Caprock risk management, llc

Pegasi Energy Resources Corp.

Chris Jarvis, CFA, CMT President & CEO [email protected] Peter White Executive Vice President & CFO [email protected]

May 14, 2012 P: 646-875-4973 www.caprockrm.com

Pegasi Energy Resources Corp. engages in the exploration and production of natural gas and oil in the east Texas oil and gas region. The company holds interests in properties located in Marion and Cass County, Texas.

PGSI’s Well Positioned to Have a Breakout Year

We are initiating coverage on Pegasi Energy Resources Corporation with a STRONG BUY rating and with a 12-month price target of $1.50.

We derived our $1.50 12-month price target by applying a 6.2x multiple to our Next Twelve Months (NTM) EPS estimate of $0.24. Currently, PGSI’s shares trade at 3.5x multiple to our forward earnings estimate, a 65% discount to the company’s peer group average multiple of 10.2x.

We estimate that PGSI will become cash flow positive near the middle of the calendar year 2012 generating revenues of $10.957 million and EPS of $0.09 for the 2012 Calendar year.

For calendar year 2013 (CY21013), we estimate that PGSI’s EPS will rise 241% from $0.09 in 2012 to $0.30 in 2013.

We are confident in our investment thesis that a strong management team with geological experience and expertise in the Rodessa field and ability to accumulate and consolidate acreage will drive and maximize shareholder wealth.

Symbol: PGSI Recommendation: Strong Buy Last Price: $0.85 Target Price: $1.50 Risk: Speculative Sector: Energy

2

Caprock Risk Management, LLC 5/14/2012

Investment Summary We are initiating coverage on Pegasi Energy Resources Corporation with a STRONG BUY rating and with a 12-month price target of $1.50. We believe PGSI’s shares offer investors a unique and favorable risk/reward profile for the following three reasons:

1) PGSI’s management team has a long track record of success operating in East Texas, specifically the Rodessa field, dating back to the early 1980’s. In addition, PGSI’s management has been focused extensively on the “Corner Stone” project for over a decade now and long before PGSI became a public entity. We believe the years of experience and intimate knowledge that management brings to the table is on the cusp of bearing fruits for PGSI investors, which starts with the company’s first horizontal well that is expected to be completed by June.

2) In the Rodessa field of East Texas, where PGSI operates, ownership of mineral leases is highly fragmented. As a result, major E&P companies have avoided the area given the difficultly of acquiring acreage. This creates high barriers of entry for PGSI’s competitors and with PGSI the leading E&P in the Rodessa field in terms of acreage by a decent margin, we believe the company will continue to increase its leading acreage position, consolidating difficult leaseholds into one package. As PGSI unlocks this value through consolidation, we believe the company’s acreage portfolio alone will become of significant value for a major E&P in the near future. In short, PGSI is in the sweet spot of the Rodessa field; not too big that the highly fragmented leases are non-material to the company’s business model and big enough to be the leading acreage acquirer.

3) PGSI’s shares are currently trading at a deep discount to its peer group

average valuation as the company has flown under the radar for most institutional and individual investors. However, we believe the successful completion of the company’s first horizontal well in the coming weeks with three similar projects behind it slated to roll out over the next 12-to-18 months provides investors seeking exposure to the energy space a favorable risk/reward scenario.

In summary, we are confident in our investment thesis that a strong management team with geological experience and expertise in the Rodessa field and ability to accumulate and consolidate acreage will drive and maximize shareholder wealth. We believe at current levels, PGSI’s shares are attractive, underpinning our STRONG BUY rating.

Risks Geopolitical Risks. In our opinion, geopolitical risks remain elevated, especially with events out of the Middle East and North Africa. The “Arab Spring” has brought wide scale upheaval in the region. We believe these pressures coupled with Iran’s quest to become nuclear will intensify as we head into the second half of the year, which should

“Initiating coverage with a STRONG BUY rating, 12-month price target of $1.50”

“PGSI’s fundamentals and current valuation offers investors a unique and favorable risk/reward scenario”

3


drive volatility in the energy markets. Given the fact that PGSI’s operations are domestic, any potential impact of international instability should be mitigated.

Volatility. Although PGSI has roughly 54 million shares outstanding, the shares 3-month average trading volume per day is 37k. The relatively low level of liquidity could increase share price volatility.

Correlation to Energy Prices. PGSI’s operating results are correlated to U.S. energy prices. Given the elevated geopolitical risks and global macroeconomic cross currents in 2012, energy prices are expected to be volatile. The company does not have a risk management program in place but following the completion of the Morse #1 well, we believe management will institute a hedge program when appropriate. Common Stock is subject to the “Penny Stock” rules and quotations are based on the “Pink Sheets”. Currently, the Company’s common stock is subject to the “Penny Stock” rules of the SEC, and the trading market is limited. Common stock is currently traded based upon quotations over the counter and the bid and ask prices for the Company’s stock could have wide fluctuations.

