Peoples Energy Corporation (Company) is solely a holding Company and does not engage directly in any business of its own. Income is derived principally from the Company's utility subsidiaries, The Peoples Gas Light and Coke Company (Peoples Gas) and North Shore Gas Company (North Shore Gas). The Company also derives income from its other subsidiaries, Peoples District Energy Corporation (Peoples District Energy), Peoples Energy Services Corporation (Peoples Energy Services), Peoples Energy Resources Corp. (Peoples Energy Resources), Peoples NGV Corp. (Peoples NGV), and Peoples Energy Ventures Corporation (Peoples Energy Ventures). The Company and its subsidiaries had 2,810 employees at September 30, 1999.

The Company was incorporated in 1967 under the Illinois Business Corporation Act and has its principal executive offices at 130 East Randolph Drive, Chicago, Illinois 60601-6207 (Telephone 312-240-4000). Its business activities are segregated into six segments as described below.

The Gas Distribution segment is the Company's core business. Its two regulated utilities purchase, distribute, sell and transport natural gas. The Company also owns a storage facility in central Illinois and a pipeline which connects the facility and five major pipeline suppliers to Chicago. Operating revenues from this segment account for 82% of total consolidated operating revenues.

Peoples Gas, an operating public utility, is engaged primarily in the purchase, storage, distribution, sale, and transportation of natural gas. It has approximately 837,000 residential, commercial, and industrial retail sales and transportation customers within the City of Chicago (City).

North Shore Gas, an operating public utility, is engaged primarily in the purchase, storage, distribution, sale, and transportation of natural gas. It has approximately 146,000 residential, commercial, and industrial retail sales and transportation customers within its service area of approximately 275 square miles, located in northeastern Illinois.

The Power Generation segment is engaged in the development, construction, operation, and ownership of gas-fired electric generation facilities for sales to electric utilities and marketers. The Company and Dominion Resources Inc. are equal investors in Elwood Energy, which owns and operates a 600-megawatt peaking facility near Chicago, Illinois.

The Midstream Services segment performs wholesale activities that provide value to gas distribution utilities, marketers and pipelines. The Company owns and operates a natural gas liquids (NGL) peaking facility and is active in other asset-based wholesale activities. In addition, Peoples Gas operates a natural gas hub.

The Retail Energy Services segment markets gas and electricity and provides energy management and other services to retail customers. In addition, Peoples Gas also offers a variety of HVAC related products and services to small commercial and residential consumers.

The Oil and Gas Production segment is active in the development and production of oil and gas reserves in selected basins in the United States. The Company targets on-shore prospects with proved producing oil and gas reserves and the potential for enhancement through drilling programs.

The Company is involved in other activities such as district heating and cooling and the development of fueling stations for natural gas vehicles. These and other activities do not fall under the above segments and are reported in the Other segment.

Peoples Gas and North Shore Gas are authorized by statute and/or certificates of public convenience and necessity to conduct operations in the territories they serve. In addition, these subsidiaries operate under franchises and license agreements granted them by the communities they serve. Peoples Gas holds a perpetual, non-exclusive franchise from the City. North Shore Gas' franchises with communities within its service territory are of various terms and expiration dates.

Absent extraordinary circumstances, potential competitors are barred from constructing competing gas distribution systems in the utility subsidiaries' service territories by a judicial doctrine known as the "first in the field" doctrine. In addition, the high cost of installing duplicate distribution facilities would render the construction of a competing system impractical.

Competition in varying degrees exists between natural gas and other fuels or forms of energy available to consumers in Peoples Gas' and North Shore Gas' service areas.

