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Public Service Enterprise Group 10-Q 2005


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005

OR

£  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                  TO                 

Commission
File Number

Registrants, State of Incorporation,
Address, and Telephone Number

I.R.S. Employer
Identification No.

 

001-09120

  PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
(A New Jersey Corporation)
80 Park Plaza, P.O. Box 1171
Newark, New Jersey 07101-1171
973 430-7000
http://www.pseg.com
  22-2625848  
 

001-00973

  PUBLIC SERVICE ELECTRIC AND GAS COMPANY
(A New Jersey Corporation)
80 Park Plaza, P.O. Box 570
Newark, New Jersey 07101-0570
973 430-7000
http://www.pseg.com
  22-1212800  
 

000-49614

  PSEG POWER LLC
(A Delaware Limited Liability Company)
80 Park Plaza—T25
Newark, New Jersey 07102-4194
973 430-7000
http://www.pseg.com
  22-3663480  
 

000-32503

  PSEG ENERGY HOLDINGS L.L.C.
(A New Jersey Limited Liability Company)
80 Park Plaza—T20
Newark, New Jersey 07102-4194
973 430-7000
http://www.pseg.com
  42-1544079  


      Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports) and (2) have been subject to such filing requirements for the past 90 days. Yes S    No £

      As of October 24, 2005, Public Service Enterprise Group Incorporated had outstanding 239,296,281 shares of its sole class of Common Stock, without par value.

      As of October 24, 2005, Public Service Electric and Gas Company had issued and outstanding 132,450,344 shares of Common Stock, without nominal or par value, all of which were privately held, beneficially and of record by Public Service Enterprise Group Incorporated.

      PSEG Power LLC and PSEG Energy Holdings L.L.C. are wholly owned subsidiaries of Public Service Enterprise Group Incorporated and meet the conditions set forth in General Instruction H(1) (a) and (b) of Form 10-Q and are filing their respective Quarterly Reports on Form 10-Q with the reduced disclosure format authorized by General Instruction H.

      Indicate by check mark whether each registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

             Public Service Enterprise Group Incorporated Yes S      No £  
             Public Service Electric and Gas Company Yes £      No S  
             PSEG Power LLC Yes £      No S  
             PSEG Energy Holdings L.L.C. Yes £      No S  



TABLE OF CONTENTS

        Page

FORWARD-LOOKING STATEMENTS        ii  
PART I. FINANCIAL INFORMATION        

Item 1.

     Financial Statements        

          

           Public Service Enterprise Group Incorporated        1  

          

           Public Service Electric and Gas Company        5  

          

           PSEG Power LLC        9  

          

           PSEG Energy Holdings L.L.C.        12  

          

     Notes to Condensed Consolidated Financial Statements        

          

           Note 1. Organization and Basis of Presentation        16  

          

           Note 2. Recent Accounting Standards        19  

          

           Note 3. Discontinued Operations, Dispositions and Acquisitions        21  

          

           Note 4. Earnings Per Share (EPS)        24  

          

           Note 5. Commitments and Contingent Liabilities        24  

          

           Note 6. Risk Management        36  

          

           Note 7. Comprehensive Income (Loss), Net of Tax        40  

          

           Note 8. Changes in Capitalization        41  

          

           Note 9. Other Income and Deductions        42  

          

           Note 10. Income Taxes        44  

          

           Note 11. Financial Information by Business Segments        45  

          

           Note 12. Related-Party Transactions        46  

          

           Note 13. Guarantees of Debt        49  

Item 2.

     Management’s Discussion and Analysis of Financial Condition and Results of
      Operations (MD&A)
       52  

          

     Pending Merger        52  

          

     Overview        54  

          

     Results of Operations        59  

          

     Liquidity and Capital Resources        69  

          

     Capital Requirements        75  

          

     Accounting Matters        76  

Item 3.

     Qualitative and Quantitative Disclosures About Market Risk        76  

Item 4.

     Controls and Procedures        82  


PART II. OTHER INFORMATION

       

Item 1.

     Legal Proceedings        83  

Item 5.

     Other Information        84  

Item 6.

     Exhibits        87  

Signatures

           88  

i


FORWARD-LOOKING STATEMENTS

      Certain of the matters discussed in this report constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those anticipated. Such statements are based on management's beliefs as well as assumptions made by and information currently available to management. When used herein, the words “anticipate,” “intend,” “estimate,” “believe,” “expect,” “plan,” “hypothetical,” “potential,” “forecast,” “project,” variations of such words and similar expressions are intended to identify forward-looking statements. Public Service Enterprise Group Incorporated (PSEG), Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power) and PSEG Energy Holdings L.L.C. (Energy Holdings) undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following review should not be construed as a complete list of factors that could effect forward-looking statements.

      In addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements discussed above, factors that could cause actual results to differ materially from those contemplated in any forward-looking statements include, among others, the following:

PSEG, PSE&G, Power and Energy Holdings

business conditions, financial market, credit rating, regulatory and other risks resulting from the pending merger with Exelon Corporation;
 
credit, commodity, interest rate, counterparty and other financial market risks;
 
liquidity and the ability to access capital and maintain adequate credit ratings;
 
adverse or unanticipated weather conditions that significantly impact costs and/or operations, including generation;
 
changes in the electric industry, including changes to power pools;
 
changes in the number of market participants and the risk profiles of such participants;
 
changes in technology that make generation, transmission and/or distribution assets less competitive;
 
availability of power transmission facilities that impact the ability to deliver output to customers;
 
growth in costs and expenses;
 
operating performance or cash flow from investments falling below projected levels;
 
environmental regulations that significantly impact operations;
 
changes in rates of return on overall debt and equity markets that could adversely impact the value of pension assets and liabilities and the Nuclear Decommissioning Trust Funds;
 
ability to maintain satisfactory regulatory results;
 
changes in political conditions, recession, acts of war or terrorism;
 
continued availability of insurance coverage at commercially reasonable rates;
 
involvement in lawsuits, including liability claims and commercial disputes;
 
inability to attract and retain management and other key employees, particularly in view of the pending merger with Exelon Corporation;
 
acquisitions, divestitures, mergers, restructurings or strategic initiatives that change PSEG's, PSE&G's, Power's and Energy Holdings' strategy or structure;
 
business combinations among competitors and major customers;
 
general economic conditions, including inflation or deflation;
 
regulatory issues that significantly impact operations;

ii


changes to accounting standards or accounting principles generally accepted in the U.S., which may require adjustments to financial statements;
 
changes in tax laws and regulations;
 
ability to recover investments or service debt as a result of any of the risks or uncertainties mentioned herein;

PSEG, PSE&G and Energy Holdings

ability to obtain adequate and timely rate relief;

PSEG, Power and Energy Holdings

energy transmission constraints or lack thereof;
 
adverse changes in the market for energy, capacity, natural gas, emissions credits, congestion credits and other commodity prices, especially during significant price movements for natural gas and power;
 
surplus of energy capacity and excess supply;
 
substantial competition in the worldwide energy markets;
 
inability to effectively manage portfolios of electric generation assets, gas supply contracts and electric and gas supply obligations;
 
margin posting requirements, especially during significant price movements for natural gas and power;
 
availability of fuel and timely transportation at reasonable prices;
 
effects on competitive position of actions involving competitors or major customers;
 
changes in product or sourcing mix;
 
delays, cost escalations or unsuccessful acquisitions, construction and development;

PSEG and Power

changes in regulation and safety and security measures at nuclear facilities;

PSEG and Energy Holdings

changes in political regimes in foreign countries;
 
international developments negatively impacting business;
 
changes in foreign currency exchange rates;
 
deterioration in the credit of lessees and their ability to adequately service lease rentals; and
 
ability to realize tax benefits.

      Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and PSEG, PSE&G, Power and Energy Holdings cannot assure you that the results or developments anticipated by management will be realized, or even if realized, will have the expected consequences to, or effects on, PSEG, PSE&G, Power and Energy Holdings or their respective business prospects, financial condition or results of operations. Undue reliance should not be placed on these forward-looking statements in making any investment decision. Each of PSEG, PSE&G, Power and Energy Holdings expressly disclaims any obligation or undertaking to release publicly any updates or revisions to these forward-looking statements to reflect events or circumstances that occur or arise or are anticipated to occur or arise after the date hereof. In making any investment decision regarding PSEG's, PSE&G's, Power's and Energy Holdings' securities, PSEG, PSE&G, Power and Energy Holdings are not making, and you should not infer, any representation about the likely existence of any particular future set of facts or circumstances. The forward-looking statements contained in this report are intended to qualify for the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

iii


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

    For The Quarters
Ended
September 30,

  For The Nine Months
Ended
September 30,

    2005

  2004

  2005

  2004

    (Millions, except for share data)
(Unaudited)

OPERATING REVENUES

     $ 3,376        $ 2,749        $ 9,127        $ 8,262  

OPERATING EXPENSES

                               

Energy Costs

       1,999          1,418          5,213          4,498  

Operation and Maintenance

       560          527          1,734          1,604  

Depreciation and Amortization

       207          190          572          525  

Taxes Other Than Income Taxes

       34          30          105          103  
        
        
        
        
 

Total Operating Expenses

       2,800          2,165          7,624          6,730  
        
        
        
        
 

Income from Equity Method Investments

       29          31          96          92  
        
        
        
        
 

OPERATING INCOME

       605          615          1,599          1,624  

Other Income

       91          45          166          152  

Other Deductions

       (36 )        (23 )        (64 )        (63 )

Interest Expense

       (216 )        (207 )        (631 )        (627 )

Preferred Stock Dividends

       (1 )        (1 )        (3 )        (3 )
        
        
        
        
 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

       443          429          1,067          1,083  

Income Tax Expense

       (183 )        (177 )        (414 )        (422 )
        
        
        
        
 

INCOME FROM CONTINUING OPERATIONS

       260          252          653          661  

Loss from Discontinued Operations, including Loss on Disposal, net of tax benefit of $4, $5, $136 and $18 for the quarter and nine months ended 2005 and 2004, respectively

       (7 )        (8 )        (197 )        (22 )
        
        
        
        
 

NET INCOME

     $ 253        $ 244        $ 456        $ 639  
        
        
        
        
 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (THOUSANDS):

                               

BASIC

       239,034          237,269          238,696          236,724  
        
        
        
        
 

DILUTED

       244,286          237,728          243,212          237,883  
        
        
        
        
 

EARNINGS PER SHARE:

                               

BASIC

                               

INCOME FROM CONTINUING OPERATIONS

     $ 1.08        $ 1.06        $ 2.73        $ 2.79  

NET INCOME

     $ 1.06        $ 1.03        $ 1.91        $ 2.70  
        
        
        
        
 

DILUTED

                               

INCOME FROM CONTINUING OPERATIONS

     $ 1.06        $ 1.06        $ 2.68        $ 2.78  

NET INCOME

     $ 1.03        $ 1.03        $ 1.87        $ 2.69  
        
        
        
        
 

                               

See Notes to Condensed Consolidated Financial Statements.

1


PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS

    September 30,
2005

  December 31,
2004

    (Millions)
(Unaudited)

ASSETS

               

CURRENT ASSETS

               

Cash and Cash Equivalents

     $ 608        $ 279  

Accounts Receivable, net of allowances of $32 and $35 in 2005 and 2004, respectively

       1,764          1,621  

Unbilled Revenues

       227          340  

Fuel

       797          633  

Materials and Supplies

       279          255  

Energy Trading Contracts

       705          161  

Prepayments

       244          122  

Restricted Funds

       82          50  

Assets of Discontinued Operations

                511  

Other

       93          203  
        
        
 

Total Current Assets

       4,799          4,175  
        
        
 

      

               

PROPERTY, PLANT AND EQUIPMENT

       19,076          18,620  

Less: Accumulated Depreciation and Amortization

       (5,600 )        (5,355 )
        
        
 

Net Property, Plant and Equipment

       13,476          13,265  
        
        
 

NONCURRENT ASSETS

               

Regulatory Assets

       4,960          5,127  

Long-Term Investments

       4,326          4,181  

Nuclear Decommissioning Trust (NDT) Funds

       1,123          1,086  

Other Special Funds

       514          488  

Goodwill and Other Intangibles

       608          630  

Other

       309          292  
        
        
 

Total Noncurrent Assets

       11,840          11,804  
        
        
 

TOTAL ASSETS

     $ 30,115        $ 29,244  
        
        
 

               

See Notes to Condensed Consolidated Financial Statements.

2


PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS

    September 30,
2005

  December 31,
2004

    (Millions)
(Unaudited)

LIABILITIES AND CAPITALIZATION

               

CURRENT LIABILITIES

               

Long-Term Debt Due Within One Year

     $ 1,453        $ 386  

Commercial Paper and Loans

       371          638  

Accounts Payable

       1,089          1,362  

Derivative Contracts

       538          207  

Energy Trading Contracts

       287          125  

Accrued Interest

       228          154  

Accrued Taxes

       58          54  

Clean Energy Program

       93          82  

Other

       554          484  
        
        
 

Total Current Liabilities

       4,671          3,492  
        
        
 

NONCURRENT LIABILITIES

               

Deferred Income Taxes and Investment Tax Credits (ITC)

       4,229          4,350  

Regulatory Liabilities

       1,101          545  

Nuclear Decommissioning Liabilities

       331          310  

Other Postretirement Benefit (OPEB) Costs

       585          563  

Clean Energy Program

       261          324  

Environmental Costs

       338          366  

Derivative Contracts

       560          238  

Other

       310          307  
        
        
 

Total Noncurrent Liabilities

       7,715          7,003  
        
        
 

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5)

               

CAPITALIZATION

               

LONG-TERM DEBT

               

Long-Term Debt

       8,206          8,414  

Securitization Debt

       1,926          1,939  

Project Level, Non-Recourse Debt

       1,198          1,371  

Debt Supporting Trust Preferred Securities

       814          1,201  
        
        
 

Total Long-Term Debt

       12,144          12,925  
        
        
 

SUBSIDIARIES' PREFERRED SECURITIES

               

Preferred Stock Without Mandatory Redemption,
$100 par value, 7,500,000 authorized; issued and outstanding, 2005 and 2004—795,234 shares

       80          80  
        
        
 

COMMON STOCKHOLDERS' EQUITY

               

Common Stock, no par, authorized 500,000,000 shares; issued; 2005—265,057,913 shares and 2004—264,128,807 shares

       4,581          4,569  

Treasury Stock, at cost; 2005—25,775,063 shares; 2004—26,029,740 shares

       (968 )        (978 )

Retained Earnings

       2,480          2,425  

Accumulated Other Comprehensive Loss

       (588 )        (272 )
        
        
 

Total Common Stockholders' Equity

       5,505          5,744  
        
        
 

Total Capitalization

       17,729          18,749  
        
        
 

TOTAL LIABILITIES AND CAPITALIZATION

     $ 30,115        $ 29,244  
        
        
 

               

See Notes to Condensed Consolidated Financial Statements.

