TRANSAMERICAN ENERGY CORP, 10-Q, 1997-12-15

TRANSAMERICAN ENERGY CORP
10-Q, 1997-12-15
PETROLEUM REFINING

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 31, 1997

Registration Number 33-85930

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

TRANSAMERICAN ENERGY CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 76-0441642
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1300 NORTH SAM HOUSTON PARKWAY EAST
SUITE 200
HOUSTON, TEXAS 77032
(Address of principal executive offices) (Zip Code)

(281) 986-8822
(Registrant's telephone number, including area code)

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

Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
The number of shares of common stock of the registrant outstanding on
December 15, 1997 was 9,000.

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<PAGE> 2
TRANSAMERICAN ENERGY CORPORATION

TABLE OF CONTENTS

PART I.
FINANCIAL INFORMATION

Item 1. Financial Statements
Condensed Consolidated Balance Sheet as of October 31, 1997 and January 31, 1997 . . . . . . . . 2
Condensed Consolidated Statement of Operations for the three and nine months ended
October 31, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statement of Cash Flows for the nine months ended
October 31, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . 25
Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . 37

PART II.
OTHER INFORMATION

Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Signature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

</TABLE>

1
<PAGE> 3
PART 1 - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TRANSAMERICAN ENERGY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
OCTOBER 31, JANUARY 31,
1997 1997
---------- -----------
<S> <C> <C>

ASSETS
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . $ 5,441 $ 24,179
Cash restricted for TransTexas interest and TARC operating expenses . . . . 19,726 46,000
Debt proceeds held in disbursement account - TARC . . . . . . . . . . . . 11,891 --
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,462 78,660
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,784 12,481
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,375 25,638
---------- ----------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . 97,679 186,958
---------- ----------

Property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,159,164 2,836,696
Less accumulated depreciation, depletion and amortization . . . . . . . . . 720,915 1,451,417
---------- ----------
Net property and equipment -- based on the full cost method of accounting
for gas and oil properties of which $148,089 and $158,973 was excluded
from amortization at October 31, 1997 and January 31, 1997, respectively 1,438,249 1,385,279
---------- ----------

Cash restricted for share repurchases - TransTexas . . . . . . . . . . . . . 136,879 --
Debt proceeds held in disbursement accounts . . . . . . . . . . . . . . . . . 256,230 --
Other assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111,161 41,498
---------- ----------
$2,040,198 $1,613,735
========== ==========

LIABILITIES AND STOCKHOLDER'S EQUITY

Current liabilities:
Current maturities of long-term debt . . . . . . . . . . . . . . . . . . . $ 9,726 $ 5,787
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88,220 48,202
Payable to affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,881 1,604
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 68,200 98,861
---------- ----------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . 171,027 154,454
---------- ----------

Due to affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,226 26,295
Notes payable to affiliate . . . . . . . . . . . . . . . . . . . . . . . . . -- 46,589
Long-term debt, less current maturities . . . . . . . . . . . . . . . . . . . 1,540,128 1,276,199
Revolving credit agreement . . . . . . . . . . . . . . . . . . . . . . . . . 11,329 26,268
Production payments, less current portion . . . . . . . . . . . . . . . . . . 6,696 11,931
Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 554,554
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 53,237 31,367
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,684 32,991
Redeemable preferred stock, $0.01 par value, 10,000 shares authorized;
Series A - 1,000 shares issued and outstanding at January 31, 1997 . . . . . -- 96

Commitments and contingencies (Note 5) . . . . . . . . . . . . . . . . . . . -- --

Stockholder's equity (deficit):
Common stock, $0.01 par value, 100,000 shares authorized; 9,000 shares
issued and outstanding . . . . . . . . . . . . . . . . . . . . . . . . . -- --
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . 269,647 158,535
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . (33,776) (148,508)
---------- ----------
235,871 10,027
Advances to affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . -- (57,036)
---------- ----------
Total stockholder's equity (deficit) . . . . . . . . . . . . . . . . . . 235,871 (47,009)
---------- ----------
$2,040,198 $1,613,735
========== ==========
</TABLE>

See accompanying notes to condensed consolidated financial statements.

2
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TRANSAMERICAN ENERGY CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>

THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
------------------------ ------------------------
1997 1996 1997 1996
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Gas, condensate and natural gas liquids . . . . . . . . $ 28,303 $ 70,287 $ 140,151 $ 226,532
Transportation . . . . . . . . . . . . . . . . . . . . -- 8,928 12,055 25,798
Product sales . . . . . . . . . . . . . . . . . . . . . -- -- -- 10,857
Gain on the sale of assets . . . . . . . . . . . . . . 7,482 80 540,411 7,842
Other . . . . . . . . . . . . . . . . . . . . . . . . . 1,975 103 2,592 460
--------- ----------- --------- ----------
Total revenues . . . . . . . . . . . . . . . . . . . 37,760 79,398 695,209 271,489
--------- ----------- --------- ----------

Costs and expenses:
Operating . . . . . . . . . . . . . . . . . . . . . . . 9,983 33,334 57,870 106,724
Depreciation, depletion and amortization . . . . . . . 16,498 32,502 73,895 97,667
General and administrative . . . . . . . . . . . . . . 11,696 17,335 41,463 42,998
Taxes other than income taxes . . . . . . . . . . . . . 3,020 2,985 12,555 18,240
Litigation settlement . . . . . . . . . . . . . . . . . -- -- -- (96,000)
--------- ----------- --------- ----------
Total costs and expenses . . . . . . . . . . . . . . 41,197 86,156 185,783 169,629
--------- ----------- --------- ----------
Operating income (loss) . . . . . . . . . . . . . . . (3,437) (6,758) 509,426 101,860
--------- ----------- --------- ----------

Other income (expense):
Interest income . . . . . . . . . . . . . . . . . . . . 7,830 1,025 16,944 3,146
Interest expense, net . . . . . . . . . . . . . . . . . (14,554) (22,328) (84,486) (76,449)
Gain on the sale of TransTexas stock . . . . . . . . . -- -- -- 56,162
Other, net . . . . . . . . . . . . . . . . . . . . . . 374 18 1,109 346
--------- ----------- --------- ----------
Total other income (expense) . . . . . . . . . . . . (6,350) (21,285) (66,433) (16,795)
--------- ----------- --------- ----------
Income (loss) before income taxes and extraordinary
item . . . . . . . . . . . . . . . . . . . . . . . . (9,787) (28,043) 442,993 85,065
Income taxes (benefit) . . . . . . . . . . . . . . . . . (712) (5,059) 171,771 2,729
---------- ----------- --------- ----------
Income (loss) before extraordinary item . . . . . . . (9,075) (22,984) 271,222 82,336
Extraordinary item - early extinguishment of debt (net of
income tax benefit of $38,793) . . . . . . . . . . . . 74 -- (156,465) --
--------- ----------- --------- ----------
Net income (loss) before preferred stock dividend $ (9,001) $ (22,984) $ 114,757 $ 82,336
========= =========== ========= ==========

Series A preferred stock dividend . . . . . . . . . . . . $ -- $ -- $ 19 $ 19
========= =========== ========= ==========

Net income (loss) available for common stockholders $ (9,001) $ (22,984) $ 114,738 $ 82,317
========= =========== ========= ==========

Net income (loss) per common share:
Income (loss) before extraordinary item . . . . . . . $ (1,008) $ (2,554) $ 30,136 $ 9,146
Extraordinary item . . . . . . . . . . . . . . . . . 8 -- (17,385) --
--------- ----------- --------- ----------
$ (1,000) $ (2,554) $ 12,751 $ 9,146
========= =========== ========= ==========

Weighted average number of shares outstanding . . . . . . 9,000 9,000 9,000 9,000
========= =========== ========= ==========

</TABLE>

See accompanying notes to condensed consolidated financial statements.

3
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TRANSAMERICAN ENERGY CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION> NINE MONTHS ENDED
OCTOBER 31,
---------------------------
1997 1996
----------- ----------
<S> <C> <C>
Operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 114,757 $ 82,336
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Extraordinary item . . . . . . . . . . . . . . . . . . . . . . . . 156,465 --
Depreciation, depletion and amortization . . . . . . . . . . . . . 73,895 97,667
Amortization of discount on long-term debt . . . . . . . . . . . . 22,703 83
Amortization of discount on subordinated notes . . . . . . . . . . 4,941 --
Amortization of debt issue costs . . . . . . . . . . . . . . . . . 2,923 7,660
Gain on the sale of assets . . . . . . . . . . . . . . . . . . . . (540,411) (7,842)
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . 171,771 (14,242)
Gain on the sale of TransTexas stock . . . . . . . . . . . . . . . -- (56,162)
Proceeds from volumetric production payments . . . . . . . . . . . -- 58,621
Repayment of volumetric production payments . . . . . . . . . . . . (45,134) --
Amortization of deferred revenue . . . . . . . . . . . . . . . . . (9,420) (27,070)
Changes in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . 47,198 (9,676)
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . (4,300) (617)
Other current assets . . . . . . . . . . . . . . . . . . . . . 9,263 2,837
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . 23,215 7,336
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . (33,258) 23,885
Transactions with affiliates, net . . . . . . . . . . . . . . . (77) (21,964)
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . (2,414) 3,802
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . 7,780 (9,464)
----------- ---------
Net cash provided (used) by operating activities . . . . . (103) 137,190
----------- ---------

Investing activities:
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . (488,800) (278,579)
Prepaid Capital Improvement Program costs . . . . . . . . . . . . . . . (21,096) --
Proceeds from the sale of assets . . . . . . . . . . . . . . . . . . . 1,035,188 91,559
Increase in cash restricted for interest and operating expenses . . . . (19,726) (46,000)
Withdrawals from cash restricted for interest . . . . . . . . . . . . . 46,000 46,000
Increase in cash restricted for TransTexas share repurchases . . . . . (399,284) --
Withdrawals from cash restricted for TransTexas share repurchases . . . 262,405 --
Advances to affiliate . . . . . . . . . . . . . . . . . . . . . . . . . (13,304) (24,750)
Payment of advances by affiliate . . . . . . . . . . . . . . . . . . . 56,354 --
Purchase of TARC warrants . . . . . . . . . . . . . . . . . . . . . . . (32,942) --
Purchase of treasury stock - TransTexas . . . . . . . . . . . . . . . . (61,424) --
----------- ---------
Net cash provided (used) by investing activities . . . . . 363,371 (211,770)
----------- ---------

Financing activities:
Issuance of long-term debt . . . . . . . . . . . . . . . . . . . . . . 1,367,706 25,480
Retirement of long-term debt . . . . . . . . . . . . . . . . . . . . . (1,324,333) --
Principal payments on long-term debt . . . . . . . . . . . . . . . . . (7,767) (17,827)
Increase in debt proceeds held in disbursement accounts . . . . . . . . (429,841) (26,549)
Withdrawals from disbursement accounts . . . . . . . . . . . . . . . . 161,720 50,949
Issuance of note payable . . . . . . . . . . . . . . . . . . . . . . . 36,000 --
Retirement of note payable . . . . . . . . . . . . . . . . . . . . . . (36,000) --
Issuance of dollar-denominated production payments . . . . . . . . . . . 20,977 16,903
Principal payments on production payments . . . . . . . . . . . . . . . (27,472) (34,348)
Net proceeds from the sale of TransTexas stock . . . . . . . . . . . . -- 42,607
Principal payments on capital lease obligations . . . . . . . . . . . . (1,109) (789)
Revolving credit agreement, net . . . . . . . . . . . . . . . . . . . . (14,939) (5,534)
Dividend payment on preferred stock . . . . . . . . . . . . . . . . . . (19) (19)
Advances from TransAmerican and affiliates to TARC . . . . . . . . . . 15,026 35,785
Repayment of advances from TransAmerican by TARC . . . . . . . . . . . (66,000) (1,925)
Dividend to TransAmerican . . . . . . . . . . . . . . . . . . . . . . . (23,000) --
Debt issue costs . . . . . . . . . . . . . . . . . . . . . . . . . . . (52,849) (4,284)
Redemption of Series A preferred stock . . . . . . . . . . . . . . . . (106) --
----------- ---------
Net cash provided (used) by financing activities . . . . . . . . . . . (382,006) 80,449
----------- ---------
Increase in cash and cash equivalents . . . . . . . . . . . (18,738) 5,869
Beginning cash and cash equivalents . . . . . . . . . . . . . . . . . . . . 24,179 14,114
----------- ---------
Ending cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . $ 5,441 $ 19,983
=========== =========
</TABLE>

See accompanying notes to condensed consolidated financial statements.

4
<PAGE> 6
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. GENERAL

TransAmerican Energy Corporation (the "Company" or "TEC") was formed on
July 12, 1994 to initially hold 55 million shares of common stock (74.3% of the
then outstanding shares) of TransTexas Gas Corporation ("TransTexas") and all of
the outstanding capital stock of TransAmerican Refining Corporation ("TARC").
TransAmerican Natural Gas Corporation ("TransAmerican") contributed 55 million
shares of TransTexas common stock and all of the capital stock of TARC to the
Company in connection with the public offering of TARC's senior secured notes
(the "TARC Notes"). The Company then contributed 15 million of these shares
(20.3% of the total then outstanding) of TransTexas common stock to TARC. In
March 1996, TARC sold 4.55 million shares (6.2% of the total outstanding) of
TransTexas common stock in public offerings. As a result of the transactions
described in Note 2, the Company now holds 39.6 million shares of TransTexas
common stock (68.9% of outstanding shares) and all of the common stock of TARC.
TARC holds 1.9 million shares of TransTexas common stock (3.4% of outstanding
shares). The condensed consolidated financial statements include the financial
statements of TransTexas and TARC on a wholly-owned basis. Capitalized terms
used herein and not otherwise defined are as defined in the respective Annual
Reports on Form 10-K of TransTexas, TARC and the Company for the fiscal year
ended January 31, 1997. The condensed consolidated financial statements reflect
all adjustments, consisting of normal recurring accruals, which are, in the
opinion of management, necessary for a fair presentation of the results for the
interim periods. Interim results of operations are not necessarily indicative
of the results that may be expected for the year ending January 31, 1998. The
financial information presented herein should be read in conjunction with the
financial statements and notes included in the Company's annual report on Form
10-K for the fiscal year ended January 31, 1997. As a result of the
transactions described in Note 2, the long-term debt previously classified as
current as of January 31, 1997 has been reclassified to long-term.

In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"), which
establishes standards for reporting information about operating segments. It
also establishes standards for related disclosures about products and services,
geographic areas and major customers. This statement will be adopted by TEC
effective February 1, 1998. TEC does not believe that adoption of this
statement will have a material effect on its financial statements

In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which
establishes standards for reporting and display of comprehensive income and its
components in financial statements. This statement will be adopted by TEC
effective February 1, 1998. TEC does not believe that adoption of
this statement will have a material effect on its financial statements.

In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 128, "Earnings per Share" ("SFAS 128") and Statement of Financial
Accounting Standards No. 129, "Disclosure of Information about Capital
Structure" ("SFAS 129"). These statements will be adopted by the Company
effective January 31, 1998. SFAS 128 simplifies the computation of earnings
per share by replacing primary and fully diluted presentations with the new
basic and diluted disclosures. SFAS 129 establishes standards for disclosing
information about an entity's capital structure. The Company does not believe
that adoption of these statements will have a material effect on its financial
statements.

In October 1996, the American Institute of Certified Public Accountants
issued Statement of Position 96-1, "Environmental Remediation Liabilities"
("SOP 96-1"), which establishes new accounting and reporting standards for the
recognition and disclosure of environmental remediation liabilities. SOP 96-1
was adopted by the Company effective February 1, 1997. The adoption of SOP
96-1 did not have a material effect on the Company's financial position,
results of operations or cash flow.

As of October 31, 1997, the TEC Notes Indenture (defined below)
contained restrictions that could substantially limit the Company's ability to
use the assets of one subsidiary to satisfy the liabilities of the other.
Accordingly, the

5
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TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

condensed consolidated financial statements should be read in conjunction with
the separate condensed financial statements of TransTexas and TARC filed on
their respective quarterly reports on Form 10-Q for the nine months ended
October 31, 1997.

