VIRGINIA GAS CO, SB-2, 1997-07-24

VIRGINIA GAS CO
SB-2, 1997-07-24
NATURAL GAS TRANSMISISON & DISTRIBUTION

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<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 24, 1997

REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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VIRGINIA GAS COMPANY
(Name of Small Business Issuer as Specified in its Charter)

<TABLE>
<S> <C> <C>
DELAWARE 4923 87-0443823
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification No.)
incorporation or organization)
</TABLE>

200 EAST MAIN STREET
ABINGDON, VIRGINIA 24210
(540) 676-2380

(Address and Telephone Number of Principal Executive Offices)

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200 EAST MAIN STREET
ABINGDON, VIRGINIA 24210
(540) 676-2380

(Address of Principal Place of Business or Intended Principal Place of Business)

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MICHAEL L. EDWARDS
200 EAST MAIN STREET
ABINGDON, VIRGINIA 24210
(540) 676-2380

(Name, address and telephone number of agent for service)

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

COPIES TO:

BRIGHT & BARNES, P.C. VENABLE, BAETJER, HOWARD & CIVILETTI
Two Leadership Square, Suite 810 LLP
Oklahoma City, Oklahoma 73102 1201 New York Avenue, N.W., Suite 1000
(405) 236-8016 Washington, DC 20005
Attn: Robert C. Bright, Esq. (202) 962-4800
Attn: Ariel Vannier, Esq.

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APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
------------------------

CALCULATION OF REGISTRATION FEE

<TABLE>
<CAPTION>
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED BE REGISTERED PER SHARE(1) OFFERING PRICE(1) REGISTRATION FEE
<S> <C> <C> <C> <C>
Common Stock, par value $.001 per share.......... 2,300,000 $10.1875 $23,431,250 $7,100
</TABLE>

(1) Estimated solely for purposes of calculating the registration fee, based on
the average closing bid and asked price as of July 22, 1997.

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

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(a), MAY
DETERMINE.

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<PAGE>
VIRGINIA GAS COMPANY
CROSS REFERENCE SHEET SHOWING LOCATION IN PROSPECTUS
OF INFORMATION REQUIRED BY ITEMS IN PART I OF FORM SB-2

<TABLE>
<CAPTION>
ITEM IN FORM SB-2 LOCATION IN PROSPECTUS
--------------------------------------------------- ---------------------------------------------------
<C> <S> <C>
1. Front of Registration Statement and Outside Front
Cover of Prospectus.............................. Front of Registration Statement and Outside Front
Cover of Prospectus
2. Inside Front and Outside Back Cover Pages of
Prospectus....................................... Inside Front Cover Page and Outside Back Cover Page
of Prospectus; Available Information
3. Summary Information and Risk Factors............... Prospectus Summary; Risk Factors
4. Use of Proceeds.................................... Use of Proceeds
5. Determination of Offering Price.................... Inapplicable
6. Dilution........................................... Inapplicable
7. Selling Security Holders........................... Inapplicable
8. Plan of Distribution............................... Outside and Inside Front Cover Pages of Prospectus,
Underwriting
9. Legal Proceedings.................................. Business
10. Directors, Executive Officers, Promoters and
Control Persons.................................. Management
11. Security Ownership of Certain Beneficial Owners and
Management....................................... Management
12. Description of Securities.......................... Outside Front Cover Page of Prospectus; Prospectus
Summary; Capitalization; Description of
Securities
13. Interest of Named Experts and Counsel.............. Inapplicable
14. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities...................................... Management; Underwriting
15. Organization Within Last Five Years................ Inapplicable
16. Description of Business............................ Business; Prospectus Summary
17. Management's Discussion and Analysis or Plan of
Operation........................................ Management's Discussion and Analysis of Financial
Condition and Results of Operations
18. Description of Property............................ Business; Management's Discussion and Analysis of
Financial Condition and Results of Operations
19. Certain Relationships and
Related Transactions............................. Management
20. Market for Common Equity and Related Stockholder
Matters.......................................... Outside Front Cover Page of Prospectus; Dividend
Policy; Description of Securities; Common Stock
Price Range
21. Executive Compensation............................. Management
22. Financial Statements............................... Financial Statements
23. Changes in and Disagreement with Accountants on
Accounting and Financial Disclosure.............. Other Matters
</TABLE>
<PAGE>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
SUBJECT TO COMPLETION, DATED JULY 24, 1997

PROSPECTUS

2,000,000 SHARES
VIRGINIA GAS COMPANY
COMMON STOCK
------------------

All of the 2,000,000 shares of Common Stock, par value $.001 per share
("Common Stock") of Virginia Gas Company (the "Company") offered hereby are
being sold by the Company. The Common Stock trades on the Nasdaq National Market
System under the symbol "VGCO." On July 22, 1997, the last reported price of the
Common Stock on the Nasdaq National Market System Market was $9.75 bid and
$10.625 asked. See "Price Range of Common Stock."

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

THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" COMMENCING ON PAGE 6 HEREOF.
---------------------

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.

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<CAPTION>
PRICE UNDERWRITING PROCEEDS
TO DISCOUNTS TO
PUBLIC AND COMMISSIONS(1) COMPANY(2)
<S> <C> <C> <C>
Per Share.............................. $ $ $
Total(3)............................... $ $ $
</TABLE>

(1) The Company has agreed to indemnify the Underwriter against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."

(2) Before deducting expenses payable by the Company, estimated at $150,000.

(3) The Company has granted to the Underwriter a 30-day option to purchase up to
300,000 additional shares of Common Stock on the same terms and conditions
as set forth above solely to cover over-allotments, if any. If such option
is exercised in full, the total Price to Public, Underwriting Discounts and
Commissions and Proceeds to Company will be $__________, $__________ and
$__________, respectively. See "Underwriting."

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

The shares of Common Stock offered by this Prospectus are offered by the
Underwriter subject to prior sale, to withdrawal, cancellation or modification
of the offer without notice, to delivery to and acceptance by the Underwriter
and to certain further conditions. It is expected that delivery of the
certificates representing such shares will be made against payment therefor at
the offices of Ferris, Baker Watts, Incorporated, 1720 Eye Street, N.W.,
Washington, D.C. or through the facilities of the Depository Trust Company, on
or about , 1997.

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

FERRIS, BAKER WATTS
Incorporated

THE DATE OF THIS PROSPECTUS IS 1997
<PAGE>
VIRGINIA GAS COMPANY

The map to be included on the inside front cover page of the prospectus
depicts the existing storage facilities operated by the Company and the Early
Grove Affiliate in southwestern Virginia; the existing and proposed pipelines of
the Company and existing interstate pipelines; and natural gas production
fields. The map also depicts other local distribution companies service
territories.

The bottom of the inside front cover page depicts a schematic that
represents the different operations of the Company.

[MAP]

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE MARKET PRICE OF
THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE
PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED
AT ANY TIME.

2
<PAGE>
PROSPECTUS SUMMARY

THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE DETAILED
INFORMATION, INCLUDING RISK FACTORS, AND FINANCIAL STATEMENTS INCLUDED ELSEWHERE
OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, ALL
INFORMATION IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITER'S OVER-ALLOTMENT
OPTION WILL NOT BE EXERCISED. UNLESS THE CONTEXT OTHERWISE REQUIRES, REFERENCES
TO THE COMPANY ARE TO VIRGINIA GAS COMPANY AND ITS CONSOLIDATED SUBSIDIARIES.
FOR DEFINITIONS OF CERTAIN TERMS USED IN THIS PROSPECTUS, SEE THE GLOSSARY ON
PAGE 39.

THE COMPANY

Virginia Gas Company (the "Company"), directly or through Affiliates, is
primarily engaged in the exploration, production, marketing, gathering, storage,
and distribution of natural gas, and distribution of propane gas. The Company's
principal assets are located in the Commonwealth of Virginia, a region which is
experiencing significant economic growth and increasing demand for natural gas
and has access to three major interstate gas pipeline systems.

The Company's existing and planned assets comprise: (i) interests in 85
natural gas wells with proved developed reserves of approximately 2.6 Bcf; (ii)
gathering systems with over 102 miles of pipeline with a current annual
throughput of over 1.67 Bcf, connected to the interstate pipeline systems of
East Tennessee Gas Company ("ETNG"), CNG Transmission Company ("CNG") and
Columbia Gas Transmission Company ("TCO"); (iii) two underground storage
facilities with current capacity of 2.2 Bcf; and (iv) 120 miles of intrastate
pipeline under development with planned aggregate daily throughput of
approximately 50 MMcf/d.

The Company's business has developed in response to the growing need for
natural gas storage, pipelines and distribution in its market area, resulting
principally from economic growth and the impact of deregulation. Deregulation
has given natural gas customers more flexibility in negotiating their natural
gas purchases and transportation contracts. The Company's pipeline connections
to the ETNG, CNG, and TCO pipeline systems, and to the Company's adjacent
storage facilities, combine to create a hub which provides opportunities for
more efficient gas distribution, including to local, growing markets. At
present, the Company's business primarily consists of: (i) producing, gathering
and marketing natural gas from wells, in which the Company has an ownership
interest, to municipal distributors, local distribution companies and major oil
and gas companies; (ii) storing natural gas for municipal distributors and local
distribution companies which have supplied their own gas, or purchased gas from
third parties or the Company; and (iii) distributing propane and natural gas
purchased from third parties or the Company to local industrial, commercial and
residential customers.

The Company's principal sources of revenue have varied from time to time
depending on its level of activity in any given segment of natural gas
operations. From 1987 through 1992, substantially all of the Company's income
was derived from exploration, development and production of natural gas and from
fees derived from managing wells. From 1993 through 1996, the Company's income
reflected the growth of its storage operations. Today, the Company is building
transmission pipelines and expanding its storage capacity and expects, beginning
in 1999, to derive income primarily from natural gas storage and transportation
fees.

The Company's objective is to enhance earnings and cash flow by becoming a
leading integrated natural gas company in its market area. The Company's
strategy to achieve this objective is to construct pipeline systems, increase
the utilization of its existing storage facilities and aggressively pursue
end-user customers.

3
<PAGE>
ORGANIZATION AND OFFICES; AFFILIATES

The Company was incorporated in Delaware in March 1987. The Company's
principal executive office is located at 200 East Main Street, Abingdon,
Virginia 24210 and its telephone number is (540) 676-2380. The Company's Early
Grove Storage Facility and its related gathering system are owned and operated
through a 50% owned affiliate, Virginia Gas Storage Company (the "Early Grove
Affiliate"). The Company conducts its natural gas distribution activities
through another 50% owned affiliate, Virginia Gas Distribution Company (the
"Distribution Affiliate"). The Early Grove Affiliate and the Distribution
Affiliate are herein collectively referred to as "Affiliates." See "Risk
Factors--Relationship with Affiliates."

THE OFFERING

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<S> <C>
Common Stock Offered:...................... 2,000,000 shares of Common Stock

Common Stock to be outstanding after the
Offering:................................ 5,204,906 shares(1)

Use of Proceeds:........................... The development of transmission pipelines;
expansion of a storage facility; expansion of
propane distribution systems in southwestern
Virginia; development of exploration and
production facilities; and other general
corporate purposes. See "Use of Proceeds."

Nasdaq NMS Symbol:......................... VGCO
</TABLE>

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(1) Excludes 1,191,069 shares of Common Stock issuable upon exercise of
outstanding options and warrants at exercise prices ranging from $8.72 to
$10.00 per share.

4
<PAGE>
SUMMARY FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The following summary selected financial information should be read in
conjunction with, and is qualified in its entirety by, the more detailed
financial statements and notes thereto included elsewhere in this Prospectus.
The summary income statement data of the Company for the years ended December
31, 1994, 1995 and 1996 and the summary balance sheet data as of December 31,
1996 have been derived from the Consolidated Financial Statements of the Company
which have been audited by Arthur Andersen LLP, independent public accountants.
This data should be read in conjunction with the Consolidated Financial
Statements and Notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere herein.

<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31 JUNE 30
------------------------------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1996 1997
--------- --------- --------- ---------- --------- ---------
INCOME STATEMENT DATA:
Operations Data:
Net revenues.................................. $1,236 $1,612 $2,023 $2,770 $ 979 $4,071
Operating income.............................. 310 354 415 549 68 587
Equity in earnings of affiliates.............. 137 193 267 340 208 131
Net income.................................... 302 420 474 608 207 427
Per Share Data:
Earnings per share............................ $ 0.47 $ 0.66 $ 0.62 $ 0.21 $ 0.07 $ 0.12
Weighted average shares outstanding........... 671 640 696 1,638 1,035 3,201
Other Data:
Depreciation, depletion and amortization...... $ 171 $ 191 $ 305 $ 387 $ 129 $ 374
EBITDA........................................ 648 1,019 1,515 2,153 839 1,656
Capital investment............................ 467 1,378 2,331 11,662 4,306 3,150
Interest expense.............................. 120 288 673 1,007 521 717
</TABLE>

<TABLE>
<CAPTION>
JUNE 30, 1997
----------------------
AS
BALANCE SHEET DATA: 1996 ACTUAL ADJUSTED
--------- --------- -----------
<S> <C> <C> <C>
Net working capital............................................... $ (430) (519) 17,271
Property, plant and equipment, net................................ 16,343 19,163 19,163
Total assets...................................................... 33,510 41,416 59,206
Long-term debt.................................................... 12,138 21,137 21,137
Stockholders' equity.............................................. 17,338 15,494 33,284
</TABLE>

<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31
------------------------------------------
SELECTED OPERATING DATA: 1993 1994 1995 1996
--------- --------- --------- ---------

Gas stored (MMBtu)..................... 400,000 520,000 985,500 2,171,500

Gas storage daily maximum
deliverability (MMBtu)............... 3,724 7,846 11,531 55,997

Gas wells in operation (gross)......... 75 87 108 108

Total miles of pipeline................ 95 111 116 128

Distribution customers................. 88 123 145 203
</TABLE>

5
<PAGE>
RISK FACTORS

AN INVESTMENT IN THE COMPANY INVOLVES A HIGH DEGREE OF RISK. IN ADDITION TO
THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, PROSPECTIVE INVESTORS SHOULD
CONSIDER CAREFULLY THE FOLLOWING RISK FACTORS IN EVALUATING AN INVESTMENT IN THE
SHARES OF COMMON STOCK OFFERED HEREBY.

COMPANY INDEBTEDNESS AND RESTRICTIVE COVENANTS. Through its participation
in tax exempt bond offerings of the Industrial Development Authorities of
Russell and Buchanan Counties, Virginia, the Company has incurred significant
long-term indebtedness to develop the exploration, gathering and production
operations, storage facilities and pipelines of the Company and its Affiliates.
A significant portion of the proceeds of such indebtedness was loaned to its
Affiliates. There can be no assurance that revenues from the Company's or the
Affiliates' operations will be sufficient to satisfy the Company's long-term
debt obligations.

The debt instruments contain restrictive covenants which, among other
things, may restrict the Company's ability to incur additional parity debt,
restrict the application of proceeds and require the Company to exercise control
over an Affiliate, which it may be unable to do. See "--Relationship with
Affiliates." In addition, the covenants may limit the development by the Company
or its Affiliates of certain aspects of their business. Failure to comply could
cause acceleration of the debt, could cause the Company's existing long-term
indebtedness to lose its tax exempt status, could require the Company to pay a
higher rate of interest and could preclude the Company from participating in
future tax exempt bond offerings offered by Industrial Development Authorities
of other counties in Virginia.

Should the Company not be permitted to participate in future tax exempt bond
offerings or default on any of its indebtedness, or should any of the Company's
Affiliates be unable to repay the Company as and when required for the portions
of the indebtedness received by them, the Company's assets would be at risk and
its ability to conduct its businesses as presently being, or proposed to be,
conducted would be severely curtailed. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources."

NEED FOR ADDITIONAL CAPITAL. The Company will require substantial
additional capital to expand and diversify its operations beyond its current
plans. In the event that additional capital or adequate financing is not
available for expenditures to be incurred by the Company, there can be no
assurance that the Company will be able to complete its current projects in the
event of cost overruns, or to continue to expand its operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."

COMPLETION OF PIPELINES. In 1996, the Company began the development of an
80-mile intrastate natural gas pipeline (designated "P-25"), by acquiring
certain land easements and other property rights. The Company has also filed an
application with the Virginia State Corporation Commission ("VSCC") for issuance
of a Certificate of Public Convenience and Necessity ("CPCN") which, among other
things, would grant the Company the right of eminent domain over property needed
to construct the pipeline, which may be necessary to obtain all necessary land
rights. At present, the Company is aware of no reason why a CPCN would not be
issued. However, should the issuance of a CPCN, or of other necessary
governmental licenses, franchises and permits, be delayed or should such
issuances not occur, the Company could experience a delay in, or could be
prevented from, constructing the P-25 pipeline, or could be required to incur
significant costs to reconfigure the pipeline. Such delays, cost increases, or
the inability of the Company to build the P-25 pipeline would have a material
adverse effect on the financial performance and the prospects of the Company.
Comparable requirements would apply to construction of an additional 40-mile
intrastate pipeline ("designated P-24"). The Company recently initiated
development of the P-24 pipeline. The uncertainties that exist with respect to
the P-25 pipeline, exist with respect to the P-24 pipeline.

6
<PAGE>
In addition, capital intensive projects such as pipeline construction
frequently encounter cost overruns as a result of factors including geography of
the project, timing of construction, and adverse weather conditions. There can
be no assurance that the Company's current cost estimates will prove accurate or
that adequate financing will be available to complete these projects. See
"Business--Regulation" and "Business--Business Activities--Pipeline Operations."

COMPETITION. The natural gas industry is highly competitive. While the
Company currently operates the only underground natural gas storage facilities
in Virginia, it is possible that other companies will engage in similar or
competing activities. The Company's pipeline operation has numerous competitors
in its geographic area of operations, many of which are larger pipeline
companies with more extensive pipeline networks. Many of these competitors,
particularly those affiliated with major integrated oil and interstate and
intrastate pipeline companies, have financial resources substantially greater
than those of the Company and have access to supplies of natural gas
substantially greater than those available to the Company. Although the
Company's plan to expand its pipeline operations is designed to meet presently
growing markets, other competitors may decide to provide pipelines to these
areas. It is also possible that large volume customers or gas suppliers will
attempt to construct gas facilities to connect to an interstate pipeline or
other source of gas supply in order to bypass the Company's systems and/or avoid
use of its storage facilities.

The Company also competes in the areas of exploration, production, marketing
and distribution of propane and natural gas with major oil and gas companies,
other independent oil and gas concerns and individual producers and operators,
and, in the area of utility services, with major utility companies. Many of
these competitors have substantially greater financial and other resources than
the Company. The Company's competition may have a material adverse effect on the
Company's ability to recover its capital costs and repay outstanding
indebtedness. See "Business--Competition."

GOVERNMENTAL REGULATION. The Distribution Affiliate's natural gas
distribution operations are regulated by the VSCC. The VSCC has issued a CPCN
which authorizes the Affiliate to conduct its natural gas distribution business
in designated areas. The VSCC also sets the price of utility services at levels
intended to enable the Distribution Affiliate to recover its cost of service
plus a rate of return.

The VSCC also regulates storage rates. In June 1996 the Company applied for
a CPCN with the VSCC in connection with its storage operations at the Saltville
Facility. In July 1996 the VSCC issued an order authorizing the Company to begin
service on an interim basis subject to certain rates. A hearing was held in
December 1996 on the Company's application. A final order has not been issued by
the VSCC. The VSCC could deny the Company's application or further limit the
rates it may charge for storage.

In the future, the Company will be required to obtain additional CPCNs to
conduct its proposed pipeline operations. The Company and the Distribution
Affiliate may also periodically petition the VSCC for adjustments to rates to
compensate for changed conditions. In the event the VSCC denies such requests or
fails to give approval of such requests on a timely basis, the Company's and the
Distribution Affiliate's ability to conduct their businesses or to generate
sufficient revenues from such operations could be adversely affected. Further,
any cancellation or revocation of the Company's or the Distribution Affiliate's
CPCN, or denial by the VSCC of the Company's current and future applications,
would result in the Company or the Distribution Affiliate ceasing storage,
pipeline or distribution operations in the affected areas or the inability to
expand such operations. See "Business--Regulation."

Common carriers such as the Company's pipelines are also subject to the
jurisdiction of certain other state and federal agencies with respect to
environmental and safety matters. Changes in regulations or rulings adverse to
the Company's financial interests or failure to comply with such regulations
could have a material adverse effect on the Company's ability to generate
revenue from its storage and pipeline operations and from the Distribution
Affiliate's distribution operations. See "Business--Regulation."

7
<PAGE>
UNCERTAINTY OF PROPANE AND NATURAL GAS PRICES, SUPPLIES AND DEMAND. The
Company's revenues, profitability and future rate of growth substantially depend
upon prevailing prices for propane and natural gas and adequacy of propane and
natural gas supplies, which, in turn, depend upon numerous external factors such
as various economic, political and regulatory developments, weather, and
competition from other sources of energy. The unsettled nature of the energy
markets makes it particularly difficult to estimate future prices of propane,
natural gas and natural gas liquids or the security of propane and natural gas
supplies. The prices of propane, natural gas and natural gas liquids are subject
to wide fluctuations, and there can be no assurance that future decreases in
such prices will not occur. The Company believes that it has developed multiple
sources of propane and natural gas supply. However, there can be no assurance
that these sources will meet the Company's forecasted demand in the future. As a
result of the factors referred to above, there also can be no assurance that the
Company's forecasted demand for its products and services will prove to be
accurate. All of these factors are beyond the control of the Company. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resource" and "Business--Regulation" and
"Business--Strategy."

UNCERTAINTY OF ESTIMATES OF NATURAL GAS RESERVES AND FUTURE NET
REVENUES. There are numerous uncertainties inherent in estimating quantities of
proved natural gas reserves, including many factors beyond the control of the
Company. This Prospectus contains estimates of proved and proved developed
natural gas reserves and future net revenues therefrom based on studies
performed by the Company's engineering staff. The Company has not engaged the
services of an independent petroleum engineering firm to confirm the Company's
estimates. The estimates included in this Prospectus are based on procedures
prescribed by Statement of Financial Accounting Standards No. 69 and accordingly
are based on sales prices, cost rates and statutory income tax rates in
existence at the date of the projections or year end and therefore are an
inherently imprecise indication of future net revenues. Actual future
production, revenues, taxes, development expenditures, operating expenses and
quantities of recoverable natural gas reserves may vary substantially from those
assumed in the estimates. In addition, the Company's reserves valuations may be
subject to downward or upward revision based upon production history, results of
future development, prevailing natural gas prices and other factors. For
example, the value of the Company's reserves as of December 31, 1996, reflects
the prices of natural gas in the winter of 1996, which were approximately 25%
higher than in the prior recent heating seasons as a result of the severity of
weather conditions in the winter of 1995. See "Business--Exploration,
Production, Gathering and Marketing Operations."

RELATIONSHIP WITH AFFILIATES. The Company owns a 50% interest in the Early
Grove Affiliate and the Distribution Affiliate. The remaining 50% interest is
owned by one individual. The Company provides management services to these
Affiliates; however, there are no written management agreements governing the
operation of these Affiliates nor are there any agreements between the Company
and the individual owner relating to corporate governance, buy-sell matters or
"deadlock" issues. The inability of the Company and the other owner of the
Affiliates to agree on matters relating to the management and operation of those
Affiliates could have a material adverse effect on the financial condition of
the Company.

DEPENDENCE ON MAJOR CUSTOMERS. One of the Company's customers, United
Cities Gas Company, accounted for 31% of 1996 consolidated operating revenue and
25% of revenues for the six-month period ended as of June 30, 1997. In addition,
Knoxville Utilities Board and Hope Gas, Inc. accounted for 21% and 15%,
respectively, of revenues for the six-month period ended June 30, 1997. Two of
the Early Grove Affiliate's customers, Roanoke Gas Company and Knoxville
Utilities Board, which contract with the Early Grove Affiliate for natural gas
storage, accounted for 57% and 53% of the Early Grove Affiliate's operating
revenue for 1996 and for the six month period ended June 30, 1997, respectively.
For the six-month period in 1997, White Stone Company, W-L Construction Paving
Inc., and Buchanan General Hospital accounted for 39%, 12% and 21%,
respectively, of the operating revenues for the Distribution Affiliate. The loss
of these customers, or an adverse business or financial development affecting
any of

8
<PAGE>
these customers, could have a material adverse financial impact on the Company.
See "Business--Storage Operations."

OPERATING HAZARDS. The Company's storage, pipeline, gathering and
distribution operations are subject to the many hazards inherent in the natural
gas transmission and storage industry and in propane distribution. These include
damage to pipeline and storage facilities, related equipment and surrounding
properties caused by hurricanes, floods, fires and other acts of God,
inadvertent damage from construction and farm equipment, leakage of natural gas
and other hydrocarbons, fires and explosions and other hazards that could also
result in personal injury and loss of life, pollution and suspension of
operations. The Company's exploration and production operations involve a
variety of operating risks, including the risk of fire, explosions, blow-outs,
pipe failure, casing collapse, abnormally pressured formations, and
environmental hazards such as oil spills, gas leaks, ruptures and discharges of
toxic gases, the occurrence of any of which could result in substantial losses
to the Company due to injury and loss of life, severe damage to and destruction
of property, natural resources and equipment, pollution and other environmental
damage, clean-up responsibilities, regulatory investigation and penalties and
suspension of operations.

Any significant problems related to its facilities could adversely affect
the Company's ability to conduct its operations. The Company maintains insurance
against some, but not all, potential risks; however, there can be no assurance
that such insurance will be adequate to cover any losses or exposure for
liability. The occurrence of a significant event not fully insured against could
materially adversely affect the Company's operations and financial condition.
The Company cannot predict whether insurance will continue to be available at
premium levels that justify its purchase or whether insurance will be available
at all. See "Business--Operational Hazards and Insurance."

RELIANCE ON KEY PERSONNEL. The success of the Company will largely be
dependent upon the efforts and active participation of Michael L. Edwards. He is
party to an employment agreement with the Company. The unexpected loss of his
services could have a detrimental effect on the Company. See "Management."

DIVIDEND POLICY. The Company has paid cash dividends in each of the past
five fiscal years and in the current fiscal year. The primary objective of the
Company is to retain its earnings to support the growth of the Company.
Therefore, there can be no assurance that the Board of Directors of the Company
will authorize the Company to pay cash dividends on its Common Stock in the
future. See "Dividend Policy."

ANTI-TAKEOVER PROVISIONS. The Company's Amended and Restated Certificate of
Incorporation provides that the approval of (i) any amendment to the Certificate
or the Bylaws, (ii) the merger, dissolution, reorganization (including by share
exchange) or recapitalization of the Company, or (iii) the sale of all or
substantially all of the assets of the Company requires the affirmative vote of
the holders of 75% of the Company's issued and outstanding shares entitled to
vote thereon. This increases the percentage that would otherwise be required
under Delaware law to approve such actions. In addition, the Company's by laws
provide that members of the Company's Board of Directors are elected to terms
that are staggered. These provisions may make it more difficult to change
control of the Company or replace incumbent management. See "Description of
Securities--Certain Provisions of Certificate of Incorporation and Delaware Law"
and "Management --Executive Officers and Directors."

POSSIBLE VOLATILITY OF STOCK PRICE. The trading price of the Common Stock
could be subject to wide fluctuations in response to quarter-to-quarter
variations in operating results, announcements of unanticipated operating
results by the Company and other events or factors, such as the sale of large
blocks of shares held by existing shareholders. See "--Limited Market for Common
Stock; Shares Eligible for Resale." In addition, the stock market has from time
to time experienced extreme price and volume fluctuations which have
particularly affected the market price for certain companies in a manner often
unrelated to the operating performance of these companies. These broad market
fluctuations may adversely affect the market price of the Company's Common
Stock.

9
<PAGE>
LIMITED MARKET FOR COMMON STOCK; SHARES ELIGIBLE FOR RESALE. The Company's
Common Stock is traded on the Nasdaq National Market System under the symbol
VGCO. Average daily trading volume for the Common Stock as reported by Nasdaq
for the first half of 1997 was approximately 4,172 shares. Despite the increase
in the number of shares of Common Stock to be publicly held as a result of the
Offering, there can be no assurance that a more active trading market in the
Common Stock will develop. Because there is a small public float in the Common
Stock and it is thinly traded, sales of small amounts of Common Stock in the
public market could materially adversely affect the market price for the Common
Stock. Sales of Common Stock, or the perception that such sales could occur,
could materially adversely affect prevailing market prices for the Common Stock
and may make it more difficult for the Company to sell shares of Common Stock in
the future at times and for prices that it deems appropriate. Upon completion of
the Offering, the Company will have 5,204,906 shares of Common Stock outstanding
(5,504,906 shares if the Underwriter's over-allotment option is exercised in
full) and approximately 247,920 shares issuable upon the exercise of outstanding
employee stock options and, after August 3, 1997, an additional 789,849 shares
and, after October 4, 1997, 153,300 shares issuable upon the exercise of
warrants. The 2,000,000 shares of Common Stock sold in the Offering (2,300,000
shares if the Underwriter's over-allotment option is exercised in full) will be
freely transferable without restriction or registration under the Securities
Act, unless purchased by persons deemed to be affiliates of the Company (as that
term is defined under the Securities Act). Substantially all of the remaining
3,204,906 shares of Common Stock outstanding immediately following the Offering
(and 1,191,069 shares issuable upon exercise of options and warrants, when
exercisable) will be transferable without restriction or registration under the
Securities Act, except for approximately 1,293,188 outstanding shares and an
additional 619,954 shares issuable upon exercise of options and warrants held by
persons deemed to be affiliates of the Company (as that term is defined under
the Securities Act) which will be subject to the volume and other restrictions
under Rule 144. See "Shares Eligible for Future Sale."

ENVIRONMENTAL REGULATIONS. The production, handling, transportation and
disposal of natural gas by-products and propane are subject to regulation under
federal, state and local environmental laws. In most instances, the applicable
regulatory requirements relate to water and air pollution control and solid
waste management measures. Environmental assessments have not been performed on
all of the Company's properties. To date, expenditures for environmental control
facilities and for remediation have not been significant in relation to the
results of operations of the Company. The Company believes, however, that it is
likely that the trend in environmental legislation and regulations will continue
to be towards stricter standards, which could materially adversely affect the
Company's ability to conduct its operations. See "Business--Regulation."

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION. Certain
statements contained in this Prospectus, such as those concerning the Company's
business strategy, acquisition and expansion plans, values and revenues, capital
requirements, governmental regulation and other statements regarding matters
that are not historical facts, are forward-looking statements (as such term is
defined in the Securities Act of 1933, as amended (the "Securities Act")).
Because such forward-looking statements include risks and uncertainties, actual
results may differ materially from those expressed in or implied by such
forward-looking statements. Factors that could cause actual results to differ
materially include, but are not limited to, those discussed herein under "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business." The Company undertakes no obligation to
publicly release the results of any revision of those forward-looking statements
that may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.