On December 16, 1997, the State of Illinois enacted legislation to restructure the electric market in Illinois. Under the legislation, approximately one-third of non-residential electric customers, including customers with very large loads, were able to purchase electric power from the supplier of their choice beginning on October 1, 1999. All non-residential customers will have this choice by December 31, 2000. All residential customers will be given the choice by May 1, 2002. Customers who buy their electicity from a supplier other than the local electric utility will be required to pay transition charges to the utility through the year 2006. These charges are intended to compensate the electric utilities for revenues lost because of customers buying electricity from other suppliers. The legislation also allows an electric utility to issue bonds, in aggregate amounts up to 50% of its Illinois jurisdictional capitalization, to be financed by a specific charge to its customers. An electric utility also may transfer up to 15% of its assets to an affiliated or unaffiliated entity without approval from the Illinois Commerce Commission (Commission). In return for these and other benefits, electric utilities are required to reduce their rates to residential customers. The state's two largest electric utilities, including the utility that serves northeastern Illinois, reduced their residential rates by 15% on August 1, 1998. In addition, both utilities must further reduce their residential rates by 5% on October 1, 2001, and the other must do so on May 1, 2002. The legislation does not require electric utilities to divest their power generation assets. However, subject to certain capacity restrictions, electric utilities can divest assets without Commission approval. It is too early to determine what effects this restructuring of the electric market will have on the competitive position of the Company's subsidiaries.

In addition to restructuring the electric market, the legislation provides for additional funding for assistance to low-income energy users, including customers of the Companys' utility subsidiaries. The legislation creates a fund, financed by charges to electric and gas customers of public utilities and participating municipal utilities and electric co-ops, which supplements currently available federal energy assistance.

A substantial portion of the gas that Peoples Gas and North Shore Gas deliver to their customers consists of gas that the subsidiaries' customers purchase directly from producers and marketers rather than from the subsidiaries. These direct customer purchases have little effect on net income because the utilities provide transportation service for such gas volumes and recover margins similar to those applicable to conventional gas sales.

A pipeline may seek to provide transportation service directly to end-users. Such direct service by a pipeline to an end-user would bypass the local distributor's service and reduce the distributor's earnings. However, none of the subsidiaries' pipeline suppliers has undertaken any service bypassing the subsidiaries. Both utility subsidiaries have a bypass rate approved by the Commission which allows the utilities to renegotiate rates with customers that are potential bypass candidates.

Through its Retail Energy Services segment, the Company is involved in the marketing of gas and electricity to retail customers. The Company has seen substantial growth in its nearly three years of full operation. As one of the three largest energy suppliers in the state of Illinois, the Company now sells over 20% of all the gas to eligible retail customers. Competition in this arena comes from utility affiliates, purchased by, some larger marketers, and a number of smaller marketers as the market continues to expand. Through its positive name recognition, acquisition of customer contracts and strategic marketing efforts towards higher margin customers, the Company aims to capture major regional market share of this business. The business climate is volatile with many companies entering and exiting the business.

Peoples Gas and North Shore Gas sell natural gas having an average heating value of approximately 1,000 British thermal units (Btus) per cubic foot.* Sales are made and service rendered by Peoples Gas and North Shore Gas pursuant to rate schedules on file with the Commission containing various service classifications largely reflecting customers' different uses and levels of consumption. The Gas Charge is determined in accordance with the provisions in Rider 2, Gas Charge, to recover the costs incurred by Peoples Gas and North Shore Gas to purchase, transport, manufacture, and store gas supplies. The level of the Gas Charge under both subsidiaries' rate schedules is adjusted monthly to reflect increases or decreases in natural gas supplier charges, purchased storage service costs, transportation charges and liquefied petroleum gas costs. In addition, under the tariffs of Peoples Gas and North Shore Gas, the difference for any month between costs recoverable through the Gas Charge and revenues billed to customers under the Gas Charge is refunded to or recovered from customers. Consistent with these tariff provisions, such difference for any month is recorded either as a current liability or a current asset (with a contra entry to Gas Costs). (See Note 1L of the Notes to Consolidated Financial Statements.)

The business of the Company's utility subsidiaries is influenced by seasonal weather conditions because a large element of the subsidiaries' customer load consists of space heating. (For discussion of the effects of weather, see Other Matters in Item 7.) Therefore, weather-related deliveries can have a significant positive or negative impact on net income. (For discussion of the effect of the seasonal nature of gas revenues on cash flow, see Liquidity in Item 7.)

