UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

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

                   For the fiscal year ended December 31, 2006

                         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             (I.R.S. 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)
                           (516) 755-6650 (Hicksville)

              (Registrant's telephone number, including area code)

           Securities registered pursuant to Section 12(b) of the Act:
   Title of each class                 Name of each exchange on which registered
   -------------------                 -----------------------------------------
Common Stock, $.01 par value                   New York Stock Exchange

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                                      None
                                (Title of class)

Indicate by check mark if the  registrant is a well known  seasoned  issuer,  as
defined in Rule 405 of the Securities Act.                 X Yes  ___No

Indicate  by  check  mark if the  registrant  is not  required  to file  reports
pursuant to Section 13 or Section 15(d) of the Act.       ___Yes   X No

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 Yes  ___ No

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K (ss.  229.405 of this chapter) is not contained  herein,  and
will not be  contained,  to the best of  registrant's  knowledge,  in definitive
proxy or information  statements  incorporated  by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.             X Yes  ___ No

Indicate by check mark whether the registrant is a large accelerated filer, or a
non-accelerated filler.

Large accelerated filer X      Accelerated filer___     Non-accelerated filer___

Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Act).      ___ Yes     X No

The aggregate  market value of the voting and  non-voting  common equity held by
non-affiliates  (174,772,562  shares) of the registrant was $7,223,349,984 based
on the closing  price of the New York Stock  Exchange on February 20,  2007,  of
$41.33 per share.

As of February 20, 2007, there were 175,588,130 shares of common stock, $.01 par
value, outstanding.

                   DOCUMENTS INCORPORATED BY REFERENCE
None.

<PAGE>

<TABLE>
<CAPTION>
                               KEYSPAN CORPORATION
                                INDEX TO FORM 10-K                                                                       Page
                                                                                                                         ----
                                     PART I
                                     ------
<S>              <C>                                                                                                     <C>
ITEM 1.           BUSINESS..................................................................................................1
ITEM 1A.          RISK FACTORS.............................................................................................25
ITEM 1B.          UNRESOLVED STAFF COMMENTS................................................................................33
ITEM 2.           PROPERTIES...............................................................................................33
ITEM 3.           LEGAL PROCEEDINGS........................................................................................33
ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................................................33

                                     PART II
                                     -------
ITEM 5.           MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
                  MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES........................................................34
ITEM 6.           SELECTED FINANCIAL DATA..................................................................................37
ITEM 7.           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                  RESULTS OF OPERATION.....................................................................................38
ITEM 7A.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...............................................92
ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..............................................................95
            NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS................................................................101
            INTRODUCTION TO THE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS............................................101
            Note 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES...........................................................103
            Note 2.  BUSINESS SEGMENTS....................................................................................125
            Note 3.  INCOME TAX...........................................................................................130
            Note 4.  POSTRETIREMENT BENEFITS..............................................................................132
            Note 5.  CAPITAL STOCK........................................................................................140
            Note 6.  LONG-TERM DEBT AND COMMERCIAL PAPER..................................................................140
            Note 7.  CONTRACTUAL OBLIGATIONS, FINANCIAL GUARANTEES
                     AND CONTINGENCIES....................................................................................144
            Note 8.  HEDGING, DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUES............................................156
            Note 9.  GAS PRODUCTION AND DEVELOPMENT PROPERTY - DEPLETION..................................................161
            Note 10.  ENERGY SERVICES- DISCONTINUED OPERATIONS............................................................162
            Note 11.  2006 LIPA SETTLEMENT................................................................................164
            Note 12.  KEYSPAN GAS EAST CORPORATION SUMMARY FINANCIAL DATA.................................................166
            Note 13.  SUMMARY OF QUARTERLY INFORMATION (UNAUDITED)........................................................172
ITEM 9             CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
                   AND FINANCIAL DISCLOSURE...............................................................................175
ITEM 9A.           CONTROLS AND PROCEDURES................................................................................175

                                    PART III
                                    --------
ITEM 10.          DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE .................................................179
ITEM 11.          EXECUTIVE COMPENSATION..................................................................................187
ITEM 12.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                  MANAGEMENT AND RELATED STOCKHOLDER MATTERS..............................................................224
ITEM 13.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
                  INDEPENDENCE............................................................................................225
ITEM 14.          PRINCIPAL ACCOUNTING FEES AND SERVICES..................................................................227

                                     PART IV
                                     -------
ITEM 15.          EXHIBITS, FINANCIAL STATEMENT SCHEDULES.................................................................229
</TABLE>

                                       ii

<PAGE>


                                     PART I
                                     ------

ITEM 1.     BUSINESS

CORPORATE OVERVIEW

KeySpan  Corporation  ("KeySpan")  is a member of the  Standard  and  Poor's 500
Index.  KeySpan is a New York corporation and a holding company under the Public
Utility Holding  Company Act of 2005 ("PUHCA  2005").  KeySpan was formed in May
1998, as a result of the business combination of KeySpan Energy Corporation, the
parent of The Brooklyn  Union Gas Company,  and certain  businesses  of the Long
Island Lighting Company ("LILCO"). On November 8, 2000, KeySpan acquired Eastern
Enterprises  ("Eastern"),  now known as KeySpan  New  England,  LLC  ("KNE"),  a
Massachusetts limited liability company, which primarily owns Boston Gas Company
("Boston  Gas"),  Colonial  Gas Company  ("Colonial  Gas") and Essex Gas Company
("Essex Gas"), gas utilities operating in Massachusetts,  as well as EnergyNorth
Natural  Gas,  Inc.  ("EnergyNorth"),  a gas utility  operating  principally  in
central New Hampshire.  KeySpan operates six regulated utilities that distribute
natural  gas to  approximately  2.6  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.
KeySpan also owns, leases and operates electric  generating plants in Nassau and
Suffolk Counties on Long Island and in Queens County in New York City and is the
largest  electric  generation  operator  in New York  State.  Under  contractual
arrangements,  KeySpan  provides 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
operating subsidiaries are primarily involved in gas production and development;
underground gas storage;  liquefied natural gas ("LNG") storage; retail electric
marketing; large energy-system ownership,  installation and management;  service
and  maintenance of energy systems;  and  engineering  and consulting  services.
KeySpan  also  invests  and  participates  in the  development  of  natural  gas
pipelines,  electric  generation  and  other  energy-related  projects.  As used
herein,  "KeySpan," "we," "us" and "our" refers to KeySpan Corporation,  its six
principal gas distribution  subsidiaries and its other regulated and unregulated
subsidiaries, individually and in the aggregate.

On February 25, 2006,  KeySpan entered into an Agreement and Plan of Merger (the
"Merger   Agreement"),   with  National  Grid  plc,  a  public  limited  company
incorporated  under the laws of England and Wales  ("Parent")  and National Grid
US8, Inc., a New York Corporation  ("Merger Sub"),  pursuant to which Merger Sub
will merge with and into KeySpan (the "Merger"),  with KeySpan continuing as the
surviving  company and thereby becoming an indirect  wholly-owned  subsidiary of
the  Parent.  Pursuant to the Merger  Agreement,  at the  effective  time of the
Merger,  each  outstanding  share of KeySpan  common stock,  par value $0.01 per
share (the  "Shares"),  other than treasury shares and shares held by the Parent
and its subsidiaries, shall be canceled and shall be converted into the right to
receive $42.00 in cash, without interest.

Consummation of the Merger is subject to various closing  conditions,  including
but not limited to the receipt of requisite  regulatory  approvals  from certain
United States federal and state public utility,  antitrust and other  regulatory
authorities,  all of which have been filed and many of which have been obtained.
Specifically,  we filed our  application  for approval of the Merger pursuant to


                                       1
<PAGE>


the Federal  Power Act in May 2006 and in October  the  requisite  approval  was
obtained from the Federal Energy Regulatory  Commission ("FERC").  In early July
2006,   we  cleared   review  by  the  Federal   Trade   Commission   under  the
Hart-Scott-Rodino  Antitrust  Improvement Act and received notification that the
Committee on Foreign  Investment  in the U.S. has  determined  that there are no
issues of  national  security  sufficient  to  warrant an  investigation  of the
transaction.  On July 20,  2006 we  filed an  application  for  approval  of the
transaction with the New York Public Service Commission  ("NYPSC").  KeySpan has
also  sought  approval  of the  merger  from the New  Hampshire  Public  Utility
Commission.  In October 2006, the State of New Jersey Board of Public  Utilities
approved  a change of control of KeySpan  Communication  Corp.,  which  provides
telecommunications  services in New Jersey. In addition, the Merger was approved
by our  shareholders  at our Annual Meeting on August 17, 2006.  Shareholders of
National Grid plc approved the Merger at a meeting held on July 31, 2006.

In addition to seeking  approval of the Merger,  the application  filed with the
NYPSC also contained proposed ten-year rate plans for KeySpan Energy Delivery of
New York ("KEDNY") and KeySpan Energy Delivery of Long Island ("KEDLI"), as well
as proposals  concerning  corporate  structure  and  affiliate  rules,  the rate
treatment for synergy savings and for low income and energy efficiency programs,
among others.  Specifically,  the rate plan  proposals  provide for, among other
things,  a freeze of base  delivery  rates  for  KEDNY and KEDLI for 18  months.
Thereafter,  KEDNY's and KEDLI's gas  adjustment  clauses  would be increased to
recover, on a prospective basis, estimated gas commodity-related  costs of $68.6
million  for KEDNY and $28.7  million for KEDLI that would no longer be included
in base  rates.  In  addition,  KEDNY and KEDLI  base  delivery  rates  would be
increased  by an average  of 2.5%  ($62.4  million)  and 2.3%  ($39.4  million),
respectively  in years 3, 5, 7 and 9 of the rate plans.  The proposed rate plans
contemplate  an allowed  return on equity of 11.0% for each  entity.  Cumulative
earnings  above 11.75% would be shared  between gas sales  customers and KeySpan
over the rate plan period.  On October 3, 2006 National Grid plc filed testimony
and exhibits with the NYPSC that further  explains the exhibits and  attachments
that were previously submitted as part of the July 20, 2006 petition.

Separately  from the merger  application,  on  October 3, 2006,  KEDNY and KEDLI
filed with the NYPSC  individual  applications  for proposed annual increases in
revenues,   which  applications   assumed  that  KEDNY  and  KEDLI  remained  as
stand-alone companies. The proposed revenue increases are for approximately 9.1%
and 10.9% for KEDNY and KEDLI,  respectively.  KEDNY's  last base rate  increase
took effect  October 1, 1993 and since then base rates have been reduced twice -
once in 1996 and again in 1998.  KEDLI's  last base rate  increase  took  effect


                                       2
<PAGE>


December 1, 1995.  Since that time,  KEDLI's  base rates were  reduced  twice in
1998. The principal  factors  creating the need for rate relief are increases in
operating and maintenance  expenses,  increases in rate base, increased property
taxes and depreciation  expense, and the need to commence recovery of previously
deferred  costs  such as pension  and post  retirement  benefits,  environmental
expenditures and property taxes.

The total projected increase in revenues is comprised of two components;  (i) an
increase in base rates of $180.7  million for KEDNY and $145  million for KEDLI;
and (ii)  projected  increases of $32.8  million and $13.6 million for KEDNY and
KEDLI, respectively, for gas-related expenses that will be recovered through the
Gas  Adjustment  Clause  ("GAC")  and/or the  Transportation  Adjustment  Clause
("TAC").  The  proposed  rate of return  on  equity is 11.0% for both  KEDNY and
KEDLI.

The NYPSC may suspend the  implementation  of the proposed tariff changes for up
to eleven  months,  which  would  mean,  absent  other  intervening  events,  an
effective  date of  September  3, 2007 for new rates.  Although  KEDNY and KEDLI
proposed the new rates described  above in these tariff filings,  it will not be
necessary to implement the rate increases proposed therein if the NYPSC approves
the Merger  between  National  Grid plc and  KeySpan  and  approves  the related
ten-year rate plan previously noted, or some variation thereof.

On February  20,  2007,  NYPSC Staff  filed its direct  testimony  in the merger
proceeding.  NYSPSC  Staff  opposed  the  current  terms of the Merger on policy
grounds,   but  suggested  that  it  could  support  the  Merger  under  certain
circumstances.  KeySpan and National Grid intend to file testimony responding to
the positions taken by Staff. In addition,  on January 29, 2007, Staff filed its
direct  testimony in the rate case  proceedings  and our rebuttal  testimony was
filed on  February  21,  2007.  In  connection  with each of these  proceedings,
hearings before an administrative law judge (ALJ) are scheduled to begin in late
March. Unless a settlement among the parties is otherwise reached,  the ALJ will
issue its recommended decision to the NYPSC following such hearings. Ultimately,
the NYPSC may accept, reject, or modify all or any part of the ALJ's recommended
decision.

KeySpan and National  Grid will  continue to pursue all required  approvals  and
continue to anticipate that the Merger will be consummated in mid-2007. However,
we are unable to predict  the  outcome of these  regulatory  proceedings  and no
assurance  can be  given  that  the  Merger  will  occur  or the  timing  of its
completion.    Accordingly,   any   statements   contained   herein   concerning
expectations,  beliefs, plans, objectives,  goals, strategies,  future events or
performance and underlying  assumptions are "forward-looking  statements" and do
not take into  account  the  occurrence  or impact  of any  potential  strategic
transaction  on the future  operations,  financial  condition  and cash flows of
KeySpan.

KeySpan is a holding  company under the Public  Utility  Holding  Company Act of
2005, as amended ("PUHCA  2005").  In August 2005, the Energy Policy Act of 2005
(the  "Energy  Act") was  enacted.  The Energy Act is a broad  energy  bill that
places an  increased  emphasis  on the  production  of energy and  promotes  the
development of new technologies and alternative  energy sources and provides tax
credits to  companies  that produce  natural gas,  oil,  coal,  electricity  and
renewable  energy.  For KeySpan,  one of the more significant  provisions of the
Energy Act was the repeal of the Public Utility  Holding Company Act of 1935, as
amended ("PUHCA 1935"),  which became  effective on February 8, 2006. Since that
time, the  jurisdiction of the Securities and Exchange  Commission  ("SEC") over
certain  holding company  activities,  including the regulation of our affiliate
transactions and service companies,  has been transferred to the jurisdiction of
the Federal Energy  Regulatory  Commission  ("FERC") pursuant to PUHCA 2005. See
"Regulation  and Rate Matters" for additional  information on the Energy Act and
PUHCA 2005.


                                       3
<PAGE>

Under our holding  company  structure,  we have no  independent  operations  and
conduct  substantially  all of our  operations  through  our  subsidiaries.  Our
subsidiaries operate in the following four business segments:  Gas Distribution,
Electric Services, Energy Services and Energy Investments.

The Gas  Distribution  segment  consists of our six regulated  gas  distribution
subsidiaries,  which  operate in New York,  Massachusetts  and New Hampshire and
serve approximately 2.6 million customers.

The Electric  Services segment consists of subsidiaries that manage the electric
transmission  and  distribution  system ("T&D  System")  owned by LIPA;  provide
generating capacity and, to the extent required,  energy conversion services for
LIPA from our  approximately  4,200  megawatts  ("MW") of generating  facilities

located on Long  Island;  and  manage  fuel  supplies  for LIPA to fuel our Long
Island  generating  facilities.  The Electric  Services  segment  also  includes
subsidiaries  that own,  lease and  operate  the  2,200 MW  Ravenswood  electric
generation facility (the "Ravenswood Facility"), located in Queens County in New
York  City,  and the 250 MW  combined  cycle  generating  unit (the  "Ravenswood
Expansion") which began full commercial operation in May 2004 (collectively, the
Ravenswood  Facility and the Ravenswood  Expansion are referred to herein as the
"Ravenswood Generating Station" and have a total electric capacity of 2,450 MW).
Moreover,  subsidiaries  in  this  segment  also  provide  retail  marketing  of
electricity to commercial customers.

The Energy  Services  segment  provides  energy-related  services  to  customers
primarily located within the Northeastern  United States, with concentrations in
the New York City and Boston metropolitan areas.

The Energy  Investments  segment  includes our gas  production  and  development
activities,  domestic  pipelines,  gas storage facilities and LNG facilities and
operations.

KeySpan's  principal  executive  offices  are located at One  MetroTech  Center,
Brooklyn,  New York 11201 and 175 East Old Country  Road,  Hicksville,  New York
11801,  and its  telephone  numbers  are  (718)  403-1000  (Brooklyn)  and (516)
755-6650 (Hicksville).

KeySpan   makes   available   free  of  charge  on  or  through   its   website,
http://www.keyspanenergy.com  (Investor Relations section), its annual report on
Form 10-K,  quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments  to  those  reports  as soon as  reasonably  practicable  after  such
material is electronically filed with or furnished to the SEC. You may also read
and copy any of these  documents  at the SEC's  public  reference  room at 100 F
Street, N.E., Washington,  D.C. 20549. Please call the SEC at 1-800-SEC-0330 for
further  information  on the public  reference  room.  Our SEC  filings are also
available to the public on the SEC's web site at www.sec.gov.



                                       4
<PAGE>


GAS DISTRIBUTION OVERVIEW

Our  gas  distribution  activities  are  conducted  by  our  six  regulated  gas
distribution  subsidiaries,  which operate in three states in the Northeast: New
York, Massachusetts and New Hampshire. We are the fifth largest gas distribution
company  in  the  United  States  and  the  largest  in  the   Northeast,   with
approximately  2.6 million  customers  served  within an aggregate  service area
covering 4,273 square miles. In New York, The Brooklyn Union Gas Company,  doing
business  as  KeySpan  Energy   Delivery  New  York   ("KEDNY"),   provides  gas
distribution  services to customers  in the New York City  Boroughs of Brooklyn,
Queens and Staten Island;  and KeySpan Gas East  Corporation,  doing business as
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. In Massachusetts,  Boston Gas provides gas
distribution  services  in  eastern  and  central  Massachusetts;  Colonial  Gas
provides gas distribution services on Cape Cod and in eastern Massachusetts; and
Essex Gas provides gas distribution  services in eastern  Massachusetts.  In New
Hampshire,   EnergyNorth   provides  gas  distribution   services  to  customers
principally located in central New Hampshire.  Our New England gas companies all
do business as KeySpan Energy Delivery New England ("KEDNE").

In New York, there are two separate,  but contiguous service  territories served
by KEDNY and KEDLI, comprising approximately 1,417 square miles and 1.68 million
customers. In Massachusetts,  Boston Gas, Colonial Gas and Essex Gas serve three
service territories  consisting of 1,934 square miles and approximately  792,000
customers.  In New  Hampshire,  EnergyNorth  has a  service  territory  that  is
contiguous to Colonial Gas' and ranges from within 30 to 85 miles of the greater
Boston area. EnergyNorth provides service to approximately 80,000 customers over
a service area of approximately 922 square miles. Collectively, KeySpan owns and
operates  gas  distribution,  transmission  and storage  systems that consist of
approximately 23,336 miles of gas mains and distribution pipelines.

Natural gas is offered for sale to residential and small commercial customers on
a "firm" basis, and to most large commercial and industrial  customers on either
a "firm" or "interruptible"  basis. "Firm" service is offered to customers under
tariffed  schedules or  contracts  that  anticipate  no  interruptions,  whereas
"interruptible"  service is offered to  customers  under  tariffed  schedules or
contracts that anticipate and permit interruption on short notice,  generally in
peak-load  seasons  or for system  reliability  reasons.  We  maintain a diverse
portfolio  of firm gas supply,  storage  and  pipeline  transportation  capacity
contracts to adequately serve the  requirements of our gas sales  customers,  to
maintain system reliability and system operations, and to meet our obligation to
serve  our  customers.  We  also  engage  in  the  use of  derivative  financial
instruments from time to time to reduce the cash flow volatility associated with
the purchase price for a portion of future natural gas purchases.

KeySpan  actively  promotes a competitive  retail gas market by offering  tariff
firm  transportation  services to firm gas customers who elect to purchase their
gas supplies  from natural gas  marketers  rather than from the utility.  In New
York,  KeySpan  further  facilitates   competition  by  releasing  its  pipeline
transportation capacity and offering bundled gas supply to natural gas marketers
that would otherwise not be able to obtain their own capacity.  In Massachusetts
and New Hampshire,  there are mandatory  capacity  assignment  programs in place
whereby  capacity is released to natural gas  marketers  on behalf of  customers
they  serve.  However,  net gas  revenues  are  not  significantly  affected  by


                                       5
<PAGE>


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 sales service customers.

KeySpan also participates in interstate  markets by releasing  pipeline capacity
and by selling bundled gas services to customers  located outside of our service
territory ("off-system" customers).

KeySpan  purchases  natural  gas for  firm gas  customers  under  both  long and
short-term  supply  contracts,  as well as on the spot market,  and utilizes its
firm  pipeline  transportation  contracts to transport the gas from the point of
purchase to the market.  KeySpan also contracts for firm capacity in natural gas
underground  storage  facilities  to store  gas  during  the  summer  for  later
withdrawal  during the winter heating season when gas customer demand is higher.
KeySpan  also  contracts  for firm  winter  peaking  supplies  to meet  firm gas
customer demand on the coldest days of the year.

KeySpan  sells gas to firm gas customers at its cost for such gas, plus a charge
designed  to  recover  the costs of  distribution  (including  a return of and a
return on capital  invested in our distribution  facilities).  We share with our
firm gas  customers  net revenues  (operating  revenues less the cost of gas and
associated   revenue  taxes)  from   off-system   sales  and  capacity   release
transactions.  Further,  net  revenues  from tariff gas  balancing  services and
certain   interruptible   on-system   sales  are  refunded,   for  most  of  our
subsidiaries, to firm customers subject to certain sharing provisions.

Our gas operations can be significantly affected by seasonal weather conditions.
Annual revenues are substantially realized during the heating season as a result
of  higher  sales of gas due to cold  weather.  Accordingly,  operating  results
historically are most favorable in the first and fourth calendar quarters. KEDNY
and  KEDLI  each  operate  under  a  utility  tariff  that  contains  a  weather
normalization  adjustment that largely  offsets  variations in firm net revenues
due to fluctuations in normal weather.  However,  the tariffs for our four KEDNE
gas  distribution   companies  do  not  contain  such  a  weather  normalization
adjustment and,  therefore,  fluctuations in seasonal weather conditions between
years may have a significant  effect on results of operations and cash flows for
these four  subsidiaries.  We utilize weather  derivatives for KEDNE to mitigate
variations  in firm net revenues due to  warmer-than-normal  weather  during the
heating season.

New York Gas Distribution Systems - KEDNY and KEDLY Supply and Storage

KEDNY and KEDLI have firm long-term contracts for the purchase of transportation
and  underground  storage  services.  Gas supplies are purchased  under long and
short-term  firm  contracts,  as well as on the spot  market.  Gas  supplies are
transported by interstate  pipelines  from domestic and Canadian  supply basins.
Peaking  supplies are available to meet system  requirements on the coldest days
of the winter season.

Peak-Day Capability.  The design criteria for the New York gas system assumes an
average  temperature  of 0(0)F for  peak-day  demand.  Under such  criteria,  we
estimate that the  requirements to supply our firm gas customers would amount to
approximately 2,129 MDTH (one MDTH equals 1,000 DTH or 1 billion British Thermal
Units) of gas for a peak-day  during the 2006/07  winter season and that the gas
available to us on such a peak-day amounts to approximately 2,235 MDTH.


                                       6
<PAGE>


The highest daily throughput most recently  experienced  occurred on February 5,
2007 in which the demand of the firm New York  customers was 1,874 MDTH, and the
average temperature was 14(degree)F.  KEDNY and KEDLI have sufficient gas supply
available to meet the  requirements  of their firm gas customers for the 2006/07
winter season.

Our New York firm gas peak-day capability is summarized in the following table:

Source                                        MDTH per day         % of Total
------------------------------------------    ----------------     ------------

Pipeline                                      865                  39%
Underground Storage                           800                  36%
Peaking Supplies                              570                  25%
                                              ---                  ---

Total                                         2,235                100%
                                              =======              =======

Pipelines.  Our New York based gas distribution  utilities  purchase natural gas
for sale under  contracts  with suppliers of natural gas located in domestic and
Canadian  supply  basins and arrange for its  transportation  to our  facilities
under firm  long-term  contracts with  interstate  pipeline  companies.  For the
2006/07  gas year,  approximately  73% of our New York  natural  gas  supply was
available from domestic sources and 27% from Canadian sources. We have available
under  firm  contract  865  MDTH per day of  year-round  and  seasonal  pipeline
transportation capacity. Our major providers of interstate pipeline capacity and
related   services   include:   Transcontinental   Gas  Pipe  Line   Corporation
("Transco"),  Texas Eastern  Transmission  Corporation  ("Tetco"),  Iroquois Gas
Transmission   System,  L.P.   ("Iroquois"),   Tennessee  Gas  Pipeline  Company
("Tennessee"),   Dominion  Transmission  Incorporated  ("Dominion"),  Texas  Gas
Transmission Company, TransCanada Corporation and Union Gas.

Underground  Storage.  In order to meet  winter  demand in our New York  service
territories,  we also have long-term contracts with Transco,  Tetco,  Tennessee,
Dominion,  Equitrans,  Inc.,  National  Fuel Gas Supply  Corporation  ("National
Fuel") and Honeoye  Storage  Corporation  ("Honeoye")  for  underground  storage
capacity of 60,766 MDTH and 800 MDTH per day of maximum deliverability.

Peaking Supplies. In addition to the pipeline and underground storage supply, we
supplement our winter supply  portfolio with peaking supplies that are available
on the coldest days of the year to economically meet the increased  requirements
of our heating customers. Our peaking supplies include: (i) two LNG plants; (ii)
peaking supply contracts with dual-fuel power producers located in our franchise
areas; and (iii)  third-party  peaking supply  contracts with suppliers  located
outside  our  franchise  area.  For the  2006/07  winter  season,  we  have  the
capability to provide  maximum  peaking  supplies of 570 MDTH on extremely  cold
days.  The LNG plants  provide us with peak-day  capacity of 395 MDTH and winter
season  availability  of 2,053 MDTH. The peaking supply  contracts with the dual
fuel power  producers  provide us with peak-day  capacity of 175 MDTH and winter
season availability of 4,846 MDTH.


                                       7
<PAGE>


Gas Supply  Management.  We  currently  perform  our New  York-based  gas supply
management services internally.

Gas Costs. The current gas rate structure of each of these companies  includes a
gas  adjustment  clause  pursuant to which  variations  between actual gas costs
incurred  and gas costs  billed are  deferred  and  subsequently  refunded to or
collected from firm customers.

Combined  Gas  Supply  Portfolios.   KEDNY  and  KEDLI  combined  the  planning,
management and utilization of their  respective gas supply  portfolios to enable
each  company  to serve  its  customers  more  reliably  and  cost  effectively.
Specifically,  these  companies plan the  acquisition  of  incremental  pipeline
capacity,  underground  storage, gas supply and peaking supply contracts to meet
projected  growth in firm customer demand on a combined  portfolio  basis.  This
approach  enables these companies to realize  synergies that would otherwise not
be attainable if they were to plan  independently  for the  development of their
respective  portfolios.  These two  companies,  by  virtue  of their  geographic
proximity,  complementary customer demand profiles and similar gas contracts are
able to add  incremental  capacity more  effectively  to meet expected  customer
demand growth by planning the portfolios on a combined basis.

Deregulation.  Regulatory actions, economic factors and changes in customers and
their preferences continue to reshape our gas operations.  A number of customers
currently  purchase  their gas  supplies  from  natural gas  marketers  and then
contract  with  us for  local  transportation,  balancing  and  other  unbundled
services.  In addition,  our New York gas  distribution  companies  release firm
capacity on our  interstate  pipeline  transportation  contracts  to natural gas
marketers to ensure the  marketers'  gas supply is delivered on a firm basis and
in a reliable manner. As of January 1, 2007,  approximately 98,968 gas customers
on the New York gas distribution system are purchasing their gas from marketers.
However, net gas revenues are not significantly  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
sales service customers.

New England Gas Distribution Systems - KEDNE Supply and Storage

KEDNE has firm  long-term  contracts  for the  purchase  of  transportation  and
underground  storage  services.  Gas  supplies  are  purchased  under  long  and
short-term  firm  contracts,  as well as on the spot  market.  Gas  supplies are
transported by interstate  pipelines  from domestic and Canadian  supply basins.
Peaking  supplies are available to meet system  requirements on the coldest days
of the winter season.

Peak-Day Capability. The design criteria for the New England gas systems assumes
an average  temperature of -6(0)F in  Massachusetts  and -8(0)F in New Hampshire
for peak-day demand.  Under such criteria,  we estimate that the requirements to
supply our firm gas customers  would amount to  approximately  1,389 MDTH of gas
for a peak-day during the 2006/07 winter season and that the gas available to us
on such a peak-day amounts to approximately 1,420 MDTH.


                                       8
<PAGE>


The highest daily throughput most recently  experienced  occurred on January 26,
2007 in which the demand of the firm New England  customers (which includes both
firm sales and firm  transportation) was 1,210 MDTH, and the average temperature
was 9(0)F. KEDNE has sufficient gas supply available to meet the requirements of
their firm gas customers for the 2006/07 winter season.

Our New England firm gas peak-day capability is summarized in the following
table:

Source                                     MDTH per day        % of Total
---------------------------------------    ----------------    --------------

Pipeline                                   500                 35%
Underground Storage                        248                 18%
Peaking Supplies                           672                 47%
                                           ---------           --
Total                                      1,420               100%
                                           =========           =======

Pipelines. Our New England based gas distribution utilities purchase natural gas
for sale under  contracts  with suppliers of natural gas located in domestic and
Canadian supply basins and arrange for  transportation  to our facilities  under
firm long-term contracts with interstate  pipeline companies.  We have available
under  firm  contract  500  MDTH per day of  year-round  and  seasonal  pipeline
transportation capacity. Our major providers of interstate pipeline capacity and
related  services  include:   Algonquin  Gas  Transmission  Company,   Iroquois,
Maritimes and Northeast  Pipelines,  Portland Natural Gas  Transmission  System,
Tennessee and TETCO.

Underground  Storage.  In order to meet winter demand in our New England service
territories,  we also have long-term contracts with Tetco, Tennessee,  Dominion,
National Fuel and Honeoye for  underground  storage  capacity of 23,280 MDTH and
248 MDTH per day of maximum deliverability.

Peaking Supplies. In addition to the pipeline and underground storage supply, we
supplement our winter supply  portfolio with peaking supplies that are available
on the coldest days of the year to economically meet the increased  requirements
of our heating  customers.  Our peaking  supplies  include (i) local  production
plants  that store LNG and liquid  propane  until  vaporized,  which are located
strategically  across the service  territory and (ii)  contracts for LNG storage
and delivery with our LNG  subsidiary,  KeySpan LNG LP,  located in  Providence,
Rhode  Island  and  with   Distrigas  of   Massachusetts   located  in  Everett,
Massachusetts.  For the 2006/07 winter season, we have the capability to provide
maximum peaking supplies of 672 MDTH on extremely cold days.

Gas Supply  Management.  KeySpan has a management  contract  with Merrill  Lynch
Trading,   under   which   KeySpan   and  Merrill   Lynch   Trading   share  the
responsibilities   for  managing   KeySpan's   upstream  gas  contracted  assets
associated with its  Massachusetts  gas  distribution  subsidiaries,  as well as
providing  city-gate  delivered  supply.  KeySpan,  Merrill  Lynch  Trading  and
KeySpan's  Massachusetts gas sales customers will share in the profits generated


                                       9
<PAGE>


from  the  optimization  of  these  assets.  The  Massachusetts   Department  of
Telecommunications  and Energy  ("MADTE")  approved  this contract in March 2006
effective April 1, 2006. KeySpan provides these services  internally for its New
Hampshire gas distribution subsidiaries.

Gas  Costs.  The  current  gas rate  structure  of each of the  KEDNE  companies
includes a gas adjustment clause pursuant to which variations between actual gas
costs incurred and gas costs billed are deferred and subsequently refunded to or
collected from firm customers.

For  additional  information  and for financial  information  concerning the gas
distribution segment, see the discussion in Item 7. Management's  Discussion and
Analysis of Financial  Condition and Results of Operations - "Gas  Distribution"
and Note 2 to the Consolidated Financial Statements, "Business Segments".

ELECTRIC SERVICES OVERVIEW

We are the largest  electric  generator in New York State.  Our subsidiaries own
and  operate 5 large  generating  plants  and 13  smaller  facilities  which are
comprised of 57 generating  units in Nassau and Suffolk  Counties on Long Island
and the Rockaway Peninsula in Queens. In addition, we own, lease and operate the
Ravenswood  Generating  Station  located in Queens County,  which is the largest
generating  facility  in New York City.  The  Ravenswood  Generating  Station is
comprised of 3 large steam-generating  units, a 250 MW combined cycle generating
unit and 17 gas turbine  generators.  We also  operate and  maintain a 55 MW gas
turbine unit in Greenport, Long Island under an agreement with a third party.

As  more  fully  described  below,  we:  (i)  provide  to  LIPA  all  operation,
maintenance and construction  services and significant  administrative  services
relating  to the Long  Island  electric  T&D  System  pursuant  to a  Management
Services  Agreement (the "1998 MSA"); (ii) supply LIPA with electric  generating
capacity,  energy  conversion  and  ancillary  services  from  our  Long  Island
generating  units  pursuant to a Power Supply  Agreement  (the "1998 PSA");  and
(iii)  manage all  aspects of the fuel  supply  for our Long  Island  generating
facilities,  as well as all aspects of the capacity and energy owned by or under
contract to LIPA pursuant to an Energy  Management  Agreement  (the "1998 EMA").
The 1998 MSA,  1998 PSA and 1998 EMA became  effective  on May 28,  1998 and are
collectively referred to herein as the "1998 LIPA Agreements."

On February 1, 2006,  KeySpan and LIPA  entered into (i) an amended and restated
Management  Services Agreement (the "2006 MSA"),  pursuant to which KeySpan will
continue to operate and  maintain  the electric T&D System owned by LIPA on Long
Island  through  2013;  (ii) a new Option and Purchase and Sale  Agreement  (the
"2006 Option  Agreement"),  to replace the Generation  Purchase Rights Agreement
(the "GPRA"),  pursuant to which LIPA had the option, through December 15, 2005,
to acquire  substantially  all of the electric  generating  facilities  owned by
KeySpan on Long Island;  and (iii) a Settlement  Agreement (the "2006 Settlement
Agreement")  resolving outstanding issues between the parties regarding the 1998
LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement
Agreement  are  collectively  referred to herein as the "2006 LIPA  Agreements."
These  will  become  effective   following   approval  by  the  New  York  State


                                       10
<PAGE>


Comptroller's  Office and the New York State  Attorney  General.  (For a further
discussion  on these  LIPA  agreements  see the  discussion  under  the  caption
"Electric Services - LIPA Agreements" and Note 11 to the Consolidated  Financial
Statements "2006 LIPA Settlement").  The Electric Services segment also provides
retail marketing of electricity to commercial customers.

Portions of our Electric  Services  business can be affected by seasonal weather
conditions  and  market  conditions.   The  majority  of  the  capacity  revenue
associated  with the Ravenswood  Generating  Station is realized  during the six
months between May and October of each year.  Energy and ancillary service sales
from our Ravenswood Generating Station are directly correlated to the demand for
electricity  and competition  from other  resources.  Typically,  the demand and
price for electricity  increases  during the extreme  temperature  conditions of
summer.  However,  depending  on the  availability  of  alternative  competitive
supply, extreme temperature conditions may not result in increased revenue. As a
result,  fluctuations in weather and competitive supply between years may have a
significant  effect on results of  operations  in this  portion of our  Electric
Services business.

Generating Facility Operations

In June 1999, we acquired the 2,200 MW Ravenswood  Facility  located in New York
City from Consolidated Edison Company of New York, Inc.  ("Consolidated Edison")
for approximately $597 million. In order to reduce our initial cash requirements
to finance this acquisition, we entered into an arrangement with an unaffiliated
variable  interest  entity  through  which we lease a portion of the  Ravenswood
Facility. Under the arrangement, the variable interest entity acquired a portion
of the facility  directly from  Consolidated  Edison and leased it to our wholly
owned  subsidiary,   KeySpan-Ravenswood,   LLC  ("KSR").  For  more  information
concerning  this lease  arrangement,  see Note 7 to the  Consolidated  Financial
Statements, "Contractual Obligations, Financial Guarantees and Contingencies."

In  2004,  we  completed  construction  of the  Ravenswood  Expansion,  a 250 MW
combined cycle generating unit at the Ravenswood  Facility,  thereby  increasing
the total electric  capacity of the Ravenswood  Facility to 2,450 MW. In mid-May
2004, the Ravenswood Expansion began full commercial operations.  To finance the
Ravenswood  Expansion,  we entered into a leveraged lease financing  arrangement
pursuant to which the  Ravenswood  Expansion  was  acquired  by an  unaffiliated
lessor from KSR and  simultaneously  leased  back to it. 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."  See  Item 7.
Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operation - "Electric  Services Revenue  Mechanisms" for a further discussion of
these matters.

The Ravenswood Generating Station sells capacity,  energy and ancillary services
into the New York Independent  System Operator  ("NYISO")  electricity market at
market-based  rates,  subject to mitigation.  The Ravenswood  Generating Station
Facility  has the  ability  to  provide  approximately  25% of New  York  City's
capacity  requirements  and is a  strategic  asset  that is  available  to serve
residents and businesses in New York City.


                                       11
<PAGE>


The Ravenswood Generating Station and our New York City Operations

The  NYISO's  New York City  local  reliability  rules  require  that 80% of the
electric  capacity  needs of New York City be provided by "in-City"  generators.
Our Ravenswood  Generating  Station is an "in-City"  generator.  As the electric
infrastructure  in New York City and the  surrounding  areas continues to change
and evolve and the demand for electric power increases,  the "in-City" generator
requirement  could be further  modified.  Construction of new  transmission  and
generation  facilities may cause significant  changes to the market for sales of
capacity, energy and ancillary services from our Ravenswood Generating Station.

KeySpan  continues  to believe that New York City  represents a strong  capacity
market and has entered into an International Swap Dealers  Association  ("ISDA")
Master  Agreement for a fixed for float  unforced  capacity  financial swap (the
"Swap  Agreement")  with Morgan Stanley  Capital Group Inc.  ("Morgan  Stanley")
dated as of January  18,  2006.  The Swap  Agreement  has a three year term that
began on May 1, 2006.  The  notional  quantity  is  1,800,000kW  (the  "Notional
Quantity") of In-City  Unforced  Capacity and the fixed price is  $7.57/kW-month
("Fixed  Price"),  subject to adjustment  upon the occurrence of certain events.
Settlement  occurs on a monthly  basis  based on the In-City  Unforced  Capacity
price  determined  by the relevant New York  Independent  System  Operator  Spot
Demand Curve Auction  Market  ("Floating  Price").  For each monthly  settlement
period, the price difference equals the Fixed Price minus the Floating Price. If
such price  difference is less than zero,  Morgan Stanley pays KeySpan an amount
equal to the product of (a) the Notional  Quantity and (b) the absolute value of
such price  difference.  Conversely,  if such price  difference  is greater than
zero,  KeySpan  pays  Morgan  Stanley an amount  equal to the product of (a) the
Notional Quantity and (b) the absolute value of such price difference.

The New York  State  competitive  wholesale  market  for  capacity,  energy  and
ancillary  services  administered  by the NYISO is still  evolving  and FERC has
adopted  several price  mitigation  measures  which are subject to rehearing and
possible judicial review.  See Item 7.  Management's  Discussion and Analysis of
Financial   Condition  and  Results  of  Operation  -  "Regulatory   Issues  and
Competitive Environment" for a further discussion of these matters.

Forty-six of our  seventy-eight  generating units are dual fuel units. In recent
years,  we have  reconfigured  several of our  facilities to enable them to burn
either natural gas or oil, thus enabling us to switch periodically  between fuel
alternatives based upon cost and seasonal  environmental  requirements.  Through
other  innovative  technological  approaches,  we instituted a program to reduce
nitrogen oxides for improved environmental performance while recovering 80 MW of
energy output.


                                       12
<PAGE>


The  following  table  indicates  the 2006  summer  capacity of all of our steam
generation facilities and gas turbine ("GT") units as reported to the NYISO:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
Location of Units                     Description                      Fuel              Units           MW
--------------------------------------------------------------------------------------------------------------------
<S>                                  <C>                              <C>               <C>             <C>
Long Island City                      Steam Turbine                    Dual*             3               1,651
Long Island City                      Combined Cycle                   Dual*             1               231
Northport, L.I.                       Steam Turbine                    Dual*             4               1,552
Port Jefferson, L.I.                  Steam Turbine                    Dual*             2               383
Glenwood, L.I.                        Steam Turbine                    Gas               2               239
Island Park, L.I.                     Steam Turbine                    Dual*             2               385
Far Rockaway, L.I.                    Steam Turbine                    Dual*             1               111
Long Island City                      GT Units                         Dual*             17              423
Glenwood and Port
Jefferson Energy
Center, L.I.                          GT Units                         Dual              4               159
Throughout L.I.                       GT Units                         Dual*             12              305
Throughout L.I.                       GT Units                         Oil               30              1067
                                                                                         --              ----

TOTAL                                                                                    78              6506

====================================================================================================================
*Dual - Oil (#2 oil or #6 residual oil) or kerosene, and natural gas.
</TABLE>

For additional information and for financial information concerning the Electric
Services  segment,  see the  discussion in Item 7.  Management's  Discussion and
Analysis of Financial  Condition and Results of Operations - "Electric Services"
and Note 2 to the Consolidated Financial Statements, "Business Segments".

Agreements with LIPA

LIPA is a corporate municipal instrumentality and a political subdivision of the
State of New York.  On May 28,  1998,  certain  of LILCO's  business  units were
merged with KeySpan and LILCO's common stock and remaining  assets were acquired
by LIPA.  At the time of this  transaction,  KeySpan and LIPA entered into three
major  long-term  service  agreements  that (i)  provide to LIPA all  operation,
maintenance and construction  services and significant  administrative  services
relating to the Long Island electric  transmission and distribution system ("T&D
System")  pursuant to the Management  Services  Agreement (the "1998 MSA"); (ii)
supply LIPA with electric generating  capacity,  energy conversion and ancillary
services  from our Long Island  generating  units  pursuant to the Power  Supply
Agreement  (the "1998  PSA") and other  long-term  agreements  through  which we
provide LIPA with  approximately  one half of its customers'  energy needs;  and
(iii)  manage all  aspects of the fuel  supply  for our Long  Island  generating
facilities,  as well as all aspects of the capacity and energy owned by or under
contract to LIPA pursuant to the Energy  Management  Agreement (the "1998 EMA").
We also purchase energy,  capacity and ancillary  services in the open market on
LIPA's behalf under the 1998 EMA. The 1998 MSA, 1998 PSA and 1998 EMA all became
effective  on May 28,  1998 and are  collectively  referred  to as the 1998 LIPA
Agreements.


                                       13
<PAGE>


On February 1, 2006,  KeySpan and LIPA  entered into (i) an amended and restated
Management  Services Agreement (the "2006 MSA"),  pursuant to which KeySpan will
continue to operate and  maintain  the electric T&D System owned by LIPA on Long
Island;  (ii) a new Option and  Purchase  and Sale  Agreement  (the "2006 Option
Agreement"),  to replace the Generation  Purchase Rights  Agreement (as amended,
the "GPRA"),  pursuant to which LIPA had the option,  through December 15, 2005,
to acquire  substantially  all of the electric  generating  facilities  owned by
KeySpan on Long Island;  and (iii) a Settlement  Agreement (the "2006 Settlement
Agreement")  resolving outstanding issues between the parties regarding the 1998
LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement
Agreement  are  collectively  referred to herein as the "2006 LIPA  Agreements".
Each of the 2006 LIPA  Agreements  will become  effective  as of January 1, 2006
upon  all of the  2006  LIPA  Agreements  receiving  the  required  governmental
approvals; otherwise none of the 2006 LIPA Agreements will become effective. The
2006 LIPA Agreements become effective  following  approval by the New York State
Comptroller's Office and the New York State Attorney General.

2006  Settlement  Agreement.  Pursuant  to  the  terms  of the  2006  Settlement
Agreement,  KeySpan and LIPA agreed to resolve issues that have existed  between
the parties  relating to the various  1998 LIPA  Agreements.  In addition to the
resolution of these matters,  KeySpan's entitlement to utilize LILCO's available
tax  credits and other tax  attributes  will  increase  from  approximately  $50
million to approximately $200 million.  These credits and attributes may be used
to satisfy KeySpan's  previously  incurred indemnity  obligation to LIPA for any
federal  income tax liability that results from the recent  settlement  with the
IRS regarding the audit of LILCO's tax returns for the years ended  December 31,
1996  through  March 31,  1999.  On October  30,  2006,  the IRS  submitted  the
settlement provisions of the recently concluded IRS audit to the Joint Committee
on  Taxation  for  approval.  Key  provisions  of the  settlement  included  the
resolution of the tax basis of assets  transferred to KeySpan at the time of the
KeySpan/LILCO  merger, the tax deductibility of certain merger related costs and
the tax  deductibility  of certain  environmental  expenditures.  The settlement
enabled KeySpan to utilize 100% of the available tax credits. (See Note 3 to the
Consolidated  Financial Statements "Income Taxes" for additional  information of
the  settlement.) In recognition of these items, as well as for the modification
and extension of the 1998 MSA and the amendments to the GPRA, upon effectiveness
of the 2006 Settlement Agreement, KeySpan will record a contractual asset in the
amount of approximately $160 million,  of which  approximately $110 million will
be attributed to the right to utilize such additional credits and attributes and
approximately $50 million will be amortized over the eight year term of the 2006
MSA. In order to compensate  LIPA for the  foregoing,  KeySpan will pay LIPA $69
million in cash and will settle  certain  accounts  receivable  in the amount of
approximately $90 million due from LIPA.

Generation  Purchase  Rights  Agreement  and 2006  Option  Agreement.  Under the
amended  GPRA,  LIPA  had  the  right  to  acquire  certain  of  KeySpan's  Long
Island-based  generating  assets formerly owned by LILCO at fair market value at
the time of the exercise of such right.  LIPA was  initially  required to make a
determination  by May 2005,  but  KeySpan  and LIPA agreed to extend the date by
which LIPA was to make this  determination  to December 15, 2005. As part of the
2006  settlement  between  KeySpan and LIPA,  the parties  entered into the 2006
Option  Agreement  whereby LIPA had the option during the period January 1, 2006
to December 31, 2006 to purchase only KeySpan's Far Rockaway and/or E.F. Barrett


                                       14
<PAGE>


Generating  Stations  (and certain  related  assets) at a price equal to the net
book value of each facility.  In December 2006, KeySpan and LIPA entered into an
amendment to the 2006 Option Agreement  whereby the parties agreed to extend the
expiration  of the option  period to the later of (i)  December 31, 2007 or (ii)
180 days  following the effective  date of the 2006 Option  Agreement.  The 2006
Option  Agreement  replaces the GPRA,  the  expiration  of which has been stayed
pending effectiveness of the 2006 LIPA Agreements.  In the event such agreements
do not become  effective  by reason of  failure  to secure any of the  requisite
governmental approvals, the GPRA will be reinstated for a period of 90 days from
the date such  approval  is  denied.  If LIPA were to  exercise  the  option and
purchase one or both of the  generation  facilities  then:  (i) LIPA and KeySpan
will  enter into an  operation  and  maintenance  agreement,  pursuant  to which
KeySpan will  continue to operate  these  facilities  through May 28, 2013 for a
fixed management fee plus  reimbursement for certain costs and (ii) the 1998 PSA
and 1998 EMA will be amended to reflect that the purchased generating facilities
would no longer be covered by those agreements.  It is anticipated that the fees
received  pursuant to the operation and  maintenance  agreement  will offset the
reduction in the operation and  maintenance  expense  recovery  component of the
1998 PSA and the reduction in fees under the 1998 EMA.

Management  Services  Agreements.  Pursuant to the 1998 MSA, KeySpan manages the
day-to-day  operations,  maintenance and capital improvements of the T&D System.
When originally  executed,  the 1998 MSA had a term expiring on May 28, 2006. In
2002,  in  connection  with an  extension  of the  GPRA  term,  the 1998 MSA was
extended for 31 months through 2008. As a result of the recent  negotiations and
settlement  between KeySpan and LIPA discussed  above,  the parties entered into
the 2006 MSA.

In place of the previous compensation  structure (whereby KeySpan was reimbursed
for budgeted  costs,  and earned a management  fee and certain  performance  and
cost-based incentives), KeySpan's compensation for managing the T&D System under
the 2006 MSA consists of two  components:  a minimum  compensation  component of
$224 million per year and a variable component based on electric sales. The $224
million  component  will  remain  unchanged  for three  years and then  increase
annually by 1.7% plus inflation. The variable component,  which will comprise no
more than 20% of  KeySpan's  compensation,  is based on  electric  sales on Long
Island  exceeding a base amount of 16,558 gigawatt hours,  increasing by 1.7% in
each year. Above that level,  KeySpan will receive  approximately 1.34 cents per
kilowatt hour for the first contract  year,  1.29 cents per kilowatt hour in the
second  contract  year  (plus an annual  inflation  adjustment),  1.24 cents per
kilowatt hour in the third contract year (plus an annual inflation  adjustment),
with the per  kilowatt  hour rate  thereafter  adjusted  annually by  inflation.
Subject to certain  limitations,  KeySpan will be able to retain all operational
efficiencies realized during the term of the 2006 MSA.

LIPA will  continue to reimburse  KeySpan for certain  expenditures  incurred in
connection  with the  operation  and  maintenance  of the T&D System,  and other
payments made on behalf of LIPA,  including:  real property and other T&D System
taxes,  return  postage,   capital   construction   expenditures,   conservation
expenditures and storm costs.


                                       15
<PAGE>


The 2006 MSA  provides for a number of  performance  metrics  measuring  various
aspects of KeySpan's  performance in the operations and customer  service areas.
Poor  performance  in any metric may  subject  KeySpan  to  financial  and other
non-cost  penalties  (such  financial  penalties not to exceed $7 million in the
aggregate for all performance metrics in any contract year).  Subject to certain
limitations,  superior  performance  in  certain  metrics  can be used to offset
underperformance  in  other  metrics.   Consistent  failure  to  meet  threshold
performance levels for two metrics,  System Average Interruption  Duration Index
(two out of three  consecutive  years) and  Customer  Satisfaction  Index (three
consecutive years), will constitute an event of default under the 2006 MSA.

In the event LIPA sells the T&D  System to a private  entity  during the term of
the 2006 MSA, LIPA shall have the right to terminate the 2006 MSA, provided that
LIPA  will be  required  to pay  KeySpan's  reasonable  transition  costs  and a
termination fee of (a) $28 million if the  termination  date occurs on or before
December  31,  2009,  and (b) $20 million if the  termination  date occurs after
December 31, 2009.

Upon approval, the 2006 LIPA Agreements will be effective retroactive to January
1, 2006.  KeySpan's reported operating income and net income for 2006, under the
2006 MSA,  are  substantially  the same as they would have been if the terms and
provisions of the 1998 MSA had  continued to be applied.  At this point in time,
KeySpan  is  unable to  estimate  what the  impact  would be to its  results  of
operations, financial position and cash flows if the 2006 LIPA Agreements do not
become fully effective.

Power Supply  Agreements.  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 FERC.  Since  October 1, 2004,
pursuant to a FERC  approved  settlement,  the rates reflect a cost of equity of
9.5% with no revenue  increase.  The FERC also  approved  updated  operating and
maintenance  expense  levels and  KeySpan's  recovery of certain  other costs as
agreed to by the  parties.  Rates  charged to LIPA  include a fixed and variable
component.  The  variable  component is billed to LIPA on a monthly per megawatt
hour basis and is dependent on the number of megawatt hours dispatched. LIPA has
no obligation to purchase energy conversion services from KeySpan and is able to
purchase  energy or energy  conversion  services on a least-cost  basis from all
available sources  consistent with existing  interconnection  limitations of the
T&D System.  The 1998 PSA provides  incentives  and penalties  that can total $4
million annually for the maintenance of the output capability and the efficiency
of the  generating  facilities.  In 2006,  we earned $4.0 million in  incentives
under this agreement.

The 1998 PSA has a term of fifteen years through May 2013,  with LIPA having the
option to renew the 1998 PSA for an  additional  fifteen year term.  If the 2006
LIPA  Agreements  receive  the  requisite   governmental  approvals  and  become
effective and if LIPA  exercises  its rights under the 2006 Option  Agreement to
purchase  the two  generating  plants,  then LIPA and KeySpan will enter into an
operation and maintenance agreement,  pursuant to which KeySpan will continue to
operate these  facilities  for a fixed  management  fee plus  reimbursement  for
certain costs; and the 1998 PSA will be amended to reflect that the purchased


                                       16
<PAGE>


generating  facilities  would  no  longer  be  covered  by the 1998  PSA.  It is
anticipated  that the fees received  pursuant to the  operation and  maintenance
agreement  will offset the reduction in the operation  and  maintenance  expense
recovery component of the 1998 PSA.

Energy  Management  Agreement.  The 1998 EMA provides for KeySpan to procure and
manage fuel supplies on behalf of LIPA to fuel the generating  facilities  under
contract  to it and  perform  off-system  capacity  and  energy  purchases  on a
least-cost basis to meet LIPA's needs. In exchange for these services we earn an
annual fee of $1.5  million.  In addition,  we arrange for  off-system  sales on
behalf of LIPA of excess output from the  generating  facilities and other power
supplies  either owned or under contract to LIPA. LIPA is entitled to two-thirds
of the profit  from any  off-system  energy  sales.  In  addition,  the 1998 EMA
provides  incentives  and  penalties  that can  total $5  million  annually  for
performance  related to fuel purchases and off-system power purchases.  In 2006,
we earned EMA incentives in an aggregate of $5.0 million.

The original term for the fuel supply service is fifteen years, expiring May 28,
2013, and the original term for the power supply management  services  described
was eight years,  which  expired on May 28, 2006.  In March 2005,  LIPA issued a
Request  for  Proposal  ("RFP")  for system  power  supply  management  services
beginning May 29, 2006 and fuel  management  services for certain of its peaking
generating units beginning January 1, 2006.  KeySpan submitted a bid in response
to this RFP in April 2005. LIPA has not yet selected a service provider.

In 2005,  the EMA was  amended  to extend the term for power  supply  management
services  through  December 31, 2006 and thereafter on a  month-to-month  basis,
unless  terminated  by LIPA on sixty  days  notice,  but in no event  later than
December 31, 2007.

In the event LIPA exercises its rights under the 2006 Option Agreement,  KeySpan
and LIPA  will  enter  into an  amendment  to the 1998 EMA  reflecting  that the
facilities  that LIPA  acquires  pursuant to the Option  Agreement are no longer
covered  under the 1998 EMA and as noted  above,  an operation  and  maintenance
agreement,   whereby  KeySpan  will  continue  to  operate  the  newly  acquired
facilities for a fixed management fee plus  reimbursement  for certain costs. It
is anticipated that the fees received  pursuant to the operation and maintenance
agreement  will offset the  reduction in any fees earned by KeySpan  pursuant to
the 1998 EMA.

Under the 1998 LIPA Agreements and the 2006 LIPA Agreements,  we are required to
obtain a letter of credit in the aggregate amount of $60 million  supporting our
obligations  to provide the various  services if our long-term debt is not rated
in the "A" range by a nationally recognized rating agency.

Power Purchase Agreements.  KeySpan-Glenwood Energy Center, LLC and KeySpan-Port
Jefferson  Energy Center LLC each have 25 year power  purchase  agreements  with
LIPA  expiring in 2027 (the "2002 LIPA PPAs").  Under the terms of the 2002 LIPA
PPAs, these subsidiaries sell capacity, energy conversion services and ancillary
services to LIPA.  Each plant is designed  to produce  79.9 MW.  Pursuant to the
2002 LIPA PPAs, LIPA pays a monthly capacity fee, which guarantees full recovery
of each plant's  construction costs, as well as an appropriate rate of return on
investment.


                                       17
<PAGE>


Other Rights.  Pursuant to other  agreements  between LIPA and KeySpan,  certain
future rights have been granted to LIPA.  Subject to certain  conditions,  these
rights  include the right for 99 years (from May 1998) to lease or purchase,  at
fair market value,  parcels of land and to acquire  unlimited access to, as well
as  appropriate  easements  at, the Long Island  generating  facilities  for the
purpose of constructing new electric  generating  facilities to be owned by LIPA
or its designee. Subject to this right granted to LIPA, KeySpan has the right to
sell or lease property on or adjoining the Long Island generating  facilities to
third parties.

We own common plant assets (such as administrative office buildings and computer
systems)  formerly owned by LILCO and recover an allocable share of the carrying
costs of such plant assets through the MSA.  KeySpan has agreed to provide LIPA,
for a period of 99 years (from May 1998), the right to enter into leases at fair
market value for common plant assets or  sub-contract  for common services which
it may assign to a  subsequent  manager  of the  transmission  and  distribution
system. We have also agreed: (i) for a period of 99 years (from May 1998) not to
compete with LIPA as a provider of transmission or distribution  service on Long
Island;  (ii) that LIPA will share in synergy (i.e.,  efficiency) savings over a
10-year period  attributed to the May 28, 1998 transaction which resulted in the
formation of KeySpan  (estimated to be approximately $1 billion),  which savings
are  incorporated  into the cost structure under the 1998 LIPA  Agreements;  and
(iii)  generally not to commence any tax certiorari case (during the pendency of
the 1998 PSA)  challenging  certain  property  tax  assessments  relating to the
former LILCO Long Island generating facilities.

Guarantees and Indemnities. We have entered into agreements with LIPA to provide
for the  guarantee  of  certain  obligations,  indemnification  against  certain
liabilities  and  allocation  of   responsibility   and  liability  for  certain
pre-existing  obligations and liabilities.  In general,  liabilities  associated
with the LILCO assets transferred to KeySpan,  have been assumed by KeySpan; and
liabilities  associated  with the assets  acquired  by LIPA,  are borne by LIPA,
subject to certain specified exceptions. We have assumed all liabilities arising
from  all   manufactured   gas  plant  ("MGP")   operations  of  LILCO  and  its
predecessors,  and LIPA has assumed certain  liabilities  relating to the former
LILCO Long Island  generating  facilities and all  liabilities  traceable to the
business  and  operations  conducted  by  LIPA  after  completion  of  the  1998
KeySpan/LILCO  transaction.  An agreement  also  provides for an  allocation  of
liabilities  which  relates to the assets that were common to the  operations of
LILCO and/or shared services or liabilities which are not traceable  directly to
either the business or  operations  conducted  by LIPA or KeySpan.  In addition,
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 PSA.

ENERGY SERVICES OVERVIEW

The Energy  Services  segment  includes  companies  that provide  energy-related
services to customers located  primarily within the Northeastern  United States,
with  concentrations  in the  New  York  City  and  Boston  metropolitan  areas.
Subsidiaries in this segment provide residential and small commercial  customers


                                       18
<PAGE>


with  service  and  maintenance  of energy  systems and  appliances,  as well as
operation  and  maintenance,  design,  engineering,  consulting  and fiber optic
services to commercial, institutional and industrial customers. Our subsidiaries
in this  segment have over  200,000  service  contracts in place to provide home
energy services,  completed over 240,000 service calls during 2006 and completed
more than 16,000 installations during 2006.

For  additional  information  and financial  information  concerning  the Energy
Services  segment,  see the  discussion in Item 7.  Management's  Discussion and
Analysis of Financial  Condition and Results of Operations - "Energy  Services",
Item  8.  "Financial   Statements  and  Supplementary   Data",  Note  2  to  the
Consolidated  Financial  Statements,  "Business Segments",  and Note 10, "Energy
Services - Discontinued Operations".

ENERGY INVESTMENTS OVERVIEW

We are also engaged in Energy  Investments  which  includes gas  production  and
development  activities,  domestic  pipelines,  gas storage  facilities  and LNG
facilities and operations.

Gas Production and Development

KeySpan is engaged in the production and development of domestic natural gas and
oil through  wholly-owned  subsidiaries  Seneca-Upshur  Petroleum,  Inc.,  d/b/a
KeySpan  Production  &  Development   Company   ("Seneca-Upshur")   and  KeySpan
Exploration  and  Production,   LLC  ("KeySpan   Exploration  and  Production").
Seneca-Upshur's  assets  consist of 38 billion  cubic feet of low risk,  mature,
onshore gas producing properties. Specifically, Seneca-Upshur,  headquartered in
Buckhannon,  West Virginia,  owns and operates onshore gas producing properties,
and operates approximately 1,300 wells in north central West Virginia. To manage
the  inherent  volatility  in  commodity  prices,  Seneca-Upshur  entered into a
three-year  hedge for a  majority  of its  production.  KeySpan  Exploration  is
involved in a joint venture with Merit Energy  Corporation,  an independent  oil
and gas  producer,  which  acquired its interest in the  joint-venture  from The
Houston  Exploration Company ("Houston  Exploration").  See Item 7. Management's
Discussion  and Analysis of  Financial  Conditions  and Results of  Operations -
"Energy Investments" for a further discussion of these matters.







                                       19
<PAGE>


Domestic Pipelines and Gas Storage Facilities

We own a 20.4% interest in Iroquois Gas Transmission System LP, a partnership of
affiliates of six U.S. and Canadian  energy  companies,  which is the owner of a
411-mile interstate natural gas pipeline extending from the U.S.-Canadian border
at Waddington,  NY through western  Connecticut to its terminus in Commack,  NY,
and from  Huntington  to the Bronx.  Its wholly owned  subsidiary,  the Iroquois
Pipeline Operating Company,  headquartered in Shelton, Connecticut, is the agent
for and  operator of the  pipeline.  The Iroquois  pipeline can  transport up to
1,124,500 DTH per day of Canadian gas supply from the New  York-Canadian  border
to  markets  in the  Northeastern  United  States.  KeySpan is also a shipper on
Iroquois and currently transports up to 304,950 DTH of gas per day.

We also have a 50% interest in Islander East Pipeline  Company,  LLC  ("Islander
East"),  which 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.  In  addition,  we own a 26.25%  interest  in the
Millennium  Pipeline project which is anticipated to transport up to 525,000 DTH
of natural gas a day from Corning to Ramapo, New York,  interconnecting with the
pipeline systems of various other utilities in New York.

We are also the owner and operator of a 600,000 barrel LNG storage and receiving
facility  located  in  Providence,  Rhode  Island,  known as  KeySpan  LNG.  Our
subsidiary, Boston Gas is the facility's largest customer and contracts for more
than half of the LNG facility's storage. KeySpan LNG is regulated by FERC.

We also have equity  investments  in two gas storage  facilities in the State of
New York: Honeoye Storage  Corporation and Steuben Gas Storage Company. We own a
52% interest in Honeoye,  an underground gas storage  facility which provides up
to 4.3  billion  cubic  feet of  storage  service  to New York and New  England.
Additionally, we own 34% of a partnership that has a 50% interest in the Steuben
facility that  provides up to 6.2 billion  cubic feet of storage  service to New
Jersey and Massachusetts.

For  additional  information  concerning  these energy  related  investments  in
pipelines and gas storage facilities, see the discussion on "Energy Investments"
in Item 7  Management's  Discussion  and  Analysis of  Financial  Condition  and
Results of Operations contained herein.

ENVIRONMENTAL MATTERS OVERVIEW

KeySpan's  ordinary business  operations  subject it to regulation in accordance
with various federal,  state and local laws, rules and regulations  dealing with
the  environment,   including  air,  water,  and  hazardous  substances.   These
requirements  govern both our normal,  ongoing operations and the remediation of
impacted properties historically used in utility operations. Potential liability
associated  with our  historical  operations  may be imposed  without  regard to
fault, even if the activities were lawful at the time they occurred.


                                       20
<PAGE>


Except as set forth below, or in Note 7 to the Consolidated Financial Statements
"Contractual Obligations and Contingencies - Environmental Matters," no material
proceedings  relating to  environmental  matters have been  commenced or, to our
knowledge,  are  contemplated  by any  federal,  state or local  agency  against
KeySpan,  and we are not a defendant in any material  litigation with respect to
any matter  relating to the protection of the  environment.  We believe that our
operations  are in  substantial  compliance  with  environmental  laws  and that
requirements  imposed by  existing  environmental  laws are not likely to have a
material  adverse impact upon us. We are also pursuing claims against  insurance
carriers and potentially  responsible parties which seek the recovery of certain
environmental  costs  associated  with  the  investigation  and  remediation  of
contaminated  properties.  We believe that  investigation  and remediation costs
prudently  incurred  at  facilities  associated  with  utility  operations,  not
recoverable  through insurance or some other means, will be recoverable from our
customers in accordance with the terms of our rate recovery  agreements for each
regulated subsidiary.

Air. The Federal Clean Air Act ("CAA")  provides for the regulation of a variety
of air emissions from new and existing electric  generating plants.  Final, five
year renewable  permits in accordance  with the  requirements  of Title V of the
1990  amendments to the CAA have been issued for all of our electric  generating
facilities except that renewal applications were submitted in a timely manner in
2006 for the Ravenswood  Expansion and Far Rockaway generating station.  Renewal
permits  are  expected  to be issued in 2007.  The  existing  permits and timely
renewal applications allow our electric generating plants to continue to operate
without any additional significant expenditures, except as described below.

Our generating  facilities are located within a CAA ozone  non-attainment and PM
2.5  (fine  particulate  matter)   non-attainment   area,  and  are  subject  to
increasingly   stringent  NOx  emission  limitations  to  be  implemented  under
forthcoming  requirements of the United States  Environmental  Protection Agency
("EPA") pursuant to the Clean Air Interstate Rule ("CAIR") and potentially under
the Ozone Transport Commission's "CAIR PLUS" program. These efforts are designed
to  improve  both  ozone  and  particulate  matter  air  quality.  Our  previous
investments in low NOX boiler combustion  modifications,  the use of natural gas
firing systems at our steam  electric  generating  stations,  and the compliance
flexibility  available under these cap and trade programs,  have enabled KeySpan
to achieve our prior emission reductions in a cost-effective  manner. KeySpan is
currently   developing  its  compliance  strategy  to  address  the  anticipated
requirements  of CAIR  and  CAIR  PLUS  by  2009.  At the  present  time,  it is
anticipated  that  NOx  control  equipment  may be  required  at one or  more of
KeySpan's  Long  Island  facilities  at a cost of  between  $20 to $30  million.
However, such amounts are recoverable from LIPA.

In 2003, New York State promulgated regulations which establish separate NOX and
SO2 emission  reduction  requirements on electric  generating  facilities in New
York State,  which  commenced in late 2004 for NOX emissions and in 2005 for SO2
emissions.   KeySpan's  facilities  have  been  able  to  comply  with  the  NOX
requirements   without  material  additional  capital  expenditures  because  of
previously installed emissions control equipment and gas combustion  capability.
SO2  compliance  was achieved  through a reduction in the sulfur  content of the
fuel oil used in our Northport and Port Jefferson facilities.  Further reduction
in SO2 emissions expected to be required in 2008 will be achieved either through
reliance on natural gas or lower sulfur oil fuel.


                                       21
<PAGE>


In 2004,  the EPA issued  regulations  that  require  reductions,  on a national
basis, of mercury  emissions from electric  generating  facilities.  The mercury
regulations  have no impact on KeySpan  facilities  since their  application  is
limited to coal-fired  plants.  EPA  determined  that nickel  emissions from oil
fired  plants  do  not  pose  health  risks  that   require   regulation.   This
determination  has been  challenged  and  litigation  is pending.  Until a final
outcome is obtained,  the nature and extent of the  financial  impact on KeySpan
from nickel regulation, if any, cannot be determined.

KeySpan  recognizes the growing concern about greenhouse gas emissions and their
contribution to global climate change. Our investments in additional natural gas
firing  capability  have  resulted in  approximately  a 15%  reduction in carbon
dioxide emissions since 1990, while the electric  generation industry as a whole
increased  carbon  dioxide  emissions  by more than  25%.  The  addition  of the
efficient,   combined  cycle  unit  which  began  operation  at  the  Ravenswood
Generating  Station in 2004 has further  reduced  average  KeySpan CO2  emission
rates.

In 2003, the Governor of New York initiated a Regional Greenhouse Gas Initiative
("RGGI")  that  seeks to  establish  a  coordinated  multi-state  plan to reduce
greenhouse  gas  emissions  (primarily  carbon  dioxide  ("CO2")  from  electric
generating  emission  sources  in the  Northeast.  In  December  of 2005,  seven
northeast  states,  including  New York,  issued a memorandum  of  understanding
("MOU") capping CO2 emissions from electric generating  facilities  beginning in
2009 and,  beginning  in 2015,  gradually  requiring a 10 percent  reduction  in
regional  emissions by 2018. Each of the states will be promulgating  individual
state  rules to  implement  the MOU.  Several  congressional  initiatives  under
consideration   may  also  require   greenhouse  gas  reductions  from  electric
generating  facilities  nationwide.  At the present  time it is not  possible to
predict  the  nature of the  requirements  which  ultimately  will be imposed on
KeySpan,  nor what, if any,  financial  impact such  requirements  would have on
KeySpan  electric  generation  facilities.  However,  KeySpan  believes that the
ability of its major generating  facilities to burn low CO2 emitting natural gas
positions them for future compliance  requirements better than plants which burn
exclusively coal or oil. Additionally,  KeySpan believes that the relatively low
greenhouse gas emissions  associated  with the commercial and residential use of
natural gas may present  business  opportunities  for further  growth of its gas
business.

Water.  The Federal  Clean Water Act provides for  effluent  limitations,  to be
implemented  by a permit  system,  to regulate the discharge of pollutants  into
United  States  waters.  We  possess  permits  for our  generating  units  which
authorize  discharges  from  cooling  water  circulating  systems  and  chemical
treatment  systems.  These permits are renewed from time to time, as required by
regulation.  Additional capital expenditures  associated with the renewal of the
surface water discharge  permits for our power plants will likely be required by
the New York State  Department  of  Environmental  Conservation  ("NYSDEC").  We
continue to conduct  studies as directed by the NYSDEC to determine  the impacts
of our discharges on aquatic  resources and are engaged in discussions  with the
NYSDEC  regarding the nature of capital  upgrades or other  mitigation  measures
necessary to reduce any impacts.  It is difficult to predict with any  certainty
the costs of such capital  investments,  but these upgrades are expected to cost
up to $60  million.  However,  such  amounts  are  recoverable  from  LIPA.  The
Ravenswood  Generating  Station may also require upgrades at a cost of up to $15
million.  The actual  expenditures  will  depend upon the outcome of the ongoing
studies  and the  subsequent  determination  by the  NYSDEC  of how to apply the
standards set forth in recently  promulgated  federal  regulations under Section
316 of the Clean Water Act designed to mitigate such impacts.


                                       22
<PAGE>


Land.  The  Federal  Comprehensive  Environmental  Response,   Compensation  and
Liability Act of 1980 and certain similar state laws (collectively  "Superfund")
impose liability,  regardless of fault, upon generators of hazardous  substances
even before  Superfund was enacted for costs associated with  investigating  and
remediating contaminated property. In the course of our business operations,  we
generate materials which, after disposal, may become subject to Superfund.  From
time to time,  we have  received  notices under  Superfund  concerning  possible
claims with respect to sites where hazardous  substances generated by KeySpan or
its  predecessors  and other  potentially  responsible  parties  were  allegedly
disposed.  Normally,  the costs  associated with such claims are allocated among
the  potentially  responsible  parties  on a pro  rata  basis.  Superfund  does,
however,  provide for joint and several liability  against a single  potentially
responsible  party.  In the unlikely  event that  Superfund  claims were pursued
against us on that basis, the costs may be material to our financial  condition,
results of operations or cash flows.

KeySpan  has  identified  certain  MGP sites  which were  historically  owned or
operated by its  subsidiaries (or such companies'  predecessors).  Operations at
these sites  between the mid-1800s to mid-1900s may have resulted in the release
of  hazardous  substances.  For a  discussion  on  our  MGP  sites  and  further
information  concerning  environmental  matters,  see Note 7 to the Consolidated
Financial Statements, "Contractual Obligations and Contingencies - Environmental
Matters."

COMPETITION, REGULATION AND RATE MATTERS

Competition.  Over  the  last  several  years,  the  natural  gas  and  electric
industries  have  undergone  significant  change as market  forces moved towards
replacing  or  supplementing   rate  regulation   through  the  introduction  of
competition.  A significant number of natural gas and electric utilities reacted
to the  changing  structure  of the energy  industry by entering  into  business
combinations,  with the goal of reducing  common  costs,  gaining size to better
withstand  competitive  pressures and business cycles,  and attaining  synergies
from the  combination of operations.  We engaged in two such  combinations,  the
KeySpan/LILCO  transaction in 1998 and our November 2000  acquisition of Eastern
and  EnergyNorth  and are  anticipating  the  consummation  of the  Merger  with
National Grid plc.

The Ravenswood  Generating Station,  the merchant plant in our Electric Services
segment,  is subject to competitive and other risks that could adversely  impact
the market price for the plant's output. Such risks include, but are not limited
to, the construction of new generation or transmission  capacity serving the New
York City market.

Regulation. Public utility holding companies, like KeySpan, are now regulated by
the FERC pursuant to PUHCA 2005 and to some extent by state utility  commissions
through  the  regulation  of  certain   affiliate   transactions.   Our  utility
subsidiaries  are subject to extensive  federal and state regulation by FERC and
state utility commissions. In general, state public utility commissions, such as
the  New  York  Public  Service  Commission  ("NYPSC"),  the  MADTE  and the New
Hampshire Public Utilities Commission ("NHPUC") regulate the provision of retail


                                       23
<PAGE>


services,  including the distribution and sale of natural gas and electricity to
consumers.  Each of the  federal and state  regulators  also  regulates  certain
transactions  among our affiliates.  FERC also regulates  interstate natural gas
transportation  and electric  transmission,  and has  jurisdiction  over certain
wholesale natural gas sales and wholesale electric sales.

In  addition,  our  non-utility  subsidiaries  are subject to a wide  variety of
federal,  state and local  laws,  rules and  regulations  with  respect to their
business activities,  including but not limited to those affecting public sector
projects,  environmental  and labor laws and  regulations,  and state  licensing
requirements.

State  Utility  Commissions.  As noted above,  our  regulated  gas  distribution
utility  subsidiaries  are subject to regulation by the NYPSC,  MADTE and NHPUC.
The NYPSC  regulates KEDNY and KEDLI.  Although  KeySpan is not regulated by the
NYPSC,  it is  impacted  by  conditions  that were  included  in the NYPSC order
authorizing the 1998 KeySpan/LILCO transaction.  Those conditions address, among
other things, the manner in which KeySpan,  its service company subsidiaries and
its unregulated  subsidiaries  may interact with KEDNY and KEDLI. The NYPSC also
regulates the safety, reliability and certain financial transactions of our Long
Island  generating  facilities  and our  Ravenswood  Generating  Station under a
lightened  regulatory  standard.  Our KEDNE  subsidiaries and to some extent our
service companies are also subject to regulation by the MADTE and NHPUC.

Securities and Exchange  Commission.  As a result of the  acquisition of Eastern
and  EnergyNorth,  we became a holding  company under PUHCA 1935. The Energy Act
repealed PUHCA 1935 and replaced it with PUHCA 2005 effective  February 8, 2006.
Whereas our corporate and financial activities and those of our subsidiaries had
been subject to regulation by the SEC, FERC now has jurisdiction over certain of
our holding company activities.  However, the SEC continues to have jurisdiction
over  the  registration  and  issuance  of  our  securities  under  the  federal
securities laws.

Under our holding company structure, we have no independent operations or source
of income of our own and conduct substantially all of our operations through our
subsidiaries  and, as a result,  we depend on the earnings and cash flow of, and
dividends or distributions from, our subsidiaries to provide the funds necessary
to meet  our  debt  and  contractual  obligations  and to pay  dividends  to our
shareholders.  Furthermore,  a substantial  portion of our consolidated  assets,
earnings and cash flow is derived from the  operations of our regulated  utility
subsidiaries, whose legal authority to pay dividends or make other distributions
to us is subject to regulation by state regulatory authorities.

In addition, KeySpan operates three mutual service companies:  KeySpan Corporate
Services  LLC  ("KCS"),   KeySpan  Utility  Services  LLC  ("KUS")  and  KeySpan
Engineering & Survey, Inc. ("KENG").  These companies operate to provide various
services to KeySpan  subsidiaries,  including  regulated  utility  companies and
LIPA, at cost fairly and equitably  allocated  among them. The regulation of our
three service companies has also been transferred to FERC under PUHCA 2005.


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<PAGE>


Federal Energy Regulatory Commission.  FERC has jurisdiction over certain of our
holding company activities,  including (i) regulating certain transactions among
our affiliates  within our holding company system;  (ii) governing the issuance,
acquisition  and  disposition  of securities and assets by certain of our public
utility   subsidiaries;   and  (iii)  approving   certain  utility  mergers  and
acquisitions. In addition to its new authority pursuant to PUHCA 2005, FERC also
regulates  the  sale  of  electricity  at  wholesale  and  the  transmission  of
electricity  in interstate  commerce as well as certain  corporate and financial
activities  of companies  that are engaged in such  activities.  The Long Island
generating  facilities and the Ravenswood Generating Station are subject to FERC
regulation based on their wholesale energy transactions.

Our  Ravenswood  Generating  Station's  rates are based on a  market-based  rate
application  approved by FERC. The rates that our Ravenswood  Generating Station
may charge are subject to FERC mandated  mitigation measures due to market power
issues. The mitigation  measures are administered by the NYISO. FERC retains the
ability  in future  proceedings,  either on its own  motion or upon a  complaint
filed with FERC, to modify the Ravenswood Generating Station's rates, as well as
the mitigation measures,  if FERC concludes that it is in the public interest to
do so.

KeySpan currently offers and sells the energy,  capacity and ancillary  services
from the Ravenswood Generating Station through the energy market operated by the
NYISO. For information concerning the NYISO, see Item 7. Management's Discussion
and  Analysis of  Financial  Condition  and Results of  Operation -  "Regulatory
Issues and Competitive Environment."

FERC also has  jurisdiction to regulate  certain natural gas sales for resale in
interstate  commerce,  the transportation of natural gas in interstate  commerce
and, unless an exemption  applies,  companies  engaged in such  activities.  The
natural gas distribution  activities of KEDNY,  KEDLI, KEDNE and certain related
intrastate gas  transportation  functions are not subject to FERC  jurisdiction.
However,  to the extent that KEDNY,  KEDLI or KEDNE  purchases  or sells gas for
resale  in  interstate   commerce,   such   transactions  are  subject  to  FERC
jurisdiction  and have been  authorized  by FERC.  Our  interests  in  Iroquois,
Honeoye, Steuben and KeySpan LNG are also fully regulated by FERC as natural gas
companies.

EMPLOYEE MATTERS

As  of  December  31,  2006,  KeySpan  and  its  wholly-owned  subsidiaries  had
approximately 9,594 employees. Of that total,  approximately 6,168 employees are
covered under collective bargaining agreements.  KeySpan has not experienced any
work stoppage  during the past five years and considers  its  relationship  with
employees,  including those covered by collective bargaining  agreements,  to be
good.

ITEM 1A.    RISK FACTORS

Certain  statements  contained  in this  Annual  Report on Form 10-K  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


                                       25
<PAGE>


meaning of Section  21E of the  Securities  Exchange  Act of 1934,  as  amended.
Without  limiting the  foregoing,  all  statements  under the captions  "Item 7.
Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations" and "Item 7A. Quantitative and Qualitative  Disclosures About Market
Risk" relating to our future outlook,  anticipated capital expenditures,  future
cash flows and borrowings,  pursuit of potential  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.  The risks,  uncertainties  and factors that could cause actual
results to differ materially include but are not limited to the following:

We are a Holding  Company,  and Our Subsidiaries are Subject to State Regulation
Which Limits Their Ability to Pay Dividends and Make Distributions to Us

     We are a holding  company with no business  operations or sources of income
     of our own. We conduct all of our operations  through our  subsidiaries and
     depend on the  earnings and cash flow of, and  dividends  or  distributions
     from, our  subsidiaries to provide the funds necessary to meet our debt and
     contractual obligations and to pay dividends on our common stock.

     In addition, a substantial portion of our consolidated assets, earnings and
     cash  flow  is  derived  from  the  operation  of  our  regulated   utility
     subsidiaries,  whose  legal  authority  to  pay  dividends  or  make  other
     distributions  to us is subject to  regulation  by the  utility  regulatory
     commissions of New York, Massachusetts and New Hampshire. Pursuant to NYPSC
     orders,  the  ability  of  KEDNY  and  KEDLI  to  pay  dividends  to  us is
     conditioned upon their maintenance of a utility capital structure with debt
     not exceeding 55% and 58%, respectively,  of total utility  capitalization.
     In  addition,  the level of  dividends  paid by both  utilities  may not be
     increased from current levels if a 40 basis point penalty is incurred under
     a customer service  performance  program. At the end of KEDNY's and KEDLI's
     rate years (September 30, 2006 and November 30, 2006, respectively),  their
     ratios of debt to total utility  capitalization were in compliance with the
     ratios  set  forth  above  and we have  incurred  no  penalties  under  the
     outstanding customer service performance program.

Our Gas Distribution and Electric Services  Businesses May Be Adversely Affected
by Changes in Federal and State Regulation

     The  regulatory  environment  applicable  to our gas  distribution  and our
     electric services  businesses has undergone  substantial  changes in recent
     years,   on  both  the  federal  and  state  levels.   These  changes  have
     significantly affected the nature of the gas and electric utility and power
     industries  and the  manner  in  which  their  participants  conduct  their
     businesses.  Moreover,  existing statutes and regulations may be revised or
     reinterpreted, new laws and regulations may be adopted or become applicable
     to us or our  facilities  and future  changes in laws and  regulations  may
     affect our gas  distribution and our electric  services  businesses in ways
     that we cannot predict.

