<PAGE> 59

During the restricted period for Restricted Stock, participants will be
entitled to receive all dividends paid on Restricted Stock and to vote the
shares, but they may not sell, transfer or encumber the shares during this
period.

Bonus Stock consists of shares of Common Stock which are granted to
participants and which are not subject to any of the restrictions associated
with Restricted Stock.

A Phantom Unit is the right to receive a payment in an amount equal to the
average trading price of the shares of Common Stock at the time the award
becomes payable. Payment may be made in cash, stock or any combination thereof.
A Phantom Unit shall generally become payable if the employee remains in the
employment of the Company and certain specified business goals of the Company
established by the Committee in its discretion are met.

Termination of the employee for Cause (as defined in the Company Stock
Plans) shall result in forfeiture of all awards. In the event of an involuntary
termination other than for Cause, or in the event of termination by reason of
disability or retirement, a participant will be entitled to a pro rata share of
any outstanding option, SAR, Restricted Stock and Phantom Unit award based on
the vesting period of the grant which has elapsed; provided, however, that
Phantom Units and Restricted Stock shall be payable at the end of the restricted
period to the extent payable under an award. In the event of death, the
restricted period shall lapse on all of a participant's outstanding awards. The
Company Stock Plans further provide that all restrictions shall lapse upon a
"Change in Control" to the extent that any shares of Restricted Stock or Phantom
Units remain subject to restrictions, all defined goals shall be deemed to be
met, and the full value of the Phantom Units shall be paid in cash.

The payments and benefits provided by the Company Stock Plans as a result
of a Change in Control, when aggregated with certain other payments or benefits,
will be limited to 2.99 times the "base amount" as defined in Section 280G of
the Code (the "base amount" approximating the average of five years'
compensation preceding a Change in Control) if the employee would receive a
greater net after-tax benefit by reason of such limitation (the "Parachute
Payment Limit").

During 1996, Messrs. Whaling, Kilpatrick, Williams, Hall, Shuflin, and
Anderson and all executive officers as a group received options pursuant to the
SFR Stock Plans with respect to 35,000, 20,000, 5,000, 6,000, 7,000, 4,000, and
77,000 shares of SFR common stock, respectively. See "-- Compensation Pursuant
to SFR Plans -- Incentive Stock Compensation Plans" and "-- 1995 Option
Exercises and Outstanding Stock Option Values as of December 31, 1995". In the
event SFR consummates the Spin Off, it is anticipated that any unexercised
options for SFR stock which are surrendered by the participant will be replaced
by awards under the Company Stock Plans with similar vesting and exercise terms;
provided, however, that no award under the Company Stock Plans will be
exercisable or payable for a period of one year from the Spin Off date except
upon a Change in Control or a termination due to death or disability. The number
of shares and exercise prices of all NQSOs awarded will be adjusted so that the
participant retains the full unrealized potential value of the corresponding SFR
option. The number of shares of Common Stock subject to the NQSO will be a
fraction, the numerator of which is the product of the number of shares of SFR
common stock subject to the option times the SFR market price (based on the
trading price for a period of time prior to the record date for the Spin Off),
and the denominator of which is the Company's market price (based on the trading
price for a period of time following the Spin Off); the exercise price will be a
fraction, the numerator of which is the product of the SFR option price times
the number of SFR option shares and the denominator of which is the number of
Company option shares.

Effective with the closing of the Offerings, Messrs. Whaling, Kilpatrick,
Williams, Hall, Shuflin, and Anderson will receive NQSOs under the Company Stock
Plans in the amount of 112,500, 50,000, 20,000, 12,000, 12,000, and 12,000
shares, respectively, and restricted stock grants of 37,500, 15,000, 6,667,
3,333, 3,333, and 3,333 shares, respectively.

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<PAGE> 60

SEVERANCE PROGRAM. The Company has adopted a Severance Program for all
full-time (non-union) employees who are terminated by the Company or terminated
or constructively terminated by an acquiring company, other than for Cause (as
defined in the Severance Program). However, following a Change in Control
(defined substantially the same as in the ICP), an executive officer or key
employee who has entered into an Employment Agreement is not eligible to receive
duplicate benefits under the Employment Agreement and the Severance Program. A
participant in the Severance Program is generally entitled to an amount based
upon the participant's length of service and current salary, but not to exceed
one year's pay. In addition, a participant is entitled to continuation of health
and life insurance benefits for two years.

The payments and benefits provided by the Severance Program may be limited
in the same manner as the Parachute Payment Limit described in the description
of the Company Stock Plans above.

SAVINGS PLAN. The Company has adopted the Monterey Resources, Inc. Savings
Investment Plan (the "Savings Plan"), which, when it becomes effective, will
offer eligible employees an opportunity to make long-term investments on a
regular basis through salary contributions, which are supplemented by matching
employer contributions. Substantially all non-union employees are eligible to
participate in the Savings Plan on the first day of the month after their date
of hire. The Company will match up to 4% of an employee's compensation and the
employee's contribution may not exceed limits imposed by federal regulations.
During 1996 such limit was $9,500. In addition to the regular employer matching
program, at the end of each fiscal year, the Company's performance will be
evaluated using the same performance measures used in the ICP. If the Company's
performance meets or exceeds the goals for that year, participants will receive
up to another fifty cents on each regular matching dollar contributed by the
Company. The regular employer matching contributions as well as the performance
match are made in Common Stock.

The Savings Plan is intended to qualify as a Section 401(k) cash or
deferred compensation arrangement whereby a portion of all of an employee's
elective contributions and the employer's matching contributions are not subject
to Federal income taxes at the time of contribution to the plan, and the plan is
subject to the restrictions imposed by the Code. Investment alternatives to
which contributions may be allocated by the participants will include a variety
of investment options including a fund which will be invested in Common Stock.

It is anticipated that the Savings Plan will not become effective until the
Spin Off, at which time it is intended that the account balances of the
employees currently in the SFR Savings Plan will be transferred to the Company's
plan.

DEFERRED COMPENSATION PLAN. The Company also maintains a supplemental
deferred compensation plan ("Supplemental Plan") whereby employees earning in
excess of $95,000 per year are allowed to defer all or a portion of their salary
until a future year or until retirement. These amounts are not matched by the
Company. Employees earning in excess of $150,000 per year may also defer up to
4% of such excess amount, which amount will be matched by the Company, including
the performance match described above in "-- Savings Plans". All amounts are
credited to a notional account with the Company and credited with interest at
the rate paid on the fixed income fund of the Company Savings Plan.

It is anticipated that the Supplemental Plan will not become effective
until the Spin Off.

HOURLY RETIREMENT PLANS. The Company sponsors two retirement plans covering
union employees (the "Hourly Plans"). One Hourly Plan provides benefits that are
based on a stated amount for each year of service. The Company annually
contributes amounts which are actuarially determined to provide the plan with
sufficient assets to meet future benefit payment requirements. The second Hourly
Plan is a defined contribution plan whereby the Company matches employee
contributions up to $.60 per hour worked. Employees may make unmatched
supplemental contributions of up to an additional $1.50 per hour worked.

ESOP AND SUPPLEMENTAL ESOP. The Company has adopted the Monterey Resources,
Inc. Employee Stock Ownership Plan (the "ESOP"), which, when it becomes
effective, will provide for Company

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<PAGE> 61

contributions on behalf of eligible employees. The ESOP is intended to invest in
Common Stock. Contributions may be in cash and/or Common Stock. In addition, the
Company has adopted the Monterey Resources, Inc. Supplemental ESOP Plan, which
provides that if a participant's allocation under the ESOP is limited in any
year due to the limitations of Sections 401(a)(17) or 415 of the Code, the
participant will be credited, in a notional account, with shares of phantom
stock equal to the "lost" allocation. The notional account will also be credited
with phantom dividends and paid to the participant in cash on the termination of
employment, to the extent vested. It is anticipated that these plans will not
become effective until the Spin Off.

COMPENSATION PURSUANT TO SFR PLANS

INCENTIVE COMPENSATION PLAN. As discussed above under "-- Compensation
Pursuant to Company Plans -- Incentive Compensation Plan", SFR maintains the SFR
ICP which provides for the establishment of a variety of performance goals
which, if achieved, result in the payment of additional cash compensation to
participants for that year. The terms and conditions of the SFR ICP are
substantially similar to those described above for the Company's ICP. All
executive officers of the Company have participated in the SFR ICP, and they
received a cash bonus pursuant thereto which has been reflected in the table set
forth under "-- Executive Compensation" above. Effective with calendar year
1997, all of these officers will become participants in the Company's ICP in
lieu of the SFR ICP.

INCENTIVE STOCK COMPENSATION PLANS. SFR presently maintains the 1990
Incentive Stock Compensation Plan, as amended, and the 1995 Incentive Stock
Compensation Plan for Non-executive Employees, as amended (collectively, the
"SFR Stock Plans"). These plans are substantially the same as the stock and
stock option portions of the Company Stock Plans described above. With the
exception of certain grants in conjunction with the 1996 bonus awarded in early
1997, following the consummation of the Offerings, employees of the Company will
no longer receive grants or awards under the SFR Stock Plans. Certain executive
officers and other employees of the Company hold options previously granted
subject to, and which will remain outstanding under, the terms and conditions of
these plans and the agreements evidencing such options. These grants are subject
to conversion as described in "-- Compensation Pursuant to Company Plans" above.
As of September 1, 1996, executive officers of the Company had options awards
under the SFR Stock Plans as shown in "-- Executive Compensation" above.

SAVINGS PLANS. The Company is, and will continue to be until implementation
of the Company's Savings Plan described above, a participating subsidiary in the
Santa Fe Energy Resources, Inc. Savings Investment Plan (the "SFR Savings
Plan"). Substantially all non-union employees are eligible to participate on the
first day of the month after their date of hire. SFR will match up to 4% of an
employee's compensation. In 1996 the employee's contribution could not exceed
$9,500. In addition to such regular employer matching program, at the end of
each fiscal year, SFR's performance is evaluated using the same performance
measures used in the SFR ICP. If SFR's performance meets or exceeds the goals
for that year, participants will receive up to another fifty cents on each
regular matching dollar contributed by SFR. The regular employer matching
contributions as well as the performance match are made in SFR common stock.

The SFR Savings Plan is intended to qualify as a Section 401(k) cash or
deferred compensation arrangement whereby an employee's contributions and the
employer's matching contributions are not subject to Federal income taxes at the
time of the contribution to the Plan and the Plan is subject to the restrictions
imposed by the Code. Investment alternatives to which contributions may be
allocated by the participants include an aggressive growth fund, an
international equity fund, a growth equity fund, an equity index fund, a growth
and income fund, a balanced fund, a stable value fund and a fund which invests
in SFR common stock.

DEFERRED COMPENSATION PLAN. SFR also maintains a supplemental deferred
compensation arrangement (the "SFR Deferred Compensation Plan") whereby
employees earning in excess of $95,000 per year are allowed to defer all or a
portion of their salary until a future year or until retirement. These

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<PAGE> 62

amounts are not matched by SFR. Employees earning in excess of $150,000 per year
may also defer up to 4% of such excess amount, which amount will be matched by
SFR, including the performance match described above in "-- Savings Plans". All
amounts are contributed in cash and earn interest at the rate paid on the fixed
income fund of the SFR Savings Plan.

RETIREMENT PLANS. The Company is, and following completion of the Offerings
will continue to be until Spin Off, a participating subsidiary in the Santa Fe
Energy Resources Retirement Plan (the "SFR Retirement Plan"), a qualified
defined benefit plan maintained for substantially all salaried employees not
covered by a collective bargaining agreement, and the nonqualified Santa Fe
Energy Resources Supplemental Retirement Plan (the "SFR Supplemental Plan"). The
SFR Supplemental Plan will pay benefits to participants in the various SFR plans
in those instances where the SFR Retirement Plan formula produces a benefit in
excess of limits established by ERISA and applicable government regulations. The
SFR Retirement Plan also includes amounts deferred under the SFR Deferred
Compensation Plan as pensionable compensation. Total approximate benefits under
both the SFR Retirement Plan and SFR Supplemental Plan are shown below for
selected compensation levels and years of service. As of December 31, 1995,
Messrs. Whaling, Kilpatrick, Williams, Hall, Shuflin and Anderson were credited
with 1.0, 19.3, 25.6, 11.6, 14.8 and 14.7 years of service under the plans,
respectively.

<TABLE>
<CAPTION>
YEARS OF SERVICE
--------------------------------------------------------
AVERAGE YEARLY COMPENSATION 15 20 25 30 35
- ------------------------------------ -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
$125,000............................ $ 22,000 $ 29,000 $ 36,000 $ 54,000 $ 64,000
$150,000............................ $ 26,000 $ 35,000 $ 44,000 $ 66,000 $ 77,000
$175,000............................ $ 31,000 $ 41,000 $ 52,000 $ 78,000 $ 91,000
$200,000............................ $ 36,000 $ 48,000 $ 60,000 $ 89,000 $104,000
$225,000............................ $ 40,000 $ 54,000 $ 67,000 $101,000 $118,000
$250,000............................ $ 45,000 $ 60,000 $ 75,000 $113,000 $131,000
$300,000............................ $ 54,000 $ 72,000 $ 91,000 $136,000 $158,000
$400,000............................ $ 73,000 $ 97,000 $122,000 $182,000 $213,000
$450,000............................ $ 82,000 $110,000 $137,000 $206,000 $240,000
$500,000............................ $ 92,000 $122,000 $153,000 $229,000 $267,000
$600,000............................ $110,000 $147,000 $184,000 $275,000 $321,000
$650,000............................ $119,000 $159,000 $199,000 $299,000 $348,000
</TABLE>

Benefit figures shown are amounts payable based on a straight-life annuity
assuming retirement by the participant at age 62 in 1995 without a joint
survivorship provision. The benefits listed in the above table are not subject
to any deduction for social security or other offset amounts.

Benefits under the plans are computed based on a participant's total
compensation for the 60 consecutive months during the ten-year period
immediately prior to the termination of his covered employment for which his
total compensation is the highest, divided by 60. If a participant has not
received compensation for 60 consecutive months during such ten-year period, his
compensation shall equal the total of his compensation for the longest period of
consecutive months during such ten-year period divided by the total number of
months of compensation so considered.

Compensation recognized under the plans is the total basic compensation,
including any elective salary deferral amounts excluded from income pursuant to
Section 125 or 402 of the code, plus overtime, shift differentials and bonuses
(whether cash or stock) paid pursuant to recurring bonus programs, including
compensation deferred under the Santa Fe Energy Resources, Inc. Deferred
Compensation Plan, but excluding any special or extraordinary bonuses and any
other items of compensation. A participant's basic compensation is the regular
rate of pay specified for his position and does not include automobile
allowances, imputed income under any group term life insurance program, moving
expense or other reimbursements, fringe benefits, or similar items.

The pension compensation therefore differs from the compensation listed in
the Summary Compensation Table in several respects. Pension compensation is
based on average compensation as explained

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<PAGE> 63

above. It does not include restricted stock awards, stock options, and other
compensation in the "All Other Compensation" column of the Summary Compensation
Table (i.e., employer matching contributions to the SFR Savings Plan and the
performance match). It also does not include special or extraordinary bonuses.

The pension compensation of officers whose pension compensation differs
from the compensation contained in the Summary Compensation Table is listed
below:

<TABLE>
<CAPTION>
PENSION COMPENSATION
NAME (FINAL AVERAGE PAY)
---------------------------------------------------------------- --------------------
<S> <C>
R. Graham Whaling............................................... $334,767
David B. Kilpatrick............................................. 180,713
Jeffrey B. Williams............................................. 181,264
C. Ed Hall...................................................... 140,791
Lou E. Shuflin.................................................. 161,211
Terry L. Anderson............................................... 135,497
</TABLE>

It is anticipated that the Company will terminate participation in the SFR
Retirement Plan upon the consummation of the Spin Off.

SECURITY OWNERSHIP OF MANAGEMENT

The following table indicates (i) the number of shares of Common Stock
expected to be granted to each director, executive officer and key employee of
the Company as of the closing of the Offerings pursuant to the Company Stock
Plans (see "Management -- Compensation Pursuant to Company Plans") and (ii) the
number of shares of common stock of SFR beneficially owned as of October 15,
1996 by such persons. In the event the Spin Off occurs and the individuals
listed below retain the SFR common stock set forth below and exercise the SFR
options described in the footnotes, such individuals will receive shares of
Company Common Stock on the same basis as all other SFR shareholders.

<TABLE>
<CAPTION>
SHARES OF COMPANY SHARES OF SFR
COMMON STOCK COMMON STOCK
TO BE BENEFICIALLY OWNED
BENEFICIALLY AS OF
NAME OF BENEFICIAL OWNER OWNED(1) OCTOBER 15, 1996
------------------------------------------------ ----------------- ------------------
<S> <C> <C>
R. Graham Whaling(2)............................ 37,500 264,528
David P. Kilpatrick(3).......................... 15,000 88,937
C. Ed Hall(4)................................... 3,333 77,081
Lou E. Shuflin(5)............................... 3,333 71,083
Jeffrey B. Williams(6).......................... 6,667 73,170
Terry L. Anderson(7)............................ 3,333 49,723
Hugh L. Boyt(8)................................. -0- 273,558
Craig A. Huff(9)................................ 1,000 3,354,600
Michael A. Morphy(10)........................... 1,000 25,786
James L. Payne(11).............................. 1,000 921,913
Robert F. Vagt(12).............................. 1,000 29,069
Robert J. Wasielewski(13)....................... 1,000 5,047,083
All directors and officers as a group
(12 persons).................................. 74,166 10,276,531
</TABLE>

- ---------------

(1) In addition to the Common Stock ownership presented, it is anticipated that
unexercised SFR stock options held by Company employees at Spin Off
(including those held by executive officers and key employees listed above)
will be exchanged for options for Common Stock granted pursuant to the
Company Stock Plans. See "Management -- Compensation Pursuant to Company
Plans" for a description of the anticipated method of adjustment of share
amounts and strike prices.

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<PAGE> 64

(2) Mr. Whaling's SFR common stock ownership includes 1,318 shares arising from
participation in the SFR Savings Plan as of October 1, 1996 and 250,000
shares which could be received upon the exercise of options exercisable
within 60 days of October 15, 1996. The exercise price of such options is
$8.00. Mr. Whaling's Common Stock ownership includes 37,500 shares of
Restricted Stock anticipated to be granted upon the closing of the
Offerings.

(3) Mr. Kilpatrick's SFR common stock ownership includes 5,729 shares arising
from participation in the SFR Savings Plan as of October 1, 1996 and 74,245
shares which could be received upon the exercise of options exercisable
within 60 days of October 15, 1996. The weighted average exercise price of
such options is $12.1375. Mr. Kilpatrick's Common Stock ownership includes
15,000 shares of Restricted Stock anticipated to be granted upon the
closing of the Offerings.

(4) Mr. Hall's SFR common stock ownership includes 7,921 shares arising from
participation in the SFR Saving Plan as of October 1, 1996 and 54,196
shares which could be received upon the exercise of options exercisable
within 60 days of October 15, 1996. The weighted average exercise price of
such options is $12.1867. Mr. Hall's Common Stock ownership includes 3,333
shares of Restricted Stock anticipated to be granted upon closing of the
Offerings.

(5) Mr. Shuflin's SFR common stock ownership includes 10,838 shares arising
from participation in the SFR Savings Plan as of October 1, 1996 and 60,245
shares which could be received upon the exercise of options exercisable
within 60 days of October 15, 1996. The weighted average exercise price of
such options is $12.2566. Mr. Shuflin's Common Stock ownership includes
3,333 shares of Restricted Stock anticipated to be granted upon closing of
the Offerings.

(6) Mr. Williams' SFR common stock ownership includes 7,925 shares arising from
participation in the SFR Savings Plan as of October 1, 1996 and 65,245
shares which could be received upon exercise of options exercisable within
60 days of October 15, 1996. The weighted average exercise price of such
options is $12.7255. Mr. Williams' Common Stock ownership includes 6,667
shares of Restricted Stock anticipated to be granted upon closing of the
Offerings.

