UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-Q
                                    ---------

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

                For the quarterly period ended September 30, 2004

              [ ] 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 1-14161

                               KEYSPAN CORPORATION
                               -------------------
             (Exact name of Registrant as specified in its Charter)

          New York                                      11-3431358
          --------                                      ----------
(State or other jurisdiction of             (IRS Employer Identification No.)
 incorporation or organization)

                 One MetroTech Center, Brooklyn, New York      11201
             175 East Old Country Road, Hicksville, New York   11801
             ----------------------------------------------------------
               (Address of principal executive offices)      (Zip Code)

                            (718) 403-1000 (Brooklyn)
                           (631) 755-6650 (Hicksville)
                           ---------------------------
              (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.[X]

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

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares  outstanding  of each of the  issuer's  classes of
common stock, as of the latest practicable date.

  Class of Common Stock                         Outstanding at October 13, 2004
  ---------------------                         -------------------------------
        $.01 par value                                   160,595,889


<PAGE>



                      KEYSPAN CORPORATION AND SUBSIDIARIES

                                      INDEX
                                      -----

                     Part I. FINANCIAL INFORMATION                      Page No.
                                                                        --------

Item 1. Financial Statements

        Consolidated Balance Sheet -
        September 30, 2004 and December 31, 2003                           3

        Consolidated Statement of Income - Three and
        Nine Months Ended September 30, 2004 and 2003                      5
        Consolidated Statement of Cash Flows -
        Nine Months Ended June 30, 2004 and 2003                           6

        Notes to Consolidated Financial Statements                         7

Item 2. Management's Discussion and Analysis of Financial
        Condition and Results of Operations                               38

Item 3. Quantitative and Qualitative Disclosures
        About Market Risk                                                 71

Item 4. Controls and Procedures                                           74

                     Part II.   OTHER INFORMATION

Item 1. Legal Proceedings                                                 75

Item 6. Exhibits                                                          75

Signatures                                                                76



                                       2
<PAGE>



<TABLE>
                           CONSOLIDATED BALANCE SHEET
                                   (Unaudited)
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------

(In Thousands of Dollars)                                                September 30, 2004              December 31, 2003
--------------------------------------------------------------------------------------------------------------------------

ASSETS
<S>                                                                              <C>                          <C>
Current Assets
    Cash and temporary cash investments                                         $    361,297                 $    205,751
    Accounts receivable                                                              806,489                    1,029,459
    Unbilled revenue                                                                 212,630                      505,633
    Allowance for uncollectible accounts                                             (66,873)                     (79,184)
    Gas in storage and prepaid gas                                                   564,630                      488,521
    Material and supplies, at average cost                                           117,913                      121,415
    Other                                                                             84,976                      115,304
                                                             -------------------------------- ----------------------------
                                                                                   2,081,062                    2,386,899
                                                             -------------------------------- ----------------------------

Investments and  Other                                                               516,604                      248,565

Property
    Gas                                                                            6,790,147                    6,522,251
    Electric                                                                       2,356,169                    2,636,537
    Other                                                                            433,823                      425,576
    Accumulated depreciation                                                      (2,709,225)                  (2,610,876)
    Gas exploration and production, at cost                                          182,114                    3,088,242
    Accumulated depletion                                                           (103,867)                  (1,167,427)
                                                             -------------------------------- ----------------------------
                                                                                   6,949,161                    8,894,303
                                                             -------------------------------- ----------------------------

Deferred Charges
    Regulatory assets                                                                530,705                      578,383
    Goodwill and other intangible assets                                           1,688,287                    1,809,712
    Other                                                                            775,754                      722,320
                                                             -------------------------------- ----------------------------
                                                                                   2,994,746                    3,110,415
                                                             -------------------------------- ----------------------------

Total Assets                                                                    $ 12,541,573                 $ 14,640,182
                                                             ================================ ============================
</TABLE>

        See accompanying Notes to the Consolidated Financial Statements.



                                       3
<PAGE>

<TABLE>
                           CONSOLIDATED BALANCE SHEET
                                   (Unaudited)

<CAPTION>
--------------------------------------------------------------------------------------------------------------------------------


(In Thousands of Dollars)                                                     September 30, 2004              December 31, 2003
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>                           <C>
LIABILITIES AND CAPITALIZATION
Current Liabilities
    Current redemption of long-term debt                                             $     16,142                  $      1,471
    Accounts payable and other liabilities                                                662,127                     1,141,597
    Commercial paper                                                                      575,375                       481,900
    Dividends payable                                                                      72,248                        72,289
    Taxes accrued                                                                          43,474                        46,580
    Customer deposits                                                                      43,565                        40,370
    Interest accrued                                                                       77,493                        64,609
                                                               ----------------------------------- -----------------------------
                                                                                        1,490,424                     1,848,816
                                                               ----------------------------------- -----------------------------

Deferred Credits and Other Liabilities
    Regulatory liabilities:
          Miscellaneous liabilities                                                       154,059                       104,034
          Removal cost recovered                                                          485,394                       450,034
    Deferred income tax                                                                 1,091,443                     1,278,341
    Postretirement benefits and other reserves                                            951,889                       961,962
    Other                                                                                 113,683                       121,790
                                                               ----------------------------------- -----------------------------
                                                                                        2,796,468                     2,916,161
                                                               ----------------------------------- -----------------------------

Commitments and Contingencies (See Note 6)                                                      -                             -

Capitalization
    Common stock                                                                        3,495,111                     3,487,645
    Retained earnings                                                                     665,823                       621,430
    Accumulated other comprehensive loss                                                  (66,537)                      (59,932)
    Treasury stock                                                                       (354,165)                     (378,487)
                                                               ----------------------------------- -----------------------------
         Total common shareholders' equity                                              3,740,232                     3,670,656
    Preferred stock                                                                        75,000                        83,568
    Long-term debt                                                                      4,423,862                     5,611,432
                                                               ----------------------------------- -----------------------------
Total Capitalization                                                                    8,239,094                     9,365,656
                                                               ----------------------------------- -----------------------------

Minority Interest in Subsidiary Companies                                                  15,587                       509,549
                                                               ----------------------------------- -----------------------------
Total Liabilities and Capitalization                                                 $ 12,541,573                  $ 14,640,182
                                                               =================================== =============================
</TABLE>

        See accompanying Notes to the Consolidated Financial Statements.



                                       4
<PAGE>

<TABLE>
                        CONSOLIDATED STATEMENT OF INCOME
                                   (Unaudited)
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                       Three Months Ended September 30,             Nine Months Ended September 30,
(In Thousands of Dollars, Except Per Share Amounts)      2004                    2003                2004                    2003
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>                      <C>                 <C>                     <C>
Revenues
     Gas Distribution                               $  419,208               $  405,777         $ 3,023,350             $ 2,970,514
     Electric Services                                 503,879                  438,577           1,296,778               1,228,622
     Energy Services                                   118,580                  137,961             377,516                 399,294
     Energy Investments                                  8,767                  149,499             314,134                 454,061
                                                ------------------------------------------------------------------------------------
Total Revenues                                       1,050,434                1,131,814           5,011,778               5,052,491
                                                ------------------------------------------------------------------------------------
Operating Expenses
     Purchased gas for resale                          186,619                  172,452           1,776,322               1,792,917
     Fuel and purchased power                          176,028                  133,313             407,987                 333,311
     Operations and maintenance                        434,874                  507,381           1,404,835               1,515,206
     Depreciation, depletion and
       amortization                                     93,420                  135,656             454,737                 422,917
     Goodwill impairment charge                        122,229                        -             122,229                       -
     Operating taxes                                    89,525                   91,790             302,143                 311,754
                                                ------------------------------------------------------------------------------------
Total Operating Expenses                             1,102,695                1,040,592           4,468,253               4,376,105
                                                ------------------------------------------------------------------------------------

Gain on sale of long lived asset                             -                   13,974                   -                  13,974
Income from Equity Investments                          16,213                    2,727              30,342                  12,486
                                                ------------------------------------------------------------------------------------

Operating Income (Loss)                                (36,048)                 107,923             573,867                 702,846
                                                ------------------------------------------------------------------------------------
Other Income and (Deductions)
     Interest charges                                  (88,308)                 (78,366)           (260,848)               (226,503)
     Gain (loss) on subsidiary stock
       transactions                                          -                        -             172,894                 (11,325)
     Cost of debt redemption                           (45,879)                       -             (45,879)                (24,094)
     Minority interest                                     (58)                 (19,894)            (37,012)                (50,252)
     Other                                               4,204                   10,325              26,418                  24,779
                                                ------------------------------------------------------------------------------------
Total Other Income and (Deductions)                   (130,041)                 (87,935)           (144,427)               (287,395)
                                                ------------------------------------------------------------------------------------

Income Taxes
     Current                                          (176,828)                 (39,317)            (13,330)                 94,275
     Deferred                                          126,518                   46,720             180,115                  71,439
                                                ------------------------------------------------------------------------------------
Total Income Taxes                                     (50,310)                   7,403             166,785                 165,714
                                                ------------------------------------------------------------------------------------

Earnings (Loss) Before Change in Accounting
  Principle                                           (115,779)                  12,585             262,655                 249,738
Cummulative Change in Accounting Principle                   -                        -                   -                     174
                                                ------------------------------------------------------------------------------------

Net Income (Loss)                                     (115,779)                  12,585             262,655                 249,912
Preferred stock dividend requirements                    1,360                    1,461               4,280                   4,383
                                                ------------------------------------------------------------------------------------
Earnings (Loss) for Common Stock                    $ (117,139)              $   11,124         $   258,375             $   245,529
                                                ====================================================================================
Basic Earnings (Loss) Per Share:
  Before Change in Accounting Principle                  (0.73)                    0.07                1.61                    1.56
  Change in Accounting Principle                             -                        -                   -                       -
                                                ------------------------------------------------------------------------------------
Basic Earnings (Loss) Per Share                     $    (0.73)              $     0.07         $      1.61             $      1.56
                                                ====================================================================================
Diluted Earnings (Loss) Per Share:
  Before Change in Accounting Principle                  (0.73)                    0.07                1.60                    1.55
  Change in Accounting Principle                             -                        -                   -                       -
                                                ------------------------------------------------------------------------------------
Diluted Earnings (Loss) Per Share                   $    (0.73)              $     0.07         $      1.60             $      1.55
                                                ====================================================================================
Average Common Shares Outstanding (000)                160,357                  158,783             160,139                 157,871
Average Common Shares Outstanding - Diluted (000)      161,346                  159,539             161,091                 158,670
</TABLE>
        See accompanying Notes to the Consolidated Financial Statements.


                                       5
<PAGE>

<TABLE>
<CAPTION>
                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                   (Unaudited)
------------------------------------------------------------------------------------------------------------------------
                                                                                         Nine Months Ended September 30,
(In Thousands of Dollars)                                                                   2004                 2003
------------------------------------------------------------------------------------------------------------------------
<S>                                                                                     <C>                   <C>
Operating Activities
Net income                                                                              $ 262,655             $ 249,912
Adjustments to reconcile net income to net
      cash provided by (used in) operating activities
    Depreciation, depletion and amortization                                              454,736               422,917
    Deferred income tax                                                                    31,517                71,439
    Income from equity investments                                                        (30,342)              (12,486)
    Dividends from equity investments                                                       3,970                 1,021
    Amortization of interest rate swaps                                                       182                (7,396)
    Gain (Loss) on subsidiary stock transactions                                         (172,894)               11,325
    Gain (Loss) on sale of property                                                             -               (13,974)
    (Gain) on settlement of treasury lock                                                 (12,656)                    -
    Goodwill impairment charge                                                            122,229                     -
    Amortization of prepayments                                                            74,557                62,945
    Minority interest                                                                      37,012                50,252
Changes in assets and liabilities
    Accounts receivable                                                                   301,011               384,836
    Materials and supplies, fuel oil and gas in storage                                   (80,072)             (239,847)
    Accounts payable and other liabilities                                               (235,171)             (114,589)
    Interest accrued                                                                       12,884                22,161
    Captive insurance reserve                                                              43,214                     -
    Property tax prepayments                                                              (55,413)              (86,631)
    Other                                                                                  23,915               (45,211)
                                                                             -------------------------------------------
Net Cash Provided by Operating Activities                                                 781,334               756,674
                                                                             -------------------------------------------
Investing Activities
    Construction expenditures                                                            (563,207)             (720,217)
    Other investments                                                                           -               (50,500)
    Cost of removal                                                                       (21,249)              (19,611)
    Proceeds from sale of property                                                         13,138                13,974
    Net proceeds from sale/leaseback transaction                                          383,716                     -
    Net proceeds from subsidiary stock transactions                                       512,065               198,553
                                                                             -------------------------------------------
Net Cash Provided by (Used In) Investing Activities                                       324,463              (577,801)
                                                                             -------------------------------------------
Financing Activities
    Treasury stock issued                                                                  24,322                76,984
    Equity issuance                                                                             -               473,573
    Issuance of long-term debt                                                             49,336               710,475
    Payment of long-term debt                                                            (920,033)             (564,506)
    Issuance (Payment) of commercial paper                                                 93,475              (271,297)
    Redemption of promissory notes                                                              -              (447,005)
    Gain on settlement of treasury lock                                                    12,656                     -
    Redemption of preferred stock                                                          (8,483)              (14,293)
    Preferred stock dividends paid                                                         (4,280)               (4,383)
    Common stock dividends paid                                                          (214,075)             (203,795)
    Other                                                                                  16,831                12,808
                                                                             -------------------------------------------
Net Cash (Used in) Financing Activities                                                  (950,251)             (231,439)
                                                                             -------------------------------------------
Net Increase in Cash and Cash Equivalents                                               $ 155,546             $ (52,566)
Cash and Cash Equivalents at Beginning of Period                                          205,751               170,617
                                                                             -------------------------------------------
Cash and Cash Equivalents at End of Period                                              $ 361,297             $ 118,051
                                                                             ===========================================
</TABLE>

Cash equivalents are short-term  marketable securities purchased with maturities
of six months or less that were carried at cost which approximates fair value.

        See accompanying Notes to the Consolidated Financial Statements.


                                       6
<PAGE>


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

KeySpan  Corporation  (referred to in the Notes to the  Financial  Statements as
"KeySpan,"  "we,"  "us" and "our") is a  registered  holding  company  under the
Public  Utility  Holding  Company  Act of 1935,  as amended  ("PUHCA").  KeySpan
operates six regulated  utilities that distribute  natural gas to  approximately
2.5 million  customers  in New York City,  Long  Island,  Massachusetts  and New
Hampshire,  making  KeySpan the fifth  largest gas  distribution  company in the
United States and the largest in the Northeast. We also own and operate electric
generating  plants in Nassau and  Suffolk  Counties on Long Island and in Queens
County  in New York City and are the  largest  independent  electric  generation
operator in New York State.  Under contractual  arrangements,  we provide power,
electric  transmission  and  distribution  services,  billing and other customer
services for  approximately  1.1 million  electric  customers of the Long Island
Power Authority  ("LIPA").  KeySpan's other subsidiaries are involved in gas and
oil exploration and production;  underground gas storage;  liquefied natural gas
storage;  retail  electric  marketing;  appliance  service;  plumbing;  heating,
ventilation  and  air  conditioning  and  other   mechanical   services;   large
energy-system  ownership,  installation  and  management;  and  engineering  and
consulting  services.  We also  invest and  participate  in the  development  of
natural gas pipelines,  electric generation and other  energy-related  projects.
(See Note 2 "Business  Segments" for  additional  information  on each operating
segment.)

1. BASIS OF PRESENTATION

In our opinion,  the accompanying  unaudited  Consolidated  Financial Statements
contain all adjustments necessary to present fairly KeySpan's financial position
as of September 30, 2004,  and the results of operations  for the three and nine
months ended  September  30, 2004 and  September 30, 2003, as well as cash flows
for the nine  months  ended  September  30, 2004 and  September  30,  2003.  The
accompanying  financial  statements  should  be read  in  conjunction  with  the
consolidated  financial statements and notes included in KeySpan's Annual Report
on Form 10-K for the year  ended  December  31,  2003.  The  December  31,  2003
financial statement information has been derived from the 2003 audited financial
statements. Income from interim periods may not be indicative of future results.
Certain reclassifications were made to conform prior period financial statements
to the current period financial statement presentation.

Consolidated  earnings are seasonal in nature  primarily due to the  significant
contribution to earnings of the gas  distribution  operations.  As a result,  we
expect to earn most of our annual  earnings in the first and fourth  quarters of
the fiscal year.

Basic  earnings per share ("EPS") is calculated by dividing  earnings  available
for  common  stock by the  weighted  average  number of  shares of common  stock
outstanding  during  the  period.  No  dilution  for  any  potentially  dilutive
securities is included.  Diluted EPS assumes the  conversion of all  potentially
dilutive  securities and is calculated by dividing earnings available for common
stock,  as  adjusted,  by the sum of the  weighted  average  number of shares of
common stock outstanding plus all potentially dilutive securities.


                                       7
<PAGE>


We have approximately 3.5 million common stock options  outstanding at September
30,  2004,  that were not included in the  calculation  of diluted EPS since the
exercise price associated with these options was greater than the average market
price of our common stock.

Under the requirements of Statement of Financial  Accounting  Standards ("SFAS")
No. 128, "Earnings Per Share" our basic and diluted EPS are as follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                                Three Months Ended September 30,    Nine Months Ended September 30,
(In Thousands of Dollars, Except Per Share Amounts)                 2004                2003               2004              2003
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>                  <C>              <C>                <C>
Earnings (loss) for common stock                                $ (117,139)           $ 11,124         $ 258,375          $ 245,529
Houston Exploration dilution                                             -                 (74)                -               (212)
-----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) for common stock - adjusted                     $ (117,139)           $ 11,050         $ 258,375          $ 245,317
-----------------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (000)                          160,357             158,783           160,139            157,871
Add dilutive securities:
Options                                                                989                   -               952                  -
Convertible preferred stock                                              -                 756                 -                799
-----------------------------------------------------------------------------------------------------------------------------------
Total weighted average shares outstanding - assuming dilution      161,346             159,539           161,091            158,670
-----------------------------------------------------------------------------------------------------------------------------------
Basic earnings (loss )per share                                 $    (0.73)           $   0.07         $    1.61          $    1.56
-----------------------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share                               $    (0.73)           $   0.07         $    1.60          $    1.55
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

2. BUSINESS SEGMENTS

We have four reportable segments:  Gas Distribution,  Electric Services,  Energy
Services and Energy Investments.

The Gas  Distribution  segment  consists of six gas  distribution  subsidiaries.
KeySpan Energy Delivery New York ("KEDNY") provides gas distribution services to
customers in the New York City Boroughs of Brooklyn,  Queens and Staten  Island.
KeySpan Energy Delivery Long Island ("KEDLI") provides gas distribution services
to customers in the Long Island  Counties of Nassau and Suffolk and the Rockaway
Peninsula of Queens County. The remaining gas distribution subsidiaries,  Boston
Gas Company,  Colonial Gas Company,  Essex Gas Company and  EnergyNorth  Natural
Gas,  Inc.,  collectively  referred to as KeySpan  Energy  Delivery  New England
("KEDNE"),  provide gas distribution  service to customers in Massachusetts  and
New Hampshire.

The  Electric  Services  segment  consists  of  subsidiaries  that:  operate the
electric  transmission  and  distribution  system owned by LIPA; own and provide
capacity to and produce energy for LIPA from our generating  facilities  located
on Long  Island;  and  manage  fuel  supplies  for LIPA to fuel our Long  Island
generating facilities.  These services are provided in accordance with long-term
service  contracts having remaining terms that range from four to nine years and
power purchase  agreements  having remaining terms that range from nine years to
23 years. The Electric  Services segment also includes  subsidiaries that own or
lease and operate  the 2,450  megawatt  ("MW")  Ravenswood  electric  generation
facility  ("Ravenswood  Facility"),  located in Queens, New York, which includes
the recently completed 250 MW combined-cycle electric generating unit located at
the  Ravenswood  site  ("Ravenswood  Expansion").  Collectively  the  Ravenswood
Facility and the Ravenswood  Expansion are referred to herein as the "Ravenswood
Projects."  All of the energy,  capacity and ancillary  services  related to the


                                       8
<PAGE>


Ravenswood  Projects  is  sold  to the  New  York  Independent  System  Operator
("NYISO")  energy markets.  The Electric  Services  segment also conducts retail
marketing of electricity to commercial customers.

The Energy  Services  segment  includes  companies  that provide  energy-related
services to customers  primarily located within the Northeastern  United States,
with  concentrations  in the New York  City  metropolitan  area,  including  New
Jersey, as well as Rhode Island, Pennsylvania,  Massachusetts and New Hampshire,
through the following  two lines of business:  (i) Home Energy  Services,  which
provides residential and small commercial customers with service and maintenance
of energy systems and appliances;  and (ii) Business  Solutions,  which provides
plumbing,  heating,  ventilation,  air conditioning and mechanical services,  as
well as operation and maintenance,  design,  engineering and consulting services
to commercial and industrial  customers.  In the third quarter of 2004,  KeySpan
recorded a $122.2 million non-cash  goodwill  impairment charge in this segment.
See Note 12 "Goodwill Impairment" for further information regarding this charge.

The Energy  Investments  segment  consists of our gas exploration and production
investments, as well as certain other domestic and international  energy-related
investments.  Our gas exploration and production subsidiaries are engaged in gas
and oil  exploration  and  production,  and the  development  and acquisition of
domestic  natural  gas  and  oil  properties.   These  investments  include  our
approximate  23.5%  interest  in  The  Houston   Exploration  Company  ("Houston
Exploration") an independent natural gas and oil exploration company, as well as
our wholly-owned subsidiaries  Seneca-Upshur Petroleum,  Inc.  ("Seneca-Upshur")
and  KeySpan   Exploration  and  Production,   LLC  ("KeySpan   Exploration  and
Production"), which is engaged in a joint venture with Houston Exploration.

In June 2004,  KeySpan  exchanged 10.8 million shares of common stock of Houston
Exploration  for 100% of the stock of  Seneca-Upshur,  previously a wholly owned
subsidiary  of Houston  Exploration.  This  transaction  reduced our interest in
Houston  Exploration  from 55% to the current level of  approximately  23.5%. As
part of this transaction,  Houston Exploration retired 4.6 million of its common
shares and issued 6.8 million new shares in a public offering.  Based on Houston
Exploration's  announced  offering  price of $48.00 per  share,  Seneca-Upshur's
shares  were  valued at the  equivalent  of $449  million,  or $41.57 per share.
Seneca-Upshur's  assets  consisted  of West  Virginia gas  producing  properties
valued at $60 million,  and $389 million in cash. This transaction resulted in a
gain to KeySpan of $150.1 million. Effective June 1, 2004, Houston Exploration's
earnings and our ownership  interest in Houston  Exploration have been accounted
for  on  the  equity  basis  of  accounting.   The  deconsolidation  of  Houston
Exploration  required the recognition of certain deferred taxes on our remaining
investment resulting in a net deferred tax expense of $44.1 million.  Therefore,
the net gain on the share  exchange  less the  deferred tax  provision  was $106
million,  or $0.66 per share.  It should be noted that in the second  quarter of
2004,  KeySpan recorded a $48.2 million non-cash  impairment charge to recognize
the reduced  valuation  of proved  reserves.  See Note 10 "Gas  Exploration  and
Production Property - Depletion for further information on this charge.


                                       9
<PAGE>


Subsidiaries  in this  segment also hold a 17.4%  ownership  interest in KeySpan
Canada, a subsidiary with natural gas processing plants and gathering facilities
in Western Canada.  In April 2004,  KeySpan and KeySpan  Facilities  Income Fund
(the  "Fund"),  which  previously  owned a 39.09%  interest  in KeySpan  Canada,
consummated a transaction whereby the Fund sold 15.617 million units of the Fund
at a price of  CDN$12.60  per unit for gross  total  proceeds  of  approximately
CDN$196.8 million. The proceeds of the offering were used by the Fund to acquire
an additional  35.91%  interest in KeySpan Canada from KeySpan.  We received net
proceeds of approximately  CDN$186.3 million (or approximately  US$135 million),
after commissions and expenses. The Fund's ownership in KeySpan Canada increased
from 39.1% to 75%, and KeySpan's  ownership of KeySpan Canada  decreased to 25%.
KeySpan recorded a gain of $22.8 million ($10.1 million after-tax,  or $0.06 per
share) on this  transaction.  Effective April 1, 2004 KeySpan Canada's  earnings
and our  ownership  interest in KeySpan  Canada have been  accounted  for on the
equity basis of accounting.

In July 2004, the Fund issued an additional 10.7 million units,  the proceeds of
which  were used to fund the  acquisition  of the  midstream  assets of  Chevron
Canada  Midstream  Inc.  This  transaction  had the effect of  further  diluting
KeySpan's ownership of KeySpan Canada to 17.4%.

This segment is also  engaged in pipeline  development  activities.  KeySpan and
Duke  Energy  Corporation  each own a 50%  interest in  Islander  East  Pipeline
Company,  LLC  ("Islander  East").  Islander  East was  created  to  pursue  the
authorization  and  construction  of an interstate  pipeline  from  Connecticut,
across Long Island Sound,  to a terminus  near  Shoreham,  Long Island.  Once in
service,  the  pipeline is expected to  transport up to 260,000 DTH daily to the
Long Island and New York City energy markets.  Further,  in August 2004, KeySpan
acquired a 21% interest in the Millennium  Pipeline project which will transport
up to 500,000 DTH of natural gas a day from Corning to Ramapo,  New York,  where
it will connect to an existing pipeline.

Additionally,  subsidiaries  in this segment  hold a 20% equity  interest in the
Iroquois Gas  Transmission  System LP, a pipeline that  transports  Canadian gas
supply to markets in the Northeastern United States and the KeySpan LNG facility
in Providence,  Rhode Island, a 600,000 barrel liquefied natural gas storage and
receiving  facility.  Further,  this  segment has a 50%  interest in the Premier
Transmission Pipeline in Northern Ireland.

The  accounting  policies  of the  segments  are the same as those  used for the
preparation of the Consolidated Financial Statements. The segments are strategic
business units that are managed separately because of their different  operating
and regulatory environments.  Operating results of our segments are evaluated by
management on an operating income basis. As a result of the Houston  Exploration
stock transaction and the related  deconsolidation,  the total assets associated
with our gas  exploration  and  production  operations,  including cash from the
transaction,  were $650 million at September 30, 2004,  compared to $1.5 billion
at December  31,  2003.  Due to the KeySpan  Canada  transaction,  total  assets
associated with KeySpan's other  energy-related  investments were  approximately
$607  million at  September  30, 2004  compared to $900  million at December 31,
2003.


