10-K405

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

                                   FORM 10-K
             /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
                  For the fiscal year ended December 31, 1998
                                      OR
           / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
          For the transition period from             to
                          Commission File No. 0-21130
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                         ENERGY BIOSYSTEMS CORPORATION
            (Exact name of registrant as specified in its charter)

                  DELAWARE                               04-3078857
      (State or other jurisdiction of                   (IRS Employer
      incorporation or organization)                 Identification No.)

      ENERGY BIOSYSTEMS CORPORATION                         77381
       4200 RESEARCH FOREST DRIVE                        (zip code)
          THE WOODLANDS, TEXAS
 (Address of principal executive offices)

                                (281) 419-7000
             (Registrant's telephone number, including area code)
                         -----------------------------

       SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                                Title of Class
                    Common Stock, par value $.01 per share
                        Preferred Stock Purchase Rights

     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
                                                   ---     ---

     Indicate by check mark if disclosure of delinquent filers pursuant to 
Item 405 of Regulation S-K is not contained herein, and will not be contained, 
to the best of registrant's knowledge, in definitive proxy or information 
statements incorporated by reference in Part III of this Form 10-K or any 
amendment to this Form 10-K. /X/

     The aggregate market value of the voting stock held by non-affiliates of 
the registrant was approximately $4,817,249 as of March 26, 1999, based on 
the closing sales price of the registrant's common stock on the Nasdaq 
National Market on such date of $2.75 per share and assuming full 
conversion of the registrant's Series B Convertible Preferred Stock. For 
purposes of the preceding sentence only, all directors, executive officers 
and beneficial owners of ten percent or more of the common stock are assumed 
to be affiliates. As of March 26, 1999, 2,180,358 shares of common stock were 
outstanding and 696,400 shares of Series B Convertible Preferred Stock were 
outstanding.

     Certain sections of the registrant's definitive proxy statement relating 
to the registrant's 1999 annual meeting of stockholders, which proxy statement 
will be filed under the Securities Exchange Act of 1934 within 120 days of the 
end of the registrant's fiscal year ended December 31, 1998, are incorporated 
by reference into Part III of this Form 10-K.

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     WHEN USED IN THIS DOCUMENT, THE WORDS "ANTICIPATE," "BELIEVE," "EXPECT,"
"ESTIMATE," "PROJECT" AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY 
FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS ARE SUBJECT TO CERTAIN RISKS, 
UNCERTAINTIES AND ASSUMPTIONS. SHOULD ONE OR MORE OF THESE RISKS OR 
UNCERTAINTIES MATERIALIZE, OR SHOULD UNDERLYING ASSUMPTIONS PROVE INCORRECT, 
ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE ANTICIPATED, BELIEVED, 
EXPECTED, ESTIMATED OR PROJECTED. FOR ADDITIONAL DISCUSSION OF SUCH RISKS, 
UNCERTAINTIES AND ASSUMPTIONS, SEE "ITEM 1. BUSINESS--RISK FACTORS" INCLUDED 
ELSEWHERE IN THIS REPORT. UNLESS OTHERWISE INDICATED, ALL INFORMATION IN THIS 
DOCUMENT REFLECTS THE ONE FOR SEVEN REVERSE STOCK SPLIT OF THE OUTSTANDING 
SHARES OF COMMON STOCK EFFECTED ON DECEMBER 18, 1998.

PART I.

ITEM 1.  BUSINESS

OVERVIEW

     Energy BioSystems Corporation ("EBC" ) is developing and commercializing 
biotechnology-based processes for the energy and chemical industries. EBC's 
primary focus has been on developing biocatalytic desulfurization ("BDS"), a 
proprietary process involving the use of enzymes to remove sulfur from 
petroleum. EBC believes that BDS can be used in conjunction with and in some 
cases as a substitute for existing desulfurization technology and expects BDS 
to ultimately be significantly less expensive than conventional 
desulfurization methods at very low sulfur levels. EBC operates small BDS 
pilot plants, which are providing valuable research and development 
information as well as the basis for the design of commercial-scale BDS 
units. Recently, EBC has discovered that its proprietary biocatalytic 
technology may provide an economic basis for production of a broad family of 
chemical derivatives with potential uses in detergent, surfactant, polymer 
and adhesive markets.

     Removal of sulfur is one of the most costly issues facing industrialized 
countries worldwide and the petroleum industry and is severely limited in 
viable economic and environmental options. Sulfur removal is desirable 
because of (i) environmental regulations mandating decreased sulfur in 
refined products, (ii) an increasing level of sulfur in crude oil processed 
by refiners and (iii) high construction, operating and maintenance costs 
associated with the existence of sulfur in petroleum. Desulfurization is also 
attractive to the crude oil production market, where low-sulfur crude oil 
commands a premium price over high-sulfur crude oil.

     EBC has entered into a number of strategic alliances with recognized 
industry leaders in support of its BDS development and commercialization 
activities, providing an opportunity for EBC to build on established 
expertise and resources in critical areas. EBC has an agreement with Kellogg 
Brown & Root ("Kellogg") for the basic engineering services necessary for BDS 
implementation at customer sites. EBC also has entered into collaborations 
focusing on the application of the BDS technology as follows: with TOTAL 
Raffinage Distribution, S.A. ("TOTAL") to develop a BDS process for diesel 
fuel streams; with Koch Refining Company ("Koch") to develop a BDS process 
for certain gasoline streams; and with Texaco Group Inc. ("Texaco") to 
develop a BDS process for crude oil. EBC is also pursuing strategic 
partnering with major chemical companies to further develop and commercialize 
EBC's organic sulfur chemical technology. See "--Alliances."

     EBC has engaged primarily in research and development related to its BDS 
process and the related chemical process. In March 1998, EBC entered into an 
agreement with Petro Star Inc. ("Petro Star") regarding the design and 
installation of a BDS unit at Petro Star's Valdez Alaska refinery. Although 
significant technical progress has been made, EBC's BDS process requires 
additional research, development and testing in order to determine its 
commercial viability. See "--Risk Factors--Technological Uncertainty; Risks 
Associated with Commercialization of BDS Technology."

     EBC was incorporated in Delaware on December 20, 1989. EBC's executive 
offices are located at 4200 Research Forest Drive, The Woodlands, Texas 77381 
and its telephone number is (281) 419-7000.


                                      -1-



THE COMPANY'S TECHNOLOGY

BACKGROUND OF BDS

     The first patents covering the use of bacteria to reduce the sulfur 
content of petroleum were issued in the United States in 1948. However, early 
attempts to utilize bacteria and enzymes to selectively remove sulfur from 
hydrocarbons failed primarily because of an inability to control the action 
of the bacteria, which resulted in significant degradation of the fuel value 
of the hydrocarbon. In 1988, researchers at the Institute of Gas Technology 
("IGT") achieved a breakthrough in microbial desulfurization when they 
isolated two unique strains of bacteria. These strains have the ability to 
desulfurize coal and selectively remove sulfur from dibenzothiophene, the 
industry-recognized model for heterocyclic sulfur molecules found in coal and 
petroleum. U.S. patents were issued on these two bacterial strains in 1992.

     In 1991, EBC obtained exclusive, worldwide, royalty-free rights to IGT's 
desulfurization technology. A critical milestone was achieved in 1992 when 
the relevant genes from the patented bacteria were cloned and sequenced. 
These genes have now been extensively characterized and patented. The cloned 
genes are now being manipulated and transferred to alternative microbial 
hosts and modified to increase the expression of the desired properties. EBC 
has been issued fundamental patents on these genes, plus numerous other 
patents on the BDS process by the U.S. and foreign patent offices. With 
bacteria strain isolation and molecular cloning of the genes achieved, 
further development of BDS technology involves primarily a new combination of 
established biotechnology and chemical engineering processes.

     A fully integrated BDS pilot plant capable of processing up to five 
barrels of diesel fuel per day was constructed in late 1994 and processed 
diesel feedstock for desulfurization from March 1995 through the summer of 
1998. The pilot plant was designed with the instrumentation and scale 
necessary to provide the operating data needed for commercial scale-up. The 
pilot plant utilized hydrotreated diesel fuel from TOTAL and straight-run 
diesel fuel from Petro Star as feedstocks, allowing EBC's team of scientists 
and engineers to evaluate the performance of the biocatalyst, the reactor and 
the separations systems under a wide range of operating conditions. The 
information generated from the pilot plant was used to guide further 
development of EBC's processes and products. Ultimately, the work led to 
innovations that made the original pilot plant design obsolete. Prior to 
shutting down the original pilot plant, smaller units were designed, built 
and operated at EBC's site in The Woodlands, Texas. These units continue to 
operate and advance process development.

OVERVIEW OF THE BDS TECHNOLOGY

     BDS is a proprietary process based on naturally occurring bacteria that 
can selectively attack and remove organically bound sulfur from petroleum. 
Enzymes in the bacteria selectively cleave carbon-sulfur bonds in the 
presence of oxygen to yield an oxygenated sulfur containing hydrocarbon. 
Operating at essentially ambient temperatures and atmospheric pressure, BDS 
is expected to provide significant advantages over conventional 
hydrodesulfurization technology in achieving sulfur levels below those 
required by regulatory standards, while being flexible enough to desulfurize 
a wide range of petroleum streams. BDS is also expected to have value in 
upgrading crude oil. Since the process is oxidative, the addition of hydrogen 
is not required, thus avoiding a significant element of conventional 
desulfurization operating costs, reducing energy consumption and emissions 
(notably CO2) during refining.

     The basic steps of the BDS process are:

     -    A slurry is created containing the biocatalyst, additives and
          high-sulfur petroleum and fed to continuous flow bioreactors.


                                      -2-



     -    The slurry is continuously pumped from the reactors and the
          desulfurized oil is separated from the oil/aqueous/biocatalyst output
          stream.

     -    The aqueous phase is further treated to separate out the biocatalyst
          and water.

     -    The sulfur byproduct is captured from the aqueous phase as a
          water-soluble organosulfur compound and removed from the process.

     -    The biocatalyst and water are recycled to the bioreactor and spent
          biocatalyst is drawn off.

CONVENTIONAL DESULFURIZATION TECHNOLOGIES

     Hydrotreating is the conventional technology for the removal of sulfur, 
nitrogen and other impurities from oil. When this process is used primarily 
for the removal of sulfur, it is called hydrodesulfurization ("HDS"). In this 
process, petroleum fractions are subjected to high temperatures and pressure 
in the presence of inorganic catalysts and hydrogen. As a result, organic 
sulfur molecules are converted to hydrogen sulfide, which is further 
processed to yield elemental sulfur. HDS is relatively ineffective against 
more complex sulfur molecules found in diesel and heavier fractions.

     HDS is a costly process for refiners. A typical HDS unit costs between 
$30 million and $80 million to construct, depending on the product stream to 
be treated, the level of desulfurization required, the unit size and the 
existing refinery infrastructure. The high pressure and temperature required 
for HDS translate directly into high capital and maintenance costs because 
these units require high-pressure vessels and exotic metals, which are 
expensive to manufacture and maintain. Although some refinery units produce 
hydrogen, the large amount of hydrogen required for HDS to treat fuels to 
lower sulfur levels may require refiners to build new hydrogen production 
capacity at additional significant capital expense.

AROMATIC PROCESS IN MODERN PETROLEUM REFINING

     The world-wide petroleum industry currently produces approximately one 
million barrels per day of benzene/toluene/xylene ("BTX") aromatics. These 
products are extracted from aromatic gasoline boiling range streams, 
particularly from the product of the catalytic reforming of heavy virgin 
naphtha. BTX aromatics find use as chemical building blocks in a wide variety 
of high volume commodity applications including polymers and surfactants. As 
chemical feedstocks, they typically command a premium price over and above 
their value as high octane gasoline blending components. A small percent of 
BTX aromatics are alkylated and/or sulfonated to supply the hydrotrope and 
anionic surfactant markets throughout the world. In 1998, EBC discovered a 
direct route for the production of a new class of aromatic sulfonates by 
selective biocatalytic oxidation of certain aromatic sulfur compounds present 
in low value high-sulfur aromatic refinery distillates. The new route uses 
EBC's proprietary biocatalyst technology to oxidatively extract aromatic 
sulfur compounds directly from the as-produced refinery stream. This process 
avoids the costly aromatics recovery, purification and subsequent sulfonation 
steps employed in conventional hydrotrope and surfactant manufacturing 
routes. The new process is beneficial to the refiner because it removes 
polycyclic aromatic sulfur heterocycles ("PASH's") from these distillates, 
thereby improving the value of the distillate to the refiner. The new 
technology has the potential to provide a new low-cost supply of useful 
aromatic sulfonate products which could find immediate application as 
hydrotropes, or the sulfonates can be subsequently alkylated via conventional 
technologies to produce quality anionic surfactants.

BENEFITS OF BDS

     EBC believes that its BDS technology will offer the refining industry an 
effective complement to HDS and will in many cases of small refineries 
replace existing technology. EBC believes that BDS may provide refiners with 
the following principal benefits:


                                      -3-



- -    COST EFFECTIVENESS. BDS is designed to operate at ambient temperatures and
     pressures, in contrast to HDS, which requires thick-walled reactors and
     other equipment designed to tolerate high temperatures and pressures. As a
     result, EBC expects that its BDS units ultimately will be significantly
     less expensive to build than HDS units. In addition, the BDS process will
     not require hydrogen, which is an expensive component of HDS.

- -    EASE OF INTEGRATION. EBC believes the BDS process can be integrated into
     refinery operations without significant difficulty. Most of the components
     of the BDS units are expected to be readily available equipment. The BDS
     process is expected to generate streams that permit disposition to be
     accomplished with existing processes that are familiar to most refiners.
     The mild operating conditions of BDS are also expected to contribute to
     improved operating safety over HDS in many applications, and up to 80%
     reduced energy consumption and reduced emissions.

- -    EFFECTIVENESS AGAINST COMPLEX SULFUR MOLECULES. EBC believes that BDS will
     be effective in removing complex sulfur molecules that are resistant to
     conventional desulfurization technologies. Diesel fractions, for example,
     contain more complex sulfur molecules against which HDS is relatively
     ineffective. As a result, HDS becomes increasingly more costly and less
     effective in desulfurizing diesel fuel as the lighter-sulfur compounds are
     removed and the remaining complex molecules constitute an increasing
     proportion of the remaining sulfur. Accordingly, EBC expects that any
     reduction in the level of sulfur permitted under applicable regulations
     will ultimately make BDS increasingly cost-effective as compared to HDS.

- -    PRODUCTION OF NOVEL VALUABLE COMPLEX SULFUR MOLECULES. The organosulfur
     molecules produced from much lower value refinery streams are expected to
     provide the refiner with a higher value stream at low cost.

     While EBC believes its BDS process will be economically attractive to 
petroleum refiners and to crude oil producers, the BDS process will require 
significant capital expenditures by refiners and producers. The refining and 
oil production industries historically have been reluctant to accept new 
technologies. There is a risk, therefore, that EBC will have difficulty in 
obtaining the refining and oil production industries' acceptance of the BDS 
process. Also, the rate of purchase of EBC's BDS process may be affected by 
economic conditions in the refining and oil production industries. The 
refining and oil production industries have been subject to periods of 
depressed profitability and are affected substantially by fluctuations in the 
price of crude oil and finished products. Oil production and drilling 
activity are also largely dependent on the level and volatility of oil 
prices. Nonetheless, if a refinery is to operate and produce fuels, it must 
meet regulatory requirements regardless of the price of oil.

MARKET OVERVIEW

REFINING INDUSTRY

     One of the principal markets for EBC's BDS technology is the worldwide 
refining industry, which processes more than 66 million barrels of crude oil 
per day or approximately 24 billion barrels per year. A significant portion 
of worldwide refining capacity is concentrated among a small number of large 
corporations and national oil companies. In the United States, the top ten 
companies process approximately 60 percent of the refined petroleum products, 
and in Western Europe and Asia, the ten largest refining companies process 
more than half of the refined petroleum products.

     Refineries purchase crude oil and process it into three principal 
products: (i) middle distillates (including diesel fuel), (ii) gasoline and 
(iii) residual fuel oil (used primarily by electric utilities and ships). In 
the refining process, crude oil is subjected to distillation, resulting in 
the separation or fractionation of the hydrocarbons into several intermediate 
products. These intermediate products are subjected to additional processing 
steps before formulation into finished products. These additional processing 
steps include the removal of impurities (such as sulfur, metals 


                                      -4-



and nitrogen), the "cracking" of large hydrocarbon molecules and the upgrading 
of lower-quality intermediate products.

REFINERY DESULFURIZATION

     The refining industry is expected to spend more than $37 billion in 
capital and up to $10 billion annually in operating expenditures for sulfur 
removal through the next decade, assuming the use of conventional 
technologies. Asia accounts for approximately 40 percent of this total 
expenditure with Western Europe and the United States accounting for 
approximately 30 percent each.

     Pollution regulations have targeted sulfur in fossil fuels due to its 
harmful effects on the environment. The combustion of sulfur results in the 
emission of sulfur oxides ("SOx"), which are believed to be a cause of "acid 
rain" and smog. Regulations issued under the 1990 amendments to the 
U.S. Federal Clean Air Act (the "Amendments") required a reduction in the 
sulfur content of all on-highway diesel fuels to 500 ppm on October 1, 1993, 
from a prior national average of over 2,000 ppm. Similar regulations 
worldwide will significantly reduce the level of sulfur allowed in certain 
petroleum products, including diesel fuel. In Western Europe, diesel fuel was 
required to meet the 500 ppm sulfur specification by October 1996. In Asia, 
many countries have adopted or plan to adopt similar sulfur regulations on 
diesel fuel, which will be implemented in various stages over the next 
decade. The European Union has established regulations requiring the further 
reduction in the sulfur content of diesel fuel, with the diesel sulfur 
specification reduced to 350 ppm (or possibly 200 ppm) by the year 2000 and 
to 50 ppm or lower by the year 2005. Historically, the adoption of more 
stringent environmental standards in the United States and European Union 
have often been followed by the adoption of similarly stringent standards 
elsewhere in the developed world.

     Sulfur also inactivates catalysts contained in automobile catalytic 
converters over time, resulting in a significant increase in the emission of 
unburned hydrocarbons and nitrogen oxides ("NOx") from automobile tailpipes, 
which in turn contribute to smog. The Amendments required a targeted 
reduction in U.S. gasoline emissions of 15 percent by the year 1995 and call 
for a targeted reduction of 25 percent by the year 2000. The Environmental 
Protection Agency (the "EPA") established a detailed model (the "Complex 
Model") for determining the emissions of various gasoline formulations to be 
sold in most large cities that have not attained certain prescribed levels of 
improvement in air quality ("Nonattainment Areas"). Use of the Complex Model 
became mandatory starting in 1998 for certifying gasoline sold in 
Nonattainment Areas, which currently represents approximately 25 percent of 
all gasoline produced in the U.S. The Complex Model explicitly recognizes the 
detrimental impact of sulfur on gasoline tailpipe pollution, giving refiners 
incentive to decrease the level of sulfur in the gasoline they produce. 
Regulations in Europe further limiting gasoline sulfur levels are specified 
at 150 ppm for the year 2000 and 50 ppm for the year 2005. Industry sources 
believe that sulfur will play the key role in refiners' plans to reduce 
gasoline emissions in the next five to ten years.

     The Amendments, as well as various state and local regulations, 
generally limit the atmospheric emission of SOx by stationary sources, such 
as refineries and utilities. For example, permit regulations limit allowable 
SOx emissions from fluid catalytic cracking units ("FCCUs") (the refinery 
processing unit for upgrading heavier oil molecules to gasoline), which may 
cause refiners to constrain the output of a unit that is critical to refining 
profitability. New or modified FCCUs are also subject to SOx emissions 
limitations. The Amendments and state and local regulations also limit the 
amount of high-sulfur fuel that electric utilities may burn, restricting one 
of the refining industry's largest end markets for residual fuels. 
Consequently, the value of residual fuel is affected significantly by its 
sulfur content.

     The increasing average level of sulfur in crude oils is also expected to 
stimulate demand for new desulfurization technologies. Low-sulfur crude oils 
traditionally have been in greater demand and commanded a price premium over 
higher-sulfur crude oils. Over the last decade, the average sulfur content of 
crude oil processed by U.S. 


                                      -5-



refiners increased by more than 20 percent. In the future, refiners worldwide 
are expected to process increased volumes of high-sulfur crude oil, raising 
the demand for additional desulfurization capacity.

     Sulfur in crude oil increases refiners' operating costs because of 
sulfur's detrimental effect on refinery equipment and catalytic processes. 
Many sulfur compounds are corrosive, and the processing of high-sulfur crude 
oil necessitates more frequent maintenance of refinery processing units. The 
presence of sulfur in the feedstock for FCCUs decreases the effectiveness of 
the inorganic catalyst used to crack the fuel, increasing the operating cost 
of the FCCU and decreasing product yield. Sulfur has a similar degrading 
effect on most catalytic processes in the refinery, increasing operating 
costs on a variety of key processing units.

CRUDE OIL DESULFURIZATION

     The price of crude oil is affected by its sulfur content. The difference 
in price between low-sulfur and high-sulfur crude oils is affected by 
increasingly stringent regulation of sulfur content in finished products. 
Lower-sulfur crude oils have typically commanded a premium in the market 
compared to higher-sulfur crude. Over 50 percent of the crude oil produced 
worldwide is considered high in sulfur (greater than one percent). EBC 
believes the price difference between low-sulfur crude oil and high-sulfur 
crude oil will create an incentive for oil producers to reduce the sulfur 
levels in their product, resulting in demand for crude oil desulfurization 
technologies. EBC believes that by reducing the sulfur content of crude oil 
at the production stage, BDS has the potential to improve the marketability 
and value of higher-sulfur oil reserves and improve producers' access to 
pipelines that limit the sulfur content of crude oil. To date, conventional 
desulfurization technologies have not proven economically viable for the 
desulfurization of crude oil.

     Large reserves of high-sulfur crude oil exist in Venezuela, Canada, the 
United States, Mexico, the former Soviet Union, and the Middle East. 
Venezuela has proven reserves in excess of one trillion barrels of crude oil 
with a sulfur content greater than two percent. Canada has in excess of 
50 billion barrels of proven reserves of crude oil with a two percent or 
greater sulfur content, and the United States has approximately 125 billion 
barrels of proven reserves of crude oil with a two percent or greater sulfur 
content. Cost-effective desulfurization technology will play a key role in 
making many of these high-sulfur crude oil reserves more economically 
exploitable.