(7) Mr. Anderson's SFR common stock ownership includes 3,393 shares arising
from participation in the SFR Savings Plan as of October 1, 1996 and 43,671
shares which could be received upon exercise of options exercisable within
60 days of October 15, 1996. The weighted average exercise price of such
options is $11.9686. Mr. Anderson's Common Stock ownership includes 3,333
shares of Restricted Stock anticipated to be granted upon closing of the
Offerings.

(8) Mr. Boyt's SFR common stock ownership includes 6,313 shares arising from
participation in the SFR Savings Plan as of October 1, 1996 and 225,245
shares which could be received upon exercise of options exercisable within
60 days of October 15, 1996. The weighted average exercise price of such
options is $11.5275. It is anticipated Mr. Boyt will resign as a director
of the Company upon Spin Off and therefore he would not receive a grant of
Restricted Stock pursuant to the Company's Stock Plans.

(9) Mr. Huff's Common Stock ownership includes 1,000 shares of Restricted Stock
anticipated to be granted upon closing of the Offerings. Mr. Huff's SFR
common stock ownership includes 15,000 shares which could be received upon
the exercise of options exercisable within 60 days of October 15, 1996. The
exercise price of such options is $11.4375. Mr. Huff's SFR common stock
ownership also includes 3,338,600 shares owned by clients of Ziff Brothers
Investments ("ZBI"). Mr. Huff, who is a Principal of ZBI, disclaims
beneficial ownership of these shares.

(10) Mr. Morphy's Common Stock ownership includes 1,000 shares of Restricted
Stock anticipated to be granted upon closing of the Offerings. Mr. Morphy's
SFR common stock ownership includes 15,000 shares which could be received
upon exercise of options exercisable within 60 days of October 15, 1996.
The weighted average exercise price of such options is $10.2292.

(11) Mr. Payne's SFR common stock ownership includes 47,765 shares arising from
participation in the SFR Savings Plan as of October 1, 1996 and 722,890
shares which could be received upon exercise of options exercisable within
60 days of October 15, 1996. The weighted average exercise price of such
options is $12.7344. Mr. Payne will not be eligible for a Restricted Stock
grant pursuant to the Company's Stock Plans until Spin Off when he will
receive the 1,000 shares of Common Stock presented.

(12) Mr. Vagt's Common Stock ownership includes 1,000 shares of Restricted Stock
anticipated to be granted upon closing of the Offerings. Mr. Vagt's SFR
common stock ownership includes 15,000

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<PAGE> 65

shares which could be received upon exercise of options exercisable within
60 days of October 15, 1996. The weighted average exercise price of such
options is $10.2292.

(13) Mr. Wasielewski's SFR common stock includes 5,047,083 shares which may be
deemed to be owned by GKH Partners, L.P. ("GKH") primarily through its
participation in HC Associates. Mr. Wasielewski is a Managing Director of
GKH, the general partner of GKH Investment, L.P. and the nominee for GKH
Private, Ltd. and disclaims beneficial ownership of the shares held by HC
Associates. Mr. Wasielewski's Common Stock ownership includes 1,000 shares
of Restricted Stock anticipated to be granted upon closing of the
Offerings.

RELATIONSHIP BETWEEN THE COMPANY AND SFR

OWNERSHIP OF COMMON STOCK

SFR, whose address is 1616 South Voss, Suite 1000, Houston, Texas 77057,
owns all of the Company's currently outstanding Common Stock and after the
Offerings will own approximately 85% of the Company's outstanding shares of
Common Stock (or 83% if the Underwriters' over-allotment options are exercised
in full). Through its ability to elect all directors of the Company, SFR will
control all matters affecting the Company, including any determination with
respect to acquisition or disposition of Company assets, future issuance of
Common Stock or other securities of the Company and any dividends payable on the
Common Stock. SFR will also control the Company's exploration, development,
capital, operating and acquisition budgets.

Pursuant to Rule 144 promulgated under the Securities Act, SFR may not,
prior to the expiration in August 1998 of the two year holding period required
by Rule 144, sell any of the shares of Common Stock it owns without registration
under the Securities Act. See "Shares Eligible for Future Sale". The Company has
agreed that upon the request of SFR, the Company will register under the
Securities Act and applicable state securities laws the sale of the shares of
Common Stock owned by SFR which SFR requests to be registered. See
"-- Contractual Arrangements -- Registration Rights and Indemnification
Agreement".

INTENDED SPIN OFF

SFR has announced that after the Offerings it intends to distribute pro
rata to its common stockholders all of the shares of Common Stock that it owns
by means of a tax-free distribution. SFR's final determination to proceed will
require a declaration of the Spin Off by SFR's board of directors. Such a
declaration is not expected to be made until certain conditions, many of which
are beyond the control of SFR, are satisfied, including: (i) receipt by SFR of a
ruling from the Internal Revenue Service as to the tax-free nature of the Spin
Off; (ii) approval of the Spin Off by SFR's stockholders; (iii) the redemption
or conversion of all or a substantial portion of the shares of each outstanding
series of SFR preferred stock; and (iv) the absence of any future change in
future market or economic conditions (including developments in the capital
markets) or SFR's or the Company's business and financial condition that causes
SFR's board to conclude that the Spin Off is not in the best interests of SFR's
stockholders. The Company has been advised by SFR that it does not expect the
Spin Off to occur prior to June 1997. If SFR consummates the Spin Off, the
increased shares available in the market may have an adverse effect on the
market price of the Common Stock. The Company has been advised by SFR that as of
September 30, 1996, SFR had 41,326 common stockholders of record. See "Risk
Factors -- Intended Spin Off by SFR".

The Company has agreed to indemnify SFR if at any time during the one-year
period after the Spin Off (or if certain tax legislation is enacted and is
applicable to the Spin Off, such longer period as is required for the Spin Off
to be tax free to SFR) (the "Restricted Period") the Company takes certain
actions the effects of which result in the Spin Off being taxable to SFR. See
"-- Contractual Arrangements -- Spin Off Tax Indemnity Agreement".

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<PAGE> 66

CONTRACTUAL ARRANGEMENTS

SPIN OFF TAX INDEMNITY AGREEMENT. To protect SFR from Federal and state income
taxes, penalties, interest and additions to tax that would be incurred by it if
the Spin Off by SFR were determined to be a taxable event, the Company and SFR
have entered into an agreement under which the Company has agreed to indemnify
SFR with respect to tax liabilities resulting primarily from actions taken by
the Company at any time during the Restricted Period. The Company has also
agreed that, unless it obtains an opinion of counsel or a supplemental ruling
from the Internal Revenue Service that such action will not adversely affect the
qualification of the Spin Off as tax-free, the Company will not merge or
consolidate with another corporation, liquidate or partially liquidate, sell or
transfer all or substantially all of its assets or redeem or otherwise
repurchase any of its stock or issue additional shares of the Company's capital
stock during such Restricted Period. The Company's obligations under this
agreement could possibly deter offers or other efforts by third parties to
obtain control of the Company during such Restricted Period, which could deprive
the Company's stockholders of opportunities to sell their shares of Common Stock
at prices higher than prevailing market prices.

The Company has retained the right to contest, at its expense, any
determination by taxing authorities that the Spin Off has failed to qualify as
tax-free by reason of an action by the Company; provided, however, that if SFR
reasonably perceives, either at the commencement or during the course of any
proceeding challenging the tax-free nature of the Spin Off, that the Company
could not pay the indemnified amounts if the taxing authorities were successful
and the Company fails to furnish a guarantee or performance bond satisfactory to
SFR in an amount equal to the indemnified liability being asserted by the taxing
authority, SFR may assume the defense of any such challenge, at the Company's
expense, and may compromise, concede or settle the taxing authorities' claim.
SFR's assumption of the conduct of such defense would not relieve the Company of
its financial responsibility to SFR under this agreement. The indemnity
agreement will apply if the Spin Off occurs prior to December 31, 1997.

The Company believes that if the Company is required to make payments
pursuant to such agreement, the amount that the Company would pay to SFR would
have a material adverse effect on the Company's financial condition. The actions
for which the Company is required to indemnify SFR pursuant to this agreement
are within the Company's control, and the Company has no intention of taking any
actions during the Restricted Period that would have such an effect.

The Spin Off Tax Indemnity Agreement also contains provisions covering
certain other tax matters between SFR and the Company. Under the tax sharing
agreements and arrangements between SFR and Santa Fe Pacific Corporation
("SFP"), the former parent company of SFR, SFR and its subsidiaries receive
benefits from and are responsible for liabilities directly attributable to audit
adjustments under the California franchise tax with respect to all California
properties or operations owned or conducted by SFR and its subsidiaries prior to
the spin off of SFR by SFP. As a result of the Transactions, the Company will
acquire substantially all of the California properties and operations that would
relate to such audit matters. Accordingly, the Company will receive the benefits
and be responsible for the obligations attributable to California franchise tax
liabilities under SFR's agreements with SFP for any of the tax years ending on
or after December 31, 1984 (the years for which the audits have not been
conducted by California). SFR shall prepare and file all consolidated Federal,
combined state and local income and franchise tax returns required to be filed
while the Company is a member of SFR's affiliated group and the Company will not
be compensated for the carryback after Spin Off to SFR's affiliated group of any
Company tax items realized after the Company ceases to be a member of SFR's
affiliated group. The Company will not be compensated for the carryback after
the Spin Off to SFR's affiliated group both because it is anticipated that the
Company will make the necessary election to forego any such carryback and
because management of both SFR and the Company desire to minimize, to the extent
possible, continuing relationships and obligations between the two companies.

CONTRIBUTION AGREEMENT. Pursuant to the Contribution Agreement, SFR will
contribute to the Company substantially all of the assets and properties of the
Western Division, subject to retention by SFR of (i) the Production Payment,
(ii) the surface rights to approximately 116 acres of the Olinda

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<PAGE> 67

Property and (iii) SFR's interests in various properties that are burdened by an
overriding royalty interest held by a royalty trust formed by SFR in 1992 (the
"Excluded Assets"). The Production Payment represents in the aggregate
approximately 20% of 1995 net sales proceeds from the Midway-Sunset field and
the annual amortization thereof represents 7% of such net sales proceeds. The
Company does not believe that the retention of the Production Payment or the
Company's obligations thereunder will have a material adverse effect on the
Company's financial condition, liquidity or results of operations. The effective
date of the asset contribution pursuant to the Contribution Agreement is
expected to be November 1, 1996. Except as set forth in the Contribution
Agreement, SFR is not making any representation or warranty (including any
representation or warranty of title, merchantability or fitness for a particular
purpose) to the Company as to the assets, business or liabilities contributed to
or assumed by the Company pursuant to the Contribution Agreement. All such
assets will be contributed to the Company in their present condition. SFR is not
making any representation or warranty to the Company as to consents or approvals
required to transfer such assets to the Company or as to the legal sufficiency
of any assignment, document or instrument delivered or filed to convey title to
any properties contributed to the Company. In addition, the Company will assume
the liabilities and obligations associated with the Western Division, even if
attributable to periods prior to the contribution date, including the $245
million of indebtedness in respect of the SFR Senior Notes and interest thereon
from and after October 1, 1996, and the Company will agree to release SFR from
any liability or contribution obligation in respect of the New Credit Facility.
Pursuant to the Contribution Agreement, (a) the Company will assume, and agree
to indemnify and hold harmless SFR from and against all liabilities and
obligations of SFR relating to the contributed assets and properties, even if
attributable to periods prior to the contribution date, including (i) any
litigation pending or threatened as of the consummation of the Offerings or that
arises in the future and involves any costs incurred after the consummation of
the Offerings, (ii) environmental liabilities of contributed assets and
properties, including any costs or expenses incurred at any of the OII Site, the
Santa Fe Springs Site and the Eastside Site, (iii) any costs or liabilities that
may arise after the consummation of the Offerings that are attributable to
violations of or failure to comply with laws, rules or regulations in respect of
any property or interest therein located in California and formerly owned or
operated by the Western Division or its predecessors (other than the Excluded
Assets), and (iv) all liabilities and obligations of SFR under the terms of the
SFR Retirement Plan for Hourly Employees that has been maintained by SFR (and
which will be maintained by the Company after consummation of the Offerings) in
accordance with the contract between The Oil, Chemical and Auto Workers
International Union/AFL and SFR; and (b) SFR will agree to indemnify and hold
the Company harmless from and against any costs or liabilities relating to
assets or operations of SFR (whether or not currently owned or operated by SFR)
to the extent not attributable to the Western Division (other than the Excluded
Assets). SFR is retaining the surface rights to the Olinda Property because such
surface rights are currently under contract for sale to a third party. If the
sale is concluded with such third party, SFR will be paid a total purchase price
of $24 million, comprised of $15.5 million in cash together with an $8.5 million
note, which is secured by a lien on the property. Pursuant to the Contribution
Agreement, Monterey is obligated to purchase such note from SFR at face value
after the close of the sale and will be required to incur approximately $3.5
million in site improvement costs. If the sale of the Olinda Property has not
been consummated by August 1, 1997, Monterey is obligated, under the terms of
the Contribution Agreement, to purchase, and SFR is obligated to sell, such
surface rights for $23 million in cash. The Company does not believe that SFR's
retention or subsequent sale and development of the surface of the Olinda
Property will have a material adverse effect on the Company's ongoing operations
on such property. Upon the execution and delivery of the Contribution Agreement,
the Company and SFR intend to file deeds, bills of sale and specific conveyances
in the appropriate real property records of California to reflect the
contribution and conveyance to the Company of the real property interests
effected pursuant to the Contribution Agreement.

SERVICES AGREEMENT. SFR provides various administrative and financial
services to the Company, including administration of certain employee benefit
plans, access to telecommunications, corporate legal assistance and certain
other corporate staff and support services. Concurrently with the closing of the
Offerings, the Company and SFR intend to enter into a Services Agreement to
formalize this existing

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arrangement. The agreement is intended to be flexible (for example, on short
notice the Company may take responsibility for some or all of the services
currently being provided by SFR) and may be easily terminated by either party on
30 days' notice. As a result, no assurance is given that this service
arrangement will be maintained for any specific period in the future. Whether
SFR continues to provide some or all of these services will depend on many
factors, including the continuing agreement of the parties on the appropriate
amounts of compensation and reimbursement, the ability of the Company to provide
the services for itself and the continued willingness of SFR to provide the
services. The agreement provides that the Company will pay SFR a monthly fee for
certain listed services at specified rates. The total monthly fee for all listed
services is $120,000. Because the Services Agreement was not the result of
arm's-length negotiations, the costs charged thereunder may exceed costs
otherwise available from an unaffiliated third party. The Services Agreement is
terminable by either party on 30 days' notice and payments to SFR thereunder are
expected to decline as the Company assumes full responsibility during 1997 for
each of the services covered by such agreement.

TAX ALLOCATION AGREEMENT. After consummation of the Offerings, the Company
will continue to be included in the consolidated Federal income tax return filed
by SFR as the common parent for itself and its subsidiaries. Consistent
therewith and pursuant to the Tax Allocation Agreement, the Company has agreed
to pay to SFR an amount approximating the Federal tax liability and state and
local tax liability it would have paid if it and its subsidiaries were a
separate consolidated group. This amount will be payable regardless of whether
the SFR consolidated group, as a whole, has any current Federal, state or local
tax liability. In determining amounts payable to SFR in accordance with the
foregoing formula, the Company and its subsidiaries may only take into account
their carryforwards of losses and credits to reduce amounts they would owe if
they were a separate consolidated group. Accordingly, there are circumstances in
which the Company and its subsidiaries may receive no compensation for the
current use of their carryforwards of losses or credits by other members of the
SFR group. If the Company or its subsidiaries cease to be members of the SFR
consolidated group, the Tax Allocation Agreement will continue to apply to prior
periods, and additional payments to SFR could be required if there is an audit
or similar adjustment subsequently made that impacts the computation of amounts
to be paid SFR as described above. In addition, if the Company and its
subsidiaries cease to be members of the SFR consolidated group, they would
forfeit any future rights to compensation or credit from SFR for the utilization
of their carryforwards by members of the SFR group.

REGISTRATION RIGHTS AND INDEMNIFICATION AGREEMENT. Concurrently with the
consummation of the Offerings, the Company will enter into a Registration Rights
and Indemnification Agreement with SFR pursuant to which SFR has the right to
require the Company to effect three registrations under the Securities Act of
all or any part of the Common Stock owned by SFR and to bear the expenses of
such registration. No such registration may be required by SFR prior to the
expiration of the 180 day period following the date of this Prospectus. See
"Shares Eligible for Future Sale". In addition, the Registration Rights and
Indemnification Agreement gives SFR the right to include its shares of Common
Stock in any registration of shares of Common Stock initiated by the Company
following the Offerings. The Registration Rights and Indemnification Agreement
also contains provisions whereby the Company and SFR agree to indemnify each
other and their respective subsidiaries as well as their respective directors,
officers, employees, agents and representatives for certain costs and
liabilities relating to violations of Federal and state securities laws in
connection with any such registration of shares of Common Stock owned by SFR.

CONFLICTS OF INTEREST; TRANSACTIONS WITH AFFILIATES

The nature of the respective businesses of the Company and SFR is such as
to give rise to conflicts of interest between the two companies. Conflicts could
arise, for example, with respect to allocation of capital, dividends, incurrence
of indebtedness, tax matters, financial commitments, registration rights,
administration of benefit plans, service arrangements, potential acquisitions of
businesses or oil and gas properties and other corporate opportunities, the
issuance and sale of capital stock of the Company and the election of directors.

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The Company owns all of SFR's oil and gas properties in California, except
for the Production Payment retained by SFR and the Excluded Assets. SFR has
advised the Company that it does not currently intend to engage in the
exploration, development and production of oil and gas in California except
through its ownership of Common Stock of the Company and the Excluded Assets,
nor does it currently intend to compete with the Company in the acquisition of
California oil and gas properties. Circumstances may arise in the future,
however, that would cause SFR to engage in the exploration, development and
production of oil and gas in competition with the Company. For example,
acquisition opportunities might arise which would require financial resources
greater than those available to the Company or which are located in areas in
which the Company does not intend to operate. In addition, SFR might acquire a
competing oil and gas business as part of a larger acquisition. Thus, although
SFR has no current intention to do so, there can be no assurances that it will
not engage in the oil and gas exploration, development and production business
in competition with the Company.

The Company and SFR and its affiliates have in the past entered into
intercompany transactions and agreements incident to their respective
businesses, and the Company and SFR may be expected to enter into transactions
and agreements from time to time in the future. The Company intends that the
terms of any future transactions and agreements between the Company and SFR will
be on terms at least as favorable to the Company as it could obtain from third
parties. See "Risk Factors -- Control by SFR".

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DESCRIPTION OF CAPITAL STOCK

AUTHORIZED AND OUTSTANDING CAPITAL STOCK

As of the date of this Prospectus, the authorized capital stock of the
Company consists of 100,000,000 shares of Common Stock, par value $0.01 per
share, and 25,000,000 shares of Preferred Stock, par value $0.01 per share
("Preferred Stock"). As of the date of this Prospectus, there are 45,350,000
shares of Common Stock outstanding, all of which are held of record by SFR. See
"Relationship Between the Company and SFR -- Ownership of Common Stock". Of the
authorized shares of Preferred Stock, no shares are outstanding. Immediately
after the closing of the Offerings, a total of 53,500,000 shares of Common Stock
will be outstanding, and 3,500,000 shares of Common Stock will be reserved for
issuance under the Company's incentive compensation plans. See
"Management -- Company Benefit Plans". The following description is a summary
and is subject to and qualified in its entirety by reference to the provisions
of the Company's Charter and Bylaws, copies of which are filed as exhibits to
the Registration Statement of which this Prospectus forms a part.

COMMON STOCK

VOTING RIGHTS. Each share of Common Stock entitles the holder to one vote
on each matter submitted to a vote of the Company's stockholders, including the
election of directors. There is no cumulative voting. After the Offerings, SFR
will hold approximately 85% of the issued and outstanding Common Stock and will
hold the voting power to determine the outcome of all matters upon which the
stockholders of the Company vote. See "Risk Factors -- Control by SFR" and
"Relationship Between the Company and SFR". The Charter prohibits the taking of
any action by written stockholder consent in lieu of a meeting.