Below is selected financial information for each consolidated entity
(in millions of dollars):

<TABLE>
<CAPTION>
October 31, 1997
------------------------------------------------------------------------
Consolidation
TransTexas TARC TEC Entries Consolidated
---------- --------- ---------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data
- ------- ----- ----
Working capital (deficit) $ (75.5) $ (20.1) $ 0.5 $ 21.8 $ (73.3)
Total assets 843.9 1003.0 1,663.3 (1,470.0) 2,040.2
Long-term debt 592.2 778.9 1,396.3 (1,215.9) 1,551.5
Stockholder's equity (deficit) 39.4 180.0 245.4 (228.4) 236.4

</TABLE>

<TABLE>
<CAPTION>
Nine Months Ended October 31, 1997
------------------------------------------------------------------------------
Consolidation
TransTexas TARC TEC Entries Consolidated
---------- ------- ----------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Operations Data
- ---------- ----
Revenues $ 695.0 $ 0.6 $ -- $ (0.4) $ 695.2
Operating income (loss) 542.3 (30.9) (1.0) (0.4) 510.0
Net income (loss) 247.0 (90.0) (1.3) (40.4) 115.3

Cash Flow Data
- ---- ---- ----
Operating activities 25.7 (26.3) (2.7) 3.2 (0.1)
Investing activities 670.7 (53.8) (1,185.9) 952.1 383.1
Financing activities (716.4) 79.6 1,257.4 (955.3) (334.7)

</TABLE>

Following consummation of the TEC Notes Offering and the transactions
described below, TEC's only source of funds for its holding company operations
and debt service will be from approximately $50 million in working capital
currently held by TEC, payments on the Intercompany Loans (described below),
dividends from its subsidiaries, interest on funds in the Disbursement Account
(defined below), payments made by TARC on behalf of TEC pursuant to the
Services Agreement (as defined) and, in limited circumstances as permitted by
the TEC Notes Indenture (as defined), sales of stock TEC holds in its
subsidiaries.

During the two years following the TEC Notes Offering, TEC anticipates
that its annual cash needs for holding company operations will be approximately
$2.0 million, which TEC expects to be paid on its behalf by TARC pursuant to
the Services Agreement, and TEC's annual cash interest expense will be
approximately $54.6 million. In addition, TEC and its subsidiaries will pay
$2.5 million in the aggregate per year to TransAmerican for advisory services
and other benefits provided by TransAmerican. TransTexas will be required to
pay TEC approximately $48.9 million in interest annually on the TransTexas
Intercompany Loan. TEC expects to use this interest income together with
income generated from its working capital and, to the extent necessary, its
working capital to satisfy its cash needs, including its cash interest
payments. If TEC incurs unforeseen expenses, there is no assurance that its
capital resources will be sufficient to fund those expenses in addition to
anticipated holding company expenses and debt service.

6
<PAGE> 8
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

The TEC Notes Indenture prohibits TEC from selling stock of TransTexas
and TARC during the two years following consummation of the TEC Notes Offering
unless the proceeds from such sales would be used to make an offer to purchase
the TEC Notes. Consequently, during the two years following the consummation
of the TEC Notes Offering, unless holders of the TEC Notes rejected all or a
portion of any such offer to purchase, sales of such stock would not be a
source of funds to supplement TEC's other resources in order to pay unforeseen
expenses.

2. RECENT EVENTS

TEC NOTES OFFERING. On June 13, 1997, TEC completed a private offering
(the "TEC Notes Offering") of $475 million aggregate principal amount of
11 1/2% Senior Secured Notes due 2002 (the "TEC Senior Secured Notes") and
$1.13 billion aggregate principal amount of 13% Senior Secured Discount Notes
due 2002 (the "TEC Senior Secured Discount Notes" and, together with the TEC
Senior Secured Notes, the "TEC Notes") for net proceeds of approximately $1.3
billion. The TEC Notes are senior obligations of TEC, secured by a lien on
substantially all its existing and future assets, including the intercompany
loans described below. The indenture governing the TEC Notes (the "TEC Notes
Indenture") contains certain restrictive covenants, including, among others,
limitations on incurring additional debt, asset sales, dividends and
transactions with affiliates.

The TEC Senior Secured Notes bear interest at a rate of 11 1/2% per
annum payable semi-annually in cash in arrears on June 15 and December 15 of
each year, commencing December 15, 1997. Principal on the TEC Senior Secured
Discount Notes will accrete to 100% of the face value thereof by June 15, 1999.
Commencing December 15, 1999, cash interest on the TEC Senior Secured Discount
Notes will be payable semi-annually in arrears on June 15 and December 15 of
each year at a rate of 13% per annum. The TEC Notes will mature on June 15,
2002. The TEC Notes are not redeemable prior to June 15, 2000, except that the
Company may redeem, at its option, prior to June 15, 2000, up to 35% of the
original aggregate principal amount of the TEC Senior Secured Notes and up to
35% of the accreted value of the TEC Senior Secured Discount Notes, at the
redemption prices set forth in the indenture governing the TEC Notes (the "TEC
Notes Indenture"), plus accrued and unpaid interest, if any, to and including
the date of redemption, with the net proceeds of any equity offering. On or
after June 15, 2000, the Notes will be redeemable at the option of TEC, in
whole or in part, at the redemption prices set forth in the TEC Notes
Indenture, plus accrued and unpaid interest, if any, to and including the date
of redemption. Upon the occurrence of a Change of Control (as defined), TEC
will be required to make an offer to purchase all of the outstanding TEC Notes
at a price equal to 101% of the principal amount thereof, together with accrued
and unpaid interest, if any, or, in the case of any such offer to purchase TEC
Senior Secured Discount Notes prior to June 15, 1999, at a price equal to 101%
of the accreted value thereof, in each case, to and including the date of
purchase. In addition, TEC will be obligated, subject to certain conditions,
to make an offer to purchase TEC Notes with Excess Cash (as defined) at a price
equal to 105% of the principal amount of accreted value thereof, as applicable,
if such purchase occurs on or prior to December 31, 1997, at a price equal to
108% of the principal amount or accreted value thereof, as applicable, if such
purchase occurs during the period from January 1, 1998 through June 14, 2000,
and thereafter at the redemption prices set forth in the TEC Notes Indenture in
each case, together with accrued and unpaid interest, if any, to and including
the date of purchase.

INTERCOMPANY LOANS TO TRANSTEXAS AND TARC. With the proceeds of the
TEC Notes Offering, TEC made intercompany loans to TransTexas in the principal
amount of $450 million (the "TransTexas Intercompany Loan") and to TARC in the
original amount of $676 million (the "TARC Intercompany Loan" and, together
with the TransTexas Intercompany Loan, the "Intercompany Loans"). The
promissory note evidencing the TransTexas Intercompany Loan (i) bears interest
at a rate of 10 7/8% per annum, payable semi-annually in cash in arrears and
(ii) is secured initially by a security interest in substantially all of the
assets of TransTexas other than inventory, receivables and equipment. The
promissory note evidencing the TARC Intercompany Loan (i) accretes principal at
a rate of 16% per annum, compounded semi-annually, until June 15, 1999 to a
final accreted value of $920 million, and thereafter pays interest
semi-annually in cash in arrears on the accreted value thereof, at a rate of
16% per annum and (ii) is secured

7
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TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

initially by a security interest in substantially all of TARC's assets other
than inventory, receivables and equipment. The Intercompany Loan agreements
contain certain restrictive covenants, including, among others, limitations on
incurring additional debt, asset sales, dividends and transactions with
affiliates. The Intercompany Loans will mature on June 1, 2002. TARC used
approximately $103 million of the proceeds of the TARC Intercompany Loan to
repay certain indebtedness, including $36 million of senior secured notes of
TARC that were issued in March 1997 and $66 million of advances and notes
payable owed to an affiliate, and used approximately $437 million to complete
the TARC Notes Tender Offer described below. Remaining proceeds will be used
for the Capital Improvement Program (described below) and for general corporate
purposes.

Upon the occurrence of a Change of Control (as defined in the TEC Notes
Indenture), TEC will be required to make an offer to purchase all of the
outstanding TEC Notes at a price equal to 101% of the principal amount thereof,
together with accrued and unpaid interest, if any, or, in the case of any such
offer to purchase TEC Senior Secured Discount Notes prior to June 15, 1999, at
a price equal to 101% of the accreted value thereof, in each case, to and
including the date of purchase. Pursuant to the terms of the Intercompany
Loans, TEC may require TARC and TransTexas to pay a pro rata share of the
purchase price paid by TEC in an offer to purchase pursuant to a Change of
Control. See "Potential Effects of a Change of Control" in Note 5.

TARC WARRANTS TENDER OFFER. On June 13, 1997, TEC completed a tender
offer for the outstanding common stock purchase warrants of TARC ("TARC
Warrants") at a price of $4.50 per warrant. Pursuant to the tender offer, TEC
purchased 7,320,552 TARC Warrants for an aggregate purchase price of
approximately $33 million which is classified as a long-term asset.
TransAmerican subsequently purchased 163,679 TARC Warrants for an aggregate
purchase price of approximately $0.7 million. TEC, TransAmerican and TARC may
repurchase additional TARC Warrants, and TARC may enter into a merger with one
of its affiliates pursuant to which each remaining TARC Warrant would become
exercisable (at an exercise price of $.01) to receive $4.51 of cash instead of
one share of common stock of TARC.

DIVIDEND TO TRANSAMERICAN. TEC paid a dividend to TransAmerican in the
amount of $23 million. A portion of the dividend was used to repay the debt of
an affiliate, which had been secured by a pledge of 3.7 million shares of
TransTexas common stock. In connection with the TEC Notes Offering,
TransAmerican contributed the 3.7 million shares of TransTexas common stock to
TEC.

TEC PREFERRED STOCK REDEMPTION. On June 17, 1997, TEC redeemed all of
its outstanding preferred stock for an aggregate amount of $100,000, plus
accrued and unpaid dividends.

LOBO SALE. On May 29, 1997, TransTexas entered into and consummated a
stock purchase agreement with an unaffiliated buyer (the "Lobo Sale
Agreement"), with an effective date of March 1, 1997, to effect the sale (the
"Lobo Sale") of the stock of TransTexas Transmission Corporation ("TTC"), its
subsidiary that owned substantially all of TransTexas' Lobo Trend producing
properties and related pipeline transmission system, for a sales price of
approximately $1.1 billion, subject to adjustments as provided for in the Lobo
Sale Agreement. Purchase price adjustments were made for, among other things:
the value of certain NGLs and stored hydrocarbons; the value of gas in TTC's
pipeline; prepaid expenses relating to post-effective date operations;
post-closing expenses related to pre-closing operations; the value of oil and
gas produced and sold between the effective date of the Lobo Sale Agreement and
closing (approximately $44 million); property defects; and estimated costs
associated with liabilities incurred before

8
<PAGE> 10
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

closing. Purchase price adjustments made at the closing of the Lobo Sale are
subject to a review, reconciliation and resolution process. With proceeds from
the Lobo Sale, TransTexas repaid certain indebtedness and other obligations,
including production payments, in an aggregate amount of approximately $84
million. The remaining net proceeds have been used for the repurchase or
redemption of the Senior Secured Notes and for general corporate purposes.

Pursuant to the Lobo Sale, TransTexas is required to indemnify the
buyer for certain liabilities related to the assets owned by TTC. Although
TransTexas does not anticipate that it will incur any material indemnity
liability, no assurance can be given that TransTexas will have sufficient funds
to satisfy any such indemnity obligation or that any payment thereof will not
have a material adverse effect on its ability to fund its debt service, capital
expenditure and working capital requirements.

TRANSTEXAS SENIOR SECURED NOTES TENDER OFFER. On June 13, 1997,
TransTexas completed the Tender Offer for its Senior Secured Notes for 111 1/2%
of their principal amount (plus accrued and unpaid interest). Approximately
$785.4 million principal amount of Senior Secured Notes were tendered and
accepted by TransTexas. The Senior Secured Notes remaining outstanding were
called for redemption on June 30, 1997 pursuant to the terms of the Senior
Secured Notes Indenture.

TRANSTEXAS SUBORDINATED NOTES EXCHANGE OFFER. On June 19, 1997,
TransTexas completed an exchange offer (the "Subordinated Notes Exchange
Offer"), pursuant to which it exchanged approximately $115.8 million aggregate
principal amount of its 13 3/4% Series C Senior Subordinated Notes due 2001
(the "TransTexas Series C Subordinated Notes") for all of its outstanding
13 1/4% Senior Subordinated Notes due 2003 (the "Old TransTexas Subordinated
Notes"). On October 10, 1997, TransTexas completed a registered exchange offer
whereby it issued $115.8 million aggregate principal amount of its 13 3/4%
Series D Senior Subordinated Notes due 2001 (the "TransTexas Subordinated
Notes") in exchange for all of the outstanding TransTexas Series C Subordinated
Notes. The indenture governing the TransTexas Subordinated Notes (the
"Subordinated Notes Indenture") includes certain restrictive covenants,
including, among others, limitations on incurring additional debt, asset sales,
dividends and transactions with affiliates.

As a result of the Lobo Sale, the Tender Offer and the Subordinated
Notes Exchange Offer, TransTexas has recorded a $540 million pretax gain and a
$72 million after tax extraordinary charge during the nine months ended
October 31, 1997.

TRANSTEXAS SHARE REPURCHASE PROGRAM. In June 1997, TransTexas
implemented a stock repurchase program (the "TransTexas Share Repurchase
Program") pursuant to which it plans to repurchase common stock from its
public stockholders and from its affiliates, including TEC and TARC, in an
aggregate amount of approximately $399 million in value of stock purchased.
Shares may be purchased through open market purchases, negotiated transactions
or tender offers, or a combination of the above. It is anticipated that the
price paid to affiliated stockholders will equal the weighted average price
paid to purchase shares from the public stockholders. As of October 31, 1997,
TransTexas had repurchased 3.9 million shares of common stock from public
stockholders for an aggregate purchase price of approximately $61.4 million,
and approximately 12.6 million shares had been repurchased from TARC and TEC
for an aggregate purchase price of approximately $201 million. The purchase
price paid to the public stockholders was allocated to oil and gas properties
and considered in the calculation of the Company's depletion rate.
Approximately $25 million of this price was classified as unevaluated
properties.

TARC NOTES TENDER OFFER. On June 13, 1997, TARC completed a tender
offer (the "TARC Notes Tender Offer") for the (i) TARC Mortgage Notes for 112%
of their principal amount (plus accrued and unpaid interest), and (ii) TARC
Discount Notes for 112% of their accreted value. In connection with the TARC
Notes Tender Offer, TARC obtained consents from holders of the TARC Notes to
certain waivers under, and amendments to the indenture governing the TARC Notes
(the "TARC Notes Indenture"), which eliminate or modify certain of the
covenants and other provisions contained in the TARC Notes Indenture. TARC
Mortgage Notes and TARC Discount Notes with an

9
<PAGE> 11
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

aggregate carrying value of $423 million were tendered and accepted by TARC at
a cost to TARC of approximately $437 million (including accrued interest,
premiums and other costs). As a result of the TARC Notes Tender Offer, $22.8
million in debt issuance costs were written off and TARC recorded a total
extraordinary charge of approximately $84 million during the nine months ended
October 31, 1997. As of October 31, 1997, TARC Mortgage Notes and TARC
Discount Notes with a carrying value of approximately $16.0 million remained
outstanding.

TANK STORAGE AND TERMINAL ACQUISITION. In September 1997, TARC
purchased a tank storage facility adjacent to the refinery for a cash purchase
price of $40 million (which does not include a $3.1 million liability recorded
for environmental remediation, as discussed below). Environmental
investigations conducted by the previous owner of the facilities have indicated
soil and groundwater contamination in several areas of the property. As a
result, the former owner submitted to the Louisiana Department of Environmental
Quality (the "LDEQ") plans for the remediation of any significant indicated
contamination in such areas. TARC has analyzed these investigation and has
carried out further Phase II Environmental Assessments to verify their results.
TARC intends to incorporate any required remediation into its ongoing work at
the refinery. In connection with the purchase of the facilities, TARC agreed to
indemnify the seller from all cleanup costs and certain other damages resulting
from contamination of the property, and created a $5 million escrow account to
fund required remediation costs and indemnification claims by the seller. As a
result of TARC's Phase II Environmental Assessments, TARC believes that the
amount in escrow should be sufficient to fund the remediation costs associated
with identified contamination; however, because the LDEQ has not yet approved
certain of the remediation plans, there can be no assurance that the funds set
aside in the escrow account will be sufficient to pay all required remediation
costs. During the three months ended October 31, 1997, TARC recorded a
liability of $3.1 million for this contingency.