PRODUCTION OF ORGANOSULFUR COMPOUNDS

     In 1998, EBC discovered a method to use its proprietary catalyst 
technology to produce a class of oxidized aromatic sulfur compounds with 
excellent properties as a hydrotrope. Further chemical derivation of these 
compounds via commercially practiced methods of manufacturing produces 
excellent anionic surfactants and detergents. The new process involves a 
selective oxidative extraction of aromatic sulfur compounds from highly 
aromatic high-sulfur content diesel boiling point-range streams (cracked 
stocks) within the heart of the refinery. This new application of EBC's 
proprietary biocatalyst technology has received considerable interest from 
large refiners and surfactant manufacturers. Refiners are interested in this 
technology because oxidative extraction of polynuclear aromatic sulfur 
compounds from these "cracked stocks" increases their value and reduces 
downstream refining costs. EBC believes that surfactant manufacturers will be 
enticed by the low-cost feedstock and the possible intrinsic environmental 
friendliness of chemicals produced via a biological pathway. One of the 
markets EBC has been targeting, the linear alkyl benzene sulfonate ("LAS") 
market, is currently a four billion pound per year market with a 4% average 
annual growth rate. EBC's new product could displace or alternatively, reduce 
the use of benzene and possibly eliminate the need for a costly sulfonation 
step in the manufacture of a LAS substitute. The substitute product has 
physical and chemical properties similar to LAS. EBC plans to partner with an 
existing surfactant manufacturer to evaluate and develop this new commercial 
application of its technology. No assurance can be given that EBC will be 
successful in partnering with existing surfactant manufacturers to develop 
this technology, or will otherwise be able to successfully develop and 
commercialize this new discovery.


                                      -6-



OTHER POTENTIAL APPLICATIONS OF BIOREFINING

     EBC believes there are numerous other applications for its biorefining 
technology. These potential applications include the following:

     METALS REMOVAL. Heavy metals (principally Cadmium and Vanadium) in 
petroleum damage refinery catalysts and reduce the value of some petroleum 
products. In addition, heavy metals limit the efficiency of conventional 
desulfurization technologies. EBC has been issued a U.S. patent on crude oil 
demetalization and believes that systems can be developed for the economic 
biocatalyst removal of metals from crude oil and residual oil.

     VISCOSITY REDUCTION AND CRACKING. Bioprocessing technologies have been 
used for many years to depolymerize very viscous solutions of corn starch to 
produce high fructose corn syrup. A similar chemical process in refineries is 
called "cracking" which refers to the thermal degradation of complex 
hydrocarbon molecules into simpler, higher-value products. EBC believes a 
biocatalytic liquefaction system could be applied to molecules in some highly 
viscous crude oils, which currently have little commercial value. EBC 
believes that this process could produce crude oil with significantly reduced 
viscosity, a higher proportion of molecules in the gasoline and diesel fuel 
boiling range, and increased commercial value.

BUSINESS STRATEGY

     EBC's goal is to become the leading provider of biocatalytic solutions 
for the energy and chemical industries. EBC's strategy is to concentrate its 
internal resources on the research, development and marketing of its BDS 
technology while entering into strategic alliances to assist in the 
engineering and construction of BDS units. To commercialize BDS, EBC must 
develop the BDS process to a competitive commercial level, establish the 
infrastructure required to deliver, supply and service the BDS units, and 
sell the BDS units to refiners, oil and chemical producers. EBC believes it 
has chosen the most rapid commercialization strategy by working on these 
efforts in parallel and leveraging internal resources with strategic 
alliances.

     EBC believes that its technology has broad potential application in the 
processing of petroleum products and in the production of valuable chemicals. 
Although its technology is first directed at biocatalytic desulfurization and 
chemical production, EBC's long-term plan includes expanding the capabilities 
of its technology to address the removal of other petroleum impurities 
(e.g., nitrogen and metals), and addressing other refining processes 
(e.g., viscosity reduction and cracking).

RESEARCH AND DEVELOPMENT

     To commercialize BDS, EBC must improve the productivity of the 
biocatalyst to a competitive economic level while developing an engineered 
bioreactor system that allows the control of several process variables to 
produce optimal biocatalytic desulfurization. To accomplish these goals, EBC 
has conducted extensive research, development and testing of the biocatalyst 
and bioreactor, and has assembled a team of scientists and engineers with 
extensive experience in microbial physiology, molecular biology, 
biochemistry, fermentation, process development and scale-up, biochemical 
engineering, separations technology, and refinery process engineering and 
operations.

     The focus of EBC's research and development efforts has been to develop 
the BDS process for use in (i) treating diesel fuel, gasoline and crude oil, 
and (ii) since 1998, production of novel valuable complex sulfur chemicals for
use in a wide variety of markets. EBC expects the desulfurization of diesel 
fuel at Petro Star, where its development efforts are the most advanced, 
could be the first commercial application of its BDS technology. As a result 
of the specificity of the biocatalyst for each product application, EBC 
expects that further development will be required to commercialize its BDS 
technology for use in treating gasoline, crude oil and production of other 
chemicals. Because of the expected value and accelerated development 
accompanying the organosulfur chemical 


                                      -7-



products, there is a good possibility that commercialization of the 
organosulfur compounds will rapidly overtake the refining applications.

     In late 1992, EBC initiated operations of a continuous bench-scale unit 
capable of desulfurizing up to one-half of a barrel of crude oil per day. A 
fully integrated BDS pilot plant capable of processing up to five barrels of 
diesel fuel per day was constructed in late 1994 and processed diesel 
feedstock for desulfurization from March 1995 through the summer of 1998. The 
pilot plant was designed with the instrumentation and scale necessary to 
provide the operating data needed for commercial scale-up. The pilot plant 
utilized hydrotreated diesel fuel from TOTAL and straight-run diesel fuel 
from Petro Star as feedstocks, allowing EBC to evaluate the performance of 
the biocatalyst, the reactor and the separations systems under a wide range 
of operating conditions. The information generated from the pilot plant was 
used to guide further development of EBC's BDS processes and products. 
Ultimately, the work led to innovations that made the original pilot plant 
design obsolete. Prior to shutting down the original pilot plant, smaller 
units were designed, built and operated at EBC's site in The Woodlands, 
Texas. These units continue to operate and advance process development

     In 1994, EBC was awarded $2 million of federal funding under the 
Advanced Technology Program ("ATP") administered by the National Institute of 
Standards and Technology. The ATP project was dedicated to the development of 
a biotechnology-based method of removing sulfur from crude oil. The 
three-year program funded with this award was used to accelerate the pace of 
development in crude oil desulfurization, moving the BDS technology in this 
area from the research level toward the pilot plant phase. In 1997, EBC was 
awarded funding by the U.S. Department of Energy ("DOE") for a $2.4 million, 
three-year program dedicated to the development of a BDS application for 
gasoline. The DOE-funded program is intended to accelerate the advancement of 
EBC's BDS technology for gasoline desulfurization from bench-scale research 
and development to pilot-scale development.

     EBC had research and development expenses for the years ended December 31, 
1996, 1997, and 1998 of $9.2 million, $9.1 million and $7.7 million, 
respectively. See "Item 7. Management's Discussion and Analysis of Financial 
Condition and Results of Operations."

BIOCATALYST DEVELOPMENT

     The central element of EBC's BDS technology is the "biocatalyst," a 
microorganism originally isolated from the soil that has been genetically 
engineered to maximize its effectiveness in removing the sulfur molecules in 
petroleum. The effectiveness of the biocatalyst, as with any other catalyst, 
depends upon the optimization of three important attributes: (i) the rate of 
reaction; (ii) the specificity of the catalyst for the target molecules (the 
extent of reaction); and (iii) the stability of the catalyst under operating 
conditions. EBC has made significant progress in each of these areas with the 
stability of the catalyst now approaching commercially required levels. 
See"--Risk Factors--Technological Uncertainty; Risks Associated with 
Commercialization of BDS Technology."

     REACTION RATE. The observed reaction rate in EBC's BDS process is a 
function both of the intrinsic abilities of the biocatalyst (i.e., its 
specific activity) and of the conditions in the particular reactor. The 
intrinsic activity of the biocatalyst depends upon several factors at the 
cellular level. In 1997, EBC maximized one of these factors by "overexpressing" 
the critical enzymes in the biocatalyst's cells so that they represent about 
30 percent of its total cellular protein. The overexpression of these enzymes 
was achieved through a combination of genetic engineering strategies, the 
most significant of which were the amplification of the genes responsible for 
producing these enzymes (i.e., creating multiple copies of such genes in each 
organism) and the modification of the DNA sequence of these genes to 
encourage the cells to make between 100 and 1,000 times more of the key 
enzymes than they normally would. EBC was also able to incorporate the 
earlier discovery of a fourth component of the system into its current 
biocatalyst. When appropriately amplified with the other enzymes, the 
incorporation of this fourth component has significantly increased the 
reaction rate of the biocatalyst.


                                      -8-



     SPECIFICITY OR EXTENT. EBC's BDS process employs enzymes specifically 
directed at a certain class of sulfur molecules in petroleum to catalyze the 
desulfurization reactions. EBC's biocatalyst is already capable of removing 
sulfur to levels far lower than current regulations. Although this class of 
sulfur molecules includes the predominant types of sulfur molecules found in 
diesel fuel, anticipated regulations governing the sulfur content of diesel 
fuel are expected to require such low concentrations of sulfur that EBC's BDS 
process will also need to address less predominant, more complex sulfur 
molecules found in diesel fuel. In 1997, EBC's scientists identified and 
characterized these "desulfurization resistant" molecules and developed a 
strategy for the optimization of the biocatalyst to increase the specificity 
of the biocatalyst for such molecules. EBC believes that its lab results 
support the feasibility of this approach and that it is making rapid progress 
in broadening the biocatalyst specificity to address these molecules.

     STABILITY. The BDS biocatalyst is a living organism and a dynamic system 
in which enzymes within the cell are continually being made and destroyed. 
EBC's research and development team had observed a gradual decay of 
biocatalyst activity in the reactor system as a result of these metabolic 
processes. In 1997, EBC researchers demonstrated that the cells remained 
active in the reactor for days after desulfurization activity had ceased. 
EBC's research and development team has characterized the nature of the 
inactivation of the desulfurization characteristics of these cells and worked 
to develop new strains that degrade the desulfurization enzymes more slowly 
and are genetically engineered to produce more desulfurization enzymes while 
the biocatalyst remains in the reactor system. In 1997, EBC developed a new 
strain of the biocatalyst organism that terminates the desulfurization 
reaction at a point that allows removal of the oxidized sulfur molecules (as 
an organic sulfinate) while minimizing the metabolic consequences of complete 
conversion of the molecules to inorganic sulfate. This change increased the 
activity of the biocatalyst significantly and had very positive effects on 
its stability.

PROCESS ENGINEERING.

     In addition to efforts in biocatalyst development, EBC has allocated 
considerable resources to the development of the process technology for the 
first BDS units. EBC believes that scale-up of its BDS process can be 
accomplished with conventional process engineering technology. EBC began 
pursuing several opportunities in 1997 to accelerate the commercial viability 
of its BDS technology through more innovative use of available process 
technology. EBC's process development team substantially improved the 
efficiency of the BDS reactor system and reduced the cost the BDS process in 
1997, and is continuing to pursue additional improvements in efficiency and 
cost through process engineering efforts in three main areas: (i) separations 
technology; (ii) biocatalyst regeneration; and (iii) byproduct disposition. 
EBC's objectives in these three areas are to adapt conventional process 
technology from other commercially proven processes in a manner that lowers 
the activity and stability requirements placed on the BDS biocatalyst, 
thereby reducing the cost and improving the commercial viability of BDS 
units. Each of the three targeted engineering innovations represents an 
attempt to take greater advantage of some established characteristic or 
capability of EBC's current biocatalyst technology, creating a synergy 
between biocatalyst and process development. Representatives of EBC meet 
regularly with representatives of Kellogg to ensure that all of the targeted 
innovations are appropriate and suitable for scale-up and commercialization 
within a typical petroleum refinery. See "--Risk Factors--Technological 
Uncertainty; Risks Associated with Commercialization of BDS Technology."

     BDS PILOT PLANTS. EBC and Petrolite jointly operated EBC's largest BDS 
pilot plant at Petrolite's facilities in St. Louis, Missouri, from 1994 to 
1998. The St. Louis pilot plant, completed in late 1994, was a fully 
integrated desulfurization unit capable of processing up to five barrels of 
diesel fuel per day. It began processing diesel feedstock in March 1995 and 
was extensively revamped in 1997 to capitalize on process engineering 
improvements. The pilot plant provided the basis for the design of 
commercial-scale BDS units and operated into the summer of 1998. EBC built a 
second, smaller pilot plant during the second quarter of 1997 at its research 
facility in The Woodlands, Texas. The new pilot plant, which is capable of 
processing three gallons of diesel fuel per day, was built to facilitate 
EBC's process engineering initiatives, and was used to develop the reactor 
improvements that were 


                                      -9-



implemented at the St. Louis pilot plant in the third quarter of 1997. It is 
a fully integrated unit, with three staged BDS reactors, separations equipment, 
recycle capabilities, and a PC-based process control system. EBC consulted 
with its alliance partner, Kellogg, during the revamp of the St. Louis pilot 
plant, and Kellogg provided the design for this smaller pilot unit.

     BIOREACTOR TECHNOLOGY. EBC designed and constructed both pilot plants to 
develop the catalytic process with hydrocarbon molecules in the presence of 
air, water and various process chemicals. Variables such as temperature, 
agitation rate and pH (acidity or alkalinity) can be controlled, and measured 
amounts of oxygen and process chemicals can be added to the mixture of 
biocatalyst and petroleum, optimizing the desulfurization environment. EBC 
implemented a redesigned, staged reactor system at the St. Louis pilot plant 
during the third quarter of 1997. Experiments at the pilot plant confirmed 
that the redesigned reactor system significantly increased the level of 
desulfurization, with no increase in total reactor volume. Experiments at 
EBC's smaller pilot plant further indicated that EBC's biocatalyst can be 
used more effectively by operating with a higher concentration of biocatalyst 
in the reactor. This discovery lead to the initiation in 1997 of engineering 
research efforts focused on the development of a low-cost separation scheme 
capable of recovering the oil from the reactor effluent when a much higher 
cell-loading is used in the reactor section of the process.

     SEPARATIONS. The BDS process produces a mixture of water, desulfurized 
hydrocarbons, biocatalyst, and sulfur coproduct. The mixture must be 
separated into its components, a process which involves substantial increases 
in difficulty and cost as the concentration of biocatalyst increases. EBC 
previously has developed technology, demonstrated in the laboratory and 
successfully implemented at the EBC's St. Louis pilot plant in 1996, for the 
efficient separation of these components if the biocatalyst is present in the 
reactor at a relatively low concentration. This low concentration separation 
process employs a combination of conventional technologies which EBC believes 
can be scaled up to commercial levels without substantial difficulty. In 
connection with EBC's decision in 1997 to pursue efforts to increase the 
biocatalyst concentration used within the process as a complement to its 
efforts to increase the activity of the biocatalyst, EBC began working toward 
developing a low-cost separation process compatible with higher concentrations 
of biocatalyst that could still be scaled up economically to commercial 
levels. EBC's engineers have made good progress working closely with several 
equipment vendors and conducting experiments in the lab and the two pilot 
plants towards achievement of this objective.

     BIOCATALYST REGENERATION. As the biocatalyst used in EBC's BDS process 
circulates and is used to catalyze the BDS reaction, its activity level 
decreases with time, a phenomenon common in both biological and chemical 
catalysts. Prior to 1997, EBC's BDS process design was based upon continually 
feeding fresh biocatalyst into the process, using the biocatalyst for a 
period of time, and discarding the spent biocatalyst. In 1997, EBC discovered 
a biocatalyst formulation and a set of process operating conditions that 
allowed the biocatalyst to be regenerated, permitting the operation of the 
bioreactor with a reduced amount of biocatalyst. EBC is pursuing this new 
process concept, which it believes will significantly reduce the operating 
cost of a BDS unit. In addition, EBC believes that the coproduct of the 
biocatalyst developed for this new mode of operation provides an opportunity 
to further improve the economics of the BDS process. The longevity of the 
biocatalyst is now believed to be suitable for commercial operations. This 
biocatalyst milestone was achieved in late 1998.

     COPRODUCT DISPOSITION. The principal coproduct of the BDS process is a 
water-soluble, organic sulfur compound that can be separated from the 
biorefined petroleum at relatively low cost. EBC believes that this chemical 
product is valuable in a broad area of industrial chemical markets such as 
surfactants, adhesives, resins, etc. This principal coproduct of the BDS 
process concept currently being developed by EBC, using a regenerative 
biocatalyst, is an ionic salt of an organic sulfinic acid, called organic 
sulfinate. EBC currently is exploring the market potential with several 
interested chemical companies. A secondary byproduct of this process is the 
spent biocatalyst stream, which would be expected to be disposed of at an 
off-site commercial disposal facility as either a solid or other refinery 
waste.


                                      -10-



PRODUCTION OF THE BIOCATALYST

     Large-scale growth and production, or fermentation, of biocatalysts is 
essential to the commercialization of the BDS technology. EBC's efforts in 
developing alternative microbial hosts have been intended to select hosts 
that can be produced more rapidly and at lower cost. EBC believes that this 
fermentation will not be substantially different from the many antibiotic and 
enzyme fermentations routinely commercialized by other biotechnology companies. 
EBC currently conducts small- and intermediate-scale (300 liter) fermentations 
at its laboratory facilities. These facilities are sufficient to supply 
laboratory and preliminary pilot plant needs for the biocatalyst. See 
"--Risk Factors--Technological Uncertainty; Risks Associated with 
Commercialization of BDS Technology" and "--Risk Factors--Manufacture of 
Biocatalyst."

SCIENTIFIC ADVISORY BOARD

     EBC has retained a group of distinguished research scientists and 
engineers to provide advice on matters relating to its research, development 
and business activities. The Scientific Advisory Board, composed of four 
members, meets with EBC's scientists and management and is regularly 
available for consultation. Scientific advisors are compensated for expenses 
and all advisors have been granted options to acquire Common Stock. The 
members of the Scientific Advisory Board are as follows:

     CHARLES L. COONEY, PH.D., PROFESSOR OF CHEMICAL AND BIOCHEMICAL 
ENGINEERING, MASSACHUSETTS INSTITUTE OF TECHNOLOGY. Dr. Cooney is widely 
recognized as an expert in the field of bioreactor design and engineering. He 
is the author or co-author of more than 200 scientific publications and 
patents and has received many academic awards and honors, including being 
named Founding Fellow, American Institute for Medical and Biological 
Engineering, in 1992. In addition to his serving as Professor of Chemical and 
Biochemical Engineering, Dr. Cooney also is Executive Officer in the 
Department of Chemical Engineering and Co-Director of the Program on the 
Pharmaceutical Industry at Massachusetts Institute of Technology. Dr. Cooney 
received his B.S. in Chemical Engineering from the University of Pennsylvania 
and his M.S. and Ph.D. in Biochemical Engineering from Massachusetts 
Institute of Technology.

     NORMAN HACKERMAN, PH.D., PRESIDENT EMERITUS AND DISTINGUISHED PROFESSOR 
EMERITUS OF CHEMISTRY, RICE UNIVERSITY, AND FORMER PRESIDENT AND PROFESSOR 
EMERITUS OF CHEMISTRY, THE UNIVERSITY OF TEXAS AT AUSTIN. Dr. Hackerman is a 
member of the National Academy of Sciences and of the American Philosophical 
Society, a Fellow of the American Academy of Arts and Sciences, and Chairman 
of the Scientific Board of the Robert A. Welch Foundation. Dr. Hackerman has 
been the recipient of many awards, including the American Institute of 
Chemists Gold Medal and the Mirabeau B. Lamar Award of the Association of 
Texas Colleges and Universities. He received his A.B. and Ph.D. from Johns 
Hopkins University.

     HERBERT L. HEYNEKER, PH.D., FOUNDER AND CHIEF TECHNICAL OFFICER, EOS 
BIOTECHNOLOGY, INC. Dr. Heyneker is an authority in microbial expression of 
human proteins, including insulin, growth hormone and tPA; protein engineering; 
and expression systems for industrial microorganisms. Dr. Heyneker serves as 
a director of Genpharm International, Inc. and Introgene, B.V., and as 
chairman of the Scientific Advisory Board of Pharming, B.V. He also serves as 
a scientific advisor for Genencor International, Inc., Genomyx Corp., 
ProtoGene Laboratories, Inc., and MaxyGen, Inc. He earned his Ph.D. from the 
University of Leiden, The Netherlands and completed his post-doctoral 
fellowship at the University of California-San Francisco Medical School.

     CHARLES F. KULPA, JR., PH.D., PROFESSOR OF BIOLOGICAL SCIENCES, 
UNIVERSITY OF NOTRE DAME. Dr. Kulpa is regarded as an expert in the fields of 
microbiology, bioremediation and biochemistry. His laboratory research work is 
concentrated in the areas of environmental and applied microbiology. Dr. Kulpa 
has authored or co-authored numerous papers detailing his research in 
microbiological and biochemistry processes. Active in many scientific 


                                      -11-



organizations, Dr. Kulpa has served as President of the Indiana Branch of the 
American Society for Microbiology and currently is a director of the Southern 
Great Lakes Region, Society of Industrial Microbiology. He received his B.S., 
M.S. and Ph.D. in Microbiology from the University of Michigan.

ALLIANCES

     EBC has entered into alliances with potential customers and suppliers in 
support of its BDS development and commercialization activities. These 
alliances give EBC an opportunity to build on established expertise and 
resources in areas critical to its success. In the case of alliances with 
potential customers, EBC believes that these relationships may enhance its 
ability to sell BDS units. Entering into alliances with recognized industry 
suppliers is expected to facilitate commercialization of the BDS technology. 
However, there can be no assurance that EBC will be successful in maintaining 
its existing collaborative relationships or in establishing new relationships.

ALLIANCES WITH POTENTIAL CUSTOMERS

     TOTAL RAFFINAGE DISTRIBUTION S.A. In July 1994, EBC entered into an 
agreement with TOTAL Raffinage Distribution S.A. ("TOTAL") to collaborate on 
the application of EBC's BDS process to diesel and other middle distillate 
fuel streams. EBC and TOTAL will each bear their own costs and expenses 
incurred under the collaboration. In addition, as part of its obligations 
under the agreement, TOTAL has provided EBC with the use of analytical 
equipment valued at approximately $200,000. The agreement with TOTAL provides 
that upon commercialization, the site license fees will be waived on TOTAL's 
first commercial BDS unit. In addition, TOTAL will be entitled to receive a 
10 percent discount on future site license and service fees until it has 
recovered two and one-half times its research costs and expenses for BDS 
projects under the agreement. EBC expects that its alliance with TOTAL will 
facilitate commercialization of the BDS technology for diesel fuel and EBC's 
entrance into the European market.

     EBC's alliance agreement with TOTAL contemplates an evaluation of pilot 
plant operations, commencing after EBC's completion of the development of a 
prototype biocatalyst. EBC completed the development of a prototype 
biocatalyst in late 1996 and continues to conduct bench-scale and pilot plant 
experimentation using improved generations of the prototype biocatalyst to 
address the desulfurization targets requested by TOTAL. The prototype 
biocatalyst is intended to possess characteristics sufficiently similar to 
the commercial biocatalyst to permit the design of a commercial-scale BDS 
unit although it is not expected or intended to possess sufficient specific 
activity or other characteristics necessary to be commercially viable. When 
the BDS processes reach commercial levels for activity and extent, it is 
expected that TOTAL will build and operate at TOTAL's expense a pilot BDS 
unit at TOTAL's European Center for Research and Technology. TOTAL has 
indicated that it intends to employ its initial BDS units for the "ultra 
deep" (below 50 ppm) desulfurization of diesel, a range of desulfurization 
far below current regulatory standards in which BDS is expected to possess 
greater cost advantages as compared to HDS.