The basic marketing plans of Peoples Gas and North Shore Gas are to maintain their existing shares in all market segments and develop opportunities emerging from changes in the utility environment and technological equipment advances for new, expanded, or current natural gas applications, including cogeneration, prime movers, natural gas-fueled vehicles and natural gas air-conditioning.

Peoples Gas and North Shore Gas are subject to the jurisdiction of and regulation by the Commission, which has general supervisory and regulatory powers over practically all phases of the public utility business in Illinois, including rates and charges, issuance of securities, services and facilities, systems of accounts, investments, safety standards, transactions with affiliated interests, as defined in the Illinois Public Utilities Act, and other matters.

* All volumes of natural gas set forth in this report are stated on a 1,000 Btu (per cubic foot) billing basis.

(100 cubic feet = 1 therm; 10 therms = 1 Dekatherm - Dth)

The Company is a holding company as defined in the Public Utility Holding Company Act of 1935 (Act). By Order entered on December 6, 1968 (Holding Company Act Release No. 16233), the Securities and Exchange Commission, pursuant to Section 3(a)(1) of the Act, exempted the Company and its subsidiary companies as such from the provisions of the Act, other than Section 9(a)(2) thereof.

Most of the gas distributed by Peoples Gas and North Shore Gas is transported to the utilities' distribution systems by interstate pipelines. In their provision of gas sales services (gathering, transportation and storage services, and gas supply), pipelines are regulated by the Federal Energy Regulatory Commission (FERC) under the Natural Gas Act and the Natural Gas Policy Act of 1978. (See "Sales and Rates" and "Current Gas Supply" in Item 1.)

Peoples Gas' operation of its natural gas hub is subject to the jurisdiction of and regulation by the FERC, which has authority over the rates, terms and conditions of the hub services.

The Company and its subsidiaries are subject to federal and state environmental laws. Peoples Gas and North Shore Gas are conducting environmental investigations and work at certain sites that were the location of former manufactured gas plant operations. (See Note 3A of the Notes to Consolidated Financial Statements.) In addition, North Shore Gas has received a demand for payment of environmental response costs at a former mineral processing site in Denver, Colorado. (See Note 3B of the Notes to Consolidated Financial Statements. Also see Note 18 "Events (Unaudited) Subsequent to the Auditors' Report Dated October 29, 1999.")

Peoples Gas and North Shore Gas have each entered into various long-term and short-term firm gas supply contracts. When used in conjunction with contract peaking and contract storage, Peoples Gas' company-owned storage, and the peak-shaving facilities of the utilities, such supply is deemed sufficient to meet current and foreseeable peak and annual market requirements.

Although the Company believes North American supply to be sufficient to meet U.S. market demands for the foreseeable future, it is unable to quantify or otherwise make specific representations regarding national supply availability.

The following tabulation shows the expected design peak-day availability of gas in thousands of dekatherms (MDth) during the 1999-2000 heating season for Peoples Gas and North Shore Gas:

(1) Consists of firm gas purchases from various suppliers delivered utilizing firm pipeline transportation. The majority of the gas purchase contracts are negotiated annually. The terms of the transportation contracts vary, with the longest term being 11 years.

(2) Reflects derating of capacity, as accepted by the Commission Staff in Docket 91-0581.

(3) The contract with Peoples Energy Resources was for an initial term expiring November 30, 1999; the contract continues in effect from year to year thereafter unless canceled by either party upon 12 months' prior notice.

(4) Consists of leased storage services required to meet design day requirements with contract lengths varying from one to five years.