ACQUISITION NOTE. On December 10, 1997, TARC issued to an unaffiliated
third party a 13% Senior Secured Note due 2002 (the "Acquisition Note") in the
principal amount of $36 million to finance a portion of the purchase price of
the tank storage facility purchased in September 1997. The Acquisition Note is
secured by a mortgage on the tank storage facility, and is governed by a Note
Purchase Agreement containing restrictive covenants substantially similar to
those contained in the TARC Intercompany Loan and the TEC Indenture. The
Acquisition Note bears interest at 13%, payable semiannually on June 15 and
December 15, and matures on December 15, 2002.

3. LIQUIDITY

Cash flow from operations is sensitive to the prices TransTexas
receives for its natural gas. TransTexas from time to time enters into
commodity price swap agreements to reduce its exposure to price risk in the spot
market for natural gas. Proceeds from natural gas sales are received at
approximately the same time that production-related burdens, such as royalties,
production taxes and drilling program obligations, are payable.

TransTexas makes substantial capital expenditures for the exploration,
development and production of natural gas. TransTexas historically has financed
its capital expenditures, debt service and working capital requirements from
cash from operations, public and private offerings of debt and equity
securities, the sale of production payments, asset sales, an accounts receivable
revolving credit facility and other financings. TransTexas' debt covenants may
limit its ability to obtain additional financings or to sell properties, and
there is no assurance that cash flow from operations will be sufficient to fund
capital and debt service requirements.

For the nine months ended October 31, 1997, total capital expenditures
were $317 million, including $45 million for lease acquisitions, $206 million
for drilling and development and $66 million for TransTexas' gas gathering and
pipeline system and other equipment and seismic acquisitions. Additional
capital expenditures of $60 million are anticipated for the fourth quarter.
During fiscal 1998, TransTexas accelerated its exploration and development
drilling program, which included the successful exploration efforts in Galveston
Bay, Goliad County and Brazoria County and, as a result, its capital
expenditures for fiscal 1998 have significantly exceeded its original
anticipated amount of $220 million. In addition, TransTexas is developing
several oil and gas prospects with the potential to increase production and cash
flow from operations, but which require capital expenditures in excess of
projected cash flow over at least the next twelve months. To finance these
capital expenditure requirements and reduce its working capital deficit,
TransTexas intends to supplement its cash flow from operations with a
combination of asset sales and financings. There is no assurance that adequate
funds can be obtained on a timely basis from such sources. Failure to obtain
adequate funds for capital expenditures could have a material adverse effect on
financial position, results of operations and cash flows.

4. CAPITAL IMPROVEMENT PROGRAM

TARC's refinery is located in the Gulf Coast region along the
Mississippi River, approximately 20 miles from New Orleans, Louisiana. TARC's
business strategy is to modify, expand and reactivate its refinery and to
maximize refining margins by converting low-cost, heavy, sour crude oils into
high-value, light petroleum products including primarily gasoline and heating
oil.

In February 1995, TARC began a construction and expansion program (the
"1995 Program") designed to reactivate the refinery and increase its
complexity. From February 1995 through April 1997, TARC spent approximately
$245 million on the 1995 Program, procured a majority of the equipment required
and completed substantially all of the process design engineering and a
substantial portion of the remaining engineering necessary for its completion.

In connection with the TEC Notes Offering, the TARC Intercompany Loan
and the TARC Notes Tender Offer, TARC has adopted a revised capital improvement
program designed to increase the capacity and complexity of the refinery
("Capital Improvement Program"). The most significant projects include: (i)
converting the visbreaker unit into a delayed coking unit to process vacuum
tower bottoms into lighter petroleum products, (ii) modernizing and upgrading a
fluid catalytic cracking unit to increase gasoline production capacity and allow
the direct processing of low-cost atmospheric residual feedstocks, and (iii)
upgrading and expanding hydrotreating, alkylation and sulfur recovery units to
increase sour crude processing capacity. In addition, TARC plans to expand,
modify and add other processing units, tankage and offsite facilities as part of
the Capital Improvement Program. The Capital Improvement Program includes
expenditures necessary to ensure

10
<PAGE> 12
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

that the refinery is in compliance with certain existing air and water
discharge regulations and that gasoline produced will comply with federal
standards. TARC will act as general contractor, but has engaged a number of
specialty consultants and engineering and construction firms to assist TARC in
completing the individual projects that comprise the Capital Improvement
Program. Each of these firms was selected because of its specialized expertise
in a particular process or unit integral to the Capital Improvement Program.

The Capital Improvement Program will be executed in two phases. TARC
estimates that Phase I will be completed at a cost of $223 million, will be
tested and operational by September 30, 1998 and will result in the refinery
having the capacity to process up to 200,000 BPD of sour crude oil. Phase II
of the Capital Improvement Program includes the completion and start-up of the
Fluid Catalytic Cracking Unit utilizing state-of-the-art MSCC(SM) technology and
the installation of additional equipment expected to further improve operating
margins by allowing for a significant increase in the refinery's capacity to
produce gasoline. TARC estimates that Phase II will be completed at a cost of
$204 million and will be tested and operational by July 31, 1999. The proceeds
received or to be received by TARC from the TARC Intercompany Loan, the
TransTexas Share Repurchase Program and equity contributions from TEC will
include $427 million designated for use in the Capital Improvement Program,
which TARC believes is adequate to fund the completion of the project. As of
October 31, 1997, TARC had spent approximately $98.3 million on the Capital
Improvement Program with commitments for another approximately $67.7 million.
The foregoing estimates, as well as other estimates and projections herein, are
subject to substantial revision upon the occurrence of future events, such as
unavailability of financing, engineering problems, work stoppages, personnel
shortages and cost overruns over which TARC may not have any control, and there
can be no assurance that any such projections or estimates will prove accurate.

TARC believes, based on current estimates of refining margins and costs
of the expansion and modification of the refinery, that future undiscounted cash
flows will be sufficient to recover the cost of the refinery over its estimated
useful life. Management believes there have been no events or changes in
circumstances that would require the recognition of an impairment loss. However,
due to the inherent uncertainties in estimating future refining margins, and in
constructing and operating a large scale refinery, there can be no assurance
that TARC will ultimately recover the cost of the refinery. Management believes
that the book value of the refinery is in excess of its current estimated fair
market value.

TARC has incurred losses and negative cash flow from operations as a
result of limited refinery operations that did not cover the fixed costs of
maintaining the refinery, increased working capital requirements including debt
service, and losses on refined product sales due to financing costs and low
margins. Based on recent refining margins and projected levels of operations,
such negative cash flows are likely to continue. If TARC does not complete the
Capital Improvement Program without significant cost overruns or does not
ultimately achieve profitable operations, TARC's investment in the refinery may
not be recovered. The financial statements do not include any adjustments as a
result of such uncertainties. Additionally, the Company has pledged its entire
ownership interest of the common stock of TransTexas as collateral on the
Company's Notes. The repayment of the notes and related interest is dependent
on TARC's ability to provide cash flow. In the event TARC does not continue as
a going concern, it is likely that the Company will lose its entire investment
in TransTexas. Therefore, if the Company is unable to recover its investment in
TARC, and loses its investment in TransTexas, there is substantial doubt in the
Company's ability to continue as a going concern.

5. DISBURSEMENT ACCOUNTS

Pursuant to a disbursement agreement (the "Disbursement Agreement")
among TARC, TEC, Firstar Bank of Minnesota, N.A., as trustee (the" TEC
Indenture Trustee"), Firstar Bank of Minnesota, N.A., as disbursement agent (the
"Disbursement Agent"), and Baker & O'Brien, Inc., as construction supervisor
(the "Construction Supervisor"), $208 million of the net proceeds from the sale
of the TEC Notes was placed into accounts in the name of TARC ($135 million) and
TEC ($73 million) (together, the "TARC Disbursement Account") to be held and
invested by the Disbursement Agent until disbursed. In addition, proceeds to
TEC and TARC of approximately $201 million from the TransTexas Share Repurchase
Program have been deposited in the TARC Disbursement Account. All funds in the
TARC Disbursement Account are pledged as security for the repayment of the TEC
Notes.

The Disbursement Agent will make disbursements for the Capital
Improvement Program out of the TARC Disbursement Account in accordance with
requests made by TARC and approved by the Construction Supervisor. The
Construction Supervisor is required to review each such disbursement request by
TARC. No disbursements may be made from the TARC Disbursement Account for
purposes other than the Capital Improvement Program other than (i) up to $1.5
million per month (except for December 1997, in which disbursements may be up
to $4.5 million) to fund administrative costs and certain taxes and insurance
payments, not in excess of $25.5 million in the aggregate; provided, that if
less than $1.5 million is spent in any month (or less than $4.5 million is
spent in December 1997) the amounts that may be disbursed in one or more
subsequent months will be increased by the amount of such difference, (ii) up
to $50 million for feedstock upon certification by the Construction Supervisor
of the Mechanical Completion (as defined in the TEC Notes Indenture) of the
Delayed Coking Unit and associated facilities, (iii) up to $19 million to pay
interest on, and to redeem, repurchase, defease or otherwise retire the
remaining TARC Notes and (iv) up to $7 million for outstanding accounts
payable. In addition, interest income from the TARC Disbursement Account may
be used for the Capital Improvement Program or disbursed to fund administrative
and other costs of TARC and TEC. As of October 31, 1997, $119 million had been
disbursed to TARC out of the TARC Disbursement Account for use in the Capital
Improvement Program and $13 million for general corporate purposes.

11
<PAGE> 13
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

Pursuant to a disbursement agreement (the "TransTexas Disbursement
Agreement") among TransTexas, TEC, the TEC Indenture Trustee, and the Firstar
Bank of Minnesota, N.A. as disbursement agent, approximately $399 million of
the proceeds of the TransTexas Intercompany Loan was placed in an account (the
"TransTexas Disbursement Account") to be held and invested by the disbursement
agent until disbursed. Funds in the TransTexas Disbursement Account will be
disbursed to TransTexas as needed to fund the TransTexas Share Repurchase
Program. TransTexas may at any time request disbursement of interest earned on
the funds in the TransTexas Disbursement Account. The TransTexas Disbursement
Account is classified as "cash restricted for share repurchases" in the
accompanying condensed consolidated balance sheet. As of October 31, 1997,
approximately $262.4 million had been disbursed for use in the TransTexas Share
Repurchase Program.

6. COMMITMENTS AND CONTINGENCIES

LEGAL PROCEEDINGS

ALAMEDA. On May 22, 1993, Alameda Corporation ("Alameda") sued
TransAmerican in the 234th Judicial District Court, Harris County, Texas,
claiming that TransAmerican failed to account to Alameda for a share of the
proceeds TransAmerican received in a 1990 settlement of litigation with El Paso
Natural Gas Company ("El Paso"), and that TransAmerican has been unjustly
enriched by its failure to share such proceeds with Alameda. On September 20,
1995, the jury rendered a verdict in favor of TransAmerican. Alameda appealed
to the Fourteenth Court of Appeals, which affirmed the trial court judgment in
favor of TransAmerican. Alameda's motion for rehearing was denied, and Alameda
has appealed to the Texas Supreme Court.

ARABIAN OFFSHORE PARTNERS. On June 27, 1997, Arabian Offshore
Partners filed a lawsuit against TransTexas in the 14th Judicial District
Court, Dallas County, Texas, seeking $20 million in damages in connection with
TransTexas' refusal to proceed with the acquisition of two jack-up drilling
rigs. TransTexas' motion for summary judgment is pending before the court.

ASPEN. TransAmerican brought suit on September 29, 1993 against Aspen
Services, Inc. ("Aspen"), seeking an audit and accounting of drilling costs
that Aspen had charged while providing drilling services to TransAmerican.
This suit is pending in the 215th Judicial District Court, Harris County,
Texas. The parties' drilling agreement provided, among other things, that
Aspen would receive payment for its drilling-related costs from the production
and sale of gas from the wells that were drilled, and that the revenues that
TransAmerican would otherwise receive from the wells would be reduced by the
amounts received by Aspen. On July 19, 1995, Aspen filed a counterclaim and
third party claim against TransAmerican, TransTexas, and affiliated entities,
asserting, among other things, that these entities failed to make certain
payments and properly market the gas from these wells. Aspen sought damages
in an unspecified amount, as well as certain equitable claims. In April 1997,
the trial court ruled against Aspen on all of its claims and counterclaims.

BRIONES. In an arbitration proceeding, Jesus Briones, a lessor,
claimed that one of TransTexas' wells on adjacent lands had been draining
natural gas from a portion of his acreage leased to TransTexas on which no well
had been drilled. On October 31, 1995, the arbitrator decided that drainage
had occurred. On June 3, 1996, the arbitrator issued a letter indicating that
drainage damages would be awarded to Briones in the amount of approximately
$1.4 million. The arbitrator entered his award of damages on June 27, 1996.
On July 3, 1996, TransTexas filed a petition in the 49th Judicial District
Court, Zapata County, Texas, to vacate the arbitrator's award. Briones also
filed a petition to confirm the arbitrator's award. In April 1997, the court
granted Briones' motion for summary judgment. In August 1997, the court
entered a final judgment for Briones in the amount of approximately $1.6
million. The court amended the final judgment and denied TransTexas' motion for
new trial in October 1997. TransTexas has filed a revised motion for new trial.

12
<PAGE> 14
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

FINKELSTEIN. On April 15, 1990, H.S. Finkelstein filed suit against
TransAmerican in the 49th Judicial District Court, Zapata County, Texas,
alleging that TransAmerican failed to pay royalties and improperly marketed oil
and gas produced from certain leases. On September 27, 1994, the plaintiff
added TransTexas as an additional defendant. On January 6, 1995, a judgment
against TransAmerican and TransTexas was entered for approximately $18 million
in damages, interest and attorneys' fees. TransTexas and TransAmerican appealed
the judgment to the Fourth Court of Appeals, San Antonio, Texas, which affirmed
the judgment on April 3, 1996. TransTexas and TransAmerican filed a motion for
rehearing. On August 14, 1996, the Fourth Court of Appeals reversed the trial
court judgment and rendered judgment in favor of TransAmerican and TransTexas.
On August 29, 1996, Finkelstein filed a motion for stay and a motion for
rehearing with the court. On October 9, 1996, the court denied Finkelstein's
rehearing request. In November 1996, Finkelstein filed an application for writ
of error with the Supreme Court of Texas.

On April 22, 1991, Finkelstein filed a separate suit against
TransAmerican and various affiliates in the 49th Judicial District Court,
Zapata County, Texas, alleging an improper calculation of overriding royalties
allegedly owed to the plaintiff and seeking damages and attorneys' fees in
excess of $33.7 million. On November 18, 1993, the plaintiff added TransTexas
as an additional defendant. The parties arbitrated this matter in January
1997. A partial decision from the arbitration panel has been rendered in favor
of Finkelstein. Although the amount of damages has yet to be determined under
the panel's decision, such amount will be substantially less than that sought
by plaintiff.

EEOC. On September 30, 1997, the U.S. Equal Employment Opportunity
Commission ("EEOC") issued a Determination (the "Determination") as a result of
the Commissioner's Charge that had been filed in August 1995 against TARC and
Southeast Louisiana Contractors of Norco, Inc. ("Southeast Contractors")
pursuant to Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C.
Section 2000e et seq. ("Title VII"). In the Determination, the EEOC stated
that it found reasonable cause to believe that each of TARC and Southeast
Contractors had discriminated based on race and gender in its hiring and
promotion practices. Each violation of Title VII (for each individual
allegedly aggrieved), if proven, potentially could subject TARC and
Southeast Contractors to liability for (i) monetary damages for back pay and
front pay in an undetermined amount, and for compensatory damages and
punitive damages in an amount not to exceed $300,000 per plaintiff, (ii)
injunctive relief, (iii) attorney's fees, and (iv) interest. During the
period covered by the Commissioner's Charge and the Determination, TARC and
Southeast Contractors estimate that they received a combined total of
approximately 23,000 to 30,000 employment applications and hired (or rehired) a
combined total of approximately 3,400 to 4,100 workers, although the total
number of individuals who ultimately are covered in any conciliation proposal
or any subsequent lawsuit may be higher. TARC and Southeast Contractors deny
engaging in any unlawful employment practices. TARC and Southeast Contractors
intend to vigorously defend against the allegations contained in the
Commissioner's Charge and the findings set forth in the Determination in any
proceedings in state or federal court, regardless of whether any such lawsuit
is brought by the EEOC or any individual or groups of individuals. TARC is
unable to estimate the amount of liability, if any, related to these claims. If
TARC or Southeast Contractors are found liable for violations of Title VII based
on the matters asserted in the Determination, TARC can make no assurance that
such liability would not have a material adverse effect on its financial
condition.