3


PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS

    For The Nine Months Ended
September 30,

    2005

  2004

    (Millions)
(Unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net Income

     $ 456        $ 639  

Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:

               

Loss (Gain) on Disposal of Discontinued Operations, net of tax

       178          (5 )

Gain on Disposition of Property, Plant and Equipment

       (5 )        (1 )

Write-Down of Project Investments

       22          6  

Depreciation and Amortization

       572          525  

Amortization of Nuclear Fuel

       69          63  

Provision for Deferred Income Taxes (Other than Leases) and ITC

       155          56  

Non-Cash Employee Benefit Plan Costs

       175          161  

Leveraged Lease Losses (Income), Adjusted for Rents Received and Deferred Taxes

       9          (88 )

Gain on Sale of Investments

       (50 )        (31 )

Undistributed Earnings from Affiliates

       (40 )        (8 )

Foreign Currency Transaction (Gain) Loss

       (1 )        9  

Unrealized Losses on Energy Contracts and Other Derivatives

       4          2  

Over Recovery of Electric Energy Costs (BGS and NTC) and Gas Costs

       75          95  

Under Recovery of Societal Benefits Charge (SBC)

       (94 )        (31 )

Net Realized Gains and Income from NDT Funds

       (94 )        (96 )

Other Non-Cash Charges

       41          36  

Net Change in Certain Current Assets and Liabilities

       (447 )        (124 )

Employee Benefit Plan Funding and Related Payments

       (159 )        (154 )

Proceeds from the Withdrawal of Partnership Interests and Other Distributions

       63          121  

Other

       (22 )        79  
        
        
 

Net Cash Provided By Operating Activities

       907          1,254  
        
        
 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Additions to Property, Plant and Equipment

       (751 )        (887 )

Investments in Joint Ventures, Partnerships and Capital Leases

                (15 )

Proceeds from Sale of Property, Plant and Equipment

       226           

Proceeds from the Sale of Investments and Return of Capital from Partnerships

       26          306  

Proceeds from Collection of Notes Receivable

       132           

Restricted Funds

       (47 )        (92 )

Other

       8          (5 )
        
        
 

Net Cash Used In Investing Activities

       (406 )        (693 )
        
        
 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Net Change in Commercial Paper and Loans

       (267 )        361  

Issuance of Long-Term Debt

       728          1,398  

Issuance of Non-Recourse Debt

       4          15  

Issuance of Common Stock

       55          63  

Redemptions of Long-Term Debt

       (230 )        (2,129 )

Repayment of Non-Recourse Debt

       (20 )         

Cash Dividends Paid on Common Stock

       (401 )        (391 )

Other

       (42 )        (14 )
        
        
 

Net Cash Used In Financing Activities

       (173 )        (697 )
        
        
 

Effect of Exchange Rate Change

       1           
        
        
 

Net Increase (Decrease) in Cash and Cash Equivalents

       329          (136 )

Cash and Cash Equivalents at Beginning of Period

       279          452  
        
        
 

Cash and Cash Equivalents at End of Period

     $ 608        $ 316  
        
        
 

Supplemental Disclosure of Cash Flow Information:

               

Income Taxes Paid

     $ 102        $ 95  

Interest Paid, Net of Amounts Capitalized

     $ 618        $ 558  

               

See Notes to Condensed Consolidated Financial Statements.

4


PUBLIC SERVICE ELECTRIC AND GAS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

    For The Quarters Ended
September 30,

  For The Nine Months Ended
September 30,

    2005

  2004

  2005

  2004

    (Millions)
(Unaudited)

OPERATING REVENUES

     $ 1,934        $ 1,636        $ 5,559        $ 5,236  

OPERATING EXPENSES

                               

Energy Costs

       1,195          960          3,472          3,203  

Operation and Maintenance

       276          261          839          797  

Depreciation and Amortization

       155          140          418          393  

Taxes Other Than Income Taxes

       35          30          106          103  
        
        
        
        
 

Total Operating Expenses

       1,661          1,391          4,835          4,496  
        
        
        
        
 

OPERATING INCOME

       273          245          724          740  

Other Income

       3          4          7          10  

Other Deductions

       (1 )                 (2 )        (1 )

Interest Expense

       (86 )        (86 )        (256 )        (273 )
        
        
        
        
 

INCOME BEFORE INCOME TAXES

       189          163          473          476  

Income Tax Expense

       (74 )        (70 )        (191 )        (195 )
        
        
        
        
 

NET INCOME

       115          93          282          281  

Preferred Stock Dividends

       (1 )        (1 )        (3 )        (3 )
        
        
        
        
 

EARNINGS AVAILABLE TO PUBLIC
SERVICE ENTERPRISE GROUP
INCORPORATED

     $ 114        $ 92        $ 279        $ 278  
        
        
        
        
 

                               

See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Condensed Consolidated Financial Statements.

5


PUBLIC SERVICE ELECTRIC AND GAS COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS

    September 30,
2005

  December 31,
2004

    (Millions)
(Unaudited)

ASSETS

               

CURRENT ASSETS

               

Cash and Cash Equivalents

     $ 292        $ 6  

Accounts Receivable, net of allowances of $34 in 2005 and $32 in 2004

       784          745  

Accounts Receivable—Affiliated Companies, net

       240           

Unbilled Revenues

       227          340  

Materials and Supplies

       52          45  

Prepayments

       152          61  

Restricted Cash

       7          5  

Other

       20          19  
        
        
 

Total Current Assets

       1,774          1,221  
        
        
 

PROPERTY, PLANT AND EQUIPMENT

       10,466          10,159  

Less: Accumulated Depreciation and Amortization

       (3,583 )        (3,471 )
        
        
 

Net Property, Plant and Equipment

       6,883          6,688  
        
        
 

NONCURRENT ASSETS

               

Regulatory Assets

       4,960          5,127  

Long-Term Investments

       142          138  

Other Special Funds

       289          278  

Other

       124          134  
        
        
 

Total Noncurrent Assets

       5,515          5,677  
        
        
 

TOTAL ASSETS

     $ 14,172        $ 13,586  
        
        
 

               

See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Condensed Consolidated Financial Statements.

6


PUBLIC SERVICE ELECTRIC AND GAS COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS

    September 30,
2005

  December 31,
2004

    (Millions)
(Unaudited)

LIABILITIES AND CAPITALIZATION

               

CURRENT LIABILITIES

               

Long-Term Debt Due Within One Year

     $ 478        $ 271  

Commercial Paper and Loans

       185          105  

Accounts Payable

       320          250  

Accounts Payable—Affiliated Companies, net

                404  

Accrued Interest

       43          59  

Clean Energy Program

       93          82  

Other

       382          311  
        
        
 

Total Current Liabilities

       1,501          1,482  
        
        
 

NONCURRENT LIABILITIES

               

Deferred Income Taxes and ITC

       2,582          2,653  

Other Postretirement Benefit (OPEB) Costs

       551          534  

Regulatory Liabilities

       1,101          545  

Clean Energy Program

       261          324  

Environmental Costs

       283          309  

Other

       41          82  
        
        
 

Total Noncurrent Liabilities

       4,819          4,447  
        
        
 

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5)

               

CAPITALIZATION

               

LONG-TERM DEBT

               

Long-Term Debt

       2,866          2,938  

Securitization Debt

       1,926          1,939  
        
        
 

Total Long-Term Debt

       4,792          4,877  
        
        
 

PREFERRED SECURITIES

               

Preferred Stock Without Mandatory Redemption, $100 par value, 7,500,000 authorized; issued and outstanding, 2005 and 2004—795,234 shares

       80          80  
        
        
 

COMMON STOCKHOLDER'S EQUITY

               

Common Stock; 150,000,000 shares authorized, 132,450,344 shares
issued and outstanding

       892          892  

Contributed Capital

       171          170  

Basis Adjustment

       986          986  

Retained Earnings

       935          656  

Accumulated Other Comprehensive Loss

       (4 )        (4 )
        
        
 

Total Common Stockholder's Equity

       2,980          2,700  
        
        
 

Total Capitalization

       7,852          7,657  
        
        
 

TOTAL LIABILITIES AND CAPITALIZATION

     $ 14,172        $ 13,586  
        
        
 

               

See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Condensed Consolidated Financial Statements.

7


PUBLIC SERVICE ELECTRIC AND GAS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

    For the Nine Months Ended
September 30,

    2005

  2004

    (Millions)
(Unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net Income

     $ 282        $ 281  

Adjustments to Reconcile Net Income to Net Cash Flows from
Operating Activities:

               

Depreciation and Amortization

       418          393  

Provision for Deferred Income Taxes and ITC

       (77 )        (103 )

Non-Cash Employee Benefit Plan Costs

       124          118  

Non-Cash Interest Expense

       13          11  

Employee Benefit Plan Funding and Related Payments

       (104 )        (104 )

Over Recovery of Electric Energy Costs (BGS and NTC)

       81          42  

(Under) Over Recovery of Gas Costs

       (6 )        53  

Under Recovery of SBC

       (94 )        (31 )

Other Non-Cash Credits

       3          2  

Gain on Sale of Property, Plant and Equipment

                (1 )

Net Changes in Certain Current Assets and Liabilities:

               

Accounts Receivable and Unbilled Revenues

       (166 )        125  

Materials and Supplies

       (7 )         

Prepayments

       (91 )        (103 )

Accrued Taxes

       (21 )        (5 )

Accrued Interest

       (16 )        (26 )

Accounts Payable

       (334 )        (258 )

Other Current Assets and Liabilities

       102          (74 )

Residential Gas Hedges

       437          86  

Other

       (80 )        4  
        
        
 

Net Cash Provided By Operating Activities

       464          410  
        
        
 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Additions to Property, Plant and Equipment

       (372 )        (290 )

Proceeds from the Sale of Property, Plant and Equipment

                1  

Restricted Funds

       (3 )        (98 )
        
        
 

Net Cash Used In Investing Activities

       (375 )        (387 )
        
        
 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Net Change in Short-Term Debt

       80          285  

Issuance of Long-Term Debt

       250          710  

Redemption of Securitization Debt

       (105 )        (99 )

Redemption of Long-Term Debt

       (125 )        (891 )

Issuance of Securitization Debt

       103           

Deferred Issuance Costs

       (3 )         

Cash Dividends Paid on Common Stock

                (100 )

Preferred Stock Dividends

       (3 )        (3 )
        
        
 

Net Cash Provided By (Used In) Financing Activities

       197          (98 )
        
        
 

Net Increase (Decrease) In Cash and Cash Equivalents

       286          (75 )

Cash and Cash Equivalents at Beginning of Period

       6          140  
        
        
 

Cash and Cash Equivalents at End of Period

     $ 292        $ 65  
        
        
 

Supplemental Disclosure of Cash Flow Information:

               

Income Taxes Paid

     $ 249        $ 301  

Interest Paid, Net of Amounts Capitalized

     $ 250        $ 281  

               

See disclosures regarding Public Service Electric and Gas Company
included in the Notes to Condensed Consolidated Financial Statements.

8


PSEG POWER LLC
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

    For the Quarters Ended
September 30,

  For the Nine Months Ended
September 30,

    2005

  2004

  2005

  2004

    (Millions)
(Unaudited)

OPERATING REVENUES

     $ 1,444        $ 1,130        $ 4,234        $ 3,818  

OPERATING EXPENSES

                               

Energy Costs

       983          636          2,941          2,544  

Operation and Maintenance

       223          211          685          672  

Depreciation and Amortization

       34          29          96          78  
        
        
        
        
 

Total Operating Expenses

       1,240          876          3,722          3,294  
        
        
        
        
 

OPERATING INCOME

       204          254          512          524  

Other Income

       74          36          135          140  

Other Deductions

       (13 )        (13 )        (33 )        (44 )

Interest Expense

       (32 )        (33 )        (86 )        (85 )
        
        
        
        
 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

       233          244          528          535  

Income Tax Expense

       (101 )        (105 )        (225 )        (216 )
        
        
        
        
 

INCOME FROM CONTINUING OPERATIONS

       132          139          303          319  

Loss from Discontinued Operations, net of tax benefit of $4, $5, $13 and $18 for the quarter and nine months ended 2005 and 2004, respectively

       (6 )        (8 )        (19 )        (27 )

Loss on Disposal of Discontinued Operations, net of tax benefit of $0 and $123 for the quarter and nine months ended 2005

       (1 )                 (178 )         
        
        
        
        
 

EARNINGS AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED

     $ 125        $ 131        $ 106        $ 292  
        
        
        
        
 

                               

See disclosures regarding PSEG Power LLC
included in the Notes to Condensed Consolidated Financial Statements.