                                       10
<PAGE>


To better  align the  subsidiaries  within our  segments,  we  reclassified  the
operating results of our electric marketing  subsidiary from the Energy Services
segment to the  Electric  Services  segment in the first  quarter of 2004.  As a
result we  reclassified  the  financial  results  for all  periods of 2003.  The
revised reportable segment information is as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                Energy Investments
                                                                          -----------------------------
                                                                              Gas
                                          Gas       Electric   Energy     Exploration        Other
(In Thousands of Dollars)            Distribution   Services   Services   and Production   Investments   Eliminations   Consolidated
------------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>         <C>        <C>          <C>             <C>             <C>           <C>
Three Months Ended Sept. 30, 2004
Unaffiliated revenue                    419,208     503,879     118,580       4,975           3,792              -        1,050,434
Intersegment revenue                          -           -       7,172           -           1,274         (8,446)               -
Operating income (Loss)                 (23,627)    111,158    (142,976)     12,332           4,102          2,963          (36,048)

Three Months Ended Sept. 30, 2003
Unaffiliated revenue                    405,777     438,577     137,961     123,052          26,447              -        1,131,814
Intersegment revenue                          -          25       1,926           -           1,252         (3,203)               -
Operating income (Loss)                 (25,134)    102,125     (15,498)     50,995           8,009        (12,574)         107,923

------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

     Eliminating  items include  intercompany  interest income and expense,  the
     elimination of certain intercompany  accounts, as well as activities of our
     corporate and administrative areas

Because of the nature of our Electric Services  business,  electric revenues are
derived  from two  large  customers  - the NYISO  and  LIPA.  Electric  Services
revenues from these  customers for the three months ended September 30, 2004 and
2003  represent  approximately  45% and 38%,  respectively  of our  consolidated
revenues in both periods.
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                                 Energy Investments
                                                                           ---------------------------
                                                                               Gas
                                       Gas          Electric   Energy       Exploration       Other
(In Thousands of Dollars)          Distribution     Services   Services    and Production   Investments   Eliminations  Consolidated
------------------------------------------------------------------------------------------------------------------------------------
<S>                                 <C>           <C>          <C>            <C>             <C>           <C>          <C>
Nine Months Ended Sept. 30, 2004
Unaffiliated revenue                 3,023,350     1,296,778     377,516       276,320         37,814              -      5,011,778
Intersegment revenue                         -             -      14,755             -          3,817        (18,572)             -
Operating income (Loss)                391,090       226,273    (166,356)       85,828         22,473         14,559        573,867

Nine Months Ended Sept. 30, 2003
Unaffiliated revenue                 2,970,514     1,228,622     399,294       373,774         80,287              -      5,052,491
Intersegment revenue                         -            76       4,894             -          3,756         (8,726)             -
Operating income (Loss)                371,420       193,869     (35,083)      156,733         27,207        (11,300)       702,846

------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

     Eliminating  items include  intercompany  interest income and expense,  the
     elimination of certain intercompany  accounts, as well as activities of our
     corporate and administrative areas.

Because of the nature of our Electric Services  business,  electric revenues are
derived  from two  large  customers  - the NYISO  and  LIPA.  Electric  Services
revenues from these  customers for the nine months ended  September 30, 2004 and
2003  represent  approximately  25% and 22%,  respectively  of our  consolidated
revenues for both periods.


                                       11
<PAGE>


3. COMPREHENSIVE INCOME

The table below indicates the components of comprehensive income:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                   Three Months Ended Sept. 30,          Nine Months Ended Sept. 30,
(In Thousands of Dollars)                                           2004                 2003           2004                 2003
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                             <C>                     <C>           <C>                  <C>
Earnings (loss) for common stock                               $ (117,139)             $ 11,124      $ 258,375            $ 245,529
------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax
Reclassification adjustments for loss (gains) realized in
  net income                                                      (13,945)                8,431          2,586               19,602
Foreign currency translation adjustments                              576                   366        (16,487)              27,892
Unrealized gains (losses) on marketable securities                 (1,259)                1,209           (717)               3,458
Premiums on derivative financial instruments                            -                     -          3,437               (3,437)
Deconsolidation of certain subsidiaries                                 -                     -         (6,711)                   -
Unrealized gain (losses) on derivative financial instruments       12,461                13,740         11,288               (7,193)
------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax                      (2,167)               23,746         (6,604)              40,322
------------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income                                           $ (119,306)             $ 34,870      $ 251,771            $ 285,851
------------------------------------------------------------------------------------------------------------------------------------
Related tax (benefit) expense
Reclassification adjustments for loss (gains) realized in
  net income                                                       (8,623)                4,540            279               10,555
Foreign currency translation adjustments                              310                   197         (8,878)              15,019
Unrealized gains (losses) on marketable securities                   (955)                  652           (665)               1,863
Premiums on derivative financial instruments                            -                     -          1,851               (1,851)
Deconsolidation of certain subsidiaries                                 -                     -          5,016
Unrealized gain (losses) on derivative financial instruments        8,101                 7,398          7,470               (3,873)
------------------------------------------------------------------------------------------------------------------------------------
Total Tax (Benefit) Expense                                    $   (1,167)             $ 12,787      $   5,073            $  21,713
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

4. HEDGING AND DERIVATIVE FINANCIAL INSTRUMENTS

Financially-Settled  Commodity Derivative Instruments - Hedging Activities: From
time  to  time,  KeySpan   subsidiaries  have  utilized   derivative   financial
instruments,  such as futures, options and swaps, for the purpose of hedging the
cash flow variability  associated with changes in commodity  prices.  KeySpan is
exposed to commodity  price risk primarily  with regard to its gas  distribution
operations,   gas  exploration  and  production   activities  and  its  electric
generating facilities at the Ravenswood site.

Derivative financial instruments are employed by our gas distribution operations
to reduce the cash flow  variability  associated  with the purchase  price for a
portion  of  future  natural  gas  purchases  for our  regulated  firm gas sales
customers. The accounting for these derivative instruments is subject to SFAS 71
"Accounting  for the Effects of Certain  Types of  Regulation."  See the caption
below  "Firm Gas Sales  Derivative  Instruments  -  Regulated  Utilities"  for a
further discussion of these derivatives. Certain derivative instruments employed
by our gas  distribution  operations are not subject to SFAS 71. Utility tariffs
applicable  to certain  large-volume  customers  permit gas to be sold at prices
established  monthly  within a specified  range  expressed  as a  percentage  of
prevailing  alternate  fuel oil prices.  KEDNY uses natural gas swap  contracts,
with offsetting positions in fuel oil swap contracts of equivalent energy value,
to hedge the cash-flow  variability  of specified  portions of gas purchases and


                                       12
<PAGE>


sales associated with these customers.  The maximum length of time over which we
have hedged cash flow variability associated with forecasted purchases and sales
of natural gas and fuel oil is through  February  2005. We use standard New York
Mercantile  Exchange ("NYMEX") futures prices to value the gas futures contracts
and market quoted  forward prices to value oil swap  contracts.  The fair market
value of these  derivative  instruments at September 30, 2004 was a liability of
$1.4  million,   all  of  which  is  expected  to  be  reclassified  from  other
comprehensive income into earnings over the next twelve months.

Seneca-Upshur utilizes over-the-counter ("OTC") natural gas index swaps to hedge
the cash flow  variability  associated with forecasted sales of a portion of its
natural gas production. At September 30, 2004, Seneca-Upshur has hedge positions
in place for approximately  85% of its estimated  remaining 2004 gas production,
net of gathering  related costs.  Further,  Seneca-Upshur has hedge positions in
place for  approximately  85% of its estimated 2005 through 2007 gas production,
net of  gathering  costs.  We use  forward  index  prices  to value  these  swap
positions.  The maximum length of time over which  Seneca-Upshur has hedged such
cash flow  variability is through  December 2007. The fair market value of these
derivative  instruments  at September  30, 2004 was a liability of $2.0 million.
The estimated amount of losses associated with such derivative  instruments that
are  reported  in  other  comprehensive  income  and  that  are  expected  to be
reclassified  into  earnings  over the next twelve  months is $1.4  million,  or
approximately $0.9 million after-tax.

Derivative  financial  instruments are employed by Houston  Exploration to hedge
cash flow  variability  associated with  forecasted  sales of natural gas. Since
Houston  Exploration  is no longer a  consolidated  subsidiary,  the fair market
value of their outstanding derivative instruments are not reflected on KeySpan's
September 30, 2004 Consolidated Balance Sheet.

The Ravenswood Projects use derivative  financial  instruments to hedge the cash
flow  variability  associated with the purchase of natural gas and oil that will
be consumed during the generation of electricity.  The Ravenswood  Projects also
hedge the cash flow  variability  associated with a portion of on-peak  electric
energy sales.

With respect to price exposure associated with fuel purchases for the Ravenswood
Projects,  KeySpan employs standard NYMEX natural gas futures contracts to hedge
the cash flow variability for a portion of forecasted  purchases of natural gas.
KeySpan also employs the use of financially-settled  oil swap contracts to hedge
the cash flow variability for a portion of forecasted purchases of fuel oil that
will be consumed by the  Ravenswood  Projects.  The maximum  length of time over
which we have hedged cash flow variability  associated with forecasted purchases
of natural gas is through  September 2005. The maximum length of time over which
we have hedged cash flow  variability  associated with  forecasted  purchases of
fuel oil is through  April 2006. We use standard  NYMEX futures  prices to value
the gas futures  contracts  and market quoted  forward  prices to value oil swap
contracts.  The fair market value of these  derivative  instruments at September
30,  2004  was  $0.5  million.   A  substantial   portion  of  these  derivative
instruments,  which are reported in other comprehensive  income, are expected to
be reclassified into earnings over the next twelve months.


                                       13
<PAGE>


We have also engaged in the use of  cash-settled  swap  instruments to hedge the
cash flow  variability  associated with a portion of forecasted  electric energy
sales  from  the  Ravenswood   Projects.   Our  hedging  strategy  is  to  hedge
approximately 50% of forecasted  on-peak summer season electric energy sales and
a portion of forecasted electric energy sales for the remainder of the year. The
maximum  length of time over  which we have  hedged  cash  flow  variability  is
through  December  2005.  We use market  quoted  forward  prices to value  these
outstanding  derivatives.  The fair market value of these derivative instruments
at September 30, 2004 was $2.3 million. The estimated amount of gains associated
with such derivative instruments that are reported in other comprehensive income
and that are  expected to be  reclassified  into  earnings  over the next twelve
months is $2.1 million, or approximately $1.4 million after-tax.

The above  noted  derivative  financial  instruments  are cash flow  hedges that
qualify  for  hedge   accounting  under  SFAS  133  "Accounting  for  Derivative
Instruments  and  Hedging  Activities,"  as  amended by SFAS 149  "Amendment  of
Statement 133 on Derivative  Instruments and Hedging  Activities,"  collectively
SFAS 133, and are not considered held for trading purposes as defined by current
accounting  literature.  Accordingly,  we  carry  the fair  market  value of our
derivative  instruments on the Consolidated Balance Sheet as either a current or
deferred asset or liability, as appropriate,  and defer the effective portion of
unrealized gains or losses in accumulated other comprehensive  income. As noted,
the  fair  market  value  of  Houston   Exploration's   outstanding   derivative
instruments  are not reflected on the September  30, 2004  Consolidated  Balance
Sheet.  Gains and losses are reclassified from accumulated  other  comprehensive
income  to the  Consolidated  Statement  of  Income  in the  period  the  hedged
transaction  affects earnings.  Gains and losses are reflected as a component of
either revenue or fuel and purchased power depending on the hedged  transaction.
Hedge  ineffectiveness  results  from  changes  during  the  period in the price
differentials  between the index price of the derivative  contract and the index
price  at the  point  of sale for the cash  flow  that is being  hedged,  and is
recorded directly to earnings.

The table below  summarizes  the fair value of  outstanding  financially-settled
commodity derivative  instruments that qualify for hedge accounting at September
30, 2004 and the related line item on the Consolidated Balance Sheet. Fair value
is the amount at which  derivative  instruments  could be exchanged in a current
transaction between willing parties, other than in a forced liquidation sale. As
noted earlier,  derivative  instruments  employed by Houston  Exploration are no
longer reflected on KeySpan's Consolidated Balance Sheet.



                                       14
<PAGE>

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
(In Thousands of Dollars)                                    September 30, 2004         December 31, 2003
----------------------------------------------------------------------------------------------------------
<S>                                                                     <C>                      <C>
Gas Contracts:
  Other current assets                                                  $ 5,318                 $   3,458
  Accounts payable and other liabilities                                      -                   (35,592)
  Other deferred liabilities                                               (606)                   (4,734)

Oil Contracts:
  Other current assets                                                      527                         -
  Accounts payable and other liabilities                                 (8,060)
  Other deferred charges                                                     25                       385

Electric Contracts:
  Other current assets                                                    2,083                         -
  Other deferred charges                                                    194                       259
----------------------------------------------------------------------------------------------------------
                                                                        $ (519)                 $ (36,224)
----------------------------------------------------------------------------------------------------------
</TABLE>


Financially-Settled  Commodity  Derivative  Instruments  that Do Not Qualify for
Hedge  Accounting:  KeySpan  subsidiaries also have employed a limited number of
financial  derivatives that do not qualify for hedge accounting  treatment under
SFAS 133. In September 2004, we purchased a series of call options on the spread
between the price of heating oil and the price of natural gas. The options cover
the period  September  2004 through  February  2005 and further  complement  our
hedging strategy noted above regarding sales to certain large-volume  customers.
As stated, we sell gas to certain  large-volume  customers at prices established
monthly  within a  specified  range  expressed  as a  percentage  of  prevailing
alternate fuel oil prices. Utility tariffs, however, establish an upper limit on
the price  KeySpan  can charge for the sale of natural  gas to these  customers.
These  options  are  intended to limit  KeySpan's  exposure to heating oil price
spikes.  These options do not qualify for hedge accounting  treatment under SFAS
133. We recorded a $0.6  million  charge in other income and  deductions  on the
Consolidated  Statement  of Income to reflect  the  change in the  market  value
associated with this derivative instrument.

Firm Gas Sales Derivative  Instruments - Regulated Utilities:  We use derivative
financial  instruments to reduce the cash flow  variability  associated with the
purchase price for a portion of future natural gas purchases associated with our
Gas Distribution  operations.  Our strategy is to minimize  fluctuations in firm
gas sales prices to our regulated  firm gas sales  customers in our New York and
New England service territories. The accounting for these derivative instruments
is subject to SFAS 71. Therefore, changes in the fair value of these derivatives
have  been  recorded  as a  regulatory  asset  or  regulatory  liability  on the
Consolidated Balance Sheet. Gains or losses on the settlement of these contracts
are initially deferred and then refunded to or collected from our firm gas sales
customers consistent with regulatory requirements.  At September 30, 2004, these
derivatives  had a fair market  value of $87.1  million and are  reflected  as a
regulatory liability on the Consolidated Balance Sheet.

Physically-Settled  Commodity  Derivative  Instruments:   SFAS  133  establishes
criteria that must be satisfied in order for option contracts, forward contracts
with  optionality  features,  or contracts that combine a forward contract and a
purchase  option  contract to be exempted as normal  purchases and sales.  Based
upon a continuing  review of our  physical gas  contracts,  we  determined  that
certain  contracts for the physical  purchase of natural gas associated with our
regulated gas utilities are not exempt as normal purchases from the requirements


                                       15
<PAGE>


of SFAS 133.  Since these  contracts are for the purchase of natural gas sold to
regulated  firm gas sales  customers,  the  accounting  for these  contracts  is
subject to SFAS 71.  Therefore,  changes in the market value of these  contracts
have  been  recorded  as a  regulatory  asset  or  regulatory  liability  on the
Consolidated  Balance Sheet. At September 30, 2004, these derivatives had a fair
market value of $3.7 million and are reflected as a regulatory  liability on the
Consolidated Balance Sheet.

Interest Rate Derivative Instruments: In May 2003, we entered into interest rate
swap  agreements  in which we swapped  $250  million of 7.25% fixed rate debt to
floating  rate debt.  Under the terms of the  agreements,  we received the fixed
coupon  rate  associated  with these  bonds and paid our swap  counterparties  a
variable  interest rate based on LIBOR,  that was reset on a semi-annual  basis.
These swaps were  designated as fair-value  hedges and qualified for "short-cut"
hedge accounting treatment under SFAS 133. In the first quarter of 2004, we paid
our counterparty an average interest rate of 6.44%, and as a result, we realized
interest savings of $0.5 million.

On April 7, 2004 we terminated  these swap  agreements and received $1.2 million
from our swap  counterparties,  of which $0.7 million  represented  accrued swap
interest.  The  difference  between the  termination  settlement  amount and the
amount of accrued interest,  $0.5 million,  was being recorded as a reduction to
interest  expense  over the  remaining  life of the bonds.  In August  2004,  we
redeemed these bonds and recorded the remaining benefit.

KeySpan  has  a  leveraged  lease  financing  arrangement  associated  with  the
Ravenswood  Expansion.  In May 2004,  the facility was acquired by a lessor from
our subsidiary,  KeySpan Ravenswood, LLC, and simultaneously leased back to that
subsidiary. In connection with this sale/leaseback transaction, KeySpan utilized
a $275  million  treasury  lock (at  4.2%)  to hedge  the  10-year  US  Treasury
component of the underlying notes issued by the lessor to purchase the facility.
The  treasury  lock was in effect for a five-week  period  during which time the
10-year US Treasury  increased 70 basis points.  KeySpan did not designate  this
derivative  instrument  as a hedge for  accounting  purposes.  The treasury lock
settled in May 2004 and KeySpan  received  cash  proceeds of $12.6 million which
was recorded in other income and (deductions) in the  Consolidated  Statement of
Income.  (See Note 6. "Financial  Guarantees and  Contingencies"  for additional
information regarding the sale/leaseback transaction.)

Weather  Derivatives:  The utility tariffs associated with KEDNE's operations do
not contain weather normalization  adjustments.  As a result,  fluctuations from
normal weather may have a significant positive or negative effect on the results
of these operations.

In September  2004, we entered into  heating-degree  day put options to mitigate
the effect of fluctuations from normal weather on KEDNE's financial position and
cash flows for the 2004/2005 winter heating season - November 2004 through March
2005. These put options will pay KeySpan $40,000 per heating degree day when the
actual  temperature  is below 4,140  heating  degree days, or  approximately  5%
warmer than normal, based on the most recent 20-year average for normal weather.
The maximum  amount  KeySpan may receive on these  purchased  put options is $16


                                       16
<PAGE>


million.  The net  premium  cost for  these  options  was $1.6  million.  Unlike
previous years (see below) if weather is colder than normal KeySpan will have no
financial  obligation.   We  account  for  these  derivatives  pursuant  to  the
requirements of EITF 99-2, "Accounting for Weather Derivatives." In this regard,
such  instruments  are accounted for using the  "intrinsic  value method" as set
forth in such guidance.

In October 2003, KEDNE entered into  heating-degree day call and put options for
the 2003/2004  winter  heating  season - November 2003 through March 2004.  With
respect to sold call options,  KeySpan was required to make a payment of $27,500
per heating degree day to its  counterparties  when actual  weather  experienced
during this time frame was above 4,440  heating  degree days,  which  equates to
approximately  2% colder  than  normal  weather,  based on the then most  recent
20-year average for normal  weather.  The maximum amount KeySpan was required to
pay on its sold call options was $5.5  million.  With  respect to purchased  put
options,  KeySpan would have  received a $27,500 per heating  degree day payment
from its counterparties when actual weather was below 4,266 heating degree days,
or  approximately  2% warmer than normal.  The maximum amount KeySpan would have
received on its purchased put options was $11 million.  The net premium cost for
these options was $0.4 million.  During the first quarter of 2004,  weather,  as
measured  in heating  degree-days,  was 9.4% colder than normal and, as a result
$4.1 million was recorded as a reduction to revenues.

Derivative  contracts  are  primarily  used to manage  exposure  to market  risk
arising from changes in commodity  prices,  interest  rates and weather.  In the
event of non-performance by a counterparty to a derivative contract, the desired
impact  may  not be  achieved.  The  risk  of  counterparty  non-performance  is
generally  considered a credit risk and is actively  managed by  assessing  each
counterparty credit profile and negotiating appropriate levels of collateral and
credit  support.  We believe that our credit risk related to the above mentioned
derivative financial instruments is no greater than the risk associated with the
primary  contracts which they hedge and that the elimination of a portion of the
price risk reduces  volatility in our reported results of operations,  financial
position and cash flows and lowers overall business risk.

5. RECENT ACCOUNTING PRONOUNCEMENTS

In May 2004, the Financial Accounting Standards Board ("FASB") issued FASB Staff
Position ("FSP") 106-2  "Accounting and Disclosure  Requirements  Related to the
Medicare  Prescription  Drug,  Improvement and  Modernization Act of 2003." This
guidance  supersedes  FSP  106-1  issued  in  January  2004  and  clarifies  the
accounting and disclosure requirements for employers with postretirement benefit
plans  that  have  been or will  be  affected  by the  passage  of the  Medicare
Prescription Drug Improvement and Modernization Act of 2003 ("the Act"). The Act
introduces  two new features to Medicare  that an employer  needs to consider in
measuring its obligation  and net periodic  postretirement  benefit  costs.  The
effective  date for the new  requirements  is the first interim or annual period
beginning after June 15, 2004.


                                       17
<PAGE>


KeySpan's  retiree health benefit plan  currently  includes a prescription  drug
benefit  that  is  provided  to  retired  employees.   KeySpan  implemented  the
requirements  of FSP 106-2 in  September  2004 and  determined  that the savings
associated  with the Act will  reduce  KeySpan's  retiree  health  care costs by
approximately  $10  million in 2004.  However,  KEDLI and Boston Gas Company are
subject to certain  deferral  accounting  requirements  mandated by the New York
State Public Service  Commission  ("NYPSC") and the Massachusetts  Department of
Telecommunications  and Energy ("MA DTE"),  respectively  for pension  costs and
other  postretirement  benefit costs.  Further,  in accordance  with our service
agreements with LIPA,  variations between pension costs and other postretirement
benefit  costs  incurred by KeySpan  compared to those costs  recovered  through
rates  charged to LIPA are deferred  subject to recovery from or refund to LIPA.
As a result of these various requirements,  KeySpan estimates that approximately
$7 million of savings  attributable to the  implementation  of FSP 106-2 and the
Act will be  deferred  and used to  offset  increases  in  overall  pension  and
postretirement  benefit  costs,  with the  remaining  approximately  $3  million
available  to  KeySpan.   Therefore,   in  September  2004,   KeySpan   recorded
approximately  $2.2 million as a reduction to its health care costs representing
nine months of the benefit.  The  implementation of FSP 106-2 and the Act had no
impact on KeySpan's cash flow.

6. FINANCIAL GUARANTEES AND CONTINGENCIES

Variable  Interest Entity:  KeySpan has an arrangement with a variable  interest
entity through which we lease a portion of the Ravenswood Facility.  We acquired
the Ravenswood  Facility,  then a 2,200-megawatt  electric  generating  facility
located in Queens,  New York, in part,  through a variable  interest entity from
Consolidated  Edison Company of New York, Inc.  ("Consolidated  Edison") on June
18, 1999 for  approximately  $597  million.  In order to reduce the initial cash
requirements,  we  entered  into a lease  arrangement  ("Master  Lease")  with a
variable interest,  unaffiliated financing entity that acquired a portion of the
facility,  or six steam generating units,  directly from Consolidated Edison and
leased it to our subsidiary. The variable interest unaffiliated financing entity
acquired the property for $425  million,  financed  with debt of $412.3  million
(97% of  capitalization)  and equity of $12.7  million  (3% of  capitalization).
KeySpan has no ownership interests in the units or the variable interest entity.
KeySpan has guaranteed all payment and performance obligations of our subsidiary
under the Master Lease.  Monthly lease payments  substantially equal the monthly
interest expense on such debt securities.

The initial term of the Master  Lease  expired on June 20, 2004 and was extended
until June 20,  2009  pursuant to the terms of the Master  Lease.  On all future
semi-annual  payment  dates,  we have the option to:  (i)  either  purchase  the
facility for the original  acquisition  cost of $425  million,  plus the present
value of the lease  payments  that would  otherwise  have been paid through June
2009; or (ii)  terminate  the Master Lease and dispose of the facility.  In June
2009,  when the Master  Lease  terminates,  we may  purchase  the facility in an
amount  equal to the  original  acquisition  cost,  subject  to  adjustment,  or
surrender the facility to the lessor.  If we elect not to purchase the property,
the Ravenswood  Facility will be sold by the lessor.  We have  guaranteed to the
lessor 84% of the residual value of the original cost of the property.


                                       18
<PAGE>


We have  classified  the Master Lease as $412.3 million of long-term debt on the
Consolidated  Balance Sheet based on our current status as primary  beneficiary.
Further,  we have an asset  on the  Consolidated  Balance  Sheet  for an  amount
substantially  equal  to the  fair  market  value of the  leased  assets  at the
inception of the lease, less depreciation since that date, or approximately $380
million.  Under the terms of our two  credit  facilities,  the  Master  Lease is
considered debt in the ratio of debt-to-total capitalization.  If our subsidiary
that  leases  the  Ravenswood  Facility  were not able to  fulfill  its  payment
obligations  with respect to the Master Lease payments,  then the maximum amount
KeySpan would be exposed to under its current  guarantees would be $425 million,
plus the present value of the remaining lease payments through June 20, 2009.

Sale/leaseback  Transaction:  KeySpan  also  has  a  leveraged  lease  financing
arrangement associated with the Ravenswood Expansion.  In May 2004, the unit was
acquired  by  a  lessor  from  our  subsidiary,  KeySpan  Ravenswood,  LLC,  and
simultaneously  leased back to that  subsidiary.  All the obligations of KeySpan
Ravenswood,  LLC have been  unconditionally  guaranteed  by KeySpan.  This lease
transaction  generated cash proceeds of $385 million,  before transaction costs,
which  approximates  the fair market value of the  facility,  as determined by a
third-party  appraiser.  This lease transaction  qualifies as an operating lease
under SFAS 98 "Accounting for Leases: Sale/Leaseback Transactions Involving Real
Estate;  Sales-Type  Leases of Real  Estate;  Definition  of the Lease Term;  an
Initial Direct Costs of Direct Financing Leases, an amendment of FASB Statements
No.13,  66, 91 and a rescission of FASB Statement No. 26 and Technical  Bulletin
No.  79-11." The lease has an initial term of 36 years and the yearly  operating
lease  expense is  approximately  $17  million  per year.  Lease  payments  will
fluctuate from year to year, but are substantially paid over the first 16 years.

Asset Retirement Obligations: In 2003, KeySpan adopted SFAS 143, "Accounting for
Asset  Retirement  Obligations."  SFAS 143 required us to record a liability and
corresponding   asset  representing  the  present  value  of  legal  obligations
associated  with the retirement of tangible,  long-lived  assets that existed at
the inception of the obligation. At the time of implementation, KeySpan recorded
an asset retirement  obligation related to its investment in Houston Exploration
and its  other  gas  exploration  and  production  subsidiaries.  Since  Houston
Exploration's   operations  have  been  deconsolidated,   Houston  Exploration's
liability is no longer  reflected on KeySpan's  Consolidated  Balance Sheet. The
remaining  asset   retirement   obligation  is  related  to  our  investment  in
Seneca-Upshur and was approximately $6.6 million at September 30, 2004.

KeySpan's largest asset base is its gas transmission and distribution  system. A
legal obligation exists due to certain safety requirements at final abandonment.
In  addition,  a legal  obligation  may be  construed  to exist with  respect to
KeySpan's   liquefied  natural  gas  ("LNG")  storage  tanks  due  to  clean  up
responsibilities  upon cessation of use.  However,  mass assets such as storage,
transmission and distribution  assets are believed to operate in perpetuity and,
therefore,  have  indeterminate  cash flow estimates.  Since that exposure is in
perpetuity  and cannot be measured,  no liability was recorded  pursuant to SFAS
143.  KeySpan's ARO will be  re-evaluated  in future  periods  until  sufficient
information exists to determine a reasonable estimate of such obligation.