     TOTAL is a wholly owned subsidiary of TOTAL S.A., a leading international 
oil and gas company based in France. TOTAL S.A. participates in every phase 
of the oil and gas industry with operations in more than 80 countries worldwide 
and revenues of over $46 billion.

     KOCH REFINING COMPANY. In December 1993, EBC entered into an alliance 
with Koch Refining Company ("Koch") for the development of a 
biotechnology-based desulfurization system for refinery oil streams. The 
alliance is expected to accelerate the development of BDS for certain 
gasoline streams and customize that development for Koch's applications. 
Under the terms of the alliance, EBC is primarily responsible for improving 
the performance of the biocatalyst used in the BDS process and developing a 
commercial BDS system. Koch primarily is responsible for selecting and 
providing the target gasoline stream as well as testing desulfurized product 
quality. Koch also will provide engineering support as needed in the 
development of a BDS unit for Koch's operations. Until commercialization, EBC 
and Koch will each bear their own costs and expenses incurred in connection 
with the collaboration. Upon commercialization, Koch will be repaid for 
direct costs and expenses 


                                      -12-



incurred in assisting BDS development. Repayment will be in the form of a 
10 percent rebate on desulfurization processing fees charged to Koch until Koch 
has been repaid its share of BDS development costs. EBC expects that the 
development alliance with Koch will facilitate commercialization of EBC's BDS 
technology for target gasoline streams.

     Koch is a part of Koch Industries, one of the largest privately held 
companies in the United States. Koch Industries, with annual revenues in 
excess of $30 billion, is involved in virtually all phases of the oil and gas 
industry, as well as chemicals, chemical technology products, agriculture, 
hard minerals, real estate, and financial investments.

     TEXACO GROUP, INC. In July 1993, EBC signed an agreement with Texaco 
Group, Inc. ("Texaco") for the development of a BDS process for crude oil. 
Under the terms of the alliance, EBC primarily is responsible for improving 
the performance of the biocatalyst used in the BDS process. Texaco primarily 
is responsible for field operations, analytical chemistry work, and selecting 
and providing the target crude oil stream as well as testing desulfurized 
product quality. Process engineering is conducted jointly by the parties. EBC 
and Texaco each bear their own costs and expenses incurred in connection with 
the collaboration. In the event EBC sub-licenses Texaco's intellectual 
property and proprietary information, licensed by Texaco to EBC, EBC has 
agreed to pay Texaco an amount equal to 10 percent of the desulfurization 
processing fee charged to Texaco until such time as EBC has paid Texaco an 
aggregate amount equal to two and one-half times the aggregate amount of 
Texaco's direct costs and expenses incurred in connection with the 
collaboration. EBC expects that the development alliance with Texaco will 
facilitate commercialization of EBC's BDS technology for crude oil 
applications.

     Texaco is one of the largest oil companies in the world with operations 
in crude oil production, refining and marketing. Texaco has annual revenues 
in excess of $46 billion.

     PROSPECTIVE ADDITIONAL CUSTOMER ALLIANCES. EBC is also pursuing additional
alliances with potential customers, particularly for its organosulfur 
compounds with companies in the area of industrial chemicals.

     ALLIANCES WITH SUPPLIERS

     KELLOGG, BROWN AND ROOT. In August 1994, EBC signed an agreement with 
Kellogg, Brown and Root ("Kellogg") to collaborate on the development and 
commercialization of BDS technology. Under the terms of the collaboration, 
Kellogg will serve as an engineering consultant to EBC during completion of 
the BDS development process and will be the exclusive provider of the basic 
engineering design services required for commercial BDS units. In return for 
these services, Kellogg will receive a portion of the site license fee 
generated by the sale of BDS units. The collaboration has a minimum term of 
at least five years or the completion of 20 BDS units, whichever is longer, 
and applies to all biorefining technologies EBC develops. During the first 
phase of the collaboration, Kellogg provided 500 engineering work hours of 
service at no cost to EBC. Kellogg also agreed to provide an additional 1,500 
work hours of service at Kellogg offices at reduced rates. EBC expects that 
the development alliance with Kellogg will substantially enhance its refinery 
engineering capabilities and market access.

     Kellogg is an ISO 9001-certified, international technology-based 
engineering and construction contractor, serving primarily the hydrocarbon, 
chemical and energy related industries. Kellogg is a wholly owned subsidiary 
of Haliburton, a major supplier of highly engineered products and services 
primarily used in hydrocarbon and energy-related activities throughout the 
world. Haliburton has annual revenues in excess of $16 billion.

     BAKER PETROLITE CORPORATION. In March 1992, EBC entered into a 
collaboration agreement with Petrolite Corporation, now Baker Petrolite 
Corporation ("Petrolite"). EBC and Petrolite agreed to jointly develop EBC's 
BDS process and utilize emulsification and separations technologies and 
process chemicals developed by Petrolite, if needed. In connection with this 
collaboration, Petrolite agreed to provide the emulsification and separations 
equipment necessary for the storage, mixing, injection and delivery of 
biocatalysts and process chemicals used in 


                                      -13-



the BDS process and to pay EBC $5.4 million during the first two years of the 
agreement for research and development. Petrolite also agreed to design and 
finance construction of the pilot plant and to provide service personnel to 
operate and service the BDS units on site at customer locations.

     In October 1996, EBC entered into an agreement with Petrolite providing 
EBC with the option to amend the terms of its strategic alliance with 
Petrolite. Under the agreement, EBC made an initial payment of $1 million to 
Petrolite in December 1996 in exchange for the option and the extension of 
Petrolite's obligations to provide operational and technical support for the 
pilot plant from September 1, 1996 through December 31, 1998. EBC elected not 
to exercise its option to reduce the percentage of site license fees and 
adjusted gross profit payable to Petrolite to 9.5% from 22%, in exchange for 
which EBC would have (i) assumed responsibility for servicing the BDS units 
on site at customer locations (ii) been required to pay Petrolite an 
additional $9 million in cash and (iii) been required to issue to Petrolite a 
warrant entitling Petrolite to purchase 19,841 shares of Common Stock at an 
exercise price of $50.40 per share. EBC instead elected on March 27, 1998 to 
terminate the agreement, effective March 27, 1999. EBC believes this will 
provide the greatest future benefits including competitive bidding by 
potential service alliance partners while still at a cost as low or lower 
that that provided by continuing the agreement. EBC is obligated to pay to 
Petrolite a decreasing royalty for twenty years from the effective date of the 
termination of the agreement. The royalty decreases from 22% to 3% in the 
first ten years following the effective termination of the agreement.

     Petrolite was acquired by Baker Hughes Incorporated ("Baker Hughes") in 
1997 in connection with which it merged with Baker Hughes subsidiary Baker 
Performance Chemicals. Baker Hughes, which serves the worldwide petroleum and 
processing industries has annual revenues in excess of $3 billion.

CUSTOMER AGREEMENT

     In March 1998, EBC entered into a site license agreement with Petro 
Star Inc. ("Petro Star") regarding the design and installation of a BDS unit 
at Petro Star's Valdez, Alaska refinery. The agreement involves several 
stages of work, the first of which, involving the completion of scoping 
economics, is completed. In addition, the agreement provides EBC with certain 
rights to conduct development work and demonstrations of its BDS technology 
at Petro Star's refinery. The agreement calls for the payment of staged 
license fees and royalties to EBC, including a $200,000 initial site license 
fee which was received upon execution of the agreement and $300,000 
additional site license fees payable at various stages during the term of the 
agreement. As is customary in such arrangements in the petroleum refining 
industry, the agreement provides certain approval and termination rights to 
Petro Star at the completion of each stage prior to commercialization. In 
connection with the execution of the agreement, EBC issued a four-year 
warrant entitling Petro Star to purchase 28,571 shares of EBC Common Stock at 
an exercise price of $21.77 per share. EBC believes Petro Star will start 
detailed design engineering later in 1999. The successful implementation of a 
commercial BDS unit will be dependent upon EBC's ability to achieve additional 
improvements in the productivity of the biocatalyst (e.g., reaction rates, 
specificity and stability) and process technology (e.g., bioreactor and 
separations technology). See"--Risk Factors--Technological Uncertainty; Risks 
Associated with Commercialization of BDS Technology."

     Petro Star, a wholly owned subsidiary of Arctic Slope Regional 
Corporation, refines and distributes petroleum products throughout Alaska. 
The Anchorage-based company owns and operates oil refineries in Valdez and 
North Pole, Alaska, with distribution facilities in Fairbanks, Kodiak and 
Dutch Harbor. The Petro Star Valdez refinery is a major supplier of military 
jet fuel, as well as marine diesel and other middle distillate products.

COMPETITION

     The primary competition for BDS technology is expected to come from 
licensors of HDS technology and the manufacturers of catalysts used in those 
units. In most initial diesel fuel applications, BDS will be sold as a 
complementary process where expanded capacity is desired or a greater degree 
of desulfurization becomes necessary in connection with an existing HDS unit. 
Subsequently, BDS may be developed as a stand-alone diesel fuel 
desulfurization process, competing directly with HDS. In the case of 
gasoline, where HDS units are not 

                                      -14-


typically used, EBC expects BDS to operate as a stand-alone desulfurization 
system. EBC intends to compete on the basis of cost effectiveness, ease of 
integration, effectiveness in removing complex sulfur molecules that are 
resistant to conventional desulfurization technologies, production of 
valuable chemical coproducts and the ability to process petroleum streams 
that are difficult for HDS to process.

     HDS process technologies and catalysts are supplied by a small number of 
companies that maintain their market positions through a combination of 
recognized expertise, intellectual property rights and established 
relationships with refiners. Increasing environmental regulation has caused 
these catalyst suppliers to make significant investments in research and 
development during the past several years to develop more efficient HDS 
technologies. EBC believes that these efforts have been directed at 
refinement of the conventional HDS technology rather than development of 
entirely new processes. Many of these companies supplying HDS technology have 
substantially greater financial, technical and human resources than EBC.

     BDS may face competition from other biotechnology processes, although 
EBC believes it is the leading developer of biorefining in the world. The 
most significant competitive effort of which EBC is aware is based in Japan 
at the Petroleum Energy Center ("PEC"), a consortium of Japanese petroleum 
companies conducting research funded by the Japanese Ministry of 
International Trade and Industry. EBC believes, based upon meetings with PEC 
personnel and third-party sources, that it has a substantial lead in 
developing BDS technology and that its numerous patents provide it with a 
substantial competitive advantage over the PEC effort. EBC is also aware that 
one or more major oil companies have from time to time attempted to develop 
microbial or biocatalytic desulfurization technologies, although EBC believes 
that none of these companies has successfully developed any of these 
technologies to date. Based upon information available to EBC, EBC believes 
that these efforts do not currently present significant competition for its 
BDS technology in its primary markets.

PATENTS AND PROPRIETARY TECHNOLOGY

     EBC's ability to compete will depend in part on maintaining the 
proprietary nature of its technology. EBC has established an active program 
for the protection of its intellectual property. This program includes, among 
other things: procedures, notebooks and forms for documenting, evidencing and 
disclosing all Company inventions to management; a Patent Review Committee 
which meets regularly to discuss all intellectual property issues; a system 
for continuously monitoring patents issued to, and patent applications filed 
by, relevant third parties; a program of seminars for employees on 
intellectual property topics; personnel policies and agreements requiring 
disclosure by employees of all inventions and protection of confidential 
information; and agreements with all technical and scientific employees 
providing for the assignment of inventions made by such employees to EBC.

      EBC has an active program in place to maintain and build its 
intellectual property position. Seven U.S. patents on BDS technology have 
been issued to The Institute of Gas Technology ("IGT") and licensed 
exclusively to EBC, subject to the U.S. government's rights to certain of 
such patents. Additionally, one U.S. patent has been issued to the Korean 
Institute of Science & Technology and licensed on a nonexclusive basis to 
EBC. A U.S. patent claiming the use of BDS in combination with HDS for BDS 
technology was issued to EBC in 1993. The two-stage process for deep 
desulfurization covered by this patent involves the use of BDS in conjunction 
with conventional HDS technology, taking advantage of the significant 
synergies between the two technologies. EBC was issued three patents during 
the year ended December 31, 1994 and three patents during the year ended 
December 31, 1995. The most significant of the three patents issued in 1994 
is the "Recombinant DNA Encoding a Desulfurization Biocatalyst" patent, which 
is a fundamental recombinant DNA patent on the genetic sequences for enzymes 
that desulfurize petroleum. This patent is an important milestone in the 
development of EBC's worldwide competitive position and establishes its 
technical leadership in biodesulfurization. The remaining two patents issued 
in 1994 include "A Process for the Desulfurization and the Desalting of 
Fossil Fuels" and "Microemulsion Process for Direct Biocatalytic 
Desulfurization of Organosulfur Molecules." The patents issued in 1995 
include "Multistage Process for Deep Desulfurization of Fossil Fuels," 
"Method for Separating a Sulfur Compound from Carbonaceous Materials" and 
"Continuous Process for Biocatalytic Desulfurization of Sulfur-Bearing 
Heterocyclic Molecules." In 

                                      -15-


1996, an additional five U.S. patents were issued to EBC, including 
continuations in part on the HDS/BDS patent first issued in 1993 and the 
desalting patent first issued in 1994 as well as two entirely new patents 
related to oil/water separations technology and a novel process for the 
reduction of oil viscosity. The technologies to which these patents relate 
are expected to yield long-term improvement in the economics of 
biodesulfurization for EBC. In 1997, an additional U.S. patent was issued to 
EBC relating to a method for removing and separating metals from fossil 
fuels. In 1998, six additional patents were issued to EBC, including one for 
demetallization, and oil/water/biocataylst three phase separation process, 
and a patent covering a Rodococcus flavin reductase.

     EBC has filed patent applications in the U.S. and worldwide under the 
Patent Cooperation Treaty as well as in targeted countries not involved in 
the treaty such as Venezuela. In total, EBC has rights to 27 U.S. patents 
(including cell recombinant DNA and fundamental process patents) and 35 foreign 
patents. In addition, EBC has 13 applications pending in the U.S. patent 
office, and more than 70 foreign patent applications pending to cover BDS 
process technology and the molecular cloning of the biocatalyst gene. Patents 
issued to or licensed by EBC begin to expire in the year 2010. See "--Risk 
Factors--Patents and Proprietary Technologies."

EMPLOYEES AND CONSULTANTS

     EBC believes that its success will be based, among other things, on 
achieving and retaining scientific and technological superiority and on 
identifying and retaining capable management in order to conduct a fully 
integrated program of biorefining technology development. EBC has assembled a 
highly qualified team of scientists as well as executives with extensive 
experience in the petroleum industry. EBC's product development program 
combines basic scientific disciplines, such as molecular biology, microbial 
genetics, biochemistry and biochemical engineering, with applied disciplines 
such as fermentation, process development, refining, petroleum product 
separations and recovery, and byproduct disposition expertise.

     As of December 31, 1998, EBC employed 60 people, 20 of whom hold Ph.D. 
degrees and 9 of whom hold other advanced degrees. EBC's employees with 
doctoral degrees represent collective expertise in molecular biology, 
microbiology, biochemistry, chemistry and chemical and process engineering. 
EBC believes that its relationship with its employees is good.

GOVERNMENT REGULATION

     Certain of EBC's current and planned operations are, or may be, subject 
to regulation under various federal and state laws pertaining to protection 
of the environment and employee health and safety. In the course of its 
current research and development activities, EBC generates small quantities 
of solid and hazardous wastes that are subject to regulation under the 
Resource Conservation and Recovery Act ("RCRA") and various other federal and 
state regulations. The research and development activities of EBC are also 
subject to the Occupational Safety and Health Act ("OSHA") and similar state 
laws and regulations. Upon commercialization of EBC's technology, EBC's 
operations will be subject to the full scope of environmental and employee 
health and safety regulations including not only RCRA and OSHA, but also the 
Clean Air Act, the Federal Water Pollution Control Act, the Toxic Substances 
Control Act ("TSCA") and other applicable state and federal environmental 
laws and regulations. Although current information is not definitive enough 
to accurately predict compliance requirements with such laws and regulations, 
EBC believes that compliance will not materially affect its operations.

     Under TSCA, the U.S. Environmental Protection Agency ("EPA") regulates 
the use of chemicals for commercial purposes, and the EPA has asserted that 
it has jurisdiction under TSCA to regulate genetically engineered 
microorganisms. Prior to commercialization of EBC's biocatalyst product, EBC 
will most likely be subject to the Premanufacture Notice Requirements under 
TSCA in marketing its BDS technology. Under the Premanufacture Notice 
Requirements, if the EPA finds that EBC's biocatalyst product poses an 
unreasonable risk to the environment, it may establish controls on its 
manufacture, distribution or disposal. Based on written 

                                      -16-


communication with the EPA, EBC does not believe that compliance with TSCA 
will delay the commercialization of the BDS process.

     Commercialization of EBC's technology outside the U.S. will require 
compliance with the regulations of foreign countries. In anticipation of 
early commercialization in Europe, EBC has begun efforts to prepare for 
compliance with European Union regulations for genetically modified organisms 
("GMOs"). Directive 90/219 of the European Commission provides a framework 
for contained use of GMOs. Each of the member countries has enacted specific 
regulations consistent with this directive. Based upon discussions with 
authorities in France, Belgium and the United Kingdom regarding their 
regulations under Directive 90/219, EBC does not believe that compliance with 
such regulations will delay commercialization of the BDS process in Europe.

RISK FACTORS

TECHNOLOGICAL UNCERTAINTY; RISKS ASSOCIATED WITH COMMERCIALIZATION OF BDS 
TECHNOLOGY

     Since its inception, EBC has engaged primarily in research and 
development related to its BDS process. EBC's BDS process will require 
substantial additional research, development and testing in order to 
determine its commercial viability. EBC has not proven its BDS technology 
other than to a limited extent in laboratory, bench-scale and pilot plant 
trials. EBC's ability to make its BDS technology commercially viable will 
depend in large part on its success in (i) achieving improvement of its 
biocatalyst, including the manipulation of the genes responsible for 
desulfurization activity to increase the reaction rate and specificity 
(extent) of the biocatalyst, (ii) improving the rate at which sulfur 
molecules transfer from petroleum to the biocatalyst, (iii) more fully 
developing the catalyst regeneration process, (iv) developing a bioreactor 
for use with the BDS process capable of operating at commercial levels of 
throughput and desulfurization, (v) identifying economically viable processes 
for commercial-scale sulfur coproduct recovery and (vi) marketing its BDS 
systems effectively. The accomplishment of some or all of these objectives 
may take longer than anticipated or may never occur. EBC will require 
additional capital to continue the development and commercialization of its 
BDS technology, and there can be no assurance that such capital will be 
available or that EBC will be able to successfully commercialize the BDS 
technology.

HISTORY OF OPERATING LOSSES AND UNCERTAINTY OF FUTURE PROFITABILITY

     EBC has incurred net losses since its inception and expects its losses 
to increase in the foreseeable future as it continues its expenditures for 
the continued development and commercialization of its biorefining 
technology. EBC's only derived revenues to date from the use or sale of its 
biorefining technology has been the initial payment of the Petro Star license 
of $200,000 in 1998. At December 31, 1998, EBC had an accumulated deficit of 
$67.2 million. The time required for EBC to become profitable is uncertain, 
and there can be no assurance that EBC will achieve profitability on a 
sustained basis, if at all.

NEED FOR ADDITIONAL FUNDS

     EBC's operations to date have consumed substantial amounts of cash. The 
negative cash flow from operations is expected to continue over the 
foreseeable future. EBC believes that its existing capital resources will be 
sufficient to fund its operations through mid 1999. Accordingly, EBC is 
currently seeking additional financing through various alternatives that 
include: an equity financing, government funding and alliances with chemical 
companies and corporate partners to continue development and 
commercialization of its biorefining technology. Adequate funds for these 
purposes, whether obtained through financial markets or collaborative or 
other arrangements with corporate partners or from other resources, may not 
be available when needed or on terms acceptable to EBC. EBC's inability to 
raise funds when needed may require EBC to delay, scale back or eliminate 
some or all of its research and product development programs. EBC's 
independent public accountants have included an explanatory paragraph in 
their report on EBC's financial statements as of and for the year ended 
December 31, 1998, that describes the substantial doubt regarding EBC's 
ability to continue as a going concern. See "Item 7. Management's Discussion 
and Analysis of Financial Condition and Results of Operations."

                                      -17-


MANUFACTURE OF BIOCATALYST

     EBC currently intends to manufacture, at its own facility, only a 
quantity of biocatalyst sufficient for its in-house research and pilot plant 
needs. EBC expects that the biocatalyst to be employed in the commercial BDS 
process initially will be manufactured by a third party, including 
manufacturing at each BDS unit site to generate startup quantities. EBC has 
had discussions regarding non-exclusive biocatalyst supply arrangements with 
several parties that it believes are capable of satisfying EBC's supply 
requirements. If EBC is unable to enter into agreements for the supply of 
commercial quantities of biocatalyst, EBC may be forced to establish its own 
fermentation facilities. This alternative could delay the commercialization 
of the BDS process and would require significant capital expenditures.

MARKET ACCEPTANCE

     The BDS process will require significant capital expenditures by 
refiners and producers. The refining and oil production industries 
historically have been reluctant to accept new technologies. There is a risk, 
therefore, that EBC will have difficulty in obtaining the refining and oil 
production industries' acceptance of the BDS process. Also, the rate of 
purchase of EBC's BDS process may be affected by economic conditions in the 
refining and oil production industries. The refining and oil production 
industries have been subject to periods of depressed profitability and are 
substantially affected by fluctuations in the price of crude oil and finished 
products. Oil production and drilling activity are also largely dependent on 
the level and volatility of oil prices.

RELIANCE ON ENVIRONMENTAL REGULATION

     Demand for the BDS units and services being developed by EBC is based, 
in large part, on legislation and regulations in the United States, Europe 
and Asia that specify stringent environmental quality standards and that 
impose penalties for noncompliance. The amendments to the federal Clean Air 
Act required the EPA to develop maximum sulfur content standards for highway 
diesel fuel and new standards for gasoline content. In response, the EPA 
promulgated regulations regarding the maximum sulfur content of highway 
diesel fuel in 1990 and regulations for a reformulated gasoline program in 
1994. Similar regulations regarding the maximum sulfur content of diesel fuel 
have been adopted in Western Europe and certain Asian countries. EBC also 
expects that European and Asian countries will adopt and enforce additional 
standards requiring a reduction in the sulfur content of petroleum products. 
Any reduction of severity in current regulations, lax enforcement of current 
regulations, delay in implementation and enforcement of planned regulations, 
or reduction of severity in planned or anticipated regulations worldwide may 
delay or decrease the worldwide demand for EBC's BDS process.