DIVIDENDS. The holders of Common Stock are entitled to receive dividends
if, as and when such dividends are declared by the board of directors of the
Company out of assets legally available therefor after payment of dividends
required to be paid on shares of Preferred Stock, if any.

The Note Agreement pursuant to which the Company Senior Notes will be
issued contains covenants that, among other things, restrict the Company's
ability to pay cash dividends unless certain conditions are satisfied. Such
restriction permits the Company to pay dividends to the extent that the
aggregate dividends together with amounts previously expended to redeem or
purchase its capital stock or invested in other than permitted investments do
not exceed the sum of (i) $62 million, (ii) 100% of the Company's consolidated
net earnings (or minus 100% in the case of a deficit) for the period from the
date of the closing of the Offerings and terminating as of the end of the most
recent calendar quarter and (iii) the net cash proceeds to the Company from the
sale of its stock after the closing of the Offerings or in respect of any
convertible debt security that has been converted into stock of the Company. In
addition, dividends may not be paid under the Note Agreement if such payment
would reduce the Company's net worth below the thresholds indicated: $115
million through March 31, 1999 and, thereafter, the sum of $115 million and 20%
of the Company's consolidated net income for all then completed quarters
beginning with the quarter ending March 31, 1999. The New Credit Facility
contains similar restrictions on the payment of dividends.

LIQUIDATION OR DISSOLUTION. Upon liquidation or dissolution, holders of
Common Stock are entitled to share ratably in all net assets available for
distribution to stockholders after payment of any liquidation preferences to
holders of Preferred Stock.

OTHER PROVISIONS. The Common Stock carries no conversion or preemptive
rights. All outstanding shares of Common Stock are, and the shares of Common
Stock to be sold by the Company in the Offerings when issued will be, duly
authorized, validly issued, fully paid and nonassessable.

TRANSFER AGENT AND REGISTRAR. The Transfer Agent and Registrar for the
Common Stock is First Chicago Trust Company of New York.

LISTING. The Common Stock has been approved for listing, subject to
official notice of issuance, on the NYSE under the trading symbol "MRC".

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PREFERRED STOCK

The board of directors of the Company is authorized, without approval of
the stockholders, to cause shares of Preferred Stock to be issued in one or more
series, to determine the numbers of shares of each series, to fix the rights,
powers, preferences and privileges of each series and any qualifications,
limitations or restrictions thereon and to increase or decrease the number of
shares of each such series. Among the specific matters that may be determined by
the board of directors are: the annual rate of dividends; the redemption price,
if any; the terms of a sinking or purchase fund, if any; the amount payable in
the event of any voluntary liquidation, dissolution or winding up of the affairs
of the Company; conversion rights, if any; and voting powers, if any. Depending
upon the terms of the Preferred Stock established by the board of directors, any
or all series of Preferred Stock could have preferences over the Common Stock
with respect to dividends and other distributions and upon liquidation of the
Company or could have voting or conversion rights that could adversely affect
the holders of the outstanding Common Stock.

In addition, the Preferred Stock could delay, defer or prevent a change of
control of the Company. The Company has no present plans to issue shares of
Preferred Stock. Prior to the Spin Off, however, it is anticipated that the
Company's board of directors will adopt a preferred share purchase rights plan.
See "-- Rights Plan".

CERTAIN PROVISIONS OF THE COMPANY'S CHARTER AND BYLAWS AND DELAWARE LAW

Certain provisions of the Charter and Bylaws are intended to enhance the
likelihood of continuity and stability in the board of directors of the Company
and in its policies, but might have the effect of delaying or preventing a
change in control of the Company and may make more difficult the removal of
incumbent management even if such transactions could be beneficial to the
interests of stockholders. Set forth below is a summary description of such
provisions:

NUMBER OF DIRECTORS; FILLING VACANCIES; REMOVAL. The Company's Charter
provides that the number of directors constituting the Company's board of
directors shall be fixed by the board of directors, but shall not be less than
three nor more than 15. The Charter further provides that the directors shall be
divided into three classes, each class serving staggered three-year terms. The
board of directors of the Company, acting by a majority of the directors then in
office, may fill any vacancy or newly created directorship.

ANTI-TAKEOVER PROVISIONS. Delaware law permits and the Charter grants the
Company's board of directors broad discretionary authority to adopt certain
anti-takeover measures approved by it in response to any proposal to acquire the
Company, its assets or more than 15% of its outstanding capital stock. Measures
to be adopted could include a shareholder rights plan or bylaw provisions
requiring supermajority shareholder approval of acquisition proposals.

LIMITATION ON PERSONAL LIABILITY OF DIRECTORS. Delaware law authorizes
corporations to limit or eliminate the personal liability of directors to
corporations and their stockholders for monetary damages for breach of
director's fiduciary duty of care. The duty of care requires that, when acting
on behalf of the corporation, directors must exercise an informed business
judgment based on all material information reasonably available to them. Absent
the limitations authorized by Delaware law, directors are accountable to
corporations and their stockholders for monetary damages for conduct
constituting gross negligence in the exercise of their duty of care. Delaware
law enables corporations to limit available relief to equitable remedies such as
injunction or rescission. The Charter of the Company limits the liability of
directors of the Company to the Company or its stockholders (in their capacity
as directors but not in their capacity as officers) to the fullest extent
permitted by Delaware law. Specifically, directors of the Company will not be
personally liable for monetary damages for breach of a director's fiduciary duty
as a director, except for liability (i) for any breach of the director's duty of
loyalty to the Company or its stockholders, (ii) for acts or omissions not in
good faith or which involve intentional misconduct or a knowing violation of
law, (iii) for unlawful payments of dividends or unlawful stock repurchases or

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redemptions as provided in Section 174 of the Delaware General Corporation Law,
or (iv) for any transaction from which the director derived an improper personal
benefit.

The inclusion of this provision in the Charter may have the effect of
reducing the likelihood of derivative litigation against directors and may
discourage or deter stockholders or management from bringing a lawsuit against
directors for breach of their duty of care, even though such an action, if
successful, might otherwise have benefited the Company and its stockholders. The
Company's Bylaws provide indemnification to the Company's officers and directors
and certain other persons with respect to certain matters.

INDEMNIFICATION ARRANGEMENTS. The Charter and Bylaws provide that, to the
fullest extent permitted by the Delaware General Corporation Law, the directors
and officers of the Company shall be indemnified and shall be advanced expenses
in connection with actual or threatened proceedings and claims arising out of
their status as such. The Company has entered into indemnification agreements
with each of its directors and executive officers that provide for
indemnification and expense advancement to the fullest extent permitted under
the Delaware General Corporation Law.

SECTION 203 OF THE DELAWARE CORPORATE LAW

Section 203 of the Delaware General Corporation Law ("Section 203")
restricts certain transactions between a corporation organized under Delaware
law (or its majority owned subsidiaries) and any person holding 15% or more of
the corporation's outstanding voting stock, together with the affiliates or
associates of such person (an "Interested Stockholder"). Section 203 prevents,
for a period of three years following the date that a person becomes an
Interested Stockholder, the following types of transactions between the
corporation and an Interested Stockholder (unless certain conditions, described
below, are met): (a) mergers or consolidations, (b) sales, leases, exchanges or
other transfers of 10% or more of the aggregate assets of the corporation, (c)
issuances or transfers by the corporation of any stock of the corporation which
would have the effect of increasing the Interested Stockholder's proportionate
share of the stock of any class or series of the corporation, (d) any other
transaction which has the effect of increasing the proportionate share of the
stock of any class or series of the corporation which is owned by the Interested
Stockholder, and (e) receipt by the Interested Stockholder of the benefit
(except proportionately as a stockholder) of loans, advances, guarantees,
pledges or other financial benefits provided by the corporation.

The three-year ban does not apply if either the proposed transaction or the
transaction by which the Interested Stockholder became an Interested Stockholder
is approved by the board of directors of the corporation prior to the time such
stockholder becomes an Interested Stockholder. Additionally, an Interested
Stockholder may avoid the statutory restriction if, upon the consummation of the
transaction whereby such stockholder becomes an Interested Stockholder, the
stockholder owns at least 85% of the outstanding voting stock of the corporation
without regard to those shares owned by the corporation's officers who are also
directors or by certain employee stock plans. Business combinations are also
permitted within the three-year period if approved by the board of directors and
authorized at an annual or special meeting of stockholders by the holders of at
least 66 2/3% of the outstanding voting stock not owned by the Interested
Stockholder.

A corporation may, at its option, exclude itself from the coverage of
Section 203 by amending its certificate of incorporation or bylaws by action of
its shareholders to exempt itself from coverage, provided that such bylaw or
charter amendment shall not become effective until 12 months after the date it
is adopted. The Company has not adopted such a charter or bylaw amendment.

NO ACTION BY WRITTEN CONSENT

The Charter prohibits the taking of any action by written stockholder
consent in lieu of a meeting. Such provisions may not be amended or repealed
without the affirmative vote of the holders of at least 80% of the capital stock
of the Company entitled to vote on such matters.

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RIGHTS PLAN

Prior to the Spin Off, it is anticipated that the Company's board of
directors will adopt a preferred share purchase rights plan (the "Rights Plan")
pursuant to which, concurrently with or promptly after the Spin Off, one right
(collectively, the "Rights") to purchase one one-hundredth of a share of a newly
issued series of junior participating Preferred Stock of the Company would be
distributed as a dividend for each outstanding share of Common Stock. Such
Rights would be issuable on the terms and subject to the conditions set forth in
the Rights Plan. No Rights will be issued under the Rights Plan until the
consummation of the Spin Off. Because of the nature of the dividend, liquidation
and voting rights of the shares of the series of Preferred Stock issuable upon
exercise of a Right, the value of the one-hundredth interest in a share of this
series of Preferred Stock purchasable upon the exercise of each right should
approximate the value of one share of Common Stock. Each Right, when
exercisable, will represent the right to purchase one share of Common Stock at a
substantial premium to the per share trading price of the Common Stock on the
date the rights are distributed, subject to adjustment. The Rights will expire
no later than the tenth anniversary of the date the rights are first issued. The
Rights will be exercisable (i) 10 days after a person or group acquires
beneficial ownership of 15% or more of the Common Stock (other than any person
who owns more than 15% of the outstanding Common Stock immediately after the
Spin Off, provided such person does not thereafter acquire ownership of an
additional 1% of the Common Stock) (an "Acquiring Person"), or (ii) 10 business
days (or such later date as may be determined by the Company's board of
directors) after a person or group commences a tender offer or exchange upon
consummation of which such person or group would be an Acquiring Person.

If any person or group becomes an Acquiring Person or commences a tender
offer upon consummation of which such person or group would become an Acquiring
Person, each Right not owned by such Acquiring Person or certain related parties
would entitle its holder to purchase, at the Right's then current exercise
price, shares of Common Stock, having a value of twice the Right's exercise
price. In addition, if, after a person or group becomes an Acquiring Person, the
Company is involved in a merger or other business combination transaction with
another person in which it is not the surviving corporation, each Right will
entitle its holder to purchase, at the Right's then current exercise price,
shares of common stock of such other person or group having a value of twice the
Right's exercise price.

The purchase price payable, and the shares issuable, upon exercise of the
Rights will be subject to adjustment from time to time as specified in the
Rights Plan. The Company will generally be entitled to redeem the Rights at
$0.01 per Right at any time until 10 days after the public announcement that a
person or group has become an Acquiring Person or has commenced a tender offer
upon consummation of which such person or group would become an Acquiring
Person, provided that no such redemption may occur after the Rights have become
exercisable.

The terms of the series of junior participating Preferred Stock purchasable
upon exercise of the Rights will be established by the board of directors of the
Company upon the adoption of the rights plan, but it is expected that the terms
will be substantially as follows. Each share of such series of Preferred Stock
will have a minimum preferential quarterly dividend rate of $1.00 per share but
will be entitled to an aggregate dividend of 100 times the dividend declared on
shares of Common Stock. In the event of liquidation, the holders of such series
of Preferred Stock will receive a minimum preferred liquidation payment of $1.00
per share but will be entitled to receive an aggregate liquidation payment equal
to 100 times the payment made per share of the Common Stock. Each share of such
series of Preferred Stock will have 100 votes, voting together with the Common
Stock. The rights of this series of Preferred Stock as to dividends, liquidation
and voting, and in the event of mergers and consolidations, will be protected by
customary antidilution provisions.

The inclusion of the foregoing provisions in the Charter and Bylaws, the
existence of authorized but unissued capital stock, the adoption of the Rights
Plan and the Spin Off Tax Indemnity Agreement and the application of Section 203
to stockholders of the Company may tend to deter unfriendly offers or other
efforts to obtain control of the Company that are not approved by the Company's
board of directors

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and thereby deprive the Company's stockholders of opportunities to sell their
shares of Common Stock at prices higher than prevailing market prices.

SHARES ELIGIBLE FOR FUTURE SALE

Upon consummation of the Offerings, the Company will have outstanding a
total of 53,500,000 shares of Common Stock, including the 8,150,000 shares
offered in the Offerings. The Common Stock sold in the Offerings will be
transferable without restriction or further registration under the Securities
Act, except for any shares acquired by an "affiliate" of the Company that will
be subject to the resale limitations of Rule 144 promulgated under the
Securities Act. All of the 45,350,000 shares of Common Stock owned by SFR are
"restricted" securities within the meaning of Rule 144 and may not be sold in
the absence of registration other than through Rule 144 as described below or
another exemption from registration under the Securities Act.

In general, under Rule 144, as currently in effect, a stockholder who
(together with predecessor holders who were not "affiliates" of the Company (as
such term is defined in Rule 144 under the Securities Act, "Affiliates")) has
beneficially owned Common Stock which is treated as "restricted securities" (as
defined in Rule 144) for at least two years from the date such restricted
securities were acquired from the Company or an Affiliate, is entitled to sell,
within any three-month period, a number of shares that does not exceed the
greater of 1% of the Company's Common Stock then outstanding or the average
weekly trading volume in the Company's Common Stock during the four calendar
weeks preceding the date on which notice of such sale was filed under Rule 144.
Sales under Rule 144 are also subject to certain provisions relating to the
manner and notice of sale and availability of current public information about
the Company. In addition, Affiliates of the Company must comply with the
restrictions and requirements of Rule 144 (other than the two-year holding
period requirements) in order to sell shares of Common Stock that are not
restricted securities (such as Common Stock acquired by Affiliates in market
transactions). Furthermore, if a period of at least three years has elapsed from
the date restricted securities were acquired from the Company or an Affiliate, a
holder of such restricted securities who is not an Affiliate at the time of the
sale and has not been an Affiliate for at least three months prior to such sale
would be entitled to sell the shares immediately without regard to the volume
limitations and other conditions described above. All shares held by SFR at the
time of the Offerings will be eligible for sale in August of 1998 if and to the
extent such shares continue to be held by SFR and pursuant to and in accordance
with the volume, manner of sale and other conditions of Rule 144 described
above.

SFR will have three demand registration rights to require the Company to
register its shares of Common Stock under the Securities Act and will have
rights to participate in any future registration of securities by the Company.
See "Relationship Between the Company and SFR -- Contractual
Arrangements -- Registration Rights and Indemnification Agreement".

The Company intends to file a registration statement on Form S-8 covering
all shares of Common Stock issuable under the Company's employee benefit plans
in effect on the date of this Prospectus. The Company has outstanding stock
options and restricted stock with respect to an aggregate of approximately
342,700 shares of Common Stock as of the date of this Prospectus. None of such
options will be exercisable and none of such restricted shares will be
transferable during the Restricted Period (except under certain limited
circumstances).

The Company, SFR and each director and executive officer of the Company
have agreed that, during the period beginning from the date of this Prospectus
and continuing to and including the date 180 days after the date of this
Prospectus, they will not offer, sell, contract to sell or otherwise dispose of,
except as provided in the U.S. Underwriting Agreement and the International
Underwriting Agreement, any capital stock of the Company or any securities that
are convertible into or exchangeable for such shares without the prior written
consent of the representatives of the Underwriters. See "Underwriting". The
Registration Rights and Indemnification Agreement will provide that SFR will not
exercise its registration rights during the same 180-day period. The exercise of
registration rights could adversely affect the

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market price of the Common Stock. See "Relationship Between the Company and
SFR -- Contractual Arrangements -- Registration Rights and Indemnification
Agreement".

Prior to consummation of the Offerings, there has been no public market for
the Common Stock, and no prediction can be made as to the effect, if any, that
future sale of shares of Common Stock under Rule 144, or the availability of
such shares for future sale, will have on the market price of the Common Stock
prevailing from time to time. Nevertheless sales of substantial amounts of such
shares in the public market, or the perception that such sales could occur,
could adversely affect the prevailing market prices for the Common Stock and
could impair the Company's future ability to raise capital through an offering
of its equity securities.

LEGAL MATTERS

The validity of the Common Stock is being passed upon for the Company by
Andrews & Kurth L.L.P., Houston, Texas. Certain legal matters with respect to
the Offerings are being passed upon for the Underwriters by Cravath, Swaine &
Moore, New York, New York.

EXPERTS

The financial statements of the Western Division of Santa Fe Energy
Resources, Inc. as of December 31, 1995 and 1994 and for each of the three years
in the period ended December 31, 1995 and the balance sheet of Monterey
Resources, Inc. as of September 5, 1996 included in this Prospectus have been so
included in reliance on the report of Price Waterhouse LLP, independent
accountants, given on the authority of said firm as experts in auditing and
accounting.

The estimates of proved and proved developed reserves, the related
estimates of future net cash flows and present value thereof and other related
calculations of Ryder Scott set forth in this Prospectus have been included
herein in reliance upon the authority of said firm as experts in petroleum
engineering.

CERTAIN U.S. TAX CONSEQUENCES TO NON-U.S. HOLDERS
GENERAL

The following is a general discussion of United States Federal income and
estate tax consequences of the ownership and disposition of Common Stock by a
holder who is not a United States person (a "Non-U.S. Holder"), as defined
below. This discussion does not address all aspects of United States Federal
income and estate taxes and does not address any foreign, state or local tax
consequences. Furthermore, this discussion is based on provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), existing and proposed
regulations promulgated thereunder and administrative and judicial
interpretations thereof, as of the date hereof, all of which are subject to
change, possibly with retroactive effect. Each prospective purchaser of Common
Stock is advised to consult a tax advisor with respect to current and possible
future U.S. Federal income and estate tax consequences of holding and disposing
of Common Stock as well as any tax consequences that may arise under the laws of
any state, local or other taxing jurisdiction. For purposes of this summary, a
"U.S. Holder" with respect to the Common Stock is (i) an individual who is a
citizen or resident of the United States, (ii) a corporation or partnership
created or organized in the United States or under the laws of the United States
or of any state thereof, or (iii) an estate or trust the income of which is
includable in gross income for United States Federal income tax purposes
regardless of its source; and a "Non-U.S. Holder" is any person other than a
U.S. Holder.

DISTRIBUTIONS

Distributions on the shares of Common Stock (other than distributions in
redemption of the shares of Common Stock subject to section 302(b) of the Code)
will constitute dividends for Federal income tax purposes to the extent paid
from current or accumulated earnings and profits of the Company (as determined
under Federal income tax principles). Dividends paid to a Non-U.S. Holder of
Common Stock

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which are not effectively connected with a U.S. trade or business of the
Non-U.S. Holder will be subject to United States withholding tax at a 30% rate
or such lower rate as may be specified by an applicable income tax treaty.
Moreover, under United States Treasury regulations which are currently in
effect, withholding is generally imposed on the gross amount of the
distribution, without regard to whether the corporation has sufficient earnings
and profits to cause the distribution to be a dividend for Federal income tax
purposes. Certain certification and disclosure requirements must be complied
with in order to be exempt from withholding under the effectively connected
income exemption. Dividends that are effectively connected with the conduct of a
trade or business within the United States are subject to United States Federal
income tax on a net income basis at applicable graduated individual or corporate
rates. Any such effectively connected dividends received by a foreign
corporation may, under certain circumstances, be subject to an additional
"branch profits tax" at a 30% rate or such lower rate as may be specified by an
applicable income tax treaty.