RINEHEART. On October 8, 1996, Carlton Gene Rineheart, et al., and as
representative of a class of persons similarly situated, filed suit against 84
individuals and corporations, including TARC, in the U.S. District Court,
Middle District of Louisiana alleging negligent and improper storage, handling,
treatment, and disposal of hazardous materials from 1976 to the present at two
sites in Iberville Parish, Louisiana. The suit claims damages for physical,
mental, and property damage in the communities of Bayou Sorrel, Bayou Pigeon
and Indian Village. TARC intends to vigorously defend this claim.

SHELL OIL. On September 27, 1996, Shell Oil filed a third party suit
against TARC in the U.S. District Court, Eastern District of Louisiana for
contribution and/or indemnity relating to alleged environmental contamination
of

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

Bayou Trapagnier and surrounding lands near Norco, Louisiana. In March 1997,
TARC obtained a voluntary dismissal from Shell. Shell proceeded to trial on
the main case and settled with the plaintiffs during trial by purchasing their
land for $5 million. On June 27, 1997, Shell amended its third party action to
bring TARC back into the case. Shell has demanded $400,000 from TARC. TARC
has refused to pay such amount and is defending the case vigorously.

GENERAL. TransTexas and TARC are also named defendants in other
ordinary course, routine litigation incidental to their businesses. Although
the outcome of these lawsuits cannot be predicted with certainty, the Company
does not expect these matters to have a material adverse effect on its financial
position, results of operations or cash flows. The litigation matters discussed
above amount to significant potential liability which, if adjudicated in a
manner adverse to TARC or TransTexas in one reporting period could have a
material adverse effect on the Company's results of operations or cash flows for
that period. At October 31, 1997, the possible range of estimated losses
related to all of the aforementioned claims in addition to the estimates accrued
by TransTexas and TARC is $0 to $36 million.

ENVIRONMENTAL MATTERS

TransTexas' operations and properties are subject to extensive
federal, state and local laws and regulations relating to the generation,
storage, handling, emission, transportation and discharge of materials into the
environment. Permits are required for various of TransTexas' operations, and
these permits are subject to revocation, modification and renewal by issuing
authorities. TransTexas is also subject to federal, state and local laws and
regulations that impose liability for the cleanup or remediation of property
that has been contaminated by the discharge or release of hazardous materials
or wastes into the environment. Governmental authorities have the power to
enforce compliance with their regulations, and violations are subject to fines
or injunctions, or both. It is not anticipated that TransTexas will be
required in the near future to expend amounts that are material to the
financial condition or operations of TransTexas by reason of environmental laws
and regulations, but because such laws and regulations are frequently changed
and, as a result, may impose increasingly strict requirements, TransTexas is
unable to predict the ultimate cost of complying with such laws and
regulations.

COMPLIANCE MATTERS. TARC is subject to federal, state, and local
laws, regulations, and ordinances ("Pollution Control Laws"), which regulate
activities such as discharges to air and water, as well as handling and
disposal practices for solid and hazardous wastes. TARC believes that it is in
substantial compliance with applicable Pollution Control Laws. However, newly
enacted Pollution Control Laws, as well as increasingly strict enforcement of
existing Pollution Control Laws, may require TARC to make additional capital
expenditures. Environmental compliance and permitting issues are an integral
part of the capital expenditures anticipated in connection with the Capital
Improvement Program.

TARC uses (and in the past has used) certain materials, and generates
(and in the past has generated) certain substances or wastes that are or may be
deemed hazardous substances or wastes. In the past, the refinery has been the
subject of certain environmental enforcement actions, and has incurred certain
fines, as a result of certain of TARC's operations. TARC also was previously
subject to enforcement proceedings relating to its prior production of leaded
gasoline and air emissions. TARC believes that, with minor exception, all of
these past matters were resolved prior to or in connection with the resolution
of the bankruptcy proceedings of its predecessor in interest, TransAmerican, or
are no longer applicable to TARC's operations. As a result, TARC believes that
such matters will not have a material adverse effect on TARC's financial
position, future results of operations or cash flow.

In September 1997, TARC purchased a tank storage facility adjacent to
the refinery. Environmental investigations conducted by the previous owner of
the facilities have indicated soil and groundwater contamination in several
areas of the property. As a result, the former owner submitted to the LDEQ
plans for the remediation of any significant indicated contamination in such
areas. TARC has analyzed these investigations and has carried out further
Phase II Environmental Assessments to verify their results. TARC intends to
incorporate any required remediation into

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

its ongoing work at the refinery. In connection with the purchase of the
facilities, TARC agreed to indemnify the seller from all cleanup costs and
certain other damages resulting from contamination of the property, and created
a $5 million escrow account to fund required remediation costs and
indemnification claims by the seller. As a result of TARC's Phase II
Environmental Assessments, TARC believes that the amount in escrow should be
sufficient to fund the remediation costs associated with identified
contamination; however, because the LDEQ has not yet approved certain of the
remediation plans, there can be no assurance that the funds set aside in the
escrow account will be sufficient to pay all required remediation costs. During
the three months ended October 31, 1997, TARC recorded a liability of $3.1
million for this contingency.

REQUIREMENTS UNDER THE FEDERAL CLEAN AIR ACT. The National Emission
Standards for Hazardous Air Pollutants for Benzene Waste Operations (the
"Benzene Waste NESHAPS"), promulgated in January 1993 pursuant to the Clean Air
Act, regulate benzene emissions from numerous industries, including petroleum
refineries. The Benzene Waste NESHAPS require all existing, new, modified, or
reconstructed sources to reduce benzene emissions to a level that will provide
an ample margin of safety to protect public health. TARC will be required to
comply with the Benzene Waste NESHAPS as its refinery operations start up. At
this time, TARC cannot estimate the costs of such compliance. TARC believes
that compliance with the Benzene Waste NESHAPS will not have a material adverse
effect on its financial position, results of operations or cash flow. Until
the refinery is in full operation, however, there can be no assurance that the
regulations will not have such an effect.

In addition, the Environmental Protection Agency ("EPA") promulgated
National Emission Standards for Hazardous Air Pollutants for Hazardous Organics
(the "Hazardous Organics NESHAPS") regulations for petroleum refineries under
the Clean Air Act in 1995, and subsequently has amended such regulations.
These regulations set Maximum Achievable Control Technology ("MACT") standards
for petroleum refineries. The LDEQ has incorporated MACT standards into TARC's
air permits under federal and state air pollution prevention laws. TARC
believes that compliance with the Hazardous Organics NESHAPS will not have a
material adverse effect on TARC's financial position, results of operations or
cash flow. Until the refinery is in full operation, however, there can be no
assurance that the regulations will not have such an effect.

The EPA has promulgated federal regulations pursuant to the Clean Air
Act to control fuels and fuel additives (the "Gasoline Standards") that could
have a material adverse effect on TARC. Under the new regulations, only
reformulated gasoline can be sold in certain domestic geographic areas in which
the EPA has mandated or approved its use. Reformulated gasoline must contain a
minimum amount of oxygen, have a lower vapor pressure, and have reduced sulfur,
olefins, benzene and aromatics compared to the average 1990 gasoline. The EPA
recently promulgated final National Ambient Air Quality Standards ("NAAQS")
that revise the standards for particulate matter and ozone. The number and
extent of the areas subject to reformulated gasoline standards may increase in
the future after the NAAQs are implemented. Conventional gasoline may be used
in all other domestic markets; however, a refiner's post-1994 average
conventional gasoline must not be more polluting than it was in 1990. With
limited exceptions, to determine its compliance as of January 1, 1995, a
refiner must compare its post-1994 and 1990 average values of controlled fuel
parameters and emissions. The Gasoline Standards recognize that many gasoline
refiners may not be able to develop an individual 1990 baseline for a number of
reasons, including, for example, lack of adequate data or the absence or
limited scope of operations in 1990. Under such circumstances, the refiner
must use a statutory baseline reflecting the 1990 industry average. The EPA
has authority, upon a showing of extenuating circumstances by a refiner, to
grant an individual adjusted baseline or other appropriate regulatory relief to
that refiner.

TARC filed a petition with the EPA requesting an individual baseline
adjustment or other appropriate regulatory relief based on extenuating
circumstances. The extenuating circumstances upon which TARC relied in its
petition include the fact that the refinery was not in operation in 1990 (and
thus there is no 1990 average for purposes

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TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

of the necessary comparison) and the fact that the start-up of the refinery is
to occur on a phased-in basis. The EPA has denied TARC's request for an
individual baseline adjustment and other appropriate regulatory relief. TARC
will continue to pursue regulatory relief with the EPA. There can be no
assurance that any action taken by the EPA will not have a material adverse
effect on TARC's future results of operations, cash flow or financial position.

Title V of the Clean Air Act requires states to implement an Operating
Permit Program that codifies all federally enforceable limitations that are
applicable to a particular source. The EPA has approved Louisiana's Title V
Operating Permit Program. The deadline for a refinery to submit an Operating
Permit Application under the Louisiana program was October 12, 1996. TARC
timely submitted its Title V Operating Permit application and the LDEQ has
designated the application as being administratively complete. As yet, the
LDEQ has not responded further regarding the status of TARC's Title V Operating
Permit. TARC believes that its application will be approved. However, there
can be no assurance that additional expenditures required pursuant to Title V
Operating Permit obligations will not have a material adverse effect on TARC's
financial position, results of operations or cash flow.

CLEANUP MATTERS. TARC also is subject to federal, state, and local
laws, regulations, and ordinances that impose liability for the costs of clean
up relating to, and certain damages resulting from, past spills, disposals, or
other releases of hazardous substances ("Hazardous Substance Cleanup Laws").
Over the past several years, TARC has been, and to a limited extent continues
to be, engaged in environmental cleanup or remedial work relating to or arising
out of operations or activities at the refinery. In addition, TARC has been
engaged in upgrading its solid waste facilities, including the closure of
several waste management units. Similar to numerous other industrial sites in
the state, the refinery has been listed by the LDEQ on the Federal
Comprehensive Environmental Response, Compensation and Liability Information
System, as a result of TARC's prior waste management activities (as discussed
below).

In 1991, the EPA performed a facility assessment at TARC's refinery
pursuant to the Federal Resource Conservation and Recovery Act ("RCRA"). The
EPA performed a follow up assessment in March 1996, but has not yet issued a
report of its investigations. In July 1996, the EPA and LDEQ agreed that the
LDEQ would serve as the lead agency with respect to the investigation and
remediation of areas of concern identified in the investigation. TARC, under a
voluntary initiative approved by the LDEQ, has submitted a work plan to the
LDEQ to determine which areas may require further investigation and
remediation. The LDEQ has not yet responded to TARC's submission or issued any
further requests relating to this matter. As a result, TARC is unable at this
time to estimate what the costs, if any, will be if the LDEQ does require
further investigation or remediation of the areas identified.

TARC has been identified as a potentially responsible party ("PRP")
under the Comprehensive Environmental Response, Compensation, and Liability Act
of 1980, as amended ("CERCLA" or "Superfund"), for the cleanup of contamination
from hazardous substances at three Superfund sites (i.e. sites on the National
Priorities List ("NPL")) to which it has been alleged that TARC, or its
predecessors, sent hazardous substances in the past. CERCLA requires cleanup
of sites from which there has been a "release" or threatened release of
"hazardous substances" (as such terms are defined under CERCLA). CERCLA
requires the EPA to include sites needing long-term study and cleanup on the
NPL based on their potential effect on public health or the environment.
CERCLA authorizes the EPA to take any necessary response actions at NPL sites
and, in certain circumstances, to order PRPs liable for the release to take
such actions. PRPs are broadly defined under CERCLA to include past and
present owners and operators of a site, as well as generators and transporters
of wastes to a site from which hazardous substances are released.

The EPA may seek reimbursement of expenditures of federal funds from
PRPs under Superfund. Courts have interpreted CERCLA to impose strict, joint
and several liability upon all persons liable for the entire amount of
necessary cleanup costs. As a practical matter, at sites where there are
multiple PRPs for a cleanup, the costs of cleanup typically are allocated
according to a volumetric or other standard among the parties. CERCLA also
provides that responsible parties generally may recover a portion of the costs
of cleaning up a site from other responsible parties.

16
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TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

Thus, if one party is required to clean up an entire site, that party can seek
contribution or recovery of such costs from other responsible parties. A
number of states have laws similar to Superfund, pursuant to which cleanup
obligations, or the costs thereof, also may be imposed.

At one Superfund site, TARC has submitted information to the EPA
indicating that it should have no liability for this matter, and negotiations
with the EPA in this regard are continuing. With respect to the remaining two
sites, TARC's liability for each such matter has not been determined, and TARC
anticipates that it may incur costs related to the cleanup (and possibly
including additional costs arising in connection with any recovery or other
action brought pursuant or relating to such matters) at each such site. After
a review of the data available to TARC regarding the basis of TARC's alleged
liability at each site, and based on various factors, which depend on the
circumstances of the particular Superfund site (including, for example, the
relationship of TARC to each such site, the volume of wastes TARC is alleged to
have contributed to each such site in comparison to other PRPs without giving
effect to the ability of any other PRPs to contribute to or pay for any
liabilities incurred, and the range of likely cleanup costs at each such site),
TARC does not believe its ultimate environmental liabilities will be
significant; however, it is not possible to determine the ultimate
environmental liabilities, if any, that may arise from the matters discussed
above.

PURCHASE COMMITMENTS

TARC has various purchase commitments for materials, supplies and
services incidental to the ordinary course of business and for the Capital
Improvement Program. As of October 31, 1997, TARC had commitments for refinery
construction and maintenance of approximately $67.7 million. TARC is acting as
general contractor and can generally cancel or postpone capital projects.

PROCESSING AGREEMENTS

In April 1996, TARC entered into a processing agreement with a third
party to process feedstocks. Under the terms of the agreement, the processing
fee earned by the third party is based on the margin earned by the third party,
if any, after deducting all of its related costs such as feedstock acquisition,
hedging, transportation, processing and inspections plus a commission for each
barrel processed. As of October 31, 1997, TARC has processed 6.4 million
barrels of feedstocks under this agreement. TARC also entered into processing
agreements with this third party to process approximately 1.1 million barrels
of the third party's feedstocks for a fixed price per barrel. As of October
31, 1997 and January 31, 1997, TARC was storing approximately 0.7 million and
1.0 million barrels, respectively, of feedstock and intermediate or refined
products. For the nine months ended October 31, 1997 and 1996, TARC recorded
income (loss) from processing agreements of $3.1 million and $(8.6) million,
respectively. For the three months ended October 31, 1997 and 1996, TARC
recorded a loss from processing agreements of $0.1 million and $5.2 million,
respectively. Included in the 0.7 million barrels of product stored at the
refinery as of October 31, 1997, is approximately 0.6 million barrels of
feedstock related to a purchase commitment entered into in April 1997. The 0.6
million barrels have been sold to the third party involved in the processing
arrangement. For the nine months ended October 31, 1997, TARC incurred a loss
of approximately $4.8 million related to this purchase commitment.

PRODUCTION PAYMENTS

In April 1997, TransTexas sold to an unaffiliated third party a term
overriding royalty in the form of a dollar-denominated production payment in
certain of TransTexas' producing properties for net proceeds of $20 million.
The production payment calls for the repayment of the primary sum plus an
amount equivalent to a 16% annual interest rate on the unpaid portion of such
primary sum.

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TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

HEDGING AGREEMENTS

From time to time, TransTexas enters into commodity price swap
agreements (the "Hedge Agreements") to reduce its exposure to price risk in the
spot market for natural gas. The Hedge Agreements are accounted for as hedges
if the pricing of the hedge agreement correlates with the pricing of the natural
gas production hedged. Accordingly, gains or losses are deferred and recorded as
assets or liabilities and recognized as an increase or decrease in revenues in
the respective month the physical volumes are sold. For the nine months ended
October 31, 1997, TransTexas incurred net settlement losses pursuant to the
Hedge Agreements of approximately $7.4 million. TransTexas had no Hedge
Agreements outstanding during the quarter ended October 31, 1997.