Valuation We derived our $1.50 12-month price target by applying a 6.2x multiple to our Next Twelve Months (NTM) EPS estimate of $0.24. Currently, PGSI’s shares trade at 3.5x multiple to our forward earnings estimate, a 65% discount to the company’s peer group average multiple of 10.2x (peer group below). In our opinion, the NTM EPS estimate is the appropriate metric to use considering the completion of the Morse #1 well in the coming months as well as the completion of a second horizontal well before the end of the calendar year. Given this, using NTM will capture the company’s true earnings power going forward. PGSI’s Peer Group:

Symbol Symbol LastS/O

(000's) EPS PEMarket Cap

(mil)Spindletop O&G SPND $2.00 7,661 $0.23 8.70x $15.3Pyramid Oil Co PDO $4.45 4,684 $0.23 19.35x $20.8CKX Lands, Inc CKX $12.01 1,942 $0.49 24.51x $23.3Earthstone Energy ESTE $20.00 1,707 $1.73 11.56x $34.1PostRock Energy Corp PSTR $2.30 12,269 $2.29 1.00x $28.2Mesa energy MSEH $0.17 80,874 $0.06 2.75x $13.3Callon Petroleum Co CPE $5.11 39,444 $2.75 1.86x $201.4Trans Energy TENG $2.30 12,980 $0.70 3.29x $29.9Texas Vanguard Oil TVOC $11.75 1,417 $0.82 14.33x $16.6Energy Partners, LTD EPL $15.25 39,233 $1.06 14.39x $598.3Peer Group Average 10.17x

NTMPegasi Energy Resources Corp $0.85 54,200 $0.24 3.54x $46,070.00

Prem/(Disc) -65% Source: Thomson First Call, CRM Estimates

“We believe our multiple is conservative and as management executes PGSI’s growth strategy over the next 12-24 months, multiple expansion is likely, or closer to the PGSI’s peer group multiple of 10.2x”

“Geographical focus mitigates much of the global geopolitical risk”

4


We derived our 6.2 price-to-earnings multiple by applying a high growth firm multi-stage P/E model using the following assumptions:

Assumptions: 5-year growth rate: 20% Post 5-year growth rate: 8% Assigned Beta 1.8 (High beta reflects drilling execution risk) Dividend payout first 5-years: 0% Dividend payout post 5-years: 15% Discount rate: 11.76% (equivalent to PV-10 discount rate) = Price-to-earnings multiple: 6.2x.

Earnings Outlook We estimate that PGSI will become cash flow positive near the middle of the calendar year 2012 generating revenues of $10.957 million and EPS of $0.09 for the 2012 Calendar year (CY2012). Our estimates for CY2012 are based on the company’s existing production and the completion of Morse #1 well within the next 60-days and successful drilling and completion of Morse #2 well in the 3Q2012. For calendar year 2013 (CY21013), we estimate that PGSI’s EPS will rise 241% from $0.09 in 2012 to $0.30 in 2013. Our CY2013 estimates are based on the company drilling an additional 2 horizontal wells during the 2013 calendar year. Given managements aggressive growth strategy, we believe our estimates will likely be conservative if PGSI’s management is successful in raising additional capital to accelerate the company’s drilling and production goals over the next 24-months.

“We expect PGSI to turn cash flow positive by the middle of the year with Oil Revenue driving growth and earnings over the next 12-to-18 months.”

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6


Company Overview Pegasi Energy Resources Corporation (“PGSI”) is a Nevada corporation that is headquartered in Tyler Texas with operations in Jefferson and properties in Cass and Marion counties (see PGSI’s Acreage & Operations Map below). The Rodessa oilfield extends from western Louisiana across the southeastern corner of Cass County and into the northeastern corner of Marion County both Cass and Marion counties are part of the Rodessa oil field. The company’s strategy is to maximize shareholder wealth by focusing on low-risk (geological) profile production by targeting crude and natural gas exploration and production (E&P) adjacent to existing or indicated producing areas within the Rodessa oil field. Pegasi’s management team refers to this strategy as the “Cornerstone Project” and has a deep understanding of the Rodessa oil field as well as a long operating history of success dating back to 1980. Furthermore, and dating back to the early 1930’s, the Rodessa oil field has been operated by small independent companies given the fact that acreage is highly fragmented, which has created high barriers to enter for major oil companies looking to acquire large blocks of acreage. We believe Pegasi’s successful operating track record in the Rodessa oil field since 1980 coupled with the company’s ability to acquire and consolidate acreage through a strong communal footprint in Cass and Marion counties provides investors seeking exposure to domestic onshore exploration and production of crude oil and natural gas with a unique opportunity. Pegasi’s Acreage and Operations Map

Source: EIA, Company Data

“PGSI’s management team has a long and successful track record in East Texas, specifically the Rodessa field.”