     In addition,  our operations are subject to extensive government regulation
     and require  numerous  permits,  approvals  and  certificates  from various
     federal,  state and local governmental  agencies.  A significant portion of
     our revenues in our Gas  Distribution  and Electric  Services  segments are


                                       26
<PAGE>


     directly  dependent  on rates  established  by federal or state  regulatory
     authorities,  and any change in these rates and regulatory  structure could
     significantly  impact our  financial  results.  Increases in utility  costs
     other than gas, not otherwise offset by increases in revenues or reductions
     in other expenses, could have an adverse effect on earnings due to the time
     lag associated with obtaining regulatory approval to recover such increased
     costs and expenses in rates. Various rulemaking proposals and market design
     revisions  related to the wholesale  power market are being reviewed at the
     federal level. These proposals,  as well as legislative and other attention
     to the electric power industry could have a material  adverse effect on our
     strategies and results of operations for our electric services business and
     our  financial  condition.  In  particular,  we sell  capacity,  energy and
     ancillary services from our Ravenswood Generating Station facility into the
     New  York  Independent  System  Operator,   or  NYISO,   energy  market  at
     market-based  rates,  subject to mitigation  measures approved by the FERC.
     The pricing for  capacity,  energy sales and  ancillary  services in to the
     NYISO  market is still  evolving  and some of the FERC's  price  mitigation
     measures are subject to rehearing and possible  judicial review, as well as
     revision in response to market participant complaints or NYISO requests.

Our Risk Mitigation Techniques Such as Hedging and Purchase of Insurance May Not
Adequately Provide Protection

     To mitigate our financial exposure related to commodity price fluctuations,
     KeySpan  routinely enters into contracts to hedge a portion of our purchase
     and sale commitments, weather fluctuations,  electricity sales, natural gas
     supply and other  commodities.  However,  we do not always cover the entire
     exposure of our assets or our positions to market price  volatility and the
     coverage will vary over time.  To the extent we have unhedged  positions or
     our hedging strategies do not work as planned, fluctuating commodity prices
     could cause our sales and net income to be volatile.

     In  addition,  our  business  is  subject  to many  hazards  from which our
     insurance may not adequately provide coverage.  An unexpected outage at our
     Ravenswood Generating Station, especially in the significant summer period,
     could  materially  impact  our  financial  results.  Damage  to  pipelines,
     equipment,  properties and people caused by natural  disasters,  accidents,
     terrorism  or other  damage by third  parties  could  exceed our  insurance
     coverage.  Although we do have  insurance to protect  against many of these
     contingent  liabilities,  this insurance is capped at certain  levels,  has
     self-insured retentions and does not provide coverage for all liabilities.

SEC Rules for Exploration and Production Companies May Require Us to Recognize a
Non-Cash Impairment Charge at the End of Our Reporting Periods

     Our  investments in natural gas and oil consist of our ownership of KeySpan
     Exploration and Production and  Seneca-Upshur.  We use the full cost method
     for KeySpan  Exploration and Production and  Seneca-Upshur.  Under the full
     cost method,  all costs of  acquisition,  exploration  and  development  of
     natural  gas and oil  reserves  are  capitalized  into a full  cost pool as
     incurred, and properties in the pool are depleted and charged to operations
     using the unit-of-production  method based on production and proved reserve
     quantities.  To the extent that these 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


                                       27
<PAGE>


     and  oil  reserves  and  the  lower  of cost  or  fair  value  of  unproved
     properties,  those excess costs are charged to operations.  If a write-down
     is required,  it would result in a charge to earnings but would not have an
     impact on cash flows. Once incurred, an impairment of gas properties is not
     reversible at a later date, even if gas prices increase.

Our Operating Results May Fluctuate on a Seasonal and Quarterly Basis

     Our gas  distribution  business  is a seasonal  business  and is subject to
     weather conditions. We receive most of our gas distribution revenues in the
     first and fourth  quarters,  when demand for natural gas  increases  due to
     colder  weather  conditions.  As a  result,  we  are  subject  to  seasonal
     variations in working capital because we purchase  natural gas supplies for
     storage in the second and third quarters and must finance these  purchases.
     Accordingly,  our  results  of  operations  fluctuate  substantially  on  a
     seasonal  basis.  In  addition,  our  New  England-based  gas  distribution
     subsidiaries  do not have weather  normalization  tariffs,  as we do in New
     York. In addition,  portions of our Electric  Service business are seasonal
     and subject to weather and market conditions.  The majority of the capacity
     revenue  associated  with the  Ravenswood  Generating  Station  facility is
     realized during the six months between May and October of each year. Energy
     and ancillary service sales from our Ravenswood Generating Station facility
     are directly  correlated to the demand for electricity and competition from
     other resources.  Typically, the demand and price for electricity increases
     during  extreme   temperature   conditions.   However,   depending  on  the
     availability  of  alternative   competitive  supply,   extreme  temperature
     conditions may not result in increased revenue.  As a result,  fluctuations
     in weather and  competitive  supply  between  years may have a  significant
     effect on our results of operations  for these  subsidiaries;  both gas and
     electric.

A Substantial  Portion Of Our Revenues Are Derived From Our Agreements With LIPA
And No Assurances Can Be Made That These  Arrangements  Will Not Be Discontinued
At Some Point In The Future Or That The New Agreements Will Become Effective

     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. On February 1, 2006, KeySpan and LIPA
     entered into amended and restated  agreements whereby KeySpan will continue
     to operate  and  maintain  the  electric  T&D System  owned by LIPA on Long
     Island. The parties also entered into the 2006 Option Agreement, where LIPA
     had the right to acquire two of our  facilities,  our Far  Rockaway  and/or
     E.F.  Barrett  Generating  Stations  during the  period  January 1, 2006 to
     December 31, 2006.  On December 13, 2006,  KeySpan and LIPA entered into an
     amendment to the 2006 Option Agreement whereby the parties agreed to extend
     the  expiration  of the option period to the later of (i) December 31, 2007
     or (ii) 180 days  following  the  effective  date of the Option  Agreement.
     Additionally,  the new agreements  resolve many outstanding  issues between
     the parties  regarding the current LIPA  Agreements and provide new pricing
     and  extensions of the  Agreements.  There is a risk that these  agreements
     will not receive the necessary governmental  approvals,  which are pending,
     and the effectiveness of each of the 2006 LIPA Agreements and the amendment
     to the 2006  Option  Agreement  is  conditioned  upon all of the 2006  LIPA
     Agreements  becoming  effective.  If the 2006 LIPA Agreements do not become
     effective,  there is  uncertainty  as to whether LIPA will  exercise  their
     option  under the GPRA and the  status  of the  resolution  of the  various


                                       28
<PAGE>


     disputes between KeySpan and LIPA. At this point in time, KeySpan is unable
     to  estimate  what  the  impact  would  be to its  results  of  operations,
     financial position and cash flows if the 2006 LIPA Agreements do not become
     fully effective.

A Decline  or an  Otherwise  Negative  Change in the  Ratings  or Outlook on Our
Securities  Could  Have a  Materially  Adverse  Impact on Our  Ability to Secure
Additional Financing on Favorable Terms

     The credit rating agencies that rate our debt securities  regularly  review
     our  financial  condition  and  results of  operations.  We can  provide no
     assurances  that the ratings or outlook on our debt  securities will not be
     reduced or otherwise  negatively  changed. A negative change in the ratings
     or outlook on our debt securities could have a materially adverse impact on
     our ability to secure additional financing on favorable terms.

Our Costs of Compliance with Environmental Laws are Significant, and the Cost of
Compliance with Future Environmental Laws Could Adversely Affect Us

     Our  operations  are  subject  to  extensive   federal,   state  and  local
     environmental laws and regulations relating to air quality,  water quality,
     waste  management,  natural  resources  and the  health  and  safety of our
     employees.  These environmental laws and regulations expose us to costs and
     liabilities  relating to our  operations and our current and formerly owned
     properties.  Compliance with these legal requirements requires us to commit
     significant  capital  toward  environmental  monitoring,   installation  of
     pollution  control  equipment  and  permits  at our  facilities.  Costs  of
     compliance  with  environmental  regulations,  and in  particular  emission
     regulations,  could have a material impact on our Electric Services segment
     and our  results  of  operations  and  financial  position,  especially  if
     emission limits are tightened,  more extensive permitting  requirements are
     imposed,  additional  substances become regulated or the number and type of
     electric generating plants we operate increase.

     In  addition,  we are  responsible  for the  clean-up of  contamination  at
     certain MGP sites and at other sites and are aware of additional  MGP sites
     where we may have  responsibility for clean-up costs. While our gas utility
     subsidiaries' rate plans generally allow for the full recovery of the costs
     of  investigation  and  remediation  of most of our MGP  sites,  these rate
     recovery  mechanisms may change in the future.  To the extent rate recovery
     mechanisms  change in the future,  or if additional  environmental  matters
     arise in the future at our currently or historically  owned facilities,  at
     sites we may acquire in the future or at third-party  waste disposal sites,
     costs associated with  investigating and remediating these sites could have
     a material  adverse  effect on our  results of  operations,  cash flows and
     financial condition.

Our  Businesses  are  Subject to  Competition  and General  Economic  Conditions
Impacting Demand for Services

     The Ravenswood Facility and Ravenswood Expansion are subject to competition
     that could adversely  impact the market price for the capacity,  energy and
     ancillary  services  they  sell.  In  addition,  if new  generation  and/or
     transmission  facilities are  constructed,  and/or the  availability of our
     Ravenswood Generating Station deteriorates, then the quantities of capacity
     and energy sales could be adversely affected.  We cannot predict,  however,


                                       29
<PAGE>


     when or if new power plants or transmission facilities will be built or the
     nature  of the  future  New York City  capacity  and  energy  requirements.
     Competition  facing our unregulated Energy Services  businesses,  including
     but not limited to  competition  from other  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,
     could  adversely  impact  our  financial  results  and the  value  of those
     businesses,  resulting in decreased  earnings as well as write-downs of the
     carrying value of those businesses.

     Our  Gas  Distribution  segment  faces  competition  with  distributors  of
     alternative fuels and forms of energy,  including fuel oil and propane. Our
     ability to continue to add new gas distribution customers may significantly
     impact financial results.  The gas distribution  industry has experienced a
     decrease in consumption per customer over time,  partially due to increased
     efficiency of customers' appliances, economic factors and price elasticity.
     In addition, our Gas Distribution segment's future growth is dependent upon
     the ability to add new customers to our system in a cost-effective  manner.
     While our Long Island and New England  utilities  have  significant  growth
     potential,  we cannot be sure new  customers  will  continue  to offset the
     decrease in consumption of our existing  customer base.  There are a number
     of factors outside of our control that impact customer  conversions from an
     alternative  fuel to gas,  including  general  economic  factors  impacting
     customers' willingness to invest in new gas equipment.

Risk Associated with our Financial Swap Agreement for In-City Unforced Capacity

     KeySpan believes that the New York City market represents a strong capacity
     market due to, among other things, its local reliability rules,  increasing
     demand and the time required for new resources to be  constructed.  KeySpan
     anticipates  that demand will  increase and that the high cost to construct
     capacity  in New York  City  will  result  in  favorable  In-City  Unforced
     Capacity prices.  Therefore,  KeySpan entered into an ISDA Master Agreement
     for a fixed for floating  unforced  capacity  financial swap for a notional
     quantity of 1,800,000kW at the Fixed Price is $7.57/kW-month. If the demand
     is less than KeySpan's estimates, additional resources enter the market, or
     costs are less than forecast,  In-City Unforced Capacity prices could be on
     average  less than the Fixed Price  resulting  in a loss to KeySpan,  which
     under certain circumstances could be material.

Labor  Disruptions  at Our  Facilities  Could  Adversely  Affect Our  Results of
Operations and Cash Flow

     Approximately 6,168 employees, or 64% of our employees,  are represented by
     unions through various collective bargaining agreements that expire between
     2007  and  2011.  The  bargaining   agreements   expiring  in  2007  affect
     approximately  5% of the  unionized  workforce;  230 employees who work for
     KeySpan Home Energy  Services in New York and another 70 employees at KEDNE
     in Cape Cod,  Massachusetts.  KeySpan is currently  engaging in discussions
     with these unions for new collective bargaining agreements.  It is possible
     that our  employees  may seek an  increase  in wages  and  benefits  at the
     expiration of these agreements,  and that we may be unable to negotiate new
     agreements without labor disruption.


                                       30
<PAGE>


Counterparties to Our Transactions May Fail to Perform their Obligations,  Which
Could Harm Our Results of Operations

     Our  operations  are  exposed  to  the  risk  that  counterparties  to  our
     transactions  that  owe  us  money  or  supplies  will  not  perform  their
     obligations.  Should the  counterparties  to  arrangements  with us fail to
     perform, we might be forced to enter into alternative hedging  arrangements
     or honor our underlying  commitment at then-current  market prices that may
     exceed our contractual  prices.  In such event,  we might incur  additional
     losses to the extent of amounts,  if any,  already paid to  counterparties.
     This risk is most significant  where we have  concentrations of receivables
     from natural gas and electric  utilities and their  affiliates,  as well as
     industrial  customers  and marketers  throughout  the  Northeastern  United
     States.

We Are Exposed to Risks That Are Beyond Our Control

     The cost of repairing damage to our operating subsidiaries'  facilities and
     the potential  disruption of their operations or supplier operations due to
     storms,  natural  disasters,  wars,  terrorist acts and other  catastrophic
     events could be substantial. The occurrence or risk of occurrence of future
     terrorist  attacks or related acts of war may lead to increased  political,
     economic and  financial  market  instability  and  volatility in prices for
     natural gas which could  materially  adversely  affect us in ways we cannot
     predict at this time. A lower level of economic activity for these or other
     reasons  could  result in a  decline  in energy  consumption,  which  could
     adversely affect our net revenues.

The Long-Term  Financial  Condition of Our Gas Distribution  Business Depends on
the Continued Availability of Natural Gas Reserves

     The  development of additional  natural gas reserves  requires  significant
     capital  expenditures  by others for  exploring,  drilling  and  installing
     production,  gathering,  storage,  transportation and other facilities that
     permit  natural  gas to be  produced  and  delivered  to  our  distribution
     systems. Low prices for natural gas, regulatory  restrictions,  or the lack
     of  available  capital  for  these  projects  could  adversely  affect  the
     development  of  additional  natural gas reserves.  Additional  natural gas
     reserves may not be developed in sufficient  amounts to fill the capacities
     of our  distribution  systems,  thus  limiting our  prospects for long-term
     growth.

Gathering,  Processing and Transporting  Activities  Involve Numerous Risks that
May Result in Accidents and Other Operating Risks and Costs

     Our gas  distribution  facilities  pose a variety of hazards and  operating
     risks, such as leaks,  explosions and mechanical problems caused by natural
     disasters,  accidents,  terrorism or other damage by third  parties,  which
     could cause  substantial  financial  losses.  In addition to impairing  our
     operations,  these  risks  could  also  result  in loss of  human  life and
     environmental  pollution. In accordance with standard industry practice, we
     maintain  insurance against some, but not all, of these potential risks and
     losses.  The  occurrence  of any of  these  events  not  fully  covered  by
     insurance  could have a material  adverse effect on our financial  position
     and results of operations.


                                       31
<PAGE>


Additional  risks,  uncertainties and factors that could cause actual results to
differ materially include, but are not limited to, the following:

-    the occurrence of any event,  change or other circumstances that could give
     rise to the  termination of the Merger  Agreement with National Grid plc or
     the failure of the Merger to close for any reason;

-    volatility of fuel prices used to generate electricity;

-    fluctuations in weather and in gas and electric prices;

-    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  or  changes  in  accounting
     standards or Generally  Accepted  Accounting  Principles  which may require
     adjustments to financial statements;

-    inflationary trends and interest rates;

-    the ability of KeySpan to identify and make complementary acquisitions,  as
     well as the successful integration of such 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 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,  state  and local  utility  regulatory  policies,
     legislation  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;

-    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;

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

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


                                       32
<PAGE>


-    changes in the unforced capacity financial swap pricing structure;

-    receipt of approval for, and the timing thereof,  the 2006 LIPA Agreements;
     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 1. "Description of the Business," Item
2.  "Properties,"  Item 7.  "Management's  Discussion  and Analysis of Financial
Condition and Results of Operations" and Item 7A.  "Quantitative and Qualitative
Disclosures About Market Risk" contained herein.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

ITEM 2.     PROPERTIES

Information with respect to KeySpan's material properties used in the conduct of
its business is set forth in, or  incorporated  by reference  in, Item 1 hereof.
Except where otherwise specified,  all such properties are owned or, in the case
of certain rights-of-way,  used in the conduct of its gas distribution business,
held pursuant to municipal  consents,  easements or long-term leases, and in the
case of gas and oil properties, held under long-term mineral leases. In addition
to the information set forth therein with respect to properties utilized by each
business segment, KeySpan leases the executive headquarters located in Brooklyn,
New York.  In  addition,  we lease  other  office  and  building  space,  office
equipment,  vehicles and power operated  equipment.  Our properties are adequate
and suitable to meet our current and expected business  requirements.  Moreover,
their  productive  capacity and  utilization  meet our needs for the foreseeable
future.  KeySpan  continually  examines its real property and other property for
its contribution and relevance to our businesses and when such properties are no
longer productive or suitable,  they are disposed of as promptly as possible. In
the case of leased office space,  we  anticipate  no  significant  difficulty in
leasing  alternative  space at reasonable  rates in the event of the expiration,
cancellation or termination of a lease.

ITEM 3.     LEGAL PROCEEDINGS

See Note 7 to the Consolidated  Financial Statements,  "Contractual  Obligations
and Contingencies - Legal Matters."

ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters  were  submitted to a vote of the  security  holders  during the last
quarter of the 12 months ended December 31, 2006.


                                       33
<PAGE>


                                     PART II
                                     -------

ITEM 5.     MARKET FOR REGISTRANT'S  COMMON EQUITY,  RELATED STOCKHOLDER MATTERS
            AND ISSUER PURCHASES OF EQUITY SECURITIES

KeySpan's common stock is listed and traded on the New York Stock Exchange under
the symbol  "KSE." As of February  20,  2007,  there were  approximately  64,664
registered  record holders of KeySpan's  common stock.  In the fourth quarter of
2006 KeySpan  increased its dividend to an annual rate of $1.90 per common share
beginning with the quarterly  dividend to be paid in February 2007. Our dividend
framework is reviewed annually by the Board of Directors.  The amount and timing
of all dividend  payments is subject to the discretion of the Board of Directors
and will depend  upon  business  conditions,  results of  operations,  financial
conditions and other factors.  Based on currently foreseeable market conditions,
we intend to maintain the annual dividend approximately at the $1.90 level to be
paid on a quarterly basis at a rate of approximately $0.475. KeySpan's scheduled
dividend  payment  dates are  February 1, May 1, August 1 and November 1, or the
next business day, if such date is not a business day.

The following table sets forth, for the quarters indicated, the high and low
sales prices and dividends declared per share for the periods indicated:

 2006                         High           Low           Dividends per Share
 -----------------------------------------------------------------------------
 First Quarter                $41.52         $35.38        $0.465
 Second Quarter               $41.10         $39.68        $0.465
 Third Quarter                $41.42         $39.95        $0.465
 Fourth Quarter               $41.36         $40.40        $0.465

 2005                         High           Low           Dividends per Share
 -----------------------------------------------------------------------------
 First Quarter                $40.90         $38.04        $0.455
 Second Quarter               $40.88         $36.83        $0.455
 Third Quarter                $41.03         $36.35        $0.455
 Fourth Quarter               $37.10         $32.66        $0.455







                                       34
<PAGE>


EQUITY COMPENSATION PLAN INFORMATION

The following table sets forth securities authorized for issuance under equity
compensation plans for the year ended December 31, 2006:

<TABLE>
<CAPTION>
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
                                                                                                           Number of securities
                                             Number of securities                                         remaining available for
                                              to be issued upon                Weighted-average            future issuance under
                                           exercise of outstanding             exercise price of         equity compensation plans
                                            options, warrants and            outstanding options,           (excluding securities
Plan category                                        rights                   warrants and rights          reflected in column (a)
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
<S>                                                <C>                             <C>                          <C>
                                                       (a)                           (b)                          (c)
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
Equity compensation plans
approved by security holders
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
KeySpan Long Term
Incentive Compensation Plan
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
                 Stock Options                      9,403,104                       $33.82                         -
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
               Restricted Stock                       175,414                         N/A                          -
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
              Performance Shares                      512,176 (1)                     N/A                          -
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
Equity compensation plans not
approved by security holders                            N/A                           N/A                         N/A
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
Total                                                   (2)                          $33.82                  3,036,898 (3)
--------------------------------------- ------------------------------- ------------------------------ -----------------------------
</TABLE>

(1)  Performance shares shown at target, or 100% payout.

(2)  Includes  grants of  options,  restricted  stock,  and  performance  shares
     pursuant to KeySpan's  Long-Term  Incentive  Compensation Plan, as amended,
     and options  granted  pursuant to the Brooklyn  Union  Long-Term  Incentive
     Compensation  Plan, the Eastern  Enterprises 1995 Stock Option Plan and the
     Eastern Enterprises 1996 Non-Employee Trustee's Stock Option Plan.

(3)  This  total  amount  reflects  the  aggregate   number  of  stock  options,
     restricted stock and performance  shares available for issuance pursuant to
     KeySpan's Long-Term Incentive Compensation Plan.


See  Item  11.  Executive  Compensation  for  more  information  on  the  equity
compensation plans.







                                       35
<PAGE>


PERFORMANCE GRAPH

The following graph presents, for the period beginning December 31, 2001 through
December 31, 2006, a comparison  of  cumulative  total  shareholder  returns for
KeySpan,  the  Standard & Poor's  Utilities  Index and the Standard & Poor's 500
Index.





                                [GRAPHIC OMITTED]




<TABLE>
<CAPTION>
                             December 31, 2001                 December 31, 2002              December 31, 2003
                             -----------------                 -----------------              -----------------
<S>                               <C>                               <C>                            <C>
KeySpan                           $100.00                           $106.89                        $117.43
S&P Utility Index                 $100.00                            $70.06                         $88.27
S&P 500 Index                     $100.00                            $77.05                        $100.27


                             December 31, 2004                 December 31, 2005              December 31, 2006
                             -----------------                 -----------------              -----------------
KeySpan                           $131.83                           $125.09                        $151.01
S&P Utility Index                 $109.57                           $127.89                        $154.70
S&P 500 Index                     $111.15                           $116.59                        $134.96
</TABLE>



Assumes $100  invested on December 31, 2001 in shares of KeySpan  Common  Stock,
the S&P  Utilities  Index and the S&P 500  Index,  and that all  dividends  were
reinvested.







                                       36
<PAGE>


ITEM 6.     SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
 (In Millions of Dollars,                                                           Year Ended December 31,
 Except Per Share Amounts)                           2006             2005             2004              2003             2002
--------------------------------------------- --------------- ---------------- ---------------- ----------------- ----------------
<S>                                                <C>              <C>              <C>              <C>               <C>
Income Summary
Revenues
     Gas Distribution                           $   5,062.6     $     5,390.1    $     4,407.3    $     4,161.3     $     3,163.8
     Electric Services                              1,880.6           2,042.8          1,738.7          1,606.0           1,645.7
     Energy Services                                  203.4             191.2            182.4            158.9             208.6
     Energy Investments                                35.0              37.9            322.1            609.3             447.1
                                              --------------- ---------------- ---------------- ----------------- ----------------
Total revenues                                      7,181.6           7,662.0          6,650.5          6,535.5           5,465.2
                                              --------------- ---------------- ---------------- ----------------- ----------------
Operating expenses
     Purchased gas for resale                       3,331.5           3,597.3          2,664.5          2,495.1           1,653.3
     Fuel and purchased power                         548.6             752.1            540.3            414.6             395.9
     Operations and maintenance                     1,680.0           1,617.9          1,567.0          1,622.6           1,631.3
     Depreciation, depletion and
      amortization                                    397.5             396.5            551.8            571.7             513.7
     Operating taxes                                  411.2             407.1            404.2            418.2             380.5
     Impairment Charges                                   -                 -             41.0                -                 -
                                              --------------- ---------------- ---------------- ----------------- ----------------
Total operating expenses                            6,368.8           6,770.9          5,768.8          5,522.2           4,574.7
                                              --------------- ---------------- ---------------- ----------------- ----------------
Gain on sale of property                                1.6               1.6              7.0             15.1               4.7
Income from equity investments                         13.1              15.1             46.5             19.2              14.1
                                              --------------- ---------------- ---------------- ----------------- ----------------
Operating income                                      827.5             907.8            935.3          1,047.6             909.3

Other income and (deductions)                        (217.8)           (269.9)             4.9           (340.3)           (301.4)
Income taxes                                          175.5             239.3            325.5            281.3             229.6
                                              --------------- ---------------- ---------------- ----------------- ----------------
Earnings from continuing operations                   434.2             398.6            614.7            426.0             378.3
                                              --------------- ---------------- ---------------- ----------------- ----------------
Discontinued Operations
    Income (loss) from operations,
     net of tax                                           -              (4.1)           (79.0)            (1.9)             15.7
    Loss on disposal, net of tax                          -               2.3            (72.0)               -             (16.3)
                                              --------------- ---------------- ---------------- ----------------- ----------------
Loss from discontinued operations                         -              (1.8)          (151.0)            (1.9)             (0.6)

Cumulative change in accounting
 principles                                               -              (6.6)               -            (37.4)                -
                                              --------------- ---------------- ---------------- ----------------- ----------------
Net income                                            434.2             390.2            463.7            386.7             377.7
Preferred stock dividend requirements                     -               2.2              5.6              5.8               5.8
                                              --------------- ---------------- ---------------- ----------------- ----------------
Earnings for common stock                      $      434.2    $        388.0   $        458.1    $       380.9    $        371.9
                                              =============== ================ ================ ================= ================
Financial Summary
Earnings per share ($)                                 2.48              2.28             2.86             2.41              2.63
Cash dividends declared per share ($)                  1.86              1.82             1.78             1.78              1.78
Book value per share, year-end ($)                    25.17             25.60            24.22            22.99             20.67
Market value per share, year-end ($)                  41.18             35.69            39.45            36.80             35.24
Shareholders, year-end                               65,398            68,421           72,549           75,067            78,281
Capital expenditures ($)                              524.0             539.5            750.3          1,009.4           1,057.5
Total assets ($)                                   14,437.5          13,812.6         13,364.1         14,640.2          12,980.1
Common shareholders' equity ($)                     4,518.8           4,464.1          3,894.7          3,670.7           2,944.6
Preferred stock redemption required ($)                   -                 -             75.0             75.0              75.0
Preferred stock no redemption
 required ($)                                             -                 -                -              8.6               8.8
Long-term debt ($)                                  4,419.1           3,920.8          4,418.7          5,610.9           5,224.1
Total capitalization ($)                            8,937.9           8,384.9          8,333.2          9,365.2           8,252.5
--------------------------------------------- --------------- ---------------- ---------------- ----------------- ----------------
</TABLE>


                                       37
<PAGE>


ITEM 7.        MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND
               RESULTS OF OPERATIONS

KeySpan Corporation (referred to herein as "KeySpan," "we," "us" and "our") is a
holding  company under the Public  Holding  Company Act of 2005 ("PUHCA  2005").
KeySpan  operates  six  regulated  utilities  that  distribute  natural  gas  to
approximately 2.6 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,  lease 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  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 operating  subsidiaries are primarily
involved in gas production and development;  underground gas storage;  liquefied
natural gas storage; retail electric marketing;  large energy-system  ownership,
installation  and management;  service and  maintenance of energy  systems;  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 to the Consolidated  Financial Statements
"Business Segments" for additional information on each operating segment.)

On February 25, 2006,  KeySpan entered into an Agreement and Plan of Merger (the
"Merger   Agreement"),   with  National  Grid  plc,  a  public  limited  company
incorporated  under the laws of England and Wales  ("Parent")  and National Grid
US8, Inc., a New York Corporation  ("Merger Sub"),  pursuant to which Merger Sub
will merge with and into KeySpan (the "Merger"),  with KeySpan continuing as the
surviving  company and thereby becoming an indirect  wholly-owned  subsidiary of
the  Parent.  Pursuant to the Merger  Agreement,  at the  effective  time of the
Merger,  each  outstanding  share of KeySpan  common stock,  par value $0.01 per
share (the  "Shares"),  other than treasury shares and shares held by the Parent
and its subsidiaries, shall be canceled and shall be converted into the right to
receive $42.00 in cash, without interest.

Consummation  of the Merger is subject to various closing  conditions.  Assuming
receipt of all required approvals,  it is currently  anticipated that the Merger
will be consummated in mid-2007.  However,  we are unable to predict the outcome
of the regulatory proceedings and no assurance can be given that the Merger will
occur or the timing of its completion.  See the Introduction to the Notes to the
Consolidated  Financial  Statements  for  additional  information  regarding the
Merger.

At December 31, 2005,  KeySpan was a holding  company  under the Public  Utility
Holding  Company Act of 1935, as amended  ("PUHCA  1935").  In August 2005,  the
Energy  Policy Act of 2005 (the "Energy  Act") was enacted.  The Energy Act is a
broad energy bill that places an increased  emphasis on the production of energy
and promotes the development of new technologies and alternative  energy sources
and provides  tax credits to companies  that  produce  natural gas,  oil,  coal,
electricity  and  renewable  energy.  For KeySpan,  one of the more  significant
provisions  of the  Energy  Act was the  repeal  of  PUHCA  1935,  which  became
effective  on  February  8,  2006.  Since  that time,  the  jurisdiction  of the
Securities  and  Exchange   Commission  ("SEC")  over  certain  holding  company
activities,  including the regulation of our affiliate  transactions and service


                                       38
<PAGE>


companies,  has been  transferred  to the  jurisdiction  of the FERC pursuant to
PUHCA 2005. See the discussion  under the caption  "Regulation and Rate Matters"
for additional information on the Energy Act and PUHCA 2005.

EXECUTIVE SUMMARY

Below is a table comparing the more  significant  items impacting  earnings from
continuing  operations  and earnings  available for common stock for the periods
indicated. Management believes that this representation is necessary for a clear
understanding of the major drivers impacting comparative results for the periods
indicated.

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------------
(In Millions of Dollars, Except per Share Amounts)

Year Ended December 31,                                        2006                       2005                      2004
---------------------------------------------------------------------------------------------------------------------------------
                                                        Earnings     E.P.S.        Earnings     E.P.S.       Earnings     E.P.S.
<S>                                                     <C>           <C>           <C>        <C>           <C>          <C>
Earnings from continuing operations, less
           preferred stock dividends                    $ 434.2      $ 2.48        $ 396.4     $ 2.33        $ 609.1      $ 3.80
Discontinued operations                                       -           -           (1.8)     (0.01)        (151.0)      (0.94)
Cummulative change in accounting principle                    -           -           (6.6)     (0.04)             -           -

---------------------------------------------------------------------------------------------------------------------------------
Earnings for Common Stock                               $ 434.2      $ 2.48        $ 388.0     $ 2.28        $ 458.1      $ 2.86
---------------------------------------------------------------------------------------------------------------------------------

Components of Continuing Operations:
---------------------------------------------------------------------------------------------------------------------------------

Core operations                                         $ 395.9      $ 2.27        $ 403.2     $ 2.37        $ 359.4      $ 2.25
Incremental merger costs                                  (16.7)      (0.10)             -          -              -           -
Income tax settlements                                     55.0        0.31              -          -              -           -
Asset sales                                                   -           -              -          -          257.5        1.60
Non core operations                                           -           -              -          -           83.9        0.52
Impairment charges                                            -           -              -          -          (62.4)      (0.39)
Debt redemption costs                                         -           -           (6.8)     (0.04)         (29.3)      (0.18)

---------------------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations, less
           preferred stock dividends                    $ 434.2      $ 2.48        $ 396.4     $ 2.33        $ 609.1      $ 3.80
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Earnings from Continuing Operations 2006 vs 2005

KeySpan's earnings from continuing  operations,  less preferred stock dividends,
for the year ended December 31, 2006 were $434.2 million or $2.48 per share,  an
increase of $37.8  million,  or $0.15 per share compared to $396.4  million,  or
$2.33 per share realized in 2005. KeySpan's financial results for the year ended
December 31, 2006, reflects the following items that had a significant impact on
comparative  results:  (i)  incremental  pre-tax  Merger  related costs of $27.1
million,  primarily representing investment banking, legal, accounting and other
consulting fees; (ii) resolution of certain income tax issues;  (iii) the impact
of  cooler-than-normal  summer  weather and  competition  on KeySpan's  merchant
electric generation operations; and (iv) the impact of warmer-than-normal winter
weather on KeySpan's gas distribution businesses.


                                       39
<PAGE>


In 2006,  KeySpan  resolved  its dispute  with the New York City  Department  of
Taxation and Finance with respect to income taxes  relating to the operations of
its  merchant  electric  generating  facility.  As a  result  of  the  favorable
settlement of this issue,  KeySpan reversed a previously  recorded New York City
income tax reserve of $11.9 million ($7.1 million after federal  income  taxes),
as  well as an  interest  reserve  of  $5.9  million  ($3.4  million  after-tax)
established in connection with this dispute. In addition,  pursuant to indemnity
obligations  contained in the Long Island Lighting  Company  ("LILCO") / KeySpan
merger agreement of May 1998, KeySpan had been working with the Internal Revenue
Service ("IRS") to resolve  certain  disputes with regard to LILCO's tax returns
for the tax years ended  December 31, 1996 through  March 31, 1999 and KeySpan's
and The Brooklyn  Union Gas  Company's  (d/b/a  KEDNY) tax returns for the years
ended  September  30, 1997  through  December  31,  1998.  A  settlement  of the
outstanding  issues  was  reached  in 2006 and,  following  IRS  procedure,  the
settlement was submitted to the Joint  Committee on Taxation on October 30, 2006
for final  approval,  which is  expected  in early  2007.  Accordingly,  KeySpan
reversed $44.5 million of previously established federal income tax reserves.

KeySpan's  consolidated  results of operations  are  dependent  primarily on the
operating  results of its Gas Distribution and Electric  Services  segments.  As
indicated  in the  above  table,  KeySpan's  earnings  from its core  operations
decreased $7.3 million or $0.10 per share  reflecting,  for the most part, lower
earnings from the Electric Services segment.  The lower operating income in this
segment  resulted  from a decrease  in net  electric  revenues  associated  with
KeySpan's  merchant  electric  generation  business,  the Ravenswood  Generating
Station,  which was  significantly  impacted by the entry of competing  electric
generating  units into the New York City energy and capacity markets in 2006 and
by comparatively cooler weather during the 2006 summer. A substantial portion of
the yearly  operating  income from this  business  is  realized  during its peak
electric generating period July through September. As measured in cooling-degree
days,  weather  was 25% cooler  during  the July -  September  2006 time  period
compared to the same period in 2005,  resulting in a comparative  adverse impact
to realized electric revenues.

Operating  income for 2006 from  KeySpan's  Gas  Distribution  segment  remained
consistent  with such  earnings  realized in 2005.  KeySpan's  gas  distribution
activities are also impacted by seasonal weather fluctuations.  However, certain
of KeySpan's gas  distribution  subsidiaries  operate under utility tariffs that
contain a weather normalization adjustment that significantly offsets variations
in firm net  revenues  due to  fluctuations  in weather.  Additionally,  KeySpan
employs   weather    derivatives   to   mitigate   the   adverse   impact   from
warmer-than-normal  weather.  As measured in heating degree days, weather during
the primary heating season of 2006, January-March,  was approximately 15% warmer
than  the  same  period  of  2005  throughout   KeySpan's  service  territories.
Additionally,   weather   during   the   secondary   heating   season  in  2006,
October-December, was approximately 20% warmer than the same period of 2005. The
benefits  associated  with the  weather  normalization  adjustments  and weather
derivatives,  combined with  significantly  lower  operating  expenses more than
offset the adverse impact from the warm weather during the two heating  seasons.
See the  discussion  under  the  caption  "Review  of  Operating  Segments"  for
additional information on each operating segment.


                                       40
<PAGE>


In addition to the above, interest charges were lower year-over-year, due, for
the most part, to lower regulatory carrying charges. Also, income on certain
investments increased in 2006 compared to 2005.

Earnings per share in 2006 were adversely impacted by the higher level of common
shares  outstanding.  In May 2005,  KeySpan issued 12.1 million shares of common
stock upon the  conversion  of previously  held MEDs Equity Units.  The dilutive
effect on  earnings  per share  for a full year in 2006 from this  issuance,  in
addition to KeySpan's employee stock purchase plans, was approximately $0.07 per
share.

Earnings Available for Common Stock 2006 vs 2005

Earnings  available  for  common  stock  for  2005  also  included  losses  from
discontinued  operations associated with KeySpan's former mechanical contracting
subsidiaries;  these  companies were  discontinued in the fourth quarter of 2004
and sold in early 2005. In the fourth quarter of 2004,  KeySpan's  investment in
its mechanical  contracting  subsidiaries was written-down to fair value. During
2005, operating losses amounting to $4.1 million after-tax were incurred through
the dates of sale of these  companies,  including,  but not  limited  to,  costs
incurred for employee related benefits. Partially offsetting these losses was an
after-tax  gain  of $2.3  million  associated  with  the  related  divestitures,
reflecting  the  difference  between the fair value  estimates and the financial
impact of the actual sale  transactions.  The net income impact of the operating
losses and the disposal gain was a loss of $1.8 million,  or $0.01 per share for
the year ended December 31, 2005.

Further,  earnings  available for common stock for 2005 included a $6.6 million,
or $0.04 per share, cumulative change in accounting principle charge as a result
of implementing the accounting  requirements of Financial  Accounting  Standards
Board ("FASB")  Interpretation  No. 47 ("FIN 47")  "Accounting  for  Conditional
Asset Retirement  Obligations." This pronouncement  required KeySpan to record a
liability for the estimated  future cost associated with the legal obligation to
dispose of long-lived  assets at the time of their  retirement or disposal date.
Upon  initial  implementation,   December  31,  2005,  a  cumulative  change  in
accounting principle charge was recorded on KeySpan's  Consolidated Statement of
Income,   representing  the  present  value  of  KeySpan's   future   retirement
obligation.  See Note 7 to the Consolidated  Financial  Statements  "Contractual
Obligations,  Financial Guarantees and Contingencies" for further information on
this charge.

Earnings from Continuing Operations 2005 vs 2004

KeySpan's earnings from continuing  operations,  less preferred stock dividends,
for the year ended  December 31, 2005 were $396.4  million or $2.33 per share, a
decrease of $212.7 million,  or $1.47 per share compared to $609.1  million,  or
$3.80 per share realized in 2004. KeySpan's financial results for the year ended
December 31, 2005 and 2004 reflected the following  items that had a significant
impact on comparative  results:  (i) earnings from core  operations;  (ii) asset
sales of non-core subsidiaries recorded in 2004 and their respective results for
2004;  (iii)  impairment  charges  recorded  in 2004;  and (iv) debt  redemption
charges recorded in both 2005 and 2004.


                                       41
<PAGE>


As indicated in the preceding  table,  KeySpan's  earnings from core  operations
increased  $43.8 million or $0.12 per share in 2005 compared to 2004,  primarily
reflecting higher earnings from the Electric Services segment,  improved results
from the Energy Services segment, and a decrease in interest charges.  KeySpan's
electric services operations benefited from an increase in net electric revenues
principally as a result of higher electric prices that were due, in part, to the
warm  weather  during  the  2005  summer  and to the  impact  of two  hurricanes
experienced in 2005. Lower operating losses were incurred at the Energy Services
segment as a result of lower operating expenses.

The decrease in interest  expense  resulted  from the benefits  attributable  to
lower  outstanding  debt resulting  from debt  redemptions in 2004 and the first
quarter of 2005,  as well as from the sale of Houston  Exploration  and  KeySpan
Canada.  These favorable results were somewhat offset by a decrease in operating
income  from  KeySpan's  gas  distribution  operations  as a  result  of  higher
operating  expenses,   primarily  due  to  an  increase  in  the  provision  for
uncollectible  accounts  receivable as a result of increasing  gas costs and the
adverse impact from collection experience in 2005.

The full benefit to earnings per share from the favorable  operating  results of
the Electric Services and Energy Services  segments,  as well as the decrease in
interest charges was offset by the higher level of common shares outstanding. As
noted  earlier,  on May 16, 2005,  KeySpan  issued 12.1 million shares of common
stock upon the  scheduled  conversion  of the MEDs Equity  Units.  The  dilutive
effect of this  issuance on earnings  per share for the year ended  December 31,
2005, was approximately $0.12 per share.

The remaining items impacting  comparative earnings from continuing operations -
asset sales,  impairment  charges and debt  redemption  charges - are  discussed
below.

During  2004,  KeySpan  sold its  remaining  55% equity  interest in The Houston
Exploration Company ("Houston Exploration"),  an independent natural gas and oil
exploration  company  based in  Houston,  Texas.  We received  cash  proceeds of
approximately  $758 million in two stock transactions that resulted in after-tax
gains of $222.7 million,  or $1.39 per share. The first transaction  occurred in
June 2004 and the  second  transaction  was  completed  in  November  2004.  The
operations  of  Houston   Exploration  were  fully   consolidated  in  KeySpan's
Consolidated Financial Statements during the first five months of 2004, but were
then  accounted  for  on  the  equity  method  of  accounting  after  the  first
transaction reduced our ownership interest below 50%.

Also in 2004,  KeySpan sold its remaining  60.9%  investment  in KeySpan  Energy
Canada Partnership  ("KeySpan  Canada"),  a company that owned certain midstream
natural gas assets in Western Canada. We received cash proceeds of approximately
$255 million in two  transactions  that  resulted in a total  after-tax  gain of
$34.8 million,  or $0.21 per share.  The first  transaction  took place in April
2004 and the second  transaction  was completed in December 2004. The operations
of KeySpan Canada were fully  consolidated in KeySpan's  Consolidated  Financial
Statements during the first three months of 2004, but then were accounted for on
the  equity  method  of  accounting  after  the first  transaction  reduced  our
ownership interest below 50%.


                                       42
<PAGE>


Combined,  these asset sales provided  KeySpan with  approximately $1 billion in
cash  proceeds and  after-tax  earnings of $257.5  million,  or $1.60 per share.
Further,  during 2004,  KeySpan's share of the after-tax  operating  earnings of
Houston Exploration and KeySpan Canada was $83.9 million or $0.52 per share. See
Note 2 to the  Consolidated  Financial  Statements  "Business  Segments" and the
discussions under the caption "Review of Operating Segments" for a more detailed
discussion of each of the above noted non-core transactions.

KeySpan  recorded  three  significant  impairment  charges  during  2004:  (i) a
goodwill  impairment  charge  recorded in the Energy  Services  segment;  (ii) a
ceiling test write-down recorded in the Energy Investments  segment; and (iii) a
carrying  value  impairment  charge  also  recorded  in the  Energy  Investments
segment.  These impairment  charges resulted in after-tax  charges to continuing
operations of $62.4 million, or $0.39 per share.

Specifically,  during 2004 the Energy  Services  segment  recorded an  after-tax
non-cash  goodwill  impairment  charge of $12.6  million,  or $0.08 per share in
continuing  operations  as a result of an  evaluation  of the carrying  value of
goodwill  recorded  in  this  segment.  That  evaluation  resulted  in  a  total
impairment  charge  of  $152.4  million  after-tax,  or $0.95  per share - $12.6
million of this charge was  attributable  to  continuing  operations,  while the
remaining  $139.9  million,  or $0.87 per share,  was reflected in  discontinued
operations.  (See  Note  10 to the  Consolidated  Financial  Statements  "Energy
Services - Discontinued Operations" for additional details on this charge.)

KeySpan's  remaining  wholly owned gas production and  development  subsidiaries
recorded a non-cash impairment charge of $48.2 million ($31.1 million after-tax,
or $0.19  per  share)  in 2004 to  recognize  the  reduced  valuation  of proved
reserves.  (See Note 9 to the Consolidated  Financial Statements "Gas Production
and Development Property - Depletion," for additional details on this charge.)

In addition to the asset sales noted previously,  in the fourth quarter of 2004,
KeySpan  anticipated  selling its  previous  50%  ownership  interest in Premier
Transmission  Limited  ("Premier"),  a gas pipeline from  southwest  Scotland to
Northern  Ireland.  In the fourth quarter of 2004,  KeySpan  recorded a non-cash
impairment charge of $26.5 million - $18.8 million after-tax or $0.12 per share,
reflecting the difference between the anticipated cash proceeds from the sale of
Premier compared to its carrying value.  This investment was accounted for under
the equity method of accounting in the Energy Investments  segment.  The sale of
Premier was completed in the first quarter of 2005 and resulted in cash proceeds
of approximately $48.1 million and a pre-tax gain of $4.1 million reflecting the
difference from earlier  estimates.  (See Note 2 to the  Consolidated  Financial
Statements  "Business Segments" and the discussions under the caption "Review of
Operating Segments" for a more detailed discussion of the sale.)

The remaining  significant item impacting  comparative  results, as noted above,
was debt  redemption  costs  incurred  in both 2005 and 2004.  In 2005,  KeySpan
redeemed $500 million of 6.15% Notes due in 2006. KeySpan incurred $20.9 million
in call  premiums,  which  were  expensed  and  recorded  in  other  income  and


                                       43
<PAGE>


deductions on the Consolidated  Statement of Income,  and wrote-off $1.3 million
of  previously  deferred  financing  costs.  Further,  KeySpan  accelerated  the
amortization of approximately $11.2 million of previously  unamortized  benefits
associated  with  an  interest  rate  swap  on  these  Notes.   The  accelerated
amortization was recorded as a reduction to interest expense.  The net after-tax
expense of this debt  redemption  was $6.8 million or $0.04 per share.  In 2004,
KeySpan  redeemed  approximately  $758 million of various  series of outstanding
long-term debt. 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 rate  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 2004 debt  redemption  was $29.3  million or $0.18 per
share.

The net impact of the above  mentioned  items resulted in a decrease to earnings
from continuing operations of $6.8 million or $0.04 per share for the year ended
December 31, 2005,  compared to a gain of $249.7 million, or $1.55 per share, in
2004.

Earnings Available for Common Stock 2005 vs 2004

As noted previously,  earnings  available for common stock in 2005 also included
losses from discontinued  operations associated with KeySpan's former mechanical
contracting subsidiaries amounting to $1.8 million, or $0.01 per share. Further,
as noted,  earnings available for common stock for 2005 included a $6.6 million,
or $0.04 per share, cumulative change in accounting principle charge as a result
of  implementing   the  accounting   requirements  of  FIN  47  "Accounting  for
Conditional Asset Retirement Obligations."

Also as  noted  previously,  in 2004  KeySpan  conducted  an  evaluation  of the
carrying value of its investments in the Energy Services segment. As a result of
this evaluation,  KeySpan  recorded a loss in discontinued  operations of $151.0
million,  or $0.94 per  share.  This loss  reflects a $139.9  million  after-tax
impairment  charge  to  reflect  a  reduction  to the  carrying  value of assets
associated with our mechanical  contracting  activities and operating  losses of
$11.1 million.  (See Note 10 to the Consolidated  Financial  Statements  "Energy
Services - Discontinued Operations" for additional details on these items.)






                                       44
<PAGE>


CONSOLIDATED SUMMARY OF RESULTS

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>
-------------------------------------------------------------------------------------------------------------------------
                                                                                           Year Ended December 31,
 (In Millions of Dollars, Except Per Share Amounts)                                 2006            2005           2004
-------------------------------------------------------------------------------------------------------------------------
<S>                                                                                <C>             <C>            <C>
 Gas Distribution                                                                 $ 568.6         $ 565.7        $ 579.6
 Electric Services                                                                  293.0           342.3          289.8
 Energy Services
      Operations                                                                      5.3            (2.7)         (33.9)
      Goodwill impairment charge                                                        -               -          (14.4)
 Energy Investments
      Operations of continuing companies                                             15.5            20.6           24.4
      Operations of sold companies                                                      -               -          155.0
      Ceiling test write-down and impairment charge                                     -               -          (74.7)
 Eliminations and other                                                             (54.9)          (18.1)           9.5
-------------------------------------------------------------------------------------------------------------------------
 Operating Income                                                                   827.5           907.8          935.3
-------------------------------------------------------------------------------------------------------------------------
 Other Income and (Deductions)
      Interest charges                                                             (256.1)         (269.3)        (331.3)
      Gain on sale of subsidiary stock                                                  -             4.1          388.3
      Cost of debt redemption                                                           -           (20.9)         (45.9)
      Minority interest                                                              (0.8)           (0.4)         (36.8)
      Other income and (deductions)                                                  39.1            16.6           30.6
-------------------------------------------------------------------------------------------------------------------------
                                                                                   (217.8)         (269.9)           4.9
-------------------------------------------------------------------------------------------------------------------------
 Income taxes                                                                      (175.5)         (239.3)        (325.5)
-------------------------------------------------------------------------------------------------------------------------
 Income from Continuing Operations                                                  434.2           398.6          614.7
 Loss from discontinued operations                                                      -            (1.8)        (151.0)
 Cumulative change in accounting principles                                             -            (6.6)             -
-------------------------------------------------------------------------------------------------------------------------
 Net Income                                                                         434.2           390.2          463.7
 Preferred stock dividend requirements                                                  -             2.2            5.6
-------------------------------------------------------------------------------------------------------------------------
 Earnings for Common Stock                                                        $ 434.2         $ 388.0        $ 458.1
-------------------------------------------------------------------------------------------------------------------------

 Basic Earnings per Share:
    Continuing operations, less preferred stock dividends                         $  2.48         $  2.33        $  3.80
    Discontinued operations                                                             -           (0.01)         (0.94)
    Cumulative change in accounting principles                                          -           (0.04)             -
-------------------------------------------------------------------------------------------------------------------------
                                                                                  $  2.48         $  2.28        $  2.86
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

Operating Income 2006 vs 2005

As indicated in the above table,  operating income  decreased $80.3 million,  or
9%, for the twelve months ended December 31, 2006 compared to the same period of
2005. As noted earlier, during 2006, KeySpan incurred pre-tax incremental Merger
costs of $27.1  million  related to its proposed  merger with National Grid plc,
representing  investment banking,  legal,  accounting and other consulting fees.
For reporting purposes, the majority of these costs reside at the holding


                                       45
<PAGE>


company  level  (elimination  and  other)  and have not  been  allocated  to the
operating  segments.  The  remaining  variation is due, for the most part,  to a
decrease  of $49.3  million in the  operating  income of the  Electric  Services
segment.  As noted  earlier,  the  Ravenswood  Generating  Station was adversely
impacted by additional competing electric generating units and the comparatively
cooler 2006 summer  weather,  resulting  in a decrease of $110.3  million in net
electric  margins.   However,   net  electric  margins  from  KeySpan's  service
agreements  with LIPA and its electric  marketing  operations  increased in 2006
compared  to 2005,  offsetting  some of the  lost  margin  from  the  Ravenswood
Generating Station.  Further,  this segment also recognized a $46.5 million gain
on a fixed for floating unforced  capacity  financial swap which is reflected in
the operating results of this segment.

KeySpan's gas distribution business realized a slight increase, $2.9 million, in
operating income  year-over-year.  Operating expenses decreased $54.7 million in
2006 compared to 2005,  while net gas revenues  decreased $51.8 million over the
same time period.  The decrease in net gas revenues  reflects the  significantly
warmer  weather  experienced  during the first and fourth quarter winter heating
seasons, whereas the decrease in operating expenses was mainly driven by a lower
provision for uncollectible  accounts receivable  resulting from the decrease in
firm sales  quantities,  and from the beneficial  impact of a recent  regulatory
order and improved  accounts  receivable  collection  activities.  The favorable
comparative  results  from  the  Energy  Services  segment  were  due to  higher
operating margins on engineering,  energy supply and service contracts and lower
general and administrative  expenses.  The decrease in operating income from the
Energy  Investments  segment  reflects,  in part,  lower earnings from KeySpan's
investment in the Iroquois Gas Transmission  System  pipeline,  as well as lower
earnings from the  transportation  of liquefied natural gas. (See the discussion
under the caption  "Review of Operating  Segments"  for further  details on each
segment.)

Other income and (deductions)  reflects interest charges,  costs associated with
debt   redemptions,   income  from  subsidiary  stock   transactions  and  other
miscellaneous items. For the twelve months ended December 31, 2006, other income
and  (deductions)  reflects a net  expense of $217.8  million  compared to a net
expense of $269.9 million for the same period of 2005.  The favorable  variation
of $52.1 million is due, in part, to debt redemption  costs incurred in 2005. As
discussed previously,  in 2005, KeySpan redeemed $500 million 6.15% Series Notes
due in 2006.  KeySpan incurred $20.9 million in call premiums and wrote-off $1.3
million of previously deferred financing costs. In addition,  we accelerated the
amortization of approximately $11.2 million of previously  unamortized  benefits
associated  with an interest rate swap on the redeemed  bonds.  The write-off of
the deferred  financing costs and the  amortization  of the benefits  associated
with an interest rate swap were recorded to interest expense.

Interest  expense for the twelve months ended December 31, 2006 decreased  $13.2
million compared to the same period in 2005,  reflecting,  in part, the reversal
of a previously  recorded $5.9 million reserve established in connection with an
income tax dispute with the New York City Department of Taxation and Finance. In
2006, KeySpan resolved its dispute with the New York City Department of Taxation
and Finance  with  respect to income  taxes  relating to the  operations  of the
Ravenswood  Generating Station. As a result of the favorable  settlement of this
issue,  KeySpan  reversed the previously  recorded  interest  reserve.  Further,
comparative  interest  expense  reflects  lower  carrying  charges on regulatory


                                       46
<PAGE>


deferrals in 2006,  offset by the benefits  recorded in 2005 associated with the
amortization of the interest rate swap. The favorable  variation in other income
and (deductions) for the twelve months ended December 31, 2006,  compared to the
same period in 2005, also reflects higher income on certain investments.

Other income and  (deductions)  for the twelve  months ended  December 31, 2005,
includes the sale of  KeySpan's  50%  interest in Premier  Transmission  Limited
("Premier"),  a gas pipeline from southwest  Scotland to Northern  Ireland.  The
sale  generated  cash proceeds of  approximately  $48.1  million.  In the fourth
quarter of 2004,  KeySpan  reduced  its  carrying  value in Premier to an amount
approximating  the  anticipated  cash proceeds from the sale.  The final sale of
Premier,  which took place in the first  quarter of 2005,  resulted in a pre-tax
gain of $4.1 million reflecting the difference from earlier estimates.

Income tax expense decreased $63.8 million in 2006, compared to 2005,  primarily
reflecting  the  settlements  with the New York City  Department of Taxation and
Finance  and the IRS, as  previously  noted,  amounting  to $51.6  million;  the
remaining decrease reflects lower pre-tax income.

As a result of the items discussed  above,  earnings  available for common stock
were $434.2  million,  or $2.48 per share for the year ended  December 31, 2006,
compared  to  $388.0  million,  or $2.28 per share  realized  in 2005.  As noted
earlier,  earnings  available  for common stock for the year ended  December 31,
2005,  included losses of $1.8 million,  or $0.01 per share,  from  discontinued
operations,  as well as a $6.6 million,  or $0.04 per share cumulative change in
accounting principles charge.

Operating Income 2005 vs 2004

Operating  income  decreased  $27.5 million,  or 3%, for the twelve months ended
December 31, 2005 compared to the same period of 2004. The comparative operating
results  reflect  the  following  two  items  that had a  significant  impact on
results:  (i) operating  results of non-core  subsidiaries  recorded in 2004 and
which were sold in 2005; offset by (ii) impairment  charges recorded in 2004. As
noted earlier,  during 2004 KeySpan held equity  ownership  interests in Houston
Exploration and KeySpan  Canada.  For the twelve months ended December 31, 2004,
KeySpan's  share of the combined  operating  income of Houston  Exploration  and
KeySpan Canada was $155.0 million. KeySpan sold its remaining ownership interest
in these  non-core  operations in the fourth  quarter of 2004.  Offsetting  this
income to some extent were pre-tax non-cash  impairment charges of $89.1 million
recorded  in 2004.  As noted  earlier,  KeySpan  recorded  the  following  three
impairment charges during 2004: (i) a goodwill impairment charge recorded in the
Energy Services segment attributable to continuing  operations of $14.4 million;
(ii) a ceiling  test  write-down  of $48.2  million  to  recognize  the  reduced
valuation  of  proved  reserves  associated  with  KeySpan's   wholly-owned  gas
production and development subsidiaries;  and (iii) a non-cash impairment charge
of $26.5 million also recorded in the Energy Investments  segment reflecting the
difference  between  the  anticipated  cash  proceeds  from the sale of  Premier
compared to its carrying value.


                                       47
<PAGE>


The combined impact of the non-core  operating income recorded in 2004 offset by
the impairment  charges  contributed  $65.9 million to operating  income for the
twelve months ended  December 31, 2004.  KeySpan's core  businesses,  therefore,
posted an increase in operating  income of $38.4  million for the twelve  months
ended  December  31,  2005,  compared  to the same  period  of  2004,  primarily
reflecting  an  increase  of $52.5  million in the  Electric  Services  segment,
partially offset by a $13.9 million  decrease in the Gas  Distribution  segment.
The favorable  results from KeySpan's  electric services  operations  reflect an
increase in net  electric  revenues as a result of higher  electric  prices that
were due, in part, to the warm weather  during the summer of 2005 and the impact
of two hurricanes that occurred in the summer of 2005. Gas distribution results,
however, were adversely impacted by higher operating expenses,  primarily due to
an increase in the provision for uncollectible  accounts  receivable as a result
of higher  gas  costs  and by higher  property  taxes.  For the most  part,  the
beneficial  impact on  comparative  operating  income  from lower net  operating
losses  incurred at the Energy  Services  segment,  was offset by an increase in
expenses residing at the holding company level. Further, in 2004 KeySpan reached
a settlement with certain of its insurance  carriers regarding cost recovery for
expenses  incurred at a  non-utility  environmental  site and  recorded an $11.6
million gain from the settlement as a reduction to expense.

Other income and (deductions)  reflects interest charges,  costs associated with
debt redemptions,  income from subsidiary stock transactions,  minority interest
charges and other miscellaneous  items. For the twelve months ended December 31,
2005,  other income and  (deductions)  reflects a net expense of $269.9  million
compared to income of $4.9  million for the twelve  months  ended  December  31,
2004. This  unfavorable  variation of $274.8 million is due to higher gains from
asset sales  recorded in 2004  compared to 2005 of $384.2  million,  offset by a
decrease in interest  charges of $62.0 million,  lower debt redemption  costs of
$25.0 million and the absence of minority  interest  expenses of $36.4  million.
The following is a discussion of these items.

As noted earlier,  in the first quarter of 2005,  KeySpan  finalized its sale of
Premier.  The final sale of Premier  resulted in a pre-tax  gain of $4.1 million
reflecting  the difference  from earlier  estimates and what was recorded in the
first quarter of 2005.  For the twelve months ended  December 31, 2004,  KeySpan
realized  pre-tax income of $388.3 million from  subsidiary  stock  transactions
associated with Houston Exploration and KeySpan Canada, as discussed earlier.

Interest  expense  decreased $62.0 million,  or 19%, for the twelve months ended
December 31, 2005, compared to the same period of 2004,  reflecting the benefits
attributable to debt redemptions, as well as the sale of Houston Exploration and
KeySpan Canada.  In addition,  as noted earlier,  in 2005 KeySpan  redeemed $500
million  6.15% Series Notes due 2006.  KeySpan  incurred  $20.9  million in call
premiums,  wrote-off  $1.3 million of previously  deferred  financing  costs and
accelerated  the  amortization  of  approximately  $11.2  million of  previously
unamortized  benefits  associated with an interest rate swap on these bonds. The
accelerated  amortization  of the  interest  rate  swap  and  the  write-off  of
previously  deferred  financing costs reduced  interest  expense in 2005 by $9.9
million.

In 2004,  KeySpan  redeemed  approximately  $758  million of  various  series of
outstanding  debt and incurred $45.9 million in call premiums and wrote-off $8.2
million of previously  deferred  financing costs. The net impact of the 2005 and
2004 debt redemptions lowered comparative interest expense by $18.1 million.


                                       48
<PAGE>


For the year ended December 31, 2004 other income and (deductions) also includes
the  effects of  minority  interest  of $36.8  million  related to our  previous
majority ownership interests in Houston Exploration and KeySpan Canada. Finally,
other income and  (deductions)  for the year ended  December 31, 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,  a 250 MW combined cycle  generating
facility  located at the Ravenswood  Generating  Station site, as well as a $5.5
million foreign currency gain.

Income  taxes  decreased  $86.2  million  for the year ended  December  31, 2005
compared to 2004 due, for the most part, to lower pre-tax earnings. In addition,
tax expense for 2004  reflects:  (i) a $6.0  million  benefit  resulting  from a
revised appraisal  associated with property that was disposed of in 2003; (ii) a
tax  benefit  of $12  million  related  to the  repatriation  of  earnings  from
KeySpan's foreign  investments;  and (iii) the beneficial tax treatment afforded
to the stock transaction with Houston Exploration.

As noted  earlier,  earnings  available  for  common  stock  for the year  ended
December 31, 2005,  also included  losses of $1.8  million,  or $0.01 per share,
from  discontinued  operations,  as well as a $6.6  million,  or $0.04 per share
cumulative change in accounting principles charge. Earnings available for common
stock for the year ended December 31, 2004,  included  losses of $151.0 million,
or $0.94 per share, from discontinued operations.

As a result of the items discussed  above,  earnings  available for common stock
were $388.0  million,  or $2.28 per share for the year ended  December 31, 2005,
compared to $458.1 million, or $2.86 per share realized in 2004.

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

The Brooklyn Union Gas Company,  doing  business as 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.  KeySpan Gas
East  Corporation,  doing  business  as  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
natural gas  distribution  companies - Boston Gas  Company,  Essex Gas  Company,
Colonial 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.


                                       49
<PAGE>


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

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------------
                                                                                             Year Ended December 31,
(In Millions of Dollars)                                                            2006               2005              2004
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>                <C>               <C>
Revenues                                                                        $ 5,062.6          $ 5,390.1         $ 4,407.3
Cost of gas                                                                       3,336.6            3,607.0           2,664.7
Revenue taxes                                                                        60.4               65.8              73.3
-------------------------------------------------------------------------------------------------------------------------------
Net Gas Revenues                                                                  1,665.6            1,717.3           1,669.3
-------------------------------------------------------------------------------------------------------------------------------
Operating Expenses
   Operations and maintenance                                                       681.4              727.0             672.5
   Depreciation and amortization                                                    266.7              276.9             276.5
   Operating taxes                                                                  148.9              147.8             140.7
-------------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses                                                          1,097.0            1,151.7           1,089.7
-------------------------------------------------------------------------------------------------------------------------------
Gain on the sale of property                                                            -                0.1                 -
Operating Income                                                                $   568.6          $   565.7         $   579.6
-------------------------------------------------------------------------------------------------------------------------------
Firm gas sales and transportation (MDTH)                                          283,693            323,347           324,549
Transportation - Electric  Generation (MDTH)                                       67,273             25,076            27,656
Other sales (MDTH)                                                                190,244            187,805           155,992
Warmer (Colder) than Normal - New York & Long Island                                16.0%              (1.0%)            (1.0%)
Warmer (Colder) than Normal - New England                                            7.6%              (8.6%)            (6.8%)
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>

A MDTH is 10,000 therms and reflects the heating  content of  approximately  one
million cubic feet of gas. A therm reflects the heating content of approximately
100 cubic feet of gas. One billion cubic feet (BCF) of gas equals  approximately
1,000 MDTH.

Operating Income 2006 vs 2005

Executive Summary

Operating income increased $2.9 million for the twelve months ended December 31,
2006,  compared to the same period last year  reflecting a decrease in operating
expenses  of  $54.7  million,  substantially  offset  by a  decrease  in net gas
revenues  (revenues less the cost of gas and associated  revenue taxes) of $51.7
million.  The lower  operating  expenses were primarily due to a decrease in the
provision  for  uncollectible   accounts   receivable  of  $60.9  million.   The
exceptionally  warm  weather  during  the first and  fourth  quarters  of 2006 -
KeySpan's  primary  heating seasons - was the primary driver behind the decrease
in net gas revenues.

Net Revenues

Net gas revenues from our gas distribution  operations  decreased $51.7 million,
or 3%, for the twelve  months  ended  December  31,  2006,  compared to the same
period  last  year.  Both the New York and New  England  based gas  distribution
operations  were  adversely  impacted  by the  significantly  warmer than normal
weather  experienced  throughout the northeastern  United States during the 2006
winter heating seasons - January through April and October through December.  As
measured in heating degree days, weather in 2006 in our New York and New England
service   territories  was  approximately  16%  and  7.6%  warmer  than  normal,
respectively,  and was  approximately 16% warmer than last year across KeySpan's
service territories.


                                       50
<PAGE>


Net revenues from firm gas customers  (residential,  commercial  and  industrial
customers)  decreased  $70.2  million in 2006  compared to 2005.  The  favorable
impact to net gas revenues  from load growth  additions  was more than offset by
declining usage per customer due to the extremely warm weather during the winter
heating seasons,  the use of more efficient gas heating equipment and higher gas
costs.  KeySpan  estimates that the warm weather during the two heating  seasons
resulted in an adverse impact to net gas revenues of approximately  $32 million,
net of the  benefits  from the  weather  normalization  adjustment  and  weather
derivatives  discussed  below.  Further,  KeySpan  earned $6.5  million  less in
regulatory incentives for the twelve months ended December 31, 2006, compared to
the same period last year.

KEDNY and KEDLI  each  operate  under  utility  tariffs  that  contain a weather
normalization  adjustment  that  significantly  offsets  variations  in firm net
revenues due to fluctuations in weather. These weather normalization adjustments
resulted in a benefit to KeySpan of $57 million  during the twelve  months ended
December  31,  2006,  but this did not fully  mitigate the impact of the loss in
revenues due to the extremely warm weather experienced, as previously noted. The
New   England-based   gas   distribution   subsidiaries   do  not  have  weather
normalization  adjustments.  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 2005/2006 and 2006/2007 winter heating season.
Since  weather was warmer than normal in November  and  December of 2006,  these
derivative instruments resulted in a $9.1 million benefit to net gas revenues in
2006. (See Note 8 to the Consolidated Financial Statements "Hedging,  Derivative
Financial Instruments and Fair Values" for further information).

Firm gas distribution  rates for KEDNY,  KEDLI and KEDNE in 2006, other than for
the recovery of gas costs,  have  remained  substantially  unchanged  from rates
charged in 2005.

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  increased  $18.5 million  during the twelve months ended December
31,  2006,  compared to the same period last year  primarily  reflecting  higher
pricing.

Firm Sales, Transportation and Other Sales Quantities

Firm gas  sales  and  transportation  quantities  for the  twelve  months  ended
December  31,  2006,  decreased  12%  compared  to the same  period  in 2006 due
primarily to the warmer  weather this year  compared to last year.  On a weather
normalized basis, firm gas sales and transportation quantities decreased 2.4% in
2006  compared to 2005 due to lower usage per customer.  Customer  additions and
oil-to-gas  conversions,  however,  offset the full impact of the warmer weather
and lower usage per customer.  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.


                                       51
<PAGE>


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 a management  contract  with Merrill Lynch
Trading under which KeySpan and Merrill Lynch Trading share the responsibilities
for  managing  KeySpan's  upstream gas  contracted  assets  associated  with its
Massachusetts  gas  distribution  subsidiaries,  as well as providing  city-gate
delivered supply. KeySpan, Merrill Lynch Trading and KeySpan's Massachusetts gas
sales  customers will share in the profits  generated from the  optimization  of
these assets.  The  Massachusetts  Department of  Telecommunications  and Energy
("MADTE")  approved this contract in March 2006 effective April 1, 2006. KeySpan
provides  these  services  internally  for its New  York and New  Hampshire  gas
distribution subsidiaries.

Purchased Gas for Resale

The decrease in gas costs for the twelve months ended December 31, 2006 compared
to the same period of 2005 of $270.4 million, or 7%, is reflective of a decrease
of 14% in the quantity of gas purchased  due to the warm weather  during the two
winter heating seasons. However, the price per dekatherm of gas used by firm gas
sales  customers  increased 4%, in 2006  compared to 2005.  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 for the twelve months ended  December 31, 2006,  compared to
the  same  period  of 2005,  decreased  $54.7  million,  or 5%.  Operations  and
maintenance  expense  decreased  $45.6 million,  or 6%, in 2006 compared to 2005
primarily  as a result of a  decrease  of $60.9  million  in the  provision  for
uncollectible  accounts  receivable.  In December  2005,  The Boston Gas Company
("Boston Gas")  received a MADTE order,  effective  January 1, 2006,  permitting
Boston  Gas to fully  recover  the gas  cost  component  of bad debt  write-offs
through its cost-of-gas  adjustment clause rather than filing for recovery as an
exogenous cost.  Additionally,  in 2006 we recovered the 2005 gas cost component
of bad  debts  as well.  These  benefits  were the  primary  driver  behind  the
reduction in the provision for uncollectible accounts receivable,  combined with
a decrease in firm gas sales  quantities  in 2006  compared to 2005 and improved
collection  efforts.  (See the discussion under the caption "Regulation and Rate
Matters - Gas Matters" for  additional  details of the MADTE order.)  Offsetting
the favorable  impact of the MADTE order,  to some extent,  was higher  employee
benefit related expenses,  including  postretirement costs, and generally higher
administrative and general costs.

The decrease in depreciation and amortization  charges of $10.2 million,  or 4%,
for the twelve  months ended  December  31, 2006  compared to the same period of
2005,  reflects a decrease  in  depreciation  charges of $8.4  million and lower
regulatory  amortization  charges of $1.8 million.  The decrease in depreciation
charges reflects an adjustment to the  depreciation  allowance to correct for an
error in useful lives associated with certain gas distribution assets.


                                       52
<PAGE>


Operating Income 2005 vs 2004

Executive Summary

Operating  income  decreased  $13.9 million,  or 2%, for the twelve months ended
December 31, 2005,  compared to the same period of 2004 due to higher  operating
expenses.  Operating expenses  increased $62.0 million  reflecting  primarily an
increase in the  provision  for  uncollectible  accounts  receivable  and higher
property taxes totaling $45.8 million. Partially offsetting the higher operating
expenses  was an increase of $48.0  million in net gas revenues  resulting  from
customer  additions and oil-to-gas  conversions in our firm gas sales market, as
well as from higher net gas revenues in our large-volume heating markets.

Net Revenues

Net gas revenues from our gas distribution  operations  increased $48.0 million,
or 3%, for the twelve  months  ended  December  31,  2005,  compared to the same
period  of  2004.  Net  gas  revenues  benefited  from  customer  additions  and
oil-to-gas  conversions  in our firm gas sales market as well as from higher net
gas revenues in our large-volume  heating and interruptible  (non-firm) markets.
As  measured  in heating  degree  days,  weather in 2005 in our New York and New
England service  territories was approximately 1.0% and 8.6% colder than normal,
respectively. Compared to 2004, weather in 2005 was 1.2% colder in KeySpan's New
England service territory, while weather was consistent between years in the New
York service territory.

Net revenues  from firm gas  customers  increased  $24.3  million for the twelve
months  ended  December  31,  2005,  compared to same  period of 2004.  Customer
additions and oil-to-gas conversions,  net of attrition and conservation,  added
$25.1  million  to net gas  revenues.  Further,  we  realized  a benefit of $3.8
million as a result of the Boston Gas  Performance  Based Rate Plan (the "Plan")
that was  approved by the MADTE in 2003.  The Plan  provides  for firm gas sales
rates  to be  adjusted  each  year  based on an  inflation  factor  offset  by a
productivity  factor.  (See the caption under  "Regulation and Rate Matters" for
further information regarding the rate filing.)

Offsetting,  to some extent, the beneficial impact of the customer additions and
oil-to-gas  conversions  was the adverse impact to comparative  net gas revenues
from the additional  billing day in 2004 due to the leap year. In 2004,  KeySpan
realized $5.7 million in additional net gas revenues from the additional billing
day. Further,  KeySpan earned $8.7 million less in regulatory incentives for the
twelve months ended December 31, 2005, compared to the same period of 2004.

Also  included in net revenues is the recovery of certain  regulatory  items and
certain taxes that added $6.6 million to net revenues.  However, the recovery of
these items through  revenues does not impact net income since a similar  amount
was expensed as amortization  charges and income taxes,  as appropriate,  on the
Consolidated  Statement of Income.  Firm gas distribution rates for KEDNY, KEDLI
and KEDNE in 2005,  other than for the recovery of gas costs and resulting  from
the Plan, remained substantially unchanged from rates charged in 2004.


                                       53
<PAGE>


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.  However,  the gas  distribution
operations  of  our  New  England  based  subsidiaries  do not  have  a  weather
normalization  adjustment.  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  2004/2005  and  2005/2006  winter  heating
seasons.  These financial  derivatives  afforded KeySpan some protection against
warmer  than  normal  weather.  As a  result  of the  weather  fluctuations  and
financial  weather  derivatives,  weather had a $3.2 million favorable impact on
comparative net gas revenues.

In our large-volume heating and 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  increased  $23.7 million  during the twelve months ended December
31,  2005,  compared to the same  period of 2004,  primarily  reflecting  higher
pricing.  Further,  since weather during January 2004 was  significantly  colder
than normal, KeySpan interrupted service to a segment of its dual-fuel customers
for a number of days during that month, as permitted under its tariff, to ensure
reliable service to firm customers. The majority of interruptible profits earned
by KEDLI and KEDNE are returned to firm customers as an offset to gas costs.

Firm Sales, Transportation and Other Sales Quantities

Both actual  firm gas sales and  transportation  quantities,  as well as weather
normalized  sales  quantities  for the twelve  months  ended  December 31, 2005,
remained consistent with those quantities realized in 2004. 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
transportation 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.  The  increase in these  sales  quantities  for the
twelve  months  ended  December  31,  2005,  compared to the same period of 2004
reflects  higher  off-system  sales.  The majority of these  profits  earned are
returned to firm customers as an offset to gas costs. From April 1, 2002 through
March 31, 2005, we had an agreement  with Coral  Resources,  L.P.  ("Coral"),  a
subsidiary of Shell Oil Company,  under which Coral assisted in the origination,
structuring, valuation and execution of energy-related transactions on behalf of
KEDNY and KEDLI.  Upon  expiration of this  agreement,  these services have been
provided by KeySpan employees.  KeySpan also provides these services  internally
for its New Hampshire gas distribution  subsidiaries.  In 2004 and 2005, we also
had a portfolio  management  contract  with Merrill Lynch  Trading,  under which
Merrill  Lynch  Trading was  responsible  for  managing  KeySpan's  upstream gas
contracted   assets   associated  with  its   Massachusetts   gas   distribution
subsidiaries,  as well as providing  city-gate delivered supply. As noted above,
beginning in April 2006, KeySpan and Merrill Lynch Trading have a new three-year
agreement under which KeySpan and Merrill Lynch share the  responsibilities  for
managing   KeySpan's   upstream  gas  contracted   assets  associated  with  its
Massachusetts gas distribution subsidiaries.


                                       54
<PAGE>


Purchased Gas for Resale

The  increase  in gas costs for the  twelve  months  ended  December  31,  2005,
compared  to the same period of 2004,  of $942.3  million,  or 35%,  reflects an
increase of 23% in the price per  dekatherm of gas  purchased for firm gas sales
customers,  as  well  as an  increase  in  the  quantity  of gas  purchased  for
large-volume  heating and interruptible  (non-firm)  customers.  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

For the twelve  months ended  December 31, 2005,  operating  expenses  increased
$62.0  million,  or 6%  compared  to the same  period  in 2004.  Operations  and
maintenance  expense  increased  $54.5 million,  or 8%, in 2005 compared to 2004
primarily due to an increase of $38.7 million in the provision for uncollectible
accounts  as a result  of  increasing  gas  costs and the  adverse  impact  from
collection  experience.  Further,  the gas distribution  operations  realized an
increase in insurance and regulatory fees, as well as postretirement expenses in
2005 compared to 2004. In 2004, KeySpan recognized a benefit of approximately $3
million,  net of amounts subject to regulatory  deferral  treatment,  associated
with the  implementation  of the  Medicare  Prescription  Drug  Improvement  and
Modernization Act of 2003 ( the "Medicare Act") and  implementation of Financial
Accounting  Standards Board Staff Position ("FSP") 106-2. In addition,  in 2004,
Boston Gas  reached an  agreement  with an  insurance  carrier  for  recovery of
previously  incurred  environmental  expenditures.   Insurance  and  third-party
recoveries,  after  deducting  legal fees, are shared between Boston Gas and its
firm gas customers as provided under a previously  issued MADTE rate order. As a
result of this insurance settlement, Boston Gas recorded a $5 million benefit to
operations and maintenance expense.

Comparative  operating  taxes  increased $7.1 million due to the expiration of a
five-year property tax assessment  agreement with New York City, as well as to a
$2.5 million property tax refund received in 2004. Higher  depreciation  charges
of $4.5 million  reflecting  the  continued  expansion  of the gas  distribution
system were offset by lower regulatory amortization charges of $4.1 million.

Gas Supply and Pricing

KeySpan has  adequate  gas supply  available  to meet its gas load demand in its
service  territories  for the 2006/2007  winter  heating season as KeySpan's gas
storage was 100% full at the start of the winter heating season. The current gas
rate  structure  of  each  of our  gas  distribution  utilities  includes  a gas
adjustment clause,  pursuant to which gas costs are recovered in billed sales to
regulated  firm gas  sales  customers.  Although  KeySpan  is  allowed  to "pass
through" the cost of gas to its customers,  the volatility of natural gas prices
can have an adverse  impact on  customers'  gas bills and  recovery  of customer


                                       55
<PAGE>


accounts  receivable.  High gas  prices  have  led to an  increase  in  customer
conservation  measures and  attrition.  The MADTE order,  received in the fourth
quarter of 2005,  permitting  Boston  Gas  regulatory  recovery  of the gas cost
component of net bad debt  write-offs has helped to mitigate any increase in bad
debt expense.

With KeySpan's continuing strategy of having its storage facilities 100% full at
the start of the heating  season and through the use of  financial  derivatives,
KeySpan has effectively hedged the price of approximately  two-thirds of the gas
supply needed to serve its gas heating  customers  during the  2006/2007  winter
heating season.  This strategy mitigates the volatility of natural gas prices on
customers' winter heating gas bills.  Further,  KeySpan has programs in place to
help customers manage their gas bills, such as balanced billing plans,  deferred
payment  arrangements  and the low income home energy  assistance  program,  the
expansion  of  which  we  supported  through  the  Energy  Policy  Act of  2005.
Management believes that these measures help mitigate the impact of volatile gas
prices on customers' bills.

Other Matters

We remain committed to our ongoing gas system expansion  strategies.  We believe
that  significant  growth  opportunities  exist  on Long  Island  and in our New
England service territories, as well as continued growth in the New York service
territory, despite the volatility in gas prices. We estimate that on Long Island
approximately 37% of the residential and multi-family markets, and approximately
60% of the  commercial  market,  currently  use natural  gas for space  heating.
Further, we estimate that in our New England service  territories  approximately
50% of the residential and multi-family markets, as well as approximately 60% of
the commercial market,  currently use natural gas for space heating purposes. We
will continue to seek growth, in all of our market segments to serve new housing
and  commercial  construction  and to penetrate  existing  communities  where no
distribution  system  exists,  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.

In order to serve the  anticipated  market  requirements in our New York service
territories,  KeySpan and Spectra  Energy  Corporation  (formerly a part of Duke
Energy Corporation) formed Islander East Pipeline Company, LLC ("Islander East")
in 2000.  Once in service,  the  pipeline  is  expected to have the  capacity to
transport  up to 260,000 DTH of natural gas to the Long Island and New York City
energy markets,  enough natural gas to heat 600,000 homes. In addition,  KeySpan
has a 26.25% interest in the Millennium  Pipeline  development  project which is
anticipated to transport up to 525,000 DTH of natural gas a day to the Algonquin
pipeline.  KEDLI has executed a Precedent  Agreement  for 175,000 DTH of natural
gas per day of  transportation  capacity from the  Millennium  Pipeline  system,
increasing  to 200,000 DTH in the second year of the pipeline  being in service.
These pipeline  projects will allow KeySpan to diversify the geographic  sources
of its gas supply. See the discussion under the caption "Energy Investments" for
additional information regarding these pipeline projects.


                                       56
<PAGE>


ELECTRIC SERVICES

The Electric Services segment primarily consists of subsidiaries that own, lease
and  operate  oil and  gas-fired  electric  generating  plants in the Borough of
Queens  (including  the  "Ravenswood  Generating  Station"  which  comprises the
Ravenswood  Facility and  Ravenswood  Expansion)  and the counties of Nassau and
Suffolk on Long Island.  In  addition,  through  long-term  contracts of varying
lengths,  we (i)  provide  to the  Long  Island  Power  Authority  ("LIPA")  all
operation,  maintenance and construction services and significant administrative
services  relating to the Long Island  electric  transmission  and  distribution
("T&D")  system  pursuant to a Management  Services  Agreement (the "1998 MSA");
(ii)  supply LIPA with  electric  generating  capacity,  energy  conversion  and
ancillary  services from our Long Island  generating  units  pursuant to a Power
Supply  Agreement  (the "1998  PSA");  and (iii)  manage all aspects of the fuel
supply for our Long Island generating facilities,  as well as all aspects of the
capacity  and energy  owned by or under  contract to LIPA  pursuant to an Energy
Management  Agreement (the "1998 EMA").  The 1998 MSA, 1998 PSA and 1998 EMA all
became effective on May 28, 1998 and are collectively  referred to herein as the
"1998 LIPA Agreements."

On February 1, 2006,  KeySpan and LIPA  entered into (i) an amended and restated
Management  Services Agreement (the "2006 MSA"),  pursuant to which KeySpan will
continue to operate and  maintain  the electric T&D System owned by LIPA on Long
Island  through  2013;  (ii) a new Option and Purchase and Sale  Agreement  (the
"2006 Option  Agreement"),  to replace the Generation  Purchase Rights Agreement
(the "GPRA"),  pursuant to which LIPA had the option, through December 15, 2005,
to acquire  substantially  all of the electric  generating  facilities  owned by
KeySpan on Long Island;  and (iii) a Settlement  Agreement (the "2006 Settlement
Agreement")  resolving outstanding issues between the parties regarding the 1998
LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement
Agreement  are  collectively  referred to herein as the "2006 LIPA  Agreements."
These agreements will become effective  following approval by the New York State
Comptroller's  Office and the New York State  Attorney  General.  (For a further
discussion  on these  LIPA  agreements  see the  discussion  under  the  caption
"Electric Services - LIPA Agreements" and Note 11 to the Consolidated  Financial
Statements "2006 LIPA Settlement").  The Electric Services segment also provides
retail marketing of electricity to commercial customers.