                                      -18-


PATENTS AND PROPRIETARY TECHNOLOGIES

     EBC's success is heavily dependent upon its proprietary BDS and other 
technologies. In total, EBC has rights to 27 U.S. and 35 foreign patents. In 
addition, EBC has 13 patent applications pending in the U.S. patent office 
and more than 70 foreign patent applications pending to cover BDS process 
technology and the molecular cloning of the biocatalyst genes. There can be 
no assurance concerning the scope, validity or value of such patents, patent 
applications or related intellectual property rights. Furthermore, there can 
be no assurance that the steps taken by EBC to protect its proprietary 
technologies will be adequate to prevent misappropriation of these 
technologies by third parties, particularly where third parties may 
independently develop similar technologies, duplicate any of EBC's 
technologies or design around any proprietary technologies owned by EBC. Any 
such misappropriation could have a material adverse effect on EBC. Although 
EBC does not believe any of its proprietary technologies infringe the patent 
or other proprietary rights of third parties, there can be no assurance that 
infringement claims will not be asserted against EBC in the future or that 
any such claims will not require EBC to enter into license arrangements or 
result in litigation. In the event that EBC may be required to obtain 
licenses to patents or other proprietary rights of third parties, there can 
be no assurance that any required licenses would be made available to EBC on 
terms acceptable to EBC, or at all. If EBC does not obtain such licenses, it 
could encounter delays in commercializing its BDS technology while it 
attempts to design around such patents or could find that the 
commercialization of its BDS technology could be foreclosed. In addition, to 
the extent that EBC seeks to protect its proprietary technologies overseas, 
there can be no assurance that steps taken by EBC to protect its proprietary 
technologies will be adequate under the laws of certain foreign countries, 
which may not protect EBC's proprietary rights to the same extent as do the 
laws of the United States.

     EBC relies on secrecy to protect its proprietary technologies in addition 
to patent protection, especially where patent protection is not believed to 
be appropriate or obtainable. EBC has entered into confidentiality agreements 
with its employees, licensors and certain of its collaborators and consultants. 
There can be no assurance that such obligations of confidentiality will be 
honored, that other parties will not otherwise gain access to EBC's trade 
secrets or that EBC can effectively protect its rights to its unpatented 
trade secrets. See " --Patents and Proprietary Technology."

DEPENDENCE ON COLLABORATORS

     EBC has been dependent on collaborative relationships for development of 
certain key components of the BDS process, and EBC's commercialization 
strategy contemplates continued dependence on collaborative relationships. 
EBC has signed an agreement with Kellogg to provide the basic engineering 
designs necessary for BDS implementation at customer sites. EBC also has 
entered into an alliance with TOTAL relating to the application of the BDS 
process to diesel fuel, an alliance with Koch to develop the BDS process for 
certain gasoline products, and an alliance with Texaco to develop a process 
for desulfurizing high-sulfur crude oil. Each alliance partner is currently 
providing technical assistance during the development of the BDS process. 
Collaborative arrangements involve risks that the participating partners may 
disagree on business decisions and strategies, which may result in delays, 
additional costs or litigation. The inability of EBC to successfully maintain 
existing collaborative relationships or enter into new collaborative 
relationships could have a material adverse effect on EBC. See "-- Alliances."

LIMITED MARKETING EXPERIENCE

     EBC has only limited experience marketing its BDS technology, and has 
assembled only a small sales and marketing staff. There can be no assurance 
that EBC will be able to successfully implement its sales and marketing plan.


                                      -19-


DEPENDENCE ON KEY PERSONNEL

     EBC is dependent on the efforts of its executive officers, scientists 
and other key employees, the loss of any one of whom could have a materially 
adverse effect on EBC's business. Shortages of qualified scientists within 
certain disciplines may occur and competition for the services of qualified 
scientists may intensify. EBC may not be successful in recruiting or 
retaining such personnel in the future.

GOVERNMENT REGULATION

     Certain of EBC's current and planned operations are, or may be, subject 
to regulation under various federal and state laws pertaining to protection 
of the environment and employee health and safety. In the course of its 
current research and development activities, EBC generates small quantities 
of solid and hazardous wastes that are subject to regulation under the 
Resource Conservation and Recovery Act ("RCRA") and various other federal and 
state regulations. The research and development activities of EBC are also 
subject to the Occupational Safety and Health Act ("OSHA") and similar state 
laws and regulations. Upon commercialization of EBC's technology, EBC's 
operations will be subject to the full scope of environmental and employee 
health and safety regulations including not only RCRA and OSHA, but also the 
Clean Air Act, the Federal Water Pollution Control Act, the Toxic Substances 
Control Act ("TSCA") and other applicable state and federal environmental 
laws and regulations. In addition, commercialization of the BDS technology 
outside the United States will require compliance with the regulations of 
foreign countries. Failure to comply with applicable regulations could have 
an adverse effect on EBC. See "--Government Regulation."

COMPETITION

     EBC expects to encounter competition from suppliers of existing 
desulfurization technology in the marketing of EBC's BDS units. These 
companies have well-established relationships in the refining industry and 
have substantially greater financial, technical and human resources than EBC. 
In addition, new desulfurization technologies could be developed that are 
competitive with or superior to EBC's BDS technology. See "--Competition."


                                      -20-


DILUTIVE EFFECT OF DIVIDENDS ON PREFERRED STOCK; DEFICIENCY IN FIXED CHARGES 
AND PREFERRRED STOCK DIVIDEND COVERAGE

     EBC has been paying dividends on the Preferred Stock in Common Stock, 
although EBC may pay dividends in cash or combination of Common Stock and 
cash.  Dividends will be payable on the Preferrd Stock only when, as and if 
declared by EBC's Board of Directors as permitted under Delaware Law.  EBC 
has incurred net losses since inception and expects its losses to increase 
in the foreseeable future.  While EBC intends to pay dividends on the 
Preferred Stock in Common Stock, it is anticipated that EBC will continue to 
incur losses and thus will continue to have a deficiency in fixed charges and 
preferred stock dividend coverage.  Dividends on the Preferred Stock may be 
paid only out of capital surplus (within the meaning of the Delaware General 
Corporation Law) or net profits of EBC for the fiscal year in which the 
dividend is declared and the preceding fiscal year.  Unpaid dividends do not 
earn interest.

YEAR 2000 ISSUES

     EBC has undertaken an assessment of its financial and operational 
systems to ensure their Year 2000 compliance. Year 2000 issue results from 
the inability of certain computer programs or computerized equipment to 
accurately calculate, store or use a date subsequent to December 31, 1999. 
Typically, the year 2000 may be represented or interpreted as the year 1900. 
This could result in a system failure or miscalculations causing disruptions 
of operations, including, among other things, a temporary inability to 
process transactions, send invoices or engage in similar normal business.

     Based upon its review to date and other preliminary information, EBC 
does not anticipate that it will incur any significant costs relating to 
remediation of Year 2000 issues. EBC believes that the potential impact, if 
any, of its systems not being Year 2000 compliant should not impact its 
ability to continue its research and development activities. However, there 
can be no assurance at this time that EBC, its research and business 
partners, vendors or customers will successfully be able to identify and 
remedy all potential Year 2000 problems or that a system failure resulting 
from a failure to identify any such problems would not have a material 
adverse effect on EBC.

NASDAQ LISTING REQUIREMENTS

     Although EBC's Common Stock meets the current listing requirements of, 
and are presently included in, the Nasdaq Stock Market, EBC will have to 
maintain certain minimum financial requirements for continued inclusion on 
Nasdaq. If EBC is unable to satisfy Nasdaq's maintenance requirements, EBC's 
Common Stock may be delisted from Nasdaq. In such event, trading if any, in 
the Common Stock would thereafter be conducted in the over-the-counter 
markets and so-called "pink sheets" of the NASD's "Electronic Bulletin 
Board." Consequently, the liquidity of EBC's Common Stock could be impaired, 
not only in the number of shares which could be bought and sold, but also 
through delays in the timing of the transactions, reductions in security 
analysts' and the new media's coverage of EBC, and lower prices for EBC's 
Common Stock than might otherwise be attained.

ITEM 2. PROPERTIES

FACILITIES

     EBC's corporate offices and laboratories are situated in a 32,000 
square-foot leased building located at 4200 Research Forest Drive in The 
Woodlands, Texas, a suburb of Houston, Texas. Pursuant to the lease, monthly 
payments of $33,678 are required for base rent. The lease for this facility 
expires in 2003. Approximately 20,500 square feet of this space is devoted to 
research and development. The facility includes two laboratories designed for 
molecular biology/microbiology/microbial physiology, a process engineering 
laboratory, a biochemistry laboratory, a media preparation laboratory, and an 
analytical laboratory which provides all the routine sulfur and hydrocarbon 
analyses for the operation, a fermentation laboratory, microbiology laboratory 
and accelerated development program laboratories.

                                      -21-


ITEM 3. LEGAL PROCEEDINGS.

     There are no material pending legal proceedings required to be reported 
in response to this item.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

     At EBC's special meeting of stockholders held on December 18, 1998, the 
following proposal was submitted to and approved by the stockholders of EBC:

         Proposal: The approval of the amendment to EBC's Amended and 
Restated Certificate of Incorporation to effect a one-for-seven reverse split 
of EBC's Common Stock.  

         The results of the votes cast by the stockholders were as follows:

                                                                               
For            15,122,701            Against            110,666            Abstain            7,650






                                      -22-


PART II.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
        MATTERS.

     EBC's common stock (symbol: ENBC) is traded on the Nasdaq National 
Market. The following table sets forth the range of high and low sales prices 
for each calendar quarterly period in the two years ended December 31, 1998 
as reported on the Nasdaq National Market (prices for all periods have been 
restated to reflect the one-for-seven reverse split of EBC's common stock on 
December 18, 1998):




YEAR ENDED DECEMBER 31, 1998                                                     HIGH             LOW
- ----------------------------                                                    -------         -------
                                                                                          
First Quarter............................................................       $ 25.81         $ 14.00
Second Quarter...........................................................         18.81           10.50
Third Quarter............................................................         14.88            3.28
Fourth Quarter...........................................................          9.41            1.69

YEAR ENDED DECEMBER 31, 1997                                                     HIGH             LOW
- ----------------------------                                                    -------         -------
First Quarter............................................................       $ 57.75         $ 35.00
Second Quarter...........................................................         45.50           28.00
Third Quarter............................................................         46.41           28.00
Fourth Quarter...........................................................         54.69           18.41



     As of March 26, 1999, 2,180,358 shares of common stock were outstanding 
and EBC had approximately 134 shareholders of record.

DIVIDENDS

     EBC has never paid cash dividends on its common stock. EBC currently 
intends to retain any earnings to finance the growth and development of its 
business and does not anticipate paying cash dividends on its Common Stock in 
the foreseeable future. For a discussion of dividends paid or payable on 
Series B Redeemable Convertible Preferred Stock, see "Item 1. Business -- Risk 
Factors -- Dilutive Effect of Dividends on Preferred Stock; Deficiency in 
Fixed Charges and Preferred Stock Dividend Coverage."

ITEM 6. SELECTED FINANCIAL DATA

     The selected financial data set forth below with respect to EBC's 
statements of operations for each of the five years in the period ended 
December 31, 1998 and with respect to EBC's balance sheets as of December 31, 
1994, 1995, 1996, 1997 and 1998 are derived from the audited financial 
statements of EBC. EBC's independent public accountants, Arthur Andersen LLP, 
have included an explanatory fourth paragraph in their report on EBC's 
financial statements as of and for the year ended December 31, 1998, that 
expresses substantial doubt about EBC's ability to continue as a going 
concern as a result of its financial resources as of December 31, 1998. The 
financial data should be read in conjunction with the "Management's 
Discussion and Analysis of Financial Condition and Results of Operations" and 
EBC's Financial Statements and Notes thereto included elsewhere in this 
report.

                                      -23-





                                                              YEAR ENDED DECEMBER 31,
                                                              -----------------------
                                               1994        1995        1996        1997        1998
                                            ----------  ----------  ----------  ----------  ----------
                                                       (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                                                             
STATEMENTS OF OPERATIONS DATA:
Revenues:
      Sponsored research revenues .......   $    1,148  $    1,567  $    1,778  $    1,652  $      689
      Interest and investment income ....          573       1,401         807         650         360
                                            ----------  ----------  ----------  ----------  ----------
          Total revenues ................        1,721       2,968       2,585       2,302       1,049
Costs and Expenses:
      Research and development ..........        5,723       7,338       9,210       9,087       7,706
      General and administrative ........        2,978       2,877       2,608       2,754       2,188
                                            ----------  ----------  ----------  ----------  ----------
          Total costs and expenses ......   $    8,701      10,215  $   11,818  $   11,841  $    9,894
                                            ----------  ----------  ----------  ----------  ----------
Net loss ................................   $   (6,980) $   (7,247) $   (9,233) $   (9,539) $   (8,845)
                                            ----------  ----------  ----------  ----------  ----------
                                            ----------  ----------  ----------  ----------  ----------
Net loss per common share - basic and
      diluted ...........................   $    (5.25) $    (6.65) $    (7.29) $    (7.64) $    (5.20)
                                            ----------  ----------  ----------  ----------  ----------
                                            ----------  ----------  ----------  ----------  ----------
Shares used in computing net loss
      per common share - basic and
      diluted ...........................    1,423,949   1,461,085   1,606,861   1,681,351   1,875,414
                                            ----------  ----------  ----------  ----------  ----------
                                            ----------  ----------  ----------  ----------  ----------



     Net loss per common share has been computed by dividing the net loss, 
which has been increased for periodic accretion and dividends on the Series A 
Preferred Stock issued in October 1994 and the Series B Preferred Stock 
issued in February and March 1997, by the weighted average number of shares 
of common stock outstanding during the period. All share and per share 
information has been restated to reflect the one-for-seven reverse split on 
December 18, 1998.




                                                                DECEMBER 31,
                                                                ------------
                                              1994       1995       1996       1997       1998
                                            --------   --------   --------   --------   --------
                                                               (IN THOUSANDS)
                                                                         
BALANCE SHEET DATA:
Cash and cash equivalents................   $ 28,284   $  6,172   $  3,106   $  9,661   $  2,795
Working capital..........................     26,269     15,084      8,770     10,102      2,488
Total assets.............................     32,175     23,809     13,711     14,965      6,127
Long-term capital lease obligations......         21         11         --         --         --
Accumulated deficit......................    (21,907)   (31,321)   (42,713)   (55,204)   (67,200)
Total stockholders' equity...............     28,444     21,577     12,715     13,698      5,306



ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

  OVERVIEW

     EBC has devoted substantially all of its efforts to research and 
development. There have been no revenues from operations other than sponsored 
research revenues and there is no assurance of future revenues. EBC has a 
cumulative loss since inception of approximately $67 million and expects its 
existing financial resources to fund operations through mid-1999. As of 
March 30, 1999, EBC had approximately $1,050,000 in cash and approximately 
$327,000 in liabilities.

                                      -24-


     Effective March 30, 1999, EBC implemented a restructuring which included 
an employee headcount reduction of approximately 38 percent leaving 35 
employees. EBC is retaining certain key technical and administrative 
personnel. EBC is currently seeking additional financing through various 
alternatives that include: an equity financing, government funding and 
alliances with chemical companies and corporate partners. However, there can 
be no assurance that EBC will be able to obtain financing on acceptable 
terms. In the event EBC is unable to obtain such financing, it will consider 
other alternatives, including: (i) a license, sale or other disposition of 
EBC's BDS or other technologies, or certain rights relating thereto; (ii) a 
sale or other reorganization of EBC; or (iii) the combination of EBC with 
another entity. EBC's independent public accountants have included an 
explanatory paragraph in their report on EBC's financial statements as of and 
for the year ended December 31, 1998, that describes the substantial doubt 
regarding EBC's ability to continue as a going concern.

  RESULTS OF OPERATIONS

     EBC had total revenues for the years ended December 31, 1996, 1997 and 
1998 of $2,585,419, $2,302,225 and $1,048,791, respectively. Sponsored 
research revenues decreased by $126,907 from 1996 to 1997 as a result of a 
decrease in revenue recognized under the Petrolite agreement offset in part 
by an increase in revenues from the National Institute of Standards and 
Technology ("NIST") and Department of Energy ("DOE") grants and 
Carbide/Graphite research and development agreement. Sponsored research 
revenues decreased by $962,894 from 1997 to 1998 primarily as a result of the 
decreased revenues recognized from the NIST grant and The Carbide/Graphite 
Group, Inc. agreement offset in part by increased revenues from the DOE grant 
and the site license fee from Petro Star. In the year ended December 31, 
1996, $1,134,000 was recognized as revenue and in the year ended December 31, 
1997, $13,500 was recognized as revenue under the Petrolite agreement; as of 
December 31, 1996, 1997 and 1998, EBC had balances of $13,500, zero and zero, 
respectively, of deferred revenues under the Petrolite agreement. The amount 
recognized was based on the total payments received in relation to the total 
research and development costs to be incurred under the terms of the 
agreement. Interest and investment income decreased by $156,287 and $290,540 
in 1997 and 1998, respectively, as a result of a decrease in cash and cash 
equivalents and related investments in marketable securities.

     EBC had research and development expenses for the years ended December 31, 
1996, 1997 and 1998 of $9,210,227, $9,087,149 and $7,706,490, respectively. 
The decrease of $123,078 from 1996 to 1997 reflects the nonrecurring payment 
to Petrolite in 1996 of $1,000,000, offset in part by payment of pilot plant 
operating expenses to Baker Petrolite, hiring a vice president for process 
development and increases in catalyst production. The decrease of $1,380,659 
from 1997 to 1998 is a result of a reduction in research and development 
personnel at the end of the first quarter of 1998, the cessation of the pilot 
plant operating expenses at the end of the second quarter of 1998, offset in 
part by a charge to research and development in the first quarter of 1998 for 
warrants issued to Petro Star in the amount of $404,500. EBC expects its 
research and development expenses to decrease during 1999 as a result of the 
implementation of certain reductions in costs and expenses.

     EBC had general and administrative expenses for the years ended 
December 31, 1996, 1997 and 1998 of $2,607,972, $2,754,137 and $2,187,668, 
respectively. The $146,165 increase from 1996 to 1997 resulted primarily from 
the severance compensation payable to EBC's former chief executive officer in 
1997. The decrease of $566,469 from 1997 to 1998 reflects the reduction of 
the general and administrative personnel at the end of the first quarter of 
1998. EBC expects a slight decrease in its general and administrative 
expenses in 1999 as a result of the implementation of certain reductions in 
costs and expenses.

  LIQUIDITY AND CAPITAL RESOURCES

     Since its inception in December 1989, EBC has devoted substantially all 
of its resources to research and development. To date, all of EBC's revenues 
have resulted from interest and investment income and sponsored research 
payments from collaborative agreements. EBC has incurred cumulative losses 
since inception and, assuming EBC obtains additional financing, expects to 
incur substantial losses for at least the next several years, due 

                                      -25-


primarily to continued research and development activities and acceleration 
of the development of its biocatalyst, fermentation and bioreactor programs. 
EBC expects that losses will fluctuate from quarter to quarter and that such 
fluctuations may be substantial. As of December 31, 1998, EBC's accumulated 
deficit was approximately $67 million.

     In February 1997, EBC completed a convertible preferred stock offering 
resulting in net cash proceeds of approximately $10.2 million in exchange for 
the sale of 224,100 shares of Series B Convertible Preferred Stock. In 
October 1994, EBC completed a convertible preferred stock offering resulting 
in net cash proceeds of approximately $22.2 million in exchange for the sale 
of 480,000 shares of Series A Convertible Preferred Stock. EBC completed its 
initial public offering in the first quarter of 1993, resulting in net cash 
proceeds of approximately $14.9 million.

     For the year ended December 31, 1998, EBC used $7,297,273 of funds in 
operating activities. At December 31, 1998, EBC had cash and cash equivalents 
totaling $2,795,429 and working capital of $2,487,630.

     EBC expects to incur substantial additional research and development 
expenses, including expenses associated with biocatalyst, fermentation and 
bioreactor development. EBC is subject to cost sharing arrangements under 
various collaborative agreements, as discussed below. EBC also expects its 
general and administrative expenses to decrease as it reduces its marketing, 
sales and other personnel to conserve its resources for the development of 
EBC's proprietary BDS technology.

     EBC signed an agreement with Kellogg in August 1994, to collaborate on 
the development and commercialization of EBC's proprietary biocatalytic 
desulfurization technology for reducing sulfur levels in petroleum streams. 
Under the terms of the collaboration, Kellogg will serve as an engineering 
partner to EBC during completion of the BDS development process and will be 
the exclusive provider of the basic engineering design services required for 
the commercial BDS units. In return for these services, Kellogg will receive 
a portion of the site license fee generated by the sale of BDS units. The 
collaboration has a minimum term of at least five years or the completion of 
20 BDS units, whichever is longer, and has applications to all biorefining 
technologies EBC develops. During the first phase of the collaboration, 
Kellogg provided 500 engineering work hours of service at no cost to EBC. 
Kellogg has agreed to provide an additional 1,500 work hours of service at 
Kellogg offices at reduced rates.

     In July 1994, EBC entered into an Agreement with TOTAL to collaborate on 
the application of EBC's biodesulfurization process to diesel fuel streams. 
When the BDS processes reach commercial levels for activity and extent, it is 
anticipated that TOTAL will build and operate at TOTAL's expense a pilot BDS 
unit at TOTAL's European Centre for Research and Technology. Upon successful 
economic trials of the pilot unit, TOTAL plans to build the first commercial 
BDS unit at one of its refineries.

     In December 1993, EBC entered into a research collaboration agreement 
with Koch, to facilitate the development of BDS technology in refinery 
petroleum streams. Under the terms of the alliance, EBC will be primarily 
responsible for improving the performance of the biocatalyst used in the 
desulfurization process. Koch will be primarily responsible for selecting and 
improving the target refinery stream as well as testing desulfurized product 
quality. Koch will also provide engineering support as needed in the 
development of a BDS unit for Koch's operation. EBC and Koch will each bear 
their own costs and expenses incurred in connection with the collaboration. 
EBC expects that the development alliance with Koch will facilitate 
commercialization of EBC's BDS technology.

     In October 1993, EBC amended its previously existing Collaboration 
Agreement with Petrolite. The Collaboration Agreement, as amended (the 
"Agreement"), provides for an expanded territory covered by the Agreement and 
permits the use of third party engineering and construction companies to 
assist with certain matters. The Agreement expands the territory of 
Petrolite's participation from North America, Venezuela and Mexico to the 
entire world. In 

                                      -26-


return for the expansion of the territory covered by the Agreement, EBC's 
primary participation rate was increased from 70% of gross profits from 
biodesulfurization unit sales and fees to 78% of worldwide gross profits from 
such sales and fees. Additionally, the Agreement allows EBC, after obtaining 
the advice and input of Petrolite, to enter into an alliance with one or more 
world-class third party engineering and construction firms to provide certain 
equipment and services in connection with the design and construction of 
biodesulfurization units.

     In October 1996, EBC entered into an agreement with Petrolite providing 
EBC with the option to amend the terms of its strategic alliance with 
Petrolite. Under the agreement, EBC made an initial payment of $1 million to 
Petrolite in December 1996 in exchange for the option and the extension of 
Petrolite's obligations to provide operational and technical support for the 
pilot plant from September 1, 1996 through December 31, 1998. EBC did not 
exercise its option to reduce the percentage of site license fees and adjusted 
gross profit payable to Petrolite to 9.5% from 22%, in exchange for which EBC 
would have (i) assumed responsibility for servicing the BDS units on site at 
customer locations, (ii) paid Petrolite an additional $9 million in cash and 
(iii) issued to Petrolite a warrant entitling Petrolite to purchase 19,841 
shares of Common Stock at an exercise price of $50.40 per share. On March 27, 
1998 EBC elected to terminate the agreement as of March 27, 1999. EBC believes 
this will provide the greatest future benefits, including competitive bidding 
by potential service alliance partners, while maintaining a cost as low or 
lower than that provided by continuing the agreement.

