All of the principal plants and properties of Peoples Gas and North Shore Gas have been maintained in the ordinary course of business and are believed to be in satisfactory operating condition. The distribution facilities serve Chicago and other areas in northeastern Illinois. Peoples Gas owns and operates an underground gas storage reservoir and a liquefied natural gas plant at Manlove Field located in central Illinois. Peoples Gas also owns a natural gas pipeline system that connects Manlove Field and seven major interstate pipelines to and from Chicago. The underground storage reservoir also serves North Shore Gas under a contractual arrangement. General properties include a substantial investment in office and service buildings, garages, repair shops and motor vehicles, together with the equipment, tools and fixtures necessary to conduct utility business. Peoples Gas' main office facility is leased.

Most of the principal plants and properties of Peoples Gas and North Shore Gas, other than mains, services, meters, regulators and cushion gas in underground storage, are located on property owned in fee. Substantially all gas mains are located under public streets, alleys and highways, or under property owned by others under grants of easements. Meters and house regulators in use and a portion of services are located on premises being served. Certain storage wells and other facilities of the Manlove Field storage reservoir and certain portions of the transmission system are located on land held pursuant to leases, easements or permits.

Substantially all of the physical properties now owned or hereafter acquired by Peoples Gas or North Shore Gas are subject to (a) the first-mortgage lien of each utility's respective mortgage to U.S. Bank National Association, as Trustee, to secure each utility's respective outstanding first mortgage bonds and (b) in certain cases, other exceptions and defects that do not interfere with the use of the property.

The operational power plants are equity method investments and property is carried on the partnerships' books.

Peoples Energy Resources also is involved in developing three power projects in the western United States. At this time, Peoples Energy Resources holds options to purchase land in New Mexico, Oregon and Texas where the facilities may be located.

Peoples Energy Resources' headquarters are located in leased office space in Chicago.

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Peoples Gas utilizes its storage and pipeline supply assets as a natural gas hub in the Chicago area. Peoples Energy Resources owns and operates a propane-based peaking plant and approximately 44 miles of six and eight inch diameter pipeline which is used to buy and sell refinery fuel gas within the Chicago marketplace.

The Retail Energy Services segment does not own material tangible properties. Its primary assets are the customer service contracts and accounts. Its headquarters are located in leased office space in Chicago.

The Oil and Gas Production segment, through Peoples Energy Production, owns working interests in substantial oil and gas leasehold positions located in various areas of Texas, Louisiana, New Mexico, Arkansas, Oklahoma and North Dakota. The Company operates a number of Texas and Louisiana properties, with its principal operating areas being located in South Texas and along the Gulf Coast of Texas. As of September 30, 2003, total proved reserves were approximately 182 Bcfe, of which approximately 60 percent are operated by the Company. The Company also owns a 30 percent interest ($20.7 million) in EnerVest, which manages and develops a portfolio of oil and gas producing properties.

In fiscal 2003, the Company acquired interests in several additional South Texas and Gulf Coast Texas fields from Prize Energy Resources, L.P., a subsidiary of Magnum Hunter Resources, Inc. (Magnum Hunter) for approximately $33 million. In addition, the Company consolidated its interests in the Corpus Christi West Field through a purchase from Royal Production Company, et al for approximately $9 million and assumed operations of this field.

In June 2002, the Company acquired an interest and operated position in the East White Point field in San Patricio County, Texas (East White Point). The reserves acquired, 90 percent of which are natural gas, were purchased for approximately $10 million.

In April 2001, the Company acquired interests in the Alvarado and North La Reforma fields located in South Texas. These fields consist of approximately 11,500 gross acres (8,900 net) of developed and undeveloped oil and gas leasehold and are operated by Peoples Energy Production. The acquired reserves, 91 percent of which are natural gas, were purchased for approximately $120 million. At the time of the acquisition, this transaction doubled the Company's total proved reserves and increased its net production capacity by approximately 40 percent.

Peoples Energy Production leases office space in Houston, Texas. Total capital outlays in fiscal 2003 for drilling and exploration projects were approximately $46 million.

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The following tables summarize certain property statistics for Peoples Energy Production's holdings.

As of September 30, 2003, four gross (1.6 net) wells were in progress.

Trigen-Peoples owns a district heating and cooling facility near downtown Chicago. Substantially all of the real and personal property of Trigen-Peoples is subject to a security interest and mortgage granted to The Prudential Insurance Company of America (Prudential), its successors and assigns with respect to Trigen-Peoples senior term notes, which is nonrecourse debt to the Company. Prudential holds a security interest in the shares of Peoples District Energy owned by the Company in connection with the Trigen-Peoples nonrecourse financing.

Peoples Energy does not own material tangible properties except through its subsidiaries. Its primary assets are its investment holdings in its subsidiaries. Peoples Energy leases office space in Chicago from Peoples Gas.

The Company, Peoples Gas and North Shore Gas are involved in various other claims and legal actions arising out of the normal course of business. Management does not expect that the outcome of these other proceedings will have a material adverse effect on the Company's, Peoples Gas' and North Shore Gas' financial position or results of operations. See Notes 1K and 5 of the Notes to Consolidated Financial Statements.

None.

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The following is a list of the names, ages and positions of the executive officers of the Company. Executive officers were elected to serve for a term of one year or until their successors are duly elected and qualified.

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The common stock of the Company is listed on the New York Stock, Chicago Stock and Pacific Exchanges (trading symbol: PGL). At November 30, 2003, there were 20,892 registered shareholders.

The common stock price range and dividends declared per common share by quarters for fiscal 2003 and 2002 were as follows:

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The Company recorded higher fiscal year 2003 results compared to the fiscal 2002 period. Key factors contributing to this improvement include strong growth in operating income from the Company's diversified energy businesses, a return to more normal weather in its Gas Distribution business, and lower interest expense. Fiscal 2003 net income was $103.9 million or $2.87 per diluted share, compared with $89.1 million or $2.51 per diluted share, in fiscal 2002.

Fiscal 2002 net income decreased to $89.1 million or $2.51 per share, compared to $96.9 million or $2.74 per share in fiscal 2001. The decrease in fiscal year results was largely due to the negative impact of weather that was 16 percent warmer than fiscal 2001 and lower equity investment income, which together more than offset the benefits of lower operating costs in the Gas Distribution segment and lower interest expense. The Company's weather insurance policy offset approximately 25 percent of the negative impact of weather.

A summary of variations affecting the Company's net income between periods is presented below, followed by explanations of significant differences.

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Revenues and cost of energy sold for fiscal 2003 increased as a direct result of higher commodity prices and increased volumes sold in the current fiscal year. Colder weather contributed to increased sales and related gas costs in the Gas Distribution, Retail Energy Services and Midstream Services segments. Revenues were also impacted by increased production in the Oil and Gas Production segment. Revenues and cost of energy sold for fiscal 2002 decreased due to lower gas prices and lower volumes sold primarily caused by warmer weather. Revenue comparisons were also impacted by a change in the reporting method of a Midstream Services investment.

Operation and maintenance expense for fiscal 2003 increased primarily due to lower pension credits ($21.7 million), increased utility environmental cost ($14.7 million) and increased operation expense in the Oil and Gas Production segment ($6.6 million). Environmental costs are recovered through the utilities' rate mechanism and a like amount is included in revenues, therefore these costs did not affect operating income. Fiscal 2002 operation and maintenance decreased slightly compared to fiscal 2001. The items causing these decreases were primarily lower labor, group insurance and outside services expenses. The fiscal 2003, 2002 and 2001 pension credits totaled $1.5 million, $23.2 million and $20.1 million, respectively.

Depreciation, depletion and amortization for fiscal 2003 and 2002 increased mainly as a result of increased production in the Oil and Gas Production segment.

Taxes, other than income taxes for fiscal 2003 increased due to higher revenues in the Gas Distribution segment, offset by an adjustment to the municipal and state utility tax accrual. Taxes, other than income taxes for fiscal 2002 decreased due primarily to lower revenues in the Gas Distribution segment.

Gains on property sales decreased in fiscal 2003 and 2002 as compared to the previous years. Only one property sale occurred in fiscal 2003 resulting in a gain. Fiscal 2002 results contained gains on two property sales. Prior to fiscal 2003, these amounts were reported as other income. Comparative years have been reclassified.

Equity investment income for fiscal 2003 increased primarily from income generated from a full year of activity at SCEP and increased contributions from Elwood and EnerVest. The decrease in equity investment income for fiscal 2002 from fiscal 2001 was caused by the effect of Elwood's bond financing on partnership results. Also contributing to the decrease was the change in the reporting method of a Midstream Services investment. Finally, lower results from EnerVest in fiscal 2002 also contributed to the reduction in equity investment income from fiscal 2001.

Other income, net of other expense for fiscal 2003 decreased mainly due to a reduction in interest income along with the effects of a prior year insurance settlement. Other income, net of other expense for fiscal 2002 was lower primarily due to a reduction in interest income, offset partially by the proceeds of a settlement of a suit brought by Peoples Gas and North Shore Gas against an insurer for the recovery of environmental costs.

Interest expense declined in both fiscal 2003 and 2002 due to lower interest rates and reduced average borrowings outstanding.

Income taxes for fiscal 2003 increased due primarily to higher pretax income along with the expiration on December 31, 2002, of Section 29 income tax credits related to the Oil and Gas Production segment. Income taxes for fiscal 2002 decreased due to lower pretax income.

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A summary of the Company's operating income by segment, and variations between periods, is presented below.

The Company's core business is the distribution of natural gas. Peoples Gas and North Shore Gas purchase, store, distribute, sell and transport natural gas to approximately one million customers (825,000 for Peoples Gas and 150,000 for North Shore Gas). Peoples Gas' 4,000-mile distribution system serves Chicago and North Shore Gas' 2,000 mile distribution system serves 54 communities in northeastern Illinois. The customer base includes residential, commercial and industrial retail sales and transportation accounts, and provides a broad foundation that is not concentrated with any particular group of customers. Peoples Gas also owns a storage facility in central Illinois and a pipeline system that connects the storage facility and seven major interstate pipelines to Chicago.

Revenues of Peoples Gas and North Shore Gas are directly impacted by fluctuations in weather because both companies have a large number of heating customers. Fluctuations in weather have the potential to significantly impact year-to-year comparisons of operating income and cash flow. A common statistic used as an indicator of the affect of weather is Heating Degree Days (HDD). An HDD is a unit of measure used to represent each degree that the mean temperature for a 24-hour period is less than 65 degrees Fahrenheit.

Revenues of Peoples Gas and North Shore Gas are also affected by changes in the unit cost of the utilities' gas purchases and do not include the cost of gas supplies for customers who purchase gas directly from producers and marketers. In a normal gas price environment, the unit cost of gas does not have a significant direct effect on operating income because the utilities' tariffs provide for dollar-for-dollar recovery of gas costs. (See Note 1K of the Notes to Consolidated Financial Statements.) However, significant changes in gas costs can materially affect the reserve for uncollectible accounts, customer demand and working capital needs. (See Note 7 of the Notes to Consolidated Financial Statements.)

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The following table summarizes revenue, deliveries and other statistics for the Gas Distribution segment.

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The discussion of the Gas Distribution segment variations is primarily related to Peoples Gas and North Shore Gas activity. Segment results also include the impact of the Company's weather insurance policy. This is a five-year policy scheduled to expire at the end of fiscal 2004. There are no weather insurance receivables reflected in fiscal 2003 and 2001. Fiscal 2002 revenues include $8.7 million in weather insurance income.

The fluctuation in net margin per dekatherm delivered for fiscal 2003 versus fiscal 2002 reflects the variation in margin primarily caused by increased volumes delivered associated with colder weather. The utility's rate structure establishes a lower unit cost as volumes delivered to a customer increase. Other items affecting net margins include revenue tax accrual adjustments and a decrease in other Gas Distribution revenues primarily reflecting weather insurance accrued last year.

Fiscal 2003 revenues for Peoples Gas increased $378.6 million over fiscal 2002 resulting primarily from higher gas prices ($235.0 million), from increased deliveries due to weather that was almost 19 percent colder ($130.0 million) and higher revenue taxes. Operating income in fiscal 2003 increased $9.2 million compared with fiscal 2002 due mainly to the effects of weather ($26.0 million) and a reduction in the municipal and state utility tax accrual ($10.0 million). The revenue tax accrual adjustment resulted primarily from the effect of higher uncollectibles on the tax liabilities, which are paid based upon cash receipts. Lower pension credits ($20.8 million) and higher nonlabor operating expense partially reduced operating income.

Fiscal 2002 revenues for Peoples Gas decreased $661.2 million compared to fiscal 2001 due mainly to weather that was 16 percent warmer than fiscal 2001 and the lower gas costs. Operating income decreased $18.8 million as a result of lower gas delivery volumes resulting from the effect of the warmer weather and from an increase in the provision for uncollectible accounts ($2.2 million). Partially offsetting these effects was an increase in pension credits ($3.1 million).

The fiscal 2003, 2002 and 2001 pension credits for Peoples Gas totaled $4.2 million, $25.0 million and $21.9 million, respectively.