9


PSEG POWER LLC
CONDENSED CONSOLIDATED BALANCE SHEETS

    September 30,
2005

  December 31,
2004

    (Millions)
(Unaudited)

ASSETS

               

CURRENT ASSETS

               

Cash and Cash Equivalents

     $ 19        $ 10  

Accounts Receivable

       829          740  

Accounts Receivable—Affiliated Companies, net

                324  

Short-Term Loan to Affiliate

       62           

Fuel

       788          621  

Materials and Supplies

       195          175  

Energy Trading Contracts

       705          161  

Assets of Discontinued Operations

                511  

Other

       88          61  
        
        
 

Total Current Assets

       2,686          2,603  
        
        
 

PROPERTY, PLANT AND EQUIPMENT

       6,385          6,073  

Less: Accumulated Depreciation and Amortization

       (1,576 )        (1,482 )
        
        
 

Net Property, Plant and Equipment

       4,809          4,591  
        
        
 

NONCURRENT ASSETS

               

Deferred Income Taxes and Investment Tax Credits (ITC)

       71           

Nuclear Decommissioning Trust (NDT) Funds

       1,123          1,086  

Goodwill and Other Intangibles

       65          107  

Other Special Funds

       130          121  

Other

       146          99  
        
        
 

Total Noncurrent Assets

       1,535          1,413  
        
        
 

TOTAL ASSETS

     $ 9,030        $ 8,607  
        
        
 

LIABILITIES AND MEMBER'S EQUITY

               

CURRENT LIABILITIES

               

Long-Term Debt Due Within One Year

     $ 500        $  

Accounts Payable

       644          992  

Accounts Payable—Affiliated Companies, net

       290           

Short-Term Loan from Affiliate

                98  

Energy Trading Contracts

       287          125  

Derivative Contracts

       490          151  

Accrued Interest

       96          42  

Other

       129          113  
        
        
 

Total Current Liabilities

       2,436          1,521  
        
        
 

NONCURRENT LIABILITIES

               

Deferred Income Taxes and Investment Tax Credits (ITC)

                96  

Nuclear Decommissioning Liabilities

       331          310  

Derivative Contracts

       470          119  

Other

       182          162  
        
        
 

Total Noncurrent Liabilities

       983          687  
        
        
 

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5)

               

LONG-TERM DEBT

               

Total Long-Term Debt

       2,817          3,316  
        
        
 

MEMBER'S EQUITY

               

Contributed Capital

       2,000          2,000  

Basis Adjustment

       (986 )        (986 )

Retained Earnings

       2,224          2,118  

Accumulated Other Comprehensive Loss

       (444 )        (49 )
        
        
 

Total Member's Equity

       2,794          3,083  
        
        
 

TOTAL LIABILITIES AND MEMBER'S EQUITY

     $ 9,030        $ 8,607  
        
        
 

               

See disclosures regarding PSEG Power LLC
included in the Notes to Condensed Consolidated Financial Statements.

10


PSEG POWER LLC
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

    For the Nine Ended
September 30,

    2005

  2004

    (Millions)
(Unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net Income

     $ 106        $ 292  

Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:

               

Loss on Disposal of Discontinued operations, net of tax benefit

       178           

Gain on Disposition of Property, Plant and Equipment

       (5 )         

Depreciation and Amortization

       96          78  

Amortization of Nuclear Fuel

       69          63  

Interest Accretion on NDT Liability

       21          19  

Provision for Deferred Income Taxes and ITC

       239          134  

Unrealized (Gains) Losses on Energy Contracts and Other Derivatives

       (2 )        2  

Non-Cash Employee Benefit Plan Costs

       34          29  

Net Realized Gains and Income from NDT Fund

       (94 )        (96 )

Net Change in Certain Current Assets and Liabilities:

               

Fuel, Materials and Supplies

       (187 )        (174 )

Accounts Receivable

       235          176  

Accounts Payable

       (58 )        (174 )

Other Current Assets and Liabilities

       61          176  

Employee Benefit Plan Funding and Related Payments

       (35 )        (36 )

Other

       67          85  

Residential Gas Hedges

       (437 )        (86 )
        
        
 

Net Cash Provided By Operating Activities

       288          488  
        
        
 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Additions to Property, Plant and Equipment

       (345 )        (522 )

Sales of Property, Plant and Equipment

       226           

Short-Term Loan to Affiliate

       (62 )        77  

Other

                (4 )
        
        
 

Net Cash Used In Investing Activities

       (181 )        (449 )
        
        
 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Issuance of Recourse Long-Term Debt

                488  

Redemption of Non-Recourse Long-Term Debt

                (800 )

Short-Term Loan from Affiliate

       (98 )        262  
        
        
 

Net Cash Used In Financing Activities

       (98 )        (50 )
        
        
 

Net Increase (Decrease) in Cash and Cash Equivalents

       9          (11 )

Cash and Cash Equivalents at Beginning of Period

       10          27  
        
        
 

Cash and Cash Equivalents at End of Period

     $ 19        $ 16  
        
        
 

Supplemental Disclosure of Cash Flow Information:

               

Income Taxes Paid

     $ 9        $ 19  

Interest Paid, Net of Amounts Capitalized

     $ 62        $ 60  

               

See disclosures regarding PSEG Power LLC
included in the Notes to Condensed Consolidated Financial Statements.

11


PSEG ENERGY HOLDINGS L.L.C.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

    For the Quarters Ended
September 30,

  For the Nine Months Ended
September 30,

    2005

  2004

  2005

  2004

    (Millions)
(Unaudited)

OPERATING REVENUES

                               

Electric Generation and Distribution Revenues

     $ 325        $ 251        $ 897        $ 495  

Income from Capital and Operating Leases

       44          48          136          149  

Other

       10          12          52          57  
        
        
        
        
 

Total Operating Revenues

       379          311          1,085          701  
        
        
        
        
 

OPERATING EXPENSES

                               

Energy Costs

       203          148          552          242  

Operation and Maintenance

       58          64          207          163  

Depreciation and Amortization

       14          15          45          40  
        
        
        
        
 

Total Operating Expenses

       275          227          804          445  
        
        
        
        
 

Income from Equity Method Investments

       29          31          96          92  
        
        
        
        
 

OPERATING INCOME

       133          115          377          348  

Other Income

       5          4          14          4  

Other Deductions

       (9 )        (8 )        (12 )        (14 )

Interest Expense

       (65 )        (66 )        (193 )        (196 )
        
        
        
        
 

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND MINORITY INTEREST

       64          45          186          142  

Income Tax Expense

       (26 )        (8 )        (43 )        (34 )

Minority Interests in Earnings of Subsidiaries

       1          (1 )        (3 )        (3 )
        
        
        
        
 

INCOME FROM CONTINUING OPERATIONS

       39          36          140          105  

Income from Discontinued Operations, including Gain on Disposal, net of tax

                                  5  
        
        
        
        
 

NET INCOME

       39          36          140          110  

Preference Units Distributions

                (3 )        (3 )        (13 )
        
        
        
        
 

EARNINGS AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED

     $ 39        $ 33        $ 137        $ 97  
        
        
        
        
 

                               

See disclosures regarding PSEG Energy Holdings L.L.C.
included in the Notes to Condensed Consolidated Financial Statements.

12


PSEG ENERGY HOLDINGS L.L.C.
CONDENSED CONSOLIDATED BALANCE SHEETS

    September 30,
2005

  December 31,
2004

    (Millions)
(Unaudited)

ASSETS

               

CURRENT ASSETS

               

Cash and Cash Equivalents

     $ 256          $ 199  

Accounts Receivable:

               

Trade—net of allowances of $0 in 2005 and 2004

       137            114  

Other Accounts Receivable

       13            20  

Affiliated Companies

                  19  

Notes Receivable:

               

Affiliated Companies

       61            115  

Other

       5            138  

Inventory

       40            47  

Restricted Funds

       75            45  

Other

       7            7  
        
          
 

Total Current Assets

       594            704  
        
          
 

PROPERTY, PLANT AND EQUIPMENT

       1,916            2,084  

Less: Accumulated Depreciation and Amortization

       (252 )          (227 )
        
          
 

Net Property, Plant and Equipment

       1,664            1,857  
        
          
 

NONCURRENT ASSETS

               

Leveraged Leases, net

       2,926            2,851  

Corporate Joint Ventures

       992            894  

Partnership Interests

       212            219  

Goodwill and Other Intangibles

       537            517  

Other

       119            153  
        
          
 

Total Noncurrent Assets

       4,786            4,634  
        
          
 

TOTAL ASSETS

     $ 7,044          $ 7,195  
        
          
 

               

See disclosures regarding PSEG Energy Holdings L.L.C.
included in the Notes to Condensed Consolidated Financial Statements.

13


PSEG ENERGY HOLDINGS L.L.C.
CONDENSED CONSOLIDATED BALANCE SHEETS

    September 30,
2005

  December 31,
2004

    (Millions)
(Unaudited)

LIABILITIES AND MEMBER'S EQUITY

               

CURRENT LIABILITIES

               

Long-Term Debt Due Within One Year

     $ 39          $ 66  

Accounts Payable:

               

Trade

       58            59  

Affiliated Companies

       3            2  

Derivative Contracts

       36            37  

Accrued Interest

       74            51  

Other

       53            71  
        
          
 

Total Current Liabilities

       263            286  
        
          
 

NONCURRENT LIABILITIES

               

Deferred Income Taxes and Investment and Energy Tax Credits

       1,702            1,587  

Derivative Contracts

       71            88  

Other

       76            56  
        
          
 

Total Noncurrent Liabilities

       1,849            1,731  
        
          
 

COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5)

               

MINORITY INTERESTS

       30            35  
        
          
 

LONG-TERM DEBT

               

Project Level, Non-Recourse Debt

       1,198            1,371  

Senior Notes

       1,754            1,756  
        
          
 

Total Long-Term Debt

       2,952            3,127  
        
          
 

MEMBER'S EQUITY

               

Ordinary Unit

       1,713            1,813  

Preference Units

                  184  

Retained Earnings

       365            228  

Accumulated Other Comprehensive Loss

       (128 )          (209 )
        
          
 

Total Member's Equity

       1,950            2,016  
        
          
 

TOTAL LIABILITIES AND MEMBER'S EQUITY

     $ 7,044          $ 7,195  
        
          
 

               

See disclosures regarding PSEG Energy Holdings L.L.C.
included in the Notes to Condensed Consolidated Financial Statements.

14


PSEG ENERGY HOLDINGS L.L.C.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

    For the Nine Months Ended
September 30,

    2005

  2004

    (Millions)
(Unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net Income

     $ 140        $ 110  

Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:

               

Gain on Disposal of Discontinued Operations, net of tax

                (5 )

Depreciation and Amortization

       45          40  

Demand Side Management Amortization

       6          6  

Investment Write-off

       22           

Deferred Income Taxes (Other than Leases)

       (7 )        22  

Leveraged Lease Expense (Income), Adjusted for Rents Received and Deferred Income Taxes

       9          (88 )

Undistributed Earnings from Affiliates

       (40 )        (8 )

Gain on Sale of Investments

       (50 )        (31 )

Unrealized (Gain) Loss on Investments

       (1 )        1  

Foreign Currency Transaction (Gain) Loss

       (1 )        9  

Change in Fair Value of Derivative Financial Instruments

       6          (1 )

Other Non-Cash Charges

       4          7  

Net Changes in Certain Current Assets and Liabilities:

               

Accounts Receivable

       (3 )        229  

Inventory

       4          (5 )

Accounts Payable

       18          (38 )

Other Current Assets and Liabilities

       6          (4 )

Proceeds from Withdrawal of Partnership Interests and Other Distributions

       63          121  

Other

       (1 )        3  
        
        
 

Net Cash Provided By Operating Activities

       220          368  
        
        
 

CASH FLOWS FROM INVESTING ACTIVITIES

               

Additions to Property, Plant and Equipment

       (26 )        (64 )

Investments in Joint Ventures, Partnerships, and Leveraged Lease Agreements

                (15 )

Proceeds from the Sale of Investments and Return of Capital from Partnerships

       26          77  

Proceeds from Termination of Capital Leases

                229  

Short-Term Loan Receivable—Affiliated Company

       54          155  

Restricted Funds

       (44 )        6  

Proceeds from Collection of Notes Receivable

       132           

Other

       3          1  
        
        
 

Net Cash Provided By Investing Activities

       145          389  
        
        
 

CASH FLOWS FROM FINANCING ACTIVITIES

               

Repayment of Senior Notes

                (311 )

Proceeds from Project-Level Non-Recourse Long-Term Debt

       4          15  

Repayment of Project-Level Non-Recourse Long-Term Debt

       (20 )        (28 )

Return of Capital Contributed

       (100 )        (75 )

Cash Distributions Paid on Preference Units

       (3 )        (13 )

Redemptions of Preference Units

       (184 )        (225 )

Other

       (6 )         
        
        
 

Net Cash Used In Financing Activities

       (309 )        (637 )
        
        
 

Effect of Exchange Rate Change

       1           
        
        
 

Net Increase In Cash and Cash Equivalents

       57          120  

Cash and Cash Equivalents at Beginning of Period

       199          104  
        
        
 

Cash and Cash Equivalents at End of Period

     $ 256        $ 224  
        
        
 

Supplemental Disclosure of Cash Flow Information:

               

Income Taxes Paid (Received)

     $ 4        $ (173 )

Interest Paid, Net of Amounts Capitalized

     $ 203        $ 127  

               

See disclosures regarding PSEG Energy Holdings L.L.C.
included in the Notes to Condensed Consolidated Financial Statements.

15


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      This combined Form 10-Q is separately filed by Public Service Enterprise Group Incorporated (PSEG), Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power) and PSEG Energy Holdings L.L.C. (Energy Holdings). Information contained herein relating to any individual company is filed by such company on its own behalf. PSE&G, Power and Energy Holdings each make representations only as to itself and make no representations as to any other company.

Note 1. Organization and Basis of Presentation

Organization

      PSEG

      PSEG has four principal direct wholly owned subsidiaries: PSE&G, Power, Energy Holdings and PSEG Services Corporation (Services).

      As previously disclosed, on December 20, 2004, PSEG entered into an agreement and plan of merger (Merger Agreement) with Exelon Corporation (Exelon), a public utility holding company registered under the Public Utility Holding Company Act of 1935 (PUHCA), which is headquartered in Chicago, Illinois, whereby PSEG will be merged with and into Exelon (Merger). Under the Merger Agreement, each share of PSEG Common Stock will be converted into 1.225 shares of Exelon Common Stock.

      The Merger Agreement has been unanimously approved by both companies' Boards of Directors. On June 30, 2005, the Federal Energy Regulatory Commission (FERC) approved the Merger. On July 19, 2005, shareholders of PSEG voted to approve the Merger and on July 22, 2005, shareholders of Exelon voted to approve the issuance of common shares to PSEG shareholders to effect the Merger.

      Completion of the Merger is subject to approval by a number of governmental authorities, some of which have already been obtained. The authorities may impose conditions on completion of the Merger, require changes to the terms of the Merger or fail to approve the Merger.

      PSE&G

      PSE&G is an operating public utility engaged principally in the transmission of electric energy and distribution of electric energy and natural gas service in certain areas of New Jersey. PSE&G is subject to regulation by the New Jersey Board of Public Utilities (BPU) and the FERC.

      PSE&G also owns PSE&G Transition Funding LLC (Transition Funding) and PSE&G Transition Funding II LLC (Transition Funding II), bankruptcy-remote entities that purchased certain transition property from PSE&G and issued transition bonds secured by such property. The transition property consists principally of the right to receive electricity consumption-based per kilowatt hour charges from PSE&G electric distribution customers, which represents the irrevocable right to receive amounts sufficient to recover certain of PSE&G's transition costs related to deregulation, as approved by the BPU.