                                       57
<PAGE>

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

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
                                                              Year Ended December 31,
(In Millions of Dollars)                               2006             2005             2004
-----------------------------------------------------------------------------------------------
<S>                                                 <C>              <C>              <C>
Revenues                                           $ 1,834.2        $ 2,047.3        $ 1,738.7
Purchased fuel                                         548.4            751.4            539.6
-----------------------------------------------------------------------------------------------
Net Revenues from Operations                         1,285.8          1,295.9          1,199.1
Derivative Financial Instrument                         46.5                -                -
-----------------------------------------------------------------------------------------------
Net Electric Revenues                                1,332.3          1,295.9          1,199.1
-----------------------------------------------------------------------------------------------
Operating Expenses
   Operations and maintenance                          750.8            684.5            653.3
   Depreciation                                        102.1             91.7             88.3
   Operating taxes                                     186.9            178.6            169.7
-----------------------------------------------------------------------------------------------
Total Operating Expenses                             1,039.8            954.8            911.3
-----------------------------------------------------------------------------------------------
Gain on the sale of property                             0.5              1.2              2.0
Operating Income                                     $ 293.0          $ 342.3          $ 289.8
-----------------------------------------------------------------------------------------------
Electric sales (MWH)*                              4,480,996        6,364,279        6,232,190
Capacity(MW)*                                          2,450            2,450            2,450
Cooling degree days                                    1,130            1,472            1,045
-----------------------------------------------------------------------------------------------
</TABLE>

*Reflects the operations of the Ravenswood Generating Station only.

Operating Income 2006 vs 2005

Executive Summary

Operating  income  decreased $49.3 million,  or 14%, for the twelve months ended
December 31,  2006,  compared to the same period last year,  due  primarily to a
decrease  in net  revenues  from the  Ravenswood  Generating  Station  of $110.3
million  as a result  of lower  energy  margins  and  lower  capacity  revenues,
partially offset by higher revenues associated with KeySpan's service agreements
with LIPA and its electric marketing  activities of $10.6 million.  KeySpan also
recognized  a gain of $46.5  million on a fixed for floating  unforced  capacity
financial swap.

Net Revenues

Total electric net revenues realized in 2006 were $36.4 million higher than such
revenues realized in 2005.

KeySpan  has entered  into an  International  SWAP  Dealers  Association  Master
Agreement for a fixed for floating unforced capacity  financial swap with Morgan
Stanley Capital Group Inc. ("Swap  Agreement").  This agreement has a three year
term that began on May 1, 2006.  For the twelve  months ended  December 31, 2006
KeySpan  recognized  a gain of $46.5  million  from  this  derivative  financial
instrument.  (See Note 8 to the  Consolidated  Financial  Statements,  "Hedging,
Derivative  Financial  Instruments and Fair Values," for further  information on
this swap agreement.)

Net  revenues  for the twelve  months  ended  December 31, 2006 from the service
agreements with LIPA,  including the power purchase  agreements  associated with
two electric  peaking  facilities,  increased $96.6 million compared to the same
period  of  2005.  The  increase  is due,  for the most  part,  to  recovery  of
operations and maintenance  charges billed to LIPA of approximately  $76 million


                                       58
<PAGE>


and the recovery of depreciation charges and property taxes of approximately $14
million.  These  recoveries  had no  impact on  operating  income  since  actual
expenses increased by a like amount. Therefore, only approximately $7 million of
the increase in net revenues  resulted in a benefit to  operating  income.  This
increase in net revenues from the LIPA service  agreements  was driven by higher
off-system  electric  energy sales and  emission  credit  sales,  as well as the
recovery of certain past service costs, offset by lower performance  incentives.
In 2006,  KeySpan  earned $9.0  million  associated  with  non-cost  performance
incentives provided for under these agreements, compared to $16.4 million earned
in 2005, due to the discontinuation of certain performance  incentives contained
in the MSA.

Net revenues associated with KeySpan's electric marketing  activities  increased
$3.6 million during the twelve months ended  December 31, 2006,  compared to the
same period of 2005.

Net revenues from the Ravenswood Generating Station decreased $110.3 million, or
25% for the twelve months ended  December 31, 2006,  compared to the same period
of 2005  reflecting  lower capacity  revenues of $80.5 million and a decrease in
energy margins of $29.8 million. The decrease in capacity revenues was primarily
due to the  planned  installation  of 1,000  megawatts  of  additional  electric
capacity in New York City in 2006.

The  decrease in energy  margins in 2006  reflects,  in part,  a 50% decrease in
realized  "spark-spreads"  (the selling  price of  electricity  less the cost of
fuel,  exclusive  of hedging  gains or losses).  Further,  the level of megawatt
hours ("MWh") sold into the NYISO energy  market  decreased 30% due to increased
competition  and cooler  weather in the summer of 2006 compared to the summer of
2005 - the peak cooling season. As measured in cooling-degree  days, weather was
25%  cooler  during the summer of 2006  compared  to the summer of 2005,  and 2%
warmer than normal.  Combined,  these two items reduced energy margins by $124.9
million or 63%.  It should be noted,  that in 2005  KeySpan  benefited  from the
pricing differential between number 6-grade fuel oil and natural gas used in the
Ravenswood Generating Station. Due to the dual-fuel capability of the Ravenswood
Generating Station,  KeySpan was able to take advantage of the ability to switch
to cheaper fuel as the gap between number 6 grade fuel oil and gas prices spread
during the later part of the 2005 summer.  The two hurricanes  which occurred in
the summer of 2005 in the Gulf Coast of the United States contributed to the gap
between number 6-grade fuel oil and natural gas prices.

Partially  offsetting  these adverse impacts to comparative  energy margins were
the  benefits  recognized  from  derivative  financial  instruments.  We  employ
derivative financial instruments to economically hedge the cash flow variability
for a portion of  forecasted  purchases  of natural gas and fuel oil consumed at
the  Ravenswood  Generating  Station,  as well as for a  portion  of  forecasted
electric energy sales.  These derivative  instruments,  the impacts of which are
reflected  in net  electric  margins,  resulted in a  comparative  gain of $95.1
million  year-over-year.  Hedging  gains  realized  in 2006 were  $79.1  million
compared to hedging losses of $16.0 million realized in 2005.

The Ravenswood Generating Station is a dual-fuel electric facility that can burn
either number 6-grade fuel oil or natural gas to generate  electricity.  To take
full advantage of the dual-fuel capability of the Ravenswood Generating Station,
KeySpan uses the cheaper of the two fuels in the generation of electricity  and,


                                       59
<PAGE>


as a result, KeySpan may not be able to apply hedge accounting treatment for all
of its aforementioned risk management strategies in the future and therefore may
experience some degree of fluctuations in its recorded net electric revenues due
to changes in the market value of  outstanding  derivative  instruments  and the
related  underlying  commodity.  (See  Note  8  to  the  Consolidated  Financial
Statements "Hedging,  Derivative Financial  Instruments and Fair Values" as well
as Item 7A.  Quantitative  and  Qualitative  Disclosures  about  Market Risk for
further information on KeySpan's hedging strategies.)

The rules and  regulations  for  capacity,  energy sales and the sale of certain
ancillary  services to the NYISO energy markets continue to evolve and there are
several matters pending with the Federal Energy Regulatory  Commission ("FERC").
See the  discussion  under the caption  "Regulatory  Issues and the  Competitive
Environment" for further details on these matters.

Operating Expenses

For the twelve  months ended  December 31, 2006,  operating  expenses  increased
$85.0 million  compared to the same period of 2005.  Operations and  maintenance
expenses  increased  $66.3 million  during the twelve months ended  December 31,
2006,  compared to the same period of 2005 reflecting a $76 million  increase in
costs recovered from LIPA. As noted  previously,  this increase had no impact on
operating income since revenues  increased by a similar amount.  Therefore,  the
operations and  maintenance  expenses that impacted  operating  income  actually
decreased  approximately  $10 million  due to a decrease  in overhaul  costs and
non-outage  maintenance work on the Ravenswood  Generating  Station and our Long
Island based electric generating units.

Depreciation  expense  and  operating  taxes  increased  $18.7  million  in 2006
compared to 2005. Of this amount,  approximately  $14 million is associated with
KeySpan's Long Island based electric  generating units and are fully recoverable
from  LIPA,  as noted  above.  The  remaining  increase  in these  line items is
associated  with the Ravenswood  Generating  Station and did impact  comparative
operating income.

Operating Income 2005 vs 2004

Executive Summary

For the twelve months ended December 31, 2005,  operating income increased $52.5
million,  or 18%,  compared  to the same  period  of 2004,  primarily  due to an
increase in net revenues from the Ravenswood Generating Station of $78.7 million
mainly as a result  of  improved  pricing.  The  increase  in net  revenues  was
partially  offset by an  increase  in  operating  expenses  associated  with the
Ravenswood  Generating  Station of $11.8 million,  as well as lower net revenues
associated with KeySpan's retail electric marketing activities of $7.6 million.

Net Revenues

Total electric net revenues realized during the twelve months ended December 31,
2005,  were $96.8 million,  or 8% higher than such revenues  realized during the
corresponding period of 2004.


                                       60
<PAGE>


For the  year  ended  December  31,  2005,  net  revenues  from  the  Ravenswood
Generating Station increased $78.7 million,  or 22%, compared to the same period
in 2004 reflecting higher energy margins of $66.0 million,  as well as increased
capacity revenues of $12.7 million.  The increase in capacity revenues reflected
the  operation  of the  Ravenswood  Expansion  which  went into full  commercial
operation in May 2004, as well as load growth in New York City.

The  increase  in  energy  margins  for  2005  reflects  an  increase  of 54% in
"spark-spreads"  (the  selling  price  of  electricity  less  the  cost of fuel,
exclusive of hedging gains or losses),  as well as from an increase of 2% in the
level of MWh sold into the NYISO energy market.  These favorable  energy results
were primarily  driven by the pricing  differential  between number 6-grade fuel
oil and natural gas used in the Ravenswood  Generating Station in 2005. As noted
previously,  due to the dual-fuel nature of the Ravenswood  Generating  Station,
KeySpan was able to take  advantage  of the ability to switch to cheaper fuel as
the gap between  number 6 grade fuel oil and gas prices  spread during the later
part of the 2005 summer. Further, in 2005 KeySpan received $9.2 million from the
NYISO to settle  billing  issues  regarding  the sale of energy  provided by the
Ravenswood  Generating  Station to the NYISO in May 2000.  Weather for 2005,  as
measured in cooling  degree  days,  was 40% warmer than 2004 and 28% warmer than
normal.

As mentioned  previously,  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  Generating  Station as well as a
portion of  forecasted  electric  energy  sales.  These  derivative  instruments
resulted in hedging  losses,  which are  reflected in net electric  margins,  of
$16.0 million in 2005, compared to hedging gains of $23.0 million in 2004.

Net revenues for the twelve  months  ended  December 31, 2005,  from the service
agreements with LIPA,  including the power purchase  agreements  associated with
two  electric  peaking  facilities,  increased  $25.7  million  compared  to the
corresponding  period of 2004.  The  increase  was due, in part,  to recovery of
operating  expenses billed to LIPA of approximately $14 million and the recovery
of depreciation  charges and property taxes of approximately  $8 million.  These
recoveries had no impact on operating income since actual expenses  increased by
a like amount. The remaining increase primarily reflects an increase in emission
credits  earned  and  variable  revenues,  which  are  a  function  of  electric
generation  output.  In 2005 and  2004,  we  earned  a total  of  $16.4  million
associated  with  non-cost  performance  incentives  provided  for  under  these
agreements.

Net revenues  associated  with KeySpan's  retail electric  marketing  activities
decreased  $7.6  million  in  2005  compared  to  2004,  due  to  a  significant
curtailment in these activities.  In 2005,  KeySpan terminated all indexed price
contracts and elected to maintain only its fixed priced contracts.  As a result,
the retail electric  marketing  business had  approximately 40 MW under contract
during 2005.

Operating Expenses

For the twelve  months ended  December 31, 2005,  operating  expenses  increased
$43.5  million,  or 5%,  compared  to the same  period of 2004.  Operations  and
maintenance  expense in 2005 increased $31.2 million, or 5% over 2004 reflecting
an  increase  of $7.5  million in  operating  lease  costs  associated  with our


                                       61
<PAGE>


financing  arrangement for the Ravenswood  Expansion,  as well as an increase in
overhaul  work  and  plant  retirement  costs  associated  with  the  Ravenswood
Generating Station amounting to approximately $8 million. The remaining increase
reflected operating costs billed to LIPA of approximately $14 million.

Depreciation  expense  and  operating  taxes  increased  $12.3  million  in 2005
compared to 2004. Of this amount,  approximately  $8 million was associated with
KeySpan's Long Island based electric generating units and were fully recoverable
from  LIPA,  as noted  above.  The  remaining  increase  in these line items was
associated with the Ravenswood Generating Station.

Other Matters

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 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 power from a non-Long Island source of
between  250 to 600 MW of  electricity  by no  later  than the  summer  of 2007.
KeySpan  filed a proposal in response  to LIPA's  RFP.  In 2004,  LIPA  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.  The project has received New York State
Article X approval by having met all  operational and  environmental  permitting
requirements.  Further, the project is strategically  located in close proximity
to both the high  voltage  power  transmission  grid and the high  pressure  gas
distribution  network. In addition,  given the intense public pressure to reduce
emissions  from  existing  generating  facilities,  development  of the Melville
project is possible as a means to "virtually  re-power"  older,  less  efficient
generating units. Specifically, KeySpan believes that it would be able to reduce
emissions on Long Island in a cost  effective  manner by developing the Melville
project and retiring an older, less efficient generating facility. Additionally,
in August  2006,  the NYISO  included the  Melville  project in its  Reliability
Report as one of the market solutions to help address the long-term  reliability
of New York State's electric grid. At December 31, 2006, total capitalized costs
associated  with the siting,  permitting  and  procurement  of equipment for the
Melville facility were $63.6 million.

ENERGY SERVICES

The Energy  Services  segment  includes  companies  that provide  energy-related
services to customers located  primarily within the northeastern  United States.
Subsidiaries in this segment provide residential and small commercial  customers
with  service  and  maintenance  of energy  systems and  appliances,  as well as
operation  and  maintenance,  design,  engineering,  consulting  and fiber optic
services to commercial, institutional and industrial customers.


                                       62
<PAGE>


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

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
                                                            Year Ended December 31,
(In Millions of Dollars)                            2006              2005               2004
-----------------------------------------------------------------------------------------------
<S>                                                <C>               <C>                <C>
Revenues                                          $ 213.0           $ 202.0            $ 193.9
Less:  Operating expenses                           207.7             204.7              227.8
       Goodwill impairment                              -                 -               14.4
-----------------------------------------------------------------------------------------------
Operating  Income (Loss)                          $   5.3           $  (2.7)           $ (48.3)
-----------------------------------------------------------------------------------------------
</TABLE>

Operating Income 2006 vs 2005

The Energy Services  segment posted an operating  profit of $5.3 million for the
twelve  months ended  December 31, 2006,  compared to an operating  loss of $2.7
million  incurred during the twelve months ended December 31, 2005. The improved
performance reflects higher operating margins on engineering contracts,  as well
as  favorable  billings  under a  long-term  energy  service  and energy  supply
contract.  KeySpan's  fiber  optic  operations  realized a benefit to  operating
income from an increase in  bandwidth  sales and the  successful  completion  of
certain projects.  Finally,  general and  administrative  expenses were lower in
2006  compared  to 2005 as a result of the  implementation  of cost  containment
measures.

Operating Income 2005 vs 2004

In  January  and  February  of 2005,  KeySpan  sold its  mechanical  contracting
subsidiaries in this segment and exited such  businesses.  In the fourth quarter
of  2004,  KeySpan's  investment  in  its  discontinued  mechanical  contracting
subsidiaries  was  written-down  to an estimated fair value.  (See Note 2 to the
Consolidated  Financial Statements "Business Segments" for additional details on
the sale of the mechanical companies.)

The Energy Services  segment incurred an operating loss of $2.7 million in 2005,
compared  to a loss of $48.3  million  in  2004.  In 2004,  KeySpan  recorded  a
non-cash goodwill impairment charge in continuing operations of $14.4 million as
a result of an  evaluation  of the carrying  value of goodwill  recorded in this
segment. That evaluation resulted in a total pre-tax impairment charge of $208.6
million ($152.4  million,  or $0.95 per share after-tax) - $14.4 million of this
charge was  attributable to continuing  operations,  while the remaining  $194.2
million  ($139.9  million  after-tax,  or $0.87 per  share),  was  reflected  in
discontinued  operations.  (See Note 10 to the Consolidated Financial Statements
"Energy  Services -  Discontinued  Operations"  for  additional  details on this
charge.)

For 2005, the improved  performance over 2004, excluding the goodwill impairment
charge,  primarily reflected a reduction in operating expenses. In 2004, charges
associated  with the write-off of accounts  receivable and contract  revenues on
certain projects that were determined to be uncollectible, were incurred as well
as the write-down of inventory  balances.  Further,  this segment experienced an
increase in gross profit  margins and generally  lower  administrative  costs in
2005.


                                       63
<PAGE>


ENERGY INVESTMENTS

The Energy  Investments  segment  consists of our gas production and development
investments,  as well as  certain  other  domestic  energy-related  investments.
KeySpan's gas production and  development  activities  include its  wholly-owned
subsidiaries  Seneca  Upshur  Petroleum,  Inc.   ("Seneca-Upshur")  and  KeySpan
Exploration  and  Production,  LLC  ("KeySpan  Exploration").  Seneca-Upshur  is
engaged in gas production and development activities primarily in West Virginia.
KeySpan   Exploration   is  involved  in  a  joint  venture  with  Merit  Energy
Corporation, an independent oil and gas producer, which acquired its interest in
the joint-venture from Houston Exploration.

This segment is also  engaged in pipeline  development  activities.  KeySpan and
Spectra Energy Corporation (formerly a part of Duke Energy Corporation) each own
a 50%  interest  in  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.  Further,
KeySpan has a 26.25 % interest  in the  Millennium  Pipeline  Company  LLC,  the
developer  of the  Millennium  pipeline  project  which is  expected to have the
capacity to transport up to 525,000 DTH of natural gas a day from  Corning,  New
York 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.  These  investments  are
accounted for under the equity method of accounting.  Accordingly, equity income
from these  investments  is reflected as a component of operating  income in the
Consolidated Statement of Income.

KeySpan also owns a 600,000  barrel  liquefied  natural gas ("LNG")  storage and
receiving  facility  in  Providence,  Rhode  Island,  through  its wholly  owned
subsidiary KeySpan LNG, the operations of which are fully consolidated.

Selected  financial  data and  operating  statistics  for  these  energy-related
investments are set forth in the following table for the periods indicated.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
                                                                    Year Ended December 31,
(In Millions of Dollars)                                  2006               2005               2004
-----------------------------------------------------------------------------------------------------
<S>                                                      <C>                <C>                <C>
Revenues                                                $ 40.3             $ 43.0            $  58.9
Less: Operation and maintenance expense                   26.3               26.5               33.5
          Ceiling test write-down                            -                  -               48.2
          Impairment charge                                  -                  -               26.5
          Other operating expenses                        11.9               11.1               15.3
Add:  Equity earnings                                     13.1               15.1               25.8
           Sale of assets                                  0.3                0.1                5.0
-----------------------------------------------------------------------------------------------------
Operating Income (Loss)                                 $ 15.5             $ 20.6            $ (33.8)
-----------------------------------------------------------------------------------------------------
</TABLE>

Operating income above reflects 100% of KeySpan Canada's results from January 1,
2004 through April 1, 2004.


                                       64
<PAGE>


Operating Income 2006 vs 2005

For the twelve months ended December 31, 2006,  operating  income decreased $5.1
million compared to the same period in 2005 due, in part, to lower earnings from
KeySpan's  investment  in the Iroquois Gas  Transmission  System.  In 2005,  the
Iroquois Gas  Transmission  System  realized a benefit  from a court  settlement
relating to a gas supply  contract that was defaulted on by a counterparty in an
earlier period.  Further,  a KeySpan subsidiary engaged in the transportation of
liquefied natural gas realized lower earnings due to the warm weather during the
two winter seasons in calendar year 2006.  Finally,  comparative equity earnings
were  adversely  impacted by the sale of Premier  Transmission  Limited in March
2005.

Operating Income 2005 vs 2004

As noted previously, in the first quarter of 2005, KeySpan sold its 50% interest
in Premier,  a gas pipeline from southwest Scotland to Northern Ireland pursuant
to a Share Sale and  Purchase  Agreement  with BG Energy  Holdings  Limited  and
Premier Transmission Financing Public Limited Company ("PTFPL"), under which all
of the outstanding shares of Premier were to be purchased by PTFPL. On March 18,
2005, the sale was completed and generated  cash proceeds of $48.1  million.  In
the fourth  quarter of 2004,  KeySpan  recorded  a pre-tax  non-cash  impairment
charge of $26.5 million  reflecting the difference  between the anticipated cash
proceeds from the sale of Premier compared to its carrying value. The final sale
of Premier resulted in a pre-tax gain of $4.1 million  reflecting the difference
from earlier estimates.  This gain was recorded in other income and (deductions)
on the Consolidated Statement of Income.

During the first quarter of 2004,  KeySpan had an approximate  61% investment in
certain  midstream  natural gas assets in Western Canada through KeySpan Canada.
These assets included 14 processing plants and associated gathering systems that
produced  approximately  1.5 BCFe of natural gas daily and  provided  associated
natural gas liquids  fractionation.  These operations were fully consolidated in
KeySpan's  Consolidated  Financial  Statements.  On April 1, 2004,  KeySpan  and
KeySpan  Facilities  Income Fund (the "Fund"),  an open-ended income trust which
previously  owned a 39% interest in KeySpan  Canada,  consummated  a transaction
that  reduced  KeySpan's  ownership  interest  in  KeySpan  Canada  to 25%.  The
transaction  resulted in a gain of $22.8 million  ($10.1 million  after-tax,  or
$0.06 per share).  Effective April 1, 2004,  KeySpan  Canada's  earnings and our
ownership  interest in KeySpan Canada were 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%.

In December 2004, KeySpan sold its remaining 17.4% interest in KeySpan Canada to
the Fund and received net proceeds of approximately  $119 million and recorded a
pre-tax  gain  of  $35.8  million,  which  is  reflected  in  other  income  and
(deductions)  on the  Consolidated  Statement of Income.  The after-tax gain was
approximately $24.7 million, or $0.15 per share. (See Note 2 to the Consolidated
Financial  Statements  "Business Segments" for additional details regarding this
transaction.)


                                       65
<PAGE>


For the twelve months ended December 31, 2005, operating income for this segment
increased $54.4 million compared to the same period of 2004, reflecting non-cash
impairment charges recorded in 2004 of $74.7 million. In 2004,  KeySpan's wholly
owned gas production  and  development  subsidiaries  that remained with KeySpan
after the transaction  with Houston  Exploration,  discussed  below,  recorded a
non-cash  impairment  charge of $48.2 million to recognize the reduced valuation
of  proved  reserves.  (See  Note 1 to  the  Consolidated  Financial  Statements
"Summary  of  Significant  Accounting  Policies"  Item  F  "Gas  Production  and
Development  Property -  Depletion"  for further  information  on this  charge.)
Further,  as mentioned,  in 2004 KeySpan recorded a pre-tax non-cash  impairment
charge of $26.5 million  reflecting the difference  between the anticipated cash
proceeds from the sale of Premier compared to its carrying value.

Operating  income for the twelve months ended  December 31, 2004,  also includes
$16.5  million  in  earnings  from  KeySpan  Canada.  The  remaining  activities
reflected a decrease in operating  income of $3.8 million  primarily  due to the
sale of real property in 2004.

Houston Exploration

Selected  financial data and operating  statistics for Houston  Exploration  for
2004 are set forth in the following table.

--------------------------------------------------------------------

                                                       Year Ended
(In Millions of Dollars)                          December 31, 2004
--------------------------------------------------------------------
Revenues                                                 $    268.1
Depletion and amortization expense                            104.6
Other operating expenses                                       45.7
Add: Equity Earnings                                           20.7
--------------------------------------------------------------------
Operating Income                                         $    138.5
--------------------------------------------------------------------

During  the  first  five  months of 2004,  our gas  production  and  development
investments  included  a  55%  equity  interest  in  Houston  Exploration,   the
operations  of which  were  consolidated  in  KeySpan's  Consolidated  Financial
Statements.  On June 2, 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 23.5%.  Effective  June 2, 2004,
Houston Exploration's earnings and our ownership interest in Houston Exploration
were  accounted  for on the  equity  method of  accounting.  KeySpan  follows an
accounting  policy of income  statement  recognition for parent company gains or
losses  from common  stock  transactions  initiated  by its  subsidiaries.  As a
result,  this transaction  resulted in a gain to KeySpan of $150.1 million.  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.


                                       66
<PAGE>


In  November  2004,  KeySpan  sold  its  remaining  23.5%  interest  in  Houston
Exploration  (6.6 million  shares) and received cash  proceeds of  approximately
$369  million.  KeySpan  recorded  a pre-tax  gain of $179.6  million  which was
reflected  in other income and  (deductions)  on the  Consolidated  Statement of
Income. The after-tax gain was $116.8 million or $0.73 per share.

Other Matters

In order to serve the  anticipated  market  requirements in our New York service
territories,  KeySpan and Spectra  Energy  Corporation  (formerly a part of Duke
Energy Corporation) formed Islander East Pipeline Company, LLC ("Islander East")
in 2000.  Islander  East is  owned  50% by  KeySpan  and 50% by  Spectra  Energy
Corporation,  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 FERC and all necessary  permits from the State of New York.
The State of  Connecticut  denied  Islander  East's  request  for a  consistency
determination under the Coastal Zone Management Act ("CZMA") and application for
a permit under  Section 401 of the Clean Water Act.  Islander  East appealed the
State of  Connecticut's  determination  on the CZMA issue to the  United  States
Department of Commerce which overrode  Connecticut's denial and granted the CZMA
authorization.  The  determination  of the Secretary of Commerce was appealed to
the United  States  District  Court for the District of Columbia by the State of
Connecticut and a decision from that court is pending. Following an appeal filed
by Islander  East,  the Second Circuit Court of Appeals ruled on October 5, 2006
that, among other things, the Connecticut Department of Environmental Protection
("CTDEP")  acted  arbitrarily  and  capriciously  in denying the Clean Water Act
permit.  The Court  remanded  the matter to CTDEP to either  provide  sufficient
evidence  to  support  the denial or  otherwise  take any  action  necessary  in
furtherance  of the  development  of the project.  In December  2006,  the CTDEP
issued an order again denying the Clean Water Act permit.  Islander East filed a
motion for review with the Second  Circuit  Court of Appeals,  which is pending.
KeySpan  anticipates  that this  pipeline will be in service in late 2008. As of
December 31, 2006,  KeySpan's total capitalized costs associated with the siting
and permitting of the Islander East pipeline were approximately $30.3 million.

As  noted,  KeySpan  also owns a 26.25%  ownership  interest  in the  Millennium
Pipeline  Company LLC, the developer of the  Millennium  Pipeline  project.  The
other partners in the Millennium  Pipeline are Columbia Gas  Transmission  Corp.
("Columbia  Transmission"),  a unit of  NiSource  Incorporated  and  DTE  Energy
Company.  The Millennium Pipeline project is anticipated to have the capacity to
transport  up to 525,000  DTH of natural gas a day from  Corning to Ramapo,  New
York,  interconnecting  with the pipeline  systems of various other utilities in
New York.  The project  received a FERC  certificate  to construct,  acquire and
operate the  facilities  in 2002,  subject to certain  conditions.  On August 1,
2005, the project filed an application to amend the FERC certificate requesting,
among other  things,  authority  to phase in over time the  construction  of the
proposed  pipeline  system,  approval  of a reduction  in  capacity  and maximum
allowable operating pressure, minor route modifications, the addition of certain
facilities and the acquisition of certain facilities from Columbia Transmission.
In December  2006 the FERC  issued an order  granting  the amended  certificate.
Additionally,  Consolidated  Edison,  KEDLI and Columbia  Transmission have each
entered into amended precedent  agreements to purchase capacity on the pipeline.


                                       67
<PAGE>


KEDLI has agreed to purchase  175,000 DTH per day from the  Millennium  Pipeline
system,  increasing  to 200,000 DTH in the second year of the pipeline  being in
service.  This will provide  KEDLI with new,  competitively  priced  supplies of
natural gas from Canada and other North American  supply basins.  The conditions
in the precedent  agreements are subject to, among other things,  the receipt of
necessary  regulatory  approvals and financing.  Millennium is in the process of
securing all remaining environmental permits,  financing and the finalization of
certain  agreements  prior to actual  construction.  Subject  to the  receipt of
remaining permits and financing,  Millennium expects that the first phase of the
project will be in service by November 2008. As of December 31, 2006,  KeySpan's
investment in the Millennium Pipeline project was $18.2 million

In 2005, KeySpan LNG entered into a precedent agreement with BG LNG Services,  a
subsidiary  of  British  Gas,  to provide  liquefied  natural  gas  terminalling
service.  KeySpan LNG proposed to upgrade the liquefied  natural gas facility to
accept marine deliveries and to triple vaporization (or regasification) capacity
to  provide  these  services.  In June  2005,  the  FERC  denied  KeySpan  LNG's
application to expand the facility  citing  concerns that the proposed  upgraded
facility would not meet current federal new construction  and safety  standards.
KeySpan  sought a rehearing  with FERC, and on January 20, 2006, the FERC denied
such  request,  although  the order  provided  that  KeySpan  LNG could  file an
amendment to its original  application  addressing a revised  expansion  project
which would differ  substantially from that originally proposed by KeySpan.  Any
amended application would need to include a detailed analysis of the new project
scope,  including upgrades to the existing  facilities and alternative plans for
any service  disruptions  that may be  necessary  during  construction  of a new
expanded  project.  KeySpan has filed a petition for judicial review of the FERC
order with the United  States  Circuit  Court for the District of Columbia.  The
Court is expected to issue a decision  affirming  or vacating the FERC orders by
the second quarter of 2007.

In addition to the  proceeding at FERC,  KeySpan LNG also is involved in seeking
other required  regulatory  approvals and the  resolution of certain  litigation
regarding  such  approvals.  In  February  2005,  KeySpan LNG filed an action in
Federal District Court in Rhode Island seeking a declaratory judgment that it is
not  required to obtain a "Category B Assent" from the State of Rhode Island and
an injunction  preventing the Rhode Island Coastal Resources  Management Council
("CRMC") from enforcing the Category B assent  requirements.  In April 2005, the
Rhode  Island  Attorney  General  also filed on behalf of the state a  complaint
against  KeySpan LNG in Rhode Island State Superior Court raising  substantially
the same issues as the federal court action.  KeySpan LNG removed that action to
federal court and moved for summary  judgment.  The Court stayed the  litigation
pending  resolution of the FERC appeal process  discussed  above. As of December
31, 2006, our  investment in this project was $18.4 million,  a portion of which
may be  subject  to  reimbursement  from BG LNG  pursuant  to the  terms  of the
precedent agreement.

ALLOCATED COSTS

We are subject to the  jurisdiction of the FERC under PUHCA 2005. As part of the
regulatory  provisions of PUHCA 2005,  the FERC regulates  various  transactions
among affiliates within a holding company system. In accordance with regulations
under  PUHCA 2005 and  regulations  and  policies  of the New York State  Public


                                       68
<PAGE>


Service  Commission,  the  Massachusetts  Department of  Telecommunications  and
Energy and the New Hampshire Public Utility  Commission,  we established service
companies that provide: (i) traditional  corporate and administrative  services;
(ii) gas and electric transmission and distribution system planning,  marketing,
and gas supply  planning and  procurement;  and (iii)  engineering and surveying
services to  subsidiaries.  The  operating  income  variation  as  reflected  in
"elimination and other" is due primarily to costs residing at KeySpan's  holding
company level such as incremental  costs associated with the anticipated  Merger
with National Grid plc, as well as corporate advertising expenses. Also, KeySpan
entered into  confidential  settlement  agreements with certain of its insurance
carriers for recovery of environmental  costs associated with  investigation and
remediation of gas plant sites and non-utility  sites.  KeySpan  recorded a $5.5
million  benefit in its  Consolidated  Statement of Income for the twelve months
ended December 31, 2006, associated with these settlement agreements.

The operating income variation  between 2005 and 2004 was due primarily to costs
residing at KeySpan's  holding  company level such as corporate  advertising and
strategic review costs.  Further,  in 2004 KeySpan reached a settlement with its
insurance   carriers   regarding  cost  recovery  for  expenses  incurred  at  a
non-utility  environmental  site and  recorded  an $11.6  million  gain from the
settlement as a reduction to operating expenses.

LIQUIDITY

Cash flow from operations  increased  $655.3 million for the twelve months ended
December  31,  2006  compared  to the same  period  last year  primarily  due to
favorable working capital  requirements of approximately  $520 million and lower
income tax payments.  The favorable working capital  requirements were primarily
driven by receipt of customer  payments  associated with the 2005 fourth quarter
winter heating  season gas sales and lower payments for inventory  requirements.
Outstanding   accounts   receivable   balances  associated  with  KeySpan's  gas
distribution  activities at December 31, 2005 were  unusually high due to strong
gas sales in 2005 and high natural gas prices.  The collection of these balances
in 2006, and improved collection experience, resulted in a significant cash flow
benefit to KeySpan.  Further,  due to the impact of the warm weather experienced
during the two winter heating  seasons in 2006,  KeySpan  purchased less natural
gas in 2006 than it did 2005 to refill its inventory supplies. Also, the average
unit price  associated  with gas purchased  for inventory  purposes was lower in
2006 compared to 2005. Both of these events had a favorable  impact to KeySpan's
cash flows in 2006.

Additionally,  KeySpan's  income tax payments  were $23 million lower during the
twelve months ended December 31, 2006, compared to the same period last year. In
2005, the IRS published new regulations  related to the  capitalization of costs
of  self-constructed  property for income tax purposes that were  detrimental to
KeySpan.  As a result, in 2006 KeySpan adopted a new tax methodology  related to
the capitalization of costs of self-constructed  property that resulted in lower
income tax payments in 2006 compared to 2005.

Cash flow from  operations  decreased  $346.8  million,  or 46%,  for the twelve
months  ended  December  31, 2005  compared to 2004,  reflecting,  in part,  the
absence of Houston  Exploration  and KeySpan Canada which  combined  contributed
approximately  $230  million to  consolidated  operating  cash flow in 2004.  It
should  be  noted  that in  prior  years,  Houston  Exploration  funded  its gas


                                       69
<PAGE>


exploration and development  activities,  in part, from available cash flow from
operations.  In addition,  due to the significant increase in natural gas prices
in 2005,  KeySpan's gas distribution  utilities paid  approximately $215 million
more in 2005  compared  to 2004 for the  purchase of natural gas that was put in
inventory.  As noted  previously,  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 sale to firm customers and gas
costs billed to firm  customers  are deferred and refunded to or collected  from
customers  in a  subsequent  period.  Further,  in 2005  the IRS  published  new
regulations related to the capitalization of costs of self-constructed  property
for income tax  purposes.  As a result of these  regulations,  KeySpan  incurred
approximately  $77 million in higher  income tax payments for the twelve  months
ended  December  31, 2005  compared to the same  period in 2004.  These  adverse
impacts to cash flow from  operations  were  partially  offset by lower interest
payments and higher core earnings.

At December 31,  2006,  we had cash and  temporary  cash  investments  of $210.9
million.  During 2006,  we repaid  $572.6  million of  commercial  paper and, at
December  31, 2006,  $85.0  million of  commercial  paper was  outstanding  at a
weighted-average annualized interest rate of 5.43%. We had the ability to borrow
up to an  additional  $1.4 billion at December 31, 2006,  under the terms of our
credit facility.

KeySpan  has two  credit  facilities  which  total $1.5  billion - $920  million
available through 2010, and $580 million available through 2009 - which continue
to support KeySpan's commercial paper program for ongoing working capital needs.

The fees for the  facilities  are based on KeySpan's  current credit ratings and
are increased or decreased  based on a downgrading  or upgrading of our ratings.
The current  annual  facility  fee is 0.07% based on our credit  rating of A3 by
Moody's  Investor  Services and A by Standard & Poor's for each  facility.  Both
credit  facilities  allow  KeySpan to borrow using  several  different  types of
loans;  specifically,  Eurodollar  loans, ABR loans, or competitively bid loans.
Eurodollar  loans are based on the Eurodollar rate plus a margin that is tied to
our applicable  credit  ratings.  ABR loans are based on the higher 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 utility 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 65% as of the
last day of any fiscal quarter. Violation of these covenants 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.  At
December  31,  2006,  KeySpan's  consolidated  indebtedness  was  49.9%  of  its
consolidated capitalization and KeySpan was in compliance with all covenants.


                                       70
<PAGE>


Subject to certain conditions set forth in the credit facility,  KeySpan has the
right, at any time, to increase the commitments  under the $920 million facility
up to an additional $300 million. In addition,  KeySpan has the right to request
that the termination date be extended for an additional period of 365 days prior
to each  anniversary  of the  closing  date.  This  extension  option,  however,
requires the approval of lenders holding more than 50% of the total  commitments
to such  extension  request.  Under the  agreements,  KeySpan has the ability to
replace  non-consenting  lenders  with  other  pre-approved  banks or  financial
institutions.  Upon  effectiveness  of PUHCA  2005,  KeySpan's  ability to issue
commercial  paper was no longer  limited  by the SEC.  Accordingly,  subject  to
compliance with the foregoing conditions,  KeySpan is currently able to issue up
to $1.5 billion of commercial paper.

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.  Accordingly,  our cash flows are
dependent upon the timely payment of amounts owed to us by these counterparties.
(See the discussion under the caption "Electric  Services - LIPA Agreements" for
information regarding the proposed settlement between KeySpan and LIPA regarding
the current contractual agreements.)

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:

--------------------------------------------------------------------------
                                                  Year Ended December 31,
(In Millions of Dollars)                          2006              2005
--------------------------------------------------------------------------
Gas Distribution                               $ 400.5            $ 410.3
Electric Services                                 78.9               88.8
Energy Investments                                18.7               22.6
Energy Services and other                         25.9               17.8
--------------------------------------------------------------------------
                                               $ 524.0            $ 539.5
--------------------------------------------------------------------------

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 to
maintain our generating facilities.

Construction  expenditures  for  2007 are  estimated  to be  approximately  $570
million,  including estimated  expenditures for the Islander East and Millennium
pipelines. KeySpan and its partners are currently evaluating various options for
the financing of these projects. The amount of future construction  expenditures
is reviewed on an ongoing basis and can be affected by timing, scope and changes
in investment opportunities.


                                       71
<PAGE>


Financing

In November 2006,  KeySpan issued $400 million Senior  Unsecured  Notes at KEDNY
and $100 million Senior Unsecured Notes at KEDLI pursuant to a private placement
that was exempt from  registration  under the  Securities Act of 1933. The Notes
bear interest at a rate of 5.60%  annually and mature in 2016.  The net proceeds
from the  issuance  of the  Notes  were  used by KEDNY  and  KEDLI to  refinance
existing  intercompany  indebtedness  and for general working capital  purposes.
KeySpan  utilized a $125 million treasury lock, at 4.77%, to hedge the 5-year US
Treasury  component of the underlying notes and a $125 million treasury lock, at
4.82%, to hedge the 10-year US Treasury component of the underlying notes. These
derivative  instruments  settled on October 25, 2006 at which time  KeySpan paid
$0.2 million to the counterparty to the contracts. The loss on the settlement of
these  contracts  has been  deferred for future  collection  from firm gas sales
customers consistent with regulatory requirements.

KeySpan does not anticipate issuing permanent financing in 2007.

The following table represents the ratings of our long-term debt at December 31,
2006. During the fourth quarter of 2004 Standard & Poor's reaffirmed its ratings
on  KeySpan's  and its  subsidiaries'  long-term  debt and removed its  negative
outlook.  Further  in the second  quarter of 2005,  Fitch  Ratings  revised  its
ratings on KeySpan's and its  subsidiaries'  long-term debt to positive outlook.
Moody's Investor Services,  however,  continues to maintain its negative outlook
ratings on KeySpan's and its subsidiaries' long-term debt.

-------------------------------------------------------------------------------
                             Moody's Investor       Standard
                                 Services           & Poor's     FitchRatings
-------------------------------------------------------------------------------
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
-------------------------------------------------------------------------------

OFF-BALANCE SHEET ARRANGEMENTS

Guarantees

KeySpan had a number of financial  guarantees with its  subsidiaries at December
31, 2006. KeySpan has 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  $385  million  sale/leaseback
transaction for the Ravenswood  Expansion including future decommission costs of
$19 million;  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


                                       72
<PAGE>


Balance Sheet; the sale/leaseback obligation is not recorded on the Consolidated
Balance  Sheet.  Further,  KeySpan has  guaranteed:  (i) up to $65.2  million of
surety bonds  associated  with certain  construction  projects  currently  being
performed by former subsidiaries; (ii) certain supply contracts, margin accounts
and purchase  orders for certain  subsidiaries  in an aggregate  amount of $64.6
million;  and (iii)  $80.3  million  of  subsidiary  letters  of  credit.  These
guarantees  are  not  recorded  on the  Consolidated  Balance  Sheet.  KeySpan's
guarantees  on  certain  performance  bonds  relating  to  current  construction
projects of the  discontinued  mechanical  contracting  companies will remain in
place  throughout  the  construction  period  for these  projects.  KeySpan  has
received an indemnity bond issued by a third party to offset potential  exposure
related to a significant portion of the continuing  guarantee.  At this time, we
have no reason to believe  that our  subsidiaries  or former  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 7 to the
Consolidated   Financial   Statements,   "Contractual   Obligations,   Financial
Guarantees and Contingencies"  for additional  information  regarding  KeySpan's
guarantees,  as well as Note 10 "Energy Services - Discontinued  Operations" for
additional information on the discontinued mechanical contracting companies.)

Contractual Obligations

KeySpan has certain contractual obligations related to its outstanding long-term
debt,  outstanding  credit facility  borrowings,  outstanding  commercial  paper
borrowings, various leases, and demand charges associated with certain commodity
purchases.  KeySpan's  outstanding  short-term  and long-term debt issuances are
explained  in more  detail in Note 6 to the  Consolidated  Financial  Statements
"Long-Term Debt and Commercial  Paper."  KeySpan's leases, as well as its demand
charges  are  more  fully  detailed  in  Note  7 to the  Consolidated  Financial
Statements  "Contractual  Obligations,  Financial Guarantees and Contingencies."
The  table  below  reflects   maturity   schedules  for  KeySpan's   contractual
obligations  at December 31, 2006.  Included in the table is the long-term  debt
that has been  consolidated as part of the variable  interest entity  associated
with the Ravenswood Master Lease.

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------
 (In Millions of Dollars)
 Contractual Obligations                Total          1 - 3 Years     4 - 5 Years    After 5 Years
---------------------------------------------------------------------------------------------------
<S>                                    <C>             <C>             <C>                <C>
 Long-term Debt                       $ 4,422.9       $   717.3       $ 1,130.0          $ 2,575.6
 Capital Leases                             9.8             3.4             2.6                3.8
 Operating Leases                         549.8           215.1           133.1              201.6
 Master Lease Payments                     71.2            71.2               -                  -
 Sale/Leaseback Arrangement               549.1            92.0            78.7              378.4
 Interest Payments                      2,940.7           731.8           350.7            1,858.2
 Demand Charges                           449.0           449.0               -                  -
---------------------------------------------------------------------------------------------------
 Total Contractual
     Cash Obligations                 $ 8,992.5       $ 2,279.8       $ 1,695.1          $ 5,017.6
---------------------------------------------------------------------------------------------------
 Commercial Paper                        $ 85.0       Revolving
---------------------------------------------------------------------------------------------------
</TABLE>


                                       73
<PAGE>


For information regarding projected postretirement contributions,  see Note 4 to
the Consolidated Financial Statements "Postretirement Benefits." For information
regarding asset retirement obligations, see Note 7 to the Consolidated Financial
Statements "Contractual Obligations, Financial Guarantees and Contingencies."

DISCUSSION 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.  The  critical
accounting policies requiring such subjectivity are discussed below.

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 Statement of Financial  Accounting  Standard ("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.  The assumptions used to measure the fair value of our investments are
the  same  as  those  used  by  us  to  prepare  annual  operating  segment  and
consolidated  earnings and cash flow forecasts.  In addition,  these assumptions
are used to set annual budgetary guidelines.

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
indicate that the evaluation should be performed at an interim period during the
year.  At December 31, 2006,  KeySpan had $1.7 billion of recorded  goodwill and
has  concluded  that the fair value of the  business  units  that have  recorded
goodwill exceed their carrying value.

As noted  previously,  during  2004,  KeySpan  conducted  an  evaluation  of the
carrying value of goodwill recorded in its Energy Services segment.  As a result
of this evaluation,  KeySpan recorded a non-cash  goodwill  impairment charge of
$108.3  million  ($80.3  million  after tax,  or $0.50 per share) in 2004.  This
charge was recorded as follows: (i) $14.4 million as an operating expense on the
Consolidated  Statement of Income  reflecting  the write-down of goodwill on the
Energy  Services  segment's  continuing  operations;  and (ii) $93.9  million as
discontinued  operations reflecting the impairment on the mechanical contracting
companies.  (See  Note  10 to  the  Consolidated  Financial  Statements  "Energy
Services-Discontinued Operations" for further details.)


                                       74
<PAGE>


Also as noted previously,  at the end of 2004, KeySpan  anticipated  selling its
then 50% interest in Premier. This investment was accounted for under the equity
method of accounting in the Energy Investments segment. In the fourth quarter of
2004 KeySpan  recorded a pre-tax non-cash  impairment  charge of $26.5 million -
$18.8 million  after-tax or $0.12 per share. The impairment charge reflected the
difference  between  the  anticipated  cash  proceeds  from the sale of  Premier
compared to its  carrying  value at that time and was recorded as a reduction to
goodwill.

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 Public Service Commission ("NYPSC"), the New
Hampshire  Public  Utilities   Commission   ("NHPUC"),   and  the  Massachusetts
Department of Telecommunications and Energy ("MADTE").

Four  of  our  six  regulated  gas  utilities  (KEDNY,  KEDLI,  Boston  Gas  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  orders issued by the MADTE  relating to the  acquisition by Eastern
Enterprises  of  Colonial  Gas  Company  and Essex Gas  Company,  the base rates
charged  by these  companies  have been  frozen at their  current  levels  for a
ten-year  period ending 2009 and 2008  respectively.  Due to the length of these
base rate  freezes,  Colonial  Gas Company and Essex Gas Company had  previously
discontinued the application of SFAS 71.

SFAS 71 allows for the  deferral  of  expenses  and  income on the  Consolidated
Balance  Sheet as  regulatory  assets and  liabilities  when it is probable that
those  expenses  and income  will be allowed  in the rate  setting  process in a
period  different from the period in which they would have been reflected in the
consolidated  statements of income of an  unregulated  company.  These  deferred
regulatory  assets  and  liabilities  are then  recognized  in the  Consolidated
Statement of Income in the period in which the amounts are reflected in rates.

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. If we
were unable to continue to apply the  provisions  of SFAS 71 for any of our rate
regulated  subsidiaries,  we would apply the  provisions of SFAS 101  "Regulated
Enterprises  -  Accounting  for  the  Discontinuation  of  Application  of  FASB
Statement No. 71." We estimate that the write-off of our net  regulatory  assets
at December 31, 2006,  before  consideration  of removal cost  recovered,  could
result in a charge to net income of  approximately  $630.4  million or $3.60 per
share,  which would be classified  as an  extraordinary  item.  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.

As is further  discussed  under the caption  "Regulation  and Rate  Matters," in
October  2003 the MADTE  rendered  its decision on the Boston Gas base rate case
and Performance  Based Rate Plan proposal  submitted to the MADTE in April 2003.
The rate plans  previously  in effect for KEDNY and KEDLI have  expired  and the


                                       75
<PAGE>


rates  established  in those  plans  remain in effect.  EnergyNorth  Natural Gas
Inc.'s  base  rates  continue  as  set by  the  NHPUC  in  1993.  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. As
part of its  application for approval of the KeySpan / National Grid plc Merger,
KeySpan  has filed  proposed  rate plans for KEDNY and KEDLI with the NYPSC.  In
addition, individual applications for a proposed annual increase in revenues for
KEDNY and KEDLI were filed.  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 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.

Pension and Other Postretirement Benefits

As discussed in Note 4 to the Consolidated Financial Statements, "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 expected results are amortized
to expense over ten years.

Certain gas distribution  subsidiaries are subject to SFAS 71, and, as a result,
changes in  postretirement  expenses are deferred  for future  recovery  from or
refund to gas sales  customers.  (However,  KEDNY,  although subject to SFAS 71,
does not have a  recovery  mechanism  in place  for  changes  in  postretirement
costs.) Further, changes in postretirement expenses associated with subsidiaries
that service the LIPA  Agreements are also deferred for future  recovery from or
refund to LIPA.

For 2006,  the assumed  long-term  rate of return on our  postretirement  plans'
assets was 8.5%  (pre-tax),  net of expenses.  This is an appropriate  long-term
expected rate of return on assets based on KeySpan's investment strategy,  asset
allocation and the historical performance of equity and fixed income investments
over long periods of time. The actual 10 year compound annual rate of return for
the KeySpan Plans is greater than 8.5%.

KeySpan's master trust investment allocation policy target is 70% equity and 30%
fixed income. At December 31, 2006, the actual investment allocation was in line
with the  target.  In an effort  to  maximize  plan  performance,  actual  asset
allocation  will  fluctuate  from  year to year  depending  on the then  current
economic environment.


                                       76
<PAGE>

Based on the results of an asset and liability  study  projecting  asset returns
and expected  benefit  payments over a 10-year  period,  KeySpan has developed a
multiyear funding strategy for its postretirement  plans.  KeySpan believes that
it is  reasonable  to assume  assets  can  achieve  or  outperform  the  assumed
long-term  rate of return with the target  allocation  as a result of historical
performance of equity investments over long-term periods.

A 25 basis point increase or decrease in the assumed long-term rate of return on
plan assets would have impacted 2006 expense by approximately $6 million, before
deferrals.

The  year-end  December  31,  2006  assumed  discount  rate  used  to  determine
postretirement obligations was 6.00%. Our discount rate assumption is based upon
the Citigroup  above-median pension discount curve. A 25 basis point increase or
decrease in the assumed year-end  discount rate would have had no impact on 2006
expense.  A year-end  discount  rate of 5.75% would have  required an additional
$144 million  increase to the pension and other  postretirement  reserve balance
and  a  debit  to  accumulated  other  comprehensive  income  before  taxes  and
deferrals.

At January 1, 2006, the assumed  discount rate used to determine  postretirement
obligations  was 5.75%.  A 25 basis  point  increase  or decrease in the assumed
discount  rate at the  beginning of the year would have impacted 2006 expense by
approximately $16 million, before deferrals.

Our health care cost trend  assumptions  are developed  based on historical cost
data, the near-term  outlook and an assessment of likely long-term  trends.  The
salary growth assumptions reflect our long-term outlook.

Historically, we have funded our qualified pension plans in excess of the amount
required to satisfy minimum ERISA funding requirements. At December 31, 2006, we
had a funding credit balance in excess of the ERISA minimum funding requirements
and as a  result  KeySpan  was not  required  to make any  contributions  to its
qualified  pension  plans in 2006.  Although the KeySpan  qualified  pension and
other postretirement plans were not required to make a contribution in 2006, the
pension plans are under-funded on a projected benefit  obligation basis.  During
2006, KeySpan contributed $131 million to its postretirement plans.

The  Pension  Protection  Act of 2006 was passed in August  2006 and  provided a
comprehensive  overhaul of pension funding rules. KeySpan will implement several
pension  plan  changes  effective  January  2008 based on the new  requirements.
During 2006, KeySpan performed a stochastic  projection  analyses of its pension
plan's assets and  liabilities and concluded,  at the 50%  percentile,  that its
current  funding policy is sufficient for existing ERISA rules and will meet the
requirements of the Pension  Protection Act of 2006 for  approximately  the next
ten years.

For 2007, KeySpan expects to contribute approximately $131 million to its funded
and under funded  post-retirement plans. Future funding requirements are heavily
dependent on actual return on plan assets and prevailing interest rates.

Valuation of Derivative Instruments

We employ derivative instruments to hedge a portion of our exposure to commodity
price risk and interest rate risk, to partially hedge the cash flow  variability
associated  with  our  electric  energy  sales  from the  Ravenswood  Generation
Station, as well as to economically hedge certain other commodity exposures.

For those derivative  instruments designated as cash flow hedges, changes in the
market value are recorded in accumulated other  comprehensive  income,  (in line
with effectiveness measurements) and are not recorded through earnings until the
derivative positions are settled.  With respect to those derivative  instruments
that are not designated as hedging  instruments,  such derivatives are accounted
for on the  Consolidated  Balance Sheet at fair value,  with all changes in fair
value reported in earnings.

When available, quoted market prices are used to record a contract's fair value.
However,  market  values for  certain  derivative  contracts  may not be readily
available  or  determinable.  A  number  of  our  commodity  related  derivative
instruments are exchange traded and,  accordingly,  fair value  measurements are

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based on available quotes. Additionally, we use market quoted forward prices for
commodities  that are not  exchange  traded,  such as No.  6 grade  fuel oil and
electric power swaps. The fair value of our electric  capacity hedge is based on
published NYISO capacity bidding prices. Further, if no active market exists for
a commodity, fair values may be based on pricing models.

SFAS 133  establishes  criteria  that must be  satisfied  in order  for  forward
contracts  for the physical  delivery of  commodities  to qualify for the normal
purchases  and sales  exception.  Those  contracts  that  qualify for the normal
purchase and sale exception,  and where the exception has been elected,  are not
recognized in the financial  statements  until  settlement.  The  distinguishing
characteristics  between  contracts  that qualify for the normal  purchases  and
sales  exception  and those that do not are,  at times,  subjective  and require
judgment.

All fair value measurements,  whether calculated using available quotes or other
valuation  techniques,  are subjective and subject to  fluctuations in commodity
prices,  interest rates and overall economic market conditions and, as a result,
our fair value  measurements may not be precise and can fluctuate  significantly
from period to period.

DIVIDENDS

KeySpan's  annual dividend rate for 2007 is $1.90 per common share. Our dividend
framework is reviewed annually by the Board of Directors.  The amount and timing
of all dividend  payments is subject to the discretion of the Board of Directors
and will depend  upon  business  conditions,  results of  operations,  financial
conditions and other factors.  Based on currently foreseeable market conditions,
we intend to maintain the annual dividend at the $1.90 level.

Pursuant to NYPSC  orders,  the ability of KEDNY and KEDLI to pay  dividends  to
KeySpan is conditioned upon maintenance of a utility capital structure with debt
not exceeding 55% and 58%,  respectively,  of total utility  capitalization.  In
addition,  the level of dividends  paid by both  utilities  may not be increased
from current  levels if a 40 basis point penalty is incurred  under the customer
service performance  program. At the end of KEDNY's and KEDLI's most recent rate
years (September 30, 2006 and November 30, 2006, respectively), each company was
in  compliance  with  the  utility  capital  structure  required  by the  NYPSC.
Additionally, we have met the requisite customer service performance standards.

REGULATION AND RATE MATTERS

Gas Distribution

On September 30, 2002, KEDNY's rate agreement with the NYPSC expired.  Under the
terms of the agreement,  the then current gas  distribution  rates and all other
provisions,  including  the earnings  sharing  provision  (at a 13.25% return on
equity), remain in effect until changed by the NYPSC. Under the agreement, KEDNY
is subject to an earnings sharing provision  pursuant to which it is required to
credit firm  customers  with 60% of any utility  earnings up to 100 basis points
above a 13.25%  return  on  equity  (other  than any  earnings  associated  with
discrete  incentives)  and 50% of any  utility  earnings  in excess of 100 basis
points above such threshold  level.  KEDNY did not earn above a 13.25% return on
equity in its rate year ended September 30, 2006.

On November 30, 2000,  KEDLI's rate agreement with the NYPSC expired.  Under the
terms of the agreement,  the then current gas  distribution  rates and all other
provisions,  including the earnings  sharing  provision,  remain in effect until
changed  by the NYPSC.  Under the  agreement,  KEDLI is  subject to an  earnings
sharing  provision  pursuant to which it is required to credit to firm customers
60% of any utility earnings for any rate year ended November 30, up to 100 basis
points  above a return on equity of 11.10% and 50% of any  utility  earnings  in
excess  of a return  on equity  of  12.10%.  KEDLI did not earn  above an 11.10%
return on equity in its rate year ended November 30, 2006.

KeySpan  has  recently  filed  proposed  rate plans for KEDNY and KEDLI with the
NYPSC as part of its application for approval of the KeySpan / National Grid plc
Merger,  as well as individual  applications  for a proposed  annual increase in
revenues  for  KEDNY  and  KEDLI.  See the  "Introduction  to the  Notes  to the
Consolidated Financial Statements" for additional details on the filings.


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Boston Gas,  Colonial Gas and Essex Gas operations are subject to Massachusetts'
statutes  applicable to gas  utilities.  Rates for gas sales and  transportation
service,  distribution  safety  practices,  issuance of securities and affiliate
transactions are regulated by the MADTE.

Effective  November 1, 2003, the MADTE approved a $25.9 million increase in base
revenues for Boston Gas with an allowed return on equity of 10.2%  reflecting an
equal  balance of debt and equity.  On January 27,  2004,  the MADTE  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 MADTE also approved a Performance Based Rate Plan (the
"Plan") for up to ten years. On November 1, 2006, the MADTE approved a base rate
increase  of $8.6  million  under the Plan.  In  addition,  an  increase of $2.7
million in the local  distribution  adjustment  clause was  approved  to recover
pension  and other  postretirement  costs.  The MADTE  also  approved  a true-up
mechanism  for  pension  and other  postretirement  benefit  costs  under  which
variations  between  actual pension and other  postretirement  benefit costs and
amounts used to establish  rates are deferred and collected  from or refunded to
customers in  subsequent  periods.  This true-up  mechanism  allows for carrying
charges on deferred  assets and  liabilities at the Boston Gas  weighted-average
cost of capital.

In connection with the Eastern Enterprises  acquisition of Colonial Gas in 1999,
the MADTE  approved a merger and rate plan that resulted in a ten year freeze of
base rates to Colonial Gas firm customers.  The base rate freeze is subject only
to certain exogenous factors,  such as changes in tax laws,  accounting changes,
or regulatory,  judicial,  or legislative changes. Due to the length of the base
rate freeze,  Colonial Gas discontinued its application of SFAS 71. Essex Gas is
also under a ten-year base rate freeze and has also discontinued its application
of SFAS 71.  EnergyNorth  Natural Gas Inc.'s  base rates  continue as set by the
NHPUC in 1993.

In  December  2005,  Boston Gas  received a MADTE  order  permitting  regulatory
recovery  of the 2004  gas  cost  component  of bad  debt  write-offs.  This was
approved for full recovery as an exogenous cost  effective  November 1, 2005. In
addition,  effective  January 1, 2006, Boston Gas was permitted to fully recover
the gas cost component of bad debt write-offs through its cost-of-gas adjustment
clause  rather than  filing for  recovery as an  exogenous  cost.  Both of these
favorable recovery  mechanisms were reflected in our December 31, 2005 Allowance
for Doubtful  Accounts reserve  requirement and related expense.  On October 31,
2006,  the MADTE granted Boston Gas recovery of $12 million of the 2005 gas cost
component of bad debt write-offs from Boston Gas ratepayers  beginning  November
1, 2006.  This  amount is being  recovered  through the  cost-of-gas  adjustment
clause.

Electric Rate 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 FERC in accordance with the PSA entered into between
KeySpan and LIPA in 1998.  The original FERC approved  rates,  which had been in
effect since May 1998, expired on December 31, 2003. On October 1, 2004 the FERC
approved a settlement  reached between KeySpan and LIPA to reset rates effective
January 1, 2004.  Under the new  agreement,  KeySpan's  rates  reflect a cost of
equity of 9.5%.  The FERC approved  updated  operating and  maintenance  expense
levels and recovery of certain other costs as agreed to by the parties.


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As noted  earlier,  on February 1, 2006,  KeySpan and LIPA  entered  into (i) an
amended  and  restated  Management  Services  Agreement;  (ii) a new  Option and
Purchase and Sale Agreement, to replace the Generation Purchase Rights Agreement
as  amended;  and (iii) a  Settlement  Agreement  resolving  outstanding  issues
between the parties regarding the 1998 LIPA Agreements. (See Electric Services -
"LIPA  Agreements" for a discussion of the 2006  settlement  between KeySpan and
LIPA regarding the current contractual agreements.)

The Energy  Policy Act of 2005 and the Public  Utility  Holding  Company Acts of
1935 and 2005

In August 2005,  the Energy Policy Act of 2005 (the "Energy Act") was enacted by
Congress  and signed into law by the  President  of the United Sates of America.
The Energy Act is a broad based energy bill that places an increased emphasis on
the production of energy and promotes the  development of new  technologies  and
alternative  energy  sources by providing tax credits to companies  that produce
natural gas, oil, coal,  electricity and renewable energy.  For KeySpan,  one of
the more significant  provisions of the Energy Act was the repeal of PUHCA 1935,
effective  February  8,  2006,  and the  transfer  of  certain  holding  company
oversight from the SEC to FERC pursuant to PUHCA 2005.

Pursuant  to PUHCA  2005,  the SEC no longer has  jurisdiction  over our holding
company  activities,   other  than  those  traditionally   associated  with  the
registration and issuance of our securities  under the federal  securities laws.
FERC now has  jurisdiction  over  certain  of our  holding  company  activities,
including (i) regulating  certain  transactions  among our affiliates within our
holding company system; (ii) governing the issuance, acquisition and disposition
of  securities  and assets by certain of our public  utility  subsidiaries;  and
(iii) approving certain utility mergers and acquisitions.

Moreover,  our affiliate transactions also remain subject to certain regulations
of the NYPSC, MADTE and NHPUC, in addition to FERC.

Electric Services - LIPA Agreements

LIPA is a corporate municipal instrumentality and a political subdivision of the
State of New York.  On May 28,  1998,  certain  of LILCO's  business  units were
merged with KeySpan and LILCO's common stock and remaining  assets were acquired
by LIPA.  At the time of this  transaction,  KeySpan and LIPA entered into three
major  long-term  service  agreements  that (i)  provide to LIPA all  operation,
maintenance and construction  services and significant  administrative  services
relating to the Long Island electric  transmission and distribution system ("T&D
System")  pursuant to the Management  Services  Agreement (the "1998 MSA"); (ii)
supply LIPA with electric generating  capacity,  energy conversion and ancillary
services  from our Long Island  generating  units  pursuant to the Power  Supply
Agreement  (the "1998  PSA") and other  long-term  agreements  through  which we
provide LIPA with  approximately  one half of its customers'  energy needs;  and
(iii)  manage all  aspects of the fuel  supply  for our Long  Island  generating


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facilities,  as well as all aspects of the capacity and energy owned by or under
contract to LIPA pursuant to the Energy  Management  Agreement (the "1998 EMA").
We also purchase energy,  capacity and ancillary  services in the open market on
LIPA's behalf under the 1998 EMA. The 1998 MSA, 1998 PSA and 1998 EMA all became
effective  on May 28,  1998 and are  collectively  referred  to as the 1998 LIPA
Agreements.

On February 1, 2006,  KeySpan and LIPA  entered into (i) an amended and restated
Management  Services Agreement (the "2006 MSA"),  pursuant to which KeySpan will
continue to operate and  maintain  the electric T&D System owned by LIPA on Long
Island;  (ii) a new Option and  Purchase  and Sale  Agreement  (the "2006 Option
Agreement"),  to replace the Generation  Purchase Rights  Agreement (as amended,
the "GPRA"),  pursuant to which LIPA had the option,  through December 15, 2005,
to acquire  substantially  all of the electric  generating  facilities  owned by
KeySpan on Long Island;  and (iii) a Settlement  Agreement (the "2006 Settlement
Agreement")  resolving outstanding issues between the parties regarding the 1998
LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement
Agreement  are  collectively  referred to herein as the "2006 LIPA  Agreements".
Each of the 2006 LIPA  Agreements  will become  effective  as of January 1, 2006
upon  all of the  2006  LIPA  Agreements  receiving  the  required  governmental
approvals; otherwise none of the 2006 LIPA Agreements will become effective. The
2006 LIPA Agreements will become  effective  following  approval by the New York
State Comptroller's Office and the New York State Attorney General.

2006  Settlement  Agreement.  Pursuant  to  the  terms  of the  2006  Settlement
Agreement,  KeySpan and LIPA agreed to resolve issues that have existed  between
the parties  relating to the various  1998 LIPA  Agreements.  In addition to the
resolution of these matters,  KeySpan's entitlement to utilize LILCO's available
tax  credits and other tax  attributes  will  increase  from  approximately  $50
million to approximately $200 million.  These credits and attributes may be used
to satisfy KeySpan's  previously  incurred indemnity  obligation to LIPA for any
federal  income tax liability that results from the recent  settlement  with the
IRS regarding the audit of LILCO's tax returns for the years ended  December 31,
1996  through  March 31,  1999.  On October  30,  2006,  the IRS  submitted  the
settlement provisions of the recently concluded IRS audit to the Joint Committee
on  Taxation  for  approval.  Key  provisions  of the  settlement  included  the
resolution of the tax basis of assets  transferred to KeySpan at the time of the
KeySpan/LILCO  merger, the tax deductibility of certain merger related costs and
the tax  deductibility  of certain  environmental  expenditures.  The settlement
enabled KeySpan to utilize 100% of the available tax credits. (See Note 3 to the
Consolidated  Financial Statements "Income Taxes" for additional  information of
the  settlement.) In recognition of these items, as well as for the modification
and extension of the 1998 MSA and the amendments to the GPRA, upon effectiveness
of the 2006 Settlement Agreement, KeySpan will record a contractual asset in the
amount of approximately $160 million,  of which  approximately $110 million will
be attributed to the right to utilize such additional credits and attributes and
approximately $50 million will be amortized over the eight year term of the 2006
MSA. In order to compensate  LIPA for the  foregoing,  KeySpan will pay LIPA $69
million in cash and will settle  certain  accounts  receivable  in the amount of
approximately $90 million due from LIPA.


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Generation  Purchase  Rights  Agreement  and 2006  Option  Agreement.  Under the
amended  GPRA,  LIPA  had  the  right  to  acquire  certain  of  KeySpan's  Long
Island-based  generating  assets formerly owned by LILCO at fair market value at
the time of the exercise of such right.  LIPA was  initially  required to make a
determination  by May 2005,  but  KeySpan  and LIPA agreed to extend the date by
which LIPA was to make this  determination  to December 15, 2005. As part of the
2006  settlement  between  KeySpan and LIPA,  the parties  entered into the 2006
Option  Agreement  whereby LIPA had the option during the period January 1, 2006
to December 31, 2006 to purchase only KeySpan's Far Rockaway and/or E.F. Barrett
Generating  Stations  (and certain  related  assets) at a price equal to the net
book value of each facility.  In December 2006, KeySpan and LIPA entered into an
amendment to the 2006 Option Agreement  whereby the parties agreed to extend the
expiration  of the option  period to the later of (i)  December 31, 2007 or (ii)
180 days  following the effective  date of the 2006 Option  Agreement.  The 2006
Option  Agreement  replaces the GPRA,  the  expiration  of which has been stayed
pending effectiveness of the 2006 LIPA Agreements.  In the event such agreements
do not become  effective  by reason of  failure  to secure any of the  requisite
governmental approvals, the GPRA will be reinstated for a period of 90 days from
the date such  approval  is  denied.  If LIPA were to  exercise  the  option and
purchase one or both of the  generation  facilities  then:  (i) LIPA and KeySpan
will  enter into an  operation  and  maintenance  agreement,  pursuant  to which
KeySpan will  continue to operate  these  facilities  through May 28, 2013 for a
fixed management fee plus  reimbursement for certain costs and (ii) the 1998 PSA
and 1998 EMA will be amended to reflect that the purchased generating facilities
would no longer be covered by those agreements.  It is anticipated that the fees
received  pursuant to the operation and  maintenance  agreement  will offset the
reduction in the operation and  maintenance  expense  recovery  component of the
1998 PSA and the reduction in fees under the 1998 EMA.

Management  Services  Agreements.  Pursuant to the 1998 MSA, KeySpan manages the
day-to-day  operations,  maintenance and capital improvements of the T&D System.
When originally  executed,  the 1998 MSA had a term expiring on May 28, 2006. In
2002,  in  connection  with an  extension  of the  GPRA  term,  the 1998 MSA was
extended for 31 months through 2008. As a result of the recent  negotiations and
settlement  between KeySpan and LIPA discussed  above,  the parties entered into
the 2006 MSA.

In place of the previous compensation  structure (whereby KeySpan was reimbursed
for budgeted  costs,  and earned a management  fee and certain  performance  and
cost-based incentives), KeySpan's compensation for managing the T&D System under
the 2006 MSA consists of two  components:  a minimum  compensation  component of
$224 million per year and a variable component based on electric sales. The $224
million  component  will  remain  unchanged  for three  years and then  increase
annually by 1.7% plus inflation. The variable component,  which will comprise no
more than 20% of  KeySpan's  compensation,  is based on  electric  sales on Long
Island  exceeding a base amount of 16,558 gigawatt hours,  increasing by 1.7% in
each year. Above that level,  KeySpan will receive  approximately 1.34 cents per
kilowatt hour for the first contract  year,  1.29 cents per kilowatt hour in the
second  contract  year  (plus an annual  inflation  adjustment),  1.24 cents per
kilowatt hour in the third contract year (plus an annual inflation  adjustment),
with the per  kilowatt  hour rate  thereafter  adjusted  annually by  inflation.
Subject to certain  limitations,  KeySpan will be able to retain all operational
efficiencies realized during the term of the 2006 MSA.


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LIPA will  continue to reimburse  KeySpan for certain  expenditures  incurred in
connection  with the  operation  and  maintenance  of the T&D System,  and other
payments made on behalf of LIPA,  including:  real property and other T&D System
taxes,  return  postage,   capital   construction   expenditures,   conservation
expenditures and storm costs.

The 2006 MSA  provides for a number of  performance  metrics  measuring  various
aspects of KeySpan's  performance in the operations and customer  service areas.
Poor  performance  in any metric may  subject  KeySpan  to  financial  and other
non-cost  penalties  (such  financial  penalties not to exceed $7 million in the
aggregate for all performance metrics in any contract year).  Subject to certain
limitations,  superior  performance  in  certain  metrics  can be used to offset
underperformance  in  other  metrics.   Consistent  failure  to  meet  threshold
performance levels for two metrics,  System Average Interruption  Duration Index
(two out of three  consecutive  years) and  Customer  Satisfaction  Index (three
consecutive years), will constitute an event of default under the 2006 MSA.

In the event LIPA sells the T&D  System to a private  entity  during the term of
the 2006 MSA, LIPA shall have the right to terminate the 2006 MSA, provided that
LIPA  will be  required  to pay  KeySpan's  reasonable  transition  costs  and a
termination fee of (a) $28 million if the  termination  date occurs on or before
December  31,  2009,  and (b) $20 million if the  termination  date occurs after
December 31, 2009.

Upon approval, the 2006 LIPA Agreements will be effective retroactive to January
1, 2006.  KeySpan's reported operating income and net income for 2006, under the
2006 MSA,  are  substantially  the same as they would have been if the terms and
provisions of the 1998 MSA had  continued to be applied.  At this point in time,
KeySpan  is  unable to  estimate  what the  impact  would be to its  results  of
operations, financial position and cash flows if the 2006 LIPA Agreements do not
become fully effective.

Power Supply  Agreements.  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 FERC.  Since  October 1, 2004,
pursuant to a FERC  approved  settlement,  the rates reflect a cost of equity of
9.5%. The FERC also approved  updated  operating and maintenance  expense levels
and KeySpan's recovery of certain other costs as agreed to by the parties. Rates
charged to LIPA include a fixed and variable  component.  The variable component
is billed to LIPA on a monthly per  megawatt  hour basis and is dependent on the
number of megawatt hours  dispatched.  LIPA has no obligation to purchase energy
conversion  services  from  KeySpan  and is able to  purchase  energy  or energy
conversion  services on a least-cost basis from all available sources consistent
with  existing  interconnection  limitations  of the T&D  System.  The  1998 PSA
provides  incentives  and penalties  that can total $4 million  annually for the
maintenance  of the  output  capability  and the  efficiency  of the  generating
facilities. In 2006, we earned $4.0 million in incentives under this agreement.


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The 1998 PSA has a term of fifteen years through May 2013,  with LIPA having the
option to renew the 1998 PSA for an  additional  fifteen year term.  If the 2006
LIPA  Agreements  receive  the  requisite   governmental  approvals  and  become
effective and if LIPA  exercises  its rights under the 2006 Option  Agreement to
purchase  the two  generating  plants,  then LIPA and KeySpan will enter into an
operation and maintenance agreement,  pursuant to which KeySpan will continue to
operate these  facilities  for a fixed  management  fee plus  reimbursement  for
certain  costs;  and the 1998 PSA will be amended to reflect that the  purchased
generating  facilities  would  no  longer  be  covered  by the 1998  PSA.  It is
anticipated  that the fees received  pursuant to the  operation and  maintenance
agreement  will offset the reduction in the operation  and  maintenance  expense
recovery component of the 1998 PSA.

Energy  Management  Agreement.  The 1998 EMA provides for KeySpan to procure and
manage fuel supplies on behalf of LIPA to fuel the generating  facilities  under
contract  to it and  perform  off-system  capacity  and  energy  purchases  on a
least-cost basis to meet LIPA's needs. In exchange for these services we earn an
annual fee of $1.5  million.  In addition,  we arrange for  off-system  sales on
behalf of LIPA of excess output from the  generating  facilities and other power
supplies  either owned or under contract to LIPA. LIPA is entitled to two-thirds
of the profit  from any  off-system  energy  sales.  In  addition,  the 1998 EMA
provides  incentives  and  penalties  that can  total $5  million  annually  for
performance  related to fuel purchases and off-system power purchases.  In 2006,
we earned EMA incentives in an aggregate of $5.0 million.

The original term for the fuel supply service is fifteen years, expiring May 28,
2013, and the original term for the power supply management  services  described
was eight years,  which  expired on May 28, 2006.  In March 2005,  LIPA issued a
Request  for  Proposal  ("RFP")  for system  power  supply  management  services
beginning May 29, 2006 and fuel  management  services for certain of its peaking
generating units beginning January 1, 2006.  KeySpan submitted a bid in response
to this RFP in April 2005. LIPA has not yet selected a service provider.

In 2005,  the EMA was  amended  to extend the term for power  supply  management
services  through  December 31, 2006 and thereafter on a  month-to-month  basis,
unless  terminated  by LIPA on sixty  days  notice,  but in no event  later than
December 31, 2007.

In the event LIPA exercises its rights under the 2006 Option Agreement,  KeySpan
and LIPA  will  enter  into an  amendment  to the 1998 EMA  reflecting  that the
facilities  that LIPA  acquires  pursuant to the Option  Agreement are no longer
covered  under the 1998 EMA and as noted  above,  an operation  and  maintenance
agreement,   whereby  KeySpan  will  continue  to  operate  the  newly  acquired
facilities for a fixed management fee plus  reimbursement  for certain costs. It
is anticipated that the fees received  pursuant to the operation and maintenance
agreement  will offset the  reduction in any fees earned by KeySpan  pursuant to
the 1998 EMA.

Under the 1998 LIPA Agreements and the 2006 LIPA Agreements,  we are required to
obtain a letter of credit in the aggregate amount of $60 million  supporting our
obligations  to provide the various  services if our long-term debt is not rated
in the "A" range by a nationally recognized rating agency.


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<PAGE>


Power Purchase Agreements.  KeySpan-Glenwood Energy Center, LLC and KeySpan-Port
Jefferson  Energy Center LLC each have 25 year power  purchase  agreements  with
LIPA  expiring in 2027 (the "2002 LIPA PPAs").  Under the terms of the 2002 LIPA
PPAs, these subsidiaries sell capacity, energy conversion services and ancillary
services to LIPA.  Each plant is designed  to produce  79.9 MW.  Pursuant to the
2002 LIPA PPAs, LIPA pays a monthly capacity fee, which guarantees full recovery
of each plant's  construction costs, as well as an appropriate rate of return on
investment.

Ravenswood Generating Station

We currently sell capacity,  energy and ancillary  services  associated with the
Ravenswood  Generating  Station  through a bidding process into the NYISO energy
and capacity markets.  Energy is sold on both a day-ahead and a real-time basis.
We also have the ability to enter into bilateral  transactions  to sell all or a
portion of the energy  produced  by the  Ravenswood  Generating  Station to load
serving  entities,  i.e.  entities  that sell to  end-users  or to  brokers  and
marketers.

Other Contingencies

In 2005, LIPA completed its strategic  review  initiative that it had undertaken
in  connection  with,  among  other  reasons,  its option  under the  Generation
Purchase Rights  Agreement with KeySpan.  As part of its review,  LIPA engaged a
team of  advisors  and  consultants,  held  public  hearings  and  explored  its
strategic options, including continuing its existing operations, municipalizing,
privatizing,  selling some,  but not all of its assets,  becoming a regulator of
rates and services,  or merging with one or more  utilities.  Upon completion of
its  strategic  review,  LIPA  determined  that it would  continue  its existing
operations  and entered into the  renegotiated  2006 LIPA  Agreements  that were
discussed  above.  Following the  announcement  of the proposed  acquisition  of
KeySpan by National Grid plc,  LIPA,  National Grid plc and KeySpan have engaged
in discussions concerning the impact of the transaction on LIPA's operations. At
this time, we are unable to determine what impact,  if any, such discussions may
have on the 2006 LIPA  Agreements  and the  receipt  and timing of  governmental
approvals relating thereto.

Pursuant  to  indemnity  obligations  contained  in the LILCO /  KeySpan  Merger
Agreement,  KeySpan had been in discussions  with the IRS with regard to LILCO's
tax returns for the tax years ended  December 31, 1996  through  March 31, 1999,
and  KeySpan's  and the Brooklyn  Union Gas  Company's tax returns for the years
ended September 30, 1997 through December 31, 1998. All outstanding  issues were
resolved in 2006. The IRS submitted the case to the Joint  Committee on Taxation
on October 30, 2006 for final approval. Additionally, the IRS recently commenced
the  examination  of KeySpan's tax returns for the years ended 2002 and 2003. At
this time,  we cannot  predict  the result of these  audits.  (See Note 3 to the
Consolidated  Financial  Statements "Income Taxes" for additional  information.)


                                       85
<PAGE>


ENVIRONMENTAL MATTERS

KeySpan  is  subject to  various  federal,  state and local laws and  regulatory
programs related to the  environment.  Through various rate orders issued by the
NYPSC,  MADTE and NHPUC,  costs related to MGP environmental  cleanup activities
are recovered in rates charged to gas  distribution  customers and, as a result,
adjustments  to  these  reserve  balances  do  not  impact  earnings.   However,
environmental  cleanup activities related to the three non-utility sites are not
subject to rate recovery.

We estimate that the  remaining  cost of our MGP related  environmental  cleanup
activities,  including costs associated with the Ravenswood  Generating Station,
will be  approximately  $361.1 million and we have recorded a related  liability
for such amount.  We have also recorded an additional  $11.4 million  liability,
representing the estimated  environmental cleanup costs related to a former coal
tar  processing  facility.  As of December 31, 2006, we have expended a total of
$225.3 million on environmental  investigation and remediation activities.  (See
Note 7 to  the  Consolidated  Financial  Statements,  "Contractual  Obligations,
Guarantees and Contingencies" for a further explanation of these matters.)

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,
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 contributions 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 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, oil and  processing  services to energy  marketing  and oil and gas
production companies.


                                       86
<PAGE>


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 and in accordance with various
regulatory requirements.

We also have credit risk from LIPA, our largest customer,  and from other energy
and financial services  companies.  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.

REGULATORY ISSUES AND THE COMPETITIVE ENVIRONMENT

We are subject to various other risk exposures and uncertainties associated with
our gas and  electric  operations.  Set forth  below is a  description  of these
exposures.

The Gas Industry

New York and Long Island
------------------------

For the last  several  years,  the NYPSC has been  monitoring  the  progress  of
competition in the energy market.  Based upon its findings of the current market
and its stated desire to move toward fully  competitive  markets,  the NYPSC, in
August 2004,  issued  companion policy  statements  regarding its vision for the
future of competitive  markets and guidelines for separately stating the cost of
competitive services currently performed by New York utilities.  In the first of
these  policy  statements  the  NYPSC  provided  its  vision  for the  future of
competitive markets and required, among other items, that utilities' future rate
filings must include plans for  facilitating  customer  migration to competitive
markets and fully embedded cost of service studies that develop  unbundled rates
for the utilities' delivery service and all potentially competitive services.

The NYPSC's second policy  statement of August 2004 addressed the means by which
New  York  utilities  should  state  separately,  or  "unbundle,"  the  costs of
competitive  and  potentially   competitive   services  currently  performed  by
utilities from the cost of providing local distribution  service.  The objective
of  unbundling  is  to  facilitate   competition  by  providing  customers  with
information as to savings  available from purchasing  competitive  services from
third-party providers, and to credit the customer's utility bill for the cost of
unbundled services when they migrate to competitive suppliers. In its unbundling
policy statement, the NYPSC directed utilities to file with their next base rate
proceedings updated cost studies for unbundled  competitive  services that, once
approved by the NYPSC, would replace existing backout credits for these services
established in prior  proceedings.  The NYPSC also asked  utilities to file with


                                       87
<PAGE>


the unbundled cost studies a lost revenue  recovery  mechanism that would permit
the utility to recover revenue  associated with the difference  between the cost
the utility is able to avoid when a customer  migrates to a competitive  service
provider  and the  unbundled  rate for that service  credited to the  customer's
bill.