Peoples Gas and North Shore Gas accrue for estimated uncollectible accounts as revenues are recorded. The accrual rates are established based upon historical experience and projections of future charge-offs resulting from various factors, including the impact of natural gas prices and weather. Each quarter, Peoples Gas and North Shore Gas update the projection of future charge-offs based upon the most current information available, and adjust the reserve for uncollectible accounts, if necessary. Based on this ongoing review, Peoples Gas recorded an additional $5.0 million provision in the third quarter, increasing the reserve for uncollectible accounts to $29.2 million at September 30, 2003. During fiscal 2002, Peoples Gas recorded an additional $17.0 million charge to increase the reserve for uncollectible accounts. (See Note 7 of the Notes to Consolidated Financial Statements.)

Fiscal 2003 revenues for North Shore Gas increased $75.3 million over fiscal 2002 resulting primarily from higher gas prices ($45.0 million) and from increased deliveries due to weather that was almost 19 percent colder ($25.0 million) and higher revenue taxes. Operating income increased $4.3 million due mainly to the effects of weather ($3.7 million), partially offset by an increase in pension expense of $0.9 million. The fiscal 2003 pension expense totaled $1.7 million.

Fiscal 2002 revenues for North Shore Gas decreased $117.8 million compared to fiscal 2001 due primarily to weather that was 16 percent warmer and lower unit gas costs. Operating income decreased $5.6 million as a result of lower gas delivery volumes resulting from the affects of warmer weather.

The fiscal 2003, 2002 and 2001 pension expense for North Shore Gas totaled $1.7 million, $0.8 million and $0.7 million, respectively.

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The Power Generation segment, through Peoples Energy Resources, is engaged in the development, construction, operation and ownership of electric generation facilities for sales to electric utilities and marketers. Currently, the Company has an ownership interest in two electric generation facilities. The Company and Dominion are equal investors in Elwood, which owns and operates a 1,400-megawatt peaking facility near Chicago. Power generated by Elwood is sold through long-term contracts with Exelon, Engage and Aquila. The Company has a 27 percent interest in SCEP, a partnership with Exelon, that owns and operates a 350-megawatt facility. The Power Generation segment is also developing three additional sites to partner with or sell to investors.

The Elwood partnership recognizes revenue consistent with the contractual requirements for generator unit availability under Elwood's power sales agreements (PSAs) with its customers. Peaker plants serve to provide power on peak days when power beyond normal base load requirements is needed, which in Chicago usually occurs during the summer. As a result, a premium is placed on power capacity availability during the summer months, and the Elwood PSAs have substantial penalties for units not being available for dispatch in these months only. The terms of the PSA are such that in economic substance Elwood's customers are purchasing the majority of the plant's power capacity during summer months, and revenue is recognized accordingly.

The SCEP partnership's PSA does not have substantial penalties for nonperformance in the summer months. Also, unlike Elwood, which has market-based rates under FERC regulations in its PSAs, SCEP's rates are cost-based rates under FERC regulations. A significant cost for an electric generating plant is depreciation of fixed plant and equipment. Therefore, revenue recognition is based on a monthly demand payment that is earned and paid throughout the year on a straight-line basis.

An important business purpose of this segment is to develop power generation sites. The Company has a business development staff working to find new investment opportunities either through the development of power sites or through partnering with others in the construction of power facilities. The costs of these activities are either expensed as incurred or are capitalized as specific site development assets, as appropriate. Included in deferred charges at September 30, 2003, was $7.1 million related to this activity.

Fiscal 2003 operating income increased $1.2 million due to a full year of equity investment income generated from SCEP, which began commercial operations in July 2002, and lower operating costs ($1.2 million) associated with new investment opportunities, partially offset by last year's site-development income.

Fiscal 2002 operating income decreased $9.9 million mainly due to the inclusion in fiscal 2002's results of interest expense associated with Elwood's bond financing. In fiscal 2001, the interim financing costs for this project were reflected as corporate interest expense. The inclusion of this cost reduced equity investment income from Elwood by $16.5 million. Fiscal 2001's results also benefited from a gain on the liquidation of financial hedges associated with Elwood's gas supply requirements ($4.0 million). Adjusting for the financing and hedge impacts, operating income increased significantly due to Elwood's first full year of operation with its expanded facilities, which became commercially operable in June 2001 ($5.9 million), and from the site-development income and start up of operations at SCEP, which began commercial operations in July 2002 ($5.6 million). These benefits were somewhat offset by higher development expenses related to the pursuit of new power projects.

Aquila's senior unsecured debt rating was downgraded to below investment grade by Moody's Investor Service (Moody's) in September 2002 and by Standard & Poor's Ratings Services (S&P) in November 2002. The Company is closely monitoring the creditworthiness of Aquila, one of three companies contracting with Elwood for plant capacity and output. (See Note 4 of the Notes to Consolidated Financial Statements.)

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The Midstream Services segment is engaged in asset-based wholesale activities that provide services to marketers, utilities, pipelines and gas-fired power generation facilities in the upper Midwest. The segment's services are asset based by virtue of having the physical ability to deliver the gas. The phrase "asset based" is intended to differentiate Peoples Energy Resources' business from that of certain marketers in the wholesale natural gas business who enter into gas supply and storage contracts without any means of delivering the physical commodity, intending instead to always settle with counterparties on the delivery date through the payment of money without delivery of gas. In addition, Peoples Gas utilizes its storage and pipeline supply assets as a natural gas hub and Peoples Energy Resources owns a propane-based peaking plant and leases storage assets. Period-to-period comparisons can have large fluctuations caused by volatility in the energy markets.

Revenues for fiscal 2003 increased $113.8 million as compared to fiscal 2002. The Company is expanding its wholesale marketing and asset management activities. Such activities are now performed in a wholly owned subsidiary and therefore revenues and expenses have increased versus fiscal 2002 when such activities were performed by enovate, an equity investment for a portion of the year. Operating income increased $0.7 million due to wholesale marketing and asset management activities ($2.9 million), partially offset by income in the prior year associated with enovate ($1.9 million).

Revenues for fiscal 2002 increased $61.0 million over fiscal 2001. In previous periods, enovate results were reported as equity investment income. From late March 2002 and until the dissolution of enovate in September 2002, 100 percent of enovate's sales were recorded in revenues. Operating income decreased $5.2 million compared to fiscal 2001, due to a reduction in income from enovate ($8.2 million) which benefited from extraordinary market volatility in fiscal 2001 and from a decline in wholesale activities ($2.9 million). Partially offsetting these effects was an increase in operating income from hub activity ($5.3 million) which experienced a record year due primarily to strong seasonal pricing differentials.

The following table summarizes operating statistics for the Midstream Services segment.

Peoples Energy Services, which is the only substantial contributor to the Retail Energy Services segment, provides energy, to industrial, commercial and residential customers regionally within Illinois. Residential customer choice for Illinois became available during the period of March through May 2002, for both gas and electricity.

During the third quarter of fiscal 2003, Peoples Energy Services entered into an agreement to become the natural gas provider for the State of Illinois. Under this agreement, Peoples Energy Services will provide nearly 3 Bcf of natural gas to the State of Illinois facilities in Chicago, representing an estimated five percent increase in total natural gas volumes for this segment.

Revenues for fiscal 2003 increased $83.3 million primarily due to increased deliveries associated with customer growth and colder weather, and higher natural gas commodity prices. Margins in the Retail Energy Services segment are dependent on various factors such as the regulatory environment, commodity pricing and competitive factors, making gross revenue statistics a less reliable indicator of results. Gross margin increased $2.3 million. Higher gas and electric margins and customer growth positively impacted operating results.

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Operating income increased $2.0 million, reflecting the benefits of the increased margins offset partially by increased operating expenses.

Revenues for fiscal 2002 decreased $88.7 million due to declining natural gas commodity prices. Operating income increased $4.6 million resulting from higher margin ($5.1 million), partially offset by a slight increase in operating expenses. Power deliveries were slightly up due to warmer summer weather while power prices remained constant, resulting in increased margin from sales contracts that include a price-swing-risk mitigation factor. Additionally, the prior year included short-term electric margin losses from fixed price sales backed by seasonally priced supply.

The following table summarizes operating statistics for Peoples Energy Services.

The Oil and Gas Production segment, through Peoples Energy Production, is active in the acquisition, development and production of oil and gas reserves in selected onshore basins in the United States through direct ownership in oil, gas and mineral leases. Peoples Energy Production's primary focus is on natural gas, with growth coming from low-to-moderate-risk drilling opportunities and acquisition of proved reserves with upside potential, which can be realized through drilling, production enhancements and reservoir optimization programs. Peoples Energy Production also has an equity investment in EnerVest ($20.7 million as of September 30, 2003), which develops and manages a portfolio of oil and gas producing properties. Results from the equity investment in EnerVest improved $2.6 million during fiscal 2003.

Certain producing properties owned by Peoples Energy Production qualified for income tax credits as defined in Section 29 of the Internal Revenue Code of 1986. These credits expired on December 31, 2002. The amount recorded to income for the fiscal years ended September 30, 2003, 2002 and 2001 was $1.1 million, $4.5 million and $4.7 million, respectively.

In November 2002, the Company acquired an interest in five properties in south Texas and the upper Texas gulf area from a subsidiary of Magnum Hunter. The reserves acquired, 99 percent of which are natural gas, were purchased for approximately $33 million and added approximately 11 MMcfe per day production at the time of the acquisition. In April of 2003, the Company acquired additional interest in the Corpus Christi West Field from Royal Production and several affiliated entities for approximately $9 million. This acquisition added more than 2 MMcfe per day production at the time of the acquisition.

Fiscal 2003 revenues increased $40.6 million over fiscal 2002. Operating income in fiscal 2003 increased $15.7 million over fiscal 2002. Last year's results included the one time benefit of a settlement on hedges of $5.1 million. Excluding that impact, fiscal year results tripled due mainly to improved commodity prices and increased production. The increase in production was due to the impact of the acquired properties and the success of the Company's drilling program.

Fiscal 2002 revenues increased $11.7 million due to the impact of new production from reserves acquired in fiscal 2001, positive results from drilling programs, the East White Point acquisition in June 2002 and the settlement of hedges associated with Enron. Higher production was partially offset by a decline in net realized natural gas prices, excluding the impact of the settlement of hedges associated with Enron. Operating income decreased $3.0 million due mainly to lower results from the EnerVest partnership ($8.6 million). Net income for

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fiscal 2002 was positively impacted by the utilization of Section 29 income tax credits associated with certain producing properties ($4.5 million).

As of September 30, 2003, the Company had hedges in place for 16.1 million MMbtus for fiscal 2004, or 60 percent of estimated fiscal 2004 production, assuming a 10 percent growth over fiscal 2003 production. Of the hedges in place, approximately 60 percent are swaps at an average price of $3.56 per MMbtu. The remainder are no cost collars with a weighted average floor price of $3.80 per MMbtu and a weighted average ceiling price of $5.82 per MMbtu. The majority of these hedges are valued against the New York Mercantile Exchange's (NYMEX) Henry Hub Natural Gas Contract. In addition, as of September 30, 2003, the Company had hedges in place for 291,000 Bbls of oil at an average price of $24.79 per Bbl. The oil hedges are valued using the average daily price for the month for the NYMEX West Texas Intermediate Cushing, Oklahoma Oil Contract.

The following table summarizes operating statistics from the Oil and Gas Production segment.

The increase in the depreciation, depletion and amortization rate was caused by the inclusion of costs to develop reserves that were previously classified as proved undeveloped and the transfer of acquisition and development costs and reserves related to properties previously classified as probable, that are now classified as proved. These costs have been added to the depreciation, depletion and amortization pool.

The increase in average production taxes is the result of increased revenues during fiscal 2003. In most states, production taxes are assessed as a percentage of revenues before the impact of hedges. Revenues, excluding hedges, for the fiscal year ended September 30, 2003, increased 136 percent compared to fiscal 2002.

The Company is involved in other activities such as district heating and cooling through its Trigen-Peoples partnership and miscellaneous nonmaterial investments. These and certain business development activities do not fall under the above segments and are reported in the Other segment. The reported results also include income from the operation of fueling stations for natural gas vehicles.

Revenues, operating expense and operating income variations for fiscal years 2003 and 2002 were insignificant as compared with the previous fiscal year periods.

The cost of Corporate activities that support the business segments, as well as consolidating adjustments, are included in Corporate and Adjustments.

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The operating loss variation in fiscal 2003 for this segment was insignificant as compared with fiscal 2002. Lower corporate costs were offset by the cost impact of a higher Peoples Energy stock price on outstanding stock appreciation rights (SAR) grants under the Company's equity compensation plans.

Fiscal 2002 operating losses in this segment remained relatively flat as compared to fiscal 2001. The impact of a lower Peoples Energy stock price on outstanding grants under the Company's equity compensation plans ($4.6 million) was offset by higher corporate support expenses.

The following table summarizes activity included in the Company's other income and other expense categories.

Fiscal 2003 interest income reflects a return to more normal daily cash levels. Fiscal 2002 and 2001 activity reflected additional interest income related to cash advances to Elwood Energy and a note receivable from the sale of a turbine.

Also included in fiscal 2002 other income is a portion of the proceeds from a settlement of a suit brought by Peoples Gas and North Shore Gas against an insurer for the recovery of environmental costs which represents the amount received for the release of the insurer under certain insurance policies from pending or future claims unrelated to manufactured gas plant operations.

Fiscal 2002 and 2001 reflect impairment losses related to items owned but never used in the Company's operations. Fiscal 2002 reflects the write-down of assets located at Peoples Gas former SNG plant, transformers purchased in connection with a power site development and an investment in a supply and transportation contract. Fiscal 2001 write-downs include a turbine held for a power site development and an investment in a partnership formed to explore the development of a pipeline.

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The following table summarizes activity included in Peoples Gas' other income and other expense categories.

The following table summarizes activity included in North Shore Gas' other income and other expense categories.

Fiscal 2003 interest expense for the Company decreased $7.0 million from fiscal 2002 due to lower interest rates and lower average borrowing requirements. The reduction due to rates was primarily the result of lower rates on variable rate debt, the retirement or refinancing of higher cost notes and bonds, and increased use of commercial paper. Average borrowing requirements were reduced primarily due to the repayment of a $100.0 million note in fiscal 2002 and to increased issuances of common stock in fiscal 2003.

Fiscal 2002 interest expense decreased $15.6 million from fiscal 2001 due to several factors. Interest decreased due to a reduction in corporate short-term debt mainly due to Elwood's bond financing. This impact was partially offset by the full year of interest expense in fiscal 2002 associated with the $325.0 million in corporate notes issued in January 2001 to fund the expansion of the diversified businesses. Utility short-term borrowing requirements were much lower due to the impacts of warmer weather, lower natural gas prices and improved customer collections. Additionally, the Company benefited from lower interest rates on commercial paper and Peoples Gas' variable rate bonds.

Fiscal 2003 interest expense for Peoples Gas decreased $1.4 million from fiscal 2002 due to lower rates on variable rate debt and to the retirement or refinancing of higher cost notes and bonds. These impacts were partially offset by higher average borrowing requirements resulting from colder weather and higher natural gas prices. For fiscal 2002, interest expense for Peoples Gas decreased $13.1 million due mainly to lower average short-term borrowing requirements resulting from warmer weather, lower natural gas prices and improved customer collections. Also impacting interest expense was lower interest rates on Peoples Gas' variable rate bonds and other short-term debt.

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North Shore Gas' fiscal 2003 interest expense decreased $1.4 million from fiscal 2002 primarily due to lower interest rates. North Shore Gas' fiscal 2002 variation for interest expense was insignificant.

The Company expects fiscal 2004 earnings to be in the range of $2.70 to $2.85 per share. The target range for the coming year is based on several factors including continued operating income growth from the Company's diversified energy businesses of 10 to 20 percent, ongoing cost control measures, a return to normal weather, pension expense in the range of $11 million to $13 million, a provision for bad debt expense of approximately 2.5 percent of utility revenues and a higher average number of shares outstanding resulting in $0.05 to $0.10 per share of dilution. Capital expenditures are expected to decline from about $187 million in fiscal 2003 to about $150 million in fiscal 2004, with about $80 million in the Gas Distribution segment and the balance in the diversified energy segments. (See Forward-Looking Information.)

In preparing the Company's financial statements using GAAP, management exercises judgment in the selection and application of accounting principles, including making estimates and assumptions. Management considers its critical accounting policies to be those that are important to the representation of the Company's financial condition and results of operations. They require management's most difficult and subjective or complex judgments, including those that could result in materially different amounts if the Company reported under different conditions or using different assumptions. There were no material changes in the application of each of the critical accounting policies listed below during fiscal 2003.

Regulated Operations. Due to the regulation of the Company's utility subsidiaries, certain transactions are recorded based on the accounting prescribed in Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." Under this statement certain costs or revenues are deferred on the balance sheet until recovered or refunded through rates. Accordingly, actions of the Commission could have an effect on the amount recovered from or refunded to customers. Any differences between recoverable and refundable amounts and the amounts deferred would be recorded as income or expense at the time of any Commission action. If all or a reportable portion of the utility operations becomes no longer subject to the provision of SFAS No. 71, a write-off of related regulatory assets or liabilities would be required, unless some form of transition cost recovery continued through rates established and collected for the remaining regulated operations. No such change is foreseen by management. (See Notes 1J and 1K of the Notes to Consolidated Financial Statements.)

Environmental Activities Relating to Former Manufactured Gas Operations. The Company's utility subsidiaries, their predecessors, and certain former affiliates operated facilities in the past at multiple sites for the purpose of manufacturing gas and storing manufactured gas (manufactured gas sites). The utility subsidiaries are accruing and deferring the costs they incur in connection with environmental activities at the manufactured gas sites pending recovery through rates or other entities. The amounts deferred include costs incurred but not yet recovered through rates and management's best estimates of the costs that the utilities will incur in investigating and remediating the manufactured gas sites. Management's estimates are based upon an ongoing review by management and its outside consultants of future investigative and remedial costs.

Management considers this policy critical due to the substantial uncertainty in the estimation of future costs with respect to the amount and timing of costs, and the extent of recovery from other potentially responsible parties (PRPs). (See Notes 1L and 5A of the Notes to Consolidated Financial Statements.)

Retirement and Postretirement Benefits. The calculation of pension expense (credits) relies on actuarial assumptions including discount rate, long-term rate of return on assets and assumed future increases in compensation. These assumptions are determined annually and changes to the assumptions can have a material effect on the amounts recorded from year to year. The Company bases its discount rate assumption on yields of

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high quality long-term, fixed-income bonds. A decrease in the assumed discount rate of 25 basis points would have increased fiscal 2003 pension expense by $1.6 million.

Additionally, when an employee retires and takes his/her retirement benefit as a lump sum, a settlement amount under SFAS No. 88, "Employer's Accounting and Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," is calculated representing the difference between the actuarial liability for this employee and the lump sum. The Company has chosen to record this difference as well as a portion of previously unrecognized gains and losses in the current period instead of amortizing the difference over the expected average service life of the remaining participants. Both methods are acceptable under GAAP. Therefore, the timing of retirements can have an effect on the amount recorded in any given year. (See Note 8 of the Notes to Consolidated Financial Statements.)

In addition, the Company and its subsidiaries currently provide certain health care and life insurance benefits for retired employees. Substantially all employees may become eligible for such benefit coverage if they reach retirement age while working for the Company. Through the use of an independent actuary, the Company accrues the expected costs of such benefits during a portion of the employees' years of service. This accrual is based on assumptions regarding discount rates, rate of return on assets and health care cost trend rates. The health care cost trend rate assumption has a significant effect on the amounts reported. Increasing the assumed health care cost trend rate by one percentage point for each future year would have increased the accumulated postretirement benefit obligation at September 30, 2003 by $9.2 million and the aggregate of service and interest cost components of the net periodic postretirement benefit cost by $1.4 million annually. Decreasing the assumed health care cost trend rate by one percentage point for each future year would have decreased the accumulated postretirement benefit obligation at September 30, 2003 by $7.9 million and the aggregate of service and interest cost components of the net periodic postretirement benefit cost by $1.2 million annually. A decrease in the assumed discount rate of 25 basis points would have increased postretirement benefit cost expense by $0.2 million.

Derivative Instruments and Hedging Activities. The Company enters into financial derivative contracts to hedge price risk on natural gas purchases and sales. For each contract, management must determine whether the underlying transaction qualifies as a hedge under derivative accounting rules. If contracts do qualify as hedges, they will have a minimal effect on income until settled. Otherwise the change in the fair value of these contracts would be recorded in income monthly and result in potentially significant impacts, both positive and negative. Additionally, due to the nature of the Company's businesses, most of the Company's contracts for physical purchases and sales of gas or power meet the definition of a derivative, but are exempt from derivative accounting requirements under the normal purchase and sale exemption. Under this exemption, if the transactions are clearly intended to meet the requirements of the customers, mark-to-market accounting is not required. Management judgment is required to make this determination. (See Note 1M of the Notes to Consolidated Financial Statements.)

Provision for Uncollectible Accounts. The Company's subsidiaries accrue for estimated uncollectible accounts as revenues are recorded. The accrual rates are established based upon historical experience and projections of future charge-offs resulting from various factors, including the impacts of natural gas prices and weather. Each quarter, the Company's subsidiaries update the projection of future charge-offs based upon the most current information available, and adjust the reserve for uncollectible accounts, if necessary. (See Note 7 of the Notes to Consolidated Financial Statements.)

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Accounting Standards. In January 2003, the FASB issued Financial Interpretation No. (FIN) 46, "Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51." Under FIN 46, if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities and results of the activities of the variable interest entity should be included in consolidated financial statements with those of the business enterprise. The Company's only off-balance sheet financing is through its equity method investments, none of which qualify as a Variable Interest Entity. This implementation date has been deferred to fiscal 2004. The Company does not expect FIN 46 to significantly affect the Company's financial condition or results of operations.

The Company adopted SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets," as of October 1, 2001. These statements, in part, clarify that more assets should be distinguished and classified between tangible and intangible. The Company did not change or reclassify contractual mineral rights included in oil and gas properties on the balance sheet upon adoption of SFAS No. 142. The Company believes the treatment of such mineral rights as tangible assets under the successful efforts method of accounting for crude oil and natural gas properties is appropriate. However, the accounting profession and others are engaged in industry-wide deliberations regarding whether SFAS Nos. 141 and 142 require contractual mineral rights to be classified as intangible assets rather than tangible assets.

Competition and Deregulation. Since May 2002, all retail gas customers, including residential customers, in northern Illinois have had the opportunity to select an alternative supplier other than the local utility (an alternative gas supplier). Outside of the service territories of Peoples Gas, North Shore Gas and Nicor Gas, only large-volume customers have had the ability to choose an alternative gas supplier. Because the Gas Distribution utilities do not make any profit on the commodity cost of gas and because transportation charges are basically the same for customers using an alternative gas supplier and for sales customers, the operating income of the Gas Distribution utilities is generally not affected by whether a customer is a transportation customer or a sales customer.

With respect to retail electric competition, the phase-in of open access set forth in the December 16, 1997, electric restructuring law is now complete. Since May 1, 2002, all retail electric customers, including residential customers, have had the ability to select an alternative retail electric supplier, which is a nonutility supplier or an electric utility other than the customer's local electric utility. However, as of October 31, 2003, no company has requested the required authorization from the Commission to provide electricity service to residential customers. Customers who buy their electricity from an alternative retail electric supplier are required to pay transition charges to the utility through the year 2006. Management believes that the restructuring of the electric market in Illinois under this legislation will not have a material adverse effect on the competitive position of the Company's subsidiaries.

The following is a summary of cash flows for the Company:

Cash provided by operating activities decreased in fiscal 2003 compared to fiscal 2002 primarily due to working capital needs related to higher gas prices and increased storage. Peoples Gas' inventory gas increased by $46.6 million and Midstream Services' inventory increased by $19.4 million. The increase in net cash used in investing activities in fiscal 2003 compared to 2002 was primarily due to the collection of previously advanced cash to Elwood in fiscal 2002 as a result of project financing of that facility. The net cash used in financing

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activities decreased in fiscal 2003 compared to 2002 primarily due to the retirement in fiscal 2002 of $300.3 million of debt and to increased proceeds of $42.5 million from the issuance of common stock in fiscal 2003.

See the Consolidated Statements of Cash Flows and the discussion of major balance sheet variations for more detail.

The Company's total assets at September 30, 2003 increased $204.9 million compared to September 30, 2002, primarily caused by:

• increased gas in storage of $76.0 million as a result of an increase in physical inventory at Gas Distribution, Midstream Services and Retail Energy Services segments' storage;
• increased utility and oil and gas property net of depreciation of $62.8 million related to utility construction and oil and gas acquisitions and drilling;
• increased intangible pension asset of $30.5 million related to an additional minimum liability recorded ;
• increased receivables from customers of $31.1 million caused by higher gas costs;
• increased gas cost recoverable of $12.4 million; and
• decreased other receivables of $32.7 million related to reduced receivables from hedging activities.

The Company's total liabilities at September 30, 2003 increased $163.2 million compared to September 30, 2002, primarily caused by:

• increased long-term debt of $190.3 million related to replacing current bond maturities and terming up of commercial paper and adjustable rate debt;
• decreased commercial paper of $29.9 million;
• decreased other short-term debt and current portion of long-term debt of $140.0 million;
• decreased regulatory liabilities of $30.0 million related to the utilities' price protection program;
• increased accounts payable of $43.0 million related to higher priced gas purchases;
• increased pension and postretirement benefit liabilities of $85.7 million caused by lower discount and interest rate assumptions; and
• increased deferred income taxes of $29.6 million.

The Company's total equity at September 30, 2003 increased by $41.7 million compared to September 30, 2002, primarily caused by:

• increased common stock of $44.8 million related primarily to the continuous equity program and Direct Purchase and Investment Plan;
• increased retained earnings of $27.6 million; and
• decreased accumulated other comprehensive income (AOCI) of $30.8 million related to pension liabilities and hedging activity.

During fiscal 2003, the Company took advantage of the low interest rate environment to refinance existing debt with lower interest rate debt and to term-up adjustable rate debt. In general, debt classified as short-term due to the technical tender provisions was replaced by long-term debt. (See Note 11 of the Notes to Consolidated Financial Statements.)

The Company and its two regulated utilities have access to outside capital markets, commercial paper markets and internal sources of funds that together provide sufficient resources to meet their working capital and long-term capital requirements. The Company does not anticipate any changes that would materially alter its current liquidity position.

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Due to the seasonal nature of gas usage, a major portion of the utilities' cash collections occurs between January and June. Because of timing differences in the receipt and disbursement of cash and the level of construction requirements, the utility subsidiaries borrow from time to time on a short-term basis. Short-term borrowings are repaid with cash from operations, other short-term borrowings or refinanced on a permanent basis with debt or equity, depending on market conditions and capital structure considerations.

In addition to cash generated internally by operations, as of September 30, 2003, the Company has credit facilities of $317.5 million (Peoples Energy, $150.0 million; Peoples Gas, $167.5 million, of which $37.0 million may be utilized by North Shore Gas). Peoples Gas also has a seasonal supplemental line of $40.0 million for the winter months. These various facilities primarily support the Company's ability to borrow using commercial paper. As of September 30, 2003, Peoples Energy's entire line was available and $111.6 million of the $167.5 million Peoples Gas and North Shore Gas facilities were available. The Company's credit facilities generally contain debt triggers that permit the lenders to terminate the credit commitments to the borrowing company and declare any outstanding amounts due and payable if the borrowing company's debt-to-total capital ratio exceeds 65 percent. The credit facilities are expected to be renewed when they expire, although the exact amount of the renewals will be evaluated at that time and may change from the current levels. As of September 30, 2003, Peoples Gas had $24.4 million of loans from Peoples Energy. North Shore Gas had no such loans outstanding at September 30, 2003.

The current credit ratings for the Company, Peoples Gas and North Shore Gas are summarized on the table below.

On July 29, 2003, Fitch Ratings (Fitch) lowered the Company's senior unsecured rating from A+ to A. For both Peoples Gas and North Shore Gas, the senior secured rating was lowered from AA to AA- and the commercial paper rating was lowered from F1+ to F1. The Company's F1 commercial paper rating was affirmed and the ratings outlook for all three companies was raised from Negative to Stable. Fitch noted that the Company's consolidated business risk profile resulting from its diversification strategy has resulted in leverage and credit protection measures that are more consistent with the revised rating.

Moody's describes double-A rated debt (Aa1, Aa2 and Aa3) as high-grade and single-A rated debt (A1, A2 and A3) as upper-medium grade. S&P describes A-rated debt (A+, A and A-) as strong and triple-B rated debt (BBB+, BBB and  BBB-) as adequate. Fitch describes double-A rated debt (AA+, AA and AA-) as having a very high credit quality and single-A rated debt (A+, A and A-) as having high credit quality. The lowest investment grade credit ratings for Moody's is Baa3, for S&P is BBB- and for Fitch is BBB-. Thus, all three credit rating agencies give the Company, Peoples Gas and North Shore Gas investment grade ratings.

Regarding short-term ratings applicable to commercial paper, Moody's describes the P-1 rating as indicating a superior repayment ability and P-2 as indicating a strong repayment ability. S&P describes an A-2 rating as satisfactory. Fitch describes the F1 ratings (F1+ and F1) as indicating the highest credit quality.

The Company has filed a universal shelf registration statement on Form S-3 for the issuance from time to time of up to 1.5 million shares of common stock pursuant to a continuous equity offering in one or more negotiated transactions or "at-the-market" offerings. As of September 30, 2003, 858,300 shares of common stock have been issued through the continuous equity offering. Proceeds, net of issuance costs, totaled $32.4 million. Subsequent to September 30, 2003, and through December 11, 2003, the Company has not issued any additional shares under this registration statement. In addition, the Company issues common stock through various plans

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such as its Direct Purchase and Investment Plan and its Employee Stock Purchase Plan. (See Note 14 of the Notes to Consolidated Financial Statements.)

Capital Spending . In fiscal 2003, the Company spent $187.2 million on capital projects and investments in equity investees. The Gas Distribution segment spent $82.0 million on property, plant and equipment of which $73.0 million was spent by Peoples Gas and $9.0 million was spent by North Shore Gas. The remaining $105.2 million was spent by the diversified business segments. The majority of this capital was in the Oil and Gas Production segment, which spent $98.2 million on the acquisition of producing properties, drilling projects and the exploitation of the acquired and existing assets. Total forecasted capital spending for fiscal 2004 is estimated to be $150 million.

Working Capital Credit Facility. Elwood, the Company and Dominion have entered into a revolving working capital credit facility under which the Company and Dominion will fund Elwood's working capital requirements up to a maximum aggregate amount of $10.0 million. The facility is dated June 28, 2002, and commenced July 1, 2002. The outstanding loans would earn interest at the A-2/P-2 commercial paper rate plus 50 basis points. At September 30, 2003, the entire amount was available.

Dividends . On February 5, 2003, the Directors of the Company voted to increase the regular quarterly dividend on the Company's common stock from 52 cents per share to 53 cents per share.

The Company has certain contractual obligations directly related to the Company's operations and unconsolidated equity investees. The majority of these are long-term debt related with other substantial commitments for gas supply, transportation and storage contracts. (See Note 6 of the Notes to Consolidated Financial Statements.)

Contractual Obligations. The following table summarizes the Company's long-term minimum contractual obligations.

Off-Balance Sheet Financing. Off-balance sheet debt at September 30, 2003 and 2002, consists of the Company's pro rata share of nonrecourse debt of various equity investments, including Trigen-Peoples ($15.4 million and $15.7 million), EnerVest ($2.7 million and $5.7 million) and Elwood ($190.0 million and $196.9 million). The Company believes this off-balance sheet financing will not have a material effect on the Company's future financial condition. The Company also has commercial obligations in the form of guarantees and letters of credit in support of its unconsolidated equity investments' operations. (See Note 6 of the Notes to Consolidated Financial Statements.)

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Environmental Matters . The Company's Gas Distribution utility subsidiaries are conducting environmental investigations and remedial work at certain sites that were the locations of former manufactured gas operations. (See Note 5A of the Notes to Consolidated Financial Statements.)

In 1994, North Shore Gas received a demand from a responsible party under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (CERCLA), for environmental costs associated with a former mineral processing site in Denver, Colorado. The demand alleged that North Shore Gas is a successor to the liability of a former entity that allegedly disposed of mineral processing wastes there between 1934 and 1941. (See Note 5B of the Notes to Consolidated Financial Statements.)

Gas Charge Reconciliation Proceedings. The Commission is conducting a proceeding regarding the fiscal 2001 reconciliation of Peoples Gas' and North Shore Gas' revenues from the Gas Charge and related costs. On August 7, 2003, three intervenors (Citizens Utility Board (CUB), Illinois Attorney General (AG) and Chicago) filed testimony in Peoples Gas' proceeding and one intervenor (CUB) filed testimony in North Shore Gas' proceeding. Each of the intervenors requested disallowances, which vary in amount depending upon the issues raised and the assumptions and methodologies used to measure the impact of the issues. In the Peoples Gas proceeding, the AG and CUB have requested disallowances, which range from $8 million to $56 million, covering a variety of alleged issues other than financial hedging. CUB has requested an additional disallowance of $53 million and Chicago has requested a disallowance of $230 million based on the financial hedging issue. In the North Shore Gas proceeding, CUB raised only the hedging issue and recommended a disallowance of $10 million. The Commission's Staff (the Staff) filed its testimony in these proceedings on August 15, 2003. The Staff requested a disallowance of $31 million in the Peoples Gas proceeding and $1.4 million in the North Shore Gas proceeding covering a variety of alleged issues, none of which related to hedging. Peoples Gas and North Shore Gas submitted rebuttal testimony in response to the Staff and the intervenors on November 13, 2003. In that testimony, Peoples Gas stated that it would not oppose two disallowances proposed by the Staff, totaling approximately $5.2 million. One of these proposed disallowances, totaling $4.7 million, results in a change in the treatment for accounting and rate making purposes of gas used to support operational capabilities of Peoples Gas' underground storage. This change has no immediate effect on net income because amounts previously recovered through the Gas Charge will be capitalized as property, plant and equipment and depreciated over the asset's useful life. An offsetting liability for this amount, which is expected to be refunded to customers, will be recorded. Peoples Gas will also record property, plant and equipment and liabilities totaling $5.9 million for similar amounts recovered through the Gas Charge in fiscal 2003 and fiscal 2002. These transactions will be recorded in the first quarter of fiscal 2004. Peoples Gas opposed all other proposed disallowances and North Shore Gas opposed all disallowances in its case. The remaining procedural schedule provides for the Staff and intervenors to file rebuttal testimony, Peoples Gas and North Shore Gas to file surrebuttal testimony and evidentiary hearings to be held. An order from the Commission is not expected before the fourth quarter of fiscal 2004. Peoples Gas and North Shore Gas each believes that it conducted business prudently and in the best interest of customers within established standards but cannot predict the outcome of these proceedings.

The Company believes that its fiscal 2001 purchasing practices were consistent with the standards applied by the Commission in its past Orders and upheld by the Illinois courts. Although the Company cannot predict the outcome of these proceedings, the Company believes that it conducted business prudently and in the best interest of customers within these established standards.

Fiscal year 2002 Gas Charge reconciliation cases were initiated on November 7, 2002. Peoples Gas and North Shore Gas each filed direct testimony on August 1, 2003. A status hearing is scheduled for February 10, 2004. Fiscal year 2003 Gas Charge reconciliation cases were initiated on November 12, 2003. Peoples Gas' and North Shore Gas' direct testimony is due on April 1, 2004. A status hearing is scheduled for May 12, 2004.

North Shore Gas' indenture relating to its first mortgage bonds contains provisions and covenants restricting the payment of cash dividends and the purchase or redemption of capital stock. At September 30, 2003, such restrictions amounted to $6.9 million of North Shore Gas' total retained earnings of $80.9 million.

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Peoples District Energy owns a 50 percent equity interest in Trigen-Peoples. The Construction and Term Loan Agreement between Trigen-Peoples and Prudential related to Trigen-Peoples' project financing prohibits any distribution that would result in the partners' total capital account in Trigen-Peoples being less than $7.0 million. At September 30, 2003, the partners' capital account was $7.7 million. The Construction and Term Loan Agreement also prohibits any distribution unless the partnership's debt service coverage ratio for the four fiscal quarters prior to the distribution was at least 1.25 to 1.0. Trigen-Peoples' debt service coverage ratios for the last four fiscal quarters were 1.98 to 1.0, 1.85 to 1.0, 2.28 to 1.0, and 2.07 to 1.0.

Peoples Energy Resources owns a 50 percent equity interest in Elwood. Elwood's trust indenture and other agreements related to its project financing prohibit Elwood from making distributions, unless Elwood has maintained certain minimum historic and projected debt service coverage ratios. At July 7, 2003, the most recent semi-annual distribution date, a minimum debt service coverage ratio of 1.2 to 1.0 was required and Elwood's actual debt service coverage ratio was approximately 1.5 to 1.0.

Market Risk. The Company's earnings may vary due to changes in commodity prices (market risk) through its subsidiaries' operations and investments. To manage this market risk, the Company uses forward contracts and financial instruments, including commodity futures contracts, swaps, no-cost collars and options contracts.

It is the policy of the Company to use these instruments solely for the purpose of managing risk and not for any speculative purpose. All market risk is identified and reduced to levels less than the maximum earnings-at-risk limit approved by the Board of Directors. All hedging is conducted on registered exchanges or with counterparties that meet stringent credit requirements. Formal risk management policies and procedures are in place for all subsidiaries. Most of these instruments qualify for hedge accounting. Therefore, gains and losses from these instruments will be recorded in the income statement in the same month that the underlying hedged activity is recorded. Any hedge ineffectiveness is booked monthly to the income statement. (See Note 1M of the Notes to Consolidated Financial Statements.)

The Company monitors and controls its derivative and physical positions using analytical techniques including measuring future obligations to changes in market price (mark-to-market), sensitivity analysis and value at risk. This process provides information on credit exposure as well as the current value of the portfolio. All NYMEX valuations are based on well publicized market prices rather than model valuation projections. Monthly projections of basis valuation are based on deal quotes and adjusted for seasonality based on historical trends.

Starting in the second quarter of fiscal 2002, the Company's utilities began to use financial derivative instruments to lock in the purchase price for a portion of its future natural gas purchases. The strategy is intended to minimize fluctuations in gas costs charged to the utility gas sales customers. Since these derivative instruments are not designated as hedges and are employed to support gas costs charged to utility gas sales customers, the accounting for these derivative instruments is subject to SFAS No. 71. Therefore, changes in the market value of these derivatives are recorded as a regulatory asset or regulatory liability on the balance sheet. Gains or losses on the settlement of these contracts are included as an adjustment to gas purchases in the determination of the monthly Gas Charge passed through to customers.

The Company has positions in natural gas transportation and inventory as part of its Midstream Services operations. The Company uses derivative financial instruments to protect against loss of value in its capacity caused by changes in the market place. Most of these are considered cash flow hedges of future transactions. A small portion are used to protect the value of inventory and are accounted for as fair value hedges. Gains and losses from these instruments will be recorded in the income statement in the same month the underlying hedged activity is recorded. Although most of the physical contracts managed by the Midstream Services segment are accounted for on an accrual basis, certain contracts may be accounted for on a mark-to-market basis. As of September 30, 2003, there was no material mark-to-market effect for physical contracts.

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The Company sells fixed price and variable priced products as part of its Retail Energy Services business. Price risk is managed through the use of supplier contracts, storage and financial transactions. As of September 30, 2003, the exposure from open positions was immaterial.

The Power Generation segment has entered into power sales contracts that effectively eliminate fuel price risk.

The following table summarizes the valuation of outstanding financial contracts for fiscal 2003 and 2002.