USE OF PROCEEDS

The net proceeds to the Company from the sale of the shares of Common Stock
offered hereby (at an assumed offering price of $9.75 per share) are estimated
to be approximately $17,790,000 ($20,481,000 if

10
<PAGE>
the Underwriter's over-allotment option is exercised in full), after deducting
underwriting discounts and commissions and offering expenses payable by the
Company.

Net proceeds are expected to be used as follows: (i) $14,740,000 for the
development of the P-24 and P-25 pipelines; (ii) $2,050,000 for the expansion of
the Saltville Facility; (iii) $500,000 for the expansion of propane distribution
systems in southwestern Virginia, and (iv) $500,000 for the development of
exploration and production facilities. Any remaining amounts will be used for
general corporate purposes, including working capital. Pending the use of the
proceeds, the Company may invest the funds in short-term money market,
government and federal agency obligations, bank certificates of deposit and
savings deposits.

COMMON STOCK PRICE RANGE

The Common Stock is traded on the Nasdaq National Market System under the
symbol "VGCO." There were approximately 800 stockholders of record and 26
warrant holders of record as of June 30, 1997. The following table sets forth
the high and low closing prices, as reported by Nasdaq, for the quarters
indicated (the stock began trading on October 4, 1996):

<TABLE>
<CAPTION>
PRICE RANGE OF
COMMON STOCK
----------------
<S> <C> <C>
HIGH LOW
------- -------
1996
Fourth
Quarter......... $ 7 3/4 $ 6 1/2
1997
First Quarter... 10 1/2 7 1/4
Second
Quarter......... 10 3/4 8 3/4
Third Quarter
(through July
22, 1997)....... 10 1/2 9 3/4
</TABLE>

On July 22, 1997, the last reported bid and asked prices of the Common Stock
on the Nasdaq National Market System were $9.75 and $10.625, respectively.

11
<PAGE>
CAPITALIZATION

The following table sets forth the actual capitalization of the Company as
of June 30, 1997, and as adjusted to give effect to the sale by the Company of
2,000,000 shares of Common Stock in the Offering (at an assumed price to the
public of $9.75 per share), and the application of the estimated net proceeds
therefrom, as if such transaction had occurred as of June 30, 1997. The table
should be read in conjunction with the Company's Consolidated Financial
Statements included elsewhere in this Prospectus.

<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
----------------------------
ACTUAL AS ADJUSTED
------------- -------------
<S> <C> <C>
Current portion of long-term debt.................................................. $ 748,576 $ 748,576
------------- -------------
Long-term debt..................................................................... 21,136,694 21,136,694
------------- -------------

Stockholders' equity:
Preferred Stock, no par; $1,000 per share liquidation value; zero shares issued
and outstanding as of June 30, 1997............................................ -- --
Common Stock, par value $.001 per share; 10,000,000 shares authorized; 3,204,906
shares issued and outstanding; and 5,204,906 shares as adjusted for the
Offering(1).................................................................... 3,205 5,205
Additional paid-in capital....................................................... 13,751,471 31,539,471
Retained earnings................................................................ 1,739,799 1,739,799
------------- -------------
Total stockholders' equity......................................................... 15,494,475 33,284,475
------------- -------------
Total capitalization............................................................... $ 37,379,745 $ 55,169,745
------------- -------------
------------- -------------
</TABLE>

(1) Excludes 1,191,069 shares of Common Stock issuable upon exercise of
outstanding options and warrants at exercise prices ranging from $8.72 to
$10.00 per share.

DIVIDEND POLICY

The Company has paid cash dividends on its Common Stock in each of the past
five fiscal years. During the past two years dividends were paid to stockholders
of record as follows:

<TABLE>
<CAPTION>
DIVIDEND (PER
RECORD DATE SHARE)
- ------------------------------------------------------------- -------------------
<S> <C>
12/22/95..................................................... $ 0.2900
12/15/96..................................................... 0.0100
1/31/97..................................................... 0.0125
5/15/97..................................................... 0.0150
7/15/97..................................................... 0.0175
</TABLE>

The primary objective of the Company is to retain its earnings to support
the growth of the Company. Therefore, there is no assurance that the Board of
Directors of the Company will authorize the Company to pay cash dividends on its
Common Stock in the future.

12
<PAGE>
SELECTED CONSOLIDATED
FINANCIAL AND OPERATING DATA

The following table presents selected consolidated financial and operating
data of the Company for each of the six month periods ended June 30, 1996 and
1997, and each of the four years in the period ended December 31, 1996. The
annual financial data for 1994, 1995 and 1996 has been derived from the
consolidated financial statements of the Company audited by Arthur Andersen LLP,
independent public accountants. The financial statements, as of December 31,
1996, and for the years ended December 31, 1995 and 1996, and the report of
Arthur Andersen LLP, are included herein under the caption "Financial
Statements." In addition, this data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

<TABLE>
<CAPTION>
SIX MONTHS ENDED
FOR THE YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------------------ --------------------
<S> <C> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- ---------
Revenues:
Gas sales and well operations revenues........... $ 391,084 $ 489,180 $ 603,495 $ 698,645 $ 297,345 $2,077,017
Natural gas gathering and service revenues....... 52,245 104,250 133,794 103,768 51,872 50,883
Natural gas storage revenues..................... -- -- -- 769,025 -- 1,228,297
Management revenues.............................. 753,467 738,583 756,524 320,532 195,928 144,340
Interest income.................................. 30,701 280,182 526,797 877,748 433,763 564,331
Other income..................................... 8,732 -- 2,800 -- -- 6,082
--------- --------- --------- --------- --------- ---------
1,236,229 1,612,195 2,023,410 2,769,718 978,908 4,070,950
--------- --------- --------- --------- --------- ---------
Costs and expenses:
Production expenses.............................. 312,036 361,610 65,029 105,910 43,445 100,665
Purchased gas expense............................ -- -- -- 28,537 -- 66,113
Operations and maintenance expense............... -- -- -- 173,445 -- 229,203
Cost of natural gas sold......................... -- -- -- -- -- 1,635,003
Depreciation and amortization.................... 170,380 190,792 305,216 387,116 129,047 373,590
General and administrative....................... 413,312 425,145 708,191 645,673 303,087 447,430
Other expense.................................... 269 -- 2,752 2,771 1,146 68,039
Interest expense................................. 119,624 288,073 673,251 1,006,800 520,824 717,155
--------- --------- --------- --------- --------- ---------
1,015,621 1,265,620 1,754,439 2,350,252 997,549 3,637,198
--------- --------- --------- --------- --------- ---------
Income (loss) before earnings of affiliated
companies and income taxes....................... 220,608 346,575 268,971 419,466 (18,641) 433,752
Equity in earnings of affiliated companies......... 136,945 193,416 267,484 339,927 207,942 131,201
--------- --------- --------- --------- --------- ---------
357,553 539,991 536,455 759,393 189,301 564,953
Provision (benefit) for income taxes............... 55,426 119,906 62,581 151,827 (17,543) 137,883
--------- --------- --------- --------- --------- ---------
Net income......................................... $ 302,127 $ 420,085 $ 473,874 $ 607,566 $ 206,844 $ 427,070
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Summary of operations-Affiliates:
Early Grove Affiliate
Revenues......................................... $1,118,531 $1,638,233 $2,779,048 $3,985,444 $2,060,751 $2,179,567
Expenses......................................... 782,768 1,260,152 2,293,665 3,309,706 1,660,317 1,954,971
--------- --------- --------- --------- --------- ---------
Net income....................................... $ 335,763 $ 378,081 $ 485,383 $ 675,738 $ 400,434 $ 224,596
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Company's equity share........................... $ 167,882 $ 189,041 $ 242,692 $ 337,869 $ 200,217 $ 112,298
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Distribution Affiliate
Revenues......................................... $ 274,930 $ 455,799 $ 719,188 $1,023,065 $ 496,435 $ 676,012
Expenses......................................... 336,803 447,048 669,603 1,018,950 480,985 638,206
--------- --------- --------- --------- --------- ---------
Net income (loss)................................ $ (61,873) $ 8,751 $ 49,585 $ 4,115 $ 15,450 $ 37,806
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Company's equity share........................... $ (30,937) $ 4,375 $ 24,792 $ 2,058 $ 7,725 $ 18,903
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>

13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

The following discussion of the historical financial condition and results
of operations of the Company should be read in conjunction with the Consolidated
Financial Statements and related notes set forth in this Prospectus. Discussions
involving the Early Grove Affiliate and the Distribution Affiliate should be
read in conjunction with the Virginia Gas Storage Company Financial Statements
and related notes and the Virginia Gas Distribution Company Financial Statements
and related notes set forth in this Prospectus.

GENERAL

The Company derives revenues from its storage, exploration, production,
gathering, marketing and propane distribution operations. From its 50%
investment in the Early Grove Affiliate and the Distribution Affiliate, the
Company derives earnings from the storage, gathering and distribution operations
of these companies. The Company accounts for its investments in these companies
using the equity method.

The Company's growth has been stimulated by deregulation of the natural gas
industry and strong economic and population growth in the main markets in which
the Company competes, specifically eastern Tennessee and western Virginia.
Deregulation has given natural gas customers more flexibility in negotiating
their natural gas purchases and transportation contracts.

Most of the pipeline facilities on major interstate systems such as ETNG,
TCO and CNG are limited by capacity constraints as to the ability to deliver
additional peak-day volumes. The ability of companies to continue to supply
customers from traditional sources such as the Gulf Coast area are limited by
the high capital costs of building new pipelines and compression facilities. The
Company believes that local suppliers of natural gas, such as the Company, the
Early Grove Affiliate and the Distribution Affiliate possess a significant
advantage in delivering these services at a more economical rate due largely to
lower capital costs in developing natural gas delivery facilities.

In its exploration and production business, the Company has a revenue
interest in wells which generate revenues from sale of the well's natural gas
production. The Company also receives revenues from managing the construction,
drilling, development, and operation of natural gas facilities, including
management and operations fees. In its gas gathering business, revenues are
generated from its ownership interest in gathering pipelines for natural gas
traveling through its gathering systems. In its gas marketing operations, the
Company generates revenues from the sale of natural gas.

In its storage business, the Company receives fees for use of its storage
space in addition to injection and withdrawal fees, collectively referred to as
storage revenues. Storage charges to customers are in accordance with rates
included in tariffs approved by the VSCC.

In its propane distribution business, the Company generates revenues from
the sale of propane to industrial, commercial and residential customers.

With respect to the Early Grove Affiliate's gas gathering business, the
Company records its share of net income from fees received for natural gas
traveling through the Affiliate's gathering system and for storage fees. The
Early Grove Affiliate also sells gas during the heating season.

With respect to the Distribution Affiliate's distribution operations, the
Company records its share of net income from the difference between the prices
at which the Affiliate purchases natural gas and the prices at which it sells
natural gas to its customers. The prices at which the Distribution Affiliate
sells natural gas to its customers are in accordance with the rate schedules in
its tariff filed with the VSCC. The Distribution Affiliate purchases natural gas
under short-term contracts which reflect the market price of natural gas.

14
<PAGE>
FIRST SIX MONTHS OF 1997 AND 1996

OVERVIEW. During the six month period ended June 30, 1997, the Company
recorded net income of $427,000, compared to $207,000 for the same period in
1996, an increase of 106%. The net income per common share available to common
stockholders for the corresponding periods was $0.12 in 1997 compared with $0.07
in 1996. The number of weighted-average shares used in calculating income per
common share was 3,201,350 and 1,034,873 for the six months ended June 30, 1997
and 1996, respectively.

REVENUES. Total revenues increased 316% to $4.1 million for the six months
ended June 30, 1997 compared to $979,000 for the same period in 1996. Gas sales
and well operation revenues totaled $2.1 million for the first six months of
1997 compared to $297,000 for the same period in 1996. The increase primarily
reflects the formation of the Company's marketing operations during the first
quarter of 1997. Sales of natural gas during the first six months of 1997
totaled $1,826,000 on sales volumes of 689,000 MMBtu. Exploration and production
revenues, reflecting the Company's revenue interest in these sales of natural
gas, consisted of natural gas sales of $189,000, and well operation income of
$131,000 compared to $158,000 and $139,000, respectively, for the same period in
1996. Propane sales totaled $118,000 for the six months ended June 30, 1997.
There were no comparable propane sales for the same period in 1996 as these
operations were in the developmental stage.

Natural gas storage revenues totaled $1.2 million for the first six months
of 1997, compared to zero revenue for the same period in 1996. Initial
injections of customer gas into the Saltville Facility began in August 1996.
Contracted storage capacity for the current contract year is comprised of 10-day
(64%), 60-day (9%) and 90-day (27%) service.

Management revenues, interest and other income totaled $715,000 for the six
months ended June 30, 1997, compared with $630,000 for the same period in 1996,
an increase of 14%. The majority of the increase reflects an increase in
interest income of $131,000, offset by a decrease in management revenues of
$52,000.

COSTS AND EXPENSES. Total operating costs and expenses increased $2.4
million to $2.9 million for the six months ended June 30, 1997, compared to
$477,000 for the same period in 1996. Production and purchased gas expenses
increased to $167,000 in the six months ended June 30, 1997 from $43,000 for the
same period in 1996 as a result of increased production expenses in addition to
increased purchased gas expense attributed to the expanding propane distribution
operations.

Operations and maintenance expenses totaled $229,000 in 1997 compared to
zero for the same period in 1996, primarily reflecting operating costs incurred
in 1997 related to the Saltville Facility.

Cost of natural gas sold, related to the Company's marketing of natural gas,
totaled $1.6 million for the first six months of 1997 compared to zero for the
same period in 1996, reflecting the initiation of marketing operations and the
corresponding costs.

General and administrative costs were $447,000 for the first six months of
1997, an increase of 48% over the comparable 1996 total of $303,000, reflecting
the growth in Company operations during 1997 and the accompanying growth in
personnel and facilities.

Depreciation, depletion and amortization increased 189% to $374,000 for the
six months ended June 30, 1997 from $129,000 for the same period in 1996. The
increase reflects the recovery of costs for capital projects recently placed
into service, primarily the Saltville Facility.

INTEREST EXPENSE. Interest expense increased 38% to $717,000 during the
first six months of 1997 from $521,000 in the comparable 1996 period, due
primarily to additional tax-exempt bond financing. The Company capitalizes
interest on expenditures for significant projects while activities are in
progress to bring the assets to their intended use. Capitalized interest for the
six month periods ended June 30, 1997 and 1996 totaled $170,000 and $162,000,
respectively.

15
<PAGE>
EQUITY IN EARNINGS OF AFFILIATED COMPANIES. The Company has a 50% ownership
interest in two affiliated companies which provide natural gas storage,
gathering and distribution services. The Company accounts for its investments in
these companies using the equity method. The Company's equity in the earnings of
these affiliated companies decreased 37% to $131,000 for the first six months of
1997 from
$208,000 for the same period in 1996. The decrease reflects increased operations
expenses related to natural gas storage operations in addition to higher
interest costs. The increased costs were partially offset by increased usage
during the period by industrial customers of the Distribution Affiliate.

INCOME TAXES. Using the asset-and-liability method, deferred income taxes
reflect the temporary differences between assets and liabilities recognized for
financial reporting purposes and amounts recognized for income tax purposes. The
Company's provision for income taxes as a percentage of income before its equity
in earnings of Affiliates (the Company's equity in earnings of Affiliates is
reflected on a post-income tax basis) was 32% for the six month period ended
June 30, 1997. For the six months ended June 30, 1996, the Company's operations
reflected an income tax benefit.

EQUITY INVESTMENTS

NATURAL GAS STORAGE. Storage revenues from the Early Grove facility for the
six months ended June 30, 1997 were $1,265,000 compared with storage revenues of
$877,000 for the same period in 1996 due to increased storage capacity at the
Early Grove facility.

NATURAL GAS GATHERING. Gathering revenues totaled $159,000 for the first
six months of 1997 compared to $207,000 for the same period in 1996, reflecting
a decrease in natural gas throughput due partially to production decline and to
decreased peak winter service sales volume as a result of the milder seasonal
temperatures experienced during the first quarter 1997 as compared to the
corresponding period in 1996. Revenues from winter service sales totaled
$613,000 for the six months ended June 30, 1997, compared to $781,000 for the
same period in 1996. Purchased gas expenses related to these sales totaled
$511,000 and $664,000 for the six months ended June 30, 1997 and 1996,
respectively.

NATURAL GAS DISTRIBUTION. Distribution revenues for the first six months of
1997 were $419,000, an increase of $120,000 over revenues of $299,000 for the
same period in 1996 largely due to increased usage during the period by
industrial customers, and to decreased residential customer usage reflecting
milder seasonal temperatures. Purchased gas costs related to these sales totaled
$239,000 for the first six months in 1997 and $147,000 for the same period in
1996.

RESULTS OF OPERATIONS FOR YEARS 1996 AND 1995

OVERVIEW. During the year ended December 31, 1996, the Company recorded net
income of $608,000, compared to $474,000 for 1995. Net income per common share
available to common stockholders for the years was $0.21 in 1996 compared with
$0.62 in 1995. The number of weighted average shares used in calculating income
per common share was 1,637,576 and 695,669 for the years ended December 31, 1996
and 1995, respectively.

REVENUES. Total revenues increased 37% to $2.8 million for the year ended
December 31, 1996 compared to $2.0 million for 1995. Gas sales and well
operation revenues totaled $699,000 in 1996 compared to $603,000 in 1995, an
increase of 16%. This increase primarily reflects an increase in the average
sales price of natural gas to $2.53/Mcf in 1996 from $1.47/Mcf in 1995. Propane
operations, initiated during the second half of 1996, reflected sales totaling
$47,000 for the year ended December 31, 1996.

Natural gas gathering and service revenue decreased 22% to $104,000 for the
year ended December 31, 1996, compared to $134,000 in 1995, primarily as a
result of the Company's 1995 revision of its method of recording certain
gathering revenues. Gathering revenues for 1995 include $35,000 which would

16
<PAGE>
not have been recognized had this revision not been made. See Note 2 of Notes to
the Consolidated Financial Statements.

Natural gas storage revenue totaled $769,000 for the year ended December 31,
1996, compared to zero revenue in 1995. Initial injections of customer natural
gas into the Saltville Facility began in August 1996. Contracted storage
capacity for 1996 contract year totaled 583,000 MMBtu, consisting of 10-day
(59%), 60-day (10%), and 90-day (31%) service.

Management revenues, interest income and other revenue decreased 7% to $1.2
million in 1996, compared to $1.3 million in 1995, primarily as a result of
lower management fees related to the development of the Saltville Facility.

COSTS AND EXPENSES. Total operating costs and expenses increased 24% to
$1.3 million for the year ended December 31, 1996, compared to $1.1 million for
the same period in 1995. Total production and purchased gas expenses increased
107% to $134,000 in 1996 from $65,000 in 1995 as a result of increased
production expenses and the purchased gas expense related to the 1996
development of propane operations.

Operating and maintenance expense related to the Company's storage
operations were $173,000 in 1996, compared to zero in 1995.

General and administrative expense decreased 9% to $646,000 in 1996 from
$708,000 in 1995. This decrease was due primarily to the shift of certain
personnel and administrative functions from the corporate level to the
individual operating subsidiaries, including the Affiliates.

Depreciation, depletion and amortization increased 27% to $387,000 in 1996
from $305,000 in 1995 reflecting the recovery of costs for capital projects,
primarily the Saltville Facility, then recently placed into service.

INTEREST EXPENSE. Interest expense increased 50% to $1.0 million in 1996
from $673,000 in 1995 due primarily to additional tax-exempt bond financing and
a promissory note issued by the Company to purchase the interest of its joint
venture partner in the development of the Saltville Facility. The Company
capitalizes interest on expenditures for significant projects while activities
are in progress to bring the assets to their intended use. Capitalized interest
totaled $290,000 in 1996 and $93,000 in 1995.

EQUITY IN EARNINGS OF AFFILIATED COMPANIES. The Company's equity in the
earnings of affiliated companies increased 27% to $340,000 for 1996 from
$267,000 in 1995. The increase primarily reflects increased storage revenues
attributable to an increase in leased storage capacity.

INCOME TAXES. The Company's provision for income taxes as a percentage of
income before equity in earnings of Affiliates (the Company's equity in earnings
of Affiliates is reflected on a post-income tax basis) was 36% in 1996 and 23%
in 1995.

EQUITY INVESTMENTS

NATURAL GAS STORAGE. Storage revenues from the Early Grove Facility totaled
$2.1 million in 1996, reflecting an increase in revenues of $900,000 over 1995
revenues of $1.2 million, due largely to an increase in leased storage capacity
at the Early Grove Facility.

NATURAL GAS GATHERING. Gathering revenues totaled $378,000 in 1996,
reflecting a decrease of $159,000 from 1995 gathering revenues of $537,000,
partially reflecting a decrease in system throughput during 1996. In addition,
$110,000 of 1995 revenue reflects the revision of the method of recording
certain gathering revenues. See Note 2 of Notes to the Virginia Gas Storage
Company's Financial Statements. Revenues from winter service sales totaled $1.1
million in 1996 compared to $888,000 in 1995 due to higher prevailing natural
gas sales prices. Purchased gas expenses related to these sales totaled $974,000
and $681,000 for 1996 and 1995, respectively.

17
<PAGE>
NATURAL GAS DISTRIBUTION. Distribution revenues increased to $629,000 in
1996 from $556,000 in 1995 partially due to an increase in residential and
commercial customers, reflecting 1996 expansions of distribution facilities in
Russell and Buchanan Counties and to an increase in the average sales price for
industrial customers. Purchased gas costs related to these sales totaled
$330,000 and $234,000 in 1996 and 1995, respectively.

LIQUIDITY AND CAPITAL RESOURCES

WORKING CAPITAL

At June 30, 1997, the Company's working capital reflected a $519,000
deficit, a decrease from the $430,000 deficit at December 31, 1996. The
Company's current ratio was .87 at June 30, 1997, consistent with the ratio at
December 31, 1996. The combined working capital of the Early Grove Affiliate and
the Distribution Affiliate increased to a $1.4 million deficit at June 30, 1997
from the $600,000 deficit at December 31, 1996. The combined current ratio of
these companies was .58 at June 30, 1997.

INVESTING AND FINANCING ACTIVITIES

The Company's cash requirements in the past have been met out of cash
generated from operations, proceeds from the issuance of the Company's common
stock, amounts borrowed in conjunction with tax exempt bonds issued by the
Industrial Development Authorities of Russell and Buchanan Counties, Virginia in
addition to other borrowings. The Company's rapid pace of growth and the timing
of the completion of financing transactions periodically have limited the
Company's short term liquidity. On June 30, 1997, the Company had a cash balance
of $1,526,000 compared to $1,653,000 at December 31, 1996.

Capital investments of $3.2 million for the first six months of 1997 reflect
primarily continued development of the Saltville Facility ($1.7 million),
expansion of the Company's propane distribution operations ($1.1 million) and
development of the P-25 pipeline project ($200,000).

Capital investments of $11.6 million in 1996 reflect primarily the
development of the Saltville Facility ($10.3 million) and the P-25 pipeline
project ($900,000).

Capital investments of $2.3 million in 1995 reflect primarily the
development of the Saltville Facility ($800,000), development of other storage
facilities ($900,000) and development of the P-25 pipeline project ($400,000).

In October 1996, the Company completed an initial public offering of its
common stock. The offering resulted in the issuance of an additional 1,533,000
shares of common stock of the Company at $6 per share. Net proceeds realized
from the offering approximated $8 million.

In July 1996, the Company issued 42,000 shares of its common stock to an
officer of the Company. The net proceeds of the sale of these shares were
$252,000.

In May 1996, the Company issued 800,058 shares of its common stock to one
investor pursuant to a private placement. The net proceeds of the sale of these
shares was $4,401,317.

In September 1995, the Company issued and sold a total of 2,000 shares of
preferred stock in a private placement to a sole investor, Sirrom Capital
Corporation, at a price of $1,000 per share. Proceeds from the sale were used
for working capital, the retirement of debt and general corporate purposes. In
February 1997, the Company redeemed these shares at face value.

During 1995 the Company issued and sold a total of 124,316 shares of common
stock in conjunction with the exercise of stock options. Proceeds from the sales
totaled $496,000.

In February 1997 the Industrial Development Authority of Russell County (the
"Russell County Authority") issued its Subordinated Natural Gas Facilities
Revenue Bonds Series 1997 with principal of

18
<PAGE>
$9,100,000 with interest at 9.5% per annum, repayable from 2002 to 2017.
Approximately $3.7 million of the proceeds was loaned by the Company to the
Distribution Affiliate pursuant to an unsecured note. The proceeds are being
used for construction of a natural gas distribution facility in and around the
town of Lebanon, Virginia and for related storage and pipeline facilities.

In December 1995, the Industrial Development Authority of Buchanan County,
Virginia (the "Buchanan County Authority"), issued its Senior Subordinated
Natural Gas Facilities Revenue Bonds Series 1995 with principal of $3,750,000
with interest at 9% per annum, repayable from 1999 to 2020. Approximately $3.7
million of the proceeds, received by the Company, was loaned to the Affiliates
pursuant to an unsecured note. Proceeds were used to extend existing natural gas
distribution facilities in and around the town of Grundy, Virginia, and for
related supporting pipeline gathering and storage facilities.

In November 1994, the Buchanan County Authority issued its Natural Gas
Revenue Bond Series A with principal of $4,250,000 with interest at an effective
rate of 8.88%, repayable from 1995 to 2017. The bonds were also issued in parity
with the Russell County Bonds discussed above. Approximately $3.6 million of the
proceeds, received by the Company, was loaned to the Affiliates. Proceeds were
used to construct a natural gas distribution facility in and around the town of
Grundy, Virginia, and for related supporting exploration and production,
pipeline, and storage facilities.

In January 1994, the Russell County Authority issued its Natural Gas Revenue
Bond Series A and B with combined principal of $3,000,000 at an effective
interest rate of 7.35% per annum, repayable from 1996 to 2023. Approximately
$2.6 million of the proceeds, received by the Company, were loaned by the
Company to the Affiliates. Proceeds were used to construct a natural gas
distribution facility in and around the town of Castlewood, Virginia, and for
related supporting exploration and production, pipeline and storage facilities
in the amount of $2,630,000 and to retire $370,000 of long-term debt.

19
<PAGE>
BUSINESS

OVERVIEW

The Company's existing and planned assets comprise: (i) interests in 85
natural gas wells with proved developed reserves of approximately 2.6 Bcf; (ii)
gathering systems with over 102 miles of pipeline with a current annual
throughput of over 1.67 Bcf, connected to the interstate pipeline systems of
ETNG, CNG and TCO; (iii) two underground storage facilities with current
capacity of 2.2Bcf MMBtu; and (iv) 120 miles of intrastate pipeline under
development with planned aggregate daily throughput of approximately 50 MMcf/d.

The Company's business has developed in response to the growing need for
natural gas storage, pipelines and distribution in its market area, resulting
principally from economic growth and the impact of deregulation. Deregulation
has given natural gas customers more flexibility in negotiating their natural
gas purchases and transportation contracts. The Company's pipeline connections
to the ETNG, CNG, and TCO, and to the Company's adjacent storage facilities,
combine to create a hub which provides opportunities for more efficient gas
distribution, including to local, growing markets. At present, the Company's
business primarily consists of: (i) producing, gathering and marketing natural
gas from wells in which the Company has an ownership interest to municipal
distributors, local distribution companies and major oil and gas companies; (ii)
storing natural gas for municipal distributors and local distribution companies
which have supplied their own gas, or purchased it from third parties or the
Company; and (iii) distributing propane and natural gas purchased from third
parties or the Company to local industrial, commercial and residential
customers.

The Company's principal sources of revenue have varied depending on its
level of activity in any given segment of natural gas operations. From 1987
through 1992, substantially all of the Company's income was derived from
exploration, development and production of natural gas and from fees derived
from managing wells. From 1993 through 1996, the Company's income reflected the
growth of its storage operations. In 1996 and 1997, the Company initiated its
propane distribution and gas marketing operations, respectively. Today, the
Company is building transmission pipelines and expanding its storage capacity
and expects to derive future income primarily from natural gas storage and
transportation fees.

MARKET OVERVIEW

The Company anticipates that its business will benefit from the increasing
economic and natural gas consumption growth in the Commonwealth of Virginia and
surrounding states. The U.S. Department of Energy has forecasted that natural
gas consumption will continue a trend that has seen gas consumption rise 32%
nationwide and 77% in Virginia between 1986 and 1995. Management believes that
current upward trends in the economy, a favorable regulatory environment, the
deregulation of the industry which has resulted in end-users' ability to
purchase gas on a competitive basis from a greater variety of sources, and the
increasing availability of natural gas as a form of energy for residential,
commercial and industrial markets will enable the Company to expand into new
markets and to better develop its current markets. Management believes that it
is well positioned in its market area to capitalize on the opportunities
prevalent in the natural gas industry.

STRATEGY

The Company's objective is to enhance earnings and cash flow by becoming a
leading integrated natural gas company in its market area. The Company's
strategy to achieve this objective is to construct

20
<PAGE>
pipeline systems, increase the utilization of its existing storage facilities,
and aggressively pursue end-user customers. The Company intends to implement
this strategy through the following steps:

CONSTRUCT PIPELINE SYSTEMS. The Company is currently in the process of
acquiring rights-of-way and receiving state approval for the construction of the
P-25 intrastate pipeline which will connect its Saltville storage facility to
growing markets in Smyth, Wythe and Pulaski Counties in southwestern Virginia.
The Company also intends to build the P-24 intrastate pipeline which will
connect its Saltville storage facility to the CNG interstate pipeline. These
pipelines will allow the Company to develop a transportation business, capture
additional peak storage business, connect to increased supply sources for
existing and growing markets and provide customers with greater flexibility in
managing their gas resources.

INCREASE UTILIZATION OF EXISTING STORAGE FACILITIES. Management believes
that the working gas capacities of the Saltville and Early Grove storage
facilities can be increased to 10 Bcf and 2.2 Bcf, respectively, from their
current capacities of 0.6 Bcf and 1.6 Bcf, respectively. By increasing storage
capacity through the opportunities created by the P-24 and P-25 pipelines, the
Company expects to be able to provide additional peak storage service to
existing and new customers and to thereby enhance the profitability of its
storage operations.

PURSUE END-USER CUSTOMERS. As a result of recent regulatory changes,
natural gas customers have more flexibility to negotiate their natural gas
purchases, storage services, and transportation contracts. The Company is
actively pursuing direct sales to these end-users, such as local distribution
companies, industrial plants and municipalities, which are seeking alternative
supplies to meet their energy needs. The Company is distributing propane to
offer alternative energy choices to customers in its service area who may elect
to use propane gas or who may not otherwise be serviced with natural gas.