In their  individual rate cases filed on October 3, 2006,  KEDNY and KEDLI filed
proposed new unbundled rates. The proposed unbundled supply rates were $0.58/dth
and  $0.22/dth  for KEDNY and KEDLI,  respectively,  which would  replace  their
current supply function backout credits of $0.21/dth and $0.19/dth. The proposed
unbundled billing and payment processing rates are $0.76 per account,  per month
and $0.65 per account, per month for KEDNY and KEDLI, respectively,  which would
replace their current  billing backout  credits,  both of which are set at $0.78
per account,  per month.  Pursuant to a May 2001 Order of the NYSPSC,  customers
that  purchase  commodity  service  from  third-party  providers  and  receive a
consolidated  bill from the utility  receive a credit on their utility bills for
the unbundled billing rate. The utility then invoices the third-party  commodity
provider for the billing service at the same unbundled  billing rate credited to
the  customer's  utility bill,  which  eliminates  the risk of lost revenue.  In
contrast,  there is a risk of lost revenue with respect to the unbundled  supply
rates if  KEDNY  and  KEDLI  are not able to avoid  costs,  such as  credit  and
collections and promotional advertising expense, at the same pace as these costs
are credited to customers who migrate to competitive  gas  suppliers.  KEDNY and
KEDLI  proposed  to recover  any such  revenue  loss  through  their  respective
balancing  accounts.  KEDNY and KEDLI made the same  proposals for new unbundled
rates and lost  revenue  recovery  mechanisms  in the rate plans  filed with the
joint petition with National Grid plc on July 20, 2006.

New England
-----------

In  February  1999,  the MADTE  issued its order on  unbundling  of natural  gas
service.   For  a  five  year  transition  period,  the  MADTE  determined  that
contractual  commitments with local distribution  companies ("LDCs") to upstream
capacity would be assigned on a mandatory,  pro-rata basis to marketers  selling
gas supply to the LDCs'  customers.  The approved  mandatory  assignment  method
eliminates the possibility that the costs of upstream capacity  purchased by the
LDCs to serve firm  customers  will be  absorbed  by the LDC or other  customers
through the transition period. The MADTE also found that, through the transition
period, LDCs would retain primary  responsibility for upstream capacity planning
and  procurement  to assure  that  adequate  capacity  is  available  to support
customer  requirements and growth. Since November 1, 2000, all Massachusetts gas
customers  have the option to  purchase  their gas  supplies  from  third  party
sources other than the LDCs.

In January 2004, the MADTE began a proceeding to re-examine whether the upstream
capacity market has been  sufficiently  competitive to allow voluntary  capacity
assignment.  On June 6,  2005,  the  MADTE  issued  an order  in its  continuing
investigation into gas unbundling and found that mandatory  capacity  assignment
should be continued.

Beginning on November 1, 2001,  the NHPUC has  required  gas  utilities to offer
transportation  only services to all commercial and residential  customers.  The
New Hampshire  unbundling  program  provides for mandatory  capacity  assignment
similar to the  Massachusetts  rules.


                                       88
<PAGE>


In  September  2006,  Boston Gas filed its third annual  Performance  Based Rate
("PBR")  compliance in accordance  with the PBR rate plan approved by the MADTE.
In  October,  2006,  the DTE  issued an order  that (1)  allowed  the Boston Gas
proposed  inflation-based  increase  of  2.72%  or  $8.6  million,  (2)  allowed
exogenous  cost recovery of $12 million in bad debt expense  through the cost of
gas  adjustment  clause and (3)  disallowed an exogenous  cost recovery  request
related to new gate box maintenance  requirements pursuant to Massachusetts law.
In  November,  2006,  Boston  Gas  filed a  motion  for  reconsideration  of the
exogenous  cost  decisions  along with a motion to extend the time for filing an
appeal to the  Massachusetts  Supreme Judicial Court. The MADTE has not ruled on
the Boston Gas motion.

Electric Industry

10-Minute Spinning and Non-Spinning Reserves
--------------------------------------------

Due to the  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 such reserves,  as well as requiring a refunding of so
called alleged "excess payments"  received by sellers,  including the Ravenswood
Facility. 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 NYISO's other requests, such as
a bid cap for spinning reserves,  retroactive refunds,  recalculation of reserve
prices, etc., were rejected.

The NYISO, The Consolidated  Edison Company of New York ("Con Edison"),  Niagara
Mohawk  Power  Corporation  and  Rochester  Gas and Electric  each  individually
appealed FERC's order in federal court. The appeals were  consolidated  into one
case and 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 (the "Decision"). Essentially, the Court found errors in FERC's order
and remanded some issues back to FERC for further explanation and action.

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.  On March 4, 2005,  FERC issued an order  upholding  its
original  decision  not  to  order  refunds.  FERC  also  provided  the  further
explanation requested by the Court as to why refunds were not being ordered. The
NYISO and various New York  Transmission  Owners  requested  rehearing of FERC's
latest order and on November 17, 2005, FERC denied those requests. The NYISO and
various New York Transmission  Owners appealed FERC's November 17, 2005 order to
the United States Court of Appeals for the District of Columbia.

On September 25, 2006, the Court issued a briefing  schedule,  which was revised
on November 1, 2006.  The NYISO and various New York  Transmission  Owners filed
their brief on December 11,  2006.  FERC filed its response on February 9, 2007,
and KeySpan will file its brief on February 26, 2007.


                                       89
<PAGE>


The Ravenswood Generating Station and our New York City Operations

On February 9, 2006,  the NYISO  Operating  Committee  increased  the  "in-City"
locational  capacity  requirements  (LCR) from 80% to 83%  beginning in May 2006
through the period ending April 2007,  based, in part, on the statewide  reserve
margin of 118% set by the New York State Reliability Council.  However, in early
March 2006, the NYISO discovered data inconsistencies in the input files used in
the Multi Area  Reliability  Simulation  (MARS) computer program that is used to
determine  the  statewide  installed  reserve  margin  (Statewide  IRM)  and the
corresponding  minimum LCRs for New York City and Long Island.  Revisions to the
data,  and  rerunning  the  MARS  computer  program  resulted  in a shift in the
relationship  between the Statewide IRM and the minimum LCRs. On March 20, 2006,
the New York State Reliability Council voted to retain the Statewide IRM of 118%
and reported the  corresponding  revised minimum LCRs to the NYISO. On March 28,
2006, the NYISO Operating Committee approved revised minimum LCRs of 80% and 99%
for New York City and Long Island, respectively.  For New York City, this action
effectively  returned the  locational  requirement to the minimum level used for
the last six years (80%) and negated the increase to 83%.

KeySpan  appealed  this  decision to the NYISO Board of  Directors  claiming the
revised  study was hastily  prepared and that there were  historic  factors that
justified  using  83% as the New York City LCR.  The  NYISO  Board of  Directors
denied KeySpan's appeal on April 3, 2006 and the "in-City"  locational  capacity
requirement  beginning  May 1, 2006 through the period  ending April 30, 2007 is
currently 80%.

Our Ravenswood  Generating  Station is an "in-City"  generator.  As the electric
infrastructure  in New York City and the  surrounding  areas continues to change
and evolve and the demand for electric power increases,  the "in-City" generator
requirement  could be further  modified.  Construction of new  transmission  and
generation  facilities may cause significant  changes to the market for sales of
capacity,  energy and ancillary services from our Ravenswood Generating Station.
Approximately,  1000 MW of additional  capacity came on line in 2006. We can not
be  certain  as to the  nature  of  future  New York City  energy,  capacity  or
ancillary services market requirements or design.

NYISO In-City Capacity Mitigation
---------------------------------

The NYPSC, Con Edison and other load serving entities ("LSEs") complained to the
NYISO that in-City capacity market clearing prices during the summer of 2006 did
not decline as they had expected with the  introduction of additional  supply in
the New York City market.  The NYISO issued a letter to FERC  indicating that no
tariff  violations  occurred and that prices were as it expected.  Nevertheless,
the NYISO  stated that if changes to the market are  warranted,  the NYISO would
consider making revisions as necessary.

Accordingly,  the NYPSC and Con Edison developed additional  mitigation measures
that  would  apply  to  certain  in-City  generation  owned  by  KeySpan.  These
mitigation  measures  essentially would reduce the capacity offer cap on bids by
the  Ravenswood  Generating  Station  and  certain  other  generation  owners of
capacity into the NYISO Spot Demand Curve Auction Market.  The current offer cap
is $105/kW-year and is proposed to be reduced to $82/kW-year plus 3%.


                                       90
<PAGE>


The reduced  offer cap would be  implemented  using a conduct and impact test on
the offers of capacity from the Ravenswood  Generating  Station and other owners
of Consolidated  Edison divested  generation  units.  Under the proposal,  if an
offer to sell  capacity  is 3% or more  above  $82/kW-year,  then  the  offer is
subject to possible  mitigation.  To determine if mitigation will be applied,  a
second test, an impact test, is utilized.  If the  unmitigated  offer raises the
total  market  cost of  capacity  by 3% or more as compared to the total cost of
capacity  derived using those  generators'  $82/kW-year  reference bid, then the
offer will be mitigated to $82/kW-year.

The NYISO's  Management  Committee and NYISO's  Board of Directors  approved the
above proposal,  notwithstanding  KeySpan's  analysis and objections.  The NYISO
filed the mitigation measures with the FERC for approval. KeySpan intervened and
protested  the filing,  which is pending at FERC. At this time, we are unable to
predict  the  outcome  of this  proceeding  and what  effect it will have on our
financial condition,  results of operations,  and cash flows. However,  adoption
and  implementation  of  the  proposal  in its  current  form  could  materially
adversely  affect the revenue realized by KeySpan from the sale of capacity from
the Ravenswood  Generating  Station, as well as the potential revenue that could
be realized in connection with the fixed for floating financial Swap Agreement.

NYISO May 2006 In-City Capacity Market Error
--------------------------------------------

On December 1, 2006, the NYISO filed a complaint against  SCS/Astoria Energy LLC
("Astoria"),  an in-City  electric  generating  unit,  alleging  that it did not
follow the NYISO tariff rules related to the  certification and sale of capacity
in relation to its auctions for the sale of capacity to the NYISO  market.  As a
result,  a certain amount of capacity that was sold in the May 2006 auctions was
determined by the NYISO to be ineligible.  In its complaint,  the NYISO proposes
to impose a  deficiency  charge  against  Astoria  for the  improperly-certified
capacity.  The NYISO could then award  additional  capacity  payments to another
in-City  supplier  (including the Ravenswood  Generating  Station)  because that
supplier  would  have  sold  additional  capacity  if not for  for  the  Astoria
discrepancy. A decision by the FERC is pending.

Summer 2002 Capacity Under procurement Complaint
------------------------------------------------

On January 12, 2007,  the Court of Appeals for the District of Columbia  Circuit
("Court") issued its decision related to a KeySpan  complaint  against the NYISO
related to capacity  procurement  activities during the summer of 2002.  KeySpan
had  complained  to FERC  that the NYISO  violated  its  tariff  and as a result
received  $23.3  million  less than it would have if the NYISO had  followed the
tariff.  The Court vacated rulings by the FERC that denied KeySpan's  complaint.
The Court  determined that the NYISO did in fact violate its tariff but remanded
two issues back to the FERC for further consideration.  The two issues relate to
whether FERC should grant KeySpan's  requested relief for the tariff  violation.
At this time, we are unable to predict the outcome of this  proceeding  and what
effect it will have on KeySpan's results of operations,  financial  position and
cash flows.


                                       91
<PAGE>


ITEM 7A.        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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
production and development  activities and its electric  generating  facilities.
Our gas distribution operations utilize over-the-counter ("OTC") 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  when
economically  appropriate to do so. Seneca-Upshur utilizes OTC natural gas swaps
to hedge cash flow variability associated with forecasted sales of natural gas.

Commodity  Derivative  Instruments  that are not  Accounted  for as Hedges:  The
Ravenswood   Generating  Station  uses  derivative   financial   instruments  to
financially  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 Generating Station also financially hedges the cash
flow  variability  associated  with a portion of electric energy sales using OTC
electricity swaps.  KeySpan has also, entered into an International SWAP Dealers
Association  Master  Agreement  for  a  fixed  for  floating  unforced  capacity
financial  swap  with  Morgan  Stanley  Capital  Group  Inc.,  as  well as a gas
distribution  asset  optimization  contract  that employs  derivative  financial
instruments.

The following  tables set forth selected  financial data  associated  with these
derivative financial instruments that were outstanding at December 31, 2006.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
                                                Year of     Volumes     Fixed            Current            Fair Value
           Type of Contract                     Maturity     (mmcf)     Price($)         Price($)           ($Millions)
----------------------------------------------------------------------------------------------------------------------
                  Gas
<S>                                             <C>          <C>     <C>              <C>                       <C>
Swaps/Futures - Long Natural Gas                 2007         8,565   7.68 - 11.94     5.84 - 7.93              (17.3)
                                                 2008           670   9.08 - 9.82      7.45 - 8.90               (0.5)

OTC Swaps - Short Natural Gas                    2007         1,770   5.86 - 5.97      5.84 - 8.56               (2.3)
                                                 2008         1,614   6.77 - 6.85      7.45 - 8.90               (2.5)
                                                 2009         1,314   7.60 - 10.90     7.21 - 8.89                0.9

Optimization Contract                            2007             -              -               -                1.4

----------------------------------------------------------------------------------------------------------------------
                                                             13,933                                             (20.3)
----------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       92
<PAGE>

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
                                            Year of      Volumes        Fixed             Current          Fair Value
          Type of Contract                  Maturity    (Barrels)       Price($)          Price($)         ($Millions)
----------------------------------------------------------------------------------------------------------------------
                Oil
<S>                                           <C>        <C>         <C>               <C>                      <C>
Swaps - Long Fuel Oil                          2007       726,708     50.35 - 69.08     45.74 - 57.11           (6.9)
                                               2008        59,123     60.00 - 67.60         57.11               (0.5)
----------------------------------------------------------------------------------------------------------------------
                                                          785,831                                               (7.4)
----------------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
                                      Year of                         Fixed             Current          Fair Value
      Type of Contract                Maturity         MWh            Price($)          Price($)         ($Millions)
----------------------------------------------------------------------------------------------------------------------
        Electricity
<S>                                    <C>          <C>           <C>               <C>                       <C>
Swaps - Energy                          2007         1,154,018     66.25 - 150.50    57.00 - 118.32            22.4
                                        2008            35,536         70.10             69.08                 (0.3)
---------------------------------------------------------------------------------------------------------------------
                                                     1,189,554                                                 22.1
---------------------------------------------------------------------------------------------------------------------
</TABLE>

The following tables detail the changes in and sources of fair value for the
above derivatives:

-------------------------------------------------------------------------------
(In Millions of Dollars)                                               2006
Change in Fair Value of Derivative Hedging Instruments              ($Millions)
-------------------------------------------------------------------------------
Fair value of contracts at January 1, 2006                             $ (18.1)
Net (gains) on contracts realized                                        (73.6)
Increase in fair value of all open contracts                              86.1
-------------------------------------------------------------------------------
Fair value of contracts outstanding at December 31,                    $  (5.6)
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------
(In Millions of Dollars)
-------------------------------------------------------------------------------------------------
                                                    Fair Value of Contracts
-------------------------------------------------------------------------------------------------
                                               Maturity                                  Total
Sources of Fair Value                        In 12 Months            Thereafter        Fair Value
-------------------------------------------------------------------------------------------------
<S>                                              <C>                      <C>              <C>
Prices actively quoted                         $ (15.0)                 $ (2.1)          $ (17.1)
Local published indicies                          12.3                    (0.8)          $  11.5
-------------------------------------------------------------------------------------------------
                                               $  (2.7)                 $ (2.9)          $  (5.6)
-------------------------------------------------------------------------------------------------
</TABLE>

We measure the commodity risk of our derivative hedging  instruments  (indicated
in the  above  table)  using a  sensitivity  analysis.  Based  on a  sensitivity
analysis as of December 31, 2006 a 10%  increase/decrease  in natural gas prices
would decrease/increase the value of derivative instruments maturing in one year
by $2.4 million.

Commodity  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.


                                       93
<PAGE>


The following table sets forth selected financial data associated with these
derivative financial instruments that were outstanding at December 31, 2006.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------
                                      Year of      Volumes      Ceiling       Fixed           Current            Fair Value
      Type of Contract               Maturity       (mmcf)        ($)         Price($)         Price($)          ($Millions)
----------------------------------------------------------------------------------------------------------------------------
            Gas
<S>                                   <C>           <C>      <C>           <C>              <C>                     <C>
Options                                2007           3,900   7.00 - 8.00              -     6.30 - 6.60               2.7

Swaps                                  2007          62,792             -   6.81 - 12.28     6.30 - 8.90            (169.2)
                                       2008          28,475             -   7.16 - 11.64     7.25 - 8.90             (25.6)
----------------------------------------------------------------------------------------------------------------------------
                                                     95,167                                                          (192.1)
----------------------------------------------------------------------------------------------------------------------------
</TABLE>

See  Note  8 to  the  Consolidated  Financial  Statements  "Hedging,  Derivative
Financial  Instruments  and Fair  Values" for a further  description  of all our
derivative instruments.











                                       94
<PAGE>


ITEM 8.         Financial Statements and Supplementary Data


                           CONSOLIDATED BALANCE SHEET

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
                                                                                              December 31,
(In Millions of Dollars)                                                               2006                2005
------------------------------------------------------------------------------------------------------------------

ASSETS
<S>                                                                                <C>                  <C>
Current Assets
    Cash and temporary cash investments                                           $    210.9           $    124.5
    Restricted cash                                                                      7.9                 13.2
    Accounts receivable                                                                943.7              1,035.6
    Unbilled revenue                                                                   531.2                685.6
    Allowance for uncollectible accounts                                               (56.9)               (62.8)
    Gas in storage, at average cost                                                    646.0                766.9
    Material and supplies, at average cost                                             137.1                140.5
    Derivative contracts                                                                54.1                142.8
    Prepayments                                                                        236.2                 95.8
    Other                                                                               76.8                 78.0
                                                                          ----------------------------------------
                                                                                     2,787.0              3,020.1
                                                                          ----------------------------------------

Equity Investments and Other                                                           269.7                242.4
                                                                          ----------------------------------------

Property
    Gas                                                                              7,639.4              7,275.9
    Electric                                                                         2,575.4              2,492.3
    Other                                                                              441.5                416.3
    Accumulated depreciation                                                        (3,151.2)            (2,922.6)
    Gas production and development, at cost                                            186.9                184.2
    Accumulated depletion                                                             (113.7)              (109.2)
                                                                          ----------------------------------------
                                                                                     7,578.3              7,336.9
                                                                          ----------------------------------------

Deferred Charges
    Regulatory assets:
       Miscellaneous assets                                                            937.5                688.3
       Derivative contracts                                                            196.3                 30.9
    Goodwill and other intangible assets, net of amortization                        1,666.3              1,666.3
    Derivative contracts                                                               127.3                 75.2
    Other                                                                              875.1                752.5
                                                                          ----------------------------------------
                                                                                     3,802.5              3,213.2
                                                                          ----------------------------------------

Total Assets                                                                      $ 14,437.5           $ 13,812.6
                                                                          ========================================
------------------------------------------------------------------------------------------------------------------
</TABLE>

        See accompanying Notes to the Consolidated Financial Statements.


                                       95
<PAGE>


                           CONSOLIDATED BALANCE SHEET

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
                                                                                             December 31,
(In Millions of Dollars)                                                               2006                2005
-----------------------------------------------------------------------------------------------------------------
<S>                                                                                <C>                 <C>
LIABILITIES AND CAPITALIZATION
Current Liabilities
     Accounts payable and other liabilities                                       $  1,026.0          $  1,087.0
     Commercial paper                                                                   85.0               657.6
     Current maturities of long-term debt & capital leases                               1.2                13.0
     Taxes accrued                                                                     200.8               176.3
     Dividends payable                                                                  83.3                81.1
     Customer deposits                                                                  33.5                39.1
     Interest accrued                                                                   58.5                53.8
     Other current liability, derivative contracts                                     219.7                47.3
                                                                         ----------------------------------------
                                                                                     1,708.0             2,155.2
                                                                         ----------------------------------------

Deferred Credits and Other Liabilities
     Regulatory liabilities:
          Miscellaneous liabilities                                                     43.4                69.9
          Removal costs recovered                                                      556.2               516.4
          Derivative accounts                                                          120.6               175.4
     Asset retirement obligations                                                       47.3                47.4
     Deferred income tax                                                             1,176.4             1,157.9
     Postretirement benefits and other reserves                                      1,667.3             1,118.4
     Derivative contracts                                                               43.1                44.3
     Other                                                                             121.6               127.5
                                                                         ----------------------------------------
                                                                                     3,775.9             3,257.2
                                                                         ----------------------------------------

Commitments and Contingencies (See Note 7)                                                 -                   -

Capitalization
     Common stock                                                                    3,994.0             3,975.9
     Retained earnings                                                                 973.7               866.9
     Accumulated other comprehensive loss                                             (175.3)              (74.8)
     Treasury stock                                                                   (273.6)             (303.9)
                                                                         ----------------------------------------
          Total common shareholders' equity                                          4,518.8             4,464.1
     Long-term debt and capital leases                                               4,419.1             3,920.8
                                                                         ----------------------------------------
Total Capitalization                                                                 8,937.9             8,384.9
                                                                         ----------------------------------------

Minority Interest in Consolidated Companies                                             15.7                15.3
                                                                         ----------------------------------------
Total Liabilities and Capitalization                                              $ 14,437.5          $ 13,812.6
                                                                         ========================================
-----------------------------------------------------------------------------------------------------------------
</TABLE>

        See accompanying Notes to the Consolidated Financial Statements.


                                       96
<PAGE>

                        CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------
                                                                                       Year Ended December 31,
(In Millions of Dollars, Except Per Share Amounts)                              2006             2005             2004
------------------------------------------------------------------------------------------------------------------------
<S>                                                                         <C>              <C>              <C>
Revenues
     Gas Distribution                                                       $ 5,062.6        $ 5,390.1        $ 4,407.3
     Electric Services                                                        1,880.6          2,042.7          1,738.7
     Energy Services                                                            203.4            191.2            182.4
     Houston Exploration                                                            -                -            268.1
     Energy Investments                                                          35.0             38.0             54.0
                                                                     ---------------------------------------------------
Total Revenues                                                                7,181.6          7,662.0          6,650.5
                                                                     ---------------------------------------------------
Operating Expenses
     Purchased gas for resale                                                 3,331.5          3,597.3          2,664.5
     Fuel and purchased power                                                   548.6            752.1            540.3
     Operations and maintenance                                               1,680.0          1,617.9          1,567.0
     Depreciation, depletion and amortization                                   397.5            396.5            551.8
     Operating taxes                                                            411.2            407.1            404.2
     Impairment charges                                                             -                -             41.0
                                                                     ---------------------------------------------------
Total Operating Expenses                                                      6,368.8          6,770.9          5,768.8
                                                                     ---------------------------------------------------
Gain on sale of property                                                          1.6              1.6              7.0
Income from equity investments                                                   13.1             15.1             46.5
                                                                     ---------------------------------------------------
Operating Income                                                                827.5            907.8            935.3
                                                                     ---------------------------------------------------
Other Income and (Deductions)
     Interest charges                                                          (256.1)          (269.3)          (331.3)
     Sale of subsidiary stock                                                       -              4.1            388.3
     Cost of debt redemption                                                        -            (20.9)           (45.9)
     Minority interest                                                           (0.8)            (0.4)           (36.8)
     Other                                                                       39.1             16.6             30.6
                                                                     ---------------------------------------------------
Total Other Income and (Deductions)                                            (217.8)          (269.9)             4.9
                                                                     ---------------------------------------------------
Income Taxes
     Current                                                                     57.9            206.6            201.9
     Deferred                                                                   117.6             32.7            123.6
                                                                     ---------------------------------------------------
Total Income Taxes                                                              175.5            239.3            325.5
                                                                     ---------------------------------------------------
Earnings from Continuing Operations                                             434.2            398.6            614.7
                                                                     ---------------------------------------------------
Discontinued Operations
    Income (loss) from operations, net of tax                                       -             (4.1)           (79.0)
    Gain (loss) on disposal, net of tax                                             -              2.3            (72.0)
                                                                     ---------------------------------------------------
    Loss from Discontinued Operations                                               -             (1.8)          (151.0)
                                                                     ---------------------------------------------------
Cumulative Change in Accounting Principles, net of tax                              -             (6.6)               -
                                                                     ---------------------------------------------------
Net Income                                                                      434.2            390.2            463.7
Preferred stock dividend requirements                                               -              2.2              5.6
                                                                     ---------------------------------------------------
Earnings for Common Stock                                                   $   434.2        $   388.0        $   458.1
                                                                     ===================================================
Basic Earnings Per Share
  Continuing Operations, less preferred stock dividends                     $    2.48        $    2.33        $    3.80
  Discontinued Operations                                                           -            (0.01)           (0.94)
  Cumulative Change in Accounting Principles                                        -            (0.04)               -
                                                                     ---------------------------------------------------
Basic Earnings Per Share                                                    $    2.48        $    2.28        $    2.86
                                                                     ===================================================
Diluted Earnings Per Share
  Continuing Operations, less preferred stock dividends                     $    2.46        $    2.32        $    3.78
  Discontinued Operations                                                           -            (0.01)           (0.94)
  Cumulative Change in Accounting Principles                                        -            (0.04)               -
                                                                     ---------------------------------------------------
Diluted Earnings Per Share                                                  $    2.46        $    2.27        $    2.84
                                                                     ===================================================
Average Common Shares Outstanding (000)                                       175,040          169,940          160,294
Average Common Shares Outstanding - Diluted (000)                             176,151          170,801          161,277
------------------------------------------------------------------------------------------------------------------------
</TABLE>

        See accompanying Notes to the Consolidated Financial Statements.


                                       97
<PAGE>

<TABLE>
<CAPTION>
                      CONSOLIDATED STATEMENT OF CASH FLOWS
------------------------------------------------------------------------------------------------------------------------------
                                                                                             Year Ended December 31,
(In Millions of Dollars)                                                              2006             2005             2004
------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>              <C>              <C>
Operating Activities
Net income                                                                          $ 434.2         $  390.2          $ 463.7
Adjustments to reconcile net income to net
      cash provided by (used in) operating activities
    Depreciation, depletion and amortization                                          397.5            396.5            551.8
    Deferred income tax                                                               117.6             32.7            123.6
    Income from equity investments                                                    (13.1)           (15.1)           (46.5)
    Dividends from equity investments                                                   8.9              9.3             14.2
    Amortization of financing fees / interest rate swaps                                8.2             (1.4)           (14.9)
    Gain on sale of investments and property                                           (1.6)            (5.6)          (395.3)
    Hedging (gain)/losses                                                               2.9             (3.2)             2.5
    Amortization of property taxes                                                    146.3            126.2            101.9
    Impairment charges                                                                    -                -             41.0
    Loss from discontinued operations                                                     -              1.8            151.0
    Cumulative change in accounting principle                                             -              6.6                -
    Minority interest                                                                   0.8              0.4             36.8
Changes in assets and liabilities
    Accounts receivable                                                               317.9           (305.7)          (234.2)
    Materials and supplies, fuel oil and gas in storage                                (5.7)          (268.4)           (39.0)
    Accounts payable and accrued expenses                                            (163.4)           196.3            159.5
    Prepaid property taxes                                                           (150.5)          (136.2)          (112.1)
    Reserve payments                                                                  (51.2)           (35.7)           (37.3)
    Insurance settlements                                                              16.6             21.1                -
    Other                                                                              (6.8)            (6.5)           (16.6)
                                                                            --------------------------------------------------
Net Cash Provided by Continuing Operating Activities                                1,058.6            403.3            750.1
                                                                            --------------------------------------------------
Investing Activities
    Construction expenditures                                                        (524.0)          (539.5)          (750.3)
    Cost of removal                                                                   (32.6)           (27.8)           (36.3)
    Net proceeds from sale of property and investments                                  1.6             47.0          1,021.3
    Derivative margin call                                                            (33.9)            (8.9)               -
                                                                            --------------------------------------------------
Net Cash (Used in) Provided by Continuing Investing Activities                       (588.9)          (529.2)           234.7
                                                                            --------------------------------------------------
Financing Activities
    Treasury stock issued                                                              30.1             41.2             33.4
    Common stock issuance                                                                 -            460.0                -
    Issuance of long-term debt                                                        500.0                -             49.3
    Payment of long-term debt                                                         (13.0)          (515.0)          (920.1)
    Issuance / (payment) of commercial paper                                         (572.6)          (254.6)           430.4
    Redemption of preferred stock                                                         -            (75.0)            (8.5)
    Net proceeds from sale/leasback transaction                                           -                -            382.0
    Common and preferred stock dividends paid                                        (325.3)          (308.4)          (291.1)
    Gain on interest rate swap                                                            -                -             12.7
    Other                                                                              (2.5)            (5.4)            36.1
                                                                            --------------------------------------------------
Net Cash Used in Continuing  Financing Activities                                    (383.3)          (657.2)          (275.8)
                                                                            --------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents                                $  86.4         $ (783.1)         $ 709.0
Cash Flow from Discontinued Operations - Operating Activities                             -             (3.8)             8.1
Cash Flow from Discontinued Operations - Investing Activities                             -            (10.6)             1.3
Cash Flow from Discontinued Operations - Financing Activities                             -                -              0.2
Cash and Cash Equivalents at Beginning of Period                                      124.5            922.0            203.4
                                                                            --------------------------------------------------
Cash and Cash Equivalents at End of Period                                          $ 210.9         $  124.5          $ 922.0
                                                                            ==================================================
Interest Paid                                                                       $ 256.9         $  262.7          $ 336.5
Income Tax Paid                                                                     $ 175.7         $  198.8          $ 122.0
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

        See accompanying Notes to the Consolidated Financial Statements.


                                       98
<PAGE>

<TABLE>
<CAPTION>
                   CONSOLIDATED STATEMENT OF RETAINED EARNINGS

--------------------------------------------------------------------------------------------------
                                                                  Year Ended December 31,
(In  Millions of Dollars)                                  2006             2005            2004
--------------------------------------------------------------------------------------------------
<S>                                                     <C>              <C>             <C>
Balance at Beginning of Period                         $   866.9        $   792.2       $   621.4
Net Income for Period                                      434.2            390.2           463.7
--------------------------------------------------------------------------------------------------
                                                         1,301.1          1,182.4         1,085.1
Deductions:
Cash dividends declared on common stock                    327.4            313.3           287.3
Cash dividends declared on preferred stock                     -              2.2             5.6
--------------------------------------------------------------------------------------------------
Balance at End of Period                               $   973.7        $   866.9       $   792.2
--------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
                 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

----------------------------------------------------------------------------------------------------------------------
                                                                                      Year Ended December 31,
(In Millions of Dollars)                                                      2006             2005             2004
----------------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>              <C>              <C>
Net Income                                                                  $ 434.2          $ 390.2          $ 463.7
----------------------------------------------------------------------------------------------------------------------
Other comprehensive income, net of tax
Reclassification of (gains) losses included in net income                     (47.8)            23.8             (0.3)
Unrealized (losses) gains on derivative financial instruments                  55.4            (35.1)            15.4
Deconsolidation of certain subsidiaries                                           -                -              9.3
Foreign currency translation adjustments                                          -             (5.0)           (21.5)
Unrealized gains (losses) on marketable securities                              2.0             (0.5)             7.1
Premium on derivative instrument                                                  -                -              3.4
Accrued unfunded pension obligation                                            37.9             (3.7)            (7.8)
----------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax                                  47.5            (20.5)             5.6
----------------------------------------------------------------------------------------------------------------------
Comprehensive Income                                                        $ 481.7          $ 369.7          $ 469.3
----------------------------------------------------------------------------------------------------------------------
Related tax (benefit) expense
Reclassification of (gains) losses included in net income                     (25.8)            12.8             (0.2)
Unrealized (losses) gains on derivative financial instruments                  31.5            (20.7)             8.2
Deconsolidation of certain subsidiaries                                           -                -              5.0
Foreign currency translation adjustments                                          -             (2.7)           (11.6)
Unrealized gains (losses) on marketable securities                              1.1             (0.2)             3.8
Premium on derivative instrument                                                  -                -              1.9
Accrued unfunded pension obligation                                            20.4             (2.1)            (4.2)
----------------------------------------------------------------------------------------------------------------------
Total Tax (Benefit) Expense                                                 $  27.2          $ (12.9)         $   2.9
----------------------------------------------------------------------------------------------------------------------
</TABLE>

        See accompanying Notes to the Consolidated Financial Statements.




                                       99
<PAGE>

<TABLE>
<CAPTION>
                    CONSOLIDATED STATEMENT OF CAPITALIZATION

--------------------------------------------------------------------------------------------------------------------------
                                                                    December 31,                       December 31,
(In Millions of Dollars)                                       2006            2005                2006             2005
--------------------------------------------------------------------------------------------------------------------------
<S>                                                       <C>             <C>                   <C>              <C>
Common Shareholders' Equity                                       Shares Issued
Common stock, $0.01 par value                              184,864,124     184,864,124         $     1.8        $     1.8
Premium on capital stock                                                                         3,992.2          3,974.1
Retained earnings                                                                                  973.7            866.9
Accumulated other comprehensive loss                                                              (175.3)           (74.8)
Treasury stock                                              (9,451,408)    (10,495,743)           (273.6)          (303.9)
--------------------------------------------------------------------------------------------------------------------------
Total Common Shareholders' Equity                          175,412,716      174,368,381          4,518.8          4,464.1
--------------------------------------------------------------------------------------------------------------------------

--------------------------------------------------------------------------------------------------------------------------
Long - Term Debt                                         Interest Rate      Maturity
--------------------------------------------------------------------------------------------------------------------------

Medium and Long Term Notes                               4.65% - 9.75%      2008-2035            2,925.4          2,437.2

Gas Facilities Revenue Bonds                               Variable       2020 - 2026              230.0            230.0
                                                        4.70% - 6.95%     2020 - 2026              410.5            410.5
--------------------------------------------------------------------------------------------------------------------------
Total Gas Facilities Revenue Bonds                                                                 640.5            640.5
--------------------------------------------------------------------------------------------------------------------------

Promissory Notes to LIPA

Pollution Control Revenue Bonds                             5.15%         2016 - 2025              108.0            108.0
Electric Facilities Revenue Bonds                           5.30%         2023 - 2025               47.4             47.4
---------------------------------------------------------------------------------------------------------------------------
Total Promissory Notes to LIPA                                                                     155.4            155.4
---------------------------------------------------------------------------------------------------------------------------

Industrial Development Bonds                                5.25%             2027                 128.3            128.3
First Mortgage Bonds                                    6.34% - 8.80%     2008 - 2028               95.0             95.0
Authority Financing Notes                                  Variable       2027 - 2028               66.0             66.0
Ravenswood Master Lease & Capital Leases                                  2007 - 2014              422.1            423.0
---------------------------------------------------------------------------------------------------------------------------
Subtotal                                                                                         4,432.7          3,945.4
Unamortized interest rate hedge and debt discount                                                  (29.2)           (30.4)
Derivative impact on debt                                                                           16.8             18.8
Less: current maturities                                                                             1.2             13.0
---------------------------------------------------------------------------------------------------------------------------
Total Long-Term Debt                                                                             4,419.1          3,920.8
---------------------------------------------------------------------------------------------------------------------------
Total Capitalization                                                                           $ 8,937.9        $ 8,384.9
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

        See accompanying Notes to the Consolidated Financial Statements.







                                      100
<PAGE>


                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

INTRODUCTION TO THE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

KeySpan Corporation (referred to herein as "KeySpan," "we," "us" and "our") is a
holding  company under the Public  Holding  Company Act of 2005 ("PUHCA  2005").
KeySpan  operates  six  regulated  utilities  that  distribute  natural  gas  to
approximately 2.6 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,  lease 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  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 operating  subsidiaries are primarily
involved in gas production and development;  underground gas storage;  liquefied
natural gas storage; retail electric marketing;  large energy-system  ownership,
installation  and management;  service and  maintenance of energy  systems;  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 to the Consolidated  Financial Statements
"Business Segments" for additional information on each operating segment.)

On February 25, 2006,  KeySpan entered into an Agreement and Plan of Merger (the
"Merger   Agreement"),   with  National  Grid  plc,  a  public  limited  company
incorporated  under the laws of England and Wales  ("Parent")  and National Grid
US8, Inc., a New York Corporation  ("Merger Sub"),  pursuant to which Merger Sub
will merge with and into KeySpan (the "Merger"),  with KeySpan continuing as the
surviving  company and thereby becoming an indirect  wholly-owned  subsidiary of
the  Parent.  Pursuant to the Merger  Agreement,  at the  effective  time of the
Merger,  each  outstanding  share of KeySpan  common stock,  par value $0.01 per
share (the  "Shares"),  other than treasury shares and shares held by the Parent
and its subsidiaries, shall be canceled and shall be converted into the right to
receive $42.00 in cash, without interest.

Consummation of the Merger is subject to various closing  conditions,  including
but not limited to the receipt of requisite  regulatory  approvals  from certain
United States federal and state public utility,  antitrust and other  regulatory
authorities,  all of which have been filed and many of which have been obtained.
Specifically,  we filed our  application  for approval of the Merger pursuant to
the Federal  Power Act in May 2006 and in October  the  requisite  approval  was
obtained from the Federal Energy Regulatory  Commission ("FERC").  In early July
2006,   we  cleared   review  by  the  Federal   Trade   Commission   under  the
Hart-Scott-Rodino  Antitrust  Improvement Act and received notification that the
Committee on Foreign  Investment  in the U.S. has  determined  that there are no
issues of  national  security  sufficient  to  warrant an  investigation  of the
transaction.  On July 20,  2006 we  filed an  application  for  approval  of the
transaction with the New York Public Service Commission  ("NYPSC").  KeySpan has
also  sought  approval  of the  Merger  from the New  Hampshire  Public  Utility
Commission.  In October 2006, the State of New Jersey Board of Public  Utilities
approved  a change of control of KeySpan  Communication  Corp.,  which  provides
telecommunications  services in New Jersey. In addition, the Merger was approved
by our  shareholders  at our Annual Meeting on August 17, 2006.  Shareholders of
National Grid plc approved the Merger at a meeting held on July 31, 2006.


                                      101
<PAGE>


In addition to seeking  approval of the Merger,  the application  filed with the
NYPSC also contained proposed ten-year rate plans for KeySpan Energy Delivery of
New York ("KEDNY") and KeySpan Energy Delivery of Long Island ("KEDLI"), as well
as proposals  concerning  corporate  structure  and  affiliate  rules,  the rate
treatment for synergy savings and for low income and energy efficiency programs,
among others.  Specifically,  the rate plan  proposals  provide for, among other
things,  a freeze of base  delivery  rates  for  KEDNY and KEDLI for 18  months.
Thereafter,  KEDNY's and KEDLI's gas  adjustment  clauses  would be increased to
recover, on a prospective basis, estimated gas commodity-related  costs of $68.6
million  for KEDNY and $28.7  million for KEDLI that would no longer be included
in base  rates.  In  addition,  KEDNY and KEDLI  base  delivery  rates  would be
increased  by an average  of 2.5%  ($62.4  million)  and 2.3%  ($39.4  million),
respectively  in years 3, 5, 7 and 9 of the rate plans.  The proposed rate plans
contemplate  an allowed  return on equity of 11.0% for each  entity.  Cumulative
earnings  above 11.75% would be shared  between gas sales  customers and KeySpan
over the rate plan period.  On October 3, 2006 National Grid plc filed testimony
and exhibits with the NYPSC that further  explains the exhibits and  attachments
that were previously submitted as part of the July 20, 2006 petition.

Separately  from the merger  application,  on  October 3, 2006,  KEDNY and KEDLI
filed with the NYPSC  individual  applications  for proposed annual increases in
revenues,   which  applications   assumed  that  KEDNY  and  KEDLI  remained  as
stand-alone companies. The proposed revenue increases are for approximately 9.1%
and 10.9% for KEDNY and KEDLI,  respectively.  KEDNY's  last base rate  increase
took effect  October 1, 1993 and since then base rates have been reduced twice -
once in 1996 and again in 1998.  KEDLI's  last base rate  increase  took  effect
December 1, 1995.  Since that time,  KEDLI's  base rates were  reduced  twice in
1998. The principal  factors  creating the need for rate relief are increases in
operating and maintenance  expenses,  increases in rate base, increased property
taxes and depreciation  expense, and the need to commence recovery of previously
deferred  costs  such as pension  and post  retirement  benefits,  environmental
expenditures and property taxes.

The total projected increase in revenues is comprised of two components;  (i) an
increase in base rates of $180.7  million for KEDNY and $145  million for KEDLI;
and (ii)  projected  increases of $32.8  million and $13.6 million for KEDNY and
KEDLI, respectively, for gas-related expenses that will be recovered through the
Gas  Adjustment  Clause  ("GAC")  and/or the  Transportation  Adjustment  Clause
("TAC").  The  proposed  rate of return  on  equity is 11.0% for both  KEDNY and
KEDLI.

The NYPSC may suspend the  implementation  of the proposed tariff changes for up
to eleven  months,  which  would  mean,  absent  other  intervening  events,  an
effective  date of  September  3, 2007 for new rates.  Although  KEDNY and KEDLI
proposed the new rates described  above in these tariff filings,  it will not be
necessary to implement the rate increases proposed therein if the NYPSC approves
the Merger  between  National  Grid plc and  KeySpan  and  approves  the related
ten-year rate plan previously noted, or some variation thereof.

                                      102
<PAGE>

On February  20,  2007,  NYPSC Staff  filed its direct  testimony  in the merger
proceeding.  NYSPSC  Staff  opposed  the  current  terms of the Merger on policy
grounds,   but  suggested  that  it  could  support  the  Merger  under  certain
circumstances.  KeySpan and National Grid intend to file testimony responding to
the positions taken by Staff. In addition,  on January 29, 2007, Staff filed its
direct  testimony in the rate case  proceedings  and our rebuttal  testimony was
filed on  February  21,  2007.  In  connection  with each of these  proceedings,
hearings before an administrative law judge (ALJ) are scheduled to begin in late
March. Unless a settlement among the parties is otherwise reached,  the ALJ will
issue its recommended decision to the NYPSC following such hearings. Ultimately,
the NYPSC may accept, reject, or modify all or any part of the ALJ's recommended
decision.

KeySpan and National  Grid will  continue to pursue all required  approvals  and
continue to anticipate that the Merger will be consummated in mid-2007. However,
we are unable to predict  the  outcome of these  regulatory  proceedings  and no
assurance  can be  given  that  the  Merger  will  occur  or the  timing  of its
completion.

Note 1.  Summary of Significant Accounting Policies

A.   Organization of the Company

KeySpan Corporation, a New York corporation, was formed in May 1998, as a result
of the business  combination  of KeySpan Energy  Corporation,  the parent of The
Brooklyn Union Gas Company,  and certain  businesses of the Long Island Lighting
Company  ("LILCO").  On November 8, 2000,  KeySpan acquired Eastern  Enterprises
("Eastern"),  a  Massachusetts  business  trust,  and the parent of several  gas
utilities operating in Massachusetts. Also on November 8, 2000, Eastern acquired
EnergyNorth,  Inc. ("ENI"), the parent of a gas utility operating in central New
Hampshire.

At December 31, 2005,  KeySpan was a holding  company  under the Public  Utility
Holding  Company Act of 1935, as amended  ("PUHCA  1935").  In August 2005,  the
Energy  Policy Act of 2005 (the "Energy  Act") was enacted.  The Energy Act is a
broad energy bill that places an increased  emphasis on the production of energy
and promotes the development of new technologies and alternative  energy sources
and provides  tax credits to companies  that  produce  natural gas,  oil,  coal,
electricity  and  renewable  energy.  For KeySpan,  one of the more  significant
provisions  of the  Energy  Act was the  repeal  of  PUHCA  1935,  which  became
effective  on  February  8,  2006.  Since  that time,  the  jurisdiction  of the
Securities  and  Exchange   Commission  ("SEC")  over  certain  holding  company
activities,  including the regulation of our affiliate  transactions and service
companies, has been transferred to the FERC pursuant to PUHCA 2005.

Pursuant  to PUHCA  2005,  the SEC no longer has  jurisdiction  over our holding
company  activities,  other  than those  associated  with the  registration  and
issuance of our  securities  under the  federal  securities  laws.  FERC now has
jurisdiction  over  certain of our holding  company  activities,  including  (i)
regulating certain  transactions among our affiliates within our holding company
system;  (ii) governing the issuance,  acquisition and disposition of securities
and assets by certain of our public utility  subsidiaries;  and (iii)  approving
certain utility mergers and acquisitions.

Moreover,  our affiliate transactions also remain subject to certain regulations
of the  Public  Service  Commission  of the  State  of New York  ("NYPSC"),  the
Massachusetts  Department of Telecommunications and Energy ("MADTE") and the New
Hampshire Public Utility Commission ("NHPUC") in addition to FERC.




                                      103
<PAGE>

Under our holding company structure, we have no independent operations or source
of income of our own and conduct all of our operations  through our subsidiaries
and, as a result,  we depend on the earnings and cash flow of, and  dividends or
distributions  from, our subsidiaries to provide the funds necessary to meet our
debt and  contractual  obligations.  Furthermore,  a substantial  portion of our
consolidated  assets,  earnings and cash flow is derived from the  operations of
our regulated  utility  subsidiaries,  whose legal authority to pay dividends or
make other  distributions  to us is subject to  regulation  by state  regulatory
authorities.

Pursuant to NYPSC  orders,  the ability of KEDNY and KEDLI to pay  dividends  to
KeySpan is conditioned upon maintenance of a utility capital structure with debt
not exceeding 55% and 58%,  respectively,  of total utility  capitalization.  In
addition,  the level of dividends  paid by both  utilities  may not be increased
from current  levels if a 40 basis point penalty is incurred  under the customer
service performance program.

KeySpan's  businesses  are engaged in gas  distribution,  electric  services and
generation  and other energy  related  activities.  KeySpan's  gas  distribution
operations  are  conducted by our six regulated  gas utility  subsidiaries:  The
Brooklyn Union Gas Company d/b/a KeySpan Energy  Delivery New York ("KEDNY") and
KeySpan Gas East Corporation d/b/a KeySpan Energy Delivery Long Island ("KEDLI")
distribute  gas to  customers  in the Boroughs of  Brooklyn,  Staten  Island,  a
portion of the  Borough of Queens in New York City,  and the  counties of Nassau
and Suffolk on Long Island and the Rockaway  Peninsula in Queens,  respectively;
Boston Gas  Company,  Colonial  Gas  Company and Essex Gas  Company,  each doing
business as KeySpan  Energy  Delivery New England  ("KEDNE"),  distribute gas to
customers  in  southern,  eastern and  central  Massachusetts;  and  EnergyNorth
Natural Gas, Inc., d/b/a KeySpan Energy Delivery New England  distributes gas to
customers in central New Hampshire.  Together, these companies distribute gas to
approximately 2.6 million customers throughout the Northeast.

We own, lease and operate electric  generating  plants on Long Island and in New
York City. Under contractual  arrangements,  we provide electric 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").  On February 1, 2006,  KeySpan and LIPA  entered  into  agreements  to
extend, amend and restate these contractual arrangements. See Note 11 "2006 LIPA
Settlement" for a discussion of the settlement.

Our other  subsidiaries  are involved in gas  production  and  development;  gas
storage;  liquefied natural gas storage;  retail electric  marketing;  appliance
service;  fiber optic services; and engineering and consulting services. We also
invest in, 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.)


                                      104
<PAGE>

B.   Basis of Presentation

The Consolidated  Financial  Statements presented herein reflect the accounts of
KeySpan and its subsidiaries. Most of our subsidiaries are fully consolidated in
the financial information  presented,  except for certain subsidiary investments
in the Energy  Investments  segment which are accounted for on the equity method
as we do not have a controlling  voting  interest or otherwise have control over
the  management  of such  companies.  All  intercompany  transactions  have been
eliminated.

The preparation of financial  statements in conformity  with generally  accepted
accounting  principles  ("GAAP")  requires  management  to  make  estimates  and
assumptions  that  affect the  reported  amounts of assets and  liabilities  and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements  and the  reported  amounts  of  revenues  and  expenses  during  the
reporting period. Actual results could differ from those estimates.

C.   Accounting for the Effects of Rate Regulation

The  accounting  records for our six regulated  gas utilities are  maintained in
accordance  with the Uniform  System of Accounts  prescribed  by the NYPSC,  the
NHPUC,  and the MADTE. Our electric  generation  subsidiaries are not subject to
state rate regulation,  but they are subject to FERC  regulation.  Our financial
statements  reflect the ratemaking  policies and actions of these  regulators in
conformity with GAAP for rate-regulated enterprises.

Four of our six regulated gas utilities  (KEDNY,  KEDLI,  Boston Gas Company and
EnergyNorth  Natural Gas,  Inc.) and our Long Island based  electric  generation
subsidiaries are subject to the provisions of Statement of Financial  Accounting
Standards  ("SFAS")  71,  "Accounting  for  the  Effects  of  Certain  Types  of
Regulation."  This statement  recognizes the ability of regulators,  through the
ratemaking process, to create future economic benefits and obligations affecting
rate-regulated companies.  Accordingly, we record these future economic benefits
and  obligations  as  regulatory  assets  and  regulatory   liabilities  on  the
Consolidated Balance Sheet, respectively.

In separate merger related orders issued by the MADTE, the base rates charged by
Colonial  Gas Company and Essex Gas  Company  have been frozen at their  current
levels for  ten-year  periods  ending  2009 and 2008,  respectively.  Due to the
length of these base rate  freezes,  the  Colonial and Essex Gas  companies  had
previously discontinued the application of SFAS 71.




                                      105
<PAGE>


The following table presents our net regulatory assets at December 31, 2006 and
December 31, 2005.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
                                                                            December 31,
(In Millions of Dollars)                                                2006             2005
-----------------------------------------------------------------------------------------------
<S>                                                                  <C>               <C>
Regulatory Assets:
Regulatory tax asset                                                 $   30.2         $   33.4
Property and other taxes                                                 95.0             53.8
Environmental costs                                                     416.7            454.7
Postretirement benefits                                                 364.6            109.3
Costs associated with the KeySpan/LILCO transaction                      15.6             27.3
Derivative financial instruments                                        196.3             30.9
Other                                                                    15.4              9.8
-----------------------------------------------------------------------------------------------
Total Regulatory Assets                                               1,133.8            719.2
-----------------------------------------------------------------------------------------------
Regulatory Liabilities:
Derivative financial instruments                                       (120.6)          (175.4)
Miscellaneous                                                           (43.4)           (69.9)
-----------------------------------------------------------------------------------------------
Total Regulatory Liabilities                                           (164.0)          (245.3)
-----------------------------------------------------------------------------------------------
Net Regulatory Assets                                                   969.8            473.9
Removal Costs Recovered                                                (556.2)          (516.4)
-----------------------------------------------------------------------------------------------
                                                                     $  413.6         $  (42.5)
-----------------------------------------------------------------------------------------------
</TABLE>

The regulatory assets above are not included in utility rate base.  However,  we
record  carrying  charges  on the  property  tax and costs  associated  with the
KeySpan/LILCO transaction cost deferrals. We also record carrying charges on our
regulatory  liabilities  except for the current  market value of our  derivative
financial  instruments.  The remaining  regulatory assets represent,  primarily,
costs for which  expenditures  have not yet been made, and  therefore,  carrying
charges are not recorded.  We anticipate recovering these costs in our gas rates
concurrently with future cash  expenditures.  If recovery is not concurrent with
the cash expenditures, we will record the appropriate level of carrying charges.
Deferred gas costs of $46.3  million and $11.3  million at December 31, 2006 and
December 31, 2005,  respectively  are  reflected in accounts  receivable  on the
Consolidated  Balance Sheet.  Deferred gas costs are subject to current recovery
from customers.

D.   Revenues

Gas  Distribution.  Utility gas customers are billed  monthly or bi-monthly on a
cycle basis.  Revenues  include  unbilled  amounts  related to the estimated gas
usage that occurred from the most recent meter reading to the end of each month.


                                      106
<PAGE>


The cost of gas used is  recovered  when  billed to firm  customers  through the
operation of gas adjustment clauses ("GAC") included in utility tariffs. The GAC
provision  requires  periodic  reconciliation  of recoverable  gas costs and GAC
revenues.  Any  difference is deferred  pending  recovery from or refund to firm
customers.  Further, net revenues from tariff gas balancing services, off-system
sales and certain on-system interruptible sales are refunded, for the most part,
to firm customers subject to certain sharing provisions.

The New York and Long Island gas utility tariffs  contain weather  normalization
adjustments  that  largely  offset  shortfalls  or excesses of firm net revenues
(revenues  less gas costs and  revenue  taxes)  during a heating  season  due to
variations from normal  weather.  Revenues are adjusted each month the clause is
in effect and are generally  included in rates in the following  month.  The New
England gas utility rate structures  contain no weather  normalization  feature,
therefore their net revenues are subject to weather related demand fluctuations.
As a result, fluctuations from normal weather may have a significant positive or
negative  effect on the results of these  operations.  To mitigate the effect of
fluctuations  from normal weather on our financial  position and cash flows,  we
may enter into weather related  derivative  instruments  from time to time. (See
Note  8  "Hedging,   Derivative  Financial  Instruments  and  Fair  Values"  for
additional information on these derivatives.)

In December 2005,  The Boston Gas Company  ("Boston Gas") received a MADTE order
permitting  regulatory  recovery  of the  2004 gas  cost  component  of bad debt
write-offs.  This was approved for full recovery as an exogenous  cost effective
November  1,  2005.  In  addition,  effective  January  1, 2006  Boston  Gas was
permitted to fully recover the gas cost component of bad debt write-offs through
its  cost-of-gas  adjustment  clause  rather  than  filing  for  recovery  as an
exogenous  cost. On October 31, 2006,  the MADTE granted  Boston Gas recovery of
$12 million of the 2005 gas cost  component of bad debt  write-offs  from Boston
Gas ratepayers  beginning  November 1, 2006.  This amount will also be recovered
through the cost-of-gas adjustment clause.

Electric Services. Electric revenues are primarily derived from: (i) billings to
LIPA for  management  of  LIPA's  transmission  and  distribution  system  ("T&D
System"),  electric generation,  and procurement of fuel, and (ii): subsidiaries
that own,  lease and  operate  the 2,200  megawatt  ("MW")  Ravenswood  electric
generation  facility  ("Ravenswood  Facility")  and  the 250 MW  combined  cycle
generating  facility  located  at  the  Ravenswood  facility  site  ("Ravenswood
Expansion").  Collectively, the Ravenswood Facility and Ravenswood Expansion are
referred to as the Ravenswood Generating Station.

LIPA  Agreements.  In 1998,  KeySpan and LIPA entered into three major long-term
service  agreements  that (i)  provide to LIPA all  operation,  maintenance  and
construction  services and significant  administrative  services relating to the
Long Island  electric T&D System pursuant to the Management  Services  Agreement
(the "1998 MSA");  (ii) supply LIPA with electric  generating  capacity,  energy
conversion and ancillary services from our Long Island generating units pursuant
to the Power Supply  Agreement (the "1998 PSA"); and (iii) manage all aspects of
the  fuel  supply  for our Long  Island  generating  facilities,  as well as all
aspects of the capacity and energy owned by or under  contract to LIPA  pursuant
to the Energy Management  Agreement (the "1998 EMA"). The 1998 MSA, 1998 PSA and
1998 EMA all are  collectively  referred to as the 1998 LIPA  Agreements and are
discussed in greater detail below.


                                      107
<PAGE>


On February 1, 2006,  KeySpan and LIPA  entered into (i) an amended and restated
Management  Services Agreement (the "2006 MSA"),  pursuant to which KeySpan will
continue to operate and  maintain  the electric T&D System owned by LIPA on Long
Island;  (ii) a new Option and  Purchase  and Sale  Agreement  (the "2006 Option
Agreement"),  to replace the Generation  Purchase Rights  Agreement (as amended,
the "GPRA"),  pursuant to which LIPA had the option,  through December 15, 2005,
to effectively acquire  substantially all of the electric generating  facilities
owned by KeySpan on Long  Island;  and (iii) a Settlement  Agreement  (the "2006
Settlement   Agreement")   resolving  outstanding  issues  between  the  parties
regarding the 1998 LIPA Agreements.  The 2006 MSA, the 2006 Option Agreement and
the 2006 Settlement  Agreement are collectively  referred to herein as the "2006
LIPA  Agreements."  Each of the 2006 LIPA agreements will become  effective upon
all of the 2006 LIPA Agreements receiving the required  governmental  approvals;
otherwise  none  of the  2006  LIPA  Agreements  will  become  effective.  These
agreements  will  become  effective  following  approval  by the New York  State
Comptroller's  Office and the New York State  Attorney  General.  Following  the
announcement of the proposed  acquisition of KeySpan by National Grid plc, LIPA,
National Grid plc and KeySpan have engaged in discussions  concerning the impact
of the  transaction  on  LIPA's  operations.  At this  time,  we are  unable  to
determine what impact,  if any, the results of such  discussions may have on the
2006 LIPA  Agreements  and the  receipt  and  timing of  governmental  approvals
relating thereto.  See Note 11, "2006 LIPA Settlement" for additional details on
these agreements.

In place of the  previous  compensation  structure  under the 1998 MSA  (whereby
KeySpan was  reimbursed  for budgeted  costs,  and earned a  management  fee and
certain  performance  and cost-based  incentives),  KeySpan's  compensation  for
managing the electric  transmission and distribution  system owned by LIPA under
the 2006 MSA consists of two  components:  a minimum  compensation  component of
$224 million per year and a variable component based on electric sales. The $224
million  component  will  remain  unchanged  for three  years and then  increase
annually by 1.7%, plus inflation. The variable component, which will comprise no
more than 20% of  KeySpan's  compensation,  is based on  electric  sales on Long
Island  exceeding a base amount of 16,558 gigawatt hours,  increasing by 1.7% in
each year. Above that level,  KeySpan will receive  approximately 1.34 cents per
kilowatt hour for the first contract  year,  1.29 cents per kilowatt hour in the
second  contract  year  (plus an annual  inflation  adjustment),  1.24 cents per
kilowatt hour in the third contract year (plus an annual inflation  adjustment),
with the per kilowatt hour rate thereafter adjusted annually by inflation.

In addition,  KeySpan  sells to LIPA under the 1998 PSA all of the capacity and,
to the extent  requested,  energy  conversion  services  from its existing  Long
Island based oil and gas-fired  generating plants.  Sales of capacity and energy
conversion  services are made under rates approved by the FERC. Rates charged to
LIPA include a fixed and variable component. The variable component is billed to
LIPA on a monthly  per  megawatt  hour basis and is  dependent  on the number of
megawatt hours dispatched.  The 1998 PSA provides  incentives and penalties that
can total $4 million  annually for the maintenance of the output  capability and
the efficiency of the generating facilities.


                                      108
<PAGE>


KeySpan also  procures and manages  fuel  supplies on behalf of LIPA,  under the
1998 EMA, to fuel the  generating  facilities  under  contract to it and perform
off-system  capacity and energy  purchases on a least-cost  basis to meet LIPA's
needs.  In  exchange  for these  services  KeySpan  earns an annual  fee of $1.5
million.  In  addition,  we arrange  for  off-system  sales on behalf of LIPA of
excess output from the generating  facilities  and other power  supplies  either
owned or under  contract to LIPA.  LIPA is entitled to  two-thirds of the profit
from any off-system energy sales. In addition,  the 1998 EMA provides incentives
and penalties that can total $5 million annually for performance related to fuel
purchases  and  off-system  power  purchases.  The 1998 EMA is expected to be in
effect through 2013 for the  procurement of fuel supplies.  In 2005, the EMA was
amended to extend the term for off-system  power purchases  through December 31,
2006 and thereafter on a month-to-month basis unless terminated by LIPA on sixty
days notice, but in no event later than December 31, 2007.

KeySpan  Glenwood Energy Center,  LLC and KeySpan Port Jefferson  Energy Center,
LLC have entered into 25 year Power Purchase  Agreements with LIPA (the "PPAs").
Under the terms of the PPAs, these subsidiaries sell capacity, energy conversion
services and ancillary  services to LIPA. Each plant is designed to produce 79.9
MW. Under the PPAs,  LIPA pays a monthly  capacity fee,  which  guarantees  full
recovery of each plant's  construction  costs, as well as an appropriate rate of
return on investment.  The PPAs also obligate LIPA to pay for each plant's costs
of  operation  and  maintenance.  These costs are billed on a monthly  estimated
basis and are subject to true-up for actual costs incurred.

The Electric  Services  segment also conducts retail marketing of electricity to
commercial customers. Energy sales made by our electric marketing subsidiary are
recorded upon delivery of the related commodity.

Ravenswood  Generating Station. In addition,  electric revenues are derived from
our  investment  in  the  2,200  MW  Ravenswood   electric  generation  facility
("Ravenswood  Facility"),  (which KeySpan acquired in June 1999). KeySpan has an
arrangement with a variable  interest entity through which we lease a portion of
the Ravenswood Facility.  Further, in May 2004 KeySpan completed construction of
a 250 MW combined cycle generating  facility located at the Ravenswood  facility
site  ("Ravenswood  Expansion").  To finance the Ravenswood  Expansion,  KeySpan
entered into a leveraged lease financing  arrangement.  (See Note 7 "Contractual
Obligations,  Financial  Guarantees and  Contingencies" for a description of the
financing  arrangements  associated with the Ravenswood Generating Station.) The
Ravenswood Generating Station earns revenues through the sale, at wholesale,  of
energy,  capacity,  and ancillary  services to the New York  Independent  System
Operator  ("NYISO").  Energy and  ancillary  services are sold through a bidding
process into the NYISO energy markets on a day ahead or real time basis.

Energy Services.  Revenues earned by our Energy Services segment for service and
maintenance   contracts   associated  with  small   commercial  and  residential
appliances are recognized as earned or over the life of the service contract, as
appropriate.  Revenues earned for engineering services are derived from services


                                      109
<PAGE>


rendered under fixed price and cost-plus  contracts and generally are recognized
on  the   percentage-of-completion   method.  Fiber  optic  service  revenue  is
recognized upon delivery of service access. We have unearned revenue recorded in
deferred credits and other liabilities - other on the Consolidated Balance Sheet
totaling  $30.3 million and $29.3 million as of December 31, 2006,  and December
31, 2005, respectively. These balances represent primarily unearned revenues for
service contracts and are generally amortized to income over a one year period.

KeySpan completed its sale of its mechanical  contracting companies in the first
quarter  of  2005,  and  therefore,  no  longer  has  revenues  from  mechanical
contracting operations. (See Note 10 "Energy Services - Discontinued Operations"
for additional details on the mechanical contracting companies.)

Gas Production and  Development.  Natural gas and oil revenues earned by our gas
production and  development  activities are  recognized  using the  entitlements
method of accounting. Under this method of accounting,  income is recorded based
on the net revenue  interest in production or nominated  deliveries.  Production
gas volume  imbalances  are  incurred in the ordinary  course of  business.  Net
deliveries in excess of entitled amounts are recorded as liabilities,  while net
under  deliveries  are  recorded as assets.  Imbalances  are  reduced  either by
subsequent  recoupment of over and under  deliveries or by cash  settlement,  as
required by applicable contracts.  Production imbalances are marked-to-market at
the end of each month using the market price at the end of each  period.  During
2004  KeySpan  disposed  of its  interest  in The  Houston  Exploration  Company
("Houston Exploration"), an independent natural gas and oil exploration company.
KeySpan continues to maintain,  on a significantly smaller scale, gas production
and development activities.  (See Note 2 "Business Segments" for a discussion on
the disposition of Houston  Exploration  and KeySpan's  remaining gas production
and development activities.)

E.   Utility and Other Property - Depreciation and Maintenance

Property,  principally  utility  gas  property  is  stated at  original  cost of
construction,  which includes allocations of overheads,  including taxes, and an
allowance  for  funds  used  during  construction.  The  rates at which  KeySpan
subsidiaries  capitalized  interest for the year ended  December 31, 2006 ranged
from  1.88% to 7.02%.  Capitalized  interest  for  2006,  2005 and 2004 was $2.5
million, $1.4 million and $7.4 million, respectively.

Depreciation  is  provided on a  straight-line  basis in amounts  equivalent  to
composite rates on average depreciable  property.  In 2006, an adjustment to the
depreciation  allowance  was  recorded to correct  for an error in useful  lives
associated with certain gas distribution assets. The cost of property retired is
charged to accumulated depreciation.

KeySpan recovers cost of removal through rates charged to customers as a portion
of  depreciation  expense.  At  December  31,  2006 and 2005,  KeySpan had costs
recovered  in  excess of costs  incurred  totaling  $556.2  million  and  $516.4
million, respectively. These amounts are reflected as a regulatory liability.


                                      110
<PAGE>


The cost of repair and minor replacement and renewal of property is charged to
maintenance expense. The composite rates on average depreciable property were as
follows:

-----------------------------------------------------------------
                                     Year Ended December 31,
                                 2006         2005         2004
-----------------------------------------------------------------
Electric                         3.86%        3.75%        3.87%
Gas                              3.14%        3.72%        3.55%
-----------------------------------------------------------------
-----------------------------------------------------------------

We also had $441.5 million of other property at December 31, 2006, consisting of
assets held primarily by our corporate service  subsidiary of $307.6 million and
$104.2 million in Energy Services assets.  The corporate  service assets consist
largely of land, buildings,  office equipment and furniture,  vehicles, computer
and  telecommunications  equipment  and systems.  These assets have  depreciable
lives  ranging from three to 40 years.  We allocate  the carrying  cost of these
assets to our operating  subsidiaries through our filed allocation  methodology.
Energy  Services  assets consist  largely of computer  equipment and fiber optic
cable and related  electronics  and have service  lives ranging from seven to 40
years.

KeySpan's repair and maintenance  costs,  including planned major maintenance in
the Electric Services segment for turbine and generator overhauls,  are expensed
as incurred  unless they represent  replacement  of property to be  capitalized.
Planned  major  maintenance  cycles  primarily  range from seven to eight years.
Smaller periodic overhauls are performed approximately every 18 months.

KeySpan  capitalizes  costs incurred in connection  with its projects to develop
and build energy  facilities  after a project has been determined to be probable
of completion.

F.   Gas Production and Development Property - Depletion

KeySpan  maintains gas production  and  development  activities  through its two
wholly-owned  subsidiaries - KeySpan  Exploration and Production,  LLC ("KeySpan
Exploration") and Seneca-Upshur Petroleum, Inc.  ("Seneca-Upshur").  At December
31, 2006, these subsidiaries had net production and development  property in the
amount of $73.2  million.  These  assets are  accounted  for under the full cost
method of  accounting.  Under the full cost  method,  costs of  acquisition  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  is made as to the existence of proved  reserves.  Properties  are
depleted and charged to  operations  using the unit of  production  method using
proved reserve quantities.

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.


                                      111
<PAGE>


The ceiling test is calculated  using natural gas and oil prices in effect as of
the  balance  sheet  date,  held  flat  over  the life of the  reserves.  We use
derivative  financial  instruments  that qualify for hedge accounting under SFAS
133 "Accounting for Derivative Instruments and Hedging Activities," to hedge the
volatility of natural gas prices. In accordance with current SEC guidelines,  we
have included  estimated  future cash flows from our hedging  program in ceiling
test calculations.

As of December 31, 2006, we estimated that our capitalized  costs did not exceed
the ceiling test limitation. We used an average wellhead price of $6.15 per MCF,
adjusted for derivative instruments.

As a result of the  disposition  of Houston  Exploration  in 2004,  during  2004
KeySpan calculated 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 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 production
and development  subsidiaries' assets. This charge was recorded in depreciation,
depletion and amortization on the Consolidated Statement of Income.

Natural gas prices continue to be volatile and the risk that a write down to the
full cost pool increases when, among other things, natural gas prices are low or
there are significant downward revisions in our estimated proved reserves.

In 2004, Houston Exploration capitalized interest related to unevaluated natural
gas and oil properties,  as well as some properties under development which were
not being amortized.  For the year ended December 31, 2004, capitalized interest
was $3.4 million.

G.   Goodwill and Other Intangible Assets

The balance of goodwill and other intangible assets was $1.7 billion at December
31, 2006 and December 31, 2005, representing primarily the excess of acquisition
cost over the fair value of net assets  acquired.  Goodwill and other intangible
assets  reflect the  Eastern and  EnergyNorth  acquisitions,  the  KeySpan/LILCO
transaction,  as well as  acquisitions  of  non-utility  energy-related  service
companies  and also  relates to certain  ownership  interests  of 50% or less in
energy-related investments, which are accounted for under the equity method.


                                      112
<PAGE>


The table below summarizes the goodwill and other intangible assets balance for
each segment at December 31, 2006 and 2005:


------------------------------------------------------------------------
(In Millions of Dollars)                            At December 31,
                                                 2006            2005
------------------------------------------------------------------------
Operating Segment

Gas Distribution                               $1,436.9        $1,436.9
Energy Services                                    65.2            65.2
Energy Investments and other                      164.2           164.2
------------------------------------------------------------------------
                                               $1,666.3        $1,666.3
------------------------------------------------------------------------

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 indicated that the evaluation should be
performed at an interim  period during the year.  At December 31, 2006,  KeySpan
had $1.7 billion of recorded  goodwill and has concluded  that the fair value of
the business units that have recorded goodwill exceed their carrying value.

During 2004,  KeySpan  conducted an evaluation of the carrying value of goodwill
recorded in its Energy Services segment. As a result of this evaluation, KeySpan
recorded a non-cash goodwill  impairment charge of $108.3 million ($80.3 million
after tax, or $0.50 per share) in 2004. This charge was recorded as follows: (i)
$14.4 million as an operating  expense on the  Consolidated  Statement of Income
reflecting the write-down of goodwill on Energy  Services  segment's  continuing
operations;  and (ii) $93.9 million as  discontinued  operations  reflecting the
impairment  on the  mechanical  contracting  companies.  (See  Note  10  "Energy
Services-Discontinued Operations" for further details.)

In 2004,  KeySpan  entered  into an  agreement  to sell its then 50% interest in
Premier  Transmission  Limited  ("Premier").  This  investment was accounted for
under the equity method of accounting in the Energy Investments  segment. In the
fourth quarter of 2004 KeySpan  recorded a partial pre-tax  non-cash  impairment
charge of $26.5  million - $18.8  million  after-tax  or $0.12  per  share.  The
impairment charge reflected the difference between the anticipated cash proceeds
from the sale of Premier  compared  to its  carrying  value at that time and was
recorded as a reduction to goodwill.

H.   Hedging and Derivative Financial Instruments

From time to time, we employ  derivative  instruments  to hedge a portion of our
exposure to commodity price risk, interest rate risk and weather fluctuations as
well as to hedge  cash flow  variability  associated  with a portion of our peak
electric energy sales. Whenever hedge positions are in effect, we are exposed to
credit risk in the event of  nonperformance  by  counter-parties  to  derivative
contracts,  as well as nonperformance by the counter-parties of the transactions
against  which they are hedged.  We believe  that the credit risk related to the
futures,  options and swap  instruments is no greater than that  associated with
the primary commodity contracts which they hedge.


                                      113
<PAGE>


Financially-Settled  Commodity  Derivative  Instruments.  We  employ  derivative
financial  instruments,  such as futures,  options and swaps, for the purpose of
hedging the cash flow variability associated with forecasted purchases and sales
of various  energy-related  commodities.  All such  derivative  instruments  are
accounted  for  pursuant  to  the  requirements  of  SFAS  133  "Accounting  for
Derivative  Instruments  and  Hedging  Activities,"  as  amended  by  SFAS  149,
"Amendment  of Statement  133  Derivative  Instruments  and Hedging  Activities"
(collectively,   "SFAS  133").  With  respect  to  those  commodity   derivative
instruments  that are  designated  and  accounted  for as cash flow hedges,  the
effective  portion of  periodic  changes in the fair  market  value of cash flow
hedges is recorded as other  comprehensive  income on the  Consolidated  Balance
Sheet, while the ineffective portion of such changes in fair value is recognized
in  earnings.  Unrealized  gains and losses (on such cash flow  hedges) that are
recorded  as other  comprehensive  income  are  subsequently  reclassified  into
earnings concurrent when hedged  transactions  impact earnings.  With respect to
those  commodity  derivative  instruments  that are not  designated  as  hedging
instruments,  such  derivatives  are accounted for on the  Consolidated  Balance
Sheet at fair value, with all changes in fair value reported in earnings.

Firm Gas Sales Derivatives  Instruments - Regulated Utilities. We use derivative
financial  instruments  to reduce  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,  the fair  value  of these  derivatives  is
recorded  as  current  or  deferred  assets  and  liabilities,  with  offsetting
positions  recorded  as  regulatory  assets and  regulatory  liabilities  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.

Physically-Settled  Commodity Derivative  Instruments.  Certain of our contracts
for the physical purchase of natural gas were assessed as no longer being exempt
from the requirements of SFAS 133 as normal purchases.  As such, these contracts
are recorded on the  Consolidated  Balance Sheet at fair market value.  However,
since such contracts were executed for the purchases of natural gas that is sold
to regulated firm gas sales customers,  and pursuant to the requirements of SFAS
71,  changes in the fair  market  value of these  contracts  are  recorded  as a
regulatory asset or regulatory liability on the Consolidated Balance Sheet.

Weather  Derivatives.  The utility  tariffs  associated with our New England gas
distribution 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.  To mitigate the effect of
fluctuations  from normal weather on our financial  position and cash flows,  we
may enter into derivative  instruments  from time to time. Based on the terms of
the contracts,  we account for these instruments pursuant to the requirements of
Emerging Issues Task Force ("EITF") 99-2  "Accounting for Weather  Derivatives."
In this regard,  we account for weather  derivatives  using the "intrinsic value
method" as set forth in such guidance.


                                      114
<PAGE>


Interest  Rate   Derivative   Instruments.   We  continually   assess  the  cost
relationship between fixed and variable rate debt. Consistent with our objective
to minimize our cost of capital, we periodically enter into hedging transactions
that effectively  convert the terms of underlying debt obligations from fixed to
variable  or variable to fixed.  Payments  made or received on these  derivative
contracts  are  recognized  as an  adjustment  to interest  expense as incurred.
Hedging  transactions  that  effectively  convert the terms of  underlying  debt
obligations  from  fixed  to  variable  are  designated  and  accounted  for  as
fair-value hedges pursuant to the requirements of SFAS 133. Hedging transactions
that effectively  convert the terms of underlying debt obligations from variable
to fixed are considered cash flow hedges.

I.   Equity Investments and Other

Certain  subsidiaries  own as their  principal  assets,  investments  (including
goodwill),  representing  ownership  interests of 50% or less in  energy-related
businesses that are accounted for under the equity method. None of these current
investments  are publicly  traded.  Additionally,  KeySpan has corporate  assets
recorded on the  Consolidated  Balance Sheet  representing  funds designated for
Supplemental  Executive  Retirement Plans. These funds are invested in corporate
owned life insurance  policies.  KeySpan  records  changes in the value of these
assets in  accordance  with FAS  Technical  Bulletin  85-4  "Accounting  for the
Purchase of Life  Insurance."  As such,  increases and decreases in the value of
these  assets are recorded  through  earnings in the  Consolidated  Statement of
Income concurrent with the change in the value of the underlying assets.

J.   Income and Excise Tax

Upon  implementation of SFAS 109,  "Accounting for Income Taxes," certain of our
regulated  subsidiaries  recorded  a  regulatory  asset and a net  deferred  tax
liability  for the  cumulative  effect of  providing  deferred  income  taxes on
certain  differences  between the financial statement carrying amounts of assets
and liabilities, and their respective tax bases. This regulatory asset continues
to be amortized over the lives of the individual assets and liabilities to which
it relates.  Additionally,  investment tax credits which were available prior to
the Tax Reform Act of 1986, were deferred and generally amortized as a reduction
of income tax over the estimated lives of the related property.

We report our  collections  and payments of excise  taxes on a gross basis.  Gas
distribution  revenues  include the collection of excise taxes,  while operating
taxes include the related  expense.  For the years ended December 31, 2006, 2005
and 2004, excise taxes collected and paid were $60.4 million,  $65.8 million and
$73.3 million, respectively.

K.   Subsidiary Common Stock Issuances to Third Parties

We  follow an  accounting  policy of income  statement  recognition  for  parent
company  gains or losses  from  issuances  of common  stock by  subsidiaries  to
unaffiliated third parties.


                                      115
<PAGE>


L.  Foreign Currency Translation

We followed the  principles  of SFAS 52,  "Foreign  Currency  Translation,"  for
recording our  investments  in foreign  affiliates.  Under this  statement,  all
elements of the financial  statements are translated by using a current exchange
rate.  Translation  adjustments  result from changes in exchange  rates from one
reporting  period to  another.  At December  31, 2006 and 2005,  SFAS 52 was not
applicable  to KeySpan  since we  completed  the sale of our  remaining  foreign
investment in the first quarter of 2005.

M.   Earnings Per Share

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

Under the  requirements of SFAS 128,  "Earnings Per Share" our basic and diluted
EPS are as follows:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
                                                                                 Year Ended December 31,
(In Millions of Dollars, Except Per Share Amounts)                         2006           2005           2004
---------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>            <C>            <C>
Earnings for common stock                                              $   434.2      $   388.0      $   458.1
---------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding (000)                                175,040        169,940        160,294
Add dilutive securities:
Options                                                                      991            861            983
Performance shares                                                           120              -              -
---------------------------------------------------------------------------------------------------------------
Total weighted average shares outstanding - assuming dilution            176,151        170,801        161,277
---------------------------------------------------------------------------------------------------------------
Basic earnings per share                                               $    2.48      $    2.28      $    2.86
---------------------------------------------------------------------------------------------------------------
Diluted earnings per share                                             $    2.46      $    2.27      $    2.84
---------------------------------------------------------------------------------------------------------------
</TABLE>

N.   Stock Based Compensation

From  time to  time,  KeySpan  awards  stock  based  compensation  to  officers,
directors,  consultants and certain other management employees,  primarily under
the Long Term Performance  Incentive  Compensation Plan (the "Incentive  Plan").
The  Incentive  Plan  provides  for  the  award  of  incentive   stock  options,
non-qualified  stock  options,  performance  shares and restricted  shares.  The
purpose of the  Incentive  Plan is to  optimize  KeySpan's  performance  through
incentives  that  directly  link the  participant's  goals to those of KeySpan's
shareholders  and to  attract  and  retain  participants  who  make  significant
contributions to the success of KeySpan.

Under the Incentive  Plan,  19,250,000  shares were  authorized  for issuance of
which the total  shares  awarded to date include  16.9  million  stock  options,
222,143 shares of restricted stock, and 891,555  performance shares. At December
31, 2006, after adjusting for forfeitures,  there are  approximately 3.0 million
shares still eligible to be granted under the Incentive Plan. In addition, under
previous plans, there were an additional 1.7 million shares authorized for which
approximately 1.2 million stock options were awarded.


                                      116
<PAGE>


In 2005,  KeySpan continued to apply APB Opinion 25 "Accounting for Stock Issued
to  Employees,"  in accounting  for grants  awarded prior to January 1, 2003. No
compensation  cost had been  recognized  for these stock option awards 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 "Accounting for
Stock-Based  Compensation," our net income and earnings per share for the twelve
months ended  December 31, 2005 and 2004 would have  decreased to the  pro-forma
amounts indicated below:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
                                                                                       Year Ended December 31,
(In Millions of Dollars, Except Per Share Amounts)                                   2005                  2004
-----------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>                   <C>
Earnings available for common stock:
As reported                                                                        $ 388.0               $ 458.1
     Add: recorded stock-based compensation expense, net of tax                        7.0                   9.1
     Deduct: total stock-based compensation expense, net of tax                       (8.9)                (12.4)
-----------------------------------------------------------------------------------------------------------------
Pro-forma earnings                                                                 $ 386.1               $ 454.8
-----------------------------------------------------------------------------------------------------------------
Earnings per share:
     Basic - as reported                                                           $  2.28               $  2.86
     Basic - pro-forma                                                             $  2.27               $  2.84

     Diluted - as reported                                                         $  2.27               $  2.84
     Diluted - pro-forma                                                           $  2.26               $  2.82
-----------------------------------------------------------------------------------------------------------------
</TABLE>

In 2003,  KeySpan adopted the prospective method of transition of accounting for
stock based  compensation  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 for grants awarded after January 1, 2003.

In January 2006,  KeySpan adopted SFAS 123 (revised 2004)  "Share-Based  Payment
("SFAS 123R")." The  implementation of this standard required KeySpan to expense
certain  stock  options  that  had  previously  been  accounted  for  under  the
requirements of APB Opinion 25 and related  Interpretations,  i.e. awards issued
prior to January 1, 2003. No  compensation  cost had 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.  For the twelve
months ended December 31, 2006,  KeySpan recorded an expense of $1.4 million for
stock option  awards  previously  accounted  for under APB 25 and which have now
fully vested.



                                      117
<PAGE>


The following table presents the actual expense for all of KeySpan's stock based
compensation  awards  recorded in the  Consolidated  Statement of Income for the
periods indicated.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
                                                                                        Year Ended December 31,
(In Millions of Dollars)                                                     2006                2005               2004
-------------------------------------------------------------------------------------------------------------------------
<S>                                                                         <C>                 <C>                <C>
Performance shares                                                         $  8.2              $ (1.0)             $ 4.9
Restricted stock                                                              4.1                 0.9                0.7
Stock options                                                                 6.1                 5.5                3.7
EDSPP discount                                                                4.8                 5.4                4.7
-------------------------------------------------------------------------------------------------------------------------
Total stock-based compensation included in operations and
maintenance expense                                                          23.2                10.8               14.0
Income tax benefit                                                           (8.1)               (3.8)              (4.9)
-------------------------------------------------------------------------------------------------------------------------
Total stock based compensation expense, net of tax                         $ 15.1              $  7.0              $ 9.1
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

Prior to the  adoption of SFAS 123R,  KeySpan  presented  all tax  benefits  for
deductions  resulting  from the  exercise  of stock  options  and  disqualifying
dispositions  as  operating  cash flows in its  Consolidated  Statement  of Cash
Flows. SFAS 123R requires the benefits of tax deductions in excess of recognized
compensation  expense to be reported as a financing cash flow, rather than as an
operating cash flow. This  requirement  will reduce net operating cash flows and
increase net  financing  cash flows in periods after  adoption.  Total cash flow
will remain  unchanged from what would have been reported under prior accounting
rules.

During the twelve  months ended  December 31, 2006,  2005 and 2004 cash received
from stock options exercised was $31.1 million, $43.0 million and $32.2 million,
respectively.  The tax benefit  realized for tax  deductions  from stock options
exercised  during the twelve months ended  December 31, 2006,  2005 and 2004 was
less than the  recognized  compensation  expense and  accordingly  there were no
excess tax  deductions  reported in the  financing  section of the  Consolidated
Statement of Cash Flows.