     In July 1993, EBC entered into a research collaboration agreement with 
Texaco to facilitate the development of EBC's BDS technology in crude oil. 
Under the terms of the alliance, EBC will be primarily responsible for 
improving the performance of the biocatalyst used in the desulfurization 
process. Texaco will be primarily responsible for field operations and 
analytical chemistry work with respect to the application of EBC's BDS 
technology to crude oil. EBC and Texaco will each bear their own costs and 
expenses incurred in connection with the collaboration. EBC expects that the 
development alliance with Texaco will facilitate commercialization of EBC's 
BDS technology.

     EBC entered into a license agreement with Stanford University in 
November 1993 for the use of its patented recombinant DNA technology which 
may be employed in the development of EBC's biocatalytic desulfurization 
process. The license requires a minimum annual advance on earned royalties of 
$10,000. The final payment required under this license was made in 1997.

     EBC has experienced negative cash flow from operations since its 
inception and has funded its activities to date primarily from equity 
financings and sponsored research revenues. EBC will continue to require 
substantial funds to continue its research and development activities and to 
market, sell and commercialize its technology. EBC will need to raise 
substantial additional capital to fund its future operations. EBC's capital 
requirements will depend on many factors, including the problems, delays, 
expenses and complications frequently encountered by companies developing and 
commercializing new technologies; the progress of EBC's research and 
development activities; timing of environmental regulations; the rate of 
technological advances; determinations as to the commercial potential of 
EBC's technology under development; the status of competitive technology; the 
establishment of biocatalyst manufacturing capacity or third-party 
manufacturing arrangements; the establishment of collaborative relationships; 
the success of EBC's sales and marketing programs; the cost of filing, 
prosecuting and defending and enforcing patents and intellectual property 
rights; and other changes in economic, regulatory or competitive conditions 
in EBC's planned business. Estimates about adequacy of funding for EBC's 
activities are based upon certain assumptions, including assumptions that the 
research and development programs relating to EBC's technology can be 
conducted at projected costs and that progress towards the commercialization 
of its technology will be timely and successful. There can be no assurance 
that changes in EBC's research and development plans, acquisitions or other 
events will not result in accelerated or unexpected expenditures.

     To satisfy its capital requirements, EBC is currently seeking additional 
financing through an equity financing, government funding and through 
alliances with chemical companies and corporate partners. There can be no 
assurance that any such funding will be available to EBC on favorable terms 
or at all. If adequate funds are not 

                                      -27-


available when needed, EBC may be required to delay, scale back or eliminate 
some or all of its research and product development programs. If EBC is 
successful in obtaining additional financing, the terms of such financing may 
have the effect of diluting or adversely affecting the holdings or the rights 
of the holders of EBC's Common Stock.

     Year 2000 issues result from the inability of certain computer programs 
or computerized equipment to accurately calculate, store or use a date 
subsequent to December 31, 1999. The erroneous date can be interpreted in a 
number of different ways; typically the year 2000 is represented as the year 
1900. This could result in a system failure or miscalculation causing 
disruptions of operations, including, among other things, a temporary 
inability to process transactions, send invoices or engage in similar normal 
business.

     EBC is in the process of assessing all of its financial and operational 
systems and equipment to ensure year 2000 compliance. EBC has either obtained 
certifications as to year 2000 compliance from vendors or has tested the year 
2000 compliance of substantially all its systems and equipment and has taken 
the steps it believes will be necessary to remediate year 2000 problems 
associated with the systems and equipment that it determined not to be year 
2000 compliant. EBC plans to complete its assessment of its financial and 
operational systems and equipment in the second quarter of 1999.  EBC 
believes that the impact, if any, of its systems not being year 2000 
compliant should not impact EBC's ability to continue its research and 
development activities. However, there can be no assurance that EBC, its 
business partners, vendors and customers will successfully be able to 
identify and remedy all potential year 2000 problems or that a system failure 
resulting from a failure to identify any such problems would not have a 
material adverse effect on EBC.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

     None

ITEM 8. FINANCIAL STATEMENTS.

     The financial statements required by this Item are incorporated under 
Item 14 in Part IV of this report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.

     None.

                                      -28-


PART III.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

     The information required by this Item as to the directors and executive 
officers of EBC is hereby incorporated by reference from the information 
appearing under the captions "Election of Directors" and "Executive Officers" 
in EBC's definitive proxy statement which involves the election of directors 
and is to be filed with the Securities and Exchange Commission ("Commission") 
pursuant to the Securities Exchange Act of 1934 within 120 days of the end of 
EBC's fiscal year on December 31, 1998.

ITEM 11. EXECUTIVE COMPENSATION.

     The information required by this Item as to the management of EBC is 
hereby incorporated by reference from the information appearing under the 
captions "Executive Compensation" and "Election of Directors - Director 
Compensation" in EBC's definitive proxy statement which involves the election 
of directors and is to be filed with the Commission pursuant to the 
Securities Exchange Act of 1934 within 120 days of the end of EBC's fiscal 
year on December 31, 1998. Notwithstanding the foregoing, in accordance with 
the instructions to Item 402 of Regulation S-K, the information contained in 
EBC's proxy statement under the sub-heading "Report of the Compensation 
Committee of the Board of Directors" and "Performance Graph" shall not be 
deemed to be filed as part of or incorporated by reference into this Form 10-K.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

     The information required by this Item as to the ownership by management 
and others of securities of EBC is hereby incorporated by reference from the 
information appearing under the caption "Security Ownership of Certain 
Beneficial Owners and Management" to EBC's definitive proxy statement which 
involves the election of directors and is to be filed with the Commission 
pursuant to the Securities Exchange Act of 1934 within 120 days of the end of 
EBC's fiscal year on December 31, 1998.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     The information required by this Item as to certain business relationships 
and transactions with management and other related parties of EBC is hereby 
incorporated by reference to such information appearing under the captions 
"Certain Transactions" and "Compensation Committee Interlocks and Insider 
Participation" in EBC's definitive proxy statement which involves the 
election of directors and is to be filed with the Commission pursuant to the 
Securities Exchange Act of 1934 within 120 days of the end of EBC's fiscal 
year on December 31, 1998.

                                      -29-



PART IV.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

     (a) Documents Filed as a Part of this Report

1.  FINANCIAL STATEMENTS:



                                                                                                PAGE
                                                                                                ----
                                                                                             
Report of Independent Public Accountants.............................................            F-1
Balance Sheets as of December 31, 1997 and 1998......................................            F-2
Statements of Operations for the Years Ended December 31, 1996, 1997 and 1998........            F-3
Statements of Stockholders' Equity for the Period from December 31, 1995 to
December 31, 1998....................................................................            F-4
Statements of Cash Flows for the Years Ended December 31, 1996, 1997 and 1998........            F-5
Notes to Financial Statements........................................................            F-6



     All other schedules are omitted because they are not applicable, not 
required, or because the required information is included in the financial 
statements or notes thereto.

2.  EXHIBITS:

   Exhibits to the Form 10-K have been included only with the copies of the 
Form 10-K filed with the Commission and the Nasdaq Stock Market. Upon request 
to EBC and payment of a reasonable fee, copies of the individual exhibits 
will be furnished.




       EXHIBIT NO.                          DESCRIPTION
       -----------                          -----------
                   
         3.1(a)       Amended and Restated Certificate of Incorporation of
                      Registrant (incorporated by reference to Exhibit 2 filed
                      with Post-Effective Amendment No. 1 to the Registrant's
                      Registration Statement on Form 8-A as filed with the
                      Commission on March 15, 1993).

         3.1(b)       Certificate of the Powers, Designations, Preferences and
                      Rights of the Series A Convertible Preferred Stock
                      (incorporated by reference to Exhibit 10.2 to EBC's
                      Quarterly Report on Form 10-Q for the quarter ended
                      September 30, 1994).

         3.1(c)       Certificate of Designation of Series One Junior Participating
                      Preferred Stock of EBC (incorporated by reference to Exhibit 3.1(c)
                      to EBC's Annual Report on Form 10-K for the year ended December 31,
                      1994).

         3.1(d)       Certificate of the Powers, Designation, Preferences and
                      Rights of the Series B Convertible Preferred Stock
                      (incorporated by reference to Exhibit 3.1(d) to EBC's
                      Annual Report on Form 10-K for the year ended December 31,
                      1997).

         3.2          Bylaws of Registrant (incorporated by reference to Exhibit 3
                      filed with Post-Effective Amendment No. 1 to the
                      Registrant's Registration Statement on Form 8-A as filed
                      with the Commission on March 15, 1993).



                                     -30-





       EXHIBIT NO.                          DESCRIPTION
       -----------                          -----------
                   
         4.1          Form of Stock Purchase Agreement, dated as of October 27,
                      1994, by and between EBC and the Purchasers of the Series A
                      Convertible Preferred Stock (incorporated by reference
                      to Exhibit 10.1 to EBC's Quarterly Report on Form 10-Q for
                      the quarter ended September 30, 1994).

         4.2          Form of Stock Purchase Agreement, dated as of February 21,
                      1997, by and between EBC and the Purchasers of the Series B
                      Convertible Preferred Stock (incorporated by reference
                      to Exhibit 4.2 to EBC's Annual Report on Form 10-K for the
                      year ended December 31, 1997).

         4.3          Form of Stock Exchange Agreement, dated as of February 21,
                      1997, by and between EBC and the Exchanging Holders of
                      Series A Convertible Preferred Stock (incorporated by
                      reference to Exhibit 4.3 to EBC's Annual Report on Form 10-K
                      for the year ended December 31, 1997).

         4.4          Stockholder Rights Agreement, dated as of March 8, 1995,
                      between EBC and Society National Bank (incorporated by
                      reference to Exhibit 4.1 to EBC's Current Report on Form 8-K
                      dated March 8, 1995).

        10.1          License and Technology Assistance Agreement, dated January 15,
                      1991, between EBC and Institute of Gas Technology ("IGT")
                      (incorporated by reference to the similarly numbered exhibit
                      to EBC's Registration Statement on Form S-1 (No. 33-56718)).

        10.2          First Amendment to License and Technology Assistance
                      Agreement, dated June 25, 1992, between EBC and IGT
                      (incorporated by reference to the similarly numbered
                      exhibit to EBC's Registration Statement on Form S-1 (No.
                      33-56718)).

        10.3          Agreement, dated August 27, 1992, among EBC, IGT, the
                      University of North Dakota ("UND") and Dr. Kevin Young
                      (incorporated by reference to the similarly numbered
                      exhibit to EBC's Registration Statement on Form S-1 (No.
                      33-56718)).

        10.4          Agreement, dated September 30, 1992, among EBC, UND and
                      Dr. Kevin Young (incorporated by reference to the
                      similarly numbered exhibit to EBC's Registration Statement
                      on Form S-1 (No. 33-56718)).

        10.5          Collaboration Agreement, dated March 5, 1992, between EBC
                      and Petrolite Corporation (incorporated by reference to
                      the similarly numbered exhibit to EBC's Registration
                      Statement on Form S-1 (No. 33-56718)).

        10.6          Lease Agreement, dated January 24, 1994, between The
                      Woodlands Corporation and EBC (incorporated by reference
                      to Exhibit 10.6 to EBC's Annual Report on Form 10-K for
                      the fiscal year ended December 31, 1993).

        10.7          Registration Agreement, dated January 30, 1992, among EBC,
                      The Travelers Indemnity Company and Gryphon Ventures II,
                      Limited Partnership (incorporated by reference to the
                      similarly numbered exhibit to EBC's Registration Statement
                      on Form S-1 (No. 33-56718)).

        10.8          Registration Agreement, dated April 29, 1991, between EBC
                      and Gryphon Ventures II, Limited Partnership (incorporated
                      by reference to the similarly numbered exhibit to EBC's
                      Registration Statement on Form S-1 (No. 33-56718)).

        10.9**        Energy BioSystems Corporation 1992 Stock Compensation
                      Plan (incorporated by 



                                     -31-




       EXHIBIT NO.                          DESCRIPTION
       -----------                          -----------
                   
                      reference to Exhibit 10.10 to EBC's Registration Statement on
                      Form S-1 (No. 33-56718)).

        10.10**       Employment Agreement, dated January 31, 1996, between
                      EBC and Daniel J. Monticello (incorporated by reference to
                      Exhibit 10.10 to EBC's Annual Report on Form 10-K for the
                      year ended December 31, 1997).

        10.11**       Consultant Agreement between EBC and John T. Preston
                      (incorporated by reference to Exhibit 10.12 to EBC's
                      Registration Statement on Form S-1 (No. 33-56718)).

        10.12**       Employment Agreement, dated July 18, 1995, between EBC
                      and Paul G. Brown, III (incorporated by reference to the
                      similarly numbered exhibit to EBC's Registration Statement
                      on Form S-1 (No. 33-96096)).

        10.13**       Amended and Restated Consultant Agreement between EBC
                      and William M. Haney, III (incorporated by reference to
                      the Exhibit 10.14 to EBC's Registration Statement on
                      Form S-1 (No. 33-56718)).

        10.14**       Simplified Employee Pension Plan Retirement Plan Adoption
                      Agreement (incorporated by reference to Exhibit 10.15
                      to EBC's Registration Statement on Form S-1 (No. 33-56718)).

        10.15**       Energy BioSystems Corporation Non-Employee Director
                      Option Plan (incorporated by reference to the similarly
                      numbered exhibit to EBC's Registration Statement on Form S-1
                      (No. 33-96096)).

        10.16         First Amendment to Collaboration Agreement, dated July 1,
                      1992, between EBC and Petrolite Corporation (incorporated
                      by reference to the Exhibit 10.16 to EBC's Registration
                      Statement on Form S-1 (No. 33-56718)).

        10.17         Research Agreement, dated November 8, 1993, between EBC
                      and The University of Notre Dame (incorporated by
                      reference to Exhibit 10.19 to EBC's Registration Statement
                      on Form S-1 (No. 33-56718)).

        10.18         Research Collaboration Agreement, dated July 8, 1993,
                      between EBC and Texaco, Inc. (incorporated by reference to
                      Exhibit 99.1 to EBC's Quarterly Report on Form 10-Q for
                      the quarter ended June 30, 1993).

        10.19         Extension and Assignment of Research Collaboration
                      Agreement, dated June 23, 1995, between EBC and Texaco Inc.
                      (incorporated by reference to the similarly numbered
                      exhibits to EBC's Registration Statement on Form S-1
                      (No. 3-96096)).

        10.20         Second Amendment to Collaboration Agreement, dated October 18,
                      1993, between EBC and Petrolite Corporation
                      (incorporated by reference to Exhibit 99.1 to EBC's
                      Quarterly Report on Form 10-Q for the quarter ended
                      September 30, 1993).

        10.21         Lease Agreement, dated May 24, 1993, between EBC and The
                      Woodlands Corporation (incorporated by reference to
                      Exhibit 99.2 to EBC's Quarterly Report on Form 10-Q for
                      the quarter ended September 30, 1993).

        10.22         Second Amendment to License and Technology Assistance
                      Agreement, dated September 23, 1993, between EBC and IGT
                      (incorporated by reference to Exhibit 10.21 



                                     -32-




                   
                      to EBC's Annual Report on Form 10-K for the fiscal year ended
                      December 31, 1993).

        10.23         Letter Agreement dated February 10, 1994, between The 
                      M. W. Kellogg Company and EBC (incorporated by reference to
                      Exhibit 10.22 to EBC's Annual Report on Form 10-K for the
                      fiscal year ended December 31, 1993).

        10.24         Letter Agreement for Accelerated Development Program dated
                      December 8, 1993, between EBC and Koch Refining Company
                      (incorporated by reference to Exhibit 10.23 to EBC's
                      Annual Report on Form 10-K for the fiscal year ended
                      December 31, 1993).

        10.25         License Agreement dated November 1, 1993, between EBC and
                      Stanford University (incorporated by reference to Exhibit 10.25
                      to EBC's Annual Report on Form 10-K for the fiscal
                      year ended December 31, 1993).

        10.26         Collaboration Agreement dated July 7, 1994, between EBC
                      and Total Raffinage Distribution S.A. (incorporated by
                      reference to Exhibit 99.1 to EBC's Quarterly Report on
                      Form 10-Q for the second quarter ended June 30, 1994).

        10.27         Research Agreement, dated July 1, 1994, between EBC and
                      Massachusetts Institute of Technology (incorporated by
                      reference to Exhibit 10.27 to EBC's Annual Report on
                      Form 10-K for the year ended December 31, 1994).

        10.28         Research Agreement, dated November 8, 1994, between EBC
                      and The University of Notre Dame (incorporated by
                      reference to Exhibit 10.28 to EBC's Annual Report on
                      Form 10-K for the year ended December 31, 1994).

        10.29         Research, Option and License Agreement, dated December 15,
                      1994, between EBC and the University of Houston
                      (incorporated by reference to Exhibit 10.29 to EBC's
                      Annual Report on Form 10-K for the year ended December 31,
                      1994).

        10.30         Cooperative Agreement between EBC and the National
                      Institute of Standards and Technology (incorporated by
                      reference to Exhibit 10.30 to EBC's Annual Report on
                      Form 10-K for the year ended December 31, 1994).

        10.31         Extension and Assignment of Research Collaboration
                      Agreement, dated July 3, 1996, between EBC and Texaco
                      Group, Inc. (incorporated by reference to Exhibit 10.1 to
                      EBC's Quarterly Report on Form 10-Q for the quarter ended
                      June 30, 1996).

        10.32         Third Amendment and Addendum to Collaboration Agreement,
                      dated August 24, 1995, between EBC and Petrolite
                      Corporation (incorporated by reference to Exhibit 10.36 to
                      EBC's Annual Report on Form 10-K for the year ended
                      December 31, 1996).

        10.33         Fourth Amendment and Addendum to Collaboration Agreement,
                      dated October 25, 1996, between EBC and Petrolite
                      Corporation, as modified by Letter Agreement dated
                      December 30, 1996 (incorporated by reference to Exhibit 10.37
                      to EBC's Annual Report on Form 10-K for the year
                      ended December 31, 1996).

        10.34**       Employment Agreement, dated April 7, 1997, between EBC and
                      Michael A. Pacheco (incorporated by reference to Exhibit 10.26
                      to EBC's Annual Report on Form 10-K for the year
                      ended December 31, 1997).

       *10.35**       Employment Agreement, dated December 4, 1998, between EBC
                      and Peter P. Policastro.

       *10.36         Extension, Modification and Ratification of Lease, 
                      dated March 23, 1998, between EBC and Woodlands Office
                      Equities - '95 Limited.



                                     -33-





                   
       *11.1          Computation of earnings per share.

       *23.1          Consent of Arthur Andersen LLP.

       *27.1          Financial Data Schedule.



- -----------------------
*      Filed herewith
**     Management contract or compensatory plan.

       (b) Reports on Form 8-K

       None.


                                     -34-



                                  SIGNATURES

         PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES 
EXCHANGE ACT OF 1934, EBC HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS 
BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.

                                      ENERGY BIOSYSTEMS CORPORATION


                                      By:         /s/ WILLIAM E. NASSER
                                          --------------------------------------
                                                    William E. Nasser
                                          CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE
                                          OFFICER AND PRESIDENT

DATED the 26th day of March, 1999.

         PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, 
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF EBC 
AND IN THE CAPACITIES AND ON THE DATES INDICATED:



                     NAME                                         TITLE                             DATE
                     ----                                         -----                             ----
                                                                                         
             /s/ WILLIAM E. NASSER                 Chairman of the Board, Chief                March 26, 1999
- ----------------------------------------------     Executive Office and President
               William E. Nasser                   (Principal executive officer)


            /s/ PAUL G. BROWN, III                 Vice President--Finance and                 March 26, 1999
- ----------------------------------------------     Administration (Principal financial
              Paul G. Brown, III                   and accounting officer)


        /s/ DANIEL J. MONTICELLO, PH.D.            Vice President--Science and                 March 26, 1999
- ----------------------------------------------     Technology, and Director
          Daniel J. Monticello, Ph.D.


            /s/ BERNARD LEE, PH.D.                 Director                                    March 26, 1999
- ----------------------------------------------
              Bernard Lee, Ph.D.


             /s/ EDWARD B. LURIER                  Director                                    March 26, 1999
- ----------------------------------------------
               Edward B. Lurier


            /s/ THOMAS E. MESSMORE                 Director                                    March 26, 1999
- ----------------------------------------------
              Thomas E. Messmore


                /s/ RAMON LOPEZ                    Director                                    March 26, 1999
- ----------------------------------------------
                  Ramon Lopez


              /s/ JOHN S. PATTON                   Director                                    March 26, 1999
- ----------------------------------------------
                John S. Patton


              /s/ JOHN T. PRESTON                  Director                                    March 26, 1999
- ----------------------------------------------
                John T. Preston


             /s/ WILLIAM D. YOUNG                  Director                                    March 26, 1999
- ----------------------------------------------
               William D. Young



                                     -35-


                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To Energy BioSystems Corporation:

     We have audited the accompanying balance sheets of Energy BioSystems 
Corporation ("the Company") (a Delaware corporation), as of December 31, 1997 
and 1998, and the related statements of operations, stockholders' equity and 
cash flows for each of the three years in the period ended December 31, 1998. 
These financial statements are the responsibility of the Company's management. 
Our responsibility is to express an opinion on these financial statements based 
on our audits.

     We conducted our audits in accordance with generally accepted auditing 
standards. Those standards require that we plan and perform the audit to 
obtain reasonable assurance about whether the financial statements are free 
of material misstatement. An audit includes examining, on a test basis, 
evidence supporting the amounts and disclosures in the financial statements. 
An audit also includes assessing the accounting principles used and significant 
estimates made by management, as well as evaluating the overall financial 
statement presentation. We believe that our audits provide a reasonable basis 
for our opinion.

     In our opinion, the financial statements referred to above present fairly, 
in all material respects, the financial position of Energy BioSystems 
Corporation as of December 31, 1997 and 1998, and the results of its operations 
and its cash flows for each of the three years in the period ended December 31, 
1998 in conformity with generally accepted accounting principles.

     The accompanying financial statements have been prepared assuming that 
the Company will continue as a going concern. As discussed in Note 1 to the 
financial statements, the Company has financing resources expected to fund 
operations through mid 1999, and is currently pursuing additional financing. 
There is no assurance that the Company will be successful in its financing 
efforts. Additionally, the Company is implementing a restructuring, including 
substantial employee reductions in order to reduce expenses and focus its 
limited resources on critical elements leading to commercialization on of its 
patented biocatalytic desulfurization ("BDS") Process. The Company has 
devoted substantially all of its efforts to raising capital and performing 
research and development to develop BDS. As shown in the accompanying 
financial statements, the Company has not realized revenues other than 
sponsored research revenues and has an accumulated deficit of $67 million 
since its inception. These above factors raise substantial doubt about the 
Company's ability to continue as a going concern. Management's plans in 
regard to these matters are described in Note 1. The financial statements do 
not include any adjustments relating to the recoverability and classification 
of asset carrying amounts, including intangible and other assets, or the 
amount and classification of liabilities that might result should the Company 
be unable to continue as a going concern.