7


East Texas History Operating History (2000-2007): PGSI’s management team began operations in early 2000 by acquiring leases in the Rodessa field in East Texas. Management’s first leasehold purchase was roughly 1,500 gross acres (PGSI currently holds roughly 30,000 gross acres to date, representing management’s successful track record for consolidating acreage in a geographical location that is highly fragmented). In December 2002, management formed First Southern Crown, Ltd, a Texas limited liability partnership, to be a holding company for several operating entities. Management rolled up their personal investment of $3.5 million for data harvesting and acreage acquisition for the Cornerstone Program into First Southern Crown. PGSI’s History (2007-Current): In December 2007 while operating under a company named Maple Mountain Explorations, a Nevada corporation, Maple Mountain entered into a share agreement with Pegasi Energy Resources Corporation to acquire all of PGSI’s outstanding shares. This transaction would also include the folding in of First Southern Crown’s subsidiaries into Pegasi. From 2000-to-date, the company has successfully drilled 12 productive wells, of which 8 remain producing. Historically, the company’s exploration and production has been predominantly for natural gas. However, PGSI recently completed drilling the Morse Unit #1-H horizontal well that will transform and diversify the company’s existing production profile from natural gas to oil, a significant new direction for the company. This well is scheduled to be completed in June Company Management We believe PGSI’s founders and principals have a long and successful track record operating in East Texas, specifically the Rodessa oil field that dates back over 30 years. PGSI’s Mike Neufeld, CEO, and Bill Sudderth, Executive Vice President, have been partners since the early 1980’s. Mike Neufeld is a geologist with over 40 years of experience exploring and developing natural gas and oil in East Texas. Bill Sudderth is a well-seasoned land man with over three decades of experience in East Texas. Collectively, both have worked together to drill over 300 wells in Texas and Louisiana, mainly in East Texas. In our opinion, PGSI shares, underpinned by a strong management and operating team, provides a unique investment for investors seeking exposure to domestic onshore exploration and production of natural gas and oil. Below, we have highlight PGSI’s management biographies:

Michael H. Neufeld Insider Ownership (Shares) President, CEO and Director 22,970,253

Mr. Neufeld worked for Pennzoil Company from 1972 to 1976 as Development Geologist, Exploration Geologist and Senior Geologist working in Pennzoil's Gulf Coast

“PGSI’s current growth strategy, the Cornerstone Project, began over 10-years ago and is ready to bear fruit for PGSI shareholders.”

8


Division. He then joined American Resources Company from 1976 to 1977 as Senior Geologist. In 1977 he joined Hunt Oil Company as Sr. Geologist working in the Texas and Gulf Coast regions. From 1978 to 1981, Mr. Neufeld worked for Croftwood Corporation as Senior Exploration Geologist and Vice-President of Exploration working in the Gulf Coast of Louisiana and Texas. In 1983 Mr. Neufeld co-founded SMK Energy, where exploration efforts were concentrated in East Texas, Gulf Coast Louisiana and the Rocky Mountains. He graduated from Louisiana State University in 1971 with a B.S. Degree in Geology.

Bill L. Sudderth Insider Ownership (Shares) Executive Vice President 22,895,252

Mr. Sudderth began his career at Lone Star Producing Company in 1970 where he worked through 1971. In late 1971 he joined Midwest Oil Corporation and worked there until 1974, at which point he became an independent landman working the entire continental United States. In 1981 Mr. Sudderth became a Certified Professional Landman. In 1983 Mr. Sudderth co-founded SMK Energy Corporation, along with Mr. Neufeld, which later merged with Windsor Energy in 1997. Mr. Sudderth received his B.B.A. Degree from Sam Houston State University in 1970.

Billy Denman Insider Ownership (Shares) Land Manager -

Mr. Denman has over 25 years of industry expertise and currently serves as Pegasi Energy Resources Corp's Land Manager. Mr. Denman became a certified professional Landman in 1992, and previously worked with Mr. Neufeld and Mr. Sudderth at SMK Energy. Mr. Denman received his B.A. Degree from Texas Tech University. Cornerstone Project PGSI’s Cornerstone Project targets resources in and adjacent to existing/indicated producing regions of the Rodessa field and slightly north of the Rodessa fault located in Cass and Marion counties. The Rodessa field was discovered on August 3, 1930 with the first discovery oil well completed on July 7, 1935. The Rodessa field’s peak production was in 1936 when over 19 million barrels of oil were produced. Since the original discovery and production efforts, the Rodessa field has produced over 400 million barrels of oil and 2.3 trillion cubic feet of natural gas. Geographically, the Rodessa field is very large extending from the northwest corner of Louisiana up northward into Miller County, Arkansas and southwestward into Cass and Marion counties Texas (PGSI’s targeted exploration and production zones). PGSI has zoned in on proved and producing reservoirs with the Bossier and Cotton Valley (CV) Lime formations (see formation maps below) that are contained within a 225,000 acre closure against the Rodessa fault known as the “Cornerstone Area”, thus the name of PGSI’s strategy named the Cornerstone Project. The Bossier and Cotton Valley reservoirs have produced over 5 million barrels of high quality light sweet crude in the last 50 years.