                                       19
<PAGE>


Environmental Matters


New York Sites:  Within the State of New York we have  identified  43 historical
manufactured gas plant ("MGP") sites and related facilities, which were owned or
operated by KeySpan subsidiaries or such companies' predecessors.

We have  identified 28 of these sites as being  associated  with the  historical
operations of KEDNY. One site has been fully remediated.  The remaining 27 sites
will  be  investigated  and,  if  necessary,  remediated  under  the  terms  and
conditions  of  Administrative  Orders on  Consent  ("ACO"),  Voluntary  Cleanup
Agreements  ("VCA")  or  Brownfield  Cleanup  Agreements  ("BCA").  Expenditures
incurred to date by us with respect to KEDNY MGP-related  activities total $46.9
million.

We have  identified 15 of these sites as being  associated  with the  historical
operations of KEDLI.  Expenditures  incurred to date by us with respect to KEDLI
MGP-related activities total $39.4 million. One site has been fully investigated
and requires no further action. The remaining sites will be investigated and, if
necessary, remediated under the conditions of ACOs, VCAs or BCAs.

We presently  estimate  the  remaining  cost of our KEDNY and KEDLI  MGP-related
environmental  remediation  activities will be $210.7 million,  which amount has
been  accrued by us as a reasonable  estimate of probable  cost for known sites.
Expenditures incurred to date by us with respect to these MGP-related activities
total $86.3 million.

With  respect to  remediation  costs,  the KEDNY and KEDLI rate plans  generally
provide for the recovery from customers of investigation and remediation  costs.
At September 30, 2004, we have  reflected a regulatory  asset of $232.4  million
for our KEDNY/KEDLI MGP sites. In accordance with NYPSC policy,  KeySpan records
a reduction to regulatory  liabilities  as costs are incurred for  environmental
clean-up activities. At September 30, 2004, these previously deferred regulatory
liabilities  totaled $43.2  million.  In October  2003,  KEDNY and KEDLI filed a
joint petition with the NYPSC,  which is still  pending,  seeking rate treatment
for additional environmental costs that may be incurred in the future.

We are  also  responsible  for  environmental  obligations  associated  with the
Ravenswood  facility,  purchased  from  Consolidated  Edison in 1999,  including
remediation  activities  associated with its historical  operations and those of
the MGP facilities  that formerly  operated at the site. We are not  responsible
for  liabilities  arising from disposal of waste at off-site  locations prior to
the  acquisition  closing  and any  monetary  fines  arising  from  Consolidated
Edison's pre-closing conduct. We presently estimate the remaining  environmental
clean up activities  for this site will be $3.1  million,  which amount has been
accrued by us. Expenditures incurred to date total $1.9 million.

New England Sites: Within the Commonwealth of Massachusetts and the State of New
Hampshire, we are aware of 76 former MGP sites and related facilities within the
existing or former service territories of KEDNE.


                                       20
<PAGE>


Boston Gas Company, Colonial Gas Company and Essex Gas Company may have or share
responsibility under applicable  environmental laws for the remediation of 66 of
these sites. A subsidiary of National Grid USA ("National  Grid"),  formerly New
England Electric System, has assumed  responsibility for remediating 11 of these
sites,  subject  to a limited  contribution  from  Boston Gas  Company,  and has
provided full  indemnification to Boston Gas Company with respect to eight other
sites.  In  addition,  Boston Gas Company,  Colonial Gas Company,  and Essex Gas
Company have each assumed  responsibility  for remediating  three sites. At this
time, it is uncertain as to whether Boston Gas Company,  Colonial Gas Company or
Essex Gas Company have or share  responsibility for remediating any of the other
sites. No notice of responsibility  has been issued to us for any of these sites
from any governmental environmental authority.

We  presently  estimate  the  remaining  cost  of  these   Massachusetts   KEDNE
MGP-related environmental cleanup activities will be $21.1 million, which amount
has been  accrued by us as a  reasonable  estimate  of  probable  cost for known
sites.  Expenditures  incurred  by KeySpan  with  respect  to these  MGP-related
activities total $16.5 million.

In September  2004,  Boston Gas Company  reached an agreement  with an insurance
carrier  for  recovery  of  a  portion  of  previously  incurred   environmental
expenditures.  Under a  previously  issued  MA DTE  rate  order,  insurance  and
third-party  recoveries,  after  deducting legal fees, are shared between Boston
Gas and its firm gas customers. As a result of this agreement, in September 2004
Boston Gas Company  recorded a $5 million  benefit to operations and maintenance
expense.

We may have or share responsibility under applicable  environmental laws for the
remediation  of  10  MGP  sites  and  related  facilities  associated  with  the
historical  operations  of  EnergyNorth.  At four of these sites we have entered
into cost sharing  agreements  with other parties who share  responsibility  for
remediation of these sites.  EnergyNorth also has entered into an agreement with
the United States Environmental  Protection Agency ("EPA") for the contamination
from the Nashua site that was allegedly  commingled  with asbestos at the Nashua
River Asbestos Site, adjacent to the Nashua MGP site.

We  presently   estimate  the   remaining   cost  of   EnergyNorth   MGP-related
environmental  cleanup  activities will be $12.5 million,  which amount has been
accrued  by us as a  reasonable  estimate  of  probable  cost for  known  sites.
Expenditures incurred by KeySpan,  with respect to these MGP-related  activities
total $9.0 million.

By rate  orders,  the MA DTE and the New  Hampshire  Public  Utility  Commission
("NHPUC")  provide for the recovery of site  investigation and remediation costs
and, accordingly, at September 30, 2004, we have reflected a regulatory asset of
$49.6  million  for the KEDNE MGP  sites.  Colonial  Gas  Company  and Essex Gas
Company are not subject to the provisions of SFAS 71 and therefore have recorded
no  regulatory  asset.  However,  rate  plans  currently  in  effect  for  these
subsidiaries  provide for the recovery of investigation  and remediation  costs.


                                       21
<PAGE>


KeySpan  New  England,  LLC  Sites:  We are  aware  of three  non-utility  sites
associated  with  KeySpan  New  England,  LLC for  which  we may  have or  share
environmental  remediation or ongoing  maintenance  responsibility.  These three
sites,  located  in  Philadelphia,  Pennsylvania,  New  Haven,  Connecticut  and
Everett, Massachusetts, were associated with historical operations involving the
production of coke and related industrial  processes.  Honeywell  International,
Inc.  and Beazer East,  Inc.  (both former  owners  and/or  operators of certain
facilities at Everett (the  "Everett  Facility")  together  with  KeySpan,  have
entered  into  an  ACO  with  the  Massachusetts   Department  of  Environmental
Protection for the investigation and development of a remedial response plan for
a portion of that site.  KeySpan,  Honeywell and Beazer East have entered into a
cost-sharing  agreement  under which each company has agreed to pay one-third of
the costs of compliance with the consent order,  while  preserving any claims it
may have against the other  companies for, among other things,  reallocation  of
proportionate liability.

We presently estimate the remaining cost of our environmental cleanup activities
for the three  non-utility  sites will be  approximately  $22.0  million,  which
amount has been  accrued by us as a  reasonable  estimate of probable  costs for
known sites.  Expenditures incurred by KeySpan with respect to these sites total
$10.8 million.

We believe that in the aggregate,  the accrued liability for these MGP sites and
related  facilities  identified  above are reasonable  estimates of the probable
cost for the  investigation  and remediation of these sites and  facilities.  As
circumstances  warrant,  we  periodically  re-evaluate  the accrued  liabilities
associated  with  MGP  sites  and  related  facilities.  We may be  required  to
investigate  and, if necessary,  remediate each site previously  noted, or other
currently  unknown former sites and related facility sites, the cost of which is
not  presently  determinable  but may be  material  to our  financial  position,
results of  operations  or cash  flows.  Remediation  costs for each site may be
materially higher than noted,  depending upon remediation  experience,  selected
end use for each site, and actual environmental conditions encountered.

See KeySpan's  Annual  Report on Form 10-K for the year ended  December 31, 2003
Note 7 to those  Consolidated  Financial  Statements  "Contractual  Obligations,
Financial Guarantees and Contingencies" for further information on environmental
matters.

Legal Matters

From time to time we are subject to various legal proceedings arising out of the
ordinary  course of our  business.  Except as described  below,  or in KeySpan's
Annual  Report on Form 10-K for the year  ended  December  31,  2003,  we do not
consider  any of such  proceedings  to be material to our  business or likely to
result in a material  adverse  effect on our  results of  operations,  financial
condition or cash flows.


                                       22
<PAGE>


As previously  reported,  KeySpan and certain of its current and former officers
and directors are defendants in a consolidated class action lawsuit filed in the
United States District Court for the Eastern  District of New York. This lawsuit
alleges,  among other  things,  violations  of  Sections  10(b) and 20(a) of the
Securities Exchange Act of 1934, as amended ("Exchange Act"), in connection with
disclosures  relating to or following the  acquisition of the Roy Kay companies.
In June 2004,  the  parties  reached an  agreement  in  principle  to settle the
consolidated class action lawsuit.  The proposed settlement provides for KeySpan
to make  certain  payments  to  plaintiffs,  all of which is to be funded by the
insurance  carrier  providing  liability  coverage for  KeySpan's  directors and
officers.  While  KeySpan  continues  to deny any  wrongdoing,  we  believe  the
proposed settlement is in the best interest of KeySpan and its shareholders. The
settlement  is subject  to court  approval  and  finalization  of all  necessary
documentation, the timing of which cannot be determined.

KeySpan  subsidiaries,  along with  several  other  parties,  have been named as
defendants in numerous  proceedings filed by plaintiffs claiming various degrees
of injury from asbestos exposure at generating facilities formerly owned by Long
Island Lighting  Company  ("LILCO") and others.  In connection with the May 1998
transaction  with LIPA,  costs incurred by KeySpan for  liabilities for asbestos
exposure  arising from the  activities of the generating  facilities  previously
owned by LILCO are  recoverable  from LIPA  through the Power  Supply  Agreement
("PSA") between LIPA and KeySpan.

KeySpan  is  unable  to  determine  the  outcome  of  the  outstanding  asbestos
proceedings,  but does not believe that such  outcome,  if adverse,  will have a
material effect on its financial condition,  results of operation or cash flows.
KeySpan   believes   that  its  cost   recovery   rights   under  the  PSA,  its
indemnification  rights against third parties and its insurance  coverage (above
applicable  deductible  limits)  cover its  exposure  for  asbestos  liabilities
generally.







                                       23
<PAGE>


Financial Guarantees

KeySpan has issued  financial  guarantees in the normal  course of business,  on
behalf of its subsidiaries,  to various third-party creditors.  At September 30,
2004,  the  following  amounts  would have to be paid by KeySpan in the event of
non-payment by the primary obligor at the time payment is due:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
                                                                               Amount of
Nature of Guarantee (In Thousands of Dollars)                                   Exposure      Expiration Dates
-----------------------------------------------------------------------------------------------------------------
<S>                                                      <C>                  <C>               <C>
Medium-Term Notes - KEDLI                                 (i)                 $   525,000        2008-2010
Industrial Development Revenue Bonds                      (ii)                    128,000          2027
Ravenswood - Master Lease                                 (iii)                   425,000          2019
Ravenswood - Sale/leaseback                               (iv)                    385,000          2040
Surety Bonds                                              (v)                     269,000        Revolving
Commodity Guarantees and Other                            (vi)                     77,000          2005
Letters of Credit                                         (vii)                    74,000          2005
-----------------------------------------------------------------------------------------------------------------
                                                                              $ 1,883,000
-----------------------------------------------------------------------------------------------------------------
</TABLE>


The following is a description of KeySpan's outstanding subsidiary guarantees:

(i)  KeySpan has fully and unconditionally guaranteed $525 million to holders of
     Medium-Term  Notes  issued  by KEDLI.  These  notes are due to be repaid on
     January  15, 2008 and  February  1, 2010.  KEDLI is required to comply with
     certain  financial  covenants under the debt agreements.  The face value of
     these notes is  included  in  long-term  debt on the  Consolidated  Balance
     Sheet.

(ii) KeySpan has fully and unconditionally guaranteed the payment obligations of
     its  subsidiaries  with regard to $128  million of  Industrial  Development
     Revenue  Bonds  issued   through  the  Nassau  County  and  Suffolk  County
     Industrial   Development   Authorities   for   the   construction   of  two
     electric-generation  peaking plants on Long Island. The face value of these
     notes are included in long-term debt on the Consolidated Balance Sheet.

(iii)KeySpan has guaranteed all payment and  performance  obligations of KeySpan
     Ravenswood, LLC, the lessee under the Master Lease. The initial term of the
     Master Lease expired on June 20, 2004 and was extended until June 20, 2009.
     The Master Lease is  classified  as $412.3  million  long-term  debt on the
     Consolidated Balance Sheet.

(iv) KeySpan has guaranteed all payment and  performance  obligations of KeySpan
     Ravenswood, LLC, the lessee under the sale/leaseback transaction associated
     with the 250 MW Ravenswood Expansion.  The initial term of the lease is for
     36 years. As noted  previously,  this lease qualifies as an operating lease
     and is therefore not reflected on the Consolidated Balance Sheet.


                                       24
<PAGE>


(v)  KeySpan  has  agreed  to  indemnify  the  issuers  of  various  surety  and
     performance bonds associated with certain  construction  projects currently
     being performed by subsidiaries  within the Energy Services segment. In the
     event that the operating  companies in the Energy Services  segment fail to
     perform their obligations under contract, the injured party may demand that
     the surety make payments or provide services under the bond.  KeySpan would
     then be obligated to reimburse  the surety for any expenses or cash outlays
     it incurs.

(vi) KeySpan  has  guaranteed  commodity-related  payments  for  certain  of its
     subsidiaries.  These guarantees are provided to third-parties to facilitate
     physical  and  financial  transactions  involved in the purchase of natural
     gas, oil and other petroleum products for electric production and marketing
     activities.  The guarantees  cover actual  purchases by these  subsidiaries
     that are still outstanding as of September 30, 2004.

(vii)KeySpan has arranged  for stand-by  letters of credit to be issued to third
     parties that have extended credit to certain subsidiaries.  Certain vendors
     require us to post  letters of credit to guarantee  subsidiary  performance
     under our contracts and to ensure payment to our subsidiary  subcontractors
     and vendors  under those  contracts.  Certain of our vendors  also  require
     letters of credit to ensure  reimbursement  for amounts they are disbursing
     on  behalf  of  our  subsidiaries,  such  as  to  beneficiaries  under  our
     self-funded insurance programs. Such letters of credit are generally issued
     by a bank or similar  financial  institution.  The letters of credit commit
     the issuer to pay  specified  amounts to the holder of the letter of credit
     if the  holder  demonstrates  that  we have  failed  to  perform  specified
     actions. If this were to occur,  KeySpan would be required to reimburse the
     issuer of the letter of credit.

     To date,  KeySpan has not had a claim made  against it for any of the above
     guarantees  and we have no reason to  believe  that our  subsidiaries  will
     default on their current obligations. However, we cannot predict when or if
     any defaults may take place or the impact any such defaults may have on our
     consolidated results of operations, financial condition or cash flows.

Other  Contingencies:  We derive a  substantial  portion of our  revenues in our
Electric  Services  segment from a series of  agreements  with LIPA  pursuant to
which we manage  LIPA's  transmission  and  distribution  system  and supply the
majority of LIPA's  customers'  electricity  needs. The agreements  terminate at
various  dates  between May 29, 2006 and May 28,  2013,  and at this time we can
provide no assurance that any of the agreements will be renewed or extended,  or
if they were to be renewed or extended,  the terms and  conditions  thereof.  In
addition, given the complexity of these agreements,  disputes arise from time to
time between  KeySpan and LIPA  concerning  the rights and  obligations  of each
party to make and receive  payments  as required  pursuant to the terms of these
agreements. As a result, KeySpan is unable to determine what effect, if any, the
ultimate  resolution of these  disputes  will have on its  financial  condition,
results of operations or cash flows.


                                       25
<PAGE>


In addition,  LIPA is in the process of performing a long-term  strategic review
initiative regarding its future direction. It has engaged a team of advisors and
consultants and is conducting public hearings to develop  recommendations  to be
submitted to the LIPA Trustees by year-end.  Some of the strategic  options that
LIPA is considering  include whether LIPA should continue its operations as they
presently  exist,  fully  municipalize  or privatize,  sell some, but not all of
their assets and become a regulator of rates and services,  or merge with one or
more utilities.  In the near term, LIPA must make a determination by May 2005 as
to whether they will exercise its option to purchase our Long Island  generating
plants pursuant to the terms of the Generation Purchase Rights Agreement.  Until
LIPA makes a determination on its future  direction,  we are unable to determine
what the outcome of this strategic review will have on our financial  condition,
results of operations  or cash flows.  Any action that may be taken will have to
take into consideration the long-term nature of our existing contracts.

7. STOCK OPTIONS

Stock options have been issued to KeySpan officers,  directors and certain other
management  employees  and  consultants  as approved by the Board of  Directors.
These  options  generally  vest  over a  three-to-five  year  period  and have a
ten-year exercise period.  Moreover,  under a separate plan, Houston Exploration
has issued stock options to its directors and key Houston Exploration employees.
(Beginning in 2004, KeySpan officers that serve on the Houston Exploration Board
of Directors do not receive Houston Exploration stock options.) In 2003, KeySpan
and  Houston  Exploration  adopted  the  prospective  method  of  transition  of
accounting for stock option expense in accordance  with SFAS 148 "Accounting for
Stock-Based Compensation - Transition and Disclosure." Accordingly, compensation
expense has been recognized by employing the fair value  recognition  provisions
of SFAS 123 "Accounting for Stock-Based  Compensation"  for grants awarded after
January 1, 2003.

KeySpan and Houston  Exploration  continue to apply APB Opinion 25,  "Accounting
for Stock Issued to Employees,"  and related  Interpretations  in accounting for
grants awarded prior to January 1, 2003.  Accordingly,  no compensation cost has
been recognized for these fixed stock option plans in the Consolidated Financial
Statements  since the exercise  prices and market values were equal on the grant
dates. Had  compensation  cost for these plans been determined based on the fair
value at the grant dates for awards  under the plans  consistent  with SFAS 123,
net income and earnings per share would have decreased to the pro-forma  amounts
indicated  below.  The 2004  pro-forma  impact of  Houston  Exploration's  stock
options are reflected for the five month period ended May 31, 2004.


                                       26

<PAGE>


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                 Three Months Ended September 30,    Nine Months Ended September 30,
(In Thousands of Dollars, Except Per Share Amounts)                  2004             2003                2004              2003
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>                <C>                 <C>               <C>
Earnings available for common stock:                            $ (117,139)         $ 11,124           $ 258,375         $ 245,529
As reported
     Add: recorded stock-based compensation expense, net of tax      1,363               868               4,156             3,132
     Deduct: total stock-based compensation expense, net of tax     (1,935)           (2,707)             (6,894)           (9,043)
-----------------------------------------------------------------------------------------------------------------------------------
Pro-forma earnings                                              $ (117,711)          $ 9,285           $ 255,637         $ 239,618
-----------------------------------------------------------------------------------------------------------------------------------
Earnings per share:
     Basic - as reported                                           $ (0.73)           $ 0.07              $ 1.61            $ 1.56
     Basic - pro-forma                                             $ (0.73)           $ 0.06              $ 1.60            $ 1.52

     Diluted - as reported                                         $ (0.73)           $ 0.07              $ 1.60            $ 1.55
     Diluted - pro-forma                                           $ (0.73)           $ 0.06              $ 1.59            $ 1.51
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

8. POSTRETIREMENT BENEFITS

Pension  Plans:  The  following  information  represents  the  consolidated  net
periodic  pension cost for the nine months ended September 30, 2004 and 2003 for
our noncontributory  defined benefit pension plans which cover substantially all
employees. Benefits are based on years of service and compensation.  Funding for
pensions is in  accordance  with  requirements  of federal law and  regulations.
KEDLI and  Boston  Gas  Company  are  subject  to  certain  deferral  accounting
requirements  mandated by the NYPSC and MA DTE,  respectively  for pension costs
and other postretirement benefit costs. Further, KeySpan's electric subsidiaries
are subject to certain "true-up"  provisions in accordance with the LIPA service
agreements.

The calculation of net periodic pension cost is as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
                                                                             Nine Months Ended September 30,
(In Thousands of Dollars)                                                  2004                          2003
----------------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>                            <C>
Service cost, benefits earned during the period                       $   39,681                    $   35,648
Interest cost on projected benefit obligation                            108,181                       103,703
Expected return on plan assets                                          (118,700)                      (97,917)
Net amortization and deferral                                             47,480                        50,212
----------------------------------------------------------------------------------------------------------------------
Total pension cost                                                    $   76,642                    $   91,646
----------------------------------------------------------------------------------------------------------------------
</TABLE>


Other  Postretirement   Benefits:   The  following  information  represents  the
consolidated net periodic other postretirement  benefit cost for the nine months
ended September 30, 2004 and 2003 for our noncontributory  defined benefit plans
covering certain health care and life insurance  benefits for retired employees.
We have been funding a portion of future benefits over employees' active service
lives  through  Voluntary  Employee  Beneficiary  Association  ("VEBA")  trusts.
Contributions  to  VEBA  trusts  are  tax  deductible,  subject  to  limitations
contained in the Internal Revenue Code.


                                       27
<PAGE>


Net periodic other postretirement benefit cost included the following
components:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                                                              Nine Months Ended September 30,
(In Thousands of Dollars)                                                     2004                        2003
----------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>                         <C>
Service cost, benefits earned during the period                            $ 15,090                    $ 14,119
Interest cost on accumulated
   postretirement benefit obligation                                         55,508                      52,352
Expected return on plan assets                                              (25,419)                    (20,648)
Net amortization and deferral                                                35,097                      26,861
----------------------------------------------------------------------------------------------------------------
Other postretirement cost                                                  $ 80,276                    $ 72,685
----------------------------------------------------------------------------------------------------------------
</TABLE>


In 2004,  KeySpan is expected to  contribute  approximately  $102 million to its
pension plans and approximately $40 million to its other postretirement  benefit
plans.  For the nine months  ended  September  30,  2004,  $130 million has been
contributed.  These estimated contribution levels are subject to change based on
future market  returns,  interest rates and certain other  measurements.  Actual
contributions, therefore, may vary from these levels.

9. LONG-TERM DEBT and COMMERCIAL PAPER

In August 2004, KeySpan redeemed approximately $758 million of outstanding debt.
The table below indicates the various series of debt redeemed and the associated
KeySpan subsidiary:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
KeySpan Subsidiary                             Series                               Due Date                      Amount ($000)
----------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>                                     <C>                                  <C>
KeySpan Corporation                      7.25% Medium Term Notes                 November 2005                     $ 700,000
EnergyNorth Natural Gas                  9.70% Series B                         September 2019                         7,000
EnergyNorth Natural Gas                  9.75% Series C                         September 2020                        10,000
EnergyNorth Natural Gas                  8.44% Series D                           January 2009                         1,667
EnergyNorth Natural Gas                  7.40% Series E                         September 2027                        21,285
Essex Gas Company                       10.10% Series 1990                       December 2020                         8,000
Essex Gas Company                        7.28% Series 1996                       December 2016                        10,000
----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                   $ 757,952
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


KeySpan   incurred  $54.5  million  in  call  premiums   associated  with  these
redemptions,  of which  $45.9 was  expensed  and  recorded  in other  income and
deductions on the Consolidated  Statement of Income. The remaining amount of the
call premiums have been deferred for future recovery. Further, KeySpan wrote-off
$8.2 million of previously deferred financing costs which have been reflected in
interest  expense on the Consolidated  Statement of Income.  The total after-tax
expense of the debt redemption was $29.3 million or $0.18 per share.


                                       28
<PAGE>


Also during the third quarter of 2004, KEDNY retired a portion, $8.0 million, of
its outstanding Gas Facilities Revenue Bonds. The funds used to retire this debt
were drawn from a special deposit  defeasance  trust  previously  established by
KEDNY.  Approximately  $640  million  of Gas  Facilities  Revenue  Bonds  remain
outstanding.

At September 30, 2004, KeySpan had $460 million of MEDS Equity Units outstanding
at 8.75%  consisting of a three-year  forward  purchase  contract for our common
stock and a six-year note. The purchase  contract commits us, in May 2005, three
years  after the date of issuance  of the MEDS  Equity  Units,  to issue and the
investors to purchase, a number of shares of our common stock based on a formula
tied to the market price of our common  stock at that time.  The 8.75% coupon is
composed of interest  payments on the six-year note of 4.9% and premium payments
on the three-year equity forward contract of 3.85%.  These instruments have been
recorded as long-term  debt on the  Consolidated  Balance Sheet.  Further,  upon
issuance  of the MEDS  Equity  Units,  we  recorded a direct  charge to retained
earnings of $49.1  million,  which  represents  the present value of the forward
contract's premium payments.

There were 9.2 million MEDS Equity units issued which are subject to  conversion
upon execution of the three-year forward purchase contract. The number of shares
to be issued depends on the average closing price of KeySpan's common stock over
the 20 day trading period ending on the third trading day prior to May 16, 2005.
If the  average  closing  price  over this  time  frame is less than or equal to
$35.30 of  KeySpan's  common  stock,  13 million  shares will be issued.  If the
average  closing  price over this time frame is greater than or equal to $42.36,
10.9  million  shares  will be issued.  The  number of shares  issued at a price
between  $35.30 and $42.36 will be between  10.9  million and 13 million  shares
based upon a sliding scale.

These  securities  are  currently not  considered  convertible  instruments  for
purposes of applying SFAS 128 "Earnings Per Share" calculations, unless or until
such time as the market  value of  KeySpan's  common  stock  reaches a threshold
appreciation  price ($42.36 per share) that is higher than the current per share
market value. Interest payments do, however,  reduce net income and earnings per
share.

In June 2004, KeySpan completed the restructuring of its credit  facilities.  We
entered into a new $640 million five year revolving  credit  facility to replace
the $450  million,  364 day facility  which expired in June. We also amended our
existing  three year $850 million  facility due June 2006 to reduce  commitments
thereunder  by $190  million  to a new  level of $660  million.  The two  credit
facilities total $1.3 billion and are each syndicated among sixteen banks. These
facilities  continue to support  KeySpan's  commercial paper program for working
capital needs.

The fees for these  facilities  are  subject to a  ratings-based  grid,  with an
annual fee of 0.08% on the new  five-year  facility  and 0.125% on the  existing
three-year  facility.  Both credit  agreements allow for KeySpan to borrow using
several different types of loans;  specifically,  Eurodollar  loans,  Adjustable
Bank Rate (ABR)  loans,  or  competitively  bid loans.  Eurodollar  loans in the
five-year  facility are based on the Eurodollar  rate plus a margin of 0.40% for
loans up to 33% of the total five-year  facility,  and an additional  0.125% for


                                       29
<PAGE>


loans  over 33% of the total  five-year  facility.  In the  three-year  facility
Eurodollar  loans are based on the  Eurodollar  rate plus a margin of 0.625% for
loans up to 33% of the total three-year  facility,  and an additional 0.125% for
loans  over 33% of the  total  three-year  facility.  ABR loans are based on the
highest  of the  Prime  Rate,  the base CD rate plus 1%,  or the  Federal  Funds
Effective  Rate plus  0.5%.  Competitive  bid  loans  are  based on bid  results
requested by KeySpan from the lenders.  We do not anticipate  borrowing  against
these facilities;  however, if the credit rating on our commercial paper program
were to be downgraded, it may be necessary to do so.