LETTER OF CREDIT

In January 1996, TransTexas entered into a reimbursement agreement
with an unaffiliated third party pursuant to which the third party caused a $20
million letter of credit to be issued to collateralize a supersedeas bond on
behalf of TransTexas. If there is a draw under the letter of credit,
TransTexas is required to reimburse the third party within 60 days. TransTexas
has agreed to issue up to 8.6 million shares of its common stock to the third
party if this contingent obligation to such third party becomes fixed and
remains unpaid for 60 days. TransTexas does not believe that this contingency
will occur. If the obligation becomes fixed, and alternative sources of
capital are not available, TransTexas could elect to sell shares of TransTexas'
common stock prior to the maturity of the obligation and use the proceeds of
such sale to repay the third party. Based on TransTexas' current
capitalization, the issuance of shares of TransTexas' common stock to satisfy
this obligation would result in deconsolidation of TransTexas for federal
income tax purposes.

POTENTIAL TAX LIABILITY

Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and of a
contingent liability for interest of $102 million owed by TransAmerican.
TransAmerican has taken the federal tax position that the entire amount of this
debt cancellation is excluded from its income under the cancellation of
indebtedness provisions (the "COD Exclusion") of the Internal Revenue Code of
1986, as amended, and has reduced its tax attributes (including its net
operating loss and credit carryforwards) as a consequence of the COD Exclusion.
No federal tax opinion was rendered with respect to this transaction, however,
and TransAmerican has not obtained a ruling from the Internal Revenue Service
(the "IRS") regarding this transaction. TransTexas believes that there is
substantial legal authority to support the position that the COD Exclusion
applies to the cancellation of TransAmerican's indebtedness. However, due to
factual and legal uncertainties, there can be no assurance that the IRS will
not challenge this position, or that such challenge would not be upheld. Under
an agreement between TransTexas, TransAmerican and certain of TransAmerican's
subsidiaries (the "Tax Allocation Agreement"), TransTexas has agreed to pay an
amount equal to any federal tax liability (which would be approximately $25.4
million) attributable to the inapplicability of the COD Exclusion. Any such
tax would be offset in future years by alternative minimum tax credits and
retained loss and credit carryforwards to the extent recoverable from
TransAmerican. As a member of the TNGC Consolidated Group (defined below),
each of TransTexas, TEC and TARC will be severally liable for any tax liability
resulting from the above-described transactions. The IRS has commenced an
audit of the consolidated federal income tax returns of the TNGC Consolidated
Group for its taxable years ended July 31, 1994 and 1995. At this time, it is
not possible to predict the scope of the IRS' review or whether any tax
deficiencies will be proposed by the IRS as a result of its review.

Based upon independent legal advice, TransTexas has determined that it
will not report any significant federal income tax liability as a result of the
Lobo Sale. There are, however, significant uncertainties regarding TransTexas'
tax position and no assurance can be given that TransTexas' position will be
sustained if challenged by the IRS. TransTexas is part of an affiliated group
for tax purposes (the "TNGC Consolidated Group"), which includes TNGC

18
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TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

Holdings Corporation, the sole stockholder of TransAmerican. No letter ruling
has been or will be obtained from the IRS regarding the Lobo Sale by any member
of the TNGC Consolidated Group. If the IRS were to successfully challenge
TransTexas' position, each member of the TNGC Consolidated Group would be
severally liable under the consolidated tax return regulations for the
resulting taxes, in the estimated amount of up to $250 million (assuming the
use of existing tax attributes of the TNGC Consolidated Group), possible
penalties equal to 20% of the amount of the tax, and interest at the statutory
rate (currently 9%) on the tax and penalties (if any). The Tax Allocation
Agreement has been amended so that TransAmerican will become obligated to fund
the entire tax deficiency (if any) resulting from the Lobo Sale. There can be
no assurance that TransAmerican would be able to fund any such payment at the
time due and the other members of the TNGC Consolidated Group, thus, may be
required to pay the tax. TransTexas has reserved approximately $75 million
with respect to the potential tax liability for financial reporting purposes to
reflect a portion of the federal tax liability that TransAmerican might not be
able to pay. If TransTexas were required to pay this tax deficiency, it is
likely that it would be required to sell significant assets or raise additional
debt or equity capital to fund the payment.

Under certain circumstances, TransAmerican or TEC may sell or otherwise
dispose of shares of common stock of the Company. If, as a result of any sale
or other disposition of the Company's common stock, the aggregate ownership of
TransTexas by members of the TNGC Consolidated Group (excluding TransTexas) is
less than 80% (measured by voting power and value), TransTexas will no longer be
a member of the TNGC Consolidated Group for federal tax purposes
("Deconsolidation") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement. Further, if TEC or TARC sells or otherwise transfers any
stock of TARC, or issues any options, warrants or other similar rights relating
to such stock, outside of the TNGC Consolidated Group, which represents more
than 20% of the voting power or equity value of TARC, then a Deconsolidation of
TARC would occur. A Deconsolidation of TARC would result in a Deconsolidation
of TransTexas if the TNGC Consolidated Group, excluding TARC, does not then own
at least 80% of the voting power and equity value of TransTexas. Upon a
Deconsolidation of TransTexas, members of the TNGC Consolidated Group that own
TransTexas' common stock could incur a substantial amount of federal income tax
liability. If such Deconsolidation occurred during the fiscal year ending
January 31, 1998, the aggregate amount of this tax liability is estimated to be
between $50 million and $100 million, assuming no reduction for tax attributes
of the TNGC Consolidated Group. However, such tax liability generally would be
substantially reduced or eliminated in the event that the IRS successfully
challenged TransTexas' position on the Lobo Sale. Each member of a consolidated
group filing a consolidated federal income tax return is severally liable to the
IRS for the consolidated federal income tax liability of the consolidated
group. There can be no assurance that each TNGC Consolidated Group member will
have the ability to satisfy any tax obligation attributable to the Transactions
at the time due and, therefore, other members of the group, including TEC,
TransTexas or TARC, may be required to pay the tax.

Generally, under the Tax Allocation Agreement, if net operating losses
of TransTexas are used by other members of the TNGC Consolidated Group, then
TransTexas is entitled to the benefit (through reduced current taxes payable)
of such losses in later years to the extent TransTexas has taxable income,
remains a member of the TNGC Consolidated Group and the other group members
have the ability to pay such taxes. If TransAmerican, TARC or TEC transfers
shares of common stock of TransTexas (or transfers options or other rights to
acquire such shares) and, as a result of such transfer, Deconsolidation of
TransTexas occurs, TransTexas would not thereafter receive any benefit
pursuant to the Tax Allocation Agreement for net operating losses of TransTexas
used by other members of the TNGC Consolidated Group prior to the
Deconsolidation of TransTexas.

TransTexas is required, under the Tax Allocation Agreement, to pay any
Texas franchise tax (which is estimated not to exceed $11.4 million)
attributable to prior year transactions. TransTexas paid approximately $5.4
million of such tax as of the closing of the Lobo Sale and will pay a
substantial amount of the remaining tax within the ensuing 12-month period.

19
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TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

POTENTIAL EFFECTS OF A CHANGE OF CONTROL

The Subordinated Notes Indenture provides that, upon the occurrence of
a Change of Control, each holder of the TransTexas Subordinated Notes will have
the right to require TransTexas to repurchase such holder's notes at 101% of
the principal amount thereof plus accrued and unpaid interest. Pursuant to the
terms of the TransTexas Intercompany Loan, upon the occurrence of a Change of
Control, TEC would have the right to require TransTexas and TARC to repay the
principal of the TransTexas Intercompany Loan in an amount equal to a pro rata
share of the amount TEC is required to pay under the TEC Notes Indenture. Such
pro rata share would be calculated using the ratio of the outstanding principal
amount of the TransTexas Intercompany Loan (or, for TARC, the accreted value of
the outstanding principal amount of the TARC Intercompany Loan) to the sum of
(i) the outstanding principal amount of the TransTexas Intercompany Loan plus
(ii) the accreted value of the outstanding principal amount of the TARC
Intercompany Loan. A Change of Control would be deemed to occur under the
Subordinated Notes Indenture in the case of certain changes or other events in
respect of the ownership of TransTexas, including any circumstances pursuant to
which any person or group other than John R. Stanley (or his heirs, his estate,
or any trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or becomes the beneficial owner of more than 50% of
the total voting power of TransTexas' then outstanding voting stock and during
the 90-day period thereafter the rating on the notes is downgraded or
withdrawn. A Change of Control would be deemed to occur under the TEC Notes
Indenture, the TransTexas Intercompany Loan and the TARC Intercompany Loan in
the case of certain changes or other events in respect of the ownership or
control of TEC, TransTexas, or TARC including any circumstance pursuant to
which (i) any person or group, other than John R. Stanley (or his heirs, his
estate, or any trust in which he or his immediate family members have, directly
or indirectly, a beneficial interest in excess of 50%) and his subsidiaries or
the TEC Indenture Trustee is or becomes the beneficial owner of more than 50%
of the total voting power of TEC's then outstanding voting stock, or (iii) TEC
or any of its subsidiaries own some of TransTexas' or TARC's capital stock,
respectively, but less than 50% of the total voting stock or economic value of
TransTexas or TARC, respectively, unless the TEC Notes have an investment grade
rating for the period of 120 days thereafter. The term "person," as used in
the definition of Change of Control, means a natural person, company,
government or political subdivision, agency or instrumentality of a government
and also includes a "group," which is defined as two or more persons acting as
a partnership, limited partnership or other group. In addition, certain
changes or other events in respect of the ownership or control of TransTexas
that do not constitute a Change of Control under the Subordinated Notes
Indenture or the TEC Notes Indenture may result in a "change of control" of
TransTexas under the terms of TransTexas' credit facility (the "BNY Facility")
and certain equipment financing. Such an occurrence could create an obligation
for TransTexas to repay such other indebtedness. At October 31, 1997,
TransTexas had approximately $29.7 million of indebtedness (excluding the
Senior Secured Notes and the TransTexas Subordinated Notes) subject to such
right of repayment or repurchase. In the event of a Change of Control under
the TEC Notes Indenture or a "change of control" under the terms of other
outstanding indebtedness, there can be no assurance that TransTexas or TARC
will have sufficient funds to satisfy any such payment obligations.

A change of control or other event that results in deconsolidation of
TransTexas and TransAmerican for federal income tax purposes could result in
acceleration of a substantial amount of federal income taxes. These matters,
individually and in the aggregate, amount to significant potential liability
which, if adjudicated in a manner adverse to TransTexas in one reporting
period, could have a material adverse effect on TransTexas' cash flow or
operations for that period. Although the outcome of these contingencies or the
probability of the occurrence of these contingencies cannot be predicted with
certainty, TransTexas does not expect these matters to have a material adverse
effect on its financial position.

20
<PAGE> 22
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

7. OTHER CURRENT ASSETS

The major components of other current assets are as follows (in
thousands of dollars):

<TABLE>
<CAPTION>
October 31, January 31,
1997 1997
------- ------
<S> <C> <C>
Prepayments:
Trade $ 6,798 $ 9,580
Insurance 2,912 2,913
Deferred loss on commodity price swap agreements -- 8,276
Other 2,665 4,869
---------- ----------
$ 12,375 $ 25,638
========== ==========
</TABLE>

8. ACCRUED LIABILITIES

The major components of accrued liabilities are as follows (in
thousands of dollars):

<TABLE>
<CAPTION>
October 31, January 31,
1997 1997
----------- -----------
<S> <C> <C>
Royalties $ 8,213 $ 27,607
Taxes other than income taxes 9,190 13,501
Interest 28,556 20,978
Payroll 7,829 6,012
Litigation settlements and other -- 1,263
Settlement values of commodity price swap agreements -- 13,276
Insurance 6,266 7,840
Other 8,146 8,384
--------- ----------
$ 68,200 $ 98,861
========= ==========
</TABLE>

Included in litigation settlements and other at January 31, 1997 are
certain non-recurring costs associated with the Lobo Sale.

9. OTHER LIABILITIES

The major components of other liabilities are as follows (in thousands
of dollars):

<TABLE>
<CAPTION>
October 31, January 31,
1997 1997
---------- -----------
<S> <C> <C>
Litigation settlements and accruals $ 10,008 $ 9,641
Interest 2,813 --
Short-term obligations expected to be refinanced:
Litigation settlements -- 2,500
Accrued capital expenditures -- 19,738
Other 4,863 1,112
---------- ----------
$ 17,684 $ 32,991
========== ==========
</TABLE>

During the months of April and May 1997, TransTexas obtained
additional financing in the aggregate amount of approximately $45.8 million, of
which approximately $13.8 million remains outstanding as of October 31, 1997.
Proceeds from these transactions, net of current maturities, were used to pay
the obligations listed above under the caption "Short-term obligations expected
to be refinanced" at January 31, 1997 and for general corporate purposes.

21
<PAGE> 23
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

10. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

The following information reflects the Company's noncash investing and
financing activities (in thousands of dollars):
<TABLE>
<CAPTION>
Nine Months Ended
October 31,
---------------------------
1997 1996
---------- ----------
<S> <C> <C>
Accounts payable for property and equipment $ 58,851 $ 53,803
Interest accretion on TARC Notes capitalized
in property and equipment 48,046 11,687
Product financing arrangements -- (11,022)
Exchange of Subordinated Notes 115,815 --
</TABLE>

11. LITIGATION SETTLEMENT

FARIAS. On February 15, 1996, Celita Suzana Farias filed a wrongful
death action in the 93rd District Court, Hidalgo County, Texas, against
TransTexas and one of its contractors for fatal injuries suffered by the
plaintiff's husband at the Yzaguirre Heirs #3 Well on February 13, 1996. The
plaintiff alleges the defendants operated a crane in such a manner that they
were negligent and grossly negligent. The plaintiff seeks unspecified damages.
On March 7, 1996, the mother of the deceased TransTexas employee filed a
petition in intervention also alleging negligence, gross negligence and malice
and seeking unspecified damages. This litigation was settled in August 1997.

12. CREDIT AGREEMENTS

TransTexas and BNY Financial Corporation are parties to a Second
Amended and Restated Accounts Receivable Management and Security Agreement (the
"BNY Facility"), dated as of October 14, 1997. As of October 31, 1997,
outstanding advances under the BNY Facility totaled approximately $11.3
million. Interest accrues

22
<PAGE> 24
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

on advances at the rate of (i) the higher of (a) the prime rate of The Bank of
New York or (b) the Federal Funds Rate plus 1/2 of 1% plus (ii) 1/2 of 1%.
Obligations under the BNY Facility are secured by liens on TransTexas'
receivables and inventory.

12. TRANSACTIONS WITH AFFILIATES

TARC purchases natural gas from TransTexas on an interruptible basis.
The total cost of natural gas purchased for the nine months ended October 31,
1997 and 1996 was approximately $0.4 million and $2.2 million, respectively.
During the quarter ended October 31, 1997, TARC paid TransTexas approximately
$3.2 million which represented the payable to TransTexas for natural gas
purchased.

Southeast Contractors provides construction personnel to TARC in
connection with the Capital Improvement Program. These construction workers
are temporary employees, and the number and composition of the workforce will
vary throughout the Capital Improvement Program. Southeast Contractors charges
TARC for the direct costs it incurs (which consist solely of employee payroll
and benefits) plus administrative costs and fees of up to $2.0 million per
year. Total labor costs charged by Southeast Contractors for the nine months
ended October 31, 1997 and 1996 were $26.8 million and $13.5 million,
respectively, of which $3.9 million and $1.8 million were payable at October
31, 1997 and January 31, 1997, respectively.

On June 13, 1997, a services agreement was entered into among
TransAmerican, TransTexas, TARC and TEC. Under the agreement, TransTexas will
provide accounting, legal, administrative and other services to TARC, TEC and
TransAmerican and its affiliates. TransAmerican will provide advisory services
to TransTexas, TARC and TEC. TARC will pay to TransTexas approximately
$300,000 per month for services rendered to, and for allocated expenses paid by
TransTexas on behalf of TARC and TEC. TransAmerican will pay to TransTexas
approximately $20,000 per month for such services. TEC and its subsidiaries
will pay $2.5 million in the aggregate per year to TransAmerican for advisory
services and benefits provided by TransAmerican. As of October 31, 1997, $1.2
million and $1.0 million was payable by TARC to TransTexas and TransAmerican,
respectively, pursuant to the services agreement. TransTexas' receivable for
such services from TransAmerican was $0.1 million as of October 31, 1997.

In July and September 1997, TEC advanced an aggregate of $46 million to
TARC. All of the advances are governed by the terms of a promissory note that
is due June 14, 2002 bearing interest at a rate that, when added to the interest
paid by TransTexas on the TransTexas Intercompany Loan, will equal the amount of
interest payable on the TEC Notes. In November and December 1997, TARC repaid
approximately $33.9 million in principal and interest to TEC.