BUSINESS ACTIVITIES

The Company's principal business activities are as follows:

STORAGE OPERATIONS

The Company has the only two underground natural gas storage facilities in
the Commonwealth of Virginia: The Saltville Facility (defined below), located in
Smyth and Washington counties, (owned by the Company) and the Early Grove
Facility, located in Scott and Washington Counties (owned by the Early Grove
Affiliate). Customers contract for storage for annual periods ranging from one
to 15 years, which includes the heating season months of November through March.
Contract storage fees are prorated and paid in equal amounts over a twelve-month
period, with additional payments for injection and withdrawal fees. These
contracts are subject to termination if the storage facility operating company
fails to perform.

The Company is continually assessing the feasibility of developing
additional natural gas storage facilities in its area of operation and is
analyzing available geological and geophysical data and land records related
thereto.

SALTVILLE FACILITY. The Company has developed a high deliverability salt
cavern storage facility in Saltville, Virginia ("Saltville Facility") for use as
a high rate, peak usage storage facility. The Saltville Facility utilizes
caverns created in underground salt beds to store natural gas. The Company's
engineering staff believes the ultimate working gas capacity of the Saltville
Facility could be up to 10 Bcf. In June 1996, the Company filed an application
with the VSCC for a CPCN for the operation of the Saltville Facility as a
storage facility. In July 1996, the VSCC issued an order authorizing the Company
to begin service on an interim basis using the rates set forth in the
application. These interim rates for 10-day, 60-day and 90-day service are
$5.64, $1.86 and $1.50 per MMBtu stored, respectively, plus $0.05 per MMBtu
injected and $0.05 per MMBtu withdrawn. In August 1996, the Company injected the
first working gas into the field. Peak daily withdrawal rates of 40,000 MMBtu
were achieved in January 1997. Current customer commitments total 657,400 MMBtu
of capacity, the current maximum capacity of the Saltville Facility, for the
1997/1998 heating season.

21
<PAGE>
An industry company has an option to jointly develop with the Company other
storage caverns that are not part of the current and proposed Saltville Facility
operations. This company's participation in such development will be on a
50%-50% basis.

The Company currently services contracts for storage with the following
entities (contracted storage is expressed per contract year that includes the
heating season beginning in the year stated; revenues are expressed per calendar
year and include injection and withdrawal fees):

UNITED CITIES GAS COMPANY. Contracted annual storage is for 300,000 MMBtu
through 2011. The estimated annual revenues expected to be generated from this
contract are $1,722,000.

KNOXVILLE UTILITIES BOARD. Contracted annual storage is for 40,000 MMBtu,
increasing in 1997 to 90,000 MMBtu through 2000. The estimated annual revenues
expected to be generated from this contract are $516,600.

CITIZENS GAS UTILITY DISTRICT. Contracted annual storage is for 3,000 MMBtu
through 2006. The estimated annual revenues expected to be generated from this
contract are $17,220.

CITY OF ETOWAH, TENNESSEE. Contracted annual storage is for 2,000 MMBtu
through 2007. The estimated annual revenues expected to be generated from this
contract are $11,480.

HAWKINS COUNTY UTILITY DISTRICT. Contracted annual storage is for 180,000
MMBtu of 90-day service through 2006 and 5,000 MMBtu of 10-day service through
2007. The estimated annual revenues expected to be generated from these
contracts are $316,700.

SEVIER COUNTY UTILITY DISTRICT. Contracted annual storage is for 60,000
MMBtu through 2006. The estimated annual revenues expected to be generated from
this contract are $117,600.

ALCOA. Contracted annual storage is for 17,400 MMBtu through 2002. The
estimated annual revenues expected to be generated from this contract are
$99,876.

EARLY GROVE FACILITY. The Early Grove Facility is an underground natural
gas storage facility, owned and operated by the Early Grove Affiliate. The Early
Grove Affiliate has received a CPCN from the VSCC, which authorizes it to engage
in the sale, transportation (including storage), or assignment of natural gas
and to charge rates approved by the VSCC. The Early Grove Facility has 29
storage wells, a certificated area of 2,900 acres, and has received approval to
charge rates for 60-day, 90-day, 120-day and 150-day service of $1.86, $1.50,
$1.33 and $0.85 per MMBtu stored, respectively, plus $.05 per MMBtu injected and
$.05 per MMBtu withdrawn.

Contracted storage volume for 60-day, 90-day and 150-day service has
increased from 520,000 MMBtu for the 1994/1995 heating season to 1,560,000 MMBtu
for the 1996/1997 heating season. The deliverability of the Early Grove Facility
has been increased by reworking existing wells, drilling new wells, injecting
additional base gas, installing new compression equipment and increasing the
maximum operating pressure of the field to 2,000 PSI from 1,400 PSI. Peak
January deliverability has been increased from 1,000 MMBtu to over 16,000 MMBtu
per day from 1992 to 1997. Further improvements, including drilling new wells,
adding additional base gas and increasing the maximum operating pressure to up
to 2,400 PSI, are planned. Management believes these improvements would increase
the field's capacity to 2,200,000 MMBtu in the future.

The Early Grove Affiliate currently has contracts for storage with the
following entities (contracted storage is expressed per contract year that
includes the heating season beginning in the year stated; revenues are expressed
per calendar year and include injection and withdrawal fees):

KNOXVILLE UTILITIES BOARD. Contracted annual storage is for 450,000 MMBtu
for 1997 through 2002. The estimated annual revenues expected to be generated
from this contract are $720,000.

22
<PAGE>
POWELL-CLINCH UTILITY DISTRICT. Contracted annual storage is for 525,000
MMBtu for 1997, increasing an additional 75,000 MMBtu for each subsequent year
up to 975,000 MMBtu for 2003 and remaining at up to 975,000 MMBtu for each year
through 2009. The estimated annual revenues expected to be generated from this
contract are $498,750 per year in 1997, increasing to a maximum of $926,250 in
2004.

ROANOKE GAS COMPANY. Contracted annual storage is for 180,000 MMBtu for
1997 through 2007. The estimated annual revenues expected to be generated from
this contract are $288,000.

UNITED CITIES GAS COMPANY. Contracted annual storage is for 180,000 MMBtu
through the 2000 contract year. The estimated annual revenues expected to be
generated from this contract are $352,800.

PUBLIC UTILITY DISTRICT OF JEFFERSON AND COCKE COUNTIES. Contracted annual
storage is for 150,000 MMBtu from 1997 through 2002. The estimated annual
revenues expected to be generated from this contract are $142,500.

PIPELINE OPERATIONS

In 1996, the Company initiated environmental and feasibility studies for the
construction of the P-25 pipeline which will connect the Company's Saltville
Facility to the ETNG interstate pipeline system and transport natural gas to
growing markets in Smyth, Wythe and Pulaski Counties in southwestern Virginia.
These areas currently are served only by the ETNG pipeline, which has
insufficient capacity to meet the area's needs.

The first phase of construction of the P-25 pipeline consists of 20 miles of
pipe connecting the Company's Saltville Facility to the ETNG interstate pipeline
system and twinning the ETNG line to the town of Marion. The remaining phases
will extend the P-25 pipeline from Marion, Virginia to Radford, Virginia. The
Company has entered into a 15-year contract with United Cities Gas Company, the
local distribution company ("UCGC") which serves Smyth, Wythe and Pulaski
Counties, to provide pipeline capacity to supply 20,000 MMBtu per day, or 67% of
expected pipeline capacity. The Company has filed for a CPCN with the VSCC and
expects a decision by late 1997 or early 1998. At present, the Company is aware
of no reason why a CPCN would not be issued. Tariffs would be set by the VSCC
and charged by the Company for reserved capacity in the pipeline. The Company
expects to complete obtaining land easements, permits and to begin construction
upon obtaining the CPCN. Assuming no unforeseen impediment to its development,
the Company expects the P-25 pipeline to commence operations in late 1998.

The Company has recently initiated environmental studies and acquisitions of
rights-of-way for permits for the construction of the P-24 pipeline. When
completed, the P-24 pipeline would connect the Company's Saltville Facility to
the CNG interstate pipeline system. The P-24 pipeline is expected to provide a
strategic interconnect between the ETNG and CNG interstate pipeline systems and
would result in additional sources of natural gas supply for the Company's
Saltville Facility.

NATURAL GAS AND PROPANE DISTRIBUTION OPERATIONS

The Company, through the Distribution Affiliate, owns and operates natural
gas distribution systems in Russell and Buchanan Counties in Virginia. The
Distribution Affiliate has a CPCN authorizing it to provide natural gas service
to Russell and Buchanan Counties. The Distribution Affiliate's tariffs to its
customers are set by the VSCC.

The Distribution Affiliate has a firm transportation service contract for a
ten-year term with ETNG for the heating season of November through March, and an
interruptible transportation contract with ETNG for the remainder of the year.
Any disruption accessing ETNG's pipeline could result in the Distribution
Affiliate's inability to serve its customers in the affected areas. See "Risk
Factors--Relationship with Other Pipeline Companies."

23
<PAGE>
The Distribution Affiliate recently completed construction of a 10-mile
pipeline providing service to the town of Lebanon in Russell County. The
Distribution Affiliate has entered into franchise agreements with the towns of
Richlands and Cedar Bluff in Tazewell County which adjoin the Distribution
Affiliate's current service areas and has applied to the VSCC for a CPCN to
provide natural gas service for Tazewell County and Dickenson County.
Restrictions under the Company's debt instruments may inhibit the Affiliate's
ability to develop these areas. See "Risk Factors--Company Indebtedness and
Restrictive Covenants."

The Company recently commenced distribution of propane gas in southwestern
Virginia. The Company believes that its ability to supply propane gas will
satisfy customers' desire for alternative fuel choices and will enable the
Company to expand market share by providing an alternative to natural gas in
areas where natural gas is not available. Because of shared costs and
similarities such as easily converted appliances, many natural gas utilities
provide both products to their customers. Customers often do not distinguish
between the two forms of gas when used in the home. The Company intends, in
part, to develop its propane distribution business through selective
acquisitions. In that regard, the Company acquired a portion of Blue Grass Oils
Incorporated's existing propane distribution business in Buchanan, Dickenson and
Russell Counties and in the western part of Tazewell County, Virginia in April
1997.

EXPLORATION, PRODUCTION, GATHERING AND MARKETING OPERATIONS

The Company's exploration and production operations consist of acquiring and
developing natural gas properties by acquiring mineral leases from landowners,
drilling and completing wells on the properties and building gas gathering
lines. These activities are typically organized on a joint venture basis with
third parties, with the Company acting as operator of the wells, retaining a
working interest in the project and receiving some promotional consideration.
The Company's net revenue interest in these wells typically averages 10 to 11%.

ACREAGE. The following table sets forth the gross and net acres of
developed and undeveloped natural gas mineral leases held by the Company as of
December 31, 1996. Undeveloped acreage includes leasehold interests which may
already have been classified as containing proved undeveloped reserves.

<TABLE>
<CAPTION>
DEVELOPED ACREAGE(1) UNDEVELOPED ACREAGE
------------------------------ --------------------------------
<S> <C> <C> <C> <C>
GROSS NET GROSS NET
------------- --------------- --------------- ---------------
Virginia.............................................. 11,096 3,537 2,239 2,239
West Virginia......................................... 257 21 -- --
------ ----- ----- -----
Total............................................. 11,353 3,558 2,239 2,239
------ ----- ----- -----
------ ----- ----- -----
</TABLE>

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

(1) Developed acreage is acreage assigned to producing wells for the spacing
unit of the producing formation. Developed acreage in certain of the
Company's properties that include multiple formations with different well
spacing requirements may be considered undeveloped for certain formations,
but has only been included as developed acreage in the presentation above.

GAS RESERVES. The Company has conducted an "in-house" estimate of the
Company's proved reserves, projected future production and estimated future net
revenues from production of proved reserves as of December 31, 1996. The
Company's estimates were based upon a review of production histories and other
geologic, economic, ownership and engineering data provided by the Company. In
determining the estimates of reserve quantities that are economically
recoverable, the Company used natural gas prices and estimated development and
production costs as of December 31, 1996. For further information concerning the
present value of future net revenues from the proved reserves, see Note 14 of
Notes to the Consolidated Financial Statements.

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<PAGE>
The following table sets forth gas reserve information estimated as of
December 31, 1996. The present values of estimated future net revenues
(discounted at 10% per annum) shown in the table are not intended to represent
the current market value of the proved reserves owned by the Company.

<TABLE>
<CAPTION>
PROVED RESERVES
---------------------------------------
<S> <C> <C> <C>
DEVELOPED UNDEVELOPED TOTAL
----------- --------------- ---------
Gas (MMcf)................................................................. 2,570 593 3,163
Present value of estimated future net revenues before income taxes (in
thousands)............................................................... $ 4,601 $ 1,194 $ 5,795
Present value of future net cash flow after income taxes (in thousands).... $ 2,848 $ 785 $ 3,633
</TABLE>

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 producer. The
reserve data set forth herein represent only estimates. Reserve engineering is a
subjective process of estimating underground accumulations of oil and gas that
cannot be measured in an exact way, and the accuracy of any reserve estimate is
a function of the quality of available data and of engineering and geological
interpretation and judgment and the existence of development plans. As a result,
estimates of different engineers often vary. In addition, results of drilling,
testing and production subsequent to the date of an estimate may justify
revision of such estimates. Accordingly, reserve estimates are often different
from the quantities of oil and gas that are ultimately recovered. Further, the
estimated future net revenues from proved reserves and the present value thereof
are based upon certain assumptions, including geologic success, prices (which
are higher during the heating season), future production levels and costs, that
may not prove correct over time. Predictions about prices and future production
levels are subject to great uncertainty, and the meaningfulness of such
estimates is highly dependent upon the accuracy of the assumptions upon which
they are based. Oil and gas prices have fluctuated widely in recent years. The
weighted average sales price utilized for the purposes of estimating the
Company's proved reserves and future net revenues therefrom as of December 31,
1996 was $4.23 per Mcf., which was a significantly higher price than present
prices due to seasonal changes and unusually high prices for the 1996/1997
heating season. The Company estimates that, if all other factors (including the
estimated quantities of economically recoverable reserves) were held constant, a
$0.10 per Mcf. decline in gas price from that used in the reserve reports would
reduce such present value by approximately $152,000. See "Risk
Factors--Uncertainty of Propane and Natural Gas Prices, Supplies and Demand."

PRODUCTION. All of the Company's wells produce primarily gas. The following
table sets forth the Company's gas production and sales data during the period
indicated.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
<S> <C> <C>
1996 1995
--------- ---------
Net production:
Gas (Mcf)................................................................................. 161,995 160,798
Average sales price per unit:
Gas (Mcf)................................................................................. $ 2.53 $ 1.47
Average net production cost ($/Mcf)....................................................... $ 0.22 $ 0.20
</TABLE>

The Company owned interests in 85 gross (21 net) natural gas wells as of
December 31, 1996. A well is categorized under state reporting regulations as an
oil well or a gas well based upon the ratio of gas to oil produced when it first
commenced production, and such designation may not be indicative of current
production.

DRILLING ACTIVITY. The Company has not drilled or completed any wells since
1994.

25
<PAGE>
OIL FIELD SERVICE OPERATIONS. The Company engages in the business of
supervising drilling operations and operating producing wells. As of December
31, 1996 the Company operated 80 wells located in Virginia and West Virginia. As
operator of producing wells, the Company is responsible for the maintenance and
verification of all production records, contracting for gas sales, distribution
of production proceeds and information, and compliance with various state and
federal regulations. Generally, the Company provides the routine day-to-day
production operations for producing wells and is paid for such services on a per
well, monthly fee basis.

GAS GATHERING OPERATIONS. The Early Grove Affiliate and the Company operate
various unregulated gas gathering systems located mainly in Dickenson and
Buchanan Counties in Virginia which connect the Company's operated wells to
interstate pipelines. The gathering systems consist of 102.6 miles of pipeline,
two 640 horsepower compressor stations and one 120 horsepower compressor
station. The gathering systems connect the Company's gas production to the ETNG,
CNG and TCO interstate pipeline systems as well as to the Distribution
Affiliate's distribution system. Total 1996 throughput for the Company's
gathering systems was 1.67 Bcf.

For such gas gathering services, the Company collects certain transportation
allowances from producers (owners of natural gas). Transportation allowances
vary depending upon contractual arrangements and currently range from $0.05 to
$0.50 per MMBtu.

MARKETING. In 1997 the Company commenced marketing operations of natural
gas. The Company currently markets and sells natural gas provided from
Company-operated wells and facilities. The Company anticipates that future
expansion of its marketing operations will include purchases of natural gas
supplies from third party sources, storing these supplies in its Saltville
Facility and marketing these supplies to its customers.

COMPETITION

The Company competes with major utility companies and pipeline companies in
the areas of utility services and pipeline operations. The deregulation of the
natural gas industry has provided the Company with marketing and transportation
opportunities; however, other pipeline companies, marketers and brokers with
resources far greater than the Company likewise are the beneficiaries of such
deregulation. While the Company and the Early Grove Affiliate currently own and
operate the only underground natural gas storage facilities in Virginia, it is
possible that other distribution and marketing companies could develop other
underground natural gas storage facilities and companies could rely on other
methods of storage such as above-ground stored liquefied natural gas. The
Company competes in the areas of exploration, production, transportation and
marketing of natural gas and distribution of propane with major oil companies,
other independent oil and gas concerns and individual producers and operators.
Many of the Company's competitors have substantially greater financial and other
resources than the Company.

REGULATION

VSCC REGULATION. The Company's and its Early Grove Affiliate's storage
operations are regulated primarily by the VSCC and the FERC, which has
jurisdiction over interstate sales of storage services. Storage rates are
subject to VSCC approval and are based on the cost of service of the facility,
which provide for an approved rate of return. A facility can apply for revised
rates based on actual costs if they are higher than previously anticipated and
conversely the VSCC may require a reduction in rates if returns are higher than
anticipated. Management believes that the rates currently in effect are adequate
to cover the cost of service and achieve the desired rate of return.

The Company's non-gathering pipeline operations will also be regulated by
the VSCC. In January 1997, the Company filed an application for a CPCN to
operate one of the pipelines. The Company has also filed with the VSCC proposed
transportation rates on the basis of revenues, expenses and investments.

26
<PAGE>
Substantially all of the operations conducted through these pipelines would
constitute common carrier pipeline activities. Such common carrier activities
are those under which transportation in the pipeline is available at tariff
rates published with the VSCC to any shipper of natural gas who requests such
services, provided that each product for which transportation is requested
satisfies the conditions and specifications for transportation.

The distribution operations of the Distribution Affiliate are also regulated
by the VSCC, which regulates the rates which may be charged to end-users,
setting them at levels sufficient to recover the cost of service to its
customers including an approved rate of return. Management believes the rates
currently in effect are adequate to cover the cost of service and achieve the
desired rate of return.

The Company's gathering facilities and propane distribution operations are
not subject to service or rate regulation from the VSCC.

FERC REGULATION. The Company's operations either are not governed by, or by
virtue of limited jurisdiction certificates having been issued by FERC, are
exempt from, further regulation by FERC under the Natural Gas Act.

ENVIRONMENTAL AND SAFETY REGULATION. The pipeline operations of the Company
are subject to various federal, state and local environmental laws. In
particular, operations in Virginia are subject to the Virginia Clean Air Act as
administered by the Virginia Department of Environmental Quality ("VDEQ"). The
Virginia Clean Air Act restricts emissions from wells, pipelines and processing
plants, and the VDEQ may curtail operations not meeting minimum standards. The
design, construction, operation and maintenance of the Company's jurisdictional
gas pipeline facilities are subject to the safety regulations established by the
United States Department of Transportation pursuant to the Natural Gas Pipeline
Safety Act of 1968, as amended, or by state agency regulations meeting the
requirements thereunder. The Company is also subject to other federal, state and
local laws covering the handling or discharge into the environment of materials
used by the Company, or otherwise relating to protection of the environment,
safety and health.

Expenditures for environmental control facilities and for remediation have
not been significant in relation to the results of operations of the Company.
The Company believes, however, that it is reasonably likely that the trend in
environmental legislation and regulations will continue to be toward stricter
standards. The Company is unaware of future environmental standards that are
reasonably likely to be adopted that will have a material effect on the
Company's results of operations, but there can be no assurance such standards
will not be adopted in the future.

The Company has designated an officer whose responsibility is to monitor
environmental compliance and potential environmental liabilities at its
facilities. No assessment has found any material environmental noncompliance or
cleanup liabilities the cost of which would have, in the aggregate, a material
effect on the Company's results of operations. However, assessments have not
been performed on all of the Company's facilities.

TITLE TO PROPERTIES

The Company's producing property interests are held primarily by leases from
third parties. The Company has obtained title opinions on substantially all of
its producing properties and believes that it has satisfactory title to such
properties in accordance with standards generally accepted in the natural gas
industry. The Company's producing properties are subject to customary royalty
interests, liens for current taxes and other burdens which the Company believes
do not materially interfere with the use of or affect the value of such
producing properties.

Substantially all of the properties comprising the Early Grove Facility and
the Saltville Facility are situated on land not owned by the Early Grove
Affiliate or the Company.

The Early Grove Affiliate's rights to develop and operate the Early Grove
Facility are derived from its ownership of mineral leasehold rights and from
surface easements.

27
<PAGE>
The Company's rights to develop and operate the Saltville Facility are
derived from a deed from the Industrial Development Authority of the town of
Saltville. The deed provides the Company with rights to store gas, rights to use
any facilities and surface area for natural gas storage use and rights to remove
salts to create cavities for natural gas storage. The deed encompasses
approximately 11,000 acres of storage rights in Washington and Smyth Counties,
Virginia.

The Company's existing pipelines, and gathering systems and distribution
systems are situated on land not owned by the Company but as to which the
Company and its Affiliates have easements from the landowners permitting the use
of such land for the construction and operation of pipeline facilities. The
Company has received or intends to receive franchises, easements, licenses,
permits and other authorizations to construct and operate proposed or future
pipelines, gathering systems and distribution systems within the jurisdiction of
various cities, counties and other government agencies and jurisdictions, as
well as along and across waterways and rights-of-way for federal, state, county
and city highways, streets and roads.

Substantially all of the Company's producing property interests are held
pursuant to leases from third parties. The Company has obtained title opinions
on substantially all of its producing properties and believes that it has
satisfactory title to such properties in accordance with standards generally
accepted in the natural gas industry. The Company's producing properties are
subject to customary royalty interests, liens for current taxes and other
burdens which the Company believes do not materially interfere with the use of
or affect the value of such producing properties.

OPERATIONAL HAZARDS AND INSURANCE

The operations of the Company and its Affiliates are subject to the usual
hazards incident to the storage, distribution, exploration for and production of
natural gas and the distribution of propane. These hazards can result in
substantial losses to the Company and its Affiliates due to personal injury and
loss of life, severe damage to and destruction of property and equipment,
pollution or environmental damage or suspension of operations. The Company and
its Affiliates maintain insurance coverage against such risks as are customarily
insured against by other businesses in the industry. For the Company, these
coverages include $2,000,000 ($1,000,000 per occurrence) of general liability
insurance (which insurance is provided in separate policies covering separate
operations), excess liability insurance in the amount of $25,000,000, workers'
compensation insurance and property and automobile insurance. Based on loss
experience, the Company believes that it and its Affiliates currently have
adequate insurance coverage. Their insurance, however, does not cover every
potential risk associated with the storage, distribution, drilling and
production of natural gas and the distribution of propane. In particular,
coverage is not obtainable for certain types of environmental hazards. The
occurrence of a significant adverse event, the risks of which are not fully
covered by insurance, would have a material adverse effect on the results of
operations of the Company. Moreover, no assurance can be given that the Company
and its Affiliates will be able to maintain adequate insurance in the future at
rates it considers reasonable.

LITIGATION

There is no pending nor, to the knowledge of the Company, any contemplated
litigation against the Company or its Affiliates which could have a material
adverse effect on their financial position or which is considered other than
routine litigation incidental to the Company's business.

OFFICE FACILITIES

The Company currently owns its headquarters office building in Abingdon,
Virginia, subject to a mortgage. This building contains 1,927 square feet of
office space. In addition, the Company leases 5,700 square feet of office space
in a building adjacent to its headquarters building.

EMPLOYEES

As of June 30, 1997, the Company employed 44 persons on a full time basis,
none of whom is covered by a collective bargaining agreement. The Company
considers its relations with its employees to be excellent.

28
<PAGE>
MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The executive officers and directors of the Company are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------------------------- --- --------------------------------------------------------------
<S> <C> <C>
Michael L. Edwards.......................... 44 Chairman of the Board and President
Karen K. Edwards............................ 39 Vice President, Secretary, Treasurer and Director
Frank A. Merendino, Jr...................... 36 Vice President of Operations
John D. Jessee.............................. 36 Vice President and Chief Financial Officer
Mark N. Witt................................ 38 Vice President of Strategic Planning
Allan R. Poole, II.......................... 50 Vice President and Director
Stacey D. Varney............................ 24 Vice President and Assistant Secretary
Peter C. Einselen........................... 57 Director
Charles A. Mills, III....................... 50 Director
</TABLE>

MICHAEL L. EDWARDS. Mr. Edwards has served as President and Chairman of the
Board of the Company since its formation in 1987. His term as a director expires
in 1999. Mr. Edwards also serves as President of each of the Company's
subsidiaries and its Affiliates. From 1983 to 1986 he served as Executive Vice
President and Director of Petroleum Development Corporation. Mr. Edwards is the
husband of Karen K. Edwards.

KAREN K. EDWARDS. Ms. Edwards has served as Vice President, Secretary,
Treasurer and Director of the Company since its formation in 1987. Her term as a
director expires in 1998. Ms. Edwards also serves as Vice President and
Secretary of each of the Company's subsidiaries and its Affiliates. She is the
wife of Michael L. Edwards.

FRANK A. MERENDINO, JR. Mr. Merendino has served as Vice President of
Operations of the Company since 1991. He was employed by the Company as
Engineering Manager in 1990. Mr. Merendino was employed as a production engineer
by Equitable Resources Exploration from 1986 to 1990. He was employed from 1984
to 1986 as a petroleum engineer by Doran & Associates.

JOHN D. JESSEE. Mr. Jessee has served as Vice President and Chief Financial
Officer of the Company since 1995. He was employed by Eastman Chemical Company
from 1994 to 1995. Mr. Jessee was employed by the Company as controller from
1992 to 1994. He was employed as controller of the golf division of The United
Company from 1989 to 1992. He was employed by Price Waterhouse from 1984 to
1989.

MARK N. WITT. Mr. Witt has served as Vice President of Strategic Planning
since 1994. He also served as Director of the Company from 1994 to May 1996.
From 1984 to 1994 Mr. Witt was employed as financial controller for global gas
for British Petroleum Co., PLC. From 1980 to 1984 he was employed by KPMG Peat
Marwick in Houston, Texas.

ALLAN R. POOLE, II. Mr. Poole has served as Vice President of the Company
since April 1996 and as a Director since September 1996. His term as a director
expires in 1998. Mr. Poole served as Vice President of Penn Virginia Resources
Corporation from 1989 to 1995. From 1978 to 1989 he was employed as regional
manager of Cabot Oil & Gas Corporation. Mr. Poole was employed as a senior
landman by Consolidated Gas Supply Corporation from 1971 to 1978.

STACEY D. VARNEY. Ms. Varney was recently appointed Vice President and has
served as Assistant Secretary of the Company since October 1996. In May 1995 she
joined the Company as Marketing Manager. Before joining the Company, she
graduated from Clinch Valley College of the University of Virginia and was
employed by Penn Virginia Oil and Gas Corporation in 1994 as an accountant.

29
<PAGE>
PETER C. EINSELEN. Mr. Einselen has served as a director of the Company
since May 1996. His term as director expires in 2000. Mr. Einselen has served as
Senior Vice President of Anderson & Strudwick Incorporated since 1990. From 1983
to 1990, he was employed by Scott & Stringfellow, Incorporated, Richmond,
Virginia.

CHARLES A. MILLS, III. Mr. Mills has served as a Director of the Company
since September 1996 and has been employed by Anderson & Strudwick Incorporated
as a Senior Vice President since 1986. He served as Chairman of the Board of
Anderson & Strudwick Incorporated from 1990 to 1992 and from 1994 to the
present. His term as a director of the Company expires in 2000. He has served as
a director of Humphrey Hospitality Trust, Inc. since 1994.

Directors of the Company receive $2,500 for attending each quarterly Board
of Directors meeting. The executive officers of the Company are elected annually
by the Board of Directors. The executive officers serve terms of one year or
until their resignation or removal.

The bylaws of the Company provide that the Board of Directors shall be
comprised of five persons divided into three classes of directors, with each
class serving staggered three year terms. The by laws may only be amended with
the approval of holders of 75% of the outstanding shares of stock of the
Company. The classification of the directors makes it more difficult for
shareholders to change the composition of the Board of Directors. The Company
believes, however, that the longer time required to elect a majority of a
classified board of directors will help ensure continuity and stability of the
Company's management and policies.

The classification provisions may also have the effect of discouraging a
third-party from accumulating large blocks of the Common Stock of the Company or
attempting to obtain control of the Company, even though such an attempt might
be beneficial to the Company and its shareholders. Accordingly, shareholders
could be deprived of certain opportunities to sell their shares of Common Stock
at a higher market price than might otherwise be the case. See "Description of
Securities--Certain Provisions of Certificate of Incorporation and Delaware
Law."

Pursuant to a Shareholders' Agreement and Voting Trust entered into on May
31, 1996, between Michael L. Edwards, Karen K. Edwards and Dr. James T. Martin,
these shareholders assigned all of their shares to Michael L. Edwards as trustee
for a period of five years. Mr. Edwards is directed in the agreement to vote
these shares for three nominees for director selected by Mr. Edwards and two
nominees selected by Dr. Martin. Pursuant to this agreement Peter C. Einselen,
Senior Vice President of Anderson & Strudwick Incorporated, was elected as Dr.
Martin's nominee for director. Pursuant to this agreement, the Edwards' nominee,
Allan R. Poole, II, and Dr. Martin's nominee, Charles A. Mills, III, a Senior
Vice President and Chairman of the Board of Anderson & Strudwick Incorporated,
were each elected to serve as directors.

Anderson & Strudwick Incorporated received a fee of $348,028 as a result of
the sale of the Company's Common Stock to Dr. Martin and has underwritten four
tax exempt bond offerings through which the Company has borrowed $20,100,000. It
receives a fee equal to 0.125% of the outstanding principal amount of the bonds
for bondholder services. Anderson & Strudwick Incorporated received commissions
totaling $610,375 from the two bond offerings which closed during the last two
years. In addition Anderson & Strudwick Incorporated served as underwriter for
the Company's initial public offering of its Common Stock in 1996 for which it
received fees of $735,840 and warrants exercisable for 153,300 shares at an
exercise price of $9.90 per share, which are subject to a shelf registration
statement.