The facilities  contain certain  affirmative and negative  operating  covenants,
including  restrictions on KeySpan's  ability to mortgage,  pledge,  encumber or
otherwise  subject  its  property  to any  lien,  as well as  certain  financial
covenants  that  require us to,  among  other  things,  maintain a  consolidated
indebtedness to consolidated  capitalization ratio of no more than 64% until the
expiration of the existing three-year facility in 2006, at which time it will be
lowered to 62%.  Violation of this covenant  could result in the  termination of
the facilities and the required  repayment of amounts  borrowed  thereunder,  as
well as possible cross defaults under other debt agreements.

10. GAS EXPLORATION and PRODUCTION PROPERTY - DEPLETION

As  described  in  Note 2  "Business  Segments,"  KeySpan's  investments  in gas
exploration  and  production   activities  consists  of  its  approximate  23.5%
ownership  interest in Houston  Exploration,  as well as KeySpan's  wholly-owned
subsidiary  KeySpan  Exploration  and  Production,  which is  engaged in a joint
drilling program with Houston  Exploration.  Further,  KeySpan's  investments in
these activities also includes its wholly-owned subsidiary Seneca-Upshur.  These
assets are  accounted  for under the full cost method of  accounting.  Under the
full cost method,  costs of acquisition,  exploration and development of natural
gas and oil reserves plus asset  retirement  obligations are capitalized  into a
"full cost pool" as incurred. Unproved properties and related costs are excluded
from  the  depletion  and  amortization  base  until a  determination  as to the
existence of proved reserves.  Properties are depleted and charged to operations
using the unit of production method.

To the extent that such  capitalized  costs (net of accumulated  depletion) less
deferred taxes exceed the present value (using a 10% discount rate) of estimated
future net cash flows from proved  natural gas and oil reserves and the lower of
cost or fair value of unproved  properties,  less  deferred  taxes,  such excess
costs are  charged to  operations,  but would not have an impact on cash  flows.
Once  incurred,  such  impairment of gas properties is not reversible at a later
date even if gas prices  increase.  The ceiling test is calculated using natural
gas and oil  prices  in  effect  as of the  balance  sheet  date,  adjusted  for
outstanding derivative instruments, held flat over the life of the reserves.

As a result of the stock transaction previously mentioned,  KeySpan now accounts
for its investment in Houston  Exploration on the equity  method,  i.e.  Houston
Exploration's operations are not consolidated with KeySpan's other subsidiaries.
Therefore,  we are now  required  to  calculate  the  ceiling  test  on  KeySpan
Exploration and Production's and Seneca-Uphsur's assets independently of Houston
Exploration's  assets.  Based on a report furnished by an independent  reservoir


                                       30
<PAGE>


engineer during the second quarter of 2004, it was determined that the remaining
proved undeveloped oil reserves held in the joint venture required a substantial
investment  in order to develop.  Therefore,  KeySpan  and  Houston  Exploration
elected not to develop these oil reserves. As a result, in the second quarter of
2004, we recorded a $48.2 million non-cash  impairment  charge to write down our
wholly-owned gas exploration and production  subsidiaries'  assets.  This charge
was recorded in  depreciation,  depletion and  amortization on the  Consolidated
Statement of Income.

11. PREFERRED STOCK

In July 2004,  KeySpan  redeemed 83,268 shares of preferred stock 6.00% Series A
par value  $100  that were  previously  issued in a private  placement.  KeySpan
redeemed  these shares at a 2% premium and incurred a cash  expenditure  of $8.5
million.


12. GOODWILL IMPAIRMENT

In  connection  with the  preparation  of third  quarter  financial  statements,
KeySpan  conducted an evaluation of the carrying  value of goodwill  recorded in
its Energy  Services  segment.  As noted in prior SEC filings,  KeySpan  records
goodwill on purchased transactions,  representing the excess of acquisition cost
over the fair value of net assets acquired.  As prescribed in SFAS 142 "Goodwill
and Other Intangible Assets", KeySpan is required to compare the fair value of a
reporting unit to its carrying amount,  including  goodwill.  This evaluation is
required to be  performed  at least  annually,  unless  facts and  circumstances
indicate that the evaluation should be performed at an interim period during the
year.  Prior to this evaluation,  the recorded  goodwill for the Energy Services
segment, as a result of prior acquisitions, was approximately $173 million.

As a result of an extremely  competitive market and sluggish economic conditions
within the construction  industry in the Northeastern  United States, the Energy
Services segment has experienced  significantly lower operating profits and cash
flows than originally  projected.  As previously  reported,  management has been
reviewing  the  operating  performance  of this  segment.  At a meeting  held on
November 2, 2004,  KeySpan's Board of Directors  authorized  management to begin
the process of disposing of a significant  portion of its ownership interests in
certain  companies  within  the Energy  Services  segment -  specifically  those
companies  engaged in  mechanical  contracting  activities.  For the nine months
ended  September 30, 2004, the  mechanical  contracting  activities  contributed
approximately 60% of the revenues recorded in the Energy Services segment.

Based upon the results  through  September  30, 2004  experienced  by the Energy
Services segment and management's  opinion that it was likely that a significant
portion  of the  Energy  Services  segment  will be sold in the  coming  months,
management  concluded that KeySpan was required under  paragraph 28 of SFAS 142,
to evaluate the  goodwill  recorded for the entire  Energy  Services  segment in
connection with the  preparation and review of its financial  statements for the
quarter.


                                       31
<PAGE>


As a result of this interim  evaluation,  KeySpan  recorded a non-cash  goodwill
impairment  charge of $122.2  million  ($90.4  million  after tax,  or $0.56 per
share) in the third  quarter  of 2004.  KeySpan  employed a  combination  of two
methodologies  in determining the estimated fair value for its investment in the
Energy Services  segment,  a market  valuation  approach and an income valuation
approach.  Under the  market  valuation  approach,  KeySpan  utilized a range of
near-term potential realizable values for the mechanical contracting businesses.
Under the income valuation approach,  the fair value was obtained by discounting
the sum of (i) the  expected  future  cash  flows and (ii) the  terminal  value.
KeySpan utilized certain significant assumptions in this valuation, specifically
the  weighted-average  cost of capital,  short and  long-term  growth  rates and
expected future cash flows. Therefore,  the significant assumptions used in this
interim evaluation may change in future  evaluations.  Approximately $50 million
of goodwill remains in this segment.

In  addition,  we will  continue  to evaluate  the fair value of the  mechanical
contracting  companies in relation to potential disposition  alternatives.  As a
result of this  evaluation  we may also be required to  write-down  the carrying
value of the mechanical contracting companies in the near term in an amount that
can not currently be determined.

At this point in time,  we are unable to  predict if any  additional  impairment
charges may be required for this segment,  the timing of any such  charges,  the
impact any such  charges  would have on our  financial  position  and results of
operations  or the  timing of any sales of our  ownership  interest  in  certain
companies operating in this segment.










                                       32
<PAGE>


13. KEYSPAN GAS EAST CORPORATION SUMMARY FINANCIAL INFORMATION

KEDLI is a wholly-owned  subsidiary of KeySpan.  KEDLI was formed on May 7, 1998
and on May 28, 1998 acquired  substantially all of the assets related to the gas
distribution  business of LILCO.  KEDLI  established a program for the issuance,
from  time  to  time,  of up to  $600  million  aggregate  principal  amount  of
Medium-Term Notes, which are fully and unconditionally guaranteed by the parent,
KeySpan  Corporation.  On February 1, 2000,  KEDLI issued $400 million of 7.875%
Medium-Term  Notes due 2010.  In January 2001,  KEDLI issued an additional  $125
million of Medium-Term  Notes at 6.9% due January 2008. The following  condensed
financial  statements  are required to be disclosed by SEC  regulations  and set
forth those of KEDLI,  KeySpan Corporation as guarantor of the Medium-Term Notes
and our other subsidiaries on a combined basis.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                 Statement of Income
------------------------------------------------------------------------------------------------------------------------------------
                                                                   Three Months Ended September 30, 2004
                                                                                    Other
(In Thousands of Dollars)                       Guarantor          KEDLI         Subsidiaries       Eliminations      Consolidated
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                              <C>              <C>               <C>                  <C>            <C>
Revenues                                       $      152        $ 114,252            936,182           $   (152)       $1,050,434
                                         ------------------------------------------------------------------------------------------
Operating Expenses
  Purchased gas                                         -           49,994            136,625                  -           186,619
  Fuel and purchased power                              -                -            176,028                  -           176,028
  Operations and maintenance                        2,102           29,893            402,879                  -           434,874
  Intercompany expense                                  -            1,341             (1,341)                 -                 -
  Depreciation and amortization                         -           13,799             79,621                  -            93,420
  Goodwill impairment charge                            -                -            122,229                  -           122,229
  Operating taxes                                       -           15,538             73,987                               89,525
                                         ------------------------------------------------------------------------------------------
Total Operating Expenses                            2,102          110,565            990,028                  -         1,102,695
                                         ------------------------------------------------------------------------------------------
Income from equity investments                          -                -             16,213                  -            16,213
                                         ------------------------------------------------------------------------------------------
Operating Income (Loss)                            (1,950)           3,687            (37,633)              (152)          (36,048)
                                         ------------------------------------------------------------------------------------------

Interest charges                                  (54,203)         (16,306)           (67,495)            49,696           (88,308)
Other income and (deductions)                     (88,066)             192              9,326             36,815           (41,733)
                                         ------------------------------------------------------------------------------------------
Total Other Income and (Deductions)              (142,269)         (16,114)           (58,169)            86,511          (130,041)
                                         ------------------------------------------------------------------------------------------

Income Taxes (Benefit)                            (30,432)          (2,626)           (17,252)                 -           (50,310)

                                         ------------------------------------------------------------------------------------------
Net Income                                     $ (113,787)       $  (9,801)         $ (78,550)          $ 86,359        $ (115,779)
                                         ==========================================================================================
</TABLE>






                                       33
<PAGE>


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                 Statement of Income
-----------------------------------------------------------------------------------------------------------------------------------
                                                                  Three Months Ended September 30, 2003
                                                                                   Other
(In Thousands of Dollars)                   Guarantor         KEDLI             Subsidiaries      Eliminations      Consolidated
---------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>            <C>                  <C>                  <C>            <C>
Revenues                                      $   185        $ 99,170            $ 1,032,644         $    (185)      $ 1,131,814
                                       ------------------------------------------------------------------------------------------
Operating Expenses
  Purchased gas                                                37,038                136,078                             172,452
  Fuel and purchased power                                                           132,649                             133,313
  Operations and maintenance                    6,742          33,457                467,182                             507,381
  Intercompany expense                          5,142             310                   (310)           (5,142)
  Depreciation and amortization                   (13)         13,519                122,150                             135,656
  Operating taxes                               1,824          16,557                 73,409                              91,790
                                       ------------------------------------------------------------------------------------------
Total Operating Expenses                       13,695         100,881                931,158            (5,142)        1,040,592
                                       ------------------------------------------------------------------------------------------

Gain on sale of property                            -          13,974                      -                 -            13,974
Income from Equity Investments                      -               -                  2,727                 -             2,727
                                       ------------------------------------------------------------------------------------------
Operating Income (Loss)                       (13,510)         12,263                104,213             4,957           107,923
                                       ------------------------------------------------------------------------------------------

Interest charges                              (54,233)        (15,661)               (54,205)           45,733           (78,366)
Other income and (deductions)                  67,923           2,838                (11,939)          (68,391)           (9,569)
                                       ------------------------------------------------------------------------------------------
Total Other Income and (Deductions)            13,690         (12,823)               (66,144)          (22,658)          (87,935)
                                       ------------------------------------------------------------------------------------------


Income Taxes (Benefit)                        (12,574)          1,223                 18,754                 -             7,403

                                       ------------------------------------------------------------------------------------------
Net Income (Loss)                             $12,754        $ (1,783)           $    19,315         $ (17,701)      $    12,585
                                       ==========================================================================================
</TABLE>

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                 Statement of Income
-----------------------------------------------------------------------------------------------------------------------------------
                                                                  Nine Months Ended September 30, 2004
                                                                                   Other
(In Thousands of Dollars)                   Guarantor         KEDLI             Subsidiaries      Eliminations      Consolidated
---------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>            <C>                  <C>                 <C>             <C>
Revenues                                     $    465       $ 766,709            $ 4,245,069        $     (465)      $ 5,011,778
                                       ------------------------------------------------------------------------------------------
Operating Expenses
  Purchased gas                                     -         437,990              1,338,332                 -         1,776,322
  Fuel and purchased power                          -               -                407,987                 -           407,987
  Operations and maintenance                   (2,959)         96,833              1,310,961                 -         1,404,835
  Intercompany expense                              -           4,129                 (4,129)                -                 -
  Depreciation and amortization                     -          62,048                392,689                 -           454,737
  Goodwill impairment charge                                        -                122,229                 -           122,229
  Operating taxes                                   -          47,814                254,329                 -           302,143
                                       ------------------------------------------------------------------------------------------
Total Operating Expenses                       (2,959)        648,814              3,822,398                 -         4,468,253
                                       ------------------------------------------------------------------------------------------

Income from Equity Investments                      -               -                 30,342                 -            30,342
                                       ------------------------------------------------------------------------------------------
Operating Income (Loss)                         3,424         117,895                453,013              (465)          573,867
                                       ------------------------------------------------------------------------------------------

Interest charges                             (160,968)        (47,000)              (208,458)          155,578          (260,848)
Other income and (deductions)                 386,109             724                187,397          (457,809)          116,421
                                       ------------------------------------------------------------------------------------------
Total Other Income and (Deductions)           225,141         (46,276)               (21,061)         (302,231)         (144,427)
                                       ------------------------------------------------------------------------------------------

Income Taxes (Benefit)                        (40,067)         22,428                184,424                 -           166,785

                                       ------------------------------------------------------------------------------------------
Net Income (Loss)                            $268,632       $  49,191            $   247,528        $ (302,696)      $   262,655
                                       ==========================================================================================
</TABLE>


                                       34
<PAGE>

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                           Statement of Income
------------------------------------------------------------------------------------------------------------------------------------
                                                                     Nine Months Ended September 30, 2003
                                                                                     Other
(In Thousands of Dollars)                           Guarantor       KEDLI         Subsidiaries        Eliminations      Consolidated
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>         <C>               <C>                  <C>            <C>
Revenues                                            $     362     $ 754,855         $ 4,297,636        $     (362)      $ 5,052,491
                                               -------------------------------------------------------------------------------------
Operating Expenses
  Purchased gas                                             -       414,658           1,378,259                 -         1,792,917
  Fuel and purchased power                                  -             -             333,311                 -           333,311
  Operations and maintenance                            8,577       104,437           1,402,192                 -         1,515,206
  Intercompany expense                                  5,207         2,227              (2,227)           (5,207)                -
  Depreciation and amortization                           (53)       58,503             364,467                 -           422,917
  Operating taxes                                           -        57,516             254,238                 -           311,754
                                               -------------------------------------------------------------------------------------
Total Operating Expenses                               13,731       637,341           3,730,240            (5,207)        4,376,105
                                               -------------------------------------------------------------------------------------

Gain on sale of property                                    -        13,974                   -                 -            13,974
Income from Equity Investments                            108             -              12,378                 -            12,486
                                               -------------------------------------------------------------------------------------
Operating Income (Loss)                               (13,261)      131,488             579,774             4,845           702,846
                                               -------------------------------------------------------------------------------------

Interest charges                                     (154,113)      (46,771)           (163,224)          137,605          (226,503)
Other income and (deductions)                         395,934        (6,188)            (53,383)         (397,254)          (60,891)
                                               -------------------------------------------------------------------------------------
Total Other Income and (Deductions)                   241,821       (52,959)           (216,607)         (259,649)         (287,394)
                                               -------------------------------------------------------------------------------------

Income Taxes (Benefit)                                (21,521)       30,756             156,479                 -           165,714
                                               -------------------------------------------------------------------------------------
Earnings before Change in Accounting
  Principle                                           250,081        47,773             206,688          (254,804)          249,738
Cummulative Effect of Change in Accounting
  Principle                                                 -             -                 174                 -               174

                                               -------------------------------------------------------------------------------------
Net Income (Loss)                                   $ 250,081     $  47,773         $   206,862        $ (254,804)      $   249,912
                                               =====================================================================================
</TABLE>







                                       35
<PAGE>


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
------------------------------------------------------------------------------------------------------------------------------------
                                                                             September 30, 2004
                                                                                    Other
                                                 Guarantor          KEDLI        Subsidiaries       Eliminations       Consolidated
                                          ------------------------------------------------------------------------------------------
<S>                                             <C>             <C>                 <C>               <C>                <C>
ASSETS
Current Assets
   Cash and temporary cash investments         $    74,262     $     2,032        $    285,003       $          -      $    361,297
   Accounts receivable, net                          8,320         100,856             617,435                  -           726,611
   Other current assets                              3,742         165,305             824,107                  -           993,154
                                          ------------------------------------------------------------------------------------------
                                                    86,324         268,193           1,726,545                  -         2,081,062
                                          ------------------------------------------------------------------------------------------

Investments                                      4,686,201           2,035             420,740         (4,592,372)          516,604
                                          ------------------------------------------------------------------------------------------
Property
   Gas                                                           1,968,793           4,821,354                  -         6,790,147
   Other                                                                 -           2,972,106                  -         2,972,106
   Accumulated depreciation and depletion                         (328,711)         (2,484,381)                 -        (2,813,092)
                                          ------------------------------------------------------------------------------------------
                                                         -       1,640,082           5,309,079                  -         6,949,161
                                          ------------------------------------------------------------------------------------------

Intercompany Accounts Receivable                 2,198,997             890           1,808,897         (4,008,784)                -

Deferred Charges                                   374,159         236,171           2,384,416                  -         2,994,746

                                          ------------------------------------------------------------------------------------------
Total Assets                                   $ 7,345,681     $ 2,147,371        $ 11,649,677       $ (8,601,156)     $ 12,541,573
                                          ==========================================================================================

LIABILITIES AND CAPITALIZATION
Current Liabilities
   Accounts payable                            $    52,148     $    56,881        $    553,098       $          -      $    662,127
   Commercial paper                                575,375               -                   -                  -           575,375
   Other current liabilities                        61,477          58,035             133,410                  -           252,922
                                          ------------------------------------------------------------------------------------------
                                                   689,000         114,916             686,508                  -         1,490,424
                                          ------------------------------------------------------------------------------------------
Intercompany Accounts Payable                            -               -           2,683,434         (2,683,434)                -
                                          ------------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax                                (88,559)        366,055             813,947                  -         1,091,443
Other deferred credits and liabilities             523,733         184,082             997,210                  -         1,705,025
                                          ------------------------------------------------------------------------------------------
                                                   435,174         550,137           1,811,157                  -         2,796,468
                                          ------------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity                      3,789,308         831,414           3,711,882         (4,592,372)        3,740,232
Preferred stock                                     75,000               -                   -                               75,000
Long-term debt                                   2,357,199         650,904           2,741,109         (1,325,350)        4,423,862
                                          ------------------------------------------------------------------------------------------
Total Capitalization                             6,221,507       1,482,318           6,452,991         (5,917,722)        8,239,094
                                          ------------------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies                -               -              15,587                  -            15,587
                                          ------------------------------------------------------------------------------------------
Total Liabilities & Capitalization             $ 7,345,681     $ 2,147,371        $ 11,649,677       $ (8,601,156)     $ 12,541,573
                                          ==========================================================================================
</TABLE>


                                       36
<PAGE>


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
------------------------------------------------------------------------------------------------------------------------------------
                                                                                 December 31, 2003
                                                                                       Other
                                                  Guarantor            KEDLI         Subsidiaries    Eliminations      Consolidated
                                           -----------------------------------------------------------------------------------------
<S>                                              <C>                <C>              <C>              <C>               <C>
ASSETS
Current Assets
   Cash and temporary cash investments          $    97,567       $     1,554       $    106,630     $          -      $    205,751
   Accounts receivable, net                           3,298           209,151          1,243,459                -         1,455,908
   Other current assets                               3,250           130,994            590,996                -           725,240
                                           -----------------------------------------------------------------------------------------
                                                    104,115           341,699          1,941,085                -         2,386,899
                                           -----------------------------------------------------------------------------------------

Investments and Other                             4,475,949             1,123            153,520       (4,382,027)          248,565
                                           -----------------------------------------------------------------------------------------
Property
   Gas                                                    -         1,899,375          4,622,876                -         6,522,251
   Other                                                  -                 -          6,150,355                -         6,150,355
   Accumulated depreciation and depletion                 -          (312,204)        (3,466,099)               -        (3,778,303)
                                           -----------------------------------------------------------------------------------------
                                                          -         1,587,171          7,307,132                -         8,894,303
                                           -----------------------------------------------------------------------------------------

Intercompany Accounts Receivable                  3,105,571                 -          1,274,293       (4,379,864)                -

Deferred Charges                                    374,076           237,870          2,498,469                -         3,110,415

                                           -----------------------------------------------------------------------------------------
Total Assets                                    $ 8,059,711       $ 2,167,863       $ 13,174,499     $ (8,761,891)     $ 14,640,182
                                           =========================================================================================

LIABILITIES AND CAPITALIZATION
Current Liabilities
   Accounts payable                             $   125,892       $   165,613       $    850,092     $          -      $  1,141,597
   Commercial paper                                 481,900                 -                  -                -           481,900
   Other current liabilities                        129,168            16,125             80,026                -           225,319
                                           -----------------------------------------------------------------------------------------
                                                    736,960           181,738            930,118                -         1,848,816
                                           -----------------------------------------------------------------------------------------
Intercompany Accounts Payable                             -           116,197          2,679,101       (2,795,298)                -
                                           -----------------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred income tax                                 (48,059)          256,882          1,069,518                -         1,278,341
Other deferred credits and liabilities              532,062           179,919            925,839                -         1,637,820
                                           -----------------------------------------------------------------------------------------
                                                    484,003           436,801          1,995,357                -         2,916,161
                                           -----------------------------------------------------------------------------------------
Capitalization
Common shareholders' equity                       3,707,785           782,223          3,562,675       (4,382,027)        3,670,656
Preferred stock                                      83,568                 -                  -                -            83,568
Long-term debt                                    3,047,395           650,904          3,497,699       (1,584,566)        5,611,432
                                           -----------------------------------------------------------------------------------------
Total Capitalization                              6,838,748         1,433,127          7,060,374       (5,966,593)        9,365,656
                                           -----------------------------------------------------------------------------------------
Minority Interest in Subsidiary Companies                 -                 -            509,549                -           509,549
                                           -----------------------------------------------------------------------------------------
Total Liabilities & Capitalization              $ 8,059,711       $ 2,167,863       $ 13,174,499     $ (8,761,891)     $ 14,640,182
                                           =========================================================================================
</TABLE>


                                       37
<PAGE>

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
------------------------------------------------------------------------------------------------------------------------------------
                                                                                Nine Months Ended September 30, 2004
                                                        ----------------------------------------------------------------------------
                                                                                                       Other
                                                              Guarantor           KEDLI             Subsidiaries      Consolidated
                                                        ----------------------------------------------------------------------------
<S>                                                          <C>                <C>                    <C>                <C>
Operating Activities
Net Cash Provided by Operating Activities                    $ (154,519)        $ 198,606              $ 737,247          $ 781,334
                                                        ----------------------------------------------------------------------------
Investing Activities
   Capital expenditures                                               -           (76,341)              (486,866)          (563,207)
   Cost of removal                                                    -            (4,700)               (16,549)           (21,249)
   Net proceeds from subsidiary stock transactions                    -                                  512,065            512,065
   Net proceeds from sale/leaseback transaction                       -                                  383,716            383,716
   Proceeds from sale of property                                     -                                   13,138             13,138
                                                        ----------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities                   -           (81,041)               405,504            324,463
                                                        ----------------------------------------------------------------------------
Financing Activities
   Treasury stock issued                                         24,322                 -                      -             24,322
   Payment of debt, net                                        (589,378)                -               (187,844)          (777,222)
   Common and preferred stock dividends paid                   (218,355)                -                      -           (218,355)
   Gain on settlement of treasury lock                           12,656                 -                      -             12,656
   Redemption of preferred stock                                 (8,483)                -                      -             (8,483)
   Other                                                          3,878                 -                 12,953             16,831
   Net intercompany accounts                                    906,574          (117,087)              (789,487)                 -
                                                                                                                                  -
                                                        ----------------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities             131,214          (117,087)              (964,378)          (950,251)
                                                        ----------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents         $  (23,305)        $     478              $ 178,373          $ 155,546
Cash and Cash Equivalents at Beginning of Period                 97,567             1,554                106,630            205,751
                                                        ----------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period                   $   74,262         $   2,032              $ 285,003          $ 361,297
                                                        ============================================================================
</TABLE>

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
-------------------------------------------------------------------------------------------------------------------------------
                                                                          Nine Months Ended September 30, 2003
                                                        -----------------------------------------------------------------------
                                                                                                   Other
                                                              Guarantor        KEDLI            Subsidiaries     Consolidated
                                                        -----------------------------------------------------------------------
<S>                                                            <C>           <C>                   <C>               <C>
Operating Activities
Net Cash Provided by Operating Activities                      $ 55,555      $ 86,851              $ 614,268         $ 756,674
                                                        -----------------------------------------------------------------------
Investing Activities
   Capital expenditures                                               -       (82,233)              (637,984)         (720,217)
   Other investments                                                                                 (50,500)          (50,500)
   Cost of removal                                                    -        (1,708)               (17,903)          (19,611)
   Proceeds from the sale of subsidiary investments              79,200             -                133,327           212,527
                                                        -----------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities              79,200       (83,941)              (573,060)         (577,801)
                                                        -----------------------------------------------------------------------
Financing Activities
   Treasury stock issued                                         76,984             -                      -            76,984
   Equity issuance                                              473,573             -                      -           473,573
   Redemption of promissory notes                              (447,005)            -                      -          (447,005)
   Payment of debt, net                                          28,703             -               (154,031)         (125,328)
   Redemption of preferred stock                                      -             -                (14,293)          (14,293)
   Common and preferred stock dividends paid                   (208,178)            -                      -          (208,178)
   Other                                                         17,240             -                 (4,432)           12,808
   Net intercompany accounts                                   (142,833)       (6,342)               149,175                 -
                                                                                                                             -
                                                        -----------------------------------------------------------------------
Net Cash Provided by (Used in) Financing Activities            (201,516)       (6,342)               (23,581)         (231,439)
                                                        -----------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents           $(66,761)     $ (3,432)             $  17,627         $ (52,566)
Cash and Cash Equivalents at Beginning of Period                 88,308         6,472                 75,837           170,617
                                                        -----------------------------------------------------------------------
Cash and Cash Equivalents at End of Period                     $ 21,547      $  3,040              $  93,464         $ 118,051
                                                        =======================================================================
</TABLE>




                                       38
<PAGE>


Item 2. Management's  Discussion and Analysis of Financial Condition and Results
of Operations

Consolidated Review of Results
------------------------------

The following is a summary of transactions  affecting comparative earnings and a
discussion  of material  changes in revenues and  expenses  during the three and
nine months  ended  September  30,  2004,  compared to the three and nine months
ended September 30, 2003.  Capitalized  terms used in the following  discussion,
but not  otherwise  defined,  have the same meaning as when used in the Notes to
the  Consolidated  Financial  Statements  included  under Item 1.  References to
"KeySpan,"  "we," "us," and "our" mean KeySpan  Corporation,  together  with its
consolidated subsidiaries.

Operating  income by segment,  as well as  consolidated  earnings  available for
common stock is set forth in the following table for the periods indicated.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
(In Thousands of Dollars, Except per Share)
----------------------------------------------------------------------------------------------------------------------------------
                                                             Three Months Ended September 30,      Nine Months Ended September 30,
                                                                   2004              2003                 2004              2003
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>               <C>                  <C>               <C>
Gas Distribution                                               $ (23,627)        $ (25,134)           $ 391,090         $ 371,420
Electric Services                                                111,158           102,125              226,273           193,869
Energy Services
     Operations                                                  (20,747)          (15,498)             (44,127)          (35,083)
     Goodwill impairment charge                                 (122,229)                -             (122,229)                -
Energy Investments
     Operations                                                   16,434            59,004              156,491           183,940
     Ceiling test write-down                                           -                 -              (48,190)                -
Eliminations and other                                             2,963           (12,574)              14,559           (11,300)
----------------------------------------------------------------------------------------------------------------------------------
Operating Income (Loss)                                          (36,048)          107,923              573,867           702,846
Interest charges                                                 (88,308)          (78,366)            (260,848)         (226,503)
Gain on Houston Exploration transaction                                -                 -              150,070            19,020
Gain (loss) on sale of KeySpan Canada                                  -                 -               22,824           (30,345)
Cost of debt redemption                                          (45,879)                -              (45,879)          (24,094)
Other income and (deductions)                                      4,146            (9,569)             (10,594)          (25,472)
Income taxes (benefit)                                           (50,310)            7,403              166,785           165,714
----------------------------------------------------------------------------------------------------------------------------------
Income (Loss) before change in accounting principle             (115,779)           12,585              262,655           249,738
Cumulative effect of a change
   in accounting principle                                             -                 -                    -               174
----------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss)                                               (115,779)           12,585              262,655           249,912
Preferred stock dividend requirements                              1,360             1,461                4,280             4,383
----------------------------------------------------------------------------------------------------------------------------------
Earnings (Loss) for Common Stock                               $(117,139)        $  11,124            $ 258,375         $ 245,529
----------------------------------------------------------------------------------------------------------------------------------
Basic Earnings per Share
   Income (loss) before change in accounting principle         $   (0.73)        $    0.07            $    1.61         $    1.56
   Change in accounting principle                                      -                 -                    -                 -
----------------------------------------------------------------------------------------------------------------------------------
                                                               $   (0.73)        $    0.07            $    1.61         $    1.56
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       39
<PAGE>


As  indicated in the above  table,  earnings for common stock  reflect a loss of
$117.1  million,  or $0.73 per share,  for the three months ended  September 30,
2004,  compared to earnings of $11.1  million,  or $0.07 per share for the three
months ended  September 30, 2003.  Earnings for common stock for the nine months
ended  September 30, 2004 were $258.4 million,  or $1.61 per share,  compared to
$245.5  million,  or $1.56 per share,  for the  corresponding  period last year.
KeySpan's  financial  results for the three and nine months ended  September 30,
2004 and 2003  reflect  a number  of  events  that had a  significant  impact on
earnings.

In September 2004,  KeySpan recorded a non-cash  goodwill  impairment  charge of
$122.2  million ($90.4 million after - tax or $0.56 per share) as a result of an
evaluation  of the carrying  value of goodwill  recorded in its Energy  Services
segment. As prescribed in Statement of Financial  Accounting  Standards ("SFAS")
142 "Goodwill and Other  Intangible  Assets," KeySpan is required to compare the
fair value of a reporting unit to its carrying amount,  including goodwill. This
evaluation  is required to be  performed  at least  annually,  unless  facts and
circumstances  indicate  that the  evaluation  should be performed at an interim
period  during the year.  Based upon the  results  through  September  30,  2004
experienced by the Energy Services segment and management's  opinion that it was
likely that a significant  portion of the Energy  Services  segment will be sold
within the coming months,  management  concluded that KeySpan was required under
paragraph  28 of SFAS  142 to  evaluate  the  goodwill  recorded  in the  Energy
Services segment.  This evaluation  resulted in the impairment charge. (See Note
12 to the Consolidated  Financial Statements  "Goodwill  Impairment" for further
details on this charge.)

In August 2004,  KeySpan  redeemed  approximately  $758  million of  outstanding
long-term debt. KeySpan incurred $54.5 million in call premiums  associated with
this  redemption,  of which $45.9 was  expensed and recorded in other income and
deductions on the Consolidated  Statement of Income. The remaining amount of the
call premiums have been deferred for future recovery. Further, KeySpan wrote-off
$8.2 million of previously deferred financing costs which have been reflected in
interest  expense on the Consolidated  Statement of Income.  The total after-tax
expense of the debt redemption was $29.3 million or $0.18 per share. (See Note 9
to the Consolidated  Financial Statements  "Long-Term Debt and Commercial Paper"
for  additional  details  on this  transaction.)  During the nine  months  ended
September 30, 2003,  KeySpan  incurred  $24.1 million in debt  redemption  costs
associated  with the  redemption of  approximately  $447 million of  outstanding
promissory notes that were issued to the Long Island Power Authority ("LIPA") in
connection with the  KeySpan/Long  Island Lighting  Company  ("LILCO")  business
combination  completed  in May 1998,  as well as costs  incurred  by The Houston
Exploration  Company ("Houston  Exploration"- our then 55% owned gas exploration
and  production  subsidiary)  to retire $100  million  8.625%  Notes.  The total
after-tax expense of the debt redemptions was $13.6 million or $0.09 per share.

In June 2004,  KeySpan  exchanged  10.8  million  shares of Houston  Exploration
common  stock for 100% of the stock of  Seneca-Upshur  Petroleum,  Inc.,  a then
wholly-owned  subsidiary of Houston  Exploration.  This transaction  reduced our
interest in Houston  Exploration from 55% to approximately 23.5% and resulted in
a  gain  to  KeySpan  of  $150.1  million.   Effective  June  1,  2004,  Houston


                                       40
<PAGE>


Exploration's  earnings and our ownership  interest in Houston  Exploration have
been accounted for on the equity method of accounting.  The  deconsolidation  of
Houston  Exploration  required the recognition of certain  deferred taxes on our
remaining  investment  resulting  in a deferred  tax  expense of $44.1  million.
Therefore,  the net gain on the share  exchange,  less the  deferred  tax on the
remaining investment, was $106.0 million, or $0.66 per share. (See Note 2 to the
Consolidated  Financial Statements "Business Segments" for a detailed discussion
of this transaction.)

On April 1, 2004, KeySpan and KeySpan Facilities Income Fund (the "Fund"), which
previously owned a 39.09% interest in KeySpan Canada (a KeySpan  subsidiary with
natural gas  processing  plants and  gathering  facilities  in Western  Canada),
consummated  a  transaction  whereby the Fund sold 15.617  million  units of the
Fund. The Fund used the proceeds of the offering to acquire an additional 35.91%
interest in KeySpan  Canada from KeySpan.  As a result of the  transaction,  the
Fund's  ownership in KeySpan  Canada  increased  from 39.1% to 75% and KeySpan's
ownership of KeySpan Canada  decreased to 25%.  KeySpan recorded a gain of $22.8
million  ($10.1  million  after-tax,  or $0.06 per  share) on this  transaction.
Effective April 1, 2004, KeySpan Canada's earnings and our ownership interest in
KeySpan Canada have been accounted for on the equity method of accounting.

In July 2004, the Fund issued an additional 10.7 million units,  the proceeds of
which  were used to fund the  acquisition  of the  midstream  assets of  Chevron
Canada  Midstream  Inc.  This  transaction  had the effect of  further  diluting
KeySpan's  ownership of KeySpan Canada to 17.4%. (See Note 2 to the Consolidated
Financial  Statements  "Business  Segments"  for a detailed  discussion  of this
transaction.)

Asset  transactions   completed  in  2003  also  had  a  significant  impact  on
comparative earnings.  These transactions included the monetization of a portion
of our  ownership  interests  in Houston  Exploration  and  KeySpan  Canada.  In
February 2003, we reduced our ownership interest in Houston Exploration from 66%
to approximately 55% following the repurchase,  by Houston  Exploration,  of six
million  shares of common  stock owned by  KeySpan.  We recorded a gain of $19.0
million on this transaction,  or $0.12 per share. Income taxes were not provided
on this  transaction,  since  the  transaction  was  structured  as a return  of
capital.

In June 2003,  we sold 39.09% of our  interest in KeySpan  Canada and recorded a
pre-tax loss of $30.3 million ($34.1 million after applying  applicable taxes or
$0.22 per share).  Additionally,  we sold our 20% interest in Taylor NGL LP that
owned and operated two extraction plants also in Canada.

As a result of these asset  transactions,  net income for the nine months  ended
September  30, 2004,  reflects a combined  after-tax  gain of $116.1  million or
$0.72 per  share.  Net income  for the nine  months  ended  September  30,  2003
reflects after-tax losses of $15.1 million or $0.10 per share.


                                       41
<PAGE>


In  June  2004,   KeySpan's   wholly-owned   gas   exploration   and  production
subsidiaries,  recorded a non-cash  impairment  charge of $48.2  million  ($31.1
million  after-tax,  or $0.19 per share) to recognize  the reduced  valuation of
proved  reserves.  (See Note 10 to the  Consolidated  Financial  Statements "Gas
Exploration and Production  Property - Depletion for additional  details on this
transaction.)

Operating  income,  as indicated in the above table,  decreased $144 million and
$129  million  for  the  three  and  nine  months  ended   September  30,  2004,
respectively,  compared to the corresponding  periods last year. The decrease in
both periods primarily reflects the $122.2 million non-cash goodwill  impairment
charge  recorded in the Energy Services  segment,  and generally lower operating
results of this segment.  Further,  comparative  operating  income was adversely
impacted  by lower  operating  income  from the Energy  Investment  segment as a
result of the reduction in KeySpan's  ownership interest in Houston  Exploration
and KeySpan Canada,  each of which are now accounted for on the equity method of
accounting. In addition, for the nine months ended September 30, 2004, operating
income in the Energy  Investments  segment was  adversely  impacted by the $48.2
million non-cash  impairment charge to recognize the reduced valuation of proved
reserves.  The higher  comparative  operating  income in the  Electric  Services
segment for both the  quarter and period  ending  September  30, 2004  primarily
reflects higher net electric margins  associated with the Ravenswood  Expansion,
(a recently constructed 250 MW combined cycle generating facility located at the
Ravenswood  Facility  site).  In the Gas  Distribution  segment  slightly  lower
operating  losses  for the  third  quarter  of  2004  primarily  reflects  lower
operating  expenses,  while for the nine months ended September 30, 2004 the Gas
Distribution   segment   benefited   from  customer   additions  and  oil-to-gas
conversions throughout our service territories,  as well as from a rate increase
resulting from the Boston Gas Company rate proceeding  concluded last fall. (See
the  discussion  under the caption  "Review of Operating  Segments"  for further
details on each segment.)

The increase in interest expense of $9.9 million,  or 13%, and $34.3 million, or
15% for the  three and nine  months  ended  September  30,  2004,  respectively,
compared to the same  periods  last year,  reflects a number of items.  As noted
earlier, interest expense for both the three and nine months ended September 30,
2004  includes the  write-off of $8.2 million of  previously  deferred  issuance
costs as a result of the  redemption  of $758 million of  outstanding  long-term
debt. In addition,  interest expense in 2004 was impacted by the  implementation
of FASB  Interpretation  No. 46 ("FIN 46"),  "Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51." This Interpretation  required us to,
among other things,  consolidate  the  Ravenswood  Master Lease (the lease under
which  KeySpan  operates  a  portion  of  the  Ravenswood   electric  generating
facilities)  and  classify  the  lease  obligation  as  long-term  debt  on  the
Consolidated  Balance Sheet based on our current status as primary  beneficiary.
As a result of  implementing  FIN 46,  beginning  January 1, 2004 lease payments
have been reflected as interest expense on the Consolidated  Statement of Income
resulting in an increase to interest  expense of $7.6 million and $22.4  million
for the quarter and nine months ended  September  30, 2004,  respectively.  (See
Note 6 "Financial  Guarantees and Contingencies  for further  information on the
Master Lease".)


                                       42
<PAGE>


Further,  comparative  interest  expense for the nine months also  reflects  the
benefits realized in 2003 associated with interest rate swaps. In February 2003,
we  terminated an interest rate swap  agreement  with a notional  amount of $270
million.  This swap was used to hedge a portion of outstanding  promissory notes
that  were  issued  to  LIPA  in  connection  with  the  KeySpan/LILCO  business
combination.  As noted previously,  in March 2003, we called  approximately $447
million  of the  outstanding  promissory  notes,  and  settled  the  outstanding
derivative  instrument.  The cash proceeds from the  termination of the interest
rate hedge were $18.4 million,  of which $8.1 million  represented  accrued swap
interest.  The  difference  between the  termination  settlement  amount and the
amount of accrued swap interest,  $10.3 million, was recorded to earnings (as an
adjustment  to interest  expense) in the first  quarter of 2003 and  effectively
offset a portion of the redemption charges.

Offsetting,  to some  extent,  these  adverse  impacts to  comparative  interest
expense are the benefits associated with a lower level of outstanding commercial
paper  and  long-term  debt,  as well as lower  interest  rates  on  outstanding
commercial paper.

In addition to the asset sales and debt redemption costs previously noted, other
income and  (deductions) for the nine months ended September 30, 2004 reflects a
$12.6  million  gain  recorded  on  the  settlement  of a  derivative  financial
instrument  entered  into in  connection  with  the  sale/leaseback  transaction
associated  with the  Ravenswood  Expansion,  as well as the effects of minority
interest of $37.0  million  related to our  previous  controlling  interests  in
Houston  Exploration  and  KeySpan  Canada.  (See  Note  6  and  Note  4 to  the
Consolidated Financial Statements,  "Financial Guarantees and Contingencies" and
"Hedging and  Derivative  Financial  Instruments,"  for  additional  information
regarding the sale/leaseback transaction and derivative financial instrument.)

Other income and  (deductions) for the nine months ended September 30, 2003 also
includes a $10.6 million  severance tax refund for severance  taxes paid in 2002
and earlier periods. The effects of minority interest of $19.9 million and $50.3
million for the three and nine months ended September 30, 2003 respectively, are
also reflected in other income and (deductions).

Income tax expense  generally  reflects the level of pre-tax income and, for the
nine months ended  September  30,  2004, a $6.0 million  benefit to income taxes
resulting from a revised appraisal associated with property that was disposed of
in 2003.  Further,  income tax expense for the nine months ended  September  30,
2004 reflects the beneficial tax treatment  afforded the stock  transaction with
Houston Exploration.

Consistent with our prior earnings guidance, KeySpan's consolidated earnings for
2004 are  forecasted  to be in the range of $2.55 to $2.75 per share,  excluding
special  items.  Earnings  from  continuing  core  operations  (defined for this
purpose as all continuing operations other than exploration and production, less
preferred  stock  dividends) are forecasted to be in the range of $2.20 to $2.30
per share.  Earnings from gas exploration and production  operations,  excluding
the impact of the gain on the sale of Houston  Exploration and the impact of the
non-cash  impairment charge, are forecasted to be in the range of $0.35 to $0.45
per  share.  The  original  non-core  earnings  forecast   associated  with  gas
exploration and production activities remains in effect, as the favorable impact
of higher  realized gas prices and  production  levels are  offsetting the lower
ownership interest.


                                       43
<PAGE>


It should be noted that KeySpan's board of directors has approved an annual
dividend increase of 4 cents per share, effective upon the declaration of the
February 1, 2005 dividend.

Consolidated earnings are seasonal in nature due to the significant contribution
to earnings of the gas distribution  operations.  As a result, we expect to earn
most of our annual earnings in the first and fourth quarters of the fiscal year.


Review of Operating Segments
----------------------------

KeySpan's segment results are reported on an Operating Income basis.  Management
believes that this Generally Accepted Accounting  Principle (GAAP) based measure
provides a reasonable indication of KeySpan's underlying  performance associated
with its operations. The following is a discussion of financial results achieved
by KeySpan's operating segments presented on an operating income basis.

Gas Distribution

KeySpan Energy Delivery New York ("KEDNY") provides gas distribution  service to
customers in the New York City Boroughs of Brooklyn, Staten Island and a portion
of Queens,  and KeySpan  Energy  Delivery  Long Island  ("KEDLI")  provides  gas
distribution  service to  customers  in the Long  Island  counties of Nassau and
Suffolk and the  Rockaway  Peninsula  of Queens  County.  Four gas  distribution
companies - Boston Gas Company,  Colonial Gas  Company,  Essex Gas Company,  and
EnergyNorth  Natural Gas Inc., each doing business under the name KeySpan Energy
Delivery New England ("KEDNE"), provide gas distribution service to customers in
Massachusetts and New Hampshire.


                                       44
<PAGE>


The table below  highlights  certain  significant  financial  data and operating
statistics for the Gas Distribution segment for the periods indicated.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                   Three Months Ended September 30,               Nine Months Ended September 30,
(In Thousands of Dollars)                           2004                       2003                 2004                    2003
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>                         <C>                <C>                     <C>
Revenues                                        $ 419,208                   $ 405,777          $ 3,023,350             $ 2,970,514
Cost of gas                                       186,619                     173,116            1,776,322               1,744,732
Revenue taxes                                       7,211                      10,191               52,260                  66,077
-----------------------------------------------------------------------------------------------------------------------------------
Net Revenues                                      225,378                     222,470            1,194,768               1,159,705
-----------------------------------------------------------------------------------------------------------------------------------
Operating Expenses
   Operations and maintenance                     148,816                     163,372              489,357                 492,586
   Depreciation and amortization                   63,381                      59,996              207,131                 197,005
   Operating taxes                                 36,808                      38,210              107,190                 112,668
-----------------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses                          249,005                     261,578              803,678                 802,259
-----------------------------------------------------------------------------------------------------------------------------------
Gain on sale of property                                -                      13,974                    -                  13,974
Operating Income                                $ (23,627)                  $ (25,134)         $   391,090             $   371,420
-----------------------------------------------------------------------------------------------------------------------------------
Firm gas sales and transportation (MDTH)           26,576                      26,668              229,360                 238,382
Transportation - Electric Generation (MDTH)        13,304                      15,567               26,077                  29,715
Other Sales (MDTH)                                 30,454                      35,157              111,123                 113,309
Warmer (Colder) than Normal - New York                N/A                         N/A                  (3%)                   (13%)
Warmer (Colder) than Normal - New England             N/A                         N/A                  (9%)                   (17%)
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Net Revenues

Net gas revenues  (revenues less the cost of gas and  associated  revenue taxes)
from our gas distribution  operations increased by $35.1 million, or 3%, for the
nine months ended  September 30, 2004 compared to the same period last year. Net
gas revenues  benefited from customer additions and oil-to-gas  conversions,  as
well as from a rate  increase  resulting  from the  Boston  Gas  Company's  rate
proceeding  that was  concluded  in the fourth  quarter of 2003.  As measured in
heating degree days, weather for the nine months ended September 30, 2004 in our
New York and New England service  territories was approximately 3% and 9% colder
than normal,  respectively,  compared to  approximately  13% and 17% colder than
normal last year,  respectively.  Weather was  approximately 9% warmer than last
year across KeySpan's service territories.

Net revenues from firm gas customers  (residential,  commercial  and  industrial
customers) in our New York service territory increased $4.1 million for the nine
months ended September 30, 2004 compared to the same period last year.  Customer
additions and oil-to-gas conversions,  net of attrition and conservation,  added
$1.8 million to net gas revenues. Further, we realized a $3.5 million benefit to
net gas revenues as a result of an  additional  billing day in the leap year and
$1.6 million associated with regulatory  incentives.  Weather,  which was warmer
than last year, resulted in an adverse impact to comparative net gas revenues of
$3.3 million.  KEDNY and KEDLI each operate under a utility tariff that contains
a weather normalization adjustment that significantly offsets variations in firm
net revenues due to  fluctuations  in normal  weather.  Since weather was colder
than normal we  refunded  to firm  customers  $8.8  million  through the weather
normalization  adjustment.  Also included in net gas revenues is the recovery of
property taxes that added $0.5 million to net revenues during the period.  These
revenues, however, do not impact net income since the taxes they are designed to


                                       45
<PAGE>


recover are expensed as amortization  charges on the  Consolidated  Statement of
Income.  Firm gas  distribution  rates for KEDNY and KEDLI during the first nine
months  of 2004,  other  than  for the  recovery  of gas  costs,  have  remained
substantially unchanged from rates charged last year.

Net  revenues  from firm gas  customers  in our New  England  service  territory
increased by $35.1 million  during the first nine months of 2004 compared to the
same period last year.  Customer  additions and oil-to-gas  conversions,  net of
attrition and conservation,  added $7.9 million to net gas revenues. Further, we
realized a $2.2 million benefit in net gas revenues as a result of an additional
billing  day for leap  year.  As  mentioned,  the  Massachusetts  Department  of
Telecommunications  and Energy  ("MA  DTE")  approved  a $27  million  base rate
increase for the Boston Gas Company,  which became  effective  November 1, 2003.
For the nine months ended  September 30, 2004,  the rate increase  resulted in a
benefit to net gas revenues of $27.3 million. (See the caption under "Regulation
and Rate  Matters" for further  information  regarding the rate filing.) The gas
distribution  operations  of our New England  based  subsidiaries  do not have a
weather  normalization  adjustment.  Weather,  which was warmer  than last year,
resulted in an adverse impact to comparative  net gas revenues of $10.1 million.
To mitigate the effect of  fluctuations  in normal  weather  patterns on KEDNE's
results of operations and cash flows,  weather derivatives were in place for the
2003/2004 winter heating season (November  through March).  Since weather during
the first  quarter of 2004 was  approximately  9% colder  than normal in the New
England service territories, we recorded a $4.1 million reduction to revenues to
reflect  the  loss  on  these  derivative  transactions.  Similarly,  in 2003 we
recorded  an  $11.9  million  reduction  to  revenues.  As  a  result  of  these
transactions,  comparative net revenues were favorably impacted by $7.8 million.
(See Note 4 to the  Consolidated  Financial  Statements  "Hedging and Derivative
Financial Instruments" for further information.)

In our large-volume  heating and other interruptible  (non-firm) markets,  which
include large apartment houses, government buildings and schools, gas service is
provided  under rates that are  designed to compete  with prices of  alternative
fuel,  including No. 2 and No. 6 grade heating oil. These "dual-fuel"  customers
can consume either natural gas or fuel oil for heating purposes. Net revenues in
these markets  decreased $4.1 million during the nine months ended September 30,
2004  compared  to the same  period last year.  The  majority  of  interruptible
profits earned by KEDNE and KEDLI are returned to firm customers as an offset to
gas costs.

We are  committed  to our  expansion  strategies  initiated  during the past few
years. We believe that significant growth opportunities exist on Long Island and
in our New  England  service  territories.  We  estimate  that  on  Long  Island
approximately 36% of the residential and multi-family markets, and approximately
58% of the  commercial  market,  currently  use natural  gas for space  heating.
Further, we estimate that in our New England service  territories  approximately
53% of the residential and multi-family  markets,  and  approximately 63% of the
commercial market, currently use natural gas for space heating purposes. We will
continue to seek growth,  in our market  segments,  through the expansion of our
gas distribution  system, as well as through the conversion of residential homes
from oil-to-gas for space heating  purposes and the pursuit of  opportunities to
grow multi-family, industrial and commercial markets.


                                       46
<PAGE>


Firm Sales, Transportation and Other Quantities

Firm gas sales and transportation quantities for the nine months ended September
30, 2004,  were  approximately  4% lower  compared to such  quantities  for same
period in 2003 reflecting the warmer  weather.  Net revenues are not affected by
customers opting to purchase their gas supply from other sources, since delivery
rates  charged to  transportation  customers  generally are the same as delivery
rates charged to full sales service customers. Transportation quantities related
to  electric  generation  reflect  the  transportation  of gas  to our  electric
generating  facilities  located on Long Island. Net revenues from these services
are not material.

Other sales quantities include on-system  interruptible  quantities,  off-system
sales quantities  (sales made to customers  outside of our service  territories)
and related  transportation.  We have an agreement  with Coral  Resources,  L.P.
("Coral"),  a subsidiary of Shell Oil Company,  under which Coral assists in the
origination, structuring, valuation and execution of energy-related transactions
on behalf of KEDNY and KEDLI. We also have a portfolio  management contract with
Entergy Koch Trading, LP ("EKT"),  under which EKT provides all of the city gate
supply  requirements  at market prices and manages  certain  upstream  capacity,
underground storage and term supply contracts for KEDNE. These agreements expire
on March 31, 2006.

Purchased Gas for Resale

The increase in gas costs for the nine months ended  September 30, 2004 compared
to the same period of 2003 of $31.6 million,  or 2%,  reflects an increase of 8%
in the price per dekatherm of gas  purchased,  and a 5% decrease in the quantity
of gas purchased. The current gas rate structure of each of our gas distribution
utilities includes a gas adjustment clause, pursuant to which variations between
actual  gas costs  incurred  for resale to firm  sales  customers  and gas costs
billed to firm sales  customers  are deferred and refunded to or collected  from
customers in a subsequent period.

Operating Expenses

Operating  expenses  during the third quarter of 2004 decreased $12.6 million or
5%  compared  to the same  quarter  last  year.  This  decrease  reflects  lower
operations and maintenance  expenses of $14.6 million, due in part, to a benefit
of  approximately  $2 million,  net of amounts  subject to  regulatory  deferral
treatment,  associated with the implementation of the Medicare Prescription Drug
Improvement and Modernization Act of 2003 ("Medicare Act") and implementation of
Financial  Accounting  Standards Board Staff Position ("FSP") 106-2. (See Note 5
to the Consolidated Financial Statements "Recent Accounting  Pronouncements" for
further information  regarding the Act and FSP 106-2.) In addition, in September
2004,  Boston Gas Company  reached an agreement  with an  insurance  carrier for
recovery of previously incurred environmental  expenditures.  Under a previously
issued MA DTE rate order, insurance and third-party recoveries,  after deducting
legal  fees,  are shared  between  Boston Gas and its firm gas  customers.  As a


                                       47
<PAGE>


result of the insurance  agreement,  in September  2004 Boston Gas recorded a $5
million benefit to operations and maintenance expense. The remaining decrease in
operations and maintenance  expense  reflects lower costs associated with repair
and maintenance work. Higher depreciation and amortization  expense reflects the
continued expansion of the gas distribution system.

Operating expenses for the nine months ended September 30, 2004 were essentially
the same as last year.  Lower  operations and maintenance  costs of $3.2 million
reflect the environmental  insurance  settlement and the benefit attributable to
the Medicare Act as previously  noted,  as well as lower repair and  maintenance
costs.  These  decreases to operations and maintenance  expense were offset,  in
part, by higher severance costs, as well as a higher provision for uncollectible
accounts  receivable.  Higher depreciation and amortization expense reflects the
continued  expansion of the gas distribution  system,  while the lower operating
taxes resulted from a property tax refund in our New York service territory.

Sale of Property

During  the third  quarter  of 2003,  we  recorded  $14.0  million in gains from
property sales, primarily 550 acres of real property located on Long Island.

Other Matters

In order to serve the  anticipated  market  requirements in our New York service
territories,  KeySpan and Duke Energy  Corporation formed Islander East Pipeline
Company,  LLC ("Islander  East") in 2000.  Islander East is owned 50% by KeySpan
and  50% by Duke  Energy,  and was  created  to  pursue  the  authorization  and
construction  of an  interstate  pipeline from  Connecticut,  across Long Island
Sound, to a terminus near Shoreham, Long Island.  Applications for all necessary
regulatory  authorizations  were  filed  in 2000  and  2001.  Islander  East has
received a final  certificate  from the  Federal  Energy  Regulatory  Commission
("FERC")  and all  necessary  permits  from the State of New York.  The State of
Connecticut denied Islander East's  applications for coastal zone management and
Section 401 of the Clean Water Act  authorizations.  Islander  East appealed the
State of Connecticut's determination on the coastal zone management issue to the
United States Department of Commerce. On May 6, 2004, the Department of Commerce
overrode   Connecticut's   denial  and  granted  the  coastal  zone   management
authorization.  Islander East's petition for a declaratory order challenging the
denial of the Section 401  authorization  is pending  with  Connecticut's  State
Superior  Court.  Once in service,  the  pipeline is expected to transport up to
260,000 DTH daily to the Long Island and New York City  energy  markets,  enough
natural gas to heat  600,000  homes.  The  pipeline  will also allow  KeySpan to
diversify  the  geographic  sources of its gas supply.  Various  options for the
financing of this  pipeline  construction  are  currently  being  evaluated.  At
September  30, 2004,  our  investment  in the Islander  East  pipeline was $19.1
million.


                                       48
<PAGE>


Electric Services

The Electric  Services segment  primarily  consists of subsidiaries that own and
operate oil and gas-fired  electric  generating  plants in the Borough of Queens
(including the "Ravenswood  Projects") and the counties of Nassau and Suffolk on
Long Island.  In addition,  through long-term  contracts of varying lengths,  we
manage the electric  transmission and distribution  ("T&D") system, the fuel and
electric  purchases,  and the  off-system  electric sales for LIPA. The Electric
Services  segment also provides  retail  marketing of  electricity to commercial
customers, the earnings of which were previously reported in the Energy Services
segment.  Financial  results for 2003 have been  reclassified  to reflect  these
activities in the Electric Services segment.

Selected  financial data for the Electric  Services  segment is set forth in the
table below for the periods indicated.

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                         Three Months Ended September 30,                 Nine Months Ended September 30,
(In Thousands of Dollars)                    2004                    2003                  2004                    2003
---------------------------------------------------------------------------------------------------------------------------
<S>                                     <C>                     <C>                    <C>                     <C>
Revenues                                $  503,879             $   438,602            $ 1,296,778              $ 1,228,698
Purchased fuel                             175,906                 132,520                407,613                  381,116
---------------------------------------------------------------------------------------------------------------------------
Net Revenues                               327,973                 306,082                889,165                  847,582
---------------------------------------------------------------------------------------------------------------------------
Operating Expenses
   Operations and maintenance              153,712                 151,678                472,880                  495,873
   Depreciation                             21,590                  16,492                 65,556                   49,300
   Operating taxes                          41,513                  35,787                124,456                  108,540
---------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses                   216,815                 203,957                662,892                  653,713
---------------------------------------------------------------------------------------------------------------------------
Operating Income                        $  111,158             $   102,125            $   226,273              $   193,869
---------------------------------------------------------------------------------------------------------------------------
Electric sales (MWH)*                    2,177,030               1,854,740              4,807,667                3,617,522
Capacity(MW)*                                2,450                   2,200                  2,450                    2,200
Cooling degree days                            751                     824                  1,051                    1,000
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
     *Reflects the operations of the Ravenswood Projects only.


Net Revenues

Total electric net revenues realized during the third quarter of 2004 were $21.9
million,  or 7% higher than such revenues  realized  during the third quarter of
2003. For the nine months ended September 30, 2004,  total electric net revenues
were $41.7 million, or 5% higher than the same period last year. The increase in
both the quarter and nine months ended  September 30, 2004, is  attributable  to
the operations of the Ravenswood Expansion.

Net revenues from the Ravenswood Projects increased $14.2 million, or 13% in the
third  quarter of 2004 compared to the third  quarter of 2003.  Comparative  net
revenues  reflect  increased  energy margins of $6.4 million,  as well as higher
capacity revenues of $7.8 million.


                                       49
<PAGE>


For the nine months ended  September 30, 2004,  net revenues from the Ravenswood
Projects  reflect a $38.3  million,  or 16%  increase  over the same period last
year.  Comparative  net  revenues  reflect  increased  energy  margins  of $26.3
million, as well as higher capacity revenues of $12.0 million.

The  increase  in  capacity  revenues  for both the  quarter  and period  ending
September 30, 2004  compared to the  corresponding  periods last year  primarily
reflect the operations of the Ravenswood  Expansion.  (See the discussion  below
under "Other Matters" for a description of the Ravenswood Expansion.)

The  increase in energy  margins  for both the  quarter  and nine  months  ended
September 30, 2004,  reflects a higher level of megawatt hours ("MWh") sold into
the  New  York  Independent  System  Operator  ("NYISO")  energy  market,  while
"spark-spreads"  (the selling price of electricity  less the cost of fuel,  plus
hedging gains or losses) remained essentially  constant.  The increase in energy
sales  quantities  reflects  the  operations  of the  Ravenswood  Expansion.  As
measured in cooling  degree-days,  weather  during the third quarter of 2004 was
approximately  9% cooler than the same quarter last year and  approximately  11%
cooler than normal.  For the nine months ended  September 30, 2004,  weather was
approximately  5% warmer  compared to the same period in 2003.  Further,  energy
sales  quantities  for the nine months ended  September 30, 2003 were  adversely
impacted by the scheduled major overhaul of our largest electric generating unit
during the first quarter of 2003.

We  employ  derivative  financial  hedging  instruments  to hedge  the cash flow
variability  for a portion of  forecasted  purchases of natural gas and fuel oil
consumed at the  Ravenswood  Projects.  Further,  we have  engaged in the use of
derivative  financial  hedging  instruments  to hedge the cash flow  variability
associated  with a portion of  forecasted  peak  electric  energy sales from the
Ravenswood  Projects.  These derivative  instruments  resulted in hedging gains,
which are  reflected in net electric  margins,  of $21.4 million for the quarter
ended  September  30,  2004,  compared to hedging  gains of $8.5 million for the
quarter ended  September 30, 2003. For the nine months ended  September 30, 2004
derivative  instruments  resulted in net hedging gains of $18.7 million compared
to hedging  gains of $10.3  million  for the same period in 2003.  The  benefits
derived from KeySpan's hedging strategy contributed to consistent  spark-spreads
for  all  periods  reported  despite  the  cooler  weather.  (See  Note 4 to the
Consolidated Financial Statements "Hedging and Derivative Financial Instruments"
as well as Item 3.  Quantitative and Qualitative  Disclosures  about Market Risk
for further information").

The rules and  regulations  for  capacity,  energy sales and the sale of certain
ancillary  services to the NYISO energy markets  continue to evolve and the FERC
has adopted  several  price  mitigation  measures that have  adversely  impacted
earnings from the Ravenswood Facility over time and more recently the Ravenswood
Expansion.  Certain of these mitigation  measures are still subject to rehearing
and possible  judicial  review.  The final  resolution of these issues and their
effect on our financial position, results of operations and cash flows cannot be
fully  determined  at this  time.  (See the  caption  "Market  and  Credit  Risk
Management  Activities"  for a further  discussion  of these  matters.  Also see
KeySpan's  2003 Annual Report on Form 10-K for the Year Ended  December 31, 2003
Item 7. Management's  Discussion and Analysis of Financial Condition and Results
of Operations under the caption "Market and Credit Risk Management Activities.)


                                       50
<PAGE>


Net revenues from the service agreements with LIPA, including the power purchase
agreements  associated  with two electric  peaking  facilities,  increased  $9.1
million for the three months  ended  September  30,  2004,  compared to the same
period  last  year.  This  increase  reflects,  in part,  recovery  from LIPA of
approximately  $6 million in higher  property  taxes and  depreciation  charges.
These  recoveries had no impact on operating  income since actual property taxes
and depreciation  charges increased by a like amount.  The remaining increase of
approximately $3 million in comparative  revenues reflects the beneficial impact
from the timing of certain  cost  recoveries,  partially  offset by lower energy
margins that are shared with LIPA. This variation does impact operating income.

Net revenues from the service agreements with LIPA, including the power purchase
agreements  associated  with two electric  peaking  facilities,  increased  $5.3
million for the nine  months  ended  September  30,  2004,  compared to the same
period  last  year.  This  increase  reflects,  in part,  recovery  from LIPA of
approximately $18 million in higher property taxes and depreciation  charges. As
mentioned,  these  recoveries  had no impact on  operating  income  since actual
property taxes and  depreciation  charges  increased by a like amount.  Further,
comparative  revenues reflect  adjustments to the cost recovery mechanism in the
LIPA Service  Agreements to better align actual costs  incurred with recovery of
such costs.  These  adjustments  reduced  revenues  during the nine months ended
September 30, 2004 by approximately $12 million compared to the same period last
year.  These  adjustments  to revenues had no impact on  operating  income since
actual  operating costs  decreased by a like amount.  Excluding these two items,
net revenues from the service agreements with LIPA decreased  approximately $0.7
million for the nine  months  ended  September  30,  2004,  compared to the same
period last year.  The slight  reduction in net revenues  reflects  lower energy
margins  that are shared  with LIPA,  offset by the  beneficial  impact from the
timing of certain cost recoveries.

For a description of the LIPA Service Agreements and power purchase  agreements,
see KeySpan's  2003 Annual  Report on Form 10-K for the Year Ended  December 31,
2003 Item 7.  Management's  Discussion  and Analysis of Financial  Condition and
Results  of  Operations   under  the  caption   "Electric   Services  -  Revenue
Mechanisms.")

Operating Expenses

Operating expenses increased $12.9 million,  or 6%, in the third quarter of 2004
compared to the same quarter of 2003. The increase in operations and maintenance
expense  of  $2.0  million  primarily  reflects  lease  costs  of  $4.5  million
associated  with  the  sale/leaseback   transaction   involving  the  Ravenswood
Expansion  that went into effect May 2004,  as well as an increase in repair and
maintenance  cost,  including  removal  costs,  associated  with the  Ravenswood
Projects.  These expenses were partially offset by KeySpan's  implementation  of
FIN 46 which  required  KeySpan to consolidate  the Ravenswood  Master Lease and
classify the lease  obligation  as long-term  debt on the  Consolidated  Balance
Sheet.  Further, an asset was recorded on the Consolidated  Balance Sheet for an
amount  substantially equal to the fair market value of the leased assets at the
inception  of the lease,  less  depreciation  since  that  date.  As a result of
implementing FIN 46, beginning  January 1, 2004, lease payments  associated with


                                       51
<PAGE>


the  Ravenswood  Master  Lease have been  reflected  as interest  expense on the
Consolidated  Statement of Income and the leased  assets are being  depreciated.
The  reclassification  of lease  payments  to  interest  expense  resulted  in a
comparative decrease to operations and maintenance expense of $7.6 million. (See
Note  6 to the  Consolidated  Financial  Statements  "Financial  Guarantees  and
Contingencies"   for  additional   information   regarding   KeySpan's   leasing
arrangements.)

The increase in depreciation  expense of $5.1 million  primarily  relates to the
depreciation  of the leased  assets  under the  Ravenswood  Master  Lease  which
increased  depreciation by $4.1 million.  The remaining increase in depreciation
expense is associated with KeySpan's Long Island based electric generating units
and are fully  recoverable  from LIPA.  The  higher  operating  taxes  primarily
reflect an increase in property taxes which are fully  recoverable  from LIPA as
noted earlier.

Operating expenses  increased $9.2 million,  or 1%, during the nine months ended
September 30, 2004  compared to the same period of 2003 due to higher  operating
taxes  and  depreciation  charges,  partially  offset  by lower  operations  and
maintenance expenses. Operations and maintenance expense decreased $23.0 million
reflecting, in part, $12 million in lower costs associated with the LIPA Service
Agreements  as  noted  earlier.   The  remaining   decrease  in  operations  and
maintenance   expense   is   primarily   due  to  the  impact  of  FIN  46.  The
reclassification  of lease payments  associated with the Ravenswood Master Lease
to  interest  expense  resulted in a  comparative  decrease  to  operations  and
maintenance expense of $22.4 million.  However,  KeySpan incurred lease costs of
$6.0  million  associated  with the  sale/leaseback  transaction  involving  the
Ravenswood  Expansion  as  well  as  increased  repair  and  maintenance  costs,
including  removal  costs,  associated  with  the  Ravenswood  Projects,   which
partially offset the beneficial impact of FIN 46.

The increase in depreciation  expense of $16.3 million  primarily relates to the
depreciation  of the leased  assets  under the  Ravenswood  Master  Lease  which
increased  depreciation by $12.3 million. The remaining increase in depreciation
expense is associated with KeySpan's Long Island based electric generating units
and are fully  recoverable  from LIPA.  The  higher  operating  taxes  primarily
reflect an increase in property taxes which are fully  recoverable from LIPA, as
noted earlier.

Other Matters

The Ravenswood  Expansion,  a 250 MW combined  cycle  generating  facility,  was
synchronized  to the electric grid in December  2003 and  commenced  operational
testing in January 2004. In March,  the facility  completed full load Dependable
Maximum Net Capacity  testing and in May 2004 the facility began full commercial
operations.  The entire  capacity and energy  produced  from this plant is being
sold into the NYISO markets.

To finance  this  facility,  KeySpan  entered into a leveraged  lease  financing
arrangement.  In May  2004,  the  facility  was  acquired  by a lessor  from our
subsidiary,  KeySpan Ravenswood,  LLC, and simultaneously leased back to it. All
the  obligations  of our  subsidiary  under the lease have been  unconditionally
guaranteed by KeySpan.  This lease  transaction  generated cash proceeds of $385


                                       52
<PAGE>


million,  before  transaction costs, which approximates the fair market value of
the facility, as determined by a third-party appraiser. The lease has an initial
term of 36 years and the yearly  operating  lease expense will be  approximately
$17 million per year.  Lease  payments will fluctuate from year to year, but are
substantially  paid  over the first 16  years.  (See Note 6 to the  Consolidated
Financial  Statements,  "Financial  Guarantees and Contingencies" for additional
information regarding this financing arrangement.)

In 2003,  the New  York  State  Board  on  Electric  Generation  Siting  and the
Environment  issued  an  opinion  and  order  which  granted  a  certificate  of
environmental  capability  and public need for a 250 MW combined  cycle electric
generating  facility  in  Melville,   Long  Island,   which  is  now  final  and
non-appealable. Also in 2003, LIPA issued a Request for Proposal ("RFP") seeking
bids from  developers  to  either  build and  operate a Long  Island  generating
facility,  and/or a new cable that will link Long Island to  dedicated  off-Long
Island power of between 250 to 600 MW of electricity by no later than the summer
of 2007. KeySpan and American National Power Inc. ("ANP") filed a joint proposal
in  response  to LIPA's  RFP.  Under the  proposal,  KeySpan  and ANP would have
jointly  owned and  operated  two 250 MW electric  generating  facilities  to be
located on Long Island,  one of which is the Melville  site and the other in the
town of  Brookhaven  which also has received all permits and  approvals.  In May
2004,  LIPA  tentatively  selected  proposals  submitted by two other bidders in
response to the RFP.  KeySpan remains  committed to the Melville project and the
benefits to Long Island's energy future that this project would supply.  We will
continue to explore specific  options for this facility.  At September 30, 2004,
total capitalized  costs associated with the siting,  permitting and procurement
of equipment for the Melville facility were approximately $58.1 million.  Energy
Services

The Energy Services segment includes  subsidiaries  that provide  energy-related
services to customers  primarily located within the Northeastern  United States,
with concentrations in the New York City metropolitan area including New Jersey,
as well as Rhode Island, Pennsylvania,  Massachusetts and New Hampshire, through
the  following  lines of  business:  (i) Home Energy  Services,  which  provides
residential  and small  commercial  customers  with service and  maintenance  of
energy systems and appliances; (ii) Business Solutions, which provides plumbing,
heating,  ventilation,  air  conditioning  and mechanical  services,  as well as
operation  and  maintenance,  design,  engineering  and  consulting  services to
commercial and industrial customers.

The  table  below  highlights  selected  financial  information  for the  Energy
Services segment.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------------
                                             Three Months Ended September 30,                  Nine Months Ended September 30,
(In Thousands of Dollars)                     2004                        2003                 2004                      2003
--------------------------------------------------------------------------------------------------------------------------------
<S>                                        <C>                         <C>                  <C>                       <C>
Revenues                                  $  125,752                   $ 139,887           $  392,271                 $ 404,188
Less: cost of sales                          112,754                     118,807              325,385                   334,257
--------------------------------------------------------------------------------------------------------------------------------
Gross profit                                  12,998                      21,080               66,886                    69,931
Operating expenses                           (33,745)                    (36,578)            (111,013)                 (105,014)
Goodwill impairment charge                  (122,229)                          -             (122,229)                        -
--------------------------------------------------------------------------------------------------------------------------------
Operating (Loss)                          $ (142,976)                  $ (15,498)          $ (166,356)                $ (35,083)
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       53
<PAGE>


The Energy Services  segment  incurred  operating losses of $143 million for the
third  quarter of 2004  compared to losses of $15.5 million for the same quarter
last year.  For the nine months ended  September 30, 2004,  the Energy  Services
segment  realized  operating  losses of $166.4 million compared to $35.1 million
for the same period last year.  As noted  earlier,  in September  2004,  KeySpan
recorded a non-cash goodwill  impairment charge of $122.2 million ($90.4 million
after - tax or $0.56 per  share) as a result of an  evaluation  of the  carrying
value of goodwill  recorded in this segment.  Based upon the  operating  results
experienced in this segment through September 30, 2004, excluding the impairment
charge, and management's  opinion that it was likely that a significant  portion
of the Energy Services segment will be sold within the coming months, management
concluded  that  KeySpan was  required to evaluate  the goodwill at this interim
period.  This  evaluation  resulted in the  aforementioned  non-cash  impairment
charge. Approximately $50 million of goodwill remains in this segment. (See Note
12 to the Consolidated  Financial Statements  "Goodwill  Impairment" for further
details on this charge.)

Lower  operating  results for the three months ended September 30, 2004 compared
to the same  quarter  last  year,  excluding  the  goodwill  impairment  charge,
reflects  lower gross  profit  margin  estimates on certain  Business  Solutions
projects.  Lower operating  results for the nine months ended September 30, 2004
compared to the same period last year, excluding the goodwill impairment charge,
was due to  higher  operating  expenses.  The  increase  in  operating  expenses
principally  reflects the write-off of accounts receivable and contract revenues
on  certain  projects  that  were  deemed  to be  uncollectible,  as well as the
write-down of inventory balances.  Further,  gross margin  profitability in this
segment was adversely  impacted by increased cost estimates on certain  Business
Solutions projects.

Energy Investments

The Energy  Investment  segment  consists of our gas  exploration and production
operations,  as well as certain other domestic and international  energy-related
investments.  Our  gas  exploration  and  production  subsidiaries  include  our
approximate  23.5%  ownership  interest  in  The  Houston   Exploration  Company
("Houston  Exploration"),  as  well  as our  wholly-owned  subsidiaries  KeySpan
Exploration  and  Production  LLC ("KeySpan  Exploration  and  Production")  and
Seneca-Upshur  Petroleum,  Inc.  These  companies  are  engaged  in gas  and oil
exploration  and  production,  and the  development  and acquisition of domestic
natural gas and oil properties.

As mentioned  earlier,  in June 2004,  KeySpan  exchanged 10.8 million shares of
Houston  Exploration  common  stock  for  100%  of the  stock  of  Seneca-Upshur
Petroleum,  Inc., then a wholly owned  subsidiary of Houston  Exploration.  This
transaction  reduced our interest in Houston Exploration from 55% to the current
level of 23.5%. As part of this transaction,  Houston  Exploration,  retired 4.6
million of its common  shares  and  issued  6.8  million  new shares in a public
offering.  Based on Houston Exploration's announced offering price of $48.00 per
share,  Seneca-Upshur's shares were valued at the equivalent of $449 million, or
$41.57 per share.  Seneca-Upshur's  assets consisted of West Virginia  producing
properties  valued at $60 million,  and $389 million in cash.  This  transaction


                                       54
<PAGE>


resulted in a gain to KeySpan of $150.1 million. Effective June 1, 2004, Houston
Exploration's  earnings and our ownership  interest in Houston  Exploration have
been accounted for on the equity method of accounting.  The  deconsolidation  of
Houston  Exploration  required the recognition of certain  deferred taxes on our
remaining  investment  resulting  in a deferred  tax  expense of $44.1  million.
Therefore,  the net gain on the share exchange,  less the deferred tax provision
on the remaining investment, was $106.0 million, or $0.66 per share.

Selected  financial data and operating  statistics for our gas  exploration  and
production  activities  are set forth in the  following  table  for the  periods
indicated.  Operating  income below  represents  100% of our gas exploration and
production subsidiaries' results for the five months ended May 31, 2004 and four
month of equity earnings for our 23.5% interest in Houston Exploration.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                       Three Months Ended September 30,           Nine Months Ended September 30,
(In Thousands of Dollars)                                2004                    2003             2004                      2003
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>                    <C>               <C>                       <C>
Revenues                                             $  4,975                $ 123,052         $ 276,320                 $ 373,774
Less: Depletion and amortization expense                1,279                   48,641           107,738                   145,559
         Full cost ceiling test write-down                  -                        -            48,190                         -
         Other operating expenses                       1,704                   23,416            47,449                    71,482
Plus: Equity earnings                                  10,340                        -            12,885                         -
-----------------------------------------------------------------------------------------------------------------------------------
Operating Income                                     $ 12,332                $  50,995         $  85,828                 $ 156,733
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The decline in  operating  income of $38.7  million for the three  months  ended
September  30, 2004 and $70.9  million for the nine months ended  September  30,
2004,  compared to the corresponding  periods in 2003, reflects the reduction in
KeySpan's  ownership interest in Houston  Exploration.  As mentioned earlier, in
2003 KeySpan maintained a 55% ownership interest in Houston Exploration compared
to an approximate 23.5% interest since June 2, 2004.  Further,  the reduction in
operating income for the nine months ended September 30, 2004 reflects the $48.2
million  non-cash  impairment  charge  recorded by  KeySpan's  wholly-owned  gas
exploration  and  production  subsidiaries  to reflect the reduced  valuation of
proved  reserves.  (See Note 10 to the  Consolidated  Financial  Statements "Gas
Exploration  and  Production  Property - Depletion"  for further  details on the
impairment charge.)

Seneca-Upshur utilizes over-the-counter ("OTC") natural gas index swaps to hedge
the cash flow  variability  associated with forecasted sales of a portion of its
natural gas production. At September 30, 2004, Seneca-Upshur has hedge positions
in place for approximately  85% of its estimated  remaining 2004 gas production,
net of gathering  related costs.  Further,  Seneca-Upshur has hedge positions in
place for  approximately  85% of its estimated 2005 through 2007 gas production,
net of  gathering  costs.  We use  forward  index  prices  to value  these  swap
positions.  (See Note 4 to the Consolidated  Financial  Statements  "Hedging and
Derivative  Financial   Instruments"  for  further  details  on  the  derivative
financial instruments.)

This segment also consists of KeySpan  Canada;  our 20% interest in Iroquois Gas
Transmission System LP ("Iroquois");  our wholly-owned  600,000 barrel liquefied
natural  gas ("LNG")  storage and  receiving  facility  located in Rhode  Island
("KeySpan LNG"); and our 50% interest in Premier Transmission Limited located in
Northern  Ireland.  In addition  this  segment has  ownership  interests  in two
proposed gas pipelines.


                                       55
<PAGE>


In April 2004,  KeySpan and KeySpan  Facilities  Income Fund,  which  previously
owned  a  39.09%  interest  in  KeySpan  Canada,  (the  "Fund")  entered  into a
transaction whereby the Fund sold 15.617 million units of the Fund at a price of
CDN$12.60 per unit for gross total proceeds of approximately  CDN$196.8 million.
The  proceeds  of the  offering  were used by the Fund to acquire an  additional
35.91%  interest  in  KeySpan  Canada (a KeySpan  subsidiary  with  natural  gas
processing plants and gathering  facilities in Western Canada) from KeySpan.  We
received  net  proceeds of  approximately  CDN$186.3  million (or  approximately
US$135 million),  after commissions and expenses. As a result of the transaction
the Fund's  ownership  in KeySpan  Canada  was  increased  from 39.1% to 75% and
KeySpan's  ownership of KeySpan Canada decreased to 25%. KeySpan recorded a gain
of  $22.8  million  ($10.1  million  after-tax,  or  $0.06  per  share)  on this
transaction.  Effective  April  1,  2004,  KeySpan  Canada's  earnings  and  our
ownership  interest  in KeySpan  Canada  have been  accounted  for on the equity
method of accounting.

In July 2004, the Fund issued an additional 10.7 million units,  the proceeds of
which  were used to fund the  acquisition  of the  midstream  assets of  Chevron
Canada  Midstream  Inc.  This  transaction  had the effect of  further  diluting
KeySpan's ownership of KeySpan Canada to 17.4%.

Selected  financial  data and  operating  statistics  for  these  energy-related
investments  are set forth in the  following  table for the  periods  indicated.
Operating  income below  represents 100% of KeySpan  Canada's  results for three
months ended March 31, 2004 and six months of equity earnings since April 2004.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                       Three Months Ended September 30,            Nine Months Ended September 30,
(In Thousands of Dollars)                                 2004                    2003               2004                    2003
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>                    <C>                <C>                     <C>
Revenues                                                $ 5,066                $ 27,699           $ 41,631                $ 84,043
Less:  Operation and maintenance expense                  5,498                  16,709             28,077                  52,743
          Other operating expenses                        1,339                   5,708              8,538                  16,471
Plus:  Equity earnings                                    5,873                   2,727             17,457                  12,378
-----------------------------------------------------------------------------------------------------------------------------------
Operating Income                                        $ 4,102                $  8,009           $ 22,473                $ 27,207
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The  decrease  in  comparative  operating  income for both the  quarter and nine
months ended  September 30, 2004 compared to same periods last year reflects our
lower  ownership  interest in KeySpan  Canada.  Operating  income from our other
energy-related investments in 2004 was substantially the same as 2003.

We have  stated in the past that we may sell or  otherwise  dispose  of  certain
Energy  Investments  assets.  Based on current market  conditions,  however,  we
cannot predict when, or if, additional sales or dispositions of these assets may
take place,  or the effect that any such additional sale or disposition may have
on our financial position, results of operations or cash flows.


                                       56
<PAGE>


Allocated Costs

We are subject to the  jurisdiction  of the Securities  and Exchange  Commission
("SEC") under the Public Utility  Holding  Company Act ("PUHCA") as amended.  As
part  of  the  regulatory   provisions  of  PUHCA,  the  SEC  regulates  various
transactions  among  affiliates  within a holding company system.  In accordance
with the SEC's  regulations  under PUHCA and the New York State  Public  Service
Commission,  we have service companies that provide:  (i) traditional  corporate
and administrative services; (ii) gas and electric transmission and distribution
systems planning,  marketing, and gas supply planning and procurement; and (iii)
engineering and surveying services to subsidiaries.  Operating income variations
reflected  in  "eliminations  and other"  associated  with  these  non-operating
subsidiaries  reflect,  in part,  allocation  adjustments  recorded in 2003.  As
required  by the SEC,  during  the third  quarter  of 2003 we  adjusted  certain
provisions in our  allocation  methodology  that resulted in certain costs being
allocated back to certain non-operating subsidiaries.  Further, operating income
variations are also due to the timing of certain corporate allocations.

Liquidity

Cash flow from operating activities increased $24.7 million, or 3%, for the nine
months ended September 30, 2004 compared to the same time last year,  reflecting
the consolidation our newly created "captive" insurance company,  which included
$43.2 million of cash and short-term  marketable  securities.  Comparative  cash
flow from operating  activities also reflects the favorable impact of the timing
of certain property tax payments, offset by lower cash flow from gas exploration
and production activities due to the lower ownership interest.

KeySpan  currently has funds invested  outside the United  States.  We intend to
repatriate approximately $200 million as a result of the passage, on October 26,
2004, of the American Jobs Creation Act of 2004. A significant provision of this
Act as it  relates  to  KeySpan  is the 85%  dividend  deduction  for  dividends
received   from   foreign   corporations.   The  Act  will   allow   KeySpan  to
tax-effectively bring these funds back into the United States.

At September  30, 2004,  we had cash and temporary  cash  investments  of $361.3
million.  During the nine months ended  September  30, 2004,  we borrowed  $93.5
million of  commercial  paper and, at  September  30,  2004,  $575.4  million of
commercial paper was outstanding at a weighted-average  annualized interest rate
of 1.9%.  We had the  ability  to borrow up to an  additional  $725  million  at
September 30, 2004, under the terms of our credit facility.

In June 2004, KeySpan completed the restructuring of its credit  facilities.  We
entered into a new $640 million five year revolving  credit  facility to replace
the $450  million,  364 day facility  which expired in June. We also amended our
existing  three year $850 million  facility due June 2006 to reduce  commitments
thereunder  by $190  million  to a new  level of $660  million.  The two  credit
facilities total $1.3 billion and are each syndicated among sixteen banks. These
facilities  continue to support  KeySpan's  commercial paper program for working
capital needs.


                                       57
<PAGE>


The fees for these  facilities  are  subject to a  ratings-based  grid,  with an
annual fee of 0.08% on the new  five-year  facility  and 0.125% on the  existing
three-year  facility.  Both credit  agreements allow for KeySpan to borrow using
several different types of loans;  specifically,  Eurodollar  loans,  Adjustable
Bank Rate (ABR)  loans,  or  competitively  bid loans.  Eurodollar  loans in the
five-year  facility are based on the Eurodollar  rate plus a margin of 0.40% for
loans up to 33% of the total five-year  facility,  and an additional  0.125% for
loans  over 33% of the total  five-year  facility.  In the  three-year  facility
Eurodollar  loans are based on the  Eurodollar  rate plus a margin of 0.625% for
loans up to 33% of the total three-year  facility,  and an additional 0.125% for
loans  over 33% of the  total  three-year  facility.  ABR loans are based on the
highest  of the  Prime  Rate,  the base CD rate plus 1%,  or the  Federal  Funds
Effective  Rate plus  0.5%.  Competitive  bid  loans  are  based on bid  results
requested by KeySpan from the lenders.  We do not anticipate  borrowing  against
these facilities;  however, if the credit rating on our commercial paper program
were to be downgraded, it may be necessary to do so.

The facilities  contain certain  affirmative and negative  operating  covenants,
including  restrictions on KeySpan's  ability to mortgage,  pledge,  encumber or
otherwise  subject  its  property  to any  lien,  as well as  certain  financial
covenants  that  require us to,  among  other  things,  maintain a  consolidated
indebtedness to consolidated  capitalization ratio of no more than 64% until the
expiration of the existing three-year facility in 2006, at which time it will be
lowered to 62%.  Violation of this covenant  could result in the  termination of
the facilities and the required  repayment of amounts  borrowed  thereunder,  as
well as possible cross defaults under other debt agreements.

Under the terms of the credit agreements, KeySpan's debt-to-total capitalization
ratio  reflects  80% equity  treatment  for the MEDS Equity  Units issued in May
2002. At September 30, 2004, consolidated indebtedness,  as calculated under the
terms of the credit agreements was 52.6% of consolidated capitalization.

Houston  Exploration  and KeySpan Canada also have revolving  credit  facilities
with commercial banks. During the time period that Houston Exploration's results
were  consolidated  with  KeySpan's (the five months ended May 31, 2004) Houston
Exploration  borrowed  $49  million  under its credit  facility  and repaid $136
million. KeySpan Canada repaid $17.7 million under its facility during the first
three  months of 2004 (the time  period in which its results  were  consolidated
with   KeySpan's).   These   borrowings  and  repayments  are  included  in  the
Consolidated  Cash Flow Statement.  Cash borrowings and repayments under Houston
Exploration's and KeySpan Canada's credit facilities after the date of the stock
transactions are not reflected in the Consolidated Cash Flow Statement.

A substantial  portion of consolidated  revenues are derived from the operations
of businesses within the Electric  Services segment,  that are largely dependent
upon two  large  customers  - LIPA and the  NYISO.  Additionally,  our KEDNE gas
supply is concentrated with Entergy-Koch  Trading.  Accordingly,  our cash flows
are dependent  upon the timely  payment or delivery of amounts or commodity owed
to us by these counterparties.


                                       58
<PAGE>


We  satisfy  our  seasonal  working  capital   requirements   primarily  through
internally generated funds and the issuance of commercial paper. We believe that
these  sources of funds are  sufficient  to meet our  seasonal  working  capital
needs.

Capital Expenditures and Financing

Construction Expenditures

The table below sets forth our construction expenditures by operating segment
for the periods indicated:

-----------------------------------------------------------------------------
                                          Nine Months Ended September 30,
(In Thousands of Dollars)              2004                            2003
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
Gas Distribution                    $ 295,995                      $ 274,702
Electric Services                     104,443                        200,425
Energy Investments                    150,586                        235,322
Energy Services and other              12,183                          9,768
-----------------------------------------------------------------------------
                                    $ 563,207                      $ 720,217
-----------------------------------------------------------------------------


Construction  expenditures related to the Gas Distribution segment are primarily
for  the  renewal,   replacement  and  expansion  of  the  distribution  system.
Construction  expenditures for the Electric  Services segment reflect costs: (i)
to  maintain  our  generating  facilities;  and (ii)  construct  the  Ravenswood
Expansion.  Construction  expenditures related to the Energy Investments segment
primarily   reflect  costs   associated  with  gas  exploration  and  production
activities, including those of Houston Exploration through May 31, 2004, as well
as costs related to KeySpan Canada's gas processing  facilities through April 1,
2004.

Financing

In August 2004, KeySpan redeemed approximately $758 million of outstanding debt.
KeySpan incurred $54.5 million in call premiums associated with this redemption,
of which $45.9 million was expensed and recorded in other income and  deductions
on the Consolidated  Statement of Income.  The remaining call premiums have been
deferred  for  future  recovery.  Further,  KeySpan  wrote-off  $8.2  million of
previously  deferred  financing  costs  which have been  reflected  in  interest
expense on the Consolidated Statement of Income. (See Note 9 to the Consolidated
Financial Statements "Long-Term Debt and Commercial Paper for additional details
of this transaction.)

Also during the third quarter of 2003, KEDNY retired a portion, $8.0 million, of
its outstanding Gas Facilities Revenue Bonds. The funds used to retire this debt
were drawn from a special deposit  defeasance  trust  previously  established by
KEDNY.  Approximately  $640  million  of Gas  Facilities  Revenue  Bonds  remain
outstanding.


                                       59
<PAGE>


In August 2004, KeySpan redeemed 83,268 shares of preferred stock 6.00% Series A
par value  $100  that were  previously  issued in a private  placement.  KeySpan
redeemed  these shares at a 2% premium and incurred a cash  expenditure  of $8.5
million.

During the second  quarter  of 2004,  KeySpan  entered  into a  leveraged  lease
financing arrangement associated with the Ravenswood Expansion. In May 2004, the
facility was acquired by a lessor from our subsidiary,  KeySpan Ravenswood, LLC,
and simultaneously leased back to that subsidiary. All of the obligations of our
subsidiary under the lease have been unconditionally guaranteed by KeySpan. This
lease transaction  generated cash proceeds of $385 million,  before  transaction
costs, which approximates fair market value of the facility,  as determined by a
third-party  appraiser.  (See Note 6 to the Consolidated  Financial  Statements,
"Financial  Guarantees and Contingencies" for additional  information  regarding
this financing arrangement.)

In October, KeySpan filed a new universal shelf Registration Statement to issue,
from time to time, up to $3 billion in securities.  We will continue to evaluate
our capital  structure  and  financing  strategy  for the  remainder of 2004 and
beyond.

The following  table  represents  the ratings of our long-term debt at September
30, 2004. Currently,  Standard & Poor's and Moody's Investor Services ratings on
KeySpan's and its subsidiaries' long-term debt are on negative outlook.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
                              Moody's Investor           Standard
                                  Services               & Poor's            FitchRatings
-----------------------------------------------------------------------------------------------
<S>                                <C>                     <C>                   <C>
KeySpan Corporation                  A3                     A                     A-
KEDNY                               N/A                     A+                    A+
KEDLI                                A2                     A+                    A-
Boston Gas                           A2                     A                     N/A
Colonial Gas                         A2                     A+                    N/A
KeySpan Generation                   A3                     A                     N/A
-----------------------------------------------------------------------------------------------
</TABLE>


Off-Balance Sheet Arrangements

Guarantees

KeySpan has a number of financial  guarantees  with its  subsidiaries  that have
remained substantially unchanged since December 31, 2003. At September 30, 2004,
KeySpan  had  fully  and  unconditionally   guaranteed:   (i)  $525  million  of
medium-term  notes issued by KEDLI;  (ii) the obligations of KeySpan  Ravenswood
LLC, which is the lessee under the $425 million Master Lease associated with the
Ravenswood  Facility and the lessee under the  sale/leaseback  transaction;  and
(iii) the payment  obligations  of our  subsidiaries  related to $128 million of
tax-exempt bonds issued through the Nassau County and Suffolk County  Industrial
Development Authorities for the construction of two electric-generation  peaking
facilities  on Long  Island.  The  medium-term  notes,  the Master Lease and the
tax-exempt  bonds  are  reflected  on  the   Consolidated   Balance  Sheet;  the
sale/leaseback  transaction is not recorded on the  Consolidated  Balance Sheet.
Further,  KeySpan  has  guaranteed:  (i) up to  $269  million  of  surety  bonds


                                       60
<PAGE>


associated  with certain  construction  projects  currently  being  performed by
subsidiaries within the Energy Services segment;  (ii) certain supply contracts,
margin  accounts and purchase  orders for certain  subsidiaries  in an aggregate
amount of $77 million;  and (iii) $74 million of  subsidiary  letters of credit.
These  guarantees are not recorded on the  Consolidated  Balance Sheet.  At this
time, we have no reason to believe that our  subsidiaries  will default on their
current obligations. However, we cannot predict when or if any defaults may take
place or the  impact  such  defaults  may have on our  consolidated  results  of
operations,  financial  condition or cash flows. (See Note 6 to the Consolidated
Financial  Statements,  "Financial  Guarantees and Contingencies" for additional
information regarding KeySpan's guarantees.)

Contractual Obligations

KeySpan has certain contractual obligations related to its outstanding long-term
debt,  outstanding  credit facility  borrowings,  outstanding  commercial  paper
borrowings,  operating and capital  leases,  and demand charges  associated with
certain commodity purchases.  Except for the recent  sale/leaseback  transaction
associated with the Ravenswood  Expansion and the recent debt  redemption,  both
previously noted, these obligations have remained substantially  unchanged since
December  31,  2003.  Cash  obligations   associated  with  the   sale/leaseback
transaction  are  anticipated to be: (i) $2.7 million for the remainder of 2004;
(ii) $69.4 million for fiscal years 2005 through  2007;  (iii) $73.4 million for
fiscal years 2008 and 2009;  and (iv) $465.1 million  thereafter.  Cash interest
savings as a result of the recent debt  redemption are estimated to be (i) $13.9
million for the  remainder  of 2004;  (ii) $65.3  million for fiscal  years 2005
through 2007;  (iii) $9.3 million for fiscal years 2008 and 2009; and (iv) $53.2
million  thereafter.  (For additional  details  regarding these  obligations see
KeySpan's  Annual Report on Form 10-K for the Year Ended December 31, 2003, Item
7  Management's  Discussion  and Analysis of Financial  Condition and Results of
Operations,  Note 6  "Long-Term  Debt," as well as Note 7 to those  Consolidated
Financial  Statements   "Contractual   Obligations,   Financial  Guarantees  and
Contingencies.")

Discussions of Critical Accounting Policies and Assumptions

In preparing our financial  statements,  the  application of certain  accounting
policies  requires   difficult,   subjective  and/or  complex   judgments.   The
circumstances  that make these judgments  difficult,  subjective  and/or complex
have to do with the need to make estimates  about the impact of matters that are
inherently  uncertain.  Actual effects on our financial  position and results of
operations  may vary  significantly  from expected  results if the judgments and
assumptions  underlying the estimates  prove to be inaccurate.  At September 30,
2004,  KeySpan's  critical  accounting  policies and  assumptions  have remained
substantially  unchanged since December 31, 2003. Below is a brief discussion of
those  critical  accounting  policies  requiring such  subjectivity.  For a more
detailed  discussion of these  policies and  assumptions  see  KeySpan's  Annual
Report on Form 10-K for the Year Ended December 31, 2003,  Item 7.  Management's
Discussion  and  Analysis  of  Financial  Condition  and  Results of  Operations
"Discussion of Critical Accounting Policies and Assumptions."


                                       61
<PAGE>


Percentage of Completion Accounting

Percentage-of-completion  accounting  is a method of  accounting  for  long-term
construction  type contracts in accordance  with Generally  Accepted  Accounting
Principles  and,  accordingly,  the method used for  engineering  and mechanical
contracting  revenue  recognition  by  the  Energy  Services  segment.   Due  to
uncertainties     inherent     within     estimates     employed     to    apply
percentage-of-completion  accounting,  it is  possible  that  estimates  will be
revised as project work progresses. Changes in estimates resulting in additional
future  costs to  complete  projects  can  result  in  reduced  margins  or loss
contracts.

Valuation of Goodwill

KeySpan records  goodwill on purchase  transactions,  representing the excess of
acquisition  cost over the fair value of net  assets  acquired.  In testing  for
goodwill  impairment  under SFAS 142  "Goodwill  and Other  Intangible  Assets",
significant  reliance  is placed  upon a number of  estimates  regarding  future
performance  that  require  broad   assumptions  and  significant   judgment  by
management.  A  change  in the  fair  value  of our  investments  could  cause a
significant change in the carrying value of goodwill.

In  connection  with the  preparation  of third  quarter  financial  statements,
KeySpan  conducted an evaluation of the carrying  value of goodwill  recorded in
its Energy Services  segment.  As prescribed in SFAS 142, KeySpan is required to
compare the fair value of a reporting  unit to its  carrying  amount,  including
goodwill. This evaluation is required to be performed at least annually,  unless
facts and circumstances  indicated that the evaluation should be performed at an
interim period during the year. Prior to this evaluation,  the recorded goodwill
for the  Energy  Services  segment,  as a  result  of  prior  acquisitions,  was
approximately $173 million.

As a result of an extremely  competitive market and slugish economic  conditions
within the construction  industry in the Northeastern  United States, the Energy
Services segment has experienced  significantly lower operating profits and cash
flows than originally  projected.  As previously  reported,  management has been
reviewing  the  operating  performance  of this  segment..  At a meeting held on
November 2, 2004,  KeySpan's Board of Directors  authorized  management to begin
the process of disposing of a significant  portion of its ownership interests in
certain  companies  within  the Energy  Services  segment -  specifically  those
companies  engaged in  mechanical  contracting  activities.  For the nine months
ended  September 30, 2004, the  mechanical  contracting  activities  contributed
approximately 60% of the revenues recorded in the Energy Services segment.

Based upon the results  through  September  30, 2004  experienced  by the Energy
Services segment and management's  opinion that it was likely that a significant
portion of the Energy  Services  segment will be sold within the coming  months,
specifically the mechanical  contracting  companies,  management  concluded that
KeySpan was required to evaluate the  goodwill  recorded in the Energy  Services
segment.

As a result of this interim  evaluation,  KeySpan  recorded a non-cash  goodwill
impairment  charge of  $122.2  million  ($90.4  million  or $0.56 per  share) in
September  2004.   KeySpan  employed  a  combination  of  two  methodologies  in
determining  the estimated fair value for its investment in the Energy  Services
segment, a market valuation approach and an income valuation approach. Under the
market  valuation  approach,  KeySpan  utilized a range of  near-term  potential
realizable values for the mechanical  contracting  businesses.  Under the income
valuation  approach,  the fair value was obtained by discounting  the sum of (i)
the expected future cash flows and (ii) the terminal value. KeySpan was required
to make certain significant assumptions,  specifically the weighted-average cost
of capital,  short and  long-term  growth rates and expected  future cash flows.
Therefore,  the  significant  assumptions  used in this interim  evaluation  may
change in future evaluations.

In  addition,  we will  continue  to evaluate  the fair value of the  mechanical
contracting  companies in relation to  potential  disposition  alternatives  and
their carrying  value. As a result of this evaluation we may also be required to
write-down  the carrying  value of the  mechanical  contracting  companies in an
amount that can not currently be determined.


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<PAGE>


At this point in time,  we are unable to  predict if any  additional  impairment
charges may be required for this segment,  the timing of any such  charges,  the
impact any such  charges  would have on our  financial  position  and results of
operations,  or the  timing of any sales of our  ownership  interest  in certain
companies operating in this segment. (See Note 12 to the Consolidated  Financial
Statements "Goodwill Impairment" for further details.)

Accounting for the Effects of Rate Regulation on Gas Distribution Operations

The financial  statements of the Gas Distribution segment reflect the ratemaking
policies and orders of the New York State Public Service  Commission  ("NYPSC"),
the New Hampshire Public Utility Commission ("NHPUC"), and the MA DTE.

Four of our six regulated gas utilities  (KEDNY,  KEDLI,  Boston Gas Company and
EnergyNorth  Natural  Gas,  Inc.)  are  subject  to the  provisions  of SFAS 71,
"Accounting  for the Effects of Certain  Types of  Regulation."  This  statement
recognizes the actions of regulators,  through the ratemaking process, to create
future economic benefits and obligations affecting rate-regulated companies.

In separate  merger-related  orders issued by the MA DTE, the base rates charged
by Colonial Gas Company and Essex Gas Company have been frozen at their  current
levels for a ten-year  period ending 2009.  Due to the length of these base rate
freezes,  the Colonial and Essex Gas Companies had previously  discontinued  the
application of SFAS 71.

As is further  discussed  under the caption  "Regulation  and Rate Matters," the
rate plans previously in effect for KEDNY and KEDLI have expired.  The continued
application  of SFAS 71 to  record  the  activities  of  these  subsidiaries  is
contingent  upon the actions of regulators  with regard to future rate plans. We
are currently  evaluating various options that may be available to us including,
but not  limited  to,  proposing  new plans for KEDNY and  KEDLI.  The  ultimate
resolution  of any future  rate plans  could  have a  significant  impact on the
application  of SFAS 71 to these  entities  and,  accordingly,  on our financial
position,  results of operations and cash flows.  However,  management  believes


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<PAGE>


that currently available facts support the continued  application of SFAS 71 and
that all regulatory assets and liabilities are recoverable or refundable through
the regulatory  environment.  It should be noted that the MA DTE approved a base
revenue  increase for the Boston Gas Company in the fourth quarter of 2003. (See
the discussion  under the caption  "Regulation  and Rate Matters" for additional
information regarding the DTE's rate decision.)

Rate  regulation is undergoing  significant  change as regulators  and customers
seek lower  prices for  utility  service and greater  competition  among  energy
service  providers.  In the event  that  regulation  significantly  changes  the
opportunity  for us to  recover  costs in the  future,  all or a portion  of our
regulated operations may no longer meet the criteria for the application of SFAS
71.  In  that  event,  a  write-down  of  our  existing  regulatory  assets  and
liabilities could result. In management's  opinion,  our regulated  subsidiaries
that  currently  are subject to the  provisions  of SFAS 71 will  continue to be
subject to SFAS 71 for the foreseeable future.

Pension and Other Postretirement Benefits

KeySpan participates in both non-contributory  defined benefit pension plans, as
well   as   other   post-retirement   benefit   ("OPEB")   plans   (collectively
"postretirement plans").  KeySpan's reported costs of providing pension and OPEB
benefits  are  dependent  upon  numerous  factors  resulting  from  actual  plan
experience  and  assumptions  of  future  experience.  Pension  and  OPEB  costs
(collectively   "postretirement   costs")  are   impacted  by  actual   employee
demographics,  the level of  contributions  made to the plans,  earnings on plan
assets,  and health care cost trends.  Changes made to the  provisions  of these
plans may also impact current and future  postretirement  costs.  Postretirement
costs  may  also  be   significantly   affected  by  changes  in  key  actuarial
assumptions,  including  anticipated  rates of  return  on plan  assets  and the
discount  rates  used  in  determining  the  postretirement  costs  and  benefit
obligations. Actual results that differ from our assumptions are accumulated and
amortized over ten years.

Historically, we have funded our qualified pension plans in excess of the amount
required to satisfy minimum ERISA funding  requirements.  At September 30, 2004,
we had a  funding  credit  balance  in  excess  of  the  ERISA  minimum  funding
requirements.  Although we have presently  exceeded ERISA funding  requirements,
our pension plans, on an actuarial basis, are currently underfunded.  Therefore,
for 2004,  KeySpan  expects to  contribute a total of $142 million to its funded
and unfunded  post-retirement  plans.  Future funding  requirements  are heavily
dependent on actual return on plan assets and prevailing  interest rates and may
vary from prior  estimates.  (In addition to Item 7 Management's  Discussion and
Analysis of Financial  Condition and Results of  Operations in KeySpan's  Annual
Report on Form 10-K for the Year Ended  December  31,  2003,  see also Note 4 of
those Consolidated Financial Statements, "Postretirement Benefits.")

Full Cost Accounting

Our gas  exploration  and  production  subsidiaries  use the full cost method to
account for their natural gas and oil  properties.  Under full cost  accounting,
all costs incurred in the acquisition,  exploration,  and development of natural
gas and oil reserves plus asset  retirement  obligations are capitalized  into a
"full cost pool."  Capitalized  costs include costs of all unproved  properties,
internal  costs  directly  related  to  natural  gas  and  oil  activities,  and
capitalized interest.


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<PAGE>


Under full cost  accounting  rules,  total  capitalized  costs are  limited to a
ceiling equal to the present  value of future net  revenues,  discounted at 10%,
plus the lower of cost or fair  value of  unproved  properties  less  income tax
effects (the  "ceiling  limitation").  A quarterly  ceiling test is performed to
evaluate  whether  the net book value of the full cost pool  exceeds the ceiling
limitation. If capitalized costs (net of accumulated depreciation, depletion and
amortization)  less deferred  taxes are greater than the  discounted  future net
revenues or ceiling limitation, a write-down or impairment of the full cost pool
is  required.  At  June  30,  2004,  such a  write-down  was  required  for  our
wholly-owned gas exploration and production  subsidiaries' full cost pool and we
recorded  a non-cash  impairment  charge of $48.2  million.  (See Note 10 to the
Consolidated  Financial  Statements "Gas  Exploration and Production  Property -
Depletion" for additional details regarding this charge.)

Natural gas and oil reserve quantities represent estimates only. Under full cost
accounting,  reserve  estimates  are used to  determine  the full  cost  ceiling
limitation as well as the depletion  rate.  Our gas  exploration  and production
subsidiaries estimate proved reserves and future net revenues using sales prices
estimated  to be in  effect  as of the  date it  makes  the  reserve  estimates.
Further,  our  subsidiaries  employ  independent   petroleum  engineers  in  the
preparation  of estimated  reserve  quantities.  Natural gas prices,  which have
fluctuated  widely  in  recent  years,  affect  estimated  quantities  of proved
reserves and future net revenues.  Any estimates of natural gas and oil reserves
and their values are  inherently  uncertain,  including  many factors beyond our
control.

Accounting for Sales of Stock by a Subsidiary

KeySpan  applies the  accounting  principle of income  recognition  for gains or
losses associated with the sale of stock by its subsidiaries. As provided for in
Staff  Accounting  Bulletin  Topic 5-H ("SAB  51"),  the SEC  allows  for income
recognition  of gains or losses on subsidiary  stock  transactions  in instances
where  the  transaction  is  not  part  of a  broader  corporate  reorganization
contemplated  by the parent.  Provided  that no other capital  transactions  are
contemplated  with regard to the shares issued,  income  statement  treatment in
consolidation  for  issuance of stock by a  subsidiary  is  appropriate.  SAB 51
requires  that this  accounting  treatment,  if elected by the  parent,  must be
consistently  applied  to  all  subsidiary  stock  transactions  that  meet  the
conditions  for income  statement  recognition.  As noted  earlier,  KeySpan has
appropriately  applied this accounting  treatment to its recent subsidiary stock
transactions.

Regulation and Rate Matters

Gas Matters

As of September 30, 2004, the rate  agreements for KEDNY and KEDLI have expired.
Under the terms of the KEDNY and KEDLI rate agreements,  gas distribution  rates
and all other  provisions  will remain in effect until changed by the NYPSC.  At
this time, we are currently  evaluating various options that may be available to
us  regarding  the KEDNY and KEDLI rate  plans,  including  but not  limited to,
proposing new rate plans.


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<PAGE>


Effective November 1, 2003, the MA DTE approved a $25.9 million increase in base
revenues  for the Boston Gas Company  with an allowed  return on equity of 10.2%
reflecting an equal balance of debt and equity.  On January 27, 2004, the MA DTE
issued  its  order  on  Boston   Gas   Company's   Motion   for   Recalculation,
Reconsideration  and  Clarification  that granted an additional  $1.1 million in
base  revenues,  for a  total  of  $27  million.  The  MA DTE  also  approved  a
Performance  Based Rate Plan (the  "Plan")  for up to ten years.  On October 29,
2004,  the MA DTE approved a base rate  increase of $4.6 million under the Plan.
In addition,  an increase of $7.9 million in the local  distribution  adjustment
clause was approved to recover pension and other postretirement costs.