Under current United States Treasury regulations, dividends paid to an
address outside the United States are presumed to be paid to a resident of such
country for purposes of the withholding discussed above, and, under the current
interpretation of United States Treasury regulations, for purposes of
determining the applicability of a tax treaty rate. Under proposed United States
Treasury regulations (the "Proposed Regulations") not currently in effect,
however, a Non-U.S. Holder of Common Stock would be required to satisfy
applicable certification and other requirements to qualify for withholding at an
applicable treaty rate. The Proposed Regulations would require a Non-U.S. Holder
to file a beneficial owner withholding certificate, e.g., a Form W-8, to obtain
the lower treaty rate. The Proposed Regulations would apply to dividends paid
after December 31, 1997, subject to certain transitional rules.

A Non-U.S. Holder of Common Stock may obtain a refund of any excess amounts
withheld by filing an appropriate claim for refund with the Internal Revenue
Service (the "IRS").

GAIN ON DISPOSITION OF COMMON STOCK

A Non-U.S. Holder will generally not be subject to United States Federal
income tax with respect to gain recognized on a sale or other disposition of
Common Stock unless (i) the gain is effectively connected with a trade or
business of the Non-U.S. Holder in the United States, (ii) in the case of a Non-
U.S. Holder who is an individual and holds the Common Stock as a capital asset,
such holder is present in the United States for 183 or more days in the taxable
year of the sale or other disposition and certain other conditions are met, or
(iii) the Company is or has been a "U.S. real property holding corporation" for
United States Federal income tax purposes. The Company believes that it is
currently a "U.S. real property holding corporation" for Federal income tax
purposes. So long as the Common Stock continues to be regularly traded on an
established securities market, only a Non-U.S. Holder who holds or held (at any
time during the shorter of the five year period preceding the date of
disposition or the holder's holding period) more than five percent of the Common
Stock will be subject to U.S. Federal income tax on the disposition of the
Common Stock. Such holders should consult their tax advisors concerning this and
other tax effects of the ownership and disposition of Common Stock.

FEDERAL ESTATE TAX

Common Stock held by an individual Non-U.S. Holder at the time of death
will be included in such holder's gross estate for United States Federal estate
tax purposes, unless an applicable estate tax treaty provides otherwise.

INFORMATION REPORTING AND BACKUP WITHHOLDING TAX

Under Treasury regulations, the Company must report annually to the IRS and
to each Non-U.S. Holder the amount of dividends paid to such holder and the tax
withheld with respect to such dividends. These information reporting
requirements apply even if withholding was not required because the dividends
were effectively connected with a U.S. trade or business in the United States of
the Non-U.S. Holder or withholding was reduced or eliminated by an applicable
income tax treaty. Copies of the

76
<PAGE> 77

information returns reporting such dividends and withholding may also be made
available to the tax authorities in the country in which the Non-U.S. Holder
resides under the provisions of an applicable income tax treaty.

Backup withholding (which generally is a withholding tax imposed at the
rate of 31% on certain payments to persons that fail to furnish certain
information under the United States information reporting requirements) will
generally not apply to dividends paid to Non-U.S. Holders that either are
subject to the U.S. withholding tax, whether at 30% or a reduced treaty rate, or
that are exempt from such withholding of effectively connected income. As a
general matter, information reporting and backup withholding will not apply to a
payment by or through a foreign office of a foreign broker of the proceeds of a
sale of Common Stock effected outside the United States. However, information
reporting requirements (but not backup withholding) will apply to a payment by
or through a foreign office of a broker of the proceeds of a sale of Common
Stock effected outside the United States where that broker (i) is a United
States person, (ii) is a foreign person that derives 50% or more of its gross
income for certain periods from the conduct of a trade or business in the United
States or (iii) is a "controlled foreign corporation" as defined in the Code
(generally, a foreign corporation controlled by United States shareholders),
unless the broker has documentary evidence in its records that the holder is a
Non-U.S. Holder and certain conditions are met or the holder otherwise
establishes an exemption. Payment by a United States office of a broker of the
proceeds of a sale of Common Stock is subject to both backup withholding and
information reporting unless the holder certifies to the payor in the manner
required as to its non-United States status under penalties of perjury or
otherwise establishes an exemption.

Amounts withheld under the backup withholding rules do not constitute a
separate United States federal income tax. Rather, any amounts withheld under
the backup withholding rules will be refunded or allowed as a credit against the
holder's United States Federal income tax liability, if any, provided the
required information or appropriate claim for refund is filed with the IRS.

77
<PAGE> 78

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
MONTEREY RESOURCES, INC.
Audited Balance Sheet
Report of Independent Accountants.................................................... F-2
Balance Sheet -- September 5, 1996................................................... F-3
Notes to Balance Sheet............................................................... F-4
Pro Forma Financial Statements
Unaudited Pro Forma Condensed Statement of Operations for the nine months ended
September 30, 1996................................................................ F-6
Unaudited Pro Forma Condensed Balance Sheet -- September 30, 1996.................... F-7
Unaudited Pro Forma Condensed Statement of Operations for the year ended December 31,
1995.............................................................................. F-8
Notes to Pro Forma Condensed Financial Statements.................................... F-9
WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.
Audited Financial Statements
Report of Independent Accountants.................................................... F-13
Statement of Operations for the years ended December 31, 1993, 1994 and 1995......... F-14
Balance Sheet -- December 31, 1994 and 1995.......................................... F-15
Statement of Cash Flows for the years ended December 31, 1993, 1994 and 1995......... F-16
Statement of Division Equity for the years ended December 31, 1993, 1994 and 1995.... F-17
Notes to Financial Statements........................................................ F-18
Unaudited Financial Information
Supplemental Information to Financial Statements..................................... F-28
Unaudited Financial Statements
Statement of Operations for the nine months ended September 30, 1995 and 1996........ F-32
Balance Sheet -- December 31, 1995 and September 30, 1996............................ F-33
Statement of Cash Flows for the nine months ended September 30, 1995 and 1996........ F-34
Statement of Division Equity for the nine months ended September 30, 1995 and 1996... F-35
Notes to Unaudited Financial Statements.............................................. F-36
</TABLE>

F-1
<PAGE> 79

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholder of
Monterey Resources, Inc.

In our opinion, the accompanying balance sheet presents fairly, in all material
respects, the financial position of Monterey Resources, Inc. at September 5,
1996, in conformity with generally accepted accounting principles. This
financial statement is the responsibility of the management of Monterey
Resources, Inc.; our responsibility is to express an opinion on this financial
statement based on our audit. We conducted our audit of this statement in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statement is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statement, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for the opinion expressed
above.

PRICE WATERHOUSE LLP

Houston, Texas
September 17, 1996

F-2
<PAGE> 80

MONTEREY RESOURCES, INC.

BALANCE SHEET
(IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
SEPTEMBER 5,
1996
------------
<S> <C>
ASSETS
Cash............................................................................ $0.5
====
SHAREHOLDER'S EQUITY
Shareholder's Equity
Preferred stock, $0.01 par value, 25,000,000 shares authorized, no shares
issued or outstanding...................................................... $ --
Common stock, $0.01 par value, 100,000,000 shares authorized, 45,350,000
shares issued and outstanding.............................................. 0.5
----
$0.5
====
</TABLE>

The accompanying notes are an integral part of this financial statement.

F-3
<PAGE> 81

MONTEREY RESOURCES, INC.

NOTES TO BALANCE SHEET

(1) ORGANIZATION AND BASIS OF PRESENTATION

Monterey Resources, Inc. ("Monterey" or the "Company") was incorporated in
August 1996 and is a wholly owned subsidiary of Santa Fe Energy Resources, Inc.
("SFR") engaged in the production, development and acquisition of oil and
natural gas in the State of California. The Company's fiscal year end is
December 31. In connection with the organization of Monterey, SFR contributed
$461,000 in exchange for 1,000 shares of Monterey common stock. On September 17,
1996, the Company's board of directors approved a 45,350-to-1 stock split of its
common stock. Accordingly, common stock and paid-in-capital have been restated
to give effect to this stock split. At or prior to the closing of the public
offering of the Company's common stock, SFR will contribute to the Company
substantially all of the assets and operations of its Western Division, and the
Company will assume the obligations and liabilities of SFR related thereto,
including $245 million of long-term debt. Such contribution will be effected
pursuant to a contribution and conveyance agreement (the "Contribution
Agreement"), the effective date for which is expected to be November 1, 1996.
SFR is retaining a dollar-denominated production payment (the "Production
Payment") on the Midway-Sunset field, pursuant to which SFR has the right to
receive the net proceeds of production up to a cumulative maximum of $30 million
plus interest thereon at a rate of 8% per annum, at which time the Production
Payment terminates and the Company will receive and retain all future proceeds
of production from such property interest. The Production Payment is prepayable
without penalty at any time in whole at the Company's option. SFR and the
Company will enter into a new $75 million revolving credit facility with a group
of banks and SFR is expected to borrow approximately $16 million thereunder,
which will be assumed by the Company in accordance with the Contribution
Agreement. In addition, SFR and the Company will enter into certain intercompany
agreements regarding corporate services, taxes, indemnification and certain
other matters. Upon receipt by the Company of the proceeds of the public
offering, such proceeds will be used to repay certain obligations incurred upon
SFR's contribution of the assets and operations to the Company.

SFR is retaining the surface rights to approximately 116 acres in Orange
County, California (the "Olinda Property") because such surface rights are
currently under contract for sale to a third party. If the sale is concluded
with such third party, SFR will be paid a total purchase price of $24 million,
comprised of $15.5 million in cash together with a promissory note in the
principal amount of $8.5 million which is secured by a lien on the property.
Pursuant to the Contribution Agreement, Monterey is obligated to purchase such
note from SFR at face value after the close of the sale and will be required to
incur approximately $3.5 million in site improvement costs. If the sale of the
Olinda Property has not been consummated by August 1, 1997, Monterey is
obligated under the terms of the Contribution Agreement to purchase, and SFR is
obligated to sell, such surface rights for $23 million in cash.

(2) INCENTIVE STOCK COMPENSATION PLANS

The Company has adopted the 1996 Incentive Stock Compensation Plan for Key
Employees (the "Key Employee Plan") and the 1996 Incentive Stock Compensation
Plan for Nonexecutive Employees (the "Nonexecutive Plan" and, together with the
Key Employee Plan, the "Company Stock Plans"). The Company Stock Plans will also
permit the Compensation and Benefits Committee of the board of directors (the
"Committee") to grant (i) options to purchase shares of Common Stock, which may
be, under the Key Employee Plan, either Incentive Stock Options, as defined in
Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or
NQSOs, and, which may be, under the Nonexecutive Plan, NQSOs only, (ii) shares
of Restricted Stock, (iii) Stock Appreciation Rights ("SARs"), (iv) Phantom
Units and (v) Bonus Stock. Options and awards with respect to no more than
3,000,000 shares of Common Stock may be issued under the Key Employee Plan. The
Nonexecutive Plan allows for the grant of up to 500,000 shares annually. The
Committee, in its discretion, will select those employees to whom awards will be
granted, the form and amount of awards, and the terms and

F-4
<PAGE> 82

conditions of awards. All nonexecutive employees of the Company who are
responsible for the Company's growth and profitability will be eligible to
receive awards under the Nonexecutive Plan.

Effective as of the closing of the public offering discussed in Note 1,
268,500 NQSOs and 74,166 shares of restricted stock will be issued to certain
key employees and directors.

In October 1995 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation" ("SFAS 123"), which established financial accounting and reporting
standards for stock-based employee compensation plans. SFAS 123 encourages
companies to adopt a fair value based method of accounting for such plans but
continues to allow the use of the intrinsic value based method prescribed by
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" ("Opinion 25"). Companies electing to continue accounting in
accordance with Opinion 25 must make pro forma disclosures of net income and
earnings per share as if the fair value based method defined in SFAS 123 had
been applied. The Company will account for stock-based compensation in
accordance with Opinion 25 and will make pro forma disclosures in accordance
with the provisions of SFAS 123 in its financial statements.

F-5
<PAGE> 83

MONTEREY RESOURCES, INC.

UNAUDITED PRO FORMA CONDENSED STATEMENT OF OPERATIONS
(IN MILLIONS OF DOLLARS, EXCEPT AS NOTED)

<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1996
------------------------------------------------------------------------------
PRO FORMA PRO FORMA
WESTERN ADJUSTMENTS WESTERN ADJUSTMENTS MONTEREY
DIVISION FOR THE DIVISION FOR THE RESOURCES, INC.
HISTORICAL CONTRIBUTION PRO FORMA OFFERINGS PRO FORMA(A)
---------- ----------- --------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Revenues....................... $214.8 $ -- $ 214.8 $ -- $ 214.8
------ ----- - ------- ------- -------
Costs and Expenses
Production and operating..... 76.7 -- 76.7 -- 76.7
Cost of crude oil
purchased................. 21.4 -- 21.4 -- 21.4
Exploration, including dry
hole costs................ 1.2 -- 1.2 -- 1.2
Depletion, depreciation &
amortization.............. 27.9 -- 27.9 -- 27.9
General and administrative... 5.8 -- 5.8 1.2(c) 7.0
Taxes (other than income).... 6.8 -- 6.8 -- 6.8
------ ------ ------- ------ -------
139.8 -- 139.8 1.2 141.0
------ ------ ------- ------ -------
Income from Operations......... 75.0 -- 75.0 (1.2) 73.8
Interest, net................ (18.4) (2.6)(b) (21.0) 6.4(d) (14.6)
------ ------ ------- ------ -------
Income Before Income Taxes..... 56.6 (2.6) 54.0 5.2 59.2
Income tax expense........... (20.6) 1.0(e) (19.6) (2.0)(e) (21.6)
------ ------ ------- ------ -------
Net Income (Loss).............. $ 36.0 $(1.6) $ 34.4 $ 3.2 $ 37.6
====== ===== ======= ======= =======
Earnings per share (in
dollars)..................... $ 0.79 $ 0.70
====== =======
Average shares outstanding
(millions)................... 45.3 8.3(f) 53.6
====== ====== =======
</TABLE>

The accompanying notes are an integrated part of these pro forma condensed
financial statements.

F-6
<PAGE> 84

MONTEREY RESOURCES, INC.

UNAUDITED PRO FORMA CONDENSED BALANCE SHEET
(IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1996
--------------------------------------------------------------------------
PRO FORMA PRO FORMA
WESTERN ADJUSTMENTS WESTERN ADJUSTMENTS MONTEREY
DIVISION FOR THE DIVISION FOR THE RESOURCES, INC.
HISTORICAL CONTRIBUTION PRO FORMA OFFERINGS PRO FORMA
---------- ----------- --------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
ASSETS
$ 107.2(c)
Cash and cash equivalents.......... $ -- $ -- $ -- (89.8)(d) $ 17.4
Accounts receivable.............. 40.4 -- 40.4 -- 40.4
Note receivable.................. -- 8.5(b) 8.5 -- 8.5
Other current assets............. 2.8 -- 2.8 -- 2.8
-------- ------ ------- ------ --------
43.2 8.5 51.7 17.4 69.1
-------- ------ ------- ------ --------
Properties and Equipment, at cost
Oil and gas (successful efforts
accounting)................... 1,004.9 -- 1,004.9 -- 1,004.9
Other............................ 21.2 -- 21.2 -- 21.2
-------- ------ ------- ------ --------
1,026.1 -- 1,026.1 -- 1,026.1
Accumulated depletion,
depreciation, amortization and
impairment.................... (647.1) -- (647.1) -- (647.1)
-------- ------ ------- ------ --------
379.0 -- 379.0 -- 379.0
-------- ------ ------- ------ --------
Other Assets....................... 1.5 -- 1.5 -- 1.5
-------- ------ ------- ------ --------
$ 423.7 $ 8.5 $ 432.2 $ 17.4 $ 449.6
======== ====== ======= ====== ========
LIABILITIES & SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable................. $ 21.1 $ 3.5(b) $ 24.6 $ -- $ 24.6
Current portion of long-term
debt.......................... 35.0 -- 35.0 (35.0)(d) --
Production payment payable....... -- 30.0(a) 30.0 (30.0)(e) --
Other current liabilities........ 9.0 (0.7)(a) 8.3 -- 8.3
-------- ------ ------- ------ --------
65.1 32.8 97.9 (65.0) 32.9
-------- ------ ------- ------ --------
16.0(a) 30.0(e)
Long-Term Debt..................... 210.0 8.5(b) 234.5 (51.0)(d) 213.5
-------- ------ ------- ------ --------
Long-Term Obligations.............. 6.5 (2.4)(a) 4.1 -- 4.1
-------- ------ ------- ------ --------
(24.2)(a)
Deferred Income Taxes.............. 82.3 (1.4)(b) 56.7 (1.5)(d) 55.2
-------- ------ ------- ------ --------
Shareholders' Equity
Common stock (45,350,000 shares
issued and outstanding,
historical, and 53,324,166
shares issued and outstanding,
pro forma).................... -- 0.4(a) 0.4 0.1(c) 0.5
1.0(f)
Paid-in capital.................. -- 40.7(a) 40.7 107.1(c) 148.8
Unamortized restricted stock
awards........................ -- -- -- (1.0)(f) (1.0)
Retained earnings................ -- (2.1)(b) (2.1) (2.3)(d) (4.4)
Western Division equity.......... 59.8 (59.8)(a) -- -- --
-------- ------ ------- ------ --------
59.8 (20.8) 39.0 104.9 143.9
-------- ------ ------- ------ --------
$ 423.7 $ 8.5 $ 432.2 $ 17.4 $ 449.6
======== ====== ======= ====== ========
</TABLE>

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

F-7
<PAGE> 85

MONTEREY RESOURCES, INC.

UNAUDITED PRO FORMA CONDENSED STATEMENT OF OPERATIONS
(IN MILLIONS OF DOLLARS, EXCEPT AS NOTED)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
------------------------------------------------------------------------------
PRO FORMA PRO FORMA
WESTERN ADJUSTMENTS WESTERN ADJUSTMENTS MONTEREY
DIVISION FOR THE DIVISION FOR THE RESOURCES, INC.
HISTORICAL CONTRIBUTION PRO FORMA OFFERINGS PRO FORMA(A)
---------- ----------- --------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Revenues....................... $211.3 $ -- $ 211.3 $ -- $ 211.3
------ ------ ------- ----- -------
Costs and Expenses
Production and operating..... 85.3 -- 85.3 -- 85.3
Exploration, including dry
hole costs................ 2.3 -- 2.3 -- 2.3
Depletion, depreciation &
amortization.............. 32.4 -- 32.4 -- 32.4
General and administrative... 7.3 -- 7.3 2.1(c) 9.4
Taxes (other than income).... 7.9 -- 7.9 -- 7.9
------ ------ ------- ----- -------
135.2 -- 135.2 2.1 137.3
------ ------ ------- ----- -------
Income from Operations......... 76.1 -- 76.1 (2.1) 74.0
Interest, net................ (25.1) (3.5)(b) (28.6) 8.6(d) (20.0)
Other income (expense)....... (0.6) -- (0.6) -- (0.6)
------ ----- -------- ----- -------
Income Before Income Taxes..... 50.4 (3.5) 46.9 6.5 53.4
Income tax expense........... (16.0) 1.4(e) (14.6) (2.5)(e) (17.1)
------ ----- ------- ----- -------
Net Income (Loss).............. $ 34.4 $(2.1) $ 32.3 $ 4.0 $ 36.3
====== ===== ======= ===== =======
Earnings per share (in
dollars)..................... $ 0.76 $ 0.68
====== =======
Average shares outstanding
(millions)................... 45.3 8.3(f) 53.6
====== ===== =======
</TABLE>

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

F-8
<PAGE> 86

MONTEREY RESOURCES, INC.