(5) Manlove Field, Peoples Gas' underground storage facility located near Champaign, Illinois, has seasonal top-gas inventory of approximately 26,400 MDth for system supply of which approximately 1,566 MDth is dedicated to North Shore Gas. Peoples Gas also owns a liquefied natural gas (LNG) plant at Manlove Field for the primary purpose of supporting late-season deliverability from the storage facility. The LNG plant has a storage capacity of 2,000 MDth and is capable of regasifying 300 MDth of gas per day. For the 1999-2000 heating season, Manlove Field complex will have a maximum peak-day delivery capability of approximately 1,056 MDth (including 63 MDth for the use of North Shore Gas).

(6) The contract with Peoples Gas was for an initial term expiring May 1, 1990. However, by its terms, the contract continues in effect unless canceled by either party upon 120 days notice prior to April 30 of any year thereafter.

(7) Consists of gas supplies purchased directly from producers and marketers by the utilities' commercial, industrial, and larger residential customers.

The sources of gas supply (including gas transported for customers) in MDth for Peoples Gas and North Shore Gas for the three years ended September 30, 1999, 1998 and 1997 were as follows:

Peoples Energy Sevices purchased the majority of the natural gas required to serve its retail customers from a single wholesale supplier, with the remaining requirements met through purcahses from a small number of other suppliers. The gas supply agreement with the major supplier extends through March 31, 2002. The agreement applies to deliveries to serve retail customers in the northern Illinois market area. All gas is delivered to Peoples Energy Services at the Chicago city gates for those local distribution companies. Peoples Energy Services does not contract for interstate pipeline capacity in connection with purchases from the maajor supplier.

All of the principal plants and properties of Peoples Gas and North Shore Gas have been maintained in the ordinary course of business and are believed to be in satisfactory operating condition. The distribution facilities serve the City and other areas in northeastern Illinois. Peoples Gas owns and operates an underground gas storage reservoir and an LNG plant at Manlove Field located near Champaign, Illinois. Peoples Gas also owns a transmission system that transports gas from Manlove Field to Chicago. The underground storage reservoir and LNG plant also serve North Shore Gas. General properties include a substantial investment in office and service buildings, garages, repair shops and motor vehicles, together with the equipment, tools and fixtures necessary to conduct utility business.

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

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

The Company owns and operates a plant in Will County, Illinois that gasifies natural gas liquids to support the sale of winter peaking services to area natural gas utilities and marketers. The current seasonal capacity of the plant is approximately 800,000 MMbtu. The plant is fully paid for and no liens exist on the property.

During the current fiscal year, the Company acquired, either directly or through partnerships, working interests in various oil and gas reserves. Currently, these interests are located in Texas, Louisiana, North Dakota, Colorado and Arkansas. The total investment in these properties is approximately $43.7 million. As of September 30, 1999, total proved oil and gas reserves owned by Peoples Energy Production were 43.9 equivalent Bcf. Reserve information on these properties was provided by the following engineering firms: Ryder Scott Company Petroleum Engineers,; Miller & Lent, LTD - International Oil and Gas Consultant,; McCartney Engineering, LLC,; Cawley, Gillespie & Associates, Inc. - Petroleum Engineers and Prator Bett, LLC - Petroleum Engineers.

See Note 3 of the Notes to Consolidated Financial Statements.

None.

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

The common stock of the Company is listed on the New York, Chicago, and Pacific Stock Exchanges (trading symbol: PGL). At November 30, 1999, there were 24,753 registered shareholders.

The common stock price range and dividends declared per common share by quarters for fiscal 1999 and 1998 were as follows:

Representative of its progress towards becoming a more diversified energy company, Peoples Energy is reporting, for the first time, year-end operating income and equity investment income for each of its six business segments: Gas Distribution, Power Generation, Midstream Services, Retail Energy Services, Oil and Gas Production and Other. (See Note 2 of the Notes to Consolidated Financial Statements.) North Shore Gas is active in the Gas Distribution segment only. Peoples Gas' main activity is in the Gas Distribution segment but is also involved in activity reported in the Midstream and Retail Energy Services segments.

In 1999, net income for the Company increased $13.2 million to $92.6 million, due primarily to an increase in operating income and equity investment income from diversified business segments, the elimination of the decommissioning reserve associated with the 1995 retirement of Peoples Gas' synthetic natural gas plant and a state tax refund. These effects were partially offset by lower operating income from the gas distribution segment.