LIMITATION OF LIABILITY AND INDEMNIFICATION

As permitted by the Delaware General Corporation Law, the Company's
Certificate of Incorporation provides that, to the fullest extent permitted by
the Delaware General Corporation Law, no director shall be personally liable to
the Company or its shareholders for monetary damages for the breach of fiduciary

30
<PAGE>
duty in such capacity, except that liability is not eliminated (i) for breach of
the director's duty of loyalty to the Company or its shareholders, (ii) for acts
or omissions by the director not in good faith or which involve intentional
misconduct or a knowing violation of law, (iii) for willful or negligent
declaration of an unlawful dividend, stock purchase or redemption, or (iv) for
any transaction from which such director received an improper personal benefit.
In addition, the Company's bylaws provide generally for indemnification by the
Company for all officers, directors, employees or agents to the fullest extent
permitted by Delaware law.

The Company has been advised that insofar as any of the foregoing provisions
may be invoked to disclaim liability for damages arising under the Securities
Act of 1933, as amended (the "Act"), it is the opinion of the Securities and
Exchange Commission that such provision is against public policy as expressed in
the Act and is therefore unenforceable.

EXECUTIVE COMPENSATION

The following table presents information concerning the annual and long-term
compensation of the executive officers whose salary and bonus were greater than
$100,000 in 1996. This table presents compensation for services rendered in all
capacities to the Company in 1996, 1995 and 1994.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
NAME AND ALL OTHER
PRINCIPAL POSITION YEAR SALARY(1) BONUS(1) COMPENSATION(2)
- ----------------------------------------------------- --------- ---------- --------- -----------------
<S> <C> <C> <C> <C>
Michael L. Edwards................................... 1996 $ 150,000 $ 50,727 $ 2,889
President and Chief Executive Officer 1995 150,000 -- 1,524
1994 102,086 20,661 3,000

Frank A. Merendino, Jr............................... 1996 82,500 26,429 6,496
Vice President of Operations 1995 82,500 16,382 422
1994 75,000 8,728 1,174

John D. Jessee....................................... 1996 82,500 25,628 7,074
Vice President and Chief Financial Officer 1995 31,250 -- --
1994 34,567 7,312 --
</TABLE>

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

(1) Amounts include cash compensation earned and received by the named officers
as well as amounts deferred under a 401(k) Savings Plan.

(2) Amounts shown include Company contributions to a 401(k) Savings Plan,
vehicle allowances and directors' fees.

EMPLOYMENT AGREEMENT

On May 23, 1996, the Company entered into a ten-year employment agreement
with Michael L. Edwards which provides for an annual salary of $155,000. Mr.
Edwards will also receive annual bonuses computed on the basis of 10% of the
Company's pre-tax earnings on all amounts from $1,000,000 to $1,999,999 and 15%
of the Company's pre-tax earnings on all amounts in excess of $2,000,000,
provided his bonus for 1996 was $50,000. Payment of this bonus has been
deferred. In the event Mr. Edwards' employment is terminated by the Company for
any reason other than for cause during the term of the employment agreement, at
the election of Mr. Edwards the Company will be obligated to purchase all or a
portion of the shares held by him and/or his wife at a price equal to 150% of
the market value of the Company's shares on the date of termination. In
addition, the Company will be obligated to pay Mr. Edwards in a lump sum all
salary amounts payable to Mr. Edwards through the term of the employment
agreement plus an additional $2,000,000.

31
<PAGE>
EMPLOYEE BENEFIT PLANS

The Company sponsors a qualified tax deferred savings plan in accordance
with the provisions of Section 401(k) of the Internal Revenue Code. Employees
may defer up to 20% of their compensation, subject to certain limitations.
Effective July 1, 1996, the Company matches 100% of permitted employee
contributions.

EMPLOYEE STOCK PURCHASE LOANS

On May 17, 1996, the Board of Directors of the Company approved a plan
whereby the Company made available to certain key employees five year
interest-free loans for the purpose of purchasing a total of 40,000 shares of
the Company's Common Stock at a purchase price of $6.00 per share, which was the
fair market value of the shares on that date. In the event an employee who has
been given a loan pursuant to this plan terminates his employment with the
Company at any time prior to the due date of the loan, the loan is then
immediately due and payable, with interest from the date of the loan at prime
rate plus 2%, compounded monthly. All certificates for shares issued under this
plan to a key employee shall be held by the Company as security until the loan
is paid in full. On July 31, 1996, the Company made a loan of $90,000 to Michael
L. and Karen K. Edwards to purchase 15,000 shares and $90,000 to Allan R. Poole
II, to purchase 15,000 shares.

KEY MAN INSURANCE

The Company maintains a key man life insurance policy in the amount of
$2,000,000 on the life of Michael L. Edwards. The Company is the beneficiary of
this policy.

32
<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth the number and percentage of shares of Common
Stock held beneficially by the owners of more than five percent of the Company's
issued and outstanding Common Stock as of June 30, 1997 or by directors or
officers of the Company:

<TABLE>
<CAPTION>
NAME AND ADDRESS OF AMOUNT OF
BENEFICIAL OWNER OWNERSHIP PERCENT OF CLASS
- ------------------------------------------------------------------------------------- ----------- -----------------
<S> <C> <C>
Dr. James T. Martin.................................................................. 800,058 19.41%
Tupenny House
Tuckerstown, Bermuda

Michael L. and Karen K. Edwards...................................................... 746,226(1) 18.10%
200 East Main Street
Abingdon, Virginia 24210

Michael L. Edwards................................................................... 3,600 0.09%
200 East Main Street
Abingdon, Virginia 24210

Frank A. Merendino, Jr. ............................................................. 38,742(2) 0.94%
135 Douglas Lane
Bristol, Tennessee 37620

Mark N. Witt......................................................................... 136,316(3) 3.31%
288 Clubhouse Drive
Abingdon, Virginia 24211

John D. Jessee....................................................................... 4,200 0.10%
152 Kennedy Drive
Lebanon, Virginia 24266

Allan R. Poole, II................................................................... 57,000 1.38%
1032 Hanover Court
Kingsport, Tennessee 37660

Peter C. Einselen.................................................................... 5,000 0.12%
1 King Street
St. Augustine, Florida 32084

Charles A. Mills, III................................................................ 2,000 0.05%
3 Commercial Place, Suite 100
Norfolk Southern Tower
Norfolk, Virginia 23510

Includes all executive officers and directors as a group............................. 993,084 24.09%
</TABLE>

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

(1) Includes 363,663 shares which may be issued to Mr. and Mrs. Edwards upon
exercise of a warrant.

(2) Includes 8,371 shares which may be issued to Mr. Merendino upon exercise of
a warrant.

(3) Includes 127,920 shares which may be issued to Mr. Witt upon exercise of an
option.

33
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of the Offering, the Company will have 5,204,906 shares of
Common Stock outstanding (5,504,906 shares if the Underwriters' over-allotment
option is exercised in full). The 2,000,000 shares sold in this Offering
(2,300,000 shares if the Underwriters' over-allotment option is exercised in
full) will be freely transferable without restriction, unless purchased by
persons deemed to be "affiliates" of the Company (as that term is defined under
the Securities Act). Substantially all of the remaining 3,204,906 shares of
Common Stock outstanding immediately following the Offering will be transferable
without restriction, except for approximately 1,293,188 shares owned by persons
deemed to be affiliates of the Company (as that term is defined under the
Securities Act) which will be subject to certain volume restrictions under Rule
144 under the Securities Act. A total of 943,149 shares are issuable upon
exercise of warrants at an exercise price of $9.90 per share registered pursuant
to a currently effective shelf registration (the "Registered Warrants").
Warrants representing 789,849 shares are exercisable commencing August 3, 1997.
Warrants representing 153,300 are exercisable on October 4, 1997. An additional
247,920 shares of Common Stock are issuable pursuant to the exercise of options,
of which options for 127,920 shares are presently exercisable.

In general, under Rule 144, as recently amended, a person (or persons whose
shares are aggregated) including an affiliate, who has beneficially owned his
shares for one year, may sell in the open market within any three-month period a
number of shares that does not exceed the greater of (i) 1% of the then
outstanding shares of the Company's Common Stock (approximately 5,200 shares
immediately after this Offering, or 5,500 if the Underwriters' over-allotment
option is exercised in full) or (ii) the average weekly trading volume in the
Common Stock on the Nasdaq during the four calendar weeks preceding such sale.
Sales under Rule 144 are also subject to certain limitations on the manner of
sale, notice requirements and availability of current public information about
the Company. A person (or persons whose shares are aggregated) who is deemed not
to have been an "affiliate" of the Company at any time during the 90 days
preceding a sale by such person and who has beneficially owned his shares for at
least two years, will be able to sell such shares in the public market under
Rule 144(k) without regard to the volume limitations, manner of sale provisions,
notice requirements or availability of current information referred to above.
Restricted shares properly sold in reliance upon Rule 144 are thereafter freely
tradable without restrictions or registration under the Securities Act, unless
thereafter held by an "affiliate" of the Company.

The Company's executive officers and directors and certain stockholders of
the Company who collectively own an aggregate of 1,293,188 shares of Common
Stock have agreed that they will not, directly or indirectly, offer, sell,
contract to sell, make a short sale, pledge or otherwise dispose of any shares
of Common Stock (or any securities convertible into or exchangeable or
exercisable for any other rights to purchase or acquire Common Stock) for a
period of 180 days after the date of this Prospectus, without the prior written
consent of Ferris, Baker Watts, Incorporated.

The Company has agreed that for a period of 180 days following the date of
this Prospectus it will not, without the prior written consent of Ferris, Baker
Watts, Incorporated, directly or indirectly, issue, offer, sell, offer to sell,
contract to sell, grant any option to purchase, pledge or otherwise dispose (or
announce any such issuance, offer, sale, offer of sale, contract of sale, grant
of any option to purchase, pledge or other dispostion) any shares of Common
Stock or any other equity securities of the Company except for the shares of
Common Stock offered hereby and shares issued pursuant to the exercise of
options or warrants outstanding on the date hereof.

After the 180-day period, the shares of Common Stock subject to the
restriction will be eligible for sale in the public market.

34
<PAGE>
DESCRIPTION OF SECURITIES

COMMON STOCK

The Company has authorized 10,000,000 shares of Common Stock, par value
$.001 per share. As of June 30, 1997 there were 3,204,906 shares of Common Stock
issued and outstanding. In addition, options and warrants for 1,191,069 shares
are currently outstanding. The holders of Common Stock are entitled to one vote
per share and to share ratably on a share for share basis with respect to any
dividends when, as and if declared by the Board of Directors out of legally
available funds. See "Dividend Policy." Upon the liquidation, dissolution or
winding up of the Company, whether voluntary or involuntary, holders of Common
Stock are entitled to share ratably, after payment of liabilities and the
liquidation preference of any then outstanding Preferred Stock. Holders of
Common Stock have no preemptive rights, except those rights granted to certain
option and warrant holders, and no right to convert their Common Stock into any
other securities. There are no redemption or sinking fund provisions applicable
to the Common Stock. All outstanding shares of Common Stock are, and all shares
of Common Stock offered hereby will be, fully paid and nonassessable.

SHAREHOLDERS' AGREEMENT AND VOTING TRUST

A Shareholders' Agreement and Voting Trust (the "Voting Trust Agreement")
was entered into effective May 31, 1996, by the Company, Michael L. Edwards,
Karen K. Edwards and Dr. James T. Martin. Simultaneous with the execution of his
subscription for 800,058 shares of the Company's Common Stock, Dr. Martin
executed the Voting Trust Agreement providing for the delivery of his shares
along with those of Mr. and Ms. Edwards to Mr. Edwards as trustee for a period
of five years from the date of assignment. The Voting Trust Agreement provides
that Mr. Edwards as trustee must vote the shares at all meetings of the
Company's shareholders in favor of the election of two nominees to the Board of
Directors selected by Dr. Martin and three nominees to the Board of Directors
selected by Mr. Edwards. The withdrawal of the Common Stock pursuant to the
Voting Trust Agreement may only be accomplished by unanimous agreement of the
parties. The beneficial ownership of the shares underlying the Voting Trust
Agreement is assignable. Dividends payable on the underlying shares are
distributable by the trustee to the shareholders. If Dr. Martin decides to sell
5% or more of the outstanding shares of the Company held by him to a third
party, he must first give notice to the Company and offer the Company the right
to purchase the shares pursuant to a right of first refusal. If a purchaser
acquires 10% or more of the shares held by Dr. Martin, such purchaser must
become a party to the Voting Trust Agreement.

PREFERRED STOCK

The Company has authorized 2,000 shares of Preferred Stock, no par value,
none of which is issued and outstanding.

CERTAIN PROVISIONS OF CERTIFICATE OF INCORPORATION AND DELAWARE LAW

The Company's Amended and Restated Certificate of Incorporation (the
"Certificate") contains certain provisions that may have the effect of delaying,
deferring or preventing a change of control of the Company. Specifically, the
Certificate provides that to effect: (i) any amendment to the Certificate or the
bylaws; (ii) a merger, dissolution, reorganization (including by share exchange)
or recapitalization of the Company; or (iii) a sale of all or substantially all
of the assets of the Company, the stockholders of the Company must approve the
transaction by an affirmative vote of the holders of 75% of the Company's
capital stock entitled to vote thereon. This increases the percentage that would
otherwise be required under Delaware law to approve such actions, and thus may
make it more difficult to effect a takeover of the Company. Further, the
Company's by laws provides that members of the Company's Board of Directors are
elected to terms that are staggered.

35
<PAGE>
The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203"), which subject to certain exceptions, prohibits a Delaware
corporation from engaging in any business combination with any interested
shareholder for a period of three years after that person became an interested
shareholder, unless: (i) prior to such time, the board of directors of the
corporation approved either the business combination or the transaction which
resulted in the shareholder becoming an interested shareholder; (ii) upon
consummation of the transaction which resulted in the shareholder becoming an
interested shareholder, the interested shareholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced, excluding for purposes of determining the number of shares
outstanding those shares owned (x) by persons who are directors and also
officers and (y) by employee stock plans in which employee participants do not
have the right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or (iii) on or subsequent
to such date, the business combination is approved by the board of directors and
authorized at an annual or special meeting of shareholders, and not by written
consent, by the affirmative vote of at least 66 2/3 % of the outstanding voting
stock which is not owned by the interested shareholder.

Section 203 defines business combination to include: (i) any merger or
consolidation involving the corporation and the interested shareholder; (ii) any
sale, transfer, pledge or other disposition involving the interested shareholder
of 10% or more of the assets of the corporation; (iii) subject to certain
exceptions, any transaction which results in the issuance or transfer by the
corporation of any stock of the corporation to the interested shareholder
(except proportionately as a shareholder); (iv) any transaction involving the
corporation which has the effect of materially increasing the proportionate
share of the stock of any class or series of the corporation beneficially owned
by the interested shareholder; or (v) the receipt by the interested shareholder
of the benefit of any loans, advances, guarantees, pledges or other financial
benefits provided by or through the corporation. In general, Section 203 defines
an interested shareholder as any entity or person beneficially owning 15% or
more of the outstanding voting stock of the corporation and any entity or person
affiliated with or controlling or controlled by such entity or person.

TRANSFER AGENT AND REGISTRAR

The Transfer Agent and Registrar for the Common Stock is First Union
National Bank of North Carolina, Charlotte, North Carolina.

36
<PAGE>
UNDERWRITING

Subject to the terms and conditions set forth in the Underwriting Agreement,
the form of which is filed as an exhibit to the Registration Statement of which
this Prospectus forms a part (the "Underwriting Agreement"), the Company has
agreed to sell the number of shares of Common Stock to Ferris, Baker Watts,
Incorporated (the "Underwriter"), and the Underwriter has agreed to purchase the
aggregate number of shares of Common Stock set forth opposite its name below.

<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
- --------------------------------------------------------------------------- -----------------
<S> <C>
Ferris, Baker Watts, Incorporated..........................................

-----------------
Total.................................................................... 2,000,000
-----------------
-----------------
</TABLE>

The nature of the Underwriter's obligations under the Underwriting Agreement
is such that all shares of Common Stock offered hereby, excluding shares covered
by the over-allotment option granted to the Underwriter, must be purchased if
any are purchased. The Underwriting Agreement provides that the obligations of
the Underwriter to pay for and accept delivery of the shares of Common Stock
offered hereby are subject to the approval of certain legal matters by counsel
and to certain other conditions.

The Company has been advised by the Underwriter that the Underwriter
proposes to offer the shares of Common Stock to the public at the public
offering price set forth on the cover page of this Prospectus, and to certain
dealers at such public offering price less a selling concession not in excess of
$ per share. The Underwriter may allow, and such dealers may reallow, a
concession not in excess of $ per share to certain other underwriters or
to certain other brokers or dealers.

The Company has granted the Underwriter an option, exercisable within 30
days after the date of this Prospectus, to purchase up to an additional 300,000
shares of Common Stock to cover over- allotments, at the same price per share to
be paid by the Underwriter for the other shares offered hereby. The Underwriter
may purchase such shares only to cover over-allotments, if any, in connection
with the Offering made hereby.

The executive officers, directors and certain stockholders of the Company
have agreed that they will not offer, sell, contract to sell or grant an option
to purchase or otherwise dispose of any shares of Common Stock, options to
acquire shares of Common Stock or any securities exercisable for or convertible
into Common Stock owned by them, in the open market, for a period of 180 days
from the date of this Prospectus, without the prior written consent of the
Underwriter. The Company has agreed not to offer, sell or issue any shares of
Common Stock, options to acquire Common Stock or securities exercisable for or
convertible into shares of Common Stock for a period of 180 days after the date
of this Prospectus, without the prior written consent of the Underwriter, except
that the Company may issue securities upon the exercise of all outstanding stock
options and warrants.

The Company and the Underwriter have agreed to indemnify each other against
certain liabilities, including liabilities under the Securities Act, which may
arise out of or be based upon any untrue statement or alleged untrue statement
of any material fact made by the indemnifying party and contained in this
Prospectus, the Registration Statement, any supplement or amendment thereto, or
any documents filed with state securities authorities, or any omission or
alleged omission of the indemnifying party to state a material fact required to
be stated in any such document or required to make the statements in any such
document, in light of the circumstances in which they are made, not misleading.

The Underwriter intends to make a market in the securities of the Company,
as permitted by applicable laws and regulations. The Underwriter, however, is
not obligated to make a market in such securities and any such market making may
be discontinued at any time at the sole discretion of the Underwriter.

37
<PAGE>
The Underwriter has informed the Company that it does not intend to confirm
any sales to accounts over which they exercise discretionary authority.

The Company has agreed to pay to the Underwriter a non-accountable expense
allowance equal to one percent of the gross offering proceeds.

LEGAL MATTERS

The validity of the issuance of the shares of Common Stock offered hereby
will be passed upon for the Company by Bright & Barnes, a Professional
Corporation, Oklahoma City, Oklahoma. Venable, Baetjer, Howard & Civiletti LLP,
Washington, D.C. has acted as counsel for the Underwriter with respect to
certain legal matters relating to the Common Stock offered hereby.

EXPERTS

The financial statements of the Company, and the financial statements of
Virginia Gas Storage Company and Virginia Gas Distribution Company, as of
December 31, 1996, and for each of the two years in the period then ended,
included in this Prospectus have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their reports with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in giving said reports.

OTHER MATTERS

In January 1996 the Company retained Arthur Andersen LLP as its independent
public accountants. Another auditor had served in this capacity since 1992.
There were no disagreements with the former auditors on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedures at the time of the change or with respect to the Company's financial
statements which, if not resolved to the former auditors' satisfaction, would
have caused them to make reference to the subject matter of the disagreement in
connection with their reports. The former auditors' reports did not contain an
adverse opinion or disclaimer of opinion and were not modified as to
uncertainty, audit scope or accounting principles. Prior to retaining Arthur
Andersen LLP, the Company had not consulted with Arthur Andersen LLP regarding
accounting principles.

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports and other information with the Securities and Exchange
Commission (the "Commission" or "SEC"). Such reports, proxy and other
information filed by the Company may be inspected and copied at the public
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Judiciary Plaza, Washington, D.C. 20549, and at the public reference facilities
maintained by the commission at Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661; and 7 World Trade Center, Suite 1300, New York,
New York 10048. Copies of such materials may also be obtained at prescribed
rates from the Public Reference Section of the Commission at its principal
office at 450 Fifth Street, N.W., Washington, D.C. 20549. The Company's Common
Stock is listed on the Nasdaq National Market System. Documents filed by the
Company may also be inspected at the offices of the National Association of
Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.

The Company has filed with the Commission a Registration Statement on Form
SB-2 under the Act, with respect to the securities offered hereby. This
Prospectus does not contain all the information set forth in the Registration
Statement and the exhibits thereto, to which reference is hereby made.
Statements made in this Prospectus as to the contents of any contract, agreement
or other documents referred to 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

38
<PAGE>
the matter involved, and each such statement shall be deemed qualified in its
entirety by such reference. A copy of the Registration Statement, and the
exhibits and schedules thereto, may be inspected without charge at the public
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Judiciary Plaza, Washington, D.C. 20549, and at the Public Regional Office of
the Commission at 7 World Trade Center, Suite 1300, New York, New York 10048,
and copies of all or any part of the Registration Statement may be obtained from
such offices or by mail from the Public Reference Section of the Commission at
its principal office upon the payment of the fees prescribed by the Commission.

The Commission also maintains a World Wide Web site (http://www.sec.gov)
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.

GLOSSARY

BCF. Billion cubic feet.

BLOW-OUT. A sudden, violent expulsion of oil, gas, and mud (and sometimes
water) from a drilling well, followed by an uncontrolled flow from the well. It
occurs when high pressure gas is encountered in the hole and sufficient
precautions have not been taken.

BTU. British thermal unit, which is the heat required to raise the
temperature of a one-pound mass of water from 58.5 to 59.5 degrees Fahrenheit.

CASING. Heavy steel pipe used to seal off fluids from the hole or to keep
the hole from caving in. There may be several strings of casing, one inside the
other, in a single well.

DELIVERABILITY. The amount of natural gas that a pipeline or producer is
able to deliver, limited either by terms of its supply contracts or its own
plant capacity.

DTH. One decatherm. One decatherm is equal to one million British thermal
units (10 therms).

GATHERING SYSTEMS. Pipelines and other equipment, including regulators,
compressors, dehydrators and associated equipment, needed to transport natural
gas from the wells to the transmission pipeline.

GROSS. A Gross number includes all acreage or wells in which the Company
owns an interest.

INJECTION. The introduction of gas under high pressure into a geological
formation.

MMBTU. One million British thermal units.

MBTU. One thousand British thermal units.

MCF. One thousand cubic feet.

MMCF. One million cubic feet.

NET. A Net number is the Gross number multiplied by the percentage interest
which the Company has in acreage or in wells.

PRESENT VALUE. When used with respect to gas reserves, present value means
the estimated future gross revenue to be generated from the production of proved
reserves, net of estimated production and future development costs, using prices
and costs in effect as of December 31, 1996, without giving effect to
non-property related expenses such as general and administrative expenses, debt
service and future income tax expense or to depreciation, depletion and
amortization, discounted using an annual discount rate of 10%.

39
<PAGE>
PROVED DEVELOPED RESERVES. Reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods.

PROVED RESERVES. The estimated quantities of natural gas and natural gas
liquids which geological and engineering data demonstrate with reasonable
certainty to be recoverable in future years from known reservoirs under existing
economic and operating conditions.

PSI. Pounds per square inch.

SERVICE. The amount of gas necessary to fulfill customer supply contract
quantities for the periods indicated if the customer withdraws all contracted
gas at full contract amounts.

THERM. One hundred thousand British thermal units.

WORKING GAS. The portion of the storage volume that can be removed from a
storage reservoir for deliveries and still maintain pressure sufficient to meet
design deliverability.

WORKING INTEREST. The operating interest which gives the owner the right to
drill, produce and conduct operating activities on the property and a share of
production.

40
<PAGE>
The map on the inside back cover highlights the two counties, Buchanan and
Russell, in southwestern Virginia, in which the Distribution Affiliate is
certificated to provide service by the VSCC and the two adjacent counties,
Tazewell and Dickensen, as to which the Distribution Affiliate has applied for
such certification. The map depicts: (i) the Company's natural gas gathering
systems located in Dickenson and Buchanan counties; (ii) Triangles depict the
Company's natural gas compression facilities located in Dickenson, Buchanan and
Washington counties; (iii) the interstate pipelines located in the Company's
area of operations; (iv) the Company's and its affiliates natural gas storage
facilities; and (v) other companies' pipelines in relation to the Company's.

[MAP]

41
<PAGE>
FINANCIAL STATEMENTS
INDEX

<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

Report of Independent Public Accountants................................................................. F-2
Consolidated Balance Sheets.............................................................................. F-3
Consolidated Statements of Income........................................................................ F-4
Consolidated Statements of Changes in Stockholders' Equity............................................... F-5
Consolidated Statements of Cash Flows.................................................................... F-6
Notes to Consolidated Financial Statements............................................................... F-7

VIRGINIA GAS STORAGE COMPANY

Report of Independent Public Accountants................................................................. F-24
Balance Sheets........................................................................................... F-25
Statements of Income..................................................................................... F-26
Statements of Changes in Stockholders' Equity............................................................ F-27
Statements of Cash Flows................................................................................. F-28
Notes to Financial Statements............................................................................ F-29

VIRGINIA GAS DISTRIBUTION COMPANY

Report of Independent Public Accountants................................................................. F-37
Balance Sheets........................................................................................... F-38
Statements of Income..................................................................................... F-39
Statements of Changes in Stockholders' Equity............................................................ F-40
Statements of Cash Flows................................................................................. F-41
Notes to Financial Statements............................................................................ F-42
</TABLE>

F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of
Virginia Gas Company:

We have audited the accompanying consolidated balance sheet of Virginia Gas
Company and Subsidiaries as of December 31, 1996, and the related consolidated
statements of income, changes in stockholders' equity, and cash flows for the
years ended December 31, 1996 and 1995. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Virginia Gas Company and
Subsidiaries as of December 31, 1996, and the results of their operations and
their cash flows for the years ended December 31, 1996 and 1995, in conformity
with generally accepted accounting principles.

ARTHUR ANDERSEN LLP

Richmond, Virginia
March 7, 1997

F-2
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
CURRENT ASSETS:
Cash........................................................................... $ 1,526,050 $ 1,652,838
Accounts receivable............................................................ 1,659,113 1,073,276
Notes receivable............................................................... 118,779 114,556
Other current assets........................................................... 232,689 134,862
------------- -------------
Total current assets................................................... 3,536,631 2,975,532
PROPERTY AND EQUIPMENT, NET........................................................ 19,162,628 16,343,480
INVESTMENT IN AFFILIATED COMPANIES................................................. 4,374,221 4,243,020
NOTES RECEIVABLE--AFFILIATED COMPANIES............................................. 12,956,871 9,371,062
OTHER ASSETS....................................................................... 1,385,805 577,309
------------- -------------
Total assets........................................................... $ 41,416,156 $ 33,510,403
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable.................................................................. $ 1,250,000 $ 250,000
Current portion of long-term debt.............................................. 748,576 1,244,490
Accounts payable............................................................... 1,582,564 1,197,555
Funds held for future distribution............................................. 304,388 544,475
Other current liabilities...................................................... 170,452 168,709
------------- -------------
Total current liabilities.............................................. 4,055,980 3,405,229
LONG-TERM DEBT..................................................................... 21,136,694 12,137,729
DEFERRED INCOME TAXES.............................................................. 729,007 629,914
------------- -------------
Total liabilities...................................................... 25,921,681 16,172,872
------------- -------------
STOCKHOLDERS' EQUITY:
Preferred stock--No par, 2,000 shares authorized, issued and outstanding as of
December 31, 1996............................................................ -- 1,725,000
Common stock--par value $.001, 10,000,000 shares authorized, 3,204,906
(unaudited) and 3,150,744 shares issued and outstanding as of June 30, 1997
and December 31, 1996, respectively.......................................... 3,205 3,151
Additional paid-in capital..................................................... 13,751,471 14,152,137
Retained earnings.............................................................. 1,739,799 1,457,243
------------- -------------
Total stockholders' equity............................................. 15,494,475 17,337,531
------------- -------------
Total liabilities and stockholders' equity............................. $ 41,416,156 $ 33,510,403
------------- -------------
------------- -------------
</TABLE>

The accompanying notes are an integral part of these consolidated balance
sheets.