      Power

      Power is a multi-regional, wholesale energy supply company that integrates its generating asset operations with its wholesale energy, fuel supply, energy trading and marketing and risk management function through three principal direct wholly owned subsidiaries: PSEG Nuclear LLC (Nuclear), PSEG Fossil LLC (Fossil) and PSEG Energy Resources & Trade LLC (ER&T). Nuclear and Fossil own and operate generation and generation-related facilities. ER&T is responsible for the day-to-day management of the portfolio. Fossil, Nuclear and ER&T are subject to regulation by the FERC and Nuclear is subject to regulation by the Nuclear Regulatory Commission (NRC).

16


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Energy Holdings

      Energy Holdings has two principal direct wholly owned subsidiaries: PSEG Global L.L.C. (Global), which owns and operates international and domestic projects engaged in the generation and distribution of energy, including power production facilities and electric distribution companies and PSEG Resources L.L.C. (Resources), which has primarily invested in energy-related leveraged leases. Energy Holdings also owns Enterprise Group Development Corporation (EGDC), a commercial real estate property management business.

      Services

      Services provides management and administrative services to PSEG and its subsidiaries. These include accounting, legal, communications, human resources, information technology, treasury and financial services, investor relations, stockholder services, real estate, environmental, health and safety, insurance, risk management, tax, library, records and information services, security, corporate secretarial and certain planning, budgeting and forecasting services. Services charges PSEG and its subsidiaries for the cost of work performed and services provided pursuant to the terms and conditions of intercompany service agreements.

Basis of Presentation

      PSEG, PSE&G, Power and Energy Holdings

      The respective financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for Quarterly Reports on Form 10-Q. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been condensed or omitted pursuant to such rules and regulations. These Condensed Consolidated Financial Statements and Notes to Condensed Consolidated Financial Statements (Notes) should be read in conjunction with and update and supplement matters discussed in PSEG's, PSE&G's, Power's and Energy Holdings' respective Annual Reports on Form 10-K for the year ended December 31, 2004 and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2005 and June 30, 2005.

      The unaudited condensed consolidated financial information furnished herein reflects all adjustments which are, in the opinion of management, necessary to fairly state the results for the interim periods presented. All such adjustments are of a normal recurring nature. The year-end Condensed Consolidated Balance Sheets were derived from the audited Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2004. Certain reclassifications of prior period data have been made to conform with the current presentation.

Pension and Other Postretirement Benefits (OPEB)

      PSEG

      PSEG sponsors several qualified and nonqualified pension plans and OPEB plans covering PSEG and its participating affiliates' current and former employees who meet certain eligibility criteria. As a result of union negotiations, certain changes to the pension plans and OPEB plans were made and communicated in March 2005. These include increases to the benefit formula in the pension plan, supplemental pension benefits and certain other changes to OPEB. Substantially all changes to the pension plans became effective May 1, 2005 and the majority of changes to the OPEB plans will be effective January 1, 2006 or July 1, 2006. The pension benefits and OPEB obligations, as well as the asset values, have been re-measured as of March 31, 2005 to reflect the effect of the plan changes. With these assumption changes and based on a discount rate of 6.0%, the new pension projected benefit obligation and accumulated benefit obligation as of March 31, 2005 were $3.5 billion and $2.9 billion, respectively. The new OPEB accumulated benefit obligation as of March 31, 2005 was $1.1 billion. The

17


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

annual net periodic pension benefit costs for 2005 increase by approximately $2 million or 2% and the 2005 annual net OPEB costs increase by approximately $11 million or 11% from costs that would have been expensed in 2005 had the plans' provisions remained unchanged.

      The following table provides the components of net periodic benefit costs relating to all qualified and nonqualified pension plans and OPEB plans on an aggregate basis:

    Pension Benefits

  OPEB

  Pension Benefits

  OPEB

    Quarters Ended
September 30,

  Quarters Ended
September 30,

  Nine Months Ended
September 30,

  Nine Months Ended
September 30,

    2005

  2004

  2005

  2004

  2005

  2004

  2005

  2004

    (Millions)

                                                               

Components of Net Periodic Benefit Costs:

                                                               

Service Cost

     $ 22        $ 21        $ 4        $ 5        $ 67        $ 62        $ 13        $ 17  

Interest Cost

       52          49          16          13          155          147          46          41  

Expected Return on Plan Assets

       (62 )        (58 )        (2 )        (2 )        (187 )        (174 )        (7 )        (6 )

Amortization of Net

                                                               

Transition Obligation

                         7          7                            21          21  

Prior Service Cost

       4          4          3                   12          12          6           

Loss

       12          9                            35          28          2           
        
        
        
        
        
        
        
        
 

Net Periodic Benefit Costs

       28          25          28          23          82          75          81          73  

Effect of Regulatory Asset

                         5          5                            15          15  
        
        
        
        
        
        
        
        
 

Total Benefit Costs

     $ 28        $ 25        $ 33        $ 28        $ 82        $ 75        $ 96        $ 88  
        
        
        
        
        
        
        
        
 

                                                               

      PSEG, PSE&G, Power and Energy Holdings

      Pension costs and OPEB costs for PSEG, PSE&G, Power, Energy Holdings and Services are detailed as follows:

    Pension Benefits

  OPEB

  Pension Benefits

  OPEB

    Quarters Ended
September 30,

  Quarters Ended
September 30,

  Nine Months Ended
September 30,

  Nine Months Ended
September 30,

    2005

  2004

  2005

  2004

  2005

  2004

  2005

  2004

    (Millions)

                                                               

PSE&G

     $ 14        $ 13        $ 29        $ 25        $ 41        $ 39        $ 84        $ 79  

Power

       8          8          3          2          24          23          9          6  

Energy Holdings

       1          1                            2          2                    

Services

       5          3          1          1          15          11          3          3  
        
        
        
        
        
        
        
        
 

Total Benefit Costs

     $ 28        $ 25        $ 33        $ 28        $ 82        $ 75        $ 96        $ 88  
        
        
        
        
        
        
        
        
 

                                                               

Stock Compensation

      PSEG

      PSEG applies Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) and related interpretations in accounting for stock-based compensation plans. Accordingly, no compensation cost has been recognized for fixed stock option grants since the exercise price of the stock options equaled the market price of the underlying stock on the date of grant.

      PSEG also grants restricted stock and performance units to certain key executives and employees. In 2005, 270,000 shares of restricted stock have been granted under the 2004 Long-Term Incentive Plan to certain key executives and employees. These shares vest on a staggered schedule beginning in January 2006 and become fully vested in January 2008, except for accelerated vesting in the case of retirement or involuntary separation without cause. Compensation expense on the restricted stock grants is recorded ratably over the vesting period. Compensation expense for performance units is measured and recognized once it can be determined that the performance goals will be achieved.

18


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      The following table illustrates the effect on Net Income and Earnings Per Share if PSEG had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” (SFAS 123) to stock-based employee compensation:

    Quarters Ended
September 30,

  Nine Months Ended
September 30,

    2005

  2004

  2005

  2004

    (Millions, except for share data)

                               

Net Income, as reported

     $ 253        $ 244        $ 456        $ 639  

Add: Total stock-based compensation expensed during the period, net of related tax effects

       1          1          3          1  

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

       (2 )        (2 )        (5 )        (4 )
        
        
        
        
 

Pro forma Net Income

     $ 252        $ 243        $ 454        $ 636  
        
        
        
        
 

Earnings Per Share:

                               

Basic—as reported

     $ 1.06        $ 1.03        $ 1.91        $ 2.70  

Basic—pro forma

     $ 1.05        $ 1.02        $ 1.90        $ 2.68  

Diluted—as reported

     $ 1.03        $ 1.03        $ 1.87        $ 2.69  

Diluted—pro forma

     $ 1.03        $ 1.02        $ 1.87        $ 2.67  

                               

      See Note 4. Earnings Per Share for further information.

Note 2. Recent Accounting Standards

SFAS No. 154, “Accounting Changes and Error Corrections” (SFAS 154)

      PSEG, PSE&G, Power and Energy Holdings

      In May 2005, the Financial Accounting Standards Board (FASB) issued SFAS  154, which is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS 154 requires retrospective application to prior periods' financial statements of voluntary changes in accounting principles unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.

      SFAS 154 requires that a change in depreciation, amortization or depletion method for long-lived non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. The adoption of SFAS 154 is not expected to have a material effect on PSEG, PSE&G, Power or Energy Holdings.

SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R)

      PSEG

      In December 2004, the FASB issued SFAS 123R, which revises SFAS 123 and supersedes APB 25 and its related implementation guidance. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123R is effective for the first annual reporting period beginning after June 15, 2005 and requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). Adoption of SFAS 123R is not expected to have a material effect on PSEG's financial statements.

19


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

FASB Interpretation No. (FIN) 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47)

      PSEG, PSE&G, Power and Energy Holdings

      In March 2005, the FASB issued FIN 47 to clarify the term “conditional asset retirement obligation” as used in SFAS No. 143, “Accounting for Asset Retirement Obligations.” Conditional asset retirement obligation refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The fair value of a liability for the conditional asset retirement obligation should be recognized when incurred - generally, upon acquisition, construction, development and/or through the normal operation of the asset. Uncertainty about the timing and/or method of settlement should be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. PSEG, PSE&G, Power and Energy Holdings are currently evaluating the impact that adoption of FIN 47 may have on their respective financial statements.

FSP No. 109-1, “Application of FASB Statement No. 109, “Accounting for Income Taxes”, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (FSP 109-1)

      PSEG, Power and Energy Holdings

      On December 21, 2004, the FASB issued FSP 109-1, which was effective upon issuance, to provide guidance on the application of SFAS No. 109, “Accounting for Income Taxes” (SFAS 109), to the provision within the American Jobs Creation Act of 2004 (Jobs Act) that provides a tax deduction on qualified production activities. The Jobs Act includes a tax deduction of up to 9% (when fully phased-in) of the lesser of (a) “qualified production activities income,” as defined in the Jobs Act, or (b) taxable income (after the deduction for the utilization of any net operating loss carryforwards). The tax deduction is limited to 50% of W-2 wages paid by the taxpayer. FSP 109-1 clarifies that the manufacturer's deduction provided for under the Jobs Act should be accounted for as a special deduction in accordance with SFAS 109 and not as a tax rate reduction. PSEG, Power and Energy Holdings do not believe that the manufacturer's deduction or the application of FSP 109-1 will have a material effect on their respective financial statements.

FSP No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (FSP 109-2)

      PSEG and Energy Holdings

      On December 21, 2004, the FASB issued FSP 109-2, which was effective upon issuance, to provide guidance on the application of the provision in the Jobs Act that allows a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer, provided certain criteria are met. The Jobs Act provides a one-year window to repatriate earnings from foreign investments and claim a special 85% dividends received tax deduction on such distributions.

      PSEG has approved Domestic Reinvestment Plans, which provided for the repatriation of approximately $182 million through October 2005, of which approximately $140 million was eligible for the reduced tax rate pursuant to the Jobs Act. The tax expense associated with such repatriation totaled approximately $9 million and was recorded in the quarter ended September 30, 2005. In addition, Global's projections indicate that additional earnings could be generated by its international investments over the balance of 2005 that could increase the amount of funds that could reasonably be

20


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

considered for repatriation in 2005 by approximately $50 million, which would result in an additional $2 million of tax expense. Other than amounts discussed above, Global has made no change in its current intention to indefinitely reinvest accumulated earnings of its foreign subsidiaries.

Proposed Standards

      PSEG and Energy Holdings

      In July 2005, the FASB issued proposed guidance concerning the accounting for uncertain tax positions and the accounting for the timing of cash flows relating to income taxes generated by leveraged lease transactions.

      The proposal concerning uncertain tax positions would require that an uncertain tax position meet a probable recognition threshold based on the merits of the position in order for the benefit to be recognized in the financial statements. The proposal also addresses the accrual of interest and penalties related to tax uncertainties and the classification of liabilities on the balance sheet. If implemented in its present form, the impact of this proposal on PSEG and Energy Holdings could be material.

      The proposal concerning leveraged leases would require a lessor to perform a recalculation of a leveraged lease when there is a change in the timing of the realization of tax benefits generated by the lease. It would also require a lessor to re-evaluate classification as a leveraged lease when a recalculation of the lease is performed. If implemented in its present form, the impact of this proposal on PSEG and Energy Holdings could be material.

Note 3. Discontinued Operations, Dispositions and Acquisitions

Discontinued Operations

      Power

      Waterford Generation Facility (Waterford)

      On May 27, 2005, Power entered into an agreement to sell its electric generation facility located in Waterford, Ohio to a subsidiary of American Electric Power Company, Inc. Since commencing construction of the project, the dramatic increase in natural gas prices relative to the price increase of coal and the failure to receive capacity compensation for the facility caused Power to consider alternatives for the project. After reviewing the alternatives in conjunction with other strategic and financial considerations, Power concluded that the value to be received from the sale of Waterford represented a means to accelerate the realization of the plant's value. The sale price for the facility and inventory was $220 million.

      During 2005, Power recognized a loss on disposal of $178 million, net of tax. Power completed the sale of Waterford on September 28, 2005. The proceeds of the sale, together with an anticipated reduction in tax liability, are approximately $320 million, which will be used to retire debt at Power.

      Waterford's operating results for the quarters and nine months ended September 30, 2005 and 2004 are summarized below:

      Quarters Ended
September 30,

  Nine Months Ended
September 30,

      2005

  2004

  2005

  2004

      (Millions)
      

                               
      

Operating Revenues

     $ 13        $ 3        $ 18        $ 4  
      

Loss Before Income Taxes

     $ (10 )      $ (12 )      $ (32 )      $ (44 )
      

Net Loss

     $ (6 )      $ (8 )      $ (19 )      $ (27 )
      

                               

21


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      The carrying amounts of the assets of Waterford as of December 31, 2004 are summarized in the following table:

      As of
December 31,
2004

      (Millions)
             

       
             

Current Assets

     $ 4  
             

Noncurrent Assets

       507  
          
 
             

Total Assets of Discontinued Operations

     $ 511  
          
 
             

       

      Energy Holdings

      Carthage Power Company (CPC)

      In December 2003, Global entered into a definitive purchase and sale agreement related to the sale of its majority interest in CPC, which owns and operates a power plant located in Rades, Tunisia. In December 2003, Global also recognized an estimated loss on disposal of $23 million for the initial write-down of its carrying amount of CPC to its fair value less cost to sell. During the first quarter of 2004, Energy Holdings re-evaluated the carrying value of CPC's assets and liabilities and determined that an additional write-down to fair value of $2 million was required, which offset CPC's Net Income for the quarter ended March 31, 2004. In May 2004, Global completed the sale of CPC for approximately $43 million in cash and recognized a gain on disposal of $5 million.