NOTES TO PRO FORMA CONDENSED FINANCIAL STATEMENTS

(1) BASIS OF PRESENTATION

The unaudited pro forma condensed statements of operations of the Company
for the nine months ended September 30, 1996 and the year ended December 31,
1995, and the unaudited pro forma condensed balance sheet as of September 30,
1996 (collectively "the Pro Forma Financial Statements") have been prepared from
the historical financial statements of the Western Division of Santa Fe Energy
Resources, Inc. ("SFR") presented elsewhere in this prospectus. The Pro Forma
Financial Statements are based on numerous assumptions and include the
adjustments as explained in Note 2 below. The unaudited pro forma condensed
statements of operations for the nine months ended September 30, 1996 and the
year ended December 31, 1995 have been prepared as if the transactions described
below had occurred as of January 1, 1995. The unaudited pro forma condensed
balance sheet has been prepared as if the transactions described below had
occurred as of September 30, 1996.

Prior to or concurrently with the consummation of the Offerings, the
following transactions will occur: (a) the Company and SFR will enter into a
contribution and conveyance agreement (the "Contribution Agreement"), pursuant
to which, among other things: (i) SFR will contribute to the Company
substantially all of the assets and properties of the Western Division, subject
to the retention by SFR of the Production Payment (as defined below) and certain
other assets; (ii) SFR will retain a production payment (the "Production
Payment") in an aggregate amount not to exceed $30 million, with respect to
certain properties in the Midway-Sunset field, which Production Payment will be
prepayable in whole or in part without penalty by the Company at any time or
from time to time; and (iii) the Company will assume all obligations and
liabilities of SFR associated with or allocated to the assets and properties of
the Western Division, including $245 million of indebtedness in respect of SFR's
10.23% Series E Notes due 1997, 10.27% Series F Notes due 1998 and 10.61% Series
G Notes due 2005 (the "Series E Notes", "Series F Notes" and "Series G Notes",
respectively, and the "SFR Senior Notes", collectively); (b) the Company will
(i) use a portion of the net proceeds of the Offerings to repay in full the $70
million aggregate principal amount of the Series E Notes and Series F Notes and
accrued and unpaid interest thereon, and to pay a prepayment penalty of
approximately $2.5 million thereon and (ii) issue $175 million in aggregate
principal amount of its 10.61% Senior Notes due 2005 (the "Company Senior
Notes") to holders of the Series G Notes in exchange for the cancellation of
such notes, and pay a $1.3 million consent fee in connection therewith; (c) (i)
SFR and the Company will enter into a new $75 million revolving credit facility
with a group of banks (the "New Credit Facility") and SFR is expected to borrow
approximately $16 million thereunder, which will be assumed by the Company in
accordance with the Contribution Agreement, and (ii) upon consummation of the
Offerings, the Company will repay all such indebtedness outstanding under the
New Credit Facility with a portion of the net proceeds of the Offerings; and (d)
SFR and the Company will enter into certain intercompany agreements regarding
corporate services, taxes, indemnification and certain other matters. The
transactions described above, excluding the Offerings, are referred to herein
collectively as the "Transactions".

SFR is retaining the surface rights to approximately 116 acres in Orange
County, California (the "Olinda Property"), because such surface rights are
currently under contract for sale to a third party. If the sale is concluded
with such third party, SFR will be paid a total purchase price of $24 million,
comprised of $15.5 million in cash together with a promissory note in the
principal amount of $8.5 million which is secured by a lien on the property.
Pursuant to the Contribution Agreement, Monterey is obligated to purchase such
note from SFR at face value after the close of the sale and will be required to
incur approximately $3.5 million in site improvement costs. If the sale of the
Olinda Property has not been consummated by August 1, 1997, Monterey is
obligated under the terms of the Contribution Agreement to purchase, and SFR is
obligated to sell, such surface rights for $23 million in cash.

In addition to the Offerings and the Transactions described above, SFR has
(a) commenced an offer to purchase for cash (the "SFR Tender Offer") outstanding
shares of its Convertible Preferred Stock, 7% Series (the "Convertible Preferred
Stock"); and (b) executed a Supplemental Indenture relating to

F-9
<PAGE> 87

MONTEREY RESOURCES, INC.

NOTES TO PRO FORMA CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

its $100 million outstanding principal amount of 11% Senior Subordinated
Debentures due 2004 (the "SFR Debentures") pursuant to which certain amendments
have been made to the indenture relating to the SFR Debentures to permit the
Transactions and the Spin Off (defined herein) to be effected (the "SFR
Debenture Amendments").

The Company intends but is not obligated to prepay the Production Payment
in full promptly after the closing of the Offerings.

The Pro Forma Financial Statements are not necessarily indicative of the
current or future financial position or results of operations of the Company had
the transfer of the Western Division and offering occurred earlier and such
statements should be read in the context of the related historical financial
statements and notes thereto appearing elsewhere herein. The pro forma
adjustments are based upon currently available information and contain estimates
and assumptions. Management believes that the estimates and assumptions provide
a reasonable basis for presenting the significant effects of the transactions as
contemplated and that the pro forma adjustments give appropriate effect to these
estimates and assumptions and are properly applied in the Pro Forma Financial
Statements.

(2) PRO FORMA ADJUSTMENTS

The pro forma adjustments to the financial statements indicated are as set
forth below:

Unaudited Pro Forma Condensed Statement of Operations for the nine months
ended September 30, 1996.

(a) The unaudited pro forma condensed statement of operations does not
reflect the following nonrecurring charges which are directly related
to the Transactions and the Offerings: (i) $2.5 million ($1.5 million
after tax) prepayment penalty related to the retirement of the Series E
Notes and the Series F Notes, and (ii) a $1.3 million ($0.8 million
after tax) consent fee related to the exchange of the Company Senior
Notes for the Series G Notes. Such charges will be reflected as
extraordinary items in the Company's Statement of Operations. In
addition, the unaudited pro forma condensed statement of operations
does not reflect approximately $3.5 million of nonrecurring charges
which Monterey will be required to incur related to site improvements
at the Olinda Property. See Note (b) to the unaudited pro forma
condensed balance sheet as of September 30, 1996, below.

In February 1996 the Bureau of Land Management of the United States
Department of the Interior (which oversees the Company's leases of
Federal lands) agreed, effective as of June 1, 1996, to reduce the
royalties payable on any Federal lease that produces crude oil with a
weighted average gravity of less than 20 degrees API (see the
discussion under "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- General"). On a pro forma basis
such royalty relief would result in a $3.8 million increase in revenues
and a $1.1 million increase in production and operating costs (a $2.7
million increase in income before income taxes and a $1.6 million
increase in net income). The effect of such royalty relief is not
reflected in the unaudited pro forma condensed statement of operations
since the royalty provisions are not permanent, but are subject to
periodic review and termination.

(b) Reflects interest expense with respect to the Production Payment at 8%
per annum ($1.8 million) and $16.0 million outstanding under the terms
of the New Credit Facility at 7% per annum ($0.8 million).

(c) Reflects (i) the reversal of $4.8 million of general and administrative
expenses allocated to the Western Division by SFR, (ii) $5.8 million of
estimated incremental direct and indirect general and administrative
expenses associated with the operations of the Company as a stand-alone

F-10
<PAGE> 88

MONTEREY RESOURCES, INC.

NOTES TO PRO FORMA CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

entity and (iii) the amortization of certain restricted stock awards
effective as of the closing of the Offerings ($0.2 million). The
estimated general and administrative expenses include additional
salaries and benefits, investor reporting and communications, annual
costs of computer hardware and telecommunications systems, annual
computer software licenses and maintenance, separate insurance and
other costs.

(d) Reflects the reversal of interest expense with respect to the Series E
Notes and Series F Notes ($5.4 million) and interest expense related to
the $16.0 million outstanding under the New Credit Facility ($0.8
million), both of which will be retired with a portion of the proceeds
from the Offerings. Also reflects the reversal of interest expense with
respect to the Production Payment ($1.8 million) which will be retired
with $30.0 million borrowed under the New Credit Facility and the
accrual of interest expense ($1.6 million) with respect to such
borrowings. An increase of 0.5% in the effective interest rate with
respect to amounts outstanding under the New Credit Facility would
result in a $0.1 million increase in pro forma interest expense.

(e) Reflects the income tax effects of the pro forma adjustments.

(f) Reflects the issuance of 8.2 million shares of common stock in the
Offerings and 74,166 restricted shares effective as of the closing of
the Offerings.

Unaudited Pro Forma Condensed Balance Sheet as of September 30, 1996

(a) Gives effect to (i) the contribution of the net assets of the Western
Division by SFR pursuant to the Contribution Agreement and the
assumption of certain Western Division liabilities by SFR; (ii) the
$16.0 million liability for amounts drawn on the New Credit Facility
and assumed by the Company in accordance with the Contribution
Agreement; and (iii) the $30.0 million Production Payment retained by
SFR.

Upon contribution by SFR of the net assets of the Western Division
pursuant to the Contribution Agreement and the assumption of certain
Western Division liabilities by SFR, the tax basis applicable to the
Western Division net assets will increase, and the deferred income tax
liability will decrease, as a result of the tax gain recognized by SFR.

(b) Gives effect to (i) Monterey's purchase of SFR's $8.5 million note
receivable on the Olinda Property using borrowings available under the
New Credit Facility, and (ii) $3.5 million ($2.1 million, net of
related taxes) of site improvement costs that Monterey will be required
to incur pursuant to the contract for sale entered into by SFR and a
third party relating to the Olinda Property. See "Relationships between
the Company and SFR -- Contractual Agreements."

(c) Gives effect to the receipt by Monterey of $107.2 million in proceeds
from the Offerings (consisting of the sale of 8.2 million shares at
$14.50 per share), net of underwriting discounts of $8.0 million and
estimated expenses of the Offerings of $3.0 million.

(d) Gives effect to (i) the retirement of the Series E Notes ($35.0
million) and Series F Notes ($35.0 million) assumed by the Company
pursuant to the Contribution Agreement; (ii) the repayment of the $16.0
million outstanding under the New Credit Facility; (iii) the payment of
a $2.5 million prepayment penalty ($1.5 million, net of related taxes)
related to the retirement of the of the Series E Notes and Series F
Notes; and (iv) the payment of a $1.3 million consent fee ($0.8
million, net of related taxes) incurred in the exchange of the
Company's Senior Notes for the Series G Notes.

(e) Reflects the retirement of the Production Payment utilizing $30.0
million in borrowings under the New Credit Facility.

F-11
<PAGE> 89

MONTEREY RESOURCES, INC.

NOTES TO PRO FORMA CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)

(f) Reflects the issuance of 74,166 restricted shares effective as of the
closing of the Offerings.

Unaudited Pro Forma Condensed Statement of Operations for the year ended
December 31, 1995

(a) The unaudited pro forma condensed statement of operations does not
reflect the following nonrecurring charges which are directly related
to the Transactions and the Offerings: (i) a $2.5 million ($1.5 million
after tax) prepayment penalty related to the retirement of the Series E
Notes and the Series F Notes, and (ii) a $1.3 million ($0.8 million
after tax) consent fee related to the exchange of the Company Senior
Notes for the Series G Notes. Such charges will be reflected as
extraordinary items in the Company's Statement of Operations. In
addition, the unaudited pro forma condensed statement of operations
does not reflect approximately $3.5 million of nonrecurring charges
which Monterey will be required to incur related to site improvements
at the Olinda Property. See Note (b) to the unaudited pro forma
condensed balance sheet as of September 30, 1996, above.

In February 1996 The Bureau of Land Management of the United States
Department of the Interior (which oversees the Company's leases of
Federal lands) agreed, effective as of June 1, 1996, to reduce the
royalties payable on any Federal lease that produces crude oil with a
weighted average gravity of less than 20 degrees API (see the
discussion under "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- General"). On a pro forma basis
such royalty relief would result in a $7.4 million increase in revenues
and a $2.0 million increase in production and operating costs (a $5.4
million increase in income before income taxes and a $3.2 million
increase in net income). The effect of such royalty relief is not
reflected in the unaudited pro forma condensed statement of operations
since the royalty relief provisions are not permanent, but are subject
to periodic review and termination.

(b) Reflects interest expense with respect to the Production Payment at 8%
($2.4 million) and $16.0 million outstanding under the terms of the New
Credit Facility at 7% ($1.1 million).

(c) Reflects (i) the reversal of $6.4 million of general and administrative
expenses allocated to the Western Division by SFR, (ii) $8.1 million of
estimated incremental direct and indirect general and administrative
expenses associated with the operations of the Company as a stand-alone
entity and (iii) the amortization of certain restricted stock awards
effective as of the closing of the Offering ($0.4 million). The
estimated general and administrative expenses include additional
salaries and benefits, investor reporting and communications, annual
costs of computer hardware and telecommunications systems, annual
computer software licenses and maintenance, separate insurance and
other costs.

(d) Reflects the reversal of interest expense with respect to the Series E
Notes and Series F Notes ($7.2 million) and interest expense associated
with $16.0 million outstanding under the terms of the New Credit
Facility ($1.1 million), both of which will be retired with a portion
of the proceeds of the Offerings. Also reflects the reversal of
interest expense with respect to the Production Payment ($2.4 million)
which will be retired with $30.0 million borrowed under the New Credit
Facility and the accrual of interest expense ($2.1 million) with
respect to such borrowing. An increase of 0.5% in the effective
interest rate with respect to amounts outstanding under the New Credit
Facility would result in a $0.2 million increase in pro forma interest
expense.

(e) Reflects the income tax effects of the pro forma adjustments.

(f) Reflects the issuance of 8.2 million shares of common stock in the
Offerings and 74,166 restricted shares effective as of the closing of
the Offerings.

F-12
<PAGE> 90

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders
of Santa Fe Energy Resources, Inc.

In our opinion, the accompanying balance sheet and the related statements of
operations, of cash flows and of division equity present fairly, in all material
respects, the financial position of the Western Division of Santa Fe Energy
Resources, Inc. at December 31, 1995 and 1994, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1995, in conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.

PRICE WATERHOUSE LLP

Houston, Texas
September 17, 1996

F-13
<PAGE> 91

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

STATEMENT OF OPERATIONS
(IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1993 1994 1995
------ ------ ------
<S> <C> <C> <C>
Revenues
Crude oil and liquids........................................ $180.2 $173.5 $205.0
Natural gas.................................................. 3.7 1.6 1.9
Crude oil marketing and trading.............................. 2.6 3.3 4.2
Other........................................................ 0.6 0.7 0.2
------ ------ ------
187.1 179.1 211.3
------ ------ ------
Costs and Expenses
Production and operating..................................... 100.3 86.3 85.3
Exploration, including dry hole costs........................ 1.7 1.4 2.3
Depletion, depreciation and amortization..................... 41.2 32.0 32.4
Impairment of oil and gas properties......................... 49.1 -- --
General and administrative................................... 9.2 7.8 7.3
Taxes (other than income).................................... 8.4 8.7 7.9
Restructuring charges........................................ 11.9 1.1 --
Loss (gain) on disposition of oil and gas properties......... 0.2 (0.3) --
------ ------ ------
222.0 137.0 135.2
------ ------ ------
Income (Loss) from Operations.................................. (34.9) 42.1 76.1
Interest income.............................................. 0.2 -- --
Interest expense............................................. (27.2) (26.4) (25.8)
Interest capitalized......................................... 0.3 0.6 0.7
Other income (expense)....................................... (0.4) (0.1) (0.6)
------ ------ ------
Income (Loss) Before Income Taxes.............................. (62.0) 16.2 50.4
Income taxes................................................. 26.9 (4.7) (16.0)
------ ------ ------
Net Income (Loss).............................................. $(35.1) $ 11.5 $ 34.4
====== ====== ======
</TABLE>

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

F-14
<PAGE> 92

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

BALANCE SHEET
(IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
1994 1995
------- -------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents........................................... $ -- $ --
Accounts receivable................................................. 22.6 20.6
Inventories......................................................... 1.3 1.4
Other current assets................................................ 1.2 0.6
------- -------
25.1 22.6
------- -------
Properties and Equipment, at cost
Oil and gas (on the basis of successful efforts accounting)......... 921.1 970.8
Other............................................................... 20.4 20.0
------- -------
941.5 990.8
Accumulated depletion, depreciation, amortization and impairment.... (591.9) (623.5)
------- -------
349.6 367.3
------- -------
Other Assets.......................................................... 1.4 1.4
------- -------
$ 376.1 $ 391.3
======= =======
LIABILITIES AND DIVISION EQUITY
Current Liabilities
Accounts payable.................................................... $ 11.1 $ 8.3
Interest payable.................................................... 6.5 6.4
Taxes payable....................................................... 3.3 2.0
Accrued employee benefits........................................... 2.9 2.7
Other current liabilities........................................... 2.8 1.5
------- -------
26.6 20.9
Long-Term Debt........................................................ 245.0 245.0
Other Long-Term Obligations........................................... 5.4 5.7
Deferred Income Taxes................................................. 67.0 74.7
Commitments and Contingencies (Note 9)................................ -- --
Division Equity....................................................... 32.1 45.0
------- -------
$ 376.1 $ 391.3
======= =======
</TABLE>

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

F-15
<PAGE> 93

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

STATEMENT OF CASH FLOWS
(IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1993 1994 1995
------ ------ ------
<S> <C> <C> <C>
Operating Activities:
Net income (loss)............................................. $(35.1) $ 11.5 $ 34.4
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation, depletion and amortization................... 41.2 32.0 32.4
Impairment of oil and gas properties....................... 49.1 -- --
Deferred income taxes...................................... (27.9) 4.7 7.7
Net loss (gain) on disposition of properties............... 0.2 (0.3) --
Exploratory dry hole costs................................. -- -- 1.0
Restructuring charges...................................... 11.3 -- --
Other...................................................... 0.3 (0.1) (0.2)
Changes in operating assets and liabilities
Decrease (increase) in accounts receivable............... 7.2 (5.5) 2.0
Decrease (increase) in other current assets.............. 0.8 0.5 0.5
Increase (decrease) in interest payable.................. (0.2) -- --
Increase (decrease) in accounts payable.................. 1.1 (3.5) (2.8)
Increase (decrease) in other current liabilities......... 0.1 4.9 (2.8)
Net change in other assets and liabilities............... (1.4) 1.3 3.5
------ ------ ------
Net Cash Provided by Operating Activities....................... 46.7 45.5 75.7
------ ------ ------
Investing Activities:
Capital expenditures, including exploratory dry hole costs.... (37.6) (27.3) (52.9)
Acquisition of producing properties........................... (8.9) -- (1.3)
Proceeds from sales of properties............................. 28.3 9.1 --
------ ------ ------
Net Cash Used in Investing Activities........................... (18.2) (18.2) (54.2)
------ ------ ------
Financing Activities:
Principal payments on long-term borrowings.................... (5.4) (12.6) --
Dividends to parent........................................... (23.1) (14.7) (21.5)
------ ------ ------
Net Cash Used in Financing Activities........................... (28.5) (27.3) (21.5)
------ ------ ------
Net Increase (Decrease) in Cash and Cash Equivalents............ -- -- --
Cash and Cash Equivalents at Beginning of Period................ -- -- --
------ ------ ------
Cash and Cash Equivalents at End of Period...................... $ -- $ -- $ --
====== ====== ======
</TABLE>

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

F-16
<PAGE> 94

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

STATEMENT OF DIVISION EQUITY
(IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1993 1994 1995
------ ------ ------
<S> <C> <C> <C>
Balance at beginning of period.................................. $ 93.5 $ 35.3 $ 32.1
Net income (loss)............................................... (35.1) 11.5 34.4
Dividends to parent............................................. (23.1) (14.7) (21.5)
------ ------ ------
Balance at end of period........................................ $ 35.3 $ 32.1 $ 45.0
====== ====== ======
</TABLE>

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

F-17
<PAGE> 95

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS

(1) ORGANIZATION AND BASIS OF PRESENTATION

Monterey Resources, Inc. ("Monterey" or the "Company") was incorporated in
August 1996 and is a wholly-owned subsidiary of Santa Fe Energy Resources, Inc.
("SFR") engaged in the production, development and acquisition of oil and
natural gas in the State of California. In connection with the organization of
Monterey, SFR contributed $461,000 to Monterey in exchange for 1,000 shares of
Monterey common stock. At or prior to the closing of the public offering of the
Company's common stock (the "Offering"), SFR will contribute to the Company
substantially all of the assets and operations of its Western Division, and the
Company will assume the obligations and liabilities of SFR related thereto,
including $245 million of long-term debt. Such contribution will be effected
pursuant to a contribution and conveyance agreement, the effective date for
which is expected to be November 1, 1996. SFR is retaining a dollar-denominated
production payment (the "Production Payment") on the Midway-Sunset field,
pursuant to which SFR has the right to receive net proceeds of production up to
a cumulative maximum of $30 million plus interest thereon at a rate of 8% per
annum, at which time the Production Payment terminates and the Company will
receive and retain all future proceeds of production from such property
interest. The Production Payment is prepayable without penalty at any time in
whole at the Company's option. SFR and the Company will enter into a new $75
million revolving credit facility with a group of banks and SFR is expected to
borrow approximately $16 million thereunder, which will be assumed by the
Company in accordance with the Contribution Agreement. In addition, SFR and the
Company will enter into certain intercompany agreements regarding corporate
services, taxes, indemnification and certain other matters. Upon receipt by the
Company of the proceeds of the public offering, such proceeds will be used to
repay certain obligations incurred upon SFR's contribution of the assets and
operations to the Company.