“The Cornerstone Project is diversifying the PGSI’s assets into Oil as well as becoming the company’s revenue and earnings growth driver.”

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Bossier/Cotton Valley Formations

Source: Company Data The Rodessa field has historically been predominately explored and produced by small independent operators and is not a legacy field for any major oil company since inception. As a result, mineral rights are highly fragmented creating high barriers to entry for major exploration and production (“E&P’s) companies seeking to acquire acreage in the Rodessa field. Several major E&P’s have attempted to acquire large acreage positions, however, the highly fragment leases that require an intensive time investment as well as expertise necessary to consolidate the acreage necessary for major E&P’s have led these companies to focus elsewhere geographically. For PGSI, this creates a competitive advantage in the Rodessa field as management has a long track record of operating and acquiring acreage through cultivating existing communal relationships in Cass and Marion counties. In our opinion, PGSI’s ability to consolidate acreage in the Rodessa field as well as being the largest acreage holder in the 225,000 acres of the Bossier/Cotton Valley formation unlocks significant value for shares of PGSI. PGSI’s Competitive Advantages: Process Driven PGSI’s 3 step process for identifying, acquiring, and producing acreage in the Rodessa field is highly unique and specific to PGSI. The process is fortified with years of expertise/ experience targeting high valued acreage in addition to the company’s ability to consolidate key acreage by leveraging PGSI’s landmens’ deep rooted community relationships with mineral owners. Overlaying PGSI’s experience/expertise and

“PGSI is the leading acreage holder in the Rodessa field… …high barriers to enter will likely keep PGSI at the top of the acreage list.”

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communal ties is PGSI’s cutting edge technology platform that enables the company to move more swiftly and efficiently relative to other E&Ps operating in the Rodessa field. Below, we have provided a schematic overview of the company’s process: PGSI’s 3 Step E&P Process:

Source: Company Data, CRM estimates April 2012 Site Visit During our site visit in early April to the company’s headquarters in Tyler Texas and land operations in Jefferson, our expectations were exceeded by PGSI’s E&P process, information systems, and landmens’ long standing relationships with the community. Clearly looking at Mike Neufeld’s and Bill Sudderth’s successful track record in East Texas, PGSI’s geological efforts are certainly a major strength for the company. With that said, our site visit also provided us with a unique insight that is difficult to attain from an annual report or other financial information available to the investment community. In our opinion, the insight and information (we go into more detail on the following page) that we gathered during our site visit accentuates PGSI’s multiple competitive advantages that enhances and optimizes PGSI’s business model, which we believe will drive shareholder wealth for the foreseeable future and is currently being undervalued by the market today.

Geology

PGSI’s Technology Platform

(Right of Way Land Services, LLC)

PGSI’s 25 Staffed Landmen Team

(Right of Way Land Services, LLC)

#1) Mike Neufeld Identifies Attractive Acreage.

#2) Bill Sudderth and Billy Denman call up PGSI’s mapping system.

#2) If acreage acquisition is feasible, go to step 3, if not repeat 1.

If #3 is not feasible, restart the process.

#3) If acreage identified can be acquired, PGSI’s landmen make contact with leaseholders

“PGSI’s has three competitive advantages in the Rodessa field that will drive and maximize shareholder wealth.”

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Right Of Way Land Services, LLC Jim Gallant is the founder and CEO of Right Of Way Land Services and has a long and solid relationship with PGSI’s management team of Mike Neufeld, Bill Sudderth, and Bill Denman. Mr. Gallant, with the help of Mr. Denman, conceptualized and formed Right of Way Land Services in the early 2000’s. Since then, Jim Gallant and his team have built a mapping technology around PGSI management’s needs, customizing the program and fine tuning the platform to its current day form. In addition, Right Of Way Land Services provides PGSI with a staff of 25 professional landmen that are deeply rooted in the Cass and Marion county communities, enabling PGSI to consolidate acreage that in the past, has been difficult to acquire by outside E&Ps. In short, Right Of Way provides PGSI with a cutting edge technology platform as well as boots on the ground in the Rodessa field that is well respected in the community. Technology: PGSI uses a cutting edge front-end system that was designed specifically for the company by Right Of Way Land Services, LLC (company based in Fort Worth Texas) to target new acreage as well as to manage existing acreage in real-time. The front-end interface is a web based program (screen shot on the following page) that provides PGSI with 1) real-time mapping information for prospective and current acreage, 2) easy access for management, and 3) very user-friendly interface that promotes efficient and timely use of information. In our opinion, PGSI is effectively using this high-end technology platform that many of the major E&P’s would likely be envious of. PGSI’s Land Management Front-End System: Cutting Edge Technology for PGSI

Source: Right of Way Land Services, LLC In summary, PGSI has three very distinctive competitive advantages: 1) Management’s geological experience and expertise for East Texas, specifically the Rodessa field, 2) experienced landmen that are utilizing a cutting edge proprietary mapping platform, and 3) using local landmen to consolidate leases in a highly fragment market. We believe

“ROWLS provides cutting edge technology and boots on the ground for PGSI, a vital part to our investment thesis and PGSI’s attractiveness.”