In 1998, net income for the Company decreased $19.0 million to $79.4 million, principally as a result of weather that was 18 percent warmer than the prior year. Increases in costs associated with outside professional services and advertising expense also contributed to the decline in net income. These effects were offset, in part, by increased earnings from diversified business segments, a reduction in the provision for uncollectible accounts, and lower group insurance expense.

In 1999, net income for Peoples Gas increased $9.8 million to $78.2 million, primarily as a result of the elimination of the decommissioning reserve associated with the 1995 retirement of its synthetic natural gas plant, a state income tax refund, and an increase in income from hub activities.

In 1998, net income for Peoples Gas decreased $16.7 million to $68.4 million, due primarily to weather that was warmer than the prior year. Increases in the costs associated with outside professional services and depreciation expense also contributed to the decline of net income. These effects were partially offset by decreases in the provision for uncollectible accounts and labor costs.

In 1999, net income for North Shore Gas decreased by $493,000 to $12.5 million, primarily as a result of increases in operation and maintenance expenses and depreciation expense, partially offset by a state income tax refund.

In 1998, net income for North Shore Gas decreased $1.8 million to $13.0 million, principally as a result of weather that was warmer than the prior year. Increases in labor costs and depreciation expense also contributed to the decline in net income. These effects were offset in part by a decrease in pension expense and a decline in the costs associated with outside professional services.

A summary of variations affecting income between years is presented below, with explanations of significant differences following:

The Company's core business is the distribution of natural gas. Its two regulated utilities purchase, distribute, sell and transport natural gas to approximately 1 million retail customers through a 6,000 mile distribution system serving the City of Chicago and 54 communities in northeastern Illinois. The Company also owns a storage facility in central Illinois and a pipeline which connects the facility and five major pipeline suppliers to Chicago.

Gross revenues of Peoples Gas and North Shore Gas are affected by changes in the unit cost of the utilities' gas purchases and do not include the cost of gas supplies for customers who purchase gas directly from producers and marketers rather than from the utilities. The unit cost of gas does not have a direct significant effect on operating income because of the utilities' tariffs that provide for dollar-for-dollar recovery of gas costs. (See Note 1L of the Notes to Consolidated Financial Statements.

In 1999, operating revenues for the Company decreased compared to 1998 due mainly to lower unit costs of gas. Operating income decreased $5.4 million to $154.9 million in 1999, due chiefly to a decrease in gas deliveries. Also negatively affecting operating income were lower pension credits and an increase in depreciation expense due to depreciable property additions. Partially offsetting these effects were reductions in labor, group insurance expense and the provision for uncollectible accounts.

In 1998, operating revenues for the Company decreased from the previous year due primarily to weather being 18 percent warmer. Operating income decreased $29.4 million to $160.2 million in 1998, due mainly to the effect of warmer weather. Also contributing to the decrease in operating income was an increase in the cost of outside professional services. Offsetting these negative impacts were a lower provision for uncollectible accounts and a reduction in group insurance expense.

In 1999, operating income decreased $3.9 million to $130.4 million for Peoples Gas due primarily to increased customer conservation, a prior period accrual adjustment, a decrease in other operating revenues, lower pension credits and an increase in depreciation expense due to depreciable property additions. Partially offsetting these effects were reductions in labor costs, group insurance expense and the provision for uncollectible accounts.

In 1998, operating income for Peoples Gas decreased $26.6 million to $134.3 million, due chiefly to lower gas deliveries resulting from the effects of warmer weather. Also contributing to this negative effect were increases in outside professional services and depreciation expense due largely to depreciable property additions. Partially offsetting these effects were reductions in group insurance expense, labor costs and higher pension credits.

In 1999, operating revenues for North Shore Gas decreased $1.5 million to $24.4 million, due mainly to a decrease in gas deliveries. Also negatively affecting operating income were lower pension credits and increases in labor costs and depreciation expense due primarily to depreciable property additions.