Prior to the contribution as described above, the assets of the Company
were operated as a division of SFR and the accompanying financial statements
reflect such predecessor operations. For the purposes of preparing these
financial statements under generally accepted accounting principles, allocations
were made from certain SFR income statement and balance sheet accounts. Such
allocations are considered reasonable by management and were primarily based on
identifiable revenues, operating costs, assets and liabilities. General and
administrative expenses represent corporate overhead allocations. If the Company
had been a separate, unaffiliated entity, the Company estimates that general and
administrative expense would have been higher by $1.2 million, $1.2 million and
$2.1 million in 1993, 1994 and 1995, respectively. Certain general and
administrative expenses associated with production and exploration operations
are included in Production and Operating and Exploration costs in the Statement
of Operations. In addition, certain net hedging losses have been allocated to
the Company (see Note 9).

SFR provides cash management services to the Company through a centralized
treasury system, and therefore all intercompany accounts are settled daily and
no cash or intercompany balances are maintained by the Company. Included in such
settlements are corporate overhead allocations which are reflected in the
Company's statement of operations as follows: (i) production and operating
expense includes $0.9 million in 1993, $3.0 million in 1994 and $1.9 million in
1995; (ii) exploration expense includes $0.3 million in 1993, $0.5 million in
1994 and $0.5 million in 1995; and (iii) general and administrative expense
includes $9.1 million in 1993, $7.9 million in 1994 and $6.4 million in 1995.
All net cash generated from the Company's operations, after considering revenues
and deductions for expenses, capital expenditures and working capital
requirements, is deemed to be cash dividends to parent.

F-18
<PAGE> 96

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Oil and Gas Operations

The Company follows the successful efforts method of accounting for its oil
and gas exploration and production activities. Costs (both tangible and
intangible) of productive wells and development dry holes, as well as the cost
of prospective acreage, are capitalized. The costs of drilling and equipping
exploratory wells which do not find proved reserves are expensed upon
determination that the well does not justify commercial development. Other
exploratory costs, including geological and geophysical costs and delay rentals,
are charged to expense as incurred.

Depletion and depreciation of proved properties are computed on an
individual field basis using the unit-of-production method based upon proved oil
and gas reserves attributable to the field. Certain other oil and gas properties
are depreciated or amortized on a straight-line basis.

In the fourth quarter of 1995 the Company changed its impairment policy to
conform to the provisions of Statement of Financial Accounting Standards
("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of". In accordance with the provisions of SFAS
No. 121 individual proved properties are reviewed periodically to determine if
the carrying value of the property exceeds the expected undiscounted future net
revenues from the operation of the property. Based on this review and the
continuing evaluation of development plans, economics and other factors, as
appropriate, the Company records impairment (additional depletion and
depreciation) to the extent that the carrying value of the property exceeds the
present value of such expected future net revenues. No impairments were recorded
in connection with the adoption of SFAS No. 121. Under its previous policy,
which required impairments to be recognized to the extent carrying value
exceeded undiscounted future net revenues, the Company recorded impairments of
$49.1 million in 1993.

The Company provides for future abandonment and site restoration costs with
respect to certain of its oil and gas properties. The Company estimates that
with respect to these properties such future costs total approximately $19.1
million and such amount is being accrued over the expected life of the
properties. At December 31, 1995, Accumulated Depletion, Depreciation,
Amortization and Impairment includes $4.8 million with respect to such costs.

The value of undeveloped acreage is aggregated and the portion of such
costs estimated to be nonproductive, based on historical experience, is
amortized to expense over the average holding period. Additional amortization
may be recognized based upon periodic assessment of prospect evaluation results.
The cost of properties determined to be productive is transferred to proved
properties; the cost of properties determined to be nonproductive is charged to
accumulated amortization.

Maintenance and repairs are expensed as incurred; major renewals and
improvements are capitalized. Gains and losses arising from sales of properties
are included in income currently.

The Company's financial statements reflect its proportionate interest in
the revenues, costs, expenses and capital with respect to properties in which
its ownership is less than 100%.

Revenue Recognition

Revenues from the sale of crude oil and liquids produced are generally
recognized upon the passage of title (generally when the crude oil and liquids
leave the field), net of royalties and net profits interests. Revenues from
natural gas production are generally recorded using the entitlement method, net
of royalties and net profits interests.

A portion of the Company's oil sales are hedged. See Note 9 -- Commitments
and Contingencies -- Oil Hedging.

F-19
<PAGE> 97

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Revenues from crude oil marketing and trading represent the margin
resulting from such activities. Such amount for 1993 represents sales of crude
oil purchased from third parties of $11.1 million less $11.0 million cost of
purchases plus $2.5 million marketing margin with respect to sales of crude oil
produced from the Company's leases. Such amount for 1994 represents sales of
crude oil purchased from third parties of $11.9 million less $11.7 million cost
of purchases plus $3.1 million marketing margin with respect to sales of crude
oil produced from the Company's leases. Such amount for 1995 represents sales of
crude oil purchased from third parties of $6.6 million less $6.5 million cost of
purchases plus $4.1 million marketing margin with respect to sales of crude oil
produced from the Company's leases.

Accounts Receivable

Accounts Receivable relates primarily to sales of oil and gas and amounts
due from joint interest partners for expenditures made by the Company on behalf
of such partners. The Company reviews the financial condition of potential
purchasers and partners prior to signing sales or joint interest agreements.

Inventories

Inventories are valued at the lower of cost (average price or first-in,
first-out) or market. Crude oil inventories at December 31, 1994 and 1995 were
$0.9 million and $0.8 million, respectively, and materials and supplies
inventories at such dates were $0.4 million and $0.6 million, respectively.

Environmental Expenditures

Environmental expenditures relating to current operations are expensed or
capitalized, as appropriate, depending on whether such expenditures provide
future economic benefits. Liabilities are recognized when the expenditures are
considered probable and can be reasonably estimated. Measurement of liabilities
is based on currently enacted laws and regulations, existing technology and
undiscounted site-specific costs. Generally, such recognition coincides with the
Company's commitment to a formal plan of action.

Income Taxes

The Company follows the asset and liability approach to accounting for
income taxes. Deferred tax assets and liabilities are determined using the tax
rate for the period in which those amounts are expected to be received or paid,
based on a scheduling of temporary differences between the tax bases of assets
and liabilities and their reported amounts. Under this method of accounting for
income taxes, any future changes in income tax rates will affect deferred income
tax balances and financial results.

The taxable income or loss of the Company is included in the consolidated
income tax returns filed by SFR. Payments of taxes currently due are included in
settlements with the parent. Income tax obligations reflected in these financial
statements are calculated assuming the Company files a separate income tax
return.

Use of Estimates

The preparation of the Company's financial statements in conformity with
generally accepted accounting principles requires the Company to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities and the
periods in which certain items of revenue and expense are included. Actual
results may differ from such estimates.

F-20
<PAGE> 98

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Earnings Per Share

Earnings per share has been omitted from the statement of operations
because the Company was not a separate entity with its own capital structure
until September 1996.

(3) FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107 "Disclosure About Fair Value of Financial Instruments"
requires the disclosure, to the extent practicable, of the fair value of
financial instruments which are recognized or unrecognized in the balance sheet.
The fair value of the financial instruments disclosed herein is not
representative of the amount that could be realized or settled, nor does the
fair value amount consider the tax consequences, if any, of realization or
settlement. The following table reflects the financial instruments for which the
fair value differs from the carrying amount of such financial instrument in the
Company's December 31, 1994 and 1995 balance sheets (in millions of dollars):

<TABLE>
<CAPTION>
1994 1995
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Long-Term Debt................... 245.0 239.7 245.0 267.9
</TABLE>

The fair value of the Company's long-term debt is based upon current
borrowing rates available for financings with similar terms and maturities.

(4) CORPORATE RESTRUCTURING PROGRAM

In the fourth quarter of 1993 SFR adopted a corporate restructuring program
which included, among other things, (i) the concentration of capital spending in
SFR's core operating areas (one of which is the San Joaquin Valley of
California); (ii) the disposition of non-core assets; and (iii) an evaluation of
SFR's cost structures. As a result of the program, certain of the Company's
producing properties were sold to Vintage Petroleum, Inc. ("Vintage") and the
Company's salaried work force was reduced.

In implementing the corporate restructuring program, the Company recorded
restructuring charges of $11.9 million in 1993, comprised of losses on property
dispositions of $11.3 million and accruals for certain personnel benefits and
related costs of $0.6 million. In the first quarter of 1994 the Company recorded
additional restructuring charges of $1.1 million comprised of severance,
benefits and relocation expenses associated with the cost reduction program.

Sale to Vintage. In the fourth quarter of 1993 producing properties were
sold to Vintage for net proceeds totaling $34.9 million in cash, $26.2 million
of which was collected in 1993. The Company's income from operations for 1993
includes $2.7 million attributable to the assets sold to Vintage.

(5) CASH FLOWS

The Company made interest payments of $27.4 million, $26.3 million and
$25.8 million in 1993, 1994 and 1995, respectively.

(6) FINANCING AND DEBT

Long-term debt outstanding at December 31, 1994 and 1995 of $245.0 million
(which matures $35.0 million in 1997 (Series E Senior Notes), $35.0 million in
1998 (Series F Senior Notes) and $25.0 million per year in 1998 through 2005
(Series G Senior Notes)) represents unsecured outstanding indebtedness of SFR to
be assumed by the Company at or prior to the closing of the Offerings. Such debt
bears interest as follows: Series E -- 10.23%; Series F -- 10.27% and Series
G -- 10.61%. The Note

F-21
<PAGE> 99

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Agreement with respect to such indebtedness includes covenants which among other
things restrict the payment of dividends and the incurrence of additional
indebtedness.

In 1994 the Company retired the $12.6 million outstanding balance of a term
loan which the Company had incurred in 1991 in connection with the purchase of
certain producing properties.

(7) SEGMENT INFORMATION

The principal business of the Company consists of the acquisition,
exploration and development of oil and gas properties and the production and
sale of crude oil and liquids and natural gas. All such operations are located
in the United States.

Crude oil and liquids accounted for more than 96% of revenues in 1993, 1994
and 1995. The following table (which, with respect to certain properties,
includes royalty and working interest owners' share of production) reflects
sales to crude oil purchasers who accounted for more than 10% of the Company's
crude oil and liquids revenues (in millions of dollars):

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1993 1994 1995
---- ---- ----
<S> <C> <C> <C>
Celeron Corporation.............................................. 28 31 28
Shell Oil Company................................................ 31 42 44
</TABLE>

(8) PENSION AND OTHER EMPLOYEE BENEFIT PLANS

Pension Plans

The Company sponsors a pension plan covering certain hourly-rated employees
in California (the "Hourly Plan"). The Hourly Plan provides benefits that are
based on a stated amount for each year of service. The Company annually
contributes amounts which are actuarially determined to provide the Hourly Plan
with sufficient assets to meet future benefit payment requirements.

The following table sets forth the funded status of the Hourly Plan at
December 31, 1994 and 1995 (in millions of dollars):

<TABLE>
<CAPTION>
1994 1995
---- -----
<S> <C> <C>
Plan assets at fair value, primarily invested in fixed-rate
securities......................................................... 7.5 8.7
Actuarial present value of projected benefit obligations
Accumulated benefit obligations
Vested.......................................................... (9.3) (10.4)
Nonvested....................................................... (0.3) (0.4)
----- ----
Excess of projected benefit obligation over plan assets.............. (2.1) (2.1)
Unrecognized net (gain) loss from past experience different from that
assumed and effects of changes in assumptions...................... (0.4) (0.3)
Unrecognized prior service cost...................................... 0.5 0.4
Unrecognized net obligation.......................................... 1.3 1.2
Additional minimum liability......................................... (1.3) (1.3)
----- ----
Accrued pension liability............................................ (2.0) (2.1)
===== ====
Major assumptions at year-end
Discount rate...................................................... 8.25% 7.50%
Expected long-term rate of return on plan assets................... 8.50% 8.50%
</TABLE>

F-22
<PAGE> 100

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

The following table sets forth the components of pension expense for the
Hourly Plan for 1993, 1994 and 1995 (in millions of dollars):

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1993 1994 1995
---- ---- ----
<S> <C> <C> <C>
Service cost.................................................. 0.2 0.2 0.2
Interest cost................................................. 0.7 0.8 0.8
Return on plan assets......................................... (0.8) (0.4) (1.4)
Net amortization and deferral................................. 0.4 -- 0.9
---- ---- ----
0.5 0.6 0.5
==== ==== ====
</TABLE>

SFR has a defined benefit retirement plan (the "SFR Plan") covering
substantially all salaried employees not covered by collective bargaining
agreements and a nonqualified supplemental retirement plan (the "Supplemental
Plan"). The Supplemental Plan will pay benefits to participants in the SFR Plan
in those instances where the SFR Plan formula produces a benefit in excess of
limits established by ERISA and the Tax Reform Act of 1986. Benefits payable
under the SFR Plan are based on years of service and compensation during the
five highest paid years of service during the ten years immediately preceding
retirement. SFR's funding policy is to contribute annually not less than the
minimum required by ERISA and not more than the maximum amount deductible for
income tax purposes. The Company has been allocated its proportionate share of
the expense associated with such plans. The Company's share of such expenses
totaled $0.2 million, $0.2 million and $0.2 million in 1993, 1994 and 1995,
respectively.

Postretirement Benefits Other Than Pensions

SFR provides healthcare and life insurance benefits for substantially all
employees who retire under the provisions of a SFR-sponsored retirement plan and
their dependents. Participation in the plans is voluntary and requires a monthly
contribution by the employee. Effective January 1, 1993 SFR adopted the
provisions of SFAS No. 106 -- "Employers' Accounting for Postretirement Benefits
Other Than Pensions." The Statement requires the accrual, during the years the
employee renders service, of the expected cost of providing postretirement
benefits to the employee and the employee's beneficiaries and covered
dependents. The Company has been allocated its proportionate share of SFR's
expense with respect to such benefits. The Company's share of such expense
totaled $0.2 million in 1993 and $0.1 million in each of the years 1994 and
1995.

Savings Plan

SFR has a savings plan available to substantially all salaried employees
and intended to qualify as a deferred compensation plan under Section 401(k) of
the Internal Revenue Code (the "401(k) Plan"). SFR will match employee
contributions for an amount up to 4% of each employee's base salary. In
addition, if at the end of each fiscal year SFR's performance for such year has
exceeded certain predetermined criteria, each participant will receive an
additional matching contribution equal to 50% of the regular matching
contribution. The Company has been allocated its proportionate share of
contributions to the 401(k) Plan, which are charged to expense. The Company's
share of such contributions totaled $0.3 million in 1993 and $0.2 million in
each of the years 1994 and 1995.

F-23
<PAGE> 101

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(9) COMMITMENTS AND CONTINGENCIES

Oil Hedging

From time to time SFR hedges a portion of its oil sales to provide a
certain minimum level of cash flow from its sales of oil and gas. While the
hedges are generally intended to reduce SFR's exposure to declines in market
price, SFR's gain from increases in market price may be limited. SFR uses
various financial instruments whereby monthly settlements are based on
differences between the prices specified in the instruments and the settlement
prices of certain futures contracts quoted on the New York Mercantile Exchange
("NYMEX") or certain other indices. Generally, in instances where the applicable
settlement price is less than the price specified in the contract, SFR receives
a settlement based on the difference; in instances where the applicable
settlement price is higher than the specified price, SFR pays an amount based on
the difference. The instruments utilized by SFR differ from futures contracts in
that there is no contractual obligation which requires or allows for the future
delivery of the product. Gains or losses on hedging activities are recognized in
oil and gas revenues in the period in which the hedged production is sold.

SFR's hedging program in 1995 has been to hedge the price of its light oil
production. In certain months when a favorable price could be obtained, heavy
oil quantities (i.e., quantities in excess of light oil production) were hedged.
The allocation of hedging gains and losses to the Western Division during this
period has been calculated on the basis of its light oil production and its
heavy oil hedges as determined above. During 1995 such hedges resulted in a $0.1
million reduction in the Company's revenues.

At December 31, 1995 SFR had open crude hedges on (i) an average of 15,000
barrels per day for the period January to April 1996 at an average NYMEX WTI
price of $18.52 per barrel and (ii) provided
that the NYMEX WTI price is greater than $16.80 per barrel, up to an additional
15,000 barrels per day for the period January through March 1996 at an average
NYMEX WTI price of $18.65 per barrel. The "approximate break-even price" (the
average of the daily settlement prices which result in no settlement being due
to or from SFR) with respect to all such contracts is approximately $18.56 per
barrel. The Company will be allocated hedging gains or losses with respect to
such contracts.

In addition to its oil sales hedges, for the first six months of 1996 SFR
has hedged 20 MMcf per day of the natural gas it purchases for use in steam
generation operations in the San Joaquin Valley of California. Monthly
settlements are based on the difference between the settlement price quoted on
the NYMEX and the index price for San Juan Basin natural gas. Gains or losses
are recognized in production and operating costs in the period in which the
hedged gas is consumed in operations. All such gains and losses are allocated to
the Company.

Environmental Regulation

Federal, state and local laws and regulations relating to environmental
quality control affect the Company in all of its oil and gas operations. Set
forth below are descriptions of three sites for which the Company has been
identified as a potentially responsible party ("PRP") and for which the Company
may be held jointly and severally liable with other PRPs.

The Company has been identified as one of over 250 PRPs at a superfund site
in Los Angeles County, California. The site was operated by a third party as a
waste disposal facility from 1948 until 1983. The Environmental Protection
Agency ("EPA") is requiring the PRPs to undertake remediation of the site in
several phases, which include site monitoring and leachate control, gas control
and final remediation. In 1989 the EPA and a group of PRPs that includes the
Company entered into a consent decree covering the site monitoring and leachate
control phases of remediation. The Company was a member of the group Coalition
Undertaking Remediation Efforts ("CURE") which was responsible for

F-24
<PAGE> 102

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

constructing and operating the leachate treatment plant. This phase is now
complete and the Company's share of costs with respect to this phase was $1.6
million ($0.9 million after recoveries from working interest participants in the
unit in which the wastes were generated). Another consent decree provides for
the predesign, design and construction of a gas plant to harness and market
methane gas emissions. The Company is a member of the New CURE group which is
responsible for the gas plant construction and operation and landfill cover.
Currently, New CURE is in the design stage of the gas plant. The Company's share
of costs of this phase is expected to be $1.7 million and such costs have been
provided for in the financial statements. Another consent decree has been
entered into allowing for the settlement of the pending lawsuits against the
municipalities and transporters not named by the EPA. The settlement payment by
such municipalities and transporters totals approximately $70.0 million of which
approximately $52.0 million will be credited against future expenses. The
Company cannot currently estimate the cost of any subsequent phases of work or
final remediation which may be required by the EPA. The Company has entered into
a Joint Defense Agreement with the other PRPs to defend against a lawsuit filed
in September 1994 by ninety-five homeowners alleging, among other things,
nuisance, trespass, strict liability and infliction of emotional distress. At
this stage of the lawsuit the Company is not able to estimate costs or potential
liability.