The following  represents a discussion of the various  awards  granted under our
stock based compensation plans:

Performance shares

Performance  shares were awarded under the Incentive Plan in 2004 and 2005 based
upon the attainment of overall corporate  performance  goals.  These performance
shares are measured over a three year period by comparing  KeySpan's  cumulative
total  shareholder  return to the S&P Utilities  Group.  For actual  performance
achieved at a  threshold  level,  50% of the award will be  granted;  for actual
performance achieved at a targeted level, 100% of the award will be granted; and
for actual performance  achieved at the maximum level, 150% of the award will be
granted.  The 2004  and 2005  awards  are  being  expensed  ratably  over  their
remaining performance periods.


                                      118
<PAGE>


During 2005, it became  apparent to management that the 2003  performance  share
award would not be achieved  and the 2004  performance  share award would not be
achieved at the level of expense  being  recorded.  Since these  awards meet the
definition  of a  performance  condition  not achieved  under SFAS 123,  KeySpan
reversed the  previously  recognized  expense for the 2003 award and one half of
previously recognized expense for the 2004 award amounting to $3.8 million ($2.5
million after tax).

The 2006 performance share award reflects the new performance condition criteria
under SFAS 123R. In 2006, 315,900  performance shares were granted.  Performance
shares were  granted  with a  three-year  performance  period with a  threshold,
target and maximum performance level. The number of performance shares earned at
the end of the  performance  period  can  range  from  0% to 150% of the  shares
granted  and  will  be  linked  to  two  performance  measures:  the  percentage
improvement in return on invested capital,  or "ROIC," and KeySpan's  cumulative
three-year  total  stockholder  return,  or "TSR,"  relative  to the  cumulative
three-year  TSR for the  Standard  and Poor's  Utilities  Group,  using a matrix
approach that encompasses  both measures.  The ROIC goal will act as the primary
trigger.  If the ROIC goal  performance is below the threshold level, all shares
shall be forfeited without payment. Upon a change of control, performance shares
shall be distributed based upon the greater of the number of performance  shares
awarded  at  target  level or the  number  of  shares  earned  based  on  actual
performance  through the change of control date.  Performance  share awards were
priced  at fair  value on the date of grant.  The  unearned  compensation  as of
December 31, 2006 associated with all of the performance  share awards was $11.5
million.

Restricted Stock Awards

KeySpan has made certain  grants of  restricted  stock to officers and directors
under the Incentive Plan. Awards of restricted stock were made in 2002, 2005 and
2006.  These  awards  may not be sold or  otherwise  transferred  until  certain
restrictions have lapsed. The unearned  stock-based  compensation related to the
2002 and 2005 awards was  amortized  to  compensation  expense  over the vesting
period.  The  share-based  expense for these awards was determined  based on the
fair  value of the stock at the date of grant  applied  to the  total  number of
shares that were anticipated to fully vest. The 2002 and 2005 awards expense has
been fully  amortized and the 2006 award was expensed in 2006.  Upon a change of
control, all restricted stock awards will vest immediately.

Employee Discount Stock Purchase Plan

KeySpan's  Employee  Discount  Stock  Purchase  Plan  ("EDSPP")  allows  KeySpan
employees to purchase shares of KeySpan stock at a 10% discount  through payroll
deductions. KeySpan is currently expensing the discount. The number of shares of
common stock  authorized  for issuance  under the EDSPP is 1,750,000  shares and
there are 358,731 shares remaining to be issued.


                                      119
<PAGE>


Stock Options

The stock option  component of the Incentive Plan entitles the  participants  to
purchase  shares of common stock at an exercise price per share which is no less
than the  closing  price of the  common  stock on the date of the  grant.  Stock
options  generally  vest over a  three-to-five  year period and have an exercise
period of ten years.  Upon a change of control,  all stock  options  granted and
outstanding will vest immediately.

The value of all stock  option  grants  are  estimated  on the date of the grant
using  the  Black-Scholes  option-pricing  model.  There  were no stock  options
granted in 2006. The following  table presents the weighted  average fair value,
exercise price and assumptions used for the 2005 and 2004 stock option grants:


-------------------------------------------------------------------------
                                                 Year Ended December 31,
                                                  2005             2004
-------------------------------------------------------------------------
Fair value of grants issued                 $     6.15       $      5.47
Dividend yield                                    4.64%            4.74%
Expected volatility                              22.63%           23.48%
Risk free rate                                    4.10%            3.22%
Expected lives                                6.4 years        6.5 years
Exercise price                              $     39.25      $     37.54
-------------------------------------------------------------------------


A summary of the status of our fixed stock option plans and changes is presented
below for the periods indicated:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                 2006                                  2005                                  2004
-----------------  -------------------------------------  -----------------------------------  ------------------------------------

                                Weighted    Aggregate                Weighted   Aggregate                    Weighted    Aggregate
                                Average     Intrinsic                Average    Intrinsic                    Average     Intrinsic
                                Exercise      Value                  Exercise      Value                     Exercise      Value
 Fixed Options     Shares        Price    (In Millions)     Shares    Price    (In Millions)      Shares       Price   (In Millions)
-----------------------------------------------------------------------------------------------------------------------------------
<S>               <C>            <C>              <C>   <C>             <C>            <C>     <C>             <C>          <C>
Outstanding at
 beginning of
 period           10,443,055    $ 33.74                  10,540,946    $ 32.61                  10,320,743    $ 31.39
Granted during
 the year                  -    $     -                   1,451,650    $ 39.25                   1,602,850    $ 37.54
Exercised           (955,500)   $ 32.54                  (1,400,190)   $ 30.65                  (1,150,464)   $ 28.05
Forfeited            (84,451)   $ 38.54                    (149,351)   $ 36.32                    (232,183)   $ 35.18
-----------------------------------------------------------------------------------------------------------------------------------
Outstanding at
 end of period     9,403,104    $ 33.82          $ 66.4  10,443,055    $ 33.74        $ 34.8    10,540,946    $ 32.61       $ 73.2
-----------------------------------------------------------------------------------------------------------------------------------
Exercisable at
 end of period     6,885,572    $ 32.73          $ 56.1   5,673,084    $ 31.55        $ 29.1     5,523,259    $ 30.39       $ 50.6
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


The total  intrinsic value of the options  exercised  during the 12 months ended
December 31, 2006, 2005 and 2004 was approximately  $6.8 million,  $11.4 million
and $11.3 million, respectively.





                                      120
<PAGE>


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

Remaining            Options          Weighted           Range of            Options                Weighted           Range of
Contractual      Outstanding at       Average            Exercise         Exercisable at            Average            Exercise
Life            December 31, 2006   Exercise Price        Price         December 31, 2006       Exercise Price          Price
----------------------------------------------------------------------------------------------------------------------------------
<S>                 <C>                 <C>          <C>                   <C>                        <C>          <C>
 1 year                      -               -                    -                 -                      -                    -
 2 years               185,000           32.63                32.63           185,000                  32.63                32.63
 3 years               681,958           28.00        24.73 - 29.38           681,958                  28.00        24.73 - 29.38
 4 years               382,181           26.97        21.99 - 27.06           382,181                  26.97        21.99 - 27.06
 5 years               960,947           22.69        22.50 - 32.76           960,947                  22.69        22.50 - 32.76
 6 years             1,511,064           39.50                39.50         1,511,064                  39.50                39.50
 7 years             1,750,205           32.66                32.66         1,422,105                  32.66                32.66
 8 years             1,165,112           32.40                32.40           766,552                  32.40                32.40
 9 years             1,414,766           37.54                37.54           655,231                  37.54                37.54
 10 years            1,351,871           39.25                39.25           320,534                  39.25                39.25
----------------------------------------------------------------------------------------------------------------------------------
                     9,403,104                                              6,885,572
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


As of December 31, 2006, there are  approximately 2.5 million options which have
not yet vested.  The  unearned  compensation  cost related to these stock option
awards is $3.2  million  which is  expected  to be  recognized  over a  weighted
average period of 2 years.

O.   Recent Accounting Pronouncements

In February 2007, Financial Accounting Standards Board ("FASB") issued Statement
of  Financial  Accounting  Standard  ("SFAS")  159 "The Fair  Value  Option  for
Financial Assets and Financial  Liabilities." This statement permits entities to
choose to measure many  financial  instruments  and certain  other items at fair
value  that  are not  currently  required  to be  measured  at fair  value.  The
objective  is to improve  financial  reporting by  providing  entities  with the
opportunity  to mitigate  volatility  in reported  earnings  caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting  provisions.  This  statement  requires a  business  entity to report
unrealized  gains and losses on items for which the fair  value  option has been
elected in  earnings at each  subsequent  reporting  date.  An entity may decide
whether to elect the fair value  option for each  eligible  item on its election
date, subject to certain requirements described in the statement. This statement
shall be effective as of the beginning of each  reporting  entity's first fiscal
year that begins after  November 15, 2007.  KeySpan is currently  reviewing  the
requirements  of this statement and, at this point in time, we can not determine
the  impact,  if any,  that this  statement  may have on results of  operations,
financial position or cash flows.

On  September  29,  2006,  the FASB issued SFAS 158  Employers'  Accounting  for
Defined Benefit Pensions and Other Postretirement Benefit Plans, an amendment of
FASB  Statements  No. 87, 88, 106 and 132(R)."  SFAS 158  requires  employers to
fully recognize all postretirement plans funded status on the balance sheet as a
net  liability or asset and requires an  offsetting  adjustment  to  accumulated
other  comprehensive  income  in  shareholders'  equity.  Certain  of  KeySpan's
subsidiaries are subject to deferral  accounting  requirements  pursuant to rate
agreements  with the  NYPSC,  MADTE and  NHPUC.  Further,  KeySpan  has  certain
contractual  rights  to  reimbursement  for  postretirement  liabilities  in its
agreements  with LIPA.  As such,  a portion of the  offsetting  position  to the
increase  in the  total  postretirement  liabilities  has  been  reflected  as a
regulatory  asset  and  contractual   asset.   SFAS  158  does  not  change  how
postretirement  benefits are accounted for and reported in the income statement;
companies will continue to apply existing accounting  guidance.  KeySpan adopted
the  provisions  of SFAS  158 in  December  2006.  See  Note 4 "Post  Retirement
Benefits" for further information on SFAS 158.


                                      121
<PAGE>


On September 15, 2006, the FASB issued SFAS 157 "Fair Value  Measurements." This
statement  defines fair value,  establishes a framework for measuring fair value
in generally accepted  accounting  principles and expands disclosures about fair
value.  SFAS 157 expands the disclosures  about the use of fair value to measure
assets and  liabilities  in interim  and annual  periods  subsequent  to initial
recognition. The disclosures focus on the inputs used to measure fair value, the
recurring fair value measurements using significant  unobservable inputs and the
effect of the measurement on earnings (or changes in net assets) for the period.
The  guidance  in SFAS 157 also  applies  for  derivatives  and other  financial
instruments   measured  at  fair  value  under  Statement  133  "Accounting  for
Derivative Instruments and Hedging Activities" at initial recognition and in all
subsequent periods. This Statement is effective for fiscal years beginning after
November 15, 2007,  and interim  periods  within those fiscal years.  KeySpan is
currently  reviewing  the  requirements  of SFAS 157,  and at this point in time
cannot  determine  what  impact,  if any,  SFAS 157 will have on its  results of
operations or financial  position.  This  Statement  will have no impact on cash
flow.

On July  13,  2006,  the FASB  issued  Interpretation  No.  48  "Accounting  for
Uncertainty  In Income  Taxes."  The FASB,  in its  interpretation  of SFAS 109,
"Accounting  for  Income  Taxes,"  seeks to reduce  the  diversity  in  practice
associated with certain aspects of the recognition and measurement  requirements
related  to  accounting  for  income  taxes.  The  Interpretation  prescribes  a
recognition  threshold and a measurement  attribute for the financial  statement
recognition  and measurement of tax positions taken or expected to be taken in a
tax  return.  For  those  benefits  to be  recognized,  a tax  position  must be
more-likely-than-not to be sustained upon examination by taxing authorities. The
amount  recognized is measured as the largest  amount of benefit that is greater
than  50  percent  likely  of  being  realized  upon  ultimate  settlement.  The
Interpretation  requires  application  for fiscal years beginning after December
15, 2006, for first quarter 2007 reporting.  KeySpan is currently  reviewing the
requirements  of this  Interpretation  and,  at this  point in time,  we can not
determine the impact,  if any, that this  Interpretation  may have on results of
operations and financial position.

In  December   2004  the  FASB  issued  SFAS  123  (revised  2004  "SFAS  123R")
"Share-Based   Payment."   SFAS  123R  focuses   primarily  on  accounting   for
transactions in which an entity obtains employee services in share-based payment
transactions.  SFAS 123R revises certain  provisions of SFAS 123 "Accounting for
Stock-Based  Compensation"  and supersedes APB Opinion 25 "Accounting  for Stock
Issued to Employees." The fair-value-based method in SFAS 123R is similar to the
fair-value-based method in SFAS 123 in most respects. However, the following are
key  differences   between  the  two:  entities  are  now  required  to  measure
liabilities  incurred to employees in share-based  payment  transactions at fair
value as compared to using the intrinsic method allowed under SFAS 123; entities
are now required to estimate the number of  instruments  for which the requisite
service is expected to be rendered, as compared to accounting for forfeitures as
they occur under SFAS 123; and incremental  compensation cost for a modification
of the terms or conditions of an award are also measured  differently under SFAS
123R compared to Statement  123. SFAS 123R also clarifies and expands SFAS 123's


                                      122
<PAGE>


guidance in several areas.  The effective date of SFAS 123R was the beginning of
the first  fiscal  year  beginning  after June 15,  2005.  KeySpan  adopted  the
prospective  method of transition for stock options 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 for grants  awarded after January 1,
2003.  Therefore  implementation  of SFAS  123R in  January  2006 did not have a
material impact on KeySpan's results of operations or financial  position and no
impact on its cash flows.

P.   Impact of Cumulative Effect of Change in Accounting Principles

KeySpan  implemented FASB  Interpretation No. 47 ("FIN 47"),  effective December
31, 2005. FIN 47 required KeySpan to record a liability and corresponding  asset
representing  the present  value of  conditional  asset  retirement  obligations
associated  with the retirement of tangible,  long-lived  assets on the date the
obligations  were  incurred.  At December 31, 2005,  we recorded a $45.6 million
liability and corresponding  asset representing the present value of conditional
asset  retirement  obligations  associated  with  the  retirement  of  tangible,
long-lived  assets  on the date the  obligations  were  incurred.  For the $45.6
million  initial asset recorded,  approximately  $4.3 million  represents  asset
retirement costs that have been deferred on the  Consolidated  Balance Sheet and
will be depreciated over the remaining life of the underlying  associated assets
lives.  The  remaining  $41.3  million  represented   cumulative  accretion  and
depreciation  expense associated with the liability and asset from the dates the
various  obligations  would have been recorded had this  Interpretation  been in
effect at the time the obligations were incurred.

Of the $41.3 million  recorded,  $11.3 million ($6.6  million,  after-tax),  was
recorded as a cumulative  change in  accounting  principle  on the  Consolidated
Statement of Income.  The remaining  $30.0 million was  attributable  to the Gas
Distribution  segment and was recorded as a reduction to removal cost recovered.
For asset retirement costs incurred in the Gas Distribution segment,  KeySpan is
recovering  these costs from  utility  customers  and has been  expensing a like
amount through its depreciation  expense. A portion of this depreciation expense
represents removal costs not yet incurred. The $30.0 million recorded to removal
cost recovered is for purposes of reclassifying a portion of this reserve to the
asset retirement obligation.  (See Note 7, "Contractual  Obligations,  Financial
Guarantees  and  Contingencies  -  Asset  Retirement  Obligations"  for  further
details.)


                                      123
<PAGE>


Under Accounting Principle Board Opinion No. 20 ("APB 20"), the pro-forma impact
of the  retroactive  application  resulting  from the  adoption  of a change  in
accounting principle is to be disclosed as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------
                                                                                                  Year Ended December 31,
(In Millions of Dollars, Except Per Share Amounts)                                              2005                  2004
----------------------------------------------------------------------------------------------------------------------------
<S>                                                                                            <C>                   <C>
Earnings for common stock                                                                     $ 388.0               $ 458.1
Add back: Cumulative effect of a change in accounting principle                                   6.6                     -
----------------------------------------------------------------------------------------------------------------------------
Earnings for common stock before cumulative effect of a change in
accounting principle                                                                            394.6                 458.1
     Less: FIN 47 Accretion expense, net of taxes                                                (0.5)                 (0.4)
     Add: FIN 47 Depreciation expense, net of taxes                                              (0.2)                 (0.2)
----------------------------------------------------------------------------------------------------------------------------
Pro-forma earnings                                                                            $ 393.9               $ 457.5
----------------------------------------------------------------------------------------------------------------------------

Earnings per share before cumulative change in accounting principle:
     Basic - as reported                                                                      $  2.32               $  2.86
     Basic - pro-forma                                                                        $  2.32               $  2.85

     Diluted - as reported                                                                    $  2.31               $  2.84
     Diluted - pro-forma                                                                      $  2.31               $  2.84
----------------------------------------------------------------------------------------------------------------------------

Earnings per share for common stock:
     Basic - as reported                                                                      $  2.28               $  2.86
     Basic - pro-forma                                                                        $  2.32               $  2.85

     Diluted - as reported                                                                    $  2.27               $  2.84
     Diluted - pro-forma                                                                      $  2.31               $  2.84
----------------------------------------------------------------------------------------------------------------------------
</TABLE>


In addition to the above disclosure, FIN 47 requires disclosure of the pro-forma
impact of the liability for the asset retirement obligation for the beginning of
the earliest  year  presented  and at the end of all years  presented as if this
Interpretation  had been applied during all periods effected.  The disclosure is
as follows:

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------
(In Millions of Dollars)                                             December 31,
                                                              2006                  2005
------------------------------------------------------------------------------------------
<S>                                                          <C>                    <C>
Asset retirement obligation - January 1                     $ 47.4                 $ 44.9
Accretion                                                      2.6                    2.5
Cost Incurred                                                 (2.7)                     -
------------------------------------------------------------------------------------------
Asset retirement obligation - December 31                   $ 47.3                 $ 47.4
------------------------------------------------------------------------------------------
</TABLE>





                                      124
<PAGE>


Q.   Accumulated Other Comprehensive Income

As required by SFAS 130,  "Reporting  Comprehensive  Income," the  components of
accumulated other comprehensive income are as follows:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
                                  December 31,
(In Millions of Dollars)                                            2006              2005
-------------------------------------------------------------------------------------------
<S>                                                               <C>                <C>
Unrealized gains (losses) on marketable securities              $    1.1           $  (0.9)
Accrued unfunded pension obligation                                (25.6)            (63.5)
SFAS 158 transition                                               (148.0)                -
Unrealized losses on derivative financial instruments               (2.8)            (10.4)
-------------------------------------------------------------------------------------------
Accumulated other comprehensive loss                            $ (175.3)          $ (74.8)
-------------------------------------------------------------------------------------------
</TABLE>



R.   Pension and Other Postretirement Plan Assets

Consistent  with past practice and as required by SFAS 158,  KeySpan  values its
pension and other postretirement assets using the year-end market value of those
assets. Benefit obligations are also measured at year-end.

Note 2. Business Segments

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

The Gas Distribution segment consists of our six gas distribution  subsidiaries.
KEDNY  provides  gas  distribution  services to  customers  in the New York City
Boroughs of Brooklyn,  Queens and Staten 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,  collectively  referred  to as  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 existing  long-term
service  contracts  having  remaining terms that range from one to six years and
power  purchase  agreements  having  remaining  terms  that range from six to 20
years. On February 1, 2006, KeySpan and LIPA agreed to extend, amend and restate
these  contractual  arrangements.  (See Note 11,  "2006 LIPA  Settlement"  for a
further  discussion of these  agreements.)  The Electric  Services  segment also
includes  subsidiaries  that own or lease and  operate  the 2,200 MW  Ravenswood
Facility located in Queens,  New York, and the 250 MW combined-cycle  Ravenswood
Expansion.  Collectively  the Ravenswood  Facility and Ravenswood  Expansion are
referred to as the "Ravenswood Generating Station". All of the energy,  capacity
and ancillary services related to the Ravenswood  Generating Station are sold to
the NYISO energy  markets.  To finance the purchase  and/or  construction of the
Ravenswood Generating Station, KeySpan entered into leasing arrangement for each
facility.  The Electric  Services  segment  also  conducts  retail  marketing of
electricity  to  commercial  customers.  (See Note 7  "Contractual  Obligations,
Financial  Guarantees  and  Contingencies"  for  further  details on the leasing
arrangements.)


                                      125
<PAGE>


The Energy  Services  segment  includes  companies  that provide  energy-related
services to customers located  primarily within the Northeastern  United States.
Subsidiaries in this segment provide residential and small commercial  customers
with  service  and  maintenance  of energy  systems and  appliances,  as well as
operation  and  maintenance,  design,  engineering,  consulting  and fiber optic
services to commercial, institutional and industrial customers.

In 2005,  KeySpan sold its mechanical  contracting  subsidiaries.  The operating
results  and  financial  position  of these  companies  have been  reflected  as
discontinued operations on the Consolidated Statement of Income and Consolidated
Statement  of Cash  Flows for 2005.  In the fourth  quarter  of 2004,  KeySpan's
investment in its mechanical  contracting  subsidiaries  was  written-down to an
estimated  fair  value.  During  2004,  KeySpan  recorded  a  non-cash  goodwill
impairment  charge of $108.3  million  ($80.3  million  after tax,  or $0.50 per
share)  associated  with  its  mechanical  contracting  operations  and  certain
remaining operations. In addition, an impairment charge of $100.3 million ($72.1
million  after-tax or $0.45 per share) was also  recorded to reduce the carrying
value of the remaining assets of the mechanical contracting companies. (See Note
10 "Energy Services - Discontinued  Operations" for additional details regarding
these  charges.)  During the first six  months of 2005,  operating  losses  were
incurred through the dates of sale of these companies of $4.1 million after-tax,
including  but not limited to costs  incurred  for  employee  related  benefits.
Partially offsetting these losses was a gain of $2.3 million associated with the
related divestitures, reflecting the difference between the fair value estimates
and the financial impact of the actual sale transactions.  The net income impact
of the operating  losses and the disposal  gain was a loss of $1.8  million,  or
$0.01 per share for the twelve months ended December 31, 2005.

The Energy  Investments  segment  consists of our gas production and development
investments,  as well as  certain  other  domestic  energy-related  investments.
KeySpan's gas production and  development  activities  include its  wholly-owned
subsidiaries  Seneca  Upshur  Petroleum,  Inc.   ("Seneca-Upshur")  and  KeySpan
Exploration  and  Production,  LLC  ("KeySpan  Exploration").  Seneca-Upshur  is
engaged in gas production and development activities primarily in West Virginia.
KeySpan   Exploration   is  involved  in  a  joint  venture  with  Merit  Energy
Corporation,  an independent oil and gas producer that purchased its interest in
the Joint Venture from Houston Exploration.

This segment is also  engaged in pipeline  development  activities.  KeySpan and
Spectra Energy Corporation (formerly part of Duke Energy Corporation) each own a
50% interest in the 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,  KeySpan  has a 26.25%  interest in the  Millennium  Pipeline
Company LLC, the developer of the Millennium pipeline project, which is expected
to have the  capacity to  transport  up to 525,000 DTH of natural gas a day from
Corning,  New York to Ramapo,  New York,  where it will  connect to an  existing
pipeline. Additionally,  subsidiaries in this segment hold a 20% equity interest


                                      126
<PAGE>


in the Iroquois Gas Transmission  System LP, a pipeline that transports Canadian
gas supply to markets in the northeastern  United States.  These investments are
accounted  for under the equity  method.  Accordingly,  equity income from these
investments is reflected as a component of operating  income in the Consolidated
Statement of Income.

Through its wholly owned subsidiary,  KeySpan LNG, KeySpan owns a 600,000 barrel
liquefied  natural gas  storage and  receiving  facility  in  Providence,  Rhode
Island, the operations of which are fully consolidated.

In the  first  quarter  of  2005,  KeySpan  sold  its 50%  interest  in  Premier
Transmission  Limited  ("Premier"),  a gas pipeline from  southwest  Scotland to
Northern  Ireland.  On February 25, 2005,  KeySpan entered into a Share Sale and
Purchase  Agreement  with BG Energy  Holdings  Limited and Premier  Transmission
Financing  Public  Limited  Company  ("PTFPL"),  pursuant  to  which  all of the
outstanding  shares of Premier were to be purchased by PTFPL. On March 18, 2005,
the sale was  completed  and  generated  cash  proceeds of  approximately  $48.1
million.  In the fourth  quarter of 2004,  KeySpan  recorded a pre-tax  non-cash
impairment  charge  of $26.5  million  reflecting  the  difference  between  the
anticipated  cash  proceeds  from the sale of Premier  compared to its  carrying
value.  The final sale of Premier  resulted  in a pre-tax  gain of $4.1  million
reflecting the difference from earlier estimates;  this gain was recorded in the
first quarter of 2005.

During  the  first  five  months of 2004,  our gas  exploration  and  production
investments  also  included a 55% equity  interest  in The  Houston  Exploration
Company ("Houston Exploration"),  an independent natural gas and oil exploration
company  located  in  Houston,   Texas,  the  operations  of  which  were  fully
consolidated in KeySpan's  Consolidated  Financial Statements.  On June 2, 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 23.5%.  Effective June 1, 2004,  Houston  Exploration's
earnings and our ownership interest in Houston Exploration were accounted for on
the equity method of accounting.  This transaction resulted in a gain to KeySpan
of $150.1  million and was  reflected  in other income and  (deductions)  on the
Consolidated  Statement of Income. 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.

In  November  2004,  KeySpan  sold  its  remaining  23.5%  interest  in  Houston
Exploration  (6.6 million  shares) and received cash  proceeds of  approximately
$369  million.  KeySpan  recorded  a  pre-tax  gain of $179.6  million  which is
reflected  in other income and  (deductions)  on the  Consolidated  Statement of
Income. The after-tax gain was $116.8 million or $0.73 per share.

Houston Exploration's  revenues,  which are reflected in KeySpan's  Consolidated
Statement of Income in 2004 were $268.1 million. Houston Exploration's operating
income,  including  KeySpan's  share of equity  earnings,  was $138.5 million in
2004.


                                      127
<PAGE>


During the first quarter of 2004, we also had an  approximate  61% investment in
certain  midstream  natural gas assets in Western Canada through  KeySpan Energy
Canada  Partnership  ("KeySpan  Canada").  These assets  included 14  processing
plants and associated gathering systems that produced  approximately 1.5 BCFe of
natural gas daily and  provided  associated  natural gas liquids  fractionation.
These  operations were fully  consolidated in KeySpan's  Consolidated  Financial
Statements.  On April 1, 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 and
acquired an additional  35.91%  interest in KeySpan  Canada from  KeySpan.  As a
result of this transaction,  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) at the time of this  transaction.  This gain was  reflected  in other
income and (deductions) on the Consolidated Statement of Income. Effective April
1, 2004 KeySpan Canada's  earnings and our ownership  interest in KeySpan Canada
were 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%. KeySpan continued to account for
its  investment  in KeySpan  Canada on the equity basis of  accounting  since it
still exercised significant influence over this entity.

In December 2004, KeySpan sold its remaining 17.4% interest in KeySpan Canada to
the Fund and received net proceeds of approximately  $119 million and recorded a
pre-tax gain of approximately $35.8 million,  which is reflected in other income
and (deductions) on the Consolidated Statement of Income. The after-tax gain was
approximately $24.7 million, or $0.15 per share.

KeySpan  Canada's  revenues,  which  are  reflected  in  KeySpan's  Consolidated
Statement  of Income in 2004 were  $25.2  million.  KeySpan  Canada's  operating
income, including KeySpan's share of equity earnings, was $16.5 million in 2004.

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.  For fiscal year 2004,  the operating
data of  Houston  Exploration  has been  separately  displayed.  The  reportable
segment information is as follows:


                                      128
<PAGE>


<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------------
                                               Gas           Electric      Energy        Energy
(In Millions of Dollars)                   Distribution      Services     Services     Investments     Eliminations  Consolidated
---------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2006
<S>                                           <C>            <C>            <C>            <C>                <C>      <C>
Unaffiliated revenue                            5,062.6       1,880.6        203.4           35.0                 -      7,181.6
Intersegment revenue                                  -             -          9.6            5.3             (14.9)           -
Depreciation, depletion and amortization          266.7         102.2          8.3            7.3              13.0        397.5
Gain on sales of property                             -           0.5            -            0.3               0.8          1.6
Income from equity investments                        -             -            -           13.1                 -         13.1
Operating income                                  568.6         293.0          5.3           15.5             (54.9)       827.5
Interest income                                     1.5           0.6          0.1            0.4              10.6         13.2
Interest charges                                  179.6          65.0         20.9            1.5             (10.9)       256.1
Total assets                                   10,536.6       2,471.8        192.3          351.3             885.5     14,437.5
Equity method investments                             -             -            -          124.2                 -        124.2
Construction expenditures                         400.5          78.9          8.0           18.7              17.9        524.0
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Eliminating  items  include  intercompany  interest  income and  expense and the
elimination  of  certain  intercompany  accounts  as well as  activities  of our
corporate and administrative subsidiaries.

Electric  Services revenues from LIPA and the NYISO of $1.8 billion for the year
ended  December  31,  2006  represents  approximately  26% of  our  consolidated
revenues during that period.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                              Gas           Electric     Energy        Energy
(In Millions of Dollars)                  Distribution      Services    Services     Investments    Eliminations      Consolidated
-----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2005
<S>                                          <C>            <C>           <C>            <C>               <C>          <C>
Unaffiliated revenue                           5,390.1       2,042.7       191.2           38.0                -           7,662.0
Intersegment revenue                                 -           4.6        10.8            5.0            (20.4)                -
Depreciation, depletion and amortization         277.0          91.7         7.6            6.8             13.4             396.5
Gain on sales of property                          0.1           1.2           -            0.1              0.2               1.6
Income from equity investments                       -             -           -           15.1                -              15.1
Operating income                                 565.7         342.3        (2.7)          20.6            (18.1)            907.8
Interest income                                    0.9           0.8         0.2            2.8              7.6              12.3
Interest charges                                 178.2          71.7        18.4            1.8             (0.8)            269.3
Total assets                                  10,052.5       2,348.0       199.0          341.9            871.2          13,812.6
Equity method investments                            -             -           -          106.7                -             106.7
Construction expenditures                        410.3          88.8         8.4           22.6              9.4             539.5
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Eliminating  items  include  intercompany   interest  income  and  expense,  the
elimination  of certain  intercompany  accounts,  as well as  activities  of our
corporate and administrative subsidiaries.

Electric  Services revenues from LIPA and the NYISO of $2.0 billion for the year
ended  December  31,  2005  represents  approximately  26% of  our  consolidated
revenues during that period.


                                      129
<PAGE>


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                     Gas         Electric    Energy        Houston      Other Energy
(In Millions of Dollars)         Distribution    Service     Services    Exploration     Investments    Eliminations    Consolidated
------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004
<S>                                  <C>         <C>           <C>            <C>           <C>           <C>             <C>
Unaffiliated revenue                  4,407.3     1,738.7       182.4          268.1          54.0                -         6,650.5
Intersegment revenue                        -           -        11.5              -           4.9            (16.4)              -
Depreciation, depletion and
 amortization                           276.5        88.2         7.5          104.6          59.7             15.3           551.8
Gain on sales of property                   -         2.0           -              -           5.0                -             7.0
Income from equity investments              -           -           -           20.7          25.8                -            46.5
Operating income                        579.6       289.8       (48.3)         138.5         (33.8)             9.5           935.3
Interest income                           2.2         9.9           -            3.5           3.0             (9.2)            9.4
Interest charges                        176.8        72.9        19.4            3.5           3.9             54.8           331.3
Total assets                          8,908.8     2,144.3       246.6              -         701.3          1,363.1        13,364.1
Equity method investments                   -           -           -              -         107.1                -           107.1
Construction expenditures               414.5       150.3        13.7          146.5          13.7             11.6           750.3
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Eliminating  items  include  intercompany  interest  income and  expense and the
elimination  of  certain  intercompany  accounts  as well as  activities  of our
corporate and administrative subsidiaries.

Electric Services revenues from LIPA and the NYISO of $1.7 billion for the year
ended December 31, 2004 represents approximately 25% of our consolidated
revenues during that period.

Note 3. Income Tax

KeySpan files a consolidated  federal income tax return. A tax sharing agreement
between the  KeySpan's  holding  company and its  subsidiaries  provides for the
allocation  of a realized  tax  liability  or asset based upon  separate  return
contributions of each subsidiary to the  consolidated  taxable income or loss in
the consolidated  income tax return. The subsidiaries  record income tax payable
or receivable from KeySpan  resulting from the inclusion of their taxable income
or loss in the consolidated return.

Income tax expense is  reflected  as follows in the  Consolidated  Statement  of
Income:


----------------------------------------------------------------------------
                                            Year Ended December 31,
(In Millions of Dollars)              2006            2005             2004
----------------------------------------------------------------------------
Current Income Tax
  Federal                             41.3           175.7            205.1
  State and Local                     16.6            30.9             (3.2)
                            ------------------------------------------------
Total Current Income Tax           $  57.9         $ 206.6          $ 201.9
                            ------------------------------------------------
Deferred Income Tax
  Federal                             93.8            17.1            118.3
  State and Local                     23.8            15.6              5.3
                            ------------------------------------------------
Total Deferred Income Tax          $ 117.6         $  32.7          $ 123.6
----------------------------------------------------------------------------
Total income tax                   $ 175.5         $ 239.3          $ 325.5
----------------------------------------------------------------------------





                                      130
<PAGE>


At December 31, the significant components of KeySpan's deferred tax assets and
liabilities calculated under the provisions of SFAS No.109 "Accounting for
Income Taxes" were as follows:

--------------------------------------------------------------------------------
                                                          December 31,
(In Millions of Dollars)                           2006                  2005
--------------------------------------------------------------------------------
Reserves not currently deductible             $     46.1             $     28.4
State income tax                                   (49.7)                 (20.6)
Property related differences                    (1,179.3)              (1,080.8)
Regulatory tax asset                               (29.3)                 (24.5)
Employess benefits and compensation                 24.6                  (30.3)
Property taxes                                     (82.7)                 (84.1)
Other items - net                                   93.9                   54.0
--------------------------------------------------------------------------------
Net deferred tax liability                    $ (1,176.4)            $ (1,157.9)
--------------------------------------------------------------------------------


The federal income tax amounts included in the Consolidated  Statement of Income
differ from the amounts which result from applying the statutory  federal income
tax rate to income before income tax.

The table below sets forth the reasons for such differences:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
                                                                                 Year Ended December 31,
(In Millions of Dollars)                                           2006                 2005                2004
---------------------------------------------------------------------------------------------------------------------
<S>                                                               <C>                  <C>                 <C>
Computed at the statutory rate                              $      213.2         $      223.3         $     329.1
Adjustments related to:
State income tax, net of Federal benefit                            29.4                 29.0                24.8
Tax credits                                                         (1.3)                (1.4)               (2.2)
Removal costs                                                       (2.1)                (2.9)               (0.6)
Accrual to return adjustments                                       (3.8)                 6.7               (10.7)
Sale of subsidiary stock                                               -                    -               (22.5)
Minority interest in Houston Exploration                               -                    -                12.9
Contribution of land                                                   -                 (3.8)                  -
Dividends paid to employee benefit plan                             (3.7)                (3.9)               (3.6)
Impact of IRS audit settlement                                     (44.5)                   -                   -
Impact of NYC audit settlement                                      (7.1)                   -                   -
Other items - net                                                   (4.6)                 (7.7)               (1.7)
---------------------------------------------------------------------------------------------------------------------
Total income tax                                            $      175.5         $      239.3         $     325.5
---------------------------------------------------------------------------------------------------------------------
Effective income tax rate (1)                                        29%                  38%                 35%
---------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Reflects both federal as well as state income taxes.

KeySpan's  consolidated  effective  income  tax rate,  including  city and state
income taxes,  was 28.8% for the twelve months ended  December 31, 2006 compared
to 37.5% for the  corresponding  period in 2005. In 2006,  KeySpan  resolved its
dispute with the New York City  Department  of Taxation and Finance with respect
to income taxes relating to the operations of its merchant  electric  generating
facility.  As a  result  of the  favorable  settlement  of this  issue,  KeySpan
reversed a previously  recorded tax reserve of $11.9 million ($7.1 million after
federal income taxes). In addition,  pursuant to indemnity obligations contained
in the Long Island Lighting Company  ("LILCO") / KeySpan merger agreement of May
1998,  KeySpan had been  working with the Internal  Revenue  Service  ("IRS") to
resolve certain disputes with regard to LILCO's tax returns for the tax years


                                      131
<PAGE>


ended  December 31, 1996 through  March 31, 1999 and  KeySpan's and The Brooklyn
Union Gas Company's  (d/b/a KEDNY) tax returns for the years ended September 30,
1997 through  December 31, 1998.  A  settlement  of the  outstanding  issues was
reached in 2006 and,  following IRS  procedure,  the settlement was submitted to
the Joint Committee on Taxation on October 30, 2006 for final approval, which is
expected  in  early  2007.  Accordingly,   KeySpan  reversed  $44.5  million  of
previously  established  tax  reserves.  Further,  a $3.4  million  benefit  was
recorded in 2006  reflecting  an accrual for prior  investment  tax credits that
KeySpan is  entitled  to.  KeySpan  has  recently  filed  amended tax returns to
reflect its  entitlement  to investment  tax credits for the period 2000 through
2004.  The  decrease  in the  effective  tax rate for the  twelve  months  ended
December 31, 2006 compared to the same period in 2005,  was primarily due to the
aforementioned items.

The IRS has also recently commenced the examination of KeySpan's tax returns for
the years ended  December 31, 2002 and 2003. At this time, we cannot predict the
result of these audits.

The  American  Jobs  Creation  Act of 2004,  signed into law on October 22, 2004
provides for a special one-time tax deduction,  or dividend  received  deduction
("DRD") of 85% of qualifying  foreign  earnings that were repatriated in 2004 or
2005.  We  currently   estimate  that  KeySpan  has  repatriated   dividends  of
approximately  $9.5 million of earnings under this provision and received,  as a
result, a tax benefit of $2.8 million.

As of December 31, 2006 KeySpan has $412 million of state net  operating  losses
which will expire between 2011 and 2022.

Note 4.  Postretirement Benefits

Pension Plans. The following information represents the consolidated results 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 MADTE, 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>
------------------------------------------------------------------------------------------------
                                                                  Year Ended December 31,
(In Millions of Dollars)                                   2006           2005           2004
------------------------------------------------------------------------------------------------
<S>                                                       <C>           <C>            <C>
Service cost, benefits earned during the period     $       62.7    $     56.5     $     52.9
Interest cost on projected benefit obligation              155.1         148.5          144.2
Expected return on plan assets                            (186.0)       (173.1)        (158.2)
Net amortization and deferral                               88.7          74.1           63.3
Special termination benefits                                   -          2.2               -
------------------------------------------------------------------------------------------------
Total pension cost                                  $      120.5    $    108.2     $    102.2
------------------------------------------------------------------------------------------------
</TABLE>




                                      132
<PAGE>


The following  table sets forth the pension plans' funded status at December 31,
2006 and December 31, 2005.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                                                                        Year Ended December 31,
(In Millions of Dollars)                                                                2006             2005
----------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>              <C>
Change in benefit obligation:
Benefit obligation at beginning of period                                           $ (2,715.0)      $ (2,520.1)
Service cost                                                                             (62.7)           (56.6)
Interest cost                                                                           (155.0)          (148.5)
Amendments                                                                               (11.5)            (0.1)
Actuarial loss                                                                            28.3           (117.9)
Benefits paid                                                                            133.8            130.4
Special termination benefits                                                                 -             (2.2)
----------------------------------------------------------------------------------------------------------------
Benefit obligation at end of period                                                 $ (2,782.1)      $ (2,715.0)
----------------------------------------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of period                                       2,213.5          2,028.9
Actual return on plan assets                                                             299.6            166.7
Employer contribution                                                                     94.9            148.3
Benefits paid                                                                           (133.8)          (130.4)
----------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of period                                             2,474.2          2,213.5
----------------------------------------------------------------------------------------------------------------

Funded status                                                                           (307.9)          (501.5)
----------------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
<S>                                                                                     <C>
Amounts recognized in the statement of financial position consist of:
Noncurrent assets                                                                   $        -
Current liabilities                                                                       (6.3)
Noncurrent liabilities                                                                  (301.6)
-----------------------------------------------------------------------------------------------
Total                                                                               $   (307.9)
-----------------------------------------------------------------------------------------------

Amounts recognized in accumulated other comprehensive income consist of:
Net gain/(loss)                                                                     $   (451.8)
Prior service cost                                                                       (49.4)
-----------------------------------------------------------------------------------------------
Total                                                                               $   (501.2)*
-----------------------------------------------------------------------------------------------
Estimated amounts of accumulated other comprehensive income to be
recognized in the next fiscal year through net periodic pension cost:
Net gain/(loss)                                                                     $    (53.3)
Prior service cost                                                                       (10.3)
-----------------------------------------------------------------------------------------------
Total                                                                               $    (63.6)*
-----------------------------------------------------------------------------------------------
</TABLE>
*The above  amounts  are  before  adjustments  for  regulatory  and  contractual
deferrals and deferred taxes

                                      133
<PAGE>


The  table  below  details  the  end-of-year  assumptions  used for both the net
periodic cost calculations and liability amounts.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
                                                                Year End December 31,
                                                      2006        2005        2004      2003
-----------------------------------------------------------------------------------------------
<S>                                                  <C>         <C>         <C>        <C>
Assumptions:
Obligation discount                                   6.00%       5.75%       6.00%      6.25%
Asset return, net of expenses                         8.50%       8.50%       8.50%      8.50%
Average annual increase in compensation               4.00%       4.00%       4.00%      4.00%
-----------------------------------------------------------------------------------------------
</TABLE>

The following  benefit  payments,  which reflect  expected  future  service,  as
appropriate, are expected to be paid in the years indicated:


-------------------------------------------------
(In Millions of Dollars)         Pension Benefits
-------------------------------------------------

      2007                           $ 138.3
      2008                           $ 141.8
      2009                           $ 145.5
      2010                           $ 150.4
      2011                           $ 156.0
      Years 2012- 2016               $ 906.4
-------------------------------------------------


Under Funded Pension  Obligation.  SFAS 158  "Employers'  Accounting for Defined
Benefit  Pension and Other  Postretirement  Plans"  requires  full balance sheet
recognition  of the net  overfunded  or  underfunded  status of each pension and
other  postretirement plan. The funded status of pension plans is to be measured
as the  difference  between  the fair value of plan assets  minus the  projected
benefit obligation. At December 31, 2006, KeySpan's projected benefit obligation
was in  excess  of  pension  assets  by  $307.9  million.  Amounts  that are not
recognized in net periodic  benefit costs will be recorded  through  accumulated
other  comprehensive  income.  At December 31, 2006,  the amount  recognized  in
accumulated  other  comprehensive  income  was  $134.7  million,  net of tax and
regulatory and contractual deferrals.





                                      134
<PAGE>


The following  table  reconciles  the 2005  Consolidated  Balance Sheet with the
impact of SFAS 158:

------------------------------------------------------------------------------
(In Millions of Dollars)                                       Pension
------------------------------------------------------------------------------
                                                        Liability       AOCI
------------------------------------------------------------------------------
Prepaid Asset December 31, 2005                        $  218.9      $      -
Additional minimum liability                             (257.4)        (63.5)
------------------------------------------------------------------------------
Balance at  December 31, 2005                             (38.5)        (63.5)
2006 activity                                             (25.6)            -
Reduction to additional minimum liability                 137.0         137.0
Incremental SFAS 158 liability                           (380.8)       (380.8)
Intangible asset reversal                                     -         (41.1)
Incremental deferrals and deferred taxes                      -         213.7
------------------------------------------------------------------------------
Balance at December 31, 2006                           $ (307.9)     $ (134.7)
------------------------------------------------------------------------------

At December  31, 2006 the  projected  benefit  obligation,  accumulated  benefit
obligation and value of assets for plans with accumulated benefit obligations in
excess  of plan  assets  were  $1.4  billion,  $1.3  billion  and $1.2  billion,
respectively.

At December 31, 2005 the accumulated benefit obligation was in excess of pension
assets. As prescribed by SFAS 87 "Employers'  Accounting for Pensions,"  KeySpan
had a $257.4 million  minimum  liability at December 31, 2005, for this unfunded
pension  obligation.  As permitted under accounting  guidelines then applicable,
these accruals were offset by a  corresponding  debit to a long-term asset up to
the amount of accumulated unrecognized prior service costs. Any remaining amount
was to be recorded in accumulated other comprehensive income on the Consolidated
Balance Sheet.

Therefore,  at December 31, 2005, we had a long-term  asset in deferred  charges
other of $41.1 million,  representing  the amount of unrecognized  prior service
cost and a debit to accumulated other comprehensive  income of $97.8 million, or
$63.6 million after-tax.  The remaining amount of $118.3 million was recorded as
a contractual  receivable from LIPA of $103.8 million and a regulatory  asset of
$14.5  million,  representing  the amounts that could be recovered from LIPA and
the Boston Gas ratepayer in accordance with our service and rate agreements.

At December  31, 2005 the  projected  benefit  obligation,  accumulated  benefit
obligation and value of assets for plans with accumulated benefit obligations in
excess  of plan  assets  were  $1.4  billion,  $1.3  billion  and $997  million,
respectively.

Other  Postretirement   Benefits.   The  following  information  represents  the
consolidated  results for our  non-contributory  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.


                                      135
<PAGE>



Net  periodic   other   postretirement   benefit  cost  included  the  following
components:


<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------
                                                             Year Ended December 31,
(In Millions of Dollars)                                  2006        2005      2004
--------------------------------------------------------------------------------------
<S>                                                      <C>         <C>        <C>
Service cost, benefits earned during the period         $  24.9     $  24.4    $ 19.7
Interest cost on accumulated
   postretirement benefit obligation                       74.9        75.7      70.2
Expected return on plan assets                            (36.6)      (36.1)    (33.9)
Net amortization and deferral                              57.3        59.9      41.0
Special termination benefit                                   -         1.7         -
--------------------------------------------------------------------------------------
Other postretirement cost                               $ 120.5     $ 125.6    $ 97.0
--------------------------------------------------------------------------------------
</TABLE>















                                      136
<PAGE>


The following table sets forth the plans' funded status at December 31, 2006 and
December 31, 2005.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
                                                                                    Year Ended December 31,
(In Millions of Dollars)                                                              2006          2005
-----------------------------------------------------------------------------------------------------------
<S>                                                                                <C>            <C>
Change in benefit obligation:
Benefit obligation at beginning of period                                        $ (1,414.3)    $ (1,336.7)
Actual Medicare Part D subsidy received                                                (0.9)             -
Expected less actual Medicare Part D subsidy received in 2006                          (2.7)             -
Service cost                                                                          (24.9)         (24.4)
Interest cost                                                                         (74.9)         (75.7)
Plan participants' contributions                                                       (3.5)          (3.4)
Amendments                                                                                -            3.2
Actuarial gain (loss)                                                                 132.4          (38.3)
Benefits paid                                                                          65.8           62.7
Special termination benefit                                                               -           (1.7)
-----------------------------------------------------------------------------------------------------------
Benefit obligation at end of period                                                (1,323.0)      (1,414.3)
-----------------------------------------------------------------------------------------------------------
Change in plan  assets:
Fair value of plan assets at beginning of period                                      469.6          464.0
Actual return on plan assets                                                           56.8           29.1
Employer contribution                                                                  36.3           35.8
Plan participants' contributions                                                        3.5            3.4
Benefits paid                                                                         (65.8)         (62.7)
-----------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of period                                            500.4          469.6
-----------------------------------------------------------------------------------------------------------

Funded status                                                                        (822.6)        (944.7)
-----------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------
<S>                                                                                  <C>
Amounts recognized in the statement of financial position consist of:
Noncurrent assets                                                                $     13.6
Current liabilities                                                                    (6.6)
Noncurrent liabilities                                                               (829.6)
--------------------------------------------------------------------------------------------
Total                                                                            $   (822.6)
--------------------------------------------------------------------------------------------

Amounts recognized in accumulated other comprehensive income consist of:
Net gain / (loss)                                                                $   (337.9)
Prior service cost                                                                     85.1
--------------------------------------------------------------------------------------------
Total                                                                            $   (252.8)*
--------------------------------------------------------------------------------------------
Estimated amounts of accumulated other comprehensive income to be recognized in
the next fiscal year through net periodic pension cost:
Net gain / (losss)                                                               $    (61.4)
Prior service cost                                                                     12.3
--------------------------------------------------------------------------------------------
Total                                                                            $    (49.1)*
--------------------------------------------------------------------------------------------
</TABLE>
*The above  amounts  are  before  adjustments  for  regulatory  and  contractual
deferrals and deferred taxes

                                      137
<PAGE>

The  table  below  details  the  end-of-year  assumptions  used for both the net
periodic cost calculations and liability amounts.

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------
                                                                    Year End December 31,
                                                         2006         2005         2004      2003
---------------------------------------------------------------------------------------------------
<S>                                                     <C>          <C>          <C>       <C>
Assumptions:
Obligation discount                                      6.00%        5.75%        6.00%     6.25%
Asset return, net of tax                                 8.25%        8.25%        8.25%     8.00%
Average annual increase in compensation                  4.00%        4.00%        4.00%     4.00%
---------------------------------------------------------------------------------------------------
</TABLE>


The  measurement  of plan  liabilities  assumes a health care cost trend rate of
9.0%  grading  down to 4.75% in the year 2012.  A 1% increase in the health care
cost  trend  rate  would  have  the  effect  of   increasing   the   accumulated
postretirement  benefit obligation as of December 31, 2006 by $157.3 million and
the net  periodic  health care  expense by $14.5  million.  A 1% decrease in the
health care cost trend rate would have the effect of decreasing the  accumulated
postretirement  benefit obligation as of December 31, 2006 by $137.4 million and
the net periodic health care expense by $12.3 million.

The following  benefit  payments,  which reflect  expected  future  service,  as
appropriate, are expected to be paid in the years indicated:


-------------------------------------------------------------------------------
                                    Gross Benefit           Subsidiary Receipts
(In Millions of Dollars)               Payments                   Expected**
-------------------------------------------------------------------------------

      2007                              $ 68.0                     $ 3.9
      2008                              $ 72.4                     $ 4.3
      2009                              $ 77.1                     $ 4.6
      2010                              $ 81.6                     $ 4.9
      2011                              $ 85.6                     $ 5.2
      Years 2012- 2016                 $ 472.4                    $ 29.7
--------------------------------------------------------------------------------

**  Rebates  are based on  calendar  year in which  prescription  drug costs are
incurred. Actual receipt of rebates may occur in the following year.



Under Funded Other  Postretirement  Obligation.  As noted  previously,  SFAS 158
requires full balance sheet  recognition  of the net  overfunded or  underfunded
status of each pension and other postretirement plan. The funded status of other
postretirement  plans is to be measured as the difference between the fair value
of plan assets minus the accumulated benefit  obligation.  At December 31, 2006,
KeySpan's  accumulated  benefit  obligation was in excess of other  postretiment
assets  by $822.6  million.  Amounts  that are not  recognized  in net  periodic
benefit costs will be recorded through accumulated other  comprehensive  income.
At December 31, 2006, the amount recognized in accumulated  other  comprehensive
income was $39.0 million, net of tax and regulatory and contractual deferrals.


                                      138
<PAGE>

The following  table  reconciles  the 2005  Consolidated  Balance Sheet with the
impact of FAS 158:

-------------------------------------------------------------------------------
(In Millions of Dollars)                                         OPEB
-------------------------------------------------------------------------------
                                                       Liability         AOCI
------------------------------------------------------------------------------
 Accrual at December 31, 2005                        $ (484.7)         $     -
-------------------------------------------------------------------------------
2006 activity                                           (85.1)               -
Incremental SFAS 158 liability                         (252.8)          (252.8)
Incremental deferrals and deferred taxes                    -            213.8
-------------------------------------------------------------------------------
Balance at December 31, 2006                         $ (822.6)         $ (39.0)
-------------------------------------------------------------------------------

At December 31, 2006,  KeySpan had a contractual  receivable from LIPA of $583.7
million representing  pension and other postretirement  benefits associated with
the electric  business unit employees  recorded in deferred charges other on the
Consolidated  Balance Sheet.  LIPA has been  reimbursing us for costs related to
the  postretirement   benefits  of  the  electric  business  unit  employees  in
accordance with the LIPA Agreements.

Pension/Other  Post Retirement  Benefit Plan Assets.  KeySpan's weighted average
asset allocations at December 31, 2006 and 2005, by asset category, for both the
pension and other postretirement benefit plans are as follows:

-----------------------------------------------------------------------------
                                       Pension                    OPEB
Asset Category                    2006         2005         2006       2005
-----------------------------------------------------------------------------
Equity securities                   67%          65%          69%        70%
Debt securities                     26%          27%          24%        23%
Cash and equivalents                 1%           3%           2%         2%
Venture capital                      6%           5%           5%         5%
-----------------------------------------------------------------------------
Total                              100%         100%         100%       100%
-----------------------------------------------------------------------------

The long-term  rate of return on assets  (pre-tax) is assumed to be 8.5%, net of
expenses which management believes is an appropriate  long-term expected rate of
return on assets based on our investment strategy,  asset allocation mix and the
historical  performance of equity and fixed income investments over long periods
of time. The actual ten- year compound rate of return, net of expenses,  for our
Plans is greater than 8.5%.

Our  master  trust  investment  allocation  policy  target for the assets of the
pension  and other  postretirement  benefit  plans is 70%  equity  and 30% fixed
income.

KeySpan has developed a multi-year  funding  strategy for its plans.  We believe
that it is reasonable  to assume  assets can achieve or  outperform  the assumed
long-term  rate of return with the target  allocation  as a result of historical
performance of equity investments over long-term periods.

Cash Contributions. In 2007, KeySpan is expected to contribute approximately $95
million  to its  pension  plan  and  approximately  $36  million  to  its  other
postretirement benefit plan.

Defined  Contribution  Plan.  KeySpan also offers both its union and  management
employees a defined  contribution  plan. Both the KeySpan Energy 401(k) Plan for
Management  Employees and the KeySpan Energy 401(k) Plan for Union Employees are
available to all eligible employees.  These Plans are defined contribution plans
subject  to  Title I of the  Employee  Retirement  Income  Security  Act of 1974
("ERISA").  Eligible  employees  contributing  to the Plan may  receive  certain

                                      139
<PAGE>


employer  contributions  including matching  contributions and a 10% discount on
the  purchase of KeySpan  common stock in the Plan.  The matching  contributions
were in KeySpan's  common stock until January 2006.  The matching  contributions
are now  determined  at  election  of  KeySpan  employees.  For the years  ended
December 31, 2006, 2005 and 2004, we recorded an expense of $14.7 million, $15.2
million, and $14.7 million, respectively.

Required disclosures on the Impact of the Adoption of SFAS No.158 on the Balance
Sheet.  SFAS  158  requires  that in the  transition  year  KeySpan  must  first
calculate the minimum pension liability as of the end of the year the statute is
implemented  and disclose  the change that would have been  reflected in OCI for
that year.  The difference  between the recorded  amounts in OCI and the amounts
reflected in the implementation of SFAS 158 constitute the transition adjustment
amount. The following table reflects the effect of the transition.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------
(In Millions of Dollars)
-------------------------------------------------------------------------------------------------------------
                                                      December 31, 2006    SFAS 158        December 31,
                                                      Before SFAS 158      Transition          2006
-------------------------------------------------------------------------------------------------------------
<S>                                                        <C>               <C>            <C>
Miscellaneous regulatory assets                           $   710.9        $  226.6        $   937.5
Other deferred charges                                    $   695.2        $  179.9        $   875.1
Deferred income taxes                                     $ 1,309.0        $ (132.6)       $ 1,176.4
Postretirement benefits and other reserves                $ 1,033.0        $  634.3        $ 1,667.3
Accumulated other comprehensive Income                    $   (27.3)       $ (148.0)       $  (175.3)
Total common equity                                       $ 4,666.8        $ (148.0)       $ 4,518.8
-------------------------------------------------------------------------------------------------------------
</TABLE>

Note 5. Capital Stock

Common Stock.  Currently  KeySpan has  450,000,000  shares of authorized  common
stock. At December 31, 2006,  KeySpan had 9.5 million shares,  or $273.6 million
of treasury stock  outstanding.  During 2006,  KeySpan issued  approximately 1.0
million  shares out of treasury  for the  dividend  reinvestment  feature of our
Investor Program, the Employee Discount Stock Purchase Plan, the 401(k) Plan and
the Long-Term Incentive Compensation Plan.

On May 16,  2005,  KeySpan  issued  12.1  million  shares  of common  stock,  in
association  with the MEDS Equity  Units  conversion,  at an  issuance  price of
$37.93 per share pursuant to the terms of the forward purchase contract. KeySpan
received proceeds of approximately $460 million from the equity conversion.  The
number of shares issued was dependent on the average closing price of our common
stock over the 20 day trading  period  ending on the third  trading day prior to
May 16, 2005.  (See Note 6  "Long-Term  Debt and  Commercial  Paper" for further
details on the MEDS Equity Units.)

Preferred Stock. We have the authority to issue 100,000,000  shares of preferred
stock with the following classifications:  16,000,000 shares of preferred stock,
par value $25 per share; 1,000,000 shares of preferred stock, par value $100 per
share; and 83,000,000 shares of preferred stock, par value $.01 per share. There
was no outstanding preferred stock at December 31, 2006 and 2005.

Note 6. Long-Term Debt And Commercial Paper

Notes Payable.  During 2006,  KeySpan  issued at KEDNY and KEDLI,  respectively,
$400  million and $100 million of Senior  Unsecured  Notes at 5.60% due November
29, 2016. Additionally, KEDLI has $125 million of Medium-Term Notes at 6.90% due
January 15, 2008, and $400 million of 7.875%  Medium-Term  Notes due February 1,
2010,  outstanding  at December 31, 2006 each of which is guaranteed by KeySpan.


                                      140
<PAGE>


KeySpan  also has $1.9  billion  of medium and long term  notes  outstanding  at
December 31, 2005 of which $950 million of these notes were  associated with the
acquisition  of  Eastern  and ENI.  These  notes  were  issued in two  series as
follows:  $700  million of 7.625% Notes due 2010 and $250 million of 8.00% Notes
due 2030. In addition,  KeySpan has $467.2 million of notes outstanding pursuant
to the MEDS Equity Units  conversion in 2005. The MEDS Equity Units consisted of
a three-year forward purchase contract for our common stock and a six-year note.
The purchase  contract required us, three years from the date of issuance of the
MEDS Equity  Units,  May 16, 2005,  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 was  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%.

In 2005, KeySpan was required to remarket the note component of the Equity Units
and  reset  the  interest  rate to the then  current  market  rate of  interest;
however,  the reset  interest  rate could not be set below 4.9%.  In March 2005,
KeySpan  remarketed  the note component of $394.9 million of the Equity Units at
the reset  interest  rate of 4.9% through their  maturity date of May 2008.  The
balance of the notes  ($65.1  million)  were held by the  original  MEDS  equity
holders  in  accordance  with  their  terms  and not  remarketed.  KeySpan  then
exchanged $300 million of the remarketed notes for $307.2 million of new 30 year
notes bearing an interest rate of 5.8%. Therefore,  KeySpan now has $160 million
of 4.9% notes outstanding with a maturity date of May 2008 and $307.2 million of
5.8% notes outstanding with a maturity date of April 2035 that are classified as
medium and long term notes.

On May 16,  2005  KeySpan  issued 12.1  million  shares of common  stock,  at an
issuance  price of $37.93  per  share,  pursuant  to the terms of the  financial
purchase  contract  described above.  KeySpan received proceeds of approximately
$460  million  from the  equity  conversion.  The  number of shares  issued  was
dependent  on the  average  closing  price of our  common  stock over the 20 day
trading period ending on the third trading day prior to May 16, 2005.

The remaining  debt of $483.2  million had interest  rates ranging from 4.65% to
9.75%.

Gas Facilities  Revenue Bonds.  KEDNY can issue tax-exempt bonds through the New
York State Energy Research and Development Authority ("NYSERDA"). Whenever bonds
are issued for new gas facilities projects,  proceeds are deposited in trust and
subsequently withdrawn to finance qualified  expenditures.  There are no sinking
fund  requirements  on any of our Gas  Facilities  Revenue Bonds  ("GFRBs").  At
December 31, 2006, $640.5 million of GFRBs were  outstanding.  The interest rate
on the variable  rate series due through July 1, 2026 is reset weekly and ranged
from 2.55% to 3.65% during the year ended  December 31, 2006,  at which time the
rate was 3.65%.

Promissory  Notes to LIPA. In  connection  with the  KeySpan/LILCO  transaction,
KeySpan  and  certain of its  subsidiaries  issued  promissory  notes to LIPA to
support certain debt obligations  assumed by LIPA. At December 31, 2006,  $155.4
million of these promissory notes remained  outstanding.  Under these promissory
notes,  KeySpan is  required  to obtain  letters of credit to secure its payment
obligations  if its long-term  debt is not rated at least in the "A" range by at
least two nationally  recognized  statistical  rating agencies.  At December 31,
2006, KeySpan was in compliance with this requirement.


                                      141
<PAGE>


Industrial  Development  Revenue  Bonds.  At  December  31,  2006,  KeySpan  had
outstanding  $128.3 million of tax-exempt  bonds with a 5.25% coupon maturing in
June 2027.  Fifty-three million dollars of these Industrial  Development Revenue
Bonds were issued in its behalf through the Nassau County Industrial Development
Authority   for  the   construction   of  the   Glenwood   Energy   Center,   an
electric-generation  peaking plant, and the balance of $75 million was issued in
its behalf by the Suffolk County Industrial  Development  Authority for the Port
Jefferson  Energy  Center an  electric-generation  peaking  plant.  KeySpan  has
guaranteed all payment  obligations of these  subsidiaries  with regard to these
bonds.

First  Mortgage  Bonds.  Colonial Gas Company had  outstanding  $95.0 million of
first  mortgage  bonds at  December  31,  2006.  These  bonds are secured by gas
utility  property.  The first  mortgage  bond  indentures  include,  among other
provisions, limitations on: (i) the issuance of long-term debt; (ii) engaging in
additional lease  obligations;  and (iii) the payment of dividends from retained
earnings. At December 31, 2006, these bonds remain outstanding and have interest
rates ranging from 6.34% to 8.80% and maturities that range from 2008-2028.

Authority Financing Notes.  Certain of our electric generation  subsidiaries can
issue tax-exempt bonds through the NYSERDA.  At December 31, 2006, $41.1 million
of Authority  Financing Notes 1999 Series A Pollution  Control Revenue Bonds due
October 1, 2028 were  outstanding.  The  interest  rate on these  notes is reset
based on an auction  procedure.  The interest rate during 2006 ranged from 2.70%
to 3.65%, through December 31, 2006, at which time the rate was 3.65%.

We also have  outstanding  $24.9  million  variable  rate 1997 Series A Electric
Facilities  Revenue Bonds due December 1, 2027. The interest rate on these bonds
is reset  weekly and ranged from 2.98% to 4.00% for the year ended  December 31,
2006, at which time the rate was 3.95%.

Ravenswood  Master Lease. We have an arrangement  with an unaffiliated  variable
interest  financing  entity  through which we lease a portion of the  Ravenswood
Facility.  We acquired the Ravenswood  Facility,  in part,  through the variable
interest entity, from the Consolidated Edison Company of New York ("Consolidated
Edison") on June 18, 1999 for approximately $597 million. In order to reduce the
initial  cash  requirements,  we entered  into a lease  agreement  (the  "Master
Lease")  with the  variable  interest  entity  that  acquired  a portion  of the
facility, or three steam generating units, directly from Consolidated Edison and
leased  it to a KeySpan  subsidiary.  The  variable  interest  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 are  substantially  equal to the
monthly interest expense on the debt securities.


                                      142
<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 as
defined in Financial  Accounting  Standards  Board  Interpretation  No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51." 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
$307.7 million.  Under the terms of our credit  facilities,  the Master Lease is
considered  debt in the  ratio  of  debt-to-total  capitalization.  (See  Note 7
"Contractual Obligations, Financial Guarantees and Contingencies" for additional
information  regarding the leasing arrangement  associated with the Master Lease
Agreement.)

Commercial  Paper  and  Revolving  Credit  Agreements.  KeySpan  has two  credit
facilities, which total $1.5 billion - $920 million for five years through 2010,
and $580  million  through  2009 - which  will  continue  to  support  KeySpan's
commercial paper program for ongoing working capital needs.

The fees for the  facilities  are based on KeySpan's  current credit ratings and
are increased or decreased  based on a downgrading  or upgrading of our ratings.
The current  annual  facility  fee is 0.07% based on our credit  rating of A3 by
Moody's  Investor  Services and A by Standard & Poor's for each  facility.  Both
credit  facilities allow for KeySpan to borrow using several  different types of
loans;  specifically,  Eurodollar  loans, ABR loans, or competitively bid loans.
Eurodollar  loans are based on the Eurodollar rate plus a margin that is tied to
our applicable  credit  ratings.  ABR loans are based on the higher 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 utility 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 65% at the
last day of any fiscal quarter. Violation of these covenants 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.  At
December  31,  2006,  KeySpan's  consolidated  indebtedness  was  49.9%  of  its
consolidated capitalization and KeySpan was in compliance with all covenants.

Subject to certain conditions set forth in the credit facility,  KeySpan has the
right, at any time, to increase the commitments  under the $920 million facility
up to an additional $300 million. In addition,  KeySpan has the right to request
that the termination date be extended for an additional period of 365 days prior
to each  anniversary  of the  closing  date.  This  extension  option,  however,
requires the approval of lenders holding more than 50% of the total  commitments
to such  extension  request.  Under the  agreements,  KeySpan has the ability to
replace  non-consenting  lenders  with  other  pre-approved  banks or  financial
institutions.

At December 31,  2006,  we had cash and  temporary  cash  investments  of $210.9
million.  During 2006,  we repaid  $572.6  million of  commercial  paper and, at
December  31, 2006,  $85.0  million of  commercial  paper was  outstanding  at a
weighted  average  annualized  interest  rate of 5.43%.  At December  31,  2006,
KeySpan had the ability to issue up to an  additional  $1.4  billion,  under its
commercial paper program.


                                      143
<PAGE>


Capital Leases.  Our subsidiaries  lease certain  facilities and equipment under
long-term  leases,  which expire on various  dates  through  2014.  The weighted
average interest rate on these obligations was 6.0%.

Debt Maturity.  The following table reflects the maturity  schedule for our debt
repayment requirements,  including capitalized leases and related maturities, at
December 31, 2006:

-------------------------------------------------------------------------------
                                    Long-Term         Capital
 (In Millions of Dollars)               Debt           Leases           Total
-------------------------------------------------------------------------------
 Repayments:
2007                                $       -         $  1.2         $     1.2
2008                                    305.0            1.1             306.1
2009                                    412.3            1.2             413.5
2010                                  1,110.0            1.3           1,111.3
2011                                     20.0            1.3              21.3
    Thereafter                        2,575.6            3.7           2,579.3
-------------------------------------------------------------------------------
                                    $ 4,422.9         $  9.8         $ 4,432.7
-------------------------------------------------------------------------------

Note 7.       Contractual Obligations, Financial Guarantees and Contingencies

Lease Obligations.  Lease costs included in operating expense were $76.2 million
in 2006 including the lease of KeySpan's Brooklyn headquarters of $10.7 million.
KeySpan  has  a  leveraged  lease  financing  arrangement  associated  with  the
Ravenswood  Expansion.  The yearly operating lease expense is approximately  $17
million  per year.  (See the  caption  below  "Sale/Leaseback  Transaction"  for
further  details  of this  lease.)  Lease  costs also  include  leases for other
buildings, office equipment,  vehicles and power operated equipment. Lease costs
for the year  ended  December  31,  2005 and 2004 were $76.5  million  and $67.7
million, respectively. As previously mentioned, the Master Lease is consolidated
and, as a result,  lease  payments  are  reflected  as  interest  expense on the
Consolidated  Statement of Income.  The future minimum cash lease payments under
various  leases,  excluding  the Master  Lease,  but  including  the  Ravenswood
Expansion lease, all of which are operating leases,  are $103.8 million per year
over the next five years and $580.1  million,  in the  aggregate,  for all years
thereafter.  (See discussion below for further information  regarding the Master
Lease and the Ravenswood Expansion sale/leaseback transaction.)

Variable  Interest  Entity.  As  mentioned,  KeySpan has an  arrangement  with a
variable  interest  entity  through which it leases a portion of the  Ravenswood
Facility.  We  acquired  the  Ravenswood  Facility,  a  2,200-megawatt  electric
generating  facility located in Queens,  New York, in part, through the variable
interest  entity from  Consolidated  Edison on June 18, 1999, for  approximately
$597 million. In order to reduce the initial cash requirements,  we entered into
the Master Lease with a variable  interest,  unaffiliated  financing entity that
acquired a portion of the facility,  or three steam generating  units,  directly


                                      144
<PAGE>


from Consolidated  Edison and leased it to our subsidiary,  KeySpan  Ravenswood,
LLC. 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 KeySpan  Ravenswood,  LLC, under the
Master Lease.  Monthly lease payments  substantially  equal the monthly interest
expense on such debt  securities.  Interest  expense for the year ended December
31, 2006 was $30.0 million.

The term of the  Master  Lease  extends  through  June 20,  2009.  On all future
semi-annual  payment  dates,  we have the  right 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, as residual value, 84% of the acquisition cost of the property.

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
$307.7 million. If KeySpan Ravenswood,  LLC, was 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.
The future minimum cash lease payments  under this lease is  approximately  $171
million over the next five years and $378  million,  in the  aggregate,  for all
years thereafter.  The sale/leaseback  transaction resulted in a pre-tax gain of
approximately $6 million which has been deferred and is being amortized over the
life of the lease.


                                      145
<PAGE>


Asset Retirement  Obligations.  On December 31, 2005, KeySpan implemented FIN 47
"Accounting for Conditional Asset Retirement  Obligations." FIN 47 was issued to
clarify that the term conditional  asset obligation used in SFAS 143 "Accounting
for Asset  Retirement  Obligations"  refers to a legal  obligation to perform an
asset retirement  activity in which the timing and (or) method of settlement are
conditional  on a future  event that may or may not be within the control of the
entity.  Previously,  KeySpan  adopted  SFAS 143 on January  1,  2003.  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.

The following  table  presents our asset  retirement  obligation at December 31,
2006 and December 31, 2005:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
  (In Millions of Dollars)
  -----------------------------------------------------------------------------------------
  December 31,                                                    2006               2005
  -----------------------------------------------------------------------------------------
 <S>                                             <C>              <C>                <C>
  Asset Retirement Obligations
  Asbestos removal                               (i)             $  3.5             $  3.5
  Tanks removal and cleaning                     (ii)               7.3                6.9
  Main -cutting, purging and capping             (iii)             29.7               30.6
  Wells - plug and capping                       (iv)               0.2                0.2
  KeySpan LNG tank demolition                    (v)                2.3                2.1
  Waste water treatment pond removal             (vi)               1.5                1.4
  Fiber network removal                          (vii)              0.9                0.8
  Exploration wells-plug and capping             (viii)             1.9                1.9

  -----------------------------------------------------------------------------------------
  Total Asset Retirement Obligations                             $ 47.3             $ 47.4
  -----------------------------------------------------------------------------------------
</TABLE>

(i)  Asbestos-containing  materials  exist in roof flashing,  floor tiles,  pipe
     insulation and mechanical room insulation  within our common  facilities as
     well as in our older generation  plants.  KeySpan has a legal obligation to
     remove asbestos upon either a major renovation or demolition.

(ii) KeySpan has numerous  storage  tanks that contain  among other things waste
     oil, #2 and #6 grade fuel oil,  diesel  fuel,  multi  chemicals,  lube oil,
     kerosene,  ammonia,  and other waste  contaminants.  All of these tanks are
     subject to  cleaning  and  removal  requirements  prior to  demolition  and
     retirement if so specified by law or regulation.

(iii) KeySpan  has  a  legal   requirement  to  cut  (disconnect  from  the  gas
     distribution system), purge (clean of natural gas and PCB contaminants) and
     cap gas mains  within its gas  distribution  and  transmission  system when
     mains are retired in place. Gas mains are generally abandoned in place when
     retired,  unless the main and other  equipment  needs to be removed  due to
     sewer or water system  rerouting or other  roadblock work. When such a main
     and equipment are removed certain PCB test procedures must be employed.


                                      146
<PAGE>


(iv) KeySpan owns  approximately  52% of an underground gas storage  facility in
     western  New  York  State.  The  facility  includes  39 gas  injection  and
     extraction  wells.  There is a regulatory  obligation to close and seal the
     wells.

(v)  KeySpan  owns a 600,000  gallon  Liquefied  Natural  Gas  ("LNG")  tank and
     ancillary  facilities  located in  Providence,  RI under a 30 year contract
     with New England Gas Company  entered into on November 1, 1999.  At the end
     of the contract, the contract can be; (i) Extended; or (ii) New England Gas
     Company  can  require  KeySpan  to  dismantle  and  remove the LNG tank and
     ancillary  facilities  or; (iii)  KeySpan can elect to dismantle and remove
     the LNG tank and ancillary facilities.  Since we may or may not be required
     to  dismantle  and  remove  the LNG  tank  and  ancillary  facilities,  the
     obligation  to perform was  discounted  to a 50%  probability  as premitted
     under FIN 47.

(vi) KeySpan has several  wastewater  treatment ponds associated with certain of
     its power stations. There are closure requirements for wastewater treatment
     pond  systems  based on  regulations  promulgated  by the State of New York
     which were effective May 11, 2003.

(vii) KeySpan   Communications   has   portions  of  its  fiber  optic   network
     (underground  and  above  ground)  that are  required  to be  removed  upon
     termination of various agreements.

(viii) KeySpan has a regulatory obligation to close and seal the wells primarily
     associated with its gas production and development activities.

Financial  Guarantees.  KeySpan has issued  financial  guarantees  in the normal
course of business,  primarily on behalf of its  subsidiaries,  to various third
party  creditors.  At December 31, 2006, 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     Expiration
   (In Millions of Dollars)                                     Exposure        Dates
----------------------------------------------------------------------------------------------
<S>                                               <C>           <C>         <C>
   Guarantees for Subsidiaries
   Medium-Term Notes - KEDLI                      (i)          $   525.0     2008 - 2010
   Industrial Development Revenue Bonds           (ii)             128.3        2027
   Ravenswood - Master Lease                      (iii)            425.0        2009
   Ravenswood - Sale/leaseback                    (iv)             403.5        2019
   Surety Bonds                                   (v)               65.2     2006 - 2010
   Commodity Guarantees and Other                 (vi)              64.6     2006 - 2009
   Letters of Credit                              (vii)             80.3     2007 - 2010
----------------------------------------------------------------------------------------------
                                                               $ 1,691.9
----------------------------------------------------------------------------------------------
</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 are  included in  long-term  debt on the  Consolidated  Balance
     Sheet.


                                      147
<PAGE>


(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 term  extends
     through 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,  including  future  decommissioning
     costs. The initial term of the lease is for 36 years. As noted  previously,
     this lease  qualifies  as an  operating  lease and is not  reflected on the
     Consolidated Balance Sheet.

(v)  KeySpan  has  agreed  to  indemnify  the  issuers  of  various  surety  and
     performance  bonds  associated  with certain  construction  projects  being
     performed  by  certain   former   subsidiaries.   In  the  event  that  the
     subsidiaries fail to perform their obligations under contracts, 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.  Although  KeySpan is not  guaranteeing
     any new  bonds  for any of the  former  subsidiaries,  KeySpan's  indemnity
     obligation   supports   the   contractual   obligation   of  these   former
     subsidiaries.  KeySpan  has  also  received  from a  former  subsidiary  an
     indemnity bond issued by a third party  insurance  company,  the purpose of
     which is to  reimburse  KeySpan in an amount up to $80 million in the event
     it is required to perform under all other indemnity obligations  previously
     incurred by KeySpan to support  such  company's  bonded  projects  existing
     prior to divestiture. At December 31, 2006, the total cost to complete such
     remaining bonded projects is estimated to be approximately $28.5 million.

(vi) KeySpan has guaranteed  commodity-related  payments for subsidiaries within
     the  Electric  Services  segment.  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 December 31, 2006.

(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


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     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  or former
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.

Fixed Charges Under Firm Contracts.  Our utility subsidiaries and the Ravenswood
Generating Station have entered into various contracts for gas delivery, storage
and supply services. Certain of these contracts require payment of annual demand
charges in the aggregate amount of approximately $449 million. We are liable for
these payments regardless of the level of service we require from third parties.
Such charges associated with gas distribution operations are currently recovered
from utility customers through the gas adjustment clause.

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, 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.

On March 20, 2006, a purported class action lawsuit was filed alleging breach of
fiduciary duty against KeySpan and its directors. The complaint, which was filed
in the New York  State  Supreme  Court for the  County of Kings  (the  "Court"),
related to the  execution of the Merger  Agreement  with  National  Grid plc and
alleged that the merger consideration which KeySpan's stockholders would receive
in connection  with the proposed  merger  transaction  was inadequate and unfair
because the transaction value of $42.00 for each share of KeySpan's common stock
outstanding did not provide its stockholders with a meaningful  premium over the
market price of the common  stock.  On April 19,  2006,  we moved to dismiss the
complaint  for  failure to state a cause of action  upon which  relief  could be
granted.  On May 26, 2006,  the  plaintiff  served an amended  complaint  adding
National Grid plc as a defendant.  The amended  complaint  alleged that National
Grid plc aided and  abetted  the alleged  breach of  fiduciary  duties and added
claims of  inadequate  disclosure  with respect to KeySpan's  preliminary  proxy
materials. In June 2006, the parties agreed in principle to settle the case, the
terms of which  provide for,  among other  things,  the  inclusion of additional
disclosures in our 2006 Annual Meeting Proxy Statement concerning the background
and principle  events leading to execution of the Merger  Agreement,  as well as


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the payment of plaintiff's  counsel fees of up to $350,000  following closing of
the transaction.  In October 2006, definitive settlement documents were executed
by the parties and submitted to the Court.  The settlement  remains subject to a
number of conditions, including Court approval following notice to shareholders.

Several   lawsuits  have  been  filed  which  allege   damages   resulting  from
contamination associated with the historic operations of former manufactured gas
plants  located  in Bay Shore and  Staten  Island,  New York.  KeySpan  has been
conducting site  investigations  and remediations at these locations pursuant to
Orders on Consent with the DEC.  With respect to Bay Shore,  on July 12, 2006, a
purported class action and a separate  complaint were filed.  Motions to dismiss
these matters have been filed and are pending. On November 27, 2006 and December
28,  2006,  two other  lawsuits  were filed by property  owners in the Bay Shore
area. In addition,  on October 31, 2006, a lawsuit was filed alleging damages in
Staten Island,  New York.  KeySpan intends to contest each of these  proceedings
vigorously.  On  February  8, 2007,  we received a Notice of Intent to File Suit
from the Office of the Attorney General for the State of New York ("AG") against
KeySpan and four other  companies in  connection  with the cleanup of historical
contamination  found in certain lands located in Greenpoint,  Brooklyn and in an
adjoining  waterway.  KeySpan has previously agreed to remediate portions of the
properties  referenced in this notice and will work  cooperatively  with the DEC
and AG to address environmental  conditions associated with the remainder of the
properties.  At this time,  we are unable to predict  what  effect,  if any, the
outcome of these  proceedings will have on our financial  condition,  results of
operation and 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.  KeySpan and LIPA have entered
into agreements to extend,  amend, and restate these  contractual  arrangements.
See Note 11 "2006 LIPA Settlement" for a further discussion of these agreements.

LIPA  completed  its  strategic  review  initiative  that it had  undertaken  in
connection with, among other reasons,  its option under the Generation  Purchase
Rights  Agreement  with KeySpan.  As part of its review,  LIPA engaged a team of
advisors and  consultants,  held public  hearings  and  explored  its  strategic
options,   including   continuing  its  existing   operations,   municipalizing,
privatizing,  selling some,  but not all of its assets,  becoming a regulator of
rates and services,  or merging with one or more  utilities.  Upon completion of
its  strategic  review,  LIPA  determined  that it would  continue  its existing
operations  and entered  into the  renegotiated  2006 LIPA  Agreements  that are
discussed in Note 11 "2006 LIPA  Settlement."  Following the announcement of the
proposed  acquisition of KeySpan by National Grid plc,  LIPA,  National Grid plc
and KeySpan have engaged in discussions concerning the impact of the transaction
on LIPA's  operations.  At this time, we are unable to determine what impact, if
any, such  discussions  may have on the 2006 LIPA Agreements and the receipt and
timing of governmental approvals relating thereto.


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ENVIRONMENTAL MATTERS

Air. Our generating  facilities are located within a Clean Air Act ("CAA") ozone
non-attainment and PM 2.5 (fine particulate matter) non-attainment area, and are
subject to  increasingly  stringent NOx emission  limitations  to be implemented
under  forthcoming  requirements of the United States  Environmental  Protection
Agency  ("EPA")   pursuant  to  the  Clean  Air  Interstate  Rule  ("CAIR")  and
potentially under the Ozone Transport  Commission's  "CAIR PLUS" program.  These
efforts are designed to improve both ozone and  particulate  matter air quality.
Our previous investments in low NOx boiler combustion modifications,  the use of
natural gas firing systems at our steam electric  generating  stations,  and the
compliance  flexibility  available  under  these  cap and trade  programs,  have
enabled  KeySpan to achieve our prior  emission  reductions in a  cost-effective
manner.  KeySpan is currently  developing its compliance strategy to address the
anticipated  requirements  of  CAIR  and  CAIR  PLUS  by  2009.  Since  detailed
requirements under CAIR have not yet been fully articulated,  it is not possible
to definitively estimate capital expenditures that may be required to meet these
regulatory  mandates.  At the present time, it is  anticipated  that NOx control
equipment may be required at one or more of KeySpan's Long Island  facilities at
a cost between $20 to $30 million.  However,  such amounts are recoverable  from
LIPA.