      The operating results of CPC for the nine months ended September 30, 2004 are summarized below:

      Nine Months Ended
September 30, 2004

      (Millions)
             

       
             

Operating Revenues

     $ 38  
             

Pre-Tax Operating Income

     $ 2  
             

Net Income

     $ 2  

Dispositions

      Energy Holdings

      Meiya Power Company Limited (MPC)

      In December 2004, Global closed on the sale of its 50% equity interest in MPC to BTU Power Company for approximately $236 million, of which $100 million was paid in cash. The balance of approximately $136 million was provided in the form of a secured promissory note due on March 31, 2005, which was later amended to extend the maturity date to April 2005 and increase the amount due. The sale resulted in an after-tax gain of approximately $2 million, which was recorded in the fourth quarter of 2004. Global received payments of $38 million and $99 million in January 2005 and April 2005, respectively, representing the full payment of the outstanding receivable.

      Luz Del Sur S.A.A. (LDS)

      In April 2004, Global sold a portion of its indirect ownership in LDS in the Lima stock exchange, reducing its ownership from 44% to 38% and received gross proceeds of approximately $31 million. Global realized an after-tax gain of approximately $5 million in the second quarter of 2004 related to the LDS sale which is recorded in Income from Equity Method Investments on the Condensed Consolidated Statements of Operations.

22


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Solar Electric Generating Systems (SEGS) Projects

      In January 2005, Resources and Global sold their minority limited partner interests in three SEGS projects for proceeds of approximately $7 million resulting in an after-tax gain of $4 million.

      Dhofar Power Company S.A.O.C. (Dhofar Power)

      In April 2005, Global sold a 35% interest in Dhofar Power through a public offering on the Omani stock exchange as required under the Concession Agreement, reducing Global's ownership in Dhofar Power from 81% to 46%. Net proceeds from the sale approximated $25 million, resulting in a modest gain. As a result, Global's investment in Dhofar Power has been accounted for under the equity method following the sale. Global's investment in Dhofar Power was $20 million and $53 million as of September 30, 2005 and December 31, 2004, respectively.

      Resources

      Resources was the lessor of a Boeing B767 to United Airlines (UAL). In December 2002, UAL filed for Chapter 11 bankruptcy protection. On June 13, 2005, Resources received a notice from the Trustee under the UAL lease that the lenders had terminated the lease and repossessed the aircraft. Upon receipt of this notice, Resources recorded a $15 million charge, after-tax, in June 2005 to eliminate its carrying value of this investment since management believes that there will be insufficient proceeds to recover any of the recorded amount of the investment due to the termination.

      In January 2005, the KKR Fund sold its investment in KinderCare Learning Centers, Inc. and Resources received proceeds of approximately $17 million resulting in an after-tax gain of approximately $1 million.

      In March 2004, Resources entered into an agreement with Midwest Generation LLC, an indirect subsidiary of Edison Mission Energy, to terminate its lease investment in the Collins generating facility in Illinois. In March 2004, Resources recorded a $17 million pre-tax charge to reduce its carrying value of the Collins Lease. In April 2004, Resources closed on the termination of the lease agreement and received gross proceeds of approximately $184 million. The actual loss on the termination of the lease was $11 million, after-tax. As a result of the sale, Resources paid approximately $100 million in taxes.

      In January 2004, Resources terminated two lease transactions with Qantas Airways and China Eastern Airlines Co., Ltd resulting from the lessees exercising their respective purchase options. Resources received aggregate gross cash proceeds of approximately $45 million and recorded an after-tax gain of $4 million. As a result of the sale, Resources paid approximately $36 million in taxes.

Acquisitions

      Energy Holdings

      Texas Independent Energy, L.P. (TIE)

      In July 2004, Global signed an agreement to acquire all of TECO Energy, Inc.'s 50% equity interest in TIE for less than $1 million. With this purchase, Global owns 100% of TIE and consolidated this investment beginning July 1, 2004.

      Energy Holdings' consolidated Operating Revenues for the nine months ended September 30, 2004 would have increased from $701 million to $961 million had the acquisition of TIE occurred at the beginning of 2004. Energy Holdings' consolidated Net Income for the nine months ended September 30, 2004 would have increased from $110 million to $112 million had the acquisition of TIE occurred at the beginning of 2004. This pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

23


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note 4. Earnings Per Share (EPS)

PSEG

      Diluted EPS is calculated by dividing Net Income by the weighted average number of shares of common stock outstanding, including shares issuable upon exercise of stock options outstanding under PSEG’s stock option plans, upon payment of performance units and upon conversion of Participating Units. The following table shows the effect of these stock options, performance units and Participating Units on the weighted average number of shares outstanding used in calculating diluted EPS:

    Quarters Ended September 30,

  Nine Months Ended September 30,

    2005

  2004

  2005

  2004

    Basic

  Diluted

  Basic

  Diluted

  Basic

  Diluted

  Basic

  Diluted

                                                               

EPS Numerator:

                                                               

Earnings (Millions)

                                                               

Continuing Operations

     $ 260        $ 260        $ 252        $ 252        $ 653        $ 653        $ 661        $ 661  

Discontinued Operations

       (7 )        (7 )        (8 )        (8 )        (197 )        (197 )        (22 )        (22 )
        
        
        
        
        
        
        
        
 

Net Income

     $ 253        $ 253        $ 244        $ 244        $ 456        $ 456        $ 639        $ 639  
        
        
        
        
        
        
        
        
 

EPS Denominator (Thousands):

                                                               

Weighted Average Common Shares Outstanding

       239,034          239,034          237,269          237,269          238,696          238,696          236,724          236,724  

Effect of Stock Options

                1,052                   303                   1,044                   445  

Effect of Stock Performance Units

                36                   18                   36                   18  

Effect of Participating Units

                4,164                   138                   3,436                   696  
        
        
        
        
        
        
        
        
 

Total Shares

       239,034          244,286          237,269          237,728          238,696          243,212          236,724          237,883  
        
        
        
        
        
        
        
        
 

EPS:

                                                               

Continuing Operations

     $ 1.08        $ 1.06        $ 1.06        $ 1.06        $ 2.73        $ 2.68        $ 2.79        $ 2.78  

Discontinued Operations

       (0.02 )        (0.03 )        (0.03 )        (0.03 )        (0.82 )        (0.81 )        (0.09 )        (0.09 )
        
        
        
        
        
        
        
        
 

Net Income

     $ 1.06        $ 1.03        $ 1.03        $ 1.03        $ 1.91        $ 1.87        $ 2.70        $ 2.69  
        
        
        
        
        
        
        
        
 

                                                               

      There were approximately 5.3 million and 2.9 million stock options excluded from the weighted average common shares calculation used for diluted EPS due to their antidilutive effect for the quarter and nine months ended September 30, 2004, respectively. No stock options had an antidilutive effect for the quarter and nine months ended September 30, 2005.

      Dividend payments on common stock for the quarters ended September 30, 2005 and 2004 were $0.56 and $0.55 per share, respectively, and totaled approximately $134 million and $131 million, respectively. Dividend payments on common stock for the nine months ended September 30, 2005 and 2004 were $1.68 and $1.65 per share, respectively, and totaled approximately $401 million and $391 million, respectively.

Note 5. Commitments and Contingent Liabilities

Guaranteed Obligations

      Power

      Power has unconditionally guaranteed payments by its subsidiary, ER&T, in certain commodity-related transactions in the ordinary course of business. These payment guarantees were provided to counterparties in order to obtain credit under physical and financial agreements for gas, pipeline capacity, transportation, oil, electricity and related commodities and services. These Power payment guarantees support the current exposure, interest and other costs on sums due and payable by ER&T under these agreements. Guarantees offered for trading and marketing cover lines of credit between entities and are often reciprocal in nature. The exposure between counterparties can move in either direction. The face value of the guarantees outstanding as of September 30, 2005 and December 31, 2004 was $1.7 billion and $1.6 billion, respectively. In order for Power to incur a liability for the face value of the outstanding guarantees, ER&T would have to fully utilize the credit granted to it by every

24


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

counterparty to whom Power has provided a guarantee and all of ER&T’s contracts would have to be “out-of-the-money” (if the contracts are terminated, Power would owe money to the counterparties). The probability of all contracts at ER&T being simultaneously “out-of-the-money” is highly unlikely. For this reason, the current exposure at any point in time is a more meaningful representation of the potential liability to Power under these guarantees. The current exposure consists of the net of accounts receivable and accounts payable and the forward value on open positions, less any margins posted. The current exposure from such liabilities was $687 million and $507 million as of September 30, 2005 and December 31, 2004, respectively.

      Power is subject to collateral calls related to commodity contracts that are bilateral and is subject to certain creditworthiness standards as guarantor under performance guarantees for ER&T’s agreements. There has been a significant increase in commodity prices, including fuel, emission allowances and electric. Over the last year, both natural gas prices and electric prices in PJM have more than doubled. These price increases can have an impact on contract terms and conditions, as margin calls on contracts entered into in the normal course of business will increase with price increases. As of September 30, 2005, Power had paid cash margin of approximately $251 million and received cash margin of approximately $99 million. In addition, as of September 30, 2005, letters of credit issued by Power were outstanding in the amount of approximately $705 million (including $205 million issued to PSE&G) to satisfy trading collateral obligations and support various contractual and environmental obligations. Assuming no changes in energy prices and positions, Power’s collateral requirements can be expected to decline over time as its contracts expire. In the event of a deterioration of Power’s credit rating to below investment grade, many of these agreements allow the counterparty to demand that ER&T provide further performance assurance, generally in the form of a letter of credit or cash. As of September 30, 2005, if Power were to lose its investment grade rating and, assuming all counterparties to which ER&T is “out-of-the-money” were contractually entitled to demand, and demanded, performance assurance, ER&T could be required to post additional collateral in an amount equal to approximately $1.2 billion. PSEG and Power entered into additional credit agreements in October 2005 increasing available liquidity by $500 million. Power believes that it has sufficient access to liquidity to post such collateral, as may be necessary.

      Energy Holdings

      Energy Holdings and/or Global have guaranteed certain obligations of their subsidiaries or affiliates, including the successful completion, performance or other obligations related to certain projects.

      The contingent obligations as of September 30, 2005 and December 31, 2004 are as follows:

                As of

Subsidiaries/Affiliates

     Location

     Description

   Expiration
Date

  September 30,
2005

  December 31,
2004

                (Millions)

Elektrownia Skawina S.A. (Skawina)

     Poland      Equity commitment    August 2007    $ 9      $ 26  

PSEG Global Funding II LLC

     Delaware      Contingent guarantee related to debt service obligations associated with Chilquinta    April 2011      25        25  

Elektrocieplownia Chorzow Sp. Z o.o. (ELCHO)

     Poland      Contingent guarantee related to debt service obligations    October 2009      32         

Prisma 2000 S.p.A. (Prisma)

     Italy      Leasing agreement guarantee    N/A      22        35  

PSEG Energy Technologies Asset Management Company LLC

     New Jersey      Performance guarantees    N/A      7        13  

Other

     Various      Various    N/A      45        39  

                
      
 

Total Contingent Obligations

               $ 140      $ 138  

                
      
 

                           

25


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      In September 2003, Energy Holdings completed the sale of PSEG Energy Technologies Inc. (Energy Technologies) and nearly all of its assets. However, Energy Holdings retained certain outstanding construction and warranty obligations related to ongoing construction projects previously performed by Energy Technologies. These construction obligations have performance bonds issued by insurance companies for which exposure is adequately supported by the outstanding letters of credit shown in the table above for PSEG Energy Technologies Asset Management Company LLC. As of September 30, 2005, there were $29 million of such bonds outstanding, which are related to uncompleted construction projects. These performance bonds are not included in the $140 million of guaranteed obligations above.

      In addition to the amounts discussed above, certain subsidiaries of Energy Holdings also have contingent obligations related to their respective projects, which are non-recourse to Energy Holdings or Global.

Environmental Matters

      PSEG, PSE&G and Power

      Hazardous Substances

      The New Jersey Department of Environmental Protection (NJDEP) adopted regulations concerning site investigation and remediation that require an ecological evaluation of potential damages to natural resources in connection with an environmental investigation of contaminated sites. These regulations may substantially increase the costs of environmental investigations and necessary remediation, particularly at sites situated on surface water bodies. PSE&G, Power and respective predecessor companies own or owned and/or operate or operated certain facilities situated on surface water bodies, certain of which are currently the subject of remedial activities. The financial impact of these regulations is not currently estimable. However, neither PSE&G nor Power anticipates that compliance with these regulations will have a material adverse effect on their respective financial positions, results of operations or net cash flows.

      The U.S. Environmental Protection Agency (EPA) has determined that a six-mile stretch of the Passaic River in the area of Newark, New Jersey is a “facility” within the meaning of that term under the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA). PSE&G and certain of its predecessors conducted industrial operations at properties adjacent to the Passaic River facility. The operations included one operating electric generating station (Essex Site), one former generating station and four former Manufactured Gas Plants (MGPs). PSE&G’s costs to clean up former MGPs are recoverable from utility customers through the Societal Benefits Clause (SBC). PSE&G has sold the site of the former generating station and obtained releases and indemnities for liabilities arising out of the site in connection with the sale. The Essex Site was transferred to Power in August 2000. Power assumed any environmental liabilities of PSE&G associated with the electric generating stations that PSE&G transferred to it, including the Essex Site.

      In 2003, the EPA notified 41 potentially responsible parties (PRPs), including PSE&G and Power, that it was expanding its assessment of the Passaic River Study Area to the entire 17-mile tidal reach of the lower Passaic River. The EPA further indicated, with respect to PSE&G, that it believed that hazardous substances had been released from the Essex Site and a former MGP located in Harrison, New Jersey (Harrison Site), which also includes facilities for PSE&G’s ongoing gas operations. The EPA has estimated that its study would require five to eight years to complete and would cost approximately $20 million, of which it would seek to recover $10 million from the PRPs, including PSE&G and Power. Power is evaluating recoverability of any disbursed amounts from its insurance carriers.