ARTHUR ANDERSEN LLP



Houston, Texas
March 30, 1999


                                      F-1



                          ENERGY BIOSYSTEMS CORPORATION

                                 BALANCE SHEETS





                                                                                                   DECEMBER 31,
                                                                                                ------------------
                                                                                      1997                        1998
                                                                                  -------------------         ------------------
                                ASSETS
                                                                                                     
Current assets:
   Cash and cash equivalents ...........................................          $  9,661,310                $  2,795,429
   Short term investments ..............................................               693,279                        --
   Prepaid expenses and other current assets ...........................             1,013,872                     512,487
                                                                                  ------------                ------------
        Total current assets ...........................................            11,368,461                   3,307,916
                                                                                  ------------                ------------

Furniture, equipment and leasehold improvements, net ...................             2,624,332                   1,675,992
Intangible and other assets, net .......................................               972,266                   1,142,837
                                                                                  ------------                ------------
        Total assets ...................................................          $ 14,965,059                $  6,126,745
                                                                                  ------------                ------------
                                                                                  ------------                ------------

        LIABILITIES & STOCKHOLDERS' EQUITY

Current liabilities:
   Accounts payable, accrued liabilities and 
        capital lease obligations.......................................          $   868,230                $    513,673
   Deferred revenue ....................................................              180,000                     180,000
   Note payable ........................................................              218,606                     126,613
                                                                                  ------------                ------------
        Total current liabilities ......................................             1,266,836                     820,286
                                                                                  ------------                ------------

Commitments and Contingencies

Stockholders' equity:
   Series B convertible preferred stock $0.01 par value
         (liquidation value $35,105,000, 760,000 shares authorized,
        702,100 and 696,400 shares issued and outstanding,
        respectively) ..................................................            33,853,380                  33,955,166
   Common stock, $0.01 par value (4,285,714 shares
        authorized, 1,750,204 and 2,179,142 shares
        issued and outstanding, respectively) ..........................                17,502                      21,791
   Additional paid-in capital ..........................................            35,031,606                  38,529,097
   Accumulated deficit .................................................           (55,204,265)                (67,199,595)
                                                                                  ------------                ------------
        Total stockholders' equity .....................................            13,698,223                   5,306,459
                                                                                  ------------                ------------
        Total liabilities and stockholders' equity .....................          $ 14,965,059                $  6,126,745
                                                                                  ------------                ------------
                                                                                  ------------                ------------



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


                                      F-2



                          ENERGY BIOSYSTEMS CORPORATION

                            STATEMENTS OF OPERATIONS




                                                                          YEAR ENDED DECEMBER 31,
                                                                       -----------------------------
                                                               1996                1997                1998
                                                          --------------      --------------      --------------
                                                                                      
REVENUES:
   Sponsored research revenues......................      $    1,778,683      $    1,651,776      $      688,882
   Interest and investment income...................             806,736             650,449             359,909
                                                          --------------      --------------      --------------
        Total revenues..............................           2,585,419           2,302,225           1,048,791
                                                          --------------      --------------      --------------

COSTS AND EXPENSES:
   Research and development.........................           9,210,227           9,087,149           7,706,490 
   General and administrative.......................           2,607,972           2,754,137           2,187,668 
                                                          --------------      --------------      -------------- 
        Total costs and expenses....................          11,818,199          11,841,286           9,894,158 
                                                          --------------      --------------      -------------- 
NET LOSS............................................      $   (9,232,780)     $   (9,539,061)     $   (8,845,367)
                                                          --------------      --------------      -------------- 
                                                          --------------      --------------      -------------- 
NET LOSS PER COMMON SHARE - BASIC
  AND DILUTED.......................................      $        (7.29)    $         (7.64)     $        (5.20)
                                                          --------------      --------------      -------------- 
                                                          --------------      --------------      -------------- 
SHARES USED IN COMPUTING NET LOSS
    PER COMMON SHARE................................           1,606,861           1,681,351           1,875,414



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


                                      F-3



                          ENERGY BIOSYSTEMS CORPORATION

                       STATEMENTS OF STOCKHOLDERS' EQUITY




                                            PREFERRED STOCK       COMMON STOCK
                                            ---------------       ------------       ADDITIONAL    ACCUMULATED    TOTAL
                                          SHARES     AMOUNT       SHARES    AMOUNT     PAID-IN       DEFICIT      -----
                                          ------     ------       ------    ------     CAPITAL     -----------
                                                                                     ----------
                                                                                            
BALANCE AT DECEMBER 31, 1995             480,000   $22,968,152   1,512,038  $15,120  $29,914,066  $(31,320,522)  $21,576,816
Exercise of stock options in 1996
   ($2.1252 to $38.50 per share)....          --            --      84,171      842      370,670            --       371,512
Dividends on Series A Preferred
   Stock paid in Common Stock.......          --    (2,160,000)     46,238      462    2,159,463            --           (75)
Accretion and dividends on
   Series A Preferred Stock.........          --     2,487,433          --       --     (327,433)   (2,160,000)           --
Net loss............................          --            --          --       --           --    (9,232,780)   (9,232,780)
                                        --------  ------------   ---------  -------  -----------  ------------   -----------
BALANCE AT DECEMBER 31, 1996             480,000    23,295,585   1,642,447   16,424   32,116,766   (42,713,302)   12,715,473
Exercise of stock options in 1997
   ($2.1252  to $43.75 per share....          --            --      38,663      387      350,576            --       350,963
Issuance of Series B Preferred
   Stock............................     224,100    10,171,120          --       --           --            --    10,171,120
Exchange of Series A Preferred f
   Stock for Series B Preferred
   Stock............................    (478,000)  (22,853,138)         --       --           --            --   (22,853,138)
Issuance of Series B Preferred Stock
   for Series A Preferred Stock.....     478,000    22,853,138          --       --           --            --    22,853,138
Issuance of Common Stock in                                                                                      
   exchange for Series A Preferred
   Stock............................      (2,000)      (99,526)      1,797       18       99,508            --            --
Dividends on Series A Preferred
   Stock paid in Common Stock.......          --      (691,575)     14,074      141      691,387            --           (47)
Accretion and dividends on
   Series A Preferred Stock.........          --       360,604          --       --      (67,904)     (292,700)           --
Dividends on Series B Preferred
   Stock paid in Common Stock.......          --    (2,132,629)     53,223      532    2,131,872            --          (225)
Accretion and dividends on
   Series B Preferred Stock.........          --     2,949,801          --       --     (290,599)   (2,659,202)           --
Net loss............................          --            --          --       --         --      (9,539,061)   (9,539,061)
                                        --------  ------------   ---------  -------  -----------  ------------   -----------
BALANCE AT DECEMBER 31, 1997             702,100    33,853,380   1,750,204   17,502   35,031,606   (55,204,265)   13,698,223

Exercise of stock options in 1998                                                                       
   ($9.94 per share)................          --           --        4,286       43       42,557            --        42,600
Warrants issued.....................          --           --           --       --      404,500            --       404,500
Dividends on Series B Preferred                                                                    
   Stock paid in Common Stock.......          --    (3,144,825)    417,203    4,172    3,140,601            --           (52)
Accretion and dividends on                                                                                       
   Series B Preferred Stock.........          --     3,531,611          --       --     (381,648)   (3,149,963)           --
Conversion of Series B Preferred                                                                                 
   Stock to Common Stock............      (5,700)     (285,000)      5,615       56      284,944            --            --
Fractional shares paid in cash
   at one-for-seven reverse split...                                   (54)      (1)        (195)                       (196)
Stock issued to consultant
   ($2.63 to $4.81 per share).......                                 1,888       19        6,732                       6,751
Net loss ...........................          --           --           --       --           --    (8,845,367)   (8,845,367)
                                        --------  ------------   ---------  -------  -----------  ------------   -----------
BALANCE AT DECEMBER 31, 1998             696,400  $ 33,955,166   2,179,142  $21,791  $38,529,097  $(67,199,595)  $ 5,306,459
                                        --------  ------------   ---------  -------  -----------  ------------   -----------
                                        --------  ------------   ---------  -------  -----------  ------------   -----------


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


                                      F-4



                          ENERGY BIOSYSTEMS CORPORATION

                            STATEMENTS OF CASH FLOWS




                                                                             YEAR ENDED DECEMBER 31,
                                                               --------------------------------------------------
                                                                   1996               1997               1998
                                                               ------------       ------------       ------------
                                                                                          
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                                     $(9,232,780)       $(9,539,061)       $(8,845,367)
   Adjustments to reconcile net loss to net cash used 
   in operating activities:
      Depreciation and amortization                               1,160,179          1,255,622          1,243,100
      Issuance of stock for services                                  --             --                     6,751
      Research and development expense                                    
         recorded for warrant issuance                                --             --                   404,500
      Loss on disposal of furniture, equipment and
        leasehold improvements                                        --             --                    33,855
   Changes in assets and liabilities:
      Decrease in trading securities                              4,444,020          --                   --
      Decrease (increase) in prepaid expenses and
        other current assets                                        172,079            (27,373)           501,385
      Decrease in notes receivable                                   38,950              6,683            --
      Increase in intangible and other assets                      (182,196)          (231,736)          (290,496)
      Increase (decrease) in accounts payable and                                                  
        accrued liabilities                                         (53,951)           327,091           (351,001)
      Decrease in deferred revenue                               (1,134,000)           (13,500)           --
                                                               ------------       ------------       ------------
   Net cash used in operating activities                         (4,787,699)        (8,222,274)         7,297,273
                                                               ------------       ------------       ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Capital expenditures                                            (936,877)          (682,017)          (208,691)
   Net sale of investments held to maturity                       2,588,713          5,198,305            693,279
                                                               ------------       ------------       ------------
      Net cash provided by investing activities                   1,651,836          4,516,288            484,588
                                                               ------------       ------------       ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Payments on notes payable, net                                  (294,713)          (252,443)           (91,993)
   Payments on capital lease obligations                             (7,256)            (8,076)            (3,556)
   Proceeds from Series B Preferred Stock, net                        --            10,171,120            --
   Proceeds from exercise of Stock Options, net                     371,436            350,691             42,353
                                                               ------------       ------------       ------------
      Net cash provided by (used in) financing activities            69,467         10,261,292            (53,196)
                                                               ------------       ------------       ------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                                                                 (3,066,396)         6,555,306         (6,865,881)
                                                               ------------       ------------       ------------
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
                                                                  6,172,400          3,106,004          9,661,310
                                                               ------------       ------------       ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR                       $  3,106,004       $  9,661,310       $  2,795,429
                                                               ------------       ------------       ------------
                                                               ------------       ------------       ------------
SUPPLEMENTAL INFORMATION OF NONCASH FINANCING
ACTIVITIES:
   Outstanding note payable for prepaid insurance              $    252,442       $    218,606       $    126,613
                                                               ------------       ------------       ------------
                                                               ------------       ------------       ------------


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


                                      F-5



                          ENERGY BIOSYSTEMS CORPORATION


                          NOTES TO FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


1.   DESCRIPTION OF THE COMPANY

     Energy BioSystems Corporation ("EBC"), formerly Environmental BioScience
Corporation, was incorporated in the State of Delaware on December 20, 1989, and
commenced operations in January 1990. EBC was formed to develop and
commercialize innovative biotechnology-based processes for the refining of
fossil fuels. EBC's focus to date has been on developing biocatalytic
desulfurization ("BDS"), a proprietary process involving the use of enzymes to
remove sulfur from petroleum.

     Effective March 30, 1999, EBC implemented a restructuring, including a 
substantial employee reduction, in order to reduce expenses and focus its 
resources on the critical elements leading to commercialization of its 
patented BDS process. EBC is retaining certain key technical and 
administrative personnel. EBC is currently seeking additional financing 
through various alternatives that include: an equity financing, government 
funding and alliances with chemical companies and corporate partners. 
However, there can be no assurance that EBC will be able to obtain financing 
on acceptable terms. In the event EBC is unable to obtain financing, EBC will 
consider other financing alternatives, including: (i) a license, sale or 
other disposition of EBC's BDS or other technologies, or certain rights 
relating thereto; (ii) a sale or other reorganization of EBC; or (iii) the 
combination of EBC with another entity.

     As shown in EBC's financial statements, EBC has devoted substantially all
of its efforts to research and development. There have been no revenues from
operations other than sponsored research revenues (see Note 7) and there is no
assurance of future revenues. During 1998, EBC used $7,297,273 in cash for 
operating activities. As of December 31, 1998, EBC had $2,795,429 in cash and 
$820,286 in liabilities. EBC has a cumulative loss since inception of 
approximately $67 million and expects its existing financial resources to 
fund operations through mid 1999. All of the above factors raise substantial 
doubt about EBC's ability to continue as a going concern.

     EBC's property and equipment and intangible and other assets are unique 
to the proprietary technology and processes that EBC has and continues to 
develop. Realization of EBC's investments in these assets is dependent upon 
the success of future operations or the sale or licensing of intellectual 
properties. If EBC is unable to continue as a going concern, the recorded 
asset carrying amounts may be greater than the amounts that will be realized 
in the event of liquidation.

     EBC's BDS process will require substantial additional research, development
and testing in order to determine its commercial viability. EBC has proven
its BDS technology only to a limited extent in laboratory, bench-scale and
pilot plant trials, which is not yet sufficient for full commercialization. 
If EBC successfully field tests its BDS technology, the commercialization of 
the BDS technology will require significant additional time and expenditures. 
The commercialization of the technology will depend on, among other things, 
EBC's success in achieving improvement of its biocatalyst and success in 
developing fermentation processes, as well as EBC's ability to manufacture or 
contract for the manufacture of sufficient biocatalyst for use in commercial 
BDS units; to apply process engineering to design bioreactor systems capable 
of accomplishing the BDS process on a commercial scale; and to market its BDS 
systems effectively. The accomplishment of some or all of these objectives 
may be delayed or may never occur. EBC will require additional capital to 
continue as a going concern and to continue the development and 
commercialization of its BDS technology, and there can be no assurance that 
such capital will be available or that EBC will be able to successfully 
commercialize its BDS technology.

     In December 1998, EBC declared a one-for-seven reverse stock split which 
was effective December 18, 1998.  All references to earnings per share and 
share amounts prior to December 18, 1998 have been retroactively restated to 
reflect the reverse stock split.


                                      F-7



                          ENERGY BIOSYSTEMS CORPORATION

                   NOTES TO FINANCIAL STATEMENTS - (CONTINUED)


2.   ACCOUNTING POLICIES

     CASH, CASH EQUIVALENTS AND SHORT TERM INVESTMENTS

     EBC considers short term investments with original maturities of 90 days 
or less to be cash equivalents. Debt and equity securities that EBC has the 
intent and ability to hold to maturity are classified as "held to maturity" 
and reported at amortized cost. Debt and equity securities that are held for 
current resale are classified as "trading securities" and reported at fair 
value with unrealized gains and losses included in earnings. Debt and equity 
securities not classified as either "held to maturity" or "trading 
securities" are classified as "securities available for sale" and reported at 
fair value, with unrealized gains and losses excluded from earnings and 
reported as a separate component of stockholders' equity. At December 31, 
1997, short term investments consisted entirely of held-to-maturity securities.

     At December 31, 1997 and 1998, EBC held cash and cash equivalents in excess
of the federally insured amounts.

     FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

     Furniture and equipment consists of office furniture and equipment,
computers and laboratory equipment and is carried at cost. Depreciation is
calculated on the straight-line method using a five-year estimated useful life.
Leasehold improvements are amortized on the straight-line method over the term
of the lease or the useful life of the assets, whichever is shorter.

     Maintenance and repairs that do not improve or extend the life of assets 
and expenditures for research and development equipment for which there is no 
future alternative use are expensed as incurred. Expenditures which improve 
or extend the life of assets are capitalized.

     INTANGIBLE AND OTHER ASSETS

     Intangible and other assets mainly consist of patent costs, which are
primarily legal fees. These costs are being amortized over 17 years. Accumulated
amortization at December 31, 1997 and 1998 amounted to $297,180 and $417,104,
respectively.

     RESEARCH AND DEVELOPMENT

     Sponsored research revenue is recognized based on the percentage of total
research payments to be received in relation to the total research and
development costs to be incurred under the specific research agreements. All
research and development costs, both generated internally and from research and
development contracts, are expensed as incurred. EBC allocates certain indirect
costs to research and development expenses which consist primarily of overhead
related to the administration of research and development activities.

     NET LOSS PER COMMON SHARE

     Net loss per common share has been computed by dividing the net loss, which
has been increased for periodic accretion and accrued dividends on the Series A
Convertible Preferred Stock and Series B Convertible Preferred Stock issued in
October 1994 and February 1997, respectively, by the weighted average number of
shares of Common Stock outstanding during the periods. The net loss per share
has been restated to reflect the one-for seven reserve split on December 18,
1998.


                                      F-8



                          ENERGY BIOSYSTEMS CORPORATION

                   NOTES TO FINANCIAL STATEMENTS - (CONTINUED)


     In March 1997, the Financial Accounting Standards Board issued Statement 
of Financial Accounting (SFAS) No. 128, "Earnings Per Share." SFAS 128 
revises the standards for computing earnings per share previously found in 
APB Opinion No. 15, EARNINGS PER SHARE. The SFAS also retroactively revises 
the presentation of earnings per share in the financial statements. EBC 
adopted this SFAS for the year ended December 31, 1997. In all applicable 
years, all Common Stock equivalents were antidilutive and, accordingly, were 
not included in the computation.

     USE OF ESTIMATES

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

PRESENTATION

     Certain reclassifications have been made to prior year balances to 
conform to current year presentation.

3.   FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

     A summary of furniture, equipment and leasehold improvements is as follows:




                                                                                       DECEMBER 31,
                                                                                       ------------
                                                                                 1997                  1998
                                                                         --------------------  -----------------
                                                                                         
Office furniture and equipment......................................     $         408,356     $         407,976
Laboratory equipment................................................             3,781,153             3,938,885
Computer equipment..................................................               852,506               638,071
Leasehold improvements..............................................             1,711,852             1,734,011
Equipment under capital lease.......................................                55,203                55,203
Automobiles.........................................................                23,670                23,670
                                                                         -----------------     -----------------
                                                                                 6,832,740             6,797,816
Less--Accumulated depreciation and amortization.....................            (4,208,408)           (5,121,824)
                                                                         ------------------    ------------------
Furniture, equipment and leasehold improvements, net................     $       2,624,332     $       1,675,992
                                                                         ------------------    ------------------
                                                                         ------------------    ------------------



                                      F-9



                          ENERGY BIOSYSTEMS CORPORATION

                   NOTES TO FINANCIAL STATEMENTS - (CONTINUED)


4.   STOCKHOLDERS' EQUITY

     SERIES B CONVERTIBLE PREFERRED STOCK

     In February and March 1997, EBC sold and aggregate of 224,100 shares of
Series B Convertible Preferred Stock at $50.00 per share in a private placement.
The net proceeds from the offering were approximately $10.2 million. The
placement agent for the Series B Preferred Stock received warrants to purchase
an aggregate of 20,319 shares of Series B Preferred Stock at an exercise price
of $50.00 per share of Series B Preferred Stock in addition to customary
commissions. The warrants have been recorded at an estimated fair value of
$466,000, which was computed using the Black-Scholes option pricing model and
the following assumptions: risk free interest rate of 6.51 percent; expected
dividend yield of zero; expected life of three years, and an expected volatility
of 68 percent.

     Dividends on the Series B Preferred Stock are cumulative from February 27,
1997 and payable semi-annually commencing May 1, 1997, at an annual rate equal
to (i) $4.00 per share of Series B Preferred Stock to the extent the dividend is
paid in cash and (ii) $4.50 per share of Series B Preferred Stock to the extent
the dividend is paid in common stock. Dividends on shares of Series B Preferred
Stock are payable in cash or common stock of EBC, or a combination thereof, at
EBC's option.

     Shares of Series B Preferred Stock are convertible into shares of common
stock at a conversion price equal to $50.75 per share, subject to certain
adjustments. The Series B Preferred Stock may be redeemed by EBC under certain
circumstances after February 26, 1999 and is required to be redeemed, subject to
certain limitations, on February 26, 2002 at a redemption price of $50.00 per
share, plus accrued and unpaid dividends. It is EBC's intent, however, to redeem
the Series B Stock for common stock. Accordingly, the Series B Preferred Stock
is included in stockholders' equity. In April and July 1998, 4,000 shares and
1,700 shares of the Series B Preferred Stock were converted to 3,941 shares and
1,675 shares of common stock, respectively.

     Concurrently with the private placement, EBC conducted an exchange offering
and consent solicitation with respect to its outstanding Series A Preferred
Stock, pursuant to which EBC offered to exchange one share of Series B Preferred
Stock for each of its 480,000 outstanding shares of Series A Preferred Stock and
requested the holders of its Series A Preferred Stock consent to the ranking of
the Series B Preferred Stock on a parity with the Series A Preferred Stock with
respect to the payment of dividends and liquidation preference. EBC did not
receive any cash proceeds from the exchange offering. Of the 480,000 shares of
Series A Preferred Stock outstanding, 478,000 shares were exchanged for the same
number of shares of Series B Preferred Stock. In September 1997 the remaining
2,000 shares of Series A Preferred Stock were exchanged for 1,797 shares of
common stock.

     The carrying amount of the Series B Preferred Stock is increased for
accrued and unpaid dividends plus periodic accretion, using the effective
interest method, such that the carrying amount will equal the redemption amount
on the Series B Preferred Stock on February 26, 2002.

     SERIES A CONVERTIBLE PREFERRED STOCK

     In October 1994, EBC sold 480,000 shares of Series A Convertible Preferred
Stock at $50.00 per share in a private placement. The net proceeds from the
offering were approximately $22.2 million. The placement agents for the Series A
Convertible Preferred Stock received warrants to purchase an aggregate of 28,800
shares of Series A Convertible Preferred Stock at an exercise price of $50.00
per share of Series A Convertible Preferred Stock, in addition to customary
commissions.

     Dividends on the Series A Convertible Preferred Stock were cumulative and
payable semi-annually from October 27, 1994, at an annual rate equal to (i)
$4.00 per share if paid in cash and (ii) $4.50 per share if paid in Common
Stock. All but 2,000 shares of the 480,000 shares of Series A Preferred Stock
outstanding were exchanged for shares of Series B Preferred Stock in an exchange
offering.


                                      F-10



                          ENERGY BIOSYSTEMS CORPORATION

                   NOTES TO FINANCIAL STATEMENTS - (CONTINUED)


     Shares of Series A Preferred Stock were convertible into shares of EBC's
common stock at the option of the holder at a conversion price equal to $57.75
per share of common stock, subject to certain adjustments. In September 1997,
the remaining 2,000 shares of Series A Preferred Stock not exchanged for Series
B Preferred Stock were converted into 1,797 shares of common stock.