Water.  Additional  capital  expenditures  associated  with the  renewal  of the
surface water discharge  permits for our power plants will likely be required by
the  Department  of  Environmental   Conservation   ("DEC").  We  are  currently
conducting  studies  as  directed  by the DEC to  determine  the  impacts of our
discharges  on aquatic  resources  and are engaged in  discussions  with the DEC
regarding the nature of capital upgrades or other mitigation  measures necessary
to reduce any impacts. These upgrades are expected to cost up to $60 million for
the Long Island units,  however,  such amounts are  recoverable  from LIPA.  The
Ravenswood  Generating  Station may also require upgrades at a cost of up to $15
million.  The actual  expenditures  will  depend upon the outcome of the ongoing
studies  and  the  subsequent  determination  by the  DEC of  how to  apply  the
standards set forth in recently  promulgated  federal  regulations under Section
316 of the Clean Water Act designed to mitigate such impacts.

Land, Manufactured Gas Plants and Related Facilities.

New York Sites.  Within the State of New York we have  identified  43 historical
MGP sites and  related  facilities,  which  were  owned or  operated  by KeySpan
subsidiaries or such companies' predecessors.  These former sites, some of which
are no longer owned by KeySpan, have been identified to the DEC for inclusion on
appropriate  site  inventories.  Administrative  Orders on  Consent  ("ACO")  or
Voluntary Cleanup  Agreements ("VCA") have been executed with the DEC to address
the investigation and remediation  activities  associated with certain sites and
one waterway.  In March 2005, KeySpan withdrew its previously filed applications
under the DEC's  Brownfield  Cleanup  Program ("BCP") because of the uncertainty
associated  with  contribution  suits which we may need to bring  against  other
parties who impacted  these sites for their share of remedial  cost. As a result
of the December 2004 Cooper Industries v. Aviall Services,  Inc. decision by the
United States  Supreme Court and the emerging case law in New York,  KeySpan has
evaluated the potential for third party recovery at each of the remaining sites.
KeySpan intends to enter into an ACO for fifteen of these sites and continues to
evaluate how to proceed with respect to participation  in the DEC's  remediation
programs for the other sites.


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KeySpan has identified 28 of these sites as being associated with the historical
operations of KEDNY. One site has been fully  remediated.  Subject to the issues
described  in  the  preceding   paragraph,   the  remaining  27  sites  will  be
investigated  and, if necessary,  remediated  under the terms and  conditions of
ACOs, VCAs or Brownfield Cleanup Agreements  ("BCA").  Expenditures  incurred to
date by us with respect to KEDNY MGP-related activities total $80.1 million.

The  remaining  15 sites  have  been  identified  as being  associated  with the
historical  operations  of  KEDLI.  One  site has been  fully  investigated  and
requires no further action.  The remaining  sites will be  investigated  and, if
necessary,  remediated  under the terms and  conditions  of ACOs,  VCAs or BCAs.
Expenditures incurred to date by us with respect to KEDLI MGP-related activities
total $62.5 million.

We presently  estimate  the  remaining  cost of our KEDNY and KEDLI  MGP-related
environmental  remediation  activities will be $325.4 million,  which amount has
been  accrued by us as a reasonable  estimate of probable  cost for known sites.
However,  remediation  costs for each site may be materially  higher than noted,
depending upon changing technologies and regulatory standards,  selected end use
for each site, and actual environmental conditions encountered.

With respect to remediation  costs, KEDNY and KEDLI rate plans generally provide
for the  recovery  from  customers of  investigation  and  remediation  costs of
certain  sites.  At December 31, 2006, we have  reflected a regulatory  asset of
$373.2 million for  KEDNY/KEDLI  MGP sites.  KeySpan has recently filed proposed
rate  plans for KEDNY and KEDLI  with the NYPSC as part of its  application  for
approval  of the  KeySpan /  National  Grid plc  merger,  as well as  individual
applications  for a proposed  annual  increase in revenues  for KEDNY and KEDLI.
Among other things,  these filings seek recovery of deferred expenses associated
with  remediation  of MGP sites,  as well as  recovery  of  ongoing  remediation
expenses.

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 $1.4  million,  which amount has been
accrued by us. Expenditures incurred to date total $3.6 million.

New England Sites. Within the Commonwealth of Massachusetts and the State of New
Hampshire, we are aware of 74 former MGP sites and related facilities within the
existing or former service territories of KEDNE.


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Boston Gas Company, Colonial Gas Company and Essex Gas Company may have or share
responsibility under applicable  environmental laws for the remediation of 64 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 assumed  responsibility  for remediating  three sites each. 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 $8.8 million, which amount
has been  accrued by us as a  reasonable  estimate  of  probable  cost for known
sites,  however  remediation  costs for each site may be materially  higher than
noted,  depending upon changing technologies and regulatory standards,  selected
end  use  for  each  site,  and  actual  environmental  conditions  encountered.
Expenditures  incurred since November 8, 2000, the date KeySpan acquired Eastern
Enterprises, with respect to these MGP-related activities total $34.7 million.

In 2004, Boston Gas Company reached  settlements with certain insurance carriers
for recovery of a portion of  previously  incurred  environmental  expenditures.
Under  a  previously   issued  MADTE  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 these settlements, in 2004 Boston Gas Company
recorded a $5.0 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 EPA for the contamination from the Nashua site that was allegedly commingled
with  asbestos at the  so-called  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 $25.5 million,  which amount has been
accrued by us as a reasonable estimate of probable cost for known sites, however
remediation costs for each site may be materially  higher than noted,  depending
upon changing technologies and regulatory  standards,  selected end use for each
site, and actual environmental  conditions  encountered.  Expenditures  incurred
since November 8, 2000, with respect to these MGP-related activities total $23.0
million.

By rate  orders,  the MADTE  and the  NHPUC  provide  for the  recovery  of site
investigation and remediation costs and,  accordingly,  at December 31, 2006, we
have reflected a regulatory  asset of $43.4 million for the KEDNE MGP sites.  As
previously mentioned, 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 orders currently in effect for these subsidiaries provide for the
recovery of investigation and remediation costs.


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KeySpan  New  England  LLC  Sites.  We are  aware  of  three  non-utility  sites
associated  with  KeySpan  New  England,  LLC,  a  successor  company to Eastern
Enterprises, 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,  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  entered  into a  cost-sharing  agreement  under which each  company
agreed to pay one-third of the costs of compliance with the consent order, while
preserving  any claims  against the other  companies  for,  among other  things,
reallocation  of  proportionate  liability.  In 2002,  Beazer East  commenced an
action in the U.S.  District Court for the Southern  District of New York, which
sought a judicial  determination  on the allocation of liability for the Everett
Facility.  A  confidential  settlement  agreement has been executed on favorable
terms to KeySpan and the Beazer lawsuit has been discontinued.

In 2004,  KeySpan  reached a settlement with insurance  carriers  regarding cost
recovery  for  expenses at one of the above  noted  sites and  recorded an $11.6
million  reduction to operating  expenses.  We presently  estimate the remaining
cost of our  environmental  cleanup  activities for the three  non-utility sites
will be  approximately  $11.4 million,  which amount has been accrued by us as a
reasonable estimate of probable costs for known sites, however remediation costs
for each site may be  materially  higher than  noted,  depending  upon  changing
technologies  and  regulatory  standards,  selected  end use for each site,  and
actual  environmental   conditions  encountered.   Expenditures  incurred  since
November 8, 2000, with respect to these sites total $21.4 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.

Insurance  Reimbursement  of MGP Response Costs. We have instituted  lawsuits in
New York,  Massachusetts and New Hampshire against numerous  insurance  carriers
for  reimbursement  of costs incurred for the  investigation  and remediation of
these MGP sites.

In January 1998 and July 2001, KEDLI and KEDNY,  respectively,  filed complaints
for the recovery of its  remediation  costs in the New York State  Supreme Court
against the  various  insurance  companies  that  issued  general  comprehensive
liability  policies to KEDLI and KEDNY. The outcome of these proceedings  cannot
yet be determined.


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In March  1999,  Boston Gas Company and a  subsidiary  of National  Grid filed a
complaint for the recovery of remediation  costs in the  Massachusetts  Superior
Court against  various  insurance  companies that issued  comprehensive  general
liability  policies to National Grid and its predecessors with respect to, among
other  things,  the 11 sites for which  Boston Gas  Company has agreed to make a
limited  contribution.  In October 2002, Boston Gas Company filed a complaint in
the United States  District Court -  Massachusetts  District  against one of the
insurance  companies that issued  comprehensive  general  liability  policies to
Boston  Gas  Company  for its  remaining  sites.  In  November  2005,  the trial
commenced  on the  declaratory  judgment  action of Boston Gas  against  Century
Indemnity for insurance coverage for the costs incurred in the investigation and
remediation  at the former Boston Gas Everett MGP site and in December 2005, the
jury returned a verdict in favor of KeySpan.  KeySpan  anticipates  that Century
Indemnity will appeal this verdict.  The outcome of these proceedings cannot yet
be determined.

EnergyNorth  has filed a number of lawsuits in both the New  Hampshire  Superior
Court and the United States District Court for the District of New Hampshire for
recovery of its remediation costs against the various  insurance  companies that
issued  comprehensive  general liability and excess liability insurance policies
to EnergyNorth and its predecessors. In October 2004, EnergyNorth's case against
the London Market Insurers for the costs incurred  investigating and remediating
the former MGP site in Laconia went to trial and the jury  returned a verdict in
favor of EnergyNorth,  finding that  EnergyNorth was entitled to recover against
London Market Insurers.  In February 2005, the trial of  EnergyNorth's  coverage
action  for the Dover  MGP site  began  against  the only  remaining  defendant,
Century  Indemnity  (all  other  carriers  settled  prior to  trial)  and at the
conclusion  of the trial the federal judge  directed a verdict in  EnergyNorth's
favor on all issues.  Century  Indemnity  filed an appeal with the First Circuit
Court of Appeals and in a decision  dated June 28, 2006, the First Circuit court
of Appeals denied Century  Indemnity appeal in its entirety.  In a jury trial in
the Nashua MGP action  commenced  against the London Market Insurers and Century
Indemnity  in  November  2005,  the jury  returned a verdict in favor of KeySpan
finding  that  London  and  Century   Indemnity   were  obligated  to  indemnify
EnergyNorth  for response  costs  incurred at the site.  Century  Indemnity  has
sought  reconsideration  of this verdict.  The outcome of this proceeding cannot
yet be determined.

In 1993, KeySpan New England LLC filed a declaratory judgment action against the
Hanover and Travelers  insurance  companies in the Superior  Court for Middlesex
County for the Everett Facility.  The declaratory judgment action sought to have
the court compel the insurers to defend  KeySpan New England,  LLC in connection
with the  Massachusetts  Department  of  Environmental  Protection's  Notice  of
Responsibility  ("NOR").  In 2004,  the Court granted  KeySpan New England LLC's
unopposed motion for leave to file a Second Amended  Complaint in this action to
seek a declaratory ruling that the insurers have a duty to indemnify KeySpan New
England LLC for the costs  associated  with the  Everett  NOR and certain  other
related private actions.  The Second Amended  Complaint also adds certain excess
insurance  carriers as defendants in the action.  The outcome of this proceeding
cannot yet be determined.

KeySpan has entered into confidential  settlement agreements with certain of the
defendant   insurance  carriers  for  recovery  of  costs  associated  with  the
investigation  and  remediation of the sites included in the above  proceedings.
Pursuant to these settlements, KeySpan recorded a benefit of $5.5 million in its
Consolidated  Statement of Income for the twelve months ended December 31, 2006,
reflecting  the  benefit  accruing  to  KeySpan's   shareholders.   Recovery  of


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environmental  costs from insurance  carriers  associated with utility MGP sites
are refunded to KeySpan's  ratepayers,  subject to certain  sharing  provisions.
During the past year,  KeySpan  has  received  approximately  $22  million  from
insurance carriers in settlements for recovery of environmental costs associated
with remediation of MGP sites.

Note 8.  Hedging, Derivative Financial Instruments and Fair Values

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  production  and  development   activities  and  its  electric
generating  facilities at the  Ravenswood  Generating  Station.  As discussed in
greater  detail below,  certain  derivative  financial  instruments  employed by
KeySpan are accounted  for as cash-flow  hedges 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.  However,  KeySpan  also  employs  derivative  financial
instruments  that do not qualify for hedge accounting  treatment.  Additionally,
certain  derivative  financial  instruments  employed  by our  Gas  Distribution
operations are subject to SFAS 71  "Accounting  for the Effects of Certain Types
of Regulation."

Commodity  Derivative  Instruments - Hedge  Accounting:  Our Energy  Investments
subsidiary, Seneca-Upshur, utilizes OTC natural gas swaps to hedge the cash flow
variability  associated  with  forecasted  sales of a portion of its natural gas
production. At December 31, 2006, Seneca-Upshur has hedge positions in place for
approximately  70% of its  estimated  2006 through 2009 gas  production,  net of
gathering  costs.  We use  market  quoted  forward  prices to value  these  swap
positions.  The maximum length of time over which  Seneca-Upshur has hedged such
cash  flow  variability  is  through  December  2009.  The  fair  value of these
derivative instruments at December 31, 2006 was a liability of $3.9 million. The
estimated amount of losses associated with such derivative  instruments that are
reported in accumulated other  comprehensive  income and that are expected to be
reclassified  into  earnings  over  the  next  twelve  months  is $2.3  million.
Ineffectiveness   associated  with  these   outstanding   derivative   financial
instruments was immaterial for the twelve months ended December 31, 2006.

Certain derivative  instruments employed by our gas distribution  operations are
not  subject  to SFAS  71 and  thus  are  not  subject  to  deferral  accounting
treatment. KeySpan uses OTC natural gas swaps to hedge the cash-flow variability
of gas purchases associated with certain large-volume gas sales customers. These
gas swaps are  accounted  for as cash-flow  hedges.  KeySpan uses market  quoted
forward  prices to value these swap  positions.  The maximum length of time over
which we have hedged such cash flow  variability  is through  October 2007.  The
fair value of these derivative  instruments at December 31, 2006 was a liability
of $2.0 million,  all of which is reported in  accumulated  other  comprehensive
income and is expected to be  reclassified  into earnings within the next twelve
months.  Ineffectiveness  associated with these outstanding derivative financial
instruments was immaterial in 2006.


                                      156
<PAGE>


The above noted derivative  financial  instruments are cash flow hedges that are
accounted for as hedges under SFAS 133 and are not  considered  held for trading
purposes as defined by current accounting literature.  Accordingly, we carry the
fair value of our derivative  instruments on the  Consolidated  Balance Sheet as
either a current or deferred asset or liability, as appropriate,  and record the
effective   portion  of  unrealized   gains  or  losses  in  accumulated   other
comprehensive  income.  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 on settled  transactions
are  reflected  as a component  of either  revenue or gas cost  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 price of the  purchase  or sale for the cash flow that is being  hedged,
and is recorded directly to earnings.

Commodity  Derivative  Instruments  that are not  Accounted  for as Hedges:  The
Ravenswood  Generating  Station  financially  hedges  the cash flow  variability
associated  with a portion of  electric  energy  sales and fuel  purchases.  Our
strategy  is to  financially  hedge  up to 50% of the  on-peak  capacity  of the
Ravenswood  Generating Station. The maximum length of time over which derivative
financial  instruments  are in-place is through  August 2007. To accomplish  our
stated   risk   management   strategy,   KeySpan   employs   financially-settled
electric-power  swap  contracts  with  offsetting  financially-settled  oil swap
contracts,  physical natural gas forward contracts and OTC natural gas swaps. We
use market quoted forward prices to value the electric-power swap contracts. The
fair value of the electric power derivative instruments at December 31, 2006 was
$21.9  million.  We use  market  quoted  forward  prices  to value  the oil swap
contracts  and  natural  gas  contracts.  The fair  value  of  these  derivative
instruments at December 31, 2006, was a liability of $23.7 million.

During most of 2006 and in prior years, the derivative  transactions  associated
with the Ravenswood Generating Station qualified for hedge accounting treatment.
As a result,  there is a net $1.2 million balance currently in accumulated other
comprehensive  income which is expected to be reclassified  into earnings within
the next twelve months. In 2006,  KeySpan  reclassified a $1.4 million loss from
accumulated  other  comprehensive  income  to  earnings,  based on  management's
assessment  that certain  future oil purchases  were not probable of occurrence.
Ineffectiveness   associated  with  these   outstanding   derivative   financial
instruments was immaterial in 2006.

On  January  18,  2006,  KeySpan  entered  into an  International  SWAP  Dealers
Association  Master Agreement for a fixed for float unforced capacity  financial
swap (the " Swap  Agreement")  with Morgan Stanley  Capital Group Inc.  ("Morgan
Stanley").  The Swap  Agreement has a three year term that began on May 1, 2006.
The notional  quantity was  1,800,000kW  (the  "Notional  Quantity")  of In-City
Unforced Capacity and the fixed price is $7.57/kW-month ("Fixed Price"), subject
to adjustment upon the occurrence of certain events. Cash settlement occurs on a
monthly basis based on the In-City  Unforced  Capacity  price  determined by the
relevant  New York  Independent  System  Operator  ("NYISO")  Spot Demand  Curve
Auction Market ("Floating Price"). For each monthly settlement period, the price
difference  equals  the Fixed  Price  minus the  Floating  Price.  If such price
difference is less than zero, Morgan Stanley will pay KeySpan an amount equal to
the product of (a) the  Notional  Quantity  and (b) the  absolute  value of such
price  difference.  Conversely,  if such price  difference is greater than zero,
KeySpan  will pay  Morgan  Stanley  an amount  equal to the  product  of (a) the
Notional  Quantity and (b) the  absolute  value of such price  difference.  This


                                      157
<PAGE>


derivative instrument does not qualify for hedge accounting treatment under SFAS
133. The recognized fair value  associated with this instrument is immaterial to
the consolidated  financial statements at December 31, 2006. As noted, this is a
financial  derivative  instrument and is unrelated to any physical production of
electricity.

The NYPSC,  Con Edison and other load serving  entities  ("LSEs")  have proposed
price mitigation measures that would apply to the Ravenswood Generating Station.
These price  mitigation  measures,  if approved as proposed,  would  essentially
reduce the capacity bid price that the Ravenswood  Generating  Station could bid
into the NYISO energy market. The NYISO's Management Committee and NYISO's Board
of Directors  approved the price mitigation  measures proposed by the NYPSC, Con
Edison and the other LSE's,  notwithstanding  KeySpan's analysis and objections.
The  NYISO  filed  the  mitigation  measures  with the FERC for  approval;  such
approval is pending.  At this time, we are unable to predict the outcome of this
proceeding  and what effect it will have on the potential  revenue that could be
realized in connection with the fixed for floating financial Swap Agreement.

Commodity  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 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,  the fair value of these derivatives is recorded
as current  or  deferred  assets  and  liabilities,  with  offsetting  positions
recorded as regulatory  assets and regulatory  liabilities  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 December 31, 2006 the fair
value of these derivative instruments was a liability of $192.1 million.

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 qualify for the
normal  purchases  and  sales  exception.  Certain  contracts  for the  physical
purchase of natural gas  associated  with our  regulated  gas  utilities  do not
qualify for normal  purchases  under 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. At December  31,  2006,
these derivatives had a net fair value of $101.2 million.

KeySpan has a  management  contract  with  Merrill  Lynch  Trading,  under which
KeySpan and Merrill Lynch Trading will share the  responsibilities  for managing
KeySpan's upstream gas distribution assets associated with its Massachusetts gas
distribution subsidiaries, as well as providing city-gate delivered supply. This
contract,  which  replaces the prior  arrangement  with Merrill  Lynch  Trading,
allows  for  both  KeySpan  and  Merrill  Lynch  Trading  to  employ  derivative
instruments  to  maximize  the  profitability  of  KeySpan's  portfolio  of  gas
distribution assets. Profits associated with these activities are shared between
KeySpan,  Merrill  Lynch  Trading and KeySpan's  Massachusetts  ratepayers.  The
accounting  for this  contract  is  subject  to SFAS 71 since the  contract  was
executed by KeySpan's  regulated  gas  distribution  utilities.  At December 31,
2006,  KeySpan's  proportionate  share of the fair value  associated  with these
derivative instruments amounted to $10.4 million, $9.5 million of which has been


                                      158
<PAGE>


deferred  for  future  sharing  among the  alliance  members  and  Massachusetts
ratepayers.  The remaining amount was recorded as a benefit to revenues. KeySpan
provides  these  services  internally  for its New  York and New  Hampshire  gas
distribution subsidiaries.

Interest Rate  Derivative  Instruments:  In the fourth quarter of 2006,  KeySpan
issued $400 million  Senior  Unsecured  Notes at KEDNY and $100  million  Senior
Unsecured  Notes at KEDLI.  KeySpan  utilized a $125 million  treasury  lock, at
4.77%, to hedge the 5-year US Treasury  component of the underlying  notes and a
$125 million treasury lock, at 4.82%, to hedge the 10-year US Treasury component
of the underlying  notes.  These  derivative  instruments  settled in the fourth
quarter of 2006 at which time KeySpan paid $0.2 million to the  counterparty  to
the contracts.  The loss on the settlement of these  contracts has been deferred
for future  collection from firm gas sales customers  consistent with regulatory
requirements.

The  table  below  summarizes  the fair  value of all of the  above  outstanding
derivative  instruments at December 31, 2006 and 2005, 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.


--------------------------------------------------------------------------------
(In Millions of Dollars)                December 31, 2006      December 31, 2005
--------------------------------------------------------------------------------
Gas Contracts:
  Other current assets                          $    30.7              $  132.1
  Other deferred charges                            127.1                  75.2
  Regulatory asset                                  196.3                  30.9
  Other current liability                          (211.7)                (39.8)
  Other deferred liabilities                        (42.1)                (44.3)
  Regulatory liability                             (120.6)               (175.4)

Oil Contracts:
  Other current assets                                0.3                   0.5
  Other current liability                            (7.2)                 (6.8)
  Other deferred liabilities                         (0.5)                    -

Electric Contracts:
  Other current assets                               23.2                  10.2
  Other deferred charges                              0.3                     -
  Other current liability                            (0.8)                 (0.7)
  Other deferred liabilities                         (0.6)                    -


--------------------------------------------------------------------------------
                                                $    (5.6)             $  (18.1)
--------------------------------------------------------------------------------



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 2006, 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  2006/2007  winter  heating  season - November  2006 through March 2007.
These put options will pay KeySpan up to $37,500 per heating degree day when the
actual  temperature  is below 4,159  heating  degree days, or  approximately  5%


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<PAGE>


warmer than normal, based on the most recent 20-year average for normal weather.
The maximum  amount  KeySpan will receive on these  purchased put options is $15
million.  The net  premium  cost for these  options is $1.7  million and will be
amortized over the heating  season.  Since weather was warmer than normal during
the fourth quarter of 2006,  KeySpan recorded a $9.1 million benefit to earnings
associated  with the  weather  derivative.  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 2005, we entered into  heating-degree  day put options,  which expired during
the first  quarter of 2006, to mitigate the effect of  fluctuations  from normal
weather on KEDNE's  financial  position and cash flows for the 2005/2006  winter
heating season - November 2005 through March 2006.  These put options would have
paid  KeySpan up to $40,000 per heating  degree day when the actual  temperature
was below 4,169  heating  degree days, or  approximately  5% warmer than normal,
based on the most recent 20-year average for normal weather.  The maximum amount
KeySpan would have received on these purchased put options was $16 million.  The
net premium cost for these options was $1.2 million and was  amortized  over the
heating season.  Weather for the entire primary winter heating season  -November
2005 through March 2006 - was slightly colder than normal. Therefore,  there was
no earnings  impact  associated with these weather  derivatives,  except for the
amortization of the net premium cost.

Credit  and  Collateral:  Derivative  contracts  are  primarily  used to  manage
exposure to market risk arising  from  changes in commodity  prices and interest
rates.  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.  In instances where the  counterparties'  credit
quality has declined,  or credit exposure  exceeds certain levels,  we may limit
our  credit  exposure  by  restricting  new  transactions  with  counterparties,
requiring  additional  collateral or credit  support and  negotiating  the early
termination of certain  agreements.  At December 31, 2006,  KeySpan has received
$7.9 million from its  counterparties as collateral  associated with outstanding
derivative contracts.  This amount has been recorded as restricted cash, with an
offsetting position in current liabilities on the Consolidated Balance Sheet. At
December 31, 2006,  KeySpan has $33.9 million of outstanding margin calls to its
counterparties for open derivative  instruments  associated with its strategy to
minimize  fluctuations  in gas  sales  prices  to its  regulated  firm gas sales
customers.


                                      160
<PAGE>


Long-term Debt: The following  tables depict the fair values and carrying values
of KeySpan's long-term debt at December 31, 2006 and 2005.

Fair Values of Long-Term Debt

------------------------------------------------------------------------------
                                                          December 31,
(In Millions of Dollars)                              2006              2005
------------------------------------------------------------------------------
First Mortgage Bonds                              $   111.4         $   114.1
Notes                                               3,078.5           2,692.1
Gas Facilities Revenue Bonds                          647.3             651.3
Authority Financing Notes                              66.0              66.0
Promissory Notes                                      156.7             156.6
Master Lease                                          412.0             430.5
Tax Exempt Bonds                                      131.0             130.8
------------------------------------------------------------------------------
                                                  $ 4,602.9         $ 4,241.4
------------------------------------------------------------------------------

Carrying Values of Long-Term Debt

------------------------------------------------------------------------------
                                                           December 31,
------------------------------------------------------------------------------
(In Millions of Dollars)                              2006              2005
------------------------------------------------------------------------------
First Mortgage Bonds                              $    95.0         $    95.0
Notes                                               2,925.4           2,437.2
Gas Facilities Revenue Bonds                          640.5             640.5
Authority Financing Notes                              66.0              66.0
Promissory Notes                                      155.4             155.4
Master Lease                                          412.3             412.3
Tax Exempt Bonds                                      128.3             128.3
------------------------------------------------------------------------------
                                                  $ 4,422.9         $ 3,934.7
------------------------------------------------------------------------------

All other financial  instruments included in the Consolidated Balance Sheet such
as cash,  commercial paper, accounts receivable and accounts payable, are stated
at amounts that approximate fair value.

Note 9.  Gas Production and Development Property - Depletion

As  described  in Note 2  "Business  Segments,"  during  much of 2004  KeySpan's
investment  in  gas  production  and  development  activities  consisted  of its
ownership  interest in Houston  Exploration,  as well as KeySpan's  wholly-owned
subsidiary KeySpan Exploration and Production.  Further, KeySpan's investment 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


                                      161
<PAGE>


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 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 sale of Houston  Exploration  discussed  in Note 2  "Business
Segments",  KeySpan  accounted for its investment in Houston  Exploration on the
equity  method from June 2004  through  November 19,  2004.  Therefore,  we were
required to calculate a ceiling test on KeySpan Exploration and Production's and
Seneca-Uphsur's  assets  independently  of Houston  Exploration's  assets in the
second quarter of 2004. Based on a report furnished by an independent  reservoir
engineer at that time, 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, KeySpan
recorded  a  $48.2  million  non-cash   impairment  charge  to  write  down  its
wholly-owned gas exploration and production  subsidiaries'  assets.  This charge
was recorded in  depreciation,  depletion and  amortization on the  Consolidated
Statement of Income.

Note 10.  Energy Services - Discontinued Operations

In 2004, the Energy Services segment  experienced  significantly lower operating
profits and cash flows than originally projected.  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.  In January and February of 2005,
KeySpan sold its mechanical contracting  investments.  The operating results and
cash flows of these businesses,  are reflected as discontinued operations on the
Consolidated Statement of Income and Consolidated Statement of Cash Flows.

In regard  to the  January  2005  transactions,  KeySpan  received  proceeds  of
approximately $16 million,  including approximately $5 million to be paid within
a three year period.  In addition,  KeySpan  retained  its  previously  incurred
indemnity support obligations related to certain surety, performance and payment
bonds issued for the benefit of KeySpan's former  subsidiaries prior to closing.
In June  2005,  the  balance  to be paid over the three  year  period  was fully
collected on a present value basis and a significant  portion of the performance
bonds were replaced without any remaining indemnification obligation on the part
of KeySpan.  The buyers have  completed  the projects  for which such  indemnity
obligations were incurred.

In connection  with the February 2005  transaction,  KeySpan paid or contributed
approximately  $26  million to its former  subsidiary  prior to closing the sale
transaction in exchange for, among other things,  the disposition of outstanding
shares in the former subsidiary and the settlement of intercompany  advances and
replacement  of a  performance  and  payment  bond issued for the benefit of its
former  subsidiary  with  respect  to a  pending  project,  which  bond had been
supported  by a $150  million  indemnity  obligation  of KeySpan.  In  addition,
KeySpan received from its former  subsidiary an indemnity bond issued by a third
party  insurance  company,  the purpose of which is to  reimburse  KeySpan in an


                                      162
<PAGE>


amount up to $80 million in the event it is required to perform  under all other
indemnity  obligations  previously  incurred by KeySpan to support the remaining
bonded projects of its former  subsidiary as of the closing.  As of December 31,
2006, the total cost to complete such remaining  bonded projects is estimated to
be approximately $21.9 million.  The aforementioned  guarantees are reflected in
Note  7  "Contractual  Obligations,  Financial  Guarantees  and  Contingencies".
KeySpan's  former  subsidiary has also agreed to complete the projects for which
such  indemnity  obligations  were  incurred and to  indemnify  and hold KeySpan
harmless with respect to its liabilities in connection with such bonds.

In  anticipation  of these sales and in connection  with the  preparation of the
third quarter and fourth quarter 2004 financial statements, KeySpan conducted an
evaluation  of the  carrying  value of  these  investments,  including  recorded
goodwill.  Further,  we evaluated the carrying  value of goodwill for the entire
Energy  Services  segment.  As noted,  KeySpan  records  goodwill  on  purchased
transactions, representing the excess of acquisition cost over the fair value of
net assets acquired.

As  a  result  of  these  evaluations,  KeySpan  recorded  a  non-cash  goodwill
impairment  charge of $108.3  million  ($80.3  million  after tax,  or $0.50 per
share) in 2004.  This charge was  recorded as follows:  (i) $14.4  million as an
operating  expense  on the  Consolidated  Statement  of  Income  reflecting  the
write-down of goodwill on Energy Services segment's continuing  operations;  and
(ii)  $93.9  million  ($67.8  million  after-tax)  as  discontinued   operations
reflecting the impairment on the mechanical contracting companies.

In addition,  an impairment charge of $100.3 million ($72.1 million after-tax or
$0.45 per share) was also  recorded in 2004 to reduce the carrying  value of the
remaining  assets  of the  mechanical  contracting  companies.  This  charge  is
reflected in discontinued  operations on the Consolidated Statement of Income to
reflect the estimated loss on disposal.

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. Approximately $65 million
of goodwill remains in this segment.


                                      163
<PAGE>


The information  below  highlights the major income and expense  captions of the
discontinued mechanical contracting companies.

-------------------------------------------------------------------------------

                                                       For the Year Ended
                                                          December 31,
(In Millions of Dollars)                           2005                  2004
-------------------------------------------------------------------------------

Revenues                                         $  33.8              $  338.7
Less:
    Operating expenses                              40.2                 364.9
    Goodwill impairment                                -                 108.3
-------------------------------------------------------------------------------
                                                    (6.4)               (134.5)
Income taxes (benefit)                              (2.3)                (55.5)
-------------------------------------------------------------------------------
Operating loss                                      (4.1)                (79.0)
Gain (Loss) on disposal, net of tax                  2.3                 (72.0)
-------------------------------------------------------------------------------
Net Loss                                         $  (1.8)             $ (151.0)
-------------------------------------------------------------------------------


Note 11.  2006 LIPA Settlement

LIPA is a corporate municipal instrumentality and a political subdivision of the
State of New York.  On May 28,  1998,  certain  of LILCO's  business  units were
merged with KeySpan and LILCO's common stock and remaining  assets were acquired
by LIPA.  At the time of this  transaction,  KeySpan and LIPA entered into three
major  long-term  service  agreements  that (i)  provide to LIPA all  operation,
maintenance and construction  services and significant  administrative  services
relating to the Long Island electric  transmission and distribution system ("T&D
System")  pursuant to a Management  Services  Agreement  (the "1998 MSA");  (ii)
supply LIPA with electric generating  capacity,  energy conversion and ancillary
services  from our Long  Island  generating  units  pursuant  to a Power  Supply
Agreement  (the "1998  PSA") and other  long-term  agreements  through  which we
provide LIPA with  approximately  one half of its customers'  energy needs;  and
(iii)  manage all  aspects of the fuel  supply  for our Long  Island  generating
facilities,  as well as all aspects of the capacity and energy owned by or under
contract to LIPA pursuant to an Energy Management Agreement (the "1998 EMA"). We
also  purchase  energy,  capacity and  ancillary  services in the open market on
LIPA's behalf under the 1998 EMA. The 1998 MSA, 1998 PSA and 1998 EMA all became
effective  on May 28,  1998 and are  collectively  referred  to as the 1998 LIPA
Agreements.

On February 1, 2006,  KeySpan and LIPA  entered into (i) an amended and restated
Management  Services Agreement (the "2006 MSA"),  pursuant to which KeySpan will
continue to operate and  maintain  the electric T&D System owned by LIPA on Long
Island;  (ii) a new Option and  Purchase  and Sale  Agreement  (the "2006 Option
Agreement"),  to replace the Generation  Purchase Rights  Agreement (as amended,
the "GPRA"),  pursuant to which LIPA had the option,  through December 15, 2005,
to acquire  substantially  all of the electric  generating  facilities  owned by
KeySpan on Long Island;  and (iii) a Settlement  Agreement (the "2006 Settlement
Agreement")  resolving outstanding issues between the parties regarding the 1998
LIPA Agreements. The 2006 MSA, the 2006 Option Agreement and the 2006 Settlement
Agreement  are  collectively  referred to herein as the "2006 LIPA  Agreements."
Each of the 2006 LIPA Agreements will become effective upon all of the 2006 LIPA
Agreements receiving the required governmental approvals;  otherwise none of the
2006 LIPA  Agreements  will  become  effective.  These  agreements  will  become
effective following approval by the New York State Comptroller's  Office and the


                                      164
<PAGE>


New York State  Attorney  General.  Following the  announcement  of the proposed
acquisition of KeySpan by National Grid plc, LIPA, National Grid plc and KeySpan
have engaged in discussions  concerning the impact of the  transaction on LIPA's
operations.  At this time, we are unable to determine  what impact,  if any, the
results of such discussions may have on the 2006 LIPA Agreements and the receipt
and timing of governmental approvals relating thereto.

2006  Settlement  Agreement.  Pursuant  to  the  terms  of the  2006  Settlement
Agreement,  KeySpan and LIPA agreed to resolve issues that have existed  between
the parties  relating to the various  1998 LIPA  Agreements.  In addition to the
resolution of these matters,  KeySpan's entitlement to utilize LILCO's available
tax  credits and other tax  attributes  will  increase  from  approximately  $50
million to approximately $200 million.  These credits and attributes may be used
to satisfy KeySpan's  previously  incurred indemnity  obligation to LIPA for any
federal  income tax liability that results from the recent  settlement  with the
IRS regarding the audit of LILCO's tax returns for the years ended  December 31,
1996  through  March 31,  1999.  On October  30,  2006,  the IRS  submitted  the
settlement provisions of the recently concluded IRS audit to the Joint Committee
on  Taxation  for  approval.  Key  provisions  of the  settlement  included  the
resolution of the tax basis of assets  transferred to KeySpan at the time of the
KeySpan/LILCO  merger, the tax deductibility of certain merger related costs and
the tax  deductibility  of certain  environmental  expenditures.  The settlement
enabled KeySpan to utilize 100% of the available tax credits. (See Note 3 to the
Consolidated  Financial Statements "Income Taxes" for additional  information of
the  settlement.) In recognition of these items, as well as for the modification
and extension of the 1998 MSA and the amendments to the GPRA, upon effectiveness
of the  Settlement  Agreement  KeySpan  will record a  contractual  asset in the
amount of approximately $160 million,  of which  approximately $110 million will
be attributed to the right to utilize such additional credits and attributes and
approximately $50 million will be amortized over the eight year term of the 2006
MSA. In order to compensate  LIPA for the  foregoing,  KeySpan will pay LIPA $69
million in cash and will settle  certain  accounts  receivable  in the amount of
approximately $90 million due from LIPA.

Generation Purchase Rights Agreement and 2006 Option Agreement. Under an amended
GPRA,  LIPA had the right to acquire  certain  of  KeySpan's  Long  Island-based
generating  assets  formerly owned by LILCO, at fair market value at the time of
the exercise of such right. LIPA was initially  required to make a determination
by May 2005, but KeySpan and LIPA agreed to extend the date by which LIPA was to
make this  determination  to December 15, 2005.  As part of the 2006  settlement
between  KeySpan and LIPA,  the parties  entered into the 2006 Option  Agreement
whereby  LIPA had the option  during the period  January 1, 2006 to December 31,
2006 to purchase only  KeySpan's  Far Rockaway  and/or E.F.  Barrett  Generating
Stations (and certain  related assets) at a price equal to the net book value of
each facility.  In December 2006,  KeySpan and LIPA entered into an amendment to
the 2006 Option Agreement whereby the parties agreed to extend the expiration of
the  option  period  to the  later  of (i)  December  31,  2007 or (ii) 180 days
following  the  effective  date of the 2006  Option  Agreement.  The 2006 Option
Agreement  replaces the GPRA,  the  expiration of which has been stayed  pending
effectiveness of the 2006 LIPA  Agreements.  In the event such agreements do not
become   effective  by  reason  of  failure  to  secure  any  of  the  requisite
governmental approvals, the GPRA will be reinstated for a period of 90 days from
the date such  approval  is  denied.  If LIPA were to  exercise  the  option and


                                      165
<PAGE>


purchase  one or both of the  generation  facilities  (i) LIPA and KeySpan  will
enter into an operation  and  maintenance  agreement,  pursuant to which KeySpan
will continue to operate  these  facilities,  through May 28, 2013,  for a fixed
management fee plus  reimbursement  for certain costs; and (ii) the 1998 PSA and
1998 EMA will be amended to reflect  that the  purchased  generating  facilities
would no longer be covered by those agreements.  It is anticipated that the fees
received  pursuant to the operation and  maintenance  agreement  will offset the
reduction in the operation and  maintenance  expense  recovery  component of the
1998 PSA and the reduction in fees under the 1998 EMA.

Management Services Agreements.  In place of the previous compensation structure
(whereby  KeySpan was reimbursed for budgeted costs, and earned a management fee
and certain performance and cost-based  incentives),  KeySpan's compensation for
managing the T&D System under the 2006 MSA consists of two components: a minimum
compensation  component of $224 million per year and a variable  component based
on electric sales.  The $224 million  component will remain  unchanged for three
years  and  then  increase  annually  by  1.7%,  plus  inflation.  The  variable
component,  which will comprise no more than 20% of KeySpan's  compensation,  is
based on  electric  sales on Long  Island  exceeding  a base  amount  of  16,558
gigawatt hours,  increasing by 1.7% in each year. Above that level, KeySpan will
receive  approximately 1.34 cents per kilowatt hour for the first contract year,
1.29  cents  per  kilowatt  hour in the  second  contract  year  (plus an annual
inflation  adjustment),  1.24 cents per kilowatt hour in the third contract year
(plus  an  annual  inflation  adjustment),  with  the  per  kilowatt  hour  rate
thereafter  adjusted  annually  by  inflation.  Subject to certain  limitations,
KeySpan will be able to retain all operational  efficiencies realized during the
term of the 2006 MSA.

LIPA will  continue to reimburse  KeySpan for certain  expenditures  incurred in
connection  with the  operation  and  maintenance  of the T&D System,  and other
payments made on behalf of LIPA,  including:  real property and other T&D System
taxes, return postage, capital construction expenditures and storm costs.

Upon approval, the 2006 LIPA Agreements will be effective retroactive to January
1, 2006.  KeySpan's  reported operating income and net income for 2006 under the
2006 MSA are  substantially  the same as they  would  have been if the terms and
provisions of the 1998 MSA had  continued to be applied.  At this point in time,
KeySpan  is  unable to  estimate  what the  impact  would be to its  results  of
operations, financial position and cash flows if the 2006 LIPA Agreements do not
become fully effective.

Note 12. KeySpan Gas East Corporation Summary Financial Data

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  provides gas  distribution  services to
customers  in the Long Island  counties  of Nassau and Suffolk and the  Rockaway
peninsula of Queens county.  KEDLI established a program for the issuance,  from
time to time, of up to $600 million  aggregate  principal  amount of Medium-Term


                                      166
<PAGE>


Notes, which will be 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.  Additionally,  in 2006,  KEDLI
issued $100  million of Senior  Unsecured  Notes at 5.60% due November 29, 2016.
This debt is not guaranteed by the parent, KeySpan Corporation.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
                               Statement of Income
--------------------------------------------------------------------------------------------------------------------------
                                                                    Year Ended December 31, 2006
(In Millions of Dollars)                 Guarantor       KEDLI          Other Subsidiaries    Eliminations    Consolidated
--------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>        <C>                    <C>                  <C>           <C>
Revenues                                  $   0.7     $ 1,319.4              $ 5,862.2         $   (0.7)        $ 7,181.6
                                    --------------------------------------------------------------------------------------
Operating Expenses
  Purchased gas                                 -         864.4                2,467.1                -           3,331.5
  Fuel and purchased power                      -             -                  548.6                -             548.6
  Operations and maintenance                 62.4         138.9                1,478.7                -           1,680.0
  Intercompany expense                          -           5.3                   (4.6)            (0.7)                -
  Depreciation and amortization                 -          77.5                  320.0                -             397.5
  Operating taxes                               -          65.1                  346.1                -             411.2
                                    --------------------------------------------------------------------------------------
Total Operating Expenses                     62.4       1,151.2                5,155.9             (0.7)          6,368.8
                                    --------------------------------------------------------------------------------------

Gain on sale of property                        -             -                    1.6                -               1.6
Income from equity investments                  -             -                   13.1                -              13.1
                                    --------------------------------------------------------------------------------------
Operating Income (Loss)                     (61.7)        168.2                  721.0                -             827.5
                                    --------------------------------------------------------------------------------------

Interest charges                           (166.2)        (54.4)                 (69.0)            33.5            (256.1)
Other income and (deductions)               575.2           2.3                  (62.8)          (476.4)             38.3
                                    --------------------------------------------------------------------------------------
                                    --------------------------------------------------------------------------------------
Total Other Income and (Deductions)         409.0         (52.1)                (131.8)          (442.9)           (217.8)
                                    --------------------------------------------------------------------------------------
                                    --------------------------------------------------------------------------------------

Income Taxes (Benefit)                      (86.9)         42.2                  220.2                -             175.5
                                    --------------------------------------------------------------------------------------
Net Income                                $ 434.2     $    73.9              $   369.0         $ (442.9)        $   434.2
------------------------------------======================================================================================
</TABLE>





                                      167
<PAGE>
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
     Statement of Income
-----------------------------------------------------------------------------------------------------------------------------------
                                                                            Year Ended December 31, 2005
(In Millions of Dollars)                         Guarantor         KEDLI      Other Subsidiaries     Eliminations     Consolidated
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>          <C>                  <C>                   <C>           <C>
Revenues                                          $   0.6       $ 1,432.9            $ 6,229.1          $   (0.6)        $ 7,662.0
                                            ---------------------------------------------------------------------------------------
Operating Expenses
  Purchased gas                                         -           963.0              2,634.3                 -           3,597.3
  Fuel and purchased power                              -               -                752.1                 -             752.1
  Operations and maintenance                         22.0           133.5              1,462.4                 -           1,617.9
  Intercompany expense                                  -             4.8                 (4.2)             (0.6)                -
  Depreciation and amortization                         -            76.9                319.6                 -             396.5
  Operating taxes                                     0.1            65.9                341.1                 -             407.1
                                            ---------------------------------------------------------------------------------------
Total Operating Expenses                             22.1         1,244.1              5,505.3              (0.6)          6,770.9
                                            ---------------------------------------------------------------------------------------

Gain on sale of property                                -               -                  1.6                 -               1.6
Income from equity investments                          -               -                 15.1                 -              15.1
                                            ---------------------------------------------------------------------------------------
Operating Income (Loss)                             (21.5)          188.8                740.5                 -             907.8
                                            ---------------------------------------------------------------------------------------

Interest charges                                   (144.5)          (61.9)               (83.9)             21.0            (269.3)
Other income and (deductions)                       523.8             2.9                (81.3)           (446.0)             (0.6)
                                            ---------------------------------------------------------------------------------------
Total Other Income and (Deductions)                 379.3           (59.0)              (165.2)           (425.0)           (269.9)
                                            ---------------------------------------------------------------------------------------

Income Taxes (Benefit)                              (32.4)           48.2                223.5                 -             239.3
                                            ---------------------------------------------------------------------------------------
Earnings from Continuing Operations                 390.2            81.6                351.8            (425.0)            398.6

Discontinued Operations                                 -               -                 (1.8)                -              (1.8)
Cumulative Change in Accounting Principles              -            (0.2)                (6.4)                -              (6.6)
                                            ---------------------------------------------------------------------------------------
Net Income                                        $ 390.2       $    81.4            $   343.6          $ (425.0)        $   390.2
                                            =======================================================================================
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                               Statement of Income
------------------------------------------------------------------------------------------------------------------------------------
                                                                         Year Ended December 31, 2004
(In Millions of Dollars)                       Guarantor          KEDLI        Other Subsidiaries      Eliminations     Consolidated
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>         <C>                   <C>                   <C>            <C>
Revenues                                         $   0.6       $ 1,124.4             $ 5,526.1          $   (0.6)         $ 6,650.5
                                        --------------------------------------------------------------------------------------------
Operating Expenses
  Purchased gas                                        -           664.9               1,999.6                 -            2,664.5
  Fuel and purchased power                             -               -                 540.3                 -              540.3
  Operations and maintenance                         5.3           137.8               1,423.9                 -            1,567.0
  Intercompany expense                                 -             5.4                  (5.4)                -                  -
  Depreciation and amortization                        -            79.9                 471.9                 -              551.8
  Operating taxes                                      -            65.7                 338.4                 -              404.1
  Goodwill Impairment                                  -               -                  41.0                 -               41.0
                                        --------------------------------------------------------------------------------------------
Total Operating Expenses                             5.3           953.7               4,809.7                 -            5,768.7
                                        --------------------------------------------------------------------------------------------

Gain on sale of property                               -               -                   7.0                 -                7.0
Income from equity investments                         -               -                  46.5                 -               46.5
                                        --------------------------------------------------------------------------------------------
Operating Income (Loss)                             (4.7)          170.7                 769.9              (0.6)             935.3
                                        --------------------------------------------------------------------------------------------

Interest charges                                  (204.5)          (61.5)               (267.7)            202.4             (331.3)
Other income and (deductions)                      635.4             0.8                 423.9            (723.9)             336.2
                                        --------------------------------------------------------------------------------------------
Total Other Income and (Deductions)                430.9           (60.7)                156.2            (521.5)               4.9
                                        --------------------------------------------------------------------------------------------

Income Taxes (Benefit)                             (45.5)           35.8                 335.2                 -              325.5
                                        --------------------------------------------------------------------------------------------
Earnings from Continuing Operations                471.7            74.2                 590.9            (522.1)             614.7

Discontinued Operations                                -               -                (151.0)                -             (151.0)
                                        --------------------------------------------------------------------------------------------
Net Income                                       $ 471.7       $    74.2             $   439.9          $ (522.1)         $   463.7
                                        ============================================================================================
</TABLE>

                                      168
<PAGE>

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
--------------------------------------------------------------------------------------------------------------------------------
                                                                          December 31, 2006
(In Millions of Dollars)                     Guarantor        KEDLI       Other Subsidiaries     Eliminations       Consolidated
--------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>            <C>                <C>                 <C>               <C>
ASSETS
Current Assets
   Cash and temporary cash
   investments                               $   140.5      $    34.7           $     35.7        $        -         $    210.9
   Accounts receivable, net                        0.5          175.6                710.7                 -              886.8
   Other current assets                            1.5          314.0              1,373.8                 -            1,689.3
                                      ------------------------------------------------------------------------------------------
                                                 142.5          524.3              2,120.2                 -            2,787.0
                                      ------------------------------------------------------------------------------------------

Investments and Other                          5,017.8              -                144.0          (4,892.1)             269.7
                                      ------------------------------------------------------------------------------------------
Property
   Gas                                               -        2,164.4              5,475.0                 -            7,639.4
   Other                                             -           32.3              3,171.5                 -            3,203.8
   Accumulated depreciation and
   depletion                                         -         (434.7)            (2,830.2)                -           (3,264.9)
                                      ------------------------------------------------------------------------------------------
                                                     -        1,762.0              5,816.3                 -            7,578.3
                                      ------------------------------------------------------------------------------------------

Intercompany Accounts Receivable                 969.1           80.8              1,682.9          (2,732.8)                 -

Deferred Charges                               1,942.3          502.0              1,358.2                 -            3,802.5

                                      ------------------------------------------------------------------------------------------
Total Assets                                 $ 8,071.7      $ 2,869.1           $ 11,121.6        $ (7,624.9)        $ 14,437.5
                                      ==========================================================================================

LIABILITIES AND CAPITALIZATION
Current Liabilities
  Accounts payable                           $    57.2      $   118.9           $    850.0        $        -         $  1,026.1
  Commercial paper                                85.0              -                    -                 -               85.0
  Other current liabilities                      231.8           71.4                293.7                 -              596.9
                                      ------------------------------------------------------------------------------------------
                                                 374.0          190.3              1,143.7                 -            1,708.0
                                      ------------------------------------------------------------------------------------------
Intercompany Accounts Payable                      2.6          319.4                897.0          (1,219.0)                 -
                                      ------------------------------------------------------------------------------------------
Deferred Credits and Other
Liabilities
  Deferred income tax                            (24.3)         407.0                793.7                 -            1,176.4
  Other deferred credits and
  liabilities                                  1,216.1          204.7              1,178.7                 -            2,599.5
                                      ------------------------------------------------------------------------------------------
                                               1,191.8          611.7              1,972.4                 -            3,775.9
                                      ------------------------------------------------------------------------------------------
Capitalization
  Common shareholders' equity                  4,641.5          996.8              3,772.6          (4,892.1)           4,518.8
  Long-term debt                               1,861.8          750.9              3,320.2          (1,513.8)           4,419.1
                                      ------------------------------------------------------------------------------------------
Total Capitalization                           6,503.3        1,747.7              7,092.8          (6,405.9)           8,937.9
                                      ------------------------------------------------------------------------------------------
Minority Interest in Consolidated
Companies                                            -              -                 15.7                 -               15.7
                                      ------------------------------------------------------------------------------------------
Total Liabilities and Capitalization         $ 8,071.7      $ 2,869.1           $ 11,121.6        $ (7,624.9)        $ 14,437.5
                                      ==========================================================================================
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>



                                      169
<PAGE>


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet
----------------------------------------------------------------------------------------------------------------------------------
                                                                              December 31, 2005
(In Millions of Dollars)                              Guarantor      KEDLI    Other Subsidiaries    Eliminations      Consolidated
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                    <C>         <C>              <C>               <C>               <C>
ASSETS
Current Assets
   Cash and temporary cash investments                $    79.6   $     3.5        $     41.4                          $    124.5
   Accounts receivable, net                                 0.6       149.9             822.2                               972.7
   Other current assets                                     4.0       368.9           1,550.0                             1,922.9
                                               -----------------------------------------------------------------------------------
                                                           84.2       522.3           2,413.6                -            3,020.1
                                               -----------------------------------------------------------------------------------

Investments and Other                                   4,571.0         0.7             128.2         (4,457.5)             242.4
                                               -----------------------------------------------------------------------------------
Property
   Gas                                                        -           -           7,275.9                             7,275.9
   Other                                                      -     2,111.3             981.5                             3,092.8
   Accumulated depreciation and depletion                     -      (400.6)         (2,631.2)                           (3,031.8)
                                               -----------------------------------------------------------------------------------
                                                              -     1,710.7           5,626.2                -            7,336.9
                                               -----------------------------------------------------------------------------------

Intercompany Accounts Receivable                        2,813.6        44.6              95.6         (2,953.8)                 -

Deferred Charges                                          482.5       316.1           2,414.6                             3,213.2

                                               -----------------------------------------------------------------------------------
Total Assets                                          $ 7,951.3   $ 2,594.4        $ 10,678.2       $ (7,411.3)        $ 13,812.6
                                               ===================================================================================

LIABILITIES AND CAPITALIZATION
Current Liabilities
   Accounts payable                                   $    36.4   $   149.7        $    900.9                          $  1,087.0
   Commercial paper                                       657.6           -                 -                               657.6
   Other current liabilities                              196.2       128.5              85.9                               410.6
                                               -----------------------------------------------------------------------------------
                                                          890.2       278.2             986.8                -            2,155.2
                                               -----------------------------------------------------------------------------------
Intercompany Accounts Payable                              51.8       338.3           1,049.8         (1,439.9)                 -
                                               -----------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
   Deferred income tax                                     27.2       330.6             800.1                             1,157.9
   Other deferred credits and liabilities                 634.0       225.3           1,240.0                             2,099.3
                                               -----------------------------------------------------------------------------------
                                                          661.2       555.9           2,040.1                -            3,257.2
                                               -----------------------------------------------------------------------------------
Capitalization
   Common shareholders' equity                          4,485.4       897.0           3,539.3         (4,457.6)           4,464.1
   Long-term debt                                       1,862.7       525.0           3,046.9         (1,513.8)           3,920.8
                                               -----------------------------------------------------------------------------------
Total Capitalization                                    6,348.1     1,422.0           6,586.2         (5,971.4)           8,384.9
                                               -----------------------------------------------------------------------------------
Minority Interest in Consolidated Companies                                              15.3                                15.3
                                               -----------------------------------------------------------------------------------
Total Liabilities and Capitalization                  $ 7,951.3   $ 2,594.4        $ 10,678.2       $ (7,411.3)        $ 13,812.6
                                               ===================================================================================
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                      170
<PAGE>

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
--------------------------------------------------------------------------------------------------------------------------------
                                                                                     Year Ended December 31, 2006
                                                                    ------------------------------------------------------------
                                                                                                       Other
(In Millions of Dollars)                                              Guarantor       KEDLI         Subsidiaries   Consolidated
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>          <C>              <C>            <C>
Operating Activities
   Net Cash (Used in) Provided by Continuing Operating Activities       $ (68.1)     $ 112.6           $ 1,014.1      $ 1,058.6
                                                                    ------------------------------------------------------------
Investing Activities
   Capital expenditures                                                       -        (89.0)             (435.0)        (524.0)
   Cost of removal                                                            -         (7.7)              (24.9)         (32.6)
   Proceeds from sale of property and investments                             -            -                 1.6            1.6
   Derivative margin call                                                     -        (15.2)              (18.7)         (33.9)
                                                                    ------------------------------------------------------------
Net Cash (Used in) Continuing Investing Activities                            -       (111.9)             (477.0)        (588.9)
                                                                    ------------------------------------------------------------
Financing Activities
   Treasury stock issued                                                   30.1            -                   -           30.1
   Issuance (payment) of debt, net                                       (572.6)       100.0               387.0          (85.6)
   Common and preferred stock dividends paid                             (325.3)           -                   -         (325.3)
   Intercompany dividend payments                                           8.4            -                (8.4)             -
   Other                                                                      -            -                (2.5)          (2.5)
   Net intercompany accounts                                              988.4        (69.5)             (918.9)             -
                                                                    ------------------------------------------------------------
Net Cash Provided by (Used in) Continuing Financing Activities            129.0         30.5              (542.8)        (383.3)
                                                                    ------------------------------------------------------------

Net Increase (Decrease) in Cash and Cash Equivalents                    $  60.9      $  31.2           $    (5.7)     $    86.4
Cash and Cash Equivalents at Beginning of Period                           79.6          3.5                41.4          124.5
                                                                    ------------------------------------------------------------
Cash and Cash Equivalents at End of Period                              $ 140.5      $  34.7           $    35.7      $   210.9
                                                                    ============================================================
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                         Year Ended December 31, 2005
                                                                     --------------------------------------------------------------
(In Millions of Dollars)                                                 Guarantor       KEDLI     Other Subsidiaries  Consolidated
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                         <C>          <C>                 <C>            <C>
Operating Activities
   Net Cash (Used in) Provided by Continuing Operating Activities         $ (327.7)     $ 168.5            $  562.5       $  403.3
                                                                     --------------------------------------------------------------
Investing Activities
   Capital expenditures                                                          -       (113.3)             (426.2)        (539.5)
   Cost of removal                                                               -         (2.6)              (25.2)         (27.8)
   Proceeds from sale of property and investments                                -         (2.1)               49.1           47.0
   Derivative margin call                                                        -            -                (8.9)          (8.9)
                                                                     --------------------------------------------------------------
Net Cash (Used in) Continuing Investing Activities                               -       (118.0)             (411.2)        (529.2)
                                                                     --------------------------------------------------------------
Financing Activities
   Treasury stock issued                                                      41.2            -                   -           41.2
   Common stock issued associated with MEDS conversion                       460.0            -                   -          460.0
   Issuance (payment) of debt, net                                          (754.6)           -               (15.0)        (769.6)
   Redemption of preferred stock                                             (75.0)           -                   -          (75.0)
   Common and preferred stock dividends paid                                (308.4)           -                   -         (308.4)
   Dividend paid to parent                                                   375.0            -              (375.0)             -
   Other                                                                      (1.6)           -                (3.8)          (5.4)
   Net intercompany accounts                                                  90.0        (46.1)              (43.9)             -
                                                                     --------------------------------------------------------------
Net Cash (Used in) Continuing Financing Activities                          (173.4)       (46.1)             (437.7)        (657.2)
                                                                     --------------------------------------------------------------

Net (Decrease) Increase in Cash and Cash Equivalents                      $ (501.1)     $   4.4            $ (286.4)      $ (783.1)
Net Cash Flow from Discontinued Operations                                       -            -               (14.4)         (14.4)
Cash and Cash Equivalents at Beginning of Period                             580.7         (0.9)              342.2          922.0
                                                                     --------------------------------------------------------------
Cash and Cash Equivalents at End of Period                                $   79.6      $   3.5            $   41.4       $  124.5
                                                                     ==============================================================
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                      171
<PAGE>


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
Statement of Cash Flows
------------------------------------------------------------------------------------------------------------------------------------
                                                                                       Year Ended December 31, 2004
                                                                  ------------------------------------------------------------------
(In Millions of Dollars)                                             Guarantor        KEDLI       Other Subsidiaries    Consolidated
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>           <C>                <C>               <C>
Operating Activities
   Net Cash (Used in) Provided by Continuing Operating Activities      $ (88.7)      $ 169.5             $  669.3          $  750.1
                                                                  ------------------------------------------------------------------
Investing Activities
   Capital expenditures                                                      -        (108.7)              (641.6)           (750.3)
   Cost of removal                                                           -          (7.1)               (29.2)            (36.3)
   Proceeds from sale of property and investments                            -             -              1,021.3           1,021.3
                                                                  ------------------------------------------------------------------
Net Cash (Used in) Provided by Continuing Investing Activities               -        (115.8)               350.5             234.7
                                                                  ------------------------------------------------------------------
Financing Activities
   Treasury stock issued                                                  33.4             -                    -              33.4
   Issuance (payment) of debt, net                                      (269.7)            -               (170.7)           (440.4)
   Redemption of preferred stock                                          (8.5)            -                    -              (8.5)
   Net proceeds from sale/leaseback transaction                              -             -                382.0             382.0
   Common and preferred stock dividends paid                            (291.1)            -                    -            (291.1)
   Gain on interest rate swap                                             12.7             -                    -              12.7
   Dividend paid to parent                                               447.6         (40.0)              (407.6)                -
   Other                                                                  27.6             -                  8.5              36.1
   Net intercompany accounts                                             619.8         (16.2)              (603.6)                -
                                                                  ------------------------------------------------------------------
Net Cash Provided by (Used in) Continuing Financing Activities           571.8         (56.2)              (791.4)           (275.8)
                                                                  ------------------------------------------------------------------

Net Increase (Decrease) in Cash and Cash Equivalents                   $ 483.1        $ (2.5)            $  228.4          $  709.0
Net Cash Flow from Discontinued Operations                                   -             -                  9.6               9.6
Cash and Cash Equivalents at Beginning of Period                          97.6           1.6                104.2             203.4
                                                                  ------------------------------------------------------------------
Cash and Cash Equivalents at End of Period                             $ 580.7        $ (0.9)            $  342.2          $  922.0
                                                                  ==================================================================
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>


Note 13.  Summary of Quarterly Information (Unaudited)

The  following is a table of financial  data for each quarter of KeySpan's  year
ended December 31, 2006.
<TABLE>
<CAPTION>
                                                                                        Quarter Ended
---------------------------------------------------------------------------------------------------------------------------
  (In Millions of Dollars, Except Per Share Amounts)          3/31/2006         6/30/2006         9/30/2006     12/31/2006
---------------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>               <C>               <C>            <C>
Operating Revenue                                               2,661.1           1,377.7           1,218.5        1,924.3
Operating Income                                                  389.1             107.5             135.8          195.1
Earnings for common stock                                         208.0              49.4 (a)          50.3          126.5 (b)
Basic earnings per common share                                    1.19              0.28              0.29           0.72
Diluted earnings per common share                                  1.18              0.28              0.29           0.71
Dividends declared                                                0.465             0.465             0.465          0.465
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

(a) and (b)  Pursuant  to  indemnity  obligations  contained  in the Long Island
Lighting Company  ("LILCO") / KeySpan merger agreement of May 1998,  KeySpan had
been  working  with the  Internal  Revenue  Service  ("IRS") to resolve  certain
disputes with regard to LILCO's tax returns for the tax years ended December 31,
1996 through March 31, 1999 and  KeySpan's and The Brooklyn  Union Gas Company's
(d/b/a  KEDNY) tax  returns  for the years  ended  September  30,  1997  through
December 31, 1998.  During the second  quarter of 2006, two issues were settled.
Accordingly,  KeySpan  reversed $9.5 million of previously  established  federal
income tax  reserves.  A  settlement  of the  remaining  outstanding  issues was
reached in the fourth quarter and,  following IRS procedure,  the settlement was
submitted  to the Joint  Committee  on  Taxation  on October  30, 2006 for final
approval,  which is expected in early 2007. Accordingly,  KeySpan reversed $35.0
million of  previously  established  federal  income tax  reserves in the fourth
quarter of 2006.


                                      172
<PAGE>


The  following is a table of financial  data for each quarter of KeySpan's  year
ended December 31, 2005.
<TABLE>
<CAPTION>
                                                                                                    Quarter Ended
--------------------------------------------------------------------------------------------------------------------------------
          (In Millions of Dollars, Except Per Share Amounts)             3/31/2005      6/30/2005      9/30/2005    12/31/2005
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>            <C>            <C>           <C>
Operating Revenue                                                           2,480.5        1,342.5        1,303.1       2,535.9
Operating Income                                                              438.7          103.2          102.8         263.1
Earnings  from continuing operations,
     less preferred stock dividends                                           234.4           18.0           22.6         121.4
Cumulative change in accounting principles, net of tax                            -              -              -          (6.6) (a)
Loss from discontinued operations                                                 -           (1.8)             -             -
Earnings for common stock                                                     234.4           16.2           22.6         114.8
Basic earnings per common share from continuing operations
     less preferred stock dividends                                            1.45           0.11           0.13          0.70
Basic earnings per common share from discontinued operations                      -          (0.01)             -             -
Basic earnings per common share from cumulative change in accounting
     principles                                                                   -              -              -         (0.04) (a)
Basic earnings per common share                                                1.45           0.10           0.13          0.66
Diluted earnings per common share                                              1.44           0.09           0.13          0.65
Dividends declared                                                            0.455          0.455          0.455         0.455
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>

     (a) Cumulative change in accounting  principles for  implementation of FASB
     Interpretation   No.  47  ("FIN  47")  "Accounting  for  Conditional  Asset
     Retirement Obligations."





                                      173
<PAGE>


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 To the Board of Directors and Stockholders of KeySpan Corporation:

We  have  audited  the   accompanying   Consolidated   Balance  Sheets  and  the
Consolidated   Statements  of   Capitalization   of  KeySpan   Corporation   and
subsidiaries  (the  "Company") as of December 31, 2006 and 2005, and the related
Consolidated Statements of Income,  Retained Earnings,  Comprehensive Income and
Cash Flows for each of the three years in the period  ended  December  31, 2006.
Our audits also included the financial statement schedule listed in the Index at
Item 15. These  financial  statements and financial  statement  schedule are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for our opinion.

In our opinion,  such consolidated  financial  statements present fairly, in all
material   respects,   the  financial   position  of  KeySpan   Corporation  and
subsidiaries  as of  December  31,  2006  and  2005,  and the  results  of their
operations  and their cash flows for each of the three years in the period ended
December 31, 2006, in conformity with accounting  principles  generally accepted
in the United States of America.  Also, in our opinion, such financial statement
schedule,  when  considered  in  relation  to the basic  consolidated  financial
statements taken as a whole,  presents  fairly,  in all material  respects,  the
information set forth therein.

As  discussed  in Notes 1 and 4 to the  consolidated  financial  statements,  on
December  31,  2006,  the Company  adopted  Statement  of  Financial  Accounting
Standards No. 158 "Employers'  Accounting for Defined Benefit Pensions and Other
Postretirement  Benefit  Plans." As  discussed in Notes 1 and 7, on December 31,
2005, the Company adopted Financial  Accounting  Standards Board  Interpretation
No. 47, "Accounting for Conditional Asset Retirement Obligations."

We have also  audited,  in accordance  with the standards of the Public  Company
Accounting  Oversight Board (United States),  the effectiveness of the Company's
internal control over financial  reporting as of December 31, 2006, based on the
criteria  established in Internal  Control--Integrated  Framework  issued by the
Committee of Sponsoring  Organizations of the Treadway Commission and our report
dated  February  22,  2007  expressed  an  unqualified  opinion on  management's
assessment of the effectiveness of the Company's internal control over financial
reporting  and an  unqualified  opinion on the  effectiveness  of the  Company's
internal control over financial reporting.

/s/DELOITTE & TOUCHE LLP
New York, New York
February 22, 2007


                                      174
<PAGE>


ITEM  9.       CHANGES IN AND  DISAGREEMENTS  WITH ACCOUNTANTS ON ACCOUNTING AND
               FINANCIAL DISCLOSURE

None.

ITEM 9A.       CONTROLS AND PROCEDURES

We maintain  disclosure  controls and  procedures (as defined under Exchange Act
Rule  13a-15(e))  that are  designed to ensure that  information  required to be
disclosed  by us in the  reports  we file or submit  under 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
our Chief Executive  Officer and Chief  Financial  Officer,  as appropriate,  to
allow timely decisions  regarding  required  disclosure.  Any control system, no
matter how well designed and operated,  can provide only reasonable assurance of
achieving the desired control objectives. Our management,  under the supervision
and with the  participation  of our Chief Executive  Officer and Chief Financial
Officer,  has  evaluated  the  effectiveness  of  our  disclosure  controls  and
procedures  as of  December  31,  2006.  Based upon that  evaluation,  our Chief
Executive  Officer and Chief  Financial  Officer  concluded  that the design and
operation  of our  disclosure  controls  and  procedures  were  effective at the
reasonable  assurance  level in alerting  them  timely to  material  information
required to be included in KeySpan's periodic SEC reports.

Furthermore,  there  has been no  change  in  KeySpan's  internal  control  over
financial  reporting that occurred during  KeySpan's last fiscal quarter,  which
has materially affected, or is reasonably likely to materially affect, KeySpan's
internal control over financial reporting.




                                      175
<PAGE>



MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined under Exchange Act Rule 13a-15(f)).
KeySpan's  internal  control  over  financial  reporting  is designed to provide
reasonable  assurance  regarding the reliability of financial  reporting and the
preparation  of financial  statements for external  purposes in accordance  with
accounting principles generally accepted in the United States of America.

Because of its inherent  limitations,  internal control over financial reporting
may not prevent or detect misstatements,  errors or fraud. Also,  projections of
any evaluation of  effectiveness  to future periods are subject to the risk that
controls may become  inadequate  because of changes in  conditions,  or that the
degree of or compliance with the policies or procedures may deteriorate.

Under the  supervision  and with  participation  of  KeySpan's  Chief  Executive
Officer and Chief Financial Officer,  our management  assessed the effectiveness
of our internal  control over  financial  reporting as of December 31, 2006.  In
making  this  assessment,  our  management  used the  criteria  set forth by the
Committee of Sponsoring  Organizations of the Treadway  Commission ("COSO") in a
report entitled Internal Control-Integrated Framework. Our management concluded,
as of  December  31,  2006,  that  KeySpan's  internal  control  over  financial
reporting is effective based on the COSO criteria.

Our independent  registered public  accounting firm,  Deloitte & Touche LLP, has
issued their report on  management's  assessment of KeySpan's  internal  control
over financial reporting as of December 31, 2006, which is included herein.








                                      176
<PAGE>


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of KeySpan Corporation:

We  have  audited   management's   assessment,   included  in  the  accompanying
Management's Report on Internal Control over Financial  Reporting,  that KeySpan
Corporation and  subsidiaries  (the  "Company")  maintained  effective  internal
control over  financial  reporting  as of December  31, 2006,  based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. The Company's management is
responsible for maintaining  effective internal control over financial reporting
and for its assessment of the  effectiveness  of internal control over financial
reporting.   Our  responsibility  is  to  express  an  opinion  on  management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.

We conducted  our audit in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain  reasonable  assurance  about whether  effective
internal  control  over  financial  reporting  was  maintained  in all  material
respects. Our audit included obtaining an understanding of internal control over
financial reporting,  evaluating management's assessment, testing and evaluating
the design and operating  effectiveness of internal control, and performing such
other  procedures as we considered  necessary in the  circumstances.  We believe
that our audit provides a reasonable basis for our opinions.

A company's internal control over financial  reporting is a process designed by,
or under the  supervision  of, the company's  principal  executive and principal
financial officers, or persons performing similar functions, and effected by the
company's  board of  directors,  management,  and  other  personnel  to  provide
reasonable  assurance  regarding the reliability of financial  reporting and the
preparation  of financial  statements for external  purposes in accordance  with
generally  accepted  accounting  principles.  A company's  internal control over
financial  reporting  includes those policies and procedures that (1) pertain to
the  maintenance  of records that, in reasonable  detail,  accurately and fairly
reflect the  transactions  and  dispositions  of the assets of the company;  (2)
provide  reasonable  assurance  that  transactions  are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting  principles,  and that receipts and  expenditures  of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of  unauthorized  acquisition,  use, or  disposition  of the company's
assets that could have a material effect on the financial statements.

Because  of  the  inherent   limitations  of  internal  control  over  financial
reporting,  including  the  possibility  of  collusion  or  improper  management
override of controls,  material  misstatements  due to error or fraud may not be
prevented or detected on a timely basis. Also,  projections of any evaluation of
the  effectiveness  of the internal  control over financial  reporting to future
periods are subject to the risk that the controls may become inadequate  because
of changes in conditions,  or that the degree of compliance with the policies or
procedures may deteriorate.


                                      177
<PAGE>


In our opinion,  management's  assessment that the Company maintained  effective
internal  control over  financial  reporting as of December 31, 2006,  is fairly
stated, in all material respects,  based on the criteria established in Internal
Control--Integrated   Framework   issued   by  the   Committee   of   Sponsoring
Organizations  of the  Treadway  Commission.  Also in our  opinion,  the Company
maintained, in all material respects,  effective internal control over financial
reporting as of December 31, 2006, based on the criteria established in Internal
Control--Integrated   Framework   issued   by  the   Committee   of   Sponsoring
Organizations of the Treadway Commission.

We have also  audited,  in accordance  with the standards of the Public  Company
Accounting   Oversight  Board  (United  States),   the  consolidated   financial
statements  and  financial  statement  schedule  as of and  for the  year  ended
December  31,  2006 of the  Company  and our  report  dated  February  22,  2007
expressed an  unqualified  opinion on those  financial  statements and financial
statement schedule and included an explanatory  paragraph regarding the adoption
of Statement of Financial  Accounting  Standards No. 158 "Employers'  Accounting
for Defined Benefit Pensions and Other  Postretirement  Benefit Plans," referred
to in Notes 1 and 4.


/s/DELOITTE & TOUCHE LLP
New York, New York
February 22, 2007





                                      178
<PAGE>



                                    PART III
                                    --------

ITEM 10.       DIRECTORS, EXECUTIVE OFFICERS and CORPORATE GOVERNANCE

Directors of KeySpan

The  following  individuals  were  elected as  directors  of KeySpan at our last
annual  meeting of  shareholders  held on August 17, 2006, to hold such position
for a one year term or until his or her  successor is duly elected or chosen and
qualified:

Robert B. Catell - Age 70 - Director since May 1998 Chairman and Chief Executive
Officer of KeySpan Corporation since July 1998. Joined KeySpan's subsidiary, The
Brooklyn Union Gas Company,  in 1958 and was elected Assistant Vice President in
1974,  Vice President in 1977,  Senior Vice President in 1981 and Executive Vice
President in 1984.  Elected Brooklyn Union's Chief Operating Officer in 1986 and
President in 1990.  Served as President and Chief Executive Officer from 1991 to
1996. He was then elected Chairman and Chief Executive  Officer in 1996 and held
such position through the transformation of Brooklyn Union to KeySpan. He served
as President and Chief  Operating  Officer of KeySpan from May 1998 through July
1998 and was then elected as the Chairman in July 1998.  Serves on the boards of
Alberta  Northeast Gas, Ltd., Edison Electric  Institute,  New York State Energy
Research and Development Authority, the Business Council of New York State, Inc.
and  the  New  York  City  Partnership,  and  as  Chairman  of the  Long  Island
Association.  Mr.  Catell also serves on the board of  directors  of The Houston
Exploration Company (NYSE:THX) and Keyera Energy Management Ltd. (TSX:KEY.UN).

Andrea S. Christensen - Age 67 - Director since January 2001
Special  Counsel  to the law firm of Kaye  Scholer  LLP since  January  1, 2005.
Previously  was a partner of Kaye  Scholer LLP since  1976.  Joined that firm in
1968 and previously was an associate with the law firm of Kelley, Drye & Warren.
Adjunct Professor at New York University School of Law from 1984 to 1994. Member
of the Association of the Bar of the City of New York,  American Bar Association
and International Society for Labor Law and Social Security.  Former Chairperson
of New York County Lawyers Association Committee on Labor Relations. Served as a
director  of  Brooklyn  Union from 1980 to 2000,  and the  American  Arbitration
Association  from 1988 to 1999.  Serves as a Member of the board of Inwood House
since 2000.

Robert J. Fani - Age 52 - Director since January 2005
President and Chief  Operating  Officer of KeySpan  since  October 2003.  Joined
KeySpan's subsidiary, The Brooklyn Union in 1976 and has since held a variety of
management  positions in distribution,  engineering,  planning,  marketing,  and
business development. Elected Vice President in 1992 and promoted to Senior Vice
President of Marketing and Sales in 1997 and was  responsible for all marketing,
sales, rate and regulation activities.  In September 1999, he became Senior Vice
President for Gas  Operations  and was promoted to Executive  Vice President for
Strategic  Services in February 2000 and then to President of the KeySpan Energy
Services  and Supply  Group in 2001  until  assuming  his  current  position  as


                                      179
<PAGE>


President  and  Chief  Operating   Officer.   Former  Director  of  The  Houston
Exploration Company (NYSE:THX) and serves as a director of the New York Building
Congress,  the City College of New York,  Stony Brook  University and the Energy
Partnership  of Long Island.  He is also a member of the Society of Gas Lighters
and sits on the Board of the Gas Technology Institute.

Alan H. Fishman - Age 60 - Director since May 1998
President,  Sovereign Bank, from June 2006 to December 2006.  Former  president,
Chief  Executive  Officer and a director of  Independence  Community  Bank Corp.
(NASDAQ:ICBC),  the parent  savings  and loan  holding  company of  Independence
Community Bank.  Joined Chemical Bank in 1969, named Chief Financial  Officer in
1979 and elected  Senior Vice  President  responsible  for worldwide  investment
banking  activities  in  1983.  Joined  Neuberger  &  Berman  in  1988  and  was
responsible for an investment partnership.  Joined American International Group,
Inc. in 1989 as Senior Vice President of AIG. Joined the firm of Adler & Shaykin
in 1990 as a Managing  Partner.  Former Managing Partner and founder of Columbia
Financial  Partners,  L.P. in 1992.  President  and Chief  Executive  Officer of
ContiFinancial  Corporation  from  July  1999 to  March  2001.  Chairman  of the
Brooklyn  Academy of Music and the  Brooklyn  Navy Yard and  co-chairman  of the
Downtown Brooklyn Partnership.

James R. Jones - Age 67 - Director since May 1998
Co-Chairman and Chief Executive Officer of Manatt Jones Global  Strategies,  LLP
since October 2001 and Chairman of GlobeRanger Corporation since September 1999.
Senior Counsel to the law firm of Manatt, Phelps & Phillips, LLP from March 1999
to present.  Retired as President of Warnaco,  Inc. - International  Division in
1998.  Director of Anheuser Busch (NYSE:BUD) since 1998 and Kansas City Southern
(NYSE:KSU)  since 1997.  White House Staff,  Special  Assistant and Appointments
Secretary  from 1965 to 1969 and  Congressman  from  Oklahoma from 1973 to 1987.
Partner in the law firm of Dickstein  Shapiro  Morin & Oshinsky LLP from 1987 to
1989.  Chairman and Chief Executive  Officer of the American Stock Exchange from
1989 to 1993. Served as United States Ambassador to Mexico from 1993 to 1997.

James L. Larocca - Age 63 - Director since January 2001
Distinguished  Professor of Public Policy and former Dean of the College at Long
Island  University's  Southampton  Graduate  Campus since April 2000 and Adjunct
Professor of Public Policy at Hofstra University since January 1999. Chairman of
the Long Island Regional  Planning Board.  Practiced law with the firm of Cullen
and Dykman immediately prior to his appointment to Southampton  College.  Served
in  the  cabinets  of  two  New  York  State   governors  as   Commissioner   of
Transportation,  Commissioner of Energy, Director of Federal Affairs, Trustee of
the New York Power Authority and Chairman of the Energy Research and Development
Authority.  Served as the President of the Long Island  Association from 1985 to
1993.  Served as a director of Brooklyn Union from 1992 to 1993 and from 1995 to
2000. Former director of European American Bank and ContiFinancial  Corporation.
Current director and past Chairman of the Long Island Nature Conservancy.

Gloria C. Larson - Age 56 - Director since June 2003
Partner and Co-chair of the Government  Practices Group at the law firm of Foley
Hoag LLP.  Has held  senior  positions  within the  federal  government  and the
Commonwealth of Massachusetts government, including serving as the Massachusetts
Secretary  of Economic  Affairs,  Deputy  Director of  Consumer  Protection  and
Attorney Advisor for the Federal Trade  Commission.  Current  Chairperson of the


                                      180
<PAGE>


Massachusetts Convention Center Authority since 1998. Director of Unum Provident
Corp. (NYSE:UNM). Serves as a member of the Rose F. Kennedy Greenway Conservancy
board, as well as several Boston-based not-for-profit  organizations,  including
the  Greater  Boston  Chamber  of  Commerce,   the  New  England  Council,   the
Massachusetts Women's Forum and Blue Cross Blue Shield of Massachusetts.  Serves
as co-Chair of the board of directors of MassINC.

Stephen W. McKessy - Age 69 - Director since May 1998
Elected as the Lead  Director  of  KeySpan  effective  January 1, 2006.  Retired
partner of  PricewaterhouseCoopers.  Served in various management and leadership
positions at  PricewaterhouseCoopers  from 1960 to 1997. Serves as a director of
The  Houston  Exploration  Company  (NYSE:THX),  and the Boy Scouts of  America.
Member of the board of advisors  of St.  John's  University  College of Business
Administration,  past  president and current member of the board of governors of
the Silver Spring Country Club, and member of the Property Owners Association at
SailFish Point, Florida.

Edward D. Miller - Age 65 - Director since May 1998
Served as a member of the  supervisory  board and  senior  advisor  to the Chief
Executive Officer of AXA Group from June 2001 to April 2003. Served as President
and Chief Executive Officer of AXA Financial,  Inc. from August 1997 through May
2001.  Chairman and Chief  Executive  Officer of The  Equitable  Life  Assurance
Society, the principal insurance subsidiary of AXA Financial,  Inc., from August
1997  through May 2001.  Served as Senior Vice  Chairman of The Chase  Manhattan
Bank from 1996  through  1997.  Serves as a member of the board of  directors of
American  Express Company  (NYSE:AXP) and Korn/Ferry  International  (NYSE:KFY).
Member of the board of governors of the United Way of Tri-State  and Chairman of
the board of directors of Phoenix House.  Trustee of the Inner-City  Scholarship
Fund and the New York  City  Police  Foundation.  Chairman  for New York  City's
Partnership Security and Risk Management Task Force.

Vikki L. Pryor - Age 53 - Director since March 2004
President and Chief Executive Officer of SBLI USA Mutual Life Insurance Company,
Inc. and its family of companies since 1999.  Served as Senior Vice President of
Oxford  Health Plans from June 1998 to January  1999.  Served in various  Senior
Vice  President  and Vice  President  positions  at Blue  Cross  Blue  Shield of
Massachusetts  from 1993 to 1997.  Served as Director and in a variety of senior
level positions at Allstate Life Insurance  Company from 1986 to 1992. Served in
various positions  including acting assistant district counsel,  senior attorney
and  associate in the Office of Chief Counsel of the Internal  Revenue  Service,
Chicago  office,  from 1978 to 1986.  Served on the boards of the Life Insurance
Council of New York (LICONY),  New Jersey Chamber of Commerce,  UST Corporation,
Pension  Reserves  Investment  Management  and River Source Funds, a mutual fund
company Serves on the Dean's  Advisory  Council of the University at Buffalo Law
School. Ms. Pryor is also a member of the board of the New York City Partnership
and the Forum 500 Board of Directors.


                                      181
<PAGE>



EXECUTIVE OFFICERS OF KEYSPAN

Certain  information  regarding executive officers of KeySpan and certain of its
subsidiaries is set forth below:

Robert B. Catell
Mr. Catell's biography appears under "Directors of KeySpan".

Robert J. Fani
Mr. Fani's biography appears under "Directors of KeySpan".

Wallace P. Parker Jr.
Mr. Parker,  age 57, was elected  President of the KeySpan  Energy  Delivery and
Customer  Relations  Group in January  2003. He also serves as Vice Chairman and
Chief  Executive  Officer of KeySpan  Services,  Inc. since January 2003. He had
previously  served as President,  KeySpan Energy Delivery,  since June 2001, and
from  February 2000 served as Executive  Vice  President of Gas  Operations.  He
joined KEDNY in 1971 and served in a wide variety of  management  positions.  In
1987, he was named  Assistant Vice President for marketing and  advertising  and
was elected Vice  President in 1990. In 1994,  Mr. Parker was promoted to Senior
Vice  President of Human  Resources for KEDNY and in August 1998 was promoted to
Senior Vice President of Human Resources of KeySpan.

Steven L. Zelkowitz

Mr.  Zelkowitz,  age 57, was elected  President of KeySpan's  Energy  Assets and
Supply  Group in  October  2003.  Prior to that,  he  served as  Executive  Vice
President and Chief Administrative Officer since January 2003. He joined KeySpan
as Senior Vice  President and Deputy  General  Counsel in October 1998,  and was
elected  Senior Vice  President  and General  Counsel in February  2000. In July
2001,  Mr.  Zelkowitz  was  promoted to  Executive  Vice  President  and General
Counsel,   and  in  November  2002,  he  was  named  Executive  Vice  President,
Administration  and Compliance,  with  responsibility for the offices of General
Counsel,  Human Resources,  Regulatory  Affairs,  Enterprise Risk Management and
administratively  for Internal Auditing.  Before joining KeySpan,  Mr. Zelkowitz
practiced law with Cullen and Dykman LLP in Brooklyn, New York,  specializing in
energy  and  utility  law and had been a partner  since  1984.  He served on the
firm's Executive Committee and was head of its Corporate/Energy Department.

John J. Bishar, Jr.

Mr. Bishar, age 57, was elected Executive Vice President, General Counsel, Chief
Governance Officer and Secretary  effective March 1, 2005. He became Senior Vice
President,  General Counsel and Secretary in May 2003, with  responsibility  for
KeySpan's Legal Department and the Corporate  Secretary's Office. Prior to that,
he joined KeySpan as Senior Vice President and General Counsel in November 2002.
Before  joining  KeySpan,  Mr.  Bishar  practiced law with Cullen and Dykman LLP
since 1987. He was the Managing  Partner from 1993 through 2002 and was a member
of the  firm's  Executive  Committee.  From 1980 to 1987,  Mr.  Bishar  was Vice
President,  General Counsel and Corporate  Secretary of LITCO  Bancorporation of
New York, Inc.


                                      182
<PAGE>


John A. Caroselli
Mr.  Caroselli,  age 51, was elected Executive Vice President and Chief Strategy
Officer in January 2003.  Mr.  Caroselli is  responsible  for Brand  Management,
Strategic  Marketing,  Corporate  Marketing,  Sales and Account  Management  and
Customer  Service,  Strategic  Planning,  Strategic  Performance and Information
Technology Strategy and Governance. Mr. Caroselli came to KeySpan in 2001 and at
that time served as Executive  Vice President of Strategic  Development.  Before
joining KeySpan,  Mr. Caroselli held the position of Executive Vice President of
Corporate  Development at AXA  Financial.  Prior to that, he held senior officer
positions with Chase Manhattan,  Chemical Bank and Manufacturers  Hanover Trust.
He has extensive experience in strategic planning, brand management,  marketing,
communications, human resources, and strategic execution.

Gerald Luterman
Mr. Luterman,  age 63, was elected  Executive Vice President and Chief Financial
Officer in February  2002.  He  previously  served as Senior Vice  President and
Chief  Financial  Officer since joining KeySpan in July 1999. He formerly served
as Chief Financial Officer of  barnesandnoble.com  and Senior Vice President and
Chief  Financial  Officer of Arrow  Electronics,  Inc. Prior to that,  from 1985
through 1996, he held executive  positions with American  Express.  Mr. Luterman
also serves on the Board of Directors for IKON Office Solutions Inc. (NYSE:IKN),
U.S.  Shipping  Partners  L.P.  (NYSE:USS)  and  Technology   Solutions  Company
(NASDAQ:TSCC).

David J. Manning
Mr. Manning,  age 56, was elected Executive Vice President Corporate Affairs and
Chief  Environmental  Officer  effective  March 1, 2005.  He became  Senior Vice
President for  Corporate  Affairs in April 1999.  Before  joining  KeySpan,  Mr.
Manning had been President of the Canadian  Association  of Petroleum  Producers
since 1995. From 1993 to 1995, he was Deputy Minister of Energy for the Province
of Alberta, Canada. From 1988 to 1993, he was Senior International Trade Counsel
for the Government of Alberta, based in New York City. Previously, he was in the
private practice of law in Canada as Queen's Counsel.

Anthony Nozzolillo
Mr.  Nozzolillo,  age 58, was  elected  Executive  Vice  President  of  Electric
Operations in February  2000. He previously  served as Senior Vice  President of
KeySpan's  Electric  Business Unit from December 1998 to January 2000. He joined
LILCO  in 1972  and held  various  positions,  including  Manager  of  Financial
Planning  and  Manager of Systems  Planning.  Mr.  Nozzolillo  served as LILCO's
Treasurer  from 1992 to 1994 and as Senior Vice  President  of Finance and Chief
Financial Officer from 1994 to 1998.

Nickolas Stavropoulos
Mr.  Stavropoulos,  age 47, was elected President,  KeySpan Energy Delivery,  in
June,  2004 and Executive Vice President in April 2002. He previously  served as
President  of KeySpan  Energy New  England  since  April  2002,  and Senior Vice
President  of sales and  marketing in New England  since 2000.  Prior to joining
KeySpan,  Mr.  Stavropoulos  was Senior  Vice  President  of  marketing  and gas
resources for Boston Gas Company.  Before  joining  Boston Gas, he was Executive
Vice President and Chief  Financial  Officer for Colonial Gas Company.  In 1995,
Mr.  Stavropoulos was elected Executive Vice President - Finance,  Marketing and
CFO, and assumed  responsibility  for all of  Colonial's  financial,  marketing,
information  technology and customer service functions.  Mr.  Stavropoulos was a
director of Colonial Gas Company and currently  serves on the Board of Directors
for  Enterprise  Bank and Trust  Company  (NASDAQ:EBTC)  and  Dynamics  Research
Corporation (NASDAQ:DRCO).


                                      183
<PAGE>


Joseph F. Bodanza
Mr. Bodanza,  age 59, was elected Senior Vice President  Regulatory  Affairs and
Asset  Optimization  effective  March 1, 2005. He became Senior Vice  President,
Regulatory Affairs and Chief Accounting Officer in April 2003. Prior to that, he
served as Senior Vice President of Finance  Operations  and  Regulatory  Affairs
since August 2001 and was Senior Vice President and Chief  Financial  Officer of
KEDNE.  Mr.  Bodanza  previously  served as Senior Vice President of Finance and
Management  Information  Systems  and  Treasurer  of  Eastern  Enterprise's  Gas
Distribution Operations. Mr. Bodanza joined Boston Gas Company in 1972, and held
a variety of positions in the financial  and  regulatory  areas before  becoming
Treasurer in 1984. He was elected Vice President and Treasurer in 1988.

Coleen A. Ceriello
Ms.  Ceriello,  age 48, was named Senior Vice  President  of Shared  Services of
KeySpan Corporate Services, LLC, effective March 1, 2005. She had been KeySpan's
Vice President - Property,  Security and Employee Related Services since January
2005.  Prior to that time, she served as Vice President of Property and Security
since June 2004 and Vice President of Strategic  Planning since August 1999. She
joined  KEDNY in 1980 and over the  years  held a  succession  of  positions  in
Corporate Planning,  Regulatory Relations,  Information Technology and Strategic
Planning and Performance.

John F. Haran
Mr. Haran, age 56, was elected Senior Vice President of KeySpan Energy Delivery
and Chief Gas Engineer in March 2004. He had been Senior Vice President of gas
operations for KEDNY and KEDLI in April 2002. Mr. Haran joined KEDNY in 1972,
and has held management positions in operations, engineering and marketing and
sales. He was named Vice President of KEDNY gas operations in 1996 and in 2000
moved to the position of Vice President of KEDLI gas operations.

Michael J. Taunton
Mr. Taunton, age 51, was elected Senior Vice President, Treasurer and Chief Risk
Officer  effective  March 1, 2005. He became Senior Vice President and Treasurer
in March 2004, and had been  KeySpan's  Vice President and Treasurer  since June
2000.  Prior to that time,  he served as Vice  President  of Investor  Relations
since September 1998. He joined KEDNY in 1975 and held a succession of positions
in Accounting,  Customer Service, Corporate Planning, Budgeting and Forecasting,
Marketing and Sales, and Business Process Improvement.  During the KeySpan/LILCO
merger, Mr. Taunton  co-managed the day-to-day  transition process of the merger
and then  served on the  Transition  Team  during  the  acquisition  of  Eastern
Enterprises.

Elaine Weinstein
Ms.  Weinstein,  age 59, was named Senior Vice President for Human Resources and
Chief  Diversity  Officer in March 2004.  She  previously  served as Senior Vice
President of KeySpan's Human Resources division since November 2000, and as Vice
President of Staffing and Organizational Development from September 1998, to her
election as Senior Vice President. Prior to that time, Ms. Weinstein was General
Manager of Employee  Development  since joining KEDNY in June of 1995.  Prior to
1995,  Ms.   Weinstein  was  Vice  President  of  Training  and   Organizational
Development at Merrill Lynch.


                                      184
<PAGE>


Lawrence S. Dryer
Mr. Dryer,  age 47, was elected Vice President and General Auditor in June 2003.
He previously  served in this position  from  September  1998 to August 2001. In
August 2001, he was named Senior Vice President and Chief  Financial  Officer of
KeySpan  Services,  Inc. Prior to such positions,  Mr. Dryer had been with LILCO
from 1992 to 1998 as Director of Internal  Audit.  Prior to joining  LILCO,  Mr.
Dryer was an Audit Manager with Coopers & Lybrand.

Theresa A. Balog
Ms.  Balog,  age 44, was elected Vice  President  and Chief  Accounting  Officer
effective  March 1, 2005. She became Vice President and Controller of KeySpan in
April 2003. She joined KeySpan in 2002 as Assistant Controller. Prior to joining
KeySpan,  Ms. Balog was Chief  Accounting  Officer for NiSource  Inc. and held a
variety of positions with the Columbia Energy Group.

Joseph E. Hajjar
Mr. Hajjar,  age 54, was named Vice President and Controller  effective March 1,
2005. He had been Senior Vice President and Chief  Financial  Officer of KeySpan
Services,  Inc.  since June 2003 and Senior Vice  President and Chief  Financial
Officer of KeySpan Business Solutions,  LLC, since November 2001. Before joining
KeySpan from 1998 to 2001,  Mr.  Hajjar was Executive  Vice  President and Chief
Operating Officer of Opportunity  America.  He also was previously an officer of
the Bovis group and served for over 12 years with Price Waterhouse.

Michael A. Walker
Mr.  Walker,  age 50, was named Vice  President  and Deputy  General  Counsel of
KeySpan Corporation,  effective March 1, 2005. He had been Senior Vice President
of KeySpan  Services,  Inc. since June 2004 and Senior Vice President and COO of
KeySpan  Business  Solutions,  LLC,  since June 2003.  Prior to that time he was
Senior Vice President and General Counsel of KeySpan Services, Inc. from January
2001 to December 2003.  Before joining KeySpan,  Mr. Walker was a shareholder in
the Corporate  Finance Section in the law firm of Buchanan  Ingersoll.  Prior to
joining  Buchanan  Ingersoll  he worked for  several law firms in the north east
representing both private and public sector clients on a wide variety of energy,
utility, regulatory, corporate and structured finance matters.

There  are no  family  relationships  among  any of our  executive  officers  or
directors.

Compliance with Section 16(a) of the Exchange Act

Section  16(a) of the  Exchange  Act  requires  KeySpan's  directors,  executive
officers and persons who own more than ten percent  (10%) of a registered  class
of  KeySpan's  equity  securities  to file  with  the  SEC  initial  reports  of
beneficial  ownership and reports of changes in  beneficial  ownership of common
stock and other equity securities of KeySpan. Executive officers,  directors and
greater than ten percent (10%)  shareholders  are required by SEC  regulation to
furnish KeySpan with copies of all Section 16(a) forms that they file.

To KeySpan's knowledge,  based solely on review of information  furnished to us,
reports filed  through  KeySpan and  representations  that no other reports were
required,  all Section 16(a) filing  requirements  applicable to our  directors,
executive  officers and greater than ten percent  (10%)  beneficial  owners were
complied with during the  twelve-month  period ended December 31, 2006.


                                      185
<PAGE>


Codes of Ethics

We  adopted  a code of  ethics  applicable  to our  directors,  a code of ethics
applicable to our senior  financial  officers,  and an ethical  business conduct
statement applicable to all of our directors,  officers and employees. Our codes
of ethics,  ethical business conduct statement,  corporate governance guidelines
and committee  charters can each be found on the Investor  Relations  section of
our  website,  (http://www.keyspanenergy.com)  or directly at the  Corporation's
corporate governance website (http://governance.keyspanenergy.com),  and provide
information  on the  framework  and high  standards  set by us  relating  to our
corporate  governance.  Additionally,  these documents are available in print to
any stockholder requesting a copy. The codes of ethics, ethical business conduct
statement,  corporate governance guidelines and committee charters have all been
approved by the board of directors  and are vital to securing the  confidence of
our  stockholders,   customers,  employees,  governmental  authorities  and  the
investment community.

Audit Committee

The Audit Committee provides oversight with respect to the quality and integrity
of our financial statements;  compliance with legal and regulatory requirements;
the independent  auditor's  qualifications and independence;  the performance of
our internal audit function and independent  auditors,  our business  practices,
risk assessment and risk management,  and the preparation of the Audit Committee
report  required  to be  included  in our  annual  proxy  statement.  The  Audit
Committee is comprised of Mr. Fishman, Ms. Christensen, Mr. Larocca, Mr. McKessy
and Ms.  Pryor.  Pursuant to the rules of New York Stock  Exchange  ("NYSE") all
members  of the  Audit  Committee  of our  board of  directors  are  independent
directors.  Our board of directors has determined that Mr. Fishman and Ms. Pryor
meet the  qualifications of an "audit committee  financial expert," as that term
is defined by the rules of the Securities and Exchange  Commission  ("SEC").  In
addition,  our board of directors has determined that Mr.  Fishman,  Mr. McKessy
and Ms. Pryor have "accounting or related  financial  management  expertise," in
accordance with the NYSE corporate  governance standards rules, section 303A.07.
Each  of  the  members  of the  Audit  Committee  is  financially  literate,  in
accordance with the NYSE corporate  governance standards rules, section 303A.07.
None  of  the  Audit  Committee  members  simultaneously  serves  on  the  audit
committees of more than three public companies.  The Audit Committee is composed
of five  independent  directors and operates under a written  charter adopted by
our board of directors,  as amended and restated as of January 26, 2006; and can
be   found   on   the   Investor   Relations   section   of   our   website   at
http://www.keyspanenergy.com  or directly at our  corporate  governance  website
(http://governance.keyspanenergy.com).


                                      186
<PAGE>


ITEM 11.    EXECUTIVE COMPENSATION

COMPENSATION DISCUSSION AND ANALYSIS

                  Objectives of Executive Compensation Programs

Through the  Compensation and Management  Development  Committee of the Board of
Directors (the "Committee"),  which is responsible for the administration of our
executive  compensation programs, a "pay for performance" executive compensation
philosophy  was developed  and adopted by the Board of Directors.  Our executive
compensation  philosophy for named  executive  officers and other  executives is
intended  to  provide  compensation  at  market  competitive  levels in order to
attract,  motivate and retain talented  executives and to align the interests of
these executives with those of our  shareholders.  The Committee,  which has the
primary  governance  authority  over our  executive  compensation  programs,  is
composed of five directors,  each of whom are "independent" under all applicable
New York  Stock  Exchange  and  Securities  and  Exchange  Commission  rules and
regulations.  The  Committee  operates  pursuant  to a  written  charter  and is
authorized by the Board of Directors to retain outside consultants,  advisors or
legal  counsel to  provide  independent  advice to the  Committee.  The  overall
objective  of the program is to provide a total  compensation  plan  designed to
focus on our strategic business initiatives,  financial  performance  objectives
and shareholder value.

We  adhere  to  the  following  compensation  principles  in the  design  of our
compensation programs, which are intended to support our business objectives and
further our strategic vision:

o    The  executive  compensation  programs  emphasize pay for  performance  and
     encourage retention of those employees who enhance our overall performance.

o    Compensation plan design maintains a reasonable  balance among base salary,
     annual  incentive and long-term  equity-based  incentive  compensation  and
     other  benefits  and should  further the  creation of  long-term  value for
     shareholders.

o    Incentive  compensation is linked to the achievement of specific  financial
     and strategic objectives,  which are established in advance and approved by
     the Board of Directors, upon recommendation of the Committee.

o    Annual and long-term incentive  compensation for executives are competitive
     with the levels of comparable  executives  within the energy  industry,  as
     well as general  industry,  on a nationwide  basis,  with a focus on energy
     companies for those positions unique to the energy industry.

o    Total direct  compensation,  including  base salary,  annual and  long-term
     incentives,  should be benchmarked to the 50th percentile of the nationwide
     marketplace.

o    If our  performance  results  exceed that of our peer  group,  compensation
     should  be above the 50th  percentile  for such peer  group;  likewise,  if
     performance  falls  below that of our peer  group,  compensation  should be
     below the 50th percentile.


                                      187
<PAGE>


o    In addition to external  comparisons,  compensation levels also reflect the
     internal value of each executive  compared to other  executives  within our
     organization,  as well as other factors such as succession planning and the
     achievement of exceptional individual results.

Towers Perrin, a nationally recognized compensation consultant,  was selected by
the  Committee as their  independent  compensation  consultant  in 2005.  Towers
Perrin attends Committee  meetings in order to provide advice and counsel to the
Committee  in regard to  compensation  plan design and  recommendations  made by
management.  In addition,  Towers Perrin  provides advice  regarding  changes in
legislative  and accounting  considerations  that may impact  compensation  plan
design.

To assist us in implementing our compensation programs,  surveys are prepared by
Towers Perrin to provide an  independent  review of the  compensation  levels of
executives  in peer energy  companies  and  companies in general  industry.  The
primary  survey source is the Towers Perrin Energy  Industry  database with data
from  approximately  100 energy  companies,  as well as their  general  industry
database with data from approximately 800 companies nationwide. This survey data
is used as our peer group in assessing pay levels.

Both  energy and general  industry  peer group data are used to  benchmark  base
salary  and annual  incentives,  but,  because  of factors  unique to the energy
industry, only energy industry data is used to benchmark the long-term incentive
component  of our pay  programs.  Ultimately,  Towers  Perrin  uses  statistical
analysis  to ensure  comparability  of our base  salary,  annual  and  long-term
incentive   compensation   levels  and  to  correlate  the  market  data  to  an
organization of our size and scope.

Our  compensation  plan  design  and  philosophy  is  reviewed  annually  by the
Committee,  with no material changes made during 2006. In 2006 the Committee met
five times.  In  addition to a review of the peer group data  provided by Towers
Perrin,  the  Committee  conducted a  comprehensive  assessment of our executive
compensation  programs to ensure that our philosophy and programs are consistent
with best practices and provide a reasonable level of total  compensation to our
named executive officers. In conducting this assessment,  the Committee reviewed
and relied upon  comprehensive  reports or "tally  sheets"  for each  executive,
which identified all elements of compensation  provided to the executives in the
prior year or to which they are otherwise entitled.  In addition,  the Committee
held one executive session without management participation to enable discussion
of the key elements of the named executive officers' performance  evaluation and
compensation recommendations.

                 Role of Executives in Establishing Compensation

Mr.  Catell  and Mr.  Fani  attend all  Committee  meetings.  At such  Committee
meetings,  they each  periodically  review  KeySpan's  financial  and  operating
performance,  major changes in  organizational  plans and the performance of key
officers. Certain other senior executives also attend Committee meetings and are
responsible   for  developing   potential   compensation   programs,   incentive
compensation,  plan design and individual salary recommendations with input from
both Mr. Catell and Mr. Fani,  utilizing the survey data and advice  provided by
Towers  Perrin.  With  respect  to Mr.  Catell  and Mr.  Fani,  all  discussions
regarding their  compensation is conducted by the Committee in Executive Session
without their attendance.


                                      188
<PAGE>


                              Compensation Program

Our compensation program reflects our compensation  philosophy and principles as
set forth above. To achieve our objectives,  direct compensation  includes three
basic  components:  base salary,  annual  incentive  compensation  and long-term
incentive compensation.

We place significant  emphasis on variable pay (i.e. pay that is contingent upon
performance),  with the greatest proportion of total compensation being variable
for Mr. Catell when compared to the other named executive officers.  In terms of
the variable pay component, which includes annual and long-term incentives, more
emphasis is placed on the long-term  component  than the annual  component.  Mr.
Catell has the highest portion of pay linked to long-term compensation,  placing
greater emphasis on long-term  shareholder  value. All variable pay programs are
linked directly to performance measures that drive financial results,  strategic
performance  measures  and  other  goals and  objectives  that are  intended  to
increase shareholder value.

The  following  provides  a  summary  of the mix of  compensation  for the named
executive officers for 2006:

                2006 Mix of Total Direct Compensation Components

<TABLE>
<CAPTION>
-------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
                                                                                         Long-Term
      Name                     Base Pay                 Annual Incentive                 Incentive                      Total
-------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
<S>                             <C>                           <C>                          <C>                          <C>
Mr. Catell                       22%                           22%                          56%                          100%
-------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Mr. Fani                         30%                           22%                          48%                          100%
-------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Mr. Parker                       34%                           24%                          42%                          100%
-------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Mr. Zelkowitz                    34%                           24%                          42%                          100%
-------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
Mr. Luterman                     36%                           24%                          40%                          100%
-------------------- ----------------------------- ---------------------------- ----------------------------- ----------------------
</TABLE>

Executives  are provided with benefits and  perquisites  that are intended to be
comparable  to those  provided  to  executives  in our peer  group.  These other
programs include the following:

o    ability  to  allocate  a portion of any  annual  incentive  payment  into a
     deferred stock unit plan

o    ability to allocate a portion of base  salary into a deferred  compensation
     plan

o    retirement plans

o    401(k) plan with employer match (available to all employees)


                                      189
<PAGE>


o    executive group replacement life insurance

o    severance and change in control termination protection

o    other reasonable and customary perquisites

In the design of our programs,  the compensation amounts realized in prior years
are not taken  into  consideration  when  establishing  compensation  targets or
awards. We also have no policy that would automatically  result in an adjustment
to payments if the relevant  performance  measures upon which they are based are
restated or otherwise adjusted in subsequent years in a manner that would reduce
or increase  the size of a previous  payment.  However,  in an instance  such as
this,  the  Committee  would have  discretion  to  consider  an  adjustment,  if
warranted.

Base Salary
-----------

We provide a base salary program in order to compete for executive talent in the
marketplace. Base salaries for our executives are established based on the scope
of their  responsibilities,  taking into account competitive market compensation
levels for similar positions. Generally, we believe that executive base salaries
should be targeted  near the median of the range of salaries for  executives  in
similar positions with similar  responsibilities at comparable  companies.  Base
salaries  are  reviewed  annually  and  adjusted  from  time to time to  realign
salaries with market levels,  taking into account  individual  responsibilities,
performance and experience. Other factors such as internal equity and succession
planning are also considered when setting base salary.

In  determining  the base salary  level for the named  executive  officers,  the
Committee  considers  individual  contributions,   internal  equity,  succession
planning  and  performance,  as well as  competitive  market  data.  In terms of
performance  results  and  contributions,   the  named  executive  officers  are
evaluated on an increase in overall  earnings per share,  continued focus on the
core  business  and  the  achievement  of  our  short  and  long-term  strategic
initiatives and financial goals.  For further  discussion of the named executive
officers' base salary in 2006 and 2007, see the narrative  following the Summary
Compensation Table and the Grants of Plan-Based Awards table.

Annual Incentive Compensation
-----------------------------

Annual  incentive  compensation  is intended to encourage  management to achieve
critical  short-term  goals that we believe are  integrally  linked to long-term
value creation.  The Board of Directors  adopted the Corporate  Annual Incentive
Compensation and Gainsharing Plan (the "Corporate  Plan") in September 1998. The
Corporate Plan provides annual  incentive  awards to officers and all management
employees  based on the  achievement  of  corporate  goals  that  the  Committee
believes enhance shareholder value. For 2006, the performance measurement period
included the twelve-month  period from January 1, 2006 to December 31, 2006. The
awards for this period were approved by the Committee and the Board of Directors
in February 2007 and will be paid in March 2007.  The specific  corporate  goals
for the Corporate  Plan are proposed by management  and reviewed and approved by
the Committee and the Board of Directors.


                                      190
<PAGE>

In 2006, the  performance  objectives for each of the named  executive  officers
included financial and strategic objectives consisting of the following:

o    earnings per share

o    cash flow

o    business unit operating income

o    customer satisfaction

o    control of operating expenses

o    employee diversity, and

o    individual strategic initiatives

The  incentive  award  ranges are  established  annually  by the  Committee  for
executives and management employees.  Incentive award levels provide awards that
are  competitive  both  within and  outside  the  energy  industry  when  target
performance results are achieved.

Under the Corporate Plan,  award payouts can range from zero for below threshold
performance  up to a maximum  award  potential  of two times  the  target  level
established  for  each  named  executive  officer.   Actual  award  payouts  are
calculated  using cumulative base earnings paid during the calendar year and are
determined  based  upon each  named  executive  officer's  performance  measured
against  the  established   financial,   strategic  and  individual  performance
objectives  set by the Committee and the Board of Directors.  Actual awards also
reflect  modification  based  upon each  named  executive  officer's  individual
performance rating using a modifier percentage as approved by the Committee. The
modifier  allows the Committee to use its  discretion to increase or decrease an
award  with a maximum  modification  of +/- 15%,  based on the  named  executive
officers'  performance  relative to leadership,  teamwork,  strategic  thinking,
urgency  for  results,  enterprise-wide  commitment,  developing  organizational
talent and integrity.

For each named  executive  officer,  the  specific  performance  objectives  are
weighted  dependent upon the executive's level of responsibility  for delivering
results  against  these  objectives.  The  weightings  for the  named  executive
officers with respect to each objective ranged as follows:

     Earnings Per Share: 35% to 50%
     ------------------

     Corporate/Business Unit Operating Income: zero to 25%
     ----------------------------------------

     Free Cash Flow: 10% to 20%
     --------------

     Control of Operation and Maintenance Costs: zero to 20%
     ------------------------------------------

     Diversity: 10% for each named executive officer
     ---------

     Customer Satisfaction: 10% for each named executive officer
     ---------------------

     Other Strategic Initiatives: zero to 10%
     ---------------------------


                                      191
<PAGE>


The  overall  assessment  of the  achievement  of each named  executive's  goals
determines the percent of the target award that will be paid to the executive as
an  annual   incentive   award.  In  addition,   the  Committee  may  take  into
consideration  certain  unanticipated or extraordinary items, such as changes in
accounting  or tax  rules,  that may have  impacted  the  difficulty  or ease of
achieving the desired targets and has discretion to adjust award payouts.

The  performance  metrics used in the 2006  Corporate Plan are summarized in the
chart below.  These  objectives were selected as key  performance  indicators in
support of our annual  objectives  and  long-term  strategy.  The setting of the
target level of performance generally reflects a reasonable level of improvement
in performance  when compared to the actual results  achieved in the prior year.
The threshold  level of  performance  reflects the minimum  acceptable  level of
performance.  The maximum level of performance reflects performance results that
would be considered  exceptional  when compared to the expected  target level of
results.  The corporate  performance  objectives and the  threshold,  target and
maximum  levels are reviewed and approved by both the Committee and the Board of
Directors at the beginning of each year.

                             2006 Performance Goals
<TABLE>
<CAPTION>
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
   Performance Objective              Threshold         Target          Maximum               Actual                Actual Results
                                                                                            Performance              as a % of
                                                                                            Results(1)                 Target
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
<S>                                     <C>             <C>            <C>                    <C>                    <C>
Earnings Per Share (2)                  $2.40           $2.46            $2.60                  $2.63                   200%
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Corporate Operating Income (3)          $876M           $918M          $1,100M                $970.4M                 181.1%
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Operating Income Gas Business           $548M           $567M            $606M                $598.8M                 181.1%
Unit and Energy Services (4)
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Operating Income Electric               $319M           $341M            $385M                $371.6M                 169.1%
Business Unit and Energy
Related Investments (5)
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Free Cash Flow (2)                        $0            $150M            $450M                  $511M                   200%
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Control of Operation and               $22.3M          $21.7M           $20.4M                $19.96M                   200%
Maintenance Costs (6)
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Diversity (2) (7)                        63%             70%              85%                     52%                     0%
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
Customer Satisfaction (2) (8)            87%             89%              93%                     89%                   100%
---------------------------------- ----------------- ------------- ------------------ ------------------------ ---------------------
</TABLE>

(1)  Actual  performance  results reflect  adjustment for certain  unanticipated
     expenses associated with the pending transaction with National Grid.

(2)  Goal applicable to all named executive officers.

(3)  Goal  applicable  to  Mr.  Fani.   Payout  result  reflects  business  unit
     weightings  of  gas,  electric,  energy  development  and  energy  services
     business units.

(4)  Goal applicable to Mr. Parker.

(5)  Goal applicable to Mr. Zelkowitz.

(6)  The performance  measure for the Control of Operation and Maintenance Costs
     for Mr. Luterman  reflects the expense levels  associated with his areas of
     responsibility.


                                      192
<PAGE>


(7)  The Diversity goal measures the percentage of diverse  candidates  selected
     for  positions  as compared  to the total  candidate  population  for those
     positions that are underrepresented by diverse incumbents.

(8)  The Customer  Satisfaction  goal  measures the  percentage of customers who
     have had contact with us and have provided a satisfactory  rating or better
     with respect to the level of service  provided to them. A random  sample of
     customers  is used for this survey  process.  The survey is conducted by an
     outside agency.

The  Corporate  Plan includes  both primary and  secondary  performance  trigger
mechanisms.  The primary  trigger is earnings per share.  In order for the named
executives  and all other  participants  in the  Corporate  Plan to receive  any
incentive award payment,  at least the threshold  performance  level of earnings
per share must be achieved.  If earnings per share results are between threshold
and target, the award payout for all goals is pro-rated downward consistent with
the  level  of  performance.  Once  the  target  level  of  earnings  per  share
performance  is  achieved,  all goals are paid  based  upon  actual  performance
results,  with results in excess of target paid up to the maximum award level in
the plan. The secondary  performance trigger for the business units is operating
income.  The  secondary   performance   trigger  for  all  corporate  staff  and
administrative  areas is operation  and  maintenance  expense.  If the secondary
trigger for any  business  unit or the  corporate  staff/administrative  area is
below  threshold,  the award  payout  for this  measure is  forfeited  and award
payouts  for  any  other  performance  measures  are  reduced  by 75%  for  that
particular business unit.

We believe that the existence of these trigger mechanisms clearly emphasizes the
importance of enhancing  shareholder value and ensures that incentive awards are
not paid (or are paid at substantially reduced levels) if key objectives are not
achieved.  For further  discussion of the Corporate Plan and awards  relative to
2006 performance,  see the narrative to the Summary  Compensation  Table and the
Grants of Plan-Based Awards table.

Long-Term Incentive Compensation
--------------------------------

The purpose of long-term  compensation is to encourage actions that are directly
aligned  with the  interests  of our  shareholders.  We  directly  link  officer
compensation  to  shareholder  return by awarding a portion of  compensation  in
equity.  The  Committee  recommended,  and the Board of Directors  adopted,  the
KeySpan Long-Term Performance Incentive Compensation Plan (the "Incentive Plan")
in March 1999. The Incentive Plan was approved by  shareholders  at the May 1999
Annual Meeting.  Under the Incentive Plan, we have awarded executives with three
types of equity-based  compensation:  (1) stock options,  (2) performance shares
and (3) restricted stock.

The Committee is  responsible  for approving all equity awards granted under the
Incentive Plan. The type and amount of long-term  compensation  (as a percentage
of base salary) awarded to each named executive officer is determined,  in part,
by the compensation  value of the long-term  component at the 50th percentile in
the Towers Perrin energy industry peer group.  The actual shares awarded reflect
modification based upon each named executive  officer's  individual  performance
rating using a modifier  percentage as approved by the  Committee.  The modifier
allows the Committee to increase or decrease an award using  discretion,  with a
maximum modification of +/- 20%.

All equity awards are granted on the same day the Committee  approves the awards
(typically  at a meeting in  February),  and are priced  based upon the  closing
price of our  stock on that  date.  With  respect  to  newly  hired or  promoted
executives, grants of equity awards may be approved and granted on their date of
hire or promotion.


                                      193
<PAGE>


Below is a brief  discussion of each type of equity-based  compensation  awarded
pursuant  to  the  Incentive  Plan.  For  more  detailed  information  regarding
long-term  compensation and each form of equity, see the 2006 Outstanding Equity
Awards at Fiscal Year-End table and accompanying narrative.

Stock Options
-------------

The stock option  component of the Incentive  Plan permits the  participants  to
purchase  shares  of  KeySpan  common  stock  at an  exercise  price  per  share
determined by the Committee that is no less than the closing price of the common
stock on the New York  Stock  Exchange  on the date of the  grant.  We have been
expensing  stock  options  since 2003. We did not grant stock options in 2006 or
2007.  The decision  not to grant stock  options in 2006 and 2007 was based upon
the fact that the expense  associated  with such stock  options would exceed the
compensation  value of the award and offer little incentive to executives due to
the pending transaction with National Grid.

Stock  option  awards have never been  re-priced  or granted at less than market
value.  For a  discussion  of  options  granted  prior  to  2006,  see the  2006
Outstanding Equity Awards at Fiscal Year-End table and the following narrative.

Restricted Stock
----------------

The restricted  stock  component of the Incentive Plan provides for the award of
common stock that may not be traded or otherwise  disposed of by the participant
until specific  restrictions have lapsed.  Due to the fact that restricted stock
does not vest until after a  multi-year  period has  lapsed,  the  interests  of
executives  are aligned with the  interests of  shareholders  and we believe the
award encourages the retention of key executives.

For further discussion of the restricted stock awards in 2006, see the narrative
following the Summary Compensation Table and Grants of Plan-Based Awards table.

For 2007, the named executive officers received their entire long-term incentive
award in restricted  stock.  On February 20, 2007,  the  Committee  approved the
following grants of restricted stock: Mr. Catell 26,000; Mr. Luterman 5,110; Mr.
Fani 15,000; Mr. Parker 10,000;  and Mr. Zelkowitz 10,000.  Restricted stock was
considered  the most  appropriate  form of  equity  in view of the fact that the
establishment of multi-year  performance goals was not realistic considering the
pending  acquisition of us by National Grid.  Moreover,  in order to account for
the  expected  timing of this pending  transaction,  named  executive  officers'
long-term grant levels were adjusted to provide  approximately  one-third of the
target share level.

Performance Shares
------------------

The performance  share component of the Incentive Plan entitles the participants
to receive  shares of common stock if certain  performance  goals are  achieved.
Executives  may earn from 0% to 150% of the target level of  performance  shares
granted  based upon our total  shareholder  return  relative to the Standard and
Poor's Utility Group. This type of equity  compensation  encourages  officers to
increase shareholder return because of the contingent nature of the award, which
remains at risk unless the goals are achieved.


                                      194
<PAGE>


The performance  goal for performance  shares granted in 2003, 2004 and 2005 was
linked solely to total shareholder return ("TSR"). The performance goal measures
KeySpan's  cumulative TSR for a three year performance period as compared to the
Standard and Poor's  Utilities  Group.  For the  performance  shares  granted to
officers in 2003 and 2004, the threshold  performance level was not achieved and
as a result  all  performance  shares  granted  in 2003 and 2004 were  forfeited
without  payment,  reinforcing  KeySpan's  "pay  for  performance"  compensation
philosophy.

For a complete  discussion of 2005 and 2006  performance  share grants,  see the
narrative  following  the Summary  Compensation  Table and Grants of  Plan-Based
Awards table, and the narrative  following the 2006 Outstanding Equity Awards at
Fiscal Year-End table.

                           Other Compensation Programs

Executive Group Replacement Life Insurance
------------------------------------------

The named  executive  officers  as well as all  other  executives  and  eligible
management  employees  are also  provided  with  KeySpan  paid  individual  life
insurance.  The  executives do not  participate in the group term life insurance
plan that is provided to all other  employees.  The level of benefit provided to
the executives under this replacement  coverage is equal to the level of benefit
that was formerly  provided to all  employees in the group plan.  We  determined
that the cost of this coverage as a group term policy would be more expensive to
us than the replacement coverage that is now provided.

The life  insurance  benefit for  executives  provides a benefit  level of three
times  base  salary and annual  bonus up to a maximum of  $1,500,000.  All named
executive officers are at the $1,500,000 limit. At retirement,  if the executive
is under age 65,  the  benefit  level  decreases  to a maximum of  $500,000  and
thereafter, decreases again each year between ages 66 and age 70 to a maximum of
$250,000.  For executives who terminate  employment  prior to retirement age, we
discontinue the payment of premiums.  These are variable life insurance policies
that are  individually  owned by the executive and accumulate cash value so that
at age 65 or later,  if premiums have not been paid for a 10 year period,  there
is  sufficient  value  within  the  policy  to allow us to  discontinue  premium
payments and continue to provide the benefit  level stated above in  retirement.
The cash surrender  values as of December 31, 2006, for the named executives are
as follows: Mr. Catell - $163,500; Mr. Luterman $99,700; Mr. Fani - $25,900; Mr.
Parker - $45,300;  and Mr.  Zelkowitz  - $45,200.  The  premiums  paid by us are
taxable to each named executive officer.

Perquisites
-----------

We maintain a perquisite  program for our named  executive  officers,  all other
executives  and  key  management  employees.  The  perquisites  provided  to the
executives are designed to provide a level of benefit to help attract and retain
executives.  Our named  executive  officers are reimbursed for an annual medical
exam up to a cost of $1,000 and are also  eligible  for health  club  membership
reimbursement  up to annual limit of $ 900.  The annual  medical exam and health
club  subsidy  are  viewed  as part of our  initiative  to  encourage  a healthy


                                      195
<PAGE>


lifestyle.  There  is also a  financial  and  estate  planning  perquisite  that
provides  reimbursement  up to $2,000 annually to the named executive  officers.
The reimbursements for health club and financial and estate planning are taxable
to each named executive officer.

Due to the nature of our business  which requires  emergency  response to ensure
public safety,  as well as our  geographically  dispersed  facilities,  cars and
drivers are available for Mr. Catell,  Mr. Fani,  Mr. Parker and Mr.  Zelkowitz.
The incremental cost of personal use of the company car for commutation purposes
has been valued,  and a portion of the cost of the annual lease,  the driver and
maintenance of the vehicle is imputed as income to the executives.

Each named executive  officer is also provided a leased vehicle for business and
personal use. The lease term is 48 months, with an upper dollar limit of $30,000
plus  sales tax on the value of the lease  paid by us for 2006.  If the value of
the vehicle exceeds  $30,000,  the named executive is responsible for payment of
the full amount in excess of this limit including  taxes.  The named  executives
are eligible for reimbursement of up to $1,700 annually for maintenance expense.
The executive is taxed each year for personal use of the leased vehicle.

All such perquisites are reflected in the All Other  Compensation  column of the
Summary Compensation Table and the accompanying footnotes.

Post-Retirement and Post-Employment Plans
-----------------------------------------

We also provide the following  post-retirement and post-employment  plans to our
executives:

o    Our qualified  pension plan,  supplemental  retirement  plan and individual
     agreements  are discussed in detail in the narrative  following the Pension
     Benefits  table.  We provide a qualified  pension plan to all  employees in
     order to be  competitive  in the  marketplace,  to provide a tax  effective
     method for us to fund retirement  benefits,  and to help attract and retain
     executives. In addition to the qualified plan, the named executive officers
     also participate in the KeySpan supplemental pension plan. We maintain this
     unfunded  plan to  provide  named  executive  officers  and other  eligible
     employees  with a pension  benefit  that will make up for the lost  pension
     benefits that result from the Internal Revenue Code limits on the qualified
     plan.

     We have  established  a deferred  compensation  trust and have  contributed
     assets to purchase  corporate  owned life  insurance to provide a source of
     funds for these supplemental benefits.

     Individual  supplemental  retirement  agreements  have been provided to Mr.
     Catell,  Mr. Zelkowitz and Mr.  Luterman.  The agreement for Mr. Catell was
     negotiated  when he accepted  the role of Chairman  and CEO  following  the
     merger of the  Brooklyn  Union Gas  Company  and the Long  Island  Lighting
     Company in 1998. Effective January 1, 2005, we entered into a new agreement
     with Mr. Catell that supersedes the 1998 agreement and continues to provide
     for supplemental pension benefits.


                                      196
<PAGE>


     We  also  provided  both  Mr.   Zelkowitz  and  Mr.   Luterman   individual
     supplemental  pension  agreements due to their shorter length of service as
     compared to other  executives and to provide  incentives to remain with us.
     For a more  detailed  discussion,  see the  narrative  following  the  2006
     Pension Benefits table below.

o    Executives may elect to defer until retirement or termination of employment
     from 10% to 50% of their annual incentive awards to the Officers'  Deferred
     Stock Unit Plan (the  "ODSUP").  We provide this unfunded plan to encourage
     officers to increase their stock ownership in KeySpan and further align the
     interests of the  executives  with that of our  shareholders.  The ODSUP is
     discussed in detail in the narrative  following the  Nonqualified  Deferred
     Compensation table.

o    Executives may elect to defer until retirement or termination of employment
     up to 10% of their  base  salary  to the  Deferred  Compensation  Plan.  We
     provide this unfunded  plan to allow  executives  an  opportunity  to defer
     income and associated income taxes on their compensation. In addition, when
     recruiting senior  executives,  the opportunity to defer compensation is an
     attractive feature in the recruitment  process.  The Deferred  Compensation
     Plan is discussed in the  narrative  following  the  Nonqualified  Deferred
     Compensation table.

o    Change of control  protection  and  severance  benefits are provided in Mr.
     Catell's,  Mr. Luterman's and Mr. Zelkowitz's employment agreements as well
     as to all  officers  in the  KeySpan  Senior  Executive  Change of  Control
     Severance Plan (the "Change of Control Plan").  Change of control severance
     benefits  are   discussed  in  detail  in  the   narrative   following  the
     Nonqualified   Deferred  Compensation  table.  These  individual  agreement
     benefits and the Change of Control Plan benefits are provided to ensure the
     continued  employment of the executive  leadership  team during a period of
     time when  there  may be a great  deal of  uncertainty  pending a change in
     control.

              Policy with Respect to Section 162(m) Deduction Limit

Under Section 162(m) of the Internal Revenue Code of 1986, as amended, we cannot
deduct  compensation  in  excess  of  $1,000,000  paid in any year to the  Chief
Executive Officer or any of the other named executive officers.  Certain benefit
plans and  compensation  paid  under  plans that are  performance  based are not
subject to the $1,000,000  annual limit if certain  requirements  are satisfied.
Although  our  compensation   policy  is  designed  to  relate  compensation  to
performance,  certain payments do not meet such  requirement  because they allow
the  Committee  and the Board of  Directors  to exercise  discretion  in setting
compensation.  The  Committee is of the opinion that it is in our best  interest
for the Committee and the Board of Directors to retain this  discretion in order
to preserve  flexibility in compensating such executive officers,  especially in
light of an increasingly competitive marketplace.

                    KeySpan Executive Stock Ownership Policy

The KeySpan  Executive  Stock  Ownership  Policy was adopted by the Committee in
January 2005. The policy requires increased ownership of KeySpan common stock to
ensure  that the  interests  of the  executives  are  closely  aligned  with the
interest of shareholders.  The policy  establishes target levels of ownership of
KeySpan  stock for officers  which must be achieved  within a five-year  period.
Officers that do not meet the stock ownership  requirements or are not on target
to meet such  requirements  within a five year  period  are  subject  to certain
remedial actions by the Corporation.


                                      197
<PAGE>


Our officers are expected to own shares of KeySpan common stock with a value
equal to a specific multiple of such officer's base salary, as follows:

           Position                                   Multiple of Base Salary
           --------                                   -----------------------

           Chief Executive Officer                              5x

           Chief Operating Officer                              4x

           Presidents                                           3x

           Executive Vice Presidents                            2x

           Senior Vice Presidents                             1.5x

           Vice Presidents                                      1x

All named  executive  officers are  currently in  compliance  with the ownership
policy.  In the event an executive is not in compliance,  any one or more of the
following measures will apply to the executive:

o    May not liquidate any holdings in KeySpan stock.

o    Can not reduce or  discontinue  any payroll  deductions for the purchase of
     KeySpan stock.

o    50% of the after-tax  proceeds from the exercise of stock  options,  or the
     sale of restricted stock or performance shares, are required to be retained
     as KeySpan stock.

                                   Conclusion

We strive to ensure that each  element of  compensation  delivered  to the named
executive  officers is reasonable  and  appropriate  as compared to the type and
levels of compensation  and benefits  provided to executives in the marketplace.
We also believe that such  compensation  should properly reflect the performance
and results  achieved by each individual.  We have also established  performance
measures  that  ensure  that each  component  of  compensation  is aligned  with
shareholders.  Along  with the  Committee,  we  continually  monitor  trends  in
executive  pay to ensure  that  recommendations  and plan  design  reflect  best
practice.




                                      198
<PAGE>

<TABLE>
<CAPTION>
                           Summary Compensation Table
------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Name and      Year   Salary       Bonus      Stock        Option       Non-        Change in Pension    All Other        Total ($)
Principal              ($)         ($)       Awards       Awards      Equity           Value and      Compensation
Position                                      ($)          ($)       Incentive        Nonqualified         ($)
                                              (1)                      Plan            Deferred
                                                                   Compensation      Compensation
                                                                        ($)            Earnings
                                                                                         ($)
------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
<S>         <C>    <C>             <C>    <C>               <C>    <C>              <C>                <C>              <C>
Robert B.    2006   1,140,000       0      3,514,017         0      2,223,900        721,242 (2)        336,830 (3)      7,935,989
Catell,
Chairman &
Principal
Executive
Officer
------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Gerald       2006     486,250       0        274,115         0        590,218        129,804 (2)         87,893 (4)      1,568,280
Luterman,
Executive
Vice
President
&
Principal
Financial
Officer
------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Robert J.    2006     814,500       0        581,225         0      1,104,827        997,503 (5)        239,491 (6)      3,737,546
Fani,
President
& Chief
Operating
Officer
------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Wallace      2006     625,000       0        363,098         0        797,968        592,332 (5)        212,007 (7)      2,590,405
P. Parker
Jr.,
President,
KeySpan
Energy
Delivery
and
KeySpan
Services
------------ ----- ------------ --------- ------------ ----------- -------------- ------------------- ---------------- -------------
Steven L.    2006     625,000       0        410,426         0        784,407        477,570 (5)        206,877 (8)      2,504,280
Zelkowitz,
President,
Energy
Assets
and
Supply
Group
</TABLE>



                                      199
<PAGE>


(1)  For a discussion of assumptions  made in the valuation of restricted  stock
     and  performance  shares,  see "Note 1. Summary of  Significant  Accounting
     Policies" to our audited  financial  statements for the year ended December
     31, 2006.

(2)  Includes  change in pension values (Mr.  Catell:  $709,752;  Mr.  Luterman:
     $128,210)  as well as the  earnings  on  deferred  compensation  under  the
     Deferred  Compensation  Plan that is above market and calculated based upon
     the  difference  between  the  Federal  Reserve  Prime Rate and 120% of the
     Federal Long-Term Rate (Mr. Catell: $11,490; Mr. Luterman: $1,594).

(3)  Includes the cost of life  insurance of $12,848;  the 20% match of $140,000
     contributed by us on amounts  payable under our Corporate Plan but deferred
     to the Officers'  Deferred  Stock Unit Plan;  $161,309 as the total expense
     incurred  to  provide  a car and  driver  used for  business  and  security
     purposes,  with income  imputed for  personal  commutation;  and $22,673 in
     certain other  compensation  and  perquisites,  including a leased vehicle,
     club membership, physical exam and 401(k) employer match, each of which are
     valued at less than $10,000.

(4)  Includes the cost of life  insurance  of $29,603;  the 20% match of $38,828
     contributed by us on amounts  payable under our Corporate Plan but deferred
     to the  Officers'  Deferred  Stock Unit Plan;  and $19,462 in certain other
     compensation  and  perquisites,   including  a  leased  vehicle,  financial
     planning, health club membership,  physical exam and 401(k) employer match,
     each of which are valued at less than $10,000.

(5)  Reflects the change in pension value. These named executive officers do not
     participate in the nonqualified deferred compensation plan.

(6)  Includes  the 20% match of $37,059  contributed  by us on  amounts  payable
     under our Corporate Plan but deferred to the Officers'  Deferred Stock Unit
     Plan;  $166,306 as the total  expense  incurred to provide a car and driver
     used for business and security  purposes,  with income imputed for personal
     commutation;  $11,809 for a leased  vehicle  and  $24,318 in certain  other
     compensation  and  perquisites,  including  the  cost  of  life  insurance,
     financial  planning,  health club  membership,  club  membership and 401(k)
     employer match, each of which are valued at less than $10,000.

(7)  Includes the cost of life  insurance  of $13,082;  the 20% match of $55,009
     contributed by us on amounts  payable under our Corporate Plan but deferred
     to the Officers'  Deferred  Stock Unit Plan;  $118,355 as the total expense
     incurred  to  provide  a car and  driver  used for  business  and  security
     purposes,  with income  imputed for  personal  commutation;  and $25,561 in
     certain other  compensation and perquisites,  including  supplemental  long
     term  disability,  a  leased  vehicle,   financial  planning,  health  club
     membership,  physical exam, club membership and 401(k) employer match, each
     of which are valued at less than $10,000.

(8)  Includes the cost of life  insurance  of $13,849;  the 20% match of $51,313
     contributed by us on amounts  payable under our Corporate Plan but deferred
     to the Officers'  Deferred  Stock Unit Plan;  $123,752 as the total expense
     incurred  to  provide  a car and  driver  used for  business  and  security
     purposes,  with income  imputed  for  personal  commutation;  $17,064 for a
     leased vehicle,  health club membership and 401(k) employer match valued at
     less than $10,000.



                                      200
<PAGE>

<TABLE>
<CAPTION>
                                                                                2006 Grants of Plan-Based Awards
---------- ------- ---------------------------------------- ----------------------------------- -------- ------- -------- ----------
Name       Grant   Estimated Future Payouts Under           Estimated Future Payouts              All     All    Exercise  Grant
           Date    Non-Equity Incentive Plan                Under Equity Incentive Plan          Other    Other   or Base  Date
                   Awards                                   Awards                               Stock   Option   Price    Fair
                                                                                                 Awards: Awards:    of     Value
                                                                                                 Number  Number   Option    of
                                                                                                   of      of     Awards   Stock
                                                                                                 Shares   Secur-   ($/Sh)   and
                                                                                                of Stock  ities            Option
                                                                                                or Units  Under-           Awards
                                                                                                  (#)    lying               ($)
                                                                                                         Options
                                                                                                          (#)
---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
                    Thres-          Target        Maxi-        Thres         Target     Maxi
                     hold            ($)           mum         -hold           (#)      -mum
                      ($)                          ($)          (#)                      (#)
---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
<S>       <C>      <C>              <C>         <C>             <C>         <C>       <C>       <C>         <C>    <C>   <C>
Robert B.  2/23/06  570,000          1,140,000   2,280,000           0            0         0    85,520      0      N/A   3,514,017
Catell                                                                                                                           (1)

---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Gerald     2/23/06  158,031            316,063     632,125       9,180       18,360    27,540         0      0      N/A     633,236
Luterman                                                                                                                         (2)

---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Robert J.  2/23/06  305,438            610,875   1,221,750      19,465       38,930    58,395         0      0      N/A   1,342,696
 Fani                                                                                                                            (2)
---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Wallace P  2/23/06  218,750            437,500     875,000      12,160       24,320    36,480         0      0      N/A     838,797
Parker Jr                                                                                                                        (2)

---------- ------- ------------ --------------- ----------- -------------- ---------- -------- --------- ------- -------- ----------
Steven L.  2/23/06  218,750            437,500     875,000      13,745       27,490    41,235         0      0      N/A     948,130
Zelkowitz                                                                                                                        (2)

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

(1)  Reflects the grant date fair value  pursuant to the  Statement of Financial
     Accounting  Standards No. 123 (revised  2004) -  Share-based  Payment ("FAS
     123R") of the restricted stock granted in 2006.

(2)  Reflects the grant date fair value at threshold  level pursuant to FAS 123R
     of performance shares granted in 2006.






                                      201
<PAGE>


Salary
------

On February 23, 2006, upon recommendation of the Compensation and Management
Development Committee, the Board of Directors approved base salary increases for
2006 for the named executive officers as follows:


                     Approved Base Salary Increases for 2006
<TABLE>
<CAPTION>
------------------------ ------------------------------------ ------------------------------------ ---------------------------------
      Name                     Previous Base Salary               Base Salary Increased To            Effective Date of Increase
------------------------ ------------------------------------ ------------------------------------ ---------------------------------
<S>                                 <C>                                   <C>                              <C>
Mr. Catell                          $1,075,000                            $1,140,000                         January 1, 2006
------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Mr. Luterman                          $467,000                              $488,000                        February 1, 2006
------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Mr. Fani                              $734,000                              $782,000, and then to            January 1, 2006
                                                                            $860,000 (1)                      August 1, 2006
------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Mr. Parker                            $587,000                              $625,000                         January 1, 2006
------------------------ ------------------------------------ ------------------------------------ ---------------------------------
Mr. Zelkowitz                         $545,000                              $625,000 (2)                     January 1, 2006
------------------------ ------------------------------------ ------------------------------------ ---------------------------------
</TABLE>

(1)  Mr.  Fani  received  a second  mid-year  increase  to reflect  his  planned
     succession to the Chief Executive  Officer  position.  Consistent with this
     succession plan, upon recommendation of the Committee,  on May 3, 2006, the
     Board of  Directors  approved  a base  salary  increase  for Mr.  Fani from
     $782,000 to $860,000 effective August 1, 2006.

(2)  The  increase  for Mr.  Zelkowitz  reflects  both a merit  increase  and an
     adjustment  to address  internal  equity  considerations  at the  President
     level.

On  February  21,  2007,  upon  recommendation  of the  Committee,  the Board of
Directors  approved base salary  increases for the named  executive  officers as
follows:

                     Approved Base Salary Increases for 2007
<TABLE>
<CAPTION>
----------------------- ------------------------------------ ------------------------------------ ----------------------------------
      Name                       Base Salary from                      Base Salary to                       Effective Date
----------------------- ------------------------------------ ------------------------------------ ----------------------------------
<S>                                <C>                                  <C>                               <C>
Mr. Catell                         $1,140,000                           $1,220,000                          January 1, 2007
----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Mr. Luterman                         $488,000                             $522,000                         February 1, 2007
----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Mr. Fani                             $860,000                             $919,000                          January 1, 2007
----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Mr. Parker                           $625,000                             $668,000                          January 1, 2007
----------------------- ------------------------------------ ------------------------------------ ----------------------------------
Mr. Zelkowitz                        $625,000                             $668,000                          January 1, 2007
----------------------- ------------------------------------ ------------------------------------ ----------------------------------
</TABLE>

These increases were based on the individual  executive's  performance appraisal
rating and accomplishments  for the 2005 and 2006 calendar years,  respectively,
which took into account  performance  results achieved in 2005 and 2006, as well
as competencies such as leadership,  teamwork,  strategic thinking,  urgency for
results,  enterprise-wide  commitment,   developing  organizational  talent  and
integrity.

The amounts shown in the Non-Equity  Incentive Plan  Compensation  column of the
Summary  Compensation  Committee  include any amounts deferred to the ODSUP. The
ODSUP is  described  more fully in the  narrative  following  the  Non-Qualified
Deferred Compensation table.


                                      202
<PAGE>


Stock Awards
------------

On February 23, 2006,  the  Committee  approved a grant to Mr.  Catell of 85,520
shares of restricted  stock pursuant to the Incentive Plan. The  restrictions on
the  restricted  stock will lapse  after two years on  February  23,  2008.  The
Committee has the  discretion to lapse  restrictions  after one year on February
23, 2007 based on the success of the senior  executive  transition.  On February
20, 2007, the Committee  elected not to accelerate the lapse on these restricted
shares. In the event of retirement or upon a change of control, the restrictions
on the shares granted shall fully lapse. Restricted shares constitute issued and
outstanding  shares of common stock, and therefore,  Mr. Catell has the right to
vote  such  restricted  shares.  Dividends  paid  on the  restricted  stock  are
reinvested  and are subject to all of the same  restrictions  as the  restricted
stock granted to him.

Also on February 23, 2006, the Committee  approved  performance  share grants to
the named  executive  officers  (other than Mr.  Catell).  The estimated  future
payout of performance shares at threshold, target and maximum is provided in the
2006 Grants of Plan-Based  Awards table under the Equity  Incentive  Plan Awards
columns.  Performance  shares were granted at the target level with a three-year
performance period with a threshold,  target and maximum  performance level. The
number of  performance  shares earned at the end of the  performance  period can
range from 0% to 150% of the target  level of shares  granted and will be linked
to the  following  two  performance  measures,  using  a  matrix  approach  that
encompasses both measures:

o    the percentage improvement in Return on Invested Capital ("ROIC"), and

o    KeySpan's cumulative  three-year TSR relative to the cumulative  three-year
     TSR for the Standard and Poor's Utilities Group.

The payout matrix is as follows:

<TABLE>
<CAPTION>
---------- -------- ------------ ---------------------------------------------------------------------------------------------------
                                 Three - Year Cumulative TSR Relative to S&P Utility Group
                                 ---------------------------------------------------------------------------------------------------
                                                                   Threshold                  Target                  Maximum
                                 -------------------------- ------------------------- ------------------------ ---------------------
                                     < 35th Percentile          35th Percentile           50th Percentile         90th Percentile
---------- --------
<S>                                       <C>                        <C>                      <C>                      <C>
Three
year %
Improvement
 in ROIC               < 1%                  0%                        0%                       0%                        0%
---------- --------              -------------------------- ------------------------- ------------------------ ---------------------


           Threshold    1%                  25%                       50%                       75%                     100%
---------- --------              -------------------------- ------------------------- -----------------------  ---------------------


           Target       3%                  50%                       75%                      100%                     125%
---------- --------              -------------------------- ------------------------- ------------------------ ---------------------


           Maximum      5%                  75%                      100%                      125%                     150%
---------- -------- ------------ -------------------------- ------------------------- ------------------------ ---------------------
</TABLE>


                                      203
<PAGE>


The ROIC goal will act as the primary  trigger.  If the ROIC goal performance is
below the threshold level, all shares shall be forfeited without payment. In the
event of an officer's retirement,  performance shares shall be distributed based
upon results achieved at the end of the performance period and pro-rated through
the date of retirement.  Upon a change of control,  performance  shares shall be
distributed  based  upon  the  greater  of  the  number  of  performance  shares
originally  awarded  at target  level or the  number of shares  earned  based on
actual performance through the change of control date.

The dual performance  measures were introduced in 2006 based upon an analysis of
accounting  considerations under the Statement of Financial Accounting Standards
No. 123 (revised 2004) - Share-based  Payment ("FAS 123R"). In this regard,  the
use of TSR as well as ROIC as an internal performance measure,  with ROIC as the
trigger,  allows  for  more  favorable  accounting  treatment  in the  event  of
forfeitures.  If the TSR goal is the sole measure, the FAS 123R accounting rules
will not allow for the  reversal of expense in the event  shares are  forfeited.
Using ROIC as the trigger allows for the reversal of expense in the event shares
are forfeited.

The FAS 123R value  expensed in 2006 for the  restricted  shares  granted to Mr.
Catell  and for the  performance  shares  granted to the other  named  executive
officers  is  reported in the Stock  Awards  column of the Summary  Compensation
Table.

The grant date fair value  pursuant to FAS 123R with  respect to the entire 2006
restricted  share  grant to Mr.  Catell is  reported  in the last  column of the
Grants of Plan Based Awards  table.  The amounts  reported in this table for the
other named executive  officers  reflects the grant date fair value at threshold
for the 2006 performance share awards pursuant to FAS 123R.

There were no grants of stock options to the named executive officers during
2006. Outstanding options from previous grants are reflected in the Outstanding
Equity Awards at Fiscal Year-End table.

Non-Equity Incentive Plan Compensation
--------------------------------------

The Non-Equity  Incentive Plan Compensation  column of the Summary  Compensation
Table reflects amounts earned pursuant to the Corporate Plan. These amounts will
be paid in March of 2007 and are based upon performance  results achieved during
the  twelve-month  period from January 1, 2006 to December 31, 2006.  The awards
earned  under the  Corporate  Plan are paid as cash  (with  the  option to defer
between 10% and 50% of the award to the ODSUP,  as  discussed  in the  narrative
following  the  Nonqualified  Deferred  Compensation  table)  based upon  annual
performance  results.  The amounts  reported in the  Non-Equity  Incentive  Plan
Compensation  column  include  any  amounts  deferred  pursuant  to  the  ODSUP.
Incentive   awards  for  2006   performance   were  determined  based  upon  our
performance,  strategic  business group  performance and individual  performance
results,  and were  calculated as a percentage  of  cumulative  base salary paid
during 2006. The incentive  award ranges for 2006 were zero for below  threshold
performance,  and at threshold, target and maximum as a percentage of cumulative
base salary paid as follows:


                                      204

<PAGE>


              Threshold   Target    Maximum
              ---------   ------    -------
Mr. Catell      50.0%      100%      200%
Mr. Fani        37.5%       75%      150%
Mr. Parker      35.0%       70%      140%
Mr. Zelkowitz   35.0%       70%      140%
Mr. Luterman    32.5%       65%      130%

Threshold,  target and maximum annual incentive awards for 2006 are shown in the
Grants of Plan-Based  Awards table. The actual awards paid in 2007 based on 2006
performance were modified to reflect individual performance appraisal ratings by
the following percentages: Mr. Catell: 15%; Mr. Luterman: 10%; Mr. Fani: 10%;
Mr. Parker: 10%; and Mr. Zelkowitz: 10%.

Change in Pension Value and Nonqualified Deferred Compensation Earnings
-----------------------------------------------------------------------

With respect to Mr. Catell and Mr. Luterman,  the amounts shown in the Change in
Pension Value and  Nonqualified  Deferred  Compensation  Earnings  column of the
Summary Compensation Table includes change in pension values (Catell:  $709,751;
Luterman:  $151,109)  as well as  earnings on  deferred  compensation  under the
Deferred  Compensation  Plan that is above market and calculated  based upon the
difference  between  the  Federal  Reserve  Prime  Rate and 120% of the  Federal
Long-Term Rate (Catell: $11,490; Luterman:  $1,594). The change in pension value
is calculated  using the accrued  pension  benefit as of December 31, 2005,  and
compared to the accrued pension  benefit as of December 31, 2006.  These accrued
amounts  are then  converted  to a present  value  using the  discount  rate and
mortality  assumptions as used at year-end in the valuation of our pension plan.
The change in value reflects the difference between these present value amounts.
The accrued  benefit amounts reflect the annuity amounts that are payable at age
65 or earlier if the executive is eligible for an unreduced  retirement  benefit
at an earlier age. The Deferred Compensation Plan is more fully described in the
narrative following the Non-Qualified Deferred Compensation table.



                                      205
<PAGE>

<TABLE>
<CAPTION>
                 2006 Outstanding Equity Awards at Fiscal Year-End
--------- ----------------------------------------------------------------------- --------------------------------------------------
                                    Option Awards                                                       Stock Awards
--------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Name        Number of      Number of         Equity       Option         Option       Number    Market        Equity       Equity
           Securities      Securities      Incentive     Exercise      Expiration       of      Value       Incentive     Incentive
           Underlying      Underlying     Plan Awards:    Price           Date        Shares     of            Plan         Plan
           Unexercised     Unexercised     Number of       ($)                          or     Shares         Awards:      Awards:
             Options         Options       Securities                                Units of    or           Number       Market or
              (#)            (#)           Underlying                                  Stock    Units           of         Payout
           Exercisable     Unexercisable   Unexercised                                 That      of          Unearned      Value of
                                            Unearned                                   Have     Stock         Shares,      Unearned
                                             Options                                    Not     That          Units        Shares
                                               (#)                                    Vested    Have            or         Units or
                                                                                        (#)      Not           Other       Other
                                                                                                Vested        Rights       Rights
                                                                                                  ($)          That         That
                                                                                                             Have Not       Have
                                                                                                              Vested        Not
                                                                                                              (#)           Vested
                                                                                                                           ($) (1)

--------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
<S>           <C>             <C>             <C>        <C>       <C>            <C>          <C>         <C>          <C>
Robert B.       90,040         135,060         N/A          37.54    3/9/14(a)     16,741 (2)     689,394   40,350 (4)   1,791,742
Catell         125,280          83,520                      32.40    3/4/13(b)
               297,600          74,400                      32.66   2/29/12(c)     88,490 (3)
               267,000                                      39.50   2/12/11(d)                  3,644,018
               525,000                                      22.50   1/19/10(e)
                43,800                                      22.50   1/19/10(f)
               186,667                                    27.0625   5/20/09(g)
               111,000                                     29.375   12/15/08(h)
               235,000                                      27.75   8/12/08(i)
                23,334                                      27.75   8/12/08(j)
               125,000                                     32.625   11/21/07(k)


--------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Gerald          10,960          43,840         N/A          39.25   2/23/15(l)      3,689 (5)     151,913    3,550 (7)     548,476
Luterman        16,600          24,900                      37.54    3/9/14(a)
                25,980          17,320                      32.40    3/4/13(b)      5,431 (6)                9,180 (8)
                65,600          16,400                      32.66   2/29/12(c)                    223,649
                60,000                                      39.50   2/12/11(d)
                25,000                                      22.50   1/19/10(e)
                 6,800                                      22.50   1/19/10(f)
                66,667                                      27.75   7/29/09(m)


--------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Robert J.       25,160         100,640         N/A          39.25   2/23/15(l)      5,383 (9)     221,672   8,150 (10)   1,190,623
Fani            38,240          57,360                      37.54    3/9/14(a)
                41,700          27,800                      32.40    3/4/13(b)                             19,465 (11)
                96,000          24,000                      32.66   2/29/12(c)
                60,000                                      39.50   2/12/11(d)
                18,200                                      36.59    7/1/11(n)
                83,334                                      22.50   1/19/10(e)
                30,000                                    27.0625   5/20/09(g)
                17,000                                      27.75   8/12/08(j)
</TABLE>


                                      206
<PAGE>


<TABLE>
<CAPTION>
                 2006 Outstanding Equity Awards at Fiscal Year-End
--------- ----------------------------------------------------------------------- --------------------------------------------------
                                    Option Awards                                                       Stock Awards
--------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Name        Number of      Number of         Equity       Option         Option       Number    Market        Equity       Equity
           Securities      Securities      Incentive     Exercise      Expiration       of      Value       Incentive     Incentive
           Underlying      Underlying     Plan Awards:    Price           Date        Shares     of            Plan         Plan
           Unexercised     Unexercised     Number of       ($)                          or     Shares         Awards:      Awards:
             Options         Options       Securities                                Units of    or           Number       Market or
              (#)            (#)           Underlying                                  Stock    Units           of         Payout
           Exercisable     Unexercisable   Unexercised                                 That      of          Unearned      Value of
                                            Unearned                                   Have     Stock         Shares,      Unearned
                                             Options                                    Not     That          Units        Shares
                                               (#)                                    Vested    Have            or         Units or
                                                                                        (#)      Not           Other       Other
                                                                                                Vested        Rights       Rights
                                                                                                  ($)          That         That
                                                                                                             Have Not       Have
                                                                                                              Vested        Not
                                                                                                              (#)           Vested
                                                                                                                           ($) (1)



--------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
<S>           <C>             <C>             <C>        <C>       <C>            <C>          <C>         <C>          <C>
Wallace         17,720          70,880         N/A          39.25   2/23/15(l)     5,383 (12)     221,672   5,700 (13)     770,821
P. Parker       29,880          44,820                      37.54    3/9/14(a)
Jr.             41,700          27,800                      32.40    3/4/13(b)                             12,160 (14)
                96,000          24,000                      32.66   2/29/12(c)
                60,000                                      39.50   2/12/11(d)
                18,200                                      36.59    7/1/11(n)
                68,334                                      22.50   1/19/10(e)
                 4,400                                      22.50   1/19/10(f)
                15,000                                    27.0625   5/20/09(g)
                59,000                                      27.75   8/12/08(i)
                 5,667                                      27.75   8/12/08(j)
                17,000                                     32.625   11/21/07(k)

--------- -------------- ---------------- ------------ ----------- -------------- ------------ ----------- ------------ ------------
Steven L.       17,720          70,880         N/A          39.25   2/23/15(l)     3,689 (15)     151,913   5,700 (16)     838,302
Zelkowitz       23,840          35,760                      37.54    3/9/14(a)
                25,980          17,320                      32.40    3/4/13(b)                             13,745 (17)
                65,600          16,400                      32.66   2/29/12(c)
                60,000                                      39.50   2/12/11(d)
                75,000                                      22.50   1/19/10(e)

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

Option Awards footnotes follow:
-------------------------------

(a) The stock  options were granted on March 10, 2004 and are subject to a three
year  vesting  schedule  if the total  stockholder  return  performance  goal is
achieved,  otherwise  the stock  options vest  pro-rata over a five year vesting
schedule with a 10 year exercise period.

(b) The stock  options  were granted on March 5, 2003 and are subject to a three
year  vesting  schedule  if the total  stockholder  return  performance  goal is
achieved,  otherwise  the stock  options vest  pro-rata over a five year vesting
schedule with a 10 year exercise period.

(c) The stock  options  were granted on March 1, 2002 and are subject to a three
year  vesting  schedule  if the total  stockholder  return  performance  goal is
achieved,  otherwise  the stock  options vest  pro-rata over a five year vesting
schedule with a 10 year exercise period.

(d) The stock options were granted on February 13, 2001 and were fully vested as
of February 2006 with a 10 year exercise period.

(e) The stock  options were granted on January 20, 2000 and were fully vested as
of January 2003 with a 10 year exercise period.


                                      207
<PAGE>

(f) The stock  options were granted on January 20, 2000 and were fully vested as
of January 2001 with a 10 year exercise period.

(g) The stock  options  were granted on May 20, 1999 and were fully vested as of
May 2002 with a 10 year exercise period.

(h) The stock options were granted on December 16, 1998 and were fully vested as
of December 1999 with a 10 year exercise period.

(i) The stock  options  were granted on August 13, 1998 and were fully vested as
of August 1999 with a 10 year exercise period.

(j) The stock  options  were granted on August 13, 1998 and were fully vested as
of August 2001 with a 10 year exercise period.

(k) The stock options were granted November 21, 1997 and were fully vested as of
November 2000 with a 10 year exercise period.

(l) The stock  options  were  granted on February  24, 2005 and are subject to a
three year vesting schedule if the total stockholder  return performance goal is
achieved,  otherwise  the stock  options vest  pro-rata over a five year vesting
schedule with a 10 year exercise period.

(m) The stock  options were granted on July 29, 1999 and were fully vested as of
July 2002 with a 10 year exercise period.

(n) The stock  options  were granted on July 2, 2001 and were fully vested as of
July 2006 with a 10 year exercise period.

Stock Awards footnotes follow:
------------------------------

(1)  Reflects  the  fair  value  of  all  outstanding   performance  shares  and
accumulated dividends at the threshold award level.

(2) Includes 13,295  restricted  shares granted on March 1, 2002 with reinvested
dividends of 3,446 shares accrued  through  December 31, 2006.  Such  restricted
shares are restricted for six years and fully vest on March 1, 2008.

(3)  Includes  85,520  restricted  shares  granted  on  February  23,  2006 with
reinvested  dividends of 2,970 shares accrued  through  December 31, 2006.  Such
restricted  shares are  restricted  for two years and fully vest on February 23,
2008.

(4) Reflects performance shares at threshold level granted on February 24, 2005.

(5) Includes 2,930  restricted  shares granted on March 1, 2002 with  reinvested
dividends of 759 shares  accrued  through  December 31,  2006.  Such  restricted
shares are restricted for six years and fully vest on March 1, 2008.

(6)  Includes  5,000  restricted  shares  granted  on  February  24,  2005  with
reinvested  dividends of 431 shares  accrued  through  December  31, 2006.  Such
restricted  shares are  restricted  for two years and fully vest on February 24,
2007.

(7) Reflects performance shares at threshold level granted on February 24, 2005.

(8) Reflects performance shares at threshold level granted on February 23, 2006.

(9) Includes 4,275  restricted  shares granted on March 1, 2002 with  reinvested
dividends of 1,108 shares accrued  through  December 31, 2006.  Such  restricted
shares are restricted for six years and fully vest on March 1, 2008.

(10)  Reflects  performance  shares at threshold  level  granted on February 24,
2005.

(11)  Reflects  performance  shares at threshold  level  granted on February 23,
2006.

(12) Includes 4,275  restricted  shares granted on March 1, 2002 with reinvested
dividends of 1,108 shares accrued  through  December 31, 2006.  Such  restricted
shares are restricted for six years and fully vest on March 1, 2008.

(13)  Reflects  performance  shares at threshold  level  granted on February 24,
2005.


                                      208
<PAGE>

(14)  Reflects  performance  shares at threshold  level  granted on February 23,
2006.

(15) Includes 2,930  restricted  shares granted on March 1, 2002 with reinvested
dividends of 759 shares  accrued  through  December 31,  2006.  Such  restricted
shares are restricted for six years and fully vest on March 1, 2008.

(16)  Reflects  performance  shares at threshold  level  granted on February 24,
2005.

(17)  Reflects  performance  shares at threshold  level  granted on February 23,
2006.

The  Outstanding  Equity Awards at Fiscal  Year-End table  reflects  holdings of
equity-based  interests that relate to compensation or are potential  sources of
future  compensation.  The table  represents  equity-based  interests  that were
awarded in 2006 and all prior years, as well as equity-based  interests that are
"at risk" of forfeiture or expiration prior to exercise.

The Option Awards section of the above table reflects all outstanding vested and
unvested  options.  In  the  event  of  termination  or  retirement,  the  named
executives may forfeit all or a portion of the  unexercisable  options depending
on whether or not they are retirement eligible.  At retirement or termination of
employment due to death or disability,  an adjustment to the vesting schedule is
made to the options that include a 5 year pro-rata vesting schedule to reflect a
36 month vesting schedule.  As a result, the options shall become vested and the
shares may be exercised  based upon a 36 month  pro-rata  vesting  schedule with
such options vesting monthly based on the number of full months that have lapsed
between the grant date and the date of retirement. All outstanding KeySpan stock
options will  immediately  vest on  consummation of a change of control and will
remain exercisable until the close of business on the expiration date.

The stock option award process  included a performance goal feature in the stock
option vesting  schedule for officers  which  directly links  three-year TSR for
KeySpan  common stock to the options  granted since 2001.  The TSR goal measures
the total  return to  shareholders  of KeySpan  common  stock,  including  price
appreciation and dividends.  KeySpan's  performance will be measured against the
S&P  Utility  Group  over a  three-year  performance  period,  with the goal for
KeySpan's  TSR to be at or above  the  median  of those  comprising  the  group.
Options were  granted with a five-year  pro-rata  vesting  schedule.  If KeySpan
achieves  its TSR goal at the end of the  three-year  performance  period,  then
those options that are not yet vested will vest immediately.  If the TSR goal is
not achieved in year three, the remaining unvested options will continue to vest
on the  five-year  schedule.  Stock  options  granted in 2001 and 2002 are fully
vested. For stock options granted in 2003 and 2004, the required TSR performance
target that would  accelerate  vesting was not  achieved  and the stock  options
granted in these years continue to vest over the five year period.

The Stock Awards section of the table reflects outstanding  restricted stock and
performance  shares.  Restricted stock outstanding is reflected in the Number of
Shares or Units of Stock That Have Not Vested  column  and  includes  restricted
stock granted including reinvested dividends.

In 2002,  restricted  stock was  granted to each named  executive  officer.  The
restrictions  on the  restricted  stock  granted  in 2002 will lapse on March 1,
2008. In the event of retirement,  the  restriction  period shall be adjusted to
reflect the number of full months that have lapsed between the date of the award
and the date of retirement using a 48 month restriction  period. In the event of
retirement  after the 48 month  period,  all  restrictions  would  lapse on such
shares and reinvested  dividends.  In the event of termination of employment due
to death  or  disability,  all  restrictions  would  lapse  on such  shares  and
reinvested dividends.

In 2005,  Mr.  Luterman  was  granted  5,000  shares of  restricted  stock.  The
restrictions on this grant of restricted  stock will lapse on February 24, 2007.
For both Mr.  Luterman's  2005 grant and Mr.  Catell's  2006 grant of restricted
stock  described  above, in the event of termination of employment due to death,
disability  or  retirement,  all  restrictions  would  lapse on such  shares and
reinvested  dividends.  For all restricted stock grants to date, in the event of
change  of  control,  the  restrictions  on  all  such  outstanding  shares  and
reinvested dividends will fully lapse on the date of the change of control.


                                      209
<PAGE>


Performance  shares  outstanding  are reflected at  threshold,  or 50% of target
grant level, in the Equity Incentive Plan Awards columns of the 2006 Outstanding
Equity  Awards at  Fiscal  Year-End  table.  The  awards  are  reflected  at the
threshold level due to the forfeiture of the 2004 performance shares.

Performance shares granted in 2005 have a three-year performance period (January
1, 2005 through  December 31, 2007).  The  performance  goal to be measured will
compare KeySpan's cumulative TSR for a three year period, as compared to the S&P
Utilities  Group   cumulative   shareholder   return  for  the  same  three-year
measurement period. The performance shares issued will vary based upon a sliding
scale from 50% to 150% of the number of performance shares awarded at the target
level  based  upon the level of  achievement  of the  performance  goal.  If the
threshold  level  of  the  performance  goal  is  not  achieved,  the  right  to
performance  shares will be  forfeited  without  payment.  The 2005  performance
shares  granted  will be earned on a  pro-rata  basis  based  upon the degree of
achievement of the performance  goal established by the Committee and the shares
will be  issued  and  fully  transferable,  in  accordance  with  the  following
schedule:

    KeySpan Cumulative Return               Percent of Target
    Compared  to S&P Utility Group          Performance Shares Earned
    ------------------------------          -------------------------
       0 to 34th percentile                    0 %
       35th percentile                         50%
       50th percentile                        100%
       90th percentile or over                150%

For information related to the performance measures related to the 2006 grant of
performance shares, see the narrative  following the Summary  Compensation Table
and Grants of Plan Based Awards table.

For both the 2005 and 2006 performance share awards, in the event of termination
of  employment  due  to  retirement  or  disability,   performance   shares  and
accumulated dividends shall be distributed to the named executive officers based
upon the degree of achievement of the  performance  goal at the end of the three
year performance  period, with an adjustment to the total shares calculated on a
pro-rata  basis,  utilizing  the number of full months from the beginning of the
performance  period  to the date of  retirement  or  disability,  divided  by 36
months.

In the event of termination of employment due to death,  the target award amount
will be calculated and  distributed on a pro-rata basis  utilizing the number of
full months from the beginning of the  performance  period to the date of death,
divided by 36 months regardless of performance results.

In the event of change of control, the performance shares including  accumulated
dividends will be calculated and distributed at the change of control date based
upon the greater of the number of shares originally  awarded at target level and
the number of shares earned based upon actual performance  through the change of
control date.

The Merger Agreement  provides that each  outstanding  share of our common stock
(other  than shares of our common  stock  owned by us as treasury  stock or by a
subsidiary of us, or by National Grid or a subsidiary of National  Grid) will be
converted into the right to receive $42.00 per share in cash,  without interest,


                                      210
<PAGE>


or the "merger  consideration."  With respect to all outstanding  options,  upon
consummation of the Merger all unvested options will  immediately  vest, and the
holders of all  options  shall  receive an amount in cash equal to the excess of
the merger  consideration  over the exercise  price per share  applicable to all
such outstanding  stock options.  With respect to shares of restricted stock and
reinvested   dividends,   all   restrictions  on  such  stock  will  lapse  upon
consummation of the Merger.  With respect to performance  shares issued pursuant
to our Incentive Plan, target performance levels will be assumed with respect to
performance shares granted in 2005 and 2006 and, at such target performance, the
target level of such shares and accumulated  dividends will be paid. However, if
actual  performance  levels  through  the date of change of control  result in a
greater  number of shares than target,  then such  greater  number of shares and
accumulated dividends will be paid upon consummation of the change of control.


<TABLE>
<CAPTION>
                     2006 Option Exercises and Stock Vested
--------------------- --------------------------------------------------- ----------------------------------------------------------
                                        Option Awards                                             Stock Awards
--------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
   Name                   Number of Shares    Value Realized on Exercise    Number of Shares Acquired     Value Realized on Vesting
                       Acquired on Exercise              ($)                       on Vesting                       ($)
                                (#)                                                   (#)
--------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
<S>                          <C>                     <C>                              <C>                           <C>
Robert B. Catell              100,000                 1,050,000                        0                             0

--------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Gerald Luterman                     0                         0                        0                             0
--------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Robert J. Fani                      0                         0                        0                             0
--------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Wallace P. Parker Jr.          17,000                   169,524                        0                             0

--------------------- ---------------------- ---------------------------- ----------------------------- ----------------------------
Steven L. Zelkowitz                 0                         0                        0                             0

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


Options  expire  after a 10 year term if not  otherwise  exercised.  None of the
named  executive  officer  options have  expired  prior to being  exercised.  As
reflected in the above  table,  in 2006,  Mr.  Catell and Mr.  Parker  exercised
options due to the approaching expiration date of those options.