In 1998, operating income for North Shore Gas decreased $2.8 million to $25.9 million, due primarily to a decrease in gas deliveries due mainly to the effects of warmer weather. Also negatively affecting operating income were increases in labor costs and depreciation expense due mainly to depreciable property additions. These negative effects were partially offset by increased pension credits and lower costs associated with outside professional services.

The Company's objectives for this segment center on continuous improvement, technological advancements and customer service. Initiatives for fiscal 2000 include the implementation and enhancement of the C-first customer information system, the near completion of the SureRead(sm) automatic meter reading system, gas supply optimization through an agreement with Enron North America Corp., and continued pursuit of performance-based rates. The Company is targeting returns on equity of 12% for fiscal 2000 and has no plans to file rate cases. Operating revenues are expected to increase due to normal weather and increased gas prices. Segment operating income is expected to improve due to normal weather, partially offset by increased labor and depreciation expenses.

The Company is engaged in the development, construction, operation, and ownership of gas-fired electric generation facilities for sales to electric utilities and marketers. The Company and Dominion Resources Inc. are equal investors in Elwood Energy, which owns and operates a 600-megawatt peaking facility near Chicago, Illinois.

Operating income and equity investment income amounted to $6.9 million in 1999, mostly as a result of the Company's investment in Elwood Energy. Income from this partnership, $8.5 million, was partially offset by labor and other costs associated with activities related to this project and other potential power generation projects.

The Company's objective is to own and operate more than 1,000 megawatts of peaking capacity. It is pursuing regional opportunities in and near the City of Chicago as well as considering the expansion of the Elwood facility, which has received regulatory approvals for a total of 3,100 megawatts in generating capacity. The Company expects equity investment income for fiscal 2000 to increase substantially due to the full year impact of Elwood. Annual revenues from the two contracts for the entire plant capacity are recognized based on utilization of the plant.

The Company performs wholesale activities that provide value to gas distribution utilities, marketers and pipelines. The Company operates a natural gas hub, owns and operates a natural gas liquids (NGL) peaking facility and is active in other asset-based wholesale activities.

In 1999, operating income increased $1.6 million to $9.0 million compared to 1998, due primarily to an increase in operating revenues resulting from increased Peoples Gas hub activity and additional capacity revenue from the NGL peaking facility. Partially offsetting these increases was lower operating income from wholesale marketing.

In 1998, operating income increased $5.3 million over 1997, to $7.4 million due mainly to increased revenue from wholesale marketing, Peoples Gas hub activity, and the NGL peaking facility. These impacts on operating income were partially offset by the increased cost of energy sold.

In 1999 and 1998, operating income for Peoples Gas, relative to this segment, increased $2.7 million to $6.0 million and $1.6 million to $3.3 million, respectively, resulting from increased hub activity.

The Company's objective is to become the primary player in the Midwest market center, developing additional hub services such as storage, transportation and title tracking while pursuing an exchange-traded Chicago contract. A recent agreement with Enron North America Corp. is expected to enable the Company to expand its Chicago hub and pursue wholesale marketing opportunities. The Company intends to market additional capacity from its existing NGL peaking facility and pursue the development of an additional gas peaking facility. The Company will also be active in the development of regional wholesale projects such as its proposed pipeline from the Midwest market center to Wisconsin.

The Company markets gas and electricity and provides energy management and other services to retail customers.

In 1999, the operating loss of $3.6 million was $408,000 less than in 1998 for the Company, due mainly to an increase in operating revenues from retail gas sales. Partially offsetting this improvement were increases in the cost of energy sold and higher operating costs, due to growth in operatrions infrastructure and the development of a retail electric business.

In 1999, Peoples Gas reflected an operating loss for this segment of $365,000 due to costs associated with Peoples Home Services a business unit providing home furnance and air conditioning maintenance services. Peoples Gas' involvement in this segment began in fiscal 1999.