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these competitive advantages individually, and collectively, enable PGSI to acquire and produce acreage in a swift, cost effective manner that is very difficult to replicate by another competitor, which gives PGSI a leading position in the Rodessa field.

Acreage As of December 31, 2011, PGSI had 26,868 gross acres, 18,017 net acres with 11,998 net acres with working interest. We estimate that the company has acquired a significant amount of more acreage since the beginning of the year, or north of 30,000 gross acres and 14,000 new acres with working interest. Overall, of the 225,000 gross acres of Bossier and Cotton Valley formations, we estimate that PGSI now holds roughly 13% of this total gross acreage while PGSI’s total competitors’ positions (please see “PGSI Cornerstone Project, Rodessa Field” illustration for competitors) are roughly 8,000 gross acres collectively, or just under 4%, making PGSI the biggest operator in the region. PGSI Acreage

Source: Company Data, CRM Estimates As of December 31, 2011, PGSI has 5,116 developed gross acres and 4,648 developed net acres while for undeveloped acreage the company had 21,752 gross acres and 7,350 net acres. PGSI Developed/Undeveloped Acreage

Source: Company Data, CRM Estimates

“PGSI currently holds about 13% of the total acreage in the Rodessa field… …next biggest competitor’s position is 8,000 gross acres or 4% of Rodessa’s total acreage.”

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PGSI Cornerstone Project, Rodessa Field With Competitors


Leases Per Acreage The company has roughly 1,200 leases for Cass and Marion Counties, which averages out to be about 22 gross acres per lease, 15 net acres per lease, or 10 net acres with working interest per lease (see chart below). Clearly acreage mineral ownership is highly fragmented and difficult to consolidate making the Rodessa field unattractive to larger E&P’s. However, as PGSI continues to consolidate these leases into one package, we believe a major E&P will begin to take notice as PGSI reaches critical mass required by the majors. Number of Acres Per Lease On Average


“Acreage and position in the Rodessa field a puts PGSI pole position in Marion and Cass counties.”

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Acreage Comparisons Based on PGSI’s enterprise value (see chart below), we estimate that the company is being value at roughly $2,400 per acre. Compared to recent transactions in Eagle Ford and Bakken over the past few years in which we have calculated the average cost per acre to be $14,000 (Eagle Ford) and $8,300 (Bakken) respectively, PGSI shares are trading a significant discount on a per acreage basis. We believe the discount largely reflects the fact that the major E&P’s are not in the Rodessa field given the fact that mineral leases are so fragmented and difficult to consolidate. As PGSI accumulates the Rodessa acreage, we believe these efforts will bear fruit for PGSI shares as management unlocks the value of this acreage through consolidation. Cost Per Acre Comparisons

Source: Company Data, CRM Estimates *PGSI Enterprise Value is Market Cap + LT Debt Equals $54.3 Million PGSI Growth & Diversification Strategy Over the next 12-24 months, PGSI is targeting 8 horizontal wells in each of the five target zones for total wells of 40. The wells will be predominantly oil and represents a significant new direction for the company. Not only will this strategy switch the company’s portfolio from predominantly natural gas to predominantly oil, we estimate the new production will have a significant impact on PGSI economics (see our estimates on the following page). PGSI just completed the first of these 8 horizontal wells called the Morse #1. In addition, the company expects to drill a second horizontal well in the summer called Morse #2 with roughly the same economics as Morse #1. PGSI expects to complete this well within in the next 60 days. PGSI raised capital in July 2011 with total costs for drilling and completion of $6 million, representing a significant capital investment for the company. Going forward, the company will likely use the cash flow from Morse #1 as well as raising capital or debt financing, or combination of all three, to drill Morse #2. We

“On a per acre basis, PGSI’s shares are trading at a discount to recent transactions in the Eagle Ford and Bakken.”

“Morse #1 Well a major milestone for PGSI… … Will transform and diversify the company’s assets as well as drive growth”

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believe the success of Morse #1 will enable the company to be in a strong position to finance the company’s growth strategy and ability to raise addition capital. Production 2009 2010 2011 2012ENet oil production (Bbls) 5,719 4,346 4,063 101,639Net gas production (Mcf) 64,003 61,678 117,461 200,387Average sales price per Bbl of oil $56.62 $76.11 $93.63 $100.00 Average sales price per Mcf of gas $3.25 $3.91 $3.85 $2.18

Year-Over-Year Growth 2009 2010 2011 2012ENet oil production (Bbls) -24.0% -6.5% 2401.6%Net gas production (Mcf) -3.6% 90.4% 70.6%Average sales price per Bbl of oil 34.4% 23.0% 6.8%Average sales price per Mcf of gas 20.3% -1.5% -43.3% Crude Production: Morse #1 & 2 Will Have a Material Impact on PGSI

Source: Company Data, CRM Estimates For 2012, we estimate the company will generate revenues of $10.956 million with oil revenue accounting for nearly 93%, or $10.163 million (please see our revenue per category on the following page). We estimate PGSI will generate $0.438 million for natural gas revenues. Although we forecast a significant increase for the company’s natural gas production, we have modeled in an average price per MMBtu of $2.18, which makes our natural gas estimates conservative. A strong rebound in natural gas prices would prompt us to raise our estimates, a scenario that we believe is likely given our 2012 forecast (see our macroeconomic section on page 21 for our price forecast). All of our estimates have been based on the successful completion of Morse #1 in the coming months and Morse #2 this summer.

“Morse #1 Well scheduled to be completed by June and a second horizontal well slated to be drilled and completed by the 3Q should push PGSI’s oil production over 100k barrels in 2012.”

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CRM’s 2012 Revenue Estimates Per Category

Source: Company Data, CRM Estimates CRM’s 2012 Quarterly Revenue & Gross Margin Estimates

Source: Company Data, CRM Estimates By the end of 2012, we believe that PGSI’s annual run rate for revenues should be around $20 million with oil revenue from the Morse #1 and Morse #2 accounting for the bulk of the revenue. If the company is successful in raising addition capital to drill 2 to 3 more horizontal wells heading into 2013, we believe PGSI would be on solid footing to drive and maintain a rapid growth rate over the next 12-24 months.

“PGIS’s Horizontal well will push PGSI revenue mix heavily towards oil… …however, PGSI’s natural gas assets are robust and any rebound in NG prices will create a second source of significant revenue”

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3rd Party Engineering Report PGSI’s latest engineering report, dated 1/31/2012, generated by James E. Smith & Associates estimates Total Proved (P1) to be $23.8 million with Probable of $11.1 million and Possible of $111.3 million. Total Proved and Probable (P2) is $34.874 million. We believe with the successful completion of Morse #1 and Morse #2 in the summer, the company’s PV-10 will likely be significantly high this time next year. James E. Smith &B Associates, Inc. 1/31/2012 Engineering Report PGSI PV-‐10 P2 P3

$23,763.569 $34,874.753 $146,192.042

Income Entities UnitProved

ProducingProved Non-‐Producing

Proved Behind Pipe

Proved Undeveloped

Total Proved Probable Possible

Gross Oil Production (MBBLS) 18.990 71.070 468.989 205.428 764.477 205.428 15,667.015Gross Natural Gas Production (MMCF) 1,070.717 678.711 13,968.628 11,477.167 27,195.223 11,474.746 72,487.320Net Oil Production (MBBLS) 9.473 42.612 280.896 115.173 448.154 108.280 6,663.315Net Gas Production (MMCF) 352.819 411.191 8,357.710 5,744.294 14,866.014 5,461.298 35,620.441Net Oil Price ($/BBL) $92.100 $92.100 $92.100 $92.100 $92.100 $92.100 $92.100Net Gas price ($/MCF) $3.620 $3.620 $3.620 $3.620 $3.620 $3.620 $3.620Net Oil Sales (MS) $872.463 $3,924.565 $25,870.522 $10,607.433 $41,274.983 $9,972.588 $613,691.312Net Gas Sales (MS) $1,277.205 $1,488.511 $30,254.910 $20,794.344 $53,814.971 $19,769.899 $128,945.996Total Net Sales (MS) $2,149.668 $5,413.077 $56,125.432 $31,401.778 $95,089.954 $29,742.487 $742,637.308Ad Valorem Tax (MS) $81.461 $207.466 $2,106.536 $1,174.122 $3,569.585 $1,111.997 $28,186.760Production Tax (MS) $113.173 $226.383 $3,462.006 $2,048.683 $5,850.245 $1,942.579 $37,968.254Direct Operating Expense (MS) $955.183 $1,057.251 $11,113.015 $2,235.012 $15,360.461 $2,112.854 $132,277.812Equity Investment (MS) $0.000 $640.000 $4,400.000 $8,195.000 $13,235.000 $7,832.000 $311,244.469Future Net Cash Flow (MS) $999.851 $3,281.977 $35,043.875 $17,748.961 $57,074.663 $16,743.057 $232,960.013Cum. Disc. (10%) Cash Flow (MS) $863.789 $1,914.899 $8,595.262 $12,389.619 $23,763.569 $11,111.184 $111,317.289Life (YRS) 8.7 26.8 42.6 10.3 42.6 10.8 44.7

P1

Source: James E. Smith & Associates and Company Data PGSI Total Proved (P1) Per Segment (000’s): PV-10

Source: James E. Smith & Associates and Company Data

“3rd Party Engineering shows significant Proven Behind Pipe and PV-10 should significantly increase following PUD to PDP with the Morse 1 and 2 wells coming in line in 2012.”

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PGSI Total Proved, Probable, and Possible (000’s): PV-10

Source: James E. Smith & Associates and Company Data PGSI Total P1, P2, and P3 (000’s): PV-10

Source: James E. Smith & Associates and Company Data

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Financial Review In 2011, Pegasi finished the year off on a strong note both operational and financially. Pegasi’s production rose in 2011 while production costs fell simultaneously, which we highlighted below: Operating Highlights:

Description 2010 2011 Y-O-Y %^Net Oil Production (Bbls) 4,346 4,063 -6.5%Net Gas Production (Mcf) 61,678 117,461 90.4% Total Production (MBoe) 14,626 23,640 61.6%Average sales price per Bbls of oil $76.11 $93.63 23.0%Average sales price per Mcf of gas $3.91 $3.85 -1.5%Average production cost per Boe $14.07 $10.87 -22.7%

Source: Company Data, CRM Estimates Income Statement Review:

For the Year Ending December, 31Results of Operations (000's) 2010 2011Revenues

Gas Revenues 248 458Oil Revenues 331 380Other Revenues 309 350Total Revenues 888 1,188

Operating Expenses 645 681General and Administrative 2,083 2,175Depletion and Depreciation 187 277

Total Operating Expenses 2,915 3,133

Operating Loss (2,027) (1,945)Other Expenses (4,267) (3,409)Miscellaneous Income (Loss) (197) 785

Net Loss (6,491) (4,569) Source: Company Data, CRM Estimates Total Revenues jumped 34% in 2011 year-over-year versus 2010. Gas revenues increased 85% for the same time period, primarily from the Norbord well that came online in December 2010 while Oil revenues increased 15%, mainly due to higher oil prices.

“Cratering natural gas prices more than offset an increase in gas production of over 90% in 2011 over the previous year… … a rebound in gas prices would provide PGSI investors with another significant increase in revenue streams”

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Total Operating Expenses were 7% higher, driven by an increase in depletion and depreciation. Pegasi continues to closely manage General and Administration expenses as well as SG&A expenses as both fell as a percentage of total revenues in 2011. We believe that Pegasi is on track to generate net income and cash flow from operations in 2012, given the company’s drilling program that should continue to bolster PGSI’s balance sheet. Balance Sheet Review:

Financial Condition (000's) At December 312010 2011

AssetsCash $250 $6,749Other Current Assets 775 674Total Current Assets 1,025 7,423

Net Property and Equipment 20,689 22,188Other Assets 1,266 210

Total Assets $22,980 $29,821

LiabilitiesCurrent Liabilities $11,204 $7,827LT Debt and Other Liabilities 5,147 8,657

Total Liabilities 16,351 16,484

Total Equity 6,629 13,337Total Liabilities and Equity $22,980 $29,821

Source: Company Data, CRM Estimates In 2011, Pegasi significantly improved its financial condition when it raised $5,200,000 of equity. As a result, cash increased to $6,749,000 while negative working capital decreased to $404,000 and debt to equity ratio improved to 1.2 to 1.

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Macro Economic: 2012 Energy Markets Outlook For 2012, we believe there is a significant amount of uncertainty for the energy markets that could drive major price swings in either direction from current levels making this the most difficult year in recent memory for our year-ahead preview. The two major issues overhanging the global markets are no strangers to the energy complex: 1) European debt issue and 2) Geopolitical risks. However, we believe as Europe kicks the can down the road over the systemic debt issues overhanging sovereign nations, the risk of the Euro breaking up in some format will be elevated in 2012 while geopolitical risks, which are a constant, are not appropriately discounted the heightened level of turmoil in the Middle East and beyond. In fact, we believe geopolitical risks in 2012 will dominate the headlines, especially as we head into the second half of the year. In short, 2012 could be one for the books as we expect volatility to be elevated relative to historic levels.

2012 Price Targets At the beginning of the year, we raised our WTI price target from $100 to $125 a barrel for 2012. We believe the average price for the year will be $110. Incorporating geopolitical risk such as a successful oil embargo on Iran, we believe prices can rise between $125 and $150 a barrel in relatively short order. A direct military conflict with Iran would push prices $150+ depending on the length and severity of the campaign. Our 2012 price target for natural gas is $2.50 MMBtu, which we adjusted down from our original 2012 price target of $3.75 MMBtu. We have revised down our price target given the fact that we had one of the warmest winters on record, which lead to the weakest withdrawal season in over 20-years. Although prices have recently broken the $2.00 MMBtu level, we do believe price spikes lower will likely be short lived. At current levels, or $2.34 MMBtu, we wouldn’t be surprised to see a retest of the recent lows set in April, especially as we head into the peak injection season which occurs in late May. However, we do believe fundamentals have to improve based on structural issues alone. Maximum storage capacity for the U.S. is 4.1 TCF. Once the injection season comes to an end in late October, we will likely reach capacity at 4.1 TCF, which is only about 250 BCF over the all-time high set last year (3.852 TCF), or 6.4% higher than the previous high and much lower than our current surplus of 58% over the 5-year average. Furthermore, the extreme price moves lower have caused forced shut-ins as well as natural gas rigs counts hitting a 20+ year low. If the 2012/2013 winter is colder than the national averages, we believe the withdrawal season could be one of the strongest considering declining production levels. In short, we expect a silver lining for the natural gas producers once this year’s injection season comes to an end in the fall.

“Geopolitical Risks will dominate headlines in 2012 with Europe concerns taking a back seat”

“Crude oil prices are likely to remain elevated given geopolitical risks and an improving global economy… …natural gas prices will put in a secular bottom in 2012”

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Disclosures and Certification: Independent Fee-Based Research

• CRM only accepts cash compensation for our work and do not accept any compensation contingent on the content or conclusions of the research or the resulting impact on share price.

• Report Discloser:

- CRM received a 12-month contract for $4,116 a month starting March

15, 2012 to launch and maintain independent fee-based research on Pegasi Energy Resource Corporation shares.

- CRM and/or our staff have no personal, professional, or financial

relationship with Pegasi or its subsidiaries, agents, or trading entities.

- CRM analyst credentials, including professional designations and experience: Chris Jarvis is Chairman, Chief Executive Officer, and President of Caprock. He has served as Senior Commodities Strategist for vFinance Investments, a unit of National Holdings Corporation of New York, New York. Prior to working at National, Mr. Jarvis was a senior energy and commodities strategist with Merrill Lynch and Advest.

He holds a BA from University of Massachusetts and a MBA from University of Connecticut. Christopher has earned the right to use the Chartered Financial Analyst (CFA) designation. He is a member of the CFA Institute. Lastly, Christopher has also earned the right to use the Chartered Market Technician (CMT) designation and is a member of Market Technicians Association (MTA).

CRM will provide continuing coverage on Pegasi. Interested parties can

either visit www.caprockrm.com or email Chris Jarvis at [email protected] or [email protected] for future updates.

CRM is not aware of any matters that could reasonably be expected to impair our objectivity in drafting the report.

There is no history of recommendations for the subject-company and number and distribution of recommendations for all companies we cover.

I, Christopher C. Jarvis, hereby certify that the analysis or recommendations contained in the report, if any, represent the true opinions of the author or authors.

CRM refrains from engaging in, or receiving compensation from, any investment banking or corporate finance-related activities with the issuer.

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CRM’s analyst(s) do not share information about the subject company or

the timing of the release of a research report with any person who could have the ability to trade in advance of (“front run”) the release of a report.

CRM and affiliates refrain from trading in the shares of the subject company in advance of the release of a report or update.

CRM refrains from trading in a manner that is contrary to, or inconsistent with, the employees’ or the firm’s most recent published recommendations or ratings, except in circumstances of unanticipated extreme financial hardship.

CRM abides by all laws, rules, and regulations that apply to registered or regulated analysts.

About Caprock Chris Jarvis, CFA, CMT founded Caprock Risk Management, LLC (“CRM” or “Caprock”) in 2006. Caprock’s mission is to add value for our clients by providing superior market intelligence and advisory services for energy risk management.

Management and Employees Chris Jarvis is Chairman, Chief Executive Officer, and President of Caprock. He has served as Senior Commodities Strategist for vFinance Investments, a unit of National Holdings Corporation of New York, New York. Prior to working at National, Mr. Jarvis was a senior energy and commodities strategist with Merrill Lynch and Advest. He holds a BA from University of Massachusetts and a MBA from University of Connecticut. Christopher has earned the right to use the Chartered Financial Analyst (CFA) designation. He is a member of the CFA Institute. Lastly, Christopher has also earned the right to use the Chartered Market Technician (CMT) designation and is a member of Market Technicians Association (MTA). Peter White is Executive Vice President and Chief Financial Officer. Mr. White is an innovative and proficient executive with over 30 years of experience with private and publicly traded companies in the financial and investment sectors. A CPA, Mr. White has a MBA from New York University and an MAB from Bowdoin College.

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Disclaimer

This publication is intended for informational purposes only and the opinions set forth herein should not be viewed as an offer or solicitation to buy, sell or otherwise trade Equities, futures and/or options. All opinions and information contained in this document constitute Caprock Risk Management (CRM) judgment as of the date of this document and are subject to change without notice. CRM, persons connected with it, members of the CRM, subsidiaries and affiliates ("Affiliated Companies") and their respective directors and employees may, directly or indirectly, effect or have effected a transaction for their own account in the investments referred to in the material contained herein before or after the material is published to any customer of an Affiliated Company or may give advice to customers which may differ from or be inconsistent with the information and opinions contained herein. While the information contained herein was obtained from sources believed to be reliable, no Affiliated Company accepts any liability whatsoever for any direct, indirect or consequential loss arising from any inaccuracy herein or from any use of this document or its contents. This document may not be reproduced, distributed, or published in electronic, paper, or other form for any purpose without the prior written consent of CRM. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient.

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