                                      211
<PAGE>

<TABLE>
<CAPTION>
                                                      2006 Pension Benefits
------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
    Name                           Plan Name           Number of Years Credited          Present Value of     Payments During Last
                                                               Service                Accumulated Benefit         Fiscal Year
                                                                 (#)                          ($)                     ($)
------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
<S>                     <C>                                  <C>                  <C>                                 <C>
Robert B. Catell         KeySpan Retirement Plan              48 & 6/12             2,299,169                          0

                         KeySpan Supplemental
                         Pension Plan                         48 & 6/12            10,807,207

                         Supplemental Executive
                         Retirement Plan Agreement
                                                                 N/A                5,559,066
------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Gerald Luterman          KeySpan Retirement Plan              7 & 2/12                241,490                          0

                         KeySpan Supplemental
                         Pension Plan                         7 & 2/12                554,906

                         Supplemental Retirement
                         Agreement
                                                                 N/A                  220,708
------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Robert J. Fani           KeySpan Retirement Plan              30 & 6/12             1,647,015                          0

                         KeySpan Supplemental
                         Pension Plan                         30 & 6/12             4,623,290
------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Wallace P. Parker Jr.    KeySpan Retirement Plan              35 & 6/12             1,792,745                          0

                         KeySpan Supplemental
                         Pension Plan                         35 & 6/12             4,039,073
------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
Steven L. Zelkowitz      KeySpan Retirement Plan                  8                   244,702                          0

                         KeySpan Supplemental
                         Pension Plan                             8                   709,496

                         Supplemental Retirement
                         Agreement
                                                                  8                   954,198
------------------------ --------------------------- ---------------------------- -------------------------- ----------------------
</TABLE>

The table above provides the present value ("PV") of the accrued pension benefit
payable at age 65, or  earlier if the named  executive  officer is  eligible  to
receive an unreduced  benefit at an earlier age.  The benefit  amounts  provided
reflect the PV of the accrued  benefit as of December  31,  2006.  The PV of the
accrued benefits is referred to as Accumulated Benefits in the table above.


                                      212
<PAGE>


All amounts above were calculated  based upon the pension plan  measurement date
used for our audited financial statements and financial reporting purposes under
generally accepted accounting  principles.  A 6% discount rate and the mortality
assumptions used at year-end in the plans were used in these calculations.

Under all of our pension plans and supplemental  agreements,  the earliest age a
named executive  officer may retire without a reduction to their pension benefit
for age is age 60. However,  if the named  executive's age plus service is equal
to 80 or greater, the named executive officer may retire as early as age 52 with
no reduction  for age. In this  regard,  the  calculations  provided in the 2006
Pension Benefits table assume early retirement with no reduction for age for Mr.
Fani (age 53) and Mr.  Parker (age 57) as of December 31, 2006.  Mr. Catell (age
69) and Mr.  Luterman (age 62) are also  eligible for  unreduced  benefits as of
December 31, 2006. Mr.  Zelkowitz who is age 57 as of December 31, 2006 will not
be  eligible  for an  unreduced  benefit  until  age  60.  His  accrued  benefit
calculation assumes his pension commences at age 60.

The KeySpan Retirement Plan is a qualified pension plan under ERISA and provides
retirement  benefits to employees who are vested and meet the plan's  retirement
eligibility  age. The benefit  formula for the named  executives  in the plan is
consistent  with  the  formula  provided  to  all  other  management   employees
participating  in the  plan.  The  accrued  benefit  amount  under  this plan is
calculated  using base salary and annual  incentive awards in the calculation of
compensation  under the plan.  The accrued  benefit is based upon the average of
the final five consecutive  years of compensation  multiplied by 1.5% and length
of service.  This accrued  amount,  which is payable  only as an annual  annuity
under the  plan,  has been  converted  to the PV  amount  using the  methodology
described  above.  The  form of  annuity  used in this  calculation  reflects  a
lifetime annuity with no beneficiary  option.  The normal form of annuity option
under the plan is a 50% joint and survivor option.

The named  executive  officers  also  participate  in the  KeySpan  Supplemental
Pension  Plan.  This  supplemental  plan is  maintained  to  provide  retirement
benefits  using the same broad based plan formula  under the  qualified  KeySpan
Retirement  Plan to provide for accrued  benefits that are in excess of IRC Code
Sections  415  and  401(a)(17)  and  can not be  paid  pursuant  to the  KeySpan
Retirement  Plan. The accrued amount under this  supplemental  plan is also only
payable as an annual  annuity.  The annual annuity has been been converted to PV
amount in the table.  The PV amount in the table has been  calculated  using the
methodology  described  above.  The  form of  annuity  used in this  calculation
reflects a lifetime  annuity  with no  beneficiary  option.  The normal  form of
annuity option under the plan is a 50% joint and survivor option.

Mr. Catell's  supplemental  pension benefit formula uses his base pay and annual
incentive  compensation  in  determining  the pension  benefit  amount  provided
pursuant to his agreement.  In this regard, Mr. Catell's  cumulative base salary
and highest annual bonus (as defined  below) paid over any  consecutive 36 month
period is  determined  and then divided by three to determine an annual  average
amount.  This annual  average  amount is then  multiplied  by 65%. The resulting
amount is the gross annual pension benefit.  The gross annual pension benefit is
then reduced by several other pension  amounts (i) 50% of Mr.  Catell's  primary
social security amount; (ii) his KeySpan Retirement Plan benefit;  and (iii) his
KeySpan  Supplemental  Plan Benefit to determine  his  Agreement's  supplemental


                                      213
<PAGE>


retirement  benefit.  This benefit is identified as the  Supplemental  Executive
Retirement  Plan Agreement  benefit in the 2006 Pension  Benefit  Table.  In the
event his  annual  incentive  target is  decreased,  Mr.  Catell's  supplemental
pension  benefit  under the 2005  Agreement  will be  determined  based upon the
highest  annual  target  level  approved  by our Board of  Directors  during his
employment  in the event his actual  award in any year is less than his  highest
annual target. The normal form of benefit provided under the agreement is a 100%
joint and survivor  annuity with his spouse or the actuarial  equivalent form of
benefit  including  a  single  lump  sum.  Pursuant  to  the  provision  of  the
agreements,  Mr.  Catell has  elected a lump sum option  under both his 1998 and
2005 Agreements.

We have also entered into a Supplemental Retirement Agreement with Mr. Zelkowitz
dated as of January 1, 2002.  The agreement  provides one added year of credited
service for each year worked after completion of five years of service,  up to a
maximum of ten years in the  calculation  of his pension  benefits.  The maximum
benefit would add 10 years of credited service providing an incremental  benefit
of 15% of his final five-year average earnings under the KeySpan  Retirement and
Supplemental  plans.  In addition,  at  retirement,  Mr.  Zelkowitz will receive
medical and dental coverage at the same level of employee contribution in effect
at  retirement,  with any  amounts  that may be subject to taxes  grossed up for
federal and state taxes.  If Mr.  Zelkowitz is terminated  in connection  with a
change of control, based upon eight years of actual service through December 31,
2006, the agreement will provide  additional  credited service to the maximum of
ten years.

We have also entered into a Supplemental  Retirement Agreement with Mr. Luterman
dated as of July 1, 2002. The agreement  provides that Mr. Luterman will receive
an  annual   supplemental   retirement  amount  determined  by  multiplying  Mr.
Luterman's  age 62 accrued  benefit  from the  KeySpan  Retirement  Plan and the
KeySpan Supplemental Pension Plan by 35%. Mr. Luterman vested in this benefit in
June 2005. In addition,  at retirement,  Mr.  Luterman will receive  medical and
dental  coverage  at the same  level  of  employee  contribution  in  effect  at
retirement, with any amounts that may be subject to taxes grossed up for federal
and state taxes.

      Employment Agreements Including Change of Control - Post Termination

In September  1998,  we entered into an  employment  agreement  with Mr.  Catell
relating to his  service as  Chairman  and Chief  Executive  Officer,  which was
amended on  February  24,  2000 and June 26,  2002 (the "1998  Agreement").  The
agreement  covered the period  beginning July 31, 1998 and ending July 31, 2005.
Effective  January  1,  2005,  we  entered  into  a  new  agreement  (the  "2005
Agreement"),  which supersedes the 1998 Agreement.  The 2005 Agreement  provided
for Mr. Catell's  continued  employment  until July 31, 2006. The 2005 Agreement
also provides that the term of the agreement would be extended in the event of a
change of control (as defined in the 2005 Agreement). Pursuant to the agreement,
and as a result of the pending acquisition of KeySpan by National Grid, the term
of the agreement has been extended until two years  following the closing of the
transaction.

Mr.  Catell's  employment  agreement also provides for severance  benefits to be
paid to him in the event his  employment is terminated by KeySpan  without cause
or if Mr.  Catell  terminates  his  employment  for good reason.  The  severance
benefits to be provided during the Severance  Period (as defined below) include:
(a) payment to Mr.  Catell in a single  lump sum of (i) all accrued  obligations


                                      214
<PAGE>


(the accrued obligations include any base salary,  annual or long-term incentive
compensation  actually  earned but not yet paid through the date of termination,
accrued but unpaid  vacation  pay,  and any  compensation  previously  deferred,
inclusive of any accrued interest),  and (ii) the aggregate amount of salary and
annual  incentive  compensation  that he would  have  received  had he  remained
employed  through the end of the  employment  period;  (b) continued  accrual of
Supplemental  Executive  Retirement Plan benefits (as provided in the agreement)
to the end of the term of the agreement;  (c) continuation of all other employee
benefits;  and (d)  acceleration  of vesting of all equity awards,  as if he had
remained  employed by KeySpan  during the term of the  agreement.  If Mr. Catell
voluntarily  terminates his employment,  other than for good reason, we will pay
the  accrued  obligations  to Mr.  Catell and he shall be entitled to retire and
receive all the pension benefits as provided under the various pension plans, as
well as retiree  medical and dental  coverage  provided  under the group  health
plan. In addition,  he is eligible for the benefits  under the  Executive  Group
Replacement  Life  Insurance  Policy  as  described  in the  above  Compensation
Discussion  and Analysis.  If Mr. Catell is terminated  without cause or resigns
for good reason during the Protection  Period,  Mr. Catell will be provided with
severance  at a multiple  of two times base  salary and  highest  annual  bonus,
continued benefits and additional  supplemental pension benefits accrual for the
two year period  following his  termination.  The highest annual bonus under the
agreement is  calculated  based upon the higher of the average of the three most
recent  years of bonus  received  prior to the  change of  control  and the most
recently received annual bonus.

The protection  period under his agreement begins on the date that we enter into
a definitive agreement that would constitute a change of control transaction (as
defined in the Change of Control Plan) and ends on the second anniversary of the
date following consummation of such change of control.

Mr. Catell may resign for any reason in the thirteenth  month following a change
of control with all severance benefits.  In the event that any payments or other
severance  benefits Mr.  Catell  receives  from us or otherwise are subject to a
parachute  excise tax, then Mr. Catell will be entitled to a gross-up payment in
order to put him in the same  after-tax  position  he would have been in without
the imposition of the excise tax.

In March 2006, we entered into a letter agreement with Mr. Luterman  relating to
his service as Executive Vice President and Chief Financial Officer.  The letter
agreement  provides  that in the event of his  termination  of  employment  as a
result of the change of control of KeySpan,  he would be entitled to  separation
benefits  under the Change of Control Plan  without  regard to his age as of any
date of termination  or mandatory  retirement  age. Under the qualified  pension
plan, age 65 is the mandatory  retirement  age. The Change of Control Plan would
have otherwise capped his separation benefit at this age.

                Senior Executive Change of Control Severance Plan

On October 29, 2003,  after a  competitive  market  analysis and a due diligence
review by an outside consultant,  our Board of Directors  authorized a five year
extension  of the Change of Control  Plan.  The Change of Control  Plan  expires
October 30,  2008,  unless  extended  for an  additional  period by our Board of
Directors;  provided that,  following a change of control, the Change of Control
Plan shall continue  until after all the  executives who become  entitled to any
payments or benefits thereunder shall have received such payments in full.


                                      215
<PAGE>


With the exception of Mr. Catell, all other named executive officers participate
in the Change of Control  Plan.  The Change of  Control  Plan  provides  for the
payment of severance and other benefits upon certain qualifying  terminations of
such executives within two (2) years of a "change of control" (as defined in the
Change of Control Plan). The protection  period under the Change of Control Plan
commences upon the date that we enter into a definitive agreement  contemplating
a change of  control  and will  continue  for a period  of two  years  after the
effective  date of the  actual  change  of  control.  Upon  the  signing  of the
definitive  Merger Agreement with National Grid, the protection period went into
effect on February 25, 2006.  The benefits  payable  under the Change of Control
Plan provide for:

     (i) the payment of the executive's base salary and compensation  previously
deferred by the executive, earned through the date of termination;

     (ii) the  payment of an amount  equal to three  times an  executive's  base
salary and highest  annual  bonus (as defined in footnote 1 following  the table
below) for any  President,  any  Executive  Vice  President  and any Senior Vice
President and two times an executive's  base salary and highest annual bonus for
Vice Presidents;

     (iii) the payment of amounts under retirement plan formulas,  including the
applicable two to three year period as added service and compensation  under the
plans; and

     (iv) the continuation of medical,  dental and life insurance benefits for a
period of two to three years depending on the executive's position with us.

In addition to severance benefits provided under the Change of Control Plan, the
occurrence  of a change of  control  will also  result  in the  acceleration  of
vesting of all equity based awards under the provisions of the Incentive Plan.

                 Estimated Change of Control/Severance Payments

The following table shows the amount of potential  severance  benefits including
potential  gross-up  amounts for excise taxes for the named  executive  officers
pursuant to the Change of Control Plan, or in the case of Mr.  Catell,  his 2005
Agreement,  and in the case of Mr.  Luterman,  his 2006  agreement,  assuming  a
change of  control  took  place in 2006 and the named  executive  officers  were
terminated  on December 31,  2006.  The table also shows the  estimated  present
value of continuing  coverage for the benefits  provided under our group health,
dental, executive life insurance and all retirement plans. The amounts indicated
are applicable only in the event the named  executive  officers are not retained
upon a change of control or they resign for good  reason  under the terms of the
plan. Upon termination of employment,  each named executive  officer is eligible
for outplacement  benefits not to exceed $30,000.

Mr. Catell has agreed to serve as Deputy Chairman of National Grid and Executive
Chairman  of National  Grid US8 for a two-year  period  following  the change of
control date. Assuming he serves in such capacities for such period, he will not
be  entitled  to  receive  the  severance  benefits  listed in the table  below.


                                      216
<PAGE>


Likewise,  in the  event the  other  named  executive  officers  continue  their
employment beyond a two-year  protection period,  they also will not be entitled
to receive the  payments  listed in the table  below.  However,  pursuant to the
Change of Control  Plan, an excise tax and gross-up  payment of  $2,146,137  and
$1,195,864, regardless of their continued employment, will be made to Mr. Catell
and Mr.  Fani,  respectively,  as a result of the  acceleration  of vesting upon
change  of  control  associated  with  unvested  options,  restricted  stock and
performance shares.

<TABLE>
<CAPTION>
                                                               Estimated               Estimated  Present            Estimated
                               Potential Cash                   Value of                   Value of                  Excise Tax
                                 Severance                      Welfare                    Retirement                and  Gross-up
Executive Officers               Payment (1)                    Benefits  (2)              Benefits  (3)             Payments (4)

<S>                                  <C>                            <C>                        <C>                   <C>
Robert B. Catell (5)          $       6,480,000             $          45,000         $         2,600,768            $7,069,925
Gerald Luterman               $       3,017,125             $         117,300         $           605,298            $2,299,900
Robert J. Fani                $       5,544,700             $          54,900         $         3,783,892            $6,256,851
Wallace P. Parker Jr.         $       4,075,361             $          69,300         $         2,151,370            $4,053,558
Steven L. Zelkowitz           $       3,927,516             $          72,900         $         2,135,649            $3,977,279

</TABLE>

(1)  Cash  severance  benefit is a lump sum  payment  based on the  annual  base
     salary  prior to  termination  plus the  highest  annual  bonus  times  the
     severance  multiple.  Highest annual bonus is defined as the greater of the
     bonus most  recently  paid prior to the change of control or the average of
     the three prior years ("Highest Annual Bonus").  The lump sum also includes
     an amount which represents the Highest Annual Bonus prorated from January 1
     to the date of termination  divided by 365. The severance  multiple for Mr.
     Catell  pursuant to his  employment  agreement is two times while all other
     named executive officers listed above have a multiple of three times.

(2)  Includes the cost of continuation of employee coverage for medical,  dental
     and life insurance  during the two year period for Mr. Catell and the three
     year period for all other named executive officers.

(3)  Represents the present value of the increase in the annual lifetime pension
     annuity  attributed to the added service and  compensation  associated with
     the two year period for Mr.  Catell and the three year period for all other
     named executive officers.

(4)  The  executive  officers  are  entitled  to receive a  gross-up  payment to
     eliminate  the effect on any "golden  parachute"  excise  taxes that may be
     imposed on the  executives  under  Sections  280G and 4999 of the  Internal
     Revenue  Code.  This is a tax  imposed  on the  executive  above and beyond
     ordinary  income  taxes.  The  amount  of such  gross-up  payment  has been
     calculated  taking into  consideration  the value of the all cash severance
     payments,  the value of all benefits and the  acceleration of equity awards
     attributed to change of control. This payment amount is provided to pay the
     excise  taxes that may be imposed on the  executive as well as any taxes on
     this gross-up check.  All other federal,  state and local income taxes that
     are attributed to the cash severance  payments,  benefits and equity awards
     will be paid by the executive.

(5)  Mr.  Catell's  severance  benefits are provided  pursuant to his employment
     agreement  dated January 1, 2005.  Mr.  Catell is not a participant  in the
     Change of Control Plan.


                                      217
<PAGE>


The following  table  provides a summary of the value of unvested stock options,
restricted stock and performance shares that vest upon a change of control.

      Accelerated Vesting of Equity Awards Attributed to Change of Control

<TABLE>
<CAPTION>
--------------------------- ------------------------------- ----------------------------------- ------------------------------------
                                                                  Unvested Restricted Stock          Unvested Performance Shares
                                Unvested Stock Options                     ($) (2)                             ($) (3)
                                       ($) (1)
--------------------------- ------------------------------- ----------------------------------- ------------------------------------
<S>                                     <C>                                 <C>                                 <C>
    Robert B. Catell                     1,858,813                           4,333,412                           5,074,658
--------------------------- ------------------------------- ----------------------------------- ------------------------------------
    Gerald Luterman                        467,046                             375,562                           1,371,813
--------------------------- ------------------------------- ----------------------------------- ------------------------------------
     Robert J. Fani                        851,591                             221,672                           3,014,580
--------------------------- ------------------------------- ----------------------------------- ------------------------------------
 Wallace P. Parker Jr.                     748,510                             221,672                           2,036,389
--------------------------- ------------------------------- ----------------------------------- ------------------------------------
  Steven L. Zelkowitz                      558,765                             151,913                           2,071,571
--------------------------- ------------------------------- ----------------------------------- ------------------------------------
</TABLE>

(1)  The value of all  unvested  options  reflects  the  difference  between the
     exercise  price of each unvested  option and the closing price of our stock
     at the fiscal year end ($41.18 per share).

(2)  The value of all unvested  restricted  shares reflects the closing price of
     our  stock at fiscal  year end  ($41.18  per  share)  including  reinvested
     dividends, with all restrictions assumed to be lapsed on December 31, 2006.

(3)  The value of all unvested  performance  shares  reflects  shares granted in
     2004, 2005 and 2006, and assumes that the shares and accumulated  dividends
     vested  at the  target  grant  level at the  closing  price of our stock at
     fiscal year end ($41.18  per  share).  While the 2004 grant of  performance
     shares would have vested under an assumed change of control on December 31,
     2006, in actuality these shares and accumulated dividends thereon have been
     forfeited because the performance  result required to vest this award as of
     December  31, 2006 was not  achieved.  The amounts  forfeited by each named
     executive  officer are as follows:  Mr. Catell:  $1,491,174;  Mr. Luterman:
     $274,860;  Mr. Fani:  $633,334;  Mr. Parker:  $494,749;  and Mr. Zelkowitz:
     $394,967.




                                      218
<PAGE>


<TABLE>
<CAPTION>
                                             2006 Nonqualified Deferred Compensation
------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Name                Executive                 Registrant                  Aggregate               Aggregate           Aggregate
              Contributions in Last        Contributions in              Earnings in             Withdrawals/         Balance at
                       FY                       Last FY                    Last FY              Distributions          Last FYE
                       ($)                        ($)                        ($)                      ($)                  ($)
                       (1)                        (2)                        (3)                                           (4)
------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
<S>                  <C>                         <C>                 <C>                             <C>              <C>
Robert B.             700,000                     140,000             191,220 (5)                     0                4,167,494
Catell
------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Gerald                194,141                      38,828              33,759 (5)                     0                  772,696
Luterman
------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Robert J.             185,294                      37,058                  57,189                     0                1,359,983
Fani
------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Wallace P.            275,045                      55,009                  56,410                     0                1,369,767
Parker Jr.
------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
Steven L.             256,565                      51,312                  48,834                     0                1,191,472
Zelkowitz
------------ ------------------------ --------------------------- ----------------------- ----------------------- ------------------
</TABLE>

(1)  Reflects amounts deferred by each named executive officer to the ODSUP from
     the amount  earned under the  Corporate  Plan for the purchase of our stock
     units.  The  amounts  deferred  would  have  been paid to each of the named
     executives in 2006 attributable to performance in 2005.

(2)  Represents the 20% match on the amount deferred into the ODSUP.

(3)  Includes dividends paid on shares held in the ODSUP.  Dividends paid in the
     ODSUP  are  equal  to  dividends  paid  to  all  KeySpan  stockholders  and
     therefore,  no  amount is  preferential  or above the  market  rate.  Since
     dividends paid in the ODSUP are not above the market rate,  earnings on the
     ODSUP are not included in the Summary  Compensation  Table, but rather, are
     included in this column in its entirety.

(4)  Aggregate balance of deferred  compensation  represents  amounts previously
     deferred by the named  executive  officers  and any earnings  thereon.  The
     ODSUP shares have been valued at the full market value closing price of our
     stock per share at fiscal year end ($41.18 per share).

(5)  Also  includes  earnings  on  amounts  deferred  pursuant  to the  Deferred
     Compensation Plan.

Officers' Deferred Stock Unit Plan
----------------------------------

Pursuant  to the ODSUP and  consistent  with our desire to  encourage  increased
officer stock  ownership to further align the  interests of our  executives  and
stockholders,  the named  executive  officers and certain other  executives  may
elect to defer  between 10% and 50% of their  annual cash award earned under the
Corporate Plan to deferred stock units held within the ODSUP. The deferred stock
units  track the  performance  of our  common  stock but do not  possess  voting
rights.  The deferred stock units receive  dividends which accumulate during the
deferral period.

Executives  also  receive a 20% match from us on the  amounts  deferred  in each
year,  which  amounts are reported in the All Other  Compensation  column of the
Summary  Compensation  Table.  The match component and dividends on the deferral
will track the  performance of our common stock and will generally be payable in
cash upon  retirement.  Amounts  held  within the ODSUP must be  deferred  until
retirement  or  resignation  and are  payable  in common  stock for the  amounts
deferred by the executive,  and either in stock or cash for the match  component
and dividends.  In the event of the executive's resignation prior to retirement,
the match and  dividends are  forfeited.  Each of the named  executive  officers
elected to defer the  following  amounts of their annual cash awards  payable in
2006   (attributable  to  2005  performance)  and  2007  (attributable  to  2006
performance), respectively:


                                      219
<PAGE>


                        2006                    2007
                        ----                    ----

Mr. Catell              50%                     50%

Mr. Fani                25%                     25%

Mr. Parker              50%                     50%

Mr. Zelkowitz           50%                     50%

Mr. Luterman            50%                     40%

Upon a change in control,  all deferred stock units,  the match and  accumulated
dividends will be converted to cash and  distributed to the executives  pursuant
to the plan provisions as permitted under Internal Revenue Code section 409A.

Deferred Compensation Plan
--------------------------

Pursuant to the Deferred  Compensation Plan, by December 31st of each year, each
eligible executive and management employee may elect to defer receipt of between
1% and 10% of the  following  year's base pay.  Deferred  compensation  for each
participant  shall  be  credited  to an  account  on our  books  (the  "Deferred
Account").  Interest  on amounts in a Deferred  Account  shall be  credited  and
compounded  monthly based on the average  reference  rate during such month (the
"Prime Rate").

In the event of an  executive's  separation  from  service,  the  amounts in the
executive's   Deferred   Account  shall  be  distributed   consistent  with  the
distribution  election  made by the executive  and as permitted  under  Internal
Revenue Code section 409A.

Mr.  Catell  and Mr.  Luterman  maintain  a balance in this plan while the other
named executive officers do not participate in this plan.







                                      220
<PAGE>

<TABLE>
<CAPTION>
                   2006 Director Compensation
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
Name (1)       Fees Earned   Stock Awards   Option Awards   Non-Equity Incentive     Change in Pension      All Other        Total
               or Paid in       ($) (2)          ($)          Plan Compensation          Value and        Compensation        ($)
                  Cash                                               ($)               Nonqualified            ($)
                   ($)                                                                   Deferred
                                                                                   Compensation Earnings
                                                                                            ($)
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
<S>             <C>                <C>            <C>                 <C>                    <C>             <C>           <C>
A. S.            73,500             64,000         0                   0                      0               0             137,500
Christensen
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
A. H.            81,500 (3)         64,000         0                   0                      0               0             145,500
Fishman
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
J. R.            70,500 (4)         64,000         0                   0                      0               0             134,500
Jones
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
J. L.            75,500 (5)         64,000         0                   0                      0               0             139,500
Larocca
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
G. C.            63,500 (6)         64,000         0                   0                      0               0             127,500
Larson
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
S. W.            81,500 (7)         64,000         0                   0                      0               0             145,500
McKessy
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
E. D.            70,500 (8)         64,000         0                   0                      0               0             134,500
Miller
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
V. L.            69,500 (9)         64,000         0                   0                      0               0             133,500
Pryor
------------- -------------- -------------- --------------- ---------------------- --------------------- -------------- ------------
</TABLE>

(1)  Messrs.  Catell and Fani are not listed in the above table because  neither
     receives any additional  compensation for serving on our board of directors
     or its committees.

(2)  Stock  awards are  received  as common  stock  equivalents  pursuant to the
     Directors' Deferred Compensation Plan.

(3)  Includes  $48,900  elected  by  the  director  to be  received  as a  stock
     equivalent and deferred  pursuant to the Directors'  Deferred  Compensation
     Plan.

(4)  Includes  $35,250  elected  by  the  director  to be  received  as a  stock
     equivalent and deferred  pursuant to the Directors'  Deferred  Compensation
     Plan.

(5)  Includes  $18,875  elected  by  the  director  to be  received  as a  stock
     equivalent and deferred  pursuant to the Directors'  Deferred  Compensation
     Plan.

(6)  Includes  $63,500  elected  by  the  director  to be  received  as a  stock
     equivalent and deferred  pursuant to the Directors'  Deferred  Compensation
     Plan.

(7)  Includes  $40,750  elected  by  the  director  to be  received  as a  stock
     equivalent and deferred  pursuant to the Directors'  Deferred  Compensation
     Plan.

(8)  Includes  $70,500  elected  by  the  director  to be  received  as a  stock
     equivalent and deferred  pursuant to the Directors'  Deferred  Compensation
     Plan.

(9)  Includes  $69,500  elected  by  the  director  to be  received  as a  stock
     equivalent and deferred  pursuant to the Directors'  Deferred  Compensation
     Plan.


                                      221
<PAGE>


The  directors'  compensation  as  reflected  in the table  above  includes  the
following amounts:

Non-employee directors:

$43,500 annual retainer;
$2,000 committee meeting fee;
$5,000 committee chairman retainer;
$10,000 audit committee chairman retainer;
$10,000 Lead Director retainer; and
$64,000  in common  stock  equivalents  granted  under the  Directors'  Deferred
Compensation Plan.

The employee  directors  receive no additional  compensation  for serving on the
Board or its committees.

The board of directors has adopted Directors'  Deferred  Compensation Plans (pre
2005  and post  2005  plans)  to  directly  align  the  non-employee  directors'
financial  interest  with those of the  shareholders.  The  Directors'  Deferred
Compensation  Plans provide all  non-employee  directors with the opportunity to
defer any portion of their cash compensation received as directors,  in exchange
for common  stock  equivalents  or into a deferred  cash  account.  Common stock
equivalents  are valued by  utilizing  the average of the high and low price per
share of our common stock on the first trading day of the quarter  following the
quarter in which contributions are received.  Dividends are paid on common stock
equivalents in additional  common stock  equivalents  in the same  proportion as
dividends  paid on common  stock.  Compensation  not deferred and  exchanged for
common stock equivalents may be deferred into a cash account bearing interest at
the  prime  rate.  Additionally,  a  director  may  elect to  invest  his or her
compensation  by  participating  in the  KeySpan  Investor  Program (a  dividend
reinvestment  plan).  Upon  retirement,  death or  termination  of  service as a
director,  all amounts in a director's  common stock  equivalent  account and/or
cash account  shall,  at the director's  election,  (i) be paid in a lump sum in
cash; (ii) be deferred for up to five years;  and/or (iii) be paid in the number
of annual  installments,  up to ten,  specified  by the  director.  Our  current
non-employee  directors are not entitled to benefits under any of our retirement
plan.

With the exception of Ms.  Christensen,  each listed director elected to defer a
portion or all of his or her cash earnings for 2006 into stock equivalents under
the Directors'  Deferred  Compensation  Plans. No director  elected to defer any
compensation  into the  deferred  cash  account  under the  Directors'  Deferred
Compensation Plans.

           Compensation Committee Interlocks and Insider Participation

Neither Ms. Larson nor Messrs. Jones,  Larocca,  McKessy and Miller, the current
members  of the  Committee,  is an  officer or  employee,  or former  officer or
employee, of us or any of our subsidiaries.  No interlocking relationship exists
between  the  members  of our  Board  of  Directors  or the  Committee  and  the
compensation  committee,  or board committee performing equivalent functions, of
any other company,  nor has any such  interlocking  relationship  existed in the
past.


                                      222
<PAGE>


                          Compensation Committee Report

Under the rules of the New York Stock  Exchange  and the  Sarbanes-Oxley  Act of
2002, the Board of Directors must determine that each member of the Committee is
independent under all applicable standards.  Additionally, no director may serve
unless he or she is a  "Non-employee  Director" for purposes of Rule 16b-3 under
the Securities Exchange Act of 1934, as amended,  and satisfies the requirements
of an "outside director" for purposes of Section 162 (m) of the Internal Revenue
Code. The members of the Committee are James R. Jones, James L. Larocca,  Gloria
C. Larson, Stephen W. McKessy and Edward D. Miller serving as chairperson.  None
of such  members is or has been an officer or  employee of KeySpan or any of its
subsidiaries and they meet the required standards of independence. The Committee
operates  under a written  charter  adopted by the Board of  Directors  which is
available on our internet site at http://www.keyspanenergy.com.

The Committee has reviewed and discussed the Company's  Compensation  Discussion
and Analysis with management at meetings held on December 24, 2006,  January 24,
2007 and February 20, 2007. Based on the review and  discussions,  the Committee
recommended  to the Board of  Directors  that the  Compensation  Discussion  and
Analysis be included in our annual report on Form 10-K.



            Compensation and Management Development Committee

            James R. Jones                 Stephen W. McKessy

            James L. Larocca               Edward D. Miller, Chairperson

            Gloria C. Larson







                                      223
<PAGE>



ITEM 12.       SECURITY  OWNERSHIP OF CERTAIN  BENEFICIAL  OWNERS AND MANAGEMENT
               AND RELATED STOCKHOLDER MATTERS

Security Ownership of Certain Beneficial Owners

As of February 20, 2007, there were no beneficial  owners of more than 5% of our
common stock.

Security Ownership of Management

The following table sets forth information as of February 20, 2007, with respect
to the number of shares of common stock  beneficially  owned  (including  vested
stock  options),  common  stock  equivalents  and/or  deferred  stock  units and
performance  shares credited to each director,  each named executive officer and
all directors and executive officers as a group.

<TABLE>
<CAPTION>
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
                      Name of          Amount and Nature of       Common Stock Equivalents or   Performance           Percent of
                 Beneficial Owner    Beneficial Ownership of        Deferred Stock Units(2)      Shares(3)        Outstanding Common
                                     Common Stock (including                                                          Stock((4))
                                     Vested Stock Options)(1)
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
<S>        <C>                                      <C>                                <C>              <C>             <C>
Named       R. B. Catell*                            2,358,448                          89,151           80,700          1.4%
Executive
Officers

----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            G. Luterman                                 302,737                         17,146           25,460           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            R. J. Fani*                                 449,103                         33,409           55,230           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            W. P. Parker Jr.                            470,269                         33,649           35,720           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            S. L. Zelkowitz                             297,249                         29,269           38,890           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------

Directors   A. S. Christensen                             8,871                         19,345                0           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            A. H. Fishman                                13,061                         27,584                0           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            J. R. Jones                                  11,227                         15,829                0           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            J. L. Larocca                                14,573                         17,037                0           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            G. C. Larson                                    556                         10,505                0           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            S. W. McKessy                                10,615                         23,579                0           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            E. D. Miller                                 21,318                         34,318                0           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            V. L. Pryor                                       0                          8,088                0           **
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
            All directors and                5,490,385(4)(5)(6)                        479,917          420,070          3.6%
            executives as a group,
            including those named
            above, a total of 28
            persons.
----------- ---------------------- ----------------------------- ------------------------------ ---------------- -------------------
</TABLE>

*    Messrs. Catell and Fani are also directors

**   Less than 1%.

(1)  Beneficial  ownership of common stock includes holdings in KeySpan's 401(k)
     Plan,  Employee Discount Stock Purchase Plan,  Dividend  Reinvestment Plan,
     and/or in other stock accounts,  as well as issued and  outstanding  vested
     stock  options.  Such stock  options  give the holder the right to purchase
     underlying  shares of common  stock at the  respective  exercise  price per
     share of the option.  All such stock  options  were  granted at an exercise
     price equal to the closing price of our common stock on the respective date
     of grant.


                                      224
<PAGE>


(2)  Includes common stock equivalents or deferred stock units. The term "common
     stock equivalents"  refers to units of value which track the performance of
     common stock.  Such units do not possess voting rights and have been issued
     pursuant to the Directors' Deferred  Compensation Plans. The term "deferred
     stock units" also refers to units of value which track the  performance  of
     common stock.  Such units do not possess voting rights and have been issued
     pursuant to the Officers' Deferred Stock Unit Plans.

(3)  Performance  shares have been granted with a three-year  performance period
     with a  threshold,  target and  maximum  performance  level.  At  threshold
     performance, 50% of the award shall be earned; at target, 100% of the award
     shall be earned;  and at maximum,  150% of the award  shall be earned.  The
     number of shares set forth above  assumes the target  level of  performance
     with a 100% payout.


(4)  Calculated  as  the  total  of  the  three  previous   columns  divided  by
     175,588,130 the number of shares outstanding on February 20, 2007.

ITEM 13.       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, and
               DIRECTOR INDEPENDENCE

Please see Item 11.  Executive  Compensation for a description of our employment
and change of control agreements and plans.

Directors and Officers Liability Insurance and Indemnity

We have director and officer,  or "D&O"  liability  insurance for the purpose of
reimbursing  us  when  we have  indemnified  our  directors  and  officers.  D&O
liability  insurance also provides  direct payment to our directors and officers
under   certain   circumstances   when   we   have   not   previously   provided
indemnification.  We also have  liability  insurance  which  provides  fiduciary
coverage for us, our directors, officers and employees for any alleged breach of
fiduciary  duty under the  Employee  Retirement  Income  Security  Act.  Our D&O
liability  insurance  was  purchased  from  Associated  Electric & Gas Insurance
Services, Energy Insurance Mutual, Zurich American,  Hartford, Starr Excess, St.
Paul Mercury  Insurance Co. and Liberty Mutual for a one year period  commencing
on May 28, 2006 at a cost of $3,483,325.  Fiduciary liability insurance from the
American International Group, CHUBB, Zurich American and Energy Insurance Mutual
for a one year period  commencing  on August 26, 2006 at a cost of $733,207.  We
plan to renew both programs upon expiration.

Director Independence

Pursuant  to our  Corporate  Governance  Guidelines,  which  can be found on the
Investor  Relations  section of our website at  http://www.keyspanenergy.com  or
directly        on        our        corporate         governance        website
(http://governance.keyspanenergy.com),  our board undertook a review of director
independence.  As a result of this review,  our board  affirmatively  determined
that all of the directors are  independent  under the standards set forth in the
Corporate  Governance  Guidelines,  and the  relevant  NYSE  and SEC  rules  and
regulations,  with the  exception  of Robert B.  Catell and Robert J. Fani.  Mr.
Catell cannot be deemed independent under the Corporate Governance Guidelines or
applicable rules and regulations because he serves as Chief Executive Officer of
the  Corporation.  Mr. Fani  cannot be deemed  independent  under the  Corporate
Governance  Guidelines or applicable rules and regulations  because he serves as
Chief Operating Officer and President of the Corporation.


                                      225
<PAGE>


The basis for our board's determination that the independent directors are
indeed independent is set forth in our Corporate Governance Guidelines and is
set forth, in relevant part, below:

     At all times, a majority of the directors  shall be  independent  directors
     under  the  rules of the NYSE  and the  Sarbanes-Oxley  Act of 2002 and the
     regulations   promulgated   thereunder.   The  following   guidelines   are
     established  to  assist  our board in  determining  the  independence  of a
     director:

     a.   A director will not be considered independent if, within the preceding
          three  years:  (i) the  director was employed by KeySpan or one of its
          subsidiaries;  (ii) an  immediate  family  member of the  director was
          employed by KeySpan as an officer;  (iii) the director  received  more
          than $100,000 in direct compensation from KeySpan or its subsidiaries,
          other than for board service or pension or deferred compensation; (vi)
          an immediate family member of the director received more than $100,000
          in direct  compensation from KeySpan or its  subsidiaries,  other than
          for  Board  service  or  pension  or  deferred  compensation;  (v) the
          director  was employed by or  affiliated  with  KeySpan's  independent
          auditor;  (vi) an immediate family member of the director was employed
          by KeySpan's  independent auditor;  (vii) the director was employed as
          an  executive  officer  of  another  company  where  any of  KeySpan's
          officers serve on that company's compensation  committee; or (viii) an
          immediate  family  member of the director was employed as an executive
          officer of another  company where any of KeySpan's  officers  serve on
          that company's compensation committee;

     b.   A director will not be considered  independent if: (i) the director or
          an  immediate  family  member of the director  currently  serves as an
          executive  officer of another  company that does business with KeySpan
          and the  annual  sales to, or  purchases  from,  KeySpan in any of the
          preceding  three  years,  exceeds  the  greater  of $1  million or two
          percent of the annual consolidated gross revenues of the company; (ii)
          the  director  is an  executive  officer of another  company  which is
          indebted to KeySpan,  or to which  KeySpan is indebted,  and the total
          amount of either  company's  indebtedness to the other is greater than
          one percent of the total consolidated  assets of the company he or she
          serves as an executive  officer;  and (iii) if a director serves as an
          officer,  director  or  trustee  of a  tax  exempt  organization,  and
          KeySpan's  charitable  contributions  to the  organization are greater
          than  $1  million  or  two  percent  of  that   organization's   total
          consolidated  gross  revenues.  The Board  will  annually  review  all
          commercial and charitable relationships of the directors.

     For  relationships  not covered by the  guidelines in subsection (b) above,
     the  determination  of whether the  relationship  is  material or not,  and
     therefore  whether the director  would be independent or not, shall be made
     by the  directors  who satisfy  the  independence  guidelines  set forth in
     subsections  (a) and (b) above.  For  example,  if a director  is the chief
     executive  officer of a company that  purchases  products and services from
     KeySpan  that  are not more  than  two  percent  of that  company's  annual
     revenues, the independent directors could determine,  after considering all
     of the relevant circumstances,  whether such a relationship was material or
     immaterial,   and  whether  the  director  would  therefore  be  considered
     independent.


                                      226
<PAGE>


     KeySpan  will not make  any  personal  loans or  extensions  of  credit  to
     directors or officers.

Our directors  complete and submit an annual director  questionnaire to identify
and assess  relationships  so that the entire Board can  determine  independence
under  these  standards.  The  directors  also  complete  and  submit  an annual
statement  that  they are in  compliance  with our  Corporate  Policy  Statement
Concerning   Ethical   Business  Conduct  and  our  Corporate  Policy  Statement
Concerning Affiliate Transactions. The directors also annually certify that they
have,  and continue to agree to comply with,  the KeySpan  Corporation  Board Of
Directors Code of Ethics which sets forth standards of diligence,  loyalty, good
faith and the avoidance of conflicts of interests for the directors.

ITEM 14.       PRINCIPAL ACCOUNTANT FEES AND SERVICES

The following  table  provides  information  on the aggregate  fees for services
performed by Deloitte & Touche LLP  ("Deloitte  & Touche"),  the member firms of
Deloitte & Touche Tohmatsu,  and their respective affiliates for the years ended
December 31, 2006 and December 31, 2005:

                                        2006                        2005
                                        ----                        ----

Audit Fees (a)                     $  4,164,594               $  3,682,325
Audit-Related Fees (b)                   96,200                     88,000
Tax Fees (c)                            318,419                    385,522
All Other Fees (d)                      132,010                     50,121
                                    ------------              ---------------
Total                              $  4,711,223               $  4,205,968

     (a)  In 2006,  audit fees  include  base fees for the annual and  statutory
          financial  statement audits,  audit of internal control over financial
          reporting,   and  quarterly   reviews  of  $3,509,100   and  fees  for
          consultations on financial  accounting  standards as part of the audit
          of $655,494.  In 2005, audit fees include base fees for the annual and
          statutory financial  statement audits,  audit of internal control over
          financial reporting, and quarterly reviews of $3,212,089; $185,498 for
          fees related to  financings  and fees for  consultations  on financial
          accounting standards as part of the audit of $284,738.

     (b)  Audit-related fees include benefit plan audits.

     (c)  Fees  for tax  services  billed  in 2006  and  2005  consisted  of tax
          compliance, tax consultation services and software licensing. Fees for
          tax  compliance  services  totaled  $192,928  and $313,738 in 2006 and
          2005,  respectively.  Tax compliance services include services such as
          assistance with federal,  state and local income tax returns. Fees for
          tax consultation  services and software licensing totaled $125,491 and
          $71,784 in 2006 and 2005, respectively.

     (d)  Other fees include training.

In accordance with the Audit Committee  Charter and the rules and regulations of
the SEC,  the Audit  Committee  reviews the scope of the audit and  approves the
nature  and cost of all  services  provided  by  Deloitte  &  Touche.  The Audit
Committee has reviewed the nature and scope of the services provided by Deloitte
& Touche and considers  such to have been  compatible  with the  maintenance  of
Deloitte & Touche's independence throughout its service to KeySpan.


                                      227
<PAGE>


The  Audit  Committee  has also  determined  that the  scope of  services  to be
provided  by  Deloitte & Touche in 2007 will  generally  be limited to audit and
audit related  services and tax services.  The Audit  Committee  will  expressly
approve the provision of any services by Deloitte & Touche  outside the scope of
the  foregoing  services.  Although it is the intent of the Audit  Committee  to
pre-approve  all  non-audit  services to be  provided by Deloitte & Touche,  any
inadvertent  failure to do so will not be deemed a breach of the Audit Committee
charter if: (i) the aggregate amount of all such non-audit  services provided to
the  Corporation  constitutes  not more than five percent of the total amount of
revenues paid by the  Corporation to its auditor during the fiscal year in which
the non-audit  services are provided;  (ii) such services were not recognized by
the  Corporation  at the time of the  engagement to be non-audit  services;  and
(iii) such  services are promptly  brought to the attention of the Committee and
approved  prior to the  completion of the audit by the Committee or its Chairman
pursuant to delegated authority.













                                      228
<PAGE>


                                     PART IV
                                     -------

ITEM 15.       EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Required Documents

1.  Financial Statements

The following  consolidated financial statements of KeySpan and its subsidiaries
and Reports of the Independent Registered Public Accounting Firm are included in
Item 8 and are filed as part of this Report:

     o    Consolidated Statement of Income for the year ended December 31, 2006,
          the year ended December 31, 2005, and the year ended December 31, 2004

     o    Consolidated  Statement  of  Retained  Earnings  for  the  year  ended
          December 31,  2006,  the year ended  December  31, 2005,  and the year
          ended December 31, 2004

     o    Consolidated Balance Sheet at December 31, 2006 and December 31, 2005

     o    Consolidated  Statement  of  Capitalization  at December  31, 2006 and
          December 31, 2005

     o    Consolidated  Statement of Cash Flows for the year ended  December 31,
          2006,  the year ended  December 31, 2005,  and the year ended December
          31, 2004

     o    Consolidated  Statement  of  Comprehensive  Income  for the Year ended
          December 31, 2006, the year ended December 31, 2005 and the year ended
          December 31, 2004

     o    Notes to Consolidated Financial Statements

     o    Report of the Independent Registered Public Accounting Firm


     2.   Financial Statement Schedules

Consolidated  Schedule of Valuation and  Qualifying  Accounts for the year ended
December 31, 2006, the year ended December 31, 2005, and the year ended December
31, 2004.






                                      229
<PAGE>


<TABLE>
<CAPTION>
Schedule of Valuation and Qualifying Accounts

------------------------------------------------------------------------------------------------------------------------------------
                                                         Balance at             Charged to                               Balance at
                                                        Beginning of             costs and         Net                     End of
             Descriptions                                  Period                expenses        Deductions                Period
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                         <C>                   <C>               <C>                   <C>
Twelve Months Ended December 31, 2006
-------------------------------------
    Deducted from asset accounts:
          Allowance for doubtful accounts           $          62,827    $          76,919    $       82,831        $        56,915

     Additions to liability accounts:
          Reserve for injury and damages            $           9,300    $               -    $          211        $         9,089
          Reserve for environmental expenditures    $         423,666    $               -    $       51,229        $       372,437

Twelve Months Ended December 31, 2005
-------------------------------------
    Deducted from asset accounts:
          Allowance for doubtful accounts           $          67,796    $          96,818    $      101,787        $        62,827

     Additions to liability accounts:
          Reserve for injury and damages            $           9,370    $             500    $          570        $         9,300
          Reserve for environmental expenditures    $         256,789    $         210,596    $       43,719        $       423,666

Twelve Months Ended December 31, 2004
-------------------------------------
    Deducted from asset accounts:
          Allowance for doubtful accounts           $          75,671    $          74,089    $       81,964        $        67,796

     Additions to liability accounts:
          Reserve for injury and damages            $           9,370    $               -    $            -        $         9,370
          Reserve for environmental expenditures    $         294,691    $               -    $       37,902        $       256,789

------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Reflects adjustment for discontinued operations.

All other  schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.

(b)  Exhibits

Exhibits  listed  below  which  have been  filed  with the SEC  pursuant  to the
Securities Act of 1933, as amended,  or the Securities  Exchange Act of 1934, as
amended,  and which  were  filed as noted  below,  are  hereby  incorporated  by
reference  and  made a part of this  report  with the  same  effect  as if filed
herewith.

2.1       Agreement  and Plan of Merger,  dated as of February 25, 2006,  by and
          among   National  Grid  plc,   National  Grid  US8  Inc.  and  KeySpan
          Corporation (filed as Exhibit 2.1 to KeySpan's Form 8-K dated March 1,
          2006)

3.1       Certificate  of  Incorporation  of KeySpan  effective  April 16, 1998,
          Amendment to Certificate of Incorporation of KeySpan effective May 26,
          1998,  Amendment to Certificate of Incorporation of KeySpan  effective
          June 1, 1998, Amendment to the Certificate of Incorporation of KeySpan
          effective   April  7,  1999  and  Amendment  to  the   Certificate  of
          Incorporation of KeySpan  effective May 20, 1999 (filed as Exhibit 3.1
          to KeySpan's Form 10-Q for the quarterly period ended June 30, 1999)


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<PAGE>


3.2       By-Laws of KeySpan in effect as of June 25, 2003, as amended (filed as
          Exhibit 3.1 to KeySpan's Form 10-Q for the quarterly period ended June
          30, 2003)

4.1       Credit Agreement dated as of June 24, 2005 among KeySpan  Corporation,
          the  several  lenders,  The Royal Bank of Scotland  PLC and  Citibank,
          N.A., as Co-Syndication  Agents,  The Bank of New York and The Bank of
          Nova Scotia,  as  Co-Documentation  Agents,  and JPMorgan  Chase Bank,
          N.A., as Administrative  Agent (filed as Exhibit 4.1 to KeySpan's Form
          8-K dated as of June 29, 2005)

4.2       Amended and Restated Credit  Agreement dated as of June 24, 2005 among
          KeySpan  Corporation,  the several lenders, The Royal Bank of Scotland
          PLC and Citibank, N.A., as Co-Syndication Agents, The Bank of New York
          and The Bank of Nova Scotia, as Co-Documentation  Agents, and JPMorgan
          Chase Bank,  N.A.,  as  Administrative  Agent (filed as Exhibit 4.2 to
          KeySpan's Form 8-K dated as of June 29, 2005)

4.3       Indenture,  dated as of November 1, 2000, between KeySpan  Corporation
          and the Chase Manhattan Bank, as Trustee, with respect to the issuance
          of Debt  Securities  (filed as Exhibit 4-a to Amendment  No. 1 to Form
          S-3  Registration  Statement No. 333-43768 and filed as Exhibit 4-a to
          KeySpan's Form 8-K on November 20, 2000)

4.4       Form of Note  issued in  connection  with the  issuance of the KeySpan
          Corporation  $700  million of 7.625% Notes due 2010 issued on November
          20, 2000 (filed as Exhibit 4-c to  KeySpan's  Form 8-K on November 20,
          2000)

4.5       Form of Note  issued in  connection  with the  issuance of the KeySpan
          Corporation $250 million of 8.0% Notes due 2030 issued on November 20,
          2000 (filed as Exhibit 4-d to KeySpan's Form 8-K on November 20, 2000)

4.6       Form of Note  issued in  connection  with the  issuance of the KeySpan
          Corporation $150 million of 4.65% Notes issued on April 1, 2003 (filed
          as Exhibit 4.1 to KeySpan's Form 8-K dated as of April 8, 2003)

4.7       Form of Note  issued in  connection  with the  issuance of the KeySpan
          Corporation  $150  million  of  5.875%  Notes  issued on April 1, 2003
          (filed as Exhibit 4.2 to KeySpan's Form 8-K dated as of April 8, 2003)

4.8       Form of Note  issued in  connection  with the  issuance of the KeySpan
          Corporation  $307.2  million of 5.803%  Notes issued on March 29, 2005
          (filed  as  Exhibit  4.1 to  KeySpan's  Form 8-K dated as of March 31,
          2005)


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<PAGE>


4.9       Supplemental  Remarketing  Agreement  dated as of March 21, 2005 among
          KeySpan  Corporation,  J.P. Morgan  Securities Inc. and JPMorgan Chase
          Bank,  N.A. in connection  with the  remarketing of the 4.9% Notes due
          2008 (filed as Exhibit  99.1 to  KeySpan's  Form 8-K dated as of March
          24, 2005)

4.10      Indenture,  dated  December 1, 1999,  between  KeySpan and KeySpan Gas
          East  Corporation,  the Registrants,  and the Chase Manhattan Bank, as
          Trustee,  with respect to the issuance of Medium-Term Notes, Series A,
          (filed as Exhibit 4-a to Amendment  No. 1 to KeySpan's and KeySpan Gas
          East Corporation's Form S-3 Registration Statement No. 333-92003)

4.11      Form of  Medium-Term  Note issued in  connection  with the issuance of
          KeySpan Gas East  Corporation  7 7/8% Notes issued on February 1, 2000
          (filed as Exhibit 4 to KeySpan's Form 8-K on February 1, 2000)

4.12      Form of  Medium-Term  Note issued in  connection  with the issuance of
          KeySpan  Gas East  Corporation  6.9% Notes  issued on January 19, 2001
          (filed  as  Exhibit  4.3 to  KeySpan's  Form  10-K for the year  ended
          December 31, 2000)

4.13      Participation  Agreement,  dated as of July 1, 1991,  between New York
          State Energy  Research and Development  Authority  ("NYSERDA") and The
          Brooklyn  Union Gas  Company  relating to the Gas  Facilities  Revenue
          Bonds ("GFRBs") Series 1991A and 1991B (The Brooklyn Union Gas Company
          Project)  (filed as Exhibit 4 to The Brooklyn Union Gas Company's Form
          10-K for the year ended September 30, 1991)

4.14      Indenture  of Trust,  dated as of July 1, 1991,  between  NYSERDA  and
          Manufacturers Hanover Trust Company, as Trustee, relating to the GFRBs
          Series 1991A and 1991B (The Brooklyn Union Gas Company Project) (filed
          as Exhibit 4 to The  Brooklyn  Union Gas  Company's  Form 10-K for the
          year ended September 30, 1991)

4.15      Participation Agreement, dated as of July 1, 1992, between NYSERDA and
          The Brooklyn Union Gas Company  relating to the GFRBs Series 1993A and
          1993B (The Brooklyn Union Gas Company  Project) (filed as Exhibit 4 to
          The  Brooklyn  Union  Gas  Company's  Form  10-K  for the  year  ended
          September 30, 1992)

4.16      Indenture  of Trust,  dated as of July 1, 1992,  between  NYSERDA  and
          Chemical  Bank,  as Trustee,  relating to the GFRBs  Series  1993A and
          1993B (The Brooklyn Union Gas Company  Project) (filed as Exhibit 4 to
          The Brooklyn Union Gas Company Form 10-K for the year ended  September
          30, 1992)

4.17      Participation  Agreement  dated as of July 1, 1991 between NYSERDA and
          The  Brooklyn  Union Gas Company  relating to the GFRBs  Series D (The
          Brooklyn  Union  Gas  Company  Project)  (filed  as  Exhibit  4 to The
          Brooklyn  Union Gas Company's  Form 10-K for the year ended  September
          30, 1991)


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<PAGE>


4.18      First  Supplemental  Participation  Agreement dated as of June 1, 1993
          between  NYSERDA and The Brooklyn Union Gas Company  relating to GFRBs
          Series D (The Brooklyn Union Gas Company  Project) (filed as Exhibit 4
          to The  Brooklyn  Union Gas  Company's  Form  10-K for the year  ended
          September 30, 1993)

4.19      Trust  Indenture,  dated  as of  July  1,  1991  between  NYSERDA  and
          Manufacturers  Hanover  Trust  Company  relating to the GFRBs Series D
          (filed as Exhibit 4 to The Brooklyn  Union Gas Company's Form 10-K for
          the year ended September 30, 1991)

4.20      First Supplemental  Trust Indenture,  dated as of June 1, 1993 between
          NYSERDA and Chemical Bank (as successor to Manufacturers Hanover Trust
          Company)  relating  to the GFRBs  Series D (filed as  Exhibit 4 to The
          Brooklyn  Union Gas Company's  Form 10-K for the year ended  September
          30, 1993)

4.21      Participation  Agreement,  dated January 1, 1996,  between NYSERDA and
          The  Brooklyn  Union Gas Company  relating  to GFRBs  Series 1996 (The
          Brooklyn  Union  Gas  Company  Project)  (filed  as  Exhibit  4 to The
          Brooklyn  Union Gas Company's  Form 10-K for the year ended  September
          30, 1996)

4.22      Indenture  of Trust,  dated  January  1,  1996,  between  NYSERDA  and
          Chemical Bank, as Trustee, relating to GFRBs Series 1996 (The Brooklyn
          Union Gas Company  Project)  (filed as Exhibit 4 to The Brooklyn Union
          Gas Company's Form 10-K for the year ended September 30, 1996)

4.23      Participation Agreement,  dated as of January 1, 1997, between NYSERDA
          and The  Brooklyn  Union Gas  Company  relating to GFRBs 1997 Series A
          (The Brooklyn  Union Gas Company  Project)  (filed as Exhibit 4 to The
          Brooklyn  Union Gas Company's  Form 10-K for the year ended  September
          30, 1997)

4.24      Indenture of Trust,  dated January 1, 1997,  between NYSERDA and Chase
          Manhattan  Bank,  as  Trustee,  relating  to GFRBs 1997  Series A (The
          Brooklyn  Union  Gas  Company  Project)  (filed  as  Exhibit  4 to The
          Brooklyn  Union Gas Company's  Form 10-K for the year ended  September
          30, 1997)

4.25      Supplemental  Trust  Indenture,  dated as of January  1, 2000,  by and
          between NYSERDA and The Chase Manhattan Bank, as Trustee,  relating to
          the GFRBs  1997  Series A (The  Brooklyn  Union Gas  Company  Project)
          (filed as  Exhibit  4.11 to  KeySpan's  Form  10-K for the year  ended
          December 31, 1999)

4.26      Bond  Purchase  Agreement,  dated as of October  26,  2005,  among The
          Brooklyn  Union Gas  Company  and  NYSERDA  and  Morgan  Stanley & Co.
          Incorporated,   BNY  Capital  Markets,   Inc.,   Sovereign  Securities
          Corporation,  LLC and The Williams  Capital  Group,  L.P., as Series A
          Underwriters,  for the  issuance  of $82 million  aggregate  principal
          amount of 4.7% GFRBs,  2005, Series A. (The Brooklyn Union Gas Company
          Project)  (filed as Exhibit 10.1 to KeySpan's  Form 8-K dated November
          1, 2005)


                                      233
<PAGE>


4.27      Indenture of Trust,  dated as of November 1, 2005, between NYSERDA and
          Citibank,  N.A.,  as Trustee,  relating to the issuance of $82 million
          GFRBs,  2005 Series A, 4.7% due February 2024 (The Brooklyn  Union Gas
          Company Project) (filed as Exhibit 10.1 to KeySpan's Form 10-Q for the
          quarterly period ended September 30, 2005)

4.28      Participation Agreement, dated as of November 1, 2005, between NYSERDA
          and The  Brooklyn  Union Gas Company  relating to the  issuance of $82
          million GFRBs, 2005 Series A, 4.7% due February 2024 (filed as Exhibit
          10.2 to KeySpan's Form 10-Q for the quarterly  period ended  September
          30, 2005)

4.29      Promissory  Note,  dated  as of  November  1,  2005,  executed  by the
          Brooklyn  Union Gas Company for  issuance of $82 million  GFRBs,  2005
          Series A, 4.7% due  February  2024 (filed as Exhibit 10.3 to KeySpan's
          Form 10-Q for the quarterly period ended September 30, 2005)

4.30      Bond  Purchase  Agreement,  dated as of October  26,  2005,  among The
          Brooklyn  Union Gas Company and NYSERDA and Goldman  Sachs & Co.,  BNY
          Capital Markets, Inc., Sovereign Securities  Corporation,  LLC and The
          Williams  Capital  Group,  L.P.,  as  Series A  Underwriters,  for the
          issuance of $55 million  aggregate  principal  amount of GFRBs,  2005,
          Series B (filed as Exhibit 10.2 to KeySpan's  Form 8-K dated  November
          1, 2005)

4.31      Indenture of Trust,  dated as of November 1, 2005, between NYSERDA and
          Citibank,  N.A.,  as Trustee,  relating to the issuance of $55 million
          GFRBs, 2005 Series B due June 2025 (filed as Exhibit 10.4 to KeySpan's
          Form 10-Q for the quarterly period ended September 30, 2005)

4.32      Participation Agreement, dated as of November 1, 2005, between NYSERDA
          and The  Brooklyn  Union Gas Company  relating to the  issuance of $55
          million GFRBs, 2005 Series B, due February 2025 (filed as Exhibit 10.5
          to KeySpan's  Form 10-Q for the quarterly  period ended  September 30,
          2005)

4.33      Promissory  Note,  dated  as of  November  1,  2005,  executed  by the
          Brooklyn Union Gas Company for the issuance of $55 million GFRBs, 2005
          Series B, due June 2025 (filed as Exhibit 10.6 to KeySpan's  Form 10-Q
          for the quarterly period ended September 30, 2005)

4.34      Letter of Credit and Reimbursement Agreement,  dated December 9, 2003,
          by and between KeySpan  Generation LLC and Royal Bank of Scotland Bank
          PLC (filed as Exhibit 4.34 to  KeySpan's  Form 10-K for the year ended
          December 31, 2003)


                                      234
<PAGE>


4.35      Participation  Agreement  dated as of  December 1, 1997 by and between
          NYSERDA and Long Island Lighting Company relating to the 1997 Electric
          Facilities Revenue Bonds ("EFRBs"),  Series A (KeySpan Generation LLC)
          (filed as  Exhibit  10(a) to  KeySpan's  Form  10-Q for the  quarterly
          period ended September 30, 1998)

4.36      Indenture  of Trust,  dated as of  December  1, 1997,  by and  between
          NYSERDA and The Chase Manhattan Bank, as Trustee, relating to the 1997
          EFRBs,  Series A (KeySpan  Generation  LLC) (filed as Exhibit 10(a) to
          KeySpan's Form 10-Q for the quarterly period ended September 30, 1998)

4.37      Participation  Agreement,  dated as of October 1, 1999, by and between
          NYSERDA  and KeySpan  Generation  LLC  relating to the 1999  Pollution
          Control Refunding Revenue Bonds ("PCRB's"), Series A (filed as Exhibit
          4.10 to KeySpan's Form 10-K for the year ended December 31, 1999)

4.38      Trust  Indenture,  dated as of October 1, 1999, by and between NYSERDA
          and The Chase Manhattan Bank, as Trustee,  relating to the 1999 PCRBs,
          Series A (filed as Exhibit  4.10 to  KeySpan's  Form 10-K for the year
          ended December 31, 1999)

4.39      Indenture,  dated as of December 1, 1989,  between  Boston Gas Company
          and The Bank of New York,  as Trustee  (filed as Exhibit 4.2 to Boston
          Gas Company's Form S-3 (File No. 33-31869))

4.40      Second Amended and Restated First Mortgage  Indenture for Colonial Gas
          Company,  dated as of June 1, 1992 (filed as Exhibit  4(b) to Colonial
          Gas Company's Form 10-Q for the quarter ended June 30, 1992)

4.41      First Supplemental Indenture for Colonial Gas Company dated as of June
          15, 1992 (filed as Exhibit  4(c) to Colonial Gas  Company's  Form 10-Q
          for the quarter ended June 30, 1992)

4.42      Second  Supplemental  Indenture  for Colonial Gas Company  dated as of
          September  27, 1995 (filed as Exhibit 4(c) to Colonial  Gas  Company's
          Form 10-K for the fiscal year ended December 31, 1995)

4.43      Amendment to Second  Supplemental  Indenture  for Colonial Gas Company
          dated as of October 12, 1995  (filed as Exhibit  4(d) to Colonial  Gas
          Company's Form 10-K for the fiscal year ended December 31, 1995)

4.44      Third  Supplemental  Indenture  for Colonial  Gas Company  dated as of
          December  15, 1995 (filed as Exhibit  4(f) to Colonial  Gas  Company's
          Form S-3 Registration Statement dated January 5, 1998)


                                      235
<PAGE>


4.45      Fourth  Supplemental  Indenture  for Colonial Gas Company  dated as of
          March 1, 1998 (filed as Exhibit  4(l) to Colonial Gas  Company's  Form
          10-Q for the quarter ended March 31, 1998)

4.46      Trust  Agreement,  dated as of June 22,  1990,  between  Colonial  Gas
          Company,  as Trustor,  and Shawmut Bank,  N.A.,  as Trustee  (filed as
          Exhibit  10(d) to Colonial Gas  Company's  Form 10-Q for the quarterly
          period ended June 30, 1990)

4.47      Lease  Agreement,  dated as of  November  1, 2003,  by and between the
          Suffolk  County   Industrial   Development   Agency  and  KeySpan-Port
          Jefferson  Energy  Center,  LLC (filed as Exhibit  4.14-a to KeySpan's
          Form 10-K for the year ended December 31, 2003)

4.48      Company Lease Agreement,  dated as of November 1, 2003, by and between
          KeySpan-Port  Jefferson  Energy  Center,  LLC and the  Suffolk  County
          Industrial  Development  Agency (filed as Exhibit  4.14-b to KeySpan's
          Form 10-K for the year ended December 31, 2003)

4.49      Guaranty,  dated as of November 26, 2003, from KeySpan  Corporation to
          the Suffolk  County  Industrial  Development  Agency (filed as Exhibit
          4.14-c to KeySpan's Form 10-K for the year ended December 31, 2003)

4.50      Lease  Agreement,  dated as of  November  1, 2003,  by and between the
          Nassau  County  Industrial  Development  Agency  and  KeySpan-Glenwood
          Energy Center, LLC (filed as Exhibit 4.15-a to KeySpan's Form 10-K for
          the year ended December 31, 2003)

4.51      Company Lease Agreement,  dated as of November 1, 2003, by and between
          KeySpan-Glenwood  Energy Center,  LLC and the Nassau County Industrial
          Development Agency (filed as Exhibit 4.15-b to KeySpan's Form 10-K for
          the year ended December 31, 2003)

4.52      Guaranty,  dated as of November 26, 2003, from KeySpan  Corporation to
          the Nassau  County  Industrial  Development  Agency  (filed as Exhibit
          4.14-c to KeySpan's Form 10-K for the year ended December 31, 2003)

4.53      Lease Agreement, dated June 9, 1999, between  KeySpan-Ravenswood,  LLC
          and  LIC  Funding,  Limited  Partnership  (filed  as  Exhibit  10.2 to
          KeySpan's Form 10-Q for the quarterly period ended June 30, 1999)

4.54      First Amendment to the Lease Agreement between KeySpan-Ravenswood, LLC
          and LIC Funding, Limited Partnership, dated as of June 27, 2002 (filed
          as Exhibit  10.25 to KeySpan's  Form 10-K for the year ended  December
          31, 2002)


                                      236
<PAGE>


4.55      KeySpan Corporation Guaranty dated June 9, 1999, from KeySpan in favor
          of  LIC  Funding,  Limited  Partnership  (filed  as  Exhibit  10.1  to
          KeySpan's Form 10-Q for the quarterly period ended June 30, 1999)

4.56      KeySpan  Corporation  Guaranty dated May 25, 2004, relating to the 250
          MW Ravenswood  Expansion (filed as Exhibit 10.1 to KeySpan's Form 10-Q
          for the quarterly period ended June 30, 2004)

4.57      Facility  Lease  Agreement,  dated  as of May  25,  2004,  between  SE
          Ravenswood Trust, a Delaware statutory trust, and  KeySpan-Ravenswood,
          LLC relating to the 250 MW Ravenswood  Expansion(filed as Exhibit 10.2
          to KeySpan's Form 10-Q for the quarterly period ended June 30, 2004)

4.58      Site Lease and Easement  Agreement,  dated as of May 25, 2004, between
          KeySpan-Ravenswood, LLC and SE Ravenswood Trust relating to the 250 MW
          Ravenswood Expansion (filed as Exhibit 10.3 to KeySpan's Form 10-Q for
          the quarterly period ended June 30, 2004)

4.59      Site Sublease,  dated as of May 25, 2004,  between SE Ravenswood Trust
          and  KeySpan-Ravenswood,   LLC  relating  to  the  250  MW  Ravenswood
          Expansion  (filed  as  Exhibit  10.4 to  KeySpan's  Form  10-Q for the
          quarterly period ended June 30, 2004)

4.60      Amendment,  Assignment and Assumption Agreement, dated as of September
          29,  1997,  by and among The Brooklyn  Union Gas Company,  Long Island
          Lighting Company and KeySpan Energy  Corporation (filed as Exhibit 2.5
          to Schedule 13D by Long Island Lighting Company on October 24, 1997)

10.1      Agreement and Plan of Merger,  dated as of June 26, 1997, by and among
          BL Holding  Corp.,  Long Island  Lighting  Company,  Long Island Power
          Authority and LIPA  Acquisition  Corp.  (filed as Annex D to the Joint
          Registration  Statement on Form S-4 of The Brooklyn  Union Gas Company
          and Long Island Lighting  Company,  Registration No. 333-30353 on June
          30, 1997)

10.2      Management  Services Agreement between Long Island Power Authority and
          Long Island Lighting Company dated as of June 26, 1997 (filed as Annex
          D to the  Joint  Registration  Statement  on Form S-4 of The  Brooklyn
          Union Gas Company and Long Island Lighting  Company,  Registration No.
          333-30353 on June 30, 1997)

10.3      Amendment,  dated  as  of  March  29,  2002,  to  Management  Services
          Agreement  between Long Island Lighting Company d/b/a LIPA and KeySpan
          Electric  Services  LLC dated as of June 26,  1997  (filed as  Exhibit
          10.4-b to KeySpan's Form 10-K for the year ended December 31, 2002)


                                      237
<PAGE>


10.4      Amended and Restated Management Services Agreement dated as of January
          1, 2006 between the Long Island Lighting Company  ("LILCO") d/b/a LIPA
          and KeySpan Electric  Services LLC (filed as Exhibit 10.1 to KeySpan's
          Form 8-K filed on February 7, 2006)

10.5      Power Supply  Agreement  between Long Island Lighting Company and Long
          Island Power  Authority dated as of June 26, 1997 (filed as Annex D to
          the Joint Registration Statement on Form S-4 of The Brooklyn Union Gas
          Company and Long Island Lighting  Company,  Registration No. 333-30353
          on June 30, 1997)

10.6      Energy  Management  Agreement between Long Island Lighting Company and
          Long Island Power  Authority dated as of June 26, 1997 (filed as Annex
          D to Registration  Statement on Form S-4, No.  333-30353,  on June 30,
          1997)

10.7      Amendment,  dated as of March 29, 2002, to Energy Management Agreement
          between Long Island  Lighting  Company  d/b/a LIPA and KeySpan  Energy
          Trading  Services  LLC dated as of June 26,  1997  (filed  as  Exhibit
          10.6-b to KeySpan's Form 10-K for the year ended December 31, 2002)

10.8      Generation  Purchase  Rights  Agreement  between Long Island  Lighting
          Company  and Long  Island  Power  Authority  dated as of June 26, 1997
          (filed as  Exhibit  10.17 to  KeySpan's  Form 10-K for the year  ended
          December 31, 2001)

10.9      Amendment,  dated as of March 29, 2002, to Generation  Purchase Rights
          Agreement  by and between  KeySpan  Corporation,  as Seller,  and Long
          Island  Lighting  Company d/b/a LIPA,  as Buyer,  dated as of June 26,
          1997 (filed as Exhibit 10.1 to KeySpan's  Form 10-Q for the  quarterly
          period ended March 31, 2002)

10.10     Generation  Purchase Right Extension Agreement between KeySpan and the
          Long  Island  Power  Authority  dated as of March 28,  2005  (filed as
          Exhibit 10.1 to  KeySpan's  Form 10-Q for the  quarterly  period ended
          March 31, 2005)

10.11     Option and Purchase and Sale Agreement  dated as of January 1, 2006 by
          and between LILCO d/b/a LIPA and KeySpan Electric  Services LLC (filed
          as Exhibit 10.2 to KeySpan's Form 8-K filed on February 7, 2006)

10.12     Letter Amendment to the Option and Purchase and Sale Agreement between
          KeySpan  Generation LLC and Long Island  Lighting  Company d/b/a LIPA,
          dated as of December 11, 2006 (filed as Exhibit 10.1 to KeySpan's Form
          8-K dated December 19, 2006)

10.13     Settlement  Agreement  and Release  dated as of January 1, 2006 by and
          among KeySpan,  KeySpan Generation LLC, KeySpan Electric Services LLC,
          KeySpan Energy Trading Services LLC and LIPA (filed as Exhibit 10.3 to
          KeySpan's Form 8-K filed on February 7, 2006)


                                      238
<PAGE>


10.14     Agreement of Lease between  Forest City Jay Street  Associates and The
          Brooklyn  Union Gas  Company  dated  September  15,  1988 (filed as an
          Exhibit to The  Brooklyn  Union Gas  Company's  Form 10-K for the year
          ended September 30, 1996)

10.15     Second  Amendment,  dated as of March 24, 2005, to the Lease Agreement
          dated as of September 15, 1998 between The Brooklyn  Union Gas Company
          and Forest City Jay Street  Associates,  L.P.  (filed as Exhibit 10 to
          KeySpan's Form 8-K dated as of March 30, 2005)

10.16     ISDA Master Agreement,  dated as of January 18, 2006,  between KeySpan
          Corporation  and Morgan Stanley  Capital Group Inc.  (filed as Exhibit
          10.1 to KeySpan's Form 8-K dated January 24, 2006)

10.17     Restated Exploration Agreement between The Houston Exploration Company
          and KeySpan  Exploration  and Production,  L.L.C.  dated June 30, 2000
          (filed as Exhibit 10.1 to The Houston Exploration  Company's Form 10-Q
          for the quarter ended September 30, 2000, File No. 001-11899)

10.18     Distribution  Agreement,  dated June 2, 2004, by and among The Houston
          Exploration  Company,  Seneca-Upshur  Petroleum,  Inc.,  THEC Holdings
          Corp.  and KeySpan  Corporation  (filed as Exhibit 99.2 to The Houston
          Exploration Company's Form 8-K dated as of June 3, 2004)

10.19     Asset Contribution Agreement,  dated June 2, 2004, between The Houston
          Exploration  Company  and  Seneca-Upshur  Petroleum,  Inc.  (filed  as
          Exhibit 99.3 to The Houston Exploration Company's Form 8-K dated as of
          June 3, 2004)

10.20     Tax Matters  Agreement,  dated June 2, 2004,  by and among The Houston
          Exploration  Company,  Seneca-Upshur  Petroleum,  Inc.,  THEC Holdings
          Corp.  and KeySpan  Corporation  (filed as Exhibit 99.4 to The Houston
          Exploration Company's Form 8-K dated as of June 3, 2004)

10.21     Share Sale and  Purchase  Agreement  dated  February  25, 2005 with BG
          Energy  Holdings  Limited and Premier  Transmission  Financing  Public
          Limited Company (filed as Exhibit 10.37 to KeySpan's Form 10-K for the
          year ended December 31, 2004)

10.22     Purchase  Agreement,  dated January 28, 2005,  among Robert B. Snyder,
          Frank J. Sullivan, Robert B. Snyder, Jr., Philip J. Andreoli,  William
          J. McKean,  Binsky & Snyder,  LLC,  Binsky & Snyder  Service,  LLC and
          KeySpan Business  Solutions,  LLC (filed as Exhibit 10.35 to KeySpan's
          Form 10-K for the year ended December 31, 2004)


                                      239
<PAGE>


10.23     Purchase Agreement,  dated February 11, 2005, among WDF Holding Corp.,
          WDF, Inc. and KeySpan Business Solutions,  LLC (filed as Exhibit 10.36
          to KeySpan's Form 10-K for the year ended December 31, 2004)

10.24     Note Purchase Agreement,  dated as of November 29, 2006, between KEDNY
          and  certain  investors  for the  issuance  of $400  million of Senior
          Unsecured  Notes,  due  November  29, 2016  (filed as Exhibit  10.1 to
          KeySpan's Form 8-K dated December 5, 2006)

10.25     Note Purchase Agreement,  dated as of November 29, 2006, between KEDLI
          and  certain  investors  for the  issuance  of $100  million of Senior
          Unsecured  Notes,  due  November  29, 2016  (filed as Exhibit  10.2 to
          KeySpan's Form 8-K dated December 5, 2006)

10.26     KEDNY Form of 5.60% Senior Unsecured Note due November 29, 2016 (filed
          as Exhibit 10.2 to KeySpan's Form 8-K dated December 5, 2006)

10.27     KEDLI Form of 5.60% Senior Unsecured Note due November 29, 2016 (filed
          as Exhibit 10.2 to KeySpan's Form 8-K dated December 5, 2006)


10.28     ISDA Master  Agreement  between the Company and Morgan Stanley Capital
          Group Inc.  dated as of January  18,  2006  (filed as Exhibit  10.1 to
          KeySpan's Form 8-K dated January 24, 2006)

                             Compensation Agreements
                             -----------------------

10.29*    Cash Compensation for Non-Management Directors of KeySpan

10.30*    Base Salaries of Named  Executive  Officers of KeySpan in effect as of
          February 20, 2007

10.31     Copy of the  Amendment to the  Employment  Agreement  dated January 1,
          2005 between KeySpan  Corporation and Anthony Sartor (filed as Exhibit
          10.1 to KeySpan's Form 8-K dated September 8, 2006)

10.32     Agreement and Waiver of Rights and Claims  between  KeySpan and Lenore
          F.  Puleo  dated  as of March  24,  2006  (filed  as  Exhibit  10.2 to
          KeySpan's Form 8-K dated March 30, 2006)

10.33     Letter  Agreement  between KeySpan and Gerald Luterman dated March 24,
          2006  (filed as Exhibit  10.1 to  KeySpan's  Form 8-K dated  March 30,
          2006)

10.34     Employment  Agreement,  dated February 24, 2005,  between  KeySpan and
          Robert B. Catell  (filed as Exhibit  10.10 to KeySpan's  Form 10-K for
          the year ended December 31, 2004)

10.35     Employment  Agreement,  dated  January 1, 2005,  between  KeySpan  and
          Anthony  Sartor (filed as Exhibit 10.01 to KeySpan's Form 8-K dated as
          of January 4, 2005)

10.36     Supplemental  Retirement  Agreement,  dated  January 1, 2005,  between
          KeySpan and Anthony  Sartor (filed as Exhibit 10.12 to Company's  Form
          8-K dated as of January 4, 2005)


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<PAGE>


10.37     Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan
          and Steven L.  Zelkowitz  (filed as Exhibit 10.12 to KeySpan's  Annual
          Report on Form 10-K for the year ended December 31, 2002)

10.38     Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan
          and Gerald Luterman (filed as Exhibit 10.11 to KeySpan's Annual Report
          on Form 10-K for the year ended December 31, 2002)

10.39     Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan
          and David J.  Manning  (filed as  Exhibit  10.13 to  KeySpan's  Annual
          Report on Form 10-K for the year ended December 31, 2002)

10.40     Supplemental Retirement Agreement, dated July 1, 2002, between KeySpan
          and Elaine  Weinstein  (filed as  Exhibit  10.15 to  KeySpan's  Annual
          Report on Form 10-K for the year ended December 31, 2002)

10.41     Directors'  Deferred  Compensation Plan effective April 2003 (filed as
          Exhibit  10.16 to  KeySpan's  Annual  Report on Form 10-K for the year
          ended December 31, 2003)

10.42     Officers'  Deferred Stock Unit Plan of KeySpan  Corporation  (filed as
          Exhibit  10.17 to  KeySpan's  Annual  Report on Form 10-K for the year
          ended December 31, 2002)

10.43     Officers' Deferred Stock Unit Plan of KeySpan Services, Inc. (filed as
          Exhibit  10.18 to  KeySpan's  Annual  Report on Form 10-K for the year
          ended December 31, 2002)

10.44     Corporate Annual Incentive Compensation and Gainsharing Plan (filed as
          Exhibit 10.20 to KeySpan's  Form 10-K for the year ended  December 31,
          2000)

10.45*    Corporate Annual Incentive  Compensation Plan Target Performance Award
          Level for Fiscal Year 2007

10.46     Senior  Executive  Change of Control  Severance  Plan  effective as of
          October 29, 2003 (filed as Exhibit  10.20 to  KeySpan's  Form 10-K for
          the year ended December 31, 2003)

10.47     KeySpan's  Amended Senior Executive  Change of Control  Severance Plan
          (filed as Exhibit 10.1 to KeySpan's Form 10-Q for the quarterly period
          ended March 31, 2006)

10.48     KeySpan's Amended Long-Term  Performance  Incentive  Compensation Plan
          (filed as Exhibit A to KeySpan's 2001 Proxy  Statement  filed on March
          23, 2001)

10.49*    KeySpan's   Long-Term   Performance   Incentive    Compensation   Plan
          Performance Target Award Level for Fiscal Year 2007


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<PAGE>



14        Code of Ethics (filed as Exhibit 14 to KeySpan's Annual Report on Form
          10-K for the year ended December 31, 2003).

21*       Subsidiaries of the Registrant

23.1*     Consent  of  Deloitte  & Touche  LLP,  Independent  Registered  Public
          Accounting Firm

24.1*     Power of Attorney  executed by Andrea S.  Christensen  on February 21,
          2007

24.2*     Power of Attorney executed by Robert J. Fani on February 21, 2007

24.3*     Power of Attorney executed by Alan H. Fishman on February 21, 2007

24.4*     Power of Attorney executed by James R. Jones on February 21, 2007

24.5*     Power of Attorney executed by James L. Larocca on February 21, 2007

24.6*     Power of Attorney executed by Gloria C. Larson on February 21, 2007

24.7*     Power of Attorney executed by Stephen W. McKessy on February 21, 2007

24.8*     Power of Attorney executed by Edward D. Miller on February 21, 2007

24.9*     Power of Attorney executed by Vikki L. Pryor on February 21, 2007

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




                                      242
<PAGE>



                                   SIGNATURES

Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  registrant  has duly  caused  this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

KEYSPAN CORPORATION
(Registrant)

Signature:                                                  Date:

By: /s/Gerald Luterman                                      February 22, 2007
    ------------------
Gerald Luterman
Executive Vice President
and Chief Financial Officer


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities and on the dates indicated.

Signatures:                                                 Date:

By: /s/Robert B. Catell                                     February 22, 2007
    -------------------
Robert B. Catell
Chairman of the Board of Directors
and Chief Executive Officer


By: /s/Gerald Luterman                                      February 22, 2007
    ------------------
Gerald Luterman
Executive Vice President and
Chief Financial Officer


By: /s/Theresa A. Balog                                     February 22, 2007
    -------------------
Theresa A. Balog
Vice President and
Chief Accounting Officer



*
-----------------------------------------
Andrea S. Christensen
Director


                                      243
<PAGE>


*
-----------------------------------------
Robert J. Fani
President, Chief Operating Officer and Director


*
-----------------------------------------
Alan H. Fishman
Director


*
-----------------------------------------
James R. Jones
Director


*
-----------------------------------------
James L. Larocca
Director


*
-----------------------------------------
Gloria C. Larson
Director


*
-----------------------------------------
Stephen W. McKessy
Lead Director


*
-----------------------------------------
Edward D. Miller
Director


*
-----------------------------------------
Vikki L. Pryor
Director


* Such  signature has been affixed  pursuant to a Power of Attorney  filed as an
exhibit hereto and incorporated herein by reference thereto



                                      244