In 1998, operating losses for the Company increased by $1.8 million from the prior year, to $4.0 million due chiefly to increases in the cost of energy sold, higher labor costs and increased costs of outside professional services. These negative impacts were partially offset by increased revenues from retail gas sales.

The Company's objective is to capture major regional market share in energy sales. It will develop proprietary products as it participates in the Illinois electric and gas unbundling process and will continue to build the necessary infrastructure as it grows through acquisitions and direct marketing efforts. Recently certified by the Illinois Commerce Commission (Commission) as an Alternative Retail Electric Supplier (ARES) in Illinois, the Company is one of the first ARES to provide electric products to eligible customers in the state.

The Company is active in the development and production of oil and gas reserves in selected basins in the United States. The Company targets on-shore prospects with proved producing oil and gas reserves and the potential for enhancement through drilling programs.

In 1999, the first full year of activity, operating income and equity investment income increased $2.6 million to $2.2 million, due primarily to new investments in oil and gas properties along with successful drilling of new wells.

The Company's objective is to become a top-fifty owner of U.S. gas reserves with holdings of between 350 to 400 billion cubic feet. Existing oil and gas properties will be developed through drilling and production enhancements. The Company will continue to hedge production in order to mitigate price risk and will pursue reserve acquisitions that are consistent with its basin strategy. The Company intends to develop or acquire the expertise to operate its properties.

The Company is involved in other activities such as district heating and cooling and the development of fueling stations for natural gas vehicles. These and other activities do not fall under the above segments.

The variations for the two reportable periods are primarily attributable to fluctuating costs associated with business development activities.

This category encompasses corporate activities that support the six segments, as well as consolidating adjustments.

The variations for the two reportable periods are due to increased advertising costs and higher labor costs.

Other income and deductions for the Company increased $15.5 million to $19.8 million in 1999, due mainly to the elimination of the decommissioning reserve associated with the 1995 retirement of Peoples Gas' synthetic natural gas plant (see Note 8 of the Notes to Consolidated Financial Statements) and the interest income on a state income tax refund.

In 1998, other income and deductions for the Company decreased $844,000 to $4.3 million, due mainly to a reduction in miscellaneous interest revenues.

In 1999, other income and deductions for Peoples Gas increased by $16.8 million to $18.9 million, due primarily to the elimination of the decommissioning reserve associated with the 1995 retirement of its synthetic natural gas plant, interest income arising from a state income tax refund, an increase in the allowance for other funds used during construction and a prior period loss on disposition of property.

In 1998, other income and deductions decreased $1.9 million to $2.1 million for Peoples Gas, due primarily to lower miscellaneous interest revenues. Partially offsetting this effect was an increase in the allowance for other funds used during construction.

In 1999, other income and deductions for North Shore Gas increased by $234,000 to $648,000, primarily due to interest income arising from a state income tax refund.

Interest expense for the Company increased $966,000 in 1999 due primarily to increased interest on short-term debt, offset, in part, by increases in capitalized interest expense and the allowance for borrowed funds used during construction.

Interest expense increased $217,000 in 1998 for the Company due to increased interest on short-term debt and increased interest expense on utility budget plan accounts, offset, in part, by an increase in the allowance for borrowed funds used during construction.

In 1999, interest expense for Peoples Gas decreased $523,000 to $32.6 million, primarily due to an increase in the allowance for borrowed funds used during construction and to a decrease in interest on long-term debt, partially offset by increases in other interest expense, including carrying charges on an environmental insurance recovery.

In 1999, interest expense for North Shore Gas decreased by $27,000 to $5.2 million, primarily due to a decrease in interest expense on promissory notes and interest income on a construction fund, partially offset by an increase in carrying charges on an environmental insurance recovery and an increase in interest on long-term debt.

Interest expense increased $120,000 to $5.2 million for North Shore Gas, due mainly to an increase in interest on promissory notes.