For an additional  discussion of our current gas  distribution  rate agreements,
see KeySpan's  Annual Report on Form 10-K for the Year Ended  December 31, 2003,
Item 7 Management's  Discussion and Analysis of Financial  Condition and Results
of Operations "Regulation and Rate Matters."

Electric Matters

KeySpan sells to LIPA all of the capacity and, to the extent  requested,  energy
conversion  services  from our  existing  Long  Island  based oil and  gas-fired
generating  plants.  Sales of capacity and energy  conversion  services are made
under rates approved by the Federal  Energy  Regulatory  Commission  ("FERC") in
accordance with the Power Supply Agreement  ("PSA") entered into between KeySpan
and LIPA in 1998. The prior FERC approved rates,  which had been in effect since
May 1998,  expired on December 31, 2003.  KeySpan filed with the FERC an updated
cost of service for the Long Island based generating plants in October 2003. The
rate filing included,  among other things, an annual revenue increase of 2.1% or
approximately  $6.4 million,  a return on equity of 11%,  updated  operating and
maintenance  expense  levels and recovery of certain other costs.  FERC approved
implementation  of new rates  starting  January  1,  2004,  subject  to  refund.
Settlement  negotiations with LIPA concluded in September 2004 and on October 1,
2004 the FERC approved the settlement  reached between  KeySpan and LIPA.  Under
the new Settlement Agreement,  KeySpan is entitled to a return on equity of 9.5%
with no revenue  increase.  The FERC approved updated  operating and maintenance
expense levels and recovery of certain other costs as agreed to by the parties.

Securities and Exchange Commission Regulation

KeySpan and certain of its  subsidiaries  are subject to the jurisdiction of the
SEC under  PUHCA.  The rules and  regulations  under PUHCA  generally  limit the
operations of a registered holding company to a single integrated public utility
system, plus additional  energy-related  businesses.  In addition, the principal
regulatory   provisions  of  PUHCA:  (i)  regulate  certain  transactions  among
affiliates within a holding company system including the payment of dividends by
such  subsidiaries to a holding company;  (ii) govern the issuance,  acquisition
and  disposition  of  securities  and  assets  by  a  holding  company  and  its
subsidiaries;  (iii) limit the entry by registered  holding  companies and their
subsidiaries into businesses other than electric and/or gas utility  businesses;
and (iv) require SEC approval for certain utility mergers and acquisitions. As a
result of the recent  transactions with Houston  Exploration and KeySpan Canada,
these entities are no longer subject to SEC jurisdiction under PUHCA.


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<PAGE>


KeySpan has the authorization,  under PUHCA to do the following through December
31, 2006 (the "Authorization Period"): (a) to issue and sell up to an additional
amount  of  $3.0  billion  of  common  stock,  preferred  stock,  preferred  and
equity-linked   securities,   and  long-term  debt  securities  (the  "Long-Term
Financing Limit") in accordance with certain defined parameters; (b) in addition
to the Long-Term Financing Limit, to issue and sell up to an aggregate amount of
$1.3 billion of short-term  debt; (c) to issue up to 13 million shares of common
stock under  dividend  reinvestment  and  stock-based  management  incentive and
employee  benefit  plans;  (d) to maintain  existing  and enter into  additional
hedging transactions with respect to outstanding indebtedness in order to manage
and minimize  interest rate costs;  (e) to issue  guarantees  and other forms of
credit  support in an  aggregate  principal  amount not to exceed  $4.0  billion
outstanding  at any one time;  (f) to refund,  repurchase  (through  open market
purchases, tender offers or private transactions),  replace or refinance debt or
equity  securities  outstanding  during the  Authorization  Period  through  the
issuance  of  similar  or any other type of  authorized  securities;  (g) to pay
dividends out of capital and unearned  surplus as well as  paid-in-capital  with
respect to certain subsidiaries,  subject to certain limitations;  (h) to engage
in  preliminary   development   activities  and  administrative  and  management
activities  in  connection  with  anticipated  investments  in exempt  wholesale
generators, foreign utility companies and other energy-related companies; (i) to
organize  and/or  acquire the equity  securities of entities that will serve the
purpose of facilitating authorized financings;  (j) to invest up to $3.0 billion
in exempt  wholesale  generators and foreign  utility  companies;  (k) to create
and/or  acquire  the  securities  of  entities  organized  for  the  purpose  of
facilitating  investments in other  non-utility  subsidiaries;  and (l) to enter
into  certain  types  of  affiliate  transactions  between  certain  non-utility
subsidiaries involving cost structures above the typical "at-cost" limit.

In addition,  we have committed that during the Authorization Period, our common
equity will be at least 30% of our consolidated  capitalization  and each of our
utility  subsidiaries'  common  equity  will be at  least  30% of such  entity's
capitalization.  At September 30, 2004, KeySpan's consolidated common equity was
43% of its consolidated capitalization,  including commercial paper, and each of
its  utility  subsidiaries  common  equity  was at least  40% of its  respective
capitalization.

On October 1, 2004, in accordance with its PUHCA authorization,  KeySpan filed a
new  universal  shelf  registration  statement  on Form S-3 with the SEC for the
issuance from time to time of up to $3.0 billion in securities.

Environmental Matters

KeySpan  is  subject to  various  federal,  state and local laws and  regulatory
programs related to the environment.  We estimate that the remaining cost of our
manufactured  gas  plant  ("MGP")  related   environmental  cleanup  activities,
including costs associated with the Ravenswood  facility,  will be approximately
$247.5 million and we have recorded a related liability for such amount. We have
also recorded an additional $22.0 million  liability  representing the estimated
environmental  cleanup costs related to a former coal tar  processing  facility.
Further, as of September 30, 2004, we have expended a total of $124.5 million on
environmental remediation. (See Note 6 to the Consolidated Financial Statements,
"Financial Guarantees and Contingencies".)


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<PAGE>


Market and Credit Risk Management Activities

Market Risk: KeySpan is exposed to market risk arising from potential changes in
one or more market variables,  such as energy commodity prices,  interest rates,
foreign  currency  exchange  rates,  volumetric  risk  due to  weather  or other
variables.  Such risk  includes  any or all changes in value  whether  caused by
commodity positions, asset ownership,  business or contractual obligations, debt
covenants,   exposure  concentration,   currency,  weather,  and  other  factors
regardless  of  accounting  method.  We manage our exposure to changes in market
prices using  various  risk  management  techniques  for  non-trading  purposes,
including   hedging   through   the   use  of   derivative   instruments,   both
exchange-traded  and  over-the-counter  contracts,  purchase  of  insurance  and
execution of other contractual arrangements.

KeySpan  is  exposed  to  price  risk  due to  investments  in  equity  and debt
securities held to fund benefit  payments for various employee pension and other
postretirement  benefit plans. To the extent that the value of investments  held
change,  or long-term  interest  rates  change,  the effect will be reflected in
KeySpan's  recognition  of periodic cost of such employee  benefit plans and the
determination  of the amount of cash to be contributed  to the employee  benefit
plans.

Credit Risk:  KeySpan is exposed to credit risk arising from the potential  that
our counterparties fail to perform on their contractual obligations.  Our credit
exposures  are  created  primarily  through  the sale of gas and  transportation
services  to  residential,   commercial,  electric  generation,  and  industrial
customers and the provision of retail access  services to gas marketers,  by our
regulated gas  businesses;  the sale of commodities and services to LIPA and the
NYISO;  the sale of gas,  power and  services  to our  retail  customers  by our
unregulated  energy  service  businesses;  entering  into  financial  and energy
derivative contracts with energy marketing companies and financial institutions;
and the sale of gas, natural gas liquids,  oil and processing services to energy
marketing and oil and gas production companies.

We  have  regional   concentration  of  credit  risk  due  to  receivables  from
residential,  commercial and industrial customers in New York, New Hampshire and
Massachusetts,  although this credit risk is spread over a  diversified  base of
residential, commercial and industrial customers. Customers' payment records are
monitored and action is taken,  when  appropriate.  Companies  within the Energy
Services  segment have a concentration  of credit risk to large customers and to
the governmental and healthcare industries.

We also have concentrations of credit risk from LIPA, our largest customer,  and
from  other  energy  and  financial   services   companies.   Concentration   of
counterparty  credit risk may impact overall exposure to credit risk in that our
counterparties may be similarly  impacted by changes in economic,  regulatory or
other  considerations.  We actively  monitor the credit profile of our wholesale
counterparties in derivative and other contractual arrangements,  and manage our
level of exposure accordingly. In instances where counterparties' credit quality
has declined, or credit exposure exceeds certain levels, we may limit our credit
exposure  by  restricting  new  transactions  with the  counterparty,  requiring
additional collateral or credit support and negotiating the early termination of
certain agreements.


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<PAGE>


Regulatory Issues and Competitive  Environment:  We are subject to various other
risk  exposures  and   uncertainties   associated  with  our  gas  and  electric
operations.  The most significant  contingency involves the evolution of the gas
distribution  and electric  industries  towards more competitive and deregulated
environments.  These risks have not changed  substantially  since  December  31,
2003. The following discussion is an update to the issues discussed in KeySpan's
Annual Report on Form 10-K for the Year Ended December 31, 2003.

Gas and electric Retail Competition

New York and Long Island

The NYPSC continues to conduct collaborative  proceedings on ways to develop the
competitive energy markets in New York. On July 13, 2001, the presiding officers
in the case (the "Commission") issued their recommended decision ("RD"). At that
time,  the  Commission  set a  timeframe  of three to five years for the exit of
utilities  from the  merchant  function.  Basic  rate  design  issues  were also
established.

For the last several years,  the Commission has been  monitoring the progress of
competition in the energy market.  Based upon its findings of the current market
and  its  continued  desire  to  move  toward  fully  competitive  markets,  the
Commission,  in August 2004,  issued a second policy  statement.  The underlying
vision remains unchanged. The items of importance in the new policy include:

o    Elimination  of a timeframe  for the exit of  utilities  from the  merchant
     function.  Experience,  time and maturation of each  market/customer  class
     will dictate the exit of utilities

o    Acknowledgement   that  competitive   commodity  markets  for  the  largest
     customers has occurred.  However, workable competition for the mass markets
     (i.e.  residential  and small  commercial  customers)  is taking longer and
     needs to be nurtured.

o    Future rate filings must include a plan for facilitating customer migration
     to  competitive  markets and a fully  embedded  cost of service  study that
     develops  unbundled  rates  for  the  utility's  delivery  service  and all
     potentially competitive services

o    Utilities should avoid entering into long term capacity arrangements unless
     it is necessary for reliability and safety purposes

o    Where markets are not workably competitive, the Commission must ensure that
     rates continue to be just and reasonable,  and protect customers from price
     volatility.


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<PAGE>


Electric Industry

Due to  volatility  in the  market  clearing  price of  10-minute  spinning  and
non-spinning reserves during the first quarter of 2000, the NYISO requested that
FERC approve a bid cap on reserves as well as requiring a refunding of so called
alleged "excess payments" received by sellers,  including Ravenswood. On May 31,
2000, FERC issued an order that granted  approval of a $2.52 per MWh bid cap for
10 minute non-spinning  reserves,  plus payments for the opportunity cost of not
making  energy  sales.  The  other  requests,  such as a bid  cap  for  spinning
reserves,  retroactive refunds,  recalculation of reserve prices for March 2000,
and convening a technical conference and settlement proceeding, were rejected.

The NYISO,  Con Edison,  Niagara Mohawk Power  Corporation and Rochester Gas and
Electric each  individually  appealed FERC's order to Federal court. The appeals
were  consolidated  into one case by the court.  On  November 7, 2003 the United
States Court of Appeals for the District of Columbia  (the  "Court")  issued its
decision  in the case of  Consolidated  Edison  Company  of New York,  Inc.,  v.
Federal Energy Regulatory Commission ("Decision").  Essentially, the Court found
errors in the Commission's decision and remanded some issues in the case back to
the Commission for further explanation and action. The FERC has not acted on the
remand.

On June 25,  2004,  the NYISO  submitted a motion to FERC  seeking  refunds as a
result of the Decision.  KeySpan and others  submitted  statements of opposition
opposing  the  refunds.  FERC has not acted on the remand or the NYISO's  refund
motion and we cannot predict the outcome of these proceedings.

For additional  information regarding these risks see KeySpan's Annual Report on
Form 10-K for the Year Ended December 31, 2003,  Item 7 Management's  Discussion
and Analysis of Financial Condition and Results of Operations "Market and Credit
Risk Management Activities."

Cautionary Statement Regarding Forward-Looking Statements

Certain  statements  contained in this Quarterly  Report on Form 10-Q concerning
expectations,  beliefs, plans, objectives,  goals, strategies,  future events or
performance and underlying  assumptions and other statements that are other than
statements of historical  facts,  are  "forward-looking  statements"  within the
meaning of Section  21E of the  Securities  Exchange  Act of 1934,  as  amended.
Without  limiting the  foregoing,  all  statements  under the captions  "Item 2.
Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations" and "Item 3.  Quantitative and Qualitative  Disclosures About Market
Risk" relating to our future outlook,  anticipated capital expenditures,  future
cash flows and borrowings, pursuit of potential future acquisition opportunities
and sources of funding,  are forward-looking  statements.  Such  forward-looking
statements  reflect  numerous  assumptions  and  involve  a number  of risks and
uncertainties  and actual results may differ  materially from those discussed in
such statements.

Among the factors that could cause actual results to differ materially are:

-    volatility of energy prices used to generate electricity;

-    fluctuations in weather and in gas and electric prices;


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-    general economic conditions, especially in the Northeast United States;

-    our  ability  to  successfully   manage  our  cost  structure  and  operate
     efficiently;

-    our ability to successfully  contract for natural gas supplies  required to
     meet the needs of our customers;

-    implementation of new accounting standards;

-    inflationary trends and interest rates;

-    the ability of KeySpan to identify and make complementary acquisitions,  as
     well as the successful integration of recent and future acquisitions;

-    available sources and cost of fuel;

-    creditworthiness of counterparties to derivative  instruments and commodity
     contracts;

-    the resolution of certain disputes with LIPA concerning each party's rights
     and obligations under various agreements;

-    retention of key personnel;

-    federal  and  state  regulatory   initiatives  that  increase  competition,
     threaten  cost and  investment  recovery,  and place limits on the type and
     manner in which we invest in new businesses and conduct operations;

-    the impact of federal and state utility  regulatory  policies and orders on
     our regulated and unregulated businesses;

-    potential  write-down  of our  investment  in natural gas  properties  when
     natural  gas  prices  are  depressed  or if we  have  significant  downward
     revisions in our estimated proved gas reserves;

-    competition  facing our unregulated Energy Services  businesses,  including
     but not limited to competition from other  mechanical,  plumbing,  heating,
     ventilation and air conditioning,  and engineering  companies,  as well as,
     other utilities and utility holding  companies that are permitted to engage
     in such activities;

-    the degree to which we develop  unregulated  business ventures,  as well as
     federal and state regulatory  policies  affecting our ability to retain and
     operate such business ventures profitably;

-    changes in political conditions, acts of war or terrorism;

-    changes in rates of return on overall debt and equity markets could have an
     adverse impact on the value of pension assets;

-    changes in  accounting  standards or GAAP which may require  adjustment  to
     financial statements;


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<PAGE>


-    a  change  in the  fair  value  of  our  investments  that  could  cause  a
     significant change in the carrying value of goodwill;

-    timely  receipts of payments  from our two largest  customers  LIPA and the
     NYISO; and

-    other risks detailed from time to time in other reports and other documents
     filed by KeySpan with the SEC.

For any of these  statements,  KeySpan  claims the protection of the safe harbor
for forward-looking  information  contained in the Private Securities Litigation
Reform Act of 1995,  as  amended.  For  additional  discussion  on these  risks,
uncertainties and assumptions, see "Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations."

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Financially-Settled  Commodity Derivative Instruments - Hedging Activities: From
time  to  time,  KeySpan   subsidiaries  have  utilized   derivative   financial
instruments,  such as futures, options and swaps, for the purpose of hedging the
cash flow variability  associated with changes in commodity  prices.  KeySpan is
exposed to commodity  price risk primarily  with regard to its gas  distribution
operations,   gas  exploration  and  production   activities  and  its  electric
generating facilities.  Our gas distribution  operations utilize natural gas and
fuel oil swaps to hedge the cash-flow  variability of specified  portions of gas
purchases and sales associated with certain large-volume  customers.  Derivative
financial  instruments  are employed by Houston  Exploration  to hedge cash flow
variability  associated with  forecasted  sales of natural gas.  However,  since
Houston  Exploration  is no  longer a  consolidated  subsidiary  its  derivative
financial  instruments are not reflected on the September 30, 2004  Consolidated
Balance Sheet. Seneca-Upshur utilizes over-the-counter ("OTC") natural gas index
swaps to hedge cash flow variability associated with forecasted sales of natural
gas. The Ravenswood Projects use derivative  financial  instruments to hedge the
cash flow  variability  associated with the purchase of a portion of natural gas
and oil  that  will be  consumed  during  the  generation  of  electricity.  The
Ravenswood  Projects  also  hedge the cash flow  variability  associated  with a
portion of peak electric energy sales.

KeySpan uses standard  NYMEX futures prices to value gas futures and heating oil
contracts  and market  quoted  forward  prices to value oil swap and natural gas
basis  swap  contracts  associated  with its  Ravenswood  Projects  and  certain
large-volume  customers of our gas distribution  operations.  We also use market
quoted  forward  prices  to  value  electric  derivatives  associated  with  the
Ravenswood  Projects.  Seneca-Upshur  uses forward index prices to value its OTC
swaps.


                                       72
<PAGE>


The following  tables set forth selected  financial data  associated  with these
derivative financial  instruments noted above that were outstanding at September
30, 2004.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                              Year of          Volumes          Fixed               Current              Fair Value
      Type of Contract not updated            Maturity           mmcf           Price $              Price $               ($000)
-----------------------------------------------------------------------------------------------------------------------------------
              Gas
<S>                                             <C>             <C>          <C>                  <C>                      <C>
Swaps/Futures - Long Natural Gas                 2004             2,759       5.59 - 6.18          6.80 - 7.64               3,673
                                                 2005             2,749       6.74 - 7.01          7.99 - 8.03               3,048

OTC Swaps  - Short Natural Gas                   2004               338              5.99          7.06 - 7.91                (499)
                                                 2005               695              6.58          6.68 - 8.33              (1,065)
                                                 2006             1,884              6.17          6.07 - 7.32                (449)
                                                 2007             1,812              5.86          5.53 - 6.71                   4
-----------------------------------------------------------------------------------------------------------------------------------
                                                                 10,237                                                      4,712
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------------
                                      Year of            Volumes            Fixed                Current              Fair Value
     Type of Contract                 Maturity           Barrels            Price $               Price $               ($000)
---------------------------------------------------------------------------------------------------------------------------------
        Oil
<S>                                     <C>           <C>               <C>                    <C>                       <C>
Swaps - Long Fuel Oil                    2004             34,000         24.85 - 34.40          34.00 - 35.60                180
                                         2005             84,000         24.65 - 34.40          35.21 - 36.36                347
                                         2006             12,000         30.80 - 34.40          34.15 - 35.41                 25

Swaps - Short Heating Oil                2004            628,038         49.98 - 50.19          58.21 - 58.25             (5,098)
                                         2005            765,451         52.63 - 55.23          57.31 - 58.13             (2,963)
---------------------------------------------------------------------------------------------------------------------------------
                                                       1,523,489                                                          (7,509)
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------
                                     Year of                          Fixed Margin/           Current              Fair Value
     Type of Contract                Maturity           MWh             Price $                Price $               ($000)
------------------------------------------------------------------------------------------------------------------------------
       Electricity
<S>                                    <C>          <C>              <C>                   <C>                      <C>
Swaps - Energy                          2004           389,600        27.48 - 72.00         33.33 - 81.25            2,988
                                        2005           806,400        29.95 - 101.50        35.29 - 100.13            (710)

------------------------------------------------------------------------------------------------------------------------------
                                                     1,196,000                                                       2,278
------------------------------------------------------------------------------------------------------------------------------
</TABLE>


---------------------------------------------------------------------------
                                                                     2004
Change in Fair Value of Derivative Instruments                      ($000)
---------------------------------------------------------------------------
Fair value of contracts at January 1, 2004                       $ (36,224)
Losses on contracts realized                                         3,979
Derivative balance that has been de-consolidated                    14,331
(Decrease) in fair value of all open contracts                      17,395
---------------------------------------------------------------------------
Fair value of contracts outstanding at September 30, 2004        $    (519)
---------------------------------------------------------------------------


                                       73
<PAGE>

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------
(In Thousands of Dollars)
---------------------------------------------------------------------------------------------------
                                                         Fair Value of Contracts
---------------------------------------------------------------------------------------------------
                                           Mature Within                                   Total
Sources of Fair Value                        12 Months              Thereafter          Fair Value
---------------------------------------------------------------------------------------------------
<S>                                            <C>                    <C>                  <C>
Prices actively quoted                        $ (1,339)                    -              $ (1,339)
Prices based on models and
    other valuation methods                          -                     -                     -
Local published indicies                         1,207                  (387)                  820
---------------------------------------------------------------------------------------------------
                                              $   (132)               $ (387)             $   (519)
---------------------------------------------------------------------------------------------------
</TABLE>


We measure the commodity  risk of our  derivative  hedging  instruments  using a
sensitivity analysis.  Based on a sensitivity analysis as of September 30, 2004,
a 10% increase in heating oil and natural gas prices would decrease the value of
derivative  instruments  maturing  in 2004 by $1.9  million,  while the value of
expected  physical  deliveries  for the remainder of 2004 would be enhanced $2.5
million (net benefit to KeySpan of $0.6 million).  A 10% decrease in heating oil
and  natural  gas  prices  would  enhance  the value of  derivative  instruments
maturing  in 2004  by  $1.9  million,  while  the  value  of  expected  physical
deliveries  for the remainder of 2004 would be decreased  $2.5 million (net cost
to KeySpan of $0.6 million).

Based on a  sensitivity  analysis as of  September  30,  2004, a 10% increase in
electricity  and fuel  prices  would have an  immaterial  impact on the value of
derivative  instruments  maturing in 2004, while the value of expected  physical
power  production  for the remainder of 2004 would be enhanced $1.2 million (net
benefit to KeySpan of $1.2  million).  A 10%  decrease in  electricity  and fuel
prices would have an immaterial  impact on the value of  derivative  instruments
maturing in 2004, while the value of expected physical power production would be
reduced $1.2 million (net cost to KeySpan of $1.2 million).

Firm Gas Sales Derivative  Instruments - Regulated Utilities:  We use derivative
financial  instruments to reduce the cash flow  variability  associated with the
purchase price for a portion of future natural gas purchases associated with our
Gas Distribution operations.  The accounting for these derivative instruments is
subject to SFAS 71 "Accounting  for the Effects of Certain Types of Regulation."
Therefore,  changes in the fair value of these derivatives have been recorded as
a regulatory asset or regulatory  liability on the  Consolidated  Balance Sheet.
Gains or losses on the settlement of these contracts are initially  deferred and
then refunded to or collected from our firm gas sales customers  consistent with
regulatory requirements.


                                       74
<PAGE>


The following table sets forth selected financial data associated with these
derivative financial instruments that were outstanding at September 30, 2004.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Type of             Year of     Volumes                                             Fixed           Current             Fair Value
Contract           Maturity       mmcf        Floor ($)          Ceiling ($)       Price ($)        Price ($)             ($000)
------------------------------------------------------------------------------------------------------------------------------------
<S>                  <C>        <C>         <C>                 <C>              <C>               <C>                  <C>
Options               2004        3,940      5.00 - 6.00         5.00 - 7.00                -       6.80 - 7.64            1,950
                      2005        9,420      5.00 - 6.00         5.00 - 7.00                -       6.42 - 8.03            7,769
                      2006        2,480      5.00 - 6.00         5.50 - 6.75                        5.82 - 7.07              749
Swaps                 2004       16,140                -                   -      5.90 - 6.21       6.80 - 7.64           20,221
                      2005       38,230                -                   -      6.05 - 6.25       6.42 - 8.03           53,632
                      2006        6,260                -                   -      6.27 - 6.30       5.82 - 7.07            2,804
------------------------------------------------------------------------------------------------------------------------------------
                                 76,470                                                                                   87,125
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

See Note 4 to the  Consolidated  Financial  Statements  "Hedging and  Derivative
Financial   Instruments"  for  a  further  description  of  all  our  derivative
instruments.

Item 4. Controls and Procedures

KeySpan maintains  "disclosure controls and procedures," as such term is defined
under Exchange Act Rule 13a-15(e),  that are designed to ensure that information
required to be disclosed by KeySpan in the reports it files or submits under the
Securities  Exchange Act of 1934, as amended (the "Exchange  Act"), is recorded,
processed,  summarized  and reported  within the time  periods  specified in the
Securities and Exchange  Commission's rules and forms, and that such information
is accumulated  and  communicated to KeySpan's  management,  including its Chief
Executive  Officer and Chief Financial  Officer,  as appropriate to allow timely
decisions regarding required disclosure.

An  evaluation  of  the  effectiveness  of  KeySpan's  disclosure  controls  and
procedures as of September 30, 2004 was conducted under the supervision and with
the  participation  of KeySpan's  Chief  Executive  Officer and Chief  Financial
Officer.  Based on that evaluation,  KeySpan's Chief Executive Officer and Chief
Financial  Officer  have  concluded  that  KeySpan's   disclosure  controls  and
procedures  were  adequate  and  designed  to ensure that  material  information
relating to KeySpan and its consolidated subsidiaries would be made known to the
Chief  Executive  Officer and Chief  Financial  Officer by others  within  those
entities,  particularly  during the  periods  when  periodic  reports  under the
Exchange  Act are  being  prepared.  Furthermore,  there  has been no  change in
KeySpan's  internal control over financial  reporting,  identified in connection
with the evaluation of such control,  that occurred during KeySpan's last fiscal
quarter that has  materially  affected,  or is  reasonably  likely to materially
affect,  KeySpan's  internal  control  over  financial  reporting.  Refer to the
Certifications  by KeySpan's Chief Executive Officer and Chief Financial Officer
filed as exhibits 31.1 and 31.2 to this report.



                                       75
<PAGE>



PART II.  OTHER INFORMATION
---------------------------

Item 1. Legal Proceedings

See Note 6 to the Consolidated  Financial Statements  "Financial  Guarantees and
Contingencies".

Item 6.  Exhibits and Reports on Form 8-K

(a) Exhibits

31.1*     Certification of the Chairman and Chief Executive  Officer pursuant to
          Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*     Certification  of the Executive  Vice  President  and Chief  Financial
          Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*     Certification of the Chairman and Chief Executive  Officer pursuant to
          Section 906 of the Sarbanes-Oxley Act of 2002.

32.2*     Certification  of the Executive  Vice  President  and Chief  Financial
          Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

----------------------
*Filed Herewith









                                       76
<PAGE>



                      KEYSPAN CORPORATION AND SUBSIDIARIES
                                    SIGNATURE

Pursuant  to the  requirements  of the  Securities  Exchange  Act of  1934,  the
registrant has duly caused this report to be signed on behalf of the undersigned
there unto duly authorized.

                                                 KEYSPAN CORPORATION
                                                 -------------------
                                                    (Registrant)



Date: November 4, 2004                         /s/ Gerald Luterman
                                               ------------------------
                                               Gerald Luterman
                                               Executive Vice President and
                                               Chief Financial Officer



















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