      Also, in 2003, PSEG, PSE&G and 56 other PRPs received a Directive and Notice to Insurers from the NJDEP that directed the PRPs to arrange for a natural resource damage assessment and interim

26


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

compensatory restoration of natural resource injuries along the lower Passaic River and its tributaries pursuant to the New Jersey Spill Compensation and Control Act. The NJDEP alleged in the Directive that it had determined that hazardous substances had been discharged from the Essex Site and the Harrison Site. The NJDEP announced that it had estimated the cost of interim natural resource injury restoration activities along the lower Passaic River to approximate $950 million.

      PSE&G and Power have indicated to both the EPA and NJDEP that they are willing to work with the agencies in an effort to resolve their respective claims and, along with approximately 43 other PRPs, have executed an agreement with the EPA that provides for sharing the costs of the study between the government organizations and the PRPs. PSEG, PSE&G and Power cannot predict what further actions, if any, or the costs or the timing thereof, that may be required with respect to the Passaic River or natural resource damages. However, such costs could be material.

      PSE&G

      MGP Remediation Program

      PSE&G is currently working with the NJDEP under a program to assess, investigate and remediate environmental conditions at PSE&G’s former MGP sites (Remediation Program). To date, 38 sites have been identified as sites requiring some level of remedial action. The Remediation Program is periodically reviewed, and the estimated costs are revised by PSE&G based on regulatory requirements, experience with the program and available remediation technologies. Since the inception of the Remediation Program in 1988 through September 30, 2005, PSE&G had expenditures of approximately $329 million.

      During the fourth quarter of 2004, PSE&G refined the detailed site estimates and determined that total Remediation Program costs could range between $650 million and $685 million. No amount within the range was considered to be most likely. Therefore, a liability of $321 million and $356 million was recorded at September 30, 2005 and December 31, 2004, respectively, which represents the difference between the low end of the total program cost estimate of $650 million and the total incurred costs through September 30, 2005 and December 31, 2004 of $329 million and $294 million, respectively. Of this amount, $38 million and $47 million were recorded in Other Current Liabilities and $283 million and $309 million were recorded in Other Noncurrent Liabilities on its Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004, respectively. The costs associated with the MGP Remediation Program have historically been recovered through the SBC charges to PSE&G ratepayers. As such, a $321 million and a $356 million Regulatory Asset was also recorded as of September 30, 2005 and December 31, 2004, respectively.

      Costs for the MGP Remediation Program were approximately $13 million and $35 million for the quarter and nine months ended September 30, 2005, respectively. PSE&G anticipates spending $45 million in 2005, $35 million in 2006, and an average of $26 million per year through 2016.

      New Jersey Clean Energy Program

      The BPU has approved a funding requirement for each New Jersey utility applicable to its Renewable Energy and Energy Efficiency programs for the years 2005 to 2008. The liability for the funding requirement has been recorded at the discounted present value. The costs associated with this program will be recovered from PSE&G ratepayers over the four years and therefore a Regulatory Asset was also recorded. The current and noncurrent liability for the funding requirement as of September 30, 2005 and December 31, 2004 was $354 million and $406 million, respectively.

27


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Power

      Prevention of Significant Deterioration (PSD)/New Source Review (NSR)

      The PSD/NSR regulations, promulgated under the Clean Air Act (CAA), require major sources of certain air pollutants to obtain permits, install pollution control technology and obtain offsets, in some circumstances, when those sources undergo a “major modification,” as defined in the regulations. The Federal government is seeking to order companies allegedly not in compliance with the PSD/NSR regulations to install the best available control technology at the affected plants and to pay monetary penalties of up to approximately $27,500 for each day of continued violation.

      The EPA and the NJDEP issued a demand in March 2000 under the CAA requiring information to assess whether projects completed since 1978 at the Hudson and Mercer coal-burning units were implemented in accordance with applicable PSD/NSR regulations. Power completed its response to the requests for information and, in January 2002, reached an agreement with the NJDEP and the EPA to resolve allegations of noncompliance with PSD/NSR regulations. Under that agreement, over the course of 10 years, Power agreed to install advanced air pollution controls to reduce emissions of Sulfur Dioxide (SO2), Nitrogen Oxide (NOx), particulate matter and mercury from the coal-burning units at the Mercer and Hudson generating stations. The estimated cost of the program as of September 30, 2005 includes approximately $110 million for installation of selective catalytic reduction systems (SCRs) at Mercer, which has been spent, as well as approximately $300 million to $350 million at Hudson and $150 million to $200 million for other pollution control equipment at Mercer to be installed by December 31, 2012. Power also paid a $1.4 million civil penalty and has agreed to spend up to $6 million on supplemental environmental projects. The agreement resolving the NSR allegations concerning the Hudson and Mercer coal-fired units also resolved a dispute over Bergen 2 regarding the applicability of PSD requirements and allowed construction of the unit to be completed and operations to commence.

      Power has notified the EPA and the NJDEP that it is evaluating the continued operation of the Hudson coal unit in light of changes in the energy and capacity markets, increases in the cost of pollution control equipment and other necessary modifications to the unit. Power will be unable to complete the installation of the pollution control equipment by the December 31, 2006 deadline. Power believes that system reliability concerns that PJM Interconnection L.L.C. (PJM) previously identified in the area and its discussions with NJDEP may result in the unit continuing to operate after December 31, 2006. Power cannot estimate additional costs, including any penalties, that may be associated with the continued operation of the Hudson unit beyond December 31, 2006, but such costs could be material. The costs associated with the pollution control modifications for the Hudson unit have not been included in Power’s capital expenditure projections.

      New Jersey Industrial Site Recovery Act (ISRA)

      Potential environmental liabilities related to subsurface contamination at certain generating stations have been identified. In the second quarter of 1999, in anticipation of the transfer of PSE&G’s generation-related assets to Power, a study was conducted pursuant to ISRA, which applies to the sale of certain assets. Power had a $51 million liability as of September 30, 2005 and December 31, 2004 related to these obligations, which is included in Other Noncurrent Liabilities on Power’s Condensed Consolidated Balance Sheets and Environmental Costs on PSEG’s Condensed Consolidated Balance Sheets.

New Generation and Development

      Power

      In July 2005, Power completed construction of the Bethlehem Energy Center near Albany, New York. Total costs for this project were approximately $596 million (including interest capitalized during construction (IDC) of $70 million). The plant was put into commercial operation on July 18, 2005.

28


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Power is constructing a natural gas-fired generation plant in Linden, New Jersey. Power anticipates that construction will be completed in the second quarter of 2006. Total costs are estimated at approximately $1 billion with expenditures through September 30, 2005 of approximately $968 million (including IDC of $180 million).

      Power also has contracts with outside parties to purchase upgraded turbines for Salem Units 1 and 2 and to purchase upgraded turbines and complete a power uprate for Hope Creek to modestly increase its generating capacity. Salem Unit 2 completed Phase I of its turbine replacement in 2003 and gained 24 megawatts (MW). Phase II of the replacement is currently scheduled for 2008 concurrent with steam generator replacement and is anticipated to increase capacity by 26 MW. Salem Unit 1 completed its turbine replacement in 2004 and gained 63 MW. Hope Creek completed Phase I of its turbine replacement in January 2005 and gained 15 MW. Phase II is expected to be completed in 2007 along with the thermal power uprate and is expected to add approximately 120 MW. Power’s expenditures to date approximate $200 million (including IDC of $16 million) with an aggregate estimated share of total costs for these projects of $247 million (including IDC of $27 million). Timing, costs and results of these projects are dependent on timely completion of work, timely approval from the NRC and various other factors.

      Completion of the projects discussed above within the estimated time frames and cost estimates cannot be assured. Construction delays, cost increases and various other factors could result in changes in the operational dates or ultimate costs to complete.

      Power entered into a long-term contractual services agreement with a vendor in September 2003 to provide the outage and service needs for certain of Power’s generating units at market rates. The contract covers approximately 25 years and could result in annual payments ranging from approximately $10 million to $50 million for services, parts and materials rendered.

      Energy Holdings

      Electroandes S.A. (Electroandes)

      There is a 35 MW expansion project on an existing hydro station under development at Electroandes, a generating facility in Peru. Construction on this project is expected to begin in the first half of 2006 with expected completion in 2007 at a total cost of $29 million. The project is expected to be financed by Electroandes with cash and non-recourse debt.

Basic Generation Service (BGS) and Basic Gas Supply Service (BGSS)

      PSE&G and Power

      PSE&G is required to obtain all electric supply requirements for customers that do not purchase electric supply from third-party suppliers through the annual New Jersey BGS auctions. The BGS auction process is a statewide process in which all of the New Jersey Electric Distribution Companies (EDCs) participate. The BGS auctions are “declining clock” auctions, where the EDCs accept offers for the amount of electric supply bidders are willing to offer with higher prices at the beginning of the auction. The auction proceeds when the amount of supply bid exceeds what is needed. The offer price is subsequently lowered and the process continues in a series of steps. When the amount of supply bid by the prospective suppliers matches an EDC’s electric supply needs, the auction ends. The BPU renders a decision on the auction results within two business days.

      PSE&G enters into the Supplier Master Agreement (SMA) with the winners of these BGS auctions within three business days of the BPU’s approval. PSE&G has entered into contracts with Power, as well as with other winning BGS suppliers, to purchase BGS for PSE&G’s anticipated load requirements. The winners of the auction are responsible for fulfilling all the requirements of a PJM Load Serving Entity (LSE) including capacity, energy, ancillary services, transmission and any other

29


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

services required by PJM. Suppliers assume any migration risk and must satisfy New Jersey’s renewable portfolio standards.

      The BPU permits recovery of the cost of gas hedging up to 115 billion cubic feet or approximately 80% of PSE&G’s residential gas supply annually through the BGSS tariff. For the 2005/06 winter season, Power has hedged approximately 71% of the 115 billion cubic feet allowed at an average price of $7.74 per decatherm (dth). Together with its current volumes in inventory as of September 30, 2005, Power has secured the majority of the anticipated residential volume for the 2005/06 winter season at prices that are lower than current market. Approximately 22% of the allowed residential gas volume has been hedged for the 2006 summer season at an average price of $7.62 per dth. As of September 30, 2005 and December 31, 2004, the fair value of the contract was $462 million and $25 million, respectively. PSE&G recorded an affiliate receivable from Power related to the fair market value of the contract with an offsetting Regulatory Liability. Power recorded a derivative asset with an offsetting affiliate payable to PSE&G. The change in the fair value of the contract is primarily related to significant increases in natural gas prices as previously discussed.

      Power

      Power’s objective is to enter into load-serving supply contracts and trading positions for at least 75% of its anticipated output over an 18-month to 24-month horizon. As part of this objective, Power has entered into contracts to directly supply PSE&G and other New Jersey EDCs with a portion of their BGS requirements through the New Jersey BGS auction process. In addition to the BGS related contracts, Power has entered into firm supply contracts with EDCs in Pennsylvania and Connecticut, as well as other firm sales and trading positions and commitments.

Minimum Fuel Purchase Requirements

      Power

      Power purchases coal and oil for certain of its fossil generation stations through various long-term commitments. The total minimum purchase requirements included in these commitments amount to approximately $809 million through 2012.

      Power has various multi-year requirements-based purchase commitments that total approximately $103 million per year to meet Salem’s and Hope Creek’s nuclear fuel needs, of which Power’s share is approximately $76 million per year through 2010. Power has been advised by Exelon Generation Company, LLC (Exelon Generation), the co-owner and operator of Peach Bottom, that it has similar purchase contracts to satisfy the fuel requirements for Peach Bottom through 2010, of which Power’s share is approximately $27 million per year.

      In addition to its fuel requirements, Power has entered into various multi-year contracts for firm transportation and storage capacity for natural gas, primarily to meet its gas supply obligations to PSE&G. As of September 30, 2005, the total minimum requirements under these contracts were approximately $988 million through 2016.

      These purchase obligations are in keeping with Power’s objective to enter into load-serving supply contracts and trading positions for at least 75% of its anticipated output over an 18-month to 24-month horizon and to enter into contracts for its fuel supply in comparable volumes.

      Energy Holdings

      TIE’s Guadalupe and Odessa plants have entered into gas supply agreements for their anticipated fuel requirements to satisfy obligations under their forward energy sales contracts. As of September 30, 2005, the Guadalupe and Odessa plants, which total approximately 2,000 MW of capacity, had forward energy sale contracts in place for approximately 75% of its expected output for the remainder of 2005,

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

approximately one-third of its expected output for 2006 and expect to term up additional load during the fourth quarter of 2005. TIE had fuel purchase commitments totaling $253 million to fully support such contracts.

Operating Services Contract (OSC)

      Power

      Nuclear has entered into an OSC with Exelon Generation, which commenced on January 17, 2005, relating to the operation of the Hope Creek and Salem nuclear generating stations. The OSC requires Exelon Generation to provide a chief nuclear officer and other key personnel to oversee daily plant operations at the Hope Creek and Salem nuclear generating stations and to implement the Exelon operating model, which defines practices that Exelon has used to manage its own nuclear performance program. Nuclear continues as the license holder with exclusive legal authority to operate and maintain the plants, retains responsibility for management oversight and has full authority with respect to the marketing of its share of the output from the facilities. Exelon Generation is entitled to receive reimbursement of its costs in discharging its obligations, an annual operating services fee and incentive fees up to $12 million annually based on attainment of goals relating to safety, capacity factor and operation and maintenance expenses. The OSC has a term of two years, subject to earlier termination in certain circumstances. In the event of termination, Exelon Generation will continue to provide services under the OSC for a transition period of at least 180 days and up to two years at the election of Nuclear. This period may be further extended by Nuclear for up to an additional twelve months if Nuclear determines that additional time is necessary to complete required activities during the transition period.

Nuclear Fuel Disposal

      Power

      Under the Nuclear Waste Policy Act of 1982, as amended (NWPA), the Federal government has entered into contracts with the operators of nuclear power plants for transportation and ultimate disposal of spent nuclear fuel. To pay for this service, nuclear plant owners are required to contribute to a Nuclear Waste Fund at a rate of one mil ($0.001) per Kilowatt-hour (kWh) of nuclear generation, subject to such escalation as may be required to assure full cost recovery by the Federal government. Under the NWPA, the U.S. Department of Energy (DOE) was required to begin taking possession of the spent nuclear fuel by no later than 1998. The DOE has announced that it does not expect a facility for such purpose to be available earlier than 2010.