For the nine months ended October 31, 1997, TEC has contributed
$6 million to TARC for operating expenses.

In September, November and December 1997, TEC advanced an aggregate of
approximately $34 million to TransTexas pursuant to promissory notes which
mature on June 14, 2002. The notes bear interest in an amount equal to a
proportionate share of the fixed semi-annual interest payment of $2.8 million
based upon the average outstanding balance of all notes (other than the notes
evidencing the Intercompany Loans) between TransTexas and TEC and the average
outstanding balance of all notes (other than the notes evidencing the
Intercompany Loans) between TARC and TEC.

23
<PAGE> 25
TRANSAMERICAN ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

24
<PAGE> 26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

The consolidated financial statements of TEC reflect the results of
operations of TEC's wholly and majority owned subsidiaries, TARC and
TransTexas. As of October 31, 1997, TransTexas' operations consisted of
exploration and production of natural gas, condensate and natural gas liquids
("E&P"). TARC's business is refining and storage operations ("Refining"). As
described in Note 1 of Notes to Condensed Consolidated Financial Statements,
transactions between TransTexas and TARC are significantly restricted. The
following discussion should be read in conjunction with the condensed
consolidated financial statements and notes thereto of the Company included
elsewhere in this report.

TRANSTEXAS

RESULTS OF OPERATIONS

TransTexas' results of operations are dependent upon natural gas
production volumes and unit prices from sales of natural gas, condensate and
NGLs. The profitability of TransTexas also depends on its ability to minimize
finding and lifting costs and maintain its reserve base while maximizing
production. On May 29, 1997, TransTexas consummated a stock purchase agreement
with an unaffiliated buyer (the "Lobo Sale Agreement"), with an effective date
of March 1, 1997, to effect the sale (the "Lobo Sale") of the stock of
TransTexas Transmission Corporation ("TTC"), its subsidiary that owned
substantially all of TransTexas' Lobo Trend producing properties and related
pipeline transmission system, for a sales price of approximately $1.1 billion.
Accordingly, the Company's reported results for the three and nine months ended
October 31, 1997 include the effect of reduced volumes attributable to the
producing properties sold as part of the Lobo Sale.

TransTexas' operating data for the three months and nine months ended
October 31, 1997 and 1996, is as follows:

<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 31, October 31,
--------------------- ----------------------
1997 1996 1997 1996
-------- -------- ------- --------
<S> <C> <C> <C> <C>
Sales volumes:
Gas (Bcf) (1) 10.3 38.1 63.5 112.4
NGLs (MMgal) -- 39.3 61.7 128.6
Condensate (MBbls) 92 120 518 400
Average prices:
Gas (dry) (per Mcf) (2) $ 2.66 $ 1.62 $ 2.04 $ 1.87
NGLs (per gallon) -- .38 .29 .33
Condensate (per Bbl) 18.55 22.07 19.52 20.47
Number of gross wells drilled 21 34 79 111
Percentage of wells completed 76% 79% 63% 73%
</TABLE>
- ----------------------
(1) Sales volumes for the nine months ended October 31, 1997 include 7.3 Bcf
delivered prior to the third quarter pursuant to volumetric production
payments.
(2) Average prices for the nine months ended October 31, 1997 includes amounts
delivered under volumetric production payments. The average gas price for
TransTexas' undedicated production for this period was $2.15 per Mcf. Gas
prices do not include the effect of hedging agreements.

25
<PAGE> 27
A summary of TransTexas' operating expenses is set forth below (in
millions of dollars):

<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 31, October 31,
------------------------- ----------------------
1997 1996 1997 1996
----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C>
Operating costs and expenses:
Lease $ 3.0 $ 7.0 $ 15.2 $ 19.8
Pipeline 2.7 8.9 14.1 25.2
Natural gas liquids 0.1 9.7 14.6 32.9
Well services 1.4 0.2 2.1 0.4
------------ ---------- --------- ---------
7.2 25.8 46.0 78.3
Taxes other than income taxes (1) 2.1 2.1 9.8 14.4
------------ ---------- --------- ---------
Total $ 9.3 $ 27.9 $ 55.8 $ 92.7
============ ========== ========= =========
</TABLE>
- -----------------------------
(1) Taxes other than income taxes include severance, property, and other
taxes.

TransTexas' average depletion rates have been as follows:

<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 31, October 31,
------------------------- ----------------------
1997 1996 1997 1996
----------- ---------- --------- ---------
<S> <C> <C> <C> <C>
Depletion rates (per Mcfe) $ 1.09 $ 0.94 $ 1.04 $ 0.93
=========== ========== ======== =========
</TABLE>

TransTexas' Consolidated EBITDA, as defined in the Indenture, is set
forth below (in millions of dollars). EBITDA consists of TransTexas' earnings
before consolidated fixed charges (excluding capitalized interest), income
taxes, depreciation, depletion, and amortization. EBITDA is not intended to
represent cash flow or any other measure of financial performance in accordance
with generally accepted accounting principles.

Cash flows from:
Operating activities $ 38.5 $ 21.5 $ 25.7 $ 162.8
Investing activities $ 137.3 $ (65.5) $ 670.7 $ (134.8)
Financing activities $ (210.6) $ 21.9 $ (716.4) $ (19.6)
=========== ========== ======== =========
</TABLE>

THREE MONTHS ENDED OCTOBER 31, 1997, COMPARED WITH THE THREE MONTHS ENDED
OCTOBER 31, 1996

Gas, condensate and NGLs revenues for the three months ended October
31, 1997 decreased $42.6 million from the comparable prior year quarter, due
primarily to lower prices for and decreased volumes of natural gas and NGLs,
primarily in the second and third quarters. The average monthly prices received
per Mcf of gas, ranged from $2.30 to $2.94 in the three months ended October 31,
1997, compared to a range of $1.70 to $1.99 in the same period in the prior
year. The decrease in natural gas sales volumes resulted primarily from the
divestiture of approximately 207 Bcfe of TransTexas' reserves as a result of the
Lobo Sale. Lobo Trend production was 12.1 Bcfe for the three months ended
October 31, 1996. As of October 31, 1997, TransTexas had a total of 106
producing wells compared to 832 at October 31, 1996. NGL sales volumes
decreased as a result of decreases in the volumes of natural gas processed.
Transportation revenues decreased $8.9 million over the prior year quarter due
to the divestiture of the pipeline system as a result of the Lobo Sale.

As a result of the Lobo Sale, the Tender Offer and the Subordinated
Notes Exchange Offer described in Note 2 of Notes to Condensed Consolidated
Financial Statements, TransTexas recorded a $540 million pretax gain ($175
million of which was realized in the third quarter as a result of post-closing
adjustments) and a $72 million after tax extraordinary charge during the nine
months ended October 31, 1997.

Primarily as a result of the Lobo Sale, lease operating expenses,
pipeline operating expenses and NGLs cost for the quarter ended October 31,
1997 decreased $4.0 million, $6.2 million and $9.6 million, respectively,
compared

26
<PAGE> 28

to the comparable prior year period. Well service expenses for the three months
ended October 31, 1997 increased $1.2 million as compared to the comparable
period of the prior year primarily due to costs related to providing services to
third parties. Depreciation, depletion and amortization expense for the three
months ended October 31, 1997 decreased $17.6 million due to a decrease in
TransTexas' undedicated natural gas production as a result of the Lobo Sale
offset by a $0.15 increase in the depletion rate. The depletion rate increased
primarily as a result of the transfer of approximately $30 million of previously
excluded costs of unevaluated properties into the full cost pool.

Beginning in fiscal 1996, TransTexas substantially increased its
exploration activities and has made significant capital expenditures for
leasehold interests classified as unevaluated properties. As a result of
exploratory discoveries on certain of these leases and the related capital
requirements, TransTexas has farmed out certain other interests with a carrying
value of $13 million and expects to farm out additional leases. To the extent
these activities do not result in the discovery of proved reserves, the leases
will be added to the full cost pool, which could result in continued increases
in the depletion rate. The majority of unevaluated properties will be evaluated
over the next two years.

General and administrative expenses decreased approximately $10.4
million in the three months ended October 31, 1997, due primarily to lower
litigation expenses.

Interest income for the three months ended October 31, 1997 increased
approximately $3.0 million over the comparable prior year period due to
increased cash balances in the current quarter. TransTexas does not expect to
earn significant interest income during fiscal 1999. Interest expense decreased
$5.7 million over the same period of the prior year primarily as a result of the
retirement of the Senior Secured Notes, offset in part by a decrease in the
amount of interest capitalized in connection with the acquisition of undeveloped
leasehold acreage.

NINE MONTHS ENDED OCTOBER 31, 1997, COMPARED WITH THE NINE MONTHS ENDED
OCTOBER 31, 1996

Gas, condensate and NGL revenues for the nine months ended October 31,
1997 decreased by $88.2 million from the comparable period of the prior year,
due primarily by decreases in gas, condensate and NGLs sales prices and gas
sales volumes, offset in part by increases in condensate sales volumes. The
average monthly prices received per Mcf of gas, excluding amount dedicated to
volumetric production payments, ranged from $2.94 to $1.49 in the nine months
ended October 31, 1997, compared to a range of $1.70 to $2.45 in the same period
in the prior year. The increase in condensate sales volumes is due primarily to
increased production from TransTexas' new development areas, offset in part the
divestiture of the TransTexas producing properties as a result of the Lobo Sale.
NGLs sales volumes decreased as a result of decreases in the volumes of natural
gas processed. Transportation revenues decreased by $13.7 million for the nine
months ended October 31, 1997, due primarily to the divestiture of the pipeline
system as a result of the Lobo Sale.

Lease operating expenses in the nine months ended October 31, 1997
decreased by $4.6 million from the prior year period due primarily to a decrease
in the number of producing wells as a result of the Lobo Sale, offset partially
by an increase in salt water disposal costs and the initiation of a program to
increase flow rates on certain TransTexas' wells through increased workovers and
the installation of leased wellhead compressors. Pipeline operating expenses
decreased by $11.1 due primarily to the divestiture of the pipeline system as a
result of the Lobo Sale. NGLs cost decreased by $18.3 million from the
comparable period in the prior year primarily due to a decrease in volumes of
natural gas processed as a result of the Lobo Sale. Well service expenses for
the nine months ended October 31, 1997 increased $1.7 million as compared to the
comparable prior year period primarily due to costs related to providing
services to third parties. Depreciation, depletion and amortization expense for
the nine months ended October 31, 1997 decreased by $25.1 million due to the
decrease in TransTexas' undedicated natural gas production as a result of the
Lobo Sale, partially offset by a $0.11 increase in the depletion rate. The
depletion rate increased primarily as a result of the transfer of approximately
$30 million of previously excluded costs of unevaluated properties into the full
cost pool. General and administrative expenses decreased by $5.6 million due
primarily to a decrease in litigation expense. Taxes other than income taxes
decreased by $4.6 million over the comparable prior year period due primarily to
a decrease in ad valorem, severance, and excise taxes.

Interest income for the nine months ended October 31, 1997 increased by
approximately $8.3 million over the comparable period of the prior year due to
increased average cash balances. TransTexas does not expect to earn significant
interest income during fiscal 1999. Interest expense decreased by $10.6
million primarily as a result of the retirement of the Senior Secured Notes
offset in part by the accretion on the Old Subordinated Notes.

Cash flow from operating activities for the nine months ended October
31, 1997 decreased by approximately $137.2 million from the prior-year period
due primarily to lower net income from gas and oil production activities and
cash settlement of volumetric production payments in connection with the Lobo
Sale. In addition, during 1996, TransTexas collected $58.6 million from the
sale of volumetric production payments.

Cash provided by investing activities increased by $805.5 million due
to proceeds from the sale of certain TransTexas producing properties offset in
part by the net increase in cash restricted for share repurchases pursuant to
the TransTexas Share Repurchase Program and increased capital expenditures.

Cash flow used in financing activities decreased by approximately
$696.7 million due primarily to the retirement of the Senior Secured Notes and
purchases of stock pursuant to the TransTexas Share Repurchase Program offset in
part by the TransTexas Intercompany Loan.

27
<PAGE> 29
TARC

RESULTS OF OPERATIONS

TARC's refinery was inoperative from January 1983 through February
1994. During this period, TARC's revenues were derived primarily from tank
rentals and its expenses consisted of maintenance and repairs, tank rentals,
general and administrative expenses and property taxes. TARC commenced partial
operations at the refinery in March 1994 and has operated the No. 2 Vacuum Unit
intermittently since that time. TARC may operate the No. 2 Crude Unit and the
No. 2 Vacuum Unit if market conditions are favorable. TARC's decision to
commence or suspend operations will depend on the availability of working
capital, current operating margins and the need to tie-in units as they are
completed. TARC does not consider its historical results to be indicative of
future results.

TARC's results of operations are dependent on the operating status of
certain units within its refinery, which determines the types of feedstocks
processed and refined product yields. The results are also affected by the
unit costs of purchased feedstocks and the unit prices of refined products,
which can vary significantly. The Capital Improvement Program is designed to
significantly change TARC's throughput capacity, the feedstocks processed, and
refined product yields.

TARC believes, based on current estimates of refining margins and costs
of the expansion and modification of the refinery, that future undiscounted cash
flows will be sufficient to recover the cost of the refinery over its estimated
useful life. Management believes there have been no events or changes in
circumstances that would require the recognition of an impairment loss.
However, due to the inherent uncertainties in estimating future refining
margins, and in constructing and operating a large-scale refinery, there can
be no assurance that TARC will ultimately recover the cost of the refinery.
Management believes that the book value of the refinery is in excess of its
current estimated fair market value.

THREE MONTHS ENDED OCTOBER 31, 1997, COMPARED WITH THE THREE MONTHS ENDED
OCTOBER 31, 1996

Other revenues of $0.6 million for the three months ended October 31,
1997 were from operations of TARC's terminal facility acquired in September
1997.

Processing arrangements reflect a loss of $0.1 million and $5.2 million
for the three months ended October 31, 1997 and 1996, respectively. Losses were
primarily due to unfavorable prices for refined products and price management
activities.

Operations and maintenance expense for the three months ended October
31, 1997 decreased to $2.8 million from $3.0 million for the same period in
1996, primarily due to increased amounts of labor costs capitalized in
connection with the Capital Improvement Program, partially offset by the
expensing of certain prepaid costs for storage and related facilities.

Depreciation and amortization expense for the three months ended
October 31, 1997 increased to $2.0 million from $1.7 million for the same
period in 1996, primarily due to depreciation related to the terminal facility
acquired in September 1997.

General and administrative expenses increased to $6.0 million for the
three months ended October 31, 1997 from $1.7 million for the same period in
1996, primarily due to the write-off of certain intangibles related to the
terminal facility acquired in September 1997 and increased Services Agreement
fees.

Taxes other than income taxes for the three months ended October 31,
1997 remained at the same level as in 1996.

Interest income for the three months ended October 31, 1997 increased
to $2.0 million as compared to the same period in 1996 primarily due to the
investment of proceeds from the TARC Intercompany Loan. Interest expense, net
for the three months ended October 31, 1997 increased $6.1 million, due
primarily to interest on the TARC Intercompany Loan. During the three months
ended October 31, 1997, TARC capitalized approximately $23.3 million

28
<PAGE> 30
of interest related to property and equipment additions at TARC's refinery
compared to $17.7 million for the three months ended October 31, 1996.

Equity in income of TransTexas before extraordinary items for the three
months ended October 31, 1997 increased $1.3 million as compared to the same
period in 1996. In September 1997, TARC sold approximately 8.5 million shares
of TransTexas common stock pursuant to the TransTexas Share Repurchase Program.
TARC received $136.2 million in connection with the repurchase, of which $124.5
million (representing the excess of the cash received over TARC's carrying value
of the stock) was recorded as a capital contribution.

NINE MONTHS ENDED OCTOBER 31, 1997, COMPARED WITH THE NINE MONTHS ENDED OCTOBER
31, 1996

There were no product sales for the nine months ended October 31, 1997
as compared to $10.9 million for the same period in 1996, primarily as a result
of processing the majority of refinery throughput for third parties under
processing agreements.

Other revenues of $0.6 million for the nine months ended October 31,
1997 were from operations of TARC's terminal facility acquired in September
1997.