In April 1994 the Company received a request from the EPA for information
pursuant to Section 104(e) of the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA") and a letter ordering the Company and
seven other PRPs to negotiate with the EPA regarding implementation of a
remedial plan for a site located in Santa Fe Springs, California. The Company
owned the property on which the site is located from 1921 to 1932. During that
time the property was leased to another company and in 1932 the property was
sold to that company. During the time the other company leased or owned the
property, hazardous wastes were allegedly disposed at the site. Total past and
future costs for remediation are estimated to be approximately $8.0 million. The
Company filed its response to the Section 104(e) order setting forth its
position and defenses based on the fact that the other company was the lessee
and operator of the site during the time the Company was the owner of the
property. However, the Company has also given its Notice of Intent to comply
with the EPA's order to prepare a remediation design plan. Efforts are underway
to identify additional PRP's. The cost of the remediation design plan is
estimated to be $1.0 million and the Company has provided for such costs in the
financial statements, assuming that the costs will be equally divided among the
eight PRPs.

In 1995 the Company and twelve other companies received notice that they
have been identified as PRPs by the California Department of Toxic Substances
Control (the "DTSC") as having generated and/or transported hazardous waste to
the Environmental Protection Corporation ("EPC") Eastside Landfill during its
fourteen-year operation from 1971 to 1985. EPC has since liquidated all assets
and placed the proceeds in trust for closure and post-closure activities.
However, these monies will not be sufficient to close the site. The PRPs have
entered into an enforceable agreement with the DTSC to characterize the
contamination at the site and prepare a focused remedial investigation and
feasibility study. The DTSC has agreed to implement reasonable measures to bring
new PRPs into the agreement. The DTSC will address subsequent phases of the
cleanup, including remedial design and implementation in a separate order
agreement. The cost of the remedial investigation and feasibility study is
estimated to be $1.0 million and the Company has provided for such costs in the
financial statements assuming that the costs will be divided equally among the
thirteen PRP's. The costs of subsequent phases cannot be estimated until the
remedial investigation and feasibility study is completed.

Operating Leases

The Company has noncancellable agreements with terms ranging from one to
six years to lease office space and equipment. Minimum rental payments due under
the terms of these agreements are: 1996 -- $0.8 million, 1997 -- $0.8 million,
1998 -- $0.8 million, 1999 -- $0.7 million, 2000 -- $0.7 mil-

F-25
<PAGE> 103

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

lion and $0.8 million thereafter. Rental payments made under the terms of
noncancellable agreements totaled $0.8 million in 1993, $0.9 million in 1994 and
$0.8 million in 1995.

Other Matters

The Company has certain long-term contracts ranging up to twelve years for
the supply and transportation of approximately 20 million cubic feet per day of
natural gas to the Company's operations in Kern County, California. In the
aggregate, these contracts involve a minimum commitment on the part of the
Company of approximately $10.2 million per year (based on prices equal to 102%
of the applicable index and transportation charges in effect for December 1995).

There are other claims and actions, including certain other environmental
matters, pending against the Company. While the outcome of lawsuits or other
proceedings against the Company cannot be predicted with certainty, management
does not expect these matters to have a material adverse effect on the business,
financial condition, liquidity or results of operations of the Company.

(10) INCOME TAXES

The Company's income tax expense (benefit) for the years ended December 31,
1993, 1994 and 1995 consisted of (in million of dollars):

<TABLE>
<CAPTION>
1993 1994 1995
----- ---- ----
<S> <C> <C> <C>
Current
U.S. federal................................................ -- -- 5.0
State....................................................... 1.0 -- 3.3
---- --- -----
1.0 -- 8.3
---- --- -----
Deferred
U.S. federal................................................ (22.5) 3.0 6.4
U.S. federal tax rate change................................ 1.5 -- --
State....................................................... (6.9) 1.7 1.3
---- --- -----
(27.9) 4.7 7.7
---- --- -----
(26.9) 4.7 16.0
==== === =====
</TABLE>

The Company's deferred income tax liabilities (assets) at December 31, 1994
and 1995 are composed of the following differences between financial and tax
reporting (in millions of dollars):

<TABLE>
<CAPTION>
1994 1995
----- -----
<S> <C> <C>
Capitalized costs and write-offs..................................... 67.2 72.4
State deferred liability............................................. 15.7 17.0
----- -----
Gross deferred liabilities........................................... 82.9 89.4
----- -----
Accruals not currently deductible for tax purposes................... (7.1) (7.3)
EOR credit carryforwards............................................. (6.0) (4.6)
AMT credit carryforwards............................................. (2.8) (2.8)
----- -----
Gross deferred assets................................................ (15.9) (14.7)
----- -----
Deferred tax liability............................................... 67.0 74.7
===== =====
</TABLE>

F-26
<PAGE> 104

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

A reconciliation of the Company's U.S. income tax expense (benefit)
computed by applying the statutory U.S. federal income tax rate to the Company's
income (loss) before income taxes for the years ended December 31, 1993, 1994
and 1995 is presented in the following table (in millions of dollars):

<TABLE>
<CAPTION>
1993 1994 1995
----- ---- -----
<S> <C> <C> <C>
U.S. federal income taxes (benefit) at statutory rate........ (21.7) 5.7 17.6
Increase (reduction) resulting from:
State income taxes, net of federal effect.................. (3.9) 1.1 3.0
Effect of increase in statutory rate on deferred taxes..... 1.5 -- --
Enhanced oil recovery credit............................... (3.0) (2.5) (4.2)
Permanent differences...................................... (0.2) (0.2) (0.2)
Other...................................................... 0.4 0.6 (0.2)
---- ---- -----
(26.9) 4.7 16.0
==== ==== =====
</TABLE>

The Company increased its deferred tax liability in 1993 as a result of
legislation enacted during 1993 increasing the corporate tax rate from 34% to
35% commencing in 1993.

F-27
<PAGE> 105

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

SUPPLEMENTAL INFORMATION TO
FINANCIAL STATEMENTS (UNAUDITED)

OIL AND GAS RESERVES AND RELATED FINANCIAL DATA

Information with respect to the Company's oil and gas producing activities,
all of which are located in the United States, is presented in the following
tables. Reserve quantities as well as certain information regarding future
production and discounted cash flows were determined by independent petroleum
consultants, Ryder Scott Company.

Oil and Gas Reserves

The following table sets forth the Company's net proved oil and gas
reserves at December 31, 1992, 1993, 1994 and 1995 and the changes in net proved
oil and gas reserves for the years ended December 31, 1993, 1994 and 1995.

<TABLE>
<CAPTION>
CRUDE OIL NATURAL
AND LIQUIDS GAS
(MMBBLS) (BCF)
----------- -------
<S> <C> <C>
Proved reserves at December 31, 1992........................... 190.3 18.8
Revisions to previous estimates.............................. (14.4) 0.3
Improved recovery techniques................................. 26.7 --
Purchases of minerals-in-place............................... 1.3 0.4
Sales of minerals-in-place................................... (4.8) (5.4)
Production................................................... (15.5) (2.3)
----- ----
Proved reserves at December 31, 1993........................... 183.6 11.8
Revisions of previous estimates.............................. 9.9 2.9
Improved recovery techniques................................. 12.6 --
Purchases of minerals-in-place............................... 0.2 0.1
Production................................................... (15.1) (1.4)
----- ----
Proved reserves at December 31, 1994........................... 191.2 13.4
Revisions of previous estimates.............................. 9.7 0.9
Improved recovery techniques................................. 13.7 --
Purchases of minerals-in-place............................... 0.1 --
Production................................................... (15.2) (1.9)
----- ----
Proved reserves at December 31, 1995........................... 199.5 12.4
===== ====
</TABLE>

<TABLE>
<CAPTION>
CRUDE OIL NATURAL
AND LIQUIDS GAS
(MMBBLS) (BCF)
----------- -------
<S> <C> <C>
Proved developed reserves at December 31
1992......................................................... 154.3 14.5
1993......................................................... 140.8 9.0
1994......................................................... 140.2 9.4
1995......................................................... 157.1 9.2
</TABLE>

Proved reserves are estimated quantities of crude oil and natural gas which
geological and engineering data indicate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. Proved developed reserves are proved reserves which can be
expected to be recovered through existing wells with existing equipment and
operating methods.

F-28
<PAGE> 106

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

SUPPLEMENTAL INFORMATION TO
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Estimated Present Value of Future Net Cash Flows

Estimated future net cash flows from the Company's proved oil and gas
reserves at December 31, 1993, 1994 and 1995 are presented in the following
table (in millions of dollars, except as noted):

<TABLE>
<CAPTION>
1993 1994 1995
--------- --------- ---------
<S> <C> <C> <C>
Future cash inflows............................ 1,569.9 2,428.5 2,763.0
Future production costs........................ (1,133.4) (1,219.9) (1,383.6)
Future development costs....................... (126.6) (167.9) (170.0)
Future income tax expenses..................... (44.9) (352.7) (421.5)
--------- --------- ---------
Net future cash flows........................ 265.0 688.0 787.9
Discount at 10% for timing of cash flows....... (122.0) (321.9) (361.5)
--------- --------- ---------
Present value of future net cash flows from
proved reserves (standardized measure)....... 143.0 366.1 426.4
========= ========= =========
Present value of pretax future net cash flows
from proved reserves......................... 167.1 553.8 654.4
========= ========= =========
Average sales prices
Oil ($/Barrel)............................... 8.44 12.62 13.78
Natural gas ($/Mcf).......................... 1.64 1.07 0.98
</TABLE>

The following table sets forth the changes in the present value of
estimated future net cash flows from proved reserves during 1993, 1994 and 1995
(in millions of dollars):

<TABLE>
<CAPTION>
1993 1994 1995
--------- --------- ---------
<S> <C> <C> <C>
Balance at beginning of year................... 275.4 143.0 366.1
--------- --------- ---------
Increase (decrease) due to:
Sales of oil and gas, net of production
costs..................................... (79.6) (85.2) (119.2)
Net changes in prices and production costs... (212.7) 405.5 89.9
Extensions, discoveries and improved
recovery.................................. 46.3 25.6 39.6
Purchases of minerals-in-place............... 1.0 0.6 0.8
Sales of minerals-in-place................... (24.9) -- --
Development costs incurred................... 41.8 22.7 49.1
Changes in estimated volumes................. (3.2) 20.1 8.8
Changes in estimated development costs....... 1.6 (22.7) (24.8)
Interest factor -- accretion of discount..... 13.6 20.0 56.5
Income taxes................................. 83.7 (163.5) (40.4)
--------- --------- ---------
(132.4) 223.1 60.3
--------- --------- ---------
143.0 366.1 426.4
========= ========= =========
</TABLE>

Estimated future cash flows represent an estimate of future net cash flows
from the production of proved reserves using estimated sales prices and
estimates of the production costs, ad valorem and production taxes, and future
development costs necessary to produce such reserves. No deduction has been made
for depletion, depreciation or any indirect costs such as general corporate
overhead or interest expense.

The sales prices used in the calculation of estimated future net cash flows
are based on the prices in effect at year end. Such prices have been held
constant except for known and determinable escalations.

F-29
<PAGE> 107

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

SUPPLEMENTAL INFORMATION TO
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Operating costs and ad valorem and production taxes are estimated based on
current costs with respect to producing oil and gas properties. Future
development costs are based on the best estimate of such costs assuming current
economic and operating conditions.

Income tax expense is computed based on applying the appropriate statutory
tax rate to the excess of future cash inflows less future production and
development costs over the current tax basis of the properties involved. While
applicable investment tax credits and other permanent differences are considered
in computing taxes, no recognition is given to tax benefits applicable to future
exploration costs or the activities of the Company that are unrelated to oil and
gas producing activities.

The information presented with respect to estimated future net revenues and
cash flows and the present value thereof is not intended to represent the fair
value of oil and gas reserves. Actual future sales prices and production and
development costs may vary significantly from those in effect at year-end and
actual future production may not occur in the periods or amounts projected. This
information is presented to allow a reasonable comparison of reserve values
prepared using standardized measurement criteria and should be used only for
that purpose.

Costs Incurred in Oil and Gas Producing Activities

The following table includes all costs incurred, whether capitalized or
charged to expense at the time incurred (in millions of dollars):

<TABLE>
<CAPTION>
1993 1994 1995
---- ---- ----
<S> <C> <C> <C>
Property acquisition costs
Unproved...................................................... -- -- 0.1
Proved........................................................ 3.6 -- 1.3
Exploration costs............................................... 1.7 1.4 2.5
Development costs............................................... 38.2 22.7 47.8
Other........................................................... 0.1 -- --
---- ---- ----
43.6 24.1 51.7
==== ==== ====
</TABLE>

Capitalized Costs Related to Oil and Gas Producing Activities

The following table sets forth information concerning capitalized costs at
December 31, 1994 and 1995 related to the Company's oil and gas operations (in
millions of dollars):

<TABLE>
<CAPTION>
1994 1995
------ ------
<S> <C> <C>
Oil and gas properties
Unproved....................................................... 0.3 0.4
Proved......................................................... 911.1 960.7
Other.......................................................... 9.7 9.7
Accumulated amortization of unproved properties.................. (0.1) (0.1)
Accumulated depletion, depreciation and impairment of proved
properties..................................................... (582.7) (614.8)
Accumulated depreciation of other oil and gas properties......... (3.0) (3.4)
------ ------
335.3 352.5
====== ======
</TABLE>

F-30
<PAGE> 108

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

SUPPLEMENTAL INFORMATION TO
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Results of Operations From Oil and Gas Producing Activities

The following table sets forth the Company's results of operations from oil
and gas producing activities for the years ended December 31, 1993, 1994 and
1995 (in millions of dollars):

<TABLE>
<CAPTION>
1993 1994 1995
------ ----- -----
<S> <C> <C> <C>
Revenues................................................... 187.1 179.1 211.3
Production costs:
Production and operating costs........................... (100.3) (86.3) (85.3)
Taxes (other than income)................................ (7.2) (7.6) (6.8)
Exploration, including dry hole costs...................... (1.7) (1.4) (2.3)
Depletion, depreciation and amortization................... (40.3) (31.1) (31.1)
Impairment of oil and gas properties....................... (49.1) -- --
Restructuring charges...................................... (11.9) (1.1) --
Gain (loss) on disposition of properties................... (0.2) 0.3 --
----- ----- ------
(23.6) 51.9 85.8
Income taxes............................................... 9.7 (21.2) (35.1)
----- ----- ------
(13.9) 30.7 50.7
===== ===== ======
</TABLE>

Income taxes are computed by applying the appropriate statutory rate to the
results of operations before income taxes. Applicable tax credits and allowances
related to oil and gas producing activities have been taken into account in
computing income tax expenses. No deduction has been made for indirect cost such
as corporate overhead or interest expense.

F-31
<PAGE> 109

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

STATEMENT OF OPERATIONS
(UNAUDITED)
(IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1995 1996
------ ------
<S> <C> <C>
Revenues
Sales of crude oil and liquids produced............................ $154.7 $189.7
Sales of crude oil purchased....................................... -- 21.6
Sales of natural gas produced...................................... 1.5 1.0
Crude oil marketing and trading.................................... 2.9 2.5
Other.............................................................. 0.2 --
------ ------
159.3 214.8
------ ------
Costs and Expenses
Production and operating........................................... 63.2 76.7
Cost of crude oil purchased........................................ -- 21.4
Exploration, including dry hole costs.............................. 2.0 1.2
Depletion, depreciation and amortization........................... 23.7 27.9
General and administrative......................................... 5.4 5.8
Taxes (other than income).......................................... 6.7 6.8
------ ------
101.0 139.8
------ ------
Income from Operations............................................... 58.3 75.0
Interest expense................................................... (19.3) (19.3)
Interest capitalized............................................... 0.5 0.9
Other expense...................................................... (0.6) --
------ ------
Income Before Income Taxes........................................... 38.9 56.6
Income taxes....................................................... (12.5) (20.6)
------ ------
Net Income........................................................... $ 26.4 $ 36.0
====== ======
</TABLE>

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

F-32
<PAGE> 110

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

BALANCE SHEET
(IN MILLIONS OF DOLLARS)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
DECEMBER 31, ------------------------
1995 HISTORICAL PRO FORMA
------------ --------- ------------
(NOTE 2)
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents........................... $ -- $ -- $ --
Accounts receivable................................. 20.6 40.4 40.4
Note receivable..................................... -- -- 8.5
Inventories......................................... 1.4 2.0 2.0
Other current assets................................ 0.6 0.8 0.8
------- -------- --------
22.6 43.2 51.7
------- -------- --------
Properties and Equipment, at cost
Oil and gas (on the basis of successful efforts
accounting)...................................... 970.8 1,004.9 1,004.9
Other............................................... 20.0 21.2 21.2
------- -------- --------
990.8 1,026.1 1,026.1
Accumulated depletion, depreciation, amortization
and impairment................................... (623.5) (647.1 ) (647.1)
------- -------- --------
367.3 379.0 379.0
------- -------- --------
Other Assets........................................ 1.4 1.5 1.5
------- -------- --------
$ 391.3 $ 423.7 $ 432.2
======= ======== ========
LIABILITIES AND DIVISION EQUITY
Current Liabilities
Accounts payable.................................... $ 8.3 $ 21.1 $ 24.6
Current maturities of long-term debt................ -- 35.0 35.0
Production payment payable.......................... -- -- 30.0
Interest payable.................................... 6.4 -- --
Taxes payable....................................... 2.0 5.1 5.1
Accrued employee benefits........................... 2.7 1.9 1.2
Other current liabilities........................... 1.5 2.0 2.0
------- -------- --------
20.9 65.1 97.9
Long-Term Debt........................................ 245.0 210.0 234.5
Long-Term Obligations................................. 5.7 6.5 4.1
Deferred Income Taxes................................. 74.7 82.3 56.7
Commitments and Contingencies (Note 3)................ -- -- --
Division Equity....................................... 45.0 59.8 39.0
------- -------- --------
$ 391.3 $ 423.7 $ 432.2
======= ======== ========
</TABLE>

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

F-33
<PAGE> 111

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1995 1996
------ ------
<S> <C> <C>
Operating Activities:
Net income......................................................... $ 26.4 $ 36.0
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation, depletion and amortization........................ 23.7 27.9
Deferred income taxes........................................... 6.0 7.6
Exploratory dry hole costs...................................... 1.0 0.3
Other........................................................... (0.1) (0.1)
Changes in operating assets and liabilities
Decrease (increase) in accounts receivable.................... 1.3 (19.8)
Decrease (increase) in other current assets................... 0.2 (0.5)
Increase (decrease) in accounts payable....................... 0.7 12.5
Increase (decrease) in other current liabilities.............. 6.4 (3.6)
Net change in other assets and liabilities.................... 5.1 1.4
------ ------
Net Cash Provided by Operating Activities............................ 70.7 61.7
------ ------
Investing Activities:
Capital expenditures, including exploratory dry hole costs......... (45.2) (37.8)
Acquisition of producing properties................................ (1.3) (2.8)
Proceeds from sales of properties.................................. -- 0.1
------ ------
Net Cash Used in Investing Activities................................ (46.5) (40.5)
------ ------
Financing Activities:
Dividends to parent................................................ (24.2) (21.2)
------ ------
Net Cash Used in Financing Activities................................ (24.2) (21.2)
------ ------
Net Increase (Decrease) in Cash and Cash Equivalents................. -- --
Cash and Cash Equivalents at Beginning of Period..................... -- --
------ ------
Cash and Cash Equivalents at End of Period........................... $ -- $ --
====== ======
</TABLE>

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

F-34
<PAGE> 112

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

STATEMENT OF DIVISION EQUITY
(UNAUDITED)
(IN MILLIONS OF DOLLARS)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1995 1996
----- ------
<S> <C> <C>
Balance at beginning of period........................................ $32.1 $ 45.0
Net income............................................................ 26.4 36.0
Dividends to parent................................................... (24.2) (21.2)
------ -----
Balance at end of period.............................................. $34.3 $ 59.8
====== =====
</TABLE>

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

F-35
<PAGE> 113

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)

(1) ORGANIZATION AND BASIS OF PRESENTATION

Monterey Resources, Inc. ("Monterey") was incorporated in August 1996 and
is a wholly-owned subsidiary of Santa Fe Energy Resources, Inc. ("SFR") engaged
in the production, development and acquisition of oil and natural gas in the
State of California. At or prior to the closing of the public offering of
Monterey's common stock, SFR will contribute to Monterey substantially all of
the assets and operations of its Western Division, and Monterey will assume the
obligations and liabilities of SFR related thereto, including $245 million of
long-term debt. Such contribution will be effected pursuant to a contribution
and conveyance agreement, the effective date for which is expected to be
November 1, 1996. SFR is retaining a production payment (the "Production
Payment") on the Midway-Sunset field, pursuant to which SFR has the right to
receive net proceeds of production up to a cumulative maximum of $30 million
plus interest thereon at a rate of 8% per annum, at which time the production
payment terminates and Monterey will receive and retain all future proceeds of
production from such property interest. The Production Payment is prepayable
without penalty at any time in whole at Monterey's option. SFR and the Company
will enter into a new $75 million revolving credit facility with a group of
banks and SFR is expected to borrow approximately $16 million thereunder, which
will be assumed by the Company in accordance with the Contribution Agreement. In
addition, SFR and the Company will enter into certain intercompany agreements
regarding corporate services, taxes, indemnification and certain other matters.
Upon receipt by Monterey of the proceeds of the public offering, such proceeds
will be used to repay certain obligations incurred upon SFR's contribution of
the assets and operations to Monterey.

Prior to the contribution as described above, the assets of Monterey were
operated as a division of SFR and the accompanying financial statements reflect
such predecessor operations. For the purposes of preparing these financial
statements under generally accepted accounting principles, allocations were made
from certain SFR income statement and balance sheet accounts. Such allocations
are considered reasonable by management and were primarily based on identifiable
revenues, operating costs, assets and liabilities. General and administrative
expenses represent corporate overhead allocations. If the Company had been a
separate, unaffiliated entity, the Company estimates that general and
administrative expense would have been higher by $1.7 million and $1.2 million
for the nine-month periods ended September 30, 1995 and 1996, respectively.
Certain general and administrative expenses associated with production and
exploration operations are included in Production and Operating and Exploration
costs in the Statement of Operations. In addition, certain net hedging losses
have been allocated to the Company (see Note 3).

SFR provides cash management services to the Company through a centralized
treasury system, and therefore all intercompany accounts are settled daily and
no cash balances are maintained by the Company. Included in such settlements are
corporate overhead allocations which are reflected in the Company's statement of
operations as follows: (i) production and operating expense includes $1.4
million in 1995, and $2.1 million in 1996; (ii) exploration expense includes
$0.4 million in 1995 and $0.3 million in 1996; and (iii) general and
administrative expense includes $4.8 million in 1995 and $4.8 million in 1996.
All net cash generated from the Company's operations, after considering revenues
and deductions for expenses, capital expenditures and working capital
requirements, is deemed to be cash dividends to parent.

Revenues from sales of crude oil purchased and costs of crude oil purchased
relate to the purchase and sale of low viscosity crude oil which is blended with
certain of the Company's high viscosity, low gravity crude oil production to
facilitate transportation through certain pipelines.

The unaudited financial statements of the Western Division of Santa Fe
Energy Resources, Inc. (the "Company") reflect, in the opinion of management,
all adjustments, consisting only of normal and recurring adjustments, necessary
to present fairly the Company's financial position at September 30,

F-36
<PAGE> 114

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

1996 and the Company's results of operations and cash flows for the nine-month
periods ended September 30, 1995 and 1996. Interim period results are not
necessarily indicative of results of operations or cash flows for a full-year
period.

These financial statements and the notes thereto should be read in
conjunction with the Company's audited financial statements included elsewhere
in this prospectus.

(2) SEPTEMBER 30, 1996 PRO FORMA BALANCE SHEET

The September 30, 1996 pro forma balance sheet gives effect to (i) the
contribution of the net assets of the Western Division by SFR pursuant to the
Contribution Agreement and the assumption of certain Western Division
liabilities by SFR; (ii) the $16.0 million liability for amounts drawn on the
New Credit Facility; (iii) the $30.0 million Production Payment retained by SFR;
(iv) Monterey's purchase of SFR's $8.5 million note receivable on the Olinda
Property; and (v) $3.5 million of site improvement costs related to the Olinda
Property.

Upon contribution of the net assets of the Western Division by SFR pursuant
to the Contribution Agreement and the assumption of certain Western Division
liabilities by SFR, the tax basis applicable to the Western Division net assets
will increase, and the deferred income tax liability will decrease, as a result
of the tax gain recognized by SFR.

(3) COMMITMENTS AND CONTINGENCIES

Oil Hedging

From time to time SFR hedges a portion of its oil and gas sales to provide
a certain minimum level of cash flow from its sales of oil and gas. While the
hedges are generally intended to reduce SFR's exposure to declines in market
price, SFR's gain from increases in market price may be limited. SFR uses
various financial instruments whereby monthly settlements are based on
differences between the prices specified in the instruments and the settlement
prices of certain futures contracts quoted on the New York Mercantile Exchange
("NYMEX") or certain other indices. Generally, in instances where the applicable
settlement price is less than the price specified in the contract, SFR receives
a settlement based on the difference; in instances where the applicable
settlement price is higher than the specified price, SFR pays an amount based on
the difference. The instruments utilized by SFR differ from futures contracts in
that there is no contractual obligation which requires or allows for the future
delivery of the product. Gains or losses on hedging activities are recognized in
oil and gas revenues in the period in which the hedged production is sold.

SFR's hedging program in 1996 has been to hedge the price of its light oil
production. In certain months when a favorable price could be obtained, heavy
oil quantities (i.e., quantities in excess of light oil production) were hedged.
The allocation of hedging gains and losses to the Western Division during this
period has been calculated on the basis of its light oil production and its
heavy oil hedges as determined above. During the first nine months of 1996 such
hedges resulted in a $3.1 million reduction in the Company's revenues. At
September 30, 1996 SFR had no outstanding crude oil hedges.

In addition to its oil sales hedges, during the first six months of 1996
SFR hedged 20 MMcf per day of the natural gas purchased for use in steam
generation operations in the San Joaquin Valley of California. Such hedges,
which terminated at the end of June, resulted in a $3.2 million increase in the
Company's production and operating costs in the first nine months of 1996.

F-37
<PAGE> 115

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

Environmental Regulation

The Company has been identified as one of over 250 potentially responsible
parties ("PRPs") at a superfund site in Los Angeles County, California. The site
was operated by a third party as a waste disposal facility from 1948 until 1983.
The Environmental Protection Agency ("EPA") is requiring the PRPs to undertake
remediation of the site in several phases, which include site monitoring and
leachate control, gas control and final remediation. In November 1988 the EPA
and a group of PRPs that includes the Company entered into a consent decree
covering the site monitoring and leachate control phases of remediation. The
Company was a member of the group Coalition Undertaking Remediation Efforts
("CURE") which was responsible for constructing and operating the leachate
treatment plant. This phase is now complete and the Company's share of costs
with respect to this phase was $1.6 million ($0.9 million after recoveries from
working interest participants in the unit in which the wastes were generated).
Another consent decree provides for the predesign, design and construction of a
gas plant to harness and market methane gas emissions. The Company is a member
of the New CURE group which is responsible for the gas plant construction and
operation and landfill cover. Currently, New CURE is in the design stage of the
gas plant. The Company's share of costs of this phase is expected to be $1.9
million and such costs have been provided for in the financial statements.
Pursuant to consent decrees settling lawsuits against the municipalities and
transporters not named by the EPA as PRPs, such parties are required to pay
approximately $84 million of which approximately $76 million will be credited
against future expenses. The EPA and the PRPs are currently negotiating the
final closure requirements. After taking into consideration the credits from the
municipalities and transporters, the Company estimates that its share of final
costs of the closure will be approximately $0.8 million which amount has been
provided for by the Company in its financial statements. The Company has entered
into a Joint Defense Agreement with the other PRPs to defend against a lawsuit
filed in September 1994 by ninety-five homeowners alleging, among other things,
nuisance, trespass, strict liability and infliction of emotional distress. A
second lawsuit has been filed by thirty-three additional homeowners and the
Company and the other PRP's intend to enter into a Joint Defense Agreement. At
this stage of the lawsuit the Company is not able to estimate costs or potential
liability.

In 1994 the Company received a request from the EPA for information
pursuant to Section 104(e) of CERCLA and a letter ordering the Company and seven
other PRPs to negotiate with the EPA regarding implementation of a remedial plan
for a site located in Santa Fe Springs, California. The Company owned the
property on which the site is located from 1921 to 1932. During that time the
property was leased to another company and in 1932 the property was sold to that
company. During the time the other company leased or owned the property,
hazardous wastes were allegedly disposed at the site. Total past and future
costs for remediation are estimated to be approximately $8.0 million. The
Company filed its response to the Section 104(e) order setting forth its
position and defenses based on the fact that the other company was the lessee
and operator of the site during the time the Company was the owner of the
property. However, the Company has also given its Notice of Intent to comply
with the EPA's order to prepare a remediation design plan. The PRPs estimate
total cost to complete this final remediation to be $3 million and the Company
has provided $250,000 for such costs in its financial statements.

F-38
<PAGE> 116

WESTERN DIVISION OF SANTA FE ENERGY RESOURCES, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

Landfill during its fourteen-year operation from 1971 to 1985. EPC has since
liquidated all assets and placed the proceeds in trust (the "EPC Trust") for
closure and post-closure activities. However, these monies may not be sufficient
to close the site. The PRPs have entered into an enforceable agreement with the
DTSC to characterize the contamination at the site and prepare a focused
remedial investigation and feasibility study. The DTSC has agreed to implement
reasonable measures to bring new PRPs into the agreement. The DTSC will address
subsequent phases of the cleanup, including remedial design and implementation
in a separate order agreement. The cost of the remedial investigation and
feasibility study is estimated to be $0.8 million, the cost of which will be
shared by the PRPs and the EPC Trust . The ultimate costs of subsequent phases
will not be known until the remedial investigation and feasibility study is
completed and a remediation plan is accepted by the DTSC. The Company currently
estimates final remediation could cost $2 million to $6 million and believes the
monies in the EPC Trust will be sufficient to fund the lower end of this range
of costs. The Company has provided $80,000 in its financial statements for its
share of costs related to this site.

Other Matters

The Company has certain long-term contracts ranging up to twelve years for
the supply and transportation of approximately 20 million cubic feet per day of
natural gas to the Company's operations in Kern County, California. In the
aggregate, these contracts involve a minimum commitment on the part of the
Company of approximately $10.9 million per year (based on prices equal to 102%
of the applicable index and transportation charges in effect for September
1996).

Pursuant to the Contribution Agreement, SFR will retain the surface rights
to 116 acres of the Olinda Property. SFR is retaining the surface rights to the
Olinda Property because such surface rights are currently under contract for
sale to a third party. If the sale is concluded with such third party, SFR will
be paid a total purchase price of $24 million, comprised of $15.5 million in
cash together with an $8.5 million note, which is secured by a lien on the
property. Pursuant to the Contribution Agreement, Monterey is obligated to
purchase such note from SFR at face value after the close of the sale and will
be required to incur approximately $3.5 million in site improvement costs. If
the sale of the Olinda Property has not been consummated by August 1, 1997,
Monterey is obligated, under the terms of the Contribution Agreement, to
purchase, and SFR is obligated to sell, such surface rights for $23 million in
cash. The Company does not believe that SFR's retention or subsequent sale and
development of the surface of the Olinda Property will have a material adverse
effect on the Company's ongoing operations on such property.

F-39
<PAGE> 117

UNDERWRITING

Subject to the terms and conditions of the Underwriting Agreement, the
Company has agreed to sell to each of the U.S. Underwriters named below, and
each of such U.S. Underwriters, for whom Goldman, Sachs & Co., Morgan Stanley &
Co. Incorporated and Petrie Parkman & Co., Inc., are acting as representatives,
has severally agreed to purchase from the Company, the respective number of
shares of Common Stock set forth opposite its name below:

<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
UNDERWRITER COMMON STOCK
----------------------------------------------------------- ------------
<S> <C>
Goldman, Sachs & Co. ...................................... 1,149,080
Morgan Stanley & Co. Incorporated.......................... 1,149,080
Petrie Parkman & Co., Inc. ................................ 1,149,080
Crowell, Weedon & Co. ..................................... 147,610
Dean Witter Reynolds Inc. ................................. 214,150
A.G. Edwards & Sons, Inc. ................................. 214,150
EVEREN Securities, Inc. ................................... 214,150
Fahnestock & Co. Inc. ..................................... 147,610
Gerard Klauer Mattison & Co., LLC.......................... 147,610
Johnson Rice & Company L.L.C. ............................. 147,610
Edward D. Jones & Co., L.P. ............................... 147,610
McDonald & Company Securities, Inc. ....................... 147,610
Neuberger & Berman, LLC.................................... 147,610
Oppenheimer & Co., Inc. ................................... 214,150
PaineWebber Incorporated................................... 214,150
Principal Financial Securities, Inc. ...................... 147,610
Rauscher Pierce Refsnes, Inc. ............................. 147,610
Smith Barney Inc. ......................................... 214,150
Starr Securities, Inc. .................................... 147,610
Sutro & Co. Incorporated................................... 147,610
Wasserstein Perella Securities, Inc. ...................... 214,150
---------
Total............................................ 6,570,000
=========
</TABLE>

Under the terms and conditions of the Underwriting Agreement, the U.S.
Underwriters are committed to take and pay for all of the shares offered hereby,
if any are taken.

The U.S. Underwriters propose to offer the shares of Common Stock in part
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus and in part to certain securities dealers at such
price less a concession of $0.58 per share. The U.S. Underwriters may allow, and
such dealers may reallow, a concession not in excess of $0.10 per share to
certain brokers and dealers. After the shares of Common Stock are released for
sale to the public, the offering price and other selling terms may from time to
time be varied by the representatives.

The Company has entered into an underwriting agreement (the "International
Underwriting Agreement") with the underwriters of the International Offering
(the "International Underwriters") providing for the concurrent offer and sale
of 1,580,000 shares of Common Stock in an international offering outside the
United States. The offering price and aggregate underwriting discounts and
commissions per share for the Offerings are identical. The closing of the
offering made hereby is a condition to the closing of the International
Offering, and vice versa. The representatives of the International Underwriters
are Goldman Sachs International, Morgan Stanley & Co. International and Petrie
Parkman & Co., Inc.

Pursuant to an Agreement between the U.S. and International Underwriting
Syndicates (the "Agreement Between") relating to the Offerings, each of the U.S.
Underwriters named herein has agreed that, as a part of the distribution of the
shares offered hereby and subject to certain exceptions, it will offer, sell or
deliver the shares of Common Stock, directly or indirectly, only in the United
States of America (including the States and the District of Columbia), its
territories, its possessions and other areas subject to its jurisdiction (the
"United States") and to U.S. persons, which term shall mean, for purposes of
this paragraph: (a) any individual who is a resident of the United States or (b)
any

U-1
<PAGE> 118

corporation, partnership or other entity organized in or under the laws of the
United States or any political subdivision thereof and whose office most
directly involved with the purchase is located in the United States. Each of the
International Underwriters has agreed pursuant to the Agreement Between that, as
a part of the distribution of the shares offered as a part of the International
Offering, and subject to certain exceptions, it will (i) not, directly or
indirectly, offer, sell or deliver shares of Common Stock (a) in the United
States or to any U.S. persons or (b) to any person who it believes intends to
reoffer, resell or deliver the shares in the United States or to any U.S.
persons, and (ii) cause any dealer to whom it may sell such shares at any
concession to agree to observe a similar restriction.

Pursuant to the Agreement Between, sales may be made between the U.S.
Underwriters and the International Underwriters of such number of shares of
Common Stock as may be mutually agreed. The price of any shares so sold shall be
the initial public offering price less an amount not greater than the selling
concession.

The Company has granted the U.S. Underwriters an option exercisable for 30
days after the date of this Prospectus to purchase up to an aggregate of 948,000
additional shares of Common Stock solely to cover over-allotments, if any. If
the U.S. Underwriters exercise their over-allotment option, the U.S.
Underwriters have severally agreed, subject to certain conditions, to purchase
approximately the same percentage thereof that the number of shares to be
purchased by each of them, as shown in the foregoing table, bears to the
6,570,000 shares of Common Stock offered. The Company has granted the
International Underwriters a similar option to purchase up to an aggregate of
237,000 additional shares of Common Stock.

The Company, SFR, and each director and executive officer of the Company
have agreed that, during the period beginning from the date of this Prospectus
and continuing to and including the date 180 days after the date of the
Prospectus, they will not offer, sell, contract to sell or otherwise dispose of
any shares of capital stock of the Company or any securities that are
convertible into or exchangeable for such shares (other than pursuant to stock
option or stock purchase plans existing, or on the conversion or exchange of
convertible or exchangeable securities outstanding, on the date of this
Prospectus) without the prior written consent of the representatives, except for
the shares of Common Stock offered in connection with the concurrent U.S. and
International Offerings.

The representatives of the Underwriters have informed the Company that they
do not expect sales to accounts over which the Underwriters exercise
discretionary authority to exceed five percent of the total number of shares of
Common Stock offered by them.

Prior to this offering, there has been no public market for the shares. The
initial public offering price was negotiated among the Company and the
representatives of the Underwriters. Among the factors considered in determining
the initial public offering price of the Common Stock, in addition to prevailing
market conditions, were the Company's historical performance, estimates of the
business potential and earnings prospects of the Company, an assessment of the
Company's management and the consideration of the above factors in relation to
market valuation of companies in related businesses.

The Common Stock has been approved for listing on the NYSE, subject to
official notice of issuance, under the trading symbol "MRC". In order to meet
one of the requirements for listing the Common Stock on the NYSE, the
Underwriters have undertaken to sell lots of 100 or more shares to a minimum of
2,000 beneficial holders.

The Company has agreed to indemnify the several Underwriters against
certain liabilities, including liabilities under the Securities Act of 1933.

Petrie Parkman & Co., Inc. ("Petrie Parkman") has been retained by SFR to
provide financial advisory services to SFR and the Company in connection with
the Spin Off. In this capacity, Petrie Parkman will receive fees for its
advisory services which the Company believes to be reasonable and customary.

This Prospectus may be used by underwriters and dealers in connection with
offers and sales of the Common Stock, including shares initially sold in the
international offering, to persons located in the United States.

U-2
<PAGE> 119

=============================================================================

NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.

---------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Additional Information................... 3
Certain Definitions...................... 3
Prospectus Summary....................... 4
Risk Factors............................. 15
Use of Proceeds.......................... 21
Dividend Policy.......................... 21
Dilution................................. 22
Capitalization........................... 23
Selected Historical and Pro Forma
Financial Information and Operating
Data................................... 24
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................. 27
Business................................. 35
Management............................... 52
Security Ownership of Management......... 63
Relationship Between the Company and
SFR.................................... 65
Description of Capital Stock............. 70
Shares Eligible for Future Sale.......... 74
Legal Matters............................ 75
Experts.................................. 75
Certain U.S. Tax Consequences to Non-U.S.
Holders................................ 75
Index to Financial Statements............ F-1
Underwriting............................. U-1
</TABLE>

---------------------

THROUGH AND INCLUDING DECEMBER 8, 1996 (THE 25TH DAY AFTER THE DATE OF THIS
PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
==============================================================================

=============================================================================

8,150,000 SHARES

MONTEREY RESOURCES, INC.

COMMON STOCK
(PAR VALUE $.01 PER SHARE)

---------------------
[MONTEREY RESOURCES, INC. LOGO]
---------------------

GOLDMAN, SACHS & CO.

MORGAN STANLEY & CO. INCORPORATED

PETRIE PARKMAN & CO.

REPRESENTATIVES OF THE UNDERWRITERS

================================================================================