      Pursuant to NRC rules, spent nuclear fuel generated in any reactor can be stored in reactor facility storage pools or in independent spent fuel storage installations located at reactors or away-from-reactor sites for at least 30 years beyond the licensed life for reactor operation (which may include the term of a revised or renewed license). Adequate spent fuel storage capacity is estimated to be available through 2011 for Salem 1, 2015 for Salem 2 and 2007 for Hope Creek. Power has commenced construction of an on-site storage facility that will satisfy the spent fuel storage needs of both Salem and Hope Creek through the end of their current respective license lives. Exelon Generation has advised Power that it has a licensed and operational on-site storage facility at Peach Bottom that will satisfy Peach Bottom’s spent fuel storage requirements until at least 2014.

      Exelon Generation had previously advised Power that it had signed an agreement with the DOE, applicable to Peach Bottom, under which Exelon Generation would be reimbursed for costs incurred resulting from the DOE’s delay in accepting spent nuclear fuel for permanent storage. Under this agreement, Power’s portion of Peach Bottom’s Nuclear Waste Fund fees was reduced by approximately $18 million through August 31, 2002, at which point credits were fully utilized and covered the cost of Exelon Generation’s on-site storage facility. In September 2002, the U.S. Court of Appeals for the Eleventh Circuit issued an opinion upholding a petition seeking to set aside the receipt of these credits by Exelon Generation. On August 14, 2003, Exelon Generation received a letter from the DOE

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

demanding repayment of previously received credits from the Nuclear Waste Fund. The letter also demanded a total of approximately $1.5 million of accrued interest. In August 2004, Exelon Generation advised Nuclear that it reached a settlement with the U.S. Department of Justice, under which Exelon Generation would be reimbursed for costs associated with the storage of spent nuclear fuel at the Peach Bottom facility, a portion of which would be paid to Nuclear as a co-owner of Peach Bottom. Future costs incurred resulting from DOE delays in accepting spent fuel will be reimbursed annually until the DOE fulfills its obligation to accept spent nuclear fuel. In addition, Exelon Generation and Nuclear are required to reimburse the DOE for the previously received credits from the Nuclear Waste Fund, plus lost earnings. Under this settlement, Power received approximately $27 million for its share of previously incurred storage costs for Peach Bottom, $22 million of which was used for the required reimbursement to the Nuclear Waste Fund. As a result of this settlement, Power reversed approximately $12 million of previously capitalized plant-related costs and recognized an increase of $7 million to Operating Expenses in the third quarter of 2004.

      In September 2001, Power filed a complaint in the U.S. Court of Federal Claims seeking damages caused by the DOE not taking possession of spent nuclear fuel in 1998. On October 14, 2004, an order to show cause was issued regarding whether the U.S. Court of Federal Claims has jurisdiction over the matter. Power responded to this order in November 2004. On January 31, 2005, the Judge dismissed the breach-of-contract claims of Power and three other utilities. Power moved for reconsideration in the U.S. Court of Federal Claims and jointly petitioned for permission to appeal the January 31, 2005 order to the U.S. Court of Appeals for the Federal Circuit. No assurances can be given as to any damage recovery or the ultimate availability of a disposal facility.

Spent Fuel Pool

      Power

      The spent fuel pool at each Salem unit has an installed leakage collection system. This normal leakage path was found to be obstructed. Power is developing a solution to maintain the design function of the leakage collection system and is investigating the extent of any structural degradation caused by the leakage. The investigation is scheduled to be completed by the end of 2005. If any significant degradation is identified, the repair costs could be material. The NRC issued Information Notice 2004-05 in March 2004 concerning this emerging industry issue and Power cannot predict what further actions the NRC may take on this matter.

      Elevated concentrations of tritium in the shallow groundwater near Salem Unit 1 were detected in early 2003. This information was reported to the NJDEP and the NRC, as required. Power conducted a comprehensive investigation in accordance with NJDEP site remediation regulations to determine the source and extent of the tritium in the groundwater. Power is conducting remedial actions to address the contamination, in accordance with a remedial action workplan approved by the NJDEP in November 2004. The remedial actions are expected to be ongoing for several years. The costs necessary to address this groundwater contamination issue have not been determined, however, such costs are not expected to be material.

Other

      PSEG, PSE&G, Power and Energy Holdings

      Minimum Pension Liability

      Due to the potential for a lower required discount rate and reduced earnings on the pension plan investments through September 30, 2005, PSEG, PSE&G, Power and Energy Holdings may be required to record a minimum pension liability on their respective Consolidated Balance Sheets as of December 31, 2005. As calculated under SFAS No. 87 “Employers Accounting for Pensions, a minimum pension liability exists and must be recorded when the accumulated benefit obligation (ABO) of the plan exceeds the fair value of the plan assets as of its annual measurement date. The minimum pension liability is reduced or reversed when funding occurs, or when the fair value of the pension plan assets grow to a level above that of the ABO. At this time, PSEG is monitoring the fair market value of its investments and its ABOand is evaluating options available with respect to this issue. Since PSEG’s measurement date is December 31, 2005, management

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

is unable to predict what the impact could be, however the impact could be material to PSEG’s, PSE&G’s, Power’s and Energy Holdings’ financial position and, more specifically, could result in the recognition of a minimum pension liability on the Condensed Consolidated Balance Sheets and a decrease in equity since a majority of the offset to the minimum pension liability would be recorded in Accumulated Other Comprehensive Loss (OCL).

      PSEG and PSE&G

      Investment Tax Credits (ITC)

      As of June 1999, the IRS had issued several private letter rulings that concluded that the refunding of excess deferred tax and ITC balances to utility customers was permitted only over the related assets’ regulatory lives, which were terminated upon New Jersey’s electric industry restructuring. Based on this fact, PSEG and PSE&G reversed the deferred tax and ITC liability relating to PSE&G’s generation assets that were transferred to Power and recorded a $235 million reduction of the extraordinary charge in 1999 due to the restructuring of the utility industry in New Jersey. PSE&G was directed by the BPU to seek a ruling from the IRS to determine if the ITC included in the impairment write-down of generation assets could be credited to customers without violating the tax normalization rules of the Internal Revenue Code. PSE&G filed a private letter ruling request with the IRS in 2002, which is still pending.

      In 2003, the IRS proposed regulations for comment that, if adopted, would allow utilities to elect retroactive application over periods equivalent to the ones in place prior to deregulation. While PSEG cannot predict the outcome of this matter, a requirement to refund such amounts to customers could have a material adverse impact on PSEG’s and PSE&G’s financial condition, results of operations and net cash flows.

      BPU Deferral Audit

      The BPU Energy and Audit Division conducts audits of deferred balances. A draft Deferral Audit—Phase II report relating to the 12-month period ended July 31, 2003 was released by the consultant to the BPU in April 2005. The draft report addresses the SBC, Market Transition Charge (MTC) and Non-Utility Generation (NUG) deferred balances. The BPU released the report on May 13, 2005.

      While the consultant to the BPU found that the deferral balances complied in all material respects with the BPU Orders regarding such deferrals, the consultant noted that the BPU Staff had raised certain questions with respect to the reconciliation method PSE&G employed in calculating the overrecovery of its MTC and other charges during the four-year transition period. PSE&G and the BPU Staff are continuing discussions to resolve these questions and, if a resolution cannot be achieved, a BPU proceeding may be instituted to consider the issues raised.

      While PSE&G believes the MTC methodology it used was fully litigated and resolved, without exception, by the BPU and other intervening parties in its previous electric base rate case, deferral audit and deferral proceeding that were approved by the BPU in its order on April 22, 2004, and that such order is non-appealable, PSE&G cannot predict the impact of the outcome of any such proceeding, which could be material.

      PSEG and Energy Holdings

      Leveraged Lease Investments

      From 1996 through 2002, PSEG, through its indirect wholly owned subsidiary, Resources, entered into a number of leveraged lease transactions in the ordinary course of business. Certain of those transactions that were previously entered into are similar to a type that the IRS subsequently

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

announced its intention to challenge, and PSEG understands that similar transactions entered into by other companies have been the subject of review and challenge by the IRS. As of September 30, 2005 and December 31, 2004, Resources’ total gross investment in such transactions was approximately $1.4 billion and $1.3 billion, respectively. The IRS is presently reviewing the tax returns of PSEG and its subsidiaries for tax years 1997 through 2000, years when Resources entered into some of these transactions.

      On September 27, 2005, the IRS proposed to disallow PSEG’s deductions associated with certain of these leveraged leases which have been designated by the IRS as listed transactions. Other lease transactions within the audit period are still under the IRS’s review. The IRS may propose additional disallowances in the future. If deductions associated with these lease transactions entered into by PSEG are successfully challenged by the IRS, it could have a material adverse impact on PSEG’s and Energy Holdings’ financial position, results of operations and net cash flows and could impact future returns on these transactions. PSEG believes that its tax position related to these transactions is proper based on applicable statutes, regulations and case law and believes that it should prevail with respect to any IRS challenge, although no assurances can be given.

      If the tax benefits associated with the above referenced lease transactions were completely disallowed by the IRS, approximately $650 million of PSEG’s deferred tax liabilities that have been recorded under leveraged lease accounting through September 30, 2005 could become currently payable. In addition, interest expense of approximately $80 million, after-tax, and penalties could be assessed. Although Energy Holdings believes that such an outcome is unlikely, in the event that such a payment is required, Energy Holdings believes that, assuming certain asset monetizations of its investment portfolio, it has the financial capacity to meet this potential obligation.

      The FASB is currently considering a modification to GAAP for leveraged leases. Under present GAAP, a tax settlement with the IRS that results in a change in the timing of tax liabilities would not require an accounting repricing of the lease investment. As such, income from the lease would continue to accrue at the original economic yield computed for the lease and there would be no write-down of the lease investment. See Note 2. Recent Accounting Standards for additional information.

      Power

      Restructuring Charge

      In June 2005, Power implemented a plan, approved by management, to reduce its Nuclear workforce by approximately 200 positions. The plan includes voluntary and involuntary separations offered to both represented and non-represented employees. The major cost associated with the restructuring relates to payments to the employees who are terminated. Power’s $14 million share of the estimated total cost was recorded in 2005, none of which had been paid as of September 30, 2005.

      Energy Holdings

      Rio Grande Energia S.A. (RGE)

      In December 2004, the governing tax authority in Brazil claimed past due taxes from RGE plus penalties and interest for the periods 1998 to 2004 primarily related to claims that the goodwill tax amortization period used by RGE for several years resulted in higher than allowed tax deductions. RGE used a 10-year amortization period. The tax authority maintains that the amortization period should coincide with the concession period of 30 years. Global's share of the maximum claim amount related to these tax issues is approximately $8 million. RGE believes it has valid legal defenses to these claims. The court of first instance has ruled against RGE and RGE has appealed the lower court ruling. Although RGE believes its defenses to these claims are valid and will continue to vigorously contest this matter, no assurances can be given regarding the outcome.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Sul Geradora Participações Ltda. (SGP) is a wholly owned subsidiary of RGE. The Brazilian tax authority has filed a tax assessment against SGP relating to a loan entered into between SGP and BankBoston N.A. denying the characterization of the loan as a withholding-free transaction for 2000, 2001 and 2002. The original amount of the assessment is $15 million, including tax, penalty and interest. Global, as an approximate 33% indirect owner of SGP may be responsible for approximately $5 million relating to the claim. SGP believes it has valid defenses to these claims and has filed an appeal of the assessment, although no assurances can be given regarding the outcome.

      LDS

      The Superintendencia Nacional de Administracion Tributaria (SUNAT), the governing tax authority in Peru, has claimed past due taxes for the periods between 1996-1998 and 1999-2001, plus penalties and interest, resulting from LDS’s interpretation of tax law that permitted restatement of assets to fair market value for tax purposes resulting in higher tax deductions for depreciation. LDS did not accept the SUNAT valuation and appealed. The Fiscal Court notified LDS on January 4, 2005 that a proper decision could not be based on the existing SUNAT studies and ordered another valuation study to be performed by Consejo Nacional de Tasaciones (CONATA), a Government Agency in Peru. CONATA completed the valuation of LDS assets in April 2005 and concluded that the asset value of LDS is higher than those originally used by LDS for its tax deductions for depreciation.

      In September 2005, the SUNAT accepted the Fiscal Court’s decision which validated the methodology used by LDS in revaluating its assets to market value in accordance with the then prevailing law. LDS has received a final assessment for the years 1996-1999 which will result in a refund. Since the Fiscal Court determined in its written decision the base amounts to be used for the asset revaluation, these amounts are valid for the remaining years in dispute by the SUNAT (2000 and 2001), thus limiting any additional tax exposure related to this issue.

      Electroandes

      In July 2005, Electroandes received a notice from the SUNAT claiming past due taxes for 2002 totaling approximately $2 million related to certain interest deductions. Electroandes has taken similar interest deductions subsequent to 2002. The total cumulative amount, including potential associated interest and penalties, is approximately $5 million through September 30, 2005. Electroandes believes it has valid legal defenses to these claims, although no assurances can be given.

      Dhofar Power

      Since commencing operations in Oman in May 2003, Dhofar Power has experienced a number of service interruptions, including four service interruptions in the first half of 2004, which resulted from a combination of force majeure events and breaches of general warranties of the contractors that installed equipment at Dhofar Power. Dhofar Power and the Government of Oman been in a dispute regarding the applicability and extent of any penalties under Dhofar Power’s Concession Agreement arising from these service interruptions. On July 14, 2005, the expert engaged by the parties recommended no penalties be assessed for the 2003 service interruptions and agreed with Dhofar Power’s interpretation of the Concession Agreement with respect to the criteria to be utilized in assessing penalties. The Government of Oman has exercised its right to appeal the expert’s determination to a full arbitration panel. Dhofar Power believes this matter will be favorably resolved in 2006, although no assurances can be given.

      Dhofar Power and the Government of Oman are also in disagreement on the basis of the calculation of certain monthly allowances to be paid to compensate Dhofar Power for the capital investment costs associated with the enhancements and extensions of the transmission and distribution system in Salalah. On August 24, 2005, the expert engaged by the parties found in favor of Dhofar Power with respect to the criteria to be used in determining the monthly allowances. It is uncertain at

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

this time whether the Government will exercise its right to appeal the expert’s determination to a full arbitration panel. If the Government of Oman prevails, the loss of revenue to PSEG would be approximately $1 million annually for 15 years retroactive to December 2003. PSEG believes it has valid defenses to the Government’s claim and will vigorously contest this matter. Dhofar Power believes that this matter will be favorably resolved in 2006, although no assurances can be given.