F-3
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
------------------------ --------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
------------ ---------- ------------ ------------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE:
Operating revenue.............................................. $ 3,500,537 $ 545,145 $ 1,772,970 $ 1,493,813
Interest and other income...................................... 570,413 433,763 996,748 529,597
------------ ---------- ------------ ------------
4,070,950 978,908 2,769,718 2,023,410
------------ ---------- ------------ ------------
EXPENSES:
Production expenses............................................ 100,665 43,445 105,910 65,029
Purchased gas expense.......................................... 66,113 -- 28,537 --
Operation and maintenance expense.............................. 229,203 -- 173,445 --
Cost of natural gas sold....................................... 1,635,003 -- -- --
Depreciation, depletion, and amortization...................... 373,590 129,047 387,116 305,216
General and administrative..................................... 447,430 303,087 645,673 708,191
------------ ---------- ------------ ------------
2,852,004 475,579 1,340,681 1,078,436
------------ ---------- ------------ ------------
OTHER EXPENSE:
Interest....................................................... 717,155 520,824 1,006,800 673,251
Other.......................................................... 68,039 1,146 2,771 2,752
------------ ---------- ------------ ------------
785,194 521,970 1,009,571 676,003
------------ ---------- ------------ ------------
INCOME (LOSS) BEFORE EARNINGS OF AFFILIATED COMPANIES AND INCOME
TAXES.......................................................... 433,752 (18,641) 419,466 268,971
EQUITY IN EARNINGS OF AFFILIATED COMPANIES....................... 131,201 207,942 339,927 267,484
------------ ---------- ------------ ------------
INCOME BEFORE INCOME TAXES....................................... 564,953 189,301 759,393 536,455
PROVISION (BENEFIT) FOR INCOME TAXES............................. 137,883 (17,543) 151,827 62,581
------------ ---------- ------------ ------------
NET INCOME....................................................... $ 427,070 $ 206,844 $ 607,566 $ 473,874
------------ ---------- ------------ ------------
------------ ---------- ------------ ------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS...................... $ 370,015 $ 76,844 $ 347,566 $ 428,374
------------ ---------- ------------ ------------
------------ ---------- ------------ ------------
NET INCOME PER COMMON SHARE...................................... $ 0.12 $ 0.07 $ 0.21 $ 0.62
------------ ---------- ------------ ------------
------------ ---------- ------------ ------------
</TABLE>

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

F-4
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
ADDITIONAL
PREFERRED PAID-IN
STOCK COMMON STOCK CAPITAL RETAINED EARNINGS
----------- -------------- -------------- -----------------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1994....................... $ -- $ 1,792,741 $ -- $ 925,239
Issuance of 124,316 shares of common stock
pursuant to stock option agreements.......... -- 496,000 -- --
Issuance of 2,000 shares of preferred stock and
warrants covering 54,163 shares of common
stock........................................ 1,725,000 -- 275,000 --
Net income..................................... -- -- -- 473,874
Preferred stock dividends paid................. -- -- -- (45,500)
Common stock dividends paid.................... -- -- -- (212,430)
----------- -------------- -------------- -----------------
BALANCE, December 31, 1995....................... 1,725,000 2,288,741 275,000 1,141,183
Issuance of 800,058 shares of common stock..... -- 4,401,317 -- --
Issuance of 42,000 shares of common stock...... -- 42 251,958 --
Issuance of 40,000 shares of common stock to
officers and employees, net of notes
receivable of $240,000....................... -- 40 -- --
Issuance of 1,533,000 shares of common stock... -- 1,533 7,911,657 --
Payment for cancellation of warrant and
options...................................... -- -- (975,000) --
Net income..................................... -- -- -- 607,566
Preferred stock dividends paid................. -- -- -- (260,000)
Common stock dividends paid.................... -- -- -- (31,506)
Change from no par to $.001 par value of common
stock........................................ -- (6,688,522) 6,688,522 --
----------- -------------- -------------- -----------------
BALANCE, December 31, 1996....................... 1,725,000 3,151 14,152,137 1,457,243
Preferred stock dividends paid (unaudited)..... -- -- -- (57,055)
Common stock dividends paid (unaudited)........ -- -- -- (87,459)
Net income (unaudited)......................... -- -- -- 427,070
Costs related to stock issuance (unaudited).... -- -- (125,666) --
Issuance of 54,162 shares of common stock
pursuant to exercise of warrant
(unaudited).................................. -- 54 -- --
Redemption of 2,000 shares of preferred stock
(unaudited).................................. (1,725,000) -- (275,000) --
----------- -------------- -------------- -----------------
BALANCE, June 30, 1997
(unaudited).................................... $ -- $ 3,205 $ 13,751,471 $ 1,739,799
----------- -------------- -------------- -----------------
----------- -------------- -------------- -----------------
</TABLE>

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

F-5
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
-------------------------- --------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
------------ ------------ ------------ ------------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................. $ 427,070 $ 206,844 $ 607,566 $ 473,874
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion, and amortization............ 373,590 129,047 387,116 305,216
Undistributed earnings of affiliated companies....... (131,201) (207,942) (339,927) (267,484)
Deferred income taxes................................ 99,093 (9,450) 141,596 27,693
(Increase) decrease in accounts receivable........... (585,837) 392,754 (180,903) (322,611)
(Increase) decrease in other current assets.......... (97,828) 94,754 66,720 (90,136)
Decrease in other assets............................. 84,342 6,438 20,477 78,359
Increase (decrease) in notes payable................. 1,000,000 (332,212) (332,212) 582,212
Increase (decrease) in accounts payable.............. 385,009 (850,758) (978,177) 1,692,954
(Decrease) increase in current liabilities........... (238,344) 107,108 190,145 (4,119)
------------ ------------ ------------ ------------
Net cash provided by (used in) operating
activities....................................... 1,315,894 (463,417) (417,599) 2,475,958
------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................... (3,149,551) (2,581,313) (9,803,768) (1,314,286)
Issuance of notes receivable, net...................... (3,650,000) -- -- (3,721,911)
Payments received on notes receivable.................. 59,968 62,874 128,221 16,838
Investment in joint venture............................ -- -- -- (1,016,682)
------------ ------------ ------------ ------------
Net cash used in investing activities................ (6,739,583) (2,518,439) (9,675,547) (6,036,041)
------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal.............................. (1,214,222) (2,062,281) (2,731,952) (181,222)
Proceeds from new loans................................ 9,690,632 1,042,732 1,100,000 3,750,000
Redemption of preferred stock.......................... (2,000,000) -- -- --
Proceeds from issuance of common stock, net............ (125,666) 4,401,317 12,566,547 496,000
Proceeds from issuance of preferred stock, net......... -- -- -- 1,220,000
Purchase of warrants and options....................... -- -- (975,000) --
Payment of debt issuance costs......................... (350,579) (174,663) (54,719) (382,399)
Establishment of financing reserve funds............... (558,750) -- -- (46,244)
Dividends paid......................................... (144,514) (130,000) (291,506) (257,930)
------------ ------------ ------------ ------------
Net cash provided by financing activities............ 5,296,901 3,077,105 9,613,370 4,598,205
------------ ------------ ------------ ------------
NET (DECREASE) INCREASE IN CASH.......................... (126,788) 95,249 (479,776) 1,038,122
CASH, beginning of period................................ 1,652,838 2,132,614 2,132,614 1,094,492
------------ ------------ ------------ ------------
CASH, end of period...................................... $ 1,526,050 $ 2,227,863 $ 1,652,838 $ 2,132,614
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
SUPPLEMENTAL DISCLOSURE:
Interest paid.......................................... $ 950,864 $ 684,966 $ 1,282,705 $ 656,833
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Income taxes paid...................................... $ 11,158 $ 8,658 $ 26,158 $ 95,830
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>

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

F-6
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

1. DESCRIPTION OF OPERATIONS:

Virginia Gas Company (the "Company") was organized in 1987 under the laws of
the state of Delaware. The Company, directly or through affiliated companies, is
primarily engaged in the exploration, production, marketing, gathering, storage,
and distribution of natural gas, and distribution of propane gas, principally in
the southwestern counties of the Commonwealth of Virginia.

The Company's operations are subject to certain risks and uncertainties
including, among others, the adequacy of future financing, the need for
additional capital, dependence on major customers, and current and potential
competitors with greater financial and marketing resources.

INTERIM FINANCIAL INFORMATION

The unaudited financial statements as of June 30, 1997, and for the six
months ended June 30, 1997 and 1996, include, in the opinion of management, all
adjustments (that are normal and recurring in nature) necessary to present
fairly the Company's financial position, results of operations, and cash flows.
Operating results for the six months ended June 30, 1997, are not necessarily
indicative of the results that may be expected for the year ending December 31,
1997.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements for 1996 include the accounts of three
wholly owned subsidiaries. The consolidated financial statements for 1995
include the accounts of one wholly owned subsidiary. All significant
intercompany balances and transactions have been eliminated in consolidation.

INVESTMENT IN AFFILIATED COMPANIES

The Company's investments in affiliated companies are accounted for using
the equity method. Investments carried at equity and the percentage interest
owned consist of Virginia Gas Storage Company (50 percent) and Virginia Gas
Distribution Company (50 percent).

F-7
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Combined financial information as of December 31, 1996, and for the years
ended December 31, 1996 and 1995, and as of June 30, 1997, and for the six
months ended June 30, 1997 and 1996 (unaudited), for investments in affiliated
companies accounted for by the equity method is as follows.

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Current assets..................................................................... $ 1,951,459 $ 2,386,057
Property and equipment, net........................................................ 20,327,578 16,079,543
Other assets....................................................................... 6,424,628 4,917,958
------------- -------------
$ 28,703,665 $ 23,383,558
------------- -------------
------------- -------------

Current liabilities................................................................ $ 3,343,700 $ 2,941,557
Long-term debt payable to:
Affiliated companies............................................................. 15,964,990 11,390,406
Third parties.................................................................... 9,617 13,870
Other liabilities.................................................................. 636,917 551,686
Stockholders' equity............................................................... 8,748,441 8,486,039
------------- -------------
$ 28,703,665 $ 23,383,558
------------- -------------
------------- -------------
</TABLE>
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
JUNE 30 DECEMBER 31
-------------------------- --------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
------------ ------------ ------------ ------------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues................................................. $ 2,855,579 $ 2,557,186 $ 5,008,509 $ 3,498,236
Income before income taxes............................... 397,581 630,125 1,030,079 821,876
Net income............................................... 262,402 415,884 679,853 534,968
</TABLE>

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

REVENUE RECOGNITION

The Company recognizes natural gas sales and transmission revenues upon
delivery of natural gas to the common pipeline carrier.

In January 1997, the Company's wholly owned subsidiary, Virginia Gas
Marketing Company, began marketing natural gas services. These services include
the marketing of natural gas and are later expected to include natural gas
storage services. The initial source of natural gas supply will be provided by
Company -operated wells and initial future storage services will be provided by
facilities operated by the Company and/or its affiliated companies. Revenues
attributable to the marketing operations totaled $1.8 million for the six months
ended June 30, 1997.

F-8
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
During the year ended December 31, 1995, the Company and Virginia Gas
Storage Company revised their method of recording certain revenue. Prior to
1995, recognition of production and transmission revenues was deferred for three
months after the actual production and transmission of natural gas had occurred,
primarily to match the recognition of revenues with the period these revenues
were distributed to working interest parties and royalty owners. The policy
revision to record revenues on a current basis reflects the companies' ability
to estimate net revenues on a current basis. This change is reflected on a
prospective basis beginning in January 1995 and results in 15 months of
production and transmission revenues being recognized in 1995. The effect of
this change was to increase revenue and net income by $176,000 and $131,000,
respectively, for the year ended December 31, 1995.

INCOME PER COMMON SHARE

Income per common share is computed using the weighted-average shares of
common stock and dilutive common stock equivalents (options and warrants)
outstanding during the respective periods. Net income available to common
stockholders is net income less dividends on preferred stock. The number of
weighted-average shares used in calculating income per common share was
1,637,576 and 695,669 for the years ended December 31, 1996 and 1995, and
3,201,350 (unaudited) and 1,034,873 (unaudited) for the six months ended June
30, 1997 and 1996, respectively, after retroactive effect of 103.1667 per share
stock split, as discussed in Note 9.

PROPERTY AND EQUIPMENT

The Company follows the successful efforts method of accounting for its
natural gas exploration activities. Under this method, geological and
geophysical costs and costs of carrying and retaining undeveloped properties are
expensed when incurred. All direct and certain indirect costs relating to
property acquisition, successful exploratory wells, development costs, and
support equipment and facilities are capitalized as the properties are obtained
or the facilities are placed into service. Costs of exploratory wells are
charged to expense if it is determined that proven reserves are not found.

Unproved gas properties that are individually significant are periodically
assessed for impairment of value, with losses recognized at the time of
impairment. The Company provides for depreciation, depletion, and amortization
of its investment in producing gas properties on a units-of-production method.
The remaining property and equipment is depreciated using the straight-line
method over estimated useful lives, ranging from 5 to 30 years. Maintenance and
repairs are charged to expense as incurred. Improvements and betterments are
capitalized.

CAPITALIZED INTEREST

The Company capitalizes interest on expenditures for significant projects
while activities are in progress to bring the assets to their intended use.
Interest capitalized totaled $290,398 and $92,851 for the years ended December
31, 1996 and 1995, respectively. Interest capitalized totaled $169,862
(unaudited) and $161,711 (unaudited) for the six months ended June 30, 1997 and
1996, respectively.

F-9
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
OTHER ASSETS

In conjunction with the 1997 issuance of the Russell County, the 1995
issuance of the Buchanan County and the 1994 issuance of the Russell County and
Buchanan County, Virginia, Natural Gas Facilities Revenue Bonds by the
Industrial Development Authorities of the respective counties, reserve funds
have been established by the trustee for each issuance. Amounts in the reserve
funds will be used to make payments of principal and interest, whether at
maturity, by acceleration, call for redemption, or otherwise, where trust funds
accumulated by scheduled Company payments are insufficient to satisfy bond
requirements. Such amounts are invested in debt securities issued by the U.S.
Treasury and other U.S. government corporations and agencies. The Company
records these investments at cost and recognizes related interest as earned. The
carrying value of investments approximates market value.

Costs incurred in conjunction with financing transactions are amortized on a
basis that approximates the effective interest method.

FUNDS HELD FOR FUTURE DISTRIBUTION

Revenues are collected by the Company as operator and marketer of the gas
sold on behalf of the working interest parties and held for final distribution
to them and to landowners. Until these funds are distributed, they are recorded
as funds held for future distribution.

INCOME TAXES

Income taxes are accounted for using the asset-and-liability method. Under
the asset-and-liability method, deferred income taxes reflect the temporary
differences between assets and liabilities recognized for financial reporting
purposes and amounts recognized for tax purposes.

RECLASSIFICATIONS

Certain reclassifications have been made in the 1995 balances to conform
with the 1996 presentation.

3. ACCOUNTS RECEIVABLE:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Trade receivables................................................ $ 428,182 $ 451,436
Lease operating expenses receivable.............................. 138,089 145,528
Joint-interest receivables....................................... 64,098 64,098
Due from affiliated companies.................................... 1,028,744 412,214
------------ ------------
$ 1,659,113 $1,073,276
------------ ------------
------------ ------------
</TABLE>

The majority of the Company's accounts receivable are due from companies
predominately involved in the marketing and distribution of oil and gas
products.

F-10
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

4. NOTES RECEIVABLE--AFFILIATED COMPANIES:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Note receivable from Virginia Gas Distribution Company; interest receivable at
9.5%; principal payable in maturities of $110,000 to $447,000 from 2002 to
2017............................................................................. $ 3,650,000 $ --
Note receivable from Virginia Gas Distribution Company; interest receivable at 9%;
principal payable in maturities of $4,000 to $263,000 from 1999 to 2020.......... 2,879,214 2,879,214
Note receivable from Virginia Gas Storage Company; interest receivable at 8.88%;
principal payable in maturities of $12,000 to $241,000 from 1995 to 2017......... 2,534,342 2,567,837
Note receivable from Virginia Gas Distribution Company; interest receivable at
7.35%; principal payable in maturities of $17,000 to $97,000 from 1996 to 2023... 1,276,560 1,284,833
Note receivable from Virginia Gas Storage Company; interest receivable at 7.35%;
principal payable in maturities of $13,000 to $77,000 from 1996 to 2023.......... 1,012,021 1,018,580
Note receivable from Virginia Gas Distribution Company; interest receivable at
8.88%; principal payable in maturities of $4,000 to $84,000 from 1995 to 2017.... 880,816 892,457
Note receivable from Virginia Gas Storage Company; interest receivable at 9%;
principal payable in maturities of $1,000 to $77,000 from 1999 to 2020........... 842,697 842,697
------------- -------------
13,075,650 9,485,618
Less--Current portion.............................................................. (118,779) (114,556)
------------- -------------
$ 12,956,871 $ 9,371,062
------------- -------------
------------- -------------
</TABLE>

F-11
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

5. PROPERTY AND EQUIPMENT:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Storage properties............................................................. $ 12,979,435 $ 9,226,332
Pipelines...................................................................... 1,050,139 1,039,035
Producing properties........................................................... 2,499,105 2,494,370
Propane facilities............................................................. 1,186,300 165,756
Wells, pipelines, and storage properties in progress........................... 2,235,350 3,973,172
Vehicles....................................................................... 282,921 217,955
Building and improvements...................................................... 182,029 150,898
Office equipment............................................................... 250,116 221,685
Well and pipeline equipment.................................................... 32,093 32,093
------------- -------------
20,697,488 17,521,296
Less--Accumulated depreciation, depletion, and amortization.................... (1,534,860) (1,177,816)
------------- -------------
$ 19,162,628 $ 16,343,480
------------- -------------
------------- -------------
</TABLE>

6. OTHER ASSETS:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Deferred financing costs......................................................... $ 700,737 $ 455,350
Restricted cash and investments- reserve funds................................... 670,269 116,809
Other............................................................................ 14,799 5,150
------------ ------------
$ 1,385,805 $ 577,309
------------ ------------
------------ ------------
</TABLE>

F-12
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

7. LONG-TERM DEBT:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
Note payable to the Industrial Development Authority of Russell
County, Virginia; interest payable monthly at 9.5%, beginning
in March 1997; principal payable in maturities of $275,000 to
$1,115,000 from 2002 to 2017................................. $ 9,100,000 $ --
Note payable to the Industrial Development Authority of
Buchanan County, Virginia; interest payable monthly at 9%,
beginning in February 1996; principal payable in maturities
of $5,000 to $342,000 from 1999 to 2020...................... 3,750,000 3,750,000
Note payable to the Industrial Development Authority of
Buchanan County, Virginia; interest payable monthly at an
effective rate of 8.88%, beginning in December 1994;
principal payable in maturities of $20,000 to $386,000 from
1995 to 2017................................................. 4,056,389 4,110,000
Note payable to the Industrial Development Authority of Russell
County, Virginia; interest payable monthly at an effective
rate of 7.35%, beginning in February 1994; principal payable
in maturities of $35,000 to $205,000 from 1996 to 2023....... 2,700,417 2,717,917
Note payable to Tenneco Energy Resources Corporation; interest
at Morgan Guaranty prime rate plus 3%; payable in quarterly
installments of principal plus interest through 1997......... -- 975,000
Note payable with interest at 7%; payable in monthly
installments of principal and interest of $1,099; maturing in
February 1999, with a final payment of $95,336 secured by an
asset with a book value of $147,862 as of June 30, 1997...... 104,443 107,283
Note payable with interest at 9%; interest payable in
semiannual installments, maturing October 2024............... -- 100,000
Notes payable with interest at prime plus 2%; payable in
quarterly installments of principal and interest beginning
July 1997.................................................... 590,631 --
Note payable to the Industrial Development Authority of
Washington County, Virginia with interest at 9.25%; payable
in monthly installments of principal and interest of $2,872
through October 1999; secured by an asset with a book value
of $101,142 as of June 30, 1997.............................. 72,093 85,626
Note payable to Virginia Gas Distribution Company;
</TABLE>

F-13
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

7. LONG-TERM DEBT: (CONTINUED)

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
(UNAUDITED)
<S> <C> <C>
interest payable at 9%; principal payable in maturities of
$1,000 to $91,000 from 1999 to 2020.......................... 965,000 1,000,000
Note payable to Virginia Gas Distribution Company; interest
payable at 7.35%; principal payable in maturities of $5,000
to $30,000 from 1996 to 2023................................. 392,788 395,333
Note payable to Virginia Gas Storage Company; interest payable
at 8%; balance due December 1997............................. 70,000 70,000
Notes payable through 2001 with interest from 8.95% to 10.75%;
secured by assets with a book value of $96,366 as of June 30,
1997......................................................... 83,509 71,060
------------- -------------
21,885,270 13,382,219
Less--Current portion.......................................... (748,576) (1,244,490)
------------- -------------
Long-term debt................................................. $ 21,136,694 $ 12,137,729
------------- -------------
------------- -------------
</TABLE>

In February 1997, the Industrial Development Authority of Russell County,
Virginia (the "Russell County Authority"), issued its Subordinated Natural Gas
Facilities Revenue Bonds Series 1997 with principal of $9,100,000. The bonds are
payable from and are secured by a promissory note issued by the Company to the
Russell County Authority. A portion of the proceeds was loaned to an affiliated
company and is being used to construct a natural gas distribution facility in
and around the town of Lebanon, Virginia, and for related storage and pipeline
facilities.

In December 1995, the Industrial Development Authority of Buchanan County,
Virginia (the "Buchanan County Authority"), issued its Senior Subordinated
Natural Gas Facilities Revenue Bonds Series 1995 with principal of $3,750,000.
The bonds are payable from and are secured by a promissory note issued by the
Company to the Buchanan County Authority. A portion of the proceeds was loaned
to affiliated companies and are being used to extend existing natural gas
distribution facilities in and around the town of Grundy, Virginia, and for
related supporting pipeline gathering and storage facilities.

In January 1994, the Russell County Authority issued its Natural Gas Revenue
Bond Series A and B with combined principal of $3,000,000. The bonds are payable
from and are secured by a promissory note issued by the Company to the Russell
County Authority. The proceeds were loaned by the Company to affiliated
companies to construct a natural gas distribution facility in and around the
town of Castlewood, Virginia, and for related supporting exploration and
production, pipeline and storage facilities in the amount of $2,630,000 and to
retire $370,000 of long-term debt.

In November 1994, the Buchanan County Authority issued its Natural Gas
Revenue Bond Series A with principal of $4,250,000. The bonds are payable from
and are secured by a promissory note issued by the Company to the Buchanan
County Authority. The bonds were also issued in parity with the Russell County
Bonds discussed above. A portion of the proceeds was loaned to affiliated
companies and are being used to construct a natural gas distribution facility in
an around the town of Grundy, Virginia, and for related supporting exploration
and production, pipeline, and storage facilities.

F-14
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

7. LONG-TERM DEBT: (CONTINUED)
On February 29, 1996, the Company purchased the interest of its joint
venture partner in the development of the Saltville, Virginia, natural gas
storage facility. The purchase price of the interest was $2,225,000, with
consideration consisting of a $500,000 payment in March 1996 and the issuance of
a promissory note for $1,725,000. Interest accrues at the Morgan Guaranty prime
rate plus 3 percent. Quarterly installments of principal and interest were made
during 1996. In December 1996 the Company, in accordance with terms of the
Transfer Agreement and after providing adequate security to the lender, elected
to pay the remaining principal in quarterly installments of principal and
interest through 1997. The former joint venture partner retains the option to
jointly develop with the Company on a 50-50 percent basis any additional storage
caverns on the Saltville property.

As of December 31, 1996, principal payments on long-term debt for the next
five years are as follows:

Based upon the borrowing rates currently available to the Company for loans
with similar terms and remaining maturities, the approximate fair value of
long-term debt at December 31, 1996, is approximately $12,972,000 and at June
30, 1997 is approximately $20,932,000 (unaudited).

8. STOCKHOLDERS' EQUITY:

References to the common stock of the Company in these financial statements
and in the accompanying notes reflect retroactive application of an increase in
the number of authorized shares from 20,000 to 10,000,000 and a 103.1667 per
share stock split, effected June 1996, by the shareholders of the Company. In
conjunction with the stock split, the shareholders also implemented a super
majority provision requiring the vote of 75 percent of the issued and
outstanding shares entitled to vote on any matters involving an amendment to the
certificate of incorporation or the bylaws; the merger, dissolution,
reorganization, or recapitalization of the Company; or the sale of all or
substantially all of the assets of the Company.

In October 1996, the Company completed an initial public offering of its
common stock. The offering resulted in the issuance of an additional 1,533,000
common shares of the Company at $6 per share. In connection with the offering,
the Company granted warrants to the underwriter to purchase, on a post-offering
basis, 153,300 shares of the Company's common stock at a purchase price equal to
165 percent of the public offering price, or $9.90 per share.

In September 1995, the Company issued for $2,000,000 cash consideration
2,000 shares of its Series A nonvoting preferred stock and warrants to purchase
common stock equal to 6 percent of the then outstanding common stock of the
Company (increasing 1 percent per year until September 29, 2000, and an
additional 10 percent per year thereafter through September 29, 2003, if the
preferred stock is not redeemed before then) all to one investment corporation.
The Company can redeem the preferred stock at any time with five days' notice to
the holder. The agreement under which the preferred stock and warrants were sold
contains a number of covenants, including requiring the preferred stock
purchaser's consent to certain transactions outside the ordinary course of
business, environmental compliance, and compliance

F-15
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

8. STOCKHOLDERS' EQUITY: (CONTINUED)
with covenants of other loan obligations. Dividends, whether declared or not,
accrue on the preferred stock at 13 percent per annum and are payable monthly.
The liquidation preference of the preferred stock is $2,000,000 plus unpaid
dividends. In February 1997, the Company redeemed the outstanding 2,000 shares
of preferred stock for the liquidation price of $2,000,000 plus unpaid
dividends.

Subordinated indebtedness of the Company in the amount of $780,000 was paid
from the proceeds of the preferred stock issuance during 1995, resulting in net
cash proceeds to the Company of $1,220,000. In conjunction with the issuance of
the subordinated indebtedness in April 1993, the Company issued a warrant
entitling the lender to purchase 76,756 shares of the Company's common stock at
$6.46 per share. The warrant is exercisable upon the earlier of repayment by the
Company of the debenture; the entering into a contract for the sale of all or
substantially all of the assets of the Company or any of its subsidiaries; a
bona fide offer being made by any person for, or the sale in one or more related
transactions of, more than 10 percent of the Company's then outstanding common
stock, or 10 percent of any of its subsidiaries' then outstanding common stock;
on February 28, 1998; the effective date of the first registration statement
filed by the Company covering an underwritten offering of any of its securities
to the general public; or the occurrence of an event of default under the terms
of the financing agreement. The warrant expires on February 28, 2003. Concurrent
with the issuance of the warrant, the Company has issued stock options to the
lender to purchase a number of common shares sufficient for the lender to
maintain 14 percent of the ownership of the Company's common stock on a fully
diluted basis. The options grant the lender the right to purchase the common
stock at 66 percent of issue price of any proposed common stock offerings and
were exercisable subject to the terms described earlier. The options expire on
February 28, 2003. In July 1996, the Company negotiated a release with the
lender and paid $975,000 to the lender in exchange for the cancellation of the
lender's warrant and options.

In May 1996, the Company completed a private placement for 800,058 shares of
the Company's common stock, resulting in net proceeds to the Company of
$4,401,317. All shares were sold to a single investor.

In August 1996, the company sold 42,000 shares of common stock to an officer
of the Company for $252,000 and made loans to eight employees totaling $240,000
related to the purchase of 40,000 shares of the Company's common stock.

In June 1996, the Company issued warrants on a pro rata basis to
shareholders of record of the Company as of May 17, 1996, to purchase an
aggregate of 735,686 shares of the Company's common stock at a purchase price
equal to 165 percent of the planned public offering price per share of $6, or
$9.90 per share. In conjunction with the terms of the agreement under which the
preferred stock and warrants were sold, the Company issued, in June 1996,
warrants to the preferred stockholder to purchase an aggregate of 54,163 shares
of the Company's common stock at a purchase price equal to 165 percent of the
planned public offering price per share of $6, or $9.90 per share.

9. STOCK OPTIONS:

The Company has granted certain management and directors stock options that
allow the individual to purchase previously unissued common shares at a set
price. The exercise prices of options granted approximate the estimated fair
market value, as determined by the Board of Directors, of the Company's common
stock as of the grant date. The Company is also obligated to grant options to a
member of

F-16
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

9. STOCK OPTIONS: (CONTINUED)
management upon issuance of additional shares of the Company's common stock to
ensure that his portion of the Company's common stock will not become diluted.
The Company's obligation is 2 percent of its common shares at December 31, 1996.

The Company applies APB Opinion 25 and related Interpretations in accounting
for its options. Accordingly, no compensation cost has been recognized for its
stock option plans. Had compensation cost for the Company's stock options been
determined based on the fair value at the grant dates for awards, consistent
with the method of FASB Statement No. 123, Accounting for Stock-Based
Compensation, the Company's net income and earnings per share would not be
materially different from amounts reported for the years ended December 31, 1996
and 1995.

The Company estimates the fair value of each option grant on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants: dividend yield of .67 percent and
risk free interest rate of approximately 6 percent for 1996 and 1995, and
expected lives of approximately 3 and 4 years for the options granted in 1996
and 1995, respectively. All options were granted prior to the Company's initial
public offering. Consequently, as permitted by SFAS No. 123, the Company has
excluded volatility from its fair value computations.

Changes in the options outstanding during the years ended December 31, 1996
and 1995, and for the six months ended June 30, 1997, were as follows.

<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
EXERCISE PRICE
SHARES PER SHARE
---------- ---------------
<S> <C> <C>
Outstanding, December 31, 1994..................................... 139,894 $ 4.09
Granted.......................................................... 14,650 $ 8.72
Exercised........................................................ (124,316) $ 3.99
Expired.......................................................... (15,578) $ 4.88
----------
Outstanding, December 31, 1995..................................... 14,650 $ 8.72
Granted.......................................................... 70,004 $ 8.72
----------
Outstanding, December 31, 1996..................................... 84,654 $ 8.72
----------
----------
Outstanding, June 30, 1997 (unaudited)............................. 84,654 $ 8.72
----------
----------
</TABLE>

As a result of the excess of exercise price over the share price during
1996, the Black-Scholes option-pricing model indicates that the fair value of
options granted in 1996 is zero. The weighted-average fair value of options
granted during 1995 was $1.95.

As of December 31, 1996, all outstanding options are exercisable, at an
exercise price of $8.72, and expire in 1999.

On July 1, 1997, the Company issued to certain of its officers and employees
options to purchase 120,000 shares of the Company's common stock at an exercise
price of $10 per share.

F-17
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

10. COMMITMENTS AND CONTINGENT LIABILITIES:

Certain of the Company's leases require the Company to pay minimum royalties
or rentals. The aggregate minimum royalty and rental payments on leases for the
next five years are as follows.

The Company is subject to various Federal, state, and local laws and
regulations relating to the protection of the environment. The Company believes
that it is in compliance with these laws and regulations and does not expect to
incur significant capital expenditures in future years to maintain compliance.

11. SALES TO MAJOR CUSTOMERS

One of the Company's customers accounted for 31 percent of consolidated
operating revenue for the year ended December 31, 1996. One of the Company's
customers accounted for 25 percent, one customer accounted for 21 percent, while
another customer accounted for 15 percent, respectively, of operating revenue
for the six months ended June 30, 1997.

12. INCOME TAXES:

The components of the provision (benefit) for income taxes are as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
---------------------- ---------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
---------- ---------- ---------- ---------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Current:
Federal...................................... $ 35,564 $ (7,342) $ 10,231 $ 30,996
State........................................ 3,226 (751) -- 3,892
---------- ---------- ---------- ---------
38,790 (8,093) 10,231 34,888
---------- ---------- ---------- ---------
Deferred:
Federal...................................... 82,248 (7,120) 124,985 18,176
State........................................ 16,845 (2,330) 16,611 9,517
---------- ---------- ---------- ---------
99,093 (9,450) 141,596 27,693
---------- ---------- ---------- ---------
$ 137,883 $ (17,543) $ 151,827 $ 62,581
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
</TABLE>

F-18
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

12. INCOME TAXES: (CONTINUED)
The components of deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Deferred tax assets:
Minimum tax credit carryforwards................................ $ 104,609 $ 104,609
Net operating loss carryforward................................. 86,910 86,910
----------- ------------
Total......................................................... 191,519 191,519
----------- ------------
Deferred tax liabilities:
Capital assets.................................................. 920,526 821,433
----------- ------------
Net deferred tax liabilities.................................. $ 729,007 $ 629,914
----------- ------------
----------- ------------
</TABLE>

The Company has no valuation allowances as of December 31, 1996, or as of
June 30, 1997, and there were no changes in the valuation allowance during the
years ended December 31, 1996 or 1995, or during the six months ended June 30,
1997 and 1996.

A reconciliation of the tax provision at the statutory Federal income tax
rate and the Company's actual provision for income tax is as follows.

<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
---------------------- ----------------------
1997 1996 1996 1995
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
(UNAUDITED)
Tax at statutory rate of 34%..................................... $ 192,084 $ 64,362 $ 258,194 $ 182,395
Equity in earnings of affiliated companies....................... (44,608) (70,700) (115,576) (90,945)
State income taxes, less Federal benefit......................... 11,337 (487) 10,963 7,030
Statutory depletion in excess of cost depletion.................. (13,526) (11,283) (26,693) (19,837)
Other, net....................................................... (7,404) 565 24,939 (16,062)
---------- ---------- ---------- ----------
$ 137,883 $ (17,543) $ 151,827 $ 62,581
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>

In addition, the Company has minimum tax credits that can be carried forward
indefinitely to offset future regular tax. The aggregate amount of minimum tax
credits available at December 31, 1996, is $104,609.