     COMMON STOCK

     In March 1995, EBC adopted a Stockholder Rights Plan (the "Rights Plan") in
which Preferred Stock Purchase Rights (the "Rights") were distributed for each
share of Common Stock held as of the close of business on March 27, 1995 and are
distributed to each share of Common Stock issued thereafter until the earlier of
(i) the Distribution Date (as defined in the Rights Plan), (ii) the date Rights
are redeemed or (iii) March 8, 2005. The Rights Plan is designed to deter
coercive takeover tactics and to prevent an acquirer from gaining control of EBC
without offering a fair price to all of EBC's stockholders. The Rights will
expire on March 8, 2005.

     Each Right entitles stockholders to buy one-hundredth of a share of a new
series of Junior Preferred Stock of EBC at an exercise price of $50.00 per
one-hundredth of a share. The Rights are exercisable only if a person acquires
beneficial ownership of 20% or more of EBC's outstanding Common Stock. The
Rights Plan grandfathers certain stockholders who beneficially owned more than
20% of the outstanding shares of EBC's Common Stock on the effective date of the
Rights Plan from triggering the exercisability of the Rights.

     During March 1998, EBC issued a warrant in connection with a license 
agreement (see Note 7). The warrant entitles the purchaser to purchase 28,571 
shares of Common Stock at an exercise price of $21.77 per share over a four 
year term.

     In December 1998, EBC declared a one-for-seven reverse stock split which
was effective December 18, 1998. All references to earnings per share, number of
shares and share amounts prior to December 18, 1998 have been retroactively
restated to reflect the reverse stock split.

5.   STOCK OPTIONS

     In January 1997, EBC's Board of Directors adopted the 1996 Stock Option
Plan (the "1996 Plan"). Under the 1996 Plan, EBC may issue options for and sell
up to 14,285 shares of Common Stock to employees and consultants of EBC. The
options granted under this plan may not have an exercise price per share less
than the fair market value on the date of grant and are limited to a term not to
exceed ten years

     The 1992 Stock Compensation Plan (the "1992 Plan") is composed of
non-qualified stock options, incentive stock options, year-end stock bonuses and
restricted and non-restricted stock grants. Under the 1992 Plan, 290,147 shares
of Common Stock are reserved for issuance upon the exercise of stock options.
Under a 1994 Non-Employee Director Option Plan, composed of non-qualified stock
options, 25,000 shares of Common Stock are reserved for issuance upon the
exercise of stock options.

     At December 31, 1998, employees had outstanding options to purchase 
166,581 shares of Common Stock, pursuant to the 1992 and 1996 Plans. 
Additionally, as of December 31, 1998 consultants and directors had been 
granted options to purchase 67,045 shares of Common Stock that were not 
issued under the 1992 or 1996 Plans. Options generally vest over a three-year 
period and upon the earlier of the completion of the specified performance 
milestones or nine years and ten months from the date of grant. The options 
expire ten years from the date of grant. At December 31, 1998, 97,158 shares 
of Common Stock were exercisable at per share exercise prices ranging from 
$4.81 to $91.00.

     EBC accounts for its stock options under APB Opinion No. 25 under which no
compensation cost has been recognized. For such grants, EBC records deferred 
compensation for the difference between the exercise price and the fair 
market value on the measurement date. During 1996, 1997 and 1998, EBC issued 
all options at fair market value. Had compensation cost for these options 
been determined consistent with FASB Statement No. 123, EBC's net loss and 
loss per share would have been increased to the following pro forma amounts:

                                      F-11


                                            ENERGY BIOSYSTEMS CORPORATION

                                     NOTES TO FINANCIAL STATEMENTS - (CONTINUED)




                                                             1996               1997               1998
                                                             ----               ----               ----
                                                                                    
         Net Loss:                As Reported          $   (9,232,780)    $    (9,539,060)   $    (8,845,367)
                                                       --------------      --------------    ---------------
                                  Pro Forma                (9,627,267)        (10,180,316)       (10,475,455)
                                                       --------------      --------------    ---------------
         Net Loss Per Share:      As Reported          $        (7.29)     $        (7.64)   $         (5.20)
                                                       --------------      --------------    ---------------
                                  Pro Forma                     (7.54)              (8.02)             (5.59)
                                                       --------------      --------------    ---------------




     Because the Statement 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that expected in future years. A summary of
the status of EBC's stock options at December 31, 1996, 1997 and 1998 and
changes during the years then ended is presented in the table and narrative
below:




                                        1992 PLAN                          OPTIONS NOT ISSUED UNDER PLAN
                                      ------------                        -------------------------------
                                         NUMBER         WEIGHTED AVG.         NUMBER        WEIGHTED AVG.
                                       OF OPTIONS      EXERCISE PRICE       OF OPTIONS     EXERCISE PRICE
                                      ------------     --------------     -------------    --------------
                                                                               
Balance at December 31, 1995.....          199,063          $   30.45           125,817           $ 10.22
   Granted.......................           40,881              45.22                --                --
   Exercised.....................           (3,806)             12.81           (80,366)             3.99
   Forfeited.....................           (2,190)             59.43                --                --
                                      ------------     --------------     -------------    --------------
Balance at December 31, 1996.....          233,948              33.18            45,450             21.14
   Granted.......................           46,194              63.83                --                --
   Exercised.....................          (28,829)             11.13            (9,833)             3.01
   Forfeited.....................          (20,284)             36.47                --                --
                                      ------------     --------------      ------------    --------------
Balance at December 31, 1997               231,028              35.84            35,617             26.11
                                      ------------                        -------------
   Granted.......................           49,956              18.52                --                --
   Exercised.....................           (4,286)              9.94                --                --
   Forfeited.....................         (110,118)             35.99                --                --
                                      ------------     --------------     -------------    --------------
Balance at December 31, 1998               166,581          $   31.21            35,617           $ 26.11
                                      ------------                        -------------
                                      ------------                        -------------

Exercisable at December 31, 1996           103,861          $   26.39            45,450           $  21.14
Exercisable at December 31, 1997           100,283          $   34.79            49,331           $  26.11
Exercisable at December 31, 1998            97,158          $   27.86            35,617           $  26.11



     The weighted average fair value of the options, restated to reflect the
one-for-seven reverse stock split on December 18, 1998, issued under the 1992
Plan for the years ended December 31, 1996, 1997 and 1998 was $34.44, $27.65 and
$9.09, respectively.

     During the years ended December 31, 1996, 1997 and 1998, EBC granted 
3,428, 4,000 and 17,714 options, respectively, under the Non-Employee 
Director Option Plan. These options are fully vested upon issuance. The 
weighted average exercise price per share on these grants was $55.16, $32.41 
and $13.15, respectively. As of December 31, 1996, 1997 and 1998, EBC had 
9,714, 13,714 and 67,045 options exercisable, respectively, under this plan 
with weighted average exercise price of $45.78, $43.54 and $26.26, 
respectively. The weighted average fair market value of the options issued 
under this plan during the years ended December 31, 1996, 1997 and 1998 was 
$37.17, $32.41 and $7.13, respectively.

     The fair market value of each option grant is estimated on the date of 
grant using the Black-Scholes option pricing model with the following 
weighted-average assumptions used for grants in 1996, 1997 and 1998, 
respectively: risk-free interest rates of 6.5, 6.5 and 5.8 percent for the 
1992 Plan options and 6.9, 6.5 and 5.8 percent for the Non-Employee Director 
Plan options; expected dividend yields of zero for both the 1992 Plan and the 
Non-Employee Director Plan; expected lives of nine years and ten months for 
all options; and expected volatility of 65.4, 69.6 and 71.4 percent for the 
1992 Plan and 65.1, 69.6 and 71.4 percent for the Non-Employee Director Plan.

6.   FEDERAL INCOME TAXES

     EBC has had losses since inception and, therefore, has not been subject 
to federal income taxes. As of December 31, 1998, EBC had accumulated net 
operating loss ("NOL") and research and development tax credit carryforwards 
for income tax purposes of approximately $58,100,000 and $1,801,000, 
respectively. These carryforwards begin to expire in 2005. The Tax Reform Act 
of 1986 provided for an annual limitation on the use of NOL and tax credit 
carryforwards following certain ownership changes that limit EBC's ability to 
utilize these carryforwards. In April 1991 and October 1994, EBC underwent a 
"more than 50 percent change in ownership" as defined by Internal Revenue 
Code Section 382. Additionally, because U.S. tax laws limit the time during 
which NOL and tax credit carryforwards may be applied against future taxable 
income and tax liabilities, EBC may not be able to take full advantage of its 
NOL and tax credits for federal income tax purposes.


                                      F-12




     Significant components of EBC's net deferred tax asset at December 31, 1997
and 1998 are as follows:



                                                                              1997            1998
                                                                          ------------    -----------
                                                                                    
DEFERRED TAX ASSETS RELATING TO:

Federal net operating loss carryforwards.........................         $ 15,369,029    $ 19,747,000 
Research and development credit carryovers.......................            1,284,060       1,800,821
Capital and Texas business loss carryforwards....................              653,720         830,791
Book/tax differences on depreciable, amortizable and other
  assets and accrued liabilities.................................               26,998          65,024
Deferred revenue and unrealized gains............................               61,200          61,200
                                                                          ------------    -------------
Deferred tax valuation reserve...................................          (17,395,007)    (22,504,836)
Net deferred tax asset...........................................         $         --    $        --
                                                                          ------------    -------------
                                                                          ------------    -------------


     Beginning January 1, 1993, EBC adopted SFAS 109 which requires 
recognition of deferred tax liabilities and assets for the expected future 
tax consequences of events that have been recognized in the financial 
statements or tax returns. Since EBC has had a net operating loss carry 
forward since inception and there is no assurance of future taxable income, a 
valuation allowance has been established to fully offset the deferred tax 
assets.

7.   LICENSE AND RESEARCH AGREEMENTS

     To finance its research and development budgets, EBC intends to seek
additional collaborative research and development agreements with corporate
partners.

     In March 1998, EBC entered into a site license agreement with Petro Star 
Inc. ("Petro Star") regarding the design and installation of a BDS unit at 
Petro Star's Valdez, Alaska refinery. The agreement involves several stages 
of work, the first of which, involving the completion of scoping economics, 
is completed. In addition, the agreement provides EBC with certain rights to 
conduct development work and demonstrations of its BDS technology at Petro 
Star's refinery. The agreement calls for the payment of staged license fees 
and royalties to EBC, including a $200,000 initial site license fee upon 
execution of the agreement. As is customary in such arrangements in the 
petroleum refining industry, the agreement provides certain approval and 
termination rights to Petro Star at the completion of each stage prior to 
commercialization. In connection with the execution of the agreement, EBC 
issued a four-year warrant entitling Petro Star to purchase 28,571 shares of
EBC Common Stock at an exercise price of $21.77 per share. The warrant was 
recorded as research and development expense at an estimated fair value of 
$404,500, which was computed using the Black -- Scholes option pricing model.
The successful implementation of a commercial BDS unit will be dependent 

                                      F-13


                            ENERGY BIOSYSTEMS CORPORATION

                   NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

upon EBC's ability to achieve additional improvements in the productivity of 
the biocatalyst (e.g., reaction rates, specificity and stability) and process 
technology (e.g., bioreactor and separations technology.

     Petro Star, a wholly owned subsidiary of Arctic Slope Regional Corporation,
refines and distributes petroleum products throughout Alaska. The
Anchorage-based company owns and operates oil refineries in Valdez and North
Pole, Alaska, with distribution facilities in Fairbanks, Kodiak and Dutch
Harbor. The Petro Star Valdez refinery is a major supplier of military jet fuel,
as well as marine diesel and other middle distillate products.

     In August 1997, EBC was awarded funding by the U.S. Department of Energy
("DOE") for a $2.4 million, three-year program dedicated to the development of a
BDS application for gasoline. Through December 31, 1998, EBC had recognized 
$577,804 in sponsored research revenue from the grant of which $127,223 was 
receivable at December 31, 1998.

     EBC signed an agreement with Kellogg, Brown and Root ("Kellogg") in August
1994, to collaborate on the development and commercialization of EBC's
biocatalytic desulfurization ("BDS") technology. Under the collaboration,
Kellogg will serve as an engineering partner to EBC during completion of the BDS
development process and will be the exclusive provider of the basic engineering
design services required for the commercial units. In return for these services,
Kellogg will receive a portion of the site license fee generated by the sale of
BDS units. The collaboration has a minimum term of at least five years or the
completion of 20 BDS units, whichever is longer, and has applications to all
biorefining technologies EBC develops. During the first phase of the
collaboration, Kellogg provided up to 500 engineering work hours of service at
no cost to EBC. Kellogg has also agreed to provide an additional 1,500 work
hours per year of service at Kellogg offices at reduced rates.

     In July 1994, EBC entered into an agreement with Total Raffinage 
Distribution S.A. ("Total") to collaborate on the application of EBC's 
biodesulfurization process to diesel fuel streams. Following the evaluation 
of results from EBC's domestic pilot operation, it is anticipated that Total 
will build and operate at Total's expense a pilot BDS unit at Total's 
European Centre for Research and Technology. Upon successful economic trials 
of the pilot unit, Total plans to build the first commercial BDS unit at one 
of its refineries. EBC and Total will each bear their own costs and expenses 
incurred under the collaboration. In addition, as part of its obligations 
under the agreement, Total will provide EBC with the use of analytical 
equipment valued at approximately $200,000. The Total agreement provides that 
upon commercialization, the site licenses will be waived on Total's first 
commercial BDS unit. In addition, Total will be entitled to receive a ten 
percent (10%) discount on future site licenses and service fees until it has 
recovered two and one-half times its research cost and expenses for BDS 
projects under the agreement.

     In December 1993, EBC entered into an alliance with Koch Refining 
Company ("Koch") to facilitate the development of BDS technology in crude 
oil. Under the terms of the alliance, EBC will be primarily responsible for 
improving the performance of the biocatalyst used in the desulfurization 
process. Koch will be primarily responsible for selecting and improving the 
target oil stream as well as testing desulfurized product quality. Koch will 
also provide engineering support as needed in the development of a BDS unit 
for Koch's operation. EBC and Koch will each bear their own costs and 
expenses incurred in connection with the collaboration. Repayment will be in 
the form of a ten percent (10%) rebate on desulfurization processing fees 
charged to Koch until Koch has been repaid their contribution of BDS 
development costs.

     EBC entered into a license agreement with Stanford University in 
November 1993 for the use of their patented recombinant DNA technology, which 
may be employed in the development of EBC's BDS process. The license requires 
a minimum annual advance on earned royalties of $10,000. The final payment 
under this licensing agreement was paid in 1997.


                                      F-14


                           ENERGY BIOSYSTEMS CORPORATION

                    NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

     In July 1993, EBC entered into an agreement with the Exploration and 
Development Division of Texaco, Inc. ("Texaco") to facilitate the development 
of EBC's BDS technology in crude oil. Under the terms of the alliance, EBC 
will be primarily responsible for improving the performance of the 
biocatalyst used in the desulfurization process. Texaco will be primarily 
responsible for field operations and analytical chemistry work with respect 
to the application of EBC's BDS technology to crude oil. EBC and Texaco will 
each bear their own costs and expenses incurred in connection with the 
collaboration. In the event EBC sub-licenses Texaco's intellectual and 
proprietary information, licensed by agreement to EBC by Texaco, EBC shall 
pay Texaco an amount equal to ten percent (10%) of the desulfurization 
processing fee charged to Texaco until such time as EBC has paid Texaco an 
aggregate amount equal to two and one-half times the aggregate amount of 
Texaco's direct costs and expenses incurred in connection with the 
collaboration.

     In January 1991, EBC paid $25,000 and issued 104,400 shares of its Common
Stock to the Institute of Gas Technology ("IGT") for the license to IGT's
technology for desulfurizing petroleum which expires at the later of 20 years or
when all patents related to the technology expire. As consideration for future
royalties, EBC agreed to pay IGT $400,000, of which $200,000 was paid and
charged to expense as of December 31, 1992 and the remaining $200,000 was paid
and charged to expense as of December 31, 1993. These payments eliminate the
royalty to be paid upon future revenues. Payments to IGT were approximately
none, $150,000 and none in 1994, 1995 and 1996, respectively, for research
performed under the terms of the research agreements. As part of the total
payments made to IGT in 1993, EBC had paid $150,000 under the amended agreement
which provided an additional $300,000 financing for research. The remaining
payment of $150,000 was made in June 1995.

     EBC has also entered into other contracts with various institutions for
research and development. The amounts paid under these agreements totaled
$114,900, $85,000 and $25,000 for the years ended December 31, 1996, 1997 and
1998, respectively. EBC has no commitments to pay these institutions after
December 31, 1998.

     In March 1992, EBC entered into a collaborative agreement with Petrolite
Corporation ("Petrolite") to commercialize EBC's BDS technology. Under the terms
of the agreement, both parties are to perform research and development.
Petrolite is to perform research and development in its own laboratory at its
own cost and is to fund research, as agreed under the terms of the agreement, at
EBC beginning April 1, 1992, at a rate of $225,000 per month for the first two
years of the agreement for a total of $5,400,000. Additionally, Petrolite, under
the terms of the agreement, constructed a pilot plant at its own expense, not to
exceed $1,500,000, to begin testing the effectiveness of the BDS technology. EBC
is committed to fund research and development at its own expense in the third
through fifth years of the agreement at an annual rate equal to the greater of
$2,500,000 per year or 4% of EBC's net revenues, as defined in the agreement. As
of December 31, 1997, EBC had received $5,400,000 in research payments of which
$1,134,000 has been recognized as revenue in each of the years ended December
31, 1995 and 1996 and $13,500 had been recognized for the year ended December
31, 1997. The revenue recognized was based on the percentage of total research
payments received from Petrolite in relation to the total research and
development costs incurred under the terms of the agreement. The amended
collaborative agreement dated October 18, 1993, provides for an expanded
territory covered by the agreement from North America, Venezuela and Mexico to
the entire world and permits the use of third party engineering and construction
companies to assist with certain matters. In return, EBC's obligation to pay
Petrolite decreased from 30% to 22% of all site licenses fees and adjusted gross
profit from the operation of the desulfurization units. In the event the
collaboration is terminated, the percentage of site license fees and adjusted
gross profit paid to Petrolite will be adjusted as outlined under the terms of
the agreement.

     In October 1996, EBC entered into an agreement with Petrolite providing EBC
with the option to amend the terms of its strategic alliance with Petrolite.
Under the agreement, EBC made an initial payment of $1 million to Petrolite in
December 1996, which was expensed by EBC when made, in exchange for the option
and the extension of Petrolite's obligations to provide operational and
technical support for the pilot plant from September 1, 1996 through December
31, 1998. EBC elected not to exercise its option to reduce the percentage of
site license fees and

                                      F-15


                            ENERGY BIOSYSTEMS CORPORATION

                    NOTES TO FINANCIAL STATEMENTS - (CONTINUED)

adjusted gross profit payable to Petrolite to 9.5% from 22%, in exchange for 
which EBC would have (i) assumed responsibility for servicing the BDS units 
on site at customer locations, (ii) paid Petrolite an additional $9 million 
in cash and (iii) issued to Petrolite a warrant entitling Petrolite to 
purchase 19,841 shares of Common Stock at an exercise price of $50.40 per 
share.  On March 27, 1998, EBC elected to terminate the agreement as of 
March 27, 1999.

     In December 1994, EBC was awarded a $2 million federal grant under the
Advanced Technology Programs administered by the National Institute of Standards
and Technology ("NIST"). The three-year program funded by this grant is
dedicated to the development of a biotechnology-based method of removing sulfur
from crude oil. Through December 31, 1998, EBC has recognized $1,977,366 in
sponsored research revenue relating to this grant, of which there is $172,735
of grant receivable from NIST at December 31, 1998.

8.   COMMITMENTS AND CONTINGENCIES

     EBC maintains a Simplified Employee Pension Plan (the "Plan") for all
employees. Under the terms of the Plan, employees are eligible to participate
after completion of six months of service. EBC contributes an amount equal to 8%
of the employees' annual compensation to the Plan. Employees are vested
immediately and there is at present no employee contribution. Total expenses
under the Plan were approximately $302,000, $316,000 and $284,000 for the years
ended December 31, 1996, 1997 and 1998, respectively.

     EBC maintains an operating lease agreement for its headquarters, which
expires in 2003.

     Future minimum payments under the non-cancelable operating lease consist of
the following at December 31, 1998:




                    FISCAL YEAR                                           OPERATING
                    -----------                                          ----------
                                                                      
                    1999............................................       $404,141
                    2000............................................        404,141
                    2001............................................        409,617
                    2002............................................        436,998
                    2003............................................        364,165
                                                                         ----------
                            Total minimum lease payments............     $2,019,062
                                                                         ----------
                                                                         ----------



     EBC incurred rent expense of $391,788, $395,070 and $399,724 during 1996,
1997 and 1998, respectively.

9.   RELATED-PARTY TRANSACTIONS

     EBC paid consulting fees to certain stockholders and directors totaling
$12,155, $ 13,700 and $35,000 during the years ended December 31, 1996, 1997 and
1998, respectively.


                                      F-16

EX-10.35

                             EMPLOYMENT AGREEMENT


         THIS EMPLOYMENT AGREEMENT is made this 4th day of December, 1998 
by and between Energy BioSystems Corporation, a Delaware corporation (the 
"Company"), and Peter P. Policastro, Ph.D. ("Employee").

                             W I T N E S S E T H :

         WHEREAS, the Company wishes to employ Employee and Employee wishes 
to be employed by the Company on the terms and subject to the conditions set 
forth below;

         NOW, THEREFORE, in consideration of the foregoing recital and of the 
mutual covenants herein set forth, the Company and Employee hereby agree as 
follows:

         1.       EMPLOYMENT. Effective as of January 1, 1999 (the "Effective
                  Date"), the Company hereby employs Employee as its Executive
                  Vice President and Chief Operating Officer and Employee
                  accepts such employment, for the compensation and on the terms
                  and subject to the conditions herein set forth.

         2.       COMPENSATION. The Company shall pay Employee an initial
                  monthly salary of $15,416.67 in accordance with the Company's
                  normal pay practices, which monthly salary shall be increased
                  (assuming continued employment and good performance) to
                  $16,666.67 effective on the date that is six months after the
                  Effective Date. Employee's salary shall be reviewed no less
                  than annually and from time to time changed (but not to be
                  decreased to an amount below Employee's initial monthly
                  salary) at the discretion of the Board of Directors of the
                  Company. Employee shall also be entitled to all rights and
                  benefits for which he shall be eligible under group insurance
                  and other fringe benefits which may be in force from time to
                  time (including any profit-sharing, option or other incentive
                  compensation plan either Company-wide or specific to the
                  Employee) and provided to the Company's employees generally.

         3.       DUTIES. Prior to the termination hereof, Employee agrees to
                  devote his full time and attention to the service of the
                  Company and, in furtherance thereof, to use his best efforts
                  and to perform his duties as the Company's Executive Vice
                  President and Chief Operating Officer and such other duties as
                  may be assigned to him from time to time by or under authority
                  of the Board of Directors of the Company. Employee agrees that
                  he will not undertake any other employment, consulting
                  services or business venture during the period of his
                  employment hereunder, unless the Company, by action of the
                  Board, shall consent thereto in writing. The foregoing shall
                  not be construed as preventing Employee from engaging in such
                  personal and business investment activities as are essentially
                  passive in nature and do not conflict with or adversely affect
                  in any material respect the performance or discharge of
                  Employee's duties and responsibilities hereunder.