      TIE

      On July 7, 2003, Texas Commercial Energy LLC (TCE) filed suit against the three major electric utilities in Texas, certain wholesale power generators, their related affiliated retail electric providers and certain qualified scheduling entities, as well as the Electric Reliability Council of Texas (ERCOT), in its function as the Independent System Operator for the Texas energy market. The action filed in the U.S. District Court for the Southern District of Texas (District Court), Civil Action No. C-03-249 alleges price-fixing, predatory pricing and certain common law claims. Automated Power Exchange, Inc. (APX), a named defendant, acting as the qualified scheduling entity, submitted bids on behalf of Guadalupe Power Partners, LP (Guadalupe) and Odessa-Ector Power Partners, L.P. (Odessa), as well as several other generators in the ERCOT energy market. In this connection, APX has submitted a demand for indemnification from Guadalupe and Odessa. On February 3, 2004, TCE amended its complaint and named TIE, Guadalupe, Odessa and others as additional defendants. On May 20, 2004, the District Court granted the defendants’ motion to dismiss the state and federal antitrust claims. All collateral claims were to be held in abatement pending an appeal of the ruling to the Fifth Circuit Court of Appeals (Fifth Circuit). On July 19, 2004, TCE filed a Notice of Appeal, and the parties subsequently filed briefs and reply briefs. On June 17, 2005, a two-judge panel of the Fifth Circuit issued its decision affirming the District Court’s dismissal of TCE’s state and federal antitrust claims. TCE subsequently filed a Petition seeking a rehearing before the entire panel of the Fifth Circuit. On July 19, 2005, the Fifth Circuit decided not to grant TCE’s request. On October 14, 2005, TCE filed a Petition for Certification of this matter to the U.S. Supreme Court. Global continues to believe there are valid defenses to TCE’s claims, which will be vigorously asserted.

      On February 18, 2005, Utility Choice L.P. and Cirro Group Inc. filed suit against many of the same defendants in the TCE suit, including TIE, Guadalupe and Odessa, based on facts similar to those alleged in the TCE litigation. The new action, filed in the District Court also alleges price-fixing, predatory pricing and various other claims. The District Court issued a stay of action pending the outcome of the TCE appeal and the stay continued until the TCE request to the Fifth Circuit was determined. The District Court originally lifted the stay for the sole purpose of permitting motions to dismiss to be filed but has now allowed the case to proceed to discovery and eventual trial. The defendants’ motion to dismiss was heard by the Court on October 18, 2005. The Court has not indicated when a decision can be expected. Although the District Court is still considering the defendants’ motion to dismiss, discovery is continuing and a trial date of April 3, 2006 has been set. Global continues to believe there are valid defenses to these claims, which will continue to be vigorously asserted.

Note 6. Risk Management

PSEG, PSE&G, Power and Energy Holdings

      The operations of PSEG, PSE&G, Power and Energy Holdings are exposed to market risks from changes in commodity prices, foreign currency exchange rates, interest rates and equity prices that could affect their results of operations and financial conditions. PSEG, PSE&G, Power and Energy Holdings manage exposure to these market risks through their regular operating and financing activities and, when deemed appropriate, hedge these risks through the use of derivative financial instruments. PSEG, PSE&G, Power and Energy Holdings use the term “hedge” to mean a strategy designed to manage risks of volatility in prices or rate movements on certain assets, liabilities or anticipated transactions and

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

by creating a relationship in which gains or losses on derivative instruments are expected to counterbalance the gains or losses on the assets, liabilities or anticipated transactions exposed to such market risks. Each of PSEG, PSE&G, Power and Energy Holdings uses derivative instruments as risk management tools consistent with its respective business plan and prudent business practices.

Derivative Instruments and Hedging Activities

      Energy Trading Contracts

      Power

      Power actively trades energy and energy-related products, including electricity, natural gas, electric capacity, financial transmission rights (FTRs), coal, oil, weather derivatives and emission allowances in the spot, forward and futures markets, primarily in PJM, but also in the surrounding region, which extends from Maine to the Carolinas and the Atlantic Coast to Indiana, and natural gas in the producing region.

      Power maintains a strategy of entering into positions to optimize the value of its portfolio and reduce earnings volatility of generation assets, gas supply contracts and its electric and gas supply obligations. Power engages in physical and financial transactions in the electricity wholesale markets and executes an overall risk management strategy seeking to mitigate the effects of adverse movements in the fuel and electricity markets. These contracts also involve financial transactions including swaps, options and futures. To that end, Power’s objective is to enter into contracts for at least 75% of its anticipated generation output over an 18-month to 24-month horizon. There have been significant increases in commodity prices over the last year. The resultant changes in market values for energy and related contracts that qualify for hedge accounting have resulted in significant increases to OCL. For additional information, see Note 5. Commitments and Contingent Liabilities. Power continues to believe that hedging at least 75% of its anticipated generation output is an appropriate way to reduce the volatility of its earnings.

      Power marks its derivative energy trading contracts to market in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted (SFAS 133), with changes in fair value charged to the Condensed Consolidated Statements of Operations. Wherever possible, fair values for these contracts are obtained from quoted market sources. For contracts where no quoted market exists, modeling techniques are employed using assumptions reflective of current market rates, yield curves and forward prices, as applicable, to interpolate certain prices. The effect of using such modeling techniques is not material to Power’s financial results.

      Power routinely enters into exchange-traded futures and options transactions for electricity and natural gas as part of its operations. Generally, exchange-traded futures contracts require a deposit of margin cash, the amount of which is subject to change based on market movement and in accordance with exchange rules.

      Commodity Contracts

      Power

      The availability and price of energy commodities are subject to fluctuations from factors such as weather, environmental policies, changes in supply and demand, state and federal regulatory policies, market conditions, transmission availability and other events. Power manages its risk of fluctuations of energy price and availability through derivative instruments, such as forward purchase or sale contracts, swaps, options, futures and FTRs.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

      Cash Flow Hedges

      Power uses forward sale and purchase contracts, swaps and FTR contracts to hedge forecasted energy sales from its generation stations and to hedge related load obligations. Power also enters into swaps, options and futures transactions to hedge the price of fuel to meet its fuel purchase requirements. These derivative transactions are designated and effective as cash flow hedges under SFAS 133. As of September 30, 2005, the fair value of these hedges was $(886) million. These hedges, along with realized gains on hedges of $10 million retained in OCL, result in a $(518) million after-tax impact on OCL. As of December 31, 2004, the fair value of these hedges was $(248) million, $(145) million after-tax. During the next 12 months, $263 million of net unrealized and realized losses (after-tax) on these commodity derivatives is expected to be reclassified to earnings. Approximately $166 million of unrealized losses (after-tax) on these commodity derivatives in OCL is expected to be reclassified to earnings for the twelve months ended September 30, 2007. Ineffectiveness associated with these hedges, as defined in SFAS 133, was immaterial. The expiration date of the longest dated cash flow hedge is in 2008.

      Other Derivatives

      Power also enters into certain other contracts that are derivatives, but do not qualify for hedge accounting under SFAS 133. Most of these contracts are used for fuel purchases for generation requirements and for electricity purchases for contractual sales obligations. Therefore, the changes in fair market value of these derivative contracts are recorded in Energy Costs or Operating Revenues, as appropriate, on the Condensed Consolidated Statements of Operations. The net fair value of these instruments as of September 30, 2005 and December 31, 2004 was $23 million and $14 million, respectively.

      Energy Holdings

      Other Derivatives

      TIE, a wholly owned subsidiary of Energy Holdings and Global, also enters into certain other contracts in connection with its merchant generation business that are derivatives, but do not qualify for hedge accounting under SFAS 133. Most of these contracts are used for fuel purchases for generation requirements and for electricity purchases for contractual sales obligations. Therefore, the changes in fair market value of these derivative contracts are recorded in Energy Costs or Operating Revenues, as appropriate, on the Condensed Consolidated Statements of Operations. The net fair value of these instruments as of September 30, 2005 was $(6) million.

Interest Rates

      PSEG, PSE&G, Power and Energy Holdings

      PSEG, PSE&G, Power and Energy Holdings are subject to the risk of fluctuating interest rates in the normal course of business. PSEG’s policy is to manage interest rate risk through the use of fixed and floating rate debt and interest rate derivatives.

      Fair Value Hedges

      PSEG and Power

      In March 2004, Power issued $250 million of 3.75% Senior Notes due April 2009. PSEG used an interest rate swap to convert Power's fixed-rate debt into variable-rate debt. The interest rate swap is designated and effective as a fair value hedge. The fair value changes of the interest rate swap are fully offset by the fair value changes in the underlying debt. As of September 30, 2005 and December 31,

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

2004, the fair value of the hedge was $(9) million and $(3) million, respectively, and there was no ineffectiveness related to the hedge.

      Energy Holdings

      In April 2003, Energy Holdings issued $350 million of 7.75% Senior Notes due in 2007. Energy Holdings used interest rate swaps to convert $200 million of this fixed-rate debt into variable-rate debt. The interest rate swaps are designated and effective as fair value hedges. The fair value changes of these interest rate swaps are fully offset by the fair value changes in the underlying debt. As of September 30, 2005 and December 31, 2004, the fair value of these hedges was $(5) million and $(3) million, respectively, and there was no ineffectiveness related to these hedges.

      Cash Flow Hedges

      PSEG, PSE&G and Energy Holdings

      PSEG, PSE&G and Energy Holdings use interest rate swaps and other interest rate derivatives to manage their exposures to the variability of cash flows, primarily related to variable-rate debt instruments. The interest rate derivatives used are designated and effective as cash flow hedges. The fair value changes of these derivatives are initially recorded in Accumulated Other Comprehensive Income. As of September 30, 2005, the fair value of these cash flow hedges was $(98) million, including $(6) million, $(16) million and $(76) million at PSEG, PSE&G and Energy Holdings, respectively. As of December 31, 2004, the fair value of these cash flow hedges was $(145) million, including $(11) million, $(34) million and $(100) million at PSEG, PSE&G and Energy Holdings, respectively. The $(16) million and $(34) million at PSE&G as of September 30, 2005 and December 31, 2004, respectively, is not included in OCL, as it is deferred as a Regulatory Asset and is expected to be recovered from PSE&G's customers. During the next 12 months, $22 million of unrealized losses (net of taxes) on interest rate derivatives in OCL is expected to be reclassified to earnings, including $2 million and $20 million at PSEG and Energy Holdings, respectively. As of September 30, 2005, hedge ineffectiveness associated with these hedges was immaterial.

      Other Derivatives

      Energy Holdings

      Energy Holdings has cross currency interest rate swaps whose changes in fair value were recorded in Income from Equity Method Investments on the Condensed Consolidated Statements of Operations. The fair value of these swaps was approximately $(2) million and $(4) million as of September 30, 2005 and December 31, 2004, respectively.

Foreign Currencies

      Energy Holdings

      Global is exposed to foreign currency risk and other foreign operations risk that arise from investments in foreign subsidiaries and affiliates. A key component of its risks is that some of its foreign subsidiaries and affiliates have functional currencies other than the consolidated reporting currency, the U.S. Dollar. Additionally, Global and certain of its foreign subsidiaries and affiliates have entered into monetary obligations and maintain receipts/receivables in U.S. Dollars or currencies other than their own functional currencies. Global, a U.S. Dollar functional currency entity, is primarily exposed to changes in the Brazilian Real, the Euro, the Polish Zloty, the Peruvian Nuevo Sol and the Chilean Peso. Changes in valuation of these currencies can impact the value of Global's investments. With respect to the foreign currency risk associated with the Brazilian Real, there has been a significant devaluation

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

since the initial acquisition of that investment in 1997, which has resulted in reduced U.S. Dollar earnings and cash flows relative to initial projections. Global has attempted to limit potential foreign exchange exposure by entering into revenue contracts that adjust for changes in foreign exchange rates. Global also uses foreign currency forward, swap and option agreements to manage risk related to certain foreign currency fluctuations.

      For the nine months ended September 30, 2005, the Chilean Peso, Brazilian Real and the Peruvian Nuevo Sol appreciated significantly relative to the U.S. Dollar, increasing Energy Holdings' Member's Equity by approximately $73 million and largely offsetting prior years' reductions in equity. As a result, the net cumulative foreign currency devaluations had reduced the total amount of Energy Holdings' Member's Equity by $56 million as of September 30, 2005.

      In November 2004, Energy Holdings entered into foreign currency call options in order to hedge the majority of its 2005 expected earnings denominated in Brazilian Real, Chilean Pesos and Peruvian Nuevo Soles. These options are not considered hedges for accounting purposes under SFAS 133 and, as a result, changes in their fair value are recorded directly to earnings. Due to the rise in local currency value relative to the U.S. Dollar, which increases the value of the foreign investments' earnings in U.S Dollar terms, these options did not have value.

Hedges of Net Investments in Foreign Operations

      Energy Holdings

      In March 2004 and April 2004, Energy Holdings entered into four cross-currency interest rate swap agreements. The swaps are designed to hedge the net investment in a foreign subsidiary associated with the exposure in the U.S. Dollar to Chilean Peso exchange rate. The fair value of the cross-currency swaps was $(28) million and $(21) million as of September 30, 2005 and December 31, 2004, respectively. The effective portion of the change in fair value is recorded in Cumulative Translation Adjustment within Accumulated Other Comprehensive Loss.

Note 7. Comprehensive Income (Loss), Net of Tax

    PSE&G

  Power (A)

  Energy
Holdings (B)

  Other (C)

  Consolidated
Total

    (Millions)

For the Quarter Ended September 30, 2005:

                                       

Net Income (Loss)

     $ 115        $ 125        $ 39        $ (26 )      $ 253  

Other Comprehensive (Loss) Income

                (291 )        101          (7 )        (197 )
        
        
        
        
        
 

Comprehensive Income (Loss)

     $ 115        $ (166 )      $ 140        $ (33 )      $ 56  
        
        
        
        
        
 

For the Quarter Ended September 30, 2004:

                                       

Net Income (Loss)

     $ 93        $ 131        $ 36        $ (16 )      $ 244  

Other Comprehensive (Loss) Income

                (46 )        45          (4 )        (5 )