13. SUPPLEMENTARY INFORMATION ON NATURAL GAS PRODUCING ACTIVITIES (UNAUDITED):

The following supplementary information regarding the gas producing
activities of the Company is presented in accordance with the requirements of
Statement of Financial Accounting Standards ("SFAS") No. 69. The amounts shown
include the Company's net working and royalty interests in all of its natural
gas operations. The Company has no material investments in unproved properties.

F-19
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

NATURAL GAS RESERVES

Users of this information should be aware that the process of estimating
quantities of proved and proved developed natural gas reserves is complex,
requiring significant subjective decisions in the evaluation of all available
geological, engineering, and economic data for each reservoir. The data for a
given reservoir may also change substantially over time as a result of numerous
factors including, but not limited to, additional development activity, evolving
production history, and continual reassessment of the viability of production
under varying economic conditions. Consequently, material revisions to existing
reserve estimates occur from time to time. Although every reasonable effort is
made to ensure that reserve estimates reported represent the most accurate
assessments possible, the significance of the subjective decisions required and
variances in available data for various reservoirs makes these estimates
generally less precise than other estimates presented in connection with
financial statement disclosures.

Proved reserves represent estimated quantities of natural gas that
geological and engineering data demonstrate, with reasonable certainty, to be
recoverable in future years from known reservoirs under economic and operating
conditions existing at the time the estimates were made.

Proved developed reserves are proved reserves expected to be recovered
through wells and equipment in place and under operating methods being utilized
at the time the estimates were made.

No major discovery or other favorable or adverse event subsequent to
December 31, 1996 is believed to have caused a material change in the estimates
of proved or proved developed reserves as of that date.

CAPITAL COSTS RELATING TO NATURAL GAS PRODUCING ACTIVITIES:

<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Proved natural gas properties..................................... $ 2,581,634 $ 2,573,132
Support equipment and facilities.................................. 32,093 31,882
------------ ------------
2,613,727 2,605,014
Less--Accumulated depreciation, depletion and amortization........ (668,526) (520,649)
------------ ------------
Net capitalized costs............................................. $ 1,945,201 $ 2,084,365
------------ ------------
------------ ------------
</TABLE>

COSTS INCURRED IN NATURAL GAS ACTIVITIES:

<TABLE>
<CAPTION>
1996 1995
--------- ----------
<S> <C> <C>
Proved property acquisition costs...................................... $ -- $ 320,241
Exploration costs...................................................... 2,688 4,202
Development costs...................................................... 8,502 270,091
--------- ----------
$ 11,190 $ 594,534
--------- ----------
--------- ----------
</TABLE>

RESULTS OF OPERATIONS FOR NATURAL GAS PRODUCING ACTIVITIES

The following table includes results solely from the production and sale of
natural gas and changes for property impairments. It excludes general and
administrative expenses and gains or losses on property

F-20
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

NATURAL GAS RESERVES (CONTINUED)
dispositions. The income tax expense is calculated by applying the statutory tax
rates to the revenues after deducting costs, which include depletion allowances
and giving effect to permanent differences and tax credits.

<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Revenues.............................................................. $ 416,201 $ 236,204
Cost of natural gas sold.............................................. (42,349) (26,755)
Exploration costs..................................................... (2,688) (4,202)
Depreciation, depletion and amortization.............................. (168,977) (157,394)
Revenue adjustment (see Note 2)....................................... -- 72,992
---------- ----------
202,187 120,845
Income tax expense.................................................... (43,287) (21,876)
---------- ----------
Results of operations................................................. $ 158,900 $ 98,969
---------- ----------
---------- ----------
</TABLE>

The revenue adjustment for 1995 relates to the Company's revision of its
method of recording certain revenue, as discussed in Note 2.

NATURAL GAS RESERVES (UNAUDITED)

The following table presents the estimated natural gas reserves owned by the
Company. This information includes the Company's royalty and working interest
share of the reserves in southwestern Virginia. These reserves were estimated by
the Company; however, by their nature they are subject to upward and downward
revisions as additional information regarding fields and technology becomes
available. All reserves are located in the United States.

NATURAL GAS
PROVED DEVELOPED AND UNDEVELOPED RESERVES (UNAUDITED):
(THOUSANDS OF CUBIC FEET/MCF)

<TABLE>
<S> <C>
December 31, 1995................................................................ 4,072,782
Revisions of previous estimates................................................ (1,401,793)
Production..................................................................... (160,798)
Purchase of reserves........................................................... 654,025
---------
December 31, 1995................................................................ 3,164,216
Revisions of previous estimates................................................ 160,830
Production..................................................................... (161,995)
Purchase of reserves........................................................... --
---------
December 31, 1996................................................................ 3,163,051
---------
---------
Proved Developed Producing Reserves:
December 31, 1995.............................................................. 2,316,276
---------
---------
December 31, 1996.............................................................. 2,309,325
---------
---------
</TABLE>

F-21
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

NATURAL GAS RESERVES (CONTINUED)
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS (UNAUDITED)

The following information relating to proved natural gas reserves has been
developed utilizing procedures prescribed by SFAS No. 69 and based on natural
gas reserve and production volumes estimated by the engineering staff of the
Company. It may be useful for certain comparison purposes but should not be
relied upon solely in evaluating the Company or its performance. Further,
information contained in the following table should not be considered as
representative of realistic assessments of future cash flows, nor should the
Standardized Measure of Discounted Future Net Cash Flows be viewed as
representative of the current value of the Company.

The future cash flows presented below are based on sales prices, cost rates,
and statutory income tax rates in existence as of the date of the projection. It
is expected that material revisions to some estimates of natural gas reserves
may occur in the future, development and production of the reserves may occur in
periods other than those assumed, and actual prices realized and costs incurred
may vary significantly from those used.

<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
(UNAUDITED)
Future cash inflows............................................. $ 10,870,114 $ 5,505,812
Future production costs......................................... (1,804,856) (1,680,171)
Future development costs........................................ (196,300) (242,889)
------------- -------------
Future cash inflows before income taxes......................... 8,868,958 3,582,752
Future income tax expense....................................... (2,506,544) (1,057,790)
------------- -------------
Future net cash flows........................................... 6,362,414 2,524,962
10% annual discount for estimated timing of cash flows.......... (3,514,491) (1,416,025)
------------- -------------
Standardized measure of discounted future net cash flows........ $ 2,847,923 $ 1,108,937
------------- -------------
------------- -------------
</TABLE>

CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS (UNAUDITED)

<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
(UNAUDITED)
Sales of natural gas, net of production costs..................... $ 2,372,780 $ 244,799
Development costs incurred during the period...................... 22,280 (56,189)
Purchase of minerals-in-place..................................... -- 362,994
Net change in income taxes........................................ (656,074) (168,055)
------------ ------------
Net increase (decrease)........................................... 1,738,986 383,549
Beginning of year................................................. 1,108,937 725,388
------------ ------------
End of year....................................................... $ 2,847,923 $ 1,108,937
------------ ------------
------------ ------------
</TABLE>

14. EMPLOYMENT COMMITMENTS:

On May 23, 1996, the Company entered into a ten-year employment contract
with its President and CEO (the "President"), which provides for an annual
salary of $155,000. The contract provides for a bonus

F-22
<PAGE>
VIRGINIA GAS COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

14. EMPLOYMENT COMMITMENTS: (CONTINUED)
to be paid based upon 10 percent of the Company's pretax earnings on all amounts
from $1,000,000 to $1,999,999 and 15 percent of the Company's pretax earnings on
all amounts in excess of $2,000,000. If the President is terminated by the
Company for any reason other than for cause during the term the term of the
employment contract, at the President's election, the Company would be obligated
to purchase all or a portion of the shares held by him and his family (749,826
shares as of June 30, 1997, of which 363,663 shares are issuable upon the
exercise of warrants exercisable at $9.90 per share) at a price equal to 150
percent of the market value of the Company's shares on the date of termination.
In addition, the Company would be obligated to pay the President in a lump sum
all salary amounts owed through the term of the employment agreement plus an
additional $2,000,000.

F-23
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of
Virginia Gas Storage Company:

We have audited the accompanying balance sheet of Virginia Gas Storage Company
as of December 31, 1996, and the related statements of income, changes in
stockholders' equity, and cash flows for the years ended December 31, 1996 and
1995. 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.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Virginia Gas Storage Company as
of December 31, 1996, and the results of its operations and its cash flows for
the years ended December 31, 1996 and 1995, in conformity with generally
accepted accounting principles.

ARTHUR ANDERSEN LLP

Richmond, Virginia
March 7, 1997

F-24
<PAGE>
VIRGINIA GAS STORAGE COMPANY

BALANCE SHEETS

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash........................................................................... $ 189,868 $ 148,619
Accounts receivable............................................................ 1,069,968 1,233,227
Notes receivable............................................................... 70,000 570,000
Other current assets........................................................... 18,348 85,369
------------- -------------
Total current assets................................................... 1,348,184 2,037,215
PROPERTY AND EQUIPMENT, net........................................................ 14,542,439 13,323,883
OTHER ASSETS....................................................................... 965,018 956,099
------------- -------------
Total assets........................................................... $ 16,855,641 $ 16,317,197
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt.............................................. $ 107,861 $ 104,915
Accounts payable............................................................... 1,364,582 2,193,010
Other current liabilities...................................................... 238,540 108,929
------------- -------------
Total current liabilities.............................................. 1,710,983 2,406,854
LONG-TERM DEBT..................................................................... 7,328,182 6,386,212
DEFERRED INCOME TAXES.............................................................. 619,435 551,686
------------- -------------
Total liabilities...................................................... 9,658,600 9,344,752
------------- -------------
STOCKHOLDERS' EQUITY:
Common stock -- no par value, 50,000 shares authorized, 38,200 (unaudited)
shares issued and outstanding as of June 30, 1997; no par value, 50,000
shares authorized, 38,200 issued and outstanding as of December 31, 1996..... 5,640,000 5,640,000
Retained earnings.............................................................. 1,557,041 1,332,445
------------- -------------
Total stockholders' equity............................................. 7,197,041 6,972,445
------------- -------------
Total liabilities and stockholders' equity............................. $ 16,855,641 $ 16,317,197
------------- -------------
------------- -------------
</TABLE>

The accompanying notes are an integral part of these balance sheets.

F-25
<PAGE>
VIRGINIA GAS STORAGE COMPANY

STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
-------------------------- --------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
------------ ------------ ------------ ------------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE:
Operating revenue.................................... $ 2,149,463 $ 1,952,499 $ 3,831,224 $ 2,696,594
Interest and other income............................ 30,104 108,252 154,220 82,454
------------ ------------ ------------ ------------
2,179,567 2,060,751 3,985,444 2,779,048
------------ ------------ ------------ ------------
EXPENSES:
Production expenses.................................. 110,139 132,654 222,808 277,167
Purchased gas expense................................ 510,502 664,087 974,277 680,857
Operation and maintenance expense.................... 404,381 109,361 374,579 294,249
Depreciation, depletion, and amortization............ 256,332 192,460 416,699 308,039
General and administrative........................... 392,535 278,163 700,296 356,979
------------ ------------ ------------ ------------
1,673,889 1,376,725 2,688,659 1,917,291
------------ ------------ ------------ ------------
OTHER EXPENSE:
Interest............................................. 165,380 77,309 272,941 115,010
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES............................... 340,298 606,717 1,023,844 746,747
PROVISION FOR INCOME TAXES............................... 115,702 206,283 348,106 261,364
------------ ------------ ------------ ------------
NET INCOME............................................... $ 224,596 $ 400,434 $ 675,738 $ 485,383
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
VIRGINIA GAS COMPANY'S EQUITY IN VIRGINIA GAS STORAGE
COMPANY'S EARNINGS..................................... $ 112,298 $ 200,217 $ 337,869 $ 242,692
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>

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

F-26
<PAGE>
VIRGINIA GAS STORAGE COMPANY

STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
COMMON RETAINED
STOCK EARNINGS
------------ ------------
<S> <C> <C>
BALANCE, December 31, 1994............................................................ $ 2,000,000 $ 171,324
Issuance of 18,200 shares........................................................... 3,640,000 --
Net income.......................................................................... -- 485,383
------------ ------------
BALANCE, December 31, 1995............................................................ 5,640,000 656,707
Net income.......................................................................... -- 675,738
------------ ------------
BALANCE, December 31, 1996............................................................ 5,640,000 1,332,445
Net income (unaudited).............................................................. -- 224,596
------------ ------------
BALANCE, June 30, 1997 (unaudited).................................................... $ 5,640,000 $ 1,557,041
------------ ------------
------------ ------------
</TABLE>

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

F-27
<PAGE>
VIRGINIA GAS STORAGE COMPANY

STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
------------------------ ------------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
----------- ----------- ----------- -----------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 224,596 $ 400,434 $ 675,738 $ 485,383
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation, depletion, and amortization.............. 256,332 192,460 416,699 308,039
Deferred income taxes.................................. 67,749 120,465 212,476 139,214
Decrease (increase) in accounts receivable............. 163,259 127,407 (304,140) (194,420)
Decrease (increase) in other current assets............ 67,021 (4,386) (22,353) (50,441)
Increase in other assets............................... (36,728) (12,183) (37,981) (31,946)
(Decrease) increase in accounts payable................ (828,428) (746,238) 1,092,591 64,109
Increase (decrease) in other current liabilities....... 129,611 (37,398) (58,690) (27,763)
----------- ----------- ----------- -----------
Net cash provided by operating activities........ 43,412 40,561 1,974,340 692,175
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................... (1,447,079) (1,643,823) (4,225,530) (2,870,185)
Payments received on notes receivable.................. 500,000 1,720,000 1,720,000 100,000
----------- ----------- ----------- -----------
Net cash (used in) provided by investing
activities..................................... (947,079) 76,177 (2,505,530) (2,770,185)
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal.............................. (55,084) (57,936) (117,677) (23,006)
Proceeds from new loans................................ 1,000,000 500,000 500,000 1,342,697
Proceeds from issuance of common stock................. -- -- -- 500,000
Payment of financing issuance costs.................... -- -- -- (42,131)
Establishment of financing reserve funds............... -- -- -- (75,843)
----------- ----------- ----------- -----------
Net cash provided by financing activities........ 944,916 442,064 382,323 1,701,717
----------- ----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH............................ 41,249 558,802 (148,867) (376,293)
Cash, beginning of period.................................. 148,619 297,486 297,486 673,779
----------- ----------- ----------- -----------
CASH, end of period........................................ $ 189,868 $ 856,288 $ 148,619 $ 297,486
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
SUPPLEMENTAL DISCLOSURE:
Interest paid.......................................... $ 333,254 $ 328,356 $ 606,505 $ 450,501
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Income taxes paid...................................... $ 47,635 $ 79,024 $ 159,024 $ 123,349
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>

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

F-28
<PAGE>
VIRGINIA GAS STORAGE COMPANY

NOTES TO FINANCIAL STATEMENTS

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

1. DESCRIPTION OF OPERATIONS:

Virginia Gas Storage Company (the "Company") was organized in 1992 under the
laws of the state of Virginia. The Company is 50 percent owned by Virginia Gas
Company ("VGC") and 50 percent owned by a private investor. The primary business
of the Company is to develop and operate natural gas storage and transmission
facilities.

INTERIM FINANCIAL INFORMATION

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

USE OF ESTIMATES

REVENUE RECOGNITION

The Company recognizes gas sales and transmission revenues upon delivery of
gas to the common pipeline carrier. Storage revenues are recognized evenly
throughout the contract terms with injection and withdrawal revenues recognized
as natural gas is injected or withdrawn from the storage facility.

During the year ended December 31, 1995, the Company revised its method of
recording certain revenue. Prior to 1995, recognition of transmission revenues
was deferred for three months after the actual transmission of natural gas had
occurred, primarily to match the recognition of revenues with the period these
revenues were distributed to the working interest owners. The policy revision to
record revenues on a current basis reflects the Company's ability to estimate
its net revenues on a current basis. This change is reflected on a prospective
basis beginning in January 1995 and results in 15 months of transmission
revenues being recognized in 1995. The effect of this change was to increase
revenue and net income by $110,000 and $43,000, respectively, for the year ended
December 31, 1995.

PROPERTY AND EQUIPMENT

All direct and indirect costs relating to property acquisition, development
costs and support equipment and facilities are capitalized as the properties are
obtained or the facilities are placed into service. The Company provides for
depreciation of property and equipment using the straight-line method over
estimated useful lives ranging from 5 to 30 years.

F-29
<PAGE>
VIRGINIA GAS STORAGE COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
CAPITALIZED INTEREST

The Company capitalizes interest on expenditures for significant projects
while activities are in progress to bring the assets to their intended use.
Interest capitalized totaled $283,564 and $317,312 for the years ended December
31, 1996 and 1995, respectively. Interest capitalized totaled $148,176
(unaudited) and $201,047 (unaudited) in the six months ended June 30, 1997 and
1996, respectively.

OTHER ASSETS

Costs incurred in conjunction with financing transactions are amortized on a
basis that approximates the effective interest method.

INCOME TAXES

3. ACCOUNTS RECEIVABLE:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Trade receivables.................................................................... $ 224,622 $ 618,275
Receivables from affiliated companies................................................ 638,741 469,656
Pipeline operating expenses.......................................................... 51,854 54,944
Joint-interest receivables........................................................... 154,648 90,249
Other................................................................................ 103 103
------------ ------------
$ 1,069,968 $1,233,227
------------ ------------
------------ ------------
</TABLE>

F-30
<PAGE>
VIRGINIA GAS STORAGE COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

4. NOTES RECEIVABLE:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Note receivable from shareholder; interest receivable at 8%; principal received as
consideration for the issuance of common shares. The note receivable from
shareholder was collected in March 1997............................................. $ -- $ 500,000
Note receivable from Virginia Gas Exploration Company; interest receivable at 8%;
principal balance due 1997.......................................................... 70,000 70,000
----------- ------------
70,000 570,000
Less-- Current portion................................................................ (70,000) (570,000)
----------- ------------
$ -- $ --
----------- ------------
----------- ------------
</TABLE>

5. PROPERTY AND EQUIPMENT:

6. OTHER ASSETS:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Restricted cash and investments-reserve funds......................................... $ 599,653 $ 582,233
Deferred debt issuance costs.......................................................... 357,873 365,707
Other................................................................................. 7,492 8,159
----------- ------------
$ 965,018 $ 956,099
----------- ------------
----------- ------------
</TABLE>

F-31
<PAGE>
VIRGINIA GAS STORAGE COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

7. ACCOUNTS PAYABLE:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Trade payables....................................................................... $ 623,711 $1,827,867
Payable to affiliated companies...................................................... 740,871 365,143
------------ ------------
$ 1,364,582 $2,193,010
------------ ------------
------------ ------------
</TABLE>

8. OTHER CURRENT LIABILITIES:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Amounts due affiliated companies...................................................... $ 42,519 $ 46,255
Funds held for future distribution.................................................... 144,603 8,120
Income taxes payable.................................................................. 36,047 17,569
Other................................................................................. 15,371 36,985
----------- ------------
$ 238,540 $ 108,929
----------- ------------
----------- ------------
</TABLE>

F-32
<PAGE>
VIRGINIA GAS STORAGE COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

9. LONG-TERM DEBT:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Note payable to Virginia Gas Company; interest payable at 8.88%; principal payable in
maturities of $12,000 to $241,000 from 1995 to 2017................................ $ 2,534,342 $2,567,837
Note payable to Virginia Gas Company; interest payable at 7.35%; principal payable in
maturities of $13,000 to $77,000 from 1996 to 2023................................. 1,012,021 1,018,579
Notes payable to Virginia Gas Distribution Company; interest payable at 9%; principal
payable in maturities of $1,000 to $91,000 from 1999 to 2020....................... 1,000,000 1,000,000
Notes payable to Virginia Gas Distribution Company; interest payable at 9.5%;
principal payable in maturities of $30,000 to $123,000 from 2002 to 2017........... 1,000,000 --
Note payable to Virginia Gas Company; interest payable at 9%; principal payable in
maturities of $1,000 to $77,000 from 1999 to 2020.................................. 842,697 842,697
Notes payable to Virginia Gas Distribution Company; interest payable at 8.88%;
principal payable in maturities of $3,000 to $53,000 from 1995 to 2017............. 561,141 568,557
Notes payable to Virginia Gas Distribution Company; interest payable at 7.35%;
principal payable in maturities of $6,000 to $36,000 from 1996 to 2023............. 467,767 470,798
Notes payable through 1999 with interest from 8.0% to 12.75%; secured by assets with
a book value of $19,380 as of March 31, 1997....................................... 18,075 22,659
------------ ------------
7,436,043 6,491,127
Less-- Current portion............................................................... (107,861) (104,915)
------------ ------------
Long-term debt....................................................................... $ 7,328,182 $6,386,212
------------ ------------
------------ ------------
</TABLE>

In February 1997, the Industrial Development Authority of Russell County,
Virginia (the "Russell County Authority"), issued its Subordinated Natural Gas
Facilities Revenue Bonds Series 1997 with principal of $9,100,000. A portion
($1,000,000) of the proceeds was loaned to the Company by Virginia Gas
Distribution Company.

In December 1995, the Industrial Development Authority of Buchanan County,
Virginia (the "Buchanan County Authority"), issued its Senior Subordinated
Natural Gas Facilities Revenue Bonds Series 1995 with principal of $3,750,000. A
portion ($842,697) of the proceeds was allocated to the Company by VGC which was
used by the Company to construct natural gas storage facilities to support
natural gas distribution facilities owned by Virginia Gas Distribution Company.

In January 1994, the Industrial Development Authority of Russell County,
Virginia (the "Russell County Authority"), issued its Natural Gas Revenue Bond
Series A and B with combined principal of $3,000,000. A portion ($1,330,000) of
the proceeds was allocated to the Company by an affiliated company, which was
used by the Company to construct natural gas storage and gathering facilities to
support natural gas distribution facilities owned by Virginia Gas Distribution
Company.

F-33
<PAGE>
VIRGINIA GAS STORAGE COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

9. LONG-TERM DEBT: (CONTINUED)
In November 1994, the Buchanan County Authority issued its Natural Gas
Revenue Bond Series A with principal of $4,250,000. A portion ($2,655,306) of
the proceeds was allocated to the Company by VGC which was used by the Company
to construct natural gas storage and gathering facilities to support natural gas
distribution facilities owned by Virginia Gas Distribution Company.

As of December 31, 1996, principal payments on long-term debt for the next
five years are as follows:

10. SALES TO MAJOR CUSTOMERS:

One of the Company's customers accounted for 12 percent and 20 percent while
another customer accounted for 45 percent and 29 percent, respectively, of
operating revenue for the years ended December 31, 1996 and 1995. One customer
accounted for 10 percent of 1996 operating revenue while another customer
accounted for 12 percent of 1995 operating revenue. One of the Company's
customers accounted for 44 percent and 53 percent, respectively, of operating
revenue for the six months ended June 30, 1997 and 1996, while another customer
accounted for 12 percent of operating revenue for the six months ended June 30,
1996.

11. COMMITMENTS:

Certain of the Company's leases require the Company to pay minimum rentals.
The aggregate minimum rental payments on leases for the next five years are as
follows:

F-34
<PAGE>
VIRGINIA GAS STORAGE COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

12. INCOME TAXES:

The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
---------------------- ----------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
---------- ---------- ---------- ----------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Current:
Federal.......................................................... $ 47,953 $ 85,818 $ 135,630 $ 108,482
State............................................................ -- -- -- 13,668
---------- ---------- ---------- ----------
47,953 85,818 135,630 122,150
---------- ---------- ---------- ----------
Deferred:
Federal.......................................................... 67,749 120,465 212,476 139,214
State............................................................ -- -- -- --
---------- ---------- ---------- ----------
67,749 120,465 212,476 139,214
---------- ---------- ---------- ----------
$ 115,702 $ 206,283 $ 348,106 $ 261,364
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>

The components of deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Deferred tax assets:
Minimum tax credit carryforwards...................................................... $ 4,656 $ 4,656
----------- ------------
Deferred tax liabilities:
Capital assets........................................................................ 624,091 556,342
----------- ------------
Net deferred tax liabilities.......................................................... $ 619,435 $ 551,686
----------- ------------
----------- ------------
</TABLE>

The Company has no valuation allowances as of December 31, 1996, or as of
June 30, 1997, and there were no changes in the valuation allowance during the
years ended December 31, 1996 and 1995, or during the six months ended June 30,
1997 and 1996.

A reconciliation of the tax provision at the statutory Federal income tax
rate and the Company's actual provision for income tax is as follows.
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
---------------------- ----------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
---------- ---------- ---------- ----------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Tax at statutory rate............................................ $ 115,702 $ 206,283 $ 348,106 $ 253,894
State income taxes, less Federal benefit......................... -- -- -- 10,961
Other, net....................................................... -- -- -- (3,491)
---------- ---------- ---------- ----------
$ 115,702 $ 206,283 $ 348,106 $ 261,364
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>

F-35
<PAGE>
VIRGINIA GAS STORAGE COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

13. RELATED-PARTY TRANSACTIONS:

With the exception of sales and storage fees charged to outside third
parties, a significant portion of the Company's transactions is with VGC and
affiliated companies.

VGC provides certain general and administrative services for the Company.
These services include professional services, insurance coverage and
administrative services (with associated costs). Accordingly, management fees of
$105,000 and $180,000 have been charged to the Company by VGC for the years
ended December 31, 1996 and 1995, respectively, and zero and $90,000 for the six
months ended June 30, 1997 and 1996. Other transactions with affiliated
companies include purchases of natural gas, natural gas storage and technical
services provided for and by affiliated companies.

F-36
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of
Virginia Gas Distribution Company:

We have audited the accompanying balance sheet of Virginia Gas Distribution
Company as of December 31, 1996, and the related statements of income, changes
in stockholders' equity, and cash flows for the years ended December 31, 1996
and 1995. 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.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Virginia Gas Distribution
Company as of December 31, 1996, and the results of its operations and its cash
flows for the years ended December 31, 1996 and 1995, in conformity with
generally accepted accounting principles.

ARTHUR ANDERSEN LLP

Richmond, Virginia
March 7, 1997

F-37
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY

BALANCE SHEETS

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash.............................................................................. $ 34,529 $ 16,166
Accounts receivable............................................................... 393,717 151,752
Other current assets.............................................................. 148,783 154,920
Notes receivable.................................................................. 26,246 26,004
------------- ------------
Total current assets............................................................ 603,275 348,842
PROPERTY AND EQUIPMENT, net......................................................... 5,785,139 2,755,660
NOTES RECEIVABLE.................................................................... 4,360,450 3,413,066
DEFERRED TAX ASSET.................................................................. -- 1,995
OTHER ASSETS........................................................................ 1,099,160 546,798
------------- ------------
Total assets.................................................................... $ 11,848,024 $7,066,361
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt................................................. $ 40,376 $ 39,240
Accounts payable.................................................................. 1,563,010 462,095
Other current liabilities......................................................... 29,331 33,368
------------- ------------
Total current liabilities....................................................... 1,632,717 534,703
LONG-TERM DEBT...................................................................... 8,646,425 5,018,064
DEFERRED INCOME TAXES............................................................... 17,482 --
------------- ------------
Total liabilities............................................................... 10,296,624 5,552,767
------------- ------------
STOCKHOLDERS' EQUITY:
Common stock -- no par value, 100,000 shares authorized, 75,000 (unaudited) shares
issued and outstanding as of June 30, 1997; no par value, 75,000 issued and
outstanding as of December 31, 1996............................................. 1,500,000 1,500,000
Retained earnings................................................................. 51,400 13,594
------------- ------------
Total stockholders' equity...................................................... 1,551,400 1,513,594
------------- ------------
Total liabilities and stockholders' equity...................................... $ 11,848,024 $7,066,361
------------- ------------
------------- ------------
</TABLE>

The accompanying notes are an integral part of these balance sheets.

F-38
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY

STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE SIX MONTHS FOR THE YEARS ENDED
ENDED JUNE 30 DECEMBER 31
---------------------- ----------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
---------- ---------- ---------- ----------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUE:
Operating revenue........................................... $ 419,421 $ 299,092 $ 629,280 $ 556,052
Interest income............................................. 211,303 161,284 320,836 129,249
Other income................................................ 45,288 36,059 72,949 33,887
---------- ---------- ---------- ----------
676,012 496,435 1,023,065 719,188
---------- ---------- ---------- ----------
EXPENSES:
Purchased gas expense....................................... 238,996 146,573 330,332 234,297
Operation and maintenance expense........................... 38,386 22,365 55,032 50,563
Depreciation, depletion, and amortization................... 50,751 38,037 78,013 76,162
General and administrative.................................. 73,348 82,440 191,619 125,982
---------- ---------- ---------- ----------
401,481 289,415 654,996 487,004
---------- ---------- ---------- ----------
OTHER EXPENSE:
Interest.................................................... 200,955 170,125 358,158 147,915
Other....................................................... 16,293 13,487 3,676 9,140
---------- ---------- ---------- ----------
217,248 183,612 361,834 157,055
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES...................................... 57,283 23,408 6,235 75,129
PROVISION FOR INCOME TAXES...................................... 19,477 7,958 2,120 25,544
---------- ---------- ---------- ----------
NET INCOME...................................................... $ 37,806 $ 15,450 $ 4,115 $ 49,585
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
VIRGINIA GAS COMPANY'S EQUITY IN VIRGINIA GAS DISTRIBUTION
COMPANY'S EARNINGS............................................ $ 18,903 $ 7,725 $ 2,058 $ 24,792
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>

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

F-39
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY

STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
RETAINED
COMMON EARNINGS
STOCK (DEFICIT)
------------ ----------
<S> <C> <C>
Balance, December 31, 1994.............................................................. $ 1,500,000 $ (40,106)
Net income............................................................................ -- 49,585
------------ ----------
Balance, December 31, 1995.............................................................. 1,500,000 9,479
Net income............................................................................ -- 4,115
------------ ----------
Balance, December 31, 1996.............................................................. 1,500,000 13,594
Net income (unaudited)................................................................ -- 37,806
------------ ----------
Balance, June 30, 1997 (unaudited)...................................................... $ 1,500,000 $ 51,400
------------ ----------
------------ ----------
</TABLE>

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

F-40
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 37,806 $ 15,450 $ 4,115 $ 49,585
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation, depletion, and amortization.............. 50,751 38,037 78,013 76,162
Deferred income taxes.................................. 19,477 7,062 2,120 22,197
(Increase) decrease in accounts receivable............. (241,965) (24,680) 52,074 (108,776)
Decrease (increase) in receivable from affiliate....... -- 1,562,500 1,562,500 (1,562,500)
Decrease (increase) in other current assets............ 6,137 21,779 (3,220) (81,914)
Increase in other assets............................... (14,246) (8,648) (25,239) (6,973)
Increase (decrease) in accounts payable................ 1,100,915 (169,198) 227,747 68,609
(Decrease) increase in other current liabilities....... (4,037) (65,645) (70,345) 82,471
----------- ----------- ----------- -----------
Net cash provided by (used in) operating
activities................................... 954,838 1,376,657 1,827,765 (1,461,139)
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................... (3,070,452) (180,853) (674,263) (412,178)
Loans made to affiliated companies....................... (1,000,000) (1,500,000) (1,500,000) (500,000)
Payments received on notes receivable.................... 52,374 83,998 98,200 20,741
----------- ----------- ----------- -----------
Net cash used in investing activities.......... (4,018,078) (1,596,855) (2,076,063) (891,437)
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of loan principal................................ (20,503) (20,392) (42,223) (4,644)
Proceeds from new loans.................................. 3,650,000 -- -- 2,881,314
Payment of financing costs............................... (219,394) -- -- (66,368)
Establishment of financing reserve funds................. (328,500) -- -- (259,129)
----------- ----------- ----------- -----------
Net cash provided by (used in) financing
activities................................... 3,081,603 (20,392) (42,223) 2,551,173
----------- ----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH............................ 18,363 (240,590) (290,521) 198,597
CASH, beginning of period.................................. 16,166 306,687 306,687 108,090
----------- ----------- ----------- -----------
CASH, end of period........................................ $ 34,529 $ 66,097 $ 16,166 $ 306,687
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
SUPPLEMENTAL DISCLOSURE:
Interest paid............................................ $ 349,996 $ 316,564 $ 533,085 $ 97,181
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Income taxes paid........................................ $ -- $ -- $ -- $ --
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>

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

F-41
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY

NOTES TO FINANCIAL STATEMENTS

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

1. DESCRIPTION OF OPERATIONS:

Virginia Gas Distribution Company (the "Company") was organized during 1992
under the laws of the state of Virginia. The Company is 50 percent owned by
Virginia Gas Company ("VGC") and 50 percent owned by a private investor. The
primary business of the Company is to develop and operate natural gas
distribution systems, located primarily in the southwestern counties of the
Commonwealth of Virginia.