There were no costs of products sold for the nine months ended October
31, 1997 as compared to $12.4 million for the same period in 1996, due
primarily to the Company's use in 1997 of processing arrangements pursuant to
which TARC processed feedstock owned by third parties (as opposed to TARC's
purchase of feedstock and sale of product).

Processing arrangements reflect income of $3.1 million and a loss of
$8.6 million for the nine months ended October 31, 1997 and 1996, respectively.
Income and losses were primarily due to unfavorable prices for refined products
and price management activities.

Operations and maintenance expense for the nine months ended October
31, 1997 increased $1.1 million to $10.7 million from $9.6 million for the same
period in 1996, primarily due to the increase of the Company's labor force in
connection with the Capital Improvement Program.

Depreciation and amortization expense for the nine months ended
October 31, 1997 increased $0.1 million to $5.4 million from $5.3 million for
the same period in 1996, primarily due to depreciation related to the terminal
facility acquired in September 1997.

General and administrative expenses increased $3.6 million to $11
million for the nine months ended October 31, 1997 from the $7.4 million for the
same period in 1996, primarily due to the write-off of certain intangibles
related to the terminal facility acquired in September 1997, increased services
agreement fees and an offsetting decrease in insurance expense and professional
fees.

Taxes other than income taxes for the nine months ended October 31,
1997 decreased $1.1 million to $2.7 million from $3.8 million for the same
period in 1996, primarily due to decreased property tax expense.

Loss on purchase commitments for the nine months ended October 31,
1997 consists of a $4.8 million loss related to a commitment to purchase 0.6
million barrels of feedstock. These barrels have been sold to a third party
and are now subject to a processing agreement.

Interest income for the nine months ended October 31, 1997 increased
$2.8 million as compared to the same period in 1996, primarily due to the
investment of proceeds from the TARC Intercompany Loan. Interest expense for
the nine months ended October 31, 1997 increased $10.8 million, primarily due
to interest on the TARC Intercompany Loan. During the nine months ended
October 31, 1997, the Company capitalized approximately $64.9 million of
interest related to property and equipment additions at TARC's refinery
compared to $51.0 million for the nine months ended October 31, 1996.

Equity in income of TransTexas before extraordinary item for the nine
months ended October 31, 1997 increased to $45.2 million as compared to $9.8
million for the same period in 1996, due primarily to a $540 million gain on the
sale by TransTexas of a subsidiary. In September 1997, TARC sold approximately
8.5 million shares of TransTexas common stock pursuant to the TransTexas Share
Repurchase Program. TARC received $136.2 million in connection with the
repurchase, of which $124.5 million (representing the excess of the cash
received over TARC's carrying value of the stock) was recorded as a capital
contribution. TARC recognized equity in an extraordinary item of TransTexas of
$(10.2) million for the nine months ended October 31, 1997. The extraordinary
loss of TransTexas is attributable to a loss on the early extinguishment of debt
as a result of the repurchase by TransTexas of its Senior Secured Notes and the
Subordinated Notes Exchange Offer. The gain on the sale of TransTexas stock of
$56.2 million for the nine months ended October 31, 1996 was a result of TARC's
sale of 4.55 million shares of TransTexas common stocks in March 1996.

The loss on the early extinguishment of debt of $84.4 million for the
nine months ended October 31, 1997 is a result of the completion of the TARC
Notes Tender Offer as described in Note 2 of Notes to Condensed Consolidated
Financial Statements.

29
<PAGE> 31
LIQUIDITY AND CAPITAL RESOURCES

On May 29, 1997, TransTexas consummated the Lobo Sale, with an
effective date of March 1, 1997, for a sales price of approximately $1.1
billion. With proceeds from the Lobo Sale, TransTexas repaid certain
indebtedness and other obligations including production payments, in an
aggregate amount of approximately $84 million. The remaining net proceeds have
been used for the redemption or repurchase of the Senior Secured Notes and for
general corporate purposes.

On June 13, 1997, TEC completed a private offering (the "TEC Notes
Offering") of $475 million aggregate principal amount of 11 1/2% Senior Secured
Notes due 2002 (the "TEC Senior Secured Notes") and $1.13 billion aggregate
principal amount of 13% Senior Secured Discount Notes due 2002 (the "TEC Senior
Secured Discount Notes" and, together with the TEC Senior Secured Notes, the
"TEC Notes") for net proceeds of approximately $1.3 billion.

With proceeds of the TEC Notes Offering, TEC made intercompany loans
to TransTexas in the principal amount of $450 million (the "TransTexas
Intercompany Loan") and to TARC in the original amount of $676 million (the
"TARC Intercompany Loan"and, together with the TransTexas Intercompany Loan,
the "Intercompany Loans"). The promissory note evidencing the TransTexas
Intercompany Loan (i) bears interest at a rate of 10 7/8% per annum, payable
semi-annually in cash in arrears and (ii) is secured initially by a security
interest in substantially all of the assets of TransTexas other than
inventory, receivables and equipment. The promissory note evidencing the TARC
Intercompany Loan (i) accretes principal at the rate of 16% per annum,
compounded semi-annually, until June 15, 1999 to a final accreted value of $920
million, and thereafter pays interest semi-annually in cash in arrears on the
accreted value thereof, at a rate of 16% per annum and (ii) is secured
initially by a security interest in substantially all of TARC's assets other
than inventory, receivables and equipment. The Intercompany Loans will mature
on June 1, 2002. The Intercompany Loan Agreements contain certain restrictive
covenants, including, among others, limitations on incurring additional debt,
asset sales, dividends and transactions with affiliates. Upon the occurrence
of a Change of Control (as defined), TEC will be required to make an offer to
purchase all of the outstanding TEC Notes at a price equal to 101% of the
principal amount thereof, together with accrued and unpaid interest, if any,
or, in the case of any such offer to purchase the TEC Senior Secured Discount
Notes prior to June 15, 1999, at a price equal to 101% of the accreted value
thereof, in each case, to and including the date of purchase. Pursuant to the
terms of the Intercompany Loans, TEC may require TransTexas and TARC to pay a
pro rata share of the purchase price paid by TEC in an offer to purchase
pursuant to a Change of Control. See "Potential Effects of a Change of
Control."

On June 13, 1997, TransTexas completed a tender offer for its Senior
Secured Notes for 111 1/2% of their principal amount (plus accrued and unpaid
interest). Approximately $785.4 million principal amount of Senior Secured
Notes were tendered and accepted by TransTexas. The Senior Secured Notes
remaining outstanding were called for redemption on June 30, 1997 pursuant to
the terms of the Senior Secured Notes Indenture.

On June 19, 1997, TransTexas completed an exchange offer, pursuant to
which it exchanged approximately $115.8 million aggregate principal amount of
its 13 3/4% Series C Senior Subordinated Notes due 2001 (the "TransTexas Series
C Subordinated Notes") for all of its outstanding 13 1/4% Senior Subordinated
Notes due 2003 (the "Old TransTexas Subordinated Notes"). On October 10, 1997,
TransTexas completed a registered exchange offer resulting in the issuance of
$115.8 million aggregate principal amount of its 13 3/4% Series D Senior
Subordinated Notes due 2001 (the "TransTexas Subordinated Notes") in exchange
for all of the outstanding TransTexas Series C Subordinated Notes. The
TransTexas Subordinated Notes pay interest in cash semi-annually in arrears on
each June 30 and December 31 commencing December 31, 1997. The indenture
governing the TransTexas Subordinated Notes (the "Subordinated Notes Indenture")
includes certain restrictive covenants, including, among others, limitations on
incurring additional debt, asset sales, dividends and transactions with
affiliates.

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<PAGE> 32

In June 1997, TransTexas implemented a stock repurchase program
pursuant to which it plans to repurchase common stock from its public
stockholders and from its affiliates, including TEC and TARC, in an aggregate
amount of approximately $399 million in value of stock purchased. Shares may be
purchased through open market purchases, negotiated transactions or tender
offers, or a combination of the above. It is anticipated that the price paid to
affiliated stockholders will equal the weighted average price paid to purchase
shares from the public stockholders. As of October 31, 1997, approximately 3.9
million shares had been repurchased from public stockholders for an aggregate
purchase price of approximately $61.4 million, and approximately 12.6 million
shares had been repurchased from TARC and TEC for an aggregate purchase price of
approximately $201 million.

On June 13, 1997, TARC completed a tender offer (the "TARC Notes
Tender Offer") for the (i) TARC Mortgage Notes for 112% of their principal
amount (plus accrued and unpaid interest) and (ii) TARC Discount Notes for 112%
of their accreted value. TARC Mortgage Notes and TARC Discount Notes with an
aggregate carrying value of $423 million were tendered and accepted by TARC at
a cost to TARC of approximately $437 million (including accrued interest,
premiums and other costs). As a result of the TARC Notes Tender Offer, $22.8
million in debt issuance costs were written off and TARC recorded a total
extraordinary charge of approximately $84 million during the nine months ended
October 31, 1997. As of October 31, 1997, TARC Mortgage Notes and TARC
Discount Notes with a carrying value of approximately $16.0 million remained
outstanding.

On June 13, 1997, TEC completed a tender offer for the outstanding
common stock purchase warrants of TARC ("TARC Warrants") at a price of $4.50
per warrant. Pursuant to the tender offer, TEC purchased 7,320,552 TARC
Warrants for an aggregate purchase price of approximately $33 million.
TransAmerican subsequently purchased 163,679 TARC Warrants for an aggregate
purchase price of approximately $0.7 million. TEC, TransAmerican and TARC may
repurchase additional TARC Warrants, and TARC may enter into a merger with one
of its affiliates pursuant to which each remaining TARC Warrant would become
exercisable (at an exercise price of $.01) to receive $4.51 of cash instead of
one share of common stock of TARC.

TEC paid a dividend to TransAmerican in the amount of $23 million. A
portion of the dividend was used to repay the debt of an affiliate, which had
been secured by a pledge of 3.7 million shares of TransTexas common stock. In
connection with the TEC Notes Offering, TransAmerican contributed the 3.7
million shares of TransTexas common stock to TEC.

Following consummation of the TEC Notes Offering and the transactions
described in Note 2 of Notes to Condensed Consolidated Financial Statements,
TEC's only source of funds for its holding company operations and debt service
will be from approximately $50 million in working capital currently held by
TEC, payments on the Intercompany Loans, dividends from its subsidiaries,
interest on funds on the Disbursement Account, payments made by TARC on behalf
of TEC pursuant to the Services Agreement and, in limited circumstances as
permitted by the TEC Notes Indenture, sales of stock TEC holds in its
subsidiaries.

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<PAGE> 33
TransTexas and BNY Financial Corporation are parties to a Second
Amended and Restated Accounts Receivable Management and Security Agreement (the
"BNY Facility"), dated as of October 14, 1997. As of October 31, 1997,
outstanding advances under the BNY Facility totaled approximately $11.3
million. Interest accrues on advances at the rate of (i) the higher of (a) the
prime rate of The Bank of New York or (b) the Federal Funds Rate plus 1/2 of
1% plus (ii) 1/2 of 1%. Obligations under the BNY Facility are secured by
liens on TransTexas' receivables and inventory.

The TEC Notes Indenture permits TARC to obtain a revolving credit
facility but places certain limitations on TARC's ability to incur other
indebtedness. In order to operate the refinery at expected levels after the
completion of Phase I of the Capital Improvement Program, TARC will require
additional working capital. Although TARC and a lender have engaged in
discussions concerning the terms of a revolving credit facility, there can be
no assurance TARC will be able to obtain such a facility.

During the months of April and May 1997, TransTexas obtained
additional financing in the aggregate amount of approximately $45.8 million, of
which approximately $13.8 million remains outstanding as of October 31, 1997.
Proceeds from these transactions, net of current maturities, were used to pay
certain short-term obligations outstanding at January 31, 1997.

TransTexas makes substantial capital expenditures for the exploration,
development and production of natural gas. TransTexas historically has
financed its capital expenditures, debt service and working capital
requirements from cash from operations, public and private offerings of debt
and equity securities, the sale of production payments, asset sales, its
accounts receivable revolving credit facilities and other financings.
TransTexas' debt covenants may limit its ability to obtain additional financings
or to sell properties, and there is no assurance that cash flow from operations
will be sufficient to fund capital and debt service requirements.

For the nine months ended October 31, 1997, total capital expenditures
were $317 million, including $45 million for lease acquisitions, $206 million
for drilling and development and $66 million for TransTexas' gas gathering and
pipeline system and other equipment and seismic acquisitions. Additional
capital expenditures of $60 million are anticipated for the fourth quarter.
During fiscal 1998, TransTexas accelerated its exploration and development
drilling program which included the successful exploration efforts in Galveston
Bay, Goliad County and Brazoria County and, as a result, its capital
expenditures for fiscal 1998 have significantly exceeded its original
anticipated amount of $220 million. In addition, TransTexas is developing
several oil and gas prospects with the potential to increase production and cash
flow from operations, but which require capital expenditures in excess of
projected cash flow over at least the next twelve months. To finance the capital
expenditure requirements and reduce its working capital deficit, TransTexas
intends to supplement its cash flow from operations with a combination of asset
sales and financings. There is no assurance that adequate funds can be obtained
on a timely basis from such sources. Failure to obtain adequate funds for
capital expenditures could have a material adverse effect on financial position,
results of operations and cash flows.

Although TARC may operate the No. 2 Crude Unit and the No. 2 Vacuum
Unit if it obtains a favorable processing arrangement, TARC anticipates that,
until completion of the Delayed Coking Unit, its capital needs will be limited
to expenditures for the Capital Improvement Program, general and administrative
expenses and refinery maintenance costs.

Following completion of the transactions described in Note 2 of Notes
to Condensed Consolidated Financial Statements, TARC and TEC will have
deposited approximately $529 million into accounts in the name of TARC and TEC
(together, the "TARC Disbursement Account") from which disbursements will be
made pursuant to a disbursement agreement (the "Disbursement Agreement") among
TARC, TEC, Firstar Bank of Minnesota, N.A., as trustee (the "TEC Indenture
Trustee"), Firstar Bank of Minnesota, N.A., as disbursement agent (the
"Disbursement Agent"), and Baker & O'Brien, Inc., as construction supervisor
(the "Construction Supervisor"). See Note 4 of Notes to Condensed Consolidated
Financial Statements. Of these funds, $427 million will be available only for
the Capital Improvement Program, approximately $25.5 million will be available
for general and administrative expenses, $7 million will be available for
outstanding accounts payable, $50 million will be available for working capital
upon completion of the Delayed Coking Unit and certain supporting units and $19
million will be available for the payment of interest on, or the redemption,
purchase, defeasance or other retirement of, the outstanding TARC Notes. TARC's
estimated capital

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<PAGE> 34

expenditures for the Capital Improvement Program are $201 million, $210 million
and $16 million, respectively, for the remainder of fiscal 1998, and fiscal
1999 and fiscal 2000. If engineering problems, cost overruns or delays occur
and other financing sources and other financing sources are not available, TARC
may not be able to complete both phases of the Capital Improvement Program. As
of October 31, 1997, $119 million had been disbursed to TARC out of the TARC
Disbursement Account for use in the Capital Improvement Program and $13 million
for general corporate purposes.

In April 1996, TARC entered into a processing agreement with a third
party to process feedstocks. Under the terms of the agreement, the processing
fee earned by the third party is based on the margin earned by the third party,
if any, after deducting all of its related costs such as feedstock acquisition,
hedging, transportation, processing and inspections plus a commission for each
barrel processed. As of October 31, 1997, TARC has processed 6.4 million
barrels of feedstocks under this agreement. TARC also entered into processing
agreements with this third party to process approximately 1.1 million barrels
of the third party's feedstocks for a fixed price per barrel. As of October 31,
1997 and January 31, 1997, TARC was storing approximately 0.7 million and 1.0
million barrels, respectively, of feedstock and intermediate or refined
products. For the nine months ended October 31, 1997 and 1996, TARC recorded
income (loss) from processing agreements of $3.1 million and $(8.6) million,
respectively. For the three months ended October 31, 1997 and 1996, TARC
recorded a loss from processing arrangements of $0.1 million and $5.2 million,
respectively. Included in the 0.7 million barrels of product stored at the
refinery as of October 31, 1997, is approximately 0.6 million barrels of
feedstock related to a purchase commitment entered into in April 1997. The 0.6
million barrels have been sold to the third party involved in the processing
arrangement. For the nine months ended October 31, 1997, TARC incurred a loss
of approximately $4.8 million related to this purchase commitment.

In July and September 1997, TARC received advances from TEC in the
aggregate amount of $46 million. In November and December 1997, TARC repaid
approximately $31 million in principal, and in December 1997 paid approximately
$2.9 million in interest to TEC. See Note 12 of Notes to Condensed Consolidated
Financial Statements.

In September, November and December 1997, TEC advanced an aggregate
of approximately $34 million to TransTexas pursuant to promissory notes which
mature on June 14, 2002. The notes bear interest in an amount equal to
a proportionate share of the fixed semi-annual interest payment of $2.8 million
based upon the average outstanding balance of all notes (other than the notes
evidencing the Intercompany Loans) between TransTexas and TEC and the average
outstanding balance of all notes (other than the notes evidencing the
Intercompany Loans) between TARC and TEC.

In September 1997, TARC purchased a tank storage facility adjacent to
the refinery for a cash purchase price of $40 million (which does not include a
$3.1 million liability recorded for environmental remediation as discussed
below). Environmental investigations conducted by the previous owner of the
facilities have indicated soil and groundwater contamination in several areas on
the property. As a result, the former owner submitted to the LDEQ plans for the
remediation of any significant indicated contamination in such areas. TARC has
analyzed these investigations and has carried out further Phase II Environmental
Assessments to verify their results. TARC intends to incorporate any required
remediation into its ongoing work at the refinery. In connection with the
purchase of the facilities, TARC agreed to indemnify the seller from all cleanup
costs and certain other damages resulting from contamination of the property,
and created a $5 million escrow account to fund required remediation costs and
indemnification claims by the seller. As a result of TARC's Phase II
Environmental Assessments, TARC believes that the amount in escrow should be
sufficient to fund the remediation costs associated with identified
contamination; however, because the LDEQ has not yet approved certain of the
remediation plans, there can be no assurance that the funds set aside in the
escrow account will be sufficient to pay all required remediation costs. During
the three months ended October 31, 1997, TARC recorded a liability of $3.1
million for this contingency.

On December 10, 1997, TARC issued to an unaffiliated third party a 13%
Senior Secured Note due 2002 (the "Acquisition Note") in the principal amount
of $36 million to finance a portion of the purchase price of the tank storage
facility purchased in September 1997. The Acquisition Note is secured by a
mortgage on the tank storage facility, and is governed by a Note Purchase
Agreement containing restrictive covenants substantially similar to those
contained in the TARC Intercompany Loan and TEC Indenture. The Acquisition Note
bears interest at 13%, payable semiannually on June 15 and December 15, and
matures on December 15, 2002.

Environmental compliance and permitting issues are an integral part of
the capital expenditures anticipated in connection with the expansion and
modification of the refinery. TARC does not expect to incur any additional
significant expenses for environmental compliance during fiscal 1998 or fiscal
1999 other than those budgeted for the Capital Improvement Program. There is
no assurance, however, that costs incurred to comply with environmental laws
will not have a material adverse effect on TARC's future results of operations,
cash flows or financial condition. TARC also has contingent liabilities with
respect to litigation matters as more fully described in Note 5 of Notes to
Condensed Consolidated Financial Statements.

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CONTINGENT LIABILITIES

TransTexas has significant contingent liabilities, including
liabilities with respect to litigation matters as described above. These
matters, individually and in the aggregate, amount to significant potential
liability which, if adjudicated in a manner adverse to TransTexas in one
reporting period, could have a material adverse effect on TransTexas' cash
flow or operations for that period. Although the outcome of these
contingencies or the probability of the occurrence of these contingencies
cannot be predicted with certainty, TransTexas does not expect these matters to
have a material adverse effect on its financial position.

In January 1996, TransTexas entered into a reimbursement agreement
with an unaffiliated third party pursuant to which the third party caused a $20
million letter of credit to be issued to collateralize a supersedeas bond on
behalf of TransTexas. If there is a draw under the letter of credit,
TransTexas is required to reimburse the third party within 60 days. TransTexas
has agreed to issue up to 8.6 million shares of common stock of TransTexas to
the third party if this contingent obligation to such third party becomes fixed
and remains unpaid for 60 days. TransTexas does not believe that this
contingency will occur. If the obligation becomes fixed, and alternative
sources of capital are not available, TransTexas could elect to sell shares of
TransTexas' common stock prior to the maturity of the obligation and use the
proceeds of such sale to repay the third party. Based on TransTexas' current
capitalization, the issuance of shares of TransTexas' common stock to satisfy
this obligation would result in deconsolidation of TransTexas for federal
income tax purposes.

POTENTIAL TAX LIABILITY

Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and of a
contingent liability for interest of $102 million owed by TransAmerican.
TransAmerican has taken the federal tax position that the entire amount of this
debt cancellation is excluded from its income under the cancellation of
indebtedness provisions (the "COD Exclusion") of the Internal Revenue Code of
1986, as amended, and has reduced its tax attributes (including its net
operating loss and credit carryforwards) as a consequence of the COD Exclusion.
No federal tax opinion was rendered with respect to this transaction, however,
and TransAmerican has not obtained a ruling from the Internal Revenue Service
(the "IRS") regarding this transaction. TransTexas believes that there is
substantial legal authority to support the position that the COD Exclusion
applies to the cancellation of TransAmerican's indebtedness. However, due to
factual and legal uncertainties, there can be no assurance that the IRS will
not challenge this position, or that such challenge would not be upheld. Under
an agreement between TransTexas, TransAmerican and certain of TransAmerican's
subsidiaries (the "Tax Allocation Agreement"), TransTexas has agreed to pay an
amount equal to any federal tax liability (which would be approximately $25.4
million) attributable to the inapplicability of the COD Exclusion. Any such
tax would be offset in future years by alternative minimum tax credits and
retained loss and credit carryforwards to the extent recoverable from
TransAmerican. As a member of the TNGC Consolidated Group (defined below),
each of TransTexas, TEC and TARC will be severally liable for any tax liability
resulting from the above-described transactions. The IRS has commenced an
audit of the consolidated federal income tax returns of the TNGC Consolidated
Group for its taxable years ended July 31, 1994 and 1995. At this time,
it is not possible to predict the scope of the IRS'review or whether any
tax deficiencies will be proposed by the IRS as a result of its review.

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IRS regarding the Lobo Sale by any member of the TNGC Consolidated Group. If
the IRS were to successfully challenge TransTexas' position, each member of the
TNGC Consolidated Group would be severally liable under the consolidated tax
return regulations for the resulting taxes, in the estimated amount of up to
$250 million (assuming the use of existing tax attributes of the TNGC
Consolidated Group), possible penalties equal to 20% of the amount of the tax,
and interest at the statutory rate (currently 9%) on the tax and penalties (if
any). The Tax Allocation Agreement has been amended so that TransAmerican will
become obligated to fund the entire tax deficiency (if any) resulting from the
Lobo Sale. There can be no assurance that TransAmerican would be able to fund
any such payment at the time due and the other members of the TNGC Consolidated
Group, thus, may be required to pay the tax. TransTexas has reserved
approximately $75 million with respect to the potential tax liability for
financial reporting purposes to reflect a portion of the federal tax liability
that TransAmerican might not be able to pay. If TransTexas were required to
pay this tax deficiency, it is likely that it would be required to sell
significant assets or raise additional debt or equity capital to fund the
payment.

Under certain circumstances, TransAmerican or TEC may sell or
otherwise dispose of shares of common stock of the Company. If, as a
result of any sale or other disposition of the Company's common stock, the
aggregate ownership of TransTexas by members of the TNGC Consolidated Group
(excluding TransTexas) is less than 80% (measured by voting power and value),
TransTexas will no longer be a member of the TNGC Consolidated Group for
federal tax purposes ("Deconsolidation") and, with certain exceptions, will no
longer be obligated under the terms and conditions of, or entitled to the
benefits of, the Tax Allocation Agreement. Further, if TEC or TARC sells or
otherwise transfers any stock of TARC, or issues any options, warrants or
other similar rights relating to such stock, outside of the TNGC Consolidated
Group, which represents more than 20% of the voting power or equity value of
TARC, then a Deconsolidation of TARC would occur. A Deconsolidation of TARC
would result in a Deconsolidation of TransTexas if the TNGC Consolidated Group,
excluding TARC, does not own at least 80% of the voting power and equity value
of TransTexas. Upon a Deconsolidation of TransTexas, members of the TNGC
Consolidated Group that own TransTexas' common stock could incur a substantial
amount of federal income tax liability. If such Deconsolidation occurred
during the fiscal year ending January 31, 1998, the aggregate amount of this
tax liability is estimated to be between $50 million and $100 million, assuming
no reduction for tax attributes of the TNGC Consolidated Group. However, such
tax liability generally would be substantially reduced or eliminated in the
event that the IRS successfully challenged TransTexas' position on the Lobo
Sale. Each member of a consolidated group filing a consolidated federal income
tax return is severally liable to the IRS for the consolidated federal income
tax liability of the consolidated group. There can be no assurance that each
TNGC Consolidated Group member will have the ability to satisfy any tax
obligation attributable to the Transactions at the time due and, therefore,
other members of the group, including TEC, TransTexas or TARC, may be required
to pay the tax.

Generally, under the Tax Allocation Agreement, if net operating losses
of TransTexas are used by other members of the TNGC Consolidated Group, then
TransTexas is entitled to the benefit (through reduced current taxes payable)
of such losses in later years to the extent TransTexas has taxable income,
remains a member of the TNGC Consolidated Group and the other group members
have the ability to pay such taxes. If TransAmerican, TEC or TARC transfers
shares of common stock of TransTexas (or transfers options or other rights to
acquire such shares) and, as a result of such transfer, Deconsolidation of
TransTexas occurs, TransTexas would not thereafter receive any benefit
pursuant to the Tax Allocation Agreement for net operating losses of TransTexas
used by other members of the TNGC Consolidated Group prior to the
Deconsolidation of TransTexas.

POTENTIAL EFFECTS OF CHANGE OF CONTROL

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principal of the TransTexas Intercompany Loan in an amount equal to a pro rata
share of the amount TEC is required to pay under the TEC Notes Indenture. Such
pro rata share would be calculated using the ratio of the outstanding principal
amount of the TransTexas Intercompany Loan to the sum of (i) the outstanding
principal amount of the TransTexas Intercompany Loan plus (ii) the accreted
value of the outstanding principal amount of the TARC Intercompany Loan. A
Change of Control would be deemed to occur under the Subordinated Notes
Indenture in the case of certain changes or other events in respect of the
ownership of TransTexas, including any circumstances pursuant to which any
person or group other than John R. Stanley (or his heirs, his estate, or any
Trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or become the beneficial owner of more than 50% of the
total voting power of TransTexas' then outstanding voting stock, and during the
90 days thereafter, the rating of the notes is downgraded or withdrawn. A
Change of Control would be deemed to occur under the TransTexas Intercompany
Loan in the case of certain changes or other events in respect of the
ownership or control of TEC, TransTexas, or TARC including any circumstance
pursuant to which (i) any person or group, other than John R. Stanley (or his
heirs, his estate, or any Trust in which he or his immediate family members
have, directly or indirectly, a beneficial interest in excess of 50%) and his
subsidiaries or the TEC Indenture Trustee is or becomes the beneficial owner of
more than 50% of the total voting power of TEC's then outstanding voting stock,
or (ii) TEC or any of its subsidiaries own some of TransTexas' or TARC's
capital stock, respectively, but less than 50% of the total voting stock or
economic value of TransTexas or TARC, respectively, unless the TEC Notes have
an investment grade rating for the period of 120 days thereafter. The term
"person," as used in the definition of Change of Control, means a natural
person, company, government or political subdivision, agency or instrumentality
of a government and also includes a "group," which is defined as two or more
persons acting as a partnership, limited partnership or other group. In
addition, certain changes or other events in respect of the ownership or
control of TransTexas that do not constitute a Change of Control under the TEC
Notes Indenture may result in a "change of control" of TransTexas under the
terms of the BNY Facility and certain equipment financing. Such an occurrence
could create an obligation for TransTexas to repay such other indebtedness. At
October 31, 1997, TransTexas had approximately $26.7 million of indebtedness
(excluding the Senior Secured Notes and the TransTexas Subordinated Notes)
subject to such right of repayment or repurchase. In the event of a Change of
Control under the Subordinated Notes Indenture or the TEC Notes Indenture or a
"change of control" under the terms of other outstanding indebtedness, there
can be no assurance that TransTexas will have sufficient funds to satisfy any
such payment obligations.

The Company's accounting systems are not Year 2000 compliant.
Although the Company intends to upgrade or replace its systems to meet Year
2000 compliance standards, there can be no assurance that it will timely
complete such conversion. Failure to have Year 2000 compliant systems timely
in place could have a material adverse effect on the Company's operations.

FORWARD-LOOKING STATEMENTS

Forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
are included throughout this report. All statements other than statements of
historical facts included in this Quarterly Report on Form 10-Q regarding TEC's
financial position, business strategy, plans and objectives of management for
future operations, including but not limited to words such as "anticipates,"
"expects," "believes," "estimates," "intends," "projects" and "likely" indicate
forward-looking statements. TEC's management believes that its current views
and expectations are based on reasonable assumptions; however, there are
significant risks and uncertainties that could significantly affect expected
results. Factors that could cause actual results to differ materially from
those in the forward-looking statements include, without limitation,
fluctuations in the commodity prices for natural gas, crude oil, condensate and
natural gas liquids, the extent of TransTexas' success in discovering,
developing and producing reserves, engineering problems, work stoppages, cost
overruns, personnel or materials shortages, fluctuations in commodity prices
for petroleum and refined products, casualty losses, conditions in the equity
and capital markets, the ultimate resolution of litigation and competition.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Notes 5 and 10 of Notes to Condensed Consolidated Financial
Statements for a discussion of the Company's legal proceedings.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS:

27.1 - Financial Data Schedule

99.1 - Financial statements of TransTexas dated October 31,
1997 (filed as part of TransTexas' Quarterly Report on
Form 10-Q for the quarter ended October 31, 1997, and
incorporated herein by reference thereto).

99.2 - Financial statements of TARC dated October 31, 1997
(filed as part of TARC's Quarterly Report on Form 10-Q
for the quarter ended October 31, 1997, and incorporated
herein by reference thereto).

(b) REPORTS ON FORM 8-K

On August 18, 1997, TEC filed a current report on Form 8-K dated
June 13, 1997 to report under Item 5 the completion of the TEC Notes Offering
and related transactions. Pro forma financial statements giving effect to the
TEC Notes Offering and related transactions were included in the report.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

TRANSAMERICAN ENERGY CORPORATION
(Registrant)

By: /s/ ED DONAHUE
--------------------------------------
Ed Donahue, Vice President and
Chief Financial Officer

December 15, 1997

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INDEX TO EXHIBITS

EXHIBIT
NUMBER DESCRIPTION
- ------ -----------

27.1 - Financial Data Schedule

99.1 - Financial statements of TransTexas dated October 31, 1997 (filed as
part of TransTexas' Quarterly Report on Form 10-Q for the quarter
ended October 31, 1997, and incorporated herein by reference thereto).

99.2 - Financial statements of TARC dated October 31, 1997 (filed as part of
TARC's Quarterly Report on Form 10-Q for the quarter ended October 31,
1997, and incorporated herein by reference thereto).

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET AT OCTOBER 31, 1997 AND THE
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE
MONTHS ENDED OCTOBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> FEB-01-1997
<PERIOD-END> OCT-31-1997
<CASH> 25,167
<SECURITIES> 0
<RECEIVABLES> 31,462
<ALLOWANCES> 0
<INVENTORY> 16,784
<CURRENT-ASSETS> 97,679
<PP&E> 2,159,164
<DEPRECIATION> 720,915
<TOTAL-ASSETS> 2,040,198
<CURRENT-LIABILITIES> 171,027
<BONDS> 1,551,457
0
0
<COMMON> 0
<OTHER-SE> 235,871
<TOTAL-LIABILITY-AND-EQUITY> 2,040,198
<SALES> 152,206
<TOTAL-REVENUES> 695,209
<CGS> 57,870
<TOTAL-COSTS> 127,913
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 84,486
<INCOME-PRETAX> 442,993
<INCOME-TAX> 171,771
<INCOME-CONTINUING> 271,222
<DISCONTINUED> 0
<EXTRAORDINARY> (156,465)
<CHANGES> 0
<NET-INCOME> 114,738
<EPS-PRIMARY> 12,751
<EPS-DILUTED> 0

</TABLE>