         4.       TERM AND TERMINATION.

         4.1      The term of this Agreement shall commence on the Effective
                  Date and continue, unless earlier terminated as hereinafter
                  provided, until December 31, 2001; provided that the term of
                  this Agreement will automatically renew on December 31, 2001
                  and December 31 of each subsequent year during which this
                  Agreement remains in effect (a "Renewal Date") unless the
                  Company or Employee has delivered written notice of
                  non-renewal to the other party at least six (6) months prior
                  to the relevant Renewal Date.

         4.2      This Agreement shall terminate automatically on the death of
                  Employee.

         4.3      The Company shall have the right to terminate Employee's
                  employment for cause by giving notice in writing to Employee.
                  As used herein, the term "cause" shall mean (i) dishonesty;
                  (ii) conviction of any crime other than misdemeanors or minor
                  traffic violations; (iii) material breach of any provision of
                  this Agreement; (iv) commission of any action or omission to
                  take any action in bad faith and to the detriment of the
                  Company; or (v) willful refusal or failure of Employee to obey
                  the lawful directions of the Board of Directors of the
                  Company.

         4.4      The Company shall have the right to terminate Employee's
                  employment in the event of complete disability by giving
                  notice in writing to Employee. As used herein, the term
                  "complete disability" shall mean the inability of Employee,
                  due to illness or injury, to perform his duties hereunder for
                  a period of 180 consecutive days.

         4.5      The foregoing notwithstanding, the Company may terminate
                  Employee's employment for whatever reason it deems appropriate
                  by one month's prior notice in writing, subject to the
                  Company's obligation to pay Employee the severance
                  compensation specified in Section 4.9.

         4.6      Employee shall have the right to terminate Employee's
                  employment at any time following the occurrence of a Change in
                  Control, as defined below, if Employee's duties or
                  responsibilities are materially reduced in connection with or
                  following the Change in Control from those in effect
                  immediately prior to the Change in Control, except in
                  connection with the termination of Employee's employment
                  pursuant to Sections 4.2, 4.3, 4.4, 4.5 or 4.7. For purposes
                  of this Agreement, a "Change in Control" shall be deemed to
                  have occurred if:

                                    (i) any individual, entity or group (within
                           the meaning of Section 13(d) or 14(d)(2) of the
                           Securities and Exchange Act of 1934) shall become
                           (directly or indirectly) the "beneficial owner"
                           (within the meaning of Rule 13d-3 promulgated under
                           such Act) of more than 50% of the combined voting
                           power of the then outstanding securities of the
                           Company entitled to vote generally in the election of
                           directors ("Voting Power"); or


                                     -2-



                                    (ii) the Company's stockholders shall
                           approve a merger or consolidation, sale or
                           disposition of all or substantially all of the
                           Company's assets or a plan of liquidation or
                           dissolution of the Company, other than (A) a merger
                           or consolidation in which the voting securities of
                           the Company outstanding immediately prior thereto
                           will become (by operation of law), or are to be
                           converted into, voting securities of the surviving
                           corporation or its parent corporation that,
                           immediately after such merger or consolidation, (x)
                           are owned by the same person or entity or persons or
                           entities that owned the voting securities of the
                           Company immediately prior thereto and (y) possess at
                           least 75% of the Voting Power held by the voting
                           securities of the surviving corporation or its parent
                           corporation, or (B) a merger or consolidation
                           effected to implement a recapitalization of the
                           Company (or similar transaction) in which no person
                           acquires more than 50% of the Voting Power.

         4.7      The foregoing notwithstanding, Employee shall have the right
                  to terminate Employee's employment for whatever reason
                  Employee deems appropriate by one month's prior notice in
                  writing.

         4.8      In the event of termination of Employee's employment pursuant
                  to Sections 4.2, 4.3, 4.4 or 4.7 hereof, the Company shall pay
                  Employee his salary at the then current rate up to the date of
                  such termination, and Employee shall be entitled to no further
                  compensation hereunder.

         4.9      In the event of termination of Employee's employment pursuant
                  to Sections 4.5 or 4.6 hereof, the Company shall pay Employee
                  severance compensation for a period of twelve (12) months from
                  the date of such termination.

         5.       NONDISCLOSURE; INVENTIONS; NON-COMPETITION.

         5.1      For the purposes of this Agreement the terms set forth below
                  shall have the following meanings:

         5.1.1    CONFIDENTIAL INFORMATION. That secret proprietary information
                  of the Company of whatever kind or nature disclosed to
                  Employee or known by Employee (whether or not invented,
                  discovered or developed by Employee). Such proprietary
                  information shall include information relating to the design,
                  manufacture and application of the Company's products,
                  know-how and research and development relating to the
                  Company's products, sources of supply and material, operating
                  and other cost data, lists of present, past or prospective
                  customers, customer proposals, and price lists and data
                  relating to pricing of the Company's products or services, any
                  of which information is not generally known in the industry,
                  and shall specifically include, without limitation, all
                  information contained in manuals, memoranda, formulae, 


                                     -3-



                  plans, drawings and designs, specifications, supply sources,
                  and records of the Company.

         5.1.2    CONCEPTS AND IDEAS. Those concepts and ideas known to Employee
                  relating to the Company's activities and products.

         5.1.3    INVENTIONS. Those discoveries and developments, whether or not
                  patentable, relating to the Company's activities and products
                  (whether made by Employee acting alone or in conjunction with
                  others) made on or after the date on which Employee was first
                  employed by the Company in any capacity and prior to three
                  years after the termination of Employee's employment with the
                  Company. The term "Invention" shall also include any other
                  discovery or development made by Employee on or after the date
                  on which Employee was first employed by the Company in any
                  capacity and prior to the termination of this Agreement,
                  except for any invention or discovery for which no equipment,
                  supplies, facility, or trade secret information of the Company
                  was used and which was developed entirely on the Employee's
                  own time and (i) which does not relate (a) to the business of
                  the Company, or (b) to the Company's actual or demonstrably
                  anticipated research or development, or (ii) which does not
                  result from any work performed by the Employee for the
                  Company. Such term shall not be limited to the meaning of
                  "invention" under the United States patent laws. Listed below
                  by descriptive title for purposes of identification are all
                  inventions made by Employee prior to the date on which
                  Employee was first employed by the Company in any capacity
                  which he considers to be his property and which are hereby
                  excluded from this Agreement:

                                      NONE

         5.2      All Inventions and all Concepts and Ideas shall be the
                  property of and are hereby assigned to the Company free of any
                  reserved or other rights of any kind on the part of Employee
                  in respect thereof.

         5.3      Employee will promptly make full disclosure of any such
                  Inventions and Concepts and Ideas to the Company. Further,
                  Employee will, at the Company's cost and expense, promptly
                  execute formal applications for patents and also do all other
                  acts and things (including, among others, the execution and
                  delivery of instruments of further assurance or confirmation)
                  deemed by the Company to be necessary or desirable at any time
                  or times in order to effect the full assignment to the Company
                  of Employee's right and title to such Inventions and Concepts
                  and Ideas, without, during the term of this Agreement, further
                  compensation beyond Employee's agreed salary. Employee further
                  understands that the absence of a request by the Company for
                  information, or for the making of an oath, or for the
                  execution of any document, shall in no way be construed to
                  constitute a waiver of the Company's rights under this
                  Agreement.


                                     -4-



         5.4      Except as required by Employee's duties hereunder, Employee
                  will not, directly or indirectly, use, publish, disseminate or
                  otherwise disclose any Confidential Information, Concepts and
                  Ideas or Inventions relating to the past, present or planned
                  business of the Company without the prior written consent of
                  the Company, unless any such items are, prior to such
                  disclosure, part of the written public knowledge or become
                  part of the written public knowledge through no fault of
                  Employee or are disclosed to Employee by a third party having
                  the right to do so.

         5.5      All documents, procedural manuals, guides, specifications,
                  plans, drawings, designs and similar materials, lists of
                  present, past or prospective customers, customer proposals,
                  invitations to submit proposals, price lists and data relating
                  to pricing of the Company's products and services, records,
                  notebooks and similar repositories of or containing
                  Confidential Information and Inventions, including all copies
                  thereof, that are or come into Employee's possession or
                  control by reason of Employee's employment, whether prepared
                  by Employee or others, are the property of the Company, will
                  not be used by Employee in any way adverse to the Company,
                  will not be removed from the Company's premises except as
                  Employee's normal duties require and, at the termination of
                  Employee's employment with the Company, will be left with or
                  forthwith returned by Employee to the Company.

         5.6      During the term of Employee's employment with the Company and
                  for a period of three (3) years thereafter, Employee shall
                  not, individually or on behalf of or in conjunction with any
                  other person or entity, directly or indirectly, own, manage,
                  operate, control or be employed by, solicit the Company's
                  past, present or prospective employees or customers on behalf
                  of, or, otherwise participate in any manner in any
                  corporation, partnership, proprietorship or other business
                  entity which is engaged in the development or sale of
                  technology for the microbial desulfurization of hydrocarbons
                  or in any activity or development of any product directly
                  competitive with any of the activities engaged in or products
                  developed by the Company at the time of Employee's
                  termination; provided, however, that Employee may own not more
                  than 1% of the outstanding capital stock of a company in a
                  competitive business whose stock is publicly traded.

         6.       EXPENSES. Employee shall be entitled to reimbursement for
                  reasonable expenses incurred in the performance of services
                  hereunder, provided that the same are accounted for in
                  accordance with the Company's general requirements. In
                  addition, Employee shall be entitled to (i) an allowance of
                  $5,000 to cover Employee's reasonable costs of commuting
                  (including up to one round-trip airfare per week and
                  associated local transportation expenses) from Employee's home
                  in Fort Worth, Texas to the Company's offices in The
                  Woodlands, Texas for a period of up to five months from the
                  Effective Date; (ii) interim housing in the Houston, Texas
                  metropolitan area, selected and provided by the Company at the
                  Company's expense, for a period of up to five months from the
                  Effective Date; and (iii) reimbursement of reasonable costs
                  incurred by Employee and approved in advance by the Company
                  for 


                                     -5-



                  moving household belongings from Employee's home in Fort
                  Worth, Texas to a home in the Houston, Texas metropolitan
                  area. To the extent that the Company's payment of any of the
                  amounts specified in the foregoing sentence constitute taxable
                  income to Employee for which Employee is not entitled to a
                  corresponding deduction for federal income tax purposes
                  ("Expense Reimbursement Income"), the Company will pay
                  Employee an amount (a "Gross-Up Payment") equal to the amount
                  of federal income tax payable by Employee with respect to the
                  Expense Reimbursement Income (including, for such purposes,
                  the amount of the Gross-Up Payment).

         7.       SURVIVAL; REMEDIES. Employee's duties under sections 5.2, 5.3,
                  5.4, 5.5, and 5.6 of this Agreement shall survive termination
                  of this Agreement and Employee's employment with the Company.
                  Employee acknowledges that a remedy at law for any breach or
                  threatened breach by Employee of the provisions of this
                  Agreement may be inadequate and Employee therefore agrees that
                  the Company shall be entitled to injunctive relief in case of
                  any such breach or threatened breach.

         8.       ASSIGNMENT. This Agreement and the rights and obligations of
                  the parties hereto shall bind and inure to the benefit of each
                  of the parties hereto and shall also bind and inure to the
                  benefit of any successor or successors of the Company by
                  reorganization, merger or consolidation and any assignee of
                  all or substantially all of its business and properties, but,
                  except as to any such successor or assignee of the Company,
                  neither this Agreement nor any rights or benefits hereunder
                  may be assigned by the Company or by Employee.

         9.       GOVERNING LAW. This Agreement shall be construed in accordance
                  with and governed for all purposes by the laws and public
                  policy of the State of Texas applicable to contracts executed
                  and wholly performed within such state.

         10.      SEPARABILITY. In case any one or more of the provisions
                  contained in this Agreement shall, for any reason, be held to
                  be invalid, illegal or unenforceable in any respect, such
                  invalidity, illegality or unenforceability shall not affect
                  any other provisions of this Agreement, but this Agreement
                  shall be construed as if such invalid, illegal or
                  unenforceable provision had never been contained herein. If,
                  moreover, any one or more of the provisions contained in this
                  Agreement shall for any reason be held to be excessively broad
                  as to duration, geographical scope, activity or subject, it
                  shall be construed by limiting and reducing it, so as to be
                  enforceable to the extent compatible with the applicable law
                  as it shall then appear.

         11.      WAIVER. If either party should waive any breach of any
                  provision of this Agreement, he or it shall not thereby be
                  deemed to have waived any preceding or succeeding breach of
                  the same or any other provision of this Agreement. No party
                  shall be deemed to waive any rights hereunder unless such
                  waiver be in writing and signed by such party.


                                     -6-



         12.      ENTIRE AGREEMENT. The foregoing is the entire Agreement of the
                  parties with respect to the subject matter hereof and may not
                  be amended, supplemented, cancelled or discharged except by
                  written instrument executed by both parties hereto.

         IN WITNESS WHEREOF, the parties have executed this Agreement on the 
day, month and year first above stated.

                                          ______________________________________
                                          Peter P. Policastro, Ph.D.


                                          ENERGY BIOSYSTEMS CORPORATION


                                          By: __________________________________
                                                William E. Nasser
                                                Chairman of the Board, President
                                                and Chief Executive Officer


                                     -7-

EX-10.36

                                                                EXHIBIT 10.36


          EXTENSION, MODIFICATION AND RATIFICATION OF LEASE

This Extension, Modification and Ratification of Lease ("Extension") is made 
and entered into, effective the 23rd day of March, 1998, between WOODLANDS 
OFFICE EQUITIES-'95 LIMITED, a Texas Limited Partnership successor in title 
to THE WOODLANDS CORPORATION (Lessor) and ENERGY BIOSYSTEMS CORPORATION 
(Lessee) for and in consideration of One Dollar ($1.00), and other good and 
valuable consideration

                           WITNESSETH:

1. Lessor and Lessee hereby confirm and ratify (as modified below) all of the 
   terms, conditions and covenants in that certain Lease Agreement ("Lease") 
   between parties dated May 24, 1993; Extension, Modification and Ratification
   of Lease dated January 27, 1994; Modification and Ratification of Lease 
   dated March 28, 1996, under which Lessee has leased from Lessor approximately
   32,857 square feet of net rentable area in that building located at 4200 
   Research Forest Drive, Suite 100, The Woodlands, Montgomery County, Texas 
   ("Building").

2. Lessor and Lessee agree that the Term of the Lease Agreement shall be 
   extended for Sixty (60) months changing the expiration date from October 31,
   1998 to October 31, 2003 ("Extended Term").

3. Lessor and Lessee agree that beginning November 1, 1998, the Base Rent, as 
   set out in Section 6 of the Lease Agreement, shall be increased by Two 
   thousand seventy hundred thirty-eight and 11/100 dollars ($2,738.11) per 
   month, so that the total Base Rent shall be Thirty three thousand six hundred
   seventy-eight and 42/100 dollars ($33,678.42) per month. Lessor and Lessee 
   further agree that beginning November 1, 2001, the Base Rent shall be 
   increased by Two thousand seven hundred thirty-eight and 11/100 dollars 
   ($2,738.11) per month, so that the total Base Rent shall be Thirty six 
   thousand four hundred sixteen and 53/100 dollars ($36,416.53) per month.

4. Lessor and Lessee agree that the Right of First Refusal described in 
   paragraph 35 of the Lease will be deleted in its entirety and of no further 
   use or effect.

        Signed this the 16th day of March, 1998, at The Woodlands, Texas.

LESSOR:                                               LESSEE

WOODLANDS OFFICE EQUITIES-'95 LIMITED                 ENERGY BIOSYSTEMS
By:  THE WOODLANDS COMMERCIAL PROPERTIES              CORPORATION
     COMPANY, L.P., a Texas limited
     Partnership
     Its General Partner
     By:  The Woodlands Operating Company, L.P.,
          a Texas Limited Partnership,
          Its Authorized Agent

By: /s/ Eric H. Wojner                                By: /s/ Paul G. Brown III
    --------------------------------------------          ---------------------
Name: Eric H. Wojner                                  Name: Paul G. Brown III
      -------------------------------------------          --------------------
Title: V.P. Investment Properties                     Title: V.P. Finance
      ------------------------------------------            -------------------

EX-11.1

                                                               EXHIBIT 11.1

                         ENERGY BIOSYSTEMS CORPORATION
                BASIC AND DILUTED EARNINGS PER SHARE COMPUTATION
                          YEAR ENDED DECEMBER 31, 1996


WEIGHTED AVERAGE SHARES OUTSTANDING:




      TOTAL                          # DAYS
      SHARES                       OUTSTANDING
- ------------------------------------------------
                                             
        10,584,268      x               23  =         243,438,164
        11,107,568      x               14  =         155,505,952
        11,139,268      x               27  =         300,760,236
        11,140,768      x                8  =          89,126,144
        11,142,868      x               55  =         612,857,740
        11,301,975      x               28  =         316,455,300
        11,302,025      x               16  =         180,832,400
        11,303,525      x                7  =          79,124,675
        11,309,295      x                1  =          11,309,295
        11,309,355      x                5  =          56,546,775
        11,310,855      x                7  =          79,175,985
        11,311,955      x                5  =          56,559,775
        11,316,955      x                4  =          45,267,820
        11,318,210      x               28  =         316,909,880
        11,320,010      x                4  =          45,280,040
        11,320,210      x               23  =         260,364,830
        11,325,210      x               41  =         464,333,610
        11,326,210      x                9  =         101,935,890
        11,490,770      x               52  =         597,520,040
        11,497,135      x                9  =         103,474,215
                                      ----          -------------
                                      366           4,116,778,766    /         366   =   11,248,029
                                      ====          =============                        ==========

RESTATED FOR 1:7 REVERSE SPLIT DECEMBER 18, 1998                                     =    1,606,861
                                                                                         ==========

LOSS PER SHARE:

Net Loss plus dividend accrual
 plus accretion of offering costs                  $  (11,720,213)   =       $ (7.29)
- ---------------------------------                  --------------            ========
   Weighted Avg. Shares                                 1,606,861


                                           Page 1


                         ENERGY BIOSYSTEMS CORPORATION
                BASIC AND DILUTED EARNINGS PER SHARE COMPUTATION
                          YEAR ENDED DECEMBER 31, 1997


WEIGHTED AVERAGE SHARES OUTSTANDING:




      TOTAL                          # DAYS
      SHARES                       OUTSTANDING
- ------------------------------------------------
                                             
        11,497,135      x               15  =           172,457,025
        11,502,135      x                1  =            11,502,135
        11,502,235      x                7  =            80,515,645
        11,502,395      x               18  =           207,043,110
        11,505,395      x                8  =            92,043,160
        11,506,053      x               13  =           149,578,689
        11,507,163      x                6  =            69,042,978
        11,605,377      x               52  =           603,479,604
        11,712,758      x               63  =           737,903,754
        11,763,593      x               20  =           235,271,860
        11,764,343      x               36  =           423,516,348
        11,765,343      x                8  =            94,122,744
        11,777,924      x               24  =           282,670,176
        11,778,204      x                1  =            11,778,204
        11,780,704      x               15  =           176,710,560
        11,896,470      x                1  =            11,896,470
        11,896,670      x                4  =            47,586,680
        11,899,670      x                9  =           107,097,030
        11,935,951      x                6  =            71,615,706
        12,201,434      x                4  =            48,805,736
        12,218,434      x               11  =           134,402,774
        12,251,434      x               43  =           526,811,662
                                       ---            -------------

                                       365  =         4,295,852,050

                                                      4,295,852,050   /         365  =     11,769,458
                                                                                           ==========

RESTATED FOR 1:7 REVERSE SPLIT DECEMBER 18, 1998                                     =      1,681,351
                                                                                           ==========

LOSS PER SHARE:

Net Loss plus dividend accrual
 plus accretion of offering costs                     $ (12,849,466)     =     $ (7.64)
- ---------------------------------                     -------------            =======
   Weighted Avg. Shares                                   1,681,351


                                    Page 1


                         ENERGY BIOSYSTEMS CORPORATION
                BASIC AND DILUTED EARNINGS PER SHARE COMPUTATION
                          YEAR ENDED DECEMBER 31, 1998


WEIGHTED AVERAGE SHARES OUTSTANDING:




      TOTAL                      # DAYS
      SHARES                     OUTSTANDING
- -----------------------------------------------
                                                               
        12,251,434      x              119  =       1,457,920,646
        12,281,591      x                1  =          12,281,591
        12,970,109      x               40  =         518,804,360
        12,995,109      x               50  =         649,755,450
        13,006,833      x                6  =          78,040,998
        13,011,833      x               88  =       1,145,041,304
        15,241,169      x               48  =         731,576,112
                                       ---           ------------
                                       352          4,593,420,461

 1:7 Reverse split                                    656,202,923
         2,177,254      x                3  =           6,531,762
         2,179,142      x               10  =          21,791,420
                                       ---            -----------
                                       365            684,526,105    /         365 =     1,875,414
                                      ====           ============                        =========



LOSS PER SHARE:

                                                                
      Net Loss plus dividend accrual
     plus accretion of offering costs             $ (9,761,067)    =      $ (5.20) 
     --------------------------------           --------------            ======== 
            Weighted Avg. Shares                    1,875,414

EX-23.1

                                                                    EXHIBIT 23.1

                   CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS



As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-K, into the Company's previously filed
Registration Statements on Form S-8 dated September 9, 1993 and September 13,
1993 and Form S-3 dated February 13, 1995.





Houston, Texas
March 30, 1999

EX-27.1

 


<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS INCLUDED IN THE REGISTRANT'S ANNUAL REPORT ON FORM 10-K FOR
THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.

       
                             
<PERIOD-TYPE>                   12-MOS
<FISCAL-YEAR-END>                          DEC-31-1998
<PERIOD-START>                             JAN-01-1998
<PERIOD-END>                               DEC-31-1998
<CASH>                                       2,795,429
<SECURITIES>                                         0
<RECEIVABLES>                                  308,504
<ALLOWANCES>                                         0
<INVENTORY>                                     21,522
<CURRENT-ASSETS>                             3,307,916
<PP&E>                                       6,797,816
<DEPRECIATION>                               5,121,824
<TOTAL-ASSETS>                               6,126,745
<CURRENT-LIABILITIES>                          820,287
<BONDS>                                              0
<PREFERRED-MANDATORY>                                0
<PREFERRED>                                 33,955,166
<COMMON>                                        21,791
<OTHER-SE>                                  38,529,096
<TOTAL-LIABILITY-AND-EQUITY>                 6,126,745
<SALES>                                              0
<TOTAL-REVENUES>                             1,048,791
<CGS>                                                0
<TOTAL-COSTS>                                        0
<OTHER-EXPENSES>                             9,894,158
<LOSS-PROVISION>                                     0
<INTEREST-EXPENSE>                                   0
<INCOME-PRETAX>                            (8,845,367)
<INCOME-TAX>                                         0
<INCOME-CONTINUING>                        (8,845,367)
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                               (8,845,367)
<EPS-PRIMARY>                                   (5.20)
<EPS-DILUTED>                                   (5.20)