INTERIM FINANCIAL INFORMATION

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

USE OF ESTIMATES

REVENUE RECOGNITION

The Company recognizes revenue in the period the natural gas is delivered to
the customer.

PROPERTY AND EQUIPMENT

All direct and indirect costs relating to property acquisition, development
costs, and support equipment and facilities are capitalized as the properties
are obtained or the facilities are placed into service. The Company provides for
depreciation of property and equipment using the straight-line method over
estimated useful lives ranging from 5 to 30 years.

CAPITALIZED INTEREST

The Company capitalizes interest on expenditures for significant projects
while activities are in progress to bring the assets to their intended use.
Interest capitalized totaled $74,927 and $25,930 for the years ended December
31, 1996 and 1995, respectively. Interest capitalized totaled $145,580
(unaudited) and $46,439 (unaudited) for the six months ended June 30, 1997 and
1996, respectively.

F-42
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
OTHER ASSETS

Costs incurred in conjunction with financing transactions are amortized on a
basis that approximates the effective interest method.

INCOME TAXES

3. NOTES RECEIVABLE

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Note receivable from Virginia Gas Storage Company; interest receivable at 8.88%;
principal due in maturities of $3,000 to $53,000 from 1995 to 2017................. $ 561,141 $ 568,557
Notes receivable from Virginia Gas Storage Company; interest receivable at 9%;
principal due in maturities of $1,000 to $91,000 from 1999 to 2020................. 1,000,000 1,000,000
Note receivable from Virginia Gas Pipeline Company; interest receivable at 9%;
principal due in maturities of $1,000 to $91,000 from 1999 to 2020................. 965,000 1,000,000
Note receivable from Virginia Gas Storage Company; interest receivable at 9.5%;
principal due in maturities of $30,000 to $123,000 from 2002 to 2017............... 1,000,000 --
Note receivable from Virginia Gas Storage Company; interest receivable at 7.35%;
principal due in maturities of $6,000 to $36,000 from 1996 to 2023................. 467,767 470,798
Note receivable from Virginia Gas Exploration Company; interest receivable at 7.35%;
principal due in maturities of $5,000 to $30,000 from 1996 to 2023................. 392,788 395,333
Other................................................................................ -- 4,382
------------ ------------
4,386,696 3,439,070
Less--Current portion................................................................ (26,246) (26,004)
------------ ------------
$ 4,360,450 $3,413,066
------------ ------------
------------ ------------
</TABLE>

F-43
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

4. PROPERTY AND EQUIPMENT:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Pipelines............................................................................ $ 5,447,065 $2,343,856
Project and construction in progress................................................. 570,059 555,232
Other property and equipment......................................................... 56,802 104,386
------------ ------------
6,073,926 3,003,474
Less--Accumulated depreciation and amortization...................................... (288,787) (247,814)
------------ ------------
$ 5,785,139 $2,755,660
------------ ------------
------------ ------------
</TABLE>

5. OTHER ASSETS:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Restricted cash and investments-reserve funds........................................ $ 734,895 $ 396,285
Deferred debt issuance costs......................................................... 361,610 147,191
Other................................................................................ 2,655 3,322
------------ ------------
$ 1,099,160 $ 546,798
------------ ------------
------------ ------------
</TABLE>

6. LONG-TERM DEBT:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
(UNAUDITED)
Note payable to Virginia Gas Company; interest payable at 9.5%; principal payable in
maturities of $110,000 to $447,000 from 2002 to 2017............................... $ 3,650,000 $ --
Note payable to Virginia Gas Company; interest payable at 9%; principal payable in
maturities of $4,000 to $263,000 from 1999 to 2020................................. 2,879,214 2,879,214
Note payable to Virginia Gas Company; interest payable at 7.35%; principal payable in
maturities of $17,000 to $97,000 from 1996 to 2023................................. 1,276,561 1,284,833
Note payable to Virginia Gas Company; interest payable at 8.88%; principal payable in
maturities of $4,000 to $84,000 from 1995 to 2017.................................. 880,816 892,457
Note payable through 1997 with interest, secured by an asset with a book value of
$1,505............................................................................. 210 800
------------ ------------
8,686,801 5,057,304
Less--Current portion................................................................ (40,376) (39,240)
------------ ------------
Long-term debt....................................................................... $ 8,646,425 $5,018,064
------------ ------------
------------ ------------
</TABLE>

In February 1997, the Industrial Development Authority of Russell County,
Virginia (the "Russell County Authority"), issued its Subordinated Natural Gas
Facilities Revenue Bonds Series 1997 with

F-44
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

6. LONG-TERM DEBT: (CONTINUED)
principal of $9,100,000. A portion ($3,650,000) of the proceeds was allocated to
the Company by VGC and is being used to construct a natural gas distribution
facility in and around the town of Lebanon, Virginia.

In December 1995, the Industrial Development Authority of Buchanan County,
Virginia (the "Buchanan County Authority"), issued its Senior Subordinated
Natural Gas Facilities Revenue Bonds Series 1995 with principal of $3,750,000. A
portion ($2,879,214) of the proceeds was allocated to the Company by VGC which
was used by the Company to extend existing natural gas distribution facilities
in and around the town of Grundy, Virginia.

In January 1994, Russell County Authority issued its Natural Gas Revenue
Bond Series A and B with combined principal of $3,000,000. A portion
($1,300,000) of the proceeds was allocated to the Company by VGC which was used
by the Company to construct a natural gas distribution facility in and around
the town of Castlewood, Virginia.

In November 1994, the Buchanan County Authority issued its Natural Gas
Revenue Bond Series A with principal of $4,250,000. A portion ($922,857) of the
proceeds was allocated to the Company by VGC which was used by the Company to
construct a natural gas distribution facility in and around the town of Grundy,
Virginia.

As of December 31, 1996, principal payments on long-term debt for the next
five years are as follows:

7. SALES TO MAJOR CUSTOMERS:

One of the Company's customers accounted for 35 percent and 35 percent, one
customer accounted for 20 percent and 23 percent, while another customer
accounted for 14 percent and 16 percent, respectively, of operating revenue for
the years ended December 31, 1996 and 1995. One of the Company's customers
accounted for 39 percent and 37 percent, one customer accounted for 12 percent
and 14 percent, while another customer accounted for 21 percent and 22 percent,
respectively, of operating revenue for the six months ended June 30, 1997 and
1996.

F-45
<PAGE>
VIRGINIA GAS DISTRIBUTION COMPANY

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INCLUDING NOTES APPLICABLE TO UNAUDITED PERIODS)

8. INCOME TAXES:

The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEARS ENDED
JUNE 30 DECEMBER 31
-------------------- --------------------
<S> <C> <C> <C> <C>
1997 1996 1996 1995
--------- --------- --------- ---------

<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Current:
Federal........................................... $ -- $ 896 $ -- $ 3,347
State............................................. -- -- -- --
--------- --------- --------- ---------
-- 896 -- 3,347
--------- --------- --------- ---------
Deferred:
Federal........................................... 19,477 7,062 2,120 22,197
State............................................. -- -- -- --
--------- --------- --------- ---------
19,477 7,062 2,120 22,197
--------- --------- --------- ---------
$ 19,477 $ 7,958 $ 2,120 $ 25,544
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>

The significant components of deferred tax assets and liabilities are as
follows:

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
<S> <C> <C>
(UNAUDITED)
Deferred tax assets:
Net operating loss carryforward................................. $ 128,657 $ 128,657
----------- ------------
Deferred tax liabilities:
Capital assets.................................................. 146,139 126,662
----------- ------------
Net deferred tax (liabilities) assets......................... $ (17,482) $ 1,995
----------- ------------
----------- ------------
</TABLE>

The Company's actual provision for income tax as of December 31, 1996 and
1995, and for the six months ended June 30, 1997 and 1996, approximates the tax
provision at the statutory Federal income tax rate.

9. RELATED-PARTY TRANSACTIONS:

With the exception of sales to outside third parties, a significant portion
of the Company's transactions is with VGC and affiliated companies.

VGC provides certain general and administrative services for the Company.
These services include professional services, insurance coverage and
administrative services (with associated costs). Accordingly, management fees of
$14,000 and $24,000 have been charged to the Company by VGC for the years ended
December 31, 1996 and 1995, respectively, and zero and $12,000 for the six
months ended June 30, 1997 and 1996. Other transactions with affiliated
companies include purchases of natural gas, natural gas storage and technical
services provided for and by affiliated companies.

F-46
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

NO DEALER, SALESPERSON OR ANY OTHER 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 BY THE COMPANY. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION
WOULD BE UNLAWFUL.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 6
Use of Proceeds........................................................... 10
Common Stock Price Range.................................................. 11
Capitalization............................................................ 12
Dividend Policy........................................................... 12
Selected Consolidated Financial and Operating Data........................ 13
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 14
Business.................................................................. 20
Management................................................................ 29
Shares Eligible for Future Sale........................................... 34
Description of Securities................................................. 35
Underwriting.............................................................. 37
Legal Matters............................................................. 38
Experts................................................................... 38
Other Matters............................................................. 38
Available Information..................................................... 38
Glossary.................................................................. 39
Financial Statements...................................................... F-1
</TABLE>

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

UNTIL , 1997, ALL DEALERS EFFECTING TRANSACTIONS IN THE
REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE
REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATIONS OF
DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO
THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.

VIRGINIA GAS COMPANY

COMMON STOCK

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

PROSPECTUS

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

, 1997

FERRIS, BAKER WATTS
Incorporated

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Article VI of the Registrant's Bylaws provide that the Registrant shall
indemnify its officers, directors and employees to the full extent permitted by
Section 145 of the Delaware General Corporation Law.

Section 9 of the Underwriting Agreement filed as Exhibit 1.1 hereto provides
for reciprocal indemnification between the Registrant and Ferris, Baker Watts,
Incorporated against certain liabilities in connection with the offering
contemplated by this Registration Statement, including liabilities under the
Securities Act of 1933, as amended (the "Act").

ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Registrant in connection
with the Securities being registered. All of the amounts shown are estimates
except the SEC registration fee and the NASD filing fee. The SEC registration
fee is based on the average price of the Company's Common Stock as of July 22,
1997.

<TABLE>
<S> <C>
SEC Registration Fee......................................... $ 7,100
NASD Filing Fee.............................................. 2,843
NASDAQ Listing Fee........................................... 17,500
Blue Sky Fees and Expenses................................... 7,557
Accounting Fees and Expenses................................. 20,000
Legal Fees and Expenses...................................... 70,000
Printing Expenses............................................ 20,000
Transfer Agent's Fees........................................ 5,000
---------
Total.................................................. $ 150,000
---------
---------
</TABLE>

ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES

Set forth below is certain information concerning all sales of securities by
the Registrant during the past three years that were not registered under the
Act.

1. The following shares of Common Stock have been privately placed during
the past three years:

<TABLE>
<CAPTION>
TOTAL OFFERING
DATE NUMBER OF SHARES PURCHASER PRICE
- --------------------------- ----------------- ---------------------------------------------- ------------------
<S> <C> <C> <C>
August 3, 1996............. 15,000 Michael L. and Karen K. Edwards $ 90,000
August 3, 1996............. 15,000 Allan R. Poole, II 90,000
August 3, 1996............. 4,200 John D. Jessee 25,200
August 3, 1996............. 2,000 Mark N. Witt 12,000
August 3, 1996............. 2,000 Frank A. Merendino, Jr. 12,000
August 3, 1996............. 1,000 Lydia J. Sinemus 6,000
August 3, 1996............. 800 Bradley L. Swanson 4,800
July 30, 1996.............. 42,000 Allan R. Poole, II 252,000
May 31, 1996............... 800,058 Dr. James T. Martin 4,800,345
November 1, 1994........... 20,634 Marlene Kissler and Eric Verzuh, JT 200,000
</TABLE>

These shares were sold to employees of the Company, relatives and accredited
investors in reliance on Section 4(2) of the Act based on the limited number of
purchasers, their sophistication and close

II-1
<PAGE>
relationship to principals of the Company and access to information regarding
the Company as a result of these relationships.

2. The following shares of Common Stock have been issued as the result of
the exercise of stock options:

<TABLE>
<CAPTION>
TOTAL OFFERING
DATE NUMBER OF SHARES PURCHASER PRICE
- --------------------------- ----------------- --------------------------------------------- ------------------
<S> <C> <C> <C>
December 29, 1995.......... 5,159 David Street $ 25,000
December 21, 1995.......... 23,212 Frank A. Merendino, Jr. 45,000
December 20, 1995.......... 4,127 Scott R. Colson 8,000
December 20, 1995.......... 4,127 Sara L. Colson 8,000
December 13, 1995.......... 82,534 Marlene Kissler and Eric Verzuh, JT 400,000
July 5, 1995............... 5,159 Frank A. Merendino, Jr. 10,000
December 29, 1994.......... 32,292 Joan M. Edwards 62,600
December 29, 1994.......... 6,396 Mark N. Witt 12,400
</TABLE>

These stock options were issued to employees of the Company, relatives and
accredited investors and were issued in reliance on Section 4(2) of the Act
based on the limited number of purchasers, their sophistication and close
relationship to principals of the Company and access to information regarding
the Company as a result of these relationships. No underwriters were involved in
these transactions.

3. On September 28, 1995, 2,000 shares of the Registrant's Series A
Preferred Stock were issued to Sirrom Capital Corporation for an aggregate
purchase price of $2,000,000. This sale was made in reliance on Section 4(2) of
the Act. Sirrom Capital Corporation is a venture capital firm which qualifies as
an accredited investor and is extremely sophisticated. Sirrom Capital
Corporation had access to all the records of the Company before its purchase of
this stock. No underwriter was involved in this transaction. This Preferred
Stock was redeemed in February 1997.

4. On September 28, 1995, Registrant issued a warrant to Sirrom Capital
Corporation to purchase 54,163 shares of Registrant's Common Stock, at a
purchase price of $.0001 per share. The warrant was issued in consideration of
the purchase of the Series A Preferred Stock by Sirrom Capital Corporation.
Sirrom Capital Corporation is a venture capital firm which qualifies as an
accredited investor and is extremely sophisticated. This warrant was excercised
in February 1997. Sirrom Capital Corporation had access to all the records of
the Company before its purchase of this security. No underwriter was involved in
the transaction and the sale was made in reliance on Section 4(2) of the Act.

5. As of June 30, 1997, Registrant had options issued and outstanding to an
officer of the Company to purchase up to 2% of Registrant's Common Stock, or
127,920 shares, at an exercise price of $8.72 per share. No underwriter was
involved in the transaction and the option was issued in consideration of the
employee's services. The option was issued in reliance on Section 4(2) of the
Act. As an officer of the Company this option holder had full access to
information about the Company and is sophisticated.

6. As of July 1, 1997, Registrant had options issued and outstanding to
seven officers and employees of the Company to purchase 120,000 shares of the
Registrant's Common Stock at an exercise price of $10.00 per share. No
underwriter was involved in the transactions and the options were issued in
consideration of the employees' services. The options were issued in reliance on
Section 4(2) of the Act. As officers and employees of the Company the option
holders had full access to information about the Company and are sophisticated.

ITEM 27. EXHIBITS

The following is a complete list of Exhibits filed or incorporated by
reference as part of this Registration Statement.

II-2
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
- -----------
<C> <S>

1.1 Form of Underwriting Agreement*

3.1 Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to Virginia
Gas Company's Form SB-2 Registration No. 333-5362-NY)

3.2 Bylaws (incorporated by reference to Exhibit 3.2 to Virginia Gas Company's Form SB-2 Registration No.
333-5362- NY)

4.1 Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to Virginia Gas Company's
Form SB-2 Registration No. 333-5362-NY)

4.2 Loan Agreement between Industrial Development Authority of Russell County and Virginia Gas Company dated
as of February 1, 1997*

4.3 Promissory Note between Industrial Development Authority of Russell County and Virginia Gas Company dated
as of February 1, 1997*

4.4 Loan Agreement between Industrial Development Authority of Buchanan County, Virginia and Virginia Gas
Company dated as of November 1, 1994*

4.5 Promissory Note between Industrial Development Authority of Buchanan County, Virginia and Virginia Gas
Company dated as of November 1, 1994*

5.1 Opinion of Bright & Barnes a Professional Corporation as to the legality of the securities being
registered*

9.1 Shareholders' Agreement and Voting Trust (incorporated by reference to Exhibit 9.1 to Virginia Gas
Company's Form SB-2 Registration No. 333-5362-NY)

10.1 Series A Preferred Stock Securities Purchase Agreement by and between Virginia Gas Company and Sirrom
Capital Corporation (incorporated by reference to Exhibit 10.1 to Virginia Gas Company's Form SB-2
Registration No. 333- 5362-NY)

10.2 Stock Purchase Warrant issued by Virginia Gas Company to Sirrom Capital Corporation (incorporated by
reference to Exhibit 10.2 to Virginia Gas Company's Form SB-2 Registration No. 333-5362-NY)

10.3 Placement Agreement between Virginia Gas Company and Anderson & Strudwick Incorporated (incorporated by
reference to Exhibit 10.3 to Virginia Gas Company's Form SB-2 Registration No. 333-5362-NY)

10.4 Employment Agreement between Virginia Gas Company and Mark N. Witt (incorporated by reference to Exhibit
10.5 to Virginia Gas Company's Form SB-2 Registration No. 333-5362-NY)

10.5 Employment Agreement between Virginia Gas Company and Michael L. Edwards (incorporated by reference to
Exhibit 10.6 to Virginia Gas Company's Form SB-2 Registration No. 333-5362-NY)

10.6 Warrant to Anderson & Strudwick Incorporated (incorporated by reference to Exhibit 4.2 to Virginia Gas
Company's Form SB-2 Registration No. 333-5362-NY)

10.7 Lease Agreement between J.D. Morefield, et. al. and Virginia Gas Company (incorporated by reference to
Exhibit 10.7 to Virginia Gas Company's Form SB-2 Registration No. 333-5362-NY)

10.8 Firm Gas Storage Agreement between Virginia Gas Storage Company and Roanoke Gas Company*
</TABLE>

II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
- -----------
<C> <S>
10.9 Firm Storage Service Agreement between Virginia Gas Storage Company and Powell-Clinch Utility District
(incorporated by reference to Exhibit 10.9 to Virginia Gas Company's Form SB-2 Registration No.
333-5362-NY)

10.10 Firm Storage Service Agreement between Virginia Gas Storage Company and the Public Utility District of
Jefferson and Cocke Counties, Tennessee (incorporated by reference to Exhibit 10.10 to Virginia Gas
Company's Form SB-2 Registration No. 333-5362-NY)

10.11 Gas Storage Agreement between Virginia Gas Storage Company and United Cities Gas Company (incorporated by
reference to Exhibit 10.11 to Virginia Gas Company's Form SB-2 Registration No. 333-5362-NY)

10.12 Firm Gas Storage Agreement between Virginia Gas Storage Company and Knoxville Utilities Board
(incorporated by reference to Exhibit 10.12 to Virginia Gas Company's Form SB-2 Registration No.
333-5362-NY)

10.13 Winter Service Firm Natural Gas Sales Agreement between Virginia Gas Storage Company and Knoxville
Utilities Board (incorporated by reference to Exhibit 10.13 to Virginia Gas Company's Form SB-2
Registration No. 333- 5362-NY)

10.14 Agreement for Construction, Ownership and Operation of the Haysi Gathering System between Virginia Gas
Storage Company and Penn Virginia Resources Corporation (incorporated by reference to Exhibit 10.14 to
Virginia Gas Company's Form SB-2 Registration No. 333-5362-NY)

10.15 Interruptible Gathering Service Agreement between Columbia Gas Transmission Corporation and Virginia Gas
Storage Company (incorporated by reference to Exhibit 10.15 to Virginia Gas Company's Form SB-2
Registration No. 333-5362-NY)

10.16 Transfer Agreement between Virginia Gas Company and Tenneco Energy Resources Corporation (incorporated by
reference to Exhibit 10.16 to Virginia Gas Company's Form SB-2 Registration No. 333-5362-NY)

10.17 Promissory Note in principal amount of $1,725,000 in favor of Tenneco Energy Resources Corporation
(incorporated by reference to Exhibit 10.17 to Virginia Gas Company's Form SB-2 Registration No.
333-5362-NY)

10.18 Firm Storage contract between Virginia Pipeline Company and United Cities Gas Company

10.19 Pipeline Balancing Agreement between East Tennessee Natural Gas Company and Virginia Gas Pipeline Company
(incorporated by reference to Exhibit 10.19 to Virginia Gas Company's Form SB-2 Registration No.
333-5362-NY)

10.20 Warrant to Shareholders (incorporated by reference to Exhibit 10.20 to Virginia Gas Company's Form SB-2
Registration No. 333-5362-NY)

10.21 Amendment to Transfer Agreement between Virginia Gas Company and Tenneco Energy Marketing Company,
successor-in-interest to Tenneco Energy Resources Corporation (incorporated by reference to Exhibit 10.17
to Virginia Gas Company's Form 10-KSB for the fiscal year ended December 31, 1996)

10.22 Firm Storage Service Agreement between Virginia Gas Storage Company and Sevier County Utility District
(incorporated by reference to Exhibit 10.22 to Virginia Gas Company's Form 10-KSB for the fiscal year
ended December 31, 1996)

10.23 Firm Storage Service Agreement between Virginia Gas Storage Company and Natural Gas Utility District of
Hawkins County (incorporated by reference to Exhibit 10.23 to Virginia Gas Company's Form 10-KSB for the
fiscal year ended December 31, 1996)
</TABLE>

II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
- -----------
<C> <S>
10.24 Firm Storage Service Agreement between Virginia Gas Pipeline Company and Citizens Gas Utility District
(incorporated by reference to Exhibit 10.24 to Virginia Gas Company's Form 10-KSB for the fiscal year
ended December 31, 1996)

10.25 Firm Gas Storage Agreement between Virginia Gas Pipeline Company and Knoxville Utilities Board
(incorporated by reference to Exhibit 10.25 to Virginia Gas Company's Form 10-KSB for the fiscal year
ended December 31, 1996)

10.26 Underwriting Agreement between Virginia Gas Company and Anderson Strudwick Incorporated (incorporated by
reference to Exhibit 1.1 to Virginia Gas Company's Form SB-2 Registration No. 333-5362-NY)

10.27 Description of Stock Options issued to named executive officers

10.28 Amendment to the Firm Storage Service Agreement between Virginia Gas Storage Company and Powell-Clinch
Utility District dated as of .*

10.29 Firm Storage Service Contract between Virginia Gas Storage Company and Hawkins County Utility District
dated as of .*

10.30 Firm Storage Service Contract between Virginia Gas Pipeline Company and ALCOA dated as of
.*

10.31 Gas Transportation Agreement between Virginia Gas Distribution Company and East Tennessee Gas Company
dated as of November 1, 1996.*

21.1 Subsidiaries and Affiliates of the Registrant (incorporated by reference to Exhibit 21.1 to Virginia Gas
Company's Form 10-KSB for the fiscal year ended December 31, 1996)

23.1 Consent of Bright & Barnes a Professional Corporation (included in Exhibit 5.1)*

23.2 Consent of Arthur Andersen LLP

24.1 Powers of Attorney (included in signature page)

27.1 Financial Data Schedule (incorporated by reference to Exhibit 27.1 to Virginia Gas Company's Form 10-KSB
for the fiscal year ended December 31, 1996)
-------------------------
* To be filed by amendment.
</TABLE>

ITEM 28. UNDERTAKINGS

The undersigned Registrant hereby undertakes that it will:

(1) File, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement to:

(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933, as amended (the "Act");

(ii) Reflect in the prospectus any facts or events arising after the
effective date of the Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
Registration Statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in

II-5
<PAGE>
volume and price represent no more than a 20% change in the maximum
aggregate offering price set forth in the "Calculation of Registration Fee"
table in the effective Registration Statement;

(iii) Include any material information with respect to the plan of
distribution not previously disclosed in this Registration Statement or any
material change to such information in the Registration Statement.

Provided, however, that paragraphs (1)(i) and (1)(ii) do not apply if the
information required to be included in a post-effective amendment by those
paragraphs is contained in periodic reports filed by the Registrant pursuant to
Section 13 or Section 15(d) of the Securities and Exchange Act of 1934, as
amended (the "Exchange Act") that are incorporated by reference in the
Registration Statement.

(2) That, for the purpose of determining any liability under the Securities
Act, each such post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide offering
thereof.

(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.

Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers and controlling persons of the Registrant
pursuant to provisions of its Certificate of Incorporation, its Bylaws, or the
Delaware General Corporation Law, or otherwise, the Registrant has been advised
that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act, and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.

The undersigned Registrant hereby undertakes that:

(1) For purposes of determining any liability under the Act, the information
omitted from the form of prospectus filed as part of this Registration Statement
in reliance upon Rule 430A and contained in a form of prospectus filed by the
Registrant pursuant to Rule424(b)(1) or (4) or 497(h) under the Act shall be
deemed to be a part of this Registration Statement as of the time it was
declared effective.

(2) For the purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus shall be deemed to
be a new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.

The undersigned Registrant hereby undertakes to provide the underwriters, at
the closing specified in the underwriting Agreement, certificates in such
denominations and registered in the such names as required by the underwriters
to permit prompt delivery to each purchaser.

II-6
<PAGE>
SIGNATURES

In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB-2 and authorized this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Abingdon, Commonwealth of Virginia, on July 23, 1997.

VIRGINIA GAS COMPANY

BY: /S/ MICHAEL L. EDWARDS
-----------------------------------------
Michael L. Edwards
PRESIDENT AND CHIEF EXECUTIVE OFFICER

KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned officers and
directors of Virginia Gas Company hereby constitutes and appoints Michael L.
Edwards as his or her true and lawful attorney-in-fact and agent, with full
power of substitution , for him or her and in his or her name, place and stead
in any and all capacities to sign any or all amendments or post-effective
amendments to this Registration Statement, and to file the same, and with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he or she might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, or its substitutes, may
lawfully do or cause to be done by virtue hereof.

IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.

SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
President, Chief Executive
/s/ MICHAEL L. EDWARDS Officer and Chairman of
- ------------------------------ the Board of Directors July 23, 1997
Michael L. Edwards (Principal Executive
Officer)

/s/ KAREN K. EDWARDS Vice President, Secretary,
- ------------------------------ Treasurer and Director July 23, 1997
Karen K. Edwards

/s/ PETER C. EINSELEN Director
- ------------------------------ July 23, 1997
Peter C. Einselen

/s/ JOHN D. JESSEE Vice President and
- ------------------------------ Principal Financial July 23, 1997
John D. Jessee Officer

II-7

<PAGE>
Exhibit 10.18

FIRM STORAGE SERVICE AGREEMENT

THIS AGREEMENT, made and and entered into as of this 20th day of August,
1996, by and between VIRGINIA GAS PIPELINE COMPANY, a Virginia Corporation,
hereinafter referred to as "VGPC," and UNITED CITIES GAS COMPANY, an Illinois
and Virginia corporation, hereinafter referred to as "UCG."

WITNESSETH

WHEREAS, VGPC has undertaken to provide a firm storage service from its
Saltville, Virginia property; and

WHEREAS, UCG has requested storage service from said property on a firm
basis.

NOW, THEREFORE, the parties hereby agree as follows:

ARTICLE I

QUANTITY OF SERVICE

1.1 Subject to the terms and provisions of this Agreement and the
General Terms and Conditions applicable thereto, UCG has the right to
maintain in VGPC's Saltville storage facility ("Saltville") under the terms
of this Agreement an aggregate quantity of up to 300,000 dth (the "Maximum
Storage Quantity," or "MSQ"). VGPC's obligation to accept gas at the Delivery
Point specified on Exhibit A hereto for injection into storage on any day is
limited to the Maximum Daily Injection Quantity ("MDIQ") specified on Exhibit
A hereto. VGPC, at its sole discretion, may allow injections at rates above
the MDIQ on a best efforts, interruptible basis if such injections can be
made without adverse effect upon injections of other Customers or to VGPC's
operations.

1.2 VGPC shall redeliver a thermally equivalent quantity of gas to UCG
at the Delivery Point described on Exhibit A hereto. VGPC's obligation to
withdraw gas from storage for delivery at the Storage Point on any day is
limited to the available Maximum Daily Withdrawal Quantity ("MDWQ") specified
on Exhibit A hereto. VGPC, at its sole discretion, may allow withdrawals at
rates higher than the MDWQ on a best efforts, interruptible basis if such
withdrawals can be made without adverse effect upon withdrawals of other
Customers or to VGPC's operations and such gas is available from UCG's
Storage Gas Balance.

<PAGE>

ARTICLE II

CONDITIONS OF SERVICE

2.1 UCG shall pay VGPC $0.05 per each dth injected and $0.05 per each
dth withdrawn. Subject to the provisions of Section 2.3, UCG will pay VGPC an
annual storage charge ("Annual Storage Charge") which shall be the product of
$5.64 multiplied by the Maximum Storage Quantity, which fee shall be payable
in twelve (12) equal monthly installments.

2.2 VGPC shall reimburse UCG for any injected gas that cannot be
withdrawn for delivery to UCG from Saltville at Inside FERC index for
deliveries into Tennessee Gas, Zone 1, plus interruptible transportation on
Tennessee Gas and East Tennessee.

2.3 On May 1, 1997 and each May 1 thereafter, VGPC shall pro-rate the
Annual Storage Charge for the year retroactively and prospectively to reflect
any deficiencies in performance in the prior Withdrawal Period as follows:

Adjusted Annual Actual MSQ Actual MDWQ
---------------- --------------
Storage Charge = Contract MSQ X Contract MDWQ X $5.64 X 300,000

UCG's election to use the storage service at levels below the MSQ and MDWQ
shall not be considered deficiencies in performance.

2.4 UCG shall insure that the gas delivered to VGPC at the Delivery
Point for injection into Saltville meets the minimum quality specifications
of East Tennessee Natural Gas Company's FERC Tariff. VGPC shall insure that
gas delivered to UCG at the Delivery Point meets the minimum quality
specifications of East Tennessee Natural Gas Company's FERC Tariff.

2.5 The measurement of quantities for billing purposes, in MMBtu,
delivered to or received from VGPC shall be performed by East Tennessee
Natural Gas Company.

2.6 The charges described herein for Saltville services shall be
subject to the approval of the Virginia State Corporation Commission ("VSCC")
pursuant to the appropriate rate schedule and gas tariff. However, regardless
of the rates approved by the VSCC, the rates set forth in this Article shall
be the maximum rates for the term of this contract. In the event the VSCC
shall approve a rate less than the rates specified in this Article, VGPC will
charge, for the term of the contract, UCG whichever rate is lower. If during
the term of the contract, the VSCC shall require VGPC to lower its rates,
VGPC shall

<PAGE>

immediately reflect those changes to UCG's rates. If at anytime the VSCC
should disallow the pass-through or collections by UCG of the charges which
are the subject of this Agreement, the Agreement shall be considered null and
void and the obligation of the parties shall be terminated with the exception
of resolving any balances, imbalances, payments, etc. which occur prior to
the VSCC action.

ARTICLE III

NOTICES

3.1 Notices hereunder shall be given to the respective party at the
applicable address, telephone number or facsimile machine number stated
below, or such other addresses, telephone numbers or facsimile numbers as the
parties shall respectively hereafter designate in writing from time to time:

Virginia Gas Pipeline Company
P.O. Box 2407
120 South Court Street
Abingdon, Virginia 24210
Attention: Michael L. Edwards
Telephone Number: (703) 676-2380, extension 17
Facsimile Machine Number: (703) 676-0151

United Cities Gas Company
5300 Maryland Way
Brentwood, TN 37027
Attention: Ron McDowell
Vice President/Gas Supply
Telephone Number: (615) 373-0104, extension 582
Facsimile Machine Number: (615) 790-9337

ARTICLE IV

BILLING AND PAYMENT

4.1 On or before the fifteenth (15th) day of each calendar month, VGPC
shall submit to UCG an invoice for services performed during the preceeding
month. In no event shall UCG pay for any services prior to the facilities
being completed and available for use.

4.2 UCG shall pay the amounts invoiced by the twenty-fifth (25th) day of
each month in which said invoice is received by UCG or within ten (10) days
of UCG's receipt of VGPC's invoice.

<PAGE>

4.3 Should UCG fail to pay all of the amount of any invoice as herein
provided when such amount is due, UCG shall pay a charge for late payment
which shall be included by VGPC on the next regular monthly invoice rendered
hereunder. Such charge for late payment shall accrue interest at an annual
rate equivalent to the then current Chase Manhattan Bank prime interest rate
plus two percent(2%), but not to exceed the maximum rate permitted by law. If
such failure to pay continues for thirty (30) days after payment is due, VGPC,
in addition to any other remedy it may have, may suspend further injections
and/or withdrawals of gas for UCG's account until such amount is paid;
provided, however, that if UCG, in good faith, disputes the amount of any
such invoice or part thereof and pays to VGPC such amounts as UCG concedes to
be correct, and, at any time thereafter within thirty (30) days of a demand
made by VGPC, furnishes a good and sufficient surety bond in an amount and
with sureties satisfactory to VGPC conditioned upon the payment of any
amounts ultimately found due upon such invoices after a final determination,
which may be reached either by agreement or judgement of the courts, as the
case may be, then VGPC shall not be entitled to suspend further injections
and/or withdrawals of gas unless and until default be made in the conditions
on such bond or there is a subsequent default under the conditions of this
agreement.

4.4 in the event any overcharge or undercharge in any form whatsoever
shall be found within twenty-four (24) months from the date a billing
discrepancy occurs, the appropriate party shall refund the amount of
overcharge or pay the amount of undercharge within thirty (30) days after the
final determination of the amount overcharged or undercharged has been made.
Any overcharge or undercharge found after such twenty-four (24) months shall
be deemed waived by both parties.

4.5 Both parties hereto shall have the right, at any and all reasonable
times, to examine the books and records of the other party to the extent
necessary to verify the accuracy of any statement, charge, computation or
demand made under or pursuant to this Agreement.

4.6 It is expressly understood that VGPC retains a landlord's lien
against the personal property of UCG stored hereunder for the recovery of any
and all amounts which may become due and payable under this agreement.

ARTICLE V

TERM

5.1 Subject to the provisions hereof, this Agreement shall become

<PAGE>

effective as of the date first written above and shall be in full force and
effect for a primary term through April 30, 2011 (the "Termination Date") and
shall continue and remain in force and effect for successive terms of one (1)
year each hereafter unless and until cancelled by either party giving 180
days written notice to the other party prior to the end of the primary term
and any yearly extension thereof.

5.2 United Cities shall maintain a right of first refusal on an amount
equal to the MSQ by matching competing offers for a period of five years
after the expiration of the primary term, or until April 30, 2016 (the
"Option Period"). If at any time during the Option Period, VGPC receives a
bona fide offer from a third party to use said amount of capacity, VGPC shall
give UCG written notice of such offer (an "Option Notice") and shall make
such storage capacity available to UCG on the same terms and at the same
price per dt which is set forth in such bona fide offer which VGPC is willing
to accept. If UCG declines to use such storage capacity or fails to accept
such storage capacity within a thirty day period (the "Option Exercise
Period") after receiving the Option Notice, VGPC shall be free to make such
storage capacity available to the third party.

ARTICLE VI

INDEMNITY

6.1 UCG Shall be deemed to have the exclusive control and possession of
the Gas until delivered to VGPC at the Delivery Point and after the Gas is
redelivered to UCG at the Delivery Point pursuant to Sections 1.1 and 1.2
hereof. VGPC shall be deemed to have the exclusive control and possession of
the Gas after it has been delivered to VGPC at the Delivery Point, until
such time as the Gas is redelivered to UCG at the Delivery Point pursuant to
Sections 1.1 and 1.2 hereof.

6.2 The party in control of the Gas will defend, indemnify and hold the
other harmless from and against any and all claims, causes of action or
judgements (including attorney's fees and expenses) in any way arising with
respect to the Gas while in that party's control, and the other shall not be
liable for any part thereof.

ARTICLE VII

FORCE MAJEURE

7.1 Subject to the provisions of this Article VII, no party shall be
liable to the other party for the failure to perform in conformity with this
Agreement

<PAGE>

to the extent such failure results from an event of Force Majeure which is
beyond the reasonable control of the party affected thereby, which wholly or
partially prevents the supply, transportation, sale, delivery, injection,
storage, withdrawal, or redelivery of Gas, except that it is expressly
understood by UCG and VGPC that the occurrence of an event of Force Majeure
will not excuse VGPC of its obligations under Section 2.2 hereof for a period
in excess of one month after the Termination Date.

7.2 Events of Force Majeure shall include, by way of illustration, but
not limitation: acts of God, strikes, lockouts or other industrial
disturbances, acts of public enemy, wars, insurrections, floods, and the
operation of Governmental Authority (other than at the request of the party
claiming inability to perform), earthquakes and fires, it being understood
and agreed by the parties hereto that the failure to hold the Maximum Storage
Quantity, the inability of VGPC to withdraw the MDWQ from the field and the
failure or breakage of any of VGPC's equipment, machinery or pipelines
shall not constitute Force Majeure.

7.3 Immediately upon becoming aware of the occurrence of an event of
Force Majeure, the party affected shall give notice thereof to the other
party, describing such event and stating the specific obligations, the
performance of which are, or are expected to be, delayed or prevented, and
(either in the original or in supplemental notices) stating the estimated
period during which performance may be suspended or reduced, including, to
the extent known or ascertainable, the estimated extent of such reduction of
performance. Such notice of an event of Force Majeure is to be first given
by telephone communication, and then shall be confirmed in writing within
five (5) days, giving particulars available to the reporting party, and being
supplemented if necessary within twenty (20) days to give full particulars.
Not withstanding any other provision in this Agreement, the parties mutually
agree that should some cause or event, beyond the control of VGPC, make it
appear to VGPC that the storage area is losing pressure and may no longer be
viable for storage, it may immediately notify UCG (by fax, phone or other
means) and UCG shall immediately start accepting the stored gas in order to
drain the storage area and cut down on the potential loss to VGPC, or VGPC
may otherwise dispose of such gas and pay UCG for the value thereof plus the
value of any gas otherwise lost. Thereafter this Agreement shall be
considered of no further force and effect unless VGPC can reasonably
revitalize and stabilize such storage area to hold gas pressure in which
event VGPC shall give the thirty (30) day notice as provided in Section 2.1
and the Agreement shall thereafter continue in full force and effect.

7.4 The party relying upon an event of Force Majeure shall act prudently
and use all reasonable efforts to eliminate the effects of Force Majeure as

<PAGE>

soon as reasonably practicable, provided that the settlement of strikes and
lockouts shall be entirely within the discretion of the party affected.

7.5 No suspension or reduction of performance by reason of an event of
Force Majeure shall invalidate this Agreement, and upon removal of the Force
Majeure, performance shall resume in this Agreement as soon as practicable.

7.6 To the event that there is a Force Majeure event, UCG shall not be
responsible for payment of any charges including storage capacity charges, as
a result of services not received.

ARTICLE VIII

OPERATIONAL FLOW ORDERS

8.1 UCG may be subject to certain operational flow orders ("OFO's")
issued by VGPC: (a) to alleviate conditions that threaten the integrity of
VGPC's system; (b) to maintain pressures necessary for VGPC's operations; (c)
to alleviate operational problems arising from overdeliveries or
underdeliveries by UCG in violation of this Agreement; and (d) to prevent
damage to the Saltville storage field.

8.2 Upon the issuance of an OFO, UCG must take the actions set forth in
the OFO, which may include, but are not limited to, reducing its withdrawals
from storage.

ARTICLE IX

SUCCESSORS AND ASSIGNS

9.1 This Agreement shall be binding upon and inure to the benefit of
the successors, assigns and legal representatives of the parties hereto.
Either party may freely assign this Agreement to a company which it controls,
is controlled by, or is under common control with, or any party succeeding to
substantially all the interests of UCG or VGPC. All other assignments shall
be subject to the prior written consent of the party not assigning, such
approval not to be unreasonably withheld. Either party hereto shall have the
right to pledge or mortgage its respective rights hereunder for security of
its indebtedness without the prior written consent of the other party.

<PAGE>

ARTICLE X

MISCELLANEOUS

10.1 This Agreement constitutes the entire Agreement between the
parties and no waiver by VGPC or UCG of any default of either party under
this Agreement shall operate as a waiver of any subsequent default whether of
a like or different character.

10.2 The laws of the Commonwealth of Virginia shall govern the
validity, construction, interpretation, and effect of this Agreement.

10.3 No modification of or supplement to the terms and provisions
hereof shall be or become effective except by execution of a supplementary
written agreement between the parties.

10.4 Exhibit A attached to this Agreement constitutes a part of this
Agreement and is incorporated herein.

10.5 VGPC covenants and agrees that it will take such action as may be
reasonably necessary to qualify as a Public Service Corporation under the
laws of the Commonwealth of Virginia and will apply to have this Agreement
and the rates hereunder approved by the VSCC. In the event VGPC is unable so
to qualify and obtain approval from the VSCC within a reasonable period of
time, it will promptly file for authority from the Federal Energy Regulatory
Commission to engage in the gas storage business. Should VGPC be unable to
obtain such approval from either commission, this Agreement shall be of no
further force and effect. In the event VGPC obtains approval but the agreed
storage, injection and withdrawal charges are reduced to the point VGPC feels
the project is not financially viable, it may so notify UCG in writing and
this Agreement shall be of no further force and effect.

10.6 UCG warrants that all gas received by it from Saltville will be
ultimately consumed within the Commonwealth of Virginia.

10.7 If, after proceeding with due diligence, VGPC is unable to provide
the firm storage service contemplated herein by August 31, 1996, VGPC shall
continue to proceed with due diligence to complete arrangements for such
service, and commence the firm storage service for UCG at the earliest
practicable date thereafter.

10.8 VGPC appoints UCG as its sole and exclusive agent for sales of gas
storage and transportation services from Saltville to retail customers in
UCG's Virginia territory for the life of this Agreement. VGPC recognizes that

<PAGE>

Saltville is located within UCG's certificated gas distribution territory in
the Commonwealth of Virginia ("UCG's Virginia territory") and intends to
honor all of UCG's rights and privileges associated with said territory in
accordance with Virginia statute and/or regulation. VGPC warrants that it
will not seek authority in its Saltville gas storage certificate of public
convenience and necessity to provide any gas storage, distribution or
transportation service to retail customers in UCG's Virginia territory. VGPC
further warrants that it shall not use its Saltville facilities to directly
provide gas storage, distribution or transportation service to any retail
customers in UCG's Virginia territory or to any marketers, brokers or
producers that directly serve retail customers in UCG's Virginia territory,
unless directed to do so by the Virginia State Corporation Commission, or any
other regulatory agency or judicial authority. Under this Section 10.8, VGPC
shall include any company under common management or control with VGPC,
including but not limited to Virginia Gas Company, Virginia Gas Storage
Company, Virginia Gas Distribution Company, or Virginia Gas Exploration
Company.

IN WITNESS WHEREOF, this Agreement has been executed as of the date first
written above by the parties' duly authorized officers.

Attest: UNITED CITIES GAS COMPANY

By: /s/ Glenn B. Rogers
- ---------------------------------- -----------------------------

Its: SVP
---------------------------

Attest: VIRGINIA GAS PIPELINE COMPANY

/s/ Mark L. Witt By: /s/ M.C. Edwards
- ---------------------------------- -----------------------------

Its: President
----------------------------

<PAGE>

EXHIBIT A

to that certain Gas Storage Agreement dated August 20, 1996 by and
between

UNITED CITIES GAS COMPANY

and

VIRGINIA GAS PIPELINE COMPANY

Delivery Point: Saltville receipt/delivery point, Smyth County, VA.

For Injections: ETNG Meter Number 759766.

For Withdrawals: ETNG Meter Number 759777

Maximum Daily Injection Quantity, in dth:

15,000

Maximum Daily Withdrawal Quantity, in dth:

30,000

<PAGE>

Exhibit 10.27

Description of Stock Options issued to Named Executive Officers

The Board of Directors of the Company has approved the issuance of
stock options for 120,000 shares of the Company's Common Stock to key employees.
The Company has issued options for a total of 90,000 shares to the following
executive officers named in this registration statement:

Name Shares
---- ------

Alan R. Poole, II 40,000
Frank A. Merendino, Jr. 30,000
Stacey D. Varney 10,000
John D. Jessee 10,000

The options vest as follows: one third on July 1, 1998, one third on
July 1, 1999 and one third on July 1, 2000. The options have an exercise price
of $10.00 per share and are exercisable until June 30, 2002.

<PAGE>

Exhibit 10.31

GAS TRANSPORTATION AGREEMENT
(For Use Under Rate Schedules FT-A and FT-GS)

THIS AGREEMENT is made and entered into as of the 1st day of November, 1996,
by and between EAST TENNESSEE NATURAL GAS COMPANY, a Tennessee Corporation,
hereinafter referred to as "Transporter" and VIRGINIA GAS DISTRIBUTION
COMPANY, a Virginia Corporation, hereinafter referred to as "Shipper."
Transporter and Shipper shall be referred to herein individually as the
"Party" and collectively as "Parties."

ARTICLE I - DEFINITIONS

The definitions found in Section 1 of Transporter's General Terms and
Conditions are incorporated herein by reference.

ARTICLE II - SCOPE OF AGREEMENT

Transporter agrees to accept and receive daily, on a firm basis, at the
Receipt Point(s) listed on Exhibit A attached hereto, from shipper such
quantity of gas as Shipper makes available up to the applicable
Transportation Quality stated on Exhibit A attached hereto and deliver for
Shipper to the Delivery Point(s) listed on Exhibit A attached hereto an
Equivalent Quantity of gas. The Rate Schedule applicable to this Agreement
shall be stated on Exhibit A.

ARTICLE III - RECEIPT AND DELIVERY PRESSURES

Shipper shall deliver, or cause to be delivered, to Transporter the gas to be
transported hereunder at pressures sufficient to deliver such gas into
Transporter's system at the Receipt Point(s). Transporter shall deliver the
gas to be transported hereunder to or for the account of Shipper at the
pressures existing in Transporter's system at the Delivery Point(s) unless
otherwise specified on Exhibit A.

ARTICLE IV - QUALITY SPECIFICATIONS AND STANDARDS FOR
MEASUREMENTS

For all gas received, transported, and delivered hereunder, the Parties agree
to the quality specifications and standards for measurement as provided for
in Transporter's General Terms and Conditions. Transporter shall be
responsible for the operation of measurement facilities at the Delivery
Point(s) and Receipt Point(s). In the event that measurement facilities are
not operated by Transporter, the responsibility for operations shall be
deemed to be Shipper's.

<PAGE>

GAS TRANSPORTATION AGREEMENT
(For Use Under Rate Schedules FT-A and FT-GS)

ARTICLE V - FACILITIES

The facilities necessary to receive, transport, and deliver gas as described
herein are in place and no new facilities are anticipated to be required.

ARTICLES VI

RATES AND CHARGES FOR GAS TRANSPORTATION

6.1 Rates and Charges - Commencing on the date of implementation of
this Agreement under Section 10.1, the compensation to be paid by
Shipper to Transporter shall be in accordance with Transporter's
effective Rate Schedule FT-A or FT-GS, as specified on Exhibit A.
Where applicable, Shipper shall also pay the Gas Research
Institute surcharge and Annual Charge Adjustment surcharge as
such rates may change from time to time.

6.2 Changes in Rates and Charges - Shipper agrees that Transporter
shall have the unilateral right to file with the appropriate
regulatory authority and make changes effective in (a) the rates
and charges stated in this Article, (b) the rates and charges
applicable to service pursuant to the Rate Schedule under which
this service is rendered and (c) any provisions of Transporter's
General Terms and Conditions as they may be revised or replaced
from time to time. Without prejudice to Shipper's right to contest
such changes, Shipper agrees to pay the effective rates and
charges for services rendered pursuant to this Agreement.
Transporter agrees that Shipper may protest or contest the
aforementioned filings, or may seek authorization from duly
constituted regulatory authorities for adjustment of Transporter's
existing FERC Gas Tariff as may be found necessary to assure
Transporter's existing FERC Gas Tariff as may be found necessary
to assure Transporter just and reasonable rates.

ARTICLE VII - RESPONSIBILITY DURING TRANSPORTATION

As between the parties hereto, it is agreed that from the time gas is
delivered by Shipper to Transporter at the Receipt Point(s) and prior to
delivery of such gas to or for the account of Shipper at the Delivery
Point(s), Transporter shall be responsible for such gas and shall have the
unqualified right to commingle such gas with other gas in its system and
shall have the unqualified right to handle and treat such gas as its own.
Prior to receipt of gas at

<PAGE>

GAS TRANSPORTATION AGREEMENT
(For Use Under Rate Schedules FT-A and FT-GS)

Shipper's Receipt Point(s) and after delivery of gas at Shipper's Delivery
Point(s), Shipper shall have sole responsibility for such gas.

ARTICLE VIII - BILLINGS AND PAYMENTS

Billings and payments under this Agreement shall be in accordance with
Section 16 of Transporter's General Terms and Conditions as they may be
revised or replaced from time to time.

ARTICLE IX - RATE SCHEDULES AND
GENERAL TERMS AND CONDITIONS

This Agreement is subject to the effective provisions of Transporter's FT-A
or FT-GS Rate Schedule, as specified in Exhibit A, or any succeeding rate
schedule and Transporter's General Terms and Conditions on file with the
FERC, or other duly constituted authorities having jurisdiction, as the same
may be changed or superseded from time to time in accordance with the rules
and regulations of the FERC, which Rate Schedule and General Terms and
Conditions are incorporated by reference and made a part hereof for all
purposes.

ARTICLE X - TERM OF CONTRACT

10.1 This Agreement shall be effective as of the 1st day of November,
1996, and shall remain in force and effect until 31st day of
October, 2006, ("Primary Term"), provided, however, that if the
Primary Term is one year or more, then the contract shall remain
in force and effect and the contract term will automatically
roll-over for additional five year increments ("Secondary Term")
unless Shipper, one year prior to the expiration of the Primary
Term or a Secondary Term, provides written notice to Transporter
of either (1) its intent to terminate the contract upon
expiration of the then current term or (2) its desire to
exercise its right-of-first-refusal in accord with Section 7.3 of
Transporter's General Terms and Conditions. Provided further, if
the FERC or other governmental body having jurisdiction over the
service rendered pursuant to this Agreement authorizes
abandonment of such service, this Agreement shall terminate on
the abandonment date permitted by the FERC or such other
governmental body.

<PAGE>

GAS TRANSPORTATION AGREEMENT
(For Use Under Rate Schedules FT-A and FT-GS)

10.2 In addition to any other remedy Transporter may have, Transporter
shall have the right to terminate this Agreement in the event
Shipper fails to pay all of the amount of any bill for services
rendered by Transporter hereunder when that amount is due, provided
Transporter shall give Shipper and the FERC thirty days notice
prior to any termination of service. Service may continue hereunder
if within the thirty day notice period satisfactory assurance of
payment is made in accord with Section 16 of Transporter's General
Terms and Conditions.

ARTICLE XI - REGULATION

11.1 This Agreement shall be subject to all applicable governmental
statutes, orders, rules, and regulations and is contingent upon
the receipt and continuation of all necessary regulatory approvals
or authorizations upon terms acceptable to Transporter and Shipper.
This Agreement shall be void and of no force and effect if any
necessary regulatory approval or authorization is not so obtained or
continued. All Parties hereto shall cooperate to obtain or continue
all necessary approvals or authorizations, but no Party shall be
liable to any other Party for failure to obtain or continue such
approvals or authorizations.

11.2 Promptly following the execution of this Agreement, the Parties
will file, or cause to be filed, and diligently prosecute, any
necessary applications or notices with all necessary regulatory
bodies for approval of the service provided for herein.

11.3 In the event the Parties are unable to obtain all necessary and
satisfactory regulatory approvals for service prior to the
expiration of two (2) years from the effective date hereof, then,
prior to receipt of such regulatory approvals, either Party may
terminate this Agreement by giving the other Party at least thirty
(30) days prior written notice, and the respective obligations
hereunder, except for the reimbursement of filing fees herein, shall
be of no force and effect from and after the effective date of such
termination.

11.4 The transportation service described herein shall be provided
subject to the provisions of the FERC Regulations shown by Shipper
on Exhibit A hereto.

<PAGE>

GAS TRANSPORTATION AGREEMENT
(For Use Under Rate Schedules FT-A and FT-GS)

ARTICLE XII - ASSIGNMENTS

12.1 Either Party may assign or pledge this Agreement and all rights and
obligations hereunder under the provisions of any mortgage, deed of
trust, indenture or other instrument that it has executed or may
execute hereafter as security for indebtedness: otherwise, Shipper
shall not assign this Agreement or any of its rights and obligations
hereunder, except as set forth in Section 17 of Transporter's
General Terms and Conditions.

12.2 Any person or entity that shall succeed by purchase, transfer,
merger, or consolidation to the properties, substantially or as an
entirety, of either Party hereto shall be entitled to the rights
and shall be subject to the obligations of its predecessor in
interest under this Agreement.

ARTICLE XIII - WARRANTIES

In addition to the warranties set forth in Section 22 of Transporter's
General Terms and Conditions, Shipper warrants the following:

13.1 Shipper warrants that all upstream and downstream transportation
arrangements are in place, or will be in place, as of the requested
effective date of service, and that it has advised the upstream and
downstream transporters of the receipt and delivery points under
this Agreement and any quantity limitations for each point as
specified on Exhibit A attached hereto. Shipper agrees to
indemnify and hold Transporter harmless for refusal to transport
gas hereunder in the event any upstream or downstream transporter
fails to receiver or deliver gas as contemplated by this Agreement.

13.2 Shipper agrees to indemnify and hold Transporter harmless from all
suit actions, debts, accounts, damages, costs, losses, and
expenses (including reasonable attorneys fees) arising from or out
of breach of any warranty, by the Shipper herein.

13.3 Shipper warrants that it will have title or the right to acquire
title to the gas delivered to Transporter under this Agreement.

<PAGE>

GAS TRANSPORTATION AGREEMENT
(For Use Under Rate Schedules FT-A and FT-GS)

13.4 Transporter shall not be obligated to provide or continue service
hereunder in the event of any breach of warranty; provided,
Transporter shall give Shipper and the FERC thirty days notice
prior to any termination of service. Service will continue if,
within the thirty day notice period, Shipper cures the breach of
warranty.

ARTICLE XIV - MISCELLANEOUS

14.1 Except for changes specifically authorized pursuant to this
Agreement, no modification of or supplement to the terms and
conditions hereof shall be or become effective until Shipper has
submitted a request for change through the TENN-SPEED 2 system
and Shipper has been notified through the TENN-SPEED 2 system
of Transporter's agreement to such change.

14.2 No waiver by any Party of any one or more defaults by the other
in the performance of any provision of this Agreement shall
operate or be construed as a waiver of any future default or
default, whether of a like or of a different character.

14.3 Except when notice is required through the TENN-SPEED 2 system,
pursuant to Transporter's FT-A or FT-GS Rate Schedule, as
applicable, or pursuant to Transporter's General Terms and
Conditions, any notice, request, demand, statement or bill provided
for in this Agreement or any notice that either Party may
desire to give to the other shall be in writing and mailed by
registered mail to the post office address of the Party intended
to receive the same, as the case may be, to the Party's address
shown on Exhibit A hereto or to such other address as either
Party shall designate by formal written notice to the other.
Routine communications, including monthly statements and
payments, may be mailed by either registered or ordinary mail.
Notice shall be deemed given when sent.

14.4 THE INTERPRETATION AND PERFORMANCE OF THIS AGREEMENT SHALL BE IN
ACCORDANCE WITH AND CONTROLLED BY THE LAWS OF THE STATE OF
TENNESSEE, WITHOUT REGARD TO CHOICE OF LAW DOCTRINE THAT REFERS
TO THE LAWS OF ANOTHER JURISDICTION.

14.5 The Exhibit(s) attached hereto is/are incorporated herein by
reference and made a part of this Agreement for all purposes.

14.6 If any provision of this Agreement is declared null and void, or
voidable, by a court of competent jurisdiction,

<PAGE>

GAS TRANSPORTATION AGREEMENT
(For Use Under Rate Schedules FT-A and FT-GS)

then that provision will be considered severable at Transporter's
options; and if the severability option is exercised, the
remaining provisions of the Agreement shall remain in full force
and effect.

14.7 This Agreement supersedes and cancels the Gas Sales and
Transportation Agreement(s) between Shipper and Transporter
dated (not applicable) and (not applicable) respectively.

IN WITNESS WHEREOF, the Parties hereto have caused this Agreement to be duly
executed as of the date first hereinabove written.

EAST TENNESSEE NATURAL GAS COMPANY

BY:
--------------------------------
Agent and Attorney-in-Fact

VIRGINIA GAS DISTRIBUTION COMPANY

BY: Frank Mexendino
--------------------------------
TITLE: Vice President
-----------------------------
DATE: 10/28/96
-----------------------------

<PAGE>

EXHIBIT A TO THE
FIRM TRANSPORTATION AGREEMENT
DATED NOVEMBER 1, 1996

Shipper: VIRGINIA GAS DISTRIBUTION COMPANY
Rate Schedule: FT-A
Service Package No.: 16730
Transportation Quantity: 350 Dth
Proposed Commencement Date: NOVEMBER 1, 1996
Termination Date: OCTOBER 31ST, 2006
Transportation Service will be provided under Part 284, Subpart G of FERC
Regulations.

Primary Receipt Point(s):
- -------------------------

Meter Max.D. Inter. Location
Name No. Qt. Party CO., ST
---- ------ ------- ----- ---------

SALTVILLE STOR.WD 759777 350 VIRGINIA GAS SMYTH, VA

Primary Delivery Point(s):
- --------------------------

Meter Max.D. Inter. Location
Name No. Qt. Party CO., ST
---- ------ ------- ----- ---------

VA GA - CASTLEWOOD 759148 350 VIRGINIA GAS RUSSELL, VA

*Transporter shall not be obligated to deliver more cubic feet of gas to any
Shipper than the quantity calculated using 1.03 dth per million cubic feet.

Notices not made through the TENN-SPEED 2 system shall be made to:

Shipper Invoices

VIRGINIA GAS DISTRIBUTION VIRGINIA GAS DISTRIBUTION CO.
P.O. BOX 2407 P.O. BOX 2407
ABINGDON, VA 24212 ABINGDON, VA 24212
ATTN: FRANK MERENDINO ATTN: FRANK MERENDINO

New Facilities Required: Not applicable
New Facilities Charge: Not applicable

<PAGE>

EXHIBIT A TO THE
FIRM TRANSPORTATION CONTRACT
DATED NOVEMBER 1, 1996

(This Exhibit A supersedes and cancels Exhibit A Dated (not applicable) to
the Firm Transportation Agreement dated (not applicable).

EAST TENNESSEE NATURAL GAS CO. VIRGINIA GAS DISTRIBUTION COMPANY

BY: /s/ Signature Illegible BY: /s/ Frank Merendino
------------------------ ---------------------

TITLE: AGENT AND ATTORNEY-IN-FACT TITLE: VICE PRESIDENT
--------------------------- ---------------

DATE: 10/11/96 DATE: 10/28/96
--------------------------- ----------------

<PAGE>

Exhibit 23.2

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the use of our
reports (and to all references to our Firm) included in this Form SB-2
Registration Statement.

ARTHUR ANDERSEN LLP

Richmond, Viriginia,
July 23, 1997