In 1999, income taxes for the Company increased $7.5 million to $52.6 million, due mainly to higher pre-tax income. Fiscal year 1999 also includes a tax accrual adjustment for a state income tax refund. Income taxes decreased $11.3 million to $45.1 million in 1998, due to lower pre-tax income. Fiscal years 1998 and 1997 reflect other tax accrual adjustments. Variations between periods for these adjustments are minimal.

In 1999, income taxes increased for Peoples Gas $5.9 million to $44.1 million due primarily to higher pre-tax income and to a state income tax refund. In 1998, income taxes decreased $10.1 million to $38.2 million, due mainly to lower pre-tax income.

In 1999, income taxes for North Shore Gas decreased $728,000 to $7.4 million, primarily due to lower pretax income and to a state income tax refund. In 1998, income taxes decreased $1.1 million to $8.1 million, due mainly to lower pre-tax income.

The Company expects its earnings per share for fiscal 2000 to fall between $2.65 and $2.75, assuming normal weather. The financial target for the gas distribution segment is to achieve a 12% return on common equity. The target for the diversified business segments is to achieve between 12% and 16% of total earnings, based on an EBIT range between $25 and $35 million.

Effect of Weather. Weather variations affect the volumes of gas delivered for heating purposes and, therefore, can have a significant positive or negative impact on net income, cash position and coverage ratios of the Company. Weather in fiscal years 1999 and 1998 was warmer than normal by 14% and 15%, respectively. In order to mitigate the effect of substantially warmer weather, Peoples Energy has purchased a five-year weather insurance policy. The weather insurance program, beginning in fis ny to protect earnings when weather is more than 8% warmer than normal. The Company will continue to retain all upside revenue potential when weather is colder than normal.

Accounting Standards. In fiscal 1999, Peoples Energy and its subsidiaries adopted Statement of Financial Accounting Standard (SFAS) Nos. 130, 131, and 132. Refer to Note 1P of the Notes to Consolidated Financial Statements for a further explanation.

In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This statement provides guidance on accounting for the costs of computer software developed or obtained for internal use. The statement will be adopted in fiscal year 2000. The Company does not expect the application of this standard to have a material effect on its financial condition or r

In June 1998, as amended on May 19, 1999, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative financial instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities on the consolidated balance sheet and meas alue. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and resulting designation.

Changes in the fair value of derivatives will be recognized in the current period earnings, unless specific hedge accounting criteria are met. If a transaction qualifies for hedge accounting, the gains and losses of derivatives will offset the related results of the hedged item in the current period's income statement. SFAS No. 133 requires that formal documentation be maintained and that the effectiveness of the hedge be assessed quarterly. The statement must be adopted no later than the Company' ts current risk management strategies, the Company does not expect the adoption of this standard to have a material effect on its financial condition or results of operations. The Company cannot predict how financial results may be affected by application of this standard toward any new risk management strategies it may adopt in the future.

Competition in varying degrees exists between natural gas and other fuels or forms of energy available to consumers in the Peoples Gas and North Shore Gas service areas.

On December 16, 1997, the State of Illinois enacted legislation to restructure the electric market in Illinois. Under the legislation, approximately one-third of non-residential electric customers, including customers with very large loads, were able to purchase electric power from the supplier of their choice beginning on October 1, 1999. All non-residential customers will have this choice by December 31, 2000. All residential customers will be given this choice by May 1, 2002. Customers who buy

In addition to restructuring the electric market, the legislation provides for additional funding for assistance to low-income energy users, including customers of the Company's utility subsidiaries. The legislation creates a fund, financed by charges to electric and gas customers of public utilities and participating municipal utilities and electric co-ops, which supplements currently available federal energy assistance.

Operating Statistics. The following table represents gross margin components and delivery statistics for Peoples Energy:

(a) Volumes associated with contract pooling service are included in the respective customer classes.

Operating Statistics. The following table represents gross margin components and delivery statistics for Peoples Gas:

(a) Volumes associated with contract pooling service are included in the respective customer classes.

Operating Statistics. The following table represents gross margin components and delivery statistics for North Shore Gas: